 "Joseph L Badarcco")
By the end of the last century, boards of directors and government regulators - two critical rungs on the ladder of accountability - were widely criticized and often failing conspicuously. The most vivid evidence for this conclusion is the calamitous pair of bookends - the Enron scandal and the global financial crisis - that began and ended the last decade.
The Enron collapse was appalling in its own right, but it was only one of many firms, large and small, that collapsed with the Internet bubble. By every standard of traditional accountability, Enron had a first-rate board, as did many of the other firms that collapsed, and Enron and these other companies were regulated by a wide range of state and federal bodies. What went wrong with these boards? Their members were distinguished, successful leaders, but they typically did too little, too late. Yet, with hindsight, their failure seems almost inevitable. How could part-time outsiders, however well-intentioned and successful in their own lines of work, assure accountability for complicated firms competing in a wide range of businesses around the world and engaged in rapidly evolving, highly complex activities? Most boards meet about six times a year, spend two days on each meeting, and now devote a substantial and increasing portion of this time to issues of process and compliance. This leaves little time for getting below the surface of complex issues.
The interests and ingenuity of CEOs often compounded this problem. How can a board of part-time outsiders avoid being dominated by full-time insiders with the skills, information, relationships, and savvy to run large, complex organisations? This question almost answers itself. And some CEOs have serious reservations - expressed only in confidence - about the real value of all the time and energy boards require. The head of a large and very successful private investment firm put the point bluntly, saying that the absence of a conventional board meant he could concentrate on the three groups that really mattered to a business: customers, investors, and employees.
Even CEOs who try to develop collaborative relationships with their boards sometimes have these reservations. A highly respected former CEO, currently a director of several prestigious firms, said recently that as long as boards failed to get executive compensation under control, it was hard to take the rest of their governance efforts seriously. Unfortunately, large-scale statistical studies confirm that boards have often failed to link executive compensation to company performance. Instead, executive pay is driven by some mix of managerial power and larger market forces.
After Enron and other firms failed, the US Congress passed the Sarbanes-Oxley reforms. These were designed to strengthen board governance. But how well did they work? The answer involves the other calamitous book-end of the last decade: the financial crisis that nearly caused a worldwide depression. The Sarbanes-Oxley regulations may have achieved unseen victories, but they didn't conceal or repair the deep flaws of traditional vertical governance. All of the banks that collapsed or teetered near the brink had impressive boards of directors, typically made up of hard-working, thoughtful, highly experienced and successful executives. Because of the Sarbanes-Oxley reforms, their audit committees consisted primarily of independent directors with financial expertise, yet very few boards and firms avoided the massive financial train wreck.
Many factors contributed to this failure of vertical governance, but market-driven recombination played a central role. The financial products and services offered by large banks are extremely complex and are traded daily in massive volumes in swift-moving markets. The financial crisis revealed that many experienced traders, their managers, and firm CEOs did not grasp the full complexity and implications of the products they were buying and selling and the interconnected markets surrounding their firms. If insiders were significantly in the dark, how much can be expected from part-time outsiders, the members of boards of directors?
And all this happened while the other crucial element of vertical governance, government supervision, also failed - even in giant commercial banks, such as Citigroup, that have been closely regulated for decades by a multitude of government agencies. With hindsight, we can see important gaps in bank regulation, but why did they exist? One factor is the difficulty regulators face keeping up with complex innovations in multi-trillion-dollar markets for financial services.
Author: Joseph L Badarcco
Publisher: Harvard Business Publishing
Price: Rs 995
ISBN: 9781422191644
Reprinted by permission of Harvard Business Review Press. Copyright 2013. All rights reserved
| Author speak |
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Market pressures are inevitable but often healthy. Managers need to find ways to channelise them in useful directions, Joseph L Badarcco tells Ankita Rai In the book, The Good Struggle, you write that leadership is a struggle in the uncertain and high-pressure world. What are the key skills required to lead in this unforgiving times? What’s most important, I believe, is a strong, personal sense that what you are doing really matters — to you, to your team, and to people outside your organisation. Without this deep conviction, it is hard to make sustained progress and persist in the struggle. In addition, patience, a strategic sense, and emotional intelligence are very valuable for a strong leadership. In the chapter, “What am I really accountable for?” you talk about challenges in the ‘vertical accountability’. Can Boards control over executive pay, make CEOs more responsible? There is, of course, a lot of good advice on how to make CEOs more accountable to Boards. What matters, I often hear, is the atmosphere or culture in the Board meetings — Do discussions put hard issues on the table? Is there enough time to address them in detail and with data? Are Board members candid, even blunt about serious issues and real disagreements or do they engage in some sort of Asian tea ceremony? Also, many Board members in the US say that the most significant reform in recent years has been executive-session Board meetings, without the CEO present. That said, I think the big force keeping CEOs accountable today is market pressure and market accountability and not periodic and relatively brief Board meetings. In these times of turmoil and uncertainty, you have made a case for ethical leadership. But markets only measure value by price. How can leaders counter the power of markets and market-based thinking? Market pressures are inevitable, but they are often healthy. Managers need to find ways to channelise them in useful directions inside their organisations. On the other hand, there are often short-term, quick payoff market opportunities that simply have to be blocked — by what I called third-rail rules. It is very hard to generalise about what these two pieces of guidance mean in particular situations. That is up to the judgment of the managers involved. |
