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Ed Konczal

Ed Konczal

Governance Lags Innovation

Innovation is one of the top issues for Boards and senior managers.

Three recent surveys indicate:

Survey

Finding

IBM’s 2010 Global Survey of CEOs (IBM, 2010)CEOs cited creativity as the most important leadership quality over the next five years.
Ernst & Young, 2010, Connecting innovation to profitThey [top entrepreneurs] understand that innovation is the primary force that can catapult a company to market leadership and keep it ahead of its rivals. They know from experience that the passion for innovation that started them on their journey has to be protected and nurtured.
GE Global Innovation Barometer91% of senior executives surveyed report that innovation is a strategic priority for their company

 

Senior managers from start-ups to big corporates realize that innovation is important but what about innovation governance?

It seems that innovation governance lags well behind the focus on business innovation. Authors of the article Corporate Governance and Innovation: Theory and Evidence write,

… our knowledge of how laws and institutions shape the innovation choices of firms at the micro-level through the channel of corporate governance is still relatively nascent.

I can attest to this since my search for the phrase innovation governance yielded far fewer results than for business innovation.

I used Google Trends and searched on the two phrases shown in the above chart. A few observations:

  • Business innovation is a subject of continuing interest, though it declined up to the World Economic crisis in 2008-9;
  • Innovation governance did not appear until 2007;
  • There is a wide gap between the two phrases.

The conclusion is that Innovation Governance needs far more attention. Boards, C-Level managers and researchers need to evaluate the risks and the opportunities  associated with innovation. More on this in future posts.

Innovation and Corporate Governance: Risks and Opportunities


At first glance corporate governance and innovation seem to have no relationship.

Corporate governance is, or perhaps should be, a rigidly defined set of principles and practices that are well codified. Innovation, on the other hand is not well defined, being somewhat free wheeling and creative.

Organizations are facing unprecedented rapid change and an ever increasing demand for faster decision-making. They must adapt to changes both inside—such as multi-generational employees and changing organizational arrangements—and outside the company such as regulations, competitors, and technology. 

While this is happening, the current menu of business tools and techniques is becoming less effective. The tools that worked in a Newtonian, mechanistic business world are too rigid and less effective. We are now in a Quantum world where chaos and complexity are the norms. 

The evolving business landscape demands that companies deal with “wicked problems”.  Wicked problems are messy, they are complex, don’t have direct solutions, cause experience and tools to be irrelevant, are based on conflicting, contradictory information and are connected with other problems. A wicked problem is so puzzling and confusing that it seems insoluble. This is where innovation comes in.

Perhaps this BusinessWeek article quote says it best:

“What was once central to corporations — price, quality, and much of the left-brain, digitized analytical work associated with knowledge — is fast being shipped off to lower-paid, highly trained Chinese and Indians, as well as Hungarians, Czechs, and Russians. Increasingly, the new core competence is creativity — the right-brain stuff that smart companies are now harnessing to generate top-line growth. The game is changing. It isn’t just about math and science anymore. It’s about creativity, imagination, and, above all, innovation.”

Companies  need innovation to launch new products, services and to reduce costs. Innovation is also risky since the outcomes are somewhat uncertain and could take more time and costs than anticipated. This is the nexus with Corporate governance. The Board needs to balance the need for innovation with the associated risks.

A simple definition of innovation governance is provided by Professor Jean-Philippe Deschamps  (Switzerland based IMD business school) :

Current innovation management techniques and organizational solutions tend to focus on many – not all – of the hard aspects of innovation, but much less on its softer elements. The scope of innovation is so broad that few companies appear to have thought deeply about what it takes now and will take in the future to steer and manage innovation in an integrated way, across all its aspects, hard and soft.

Innovation governance should be a key issue for Boards. As Steve Lennon puts it:

So directors need to establish a framework of corporate governance that can deliver two things that normally go together like oil and water: more innovation and less risk.

As tough as it may seem, this dilemma is at the heart of every director’s duty.

Yet, according to a report from Capgemini Consulting:

  • only 42 percent of respondents have an explicit innovation strategy;
  • only 43 percent of respondents say they have a formally accountable innovation executive.
This indicates that many companies need to look more carefully at how they govern innovation. Future posts will profile companies with best practices and other issues related to innovation governance.

 

Corporate Governance Essentials

Corporate Governance is in the news–again. Despite recent laws such as Dodd-Frank in the US, Corporate Governance continues to be a problem. Recent events such as the bankruptcy of MF Global, the $5.8 billion trading loss at JP Morgan and the trial of Rajat Gupta all indicate that good Corporate Governance is still wanting. An article  in The European Financial Review states–

The systemic failure of corporate governance is particularly associated with the Anglo-American corporate governance model that has enabled, permitted or tolerated excess power and wealth at the hands of CEOs and cultivated a ‘greed-is-good’ culture in banks.

Then there is an excellent article Corporate Apocalypse that traces the foundations of the recent Economic Crisis back to the 1950s — and states

The financial crisis is both a failure of the invisible hand of market and a failure of the visible hand of management

Seems that it may be time to revisit the fundamentals of what is Corporate Governance.

This post will be the first of a series that will look at the fundamentals of Corporate Governance and posit examples of best practices.  Let’s look at the purpose of Corporate Governance. It starts with stakeholders.

Key to the success of a business are the returns for the owners: the shareholders. However, business is increasingly becoming aware that its goal must be balanced with the interests of other stakeholders.

A company has a number of stakeholder groups. Primary groups include –

  • Owners and shareholders (public companies)
  • Employees
  • Customers
  • Communities
  • Government

There are other subgroup stakeholders as indicated in this visual:

Source: Carol Buchholtx, Business and Society

Anglo American, a large resources company, provides a good example of a corporate statement on managing the interests of stakeholders in a balanced manner.

Our responsibilities to our stakeholders

Our primary responsibility is to our investors. We seek to maximize shareholder value over time. We believe that this is best achieved through an intelligent regard for the interests of other stakeholders, including our employees, the communities affected by our operations, our customers, and business partners. A reputation for integrity and responsible behaviour underpins our commercial performance, gained by motivating employees and building trust and goodwill.

Corporate Governance is the combination of procedures, polices, systems, laws and regulations through which a company is organized and controlled. In doing so, it guides the relationships between internal and external stakeholders. Much has been written about shareholder vs. stakeholder Corporate Governance models. These are typically defined as–

Corporate Governance Model

Geography

Key Items

Anglo-SaxonUnited States, United Kingdom, Canada and Australia
  • Shareowner Focus
  • Extensive disclosure
  • Anglo-Saxon law based
German-ScandinavianGermany, Austria, West Europe, Japan
  • Stakeholder Balance
  • Moderate disclosure
  • Roman-Germanic law based
Emerging MarketsChina, Russia, South America, India
  • Stakeholder Balance
  • Low disclosure
  • Emerging legal systems
Based on  “Challenges of Governing GLOBALLY”, by Marc J. Epstein, Strategic Finance, July 2012 (PDF)

The trend is toward the stakeholder balance model. More about this in future posts.

Key Takeaways

  • The definition of Corporate Governance is rather simple. Its execution is not.
  • Corporate Governance involves different stakeholders both internal and external to the organization.
  • There are different models of Corporate Governance and they vary by geography.

Corporate Governance 2.5 A New Focus

It is time for a new corporate governance editorial focus. Why?

Corporate governance has a long history, perhaps beginning as far back as the 4th century BC, when the Chinese philosopher Mencius argued that it is acceptable to overthrow corrupt or unjust rulers, through the establishment of joint stock companies (perhaps as early as the 13th century, but certainly by the 17th century) and stock exchanges to facilitate the sale of stock, to the US Securities Act of 1933 – the first to regulate the securities markets, particularly with respect to disclosure – and the development of corporate governance codes in the 1990s. In 2002, in the US, the Enron collapse and other corporate scandals led to the Sarbanes-Oxley Act; and in 2009, the UK Walker Report recommendations were published, closely followed in 2010-11 by revisions to the UK corporate governance code, and the development of a stewardship code for institutional investors.

Still, two and half millennia of governance experience, and many regulatory and legal interventions seemed to do little to prevent the catastrophic 2008 world economic collapse. The reaction is dramatic…

“We are in the middle of the biggest revolution in corporate governance since the 1930s…

Richard Cellini, senior VP of business and legal affairs at Integrity Interactive Corp.
“After the Storm”, The Conference Board Review March / April 2009

This broad sweeping commentary is supplemented by others who focus on more specific items:

  • Risk Management

    “The crisis has also thrown up some massive failures in risk management. Even where companies had mandatory internal controls on reporting for the financial accounts, their executives did not fully grasp or clearly communicate the financial risks of many of the instruments they were betting on.”
    Source:  Corporate Governance-Lessons from the  Financial Crisis OECD

  • Not Enough Regulation

    “With (Brooksley) Born (former head of a regulatory unit who, in the late 1990s, warned about the risks associated with  complex financial instruments) out of the way, the last two years of the Clinton administration were a heyday of deregulation. OTC derivatives were off  limits. Banks were freed to make riskier investments. Wall Street was largely left to regulate itself.”
    Source: The Warning, Public Broadcasting System

  • Too Much Regulation

    “…, the U.S. government and quasi-governmental agencies have developed a near unfathomable maze of corporate performance reporting measures that have clearly helped, but are largely inadequate to safeguard corporations and improve the public trust. The end result is that investors, the public, and even management can’t evaluate the extent of their exposure regardless of the position outlined in much company information.”
    Source: Beyond Transparency: Information Overload and a Model for Intelligibility
    ROBERT L. LAUDAND DONALD H. SCHEPERS Business and Society Review 114:3 365–391

  • Communications

    “It’s time for CEOs and boards to understand how powerful customer and employee social interactions truly are, and how they are accelerated and enabled by online communications and cloud technologies. For boards to succeed, nothing less than a shift from traditional closed governance to open and socially aware independent directorship is required.”
    Source: Talkin’ ’bouta Revolution. By: LIBERT, BARRY, POTTER, STEVEN, Institutional Investor, 00203580, Apr 2011, Vol. 45, Issue 3

This small sample of key issues in corporate governance is supplemented by many others such as executive compensation, lack of board oversight, ethics, internal controls and more. All point to a need to revisit corporate governance, so we will focus our posts on these topics and others around communicating corporate governance including–

  • how to explain what corporate governance is
  • discussing the difference between corporate governance and management
  • best practices in corporate governance communications on websites
  • how to explain relationships between board/senior management on the corporate website
  • why leaders need to communicate and be visible
  • ideas for explaining the corporate strategy and progress against that strategy.

Well there it is: our new corporate governance focus.

Let us know what you think. Comments Please: readers are encouraged to provide their thoughts on what they believe should be covered in future posts.

Social Media And Corporate Governance

zhuan-jiSocial media started with young people connecting with others. Now it is sweeping through corporations like wildfire, locusts… add your own metaphor.

Well, what does this mean for Corporate Governance? Similar to the Chinese symbol Zhuan ji, it means opportunity and danger.

The opportunities include the ability to:

  • connect with stakeholders like never before
  • build trust and reputation
  • get input from stakeholders
  • communicate with existing and potential employees.

But the risks include:

  • loss of intellectual property
  • disparaging the company or co-workers
  • posting embarrassing (to the company) content
  • possible legal liabilities
  • violations of the Code of Ethics

Such social media risks are a matter for Corporate Governance. Social media has progressed faster than companies’ ability to craft risk management schemes.

Forbes magazine published an interesting article addressing these risks , “A Corporate Guide For Social Media“, in which they state–

…here is a set of guidelines for corporations considering how to integrate social media in the workplace. If you are an executive, keep in mind two points as you gear up your social media strategy:

First, social technologies including blogs, social networks and Twitter are communication tools. That means a company’s social media approach must integrate with its existing communications channels and goals.

Second, if you think these guidelines don’t apply to you, you are probably already on the endangered species list.

Intel social media guidelines

Some companies already heed this advice.

For example, Intel Social Media guidelines for posting content by employees and contractors are available to the public, using an effective minimalist design that displays its social media guidelines and includes links to relevant resources.

Interestingly, Estee Lauder have included social media as a risk factor in their annual report (spotted by Footnoted.com).

And finally, here are some useful related resources that can help to design your Social Media guidelines:

Image from Living Chinese Symbols

Corporate Governance, Ostriches and Black Swans

Simply put, a Black Swan event is one that has a low chance of happening but if it does the impact could be catastrophic. The most current example is the BP oil spill in the USA.

Underpinning Black Swans are some interesting philosophical and psychological factors of human frailties.

A black swan is a highly improbable event with three principal characteristics: It is unpredictable; it carries a massive impact; and, after the fact, we concoct an explanation that makes it appear less random, and more predictable, than it was. The astonishing success of Google was a black swan; so was 9/11. For Nassim Nicholas Taleb (author The Black Swan: The Impact of the Highly Improbable), black swans underlie almost everything about our world, from the rise of religions to events in our own personal lives.

Why do we not acknowledge the phenomenon of black swans until after they occur? Part of the answer, according to Taleb, is that humans are hardwired to learn specifics when they should be focused on generalities. We concentrate on things we already know and time and time again fail to take into consideration what we don’t know. We are, therefore, unable to truly estimate opportunities, too vulnerable to the impulse to simplify, narrate, and categorize, and not open enough to rewarding those who can imagine the “impossible.”

Black Swan: Strategy Execution for the “Outlier”

When Black Swan events occur, shareholders can suffer significant losses. Forbes magazine in their article, Of Brown Pelicans And Black Swans chronicled the financial impact of various corporate Black Swans–

Company

Start Date

End date

Market cap
(start date, in millions)

Market cap
(end date, in millions)

Money Lost

XOM

Exxon Mobil

3/24/89

4/10/89

55,275

52,170

3,105

MS

Morgan Stanley

9/10/01

9/17/01

45,171

39,259

5,912

BAC

Bank of America

9/10/01

9/17/01

92,439

87,147

5,291

MAR

Marriott International, Inc

9/10/01

9/17/01

9,996

7,892

2,104

BID

Sotheby’s

9/10/01

9/17/01

636

550

85

AXP

American Express Company

9/10/01

9/17/01

40,563

35,048

5,515

BK

The Bank of New York Mellon Corporation

9/10/01

9/21/01

27,269

22,555

4,714

XOM

Exxon Mobil

8/29/05

10/21/05

368,346

349,115

19,231

COP

Conoco Phillips

8/29/05

10/21/05

87,791

80,943

6,848

SCGLY

Societe Generale SA (ADR)

1/18/08

1/28/08

58,192

49,014

9,178

TM

Toyota

1/21/10

2/4/10

155,884

123,749

32,135

DLAKY

Deutsche Lufthansa AG

4/15/10

4/28/10

8,207

7,395

812

BAIRY

British Airways

4/15/10

4/28/10

4,338

3,952

386

BP

BP

4/22/10

6/17/10

186,431

99,273

87,158

The costs of Black Swans can be daunting.

ostrich heads

For Corporate Governance, dealing with Black Swans is risk management. The Board is responsible for oversight and the strategic direction of the company— not execution. This means Board members should take on a devil’s advocate role by asking C-Level managers questions such as–

  • How will you make the strategic direction come alive?
  • Have you considered all financial, strategic, ethical and risk issues?
  • What is the worst that could go wrong and how will you manage the outcomes?

More insights for dealing with Black Swans are covered in the report Black Swans Do Exist published by International Federation of Accountants–

  • Directors should increase their focus on risk, and engage more in detailed appreciation and understanding of the risks in their company’s products and service areas. For the financial services industry, a solution could be for boards to establish a specialized risk committee, and consider the employment of an external risk specialist.
  • Black swans do, and will always, exist. Therefore, be much more alert to the fact that, even at the extreme end of risk possibility, things do actually happen.
  • Executive remuneration should be better aligned with the longer-term real performance (in terms of profitability, not sales volume) of the organization—for example, via deferred remuneration in the form of shares.
  • Governance issues are probably best tackled with a mixture of regulatory, investor, and board responsibility. To only look to investors being more active is unlikely to be effective.

What do you think? Would this help companies deal with the arrival of a Black Swan event – and avoid the ostrich ‘head in the sand’ syndrome?

Coming soon: How Shell Uses Scenarios To Manage Risks.