Corporate crisis: the readiness is all; Does your board have the competencies to meet the most common dangers? A board assessment can prepare you for these potentially ruinous 'turning points.'.

COMPANY CRISES come in all shapes and sizes--defective products, hostile takeovers, executive misconduct, natural disasters that threaten operations, and many more. But from the point of view of directors, they all have one thing in common: They threaten the stock price and sometimes the continued existence of the company.

In 1993, an allegation of E. coli contamination in the beef served by the Jack in the Box hamburger chain caused the company's share price to plummet from $14 to about $3. A similar allegation against Taco Bell at the end of last year drove down the stock of its parent company 5.6 percent in just three trading sessions. When allegations of insider trading against Martha Stewart were first leaked to the press, the stock price of Martha Stewart Omnimedia fell some 40 percent in just three weeks. The A.H. Robins Co., the maker of the Dalkon Shield, simply no longer exists, having been driven into oblivion by personal injury lawsuits.

As those examples attest, there are few situations in which the director's fiduciary duty to the stockholders is so starkly in play as in times of crisis. Yet, in survey after survey the majority of directors responding report that they have not discussed what they will do in the event of a crisis. Moreover, many crises come unexpectedly--JetBlue certainly did not foresee the recent debacle of its passengers stranded for hours in snowbound planes. And because crises come in many different forms, it is impossible to have a detailed plan for all contingencies.

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Nevertheless, by ensuring that the board has the right mix of competencies and skills for the major and most familiar kinds of corporate crises, directors can help see to it that their companies get through hard times with as little damage to the company and the stockholders as possible--and, in many cases, avoid a crisis altogether. As Hamlet famously says, "The readiness is all."

The intersection of crises and competencies

The most common and potentially ruinous corporate crises, and the board competencies that should be in readiness to meet or avoid them, include the following:

Financial: Crisis here can encompass a number of difficulties--poor sales, unacceptable operating costs, excessive debt, and other acute financial problems. Whether a financial problem becomes a full-blown crisis is often a matter of magnitude. Poor sales may be cyclical or merely a temporary slump. But they can also become a matter of grave concern, as with the automotive companies' precipitous drop in sales for their highly profitable SUVs. Similarly, operating costs may edge up uncomfortably, or they can present a real crisis, as with fuel costs for airlines.

To help ensure that financial problems remain problems and not crises, directors, especially members of the audit committee, should exercise strong business acumen and financial literacy to monitor company financial performance effectively--and to recognize red flags when they see them. In fact, many companies are putting CFOs on their boards; some 277 seats on Fortune 500 boards were held by current or former CFOs as of 2006. These financially astute directors not only can add business value but also can help the board through the increasingly complex, and potentially disastrous, maze of compliance oversight.

Companies in turnaround offer an especially acute case of financial crisis. They need even more extensive financial competencies in areas like managing the debt holders. The board should also make sure that the company has the right finance functions in place to provide reporting mechanisms and financial measurements that enable to board to exercise effectively its heightened need for financial oversight. Ideally, the board of a company in turnaround will also include members who understand "value options" such as whether to sell the company, sell part of it, or seek an acquisition to strengthen it, all with an eye to what is best for the shareholders.

Leadership: The sudden illness, death, resignation, or removal of the CEO need not become a crisis if the board has performed adequate succession planning. When McDonald's CEO Jim Cantalupo, who had presided over a 49 percent rise in the company's stock price during his 16-month tenure, died unexpectedly, the McDonald's board named Charlie Bell to the top job six hours later. During his eight months as CEO, before he resigned to fight a fatal illness, he increased same-store sales, earnings, and the company's stock price. Since his successor, Jim Skinner, took over in 2004, the company's stock price has increased 45 percent as of January of this year. Despite these sudden disruptions, the company continued to thrive under successors who were fully prepared to assume the top job.

Unfortunately, a significant number of companies fail to do effective succession planning, running the risk of letting a sudden CEO vacancy turn into a crisis either through a protracted search for a successor or an ill-considered appointment. In the most extensive study to date of board effectiveness, recently conducted by Heidrick & Struggles in conjunction with the Center for Effective Organizations at the University of Southern California's Marshall School of Business, which incorporated responses from 768 directors at approximately 660 of the 2,000 largest publicly traded companies in the United States, less than two-thirds of directors reported that their boards were effective in planning for CEO succession. With the rate at which CEOs leave their companies at an all-time high, boards cannot afford to be caught without a succession plan.

Corporate Malfeasance: If the notorious corporate scandals of the past few years have taught us anything, it is that boards cannot afford to be complacent about the possibility of illegal and unethical behavior on the part of corporate officers. The reporting requirements of Sarbanes-Oxley and the increased responsibility they have placed on audit committees have addressed some of these concerns. Yet, as the continuing necessity of many companies to restate earnings demonstrates, the law has been only partially successful.

The board must also consider and insist upon a code of ethics and conduct for the company, review it often, and make sure that people who violate it are held accountable. Interestingly, in our board effectiveness survey, some 90 percent of respondents rated their boards as effective or very effective in ensuring ethical behavior, a figure that has been rising steadily, standing at 85 percent in 2003 and 87 percent in 2004.

Hostile takeover: With many industries continuing to consolidate and with private equity firms amassing record amounts of cash, almost any company is a likely target for a takeover. Because of this high degree of likelihood, the board should include members with experience in mergers and acquisitions and knowledge of how best to use outside advisers during the process. Further, because attempted hostile takeovers can drive the stock price up significantly, often creating unique tensions between the interests of shareholders and the interests of management, the independent directors must be prepared to take the lead in framing the deliberations in terms of what's best for shareholders. Some 89 percent of respondents in our board survey say that their boards are effective or very effective at advising during major decisions such as mergers and acquisitions.

Using the board assessment

To monitor whether the board includes the competencies that intersect with the most familiar corporate crises, boards can devote a portion of their annual self-assessment to the subject. The issues to be raised and the questions to be answered include:

* Does the board have the structure, composition, information flow, internal processes, and director qualifications that enable it to avoid or oversee crises?

* Do board dynamics create the atmosphere of candor and collaboration that is essential for navigating a crisis?

* Have the executive, audit, and compensation committees adequately addressed their specific areas of responsibility and reported satisfactorily to the entire board?

* What crisis competencies does the board lack?

* How does each director assess his or her strengths and weaknesses in this area? Those of peers?

Make sure that the assessment not only evaluates current competencies and processes but also elicits suggestions for improvement. The leader of the assessment should then include the information as part of the follow-up report to the board and initiate a discussion, if necessary, about corrective actions to improve the board's readiness.

The readiest boards

In our experience working with boards, we have found that the readiest boards are those that practice good governance generally. But even the best of boards, increasingly charged with more and more responsibilities, can slight preparation for what may seem like remote possibilities. They would do well to remember that "crisis" comes from a Greek word meaning "turning point." As that suggests, the outcome can go either way. For those who are well prepared, it's far more likely to go the right way.

The author can be contacted at [e-mail], or by phone at [phone].

Dale E. Jones is managing partner of Heidrick & Struggles' CEO and Board Practice for the Americas. He has managed executive search and leadership assignments for a wide range of public and private companies, including such Fortune 50 companies as PepsiCo Inc. and Tyson Foods Inc. He served as a corporate director for Hughes Supply, a $4.4 billion NYSE-traded company that was acquired by Home Depot in 2006. He is based in the firm's Atlanta office.

RELATED ARTICLE: And then there are disasters

From natural calamities like Hurricane Katrina to man-made events like 9/11, the blackout of August 2003, plant explosions, and environmental catastrophes, disasters loom as the largest and most unpredictable crises that companies are ever likely to face.

They not only profoundly disrupt operations but also, in the case of man-made disasters or poor response following a natural disaster, can tarnish corporate reputations, provoke ruinous litigation, incur fines, invite regulation, and alienate customers. The magnitude of the potential damage obligates the board to make sure that the company is as well prepared as possible. The board should therefore:

* Have the audit committee regularly review the risk assessment for the company, make sure it is periodically updated as conditions change, and regularly review it with the entire board.

* Regularly review the company's disaster recovery and business continuity planning.

* Make sure that a crisis management plan is in place, including clear roles and responsibilities for directors and the identification of external experts who might be called upon for assistance.

Because the operations of most companies in today's wired world heavily depend on information technology, the board should also make sure that it has the competencies to oversee the highly critical IT aspects of disaster recovery and business continuity planning. They may even consider putting a CIO on the board. As two of my colleagues recently observed: "A CIO's enterprise-wide understanding of business and technology-driven strategies could prove invaluable in stewarding a company through a natural disaster as well as contribute substantially to the board's understanding of risk and information security" (Jory J. Marino and Michael C. Nieset, "Overseeing Business Continuity Planning: Just One More Reason to Consider CIOs as Directors," Directors & Boards Boardroom Briefing, Spring 2006).

--Dale Jones