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“Governance” applies to nearly all entities: for-profit businesses, nonprofit organizations and governmental entities. It relates to the relationships between management, the board of directors, and other stakeholders, such as stockholders, donors, or citizens. At the fundamental level, good governance is all about Checks and Balances. Auditors love checks and balances, although we usually say “internal control.” Same thing. But what does that have to do with governance?

Organizations have a financial audit to gain assurance about their financial statements. To have a good financial audit, you generally need good internal control. How does an organization find out if they have good governance checks and balances? And why would it want to?

Let’s focus on the nonprofit and governmental sectors. Many of us volunteer on boards of local nonprofits, or are appointed to advisory boards for local governments. Some even hold an elected office. In these capacities, we are impacted by the effectiveness of the organization’s governance structure and how it functions. In fact, we are active participants in the system of governance. Can we just assume that the governance system is operating as it should? How would we know if it is not? And why should we be concerned about this?

Take a nonprofit that has a strong executive director. Let’s call him ED. He recruits the members of the board and, naturally, they all happen to be his buddies. They like ED because he lays out his plan for the organization and provides information to the board to support that plan. ED makes the board’s job easy. But the board doesn’t realize that they are not getting the full picture. ED tells them only enough to get approval for his plan. So instead of the board guiding the organization, ED is really calling the shots. This arrangement can accomplish some amazing things, or it can blow up in the board’s face. After all, it is the board of directors that is ultimately responsible for the organization, not the executive director.

Or let’s take a different organization with a weak but likable executive director. Let’s call him Nerdly. The board is made up of directors with big egos who are fond of micro managing. Actually they are addicted to micro managing. They stick their nose into everything. Nerdly owes his position to keeping the board happy, so he goes along with the board members. This too can result in some worthwhile accomplishments, but they may not be aligned with what is best for the organization. Does this arrangement really provide for the best utilization of resources?

In the first situation, ED’s power is not checked because he stacked the deck and is the only dealer. ED receives a 360-review, but it is filtered by an evaluation committee made up of ED’s board buddies. Staff comments that describe ED’s bullying of staff are filtered out and not seen by the full board. To the board, it looks like ED is doing a great job. How would they know otherwise?

Nerdly is reviewed only by his board. That is why he works so hard to keep the board happy. The organization’s staff have no input to Nerdly’s evaluation, so he can be indifferent to staff input. Staff are not even allowed to initiate communication to board members, so the board is not aware of staff concerns. Besides, the board members get their way with Nerdly, so they are happy. But who is looking out for the organization’s best interest? Certainly not this board or Nerdly.

One answer to these questions can be a Governance Audit: an objective review of how an organization is governed. This review looks at how the governance structure is designed, but also how it is actually operating. It assesses whether there adequate checks and balances in place for effective governance. Larger organizations may have their internal audit department perform the governance audit. Smaller organizations are, for the most part, unaware that a governance audit is even an option to consider.

Larry Atchison, CPA

December 2014