Signs of poor governance: how does one tell if a particular company's governance health is really much poorer than it appears? If the directors and officers recognize these warning signs.

• Author: Babcock, Reginald L.
• Position: Board Process

THE RULES that define good governance are complicated, and getting more so. They are based on court decisions, federal and state statutes and regulations, stock exchange rules, blue-ribbon committee recommendations, accounting industry principles, lessons from Enron and other failures, and custom, practice, and personal experiences. The subject can be daunting.

There is no substitute for having expert advice on the applicability of all the formal rules and cutting-edge practices. Every company--even a closely held business--and its directors should be assured that the very latest in good governance practice is communicated by experts and deployed effectively.

Compliance by public companies with formal rules and best practices can be discerned to a great extent from the public disclosure documents that all such companies are required to file. The extent of such disclosure is growing. But a number of common-sense indicators of whether a firm employs good governance techniques never are made public--except in cases such as Enron, where unfortunately everything eventually is revealed. In fact, companies with exemplary "public" records may have very serious inherent governance shortcomings. Enron was but one example of a company with a stellar public governance track record but with fundamental problems lying beneath the surface.

Flow does one tell if a particular company's governance health is really much poorer than it appears? Insiders, such as the directors, officers, and advisory board members, may recognize certain of these warning signs, which are nearly as applicable to private concerns and nonprofit organizations as well.

1. Directors sign and approve documents without adequate review

   The world is more complicated, securities filings are more extensive than ever, and transaction documents can be measured by the pound or the inch. Directors face a real difficulty in discharging their legal duty of care to read and understand the material that is presented to them for approval. Often the materials in question have been prepared by lawyers, and the meaning and effect of the documents are not fully understood when they receive approval. To reduce the point to its simplest level, ask which directors have read the annual report on Form 10-K they are signing. A public disclosure may indicate that all the directors signed the filing, but how many really know its contents?

2. Directors do not review the D&O liability insurance application

   Much has been said and written concerning the board's role in risk assessment and management, including the matter of the adequacy...