Clarifying the board and management dynamic on financial matters

New financial pressures confronting health systems attach priority to clarifying the reporting relationships between the health system CFO and the CEO on the one hand, and the Finance Committee and the full board on the other hand. In the context of business resiliency planning, the expectation is that these parties will work together to establish workable protocols that will support their respective duties for financial management.

Health system financial executives are currently confronting a variety of significant pressures; e.g. credit risks posed by the coronavirus; severe revenue contraction caused by limits on elective services; the need for major operational changes while waiting for revenues to rebound; the related risk of financial covenant breaches; the uncertainty of additional government stimulus and emergency response funding; possible risks associated with tapping unrestricted investment funds, and adjusting to changing consumer behavior. These pressures have been recently underscored in thoughtful commentary from Moody's Investor Services, and the consulting firm Kaufman Hall.

At the same time, health system boards are confronting new crisis-driven heightened demands on their oversight and decision-making responsibilities, especially as they relate to financial matters (in which they have a major role), operational resilience and the need to re-envision the system's strategic direction. Boards must also be mindful of personal liability issues that present themselves should the system approach or flirt with insolvency.

These and similar developments are likely to prompt a new dynamic between executive management and the board, built on a shared interest in clarifying reporting relationships and information flow on financial matters. It will be important for this new dynamic board/management relationship to be sensitively managed in order to avoid tension, or confusion regarding expectations.

This is especially the case as directors respond to governance challenges by spending more time with management than before. Indeed, a new survey from the National Association of Corporate Directors projects more frequent board engagement with management, whether by virtual means or otherwise, and between the traditional quarterly meetings on the boardroom calendar.

However, this new board/management dynamic can be comfortably grounded in a shared understanding of the roles of governance and executive leadership as they relate to financial management and oversight. This is particularly the case as both seek to satisfy enhanced expectations of their conduct created by the crisis. This is what you do, this is what we do, this is how we can best work together.

On the one hand, the board wants to make sure its fiduciary duties are exercised consistent with what it knows to be an enhanced standard of fiduciary conduct. This is particularly the case with financial matters. The finance and audit committees want to satisfy their specific oversight and decision-making duties, while the remaining directors seek a role commensurate with their stewardship responsibilities.

On the other hand, the CEO and the CFO (and other executive financial managers) want the ability to manage the financial affairs of the company through the crisis, without unnecessary interference from board members who may lack commensurate financial acumen. It's what they're trained to do.

Both sets of concerns are valid.  And the NACD survey, with its projection of increased board/financial management interaction, offers a useful prompt to proactively address the concerns for the broader benefit of the organization.

Traditional governance principles offer some general guidelines on financial roles and relationships. The Business Roundtable articulates the basics—the board approves corporate strategy, selects the CEO and monitors the performance of the CEO and the leadership team. The board delegates to the CEO — and through the CEO to other senior management — the authority and responsibility for operating the company's business. Management, led by the CEO, runs the operations of the company subject to board oversight and informs the board on the status of company operations.

The board is expected to exercise attentive oversight of corporate affairs—including the results of operations. In that role, the board is not expected to manage-or micromanage-the company's business by performing or duplicating the tasks of the CEO and senior management team. Yet in crisis circumstances, greater board involvement in operations may be necessary. Furthermore, there are some areas (e.g. the relationship with the outside auditor and executive compensation) the board has a direct role instead of an oversight role.

The Finance Committee interacts with financial managers on matters of budgeting, operating plans, and debt and capital allocation. The Audit Committee interacts with such managers on matters such as financial statements and financial reporting. The Strategic Planning Committee interacts with these managers on matters of long-term sustainability and business disruption.

But those basic principles leave a lot of gray area in which the financial related roles of the board and management can collide, especially given the pressures of directing the company from crisis to stability, and beyond. In such situations, useful clarity will come from conversations amongst the board and finance committee leadership, and the CEO and the CFO, about coordinating practical aspects of their respective duties.

Which financial managers serve as staff to key board committees? What kind of financial and operating information flow is expected, and how is it allocated between the board and the key committees? What is the timing and format of that information? Which financial managers present to the key committees and to the board, and with what frequency? Does the CFO report to governance through, together with or separate from the CEO? Some form of board/management compact on these and other similar financial management issues will set reliable expectations for all members of senior leadership.

These conversations are complicated by the recognition that while the board makes its direct delegation to the CEO, the CFO is typically considered to have a dual reporting relationship to both the CEO and to the board. But these complications can be mitigated to some degree by referring to the circumstances of the general counsel, who is considered to hold a hierarchical position equivalent to that of the CFO, and who also owes a dual reporting relationship to the CEO and to the board.

As financial pressures mount for health systems as they emerge from the depths of the pandemic, so do the performance expectations of financial management and the governing board. Proactive steps may be necessary to avoid needless tension between these critical leadership constituencies, and as well as confusion on reporting relationships and information flow. Thoughtful and perhaps informal internal conversations between these parties, perhaps facilitated by the general counsel, may offer a productive approach to avoiding controversy.

Michael W. Peregrine, a partner at the law firm of McDermott Will & Emery, advises corporations, officers, and directors on matters relating to corporate governance, fiduciary duties, and officer and director liability issues. He is outside governance counsel to many prominent hospitals and health systems, voluntary health organizations, social service agencies and health insurance companies. His views do not necessarily reflect the views of the firm or its clients

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