The Strategic Audit1

Dr. Jacques Saint-Pierre

Adjunct Professor
Department of Finance, Insurance and Real Estate
School of Business Administration
Laval University, QC, Canada, G1K 7P4

Abstract
Much of what has been written, taught, and said about corporate governance to-
date was in connection with how to protect you and your personal assets from
potential personal liabilities as a corporate director. Unfortunately, it was NOT
about how to be a value-added corporate director. As already observed by
Donaldson2, more than twenty years ago, one problem which I see with many of
these writings on governance (and it did not change much over the last twenty
years) is that they are concerned only with broad principles of governance and
offer little practical guidance on how to be a value-added board member. More
important, these writings do not directly address the fundamental issue at the
heart of investors’ concern, namely, “the capacity of the board to intervene in
the face of an unsuccessful or ailing business strategy”3, or, that an economically
successful strategic trajectory is pursued.4 This article shows you the way. It will
also give you and your company the discipline to avoid to balance one guru
experiment on top of another. The two questions answered in this paper are:
Strategic audit: What should it be? And, what should it contain?

1
This article can be used as a short case as support to a text, and at various course levels and in different fields
like finance, management, management science and governance. It outlines a compelling business problem that
focus on the concept of strategic audit and corporate governance. Permission is granted to any individual wishing
to use this article for university classroom purposes. Written permission is not required.
2
Donaldson, Gordon, “A New Tool for Boards: The Strategic Audit”, Havard Business Review, July-August
1995.
3
See Donaldson, Ibid, p.100
4
Saint-Pierre, Jacques, What Should Be the Planning Horizon of a Business? (February 24, 2012). Available at
SSRN: http://ssrn.com/abstract=2010257 or http://dx.doi.org/10.2139/ssrn.2010257
1

Electronic copy available at: https://ssrn.com/abstract=3075376

Introduction
The two questions answered in this paper are: Strategic audit: What should it
be? And, what should it contain?
In the course of its professional practice, the “strategy professional” will be
called to offer the service of the strategic audit because more and more board
members will go further than “accounting audit” and ask for a “strategic audit”
in order to evaluate the major investments proposals to develop and/or sustain a
competitive advantage. And, also, to systematically manage the uncertainties
inherent in any given strategic position in order to generate an attractive return
with less risk taken. It is called “risk advantage by BCG5.
The 10 questions proposed by Paul J. Gordon6.
Here are ten strategic audit questions suggested by Paul J. Gordon, one of the
few to write on strategic audit: 1.What businesses are we in? 2. What is our
current strategy? 3. What forces are shaping competition? 4. Is there money to
be made? 5. Where is competitive advantage? 6. What is our distinctive
competence? 7. What about functional area functional indicators? 8. What of
priorities, timing, and resources? 9. How do we best compete for the future? 10.
What provisions exist for implementation?
These questions have been proposed, twenty years ago, to think strategically. It
is a shame that so many corporate boards have not yet transcended linear
planning for a holistic non-linear worldview. However, many advances in the
economics of strategy7 have led us to rephrase and reconsider what a strategic
audit should be.
The 10 questions proposed by Ram Charan
Ram Charan in his book Boards That Deliver: Advancing Corporate
Governance from Compliance to Competitive Advantage (2011) presents also
ten questions that are relevant to our discussion under the title « The ten
Questions Every Director Should Ask ».
They are: 1. Do you have the right CEO? 2. How well is the CEO’s
compensation linked to actual performance? 3. Do you have a precise
understanding of the money-making recipe in the chosen strategy? 4. Is the
management team looking at external trends and diagnosing the opportunities
and threats presented? 5. What are the sources of organic growth? 6. How

5
BCG Henderson Institute, https://www.bcg.com/en-ca/publications/2017/taking-advantage-of-risk.aspx.
6
Gordon, Paul J., « Ten Strategic Audit Questions », Business Horizons, September-October 1997, pp.7-14.
7
See for example, Economics of Strategy, David Bisanko et al., 5th edition, 2010, John Wiley and Sons, Inc.
2

Electronic copy available at: https://ssrn.com/abstract=3075376

rigorous is the process for developing the leadership gene pool? 7. Do you have
the right approach to diagnosing financial health? 8. Are you examining
measures that capture the root causes of performance? 9. Do you get bad news
from management in time and unvarnished? 10. How productive are executives’
sessions?
My personal approach to the strategic audit
The questions I consider which should be asked as parts of a strategic audit are:
GROUP ONE:
Module one:
1. How the competitive intelligence is organized?
2. What is our competitive advantage in competitive intelligence?
Module two:
1. What is the industrial organization (structure-conduct-performance) wherein
the corporation competes?
2. How the competitive analysis has been conducted and what results have been
obtained?
3. What is the current competitive positioning of the corporation?
Module three:
1. What are our competitive advantages?
2. How are we positioned in a competitive position8/market attractiveness space
(in other words, what is our strategic trajectory)?
GROUP TWO:
1. What are our growth options?
2. What are our flexibility options?
GROUP THREE:
1. What are our financial policies?
2. What are our operational constraints?
3. What are our required returns on the investments?
GROUP FOUR:
1. Overall, for the society as a whole, in a steady state situation (i.e. without any
new tangible and intangible strategic investments), what is the economic value
(intrinsic value9) of the assets in place?

8
Actual and desired positions.
3
2. Overall, for the society as a whole, in a steady state situation (i.e. without any
new tangible and intangible strategic investments), what is the economic value
(intrinsic value) of the growth opportunities?
3. Overall, for the society as a whole, in a steady state situation (i.e. without any
new tangible and intangible strategic investments), what is the economic value
(intrinsic value) of our flexibility in exercising the growth options?
GROUP FIVE:
1. Overall, for the society as a whole, in a dynamically transformative situation
(i.e. with all the new tangible and intangible strategic investments), what is the
economic value (intrinsic value) of the assets in place?
2. Overall, for the society as a whole, in a dynamically transformative situation
(i.e. with all the new tangible and intangible strategic investments), what is the
economic value (intrinsic value) of the growth opportunities?
3. Overall, for the society as a whole, in a dynamically transformative situation
(i.e. with all the new tangible and intangible strategic investments), what is the
economic value (intrinsic value) of the flexibility in exercising the growth
options?
GROUP SIX:
1. What is the difference between the sum of the three constituents of the
intrinsic values of the dynamically transformative situation and the sum of the
three constituents of the intrinsic values of the steady state situation?
The economic value of the strategic trajectory
What you obtain at Group Six is precisely the creation or destruction of intrinsic
value of one of the strategic trajectories the company is contemplating pursuing
in the future. If you know the principles behind a “net present value”
calculation, it is exactly what you obtain at Group Six stage for every strategic
trajectory analyzed.
The reason why I use groups and modules is because I have found the modular
approach more flexible: Inside the modules or groups, you can use the
theoretical or empirical approaches with which you are the more comfortable.
The questions I have proposed address directly the questions # 3, 4, 5, 7, 8 and,
indirectly questions # 1and 2 of Ram Charan.

9
The intrinsic value should be based on economic value added or free cash flows approaches.

4
Sarbanes-Oxley et al
Sarbanes-Oxley, balanced score cards, etc. have led a revolution on the way
boards approach their duty about the strategic-review process. Now, they want
to put a dollar sign on strategic initiatives. At present, they ask questions like:
What would be the impact on our intrinsic value of a particular strategic
proposal? What will be the impact on our performance spread (the gap between
the return on capital and the cost of capital)? How to link the executives’
compensations to the execution of the strategic plan?
The questions that I have presented above are the one they should be able to
confront if their consultants or the professionals of the company have done their
job seriously. These questions allow them to get an idea of how advanced is
their strategic thinking. At the board meeting it is not the time to collect data,
but it is the place to ask the right questions and to see what you are able to
answer.
Board members like our approach for a simple reason: It corresponds to the
questions that their company is being asked by financial analysts who are
qualified research analysts. Also, it ties closely with what they should have
learned about in their executive courses on governance. Anyway, it will also be
the questions on which their strategy consultants or the professionals will have
to work on if they are certified planning professional (cf. the approved BOK
(Body of Knowledge) of the ASP).
The Strategy Profession
Accounting auditors should not be asked to conduct the Strategic Audit.
However, the profession of strategists has not taken the place that should have
been theirs. The “profession” has not been able to produce, as of yet in 2017, the
accepted and recognized elements of a “strategic audit”. More than that, there is
almost nothing published on the subject. Yet, in all respected professions, there
are well defined and accepted audits principles that you have to follow: in
accounting, in actuarial, in financial analysis, etc. And, it is not because there
were not beautiful mind to inspire the profession. We all know the Donaldson
paper but, who knows the one by Martin Shubik in 1983 (see The Strategic
Audit: A Game Theoretic Approach to Corporate Competitive Strategy). The
problem lies elsewhere.
The Future of Strategic Audit
This subject has never been on the agenda of securities regulators. I think that
everything that can be done to present “strategic audit” as a rigorous and
coherent body of knowledge and principles to protect the investors will have a
chance to find its way on the regulatory agenda. There is hope. We just have to
think about the concept of “systemic risk” that nobody was talking about ten
years ago.
5
The appellation (naming) “Strategic Audit” puts in perspective that it is
something very different from an Accounting Audit. Let me explain why we
should stick to this term.
Sure, sometimes you will have to explain what your SA, as a consultant will
contain and it is possible that your clients don’t know anything else that the
word “audit preceded by the word “accounting”. However, they should know
that there are different forms of audit: Financial Audit, Integrated Audit,
Performance Audit, Quality Audit, Regulatory Audit, Operations Audit, to name
a few.
Conclusion
It suffices to conduct an economic analysis of a competitive equilibrium to
understand that strategy is a serious part of science and a long way from art. The
competitive equilibrium exists when the marginal return on capital is equal to
the marginal cost of capital. A positive spread exists when the firm has a
competitive advantage. The work of the strategist is to find ways to maintain this
positive spread as long as possible and to differentiate the economic value of
each proposed strategic trajectory. This is not a guru’s world. This is the world
of “deliberate” strategies. This is the world of economics of strategy. And, this is
science. Like it or not.