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DYSFUNCTIONAL INHERITANCE OF BOARDS


June 2012 will mark the twenty second anniversary since Pyramid Building Society closed its doors, almost bringing the entire city of Geelong (Victoria’s largest provincial city–population circa 200,000) to its knees. The key players in this scandal included the two directors of the company, local Geelong identities, Bill Farrow and ex VFL footballer David Clarke, along with their accounting firm Andrews and Backhouse who were all cited for their role in bringing about the loss of around two billion dollars. One in three people in the Pyramid’s home town were affected and it is only after more than a decade and a half that we see evidence of economic recovery in the town. 
Sadly, over the past eighteen years, five banking and building society collapses have cost taxpayers and small investors $10 billion.  The convictions of Rodney Adler and Ray Williams for the HIH disaster with estimated losses totaling $4 billion demonstrate that nothing much has changed.

Once the special preserve of economists and lawyers, corporate governance is now the hot topic of academics, business journalists and consultants alike.  Despite the good intentions, the corporate investment in governance workshops and implementation of governance policies there has been little evidence of change when the blowtorch of scrutiny is placed on failed corporations. 
Enron, the six-time winner of Fortune’s most innovative firm award plummeted from the 7th largest US firm to bankruptcy in less than one year.  In Australia there have been an equivalent list of high profile companies that have swan dived into the history books unfortunately taking with them the lifesavings of innocent investors and shareholders many of whom may never fully recover from the demise.  In each case we subsequently witness the scandalous headlines telling of ineffective, negligent or deliberately fraudulent boards that have not fulfilled their fiduciary duties.  In response to these high profile collapses Australian regulatory authorities are seeking to increase the penalties imposed on corporate wrong-doers, given the current crisis facing the capitalist system such moves may appear attractive.  Governments and regulators are spurred into action to impose more rules, more laws, greater penalties and increased surveillance to monitor the honesty of the once trusted stewards of our companies.
But it is possible that corporate honesty or its lack isn’t the fundamental problem.  It is argued by Ghoshal, S. (2005) that the root cause of the corporate collapses can be traced back to the flawed paradigm perpetuated by business schools and promulgated throughout the corporate world.  Ghoshal believes that the underpinning philosophy of Adam Smith’s agency theory has become self fulfilling and deeply entrenched suggesting that it has created an environment where such corrupt corporate behavior is in fact almost inevitable and will continue unless there is a courageous about face in the philosophy and course curriculum delivered by university business schools.

Despite the bombardment of feature articles in business magazines providing the ’10 easy steps to good governance’ and book shelves groaning under the weight of dozens of new releases on governance, nothing seems to change and whilst the focus remains stuck on board structure and check-list processes, according to some experts, it will continue to fail dismally in preventing the breathtaking corporate collapses that have been witnessed over recent decades.  Why? it is not the fact that the chair is not the CEO, or that there are a fixed number of ‘independent’ directors to keep the others ‘honest’,  the problem in my view has little to do with board structure and everything to do with the prevailing board culture.  Culture has been described as the acquired knowledge that human beings use to interpret experience and generate social behaviour.  This knowledge forms values, creates attitudes and influences behaviour. And in the case of boards, the collective behaviour that this culture produces is unavoidably influenced by the homogenious nature of an affluent group of predominantly white males who share common experiences such as successful careers, similar religious, philosophical, educational backgrounds thus creating a hothouse for self re-inforcing over-confident egos and group think behaviours.

Anyone who is naive enough to think that increased surveillance and penalties will change the behavior of this cohort has missed the fundamental cause of the problem.  If all it took were greater penalties and increased regulatory requirements then social problems such as illegal drug trafficking or even tax evasion would be non existent! 

The subsequent investigation into the collapse of Enron has revealed that every component of the infrastructure of US capitalism was dysfunctional. Blame has been dispersed; the companies’ accounts were misleading, their auditors conniving, their lawyers conspiring, the ratings agencies asleep, the regulators inadequate (Hartcher 2002) and their shareholders woefully ill-informed.  Look no further than our own backyard, the current court hearings into the One.Tel collapse provides a text book example of the overconfident behaviour of a board that is made up of ‘successful white males’ who all shared very similar backgrounds, education and philosophies who all displayed an over-inflated sense of confidence and behaved in strikingly similar ways - all showing blatant disregard for basic due diligence.  Bond, Skase, Adler, Williams, Rich, Murdoch, Packer – sound familiar?

In the seminal economic text Wealth of Nations, penned in 1776, Scottish author Adam Smith outlined a philosophy that still underpins today’s corporate governance,  he wrote; ‘The directors of such ‘joint-stock’ companies, however, being the managers rather of other people’s money than their own, it cannot be expected that they should watch over it with the same anxious vigilance with which the partners in a private partnership frequently watch over their own.’ 

Agency theorists maintain that the core of the modern dilemma is the separation between the shareholder-owner and the hired manager. Yet Ghoshal argues strongly that in fact it is quite the opposite!  He believes that it’s the flawed idea that we cannot trust each other that lies at the heart of current corporate collapses.

Under the Smith inspired paradigm managers cannot be relied on to do their jobs (which of course is to maximize shareholder value) because their interests and incentives are not directly aligned with those of the shareholders whom they represent.  Transaction cost economics preaches the need for tight monitoring and control of people to prevent opportunistic behavior (Williamson 1975).  Ghoshal believes that these self fulfilling pessimistic assumptions have pervaded the world view of managers.

According to the OECD model of corporate governance the primary focus is on board structure specifying the distribution of rights and responsibilities among different participants in the corporation, such as the board, managers, shareholders and other stakeholders, and spells out the rules and procedures for making decisions on corporate affairs.

But as the world comes to grip with the phenomenal power of companies to shape our very existence as a result of their impact on issues like global climate change and global poverty we have seen the emergence of yet another critical factor in the range of responsibilities that they are required to discharge. Whilst Boards are quite properly required to increase shareholder wealth first and foremost, they are still demonstrably less appreciative of their broader social responsibilities as incorporated in statements corporate governance issued by organisations like the World Bank. The Bank highlights the need to balance economic, social, individual and communal goals “…aligning as nearly as possible the interests of individuals, corporations and society.”

If you were to ask most board members today what governance means to them they would quickly describe the fiduciary, regulatory and compliance responsibilities and then if pressed to describe how they go about ensuring they meet these responsibilities, they would probably identify a raft of appropriate financial reports and measurement processes and structures to capture the data that proves they meet their oversight requirements. 

Odds are that most if not all respondents would have the measures they need to meet the collective requirements of Clerp 9,  Oxley - Sarbanes and Cadbury Code of Practice all rolled into one.  If this is an accurate account then why do we continue to see companies collapse?

One clue may be held by organisational theorists and respected business authors such as Henry Mintzberg, H. and Mark?? Pfeffer who have argued that it has to do with the shared traits and insular culture of some boards that form a homogenous voice that is risk averse. Others, such as Argyris, C. and Senge, P. discuss the phenomenon of a culture that is so accustomed to success that they cannot identify with failure or flaws in past decisions.

Board homogeneity and insularity are valid observations and contribute to our understanding, however, the cyclic perpetuation can only be partly attributed to recruitment practices. Boards face the same the inclination to reproduce themselves as top management teams tending to select new members who match the group culture and who thus knowingly or unintentionally choose new members who are similar to themselves. This demographic homogeneity forms the fundamental DNA of board culture, which in turn invisibly shapes the values and behaviours of governing cohorts.  As Trompenaars (2003) explains, ‘Culture is like gravity, you don’t experience it until you jump six feet in the air.’


In order to prevent further corporate collapses and to improve board performance at the same time, the questions that need to be posed are not ‘how do we further protect our business against the self interest of our management?’  but more importantly ‘ how can we dilute and broaden the board member pool in order to diversify the thinking and paradigms brought to the table?’ ‘How can we continually evaluate and improve our decision making processes?’  When eight or nine successful professional men – lawyers and accountants (many with MBA’s) all from a similar gene pool sit around the board table and make decisions they tend to see only a very narrow view.  What is needed is a blend of rational and interpretivist thinking, we need people with high EQ’s as much as high IQ’s in the board room.  Boards need to use both intuitive and objective approaches they need to re think the agency theory view of organization and try other theoretical paradigms on for size. 
The fresh perspective garnered from outside the agency theory paradigm can offer a balance where instead of using the model of management that encourages supervision and surveillance, individual potential is nurtured through the principle of trust rather than distrust, where the single minded drive for efficiency regardless of all else, is balanced with a wider responsibility for the people involved and the communities it supports and serves, can offer improved prospects for effective and sustainable growth of the business including the retention of human resources and subsequent productivity and this ultimately means share price performance.  The regrettable treatment by the James Hardy Corporation of past employees suffering from mesotheliosis caused through workplace exposure to asbestos, is a useful case in point.

The term corporate integrity has almost become an oxymoron through the deplorable governance practices of a steady stream of corporate boards despite further and further investment in regulation and control and demands a new type of leadership from the fraternity of corporate boards to actively recover the ground that has been lost.

Ghoshal was only partly right when he called for a radical change in the ‘MacDonald’s’ MBA programs that emphasizes rational economics and agency theory.  There equally needs to be a determined cultural renaissance within the governing community that employs legitimate performance evaluation and assessment and introduces a proactive recruitment regime that embraces much greater diversity of styles, backgrounds and viewpoints.

It makes logical sense that when board directors are drawn from a wider pool with mix of skills, ethnic and philosophical backgrounds, diverse interests and world views there is greater potential for better decisions.  Only then will the board rooms effectively shake off this dysfunctional inheritance of genetic inbreeding that continues unchecked today.

As it stands, the long suffering share holders must be feeling more and more jaded from the publicised scandals and the ever increasing salary packages for CEOs for little company gain.
The sad truth is that many of the victims the mum and dad investors who have lost their life savings have never fully recovered. The devastating fallout has led to suicides, breakdowns, wrecked relationships and divorce, leaving entire families and the community as a whole diminished beyond mere financial terms. 

Just as concerning is that the culprits such as:  Williams, Adler, Bond, Skase, Farrow and others display little or no remorse for their actions. There seems to be a lack of insight into their flawed behaviour.  When it was revealed in the media in 2003 that ex Pyramid director Bill Farrow (who only received a fine for his part in the $2 billion dollar collapse) had recently received federal government grants of more than $250,000 for a private business venture there was a public outcry in the Geelong community to which Farrow responded by saying that he “would have liked to think it was time to move on”.

For many of Pyramid’s victims that will never be possible.

Posted by Chris Murphy on 07/06 at 04:48 PM
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