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 TomaskoTokyo 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 ChairmanHaving 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:
EnronWorldCom and Sprint Tyco AOL Time Warner Vivendi Ahold EDS 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 Self-cannibalization
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...
...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."
"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 EnronKenneth Lay did not ask for: Oversight
Approval
Control
Independent judgement
Challenge
Concerns "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 Issues Independence
Business and personal relations with the company
Insiders (company executives on the board)
Leadership (CEO as chairman)
Competence
Information
Time and capabilities
Size
Trust
Group dynamics ("get along by going along")
American governance system reform reflects American culture: Legalistic Rule driven Adversarial Conflict produces truth Confrontational and competitive Checks-and-balances 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
Sarbanes-Oxley
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 businessOnly 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: NoneBehavioral 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
202.362.5210202.362.9001 fax info@roberttomasko.com http://roberttomasko.com
