Greed, Growth and Governance

Emerging best practices in corporate governance


These slides were presented at a meeting of senior executives of one of the Mitsubishi companies in Tokyo on March 13, 2003.



 Greed, Growth, and Governance


Presentation by Robert Tomasko


March 13, 2003

Recent public attention has focused on the self-serving, and business-destroying, actions of a few executives.

But a more widespread driver of many business failures has been a very flawed idea of what growth is really about.

Improvements in the approach taken to corporate governance can help deal with both these problems.


 "It's people,

not management techniques,

that really grow a business."

 "But it's also people,

not markets,

that can cause a business to decline."

 "In some cases, the CEO has become more of a monarch than a manager."

- William Donaldson SEC Chairman

 Having the "right" CEO is important, but... the CEO must also have the "right" context in which to operate.

Every employee has a boss; who is the boss of the CEO?

This is the role of corporate governance.

Recent events in the business world have raised serious questions about the forms of corporate governance currently used in US and EU.


 Boards in the US and EU have been especially challenged by their oversight of growth:


WorldCom and Sprint


AOL Time Warner




 How much sleep have directors lost worrying about their companies' overvalued stock price?


"Momentum thinking" (constantly accelerated exponential growth) drives EPS and stock price...

...but also produces cravings that support destructive managerial behaviors


 "Overvalued stocks are like managerial heroin"

- Michael Jensen, Harvard Business School

Overvalued stock sets in motion a series of organizational pressures that destroy shareholder value.

Honest managers are so caught up in need to produce rising earnings that they make bad and, sometimes, unethical decisions.

Sometimes they lie.

Stock options can reinforce this downward cycle

 In business, the idea of growth has become confused with the idea of expansion

Growth is forward movement, progress beyond the limits that currently define and constrain the business.

Expansion may be a by-product of growth, but it is not what growth is really about.


 Expansion has substituted for growth; means have become confused with ends

Attempts to increase shareholder value by managing stock price have become common.

Apparent earnings growth ("empty calories") has been driven by ways that do not add value to customers:

acquisitions, stock by-backs, phony revenues, hidden assets, capitalized costs, reinvested instead of paid-out dividends

1000 US companies have restated earnings since 1997

 Unchecked (by auditors, analysts, boards) CEOs make bad decisions...

Do not listen to others

Are tempted toward personal enrichment


 High rates of expansion are impossible to sustain

Organizational forms necessary for support have internal limitations

Resources required become scarce

Markets saturate

Environments change; predators emerge

Success drives failure

If managers get power and pay by increasing the resources they control, excess cash may tempt them to expand beyond what is most profitable



Harvard Business School studied 50 large US companies that increased earnings 5 x their increase in sales (1993-96)


1997-2000: 43 of these companies suffered significant earnings downturns


 "Companies that grew the fastest generated less shareholder wealth"

... than their slightly slower peers.

According to a study of several thousand US companies through the 1990s reported in Financial Analysts Journal.

Most hotshots had dizzying growth they could not sustain.

Stocks of mid-tier growth companies did better over the decade.

 Insufficiently monitored earnings-growth tactics can backfire (when done to excess) :

Restructuring (disruptive)

Layoffs (skill shortages, knowledge losses)

Sell under-performing assets (must make smart reinvestment)

Outsource (quality and focus)

Share buy-backs (take money from reinvestment and shareholders)

Pension gains (hide poor performance)


 The biggest challenge to sustained growth is staying with an old business model too long


"There is at least one point in the history of any company when you have to change dramatically to rise to the next performance level.

Miss that moment and you start to decline."

- Andy Grove

 The real enemy of future growth is past success...


...and the hidden assumptions and mental models behind it.


Dangers inherent in blockbuster success

1. Forget to stop and figure out what you are doing right - so that you keep doing it.

2. Forget that you are doing some things wrong, and that these will have to be fixed.

3. Forgive yourself for what you are doing wrong, because it doesn't seem to be holding you back. It will.

 There is no global standard for corporate governance

Practices reflect:

Local laws

National business cultures

Investor expectations

Germans have 2-tier system:

Management board - day-to-day operations

Supervisory board - oversees senior managers

UK favors non-executive directors

Dutch board members are personally liable for accuracy of financial accounts

Brazil and Italy require audit firm rotation



There is no global standard for corporate governance

But, as capital markets become more global there will be increasing emphasis given to the standards of the large capital sources.

These are in flux now.

Study commissions are working in: US, Canada UK, France, Germany

 Board role:


"Hire monitor and, when necessary, replace management."

- or -

"Foster effective decision making and, when necessary, reverse failed policies."


 Underlying issue:

How can the board improve the effectiveness of its own decision making?

 An American CEO's view:

"What a CEO really expects from a board is good advice and counsel... for investments and decisions that serve the company and its stakeholders...

...and warnings when investments and decisions are not beneficial to the company and stakeholders."


 "What a CEO really expects from a board is good advice and counsel...

... support for investments and decisions that serve the company and its stakeholders...

...and warnings when investments and decisions are not beneficial to the company and stakeholders."

- Kenneth Lay, (former) CEO of Enron

 Kenneth Lay did not ask for:




Independent judgement




"There has been a massive failure in corporate governance. Too many directors don't take their responsibilities seriously."

- William George, CEO Medtronic, director of Novartis and Goldman Sachs

"There has been a sea change in the relationship between the board and the CEO. Boards are less willing to accept the word of the CEO."

- Raymond Troubh, Chairman Enron



Business and personal relations with the company

Insiders (company executives on the board)

Leadership (CEO as chairman)



Time and capabilities



Group dynamics ("get along by going along")


 American governance system reform reflects American culture:


Rule driven


Conflict produces truth

Confrontational and competitive


Countervailing power

 Governance reform requires both behavioral and structural changes


 Structural reforms:

Divide roles of chairman and CEO

70% of US directors favor this split

But only 15% of largest US companies have chairman who is independent of the company

Alternative: create role of "Lead director"

GE, Disney, Tyco

Require majority of directors to be outsiders

Sun, Interpublic

Add financial expertise

AT&T, Sun, Kimberly Clark

Impose increased personal accountability


 Behavioral reforms must accompany structural changes:

Recruit the right people

Confident and able to challenge the CEO and other directors

Know how to disagree without being disagreeable

Add specific skill, experience or knowledge to the board's mix

Train all directors in the dynamics of the business

Only 14% of US companies do now

Example: Pfizer Orientation and ongoing education


 Question asked in 1993 by a major institutional shareholder to IBM's board members:




How many directors have a PC on their desk tops?



Answer: None

 Behavioral reforms (cont'd):

The board, not management, needs to manage the board

An independent nominating committee recruits new directors and appoints committee chairs

The audit committee hires outside auditors

The board sets standards for what information it receives when

The board develops sources of information beyond which received from management

Directors need to set their own agenda

Devote high percentage of time to forward-facing issues

Instead of emphasis on rear-view mirror reviews of past performance and procedural routine


 Behavioral reforms (cont'd):

Create a board culture of collegiality and challenge

Don't disempower the CEO; distinguish between roles of management and governance

Encourage CEOs to bring issues to the board in advance of deciding a course of action (Target)

Rotate among board members the role of "designated devils advocate"

Fight the "Space Shuttle Columbia" syndrome

Develop sources of information beyond that received from management

Require a significant time commitment (200-300+ hours/year); pay accordingly

 How can the board improve the effectiveness of its own decision making?

1. Rethink its definition of growth

2. Lay out and manage its own processes of corporate governance

3. Develop a transition plan to phase-in these changes

  Thank you.

For additional information, please contact:

Robert Tomasko


202.362.9001 fax




© Robert M. Tomasko 2003


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