How much blame does the board bear when corporate wrongdoing comes to light?
When a corporate scandal breaks, the first question investors ask is Where were the directors? This phrase was coined by Peter Dey in 1994 when he led a report on how to improve corporate governance practices at Canadian listed companies.
Corporate scandals have always existed and many stem from weak corporate governance, often caused by a lack of communication, insufficient internal controls or a very lax attitude towards potential problems.
In 2024, the US administration criticized Boeing’s board for failing to adequately supervise the safety procedures of its aircraft, following several accidents involving its 737 Max model that resulted in numerous deaths. Its shares plummeted 32 percent. The company paid a fine of more than $200 mn, which was added to another fine paid in 2022.
A recurring question is around the extent to which the board is responsible for management decisions
Also in 2024, Sam Bankman-Fried, founder and CEO of FTX, one of the world’s leading cryptocurrency platforms, was sentenced to 25 years in prison for defrauding his investors.
In July of this year, the lawsuit filed by a group of small shareholders against the members of the board of directors of Meta, parent of Facebook, reached the oral trial stage before a settlement was reached. They had alleged that the directors were very lax in their supervisory duties, causing serious financial damage to the interests of shareholders. In 2019, the company agreed to pay a $5 bn fine to settle an investigation by the US telecommunications regulator into the leak of Facebook user’s personal data – the scandal known as Cambridge Analytica.
Where does the board’s responsibility lie?
A recurring question in these cases is around the extent to which the board is responsible for management decisions that may originate at levels of the company far removed from the board.
Normally, the first line of responsibility lies with managers and executives. They are the ones who have to report any potential problems that are detected. The lack of a culture of transparency, the failure to bring problems to the attention of the board or the fact that the risks are complex to explain or highly unlikely to occur – these factors can all lead to undetected and unreported problems turning into a nightmare.
A second line of responsibility falls to internal audit, a department that should be the ‘eyes’ of the board, beyond the narrative of senior executives. This ‘bad cop’ profile can make managers uncomfortable and sometimes means that this department does not have the necessary resources or that its work is merely to verify compliance with the regulations required by law. Making this department functionally dependent on the board of directors – through the audit committee and not just hierarchically the CEO or CFO – is an important step towards improving corporate governance.
The possibility for directors to meet alone, without the presence of executives but with the head of this department, reinforces the board’s supervisory role.
Beyond this committee, the board should have direct access to the heads of key areas such as risk, the legal department or the business areas themselves.
Spotlight and responsibility
If a scandal reaches the public, the spotlight and responsibility will always fall on the board of directors. In that case, directors should ask themselves whether they have asked the right questions, beyond reviewing all the information they regularly receive – or whether they have relied too heavily on the explanations of senior executives. Directors need to maintain a certain degree of skepticism. This reasonable doubt requires in-depth knowledge of the company’s business and financial performance, which requires training, time and dedication.
To think that a board could be surprised by a corporate scandal would be extremely serious in terms of its functioning. The board’s fiduciary responsibility must be proactive, not reactive once problems have already erupted. The board itself must periodically evaluate its effectiveness and preparedness. Just this month, investment bank Lazard appointed Dimitry Shevelenko, chief operating officer of AI firm Perplexity, to its board in recognition of how this tech can reshape the banking industry. This is an example of a proactive board.
The possibility for directors to meet alone, without the presence of executives but with the head of this department, reinforces the board’s supervisory role
Boards must encourage a culture of transparency and reporting of risks, aggressive accounting practices or any other issues that may be contrary to ethics or existing codes within companies. When problems become clear, action must be taken – even if that means removing the most senior executives, as we have seen in the recent dismissal of Nestlé’s CEO, which stemmed from a series of complaints made through the company’s internal channel.
Independent directors are key
The structure and composition of boards is a very important factor in their effectiveness, preventing excessive complacency. The role of independent directors – those who are not or have not been executives of the company and who do not own the company – is key.
Some measures that could perhaps help improve their independence would be to strive to use a recruiter that is truly independent when selecting board members.
In recent years, there has been a significant improvement in corporate governance. The rules approved by supervisors, the search for a better balance between executive and control functions, and the creation of specialized committees have contributed to this improvement. The enormous growth, complexity and diversification of large groups, both geographically and in terms of their business activities, means that it might be a good idea to have a segmentation of governance rather than a single, centralized control.
Despite the damage to their reputation, companies’ share prices have tended to recover within months of scandal, as long as the company’s business continues to grow. Where this recovery is less likely to occur, however, is in the case of court rulings that place a value on the damage caused (think Volkswagen, BP or Wirecard) and if the fundamentals of the business have also deteriorated. Such convictions have usually been handed down by the ordinary courts or by sector regulators.
Recovery or not, that same question – Where were the directors? – must still be asked. Scandals rarely occur without prior warning signs. The important thing is for the board to be aware of and able to detect, correlate and understand these signs.
Ricardo Jiménez Hernández is strategic adviser at Harmon and a former director of investor relations at Ferrovial. He is also a member of the IR Impact editorial board
Meta did not respond to a request for comment.
