I have lived through earthquakes growing up in Peru and later living in California. Today, when I see another earthquake, flood, fire or extreme weather event, I find myself looking beyond the event itself.
What happens when the factory is still standing but the business loses money? When insurance works exactly as written but doesn’t cover the economic loss? Or when management makes entirely rational decisions and the enterprise still ends up with the wrong outcome?
Those questions were on my mind during a recent visit to Peru. Winter did not feel like winter at all. I could see the impact on retail sales, tourism and restaurant menus. El Niño is not abstract there. While at the ocean, I spoke with a fisherman about what he was seeing. Warmer waters were changing the type of fish available, affecting what they could catch and making the next season even more uncertain.
A recent Reuters article on Europe’s heatwaves made me look at another piece of the equation: insurance. It described a growing gap between the economic losses businesses are experiencing from extreme heat and what traditional insurance actually covers: Sometimes the loss is simply “the revenue you don’t make.” The factory may still be standing. Nothing has burned or flooded. But production slows, cooling costs rise, workers cannot operate at the same level, customers stay away. There may be no physical damage, but there is still economic loss.
I have written before about governing under uncertainty. This made me look at it from another angle: the decisions we make before uncertainty arrives.
The Loss Before the Loss
Now, none of this is particularly new. In strategy work, I have used black-swan exercises and scenario discussions with CEOs and management teams for years. What happens if an important input disappears? Infrastructure fails? A market changes? The purpose was not to predict the event. It was about building resilience, and, for that, we needed to understand the consequences and make more informed decisions before circumstances made them for us.
What has changed, perhaps, is what we expect the board to understand. In the past, boards sometimes learned the full extent of an exposure when the loss occurred. Management knew pieces of it. Operations knew others. Risk or insurance knew what was covered. But the economic consequence did not necessarily come together at board level until something happened.
When Understanding the Risk Is Not Enough
Protecting value still matters. Controls matter. Compliance matters. Insurance matters. But increasingly, the same information that tells us what could put value at risk may also tell us something about where and how value will be created.
A change in insurance coverage may be a risk issue. It may also change the economics of a location. Higher cooling costs may be an operating issue but may also change a manufacturing decision. A disruption in supply may be an immediate revenue problem but also say something about where the business invests next.
Not every scenario belongs in the boardroom. Nor should it. But the board does need to understand when an operating exposure becomes material to the economics of the business, and when that begins to affect strategy.
That raises a different set of questions. What material risks have we chosen to transfer, mitigate or retain? Are those choices still appropriate as the business and its environment change? Are we looking beyond physical loss to understand the economic consequences of disruption?
The answer may well be to retain the risk. That can be a perfectly sound business decision. What matters at board level is whether that exposure has been understood and consciously accepted — not discovered when the loss arrives.
Insurance can provide another signal. Changes in premiums, exclusions, deductibles or available coverage around a geography or an asset are information. It doesn’t mean the insurer is right and we are wrong.
But I would want to understand why our views are diverging. The information may already exist inside the company. The question is whether the pieces come together early enough to challenge an assumption we are still using to make decisions.
When the Pieces Don’t Add Up
Let me share a version of this from the operating side. I was a corporate executive leading innovation and launching a new business inside a large global corporation. We had developed intellectual property that was central to the services solution we were building, but some of the component decisions we depended on sat within established business units. They controlled their bill of materials and, importantly, the cost.
From where I sat, supporting our technology made sense for the enterprise and the strategy we were building.
From where they sat, buying a less expensive component made sense, even if that choice did not support our own IP and strategic road map. They owned their P&L. They had their plan. They had cost targets. They would be measured against them.
I certainly didn’t appreciate their logic at the time. Looking back, what interests me is that both decisions could be right. They could make the right decision for their P&L while we made the right decision for the business we were trying to create.
The problem was that the two definitions of success did not produce the same answer.
That is a much harder problem than someone simply making a bad decision. And I wonder how often boards encounter some version of this. Risk management can correctly identify the exposure. Insurance can be properly placed. The CFO can correctly apply the company’s investment hurdle. The operating business can deliver against its targets. Everyone can be doing their job, yet the enterprise can still be exposed.
What Have We Decided Success Looks Like?
The view changes depending on which side of the table you are sitting on. As an operating executive, I could see the conflict at the level of the decision. The business unit could see its P&L. The CEO had to see across the enterprise.
The board sees something different again, and even that view changes depending on the type of table. Consider the same manufacturing facility facing the same physical exposure inside a multigenerational family business, a larger corporation allocating capital across businesses, or a private-equity-backed company operating against an investment thesis and value-creation plan. The physical risk may be the same. The decision may not be.
Time horizons differ. So do capital structures, investment criteria, tolerance for interruption and expectations of ownership. A decision that makes sense in one room may be difficult to justify in another.
That doesn’t mean one board has exercised better judgment than another. What interests me is whether directors understand what has made a particular answer look right for the enterprise they govern. That is very different from asking about the operating decision itself because the board may never see the component choice I described earlier, and probably shouldn’t. It may never see an individual change in an insurance deductible or the cost of cooling a particular facility.
But it should understand the assumptions that matter to the strategy: how the company thinks about capital, what risks it is prepared to carry, the time horizon against which investments are judged and where management may be optimizing one part of the enterprise at the expense of another. The details belong in management, but the implications may not. That is where applied governance becomes real. Not bringing more operating decisions into the boardroom, but understanding whether the way the enterprise makes those decisions still supports the value it is trying to create.
The Decision Before the Decision
By the time a significant proposal reaches the board, many choices have already shaped what directors see. Someone established the return threshold, determined the planning horizon, decided where the cost would sit, defined the performance measures, and determined what would be insured and what the company would retain. None of these are simple details surrounding a decision. Together, they help determine which choices will appear rational in the first place. Uncertainty doesn’t arrive in an empty organization. It arrives inside a system that has already made choices about assumptions, measures, accountability, risk and what success looks like.
When Uncertainty Arrives
Earthquakes have nothing to do with climate change. Heat, floods, fires and El Niño each have their own causes and dynamics. Directors don’t need to become experts in all of them. Nor can a company economically protect itself against everything that might happen.
That isn’t the point. What interests me is what these events reveal. A factory can survive while its economics change. Insurance can work exactly as written while leaving a material loss with the company. An executive can make the right decision against an approved target while creating the wrong outcome somewhere else.
None of those necessarily represents a failure. But each tells us something about the conditions under which decisions are being made. The board’s role is not to predict the next disruption, but to help ensure the organization could make good decisions when circumstances changed.
I still believe that, and would add that some of the most consequential decisions about how the company will respond may have been made long before the uncertainty arrived. We may not control the event. But we have considerably more influence over the conditions under which decisions will be made when it happens.
Perhaps that gives directors another question to bring into the room. Not only, “Are we prepared?” but “Have we created the conditions in which the right decision for one part of the business can also be the right decision for the enterprise?”
I know that is a question I would have welcomed when I was sitting on the operating side of the table.