Post-pandemic corporate governance

Human beings are wonderful amnesiacs, an observation grounded in the history of traumatic events that faded gradually into oblivion. It may well be the same with the current pandemic.

But more likely not. As the pandemic’s first phase comes to an end, we may experience greater control of citizens’ behaviour, including close monitoring of movements by means of instant communications and government-issued safe-conducts to gain access to any public event. Constitutionally protected freedoms may be infringed by a state/medical bureaucracy determined to protect us at all costs. Such coercive measures will be promoted, and may be accepted, as essential to avoiding a recurrence of some form of pandemic.

After the 2008 financial crisis, corporations surprised by that crisis greatly enhanced risk monitoring and mitigation. But the challenge of events like the pandemic is not risk but uncertainty — the fact that they are not amenable to prediction and control with typical risk models. There is no probability estimate of the occurrence of an uncertain event within a given time frame, no way to predict the likely occurrence of a rare event. The typical “predict- and- prepare” approach of risk management systems and processes does not apply. That’s exactly the approach that totally missed the early warning signals of the 2008 crisis. Yet, after 2008, corporations adopted and relied on ever more sophisticated risk models, all suffering from the same flaw: their inability to handle uncertain events.

So what is a corporate board to do? To ask management to list all possible unlikely dramatic events to which a corporation may be vulnerable and prepare contingency plans for each would paralyze any organization. An executive of BMO

Financial Group in Quebec recently admitted that his institution had planned for “all” contingencies, including nuclear attacks, fires and hurricanes, but had failed to foresee a pandemic. ( And what about tsunamis, 9.0 earthquakes, an asteroid hit, etc.?)

In an uncertain world in which unpredictable and uncontrollable events may have catastrophic consequences, a board of directors must call on management to build buffers and redundancy and to hoard strategic and financial resources. No doubt such measures will have a short- term negative impact on earnings per share, the return on assets and optimal capital structure. But that is the cost of preparedness for uncertain events.

Another challenge for boards of directors will come from the mood of the population as we emerge from the pandemic. Some flaws and irritants in our current economic system may well become intolerable. For instance, the expectation of continuous growth in earnings per share, the cost-driven global search for the cheapest labour and the disparity in income within both corporations and society may all come in for criticism and calls for reform.

Boards of directors need to be alert to early warnings of impending political and social disturbances, which may be harbingers of the next flock of black swans. If they do not effectively handle these new expectations, they can expect governments now flush with power to seize the initiative regarding work arrangements, executive compensation, wealth- sharing, offshoring, and so forth.

Contrary to what might be expected given the serious financial issues many businesses will face, the recent infatuation of large institutional shareholders with ESG ( Environment, Social, Governance) drivers and their corollary, the stakeholder model of the corporation, is unlikely to abate. Too much wind already in those sails and new gusts from the pandemic will lead to calls for even swifter compliance by publicly traded corporations.

Management and boards should act pre- emptively in five areas. The corporation’s access to critical supplies should be closely monitored. All past decisions to outsource and offshore operations in low- cost countries need to be reviewed and reassessed.

Work arrangements should be adapted to post- pandemic circumstances, as well as to people’s legitimate quest for work balance and couples’ desire for burden sharing. Though doing so will be hard, boards also need to cut the Gordian knot of executive compensation and set an acceptable ratio of top management compensation to the salary of the median employee.

As most large institutional funds have become advocates of ESG, management and the board should make clear to shareholders what this and the above adjustments will mean for the management, governance and performance of the company.

In the end, the powerful forces of continuity, habit and normalcy may bring us back to the status quo ante. We may wake up from this nightmare unscathed. Perhaps! But a board of directors should not take such a “happy ending” for granted.

Another challenge for boards of directors will come from the mood

of the population.