The cost of poor governance and why oversight matters

In entrepreneurial environments, high importance is given to providing employees with the autonomy to enable them to grow and develop business without constraint. When the balance between autonomy and oversight goes wrong however, it can have disastrous consequences.

There have been recent cases where a lack of good governance over their businesses have resulted in substantial losses for investors/shareholders. At the heart of the issue has been a lack of oversight and control.

It is essential to make sure that those managing a business have their objectives aligned with those of its owner(s), that there are good controls over money exiting the business and generating the right culture in the firm. Without good governance the consequences can include management fraud, serious breaches of legal/regulatory requirements, and decisions being made against the interest of those with significant ownership.

By the time the importance of having a robust governance framework is realised, it can be too late and incredibly costly (in terms of money, time and reputation) to rectify.

Below we pick out some common underlying causes, and why it is important to get them right.

Board representation

When a significant investment is made in a company, it is important to ensure that there is adequate and effective board representation so that good decisions are made, and that they are aligned to the interest of the owners.

Without this representation there can be both a lack of oversight to identify problems in the business, or even an inability to prevent decisions being made that are against the interest of some shareholders.

It also needs to be clear which decisions need to be escalated to the board for approval, so that no material decisions fly under the radar. Bear in mind that good relations between an investor and a company’s management at the time of a transaction may not be the same in a years’ time.

Control over cash

The ‘fraud triangle’ states that individuals are motivated to commit fraud when three elements come together:

1. There is a perceived pressure (e.g. financial stress, or need to meet targets)
2. There is some way to rationalise the fraud (e.g. resentment, or view that there is no actual harm done)
3. There is a perceived opportunity (e.g. weak controls, inadequate oversight)

A company cannot always control the external pressures affecting an employee or whether that person can rationalise committing a fraud, however they can ensure that there are controls in place to restrict the ‘perceived opportunity’.

There is still a surprising amount of firms without basic controls over how cash exits the business, for example: no requirements for dual signatories on bank accounts, lack of clarity over approval levels for large payments, no sign off procedures for expenses, not performing due diligence on suppliers (even major ones) – to name but a few.

Fraud is far more common than many people perceive, and it can often happen right in front of us if we do not have a sceptical outlook and the right controls in place.

Challenge and oversight

It is essential to have robust oversight over a business, and to challenge both the decisions being made and company performance. Poor performance is always likely to be scrutinised in depth but there may be commercial pressure to accept positive numbers without such scrutiny.

These also need to be challenged and understood – if an area of a business is outperforming all others, why is this the case? It could simply be that management of a certain area are doing an incredible job, but could it be an indication that there is something happening within the business which needs further investigation. It is critical to understand the reality behind trends and anomalies.

Managing risk

Managing risk is often perceived as only being about the downside and preventing growth; this is a misconception. When done properly, risk management is a strategic asset that drives business performance.

The most important part of managing risk is agreeing the level the business is willing to take (the risk appetite) and making sure that everyone is aligned and working towards this. An aggressive stance can be taken, but it is important that this is agreed and understood by the board.

Once it is defined, then it can be monitored, ensuring that everyone is aware if anything happens outside that agreed risk appetite. Without this, the board may misunderstand what risk is being taken, and then get a nasty shock further down the line.

Internal Audit

Independent internal audit allows stakeholders to understand how mature the control environment is within a company, and where it is taking significant risks that may affect it achieving its objectives. It is an important foundation upon which a business and its owners can rely, and it helps them ensure effective and efficient operations.

It is also a deterrent against behaviour not in the interest of the shareholders. It is often believed by companies that key processes they run are well controlled. Upon closer review, the standard process can indeed be very solid; however, for various reasons there can be exceptions which bypass it (sometimes unknown to senior management).

It can be in these cases where issues arise, and lead to errors (either accidental or intentional) that do not get picked up. Internal audit is a great mechanism for companies to highlight these exceptions, help to implement controls around them to prevent issues occurring, or find any issues that have occurred (before they are identified by 3rd parties and become harder to manage).

Why governance and oversight matter

The areas outlined above represent some of the key considerations when establishing effective governance, oversight, and risk management practices. Organisations may wish to review their current arrangements to ensure they remain appropriate and proportionate to their objectives and risk profile.

Good governance is often viewed as a cost or an administrative burden, but in reality, it is an investment in the long-term success and stability of a business. Without it, even the most promising ventures can falter (sometimes irreversibly) under the weight of poor decisions, unchecked risks, or behaviour that goes unchallenged.

By the time shortcomings are exposed, the damage to reputation, financial performance, and stakeholder confidence can be significant. The question is not whether you can afford to have effective governance and oversight in place, but whether you can afford not to.

Is your organisation’s governance framework fit for purpose? Get in touch with our internal audit team today to assess your current arrangements and safeguard your long-term success.

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