John Wylie's six ways to improve your risk culture
The danger of being a stationary target has never been greater for business, writes leading banker and investor John Wylie AM FAICD.
Ten years on from the GFC, economies around the world are growing, interest rates are low, financial markets are calm and entrepreneurs are driving new technologies to change the world and create vast wealth.
Yet many of us have a quiet fear that the good times are a little artificial, a product of the flood of cheap money post-GFC. The fact that a country like Iraq can sell US$1 billion ($1.3b) of a five-year debt, six times oversubscribed at 6.75 per cent says a lot about how surreal markets have become.
And the geopolitical situation is hardly reassuring. All up, it’s a paradoxical time.
The good news
Australia, courtesy of its education system, has globally competitive skills in service industries. This spells tremendous opportunity. Powerful businesses that barely existed 10 years ago such as Atlassian, Seek, Navitas and Magellan are testament to that.
The question for us for the next 20 years is what our ambition will be as a nation, economically. Will we be content to essentially optimise what’s on offer in our own backyard — an economy of 24 million people growing at 2.5 per cent annually? Or will we aspire to be a central player in the markets of nearly three billion people to our north, growing on average at more than five per cent per year?
Australian business leaders often talk an expansive picture about the national importance of corporate risk-taking. That’s a noble aspiration at the macro level, but often doesn’t translate into action at the micro level with investment decisions in the boardroom. Saying we should be confident and take risks doesn’t mean we do. Confidence just can’t be manufactured.
As a general proposition, it’s in the national interest that our corporate sector has a strong appetite to take risk and invest, especially outside our small domestic market.
The most important job of a board is to hire a great CEO, agree with them a strategy, establish principles in terms of culture and values, and empower and encourage them to deliver. It’s not the board’s job to micromanage the CEO or the company. But there are practical things boards can do to create a culture of successful risk-taking. Most companies set goals of excellence in product quality, excellence in safety, and excellence in culture. Relatively few set themselves an explicit goal of excellence in capital allocation. All should.
It’s great for companies to be innovative, but if they’re poor at capital allocation they won’t deliver for shareholders over the medium term. Excellence in capital allocation might not be a sufficient condition for creating sustainable shareholder value, but it is a necessary one.
Six ways to change your risk mindset
1. Unleash your inner Warren Buffett
- Be contrarian
- Many incentive structures and natural forces in corporate life are pro-cyclical: short-term CEO tenures, conventional wisdom and short-term sentiment in equity markets, passive equity investment strategies that reward momentum. Often the right long-term move is the opposite.
2. Think like a long-term shareholder
- Management incentive plans can be weighted to more equity and less cash.
- Directors should invest at least two years’ worth of board fees in company shares.
3. Have vision. Don’t be a slave to short-term financial targets
- This needs to be something more than earnings growth targets for the next three years.
- Have a narrative.
- Focus on how your strategy drives long-term value creation.
4. Get the right skills around your board table
- It’s natural to be reticent to engage with things you don’t really understand.
- The recent Asialink Business report (Match Fit: Shaping Asia-capable Leaders) made a compelling case that Australian boards would benefit by targeting directors with skills and experience in these markets to add confidence to decision-making processes.
5. Boardroom dynamics must work in your favour
- Groupthink and insufficient discussion can thwart smarter big-picture investment decisions. Study the processes in behavioural psychologist Daniel Kahneman’s outstanding Thinking, Fast and Slow.
- Designate a director to be the conduit for all requests for additional information and analysis so directors feel confident they’re not the people in the room with the least information.
- Have a “designated bastard” on every major investment decision. A confident management team should welcome a board that challenges and adds value to its investment processes.
6. Make your advisor work for you
- In the capital-allocation process, an advisor being paid a clip based on the amount of capital the company allocates is probably not a true friend of the company or its shareholders.
- If the advisor cites industry standard practice as the reason for charging a particular fee based on the amount the company spends, change the industry practice.
The AICD regularly runs courses for directors, aspiring directors and executives, covering governance and business best practice. Click here to see our upcoming courses in Western Australia.