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Opinion

What the Wirecard and Luckin Coffee scandals can teach Asia's boards

Too many company directors have no understanding of the companies they oversee

| China
Perhaps Luckin's problems could have been avoided.   © Imaginechina/AP

Mak Yuen Teen is an associate professor at the National University of Singapore Business School, specializes in corporate governance.

When companies like Wirecard, NMC Health and Luckin Coffee become embroiled in scandals, people often question the role played by the auditors. Why is the same not asked of board directors?

What usually happens is that soon after scandals arise, there is a turnover of directors, as in the case of Luckin Coffee. After the company's chief operating officer admitted in April that he had inflated sales, one of the independent directors resigned. At the extraordinary general meeting and board meeting in July, several directors were replaced and a new chairman was appointed.

But does anyone really think those board changes make any difference? And should the boards, under whose noses the scandal took place, bear some of responsibility for the fraud.?

Partly dependent on what steps directors took to ensure that proper and effective internal controls were in place, such as having independent, competent and adequately resourced internal and external auditors. Another consideration is whether directors had been proactive in seeking information and asking questions.

The Luckin board may claim that it could not be expected to be aware of many of the smoking guns, red flags and business model flaws identified in a report released by short-selling research company Muddy Waters. But if they had taken some of the above steps, perhaps Luckin's problems could have been avoided.

For example, did the Luckin board question the company's aggressive plans to capture a big slice of China's coffee drinks market, which is made up mostly of tea drinkers and where Starbucks already has a significant presence? That was the first business model flaw identified by Muddy Waters and is a question that any director with a sense of China's market should be expected to ask. Any business model that is flawed to start with will make the path to profitability challenging, increasing the risk of fraud.

The sad truth is that most boards don't ask the questions they should. David Calhoun, the former Chairman and current CEO of beleaguered aircraft maker Boeing summed what is wrong with many boards today when he told The New York Times in March that boards are invested in their CEOs "until they're not."

"If we were complacent in any way, maybe, maybe not, I don't know," Calhoun said. "We supported a CEO who was willing and whose history would suggest that he might be really good at taking a few more risks."

Despite more than 25 years of corporate governance reforms globally, mostly aimed at improving board effectiveness, it seems the Boeing's board's mantra was blind trust, when the mandate it should have been following is "trust but verify."

So, why even have a board of directors? Most corporate governance scandals show plenty of red flags on display -- even to outside observers and sometimes highlighted in the media -- but boards still failed to act. Enron, Satyam, Theranos, Wells Fargo, Wirecard -- the list goes on.

Take Theranos, the U.S. blood-testing company that collapsed under a major scandal. Bolstered by two former secretaries of states, a U.S. Army general, a well-known venture capitalist, a top Stanford University engineering professor, and a former senior executive at Apple who saw the warning signs early and bailed out fast, the Theranos board was cachet heavy. What was missing was someone with a background in phlebotomy or medicine - and a healthy dose of skepticism.

Even after the media started publishing articles questioning the science behind Theranos, the board did nothing. Even Theranos employee Tyler Shultz was unable to convince his own grandfather board member George Shultz that something was amiss, despite showing him supportive evidence. Instead, Shultz the elder took the word of Theranos CEO Elizabeth Holmes that everything was fine. Like so many other directors, he ignored the evidence staring him right in the face.

Theranos CEO Elizabeth Holmes, pictured in October 2015, said everything was fine.   © Reuters

Behavioral pitfalls such as confirmation bias, self-justification, dominant personalities, peer pressure and groupthink are all symptoms of a poor board culture. And while better board composition and processes may help in improving board culture, that's not enough either.

Going forward, regulators should direct more attention toward improving board culture in corporate governance reforms. Boards that truly want to be effective must first recognize behavioral pitfalls before they can mitigate them.

As for investors, they too need to develop a deeper understanding about whether a particular board is truly equipped to challenge management and spot window dressing placed before their eyes. Boards that look good on the surface may be totally ineffective in practice.

As a general guide, investors should respond warily to the appointment of high-ranking government officials and civil servants, individuals with impressive honorifics, senior university administrators, academics and Ph.D.s from prestigious institutions, and experts in corporate governance or compliance. Most important of all, investors need to be on the lookout for the total absence of independent directors who truly understand the company's business.

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