blog

Early Warning Signals: How to Avoid a Corporate Crisis

Trusted to serve
by Tamara Paton in Work of the board
early warning

Cybercrime, terrorist attacks, and severe weather. The sudden death of a CEO and accounting irregularities that suggest fraud. There is no shortage of corporate crises nudging directors from restful sleep today. Anticipating calamity, an entire industry of auditors, advisors and experts stands ready to advise.

Four out of five business leaders expect their companies to experience a crisis in the next year, but barely half have a plan to deal with it. Accordingly, boards ask management for business interruption plans, larger insurance policies, and freshly updated risk heat maps. We directors feel safer today, because we have talked the hell out of every doomsday scenario we can imagine.

But is that enough? What if crisis sneaks up on an organization? Are we capable of anticipating the slow-burn issue that bubbles over into fiasco?

In 20 Questions for Directors About Crisis Management, CPA Canada frames the challenge with a few definitions. Operational incidents arise in the day-to-day running of an organization. They remain in management’s hands. Sudden crises occur unexpectedly and have a major effect on the organization. Often involving shareholders, law enforcement or regulators, these events appear on the board’s radar.

Potential crises are “serious problems that grow and become critical because they were not addressed early on.” The confluence of multiple events complicates the analysis further. According to Deloitte leaders Graeme Newton and Fernando Picatoste, “recognizing when operational issues end and a corporate crisis begins is more difficult, particularly when a rolling series of modest-sized operational issues cascade into a crisis.”  A board may initially hear of a product failure for information purposes only. As the news hurts the organization’s reputation, employee morale, and revenue, the organization has a larger problem on its hands.

Fortunately, a board has the opportunity to anticipate a crisis in its early stages and pivot the organization to safer ground. Because directors are not involved in day-to-day operations, we should see the organization more objectively and spot early warning signals that management may not perceive.

What is an Early Warning Signal?

Corporate director Michael Pocalyko describes five boardroom deficiencies found in recent major corporate scandals:

  • A disconnect between the company’s stated core values and the way its leaders behave
  • A board of directors that defers to the CEO too easily
  • Needlessly complex financial statements
  • IT systems that impair internal audit, SEC audit, and reporting
  • Legal counsel that fits its opinion to align with a desired action

Beyond these concerns, corporate director and strategy consultant Doug Enns warns of the following conditions:

  • a reduction in entry barriers welcomes new competition
  • new products, processes and techniques allow competitors to differentiate and gain cost advantage
  • key customer segments begin to experience difficulty, leading to extensions of the sales cycle, inventory buildups and the need for more favourable terms to move product
  • declining margins, slowness to break-even on new products, and increased concerns on the part of sales and service personnel

In my experience, early warning signals begin at a whisper. Multiple IT projects run late. Capital expenditures on new facilities exceed their budgets. Management pays lip service to the board’s concerns, but doesn’t change its approach. A series of ill-fated decisions come before the board, and directors feel trapped into approving proposals. The lack of viable options is an early warning signal in and of itself.

How can we surface Early Warning Signals?

Risk consultant Jim DeLoach suggests that robust, frequent communication between board and management allow early warning signals to come into focus. “The timing and frequency of these communications are dictated by the severity of the risk’s impact on the organization, the velocity (or speed of onset) at which the risk impacts the organization, and the uncertainty regarding if and when the risk will manifest itself.”

Beyond management reports, directors can also look for signs from customers, employees, industry experts and even competitors. Are employee engagement scores falling? What can we learn from Net Promoter Scores? Is there instability in key customer segments’ margins?

And because we often learn best from the past, we should look for patterns revealed in previous crises. For this reason, boards benefit from an independent post-crisis review to generate and document lessons learned. Over time, these reviews generate an inventory of early warning signals to monitor.

What does a board do with an early warning?

Consultant Doug Enns recommends an Early Warning Summit, time set aside for directors and management to explore emerging issues in a frank and open manner. Although I aspire to discuss these issues at every board meeting, I’m realistic about the jam-packed agendas my boards already manage. Making time for a rich discussion once or twice each year is likely a more realistic goal.

During these conversations, I look for management’s tone. Does the CEO recognize the signal as serious? Are there emerging risks that management is missing or downplaying recklessly? If yes, I would express concern during in camera time and speak privately with the chair to ensure appropriate follow-up. Once a problem is squarely in front of management and the board, a risk-mitigating plan can emerge and evolve constructively.

 

On any given topic, a director has the potential to be the least informed person in the boardroom. Given that management will always know the business better, a board must ask questions that push beyond prepared reports. I find my colleagues with senior-level exposure to significant crises leading the board strongly in this area. I know I’ll be glad to have them close at hand, should an early warning point to a full crisis.

Thank you for reading! If you found this post useful, please share it with others in your network. Doing so helps my work reach others and would mean so much to me.

Early Warning Signals: How to Avoid a Corporate Crisis

by Tamara time to read: 4 min
0