By Dennis T. Whalen
While we’re in the midst of the second longest economic recovery in history, many economists and business leaders are questioning whether we’re nearing the end of the bull run. With slower global gross domestic product growth forecast for 2019 and 2020—particularly in the EU, the U.S., and emerging economies—and some seeing at least a modest risk of a U.S. recession in 2019 and a growing risk in 2020, there’s clearly a growing sense of caution. Financial conditions are tightening in advanced economies, and a number of Fortune 500 companies have announced first-quarter earnings forecasts that have fallen short of analysts’ forecasts.
We hear varying levels of concern from directors about a potential economic downturn and possible recession—concerns that are compounded by mounting geopolitical uncertainty and risks posed by Brexit, China’s economic challenges, trade tensions, emerging market debt, and more. While directors appear to be cautiously optimistic, as one director said, “In this environment, it’s good to be paranoid.”
Given the uncertainty that companies are facing today, it is important that board leaders frame their agendas to help ensure that the company is prepared for a potential economic downturn—possibly a severe one. While watching for signs of systemic economic weakness, board leaders should also be mindful of lessons learned from the last recession. Among the key areas for board focus today and in the months to come:
Scenario planning. What scenario planning is the company doing around a hard Brexit, tariffs, a trade war with China, rising inflation, and rising interest rates? Are there second-order effects that will impact the company’s industry, supply chain, and/or value chain? Does management prepare a set of probability scenarios for how the future might unfold and consider the threats and opportunities that those scenarios present? Do the strategic options balance a commitment to a course of action with the flexibility to adjust amid different future scenarios?
Growth, capital allocation, and cost cutting. How is the company balancing cost reduction and growth initiatives? How is it determining whether to invest in capital projects versus buybacks or dividends? How does the company balance taking advantage of growth opportunities with belt tightening in anticipation of an economic slowdown? The world is moving forward regardless of the capital cycles, and companies that are being disrupted need to make technology investments. At the same time, can the company head into a downturn with a slightly fatter balance sheet?
Liquidity, access to capital, and cash flow. What are the company’s plans to raise debt/equity in the short and medium term? How dependent is the company on short-term financing? Are credit lines secure? Is the company at risk of default on debt covenants?
Hedging against commodity, currency, and interest rate fluctuations. What will be the impact of tariffs, inflation, and recession on commodity costs and procurement strategies? How will changes impact the ability to obtain economic hedges against commodity, currency, and interest rate fluctuations?
Exposure to third parties. Does the company understand its exposure to third parties who may experience financial difficulty (customers, suppliers, lenders, and others)?
Fair value and asset impairments of businesses. Does management understand how vulnerable the company’s portfolio is to changes in value in this environment? Has management identified triggering events that may warrant impairment assessments of goodwill and other intangible assets? How will changes in financial markets impact the valuation of pension plan assets and planned or mandatory funding levels?
While we remain cautiously optimistic that the economy is on firm footing and that any recession will be short and shallow, “an ounce of prevention…” as the saying goes.
Dennis T. Whalen is Leader of KPMG’s Board Leadership Center.
This article originally appeared in the NACD BoardTalk blog.