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The Role of the Board in Preparing for Extraordinary Risk

From Nora Aufreiter, Celia Huber and Ophelia Usher writing for McKinsey & Co….

The pandemic has been a stark reminder for many organizations that they are insufficiently prepared for crises that could not merely destabilize them but put them out of business. In this episode of the Inside the Strategy Room podcast, our board perspective series looks at the board’s role in ensuring readiness for such existential risks. Nora Aufreiter is an experienced director and a McKinsey senior adviser. Celia Huber leads McKinsey’s board services work in North America, and Ophelia Usher works in McKinsey’s global Risk & Resilience practice. She coauthored the article “The disaster you could have stopped: Preparing for extraordinary risk.” This is an edited transcript of the discussion. For more conversations on the strategy issues that matter, follow the series on your preferred podcast platform.

Sean Brown: The pandemic has given many organizations a wake-up call about existential risk. Have boards done a good job of mitigating such risks?

Celia Huber: No. We run an annual global board survey of approximately 1,500 corporate directors, and we found that directors are not pleased with their performance on risk management. In fact, only 7 percent of the respondents believe that over the past year their boards were “most effective”—the highest rating—at risk management, and only 40 percent say their organizations are prepared for the next large crisis. That brings up the question of what boards should be doing now to prepare and how they should approach crisis and risk management.

Sean Brown: How should boards decide which risks to prioritize?

Ophelia Usher: It’s the high-consequence, low-likelihood events, such as the pandemic, that can cause long-term economic impact, significant reputational damage, and leadership changes. But you also want to consider the certainty of that impact [exhibit]. This is not about looking for “black swans” but identifying events that would have significant ramifications for the core of your organization and value proposition. If you provide cybersecurity, for example, a cyberattack will be a core piece of that value proposition. Identifying those predictable surprises is where boards should focus their energy and time.

Sean Brown: How can boards identify those “predictable surprises”?

Nora Aufreiter: There is often foreshadowing but it may be only in hindsight that we see the trend or the risk. Cyberattacks and activist investor campaigns are obvious risks, but at a recent hospital board meeting we talked about the nursing shortage. Nurses have been retiring for a long time, but COVID-19 dramatically accelerated those early retirements, and you cannot operate a hospital without nurses. Likewise, the current staffing shortages in many industries are trends that were predictable—the turnover of frontline workers has always been high.

Celia Huber: In addition to labor, we see issues with supply chains. Who would have thought that we couldn’t roll cars off production lines because of a microchip shortage? The inputs core to your ability to deliver your product or service are the types of risks we are talking about. In business school, I was taught to look at the value at risk times the probability of the event, but existential risks like oil spills and chemical disasters that would change the entire business need to be treated as if they could happen rather than adjusting for their probability.

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