The role of the non-executive director (NED) has become increasingly important in board governance: not only do NEDs have the power to hold the executive to account, but they are well placed to spot risks that the executive don’t see.

From my perspective as a lecturer on Henley Business School’s masters programme for board practice development, I have set out below five factors that contribute to  boards’ struggling with risk.

Let’s first recognise that not all boards are the same and there is a wide variety in quality of individual directors. There is no mandatory qualification to be a director: anyone can be appointed, so there is effectively no quality control as there might be for professional lawyers or accountants.

Second, not all industries engage with risk to the same degree, financial services firms tend to appoint a risk committee with its own chair, whereas many others rely on the risk and audit committee. In short, the handling of risk by any board depends largely on the quality of the individuals on it and the industry in which it operates.

Five contributory factors

1. Financial lens. Even in firms with a dedicated chief risk officer, risk reporting will be done through the risk and audit committee, which inevitably views risk through a financial lens as a potential cost, liability or loss. This is standard practice in most organisations run to a financial timetable accountable to shareholders for quarterly targets or dividend returns.

Potential loss is a significant motivator and much research exists on the power of risk aversion as a cognitive bias in management decisions. Caution is the watchword and taking risks requires both bravery and daring: these are typically in short supply!

2. Short-termism. It follows that many boards view risk in terms of impact within the horizon of the financial reporting cycle—either in the next quarter or next year. Risks that might impact the business in five or ten years are seldom considered, because performance targets are critical.

Nobody wants to upset the shareholders or face a vote of no confidence from an activist investor intent on changing the board to release more shareholder value. Despite recent attention to ESG issues and long-term sustainability, most boards focus on operational—not strategic—risks, as these are things they can control.

3. The risk matrix. Boards love a risk matrix, preferably reduced to four boxes based on event likelihood and impact severity. This provides a snapshot of risk in one moment and helps sift the important from the urgent, so as a distinguishing tool it has some merit.

It does, however, offer no help in managing or reducing risk, as it is merely plotting it. It is a simple visual but its simplicity is deceptive because it cannot identify emerging risks or those which are volatile. It certainly doesn’t help manage risks and it rarely helps identify them so lends false confidence to a board.

4. Nature of risk. In the public sector, risk is often seen in terms of duty of care, whether to passengers, pupils or patients. Safety is paramount but, of course, in the background lies the cost of legal fees for defence against negligence claims and compensation in the case of accident.

The same is true in industries where safety is business critical, such as construction or aviation. Here, a fixation on safety can blind a board to other risks. Saab, prior to acquisition by General Motors, built cars around safety irrespective of cost; by contrast, Boeing cut costs at the expense of safety. Many boards fail to get risk in perspective until too late.

5. Inflexible interpretation. Boards struggle with risk sometimes because what appears to be a hazard turns out to be an opportunity in disguise. The opposite is also true, an opportunity can morph into a hazard given unfolding conditions in the marketplace. Perspective matters and it is not unusual for some board members to see an opportunity where others see a risk, so consensus is not always achievable.

Minutes might reflect dissent, but there will be pressure on the chair or company secretary to report agreement. This is not always healthy as any board member can spot a risk and request it be recorded. Some risks retreat and new ones emerge, yet boards often only discuss them at board meetings.

Boards do struggle to identify and manage risks because they try to follow the guidance of the risk industry or appointed risk expert, yet risk is merely an estimated future outcome that nobody can predict with certainty. Yes, boards struggle, but they should be aiming for resilience in facing the unknown and accept that the reason boards consider risk is to deliver good judgement.

Garry Honey is the author of ‘Navigating Uncertainty – securing better judgement’ and designer of ‘What boards need to know about risk’ for Henley Business School.

On 11 September, Board Agenda is a partner to an event in London to debate whether boards struggle to identify and manage risk. Find out more information here.