If you’re a board director or aspirant, be careful that you’re not easily swayed by favourable, optimistic reports from company management. Directors can be particularly susceptible to how information is presented to them by company management. There is a tendency for company management to overemphasize the favourable news first, while less favourable news might not be given appropriate consideration. I call this the ‘good news first bias or the framing bias according to behavioural finance theory. This bias is quite prevalent in company presentations, reports and filings.
Typically, company reports begin with a summary of results and achievements written in a very optimistic language which may sometimes camouflage the reality of the situation. In oral presentations, the good news first bias manifest itself when company management speak positively about company news or spin negative news in such a way that they appear favourable. The danger to a board director is that subsequent information is viewed in light of the initial favourable, optimistic narrative and in this euphoric state, the brain isn’t alert to warning signals that the company’s position might not be so favourable.
A text analysis of a chairman’s statement and business review in its 2007 annual report published in 2008, a few months before the bank was rescued by the government, shows the extent to which company management can be excessively optimistic.
Another example is an excerpt from Lehman Brothers’ 2007 annual report before they declared bankruptcy in 2008 - one of the largest in U.S. history which precipitated the 2008 global financial crisis.
The bankruptcy occurred less than a year after the bank had posted huge profits, and after repeated assurances by the bank’s chief executives that its leverage was manageable, liquidity levels were high, and overall finances were looking good. Subsequent investigation revealed that accounting shenanigans were used to cover up the dire situation.
Hindsight is 20/20. However, board directors must maintain a healthy scepticism and recognise the risk of being overly influenced by the initial favourable narrative from company management which often lacks balance. Board members should focus on information (metrics) that is verifiable and seek external advice where necessary to interpret more complex information.
In Q1 2023, the Financial Reporting Council will begin work to overhaul the UK Corporate Governance in a bid to strengthen director accountability for governance, internal control, and corporate reporting, including auditing to restore trust in big firms and prevent further corporate scandals.
Arkjoy Risk Consultants Ltd can help organisations prepare for this significant change by providing board training and advising on how to implement effective governance & oversight frameworks to meet corporate and compliance mandates.
Get in touch today - www.arkjoy.co.uk or info@arkjoy.co.uk or book an initial consultation, choosing our risk training services.
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