Five areas of oversight to consider amid economic volatility

This article was updated October 21, 2022.

Geopolitical instability and surging inflation sit atop the macroeconomic factors that corporate leaders must account for when making business decisions. Moreover, interest rates are increasing, and supply chains continue to be stressed. The risk of a global recession is high.

Oversight in this environment will require corporate boards to test the breadth of management’s scenario analyses and its consideration of exogenous shocks.

Global GDP forecasts continue to point to a modicum of growth, but deceleration has been the theme of this year and is expected into 2023. 

Few executives have experience with the economic factors at play today. It has been more than 40 years since we’ve seen inflation this high—and interest rates are increasingly sharply at home and abroad. Even at full employment in the U.S., companies must be cautious about the impact of inflation and rising rates. Does the board understand management’s strategy, and the related risks, to maintaining a resilient organization?

Directors should be prepared to probe management on the following issues in the coming months: 

Scenario planning. Real GDP is forecast to drop by 2.3% in the fourth quarter and remain in the red through the first half of 2023. And the Fed is expected to raise rates until it is absolutely certain that inflation has been tamed. Moreover, in our own survey of business leaders, they expect higher and more persistent inflation than consumers. 

• Have companies modeled for a recession within the next several years?
• What scenarios has the company considered for supply/demand imbalances, pricing pressure and customer impact, commodity pricing and availability, and rising interest rates?
• Has the company evaluated its sensitivity to products and services heavily subject to inflation? How quickly can the company respond to shifts in customer behavior?
• Does management prepare 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, including different risks and economic realities by region?

Growth, capital allocation, and resilience. In the United States, inflation is outpacing wage growth, which will dampen consumer spending to some degree. Together with a higher cost of capital due to rising interest rates, companies should reevaluate their growth initiatives, including financing, expected returns, and time horizons. Moreover, the interest rate environment will impact dividend policies and buyback initiatives.

• Has management discussed with the board its views on how inflation and rates influence capital allocation, including fixed investment, long-term contracts, and wages and incentives? What about the company’s M&A outlook?

Fortress balance sheets will provide ballast for the most creditworthy companies to remain resilient in their operating environment and supply chains, but companies with thinner margins and more short-term financing will be challenged. Companies should also be planning for rollover risk for maturing debt due this year or next.

• What long-term growth initiatives are mission critical? Where might plans need to be adjusted and costs removed?

Building resilience—in operations, in supply chains, and on the balance sheet—requires money and may come head-to-head with the need to take costs out of the business.

Hedging against commodity, currency, and interest rate fluctuations. With more than two years of operating in an environment impacted by COVID-19 and supply-chain disruptions, companies have already adjusted sourcing and financing for many critical inputs. Now, emerging economic stressors have applied new strains.

• How might higher interest rates further impact hedging costs and long-term contracts? To what extent are customers and suppliers impacted by these forces?
• How is the availability of financing and insurance expected to be affected?

Fair value and asset impairments of businesses. Companies need to consider the accounting and financial reporting impacts of market volatility, the Russia-Ukraine war, and related sanctions.

• Does management understand how vulnerable the company’s portfolio is to changes in value given inflation and higher interest rates?
• Has management identified triggering events that may warrant impairment assessments of long-lived assets, goodwill, and other intangible assets?
• How does market volatility impact the valuation of pension plan assets and planned or mandatory funding levels?

Environmental, social, and governance (ESG) initiatives. Shareholder expectations for corporate commitments to sustainability and diversity, equity, and inclusion have grown significantly. Higher energy and commodity prices have emphasized the financial underpinnings of these issues. Similarly, company commitments to employees, communities, and other stakeholders have a real cost and could become more challenging to implement.

• Does the board understand the potential material impact of its ongoing ESG commitments?
• Has the company focused on clear and timely communication to these constituents, including updates when plans and scenarios change?

While economic growth is expected to continue, the appropriate board and management stance in the face of resurgent volatility will help keep the company strongly positioned for the future.

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