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The year 2001 will be remembered as the year of corporate scandals. The most dramatic of these occurred in the United States—in companies such as Enron, WorldCom, Tyco, and others—but Europe also had its share, with debacles at France’s Vivendi, the Netherlands’ Ahold, Italy’s Parmalat, and ABB, a Swiss-Swedish multinational company. Even before these events fully unfolded, a rising number of complaints about executive pay, concerns about the displacement of private-sector jobs to other countries through off-shoring, and issues of corporate social responsibility had begun to fuel emotional and political reactions to corporate news in the United States and abroad.
Most of these scandals involved deliberately inflating financial results, either by overstating revenues or understating costs, or diverting company funds to the private pockets of managers. Two of the most prominent examples of fraudulent “earnings management” include Enron’s creation of off–balance sheet partnerships to hide the company’s deteriorating financial position and to enrich Enron executives and WorldCom’s intentional misclassification of as much as \$11 billion in expenses as capital investments—perhaps the largest accounting fraud in history.
The Enron scandal came to symbolize the excesses of corporations during the long economic boom of the 1990s.Lindstrom (2008). Hailed by Fortune magazine as “America’s Most Innovative Company” for 6 straight years from 1996 to 2001, Enron became one of the largest bankruptcies in U.S. history. Its collapse in December 2001 followed the disclosure that it had reported false profits, using accounting methods that failed to follow generally accepted procedures. Both internal and external controls failed to detect the financial losses disguised as profits for a number of years. At first, Enron’s senior executives, whose activities brought the company to the brink of ruin, escaped with millions of dollars as they retired or sold their company stock before its price plummeted. Enron employees were not so lucky. Many lost their jobs and a hefty portion of retirement savings invested in Enron stock. Because the company was able to hide its losses for nearly 5 years, the Enron scandal shook the confidence of investors in American governance around the world. Outside agencies, such as accounting firms, credit rating businesses, and stock market analysts had failed to warn the public about Enron’s business losses until they were obvious to all. Internal controls had not functioned, either. And Enron’s board of directors, especially its audit committee, apparently did not understand the full extent of the financial activities undertaken by the firm and, consequently, had failed in providing adequate oversight. Some experts believed that the federal government also bore some responsibility. Politicians in both the legislative and executive branches received millions of dollars in campaign donations from Enron during the period when the federal government decided to deregulate the energy industry, removing virtually all government controls. Deregulation was the critical act that made Enron’s rise as a \$100 billion company possible.
In June 2002, shortly after the Enron debacle, WorldCom admitted that it had falsely reported \$3.85 billion in expenses over 5 quarterly periods to make the company appear profitable when it had actually lost \$1.2 billion during that period.“MCI, Inc.,” Microsoft® Encarta® Online Encyclopedia (2008). Experts said it was one of the biggest accounting frauds ever. In its aftermath, the company was forced to lay off about 17,000 workers, more than 20% of its workforce. Its stock price plummeted from a high of \$64.50 in 1999 to 9 cents in late July 2002 when it filed for bankruptcy protection. In March 2004, in a formal filing with the SEC, the company detailed the full extent of its fraudulent accounting. The new statement showed the actual fraud amounted to \$11 billion and was accomplished mainly by artificially reducing expenses to make earnings appear larger. After restructuring its debt and meeting other requirements imposed by a federal court, the company emerged from bankruptcy protection in April 2004 and formally changed its name to MCI Inc. Even as it emerged from bankruptcy, industry observers anticipated that MCI would need to merge with another telecommunications firm to compete against larger companies that offered a broader range of telecommunications services. The merger materialized less than a year later, in February 2005, when Verizon Communications Inc. announced its acquisition of MCI for about \$6.7 billion in cash, stocks, and dividend payments. MCI ceased to exist as an independent company under the terms of the merger, which was completed in 2006.
As Edwards (2003) notes, these scandals raised fundamental questions about the motivations and incentives of executives and about the effectiveness of existing corporate governance practices, not only in the United States, but also in other parts of the world, including, What motivated executives to engage in fraud and earnings mismanagement? Why did boards either condone or fail to recognize and stop managerial misconduct and allow managers to deceive shareholders and investors? Why did external gatekeepers, for example, auditors, credit rating agencies, and securities analysts, fail to uncover the financial fraud and earnings manipulation, and alert investors to potential discrepancies and problems? Why were shareholders themselves not more vigilant in protecting their interests, especially large institutional investors? What does this say about the motivations and incentives of money managers?Edwards (2003).
Because of the significance of these questions and their influence on the welfare of the U.S. economy, the government, regulatory authorities, stock exchanges, investors, ordinary citizens, and the press all started to scrutinize the behavior of corporate boards much more carefully than they had before. The result was a wave of structural and procedural reforms aimed at making boards more responsive, more proactive, and more accountable, and at restoring public confidence in our business institutions. The major stock exchanges adopted new standards to strengthen corporate governance requirements for listed companies; then Congress passed the Sarbanes-Oxley Act of 2002, which imposes significant new disclosure and corporate governance requirements for public companies, and also provides for substantially increased liability under the federal securities laws for public companies and their executives and directors; and the SEC adopted a number of significant reforms.
1.05: The Financial Crisis of 2008
Just as investor confidence had (somewhat) been restored and the avalanche of regulatory reform that followed the 2001 meltdown digested, a new, possibly even more damaging crisis, potentially global in scale and scope, emerged. While it has not (yet) been labeled as a “corporate governance” crisis, the “financial crisis of 2008” once again raises important questions about the efficacy of our economic and financial systems, board oversight, and executive behavior.
Specifically, as the economic news worsens—rising inflation and unemployment, falling house prices, record bank losses, a ballooning federal deficit culminating in a \$10 trillion national debt, millions of Americans losing their homes, a growing number of failures of banks and other financial institutions—CEOs, investors, and creditors are walking away with billions of dollars, while American taxpayers are being asked to pick up the tab (Freddie Mac’s chairman earned \$14.5 million in 2007; Fannie Mae’s CEO earned \$14.2 million that same year). Not surprisingly, ordinary citizens who have seen the value of the 401K plans shrink by 40% or more are asking tough questions: How did we get into this mess? Why should we support Wall Street? Where was the government? What has happened to accountability?
While the causes of the current crisis will be debated for some time—Did we rely too much on free markets or not enough? Did special interests shape public policy? Did greed rule once again? Where were the boards of Bear Stearns, Lehman Brothers, and AIG? Were regulators asleep at the wheel? Incompetent?—one thing is for sure. Another wave of regulatory reform—this time possibly global in reach—is around the corner. And once again we will be asking the questions that prompted the writing of this book: What will be the impact on investor confidence? On corporate behavior? On boards of directors? On society? | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/01%3A_Linking_Corporations_and_Society/1.04%3A_The_Meltdown_of_2001.txt |
Do shareholders own the company? To most people, this idea is so axiomatic that the question hardly seems worth asking. However, the long-simmering debate about the age-old argument over the board’s responsibilities to shareholders versus the rights of all company stakeholders flared up again recently, drawing attention once again to that central question.Bernstein (December 2007–January 2008).
In the latest round of this debate, two leading corporate governance experts—Lucian Bebchuk, Harvard Law School professor and ardent shareholder-rights proponent, and Martin Lipton, founding partner of Wachtell, Lipton, Rosen & Katz and a stalwart defender of the view that it is management’s prerogative to do what is in the best interest of the corporation—squared off in the pages of the Virginia Law Review.See Bebchuk (2007, May), p. 675; and Lipton and Savitt (2007, May), p. 733. The central issue in this debate is whether directors of a public company owe their primary fiduciary duty to its shareholders, as Bebchuk insists, or have to consider the prerogatives of all the stakeholders, as Lipton maintains.
Bebchuk (May 2007) cites a widely quoted 1988 ruling by the Delaware courts that “the shareholder franchise is the ideological underpinning upon which the legitimacy of directorial power rests” and points out that corporate law gives boards the authority to hire and fire management and set the company’s overall direction. Next, he argues that since directors are expected to serve as the shareholders’ guardians, shareholders must have the power to replace them. Thus, the fear of being replaced is supposed to make directors accountable and provide them with incentives to serve shareholder interests.
He continues by noting just how infrequently U.S. directors are actually challenged, much less removed, and concludes that shareholder power to replace directors in the United States is largely a myth. To make shareholder power real, he supports the proposal that directors be elected by a secret ballot open to rival candidates nominated by shareholders. What is more, to put them on an equal footing with the slate proposed by the board’s nominating committee (usually with management input), he suggests that challengers should be reimbursed by the corporation if they receive a threshold number of votes.
Taking the opposing view and challenging the widely accepted argument that a company’s primary goal is to maximize shareholder value, Lipton challenges the very notion that corporations are the private property of stockholders: “Shareholders do not ‘own’ corporations,” he says. “They own securities—shares of stock—which entitle them to very limited electoral rights and the right to share in the financial returns produced by the corporation’s business operations.”Lipton and Savitt (2007, May), p. 733. Directors, he argues, are not merely representatives of shareholders who have a legal responsibility to put investor interests first. Instead, the role of the board is simply and dutifully to seek what is best for the company itself, which means balancing the interests of shareholders as well as other stakeholders, such as management and employees, creditors, regulators, suppliers, and consumers. He concludes that Bebchuk’s notion that a board’s primary fiduciary obligation is to shareholders is a myth of corporate law.
2.02: Conduct or Accountability
Governance in the United States has evolved as a medley of federal law—including not only corporation law but also tax and labor law, among others—state law, and a series of codes of various self-regulating authorities ranging from the NYSE to the accounting industry. As noted in Chapter 1 "Corporate Governance: Linking Corporations and Society", state law has traditionally been the ultimate arbiter of governance issues. In contrast, in the United Kingdom, corporate reform can be affected simply through an Act of Parliament.
This unusual history of governance law in the United States has created openings for different interpretation of a variety of its provisions. For example, the law not only identifies shareholders as the “owners” of the corporation but also defines them as investors who receive ownership in the corporation in return for money or assets they invest. It stipulates that shareholders are responsible for “electing” a board of directors, the “operators” of the corporation who have overall responsibility for the business of the corporation, but it does not meaningfully address the implementation of this statute. It also specifies that the board of directors rather than its shareholders “directs” a company’s business and affairs.
Additional guidance about a board’s fiduciary role is contained in statutes governing the role and conduct of individual board members; specifically those defining a director’s obligation in terms of such principles as the duty of care, duty of loyalty, and the “business judgment rule.” The Duty of Care requires directors to be informed, prior to making a business decision, of all material information reasonably available to them in the exercise of their management of the affairs of a corporation. The Duty of Loyalty protects the corporation and its shareholders; it requires directors to act in good faith and in the best interests of the corporation and its shareholders. The prevalent legal standard is that the Duty of Loyalty requires that the director be “disinterested,” such that he or she “neither appears on both sides of a transaction nor expects to derive any personal financial benefit from it” and his or her decision must be “based on the corporate merits of the subject before the board rather than extraneous considerations or influences.”See The American Law Institute (1994), pp. 61. The Business Judgment Rule protects directors from liability for action taken by them if they act on an informed basis in good faith and in a manner they reasonably believe to be in the best interests of the corporation’s shareholders. The Business Judgment Rule does not apply in cases of fraud, bad faith, or self-dealing.
As long as these principles are adhered to and as long as directors are careful and loyal to corporate and shareholder interests, they have wide discretion to exercise their business judgment as they see fit. None of these principles provide clear guidance to the central question of who owns the corporation. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/02%3A_Governance_and_Accountability/2.01%3A_Who_Owns_the_Corporation_The_Legal_Debate.txt |
One reason that U.S. governance law is sometimes indeterminate is that the enormous differences between the two legal views described above reflect a broader, philosophical debate on the role and purpose of corporations in society. Indeed, opposing views on the purpose and accountability of the corporation—shareholders versus stakeholders, or private (property) versus public (social and political entity) conceptions of the corporation—have been part of the governance debate for well over 100 years.See, for example, Bradley, Schipani, Sundaram, and Walsh (1999), pp. 9– 86; and Matheson and Olson (1992), pp. 1313–1391.
Shareholder capitalism, until recently prevalent mainly in the United States and the United Kingdom, holds that a company is the private property of its owners. From a legal perspective, the Anglo-American corporation is essentially a capital market institution, primarily accountable to shareholders, charged with creating wealth by exploiting market opportunities. Stakeholder capitalism, on the other hand, embodies a more organic view of the corporation in which companies have broader obligations that balance the interests of shareholders with those of other stakeholders, notably employees but also including suppliers, distributors, customers, and the community at large. Under this set of beliefs, the corporation is seen as an institution with a continuing purpose, and therefore, with a life of its own. Shareholders and wealth creation for owners do not dictate its priorities. Rather, a deep concern for employees, suppliers, and customers, and implicitly for its own continued existence, defines the corporate mission.
As noted in Chapter 1 "Corporate Governance: Linking Corporations and Society", stakeholder capitalism can take different forms, reflecting the degree of commitment to different stakeholders. Germany’s legal system, for example, makes it clear that firms do not have a sole duty to pursue the interests of shareholders. Under Germany’s system of codetermination, employees and shareholders in large companies hold an equal number of seats on the companies’ supervisory boards, and the interests of both parties must be taken into account in decision making. In Denmark, employees in firms with more than 35 workers elect one third of the firm’s board members, with a minimum of 2. In Sweden, companies with more than 25 employees must have 2 labor representatives appointed to the board. These employee board members have all the rights and duties of other board members.
The situation differs somewhat in France. French firms with more than 50 workers have employee representatives at board meetings, but they do not have the right to vote. More conventional codetermination systems exist for former public-sector French firms that have been privatized; these systems can be introduced voluntarily by companies. In Finland, companies can also voluntarily adopt employee representatives on the board. Across the European Union (EU) as a whole, another type of worker participation in decision making is the works council, a group that has a say in such issues as layoffs and plant closures. A corporation with at least 1,000 employees, of which there are 150 or more in at least two EU countries, must have a “European Works Council.”
The situation in Japanese firms also differs from that of the United States and the United Kingdom. Japanese executives do not have a fiduciary responsibility to stockholders, but they can be liable for gross negligence in performing their duties. At the same time, it is accepted practice in Japan that managers align their priorities with the interests of a variety of stakeholders. For example, a recent survey revealed that if Japanese executives feel that the company is going through a tough period financially, keeping their employees on the job is much more important than maintaining dividends to shareholders. Specifically, only 3% of Japanese managers said companies should maintain dividend payments to stockholders under such circumstances. This compares with 41% in Germany, 40% in France, and 89% in both the United States and the United Kingdom.
In the United States, these issues also continue to be debated. Some time ago Reason magazine featured a spirited debate among the late Milton Friedman, former senior research fellow at the Hoover Institution and Paul Snowden Russell Distinguished Service Professor of Economics at the University of Chicago; John Mackey, founder and CEO of Whole Foods Market; and others, on the purpose of the corporation.Reason (2005, October). Friedman, a Nobel laureate in economics and the author of a famous 1970 New York Times Magazine article titled “The Social Responsibility of Business Is to Increase Its Profits,” had no patience with capitalists who claimed,
Business is not concerned “merely” with profit but also with promoting desirable “social” ends; that business has a “social conscience” and takes seriously its responsibilities for providing employment, eliminating discrimination, avoiding pollution and whatever else may be the catchwords of the contemporary crop of reformers.Friedman (1970).
He wrote that such people are “preaching pure and unadulterated socialism. Businessmen who talk this way are unwitting puppets of the intellectual forces that have been undermining the basis of a free society these past decades.”Friedman (1970).
Mackey disagreed vehemently with Friedman. A self-described ardent libertarian who likes to quote Ludwig von Mises on Austrian economics and Abraham Maslow on humanistic psychology, and is a student of astrology, Mackey believes Friedman’s view of business is too narrow and underestimates the humanitarian potential of capitalism. Selected portions of this debate are reprinted below, beginning with Mackey’s passionate, personal vision of the social responsibility of business.
In 1970 Milton Friedman wrote that “there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.” That’s the orthodox view among free market economists: that the only social responsibility a law-abiding business has is to maximize profits for the shareholders.
I strongly disagree. I’m a businessman and a free market libertarian, but I believe that the enlightened corporation should try to create value for all of its constituencies. From an investor’s perspective, the purpose of the business is to maximize profits. But that’s not the purpose for other stakeholders—for customers, employees, suppliers, and the community. Each of those groups will define the purpose of the business in terms of its own needs and desires, and each perspective is valid and legitimate.
Mackey continues,
We have not achieved our tremendous increase in shareholder value by making shareholder value the primary purpose of our business … the most successful businesses put the customer first, ahead of the investors. In the profit-centered business, customer happiness is merely a means to an end: maximizing profits. In the customer-centered business, customer happiness is an end in itself, and will be pursued with greater interest, passion, and empathy than the profit-centered business is capable of.
Not surprisingly, Friedman respected Whole Foods’ success but took issue with its business philosophy:
Maximizing profits is an end from the private point of view; it is a means from the social point of view. A system based on private property and free markets is a sophisticated means of enabling people to cooperate in their economic activities without compulsion; it enables separated knowledge to assure that each resource is used for its most valued use, and is combined with other resources in the most efficient way.
Mackey replied,
While Friedman believes that taking care of customers, employees, and business philanthropy are means to the end of increasing investor profits, I take the exact opposite view: Making high profits is the means to the end of fulfilling Whole Foods’ core business mission. We want to improve the health and well-being of everyone on the planet through higher-quality foods and better nutrition, and we can’t fulfill this mission unless we are highly profitable. High profits are necessary to fuel our growth across the United States and the world. Just as people cannot live without eating, so a business cannot live without profits. But most people don’t live to eat, and neither must a business live just to make profits.
Mackey’s logic was perhaps most effectively first articulated by Peter Drucker in 1974 in his famous book Management: Tasks, Responsibilities and Practices:
The purpose of a business is not to make a profit. Profit is a necessity and a social responsibility. A business, regardless of the economic and legal arrangements of society, must produce enough profit to cover the risks of committing today’s economic resources to the uncertainties of the future; to produce the capital for the jobs of tomorrow; and to pay for all the non-economic needs and satisfactions of society from defense and the administration of justice to the schools and the hospitals, and from the museums to the boy scouts. But profit is not the purpose of business. Rather a business exists and gets paid for its economic contribution. Its purpose is to create a customer.Drucker (1974), p. 67.
This discussion raises questions that transcend the legal debate on fiduciary obligations. It asks us to consider questions, such as, What does society want from corporations? What are the moral obligations and responsibilities of business? Who has the right to make such decisions in a public company? Is shareholder wealth maximization the right objective? And what obligations does a company have to other stakeholders, such as employees or suppliers, and the community at large? And are these objectives necessarily in conflict with each other? If so, how should trade-offs be made? What is more, the discussion suggests that to be consistent and effective, directors and boards should have ready answers to many, if not all, of the questions and know where they agree or disagree. As we shall see, regrettably, this is not true. Not only has the United States, as a society, changed its perspective on this issue several times, but also, today, the majority of directors remain confused, sometimes intimidated, by the law and often unwilling or unable to debate these issues openly. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/02%3A_Governance_and_Accountability/2.03%3A_Corporate_Purpose_-_A_Societal_Perspective.txt |
Perspective
During the first part of the 19th century, the corporation was viewed as a social instrument for the state to carry out its public policy goals, and each instance of incorporation required a special act of the state legislature. The function of the law was to protect stakeholders by making sure corporations would not pursue activities beyond their original charter or state of incorporation. By the end of the 19th century, states began to allow general incorporation, which fueled an explosive growth in the creation of companies for private business purposes. In its aftermath, concern for stakeholder welfare gave way to the concept of managing the corporation for shareholders’ profits.This section draws on Sundaram and Inkpen (2004).
In 1919 the primacy of shareholder value maximization was affirmed in a ruling by the Michigan State Supreme Court in Dodge vs. Ford Motor Company. Henry Ford wanted to invest Ford Motor Company’s considerable retained earnings in the company rather than distribute it to shareholders. The Dodge brothers, minority shareholders in Ford Motor Company, brought suit against Ford, alleging that his intention to benefit employees and consumers was at the expense of shareholders. In their ruling, the Michigan court agreed with the Dodge brothers:
A business corporation is organized and carried on primarily for the profit of the stockholders. The powers of the directors are to be employed for that end. The discretion of directors is to be exercised in the choice of means to attain that end, and does not extend to a change in the end itself, to the reduction of profits, or to the non-distribution of profits among stockholders in order to devote them to other purposes.Dodge v. Ford Motor Co. (1919).
In The Modern Corporation and Private Property, published in 1932, Adolph Berle and Gardiner Means provided important intellectual support for the shareholder value norm. In this now classic book, the authors called attention to a new phenomenon affecting corporations in the United States at the time. They noted that ownership of capital had become widely dispersed among many small shareholders, yet control was concentrated in the hands of just a few managers. Berle and Means warned that the separation of ownership and control would destroy the very foundation of the existing economic order and argued that managing on behalf of the shareholders was the sine qua non of managerial decision making because shareholders were property owners.
Following the 1929 stock market crash and the Great Depression, stakeholder concerns were being voiced once again. If the corporation is an entity separate from its shareholders, it was argued, it has citizenship responsibilities.Dodd (1932), pp. 1145–1163. According to this point of view, rather than being an agent for shareholders, the role of management is that of a trustee with citizenship responsibilities on behalf of all constituencies, even if it means a reduction in shareholder value. In the following years, states adopted a number of stakeholder statutes reflecting this new sense of corporate responsibility toward nonshareholding constituencies, such as labor, consumers, and the natural environment.
By the end of the 20th century, however, despite state-level legislative efforts to the contrary, American-style market-driven capitalism had prevailed and the pendulum swung back to the shareholder. Friedman’s view that the “sole social responsibility of business is to increase profits” energized a push back on corporate social responsibility.Friedman (1970). In the meantime, agency theoryFor agency theory, see, for example, Alchian and Demsetz (1972); and Jensen and Meckling (1976); and Fama and Jensen (1983a). Agency theory is directed at the dilemma in which one party (the shareholder as the principal) delegates work to another (management as the agent) who performs that work. Agency theory is concerned with resolving two problems that can occur in such a relationship. The first is the agency problem that arises when (a) the desires or goals of the principal and agent conflict and (b) it is difficult or expensive for the principal to verify what the agent is actually doing. The issue here is that the principal cannot verify that the agent has behaved appropriately. The second is the problem of risk sharing that arises when the principal and agent have different attitudes toward risk. In this situation, the principle and the agent may prefer different actions because of the different risk preferences. and the concept of the corporation as a nexus of contractsEasterbrook and Fischel (1991). Nexus of contracts theory views the firm not as an entity but as an aggregate of various inputs brought together to produce goods or services. Employees provide labor. Creditors provide debt capital. Shareholders initially provide equity capital and subsequently bear the risk of losses and monitor the performance of management. Management monitors the performance of employees and coordinates the activities of all the firm’s inputs. The firm is seen as simply a web of explicit and implicit contracts establishing rights and obligations among the various inputs making up the firm. had become influential doctrines in finance and economics.
To protect the interests of other stakeholders, 30 states in the United States enacted stakeholder statutes that allowed directors to consider the interests of nonshareholder constituencies in corporate decisions. Thus, the law gave boards latitude in determining what is in the best long-term interests of the corporation and how to take the interests of other stakeholders into account. Nevertheless, the mainstream of U.S. corporate law remains committed to the principle of shareholder wealth maximization.See the notes for Bainbridge (1993) “In Defense of the Shareholder Wealth Maximization Norm: A Reply to Professor Green.” | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/02%3A_Governance_and_Accountability/2.04%3A_The_Primacy_of_Shareholder_Interests_-_A_Historical_Perspective.txt |
The lack of a clear, shared consensus about why a company exists, to whom directors are accountable, and what criteria they should use to make decisions—in the law as well as in society at large—is a significant obstacle to increasing the effectiveness of the corporate governance function. When boards operate with tacit assumptions about their objectives and loyalties, they may hide potential disagreements among their members and sacrifice effectiveness. Such hidden disagreements make it difficult to get consensus on complex issues, such as what qualifications a CEO should have, whether or not to outsource parts of the value chain, or how to evaluate and compensate top management.
Lorsch (1989) first identified the confusion among directors about their accountabilities. Based on their beliefs, he categorized directors as belonging to one of three groups: traditionalists, rationalizers, or broad constructionists.Lorsch (with MacIver) (1989), chap. 3. Each has a different vision of what the modern corporation’s fundamental purpose is and, therefore, to whom and for what a board should be held accountable.
Traditionalists see themselves as accountable to shareholders only. For them, there is no need to debate the fundamental purpose of the modern corporation—it is and always has been the maximization of shareholder value. They do not believe there is a conflict between putting the shareholder first and responding to the needs of other constituencies, and therefore experience little role ambiguity or conflict. Members of this group find support for their position in a narrow interpretation of current state and federal law. They also tend to view the highly publicized abuses at Enron, WorldCom, Vivendi, and other companies as anomalies made possible by imperfections in the current system rather than as indicators of more systemic problems.
A second, larger group—the rationalizers—experiences more anxiety about their role as directors. They recognize that, in today’s complex, global economy, real tensions can occur between the interests of different constituencies and that not all decisions can be reduced to the simple “What is good for the shareholder is good for everyone else” formula. Examples include whether or not to close a domestic plant in favor of manufacturing in a low-cost, foreign location; whether or not to outsource production to lower cost suppliers; or how to respond to pressures for “greener” operations. Nevertheless, feeling constrained by the law and guided by the (primarily Delaware) law, that is the way rationalizers behave.
The final group, which Lorsch labels as the broad constructionists, recognizes specific responsibilities to constituencies other than shareholders and is willing to act on its convictions. Directors belonging to this group constantly struggle to balance their views with the more traditional view of a director’s accountabilities and—to stay within the boundaries of the law—frame their decisions in terms of what is in the best long-term interest of the corporation as a whole.
Lorsch summarized his findings as, “Thus we found the majority of directors felt trapped in a dilemma between their traditional legal responsibility to shareholders, whom they consider too interested in short-term payout, and their beliefs about what is best, in the long run, for the health of the company.”Lorsch (with MacIver) (1989), p. 49. He further observed that it appeared that, in many boards, a group norm had evolved, prohibiting open discussion of a board’s true purpose and that a lot of directors were unaware of recent rulings in the evolving legal context that grant them the latitude to consider constituencies other than shareholders.
In recent years the issue of a board’s primary role and accountability has, if anything, become even more confusing. Despite strong rhetoric from many quarters advocating maximization of shareholder value as a company’s primary goal, there is a growing recognition that a company and the board have broader responsibilities. This trend reflects the fact that real—that is, economic and psychological rather than legal—ownership of the corporation is moving from shareholders to employees, customers, and other stakeholders that make up the human capital of the firm.
This has created real problems for directors. As Lorsch notes,
Boards have a real challenge in deciding to whom they are really responsible and where their commitments ultimately lie. Directors must think about and discuss among themselves the constituencies and the time horizons they have in mind as they think about the board’s responsibilities. Many boards have skirted discussion of these complex issues. They seem too abstract, and reaching a consensus among board members about them can take more of that most precious commodity—time—than directors want to devote.Carter and Lorsch (2004), p. 57. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/02%3A_Governance_and_Accountability/2.05%3A_Governance_Without_a_Shared_Purpose.txt |
In their widely cited book The Value Imperative—Managing for Superior Shareholder Returns, McTaggart, Kontes, and Mankins (1994) write,
Maximizing shareholder value is not an abstract, shortsighted, impractical, or even, some might think, sinister objective. On the contrary, it is a concrete, future-oriented, pragmatic, and worthy objective, the pursuit of which motivates and enables managers to make substantially better strategic and organizational decisions than they would in pursuit of any other goal. And its accomplishment is essential to the welfare of all the company’s stakeholders, for it is only when wealth is created that customers will continue to enjoy a flow of new, better, and cheaper products and the world’s economies will see new jobs created and old ones improved.McTaggart, Kontes, and Mankins (1994), chap. 1.
Implicit in this statement are three important assumptions, all of which can be challenged:
1. Shareholder value is the best measure of wealth creation for the firm.
2. Shareholder value maximization produces the greatest competitiveness.
3. Shareholder value maximization fairly serves the interests of the company’s other stakeholders.
With respect to the first assumption, it can be argued that “firm value,” which also includes the values to all other financial claimants, such as creditors, debt holders, and preferred shareholders, is a better indicator of wealth. The importance of distinguishing between firm value and shareholder value lies in the fact that managers and boards can make decisions that transfer value from debt holders to shareholders and decrease total firm and social value while increasing shareholder value.
The second assumption—that shareholder value maximization produces the greatest long-term competitiveness—can also be challenged. An increasingly influential group of critics, which also includes a substantial number of CEOs, thinks product-market rather than capital-market objectives should guide corporate decision making. They worry that companies that adopt shareholder value maximization as their primary purpose lose sight of producing or delivering a product or service as their central mission and that shareholder value maximization creates a gap between the mission of the corporation and the motivations, desires, and capabilities of the company’s employees who only have direct control over real, current, corporate performance. They note that shareholder value maximization is simply not inspiring for employees, even though they often share in some of the gains through benefit, bonus, or option plans. To many of them, shareholders are nameless and faceless, under no obligation to hold their shares for any length of time, never satisfied, and always asking, “What will you do for me next?” Worse, they say, not only does shareholder-value appreciation fail to inspire employees, it may encourage them to view maximizing one’s financial well-being as a legitimate or even the only goal. Instead, they want companies to create a moral purpose that not only provides a clear focus on creating competitive advantage for the company but also unites its purpose, strategy, goals, and shared values into one overall, coherent management framework that has the power to motivate constituents and the legitimacy of the corporation’s actions in society.Ellsworth (2002), p. 6.
The third assumption—that shareholder maximization is congruent with fairly serving the interests is the firm’s other stakeholders—is perhaps most controversial. Proponents of shareholder value maximization—including many economists and finance theorists—are adamant that maximizing shareholder value is not only superior as a fiduciary standard or management objective but also as a societal norm. Jensen (2001), for example, writes,
Two-hundred years of research in economics and finance have produced the result that if our objective is to maximize the efficiency with which society utilizes its resources (that is to avoid waste and to maximize the size of the pie), then the proper and unique objective for each company in the society is to maximize the long-run total value of the firm. Firm value will not be maximized, of course, with unhappy customers and employees or with poor products. Therefore, consistent with “stakeholder theory” value-maximizing firms will be concerned about relations with all their constituencies. A firm cannot maximize value if it ignores the interest of its stakeholders.Jensen (2001), pp. 297–317.
McTaggart et al. (1994) also believe shareholder value maximization allows managers and boards to resolve any conflicts to everyone’s long-term benefit. Consider, for example, their prescription for resolving trade-offs between customer- and shareholder-focused investments:
As long as management invests in higher levels of customer satisfaction that will enable shareholders to earn an adequate return on their investment, there is no conflict between maximizing shareholder value and maximizing customer satisfaction. If, however, there is insufficient financial benefit to shareholders from attempts to increase customer satisfaction, the conflict should be resolved for the benefit of shareholders to avoid diminishing both the financial health and long-term competitiveness of the business.McTaggart et al. (1994), chap. 1.
Not surprisingly, stakeholder theorists take a different point of view. They argue that shareholders are but one of a number of important stakeholder groups and that, like customers, suppliers, employees, and local communities, shareholders have a stake in and are affected by the firm’s success or failure. To stakeholder theory advocates, an exclusive focus on maximizing stockholder wealth is both unwise and ethically wrong; instead, the firm and its managers have special obligations to ensure that the shareholders receive a “fair” return on their investment, but the firm also has special obligations to other stakeholders, which go above and beyond those required by law.Freeman (1984), p. 17.
More recently, Ian Davis, managing director of McKinsey, criticized the shareholder value maximization doctrine on altogether different grounds. He observed that, in today’s global business environment, the concept of shareholder value is rapidly losing relevance in the face of the larger role played by government and society in shaping business and industry elsewhere in the world:
In much of the world, government, labor and other social forces have a greater impact on business than in the U.S. or other more free-market Western societies. In China, for example, government is often an owner. If you’re talking in China about shareholder value, you will get blank looks. Maximization of shareholder value is in danger of becoming irrelevant.Davis (2006, November 1).
Finally, a growing number, including CEOs, while not questioning that shareholder value maximization is the right objective, are concerned about its implementation. They worry that the stock market has a bias toward short-term results and that stock price, the most common gauge of shareholder wealth, does not reflect the true long-term value of a company. Lucent Technologies CEO Henry Schacht, for example, has stated, “What has happened to us is that our execution and processes have broken down under the white hot heat of driving for quarterly revenue growth.”Henry Schacht, quoted in Fortune, July 7, 2003, and referred to in Martin, “The Coming Corporate Revolt” (2003), p. 1. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/02%3A_Governance_and_Accountability/2.06%3A_Is_Shareholder_Value_Maximization_the_Right_Objective.txt |
Although the recognition of stakeholder obligations has been with us since the birth of the modern corporate form, the development of a coherent stakeholder theory awaited a shift in legal thinking from a perspective on shareholders as “owners” to one of “investors,” more on a par with providers of other inputs that a company needs to produce goods or services.See Jensen and Meckling (1976); Fama (1980), pp. 291–293; and Fama and Jensen (1983b). For a somewhat different view, see Klein (1982). Whereas the ownership perspective, rooted in property law, provides a natural basis for the primacy of shareholder rights, the view of the corporation as a bundle of contracts permits a different view of the fiduciary obligations of corporate managers. Freeman and McVea (2001) describe stakeholder management as follows:
The stakeholder framework does not rely on a single overriding management objective for all decisions. As such it provides no rival to the traditional aim of “maximizing shareholder wealth.” To the contrary, a stakeholder approach rejects the very idea of maximizing a single-objective function as a useful way of thinking about management strategy. Rather, stakeholder management is a never ending task of balancing and integrating multiple relationships and multiple objectives.Freeman and McVea (2001), p. 194.
To pragmatists, the rejection of a single criterion for making corporate decisions is problematic. Directors occasionally face situations in which it is impossible to advance the interests of one set of stakeholders and simultaneously protect those of others. Whose interests should they pursue when there is an irreconcilable conflict? Consider the decision whether or not to close down an obsolete plant. The closing will harm the plant’s workers and the local community but will benefit shareholders, creditors, employees working at a more modern plant to which the work previously performed at the old plant is transferred, and communities around the modern plant. Without a single guiding decision criterion, how should the board decide?
The problem is not just one of uncertainty or unpredictability. Ultimately, the stakeholder model is flawed because of its failure to account adequately for what Bainbridge (1994) calls “managerial sin.”Bainbridge (1994). The absence of a single decision-making criterion allows management to freely pursue its own self-interest by playing shareholders off against nonshareholders. When management’s interests coincide with those of shareholders, management can justify its decision by saying that shareholder interests prevailed in this instance, and vice versa. The plant closing decision described above provides a useful example: Shareholders and some nonshareholder constituents benefit if the plant is closed, but other nonshareholder constituents lose. If management’s compensation is tied to firm size, we can expect it to resist any downsizing of the firm. The plant likely will stay open, with the decision being justified by the impact of a closing on the plant’s workers and the local community. In contrast, if management’s compensation is linked to firm profitability, the plant will likely close, with the decision being justified by management’s concern for the firm’s shareholders, creditors, and other constituencies that benefit from the closure decision.
It has been argued that shareholders, in fact, are more vulnerable to management misconduct than nonshareholder constituencies. Legally, shareholders have essentially no power to initiate corporate action and, moreover, are entitled to vote on only very few corporate actions.Under the Delaware code, shareholder voting rights are essentially limited to the election of directors and the approval of charter or bylaw amendments, mergers, sales of substantially all of the corporation’s assets, and voluntary dissolutions. As a formal matter, only the election of directors and the amendment of the bylaws do not require board approval before shareholder action is possible. See Delaware Code Ann. tit. 8, § § 109, 211 (1991). In practice, of course, even the election of directors, absent a proxy contest, is predetermined by the existing board nominating the following year’s board. Rather, formal decision-making power resides mainly with the board of directors.As a practical matter, of course, the sheer mechanics of undertaking collective action by thousands of shareholders preclude them from meaningfully affecting management decisions. In effect, shareholders, just like nonshareholder constituencies, have but a single mechanism by which they can “negotiate” with management: withholding their inputs (capital). But withholding inputs may be a more effective tool for nonshareholders than it is for shareholders. Some firms go for years without seeking equity investments. If the management groups in these firms disregard shareholder interests, the shareholders have no option other than to sell out at prices that will reflect management’s lack of concern for shareholder wealth. In contrast, few firms can survive for long without regular infusions of new employees and new debt financing. As a result, few management groups can prosper while ignoring nonshareholder interests. Nonshareholder constituencies often also are more effective in protecting themselves through the political process. Shareholders—especially individuals—typically have no meaningful political voice. In contrast, many nonshareholder constituencies are represented by cohesive, politically powerful interest groups. Unions, for example, played a major role in passing state antitakeover laws. Environmental concerns are increasingly a factor in regulatory actions. From this point of view, it can be argued that an explicit focus on balancing stakeholder interests is not only impractical but also unnecessary because nonshareholder constituencies already have adequate mechanisms to protect themselves from management misconduct. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/02%3A_Governance_and_Accountability/2.07%3A_Stakeholder_Theory_-_A_Viable_Alternative.txt |
Maximization?
Jensen believes the inherent conflict between the doctrine of shareholder value maximization and the objectives of stakeholder theory can be resolved by melding together “enlightened” versions of these two philosophies:
Enlightened value maximization recognizes that communication with and motivation of an organization’s managers, employees, and partners is extremely difficult. What this means in practice is that if we simply tell all participants in an organization that its sole purpose is to maximize value, we will not get maximum value for the organization. Value maximization is not a vision or a strategy or even a purpose; it is the scorecard for the organization. We must give people enough structure to understand what maximizing value means so that they can be guided by it and therefore have a chance to actually achieve it. They must be turned on by the vision or the strategy in the sense that it taps into some human desire or passion of their own—for example, a desire to build the world’s best automobile or to create a film or play that will move people for centuries. All this can be not only consistent with value seeking, but a major contributor to it.Jensen (2001), p. 16.
And,
Indeed, it is a basic principle of enlightened value maximization that we cannot maximize the long-term market value of an organization if we ignore or mistreat any important constituency. We cannot create value without good relations with customers, employees, financial backers, suppliers, regulators, and communities. But having said that, we can now use the value criterion for choosing among those competing interests. I say “competing” interests because no constituency can be given full satisfaction if the firm is to flourish and survive. Moreover, we can be sure—again, apart from the possibility of externalities and monopoly power—that using this value criterion will result in making society as well off as it can be.Jensen (2001), p. 16.
Thus, Jensen defines “enlightened” stakeholder theory simply as stakeholder theory with the specification that maximizing the firm’s total long-term market value is the right objective function. The words “long-term” are key here. As Jensen notes,
In this way, enlightened stakeholder theorists can see that although stockholders are not some special constituency that ranks above all others, long-term stock value is an important determinant (along with the value of debt and other instruments) of total long-term firm value. They would recognize that value creation gives management a way to assess the tradeoffs that must be made among competing constituencies, and that it allows for principled decision making independent of the personal preferences of managers and directors.Jensen (2001), p. 17.
Even though shareholder value maximization is increasingly being challenged on pragmatic as well as moral grounds, its roots in private property law, however—a profound element in the American ethos—guarantee that it will continue to dominate the U.S. approach to corporate law for the foreseeable future. As a practical matter, the courts have given boards increasing latitude in determining what is in the best long-term interests of the corporation and how to take the interests of other stakeholders into account. This latitude makes it imperative that directors openly and fully discuss these issues and agree on a clear, unambiguous statement of purpose for the corporation. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/02%3A_Governance_and_Accountability/2.08%3A_Resolving_the_Conflict_-_Toward_Enlightened_Value_Maximization.txt |
From a legal perspective, the board of a public corporation is charged with setting a corporation’s policy and direction, electing and appointing officers and agents to act on behalf of the corporation, and acting on other major matters affecting the corporation. In this context, individual directors’ duties and responsibilities are described in the American Bar Association’s Corporate Director’s Guidebook, Fourth Edition (2004) with language, such as the following:
• in good faith. Acting honestly and dealing fairly. In contrast, a lack of good faith would be evidenced by acting, or causing the corporation to act, for the director’s personal benefit or for some purpose other than to advance the welfare of the corporation and its economic interests and may also include acting on a corporate matter without making a reasonable effort to be appropriately informed.
• reasonably believes. Although the director’s honest belief is subjective, the qualification that it must be reasonable (i.e., based upon a rational analysis of the situation understandable to others) makes the standard of conduct also objective, not just subjective.
• best interests of the corporation. Emphasizing the director’s primary allegiance to the corporate entity.
• care. Expressing the need to pay attention, to ask questions, to act diligently to become and remain generally informed, and, when appropriate, to bring relevant information to the attention of the other directors. In particular, these activities include reading materials and engaging in other preparation in advance of meetings, asking questions of management until satisfied that all information significant to a decision is available to the board and has been considered, and requesting legal or other expert advice when appropriate to a board decision.
• person in a like position. Avoiding the implication of special qualifications and incorporating the basic attributes of common sense, practical wisdom, and informed judgment generally associated with the position of corporate director.
• under similar circumstances. Recognizing that the nature and extent of the preparation for and deliberations leading up to decision making and the level of oversight will vary, depending on the corporation concerned, its particular situation, and the nature of the decision to be made.See the Corporate Director’s Guidebook (4th ed., 2004), the American Bar Association.
This language provides guidance about how directors should comply with the underlying duty of care, the business judgment rule, and the duty of loyalty, briefly introduced in Chapter 2 "Governance and Accountability", which I restate here more formally:This book focuses on the most important laws aimed at guiding directors’ behavior. The reader should be aware that the law includes additional duties for directors such as “the duty not to entrench” and “the duty of supervision.”
• Duty of Care. The Duty of Care is the most important duty owed by a director to a corporation. A typical (state) corporation statute defining a director’s Duty of Care provides that a director’s duties must be performed “with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances.” This Duty of Care is very broad and requires directors to diligently perform their obligations.
• Business Judgment Rule. The Business Judgment Rule works in conjunction with the director’s Duty of Care. Under this rule, a director will not be held liable for mere negligence if exercising his or her Duty of Care. The rule can be stated as, “A director who exercises reasonable diligence and who, in good faith, makes an honest, unbiased decision will not be held liable for mere mistakes and errors in business judgment.” The rule protects directors from decisions that turn out badly for their corporation, even when the directors acted diligently and in good faith in authorizing the decision.
• Duty of Loyalty. The Duty of Loyalty exists as a result of the fiduciary relationship between directors and the corporation. A fiduciary relationship is defined as a relationship of trust and confidence, such as between a doctor and patient, or attorney and client. The nature of the relationship includes the concepts that neither party may take selfish advantage of the other’s trust and may not deal with the subject of the relationship in a way that benefits one party to the disadvantage of the other. A director must perform his or her duties in good faith and in a manner in which the director believes is in the best interests of the corporation and its shareholders. Essentially, this duty means that while serving a corporation, the director must give the corporation the first opportunity to take advantage of any business opportunities that he or she becomes aware of and that are within the scope of the corporation’s business. If the board of directors chooses not to take advantage of a business opportunity brought to its attention by a director, the director may then go forward without violating his or her duty.
Liability can exist for officers and directors when they cause financial harm to the corporation, act solely on their own behalf and to the detriment of the corporation, or commit a crime or wrongful act. Certain acts may subject an officer or director to personal liability, and other acts, although they would otherwise subject them to liability, may be either indemnified by or insured against by the corporation.Indemnification of officers and directors means that the corporation will reimburse them for expenses incurred and amounts paid in defending claims brought against them for actions taken on behalf of the corporation. Insurance policies can cover matters that cannot be indemnified under state law or in instances where the corporation does not have the financial resources to pay for the indemnification. Most state corporation statutes allow corporations to purchase insurance to cover matters resulting from acts taken by officers and directors. The goal of directors and officers insurance is to protect directors and officers of a corporation from liability in the event of a claim or lawsuit against them asserting wrongdoing in connection with the company’s business. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/03%3A_Role_and_Composition/3.01%3A_The_Boards_Responsibilities_-_The_Legal_Framework.txt |
What does the phrase “direct the affairs of the company” really mean? To provide greater clarity, numerous individuals and organizations have developed more specific descriptions in recent years. One frequently cited description was developed by the Business Roundtable:
• First, the paramount duty of the board of directors of a public corporation is to select the chief executive officer (CEO) and to oversee the CEO and senior management in the competent and ethical operation of the corporation on a day-to-day basis
• Second, it is the responsibility of management to operate the corporation in an effective and ethical manner to produce value for shareholders. Senior management is expected to know how the corporation earns its income and what risks the corporation is undertaking in the course of carrying out its business. The CEO and board of directors should set a “tone at the top” that establishes a culture of legal compliance and integrity. Management and directors should never put personal interests ahead of or in conflict with the interests of the corporation
• Third, it is the responsibility of management, under the oversight of the audit committee and the board, to produce financial statements that fairly present the financial condition and results of operations of the corporation and to make the timely disclosures investors need to assess the financial and business soundness and risks of the corporation
• Fourth, it is the responsibility of the board, through its audit committee, to engage an independent accounting firm to audit the financial statements prepared by management, issue an opinion that those statements are fairly stated in accordance with Generally Accepted Accounting Principles and oversee the corporation’s relationship with the outside auditor
• Fifth, it is the responsibility of the board, through its corporate governance committee, to play a leadership role in shaping the corporate governance of the corporation. The corporate governance committee also should select and recommend to the board qualified director candidates for election by the corporation’s shareholders
• Sixth, it is the responsibility of the board, through its compensation committee, to adopt and oversee the implementation of compensation policies, establish goals for performance-based compensation, and determine the compensation of the CEO and senior management
• Seventh, it is the responsibility of the board to respond appropriately to shareholders’ concerns
• Eighth, it is the responsibility of the corporation to deal with its employees, customers, suppliers and other constituencies in a fair and equitable manner.Business Roundtable (2005), p. 2.
Milstein, Gregory, and Grapsas (2006) take a somewhat broader perspective. First, they note, the board needs to take charge of its own focus, agenda, and information flow. This enables a board to provide management with meaningful guidance and support. It also helps the board focus its attention appropriately, determine its own agenda, and obtain the information it needs to make objective judgments. Second, the board must ensure that management not only performs but performs with integrity. Selecting, monitoring, and compensating management and, when necessary, replacing management, therefore continue to lie at the heart of board activity. Third, the board must set expectations about the tone and culture of the company. The standards of ethics and business conduct that are followed—or not followed—throughout a company impact the bottom line in many ways. “Tone at the top” should be a priority throughout the company and not viewed simply as a compliance matter. Fourth, the board should work with management to formulate corporate strategy. After agreeing to a strategic course with management through an iterative process, the board should determine the benchmarks that will evidence success or failure in achieving strategic objectives and then regularly monitor performance against those objectives. Fifth, it is the board’s duty to ensure that the corporate culture, the agreed strategy, management incentive compensation, and the company’s approach to audit and accounting, internal controls, and disclosure are consistent and aligned. And sixth, it is the board’s duty to help management understand the expectations of shareholders and regulators. Boards can help management recognize that shareholders have a legitimate interest in more meaningful input into the board selection process, in terms of both nominating procedures and voting methods. Similarly, boards can help management recognize and address the concerns that excessive compensation raises among shareholders, regulators, rating agencies, and others.Milstein, Holly, and Grapsas (2006, January).
Both descriptions are useful for developing a basic understanding of a board’s responsibilities. In broad terms, they fall into three categories: (a) to make decisions, (b) to monitor corporate activity, and (c) to advise management. The key issue here is deciding which board posture is appropriate at what time. While the law, corporate bylaws, and other documents frame many of the decisions a board must make, such as appointing a CEO or approving the financials, they do not provide much guidance with respect to the most important decision a board must make—when must board oversight become active intervention? For example, when should a board step in and remove the current CEO? When should directors veto a major capital appropriation or strategic move?
Lists never can fully capture the complexity and intricacies of the governance function because they do not consider the specific challenges associated with different governance scenarios. In particular, the precise role of a board will vary depending on the nature of the company, industry, and competitive situation and the presence or absence of special circumstances, such as a hostile takeover bid or a corporate crisis, among other factors.
The Nature of the Company, Industry, and Competitive Situation
It seems self-evident that a board’s role depends largely on the nature and the strategic challenges of the company and the industry. The challenges faced by small, private, or closely held companies are not the same as those of larger, public corporations. In addition to their traditional fiduciary role, directors in small companies often are key advisers in strategic planning, raising, and allocating capital, human resources planning, and sometimes even performance appraisal. In large public corporations, directors are focused more on exercising oversight than on planning, on capital allocation and control rather than on the raising of capital, and on management development and succession activities rather than on broader human resources responsibilities.
Public company ownership patterns are not homogeneous either, and different ownership structures may call for different governance approaches. The first, and most common, board situation is one in which a corporation has no controlling shareholder. In that case, directors should behave as if there is a single absentee owner whose long-term interests they serve. A primary responsibility for the board in this scenario is to appoint and, if necessary, change management, just as an intelligent owner would do if he were present. Commenting on individual director’s responsibilities in these circumstances, Buffett (1993) writes,
In this plain-vanilla case, a director who sees something he doesn’t like should attempt to persuade the other directors of his views. If he is successful, the board will have the muscle to make the appropriate change. Suppose, though, that the unhappy director can’t get other directors to agree with him. He should then feel free to make his views known to the absentee owners. Directors seldom do that, of course. The temperament of many directors would in fact be incompatible with critical behavior of that sort. But I see nothing improper in such actions, assuming the issues are serious. Naturally, the complaining director can expect a vigorous rebuttal from the unpersuaded directors, a prospect that should discourage the dissenter from pursuing trivial or non-rational causes.Buffett, annual letter to Berkshire Hathaway shareholders (1993).
The second situation occurs when the controlling owner is also the manager. At some companies, such as Google, this arrangement is facilitated by the existence of two classes of stock endowed with disproportionate voting power. In these situations, the board does not act as an agent between owners and management, and directors cannot affect change except through persuasion. Therefore, if the owner or manager is mediocre—or worse, is overreaching—there is little a director can do about it except object. And if there is no change and the matter is sufficiently serious, the outside directors should resign. Their resignation will signal their doubts about management, and it will emphasize that no outsider is in a position to correct the owner or manager’s shortcomings.Buffett (1993).
The third public corporation governance situation occurs when there is a controlling owner who is not involved in management. This case, examples of which are Hershey Foods and Dow Jones, puts the outside directors in a potentially value-creating position. If they become unhappy with either the competence or integrity of the manager, they can go directly to the owner (who may also be on the board) and make their views known. This situation helps an outside director, since he need make his case only to a single, presumably interested owner who can immediately make a change if the argument is persuasive. Even so, the dissatisfied director has only that single course of action. If he remains unsatisfied about a critical matter, he has no choice but to resign.Buffett (1993).
It will also be readily apparent that the role of the board will vary depending on the size of the company, the industries it serves, and the competitive challenges it faces. Global corporations face different challenges from domestic ones; the issues in regulated industries are different from those in technology or service industries, and high growth scenarios make different demands on boards than more mature ones. Finally, in times of turbulence or rapid change in the industry, boards often are called on to play a more active, strategic role than in calmer times. Special events or opportunities, such as takeovers, mergers, and acquisitions, fall into this category.
The Presence or Absence of Special Circumstances, Such as a Hostile Takeover Bid or a Corporate Crisis
Company crises can take on many different forms—defective products, hostile takeovers, executive misconduct, natural disasters that threaten operations, and many more. But, as boards know very well, they all have one thing in common: They threaten the stock price and sometimes the continued existence of the company. Some examples follow:
• In June 2008, with encouragement from federal regulators, JP Morgan executed a takeover bid for Wall Street giant Bear Stearns to prevent the bank’s collapse as a consequence of the U.S. mortgage debt crisis. The \$240 million acquisition price represented a substantial discount on its share price at the end of trading the week before, which valued the bank at around \$3.5 billion.
• In 2002, when allegations of insider trading against Martha Stewart were reported, the stock price of Martha Stewart Omnimedia fell some 40% in just 3 weeks.
• In 1993, an allegation of E. coli contamination in the beef served by the Jack in the Box hamburger chain caused the company’s share price to plummet from \$14 to about \$3 in a matter of hours.
• In 1985, A. H. Robins, the maker of the Dalkon Shield, an intrauterine device, was forced to declare bankruptcy, after collapsing under a wave of personal injury lawsuits.
As these examples attest, there are few situations in which directors’ fiduciary duties to shareholders are so clearly on view as in times of crisis.Jones (2007). | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/03%3A_Role_and_Composition/3.02%3A_A_Boards_Role_-A_Governance_Perspective.txt |
Beyond implementing reforms and best practices, boards are being counseled to become more involved.See, for example, Felton and Pamela Fritz (2005); and The State of the Corporate Board, 2007—A McKinsey Global Survey (2007, April). Rubber-stamping decisions, populating boards with friends of the CEO, and convening board meetings on the golf course are out; engagement, transparency, independence, knowing the company inside and out, and adding value are in. This all sounds good. There is a real danger, however, that the rise in shareholder activism, the new regulatory environment, and related social factors are pushing boards toward micromanagement and meddling.
This issue is troubling, and clear evidence that the important differences that separate governance from management—critical to effective governance—are still not sufficiently well understood by directors, executives, regulators, and the popular press alike. And regrettably, faced with the need to be more involved, the most obvious opportunity (and danger) is for boards to expand their involvement into—or, more accurately, intrude into—management’s territory.
The key issues are how and to whom boards add value.Carver (2007, November), pp. 1030–1037. Specifically, the potential of directors to add value is all too often framed in terms of their ability to add value to management by giving advice on issues such as strategy, choice of markets, and other factors of corporate success. While this may be valuable, it obscures the primary role of the board to govern, the purpose of which is to add value to shareholders and other stakeholders. John Carver, well-known governance consultant and author, does not mince words:
Governance is an extension of ownership, not of operations. Directors must be more allied with shareholders than with managers. Their mentality, their language, their concerns, their skills, their choice of interactions are subsets of ownership, not of management. As long as we view governance as übermanagement—focusing on management methods, strategies and planning—finding a new balance between micromanagement and detachment… will be hard to come by.Carver (2007, November), p. 1035.
A greater arms-length relationship between management and the board, therefore, is both desirable and unavoidable. Recent governance reforms focused on creating greater independence and minimizing managerial excess while enhancing executive accountability have already created greater tension in the relationship between management and the board. The Sarbanes-Oxley Act, for example, effectively asks boards to substitute verification for trust. Section 404 of the act requires management at all levels to “sign off” on key financial statements.
This is not necessarily bad because trust and verification are not necessarily incompatible. In fact, we need both. But we should also realize that effective governance is about striking a reasonable accommodation between verification and trust—not about elevating one over the other. The history of human nature shows that adversarial relationships can create their own pathologies of miscommunication and mismanaged expectations with respect to risk and reward. This makes defining the trade-offs that shape effective governance so difficult. Is better governance defined primarily by the active prevention of abuse? Or by the active promotion of risk taking and profitability? The quick and easy answer is that it should mean all of those things. However, as recurrent crises in corporate governance around the world have shown, it is hard to do even one of those things consistently well. What is more, a board trying to do all of these things well is not merely an active board; it is a board actively running the company. This is not overseeing management or holding management accountable—it is management. Therefore, the corporate governance reform agenda risks becoming an initiative that effectively dissolves most of the critical, traditional distinctions between the chief executive and the board.Macavoy and Milstein (2003).
3.04: Governance Guidelines
As part of the recent wave of governance reforms, the NYSE adopted new rules that require companies to adopt and publicly disclose their corporate governance policies. Specifically, the following subjects must be addressed in the guidelines:
• Director qualification standards. These standards, in addition to requiring independence, may also address other substantive qualification requirements, including policies limiting the number of boards on which a director may sit and director tenure, retirement, and succession.
• Director responsibilities. These responsibilities should clearly articulate what is expected from a director, including basic duties and responsibilities with respect to attendance at board meetings and advance review of meeting materials.
• Director access to management and, as necessary and appropriate, to an independent advisor. Clear policies should be adopted that define protocols for director access to corporate managers and identify situations when the board should retain external advisors.
• Director compensation. Director compensation guidelines should include general principles for determining the form and amount of director compensation (and for reviewing those principles, as appropriate).
• Director orientation and continuing education. Director orientation and continuing education should be the responsibility of the governance committee, if one exists. If the board does not have a separate governance committee, the full board, the nominating committee, or both, should have this responsibility.
• Management succession. Succession planning should include policies and principles for CEO selection and performance review, as well as policies regarding succession in the event of an emergency or the retirement of the CEO.
• Annual performance evaluation of the board. The board should conduct a self-evaluation at least annually to determine whether it and its committees and their individual directors are functioning effectively.
Best practice suggests that the board should review the guidelines at least annually. By elaborating on the board’s and directors’ basic duties, a carefully constructed set of governance guidelines will help both the board and individual directors understand their obligations and the general boundaries within which they will operate. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/03%3A_Role_and_Composition/3.03%3A_The_Boards_Role_-_Governance_Not_Management.txt |
Board Size
The optimal size of a board has been the subject of much debate in recent years. As a general proposition, smaller boards have a number of advantages over larger ones: They are easier to convene, require less effort to lead, and often have a more relaxed, informal culture. Research on group decision making supports the contention that smaller groups typically are more effective.The statistics in this chapter are taken from the Spencer Stuart Board Index 2007.
As a practical matter, however, board size should be governed by the skills needed to do the job. Larger corporations with more complex structures, substantial global interests, or multibusiness operations will require larger boards than smaller, mainly domestic, single-business firms. Today, the average Standard & Poor’s 500 board has 11 directors, compared to 18 directors about 25 years ago. It is unlikely boards will shrink further, however, as a result of new rules and proposals requiring that the audit, nominating or governance, and compensation committees of boards in publicly held companies be composed of independent directors only, in some cases, with specialized expertise (audit committee).
Board Membership
Fewer CEOs are accepting directorships, for two reasons. First, many boards—in the wake of the recent scandals and the Sarbanes-Oxley legislation—now insist that the chief executive concentrate fully on his or her job and restrict the number of outside boards the CEO can serve or, in some cases, prohibit it altogether. Second, as boards expand their role to areas, such as company strategy, they look for directors who have risen through specific functional areas in which the company must excel in order to compete effectively—sales and marketing, global operations, manufacturing, and others. And, in the aftermath of Sarbanes-Oxley, directors with a background in finance, especially chief financial officers (CFOs), are in strong demand.Heidrick and Struggles (2006).
For a while, it looked as though the reduced availability of CEOs and the growing demand for specialized directors would significantly reduce the talent pool of qualified directors and make it even more difficult for companies to attract new board members. Fortunately, this has not proven to be the case. If anything, the talent pool has become larger as boards are changing the definition of what constitutes a qualified candidate and widening their search. Instead of focusing almost exclusively on CEOs as candidates for the board, companies are increasingly tapping division presidents and other executives who have experience running large operations or bring specialist expertise. The redefinition of director qualifications has also expanded the talent pool of diversity candidates who may not have risen to chief executive but excel in a critical, functional area.
These changes do not mean that attracting qualified directors has become easier. Although the pool of qualified candidates is larger, many candidates are far more reluctant to serve. More than ever, candidates perform extensive due diligence about the companies recruiting them and look for ways to mitigate as much as possible the risk of associating themselves with a disaster or incurring personal liability. They are also far more critical and objective about their ability to add value, particularly in complex organizations, such as conglomerates, or industries like financial services and insurance. The overwhelming reason why candidates decline to serve, however, remains a lack of time. Given their already enormous responsibilities, many qualified and desirable director candidates feel that they will be unable to devote adequate attention to the job.
Director Independence
The proposition that boards should “act independently of management, through a thoughtful and diligent decision-making process,” has been a major focus of corporate governance reform in recent years.Macavoy and Milstein (2003), pp. 22–23. In the United States, the Sarbanes-Oxley Act of 2002, as well as the revised NYSE and NASDAQ listing rules, as affirmed by the SEC, are premised on a belief that director independence is essential to effective corporate governance. In the United Kingdom, the Cadbury Commission’s report of 1990—The Code of Best Practice—included a recommendation for having at least three nonexecutive directors on the board. Currently, reflecting this broad consensus, about 10 out of the average 12 directors of a major U.S. public company board are nonexecutives; in the United Kingdom, the corresponding number is a little less than half.
The idea of an independent board is intuitively appealing. Director independence, defined as the absence of any conflicts of interest through personal or professional ties with the corporation or its management, suggests objectivity and a capacity to be impartial and decisive and therefore a stronger fiduciary. At times a board needs to discuss issues that involve some or all of the company’s senior executives; this is difficult to do with senior executives on the board. The independence requirement also stops destructive practices, such as “rewarding” former CEOs for their accomplishments by giving them a role on the board. Having the former CEO on the board almost always limits the ability of the new CEO to develop his or her own relationship with the board and put his or her imprint on the organization. There is also limited evidence that outsider-dominated boards are more proactive in firing underperforming CEOs and less willing to go along with outsized compensation proposals or vote for poison pills.
Director independence should not be viewed as a proxy for good governance, however. At times, not having more insiders on the board actually can reduce a board’s effectiveness as an oversight body or as counsel to the CEO. Independent, nonexecutive directors can never be as knowledgeable about a company’s business as executive directors or senior managers. CEOs say that some of their most valuable directors are those with experience in the same industry, counter to current independence tests. The higher the proportion of outside directors, therefore, the more difficult it is to foster high-quality, deep board deliberations. Moreover, it is less likely that a CEO can mislead a board, intentionally or otherwise, when some of the directors are insiders who also have intimate knowledge of the company.Carter and Lorsch (2004), p. 93. Boards mostly comprised of independent directors must, at a minimum, therefore, create regular opportunities to interact with senior executives other than the CEO. The more complex a company’s business is, the more important such communications are.
The bottom line is that effective corporate governance does not depend on the independence of some particular subset of directors but on the independent behavior of the board as a whole. The focus should be on fostering board independence as a behavioral norm, a psychological quality, rather than on quasi-legal definitions of director independence. Director independence can contribute to but is no guarantee for better governance. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/03%3A_Role_and_Composition/3.05%3A_Recent_Board_Trends.txt |
CEO Positions?
Few issues in corporate governance are as contentious as the question of whether the roles of chairman and CEO should be separated or combined. In the United Kingdom, about 95% of all Financial Times Stock Exchange (FTSE) 350 companies adhere to the principle that different people should hold each of these roles. In the United States, by contrast, most companies still combine them, although the idea of splitting the two roles is gaining momentum. In the last 2 years, Boeing, Dell, the Walt Disney Company, MCI, Oracle, and Tenet Healthcare all have done so, and a new study finds that roughly one third of U.S. companies have adopted such a split-leadership structure, up from a historical level of about one fifth.This finding is reported in a September 2004 study of more than 2,500 companies across the world by Governance Metrics International, the New York–based corporate governance ratings agency.
Arguments for splitting the two roles, emanating chiefly from the United Kingdom—and other countries that overwhelmingly embrace the idea of separate roles (particularly Germany, the Netherlands, South Africa, Australia, and, to a lesser extent, Canada)—reflect four schools of thought.Coombes and Wong (2004).
The first is that the separation of the chairman and CEO positions is a key component of board independence because of the fundamental differences and potential conflicts between these roles. The CEO runs the company—the argument goes—and the chairman runs the board, one of whose responsibilities it is to monitor the CEO. If the chairman and the CEO are one and the same, it is hard for the board to criticize the CEO or to express independent opinions. A separate chairman, responsible for setting the board’s agenda, is more likely to probe and encourage debate at board meetings. Separating the two roles is, therefore, essentially a check on the CEO’s power.
A second argument is that a nonexecutive chairman can serve as a valuable sounding board, mentor, and advocate to the CEO. Proponents of this view note that CEOs today face enough challenges without having to run the board and that a relationship with the chairman based on mutual trust and regular contact is good for the CEO, shareholders, and the company. For this to happen, however, it is essential that, from the outset, the two roles be clearly defined to avoid territorial disputes or misunderstandings.
A third reason for supporting the two-role model is that a nonexecutive chairman is ideally placed to assess the CEO’s performance, taking into account the views of fellow board directors. Advocates maintain that the presence of a separate, independent chairman can help maintain a longer term perspective and reduce the risk that the CEO will focus too much on shorter term goals, especially when there are powerful incentives and rewards to do so. They add that he is also in a good position to play a helpful role in succession planning. And when a CEO departs, voluntarily or otherwise, the chairman’s continued presence in charge of the board can reduce the level of trauma in the business and the investor community.
A fourth and final argument concerns the time needed to do both jobs and do them well. It can be argued that as companies grow more complex, a strong board is more vital than ever to the health of the company, and this requires a skilled chairman who is not distracted by the daily pull of the business and can devote the required time and energy. This may take one or more days per week and involve such tasks as maintaining contact with directors between meetings, organizing board evaluations, listening to shareholder concerns, acting as an ambassador for the company, and liaising with regulators, thereby allowing the CEO to concentrate on running the business.
Although these arguments increasingly resonate with U.S. directors and shareholders, many CEOs resist the change. Why, they ask, should corporate wrongdoing at a small number of S&P 500 companies be a compelling reason for changing a system that has worked well for so long? Moral and ethical failures are part of the human condition, they note, and no rules or regulations can guarantee the honesty of a leader. Some allow that, at times, a temporary split in roles may be desirable or necessary—when a company is experiencing a crisis, for example, or when a new CEO is appointed who lacks governance and boardroom experience. But they maintain that such instances are infrequent and temporary and do not justify sweeping change. Overall, they argue, the combined model has served the U.S. economy well, and splitting the roles might set up two power centers, which would impair decision making.
Critics of the split-role model also point out that finding the right chairman is difficult and that what works in the United Kingdom does not necessarily work in the United States. Executives in the United Kingdom tend to retire earlier and tend to view the nonexecutive chairman role (often a 6-year commitment) as the pinnacle of a business career. This is not the case in the United States, where the normal retirement age is higher.
To allay concerns that combined leadership compromises a board’s independence, opponents of separation have proposed the idea of a “lead director”: a nonexecutive who acts as a link between the chairman–CEO and the outside directors, consults with the chairman–CEO on the agenda of board meetings and performs other independence-enhancing functions. Some 30% of the largest U.S. companies have taken this approach. Its defenders claim that—combined with other measures, such as requiring a majority of independent directors and board meetings without the presence of management—this alternative obviates the need for a separate chairman.
On balance, the arguments for separating the roles of chairman and CEO are persuasive because separation gives boards a structural basis for acting independently. And reducing the power of the CEO in the process may not be bad; compared with other leading Western economies, the United States concentrates corporate authority in a single person to an unusual extent.Coombes and Wong (2004). Furthermore, rather than create confusion about accountability, the separation of roles makes it clear that the board’s principal function is to govern—that is, to oversee the company’s management, and hence to protect the shareholders’ interests—while the CEO’s function is to manage the company well.
Separating the two roles, of course, is no guarantee for board effectiveness. A structurally independent board will not necessarily exercise that independence: Some companies with a separate chairman and CEO have failed miserably in carrying out their oversight functions. What is more, a chairman without a strong commitment to the job can stand in the way of board effectiveness. The separation of roles must therefore be complemented by the right boardroom culture and by a sound process for selecting the chairman. The challenge of finding the right nonexecutive chairman who must not only have the experience, personality, and leadership skills to mesh with the current board and management but also must show that the board is not a rubber stamp for the CEO, should not be underestimated. The ideal candidate must have enough time to devote to the job, strong interpersonal skills, a working knowledge of the industry, and a willingness to play a behind-the-scenes role. The best candidate is often an independent director who has served on the board for several years. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/03%3A_Role_and_Composition/3.06%3A_Board_Leadership_-_Should_We_Separate_the_Chairman_and_CEO_Positions.txt |
A greater and more effective use of committees also stands out as one of the key changes in board functioning over the last 50 years. Committees permit the board to divide up its work among the directors; they also allow board members to develop specialized knowledge about specific issues. The value of having standing committees has been recognized by the NYSE, the NASDAQ, and the Securities and Exchange Commission (SEC), and today public company boards are required to have independent audit, nominating (and governance), and compensation committees. In addition, a growing number of companies are creating board committees to better communicate with and stay abreast of the concerns of external stakeholders, referred to as public responsibility, corporate social responsibility, stakeholder relations, or external affairs committees.
The Audit Committee
The audit committee is charged with assisting the board in its oversight of (a) the integrity of the company’s financial statements and internal controls; (b) compliance with legal and regulatory requirements, as well as the company’s ethical standards and policies; (c) the qualifications and independence of the company’s independent auditor and the performance of the company’s internal audit function and its independent auditors; and (d) preparing the audit committee report for inclusion in the company’s annual proxy statement. The committee typically consists of no fewer than three members, all of whom must meet the independence and experience requirements of the NYSE and rule 10A-3 under the Securities Exchange Act of 1934, which hold that each member of the Committee must be financially “literate” and at least one member of the committee must have accounting or related financial management expertise (the so-called audit committee financial expert). Its members, including the committee chair, usually are appointed by the board on the recommendation of the nominating and governance committee.
The Nominating (and Governance) Committee
The nominating (and governance) committee has multifacetted responsibilities and is typically charged with recommending new candidates for the board of directors and determining (a) the eligibility of proposed candidates, (b) reviewing the company’s governance principles and practices, (c) establishing and overseeing self-assessment by the board, (d) recommending director compensation, and (e) implementing succession planning for the CEO. The nominating (and governance) committee normally consists of three or more independent directors; its members and chair are usually appointed by the board on the recommendation of the chairman of the board.
The Compensation Committee
The compensation committee is charged with duties related to human resources policies and procedures, employee benefit plans, and compensation. It is also responsible for preparing a report on executive compensation for inclusion in the company’s annual proxy statement. It typically consists of three or more independent members; its members are normally appointed by the board on the recommendation of the chairman of the board with the concurrence of the nominating (and governance) committee.
Other Board Committees
In addition to these standing committees, a growing number of companies make use of ad hoc committees to address specific issues—a strategy committee to look at different growth options, for example, or a finance committee to develop recommendations to recapitalize the company. While ad hoc committees can be useful, they should have clear sunset clauses to prevent their institutionalization or a balkanization of the board on important issues.
Committees can also be used to send specific signals to employees or external stakeholders about what is important to the company. A growing number of boards are creating committees to better communicate with and stay abreast of the concerns of external stakeholders. Names for such committees include the corporate social responsibility, stakeholder relations, external affairs, or public responsibilities committees. For example, the board of General Electric has created a public responsibilities committee to review and oversee the company’s positions on corporate social responsibilities and public issues of significance that affect investors and other GE key stakeholders.
Finally, most bylaws make provision for an executive committee, usually consisting of the chair, the CEO and other designated officers of the company, and key directors, such as the chairs of the standing committees. In theory, the executive committee has the power to act for the full board in case of emergencies or when there is no time for the full board to meet and deliberate, although this is fraught with danger. Fortunately, advances in communication technology have made executive committees increasingly redundant, and their use has all but disappeared from the corporate governance landscape.
Director Compensation
Setting director pay typically is not done by the compensation committee of the board. Rather, director pay decisions normally are made by the nominating committee. The justification for this structure is twofold. First, it provides for a separation of the director and executive compensation decisions. Second, it allows the nominating committee to integrate compensation with board-building strategies.
The job of director has become significantly more challenging in recent years; it demands stronger qualifications, requires more time, and increasingly carries personal financial risk. In this new governance climate, the pool of available independent directors has shrunk and pushed up director pay. Directors are typically paid with a mix of cash and equity, with equity representing about half of the total direct compensation. Nonemployee chair and lead-director pay is generally structured like that of other directors on the board (retainer, meeting fees, and equity), while employee, non-CEO chairs are typically paid like an employee (salary, incentives, and benefits). A majority of companies pay a premium to committee chairs—especially audit and compensation committee chairs—reflecting the increased time commitment and additional responsibility. With respect to the equity component of director compensation, companies have reduced their reliance on stock options and increased the use of full-value awards. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/03%3A_Role_and_Composition/3.07%3A_Board_Committees_and_Director_Compensation.txt |
In the aftermath of the governance scandals around the turn of the century, the government, regulatory authorities, stock exchanges, investors, ordinary citizens, and the press all began to scrutinize the behavior of corporate boards much more carefully than they had at anytime before. The result was an avalanche of structural and procedural reforms aimed at making boards more responsive, more proactive, and more accountable, and at restoring public confidence in U.S. business institutions.For a more detailed summary of these and related governance reforms, see, for example, Morgan Lewis, Counselors at Law, “Corporate Governance: An Overview of Recently Adopted Reforms” (2004); or Petra, “Corporate Governance Reforms: Fact or Fiction, Corporate Governance” (2006), pp. 107–115.
The congress passed the Sarbanes-Oxley Act of 2002, which imposes significant new disclosure and corporate governance requirements for public companies and also provides for substantially increased liability under the federal securities laws for public companies and their executives and directors. Subsequently, the NYSE, NASDAQ, and AMEX adopted more comprehensive reporting requirements for listed companies, and the Securities and Exchange Commission (SEC) issued a host of new regulations aimed at strengthening transparency and accountability through more timely and accurate disclosure of information about corporate performance.
The most important changes concern director independence and the composition and responsibilities of the audit, nominating, and compensation committees. Additional reforms address shareholder approval of equity compensation plans, codes of ethics and conduct, the certification of financial statements by executives, payments to directors and officers of the corporation, the creation of an independent accounting oversight board, and the disclosure of internal controls. They are described in some detail in Chapter 12 "Appendix A: Sarbanes-Oxley and Other Recent Reforms" of this book.
It is important to understand the rationale behind some of the most far-reaching reforms. The rationale for increasing director independence was that shareholders, by virtue of their inability to directly monitor management behavior, rely on the board of directors to perform critical monitoring activities and that the board’s monitoring potential is reduced or perhaps eliminated when management itself effectively controls the actions of the board. Additionally, outside directors may lack independence through various affiliations with the company and may be inclined to support management’s decisions in hopes of retaining their relationship with the firm. Requiring a board to have a majority of independent directors, therefore, increases the quality of board oversight and lessens the possibility of damaging conflicts of interest.
Audit committee reforms are among the most important changes mandated by Sarbanes-Oxley. The reasons behind these reforms are self-evident. Audit committees are in the best position within the company to identify and act in instances where top management may seek to misrepresent reported financial results. An audit committee composed entirely of outside independent directors can provide independent recommendations to the company’s board of directors. The responsibilities of the audit committee include review of the internal audit department, review of the annual audit plan, review of the annual reports and the results of the audit, selection and appointment of external auditors, and review of the internal accounting controls and safeguard of corporate assets.
Compensation committee reforms respond to the unprecedented growth in compensation for top executives and a dramatic increase in the ratio between the compensation of executives and their employees over the last 2 decades. A reasonable and fair compensation system for executives and employees is fundamental to the creation of long-term corporate value. The responsibility of the compensation committee is to evaluate and recommend the compensation of the firm’s top executive officers, including the CEO. To fulfill this responsibility objectively, it is necessary that the compensation committee be composed entirely of outside independent directors.
Nominating new board members is one of the board’s most important functions. It is the responsibility of the nominating committee to nominate individuals to serve on the company’s board of directors. Placing this responsibility in the hands of an independent nominating committee increases the likelihood that chosen individuals will be more willing to act as advocates for the shareholders and other stakeholders and be less beholden to management. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/04%3A_Recent_U.S._Governance_Reforms/4.01%3A_Recent_Governance_Reforms_-_An_Executive_Summary.txt |
To assess the efficacy of the new regulations, it is useful to ask whether Sarbanes-Oxley, the new accounting rules, or any of the other reforms would have prevented some or all of the (U.S.) 2001 scandals. In an insightful paper, Edwards asks four key questions:Edwards (2003).
1. What motivated executives to engage in fraud and earnings mismanagement? Or, put differently, is there a fundamental misalignment between management’s and shareholder interests and, if so, what are the causes of this misalignment?The term “earnings mismanagement” is used in the widest sense to include not only reporting that is illegal or inconsistent with accepted accounting standards but also statements that, while within accepted legal accounting standards, are primarily meant to deceive investors about the company’s true financial condition
2. Why did boards either condone or fail to recognize and stop managerial misconduct and allow managers to deceive shareholders and investors? Are the incentives of board members properly aligned with those of shareholders?
3. Why did external gatekeepers (e.g., auditors, credit rating agencies, and securities analysts) fail to uncover the financial fraud and earnings manipulation, and alert investors to potential discrepancies and problems? What are the incentives of gatekeepers, and are these consistent with those of shareholders and investors?
4. Why were shareholders themselves not more vigilant in protecting their interests, especially large institutional investors? What does this say about the motivations and incentives of money managers?
The Link Between Compensation Structure and Earnings (Mis)Management
As Edwards notes, it is now widely recognized that the dramatic changes in the compensation structure of American executives adopted in the 1990s were a significant contributing factor to the higher incidence of “earnings (mis)management.” Consider that, in 1989, only less than 5% of the median CEO pay of the Standard & Poor’s 500 industrial companies was equity-based—95% or more consisted of salary and cash bonuses—but by 2001, equity-based components had grown to two thirds of the median CEO compensation.Hall and Murphy (2002), p. 42. Since stock options accounted for most of this increase, executive pay became far more sensitive to short-term corporate swings in performance.It is now also recognized that a change in tax law—the addition of section 162(m) to the IRS code—was a major contributor to the increased use of stock options. For more on this subject, see Chapter 8 "CEO Performance Evaluation and Executive Compensation" in this volume. As long as stock prices climbed, executives could exercise these options profitably. The incentive to report (or misreport) continued favorable company performance was therefore substantial. Enron’s executive compensation was closely linked to shareholder value. Enron senior managers, therefore, had a strong incentive to increase earnings and the company’s (short-term) stock price.Edwards (2003).
This analysis suggests that we must reevaluate how equity-based compensation is used to motivate executives and, in particular, whether there are pay structures that mitigate or eliminate incentives to misreport. The basic rationale behind equity-based compensation is sound: to motivate managers and better align manager and stockholder interests. But such pay structures must promote long-term value creation rather than reward short-term fluctuations in share prices.
Were Boards Asleep at the Switch?
Why were boards not more alert to managerial misbehavior? To answer this question, Edwards once again turns to the Enron scandal.Edwards (2003). The company met or exceeded most governance standards. Its 14-member board had only 2 internal executives: its chairman and former CEO Kenneth Lay and President and CEO Jeffrey Skilling. The remainder of the board consisted of 5 CEOs, 4 academics, a professional investor, the former president of one of Enron’s wholly owned subsidiaries, and a former U.K. politician. So, on paper, at least, the vast majority of Enron’s directors met the “independence” requirement.See Enron’s proxy statement, May 1, 2001. Subsequent to Enron’s collapse, the independence of some Enron directors was questioned by the press and in Senate hearings because some directors received consulting fees in addition to board fees. Enron had made donations to groups with which some directors were affiliated and had also done transactions with entities in which some directors played a major role. Moreover, all had a significant ownership stake in Enron, so their interests should have been aligned with those of Enron’s shareholders.The beneficial ownership of the outside directors reported in the 2001 proxy ranged from \$266,000 to \$706 million. See Gillan and Martin (2002), p. 23.
Enron’s board structure was also strong; the audit (and compliance), compensation (and management development), and nominating (and corporate governance) committees all were made up outside independent directors. In fact, the audit committee’s state-of-the-art charter made it the “overseer of Enron’s financial reporting process and internal controls,” with “direct access to financial, legal, and other staff and consultants of the company,” and the power to retain other (outside) accountants, lawyers, or whichever consultants it deemed appropriate.See Gordon (2003).
Yet, what actually happened at Enron is very different. The Congressional Subcommittee on “The Role of the Board of Directors in Enron’s Collapse” concluded that the board failed in its fiduciary duties (its duties of care, loyalty, and candor) because it permitted high-risk accounting, inappropriate conflict of interest transactions, extensive undisclosed off-the-books activities, inappropriate public disclosure, and excessive compensation.This subcommittee is administered by the Permanent Subcommittee on Investigations, Committee on Governmental Affairs, United States Senate, July 8, 2002.
Whether or not this is a fair assessment of Enron’s board performance, it shows that in an environment of short-term, equity-based incentives combined with less than transparent financial disclosure, the potential for manipulating financial results is real and that boards must be especially diligent. Many believe the Enron board did not meet this higher standard of care.
Would Sarbanes-Oxley and the new NYSE governance rules have prevented the Enron debacle? It is hard to say. The company already met some of the new requirements, such as independence for board members and key committees. Others, for example, the new rules requiring the elimination of conflicts of interest among board members and greater disclosure of off-balance sheet arrangements and other transactions to investors, might have made a difference. In the end, however, it is highly questionable whether ethical behavior can be legislated into being. Changing the ethics of business behavior and the “sociology” of the boardroom cannot be accomplished through structural changes alone; they require fundamental cultural change, which is a far greater challenge. In his 2003 letter to shareholders, Warren Buffett summed it up well when he confessed he had often been silent on management proposals contrary to shareholders interests while serving on 19 boards since the 1960s. Most boards, he said, had an atmosphere where “collegiality trumped independence.”Warren Buffett’s letter to Berkshire Hathaway shareholders, as quoted in USA Today, March 31, 2003.
Did the Gatekeepers Fail?
What role could gatekeepers—external auditors, investment bankers, analysts, and credit rating agencies—have played in staving off the Enron and other scandals?
As noted in Chapter 1 "Corporate Governance: Linking Corporations and Society", one view holds that gatekeepers are motivated and well positioned to monitor corporate behavior because their business success ultimately depends on their credibility and reputation with investors and creditors. Lacking this credibility, why would firms even employ gatekeepers? While this may be true, we should also inquire whether the interests of gatekeepers may be more closely aligned with those of corporate managers than with investors and shareholders. Gatekeepers, after all, are typically hired, paid, and fired by the very firms that they evaluate or rate, and not by creditors or investors.Edwards (2003). This holds for auditors, credit rating agencies, lawyers, and, as we learned in a number of high-profile law suits, security analysts as well those whose compensation (until recently) was directly tied to the amount of related investments banking business their employers (the investment banks) did with the firms that they evaluated.As noted by Edwards (2003), Citigroup paid \$400 million to settle government charges that it issued fraudulent research reports; and Merrill Lynch agreed to pay \$200 million for issuing fraudulent research in a settlement with securities regulators and also agreed that, in the future, its securities analysts would no longer be paid on the basis of the firm’s related investment-banking work. Also see Coffee (2002, 2003a, 2003b); Stewart and Countryman (2002). Thus, an alternative view is that most gatekeepers are inherently conflicted and cannot be expected to act in the interests of investors and shareholders. And while recent reforms separating consulting from auditing services, restoring the “Chinese Wall” between analysts and investment banks, and mandating term limits for auditors help mitigate these problems, it is unlikely that they would have prevented or minimized scandals, such as Enron and WorldCom.
Could Institutional Shareholders Have Made a Difference?
It is a basic tenet of free-market capitalism that the system rests on the effective ownership of private property—that is, that owners choose how their assets are used to their best advantage.The popular question, “Do you know anyone who washes a rental car?” is appropriate here. Yet, the largest single category of personal property—stocks and shares (including the beneficial interest in stocks and shares held collectively via investment institutions, mainly to provide retirement income)—lack effective ownership. Those who hold shares directly—in the United States, 50% of all shares are held directly—are individually so small as to be virtually powerless. Only if shareholders can unite effectively—and, in practice, this applies only to institutional shareholders—will corporate managements be held accountable. This seldom happens except in a rare corporate crisis, by which time the damage often has been done.
In the United States, more than half of all shares are owned by life insurance companies, mutual funds, and pension funds. So-called 401(k) plans, retirement savings plans funded by employee contributions and matching contributions from the employer, have become a major factor. Mutual funds compete heavily for this business. In theory, therefore, their corporate governance activities, if any, can make a crucial difference. With the exception of few public pension funds, however, institutional investors have not played an active role in monitoring corporations. Instead, they have been content to do nothing or simply sell the stock of companies where they disagree with management’s strategy. One could argue this behavior is rational. Any other course of action is likely more costly and less rewarding for their shareholders and beneficiaries. Moreover, institutional fund managers themselves have serious conflicts of interests that incentivize them against direct intervention to prevent corporate misconduct. Their compensation—typically a flat percentage of assets under management—depends largely on the amount of assets under management. Retirement funds originating with corporations have been the most important source of new funds. Mutual fund managers, therefore, are unlikely to engage in corporate governance actions that antagonize corporate managers for fear of losing these pension funds. The law also discourages institutional investors from acquiring large positions in companies and taking a direct interest in corporate affairs, which would give institutional investors a greater incentive to engage in active corporate governance. For example, the “five and ten” rule in the Investment Company Act of 1940 is a clear attempt to limit mutual fund ownership, and section 16(b) of the Securities and Exchange Act of 1934 (the “short-swing profits” rule) discourages mutual funds from taking large equity positions and from placing a director on a portfolio company’s board of directors.The Securities and Exchange Act of 1934 requires that at least 50% of the value of a fund’s total assets satisfy two criteria: an equity position cannot exceed 5% of the value of a fund’s assets, and the fund cannot hold more then 10% of the outstanding securities of any company.
Thus, making institutional investors more active and more effective corporate monitors—while attractive from a theoretical perspective and consistent with the basic tenets of American capitalism—involves complex legal, structural, and philosophic issues: Should we encourage larger ownership in firms and more activism by institutional investors? What are the motives and incentives of fund managers, and are they likely to be consistent with those of shareholders? If we do want to encourage more institutional activism, do we want to encourage active ownership by all institutions and, in particular, by public pension funds, which may be conflicted by public or political interests? Finally, what structural and legal changes must be made to change the culture of institutional passiveness and bring about more activism?These questions are adapted from Edwards (2003). We also note that the Securities and Exchange Commission (SEC) recently made progress on this issue by requiring that a majority of mutual fund boards be comprised of “independent” directors, and by changing the definition of “independence” to be the same as that employed by Sarbanes-Oxley and the New York Stock Exchange. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/04%3A_Recent_U.S._Governance_Reforms/4.02%3A_Analysis_-_Stronger_Governance_or_Regulatory_Overkill.txt |
Has investor confidence been restored? Were the various regulatory changes effective? How sound is the American corporate governance today? As we begin to answer these questions, it is important to note that the U.S. corporate governance system has been roundly criticized and the subject of vigorous debate for many years. In 1932 Berle and Means warned that changes in ownership patterns would foreshadow “governance co-opted by management”; Mace has likened boards to “ornaments on a Christmas tree”; Drucker said boards “do not function”; while Gillies proclaimed that “boards have been largely irrelevant throughout most of the twentieth century.”Berle and Means (1932), p. 62; Mace (1971), p. 3; Drucker (1974), p. 628; and Gillies (1992), p. 3. A widely read book by Lorsch and MacIver has the colorful title Pawns or Potentates.Lorsch and MacIver (1989). Perhaps the most cynical observation comes from an anonymous executive quoted by Leighton and Thain (1997): “Our board is like a bunch of ants… on top of a big log carried by a turbulent current swiftly down a river. The ants think they are steering the log.”Leighton and Thain (1997), p. 51.
Robert Monks, pioneer among shareholder activists, founder of Institutional Shareholder Services (ISS), and well-known author on corporate governance–related subjects, recently expressed his skepticism this way:
There is almost universal agreement that corporate governance in America is failing. There was a large window of opportunity following public revulsion with the scandals of the 1990s. That energy has dissipated and virtually no “real” reform has occurred. We are in the “worst of times”—unignorable evidence of governance failure persists from the comic criminal of Health Care South to the nearly noble Royal Dutch Shell; equally unignorable is the failure on all sides to come up with credible improvement. Instead, companies complain of the cost of compliance with new laws and threaten to tie up proposals in appellate court litigation; reformers complain of the failure of new initiatives.Monks (2005, March), p. 108.
Monks continues,
Similarly, appearance and reality are conspicuously at variance with respect to recent governance “reforms.” So much attention has been paid to such widely discussed “apparent” reforms as the NYSE listing requirements and Sarbanes Oxley (“SOX”) that observers fail to note the fundamental difference between process and substance. Business leaders exacerbate the problem by polluting public dialogue with complaints of “governance fatigue.” In reality, only a cynic or an incurable optimist could detect real reform in recent enactments.Monks (2005, March), p. 109.
He concludes,
I have recently argued that most of the observed problems of governance failure arise out of the excessive power lodged in the Chief Executive Officers. Persons having power are reluctant to give it up. This is the problem, and this is the challenge. Governance is stuck in the mode of confrontation between owners and managers and the managers have won. The informing energy of business is greed; solutions that are not based in economic incentives will certainly fail. Reform proposals will be credible only to the extent they make desired action profitable. Nothing by way of change will happen unless the various corporate constituencies can achieve profits through compliance.Monks (2005, March), p. 109.
Real change, Monks (2005) argues, should focus on making shareholder responsibility a reality by removing the “many biases in the current legal/regulatory/institutional structure of governance.” Monks makes a number of intriguing, sometimes politically controversial and challenging, proposals, such as placing a tax incentive on term ownership to encourage long-term holding of securities and discourage “churning,” increasing the role of shareholders in the nomination of directors to achieve true director independence, and splitting outstanding common equity into two classes—“ownership” and “trading” shares—to more meaningfully engage institutional owners in the governance process. Calling CEO compensation the “smoking gun” of governance failure, he also urges the restoration of CEO pay to credible levels, even if this means changing existing agreements.Monks (2005, March), p. 110.
Despite all this skepticism, a reasonable argument can be made that the broad evidence is not consistent with a failed U.S. system. On the whole, the U.S. economy and stock market have performed well, both on an absolute basis and relative to other countries over the past 2 decades, even after the scandals broke. And while parts of the U.S. corporate governance system clearly failed under the exceptional strain of the 1990s, the overall system, which includes oversight by the public and the government, reacted quickly to address the problems. On balance, most of the reforms that have been enacted are welcomed. Along with other increasingly common board features—periodic self-evaluation, for example, and requiring that directors own a significant amount of company stock—they have, by and large, had a positive effect on governance and, indirectly, on company performance. This is not to deny that significant issues persist, however.
Perhaps the most visible and contentious unsolved problem is runaway executive compensation. A growing number of investors and directors, upset with absolute levels of pay and with forms of compensation that are not aligned with long-term corporate performance, want concrete change. Shareholder activists are pushing additional reforms. They continue to press, for example, for the right of shareholders to directly nominate and elect directors rather than work with the slate recommended by the board’s nominating committee. Another proposal asks that shareholder resolutions receiving majority support become binding upon boards and that shareholder votes on merger proposals be made mandatory. Support for these further proposals has been lukewarm, however, because they tend to undermine rather than strengthen the role of the board.
Others complain that the recent wave of reforms has been too narrow in focus—exclusively aimed at the immediate interests of shareholders—and has not addressed or even seriously contemplated the broader set of stakeholder concerns and societal pressures that is emerging on issues, such as companies’ growing political influence, sustainable business practices, and various dimensions of corporate social responsibility.25. In academic terms, reforms enacted to date can be characterized as being primarily focused on addressing the so-called agency problem—the innate conflict that exists between owners (investors) and management, even though managers ostensibly act in the shareholders’ interests. For more on this issue, see Chapter 3 "The Board of Directors: Role and Composition".
Finally, there is a growing concern that the recent wholesale adoption of new rules and processes may have had a number of unanticipated, unintended, negative consequences. Regulation is, and always will be, an extremely blunt instrument for solving complex problems, and impacts different companies in different ways. Many smaller companies, for example, are struggling to cope with the additional regulatory burden and comply with the new law. In recognition of this fact, proposals allowing smaller companies to scale back or postpone compliance with some of the provisions in the Sarbanes-Oxley are now under active consideration.
4.04: The Challenge - Striking a Balance
While no one disputes the need for transparency, honesty, and accuracy, corporate governance is about much more than the accuracy of the income statement and balance sheet. Compliance is a means to an end. The numbers merely summarize and reflect the full array of decisions—from strategy to structure to process—that guide a corporation. Encouraging responsible, responsive governance rather than mere compliance should be the overriding goal and the principal focus of reform. Truly effective boards understand their obligations to shareholders, other stakeholders, and society at large. They grasp the strategic challenges faced by their companies and the role they play in assisting management in seizing competitive opportunity. They also understand the dynamics of the interplay between management and directors, and they value partnership over adversarial relationships without sacrificing independence. And, especially in smaller companies, they alert management to opportunities for growth, assist in raising capital, and provide a sounding board for management on issues of strategy, asset redeployment, and fiscal and legal affairs.
Unfortunately, evidence is emerging that some boards have become even more “defensive” than before in the face of an increased exposure to shareholder and legal action. And, although there is no critical shortage of qualified directors at this time, it is not unreasonable to ask whether the new regulatory environment has made it harder to attract the right talent to serve on boards. It is, therefore, time to ask some penetrating questions: Has the regulatory pendulum swung too far? Do more regulated boards produce greater value? For shareholders? For other stakeholders? For society? Could the additional regulatory burdens reduce business productivity and creativity, or even board assertiveness, especially in smaller firms?
As we start to address these issues, we should realize that there is no unique model for developing a highly effective and responsive board, nor is there a unique model for what such a board looks like, how it organizes itself, or how it operates. It is also unlikely that it can be legislated and regulated into being. As noted earlier, changing the ethics of business behavior and the “sociology” of the boardroom cannot be accomplished through structural changes alone. Instilling ethical behavior and creating a value-creating orientation is fundamentally an internal process that can only be successfully concluded with the complete support of both management and directors. It requires openness to self-examination, a willingness to question individual and collective roles, a resolve to address issues of process, and a receptivity to change. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/04%3A_Recent_U.S._Governance_Reforms/4.03%3A_Synthesis_-_What_Is_the_State_of_U.S._Corporate_Governance.txt |
• 5.1: CEO Selection - A Key Board Responsibility
Selecting a new chief executive arguably is a board’s most important responsibility. Yet, record CEO turnover points to distinct deficits in board performance in this area.
• 5.2: Succession Planning is an Ongoing Process
An effective succession-planning process does not end with the selection of a new CEO. The board must be ready to coach the candidate it chooses, especially in the first months, and it has to agree on how it will evaluate the CEO going forward. Unfortunately, this rarely happens. More than half of the boards surveyed say they have little or no formal process for evaluating the performance of their CEOs, despite the huge responsibility entrusted to them.
• 5.3: CEO Turnover - Different Scenarios, Different Challenges
The reasons for a CEO’s departure generally fall into one of four broad categories: (a) the CEO leaves to become the chief executive of another company; (b) the CEO retires or takes an extended leave of absence; (c) the board decides to replace the CEO with someone better suited for the current environment or for likely changes in strategy or market conditions; or (d) the company’s board fires a failing CEO.
• 5.4: CEO Selection - Common Board Mistakes
Many of the succession failures can be traced to a few common mistakes, all of which are exacerbated by a board’s lack of preparedness.
• 5.5: Insider or Outsider?
• 5.6: Grooming the Next CEO
• 5.7: Succession Planning- Best Practices
05: CEO Selection and Succession Planning
Selecting a new chief executive arguably is a board’s most important responsibility. Yet, record CEO turnover points to distinct deficits in board performance in this area. The results of the 2007 Spencer Stuart Board Survey of the Standard & Poor’s 500 companies provide important clues:
• CEO succession is on the board’s discussion agenda annually at 62% of responding companies and more than once a year at 34%.
• Still, a quarter of the survey respondents said they do not have an emergency succession plan.
• Primary board responsibility for succession planning is split nearly evenly between the nominating and governance committee (41%) and the compensation committee (40%). The remaining survey respondents cited a variety of players, including the full board, all independent directors and management development consultants.
• Remarkably, when asked how the board involves the CEO in the succession-planning process, half of the respondents said that the current CEO leads the process, while a quarter said that he or she is involved at the same level as all other directors.
• Fifty-eight percent said that the CEO suggests internal candidates to the board or committee handling succession and contributes to their evaluation.
• Of the 53% of boards that use a formal review process to assess potential successors, 44% said the process includes benchmarking of internal candidates against external ones.
• Another study by Mercer Delta Consulting (2006) revealed that almost half of corporate directors surveyed were dissatisfied with their involvement in the succession-planning process.Mercer Delta (2006), Governance Surveys. Time pressures play an important role. Large majorities reported devoting many more hours to more immediate concerns, such as monitoring accounting, the Sarbanes-Oxley Act, risk, and financial performance. They also said they spent less time interacting with and preparing potential successors than on any other activity. This is unfortunate because the board’s role in CEO succession is critical to effective governance; choose the right CEO, and all subsequent decisions become easier.
The list of high-profile failures is impressive: Gil Amelio of Apple, Durk Jager of Procter & Gamble, Doug Ivester of Coca-Cola, Jill Barad of Mattel, and, most recently, Robert Nardelli of Home Deport, just to name a few. All these former CEOs of major corporations have two things in common: They are talented, intelligent individuals with strong track records as managers and leaders, yet they all failed as CEOs. Some had been promoted from within to the CEO position, whereas others had been recruited from the outside following an extensive search. Some left on their own, whereas others were forced out.
The broader statistics are equally sobering; global CEO turnover set a new record in 2005, with more than one in seven of the world’s largest companies making a change in leadership, according to Booz Allen Hamilton’s most recent annual study of chief executive succession at the world’s 2,500 largest public companies. Fewer than half of the outgoing CEOs left their office willingly, the vast majority left because of poor performance.Lucier, Kocourek, and Habbel (2006).
What accounts for this high failure rate? Clearly, the job of being a CEO has become much more difficult in recent years, which, in part, accounts for their shorter tenures. In recognition of this fact, firms increasingly are splitting the function through a separate, nonexecutive chairman who deals with outside constituencies, such as customers, as Intel’s Andy Grove did, or with the financial community, as is the practice of U.K. firms. The model of the imperial CEO who commanded from the executive suite has long given way to the team leader model. In this model, CEOs are no less powerful, but the nature of power and influence has changed. Today’s CEOs can only succeed if they enable others around them to succeed. Trust is the new leadership currency. In a world of instant communication, CEOs cannot be everywhere; therefore, they are compelled to rely on others as never before, and others will, in turn, rely only on those with similar core values.
One problem is that the vast majority of board members have little or no experience with CEO selection and succession planning. As a result, search committees often approach their task with only the broadest of requirements rather than with a well-thought out list of a company’s real needs. The sociology of the selection process comes into play as well. As they screen candidates, directors may be seduced by reputation, when dealing with a Wall Street or media favorite, for example, or be blinded by charisma. However such inexperience manifests itself, the result is the same: Directors become so focused on what candidates are like that they fail to discover what candidates can and cannot do. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/05%3A_CEO_Selection_and_Succession_Planning/5.01%3A_CEO_Selection_-_A_Key_Board_Responsibility.txt |
Effective boards view succession planning as an ongoing activity that is integrated into the broader process of regularly thinking about the firm’s evolving strategy and emerging competitive threats and identifying the skills top executives need to execute that strategy. They know which value-creating activities the firm has chosen as the cornerstone to developing a competitive advantage and what skills a CEO needs to implement them effectively. They are not caught off guard when a new chief executive must be selected because, as a matter of principle, they never stop thinking about CEO succession.
Reaching this level of performance is extremely difficult. Large companies perform literally hundreds of interrelated, value-creating activities, making it difficult for even the best boards to clearly understand how these many activities create value and what a CEO can do to affect the success with which they are carried out. To get there, boards must develop better means for systematically obtaining relevant, specific information about how the company creates value. In many firms, their principal source of information is a thick binder of market data and analysts’ reports that is distributed 2 weeks before the next board meeting. How many directors have the time or inclination to comb through these binders? How do such masses of ill-digested information help them understand the value-creation process?Khurana, Rakesh, and Cohn (2003, Spring).
An effective succession-planning process does not end with the selection of a new CEO. The board must be ready to coach the candidate it chooses, especially in the first months, and it has to agree on how it will evaluate the CEO going forward. Unfortunately, this rarely happens. More than half of the boards surveyed say they have little or no formal process for evaluating the performance of their CEOs, despite the huge responsibility entrusted to them. Worse, those who do often focus on short-term, easily measured business goals and give little attention to longer term objectives or metrics, such as the ability to lead people and manage stakeholders or professional ethics. This short-term bias is clearly evident when it comes to CEO compensation: Short-term factors continue to dominate the decision process and compensation formulas.Felton and Fritz (2005).
5.03: CEO Turnover - Different Scenarios Different Challenges
A top executive’s departure has a significant impact on a company’s operations, culture, morale, and ability to execute against objectives. This is particularly true when the departing executive is the CEO.This section draws on “The board of directors’ role in CEO succession,” (2006) interview with Heidrick & Struggles, “Building high-performance boards”; and Lucier et al. (2006).
The reasons for a CEO’s departure generally fall into one of four broad categories: (a) the CEO leaves to become the chief executive of another company; (b) the CEO retires or takes an extended leave of absence; (c) the board decides to replace the CEO with someone better suited for the current environment or for likely changes in strategy or market conditions; or (d) the company’s board fires a failing CEO.
These first two scenarios force a board into a reactive posture; the departing executive initiates the event and the company must respond in some way. A board’s ability to effectively respond to such a scenario depends on many factors, but its preparedness and the amount of time it has to react are perhaps the most important. Unless comprehensive succession plans have been in place for a while, boards may have little choice but to recruit an outsider. One of the most compelling reasons for an effective succession-planning process is that the board will have a better understanding of the skills and competencies needed to lead the company going forward, and therefore will be in a better position to decide whether to go with an insider or an outsider and what qualifications the ideal candidate should have. Thus, a well-thought-out succession-planning process enhances the board’s ability to make an informed choice among prospects and broadens its portfolio of alternatives.
The last two scenarios involve a proactive change initiated by the board, and therefore represent different challenges. As painful and disruptive as it can be, the dismissal of a CEO often provides companies a much-needed opportunity to reexamine goals, strategies, and values. One scenario involves the replacement of an incumbent CEO who has been successful up to the present time but may not be the best person to lead the company in the future. Examples include the replacement of a company’s founder whose decisions have become detrimentally biased by emotion, of a private-company’s CEO by a professional manager with experience in taking companies public, of a growth company’s CEO in need of a leader familiar with rapid multinational expansion; or of a CEO of a company facing unprecedented competitive demands. A second even more traumatic scenario involves the dismissal of an underperforming CEO or a firing for cause.
A board’s decision to appoint transitional leadership during turnarounds, mergers, or acquisitions, initial public offerings (IPOs), restructurings, or other times of substantial change provides another example of a proactive change. The right interim CEO—tested in crisis and trusted by employees, creditors, and shareholders—can steer the company through its volatile period while the search for a permanent successor continues. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/05%3A_CEO_Selection_and_Succession_Planning/5.02%3A_Succession_Planning_is_an_Ongoing_Process.txt |
Many of the succession failures can be traced to a few common mistakes, all of which are exacerbated by a board’s lack of preparedness.This section is based on Lucier et al. (2006) and Charan (2005, February).
The first occurs when emotion wins over reason. There have been several instances in which boards of high-profile public companies over-reacted when challenged with the appointment of a new CEO. One way this can occur is when a board, under strong media pressure and financial analyst scrutiny, feels it needs to act quickly and ends up choosing a well-known “star” rather than deliberately doing homework and carefully defining the specific traits, competencies, and experiences appropriate to the position.
A critical lack of knowledge of what works and, equally important, what does not, is a second factor. A board facing the departure of a CEO has a number of options, each with advantages and disadvantages. Unfortunately, three of the most popular CEO replacement recipes do not seem to work well in practice. The first is selecting a prior CEO, someone with experience as the head of another large public company. Prior CEOs appear to bring important advantages. Many of them have a track record of creating shareholder value and already know how to work effectively with a board of directors, communicate with investors and security analysts, and develop and implement strategy. There is compelling evidence, however, that prior CEOs perform no better and sometimes worse than new, previously untested CEOs. This suggests that prior CEO experience may not be as valuable as experience in the company, in the industry, or with the types of challenges the company faces. It also points to the need for candidates to have a high level of energy to take on a major new challenge.
The most popular CEO replacement strategy is poaching a currently successful CEO from another large corporation. This strategy also reflects the belief that executive leadership is a generic skill set, not specific to either the industry or company. The current evidence regarding the efficacy of this strategy is thin because only a few of these CEOs have completed their career. If, however, the generally subpar results associated with hiring prior CEOs hold true for active CEOs hired from other companies, poaching may also be a losing proposition.
Both the prior CEO and poaching strategies are based on the idea that bringing in an outsider is better than choosing someone from inside. While there are times when it makes sense to recruit an outsider, for example, when the organization needs to be shaken up, an outside search should not be the only option. Although some outsiders come into a company, rally the troops, and create a following, others are immediately overwhelmed by what they need to learn. Rather than being highly visible and engaged leaders, they lock themselves in their offices with a few key executives and volumes of data. And because they do not spend enough time with key customers, employees, and other significant stakeholders, they risk being viewed as outsiders. All other things being equal, inside candidates, at least, are familiar with the culture and the business, a trait that gives them a leg up on outside candidates. Unfortunately, when inside candidates are automatically ignored, outstanding executives and future leaders one or two layers down in the organization may leave the organization, imperiling succession down the road.
The third common replacement strategy—making the chief executive chairman of the board while promoting a second individual, from inside or outside, to the CEO position—is another example of a seemingly good idea that can be disastrous in practice. This apprentice model covers more than one third of all CEO departures in 2005. In theory, the apprentice model sounds great: not only is it consistent with best practice because it separates the roles of chairman and CEO, but it also keeps the skills and experience of the former CEO available and allows for mentoring the new CEO.
The practical evidence is more sobering. The 2005 Booz Allen Hamilton study compared three governance models: the combined chairman–CEO; distinct roles, with someone other than the previous CEO serving as chairman; and the chairmanship held by the former CEO. The results were unequivocal: the best performing companies were those in which the roles were split and the chairman was a true outsider, not the former CEO. The study attributes the apparent failure of the apprentice model to the inevitable ineffective division of responsibility and authority that it promotes. As the company’s former CEO, the new chairman for many years set the direction for the company, controlled promotions and compensation, and defined the company’s culture to both employees and external stakeholders. In his or her new position, he or she is likely to be approached by anyone who is unsettled by the successor’s strategy or actions. In more extreme cases, if the former CEO is unhappy with either the direction of the company or its performance, he or she can get the apprentice fired and take back the CEO title.
There are other shortcomings to this model. Having the former CEO around to offer guidance creates the impression that the new CEO needs more training and is not yet really qualified to do the job, undermining his or her authority. And letting the former CEO manage the board—a board whose members know or appointed the former CEO or worse, were made board members themselves by that CEO—also hampers the new chief executive’s ability to develop a good relationship with the board and gain support for his management agenda.
It should also be noted that the apprentice model is inconsistent with the new regulatory climate and the rise of shareholder activism. Sarbanes-Oxley stipulates that a majority of board members must be independent, reducing the number of insider slots, and that nominating committees consist entirely of outsiders. At the same time, shareholder activists strongly favor a model in which the chairman is an independent outsider.
A final common mistake in choosing a CEO is an over-reliance on executive recruiters. No executive recruiter can understand a company’s challenges as well as the current CEO or the board. In the absence of an effective succession-planning process and a carefully articulated list of desirable qualifications, however, recruiters may be forced to substitute their own, more generic list of desirable CEO attributes. In the absence of specific directions, executive recruiters also tend to gravitate to the prior CEO and poaching strategies for the reasons described above. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/05%3A_CEO_Selection_and_Succession_Planning/5.04%3A_CEO_Selection_-_Common_Board_Mistakes.txt |
When companies lack the culture or the processes to internally develop their next CEO, they have no choice but to look outside. More than a third of the Fortune 1,000 companies are run by external appointees. Recruiting from outside is almost always more risky than promoting from within because directors and top management cannot know outside candidates as well as they know their own people. Outsiders are often chosen because they can do a job, such as turn around the company or restructure the portfolio. The job, however, is to provide purposeful leadership to a complex organization over a sustained period of time. But, as noted earlier, the requirements for that larger job unfortunately are often not well defined by the board. What is more, a wrong outside appointment can have a devastating effect on a company’s prospects. New leaders bring new talent and different management styles, thereby threatening continuity and momentum. In many such instances—as morale drops—the energy to execute dissipates as employees worry about the security of their job, and, rather than focus on the competition, companies begin to look inward. Bad external appointments are also expensive, since even poor performance is often rewarded with rich severance packages. That does not mean going outside is always wrong. Sometimes an external candidate exists who is, very simply, the best available choice. A skillful, diligent board may discover an outstanding fit between an outsider and the job at hand, as was the case when IBM attracted Lou Gerstner.
Just as going outside is sometimes the right choice, selecting an insider can be a big mistake. In fact, in certain situations, internal candidates present the greater risk. Some concerns about insiders, ironically, stem from their very closeness to the company. As Charan notes,
as “known quantities,” they may sail through a lax due-diligence process. Or their social networks and psychological ties may complicate efforts to change the culture. Some will not have had the right experience or been tested in the right ways. Individuals from functional areas may not be up to the task of leading the entire business. Or a shift in the industry or market landscape may render carefully nurtured skills irrelevant. In some cases, the credibility of the outgoing CEO or management team may be so sullied that only a new broom can sweep the company clean.Charan (2005), p. 75.
5.06: Grooming the Next CEO
Effective succession planning requires significant company investment and senior managers who understand and are committed to individual development. In today’s ever-changing business environment, where lifetime employment is not necessarily desired and certainly not taken for granted, good succession planning helps high-potential talent acquire key leadership and managerial skills and is a useful way to retain important players.
Few companies are in the enviable position of General Electric or Microsoft, where positions at the director level and above usually have a minimum of two or three people ready to step in when the current jobholder moves on. Many companies do a decent job nurturing middle managers, but as the robust market for senior managers attests, meaningful leadership development stops well below the top. Even in companies with strong development programs, very few leaders will ever be qualified to run the company. General Electric had around 225,000 employees in 1993 when Jack Welch identified 20 potential successors; over 7 years, he narrowed this number to 3. As Charan notes, “In CEO succession, it takes a ton of ore to produce an ounce of gold.”Charan (2005), p. 76.
There are many challenges to developing the next CEO. To prepare candidates for a 10-year run in the top job, companies must identify candidates when they are around 30 years of age and expose them to the right challenges and mentors for a period of 15 or more years. Few companies have the skill, resources, or commitment to spot and evaluate potential talent this early and purposefully. What is more, most companies do not know how to provide their most talented managers with the kinds of experiences that prepare them for the CEO role. The development of the next generation of leaders requires creating challenging assignments and “stretch jobs” supported by coaching, mentoring, and action learning. Action learning brings high-potential individuals together to work on a pressing issue, such as whether to enter a new geography or launch a new product. It forces emerging leaders to look beyond their functional silos to solve strategic problems and, in the process, learn firsthand what it takes to be a general manager. Unfortunately, however, many companies still view succession planning as primarily a human resources function and equate leadership development with rotating candidates through multiple functions or cultural assignments. Although valuable, such an approach does not prepare a candidate for the unique challenges associated with being a CEO. Functional leaders learn to lead functions, not whole companies. Moreover, a major drawback of rotation-based development programs is that potential candidates often do not stay long enough in one position to live with the consequences of their decisions. The very best preparation for CEOs is progression through positions with responsibility for steadily larger and more complex profit and loss (P&L ) centers. A candidate might start by managing a single product, then a customer segment, then a country, then several product lines, then a business unit, and then a division. Whatever the progression, overall P&L responsibility at every level is critical.
Leadership development is only part of the solution. Boards can greatly improve the chances of finding a strong successor in other ways. Senior executive development should be an explicit element in the charter of the board’s compensation committee. The committee should receive and create regular reports on the pool of potential CEOs and spend time getting to know the top contenders. Promising internal candidates should be invited to give presentations at board meetings and meet informally with directors whenever possible. Directors should also be encouraged to meet with and observe candidates in their own business operations. Finally, the full board should devote more time to succession; at minimum, the list of five top contenders, both internal and external, should be reviewed and updated twice a year.
The right process starts with the board’s commitment to make succession a permanent agenda item for the board and to meaningfully link succession with strategic oversight. Directors must thoroughly understand how the CEO adds value, what the key strategy levers are that the chief executive has or must create to achieve the company’s strategic objectives, and what skill sets and leadership attributes he or she needs to be successful. This requires that directors have a deep knowledge of the firm’s competitive position and challenges, its unique competences, as well as its cultural and administrative heritage. Only this depth of knowledge allows a board to focus its search on the key executive skills and past experiences needed to effectively move the company forward.
As noted earlier, no firm can rely exclusively on developing new talent internally. Even in the most talent-rich organizations, fresh ideas and new perspectives are sometimes needed. Executive search firms can help bring in new talent from the outside but can only be effective if the board does its homework. Search firms can open doors; identify and screen candidates; conduct thorough, fact-based due diligence on candidates; and create a bridge between the board and candidates; however, they cannot tell the board what leadership qualities and experiences it should look for. It is incumbent on the board, therefore, to provide the search firm with a detailed profile of the skills, experiences, and character traits it thinks the next CEO needs to have.
In all of this, the role of the outgoing CEO, if he or she has one, should be mainly consultative. He or she must be active in spotting and grooming talent, help define the job’s requirements, provide accurate information about both internal and external candidates, and facilitate discussions between candidates and directors. But they have no vote when it comes to choosing the successor: That decision belongs to the board. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/05%3A_CEO_Selection_and_Succession_Planning/5.05%3A_Insider_or_Outsider.txt |
Succession planning is a dynamic process too often given short shrift when it is regarded as an human resources–led exercise rather than a high-priority, comprehensive board-led process. High-impact succession planning is a continuous leadership “optimization” process with the goal of identifying and developing a pool of talent armed with the skills, attributes, and experiences to fill key leadership positions, including that of CEO, as well as the cultivation of a talent pipeline to meet emerging leadership needs. Succession and development processes that are rooted in best practice principles have the following components:“The Role of the Board in CEO Succession,” a best practices study published by the National Association of Corporate Directors (NACD) in collaboration with Mercer Delta Consulting, April 2006.
1. Plan 5 to 10 years ahead. A multiyear process is essential to develop and prepare internal candidates versus recruiting from outside the company.
2. Involve the full board. The full board is required in critical parts of the process (establishing criteria, evaluating candidates, and making the decision) and should not be relegated to a committee.
3. Establish an open and ongoing dialogue and an annual review. The board and the CEO should maintain an open and ongoing dialogue on succession planning. A review of the plan and candidate assessments must be held at least once a year.
4. Develop and agree on a comprehensive set of selection criteria. Criteria for the new CEO should be developed with the company’s future strategic needs in mind and include bottom-line impact, operational impact, and leadership effectiveness dimensions.
5. Use formal assessment. Formal assessment processes from multiple sources provide information that helps boards objectively assess candidates and identify development needs.
6. Interact with internal candidates. Board members should be given ongoing opportunities to interact with internal candidates in various settings.
7. Stage the succession but avoid horse races. Candidates should be placed in a series of expanding roles that give them the opportunity to learn and grow, and allow directors to assess their abilities. The potential successors should never be publicly announced, so candidates do not feel they are competing for the role.
8. Develop a good working relationship with an executive search firm to identify, screen, and attract external candidates. While many boards prefer to develop internal candidates because they are familiar with the “territory,” the pool should be enriched with talented outsiders.
9. Have the outgoing CEO leave or stay on as chair for a limited time. The outgoing CEO should either leave the board immediately or stay on as chairman for a transitional period of 6 to 12 months maximum in order to avoid potential leadership conflicts.
10. Prepare a comprehensive emergency succession plan. Emergency succession planning should be dealt with as soon as a new CEO takes the helm. The board should review the plan every year thereafter.
For some final wisdom on this subject, consider Warren Buffett’s reassuring words to Berkshire Hathaway shareholders in his 2005 annual letter:
As owners, you are naturally concerned about whether I will insist on continuing as CEO after I begin to fade and, if so, how the board will handle that problem. You also want to know what happens if I should die tonight.
That second question is easy to answer. Most of our many businesses have strong market positions, significant momentum, and terrific managers. The special Berkshire culture is deeply ingrained throughout our subsidiaries, and these operations won’t miss a beat when I die.
Moreover, we have three managers at Berkshire who are reasonably young and fully capable of being CEO. Any of the three would be much better at certain management aspects of my job than I. On the minus side, none has my crossover experience that allows me to be comfortable making decisions in either the business arena or in investments. That problem will be solved by having another person in the organization handle marketable securities. That’s an interesting job at Berkshire, and the new CEO will have no problem in hiring a talented individual to do it. Indeed, that’s what we have done at GEICO for 26 years, and our results have been terrific.
Berkshire’s board has fully discussed each of the three CEO candidates and has unanimously agreed on the person who should succeed me if a replacement were needed today. The directors stay updated on this subject and could alter their view as circumstances change—new managerial stars may emerge and present ones will age. The important point is that the directors know now—and will always know in the future—exactly what they will do when the need arises.
The other question that must be addressed is whether the Board will be prepared to make a change if that need should arise not from my death but rather from my decay, particularly if this decay is accompanied by my delusional thinking that I am reaching new peaks of managerial brilliance. That problem would not be unique to me. Charlie and I have faced this situation from time to time at Berkshire’s subsidiaries. Humans age at greatly varying rates—but sooner or later their talents and vigor decline. Some managers remain effective well into their 80s—Charlie is a wonder at 82—and others noticeably fade in their 60s. When their abilities ebb, so usually do their powers of self-assessment. Someone else often needs to blow the whistle.
When that time comes for me, our board will have to step up to the job. From a financial standpoint, its members are unusually motivated to do so. I know of no other board in the country in which the financial interests of directors are so completely aligned with those of shareholders. Few boards even come close. On a personal level, however, it is extraordinarily difficult for most people to tell someone, particularly a friend, that he or she is no longer capable.
If I become a candidate for that message, however, our board will be doing me a favor by delivering it. Every share of Berkshire that I own is destined to go to philanthropies, and I want society to reap the maximum good from these gifts and bequests. It would be a tragedy if the philanthropic potential of my holdings was diminished because my associates shirked their responsibility to (tenderly, I hope) show me the door. But don’t worry about this. We have an outstanding group of directors, and they will always do what’s right for shareholders.
And while we are on the subject, I feel terrific. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/05%3A_CEO_Selection_and_Succession_Planning/5.07%3A_Succession_Planning-_Best_Practices.txt |
Complying with the new regulations has not only dramatically increased the workload and responsibilities of CFOs, finance teams, and directors, but it also has fundamentally changed their role and their relationship with other, nonfinancial groups within the corporation. For example, the provisions of the Sarbanes-Oxley Act call for senior finance executives and the audit committee of the board to take a much more active role in the operations of the business, as they are charged with certifying the strength of both a company’s internal controls and the information they generate. Three sections of Sarbanes-Oxley are especially relevant: section 302, which outlines corporate responsibility for financial reports; section 404, which covers management assessment of internal controls; and section 409, which requires more rapid public disclosure of so-called material events in company performance.
Traditionally, the role of the audit committee has been to oversee, monitor, and advise company management and outside auditors in conducting audits and preparing financial statements, subject to the ultimate authority of the board of directors. The Securities and Exchange Commission (SEC) first recommended that publicly held companies establish audit committees in 1972. The stock exchanges quickly followed suit by either requiring or recommending that companies establish audit committees. In 2002, Sarbanes-Oxley increased audit committees’ responsibilities and authority, and raised membership requirements and committee composition to include more independent directors. The SEC and the stock exchanges followed with additional new regulations and rules to strengthen audit committees.Keinath and Walo (2004), p. 23.
Fulfilling all of the duties and responsibilities assigned to them under recent legislation and newly adopted stock exchange rules and shifting to a more proactive oversight role represent major challenges for audit committees. Their responsibilities have been expanded in major ways and now include ensuring accountability on the part of management and internal and external auditors; making certain all groups involved in the financial reporting and internal controls process understand their roles; gaining input from the internal auditors, external auditors, and outside experts when needed; and safeguarding the overall objectivity of the financial reporting and internal controls process.
Importantly, in the wake of Sarbanes-Oxley, the relationship between management and outside auditors has been replaced by one between the audit committee and outside auditors. The audit committee now is directly responsible for appointment, compensation, retention, and oversight of independent auditors who report directly to the audit committee. And, by vesting responsibility and authority for certain audit-related actions in the audit committee—to the exclusion of the full board, management, and shareholders—Sarbanes-Oxley appears to alter the traditional delegation, under state law, of board power to a committee.
The audit committee must also establish specific procedures for handling complaints received by the company regarding accounting, internal accounting controls, or auditing matters, including confidential submission by company employees of concerns regarding questionable accounting or auditing matters. In addition, all audit services and permitted nonaudit services provided by outside accounting firms must be preapproved by the audit committee. All approvals of nonaudit services must also be disclosed in the company’s periodic reports. Certain nonaudit services by firms that perform audits are expressly prohibited.
As noted in Chapter 4 "Recent U.S. Governance Reforms", the composition and credentials of the audit committee are also tightly regulated. Public companies are required to have an audit committee consisting of at least three independent members of the board of directors. Each committee member must be “financially literate” and at least one member must be designated as the “financial expert,” as defined by applicable legislation and regulation.
Audit committees are required to define their responsibilities and operations in an audit committee charter.For an example of an audit committee charter, consult the Web site of any major public corporation., This section is based on The Institute of Internal Auditors (2006), “The Audit Committee—Purpose, Process, Professionalism.” http://www.theiia.org Such a charter should (a) clearly delineate audit committee processes, procedures, and responsibilities that have been sanctioned by the entire board; (b) define membership requirements, including a provision for a financial expert; (c) allow for yearly reviews and changes; (d) designate the minimum number of meetings to be conducted; (e) accommodate executive sessions with appropriate entities and allow for engaging outside counsel as needed; (f) outline the committee’s responsibilities in regard to risk management, compliance issues, and review of its own effectiveness; identify the specific areas the audit committee should review as well as with whom those reviews will be conducted; and include such specific roles as annual report preparation oversight and yearly agenda planning; and (g) delineate the audit committee’s relationships with the internal and external auditors; appoint, evaluate, set time limits for, and discharge (with the concurrence of the full board) the external auditors; and evaluate the independence of both the internal and external auditors. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/06%3A_Oversight_Compliance_and_Risk_Management/6.01%3A_The_New_Regulatory_Climate.txt |
Often called the “Oracle of Omaha,” Warren Buffett, the largest shareholder and CEO of Berkshire Hathaway, is well known for his adherence to the value investing philosophy, his conservatism when it comes to issues of governance and accounting, and for his personal frugality, despite his immense wealth. On the subject of a board’s audit committee, he writes,Buffett, annual letter to Berkshire Hathaway shareholders (2002).
Audit committees can’t audit. Only a company’s outside auditor can determine whether the earnings that a management purports to have made are suspect. Reforms that ignore this reality and that instead focus on the structure and charter of the audit committee will accomplish little.
As we’ve discussed, far too many managers have fudged their company’s numbers in recent years, using both accounting and operational techniques that are typically legal but that nevertheless materially mislead investors. Frequently, auditors knew about these deceptions. Too often, however, they remained silent. The key job of the audit committee is simply to get the auditors to divulge what they know.
To do this job, the committee must make sure that the auditors worry more about misleading its members than about offending management. In recent years, auditors have not felt that way. They have instead generally viewed the CEO, rather than the shareholders or directors, as their client. That has been a natural result of day-to-day working relationships and also of the auditors’ understanding that, no matter what the book says, the CEO and CFO pay their fees and determine whether they are retained for both auditing and other work. The rules that have been recently instituted won’t materially change this reality. What will break this cozy relationship is audit committees unequivocally putting auditors on the spot, making them understand they will become liable for major monetary penalties if they don’t come forth with what they know or suspect.
In my opinion, audit committees can accomplish this goal by asking four questions of auditors, the answers to which should be recorded and reported to shareholders. These questions are:
1. If the auditor were solely responsible for preparation of the company’s financial statements, would they have in any way been prepared differently from the manner selected by management? This question should cover both material and nonmaterial differences. If the auditor would have done something differently, both management’s argument and the auditor’s response should be disclosed. The audit committee should then evaluate the facts.
2. If the auditor were an investor, would he have received—in plain English—the information essential to his understanding the company’s financial performance during the reporting period?
3. Is the company following the same internal audit procedure that would be followed if the auditor himself were CEO? If not, what are the differences and why?
4. Is the auditor aware of any actions—either accounting or operational—that have had the purpose and effect of moving revenues or expenses from one reporting period to another?
If the audit committee asks these questions, its composition—the focus of most reforms—is of minor importance. In addition, the procedure will save time and expense. When auditors are put on the spot, they will do their duty. If they are not put on the spot… well, we have seen the results of that. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/06%3A_Oversight_Compliance_and_Risk_Management/6.02%3A_Warren_Buffett_on_the_Challenge_of_the_Audit_Committee.txt |
Much has been written about the board of directors’ Duty of Care in the decision-making context, which requires directors to perform their duties in good faith and with the degree of care that an ordinary person would use under similar circumstances. Most directors are similarly aware of the protections afforded by the Business Judgment Rule—courts will not second guess directors’ business decisions if the directors act on an informed basis and in good faith. By contrast, the oversight role of the board is less well defined from a legal perspective. The reason is that, in an oversight context, directors are not protected by the Business Judgment Rule if they fail to take action when they become aware of corporate impropriety. Many directors are unfamiliar with this less defined and stricter component of the Duty of Care.This section is based on Kleinman and Thompson (2002).
In adjudicating claims, the law distinguishes between two scenarios: deciding there is no problem and ignoring a problem. When a board considers a situation and makes a decision that results in a loss, the Business Judgment Rule will protect a board’s decision if the board acted in good faith and properly informed itself in the process. The protection of the Business Judgment Rule is not determined by the results of the decision but by the quality of the process employed. For example, when a board conducts a proper investigation and either takes action or consciously decides that action is not necessary, that decision, even if wrong, will be protected by the Business Judgment Rule.
By contrast, when a loss occurs because of a board’s failure to consider a problem, there has been no process, there is no decision to protect, and the Business Judgment Rule does not apply. Instead, directors may face liability for breach of the Duty of Oversight. Rather than having a court defer to the directors’ business judgment, the directors will likely be required to defend a negligence claim. Thus, when directors are aware, or should be aware, of material improper conduct, violations of law or other action that could result in material harm to the organization, the Duty of Oversight demands that directors investigate the matter and decide whether or not corrective action is needed. If the board fails to consider the situation, the board will be criticized for failure to supervise and may face liability under the Duty of Oversight. Specifically, boards can be held liable under the Duty of Oversight for failing to act when they know or should know of wrongdoing.The leading Delaware cases addressing the duty of oversight and related issues are Graham v. Allis-Chalmers Mfg. Co. (1963); In re Caremark International Derivative Litigation (1996); Aronson v. Lewis (1984); Boeing Co. v. Shrontz (1992); and In re Dataproducts Corp. Shareholders Litigation (1991). See also Hansen (1993).
Note that although the board may not take action in either case, the results in the two cases are dramatically different. The Duty of Oversight, therefore, creates an incentive for boards to respond to potential indications of wrongdoing in order to gain the benefit of the Business Judgment Rule.
How can a board protect itself? The law demands that directors investigate when there are red flags. If a director has actual knowledge of a material problem, he or she would be well advised not to wait for management to bring the topic before the board. Proper board action will always be the best defense to a Duty of Oversight claim.
Delaware law allows a corporation, in its certificate of incorporation, to eliminate or reduce the personal liability of directors for breaches of fiduciary duty, including the Duty of Care. Although the Duty of Oversight is considered a component of the Duty of Care, Delaware courts have not specifically held that such a charter provision would bar a Duty of Oversight claim. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/06%3A_Oversight_Compliance_and_Risk_Management/6.03%3A_Legal_Issues_Regarding_Oversight.txt |
Analysis of corporations that have experienced major ethical and financial difficulties shows these companies have a great deal in common in terms of their corporate culture and management profiles, as well as their accounting and governance practices. On the basis of this knowledge, we can identify a number of early warning signals or red flags that boards can use to spot the emergence of a corporate environment and culture susceptible to conflicts of interest and management abuse. For a suggestive list, see Chapter 13 "Appendix B: Red Flags in Management ".This section is based on Wood (2005).
Individually, these factors may not be predictive of future problems. In groups, however, they define a heightened risk profile and should be cause for additional scrutiny and objective analysis. For example, the combination of aggressive management practices creating rapid short-term revenue and stock-price growth coupled with weak board oversight, allowing the CEO to rapidly accumulate personal wealth through stock-based incentive compensation, has been present in a significant percentage of recent problem situations. Risk of rapid financial deterioration in such cases is exacerbated when the company also operates with aggressive financial practices and high leverage.
Audit committees would be well advised to monitor these categories of higher risk characteristics based on their proven usefulness in identifying corporate environments that may be susceptible to rapid stock price and credit deterioration, as well as fraud.
6.05: Questions About Ethics and Compliance for the Board
Building a culture of ethics and compliance is an imperative for today’s board directors. This requires senior management involvement, organization-wide commitment, an effective communications system, and an ongoing monitoring system. To ensure total commitment, directors must ask the right questions that will assist them in assessing whether an effective program is in place. The following set of questions is suggested as a starting point:
1. Does the tone at the top, as communicated by senior management, demonstrate to every employee that ethics and compliance are vital to continued business success? Does the organization’s culture support making ethical and compliant choices?
2. How has the organization supported the ethics and compliance program through training and communication efforts?
3. Can you describe the process for assessing ethics and compliance risks within the organization? Has the organization ever performed a cultural assessment?
4. How is the current ethics and compliance program structured? Does it cover the organization’s global operations? Has it addressed the high-priority areas? Has the organization’s ethics and compliance program and code of ethics or conduct been updated to comply with the requirements of Sarbanes-Oxley? Has the organization reevaluated its internal reporting mechanisms in light of Sarbanes-Oxley?
5. Does the organization have an ethics and compliance officer? Is a senior executive with adequate time, financial resources, and board access in charge of the program? Are there dedicated, full-time resources?
6. Does the ethics code include statements regarding responsibilities to employees, shareholders, suppliers, customers, and the community at large, and is it distributed to all relevant parties, including the board, employees, management, and vendors?
7. Does a reporting process exist to keep the board informed on ethics and compliance issues, as well as the actions taken to address those issues? Is ethics and compliance a regular board agenda item?
8. Is there an effective and utilized reporting mechanism in place to let all employees raise ethics and compliance issues without fear of retribution? Is there an anonymous reporting mechanism or helpline? Who fields the follow-ups on concerns raised through the helpline? Are audit committee members or the audit chair named as an additional outlet for employee concerns?
9. What type of ongoing monitoring and auditing processes are in place to assess the effectiveness of the program? Are the code of ethics and compliance program reviewed at least annually by senior management to determine if they need updating due to business, legal, or regulatory changes? Does the internal audit function conduct reviews? Are employee surveys conducted? Has the program been reviewed by outside consultants or experts for possible improvement?
10. Does the organization regularly and systematically scrutinize the sources of compliance failures and react appropriately? Does management take action on reports? Are employees appropriately and consistently disciplined? | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/06%3A_Oversight_Compliance_and_Risk_Management/6.04%3A_Red_Flags_in_Management_Culture_Strategies_and_Practices.txt |
Increasingly, companies engage in hedging, derivative, and trading activities that involve substantial risks as part of their overall corporate strategy. Although hedging activities, with derivatives or other tools, may mitigate or resolve risky positions, hedges are rarely perfect. In addition, because of the sophisticated nature of hedging, derivative, and trading activities, the risk exposure of a company is difficult to define, complicating oversight of such activities by a board of directors.
At minimum, the board of a company engaging in hedging, derivative, or trading activities should ask the following questions:
1. Where are the hedging, derivative, and trading risks embedded in the company, and who in the company is responsible for these activities?
2. Does the board of directors understand the nature and purposes of the risk positions being taken?
3. Are there risk limitations in place, and, if so, what are they and how effectively are they implemented?
4. What is the risk to reward ratio that fits into the company’s strategic plan?
5. Does the board of directors have a glossary to translate the explanations that it is likely to receive?
6.07: Enterprise Risk Management - The Boards New Tool
Whereas traditional risk management approaches focus on protecting a company’s tangible assets and the related contractual rights and obligations, the scope of a new approach called Enterprise Risk Management (ERM) is much broader. ERM, discussed in greater detail in Chapter 14 "Appendix C: Enterprise Risk Management: Ask the Board ", is more than crisis management or regulatory compliance. It is a tangible and structured approach to addressing organizational and financial risk. It is strategic in focus, aimed at enhancing and protecting a company’s tangible and intangible assets on an enterprise-wide basis. Its basic premise is that uncertainty presents both risk and opportunity, with the potential to erode or enhance value. Value is maximized when management sets strategy and objectives to strike an optimal balance between growth and return goals and related risks, and efficiently and effectively deploys resources in pursuit of the entity’s objectives.For a more detailed discussion of this subject, see Waller, Lansden, Dortch, and Davis (2005) and Chapter 14 "Appendix C: Enterprise Risk Management: Ask the Board ".
Although the management of a company is ultimately responsible for a company’s risk management, the board of directors must understand the risks facing the company and oversee the risk-management process. Best practice suggests that board committees should incorporate risk management into their charters. A company’s governance and nominating committee, for example, can ensure that the company is prepared to deal with risks and crises by evaluating the individual capabilities of the directors, nominating directors with crisis-management experience, and considering the time each director and nominee has to devote to the company. The governance and nominating committee should also work with management to establish an orientation program for new directors and succession plans for key executive officers.
More commonly, however, corporate governance guidelines delegate the responsibility for risk management to the audit committee. Alternatively, a company may appoint a risk-management officer, form a risk-management committee, or assign responsibility to a finance or compliance committee of the board. The responsible committee or group should meet regularly with the company’s internal auditor, the chief financial officer, the general counsel, and the head of compliance and individual business units to discuss specific risks and assess the effectiveness of the company’s risk-management systems.
6.08: Codes of Ethics and Codes of Conduct
In 2003, to implement sections 406 and 407 of Sarbanes-Oxley, the SEC adopted a rule requiring a company to disclose whether it has adopted a code of ethics that applies to the company’s principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. A company disclosing that it has not adopted such a code must disclose this fact and explain why it has not done so. Companies also are required to promptly disclose amendments to, and waivers from, the code of ethics relating to any of those officers.
A code of ethics (code of conduct, statement of business practice, or a set of business principles) is useful for establishing and articulating the corporate values, responsibilities, obligations, and ethical ambitions of an organization and the way it functions. It provides guidance to employees on how to handle situations that pose a dilemma between alternative, right courses of action or when faced with pressure to consider right and wrong.
A good code of ethics should be signed by the CEO and endorsed by the board of directors; it should focus on the values that are important to top management in the conduct of the business, such as integrity, responsibility, and reputation, and demonstrate a commitment to maintaining high standards both within the organization and in its dealings with others.
A good example is the code of ethics authored by Buffett for Berkshire Hathaway directors, executives, and employees, with his now famous advice:
I want employees to ask themselves whether they are willing to have any contemplated act appear the next day on the front page of their local paper—to be read by their spouses, children and friends—with the reporting done by an informed and critical reporter.Web site of Berkshire Hathaway, available at http://www.berkshirehathaway.com. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/06%3A_Oversight_Compliance_and_Risk_Management/6.06%3A_Questions_About_Hedging_Derivatives_and_Trading_Risks.txt |
Boards are being urged to play a more active role in strategy formulation. If evaluating the quality of management’s strategic and business plans, including the likelihood of realizing the intended results, is a key board responsibility, so the argument goes, should it not determine for itself whether the company has the capacity to implement and deliver? It is a good but tricky question. How might a board do this? What, for example, should a board do if management presents a bold plan for spinning off or acquiring strategic assets worldwide? Assume that the logic is consistent, that the plan makes sense, that the numbers look good, and that management has a convincing answer for every tough question asked by the board. Has the board met its fiduciary responsibility or should it seek an independent opinion to “audit” the strategic assumptions made by management and its consultants? After all, directors do not have the equivalent time and resources to review the details of strategies presented to them.
A strong argument can be made that if the board feels compelled to retain outside experts to review corporate strategy, it probably has lost confidence in the CEO and should simply fire him or her. Conversely, one can argue that hiring outside consultants is the most cost-effective way for the board to prove its independence and positively challenge top management. Which is it?
In attempts to provide guidance on this issue, numerous “codes of best practice” have been proposed in recent years urging boards to define their responsibilities with respect to strategy development as
• setting the ultimate direction for the corporation;
• reviewing, understanding, assessing, and approving specific strategic directions and initiatives;
• assessing and understanding the issues, forces, and risks that define and drive the company’s long-term performance.Bart (2004), pp. 111–125.
As the simple example above demonstrates, however, reality is considerably more complex. Traditionally, boards have become involved in strategy mainly when there were specific reasons for them to do so. The most common are the retirement of an incumbent CEO, a major investment decision or acquisition proposal, a sudden decline in sales or profits, or an unsolicited takeover bid. In recent years, however, as regulatory and other pressures increased, many boards have sought to become more deeply involved and create an ongoing strategic role, for example, by participating in annual strategy retreats or through the CEO performance evaluation process. Still, in most companies even today boards limit their involvement to approving strategy proposals and to monitoring progress toward strategic goals; very few participate in shaping and developing the company’s strategic direction.
There are a number of reasons for this. First, there is a longstanding concern on the part of both executives and directors regarding where to draw the line between having directors involved through contributing ideas about the company’s strategic direction and having directors who try to manage the company.Lorsch (1995, January–February). Specifically, there is a widely shared belief that strategy formulation is fundamentally a management responsibility and that the role of the board should be confined to making sure that an appropriate strategic planning process is in place and the actual development—and approval—of strategy is left to the CEO. Even those who do favor greater director involvement in strategy say that the degree of involvement should depend on the specific circumstances at hand. A significant acquisition proposal or a new CEO, for example, may indicate the needs for greater board involvement.
Second, in the aftermath of the Enron and other governance scandals, many boards had to focus on internal issues and on digesting the new accounting compliance rules of the landmark Sarbanes-Oxley Act. In a number of companies, this turning inward has had the undesirable side effect that the board’s decision making has become so focused on compliance issues that strategic considerations have taken a backseat.
Third, some CEOs simply do not want their boards involved in strategy discussions; they view the board’s engagement in developing strategy as interference into their managerial responsibilities and a threat to their sense of personal power. Of course, the downside of this posture is that the board may not fully understand or buy into the organization’s strategy and that board talent is underutilized. Taking this approach sometimes backfires on CEOs when formerly disengaged boards become overengaged and then make their CEOs “walk through fire” on tactics.
Fourth, there is the delicate question of how knowledgeable even the most capable directors are to assist with strategy development. Most are quite effective in dealing with short-term financial data. Strategy development, however, also demands a detailed understanding of more future- and long-term oriented issues, such as changing customer preferences, competitive trends, technological developments, and the firm’s core competencies. A typical board of directors is poorly designed and ill-equipped for this task. According to a recent McKinsey survey, more than a quarter of directors have, at best, a limited understanding of the current strategy of their companies. Only 11% claim to have a complete understanding. More than half say that they have a limited or no clear sense of their companies’ prospects 5 to 10 years down the road. Only 4% say that they fully understand their companies’ long-term position. More than half indicate that they have little or no understanding of the 5 to 10 key initiatives that their companies need in order to secure the long-term future.Felton and Fritz (2005).
Finally, while board meetings are conducive to questioning specific strategic assumptions and monitoring progress toward strategic goals, they are not a good forum for the more creative, elaborate, and nonlinear process of crafting strategy. Board discussions tend to focus on the implementation and tactics of an ongoing strategic direction. Revealing serious reservations about the underlying strategic assumptions sometimes not only is seen as distracting and inappropriate but also may be interpreted as a vote of no confidence in the current management.
The bottom line is that carving out a significant role for the board in strategy formulation is extremely difficult. First, as we have seen, there is the nature of the strategy development process itself. Characterizing a board’s involvement in strategy on a continuum from “passive” to “active” is a dangerous oversimplification. A passive posture assumes that strategic decisions are both separate and sequential, that managers generate options that boards choose from, and that managers then implement the chosen option and boards evaluate the outcomes. An active conception assumes that boards and management formulate strategy in a partnership approach, that management then implements and both groups evaluate. In reality, strategic decisions often evolve through complex, nonlinear, and fragmented processes. What is more, a board can be actively involved in strategy without being involved in its formulation. For example, a board can “shape” strategy through a process of influence over management in which it guides strategic thinking but never actually participates in the development of the strategies themselves.de Kluyver and Pearce (2009), chap. 1.
Second, as noted, certain situations dictate a more influential strategy role for the board than others. For example, at times of crisis, such as a sudden decline in performance, a new CEO, or some other major organizational change, boards tend to become more actively involved in strategy. Other determinants of the degree of board engagement in strategy issues include firm size; the nature of the core business; directors’ skills and experience; board size; occupational diversity; board tenure and board member age; board attention to strategic issues; and board processes, such as the use of strategy retreats, prior firm performance, and the relative power between the board and the chief executive officer, particularly in terms of board involvement in monitoring and evaluating this position. External factors include the concentration and level of engagement of the firm’s ownership and the degree of environmental uncertainty.Bart (2004).
Third, as a consequence of recent governance reforms that focused on making boards more independent, many now lack directors with relevant industry expertise to participate effectively in shaping strategy—much less to reshape it in an increasingly fast-paced business climate. In the current post-scandal governance climate, even as the business landscape is becoming more complex, many boards continue to give priority to compliance-oriented appointments rather than visionary ones.Carey and Patsalos-Fox (2006).
Finally, there are the ever-present constraints on time and knowledge. To become meaningfully engaged in strategy formulation, boards must become much more efficient, particularly since their time has already been stretched in recent years: The average commitment of a director of a U.S.-listed company increased from 13 hours a month in 2001 to more than twice that today, according to Korn/Ferry.Korn/Ferry (2007). Directors also need to become far more knowledgeable and proactive about grasping the company’s current strategic position and challenges more clearly. To understand the long-term health of a company, directors must pay attention not only to its current financials but also to a broader range of indicators: market performance, network positioning, organizational performance, and operational performance. Similarly, a broader appreciation of risk—including credit, market, regulatory, organizational, and operational risk—is vital. Without this knowledge, directors will have only a partial understanding of a company. While boards receive and discuss all sorts of “strategic information,” financial measures—probably the least valuable component of a board member’s strategic information requirements—still dominate. Even with better information, time constraints may prevent a broader role for the board. Boards typically perform their strategic governance role in the course of a couple of hours at every third board meeting—annually supplemented by a 2-day strategy retreat. A more active role in strategy development requires much more time.
Despite these difficulties, Nadler (2004) argues that companies should try hard to create a meaningful role for their boards in the strategy development process. The key is to create a process in which directors participate in strategic thinking and strategic decision making but do not infringe on the CEO’s and senior executive team’s fundamental responsibilities. In such a process, the CEO and management should lead and develop strategic plans with directors’ input, while the board approves the strategy and the metrics to assess progress. The direct benefits of such an engagement are many, including a deeper understanding by directors of the company and its strategic environment, a sense of ownership of the process and the resulting strategy, better decisions reflecting the broader array of perspectives, greater collaboration between the board and management on other initiatives and decisions, increased board satisfaction, and more effective external advocacy.Nadler (2004).
But, as Nadler notes, while the benefits can be significant, broader board participation in strategy development also has costs. First, directors must have a thorough understanding of the company—its capital allocation, debt levels, risks, business unit strategies, and growth opportunities, among many issues—and that takes time and commitment. Importantly, they must engage management on the major challenges facing the company and have a firm grasp on the trade-offs that must be made. A second potential cost is that increased board participation can result in less management control over outcomes. Real participation means influence, and influence means the ability to change outcomes. A well-designed process yields the benefits of participation while limiting the amount of time and potential loss of control.Nadler (2004). | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/07%3A_The_Boards_Role_in_Strategy_Development/7.01%3A_Who_Is_Responsible_for_Strategy_Development.txt |
To create a workable framework for board engagement, Nadler (2004) distinguishes between four, roughly sequential, types of strategic activity:
1. Strategic thinking. The collection, analysis, and discussion of information about the environment of the firm, the nature of competition, and business models.
2. Strategic decision making. Making a set of core directional decisions that define fundamental choices concerning the business portfolio and the dominant business model, which serve as the platform for the future allocation of limited resources and capabilities.
3. Strategic planning. Identifying priorities, setting objectives, and securing and allocating resources to execute the chosen directional decisions.
4. Strategy execution. Implementing and monitoring results and appropriate corrective action. This phase of strategy development can involve the allocation of funds, acquisitions, and divestitures.Nadler (2004).
It will be apparent that the board’s role can and should differ dramatically in these four development phases. Early in the process, the board’s focus should be on providing advice and counsel about issues, such as the process followed, perspectives taken, the inside–outside balance of environmental and competitive analyses, and presentation formats. Later, when key directional choices must be made, the board’s role becomes more evaluative and decision focused. Once directional decisions have been taken, reviewing and monitoring progress should become the board’s primary focus.
Nadler organizes the various discussions and decisions the board needs to undertake into a multistep “strategic choice process”:
1. Agreeing on the company vision. This step entails restating or confirming the company vision—a description of its aspirations in relation to multiple stakeholders, including investors, customers, suppliers, employees, legislative and regulatory institutions, and communities. Such a vision statement should be aspirational and paint a picture of what the company hopes to accomplish in tangible and measurable terms. Good vision statements talk about measures of growth, relative positions in markets or industries, or returns to shareholders. They provide a benchmark against which to assess strategic alternatives.
2. Viewing the opportunity space. This second step focuses on an analysis of the full array of strategic options the company should consider from different perspectives. For example, the analysis might look at different emerging markets, the range of available technologies to meet a customer need, the potential set of customers, or the constellation of competitors. Each of these presents a different set of “lenses” through which to look at the environment.
3. Assessing the company’s business design and internal capabilities. This third step looks inward, focusing on an assessment of the company itself, including its current business design and organization. The objective is to analyze the relative strengths and weaknesses of the firm, including its human capital, technologies, financial situation, and work processes, among others.
4. Determining the company’s future strategic intent. In this fourth step, the vision, the view of the opportunity space, and the assessment of the current business or organization are brought together to identify a future strategic intent. The purpose is to identify the most attractive opportunities for their vision and their capabilities.
5. Developing a set of business design prototypes. Having identified a strategic intent, the next step is to develop prototypes for each business design. It is useful to consider a number of distinct, viable options to provide the opportunity for real comparison, contrasting approaches, and true choice. The final decision should be made against a set of criteria developed in the strategic intent stage. The leading choices should also be tested against current organizational capabilities to understand the nature of the challenges inherent in executing each strategy. When this choice is made, initial planning of execution is complete.
This process unfolds over a period of months, with numerous meetings, work sessions, and rounds of data collection and feedback, and provides a way of building board engagement. Perhaps more importantly, management will benefit from the board’s informed point of view.Nadler (2004). | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/07%3A_The_Boards_Role_in_Strategy_Development/7.02%3A_A_Framework_for_Board_Strategy_Engagement.txt |
Two dimensions of strategy formulation merit special attention because they require substantial board involvement and typically are subject to detailed scrutiny by investors and other stakeholders—crafting a capital structure for the corporation and dealing with a takeover, merger, or acquisition proposal.
Deciding on a Capital Structure
Deciding on an appropriate capital structure is a strategic board responsibility. Businesses adopt various capital structures to meet both internal needs for capital and external requirements for returns on shareholders investments. A company’s capitalization shapes its balance sheet and is constructed from three sources of capital:
1. Long-term debt. Debt consisting mostly of bonds or similar obligations, including notes, capital lease obligations, and mortgage issues, with a repayment horizon of more than one year.
2. Preferred stock. Equity (ownership) interest in the corporation with claims ahead of the common stock and normally with no rights to share in the increased worth of a company if it grows.
3. Common stockholders’ equity. The firm’s principal ownership, made up of (a) the nominal par or stated value assigned to the shares of outstanding stock, (b) the capital surplus or the amount above par value paid the company whenever it issues stock, and (c) the earned surplus (also called retained earnings), which consists of the portion of earnings a company retains after paying out dividends and similar distributions. Thus, common stock equity is the net worth after all the liabilities (including long-term debt), as well as any preferred stock, are deducted from the total assets shown on the balance sheet.
Debt Versus Equity
In deciding on a company’s financial structure, management often seeks to minimize the cost of capital, whereas investors look for the greatest possible return. While these desires can conflict, they are not necessarily incompatible, especially with equity investors. This is because the cost of capital can be kept low and the opportunity for return on common stockholders’ equity enhanced through what is called “leverage”—creating a high percentage of debt relative to common equity. Doing so, however, increases risk. This is the inescapable trade-off both management and investors must factor into their respective decisions.
The leverage provided by debt financing is further enhanced because the interest that corporations pay is a tax-deductible expense, whereas dividends to both preferred and common stockholders must be paid with after-tax dollars. Thus, it is argued, the lower net cost of bond interest helps accrue more value for the common.
Higher debt levels increase a firm’s fixed costs that must be paid in good times and bad, and can severely limit a company’s flexibility. Specifically, as leverage is increased, (a) the risk of bankruptcy grows; (b) access to the capital markets, especially during times of tight credit, may diminish; (c) management will need to spend more time on finances and raising additional capital at the expense of focusing on operations; and (d) the cost of any additional debt or preferred stock capital the company may have to raise increases.
Because of its tax advantages and stability relative to equity capital (common stock), some finance experts have argued that higher proportions of debt capital may be advantageous to corporations. Their advice is not always heeded, however. Although periodically companies use debt to buy back common shares, a practice that can improve stock performance, most large companies rely heavily on equity financing.
Companies tend to use debt under certain circumstances more than others. For example, the decision whether or not to use debt is often related to the nature and risks of the cash flows associated with the capital investment. When diversifying into new lines of business, companies that are moving into related fields tend to use equity capital and those entering unrelated fields tend to use debt. Ownership structure is another factor. Firms with a high degree of management ownership, for example, are less likely to carry high levels of debt, as are corporations with significant institutional ownership.
Changing Patterns
In earlier days, a debt-free structure was often considered a sign of strength, and companies that were able to finance their growth with an all-common capitalization prided themselves on their “clean” balance sheet.
The advent of leveraged buyouts (LBOs) of the 1980s brought a new twist to the capitalization issue. Because of their low degree of leverage, large corporations with conservative, low-debt capitalizations became vulnerable to capture. Corporate raiders with limited financial resources were successful in raising huge amounts of noninvestment grade (“junk”) debt to finance the deals. The captured companies often would then be dismembered and stripped of cash holdings so the raiders could pay down their borrowings. In effect, the prey’s own assets were used to pay for its capture. As a takeover defense, potential targets began to assume heavy debt themselves, often to finance an internal buyout by its own management.
By purposely leveraging their prey so highly (at times with current income insufficient to meet current interest requirements) that the company could not continue to conduct business as usual, raiders forced cuts in low-return growth avenues and the sale of those divisions, which are more valuable outside the firm. In the process, a significant amount of intrinsic firm value was distributed to stockholders—especially those who had bought in for just that purpose—at the expense of other stakeholders and the company’s long-term needs. They justified their actions by stating that managers who operated with low leverage were either inept or feathering their own nest, or both.
Takeovers, Mergers, and Acquisitions
Takeovers, mergers, and acquisitions are an integral part of corporate strategy and not only provide important external growth opportunities for companies but also involve considerable risks for the firm and its shareholders. A merger signifies that two companies have joined to form one company. An acquisition occurs when one firm buys another. To outsiders, the difference might seem small and related less to ownership control than to financing. However, the critical difference is often in management control. In acquisitions, the management team of the buyer tends to dominate decision making in the combined company.This section is based on de Kluyver and Pearce (2008), chap. 9; and Rérolle and Vermeire (2005, April 29).
The advantages of buying an existing player can be compelling. An acquisition can quickly position a firm in a new business or market. It also eliminates a potential competitor and therefore does not contribute to the development of excess capacity.
Acquisitions, however, are also generally expensive. Premiums of 30% or more than the current value of the stock are not uncommon. This means that, although sellers often pocket handsome profits, acquiring companies frequently lose shareholder value. The process by which merger and acquisition decisions are made contributes to this problem. In theory, acquisitions are part of a corporate growth strategy based on the explicit identification of the most suitable players in the most attractive industries as targets to be purchased. Acquisition strategies should also specify a comprehensive framework for the due diligence assessments of targets, plans for integrating acquired companies into the corporate portfolio, and a careful determination of “how much is too much” to pay.
In practice, the acquisition process is far more complex. Once the board has approved plans to expand into new businesses or markets, or once a potential target company has been identified, the time to act is typically short. The ensuing pressures to “do a deal” are intense. These pressures emanate from senior executives, directors, and investment bankers who stand to gain from any deals, shareholder groups, and competitors bidding against the firm. The environment can become frenzied. Valuations tend to rise as corporations become overconfident in their ability to add value to the target company and as expectations regarding synergies reach new heights. Due diligence is conducted more quickly than is desirable and tends to be confined to financial considerations. Integration planning takes a backseat. Differences in corporate cultures are discounted. In this climate, even the best designed strategies can fail to produce a successful outcome, as many companies and their shareholders have learned.
Most studies carried out in this area show that the probability of a major acquisition or merger failing (as measured in terms of financial return) is greater than the probability of success. Empirically, the probability of failure increases with the size and complexity of the merger and with the degree of unfamiliarity with the target business. They also show that the buyer often pays too much for the target company because it is overoptimistic in terms of its ability to (a) do better than the existing management, (b) implement the synergies identified, and (c) integrate the target within its own company in a timely manner.
The application of new international accounting standards (and, more particularly, International Accounting Standard (IAS) 36 on impairment of assets) forces companies to examine the value of their assets, especially that of their intangible assets, on a recurring basis. As a result, each overpaid acquisition will inevitably result in impairment of goodwill, and, sooner or later, the board and management will have to publicly admit that their decision has destroyed shareholder value. This new regulation alone is a powerful reason for boards to go beyond merely approving major transactions and become much more actively involved in merger and acquisition (M&A ) activity than in the past.
The very nature of the M&A process makes the board’s involvement a particularly sensitive issue, however. An acquisition frequently results from a long, confidential negotiation process, often involving extremely technical issues, and its outcome is largely uncertain. These factors lead management to present the board with only summary and high-level information on the opportunity and to wait for the outcome of the process before organizing in-depth discussions with the board.
This is unfortunate because M&A activity represents a unique opportunity for a board to add value. Outside directors may have unique experience with the M&A process, particular intermediaries, or with all too often overlooked merger integration challenges. At the very least, the outside view offered by the board at an early stage may counterbalance the optimism of the executives driving the deal or the partiality of numerous experts pushing for its completion, resulting in a more “realistic” attitude to the opportunity.
Rérolle and Vermeire (2005) identify a number of useful best practices to assist boards in M&A planning and execution:
1. Validate the strategic benefits of the transaction. Every major acquisition must take place within an established strategic framework. Many mistakes are attributable to acquisitions that are justified only after the fact as a “strategic fit.” At a minimum, the board should ask how the opportunity came about—whether it is something the company’s management has been working on for some time, whether it concerns a business activity or market with which the company is familiar, and whether it represents geographical or other diversification.
Also, rarely can an acquisition be justified solely on the grounds of the savings it will generate because they are often illusionary. It must either meet a need that has been clearly defined up front and which the company cannot meet using its own resources, or it must enhance the company’s competitive position. In order to create value, the acquisition must make it possible to build a genuine competitive advantage or to decisively prolong an existing competitive advantage. The directors’ role is to test the solidity of this premise.
2. Verify that the price paid is reasonable. Ultimately, analyzing an opportunity culminates in a valuation. Such a valuation should reflect a realistic assessment of (a) the intrinsic value of the target in accordance with a number of different scenarios, (b) the value of expected synergies (and the cost of implementing them), (c) the positive and negative impacts of the transaction on the value of the purchaser’s company (e.g., management will have to devote considerable time to integrating the target, which may have an adverse impact on the purchaser’s business activities), and (d) the price that management offers to pay and the terms and conditions of payment.
Furthermore, when a proposed acquisition is of particular significance in light of the company’s size and when there is a possibility of a conflict of interest or a challenge by the minority shareholders concerning the price paid, it is advisable to have a fairness opinion drawn up by an independent expert.Usually, such opinions are prepared by the company’s financial advisers or other consultants hired by management (who naturally hope to gain repeat business). The board must ensure that this expert appraisal is carried out in a truly independent manner. The board must therefore verify the independence and skills of the expert(s), and, when the report is submitted, it must ensure that the work was carried out properly, in accordance with the professional standards in force. This assumes that at least one member of the board has adequate, relevant experience or that the board is assisted by another expert to help it in this task of supervision.
3. Ensure that a comprehensive due diligence process has been carried out. Due diligence is of critical importance as it enables the purchaser to verify the integrity of the seller’s financial statements, representations, and warranties, and to identify potential problems.
The due diligence must be based on broad (but relevant) objectives concerning the integration of the target. All too often, due diligence is mainly based on legal and accounting criteria, whereas the company needs to identify all the areas of major risk and, in particular, current and future operating risks, or others that may constitute an obstacle to effective integration. A comprehensive due diligence process covers items, such as an analysis of the target’s competitive advantages and their durability, the identification of key people (in particular those that the company may rely on for the purposes of integration), and the measurement of the stability of the most significant customer relations and the long-term prospects of formal or informal alliances.
4. Approve a specific integration plan. Experience has shown that integrating the target is the most complex part of the M&A process. In spite of a broad consensus on this point, this difficulty remains largely underestimated. The board can play an important role in alleviating this major problem by asking management to provide it with an integration plan prior to concluding the transaction. In particular, this plan needs to include (a) a timetable for the integration program, (b) an identification of the main initiatives undertaken by management to recover a significant portion of the control premium paid, (c) an assessment of the human resources and expertise to be earmarked for the integration process, and (d) a detailed business plan showing all the costs and benefits associated with integration.
During mergers and acquisitions, boards tend to focus on the strategic, financial, and governance aspects of a transaction. They often neglect one of the greatest sources of value in many M&A transactions: the talent of the management team in the target company. Exercising due diligence about talent is as important as paying close attention to the balance sheet, cash flow, and expected synergies of a deal. By asking management a series of questions about human capital in a merger or acquisition, boards can contribute to a smoother transition to a single company, a better merging of cultures, the loss of fewer “A” players, and a stronger talent bench for the merged company—all of which should ultimately create more value from the deal.
5. Organize the board’s work so that it is able to assist management upstream. The board’s contribution will be even more useful if it is able to contribute to management’s thought process as early as possible in the analytical and decision-making process. If M&A is a cornerstone of the company’s strategy, creating a special committee may be a useful way to deal with issues of efficiency, confidentiality, and the constraints inherent in a long and uncertain negotiating process.Rérolle and Vermeire (2005, April 29). | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/07%3A_The_Boards_Role_in_Strategy_Development/7.03%3A_The_Boards_Involvement_in_Strategy_-_Special_Situations.txt |
A key determinant of greater board effectiveness in the area of strategy is the set of metrics the board selects to monitor a company’s performance and health. The goal should be to identify a manageable number of metrics that strike a balance among different areas of the business and are directly linked to value creating activities. In addition to the standard financial metrics, key indicators should cover operations (the quality and consistency of key value-creating processes), organizational issues (the company’s depth of talent and ability to motivate and retain employees), the state of the company’s product markets and its position within them (including the quality of customer relationships), and the nature of relationships with external parties, such as suppliers, regulators, and nongovernmental organizations (NGOs).This section is based on “What directors know about their companies: A McKinsey Survey” (2006, March).
In selecting an appropriate set of metrics, it is useful to distinguish between value creation in the short, medium, and long term. Short-term health metrics show how a company achieved its recent results and therefore indicate its likely performance over the next 1 to 3 years. A consumer products company, for example, must know whether it increased its profits by raising prices or by launching a new marketing campaign that increased its market share. An auto manufacturer must know whether it met its profit targets only by encouraging dealers to increase their inventories. A retailer might want to examine its revenue growth per store and in new stores or its revenue per square foot compared with that of competitors.
Another set of metrics should highlight a company’s prospects for maintaining and improving its rate of growth and returns on capital over the next 1 to 5 years. (The time frame ought to be longer for industries, such as pharmaceuticals, that have long product cycles and must obviously focus on the number of profitable new products in the pipeline.) Other medium-term metrics should be monitored as well—for example, metrics comparing a company’s product launches with those of competitors (perhaps the amount of time needed to reach peak sales). For an online retailer, customer satisfaction and brand strength might be the most important drivers of medium-term health.
For the longer term, boards should develop metrics assessing the company’s ability to sustain earnings from current activities and to identify and exploit new areas where it can grow. They must monitor any threats—new technologies, new customer preferences, new ways of serving customers—to their current businesses. And to ensure that they have enough growth opportunities to create value when those businesses inevitably mature, they must monitor the number of new initiatives under way (as well as estimate the size of the relevant product markets) and develop metrics that track the initiatives’ progress.
Ultimately, it is people who make strategies work, so a good set of metrics should also show how well a business retains key employees and the true depth of its management talent. Again, what is important varies by industry. Pharmaceutical companies, for example, need scientific innovators but relatively few managers. Companies expanding overseas need people who can work in new countries and negotiate with governments.
7.05: Creating a Strategy-Focused Board
Fostering a strategic mind-set on the board is difficult and takes time. It requires rethinking its composition, how it approaches its responsibilities, and the way it interacts with management to help develop a strategic vision, although that must originate with the CEO. Progressive CEOs, for their part, must be able to articulate a clear strategy and have the personal confidence to build board teams that include experts who may be far more skilled in certain industry and operational areas than the CEOs themselves are.This section is based on Nadler (2004)., Carey and Patsalos-Fox (2006).
Rather than immediately seeking a deeper involvement in the strategy development process, it may be useful to ask boards to first seek a more effective balance between short- and long-term considerations in their oversight. As part of first step, they should identify and agree on a core set of metrics reflecting a balance that is tailored to the specifics of a company’s industry, maturity, culture, and current situation. In turn, management should be asked to draw up a set of long-term strategy options that the board can test and challenge. Management then can develop a detailed plan for the board’s final approval.
Ideally, this process unfolds over several board meetings and allows board members to probe specific strategic issues—does the company really have the ability to execute in a particular area, for example, and has it analyzed different options to enter the markets it wants to compete in? Finally, the board can play an important role in monitoring the progress of the plan and any changes in risk it involves. While the board can be selective in its focus on details, management must deal with all aspects of the strategic plan. Once accepted, the strategy can be expected to evolve over time, and therefore will require an ongoing dialogue between the board and management. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/07%3A_The_Boards_Role_in_Strategy_Development/7.04%3A_Monitoring_Strategy_Implementation_-_Choosing_Metrics.txt |
Regular, purposeful, CEO performance evaluation by the board is a cornerstone of effective governance. According to Spencer Stuart’s 2007 Board Index, 91% of directors surveyed said their CEO’s performance is evaluated annually; the remaining 9% conduct more frequent evaluations.This section is based on Rivero and Nadler (2003). Respondents also noted differences in implementation: 45% of respondents cited the compensation committee as taking the lead; the entire board oversees the process in 20% of the participating companies; the nominating and governance committee oversees in 16% of the companies, and the lead director in 12%.Spencer Stuart Board Index 2007.
Performance evaluation at the CEO level is difficult. Rivero and Nadler (2003) note that the difference between a good evaluation process in which everyone wants to participate and one that becomes mere window dressing is the CEO’s attitude toward the process and reactions to the feedback. At the same time, an ad hoc process sprung on the CEO can send the wrong signals about the nature of the board and CEO relationship. Both the CEO and the board need to make an investment to ensure that the process is well planned and part of the normal course of business. Minimizing potential problems at the outset, therefore, raises the odds of creating a successful, sustainable process. Common pitfalls to look for include the following:
• Uncertainty concerning roles and responsibilities. Confusion over roles and responsibilities is not uncommon. A clear charter helps, as do descriptions of roles and accountabilities, and timelines and milestones. The director leading the process (typically the chair of the compensation committee) should actively work with other board members to clarify expectations for their participation.
• Lack of time and energy. Time is the enemy of many board processes, and an elaborate CEO evaluation process that requires significant input from the board may be met with resistance. Yet, a well-designed evaluation brings structure and efficiency to many of the board’s other responsibilities, such as oversight and setting executive compensation, thereby actually saving directors time in the long run.
• Disagreement over criteria for assessment. Considerable debate over the appropriate criteria for assessing performance is normal and healthy. Before moving forward, however, the CEO and the board must agree on the dimensions of performance and objectives. Disagreements should be resolved by appealing to the strategy and business needs of the organization.
• Lack of direct information about nonquantitative performance. Financial and key operational metrics are usually readily available, but measures of softer dimensions, such as leadership effectiveness, often have to be designed specifically for the purpose of the evaluation.Rivero and Nadler (2003).
A well-thought-out process analyzes both past performance and sets goals for the future, and therefore assists the compensation committee of the board in making decisions about the CEO’s future compensation and employment. A good process helps the CEO and the board to establish focus on the company’s future direction by specifying a set of strategic objectives. This goal-setting aspect of the evaluation can also serve as part of the CEO’s ongoing leadership development, with the board providing feedback about areas where the CEO needs to do a better job, learn new skills, or focus additional attention.
An effective CEO evaluation process, therefore, looks backward, focusing on accountability and rewards for past performance, as well as forward, focusing on future objectives and whether the CEO has the vision, strategy, and personal capabilities to achieve those objectives. Although these are distinct objectives, in practice they are often integrated into the same process. Time constraints often force the board to evaluate the CEO’s performance over the previous year while simultaneously making compensation decisions, setting next year’s targets, and discussing specific areas for improvement, often in a single meeting. As Rivero and Nadler observe, this is unfortunate because when the two objectives are not clearly separated, there is a clear danger that neither gets served very well.Rivero and Nadler (2003).
When time is short the developmental part of the evaluation is often skipped altogether, forcing the board to use the compensation review to set the CEO’s future objectives. This approach is likely to emphasize what the CEO is expected to achieve (usually framed in terms of short-term financial targets) over how the CEO is expected to behave (such as giving more attention to developing future leaders). When this happens, the CEO is unlikely to receive candid, detailed feedback about his or her behavior and personal impact.
Dimensions
Defining an effective set of dimensions to be evaluated represents a major challenge. Based on the distinction made above between a CEO’s impact on corporate performance and his or her actions and effectiveness as a leader, Rivero and Nadler identify three generic sets of measurements of CEO performance: bottom-line impact, operational impact, and leadership effectiveness.
1. Bottom-line impact. Most CEO evaluation and “pay-for-performance” plans are based on the assumption that the top executive has a direct and significant impact on corporate performance, and therefore hold CEOs accountable for the company’s overall financial health. While important, relying solely on shareholder-oriented, accounting-based bottom-line measures as indicators of CEO performance has severe deficiencies. Most CEOs know that their ability to affect the company’s bottom line is indirect and often limited.
2. Operational impact. Operational impact refers to the CEO’s influence on the company’s effectiveness in operational areas, such as customer satisfaction, new product introduction, or productivity enhancement, and how well the firm implements its strategy. Operational impact measures often give a better indication of a company’s underlying potential to create value because they are directly related to the immediate stock price, which is subject to market-wide volatility. While still subject to external and internal forces outside of the CEO’s immediate control, this type of performance is more closely related to the CEO’s actions.
3. Leadership effectiveness. Leadership effectiveness addresses how well the CEO carries out his or her responsibilities, both in terms of executing specific role responsibilities—identifying a successor, meeting with key customers and investors, developing a long-term strategy—and the quality of those actions—communicating with external stakeholders, energizing the organization, and gaining the confidence of investors.Rivero and Nadler (2003).
The three categories described above are generic. While the specific dimensions and objectives that are used vary for each company, there are some general principles that leading companies follow in selecting CEO performance objectives. First, their evaluations reach beyond bottom-line performance. Financial measures of corporate performance, while critical, capture only one aspect of CEO performance. To compensate for some of the limitations of bottom-line measures, it is important to include objectives that reveal how the CEO behaves as a leader, as well as the CEO’s impact on the effectiveness of the organization. Second, they focus on a manageable number of objectives. One risk in attempting to capture multiple aspects of CEO performance is that the list of performance dimensions may grow too large to be workable. Too few dimensions, on the other hand, cause the process to be dominated by short-term financial objectives. Best practice is to use between 5 and 10 dimensions. Third, they use separate objectives for chairman and CEO performance, even if it involves the same person. In most North American companies, the CEO also serves as chairman of the board. It is important to evaluate performance in both roles. The chairman role can be assessed either as one component of a formal board evaluation process, or the dimensions of chairman effectiveness can be added to the CEO’s evaluation process. Fourth, they define measures for each objective. Creating explicit measures to track performance against the particular objective is relatively simple for all bottom-line and most operational impact objectives. For “softer” dimensions this is more of a challenge but can be achieved. For example, leadership behaviors can be measured through rating methods that ask board members to indicate how often the CEO demonstrates desired behaviors and what impact these have. Finally, they specify performance levels for each rating measure. Explicit measures for each objective assist in setting performance expectations with the CEO. Specificity helps create shared understanding of the performance standards between the CEO and the board.
Best practice also suggests that an effective CEO performance evaluation process is integrated with the company’s calendar of business planning and compensation review: Step 1 is focused on defining the CEO’s objectives. Before the start of the fiscal year, the CEO should work with the compensation committee of the board to establish key business objectives for the coming year. Using the strategic plan as a starting point, this dialogue should produce an initial set of personal performance targets and associated measurements. After reviewing and amending them if needed, the final set should be discussed and approved by the full board. These targets can then be used to create an integrated goal-setting process that aligns the objectives of each leadership level in the company.
Step 2 is a mid-year review. Six months into the year, the compensation committee and the CEO should review the targets and progress against them. Such a mid-year review can provide great value for two reasons. First, it helps the board see how the CEO is meeting or exceeding targets and to identify areas that require closer attention. Second, it provides an opportunity to amend the targets in light of changed circumstances, such as rapidly changing business conditions.
Step 3 is the year-end assessment. At the end of the fiscal year, the CEO’s performance should be measured against the previously established objectives. As part of this step, the CEO should be invited to provide a self-evaluation and be given an opportunity to address areas where targets were not met. The self-assessment is shared with the compensation committee and then the full board for input on the CEO’s performance. Evaluations by all board members go to the compensation committee, which uses the results to determine the portion of the CEO’s pay that is linked to performance. Before providing feedback to the CEO, the evaluation should first be discussed by the board in executive session, that is—without the CEO or other inside directors present.Rivero and Nadler (2003). | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/08%3A_CEO_Performance_Evaluation_and_Executive_Compensation/8.01%3A_CEO_Performance_Evaluation.txt |
A reasonable and fair compensation system for executives and employees is fundamental to the creation of long-term corporate value. However, the past 2 decades have seen an unprecedented growth in compensation for top executives and a dramatic increase in the ratio between the compensation of executives and their employees. “Runaway” executive compensation has become the subject of editorials, political debates, and battles between directors and shareholders. The reasons are not hard to understand; the numbers involved are large.
How Much Is Too Much?
In 2007, the CEO of a Standard & Poor’s 500 company received, on average, \$14.2 million in total compensation, according to the Corporate Library, a corporate governance research firm. The median compensation package received was \$8.8 million, more than 350 times the pay of the average U.S. worker.Data from The Corporate Library is based on 211 proxy statements filed in 2008 through April 9.
According to the Economic Research Institute (ERI), executive compensation has grown substantially faster than corporate earnings in recent years. The study of 45 randomly selected public companies found that executive compensation increased 20.5% in 2007, while revenues grew just 2.8%.Economic Research Institute (ERI) press release, February 15, 2008. Moreover, while performance-based bonuses for chief executives of large public companies dropped in 2007, companies more than made up for that decline by giving out bigger discretionary bonuses and other payments not tied to a specific financial target, according to Equilar, the executive compensation research firm.Financial Week, March 28, 2008. See also Equilar (2008). Equilar found that the median value of bonuses tied to performance fell 18.6% in 2007, from \$949,249 to \$772,717. Thanks, however, to sizable increases in discretionary awards and multiyear performance awards, overall CEO bonuses for 2007 increased 1.4 % to a median value of \$1.41 million from \$1.39 million in 2006.
Excessive CEO pay takes dollars out of the pockets of shareholders—including the retirement savings of America’s working families. Moreover, a poorly designed executive compensation package can reward decisions that are not in the long-term interests of a company, its shareholders, and employees.
Some CEOs may have far greater control over their pay than anybody previously suspected. Angelo Mozilo, chairman and CEO of Countrywide Financial Corp., brought in a second compensation consultant to renegotiate his package in 2006 when the first consultant said his pay package was inflated.
In an e-mail message to John England of Towers Perrin, the executive compensation consultancy who helped redo his pay package, Mozilo complained, “Boards have been placed under enormous pressure by the left-wing anti-business press and the envious leaders of unions and other so-called ‘CEO Comp Watchers.’”E-mail from Angelo Mozilo to John England, November 24, 2006, released by the U.S. House Oversight and Government Reform Committee. Mozilo renegotiated his contract with Countrywide for an annual salary of \$1.9 million, an incentive bonus of between \$4 million and \$10 million, perks and fringe benefits, as well as \$37.5 million in severance benefits. Under public pressure, he subsequently agreed to give up the severance package.
While simply comparing a CEO’s compensation to that of an average worker is not appropriate because it does not consider value creation, it makes for good press. So do high-profile reports of CEOs receiving compensation packages worth millions of dollars while shareholders lost a major part, if not all, of their investment and workers suffered benefit or job cuts. Such headlines fan the perception that despite new NASDAQ and NYSE rules mandating greater board autonomy, many directors remain beholden to management when it comes to compensation.
The CEO pay debate achieved international prominence in the early 1990s. An important milestone was the publication of Graef Crystal’s exposé on CEO pay, In Search of Excess, which clearly demonstrated the prevalence of excessive executive compensation practices in U.S. companies.Crystal (1992). Time magazine labeled CEO pay as the “populist issue that no politician can resist,” and CEO pay became a major political issue in the United States.McCarroll (1992). Legislation was introduced in the House of Representatives disallowing deductions for compensation exceeding 25 times the lowest paid worker, and the Corporate Pay Responsibility Act was introduced in the Senate to give shareholders more rights to propose compensation-related policies. The Securities and Exchange Commission (SEC) preempted the pending Senate bill in February 1992 by requiring companies to include nonbinding shareholder resolutions about CEO pay in company proxy statements, and announced sweeping new rules affecting the disclosure of top-executive compensation in the annual proxy statement in October 1992.Wall Street Journal, February 14, 1992. In 1994, the Bill Clinton tax act (the Omnibus Budget Reconciliation Act of 1993) defined nonperformance-related compensation in excess of \$1 million as “unreasonable” and therefore not deductible as an ordinary business expense for corporate income tax purposes.
Ironically, although the objective was to reduce “excessive” CEO pay, the ultimate outcome was a significant increase in executive compensation, driven by an escalation in option grants that satisfied the new IRS regulations and allowed pay significantly in excess of \$1 million to be tax deductible to the corporation. Once the act defined \$1 million compensation as reasonable, many companies increased cash compensation to \$1 million and then began to add on performance-based pay components that satisfied the act.Rose and Wolfram (2002, pp. S138–S175) document a “spike” in base salaries at \$1 million that did not exist before the new tax rules.
Stock Options
A principal driver behind the dramatic increases in executive pay in large U.S. firms over the past 3 decades has been the explosion in grants of stock options. A stock option is a right to buy shares at a particular price—the so-called strike price—at some future date. If an employee receives an option to buy 100 shares at a \$5 strike price and the stock has risen to \$10 by the vesting period, the employee can buy at the lower price and reap a quick profit. The idea is to align employees’ interests with those of shareholders’ to encourage productivity and profits. In reality the excessive use of options created a mechanism for companies to transfer profits directly to employees—mostly top executives—at the expense of shareholders.
The significant increase in the use and value of stock option awards was driven by a greater focus on equity-based compensation and changes in disclosure and tax rules that reinforced stronger linkages between stock performance and executive pay. Regrettably, there also is evidence that many boards and executives viewed options as a low-cost or even cost-free way to compensate executives.
In economic terms, the cost to the corporation of granting an option to an employee is the opportunity cost the firm gives up by not selling the option in the market, and that cost should be recognized in the firm’s accounting statements as an expense. When a company grants an option to an employee, it bears an economic cost equal to what an outside investor would pay for the option. However, because employees are more risk averse and undiversified than shareholders, and because they are prohibited from trading the options or taking actions to hedge their risk (such as short-selling company stock), employees will naturally value options less than they cost the company to grant.This argument ignores possible inside information held by the employee about the prospects of the firm, and the potential incentive benefits accruing to shareholders when employees hold options. Thus, because the company’s cost can exceed the perceived value to the employee, rather than being a low-cost way of compensating employees options constitute an expensive compensation mechanism. Its use can therefore only be justified when the productivity benefits the company expects to get from awarding costly options exceed the pay premium that must be offered to employees receiving the options.
Until recently, many U.S. companies were not very diligent in assessing the cost and value of options and treated options as being cost-free. Option grants do not incur a cash outlay and, until the recent change in accounting rules, did not bear an accounting charge. Moreover, when an option is exercised, the company incurs no cash outlay and receives a cash benefit in the form of a tax deduction for the spread between the stock price and the exercise price. These factors make the “perceived cost” of an option to the company much lower than the economic cost, and often even lower than the value of the option to the employee. As a result, many options were granted to many people, and options with favorable accounting treatment were preferred over better incentive plans with less favorable accounting treatment.
The impact of the excessive use of stock options, especially by leading technology companies, however well intended (ostensibly to attract, reward, and retain executive talent), goes well beyond the realm of executive compensation; it transferred a significant amount of wealth from shareholders to employees.
More recently the image of stock options was tainted further by two illegal acts—backdating and spring loading. Backdating involves picking a date when the stock was trading at an even lower price than the date of the options grant, resulting in an instant profit. Spring loading involves the granting of options right before a company announces news guaranteed to drive up the share price.
Backdating and spring loading violate existing accounting rules, state corporate law, federal securities laws, and tax laws. In a few instances, the U.S. Department of Justice has concluded that CEOs who backdated options committed criminal fraud. The recent backdating scandals forced numerous CEOs and other corporate officials to resign or be fired, and the SEC continues to investigate possible options backdating at more than 100 companies.
Backdating and spring loading also harm shareholders. The money paid to CEOs who improperly backdate or spring load their stock options belongs to shareholders, and when companies have to restate their earnings and pay additional taxes, shareholders lose even more. Since the Sarbanes-Oxley Act became law in 2002, companies must report stock options grants to their executives within 2 business days. Thanks to this investor protection law, it is much harder for executives to backdate stock options. But, Sarbanes-Oxley not withstanding, CEOs can still inappropriately time stock option exercises based on inside information or by spring loading their stock option grants.
In the last few years, investors submitted dozens of shareholder proposals seeking to limit executive severance and realign pay with performance. Although boards have tended to resist such proposals, contending they constrain their ability to attract, retain, and motivate managers, they have started to change their pay practices to better align interests with shareholders. PepsiCo, for example, replaced its traditional stock options with performance-based restricted shares that are worthless unless earnings targets are met. And at Merrill Lynch, all but 2% of the CEO’s pay package now consists of restricted shares untouchable until 2009. In 2003, almost 50% of the CEO’s pay package consisted of cash.
Golden Parachutes
A “golden parachute,” or change-of-control agreement, is an agreement that provides key executives with generous severance pay and other benefits in the event that their employment is terminated as a result of a change of ownership of the company. Golden parachutes are voted on by the board and, depending on the laws of the state in which the company is incorporated, may require shareholder approval. Some golden parachutes are triggered even if the control of the corporation does not change completely; such parachutes open after a certain percentage of the corporation’s stock is acquired.
Golden parachutes have been justified on three grounds. First, they may enable corporations that are prime takeover targets to hire and retain high-quality executives who would otherwise be reluctant to work for them. Second, since the parachutes add to the cost of acquiring a corporation, they may discourage takeover bids. Finally, if a takeover bid does occur, executives with a golden parachute are more likely to respond in a manner that will benefit the shareholders. Without a golden parachute, executives might resist a takeover that would be in the interests of the shareholders to save their own job.
As golden parachutes have grown more prevalent and lucrative, they have increasingly come under criticism from shareholders. Their concern is understandable since many golden parachute clauses can promise benefits well into the millions. The CEO of Gillette Co., for example, collected \$185 million when Procter & Gamble acquired the company. What is more, many golden parachute agreements do not specify that an executive has to perform successfully to be eligible for the award. In a few high-profile cases, executives cashed in their golden parachute while their companies had lost millions of dollars under their stewardship and thousands of employees were laid off. Large parachutes that are awarded once a takeover bid has been announced are particularly suspect; they are little more than going-away presents for the executives and may encourage them to work for the takeover at the expense of the shareholders.
In previous years, it was difficult to ascertain the value of executive severance packages until an executive actually left a company. New SEC executive compensation disclosure rules now require companies to disclose the terms of written or unwritten arrangements that provide payments in case of the resignation, retirement, or termination of the “named executive officers” or the five highest paid executives of a company. The SEC rules also require companies to detail the specific circumstances that would trigger payment and the estimated payment amounts for each situation.
Though this new rule will show whether an executive has an excessive severance package, it does not provide investors with a way to limit them. Congress is considering legislation that will require public companies to hold a nonbinding vote on executive pay plans, including an advisory vote if a company awards a new golden parachute package during a merger, acquisition, or proposed sale.
Despite best efforts to reign in and realign CEO pay, competition for talent keeps driving compensation to higher levels. CEO turnover has reached a record level, both in the United States and abroad, with more than one in seven of the world’s 2,500 leading companies making a change in 2005. According to a Lucier, Kocourek, and Habbel (2006), almost half of this turnover involved involuntary dismissals, four times the number a decade ago. The reason for the increase is not entirely clear. One interpretation is that recent reforms are working and that boards—under pressure from shareholders—have become more proactive in firing underperforming CEOs. The survey also shows, however, that CEOs are just as likely to leave prematurely as retire normally, either for a top job at another company or to become a “consultant”—evidence that in many companies the board–CEO relationship still is more adversarial than constructive.
Another factor pushing up compensation is the increasing prevalence of filling CEO openings through external hires rather than through internal promotions. CEOs hired from the outside typically get paid more than CEOs promoted from within. In addition, CEOs in industries with a higher prevalence of outside hiring are paid more than CEOs in industries characterized by internal promotions.Murphy and Zabojnik (2003). The competitive CEO job market also makes retention a more critical issue, further driving up pay, as boards will err on the side of paying more because of the difficulty, disruptiveness, time, and cost associated with finding a replacement.
The growing intensity of the competition for talent is not limited to CEOs. Compensation committees increasingly deal with the compensation demands of second-tier managers, especially CFOs. And even if senior executives are not threatening to leave, base salaries and target levels for bonuses are getting higher because of “benchmarking.” Many boards, acting on the advice of compensation consultants, have adopted a policy of setting their CEO’s pay above median levels, a practice known among pay critics as the “Lake Wobegon” effect where most every CEO is considered above average. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/08%3A_CEO_Performance_Evaluation_and_Executive_Compensation/8.02%3A_Executive_Compensation.txt |
The board of directors is responsible for setting CEO pay. Well-designed executive compensation packages are tied to an effective performance evaluation process, reward strong current performance, and provide incentives for creating long-term value. They must be structured to attract, retain, and motivate the right talent, and avoid paying premiums for mediocre or poor performance, or worse, for destroying long-term value. They should be designed to align the interests of management with those of shareholders and other stakeholders in both the short and the long term. While responsibility for CEO performance evaluation (and that of other key senior executives) often rests with the full board, determining appropriate compensation policies for the company’s CEO and most senior executives normally is the task of the board’s compensation committee.
The role of the compensation committee has changed significantly in recent years. In the wake of the Sarbanes-Oxley legislation, the new SEC rules, and other regulations, many boards are reevaluating the composition, charter, and responsibilities of the compensation committee. This also reflects the fact that the mission of the compensation committee has grown in recent years to include two distinct elements. Strategically, the committee has the responsibility to determine how the achievement of the overall goals and objectives of the company is best supported by specific performance-oriented compensation policies and plans. This includes designing and implementing executive compensation policies aimed at attracting, retaining, and motivating top-flight executives. Administratively, the committee has responsibility for ascertaining that the company’s executive compensation programs (covering base salary programs, short- and longer-term incentives, as well as supplemental benefits and perquisites) remain competitive within the market.
Within the context of this expanded mission, compensation committees must
• provide the necessary transparency required by the regulations through proper disclosures within the company’s SEC filings;
• recommend for board approval the specific performance criteria and annual and longer term performance targets for awards under the executive compensation program;
• review the performance of the top five officers relative to the achievement of performance objectives for use in calculating award levels under the executive compensation program;
• provide periodic oversight of all short- and long-term incentive plans, perquisites, and other benefits covering the company’s executives to ensure that such programs meet the stated performance goals of the organization;
• ensure that all committee business is conducted in a moral and ethical fashion, maintaining the highest levels of personal conduct and professional standards, and taking action to notify the board of any issues—as well as the necessary corrective action—that may affect the committee’s ability to objectively fulfill its duties and responsibilities.
8.04: Executive Compensation - Best Practices
The challenges facing compensation committees today are formidable. Increased public scrutiny, stronger pressure from shareholders, new regulations, and intense competition for executive talent are causing compensation committees to change their focus beyond providing transparency and compliance to creating value by adopting compensation policies and structures that assist in attracting, developing, and managing executive talent and driving performance.
A review of best practices of companies with a track record of overseeing successful management teams suggest that the most effective compensation committees do the following:
• Think strategically about executive compensation. Proactive compensation committees integrate their compensation policies with the company’s overall strategy. A move to a new business model, for example, may require different incentives from other growth strategies.
• Integrate compensation decisions with succession planning. Very few events have a more dramatic impact on a firm than the unexpected loss of a successful CEO. Winning companies have a succession plan in place that not only addresses “who takes over and when,” but also “why” and “how.” This requires that the board agrees on the set of skills and competencies needed to execute the company’s long-term vision—that is, adopts an objective framework for identifying the right talent to implement the company’s chosen strategy.
• Understand the limitations of benchmarking. External benchmarking is widely blamed for escalating executive pay levels. Analysis methods should not be blamed, however. The problems arise in their application. Benchmarks can be useful for assessing the competitiveness of compensation packages but should only be considered within the context of performance.
• Understand how executives view compensation issues. Executives often take a different perspective from directors in looking at compensation issues. Whereas boards are preoccupied with issues, such as the associated accounting expense, tax consequences, potential share dilution, alignment with the business strategy, and administrative complexity, executives often take a more personal, risk-based perspective.
• Communicate with major shareholders. Investors increasingly value an open dialogue about matters, such as potential board nominees or equity grant reserves; their input can give compensation committees a sense of broader shareholder views.
• Carefully select, monitor, and evaluate their advisers and advisory processes. NYSE listing standards require boards to evaluate themselves at least annually, and board self-evaluations are quickly becoming a governance best practice. The evaluation process should include the performance of consultants and other outside advisers. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/08%3A_CEO_Performance_Evaluation_and_Executive_Compensation/8.03%3A_The_Role_of_the_Compensation_Committee.txt |
In the last 3 decades, individual and institutional shareholders found their voice. Today, they assert their power as a company’s owners in many ways—from selling their shares to private or public communication with management and the board, from press campaigns to blogging, from openly talking to other shareholders to putting forward shareholder resolutions, and from calling shareholder meetings to seeking to replace individual directors or the entire board.
Although shareholder proxy proposals typically are not binding or may not receive enough votes to pass, they draw public attention to companies’ practices and often force them to reconsider their policies. As a result, a growing number of companies meet with their institutional shareholders during the planning stages of a proposal rather than wait until the implementation stage. And an increasing number of companies are submitting all-equity compensation plans for shareholder approval.
In the United States, the birth of the shareholder rights movement can be traced back to the stock market crash of the late 1920s—investors and policy makers believed this disaster was caused in significant part by companies’ lack of transparency. In its aftermath, the Securities and Exchange Commission (SEC) was formed and charged with creating public disclosure and enforcement mechanisms to protect investors and promote the dissemination of reliable corporate information to the marketplace.The SEC regulates and promulgates rules governing shareholder resolutions.
In the 1970s, activists’ agendas began to include socially oriented shareholder activism; religious investors formed a shareholder coalition called the Interfaith Center for Corporate Responsibility (ICCR) and started using the shareholder proposal process as a way of working for peace and social justice. They began organizing and filing resolutions on South African apartheid and community economic development and global finance, environment, equality, international issues, health, and militarism. Today, shareholder resolutions cover a similar range of issues and are used by public interest–minded shareholders and their allies to affect social change on a company level.
Corporate governance activism emerged in the 1980s. This brand of shareholder activism focuses on corporate governance, primarily on how a company structures and compensates its leadership. In 1985, the Council for Institutional Investors (CII) was formed to protect the financial interests of its member investors and pension funds. The CII and its member groups are actively involved in studying and promoting good corporate governance.
One of the most popular shareholder proposals today demands that shareholders be allowed to directly nominate and elect directors rather than work with the slate recommended by the board’s nominating committee. Another proposal asks that shareholder resolutions receiving majority support become binding on boards, and that shareholder votes on merger proposals be made mandatory. Support for these further proposals has been lukewarm, however, because they tend to undermine rather than strengthen the role of the board.
In 1989, following the Exxon Valdez disaster, investors and environmentalists banded together to form the Coalition for Environmentally Responsible Economies (CERES), which was built around elements of environmental disclosure. This investor-environmentalist alliance uses the power of share ownership to persuade companies to adopt a set of environmental principles and produce public, standardized, annual, environmental reports.
Today, shareholder resolutions are used more than ever as a way of influencing corporate behavior and concern issues ranging from corporate political contributions to health care, from executive compensation to board leadership, and from the environment to animal welfare. Institutional shareholders, especially hedge funds, are a major force behind these developments. Using the power of activism to influence policies at companies in which they have significant holdings, they have begun to scrutinize stock plan dilution, compensation practices, and merger proposals. Mutual fund firms, which have traditionally not been vocal on behalf of shareholder rights, are getting more involved. And more institutions are turning to their most powerful form of activism and voting “no” on key items.
A contributing factor is the short-term boost such efforts can have on stock prices. Thomson Financial studied the performance of stock in 75 companies targeted by activist investors—whether hedge funds, public pension funds, or other entities—between 2001 and 2006. Within the first 3 months of being publicly targeted, the companies on average saw their shares rise nearly 12%, well above the rise of less than 1.5% for a control group of stocks. After one year, the 75 companies posted gains of 17%, compared to a rise of 7.2% in the control group.Thompson Financial (2007).
Not surprisingly, shareholder activism is controversial. Proponents argue that companies with active and engaged shareholders are more likely to be successful in the long term than those that largely function on their own. In their view, vigilant shareholders act as fire alarms, and their mere presence helps alleviate managerial or boardroom complacency. Opponents say that “shareholder activism” is a form of disruptive, uninformed, populist meddling that encourages short-term behavior and diverts a board from a focus on value creation. Some particularly worry about the rise of hedge-fund activism. They note that although hedge funds hold great promise as active shareholders, their intense involvement in corporate governance and control also potentially raises a major problem, namely, that the interests of hedge funds sometimes diverge from those of their fellow shareholders. These polar opposites reflect the broader societal disagreement about how much power shareholders should delegate to corporate boards and when direct shareholder action becomes necessary and on what terms. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/09%3A_Responding_to_External_Pressures_and_Unforeseen_Events/9.01%3A_The_Rise_of_Shareholder_Activism.txt |
Most of the pressure on boards in the last 25 years has come from shareholders. More recently, however, a different source of pressure—the demand for corporate social responsibility (CSR)—has emerged, which is forcing directors into new governance territory occupied by stakeholders other than shareholders. While pressure on corporate executives to pay greater attention to stakeholder concerns and make CSR an integral part of corporate strategy has been mounting since the early 1990s, such pressure is only now beginning to filter through to the board.
The emergence of CSR as a more prominent item on a board’s agenda reflects a shift in popular opinion about the role of business in society and the convergence of environmental forces, such as the following:
• Globalization. There are now more than 60,000 multinational corporations estimated to be in the world.World Investment Report (2004). Perceptions about the growing reach and influence of global companies has drawn attention to the impact of business on society. This has led to heightened demands for corporations to take responsibility for the social, environmental, and economic effects of their actions. It has also spawned more aggressive demands for corporations to set their sights on limiting harm and actively seeking to improve social, economic, and environmental circumstances.
• Loss of trust. High-profile cases of corporate financial misdeeds (Enron, WorldCom, and others) and of social and environmental irresponsibility (e.g., Shell’s alleged complicity in political repression in Nigeria; Exxon’s oil spill in Prince William Sound in Alaska; Nike’s and other apparel makers’ links with “sweatshop” labor in developing countries; questions about Nestlé’s practices in marketing baby formula in the developing world) have contributed to a broad-based decline in trust in corporations and corporate leaders. The public’s growing reluctance to give corporations the benefit of the doubt has led to intensified scrutiny of corporate impact on society, the economy, and the environment, and a greater readiness to assume—rightly or wrongly—immoral corporate intent.
• Civil society activism. The growing activity and sophistication of “civil society” organizations, many of which are oriented to social and environmental causes, has generated pressure on corporations to take CSR seriously.The International Chamber of Commerce, a global advocacy group for the private sector, observed in 2000 that “non-governmental organizations have gained an enormous influence” over corporate decision making, as quoted in Barrington (2000, January–June). Well-known international nongovernmental organizations (NGOs), such as Oxfam, Amnesty International, Greenpeace, the Rainforest Action Network, and the Fair Labor Association, have influenced corporate decision making in areas, such as access to essential medicines, labor standards, environmental protection, and human rights. The advent of the Internet has increased the capacity of these organizations—as well as a plethora of national and local civic associations—to monitor corporate behavior and mobilize public opinion.“Civil society” is sometimes described as the part of society that exists between the state and the market. A more formal definition is “the voluntary association of citizens, promoting their values and interests in the public domain,” according to Saxby and Schacter (2003, p. 4). Kaldor, Anheier, and Glasius (2003, p. 2) estimate that there are approximately 48,000 international nongovernmental organizations (NGOs), and that total membership in international NGOs grew by about 70% between 1990 and 2000.
• Institutional investor interest in CSR. The growth in “socially responsible investing” has created institutional demand for equity in corporations that demonstrate a commitment to CSR. Recent growth in assets involved in socially responsible investing has outpaced growth in all professionally managed investment assets in the United States, even though the mainstream financial community has been slow to incorporate nonfinancial factors into its analyses of corporate value.“Big investors want SRI research: European institutions to allocate part of brokers’ fees to ‘nontraditional’ information,” Financial Times (UK), October 18, 2004.
These trends indicate that there is both a growing perception that corporations must be more accountable to society for their actions, and a growing willingness and capacity within society to impose accountability on corporations. This has profound implications for the future of corporate governance. It suggests that boards will soon have to deal with
• a growing pressure to give stakeholders a role in corporate governance;
• a growing pressure on corporations to disclose more and better information about their management of social, environmental, and economic issues;
• an increasing level of regulatory compulsion related to elements of corporate activity that are currently regarded as voluntary forms of social responsibility;
• a growing interest by the mainstream financial community in the link between shareholder value and nonfinancial corporate performance.
The discussion about corporate accountability to stakeholders, therefore, while often couched in the vocabulary of CSR, is really a discussion about the changing definition of corporate governance, which is why it should receive a greater priority on the board’s agenda.
Interestingly, whereas board agendas mostly focus on competition, cooperation may well become the preferred business strategy for addressing social and environmental issues. Increasingly, companies are joining forces not only with business competitors but also with human rights and environmental activists (formerly considered enemies), as well as socially responsible investors, academics, and governmental organizations. At the 2007 World Economic Forum (WEF) gathering, for example, two such coalitions were announced to address the issue of global online freedom of expression, particularly in repressive regimes. One, facilitated by Business for Social Responsibility (BSR), consists of companies facing intense criticism over complicity with suppressing online free speech in China. This coalition includes big names, such as Google, Microsoft, and Yahoo. The other gathered together socially responsible investing firms and human rights advocates, such as Amnesty International, Human Rights Watch, and Reporters Without Borders. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/09%3A_Responding_to_External_Pressures_and_Unforeseen_Events/9.02%3A_Demands_for_Corporate_Social_Responsibility_%28CSR%29.txt |
Corporate takeovers became a prominent feature of the U.S. business landscape during the 1970s and 1980s. Hostile acquisitions generally involve poorly performing firms in mature industries and occur when the board of directors of the target is opposed to the sale of the company. In this case, the acquiring firm has two options to proceed with the acquisition—a tender offer or a proxy fight.
Tender Offers and Proxy Fights
A tender offer represents an offer to buy the stock of the target firm either directly from the firm’s shareholders or through the secondary market. The purchaser typically offers a premium price to encourage the shareholders to sell their shares. The offer has a time limit, and it may have other provisions that the target company must abide by if shareholders accept the offer. The bidding company must disclose its plans for the target company and file with the SEC. Sometimes, a purchaser or group of purchasers will gradually buy up enough stock to gain a controlling interest (known as a creeping tender offer), without making a public tender offer. This is risky because the target company could discover the attempted takeover and take steps to prevent it.
Because it allows bidders to seek control directly from shareholders— by going “over the heads” of target management—the tender offer is the most powerful weapon available to the hostile bidder. Indeed, just the threat of a hostile tender offer can often bring a recalcitrant target management to the bargaining table, especially if the bidder already owns a substantial block of the target’s stock and can demonstrably afford to finance a hostile offer for control. Although hostile bidders still need a formal agreement to gain total control of the target’s assets, this is often easily accomplished once the bidder has purchased a majority of voting stock.
When there are strong differences between a board and a company’s shareholders about the firm’s long-term strategy, its executive compensation policies, or a merger or acquisition proposal, a proxy fight is likely to ensue. This occurs when the board sends out its proxy statement in which it seeks shareholder approval for a variety of actions. Proxy contests are usually waged to replace members of the board of directors, but they can also be used to gain support in other efforts like an acquisition. They tend to involve publicly traded companies but can also target closed-end mutual funds.
A leveraged buyout (LBO) is a variation of a hostile takeover. In an LBO, the buyer borrows heavily to pay for the acquisition, either from traditional bank loans or through high-yield (junk) bonds. This can be risky, since incurring so much debt can seriously harm the value of the acquiring company.
Defense Mechanisms
The management and directors of target firms may resist takeover attempts either to get a higher price for the firm or to protect their own self-interests. The most effective methods are built-in defensive measures that make a company difficult to take over. These methods are collectively referred to as “shark repellent.” Here are a few examples:
• A golden parachute, or change-of-control agreement, is an agreement that provides key executives with generous severance pay and other benefits in the event that their employment is terminated as a result of a change of ownership of the company. Golden parachutes are voted on by the board of directors and, depending on the laws of the state in which the company is incorporated, may require shareholder approval. Some golden parachutes are triggered even if the control of the corporation does not change completely; such parachutes open after a certain percentage of the corporation’s stock is acquired.
• The supermajority is a defense that requires 70% or 80% of shareholders to approve of any acquisition. This makes it much more difficult for someone to conduct a takeover by buying enough stock for a controlling interest.
• A staggered board of directors drags out the takeover process by preventing the entire board from being replaced at the same time. The terms are staggered, so that some members are elected every 2 years, while others are elected every 4 years. Many companies that are interested in making an acquisition are not willing to wait 4 years for the board to turn over.
• Dual-class stock allows company owners to hold onto voting stock, while the company issues stock with little or no voting rights to the public. This allows investors to purchase stock, but they cannot purchase control of the company.
• With a Lobster Trap strategy, the company passes a provision preventing anyone with more than 10% ownership from converting convertible securities into voting stock. Examples of convertible securities include convertible bonds, convertible preferred stock, and warrants.
In addition to preventing a takeover, there are steps boards can take to thwart a takeover once the process has begun. One of the more common defenses is the adoption of a so-called poison pill. Poison pills can take many forms and refer to anything the target company does to make itself less valuable or less desirable as an acquisition. Some examples include the following:
• A legal challenge. The target company may file suit against the bidder alleging violations of antitrust or securities laws.
• The people pill. High-level managers and other employees threaten that they will all leave the company if it is acquired. This only works if the employees themselves are highly valuable and vital to the company’s success.
• Asset or liability restructuring. With asset restructuring, the target purchases assets that the bidder does not want or that will create antitrust problems, or sells off the assets that the suitor desires to obtain. The so-called Crown Jewel defense is an example. Sometimes a specific aspect of a company is particularly valuable. A pharmaceutical company might have a highly regarded research and development (R&D ) division—a crown jewel. It might respond to a hostile bid by selling off the R&D division to another company, or spinning it off into a separate corporation. Liability restructuring maneuvers include the so-called Macaroni defensean approach by which a target company issues a large number of bonds with the condition that they must be redeemed at a high price if the company is taken over. Why is it called a Macaroni defense? Because if a company is in danger, the redemption price of the bonds expands like macaroni in a pot! Issuing shares to a friendly third party—the so-called White Knight defense—to dilute the bidder’s ownership position is another often-used tactic. In rare cases, a company decides that it would rather go out of business than be acquired, so they intentionally accumulate enough debt to force bankruptcy. This is known as the Jonestown defense.
• Flip-in. This common poison pill is a provision that allows current shareholders to buy more stock at a steep discount in the event of a takeover attempt. The provision is often triggered whenever any one shareholder reaches a certain percentage of total shares (usually 20% to 40%). This dilutes the value of the stock; it also reduces voting power because each share becomes a smaller percentage of the total
• Greenmail. Greenmail is defined as an action in which the target company repurchases the shares of an unfriendly suitor at a premium over the current market price.
• The Pac-Man Defense. A target company thwarts a takeover by buying stock in the acquiring company, then launching a takeover.
Despite the seemingly obvious advantages, takeover defenses of all kinds lately have become the target of increasingly potent shareholder activism. The primary shareholder complaints against poison pills are that they entrench management and the board and discourage legitimate tender offers. Institutional Shareholder Services (ISS; now part of RiskMetrics Group), an influential provider of proxy voting and corporate governance services, recommends that institutions vote in favor of shareholder proposals requesting that the company submit its poison pill or any future pills to a shareholder vote, or redeem poison pills already in existence. In addition, a company that has a poison pill in place that has not been approved by shareholders will suffer a significant downgrading in the ISS’s ratings system. Today, about one third of the Standard & Poor’s 500 companies continue to have poison pills.
Shareholder proposals requesting the company to submit its poison pill or any future pills to a shareholder vote, or to terminate an existing poison pill, are not binding on a board—even if overwhelmingly approved by the shareholders. However, if a company fails to implement a proposal approved by the shareholders, there likely will be significant negative consequences for the company and its incumbent directors, including the perception that the company is not responsive to the wishes of its shareholders, substantial withholding of votes in director elections, and downgraded corporate governance ratings. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/09%3A_Responding_to_External_Pressures_and_Unforeseen_Events/9.03%3A_Dealing_With_Hostile_Takeovers.txt |
Crises are inevitable. Large corporations can expect to face a crisis on average every 4 to 5 years. Every CEO will probably have to manage at least one crisis during his or her tenure. A director may have to face two or three crises during a normal tour of service on a board. Crises can take many forms—an industrial accident, product tampering, financial improprieties, sexual harassment allegations, or a hostile takeover. Any sudden event that threatens a company’s financial performance, reputation, or its relations with key stakeholders has the potential to become a crisis.This section is based on M. Nadler (2004) and D. Nadler, Behan, and M. Nadler (2006).
Some crises are preventable, others are not. Many are of a company’s own making, resulting from sins of commission or omission. In those cases, the board certainly has a role to play in crisis prevention and has clear accountability for failing to faithfully execute its fiduciary duties. A good many crises begin as problems, developing gradually over time, with plenty of opportunities for an alert board to step in and take corrective action.
Nadler (2004) groups crises into one of four categories:
1. Gradual emergence, external origin. These might involve economic downturns or the emergence of competitive threats, such as breakthrough technologies, new go-to-market strategies, alliances of major competitors, or regulatory changes that limit business practices or expand competition.
2. Gradual emergence, internal origin. Examples range from strategic mistakes (such as a poorly conceived merger) to failed product launches, the loss of key talent to competitors, and employee discrimination suits.
3. Abrupt emergence, external origin. Some of the most obvious examples are natural disasters, terrorist attacks, and product tampering.
4. Abrupt emergence, internal origin. This can include the sudden death or resignation of one or more key executives, failure of critical technology, production, or delivery systems, or the discovery of fraud.
In the event of a gradually emerging crisis, a carefully designed risk-management process should provide warnings, in plenty of time, for the company either to avoid the problem entirely or to take corrective action before it develops into a full-blown crisis. Abrupt crises are more problematic; no one can predict a terrorist attack, an earthquake, a plane crash, a shooting spree by a disgruntled employee, or a CEO’s sudden decision to quit and go to work for a competitor. But sound planning can help the company mitigate the consequences and speed the recovery. The board has an obligation to ensure that management regularly reviews, updates, and practices all aspects of crisis planning.
To deal effectively with any of these scenarios, a board must put together its own crisis-management plan, which identifies the different roles it may have to play depending on management’s role in the crisis. The most challenging situation occurs when the CEO is the source of the crisis. This scenario requires identifying what specific role board leaders and individual directors should play, and who the board should call on for independent guidance on legal, financial, or public relations issues.Bremer (2006).
Thus, the board needs to be absolutely clear about how it will be organized during a crisis, which members have particular expertise it can call upon, and who will take the lead in efforts to restore the confidence of employees, investors, and other stakeholders.
Crises Involving the CEO
During most crises, the board has an important but secondary role to play. That is, ordinarily the CEO is the chief crisis manager and communicator, and the board operates in the background to provide oversight, advice, and support. But, as noted above, when the CEO is the cause of the crisis, the board has no choice but to assume the full burden of safeguarding the interests of the company and its shareholders. That situation can arise for a host of reasons. The most obvious is the CEO’s death or sudden departure.
To determine who should take the lead in the event of a crisis, the board first must decide whether the crisis creates a real or potential conflict between the interests of management and the company. A hostile takeover bid, for example, may threaten the jobs of senior executives but still be in the best interests of shareholders. In such instances, only the board can provide the necessary leadership to maintain stability in the company and retain the confidence of employees, customers, and investors.
Every board should have a detailed plan for dealing with the sudden and unexpected loss of the CEO. Once emergency succession plans for the CEO and other top officers have been developed and agreed on by the board and the CEO, they should be reviewed and updated at least once a year.
Other Crises: The Board’s Role in Supporting and Advising the CEO
Most corporate crises are not about the CEO. Usually, therefore, the CEO will act as the chief crisis officer with the board playing a supporting role—approving key decisions, providing the CEO with a confidential sounding board, giving informed advice based on directors’ previous crisis experience or special expertise, and demonstrating confidence in the CEO and support for management’s efforts to navigate the crisis.
In a crisis, boards need two things above all else: information and a credible, candid communications policy that keeps shareholders, the media, and everybody else abreast of what is happening. If necessary, boards should launch an independent investigation of what happened and why, and retain their own outside counsel. Constant communication between the CEO and the board is also critical. The CEO must keep the board informed as events unfold and should engage the board in evaluating alternative courses of action. This provides the CEO with the benefit of the board’s collective experience with crises at other companies.
Recovery and Learning
After a crisis, the opportunity for collective introspection and improvement is brief because there is an inevitable push to regain normalcy, calm, and control. This is when the board should demonstrate its independence, leadership, and value to the organization by insisting that management stop and learn the most important lessons from its brush with disaster. It also is an opportune time to review, evaluate, and update the organization’s capabilities in the areas of risk assessment, crisis planning, and organizational recovery.Myers (2007, January–February).
The bottom line is that, in quieter times, boards could conduct their affairs in a climate of privacy and anonymity. Today, directors are increasingly exposed to all kinds of pressures—from the government, regulatory agencies, shareholders, NGOs, the press, consumers, and ordinary citizens. To deal with this heightened level of public scrutiny, boards must learn to function effectively in an environment of openness and transparency, and learn how to respond to such pressures and to unexpected events. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/09%3A_Responding_to_External_Pressures_and_Unforeseen_Events/9.04%3A_The_Boards_Role_in_Crisis_Management.txt |
• 10.1: Managing Itself - A Board’s First Priority
A strong and effective board is clear about its role in relationship to management and understands the difference between managing and governing. A board’s principal duty is to provide oversight; management’s duty is to run the company. A good board also understands that it, not management, has ultimate responsibility for directing the company’s affairs as defined by law.
• 10.2: What Defines the Best In-Class Boards?
A high-performance board governs by continually challenging—in a positive way—every significant aspect of the company’s operations: its business model, strategies, and underlying assumptions; its operating performance; and its leadership development. In doing so, a best in-class board should seek to create a culture of rigorous, relentless examination, and press for continuous improvement. This way it can set a “tone at the top” that reverberates throughout the organization.
• 10.3: The Right Leadership - The Key to Board Effectiveness
Independent board leadership capable of shepherding the board’s priorities and providing a voice for the concerns of other outside directors is critical to board effectiveness. An effective chair serves as the leader of the board, keeps directors focused on the board’s major priorities, sets meeting agendas, leads discussions, and occasionally serves as a board spokesperson.
• 10.4: Understanding the “Sociology” of the Board
No group can operate effectively without a well-defined, shared understanding of its primary role and accountability. The ongoing debate about the fundamental purpose and accountability of the modern corporation has created a problem for boards as a whole, as well as for individual directors—what behaviorists call a heightened sense of role ambiguity and, in some instances, increased role conflict.
• 10.5: Time and Information Deficits - Barriers to Board Effectiveness
To carry out their responsibilities, directors need to know a great deal. However, because of a board’s time constraints, the only effective approach is for the board to focus on lead indicators. The challenge is to know what the right lead indicators are—that is, which ones are unique to the company and its business model.
• 10.6: Building the Right Team - Board Composition
Behavioral characteristics are a major determinant of board effectiveness. Effective directors do not hesitate to ask the hard questions, work well with others, understand the industry, provide valuable input, are available when needed, are alert and inquisitive, have relevant business knowledge, contribute to committee work, attend meetings regularly, speak out appropriately at board meetings, prepare for meetings, and make meaningful contributions.
• 10.7: Board Self-Evaluation
In the aftermath of Sarbanes-Oxley, the stock exchanges mandated that boards of public companies and key committees, such as the audit committee, evaluate their own performance annually. Since there is no mandated or standard approach for such an evaluation, boards should select a process that best fits their needs.
10: Creating a High-Performance Board
A strong and effective board is clear about its role in relationship to management and understands the difference between managing and governing. A board’s principal duty is to provide oversight; management’s duty is to run the company. A good board also understands that it, not management, has ultimate responsibility for directing the company’s affairs as defined by law.
To meet these obligations, a board must take responsibility for its own agenda, or it will not be independent. Management cannot be responsible for directors’ skills and processes and should not have more than a consultative role in decisions, such as choosing new directors. Boards can no longer be just “advisers” who wait for management to come to them. As fiduciaries, they must be active monitors of management.
The specifics of the board’s role and modus operandi will vary with size, the stage and strategy of the company, and the talents and personalities of the CEO and the board. Clearly, “one size does not fit all.” There are, however, basic legal requirements and “management” skills that boards can and should adopt regardless of their role and structure. The goal should be to make the board perform as well as it wants the company managed.
Two critical determinants of board effectiveness are the directors’ individual and collective motivation and capabilities. The most effective boards score high on both dimensions; they know and respect the difference between governance and management and appreciate where and when they can add value. Conversely, boards that score low on both dimensions are likely to be ineffective and function mainly as a statutory body. Capable boards with low levels of motivation represent a missed opportunity, whereas highly motivated but less capable boards tend to meddle or micromanage. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/10%3A_Creating_a_High-Performance_Board/10.01%3A_Managing_Itself_-_A_Boards_First_Priority.txt |
What makes for a good board? In Building High-Performance Boards, executive search consultants Heidrick & Struggles observe that a high-performance board governs by continually challenging—in a positive way—every significant aspect of the company’s operations: its business model, strategies, and underlying assumptions; its operating performance; and its leadership development. In doing so, a best in-class board should seek to create a culture of rigorous, relentless examination, and press for continuous improvement. This way it can set a “tone at the top” that reverberates throughout the organization—to employees, to customers, to shareholders, and to the communities served by the company. A best in-class board, therefore, is more than a roster of prominent names; it is a well-balanced team that leverages the diverse experiences, skills, and intellects of the directors to further the strategic objectives of the company. Members of such boards focus on the big picture yet know when to drill down on specifics; they have the fortitude to speak openly and candidly, and the humility to remember that they do not run the business. Thus, being a good director is both a skill and a mindset.Heidrick and Struggles (2006).
A recent study by Bird, Buchanan, and Rogers (2004) for Bain & Company concludes that truly effective boards concentrate on value growth and practice seven habits that build their effectiveness:Bird, Buchanan, and Rogers (2004).
1. Effective boards own the strategy. Strong boards contribute to strategic thinking and feel a sense of ownership of the resulting strategy itself. The authors cite the case of Vodafone, where each year the board helps develop the agenda for a multi-day strategy retreat with senior executives. Each director contributes to the list of key strategic decisions that need to be made at the retreat. The event begins with a highly analytic overview of Vodafone’s markets and competitors, providing data that will inform those decisions. Instead of just including presentations by executives to the board, Vodafone’s process fosters debate on options, investments, and returns. When boards understand the issues at this depth and ask critical questions early on—Is the strategy bold enough? Is it achievable?—they can respond more quickly to opportunities such as major acquisitions when they arise. Decisions unfold faster. Vodafone’s swift consummation of the Mannesmann acquisition aptly demonstrates the value of such an approach.Bird, Buchanan, and Rogers (2004), p. 130.
2. Effective boards build the top team. As noted in earlier chapters, selecting, developing, and evaluating the top executive team are major board responsibilities. A truly effective board understands the significance of developing leaders to creating market value, and therefore has a strong incentive to get involved. Yet, Bain & Company’s analysis of 23 high-growth companies revealed that only a minority systematically try to develop new leadership through internal advancement.
3. Effective boards link reward to performance. Determining the right reward structure starts with how the company chooses to measure success—and how closely these measures are tied to the drivers of long-term value in the business, not with pay systems. Selecting the right approach is critical, because CEO compensation remains a controversial issue for many companies. Effective compensation schemes measure what matters and pay for performance, with a real downside for mediocre results. They also are simple and transparent and focus on sustained value creation, balancing short-term and long-term focus.
4. Effective boards focus on financial viability. As noted in earlier chapters, ensuring a company’s financial viability extends well beyond complying with the Sarbanes-Oxley Act and other applicable laws. It includes making other key financial decisions, such as choosing appropriate levels of debt and scrutinizing major investments and acquisition proposals. As Bird, Buchanan, and Rogers observe, worst practices can sometimes be instructive. They cite an investigation by former U.S. Attorney General Richard Thornburgh into WorldCom’s \$11 billion in accounting irregularities that concluded that WorldCom’s directors were often kept in the dark, particularly in matters involving some of the company’s more than 60 acquisitions. The study also revealed that the company’s directors made little effort to monitor debt levels or the company’s ability to repay obligations; yet, they “rubber-stamped” proposals by WorldCom’s senior executives to increase borrowings.
5. Effective companies match risk with return. Most boards have a process in place for assessing and managing operational risk. Yet, as noted in Chapter 6 "Oversight, Compliance, and Risk Management" in the section on enterprise risk management, few boards understand the true risks inherent in their companies’ strategies. This is critical: Almost three quarters of major acquisitions destroy rather than create value, and 70% of diversification efforts away from the core business and into new markets fail. Furthermore, Bain & Company estimates that more than 40% of recent CEO departures not related to retirement can be attributed to a controversial or failed “adjacency” move. The message: Boards need to understand and accept the risks inherent in their strategy and recognize the implications for required risk-weighted returns.
6. Effective boards manage corporate reputation. Strong boards avoid the traps of “check-the-box” compliance and a short-term horizon; they target long-term value creation and ignore guidance by “analysts” and court investors who seek long-term value. Once a course is set, they focus on transparency and effective communication to enhance their reputation.
7. Effective boards manage themselves. An effective board chair sets the tone from the top and implements an effective governance model. Such a model (a) focuses the agenda on issues of performance and regularly reviews board effectiveness, (b) builds a team of directors with the right mix of skills and experience, and (c) is clear about the value a board can contribute, and (d) ensures that directors have ample opportunities to fulfill their roles. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/10%3A_Creating_a_High-Performance_Board/10.02%3A_What_Defines_the_Best_In-Class_Boards.txt |
Independent board leadership capable of shepherding the board’s priorities and providing a voice for the concerns of other outside directors is critical to board effectiveness. While not the only way to establish such leadership, a nonexecutive chair can strengthen the independence of the board and help create a healthy check-and-balance between management and the board. As an alternative, some boards have adopted the so-called lead director model. If they do choose to appoint a nonexecutive chair, boards should ensure that the individual selected for this position has the experience, temperament, and commitment to the role to be effective. An effective chair serves as the leader of the board, keeps directors focused on the board’s major priorities, sets meeting agendas, leads discussions, and occasionally serves as a board spokesperson. According to consulting firm Spencer Stuart, the chair’s specific responsibilities cover four main areas:
1. Managing the board. This involves chairing board meetings, as well as leading executive sessions of the independent directors.
2. Communication. This includes maintaining regular communications with senior management and other directors to set meeting agendas and to discuss information flow and emerging issues.
3. Succession planning. Nonexecutive chairs are well positioned to play a leading role in CEO succession planning.
4. Board evaluations. Best practice suggests that the governance committee should manage the board and director evaluation process, with the committee chair gathering director feedback. Nevertheless, the chair has a significant role to play in conflict resolution.Spencer Stuart (2008).
In addition to being a focal point for the board, the chair can also be an important mentor for the CEO. Many people, therefore, believe he or she should be a consensus choice of both the board members and the CEO. Also, as part of his or her duties, a chair should make him- or herself visible inside the company—by participating in major company meetings, by being easily accessible to employees (in person, via e-mail, or by phone). The rationale for creating visibility is that, if bad things happen in the company, employees should know they have a person on the board—namely the chair—they can go to.
Performing all these duties well is a tall order and requires a unique combination of experience, dedication, and the right temperament. To lead effectively, a nonexecutive chair must understand the function of each board committee and the role of an individual director, and must be conscious of not undermining the CEO’s authority, especially in front of the senior management team. Learning on the job is not an option.
Beyond executive and board experience, good “people” and “communication” skills are essential. A nonexecutive chair must know how to create focus and how to build consensus on the board. He or she also needs to facilitate effective communication between the board and management and avoid becoming a barrier between the two. This requires diplomacy, an ability to be direct and concise without offending anyone, a passion for the job, and a minimal ego. An effective nonexecutive chair exercises leadership and avoids creating the impression that he or she is trying to run the show.
Who can fill these rather large shoes? According to Spencer Stuart, 73% of the nonexecutive chairs on Standard & Poor’s 500 boards are retired corporate executives. About half formerly served as the CEO of another company—experience that is extremely valuable to be effective in the role.Spencer Stuart (2008). | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/10%3A_Creating_a_High-Performance_Board/10.03%3A_The_Right_Leadership_-_The_Key_to_Board_Effectiveness.txt |
A board’s primary role is a fiduciary one. It is not surprising, therefore, that most board processes are designed with this objective in mind—to ensure management is accountable to the board and the board to shareholders. Recent reforms also reflect this bias toward the fiduciary role of the board. Consider, for example, the focus on greater disclosure, director independence, executive sessions, increased communications with major shareholders, and on separating the offices of chairman and CEO. All these changes are aimed at providing greater transparency and increased accountability. They do not, however, address the deeper issue of how the board can function better as a group.
No group can operate effectively without a well-defined, shared understanding of its primary role and accountability. The ongoing debate about the fundamental purpose and accountability of the modern corporation has created a problem for boards as a whole, as well as for individual directors—what behaviorists call a heightened sense of role ambiguity and, in some instances, increased role conflict. For example, while recent regulatory reforms promote enhanced transparency and accountability, they also may well increase directors’ anxiety about their ability to effectively carry out their responsibilities to say nothing about their personal exposure to legal and other challenges. If true, the outcome may be opposite of what is intended—a decrease in proactive conduct and more conservative “defensive” behavior on the part of directors, individually and as a group. And while recent reforms may clarify some of the formal rules that govern board composition and operation, little attention has been paid to what impact these changes are likely to have on the unstated or informal rules that govern much of actual board behavior.
Formal Versus Informal Rules
All group behavior, including that of boards, is governed by formal and informal rules. Formal rules include explicit policies about how often they meet, how they structure their meetings, who participates on what committees, and how issues are decided by discussion and vote. As with many groups, however, board behavior is also governed by a set of powerful unstated informal rules or norms. For example, asking management “tough, penetrating” questions about performance is formally encouraged and seen as part of a director’s duty. At the same time, if a director pursues an issue too long or too vigorously, he or she may be seen to violate any one of a number of unstated rules about what the other directors consider “effective” board membership.For more on formal versus informal rules in the boardroom, see Carter and Lorsch (2004), chap. 8. See also Khurana and Pick (2005), pp. 1259–1285.
This is one explanation for why so many boardroom votes are unanimous. While it is acceptable to occasionally cast a dissenting vote, if a board member repeatedly votes “against” his or her peers, however, he or she may be asked whether he or she is “for” or “against” management, and whether he or she has a hidden agenda. Norms also influence individual behavior after the group has reached a decision. For example, many boards operate under an unstated rule that directors should not criticize or reexamine the board’s past decisions.
What happens when a director violates an unstated norm? While the consequences for breaching formal board rules are fairly clear, the punishment for violating informal rules is less well defined. Because informal rules are implicit, corrective action primarily takes the form of exercising “peer” pressure. Since directors generally do not interact very much outside the boardroom, any exercise of corrective peer pressure is mainly confined to the boardroom itself, and therefore governed by the board’s prevailing set of group norms. What is more, since directors do not have the power to directly remove ineffective or confrontational peers, the scope of such corrective action is limited. And, unless the breach is so disruptive that he has no alternative, the chair, especially if he is also the CEO, will likely hesitate before confronting the offending director.
These two factors—the difficulty directors have discussing, questioning, or reconsidering the appropriateness of various norms and their uncertainty about the repercussions of breaching formal or informal rules—also explain why boards have tended to search “among their own”—that is, other CEOs with board experience—for new directors. Potentially embarrassing problems can be avoided when boards choose candidates who likely already understand the “rules,” especially the informal norms, that govern board conduct.Carter and Lorsch (2004), chap. 7.
Group Influences on Individual Behavior
It is well known that individuals behave differently in groups than they behave when they are alone. In a group, much of our individual behavior is determined by the behavior of other group members. In a board setting, this raises an important question: What happens when an individual director’s beliefs and opinions differ from those of the other members of the group? Does he vote according to his conscience, or will he likely compromise and vote with the majority in the face of real or perceived peer pressure? This dilemma occurs more often than one might think. Consider the following questions directors routinely face: Should I go along with the compensation committee’s recommendation for a substantial increase for the the CEO even though, deep down, I believe he is already paid too much? Do I vote “no” on the aggressive debt restructuring proposal when other members of the board clearly are for the proposal? How do I act when a senior board member who has mentored me before pulls me aside and urges me to go along with the majority for the sake of “unity” on the board? As these questions illustrate, group norms do not only strongly influence individual behavior—they may even dictate what perceptions, beliefs, and judgments are deemed appropriate. It is not surprising, therefore, that new board members often accept the judgment of more senior directors and choose to vote with them. This also explains why the current focus on director independence may well be misplaced; it has little or no relation to the underlying sociological issues that shape board behavior.
The above examples also illustrate how the presence of other more experienced and powerful group members can discourage individuals from participating up to their full potential. Sociologists label this phenomenon “social inhibition.” It is expressed in several different behaviors: loafing (i.e., minimizing effort while hiding behind the work of others), self-handicapping (e.g., knowingly accepting a very difficult challenge to avoid the risk of failing at a simple task), or conforming simply to get along. All of these behaviors can be found in the boardroom, and all must explicitly be addressed to create a high performance board. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/10%3A_Creating_a_High-Performance_Board/10.04%3A_Understanding_the_Sociology_of_the_Board.txt |
Effectiveness
To carry out their responsibilities, directors need to know a great deal. They must be knowledgeable about the company’s financial results, its competitive position, its customers, its products, its technologies, and the capabilities of its workforce; they must be aware of the performance and challenges of its top executives, as well as the depth and readiness of its broader talent pool. Boards also need to review information about the culture of the organization and about how customers and employees feel about the company. Finally, boards must closely monitor the company’s compliance with legal, regulatory, and ethical standards. Because of a board’s time constraints, the only effective approach is for the board to focus on lead indicators. The challenge is to know what the right lead indicators are—that is, which ones are unique to the company and its business model.
Available time is a major issue. Outside, independent board members usually hold significant leadership positions in their own organizations making it difficult for them to spend a large amount of time on board matters. Another is the inadequacy of the information provided to directors. Directors typically receive (a) operating statements, balance sheets, and statements of cash flow that compare current period and year-to-date results to plan and last year, (b) management comments about the foregoing that explain the reasons for variations from plan and provide a revised forecast of results for the remainder of the year, (c) share of market information, (d) minutes of prior board and some management committee meetings, (e) selected documents on the company, its products and services and competition, (f) financial analyst’s reports for the company and sometimes for major competitors, and (g) on an ad hoc basis, special information, such as consultants reports, customer preference data, or employee attitude surveys. A strong argument can be made that this is no longer enough, particularly in fast-changing industries and in companies with an increasingly global reach. Questions, such as, Are we going in the right direction? Are management’s assumptions about major trends and changes correct? Is the company doing the critical things to get the job done? Should our strategy be changed? cannot be answered meaningfully on the basis of mostly historical information or with summaries of proposed actions.
Dashboards and Scorecards
Originally created for CEOs, CFOs, and heads of business units to monitor hundreds of key financial, sales, and operational details, dashboards and scorecards are increasingly being introduced to the boardroom. Major companies whose boards use some form of dashboards include General Electric, Home Depot, and Microsoft.Directorship, July 11, 2008.
Web-based dashboards and their less sophisticated predecessors, scorecards, can display critical information in easy-to-understand charts and graphics on a timely basis. The most sophisticated dashboards allow users to drill down for additional details. For example, to diagnose a negative cash-flow trend, a director can quickly probe whether the shortfall is due to a receivables problem or the result of excessive spending.
A major advantage of dashboards is that they can be tailored to specific needs. Of course, any director dashboard should have a basic menu of common information, such as financial, sales, and compliance-related data. Beyond this common format, however, the configuration of the dashboard can be tailored to responsibilities of a particular director; an audit committee member might want special information on the subject of fraud prevention and detection, for example. Other examples include the ability of a director who serves on the compensation committee to immediately see whose options have been exercised, or an audit committee director’s up-to-the-minute update on Sarbanes-Oxley compliance progress.
Direct communication channels are also important. Directors should have access to top management other than the CEO. Effective boards have protocols in place that allow a director, with permission of the board chair and CEO, to speak directly with employees. Conversely, directors need to be accessible to management and employees of the organization.Brancato and Plath (2004). Many CEOs have historically followed a practice that all communication of information to the board from senior managers would flow first through the CEO, who would then relay that information to the board. This has the potential to obstruct information flow to the board. See also Ide (2003, March), p. 838.
Board Access to External Advisers
The board and board committees should, as needed, retain external experts, such as counsel, consultants, and other expert professionals, and investigate any issues they believe should be examined to fulfill the board’s duty of care. These external experts and consultants should have a direct line of communication and reporting responsibility to the board and not management. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/10%3A_Creating_a_High-Performance_Board/10.05%3A_Time_and_Information_Deficits_-_Barriers_to_Board_Effectiveness.txt |
The composition of the board should be tailored to the needs of the company. The board of an acquisitive company, for example, should be well represented with deal-making expertise and judgement, while the directors of a fast-moving technology company need a sound view of the industry’s future direction. However, every board needs to have certain essential ingredients, with the individual directors possessing knowledge in core areas, such as accounting and finance, technology, management, marketing, international operations, and industry knowledge. The best directors enrich their board with the perspective of someone who has faced some of the same problems that the company may face in the future. In addition, organizations in the early stages of building—or rebuilding—a boardroom culture, often are best served by a knowledgeable, forceful advocate for exemplary corporate governance.Brancato and Plath (2004).
Behavioral characteristics are a major determinant of board effectiveness. Effective directors do not hesitate to ask the hard questions, work well with others, understand the industry, provide valuable input, are available when needed, are alert and inquisitive, have relevant business knowledge, contribute to committee work, attend meetings regularly, speak out appropriately at board meetings, prepare for meetings, and make meaningful contributions.
The NYSE recommends that director qualification standards be included in the company’s corporate governance guidelines. Companies sometimes include other substantive qualifications, such as policies limiting the number of other boards on which a director may serve and director tenure, retirement, and succession. The chairman of the nominating committee should certify in the proxy that the committee has reviewed the qualifications of each director—both standing for election and on the board generally. Finally, every director should receive appropriate training, including his or her duties as a director when he or she is first appointed to the board. This should include an orientation-training program to ensure that incoming directors are familiar with the company’s business and governance practices. Equally important, directors should receive ongoing training, particularly on relevant new laws, regulations, and changing commercial risks, as needed.
10.07: Board Self-Evaluation
In the aftermath of Sarbanes-Oxley, the stock exchanges mandated that boards of public companies and key committees, such as the audit committee, evaluate their own performance annually. Since there is no mandated or standard approach for such an evaluation, boards should select a process that best fits their needs. At a minimum, the director performance evaluation process should ensure that each director meets the board’s qualifications for membership when the director is nominated or renominated to the board. Evaluation of the board and committees should also determine whether each has fulfilled its basic, required functions.For additional thoughts on this subject, see Anderson (2006).
In designing a suitable process, questions, such as, Why are we doing this? What areas do we need to focus on? How can we receive valid feedback? How can we act on that feedback to make a difference? Where can we find the required expertise, internally and externally? Who do we want to handle, analyze, and provide feedback to the board? To the chairman or lead director? To the CEO? To committees? To individual directors? must first be answered.
Many boards are not sufficiently aware of the type of expertise that is available to assist them in board evaluation and development. As a result, they may overestimate their own capabilities in this area and underestimate the value of external resources. One place for boards to turn is their internal or external counsel. A number of law firms are broadening their scope of service to include board evaluation. This makes sense in a litigious environment where the fear of shareholder lawsuits has arisen and where directors may be worried that the information revealed in a board evaluation process may make them more vulnerable. Retaining legal counsel to perform the evaluation may reduce this fear by having counsel assert privilege over such matters. However, even without legal privilege being asserted by counsel over the evaluation process and its documents, courts are likely to have a more favorable view of a board that chooses to take a tough look at how it can do better, documents the process intelligently, and acts on what it finds rather than one that does not evaluate itself at all.
Others may bring more important skills to the table. For example, professionals in industrial and organizational psychology often have relevant training. Depending upon a board’s likelihood of being involved in litigation, it may be advisable to ask external counsel to work collaboratively with external experts specializing in board and director performance effectiveness.
While there is no single, best approach to board evaluation, best practice suggests that an effective board and director evaluation process is (a) controlled by the board itself—not by management or outside consultants; (b) confidential and collegial—it should foster an atmosphere of candor and trust; (c) led by a champion—alternatives include the non-CEO chairman, the lead independent director or equivalent, or the chair of the nominating and governance committee; and (d) focused on identifying areas of improvement—in areas such as creating a balance of power between the board and management, focusing the board more on long-term strategy, more effectively fulfilling the board’s oversight responsibilities, the adequacy of committee structures, and updating the evaluation process itself.
A good process also evaluates individual director performance—through self-assessment and peer review. This should include consideration of independence, level of contribution, and attendance; take specific board roles into account; and provide a basis for determining the suitability of a director’s reelection. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/10%3A_Creating_a_High-Performance_Board/10.06%3A_Building_the_Right_Team_-_Board_Composition.txt |
The Encarta Dictionary defines an epilogue as “a short Chapter or Section at the end of a literary work, sometimes detailing the fate of its characters.” While this book clearly does not merit the label “literary work,” this epilogue does try to provide at least a partial answer to the question, “What is next in corporate governance?”
Specifically, we look at three sets of forces that are likely to shape corporate governance systems, principles, and practices in the years to come. We begin with the forces of globalization. Societies and corporations are connected by two inter-related sets of laws. The first is the rule of law as defined by local and national legislatures, multilateral agreements, and an emerging body of international law. These legal structures vary greatly from one part of the world to another. Most have deep and ancient societal roots, were shaped through centuries of cultural, political, and economic change, and exhibit a high degree of inertia. Proactive convergence of these structures, therefore, is unlikely, but a new global regulatory framework may be needed.
The market defines the second set of laws. Here we see a very different picture. No matter where a company operates or what it produces, these laws affect, or even determine, its fate. It should not come as a surprise, therefore, that this second set of laws is becoming—within the boundaries of applicable legal structures—the dominant force in the evolution of corporate governance practices around the world.
The second set of forces for change reflects new developments on the domestic corporate governance front. As companies continue their struggle to fully comply with the Sarbanes-Oxley Act, new accounting rules and disclosure requirements, and new pressures by institutional investors for greater shareholder democracy—principally focused on access and accountability—virtually guarantee further rule changes. The number of shareholder resolutions filed in the most recent proxy season on issues such as majority voting and ballot access has reached an all-time high. Proactive intervention by lawmakers in areas, such as “Say on Pay,” is also not out of the question. At the same time, while the trend toward private equity–dominated transactions appears to have been dealt a setback by the subprime and leveraged loan financial crisis, the large, privately owned corporation that uses public and private debt rather than public equity as its principal source of capital is likely to be a permanent feature of the global corporate governance landscape.
For the final set of forces, we return to the opening paragraph of the book, which introduced corporate governance in the context of the historical tension between individual freedom and institutional power. As noted in Chapter 9 "Responding to External Pressures and Unforeseen Events", the forces behind the Corporate Social Responsibility (CSR) movement have changed the governance landscape; they effectively have widened the range of players deemed to have a legitimate role in shaping corporate decision making and controlling the exercise of corporate power. Faced with this challenge, the appropriate response by boards is to develop a fuller appreciation of the new governance environment that is emerging. We describe this new environment in terms of a new compact between business and society. A key feature of this environment is the increasing pressure on corporations to involve stakeholders in the corporate governance system and holding the corporation answerable to the social claims and demands for nonfinancial information made by stakeholders, just as it is answerable to the financial claims and demands for information made by shareholders. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/11%3A_Epilogue_-_The_Future_of_Corporate_Governance/11.01%3A_About_Epilogues.txt |
The introduction of corporate governance regulations and best practices in one country or region increasingly affects corporate governance practices elsewhere in the world.This section draws on the 2006 Global Institutional Investor Study “Corporate Governance: From Compliance Obligation to Business Imperative,” by Institutional Shareholder Services (2006). For example, in 2002 the United Kingdom became the first country to require companies to submit executive compensation proposals to a shareholder vote.The “Directors Remuneration Report Regulations” became part of U.K. company law in 2002 and took effect the following year. The government adopted the regulations in response to concerns about excessive pay for poor performance. The new requirement is mandatory for all companies listed on the LSE index—a total of 980 companies as of March 2006. These companies must submit a remuneration report that contains a wide range of information, including cash pay, share and option grants, and performance targets for long-term plans. Companies must put the remuneration report to a nonbinding shareholder vote at the annual general meeting. Though nonbinding, the votes enable shareholders to voice their concerns on corporate compensation packages. A year later, the Netherlands took the same practice one step further by requiring companies to submit compensation reports to a binding vote by shareholders.The Tabaksblat Code of December 2003 requires that proposed remuneration policies be submitted to the general shareholders meeting for approval. If shareholders vote the report down, the company must either keep the previous compensation plan or else call an Extraordinary General Meeting of shareholders for a new vote. In 2005, Sweden and Australia both adopted requirements for nonbinding shareholder votes on compensation.This element of the Swedish Code of Corporate Governance took effect on July 1, 2005. As noted earlier, in the United States, new SEC rules mandate disclosure of executive compensation plans. In addition, a number of recent shareholder resolutions seek an advisory vote on compensation committee reports.
The U.S. Sarbanes-Oxley, along with the implementing requirements that followed, is another example of a standard whose impact extends well beyond national borders. Investors throughout the world have taken notice of Sarbanes-Oxley, and their responses, positive or negative, are shaping the development of regulations and standards in their own countries.
In Japan, perhaps more than anywhere else, the global pressures for governance reform are being felt. And, while change is slow, progress has been made toward providing greater accountability and transparency, a key concern of international investors.
Increasingly, investors use the power of the ballot box to shape corporate governance standards overseas. The 2006 Institutional Shareholder Services (ISS) Global Institutional Investor Study shows that investors in the United States, Canada, and the United Kingdom are the most likely to cast proxy votes outside their home markets, with 73% of U.S., 67% of Canadian, and 60% of U.K. investors voting at least 50% of the shares they hold outside of their home market.ISS (2006), Global Institutional Investor Study (2006).
The globalization of corporate governance is also influenced by regulators and governments, especially in developing markets. Markets compete with each other to attract global capital, and that competition includes corporate governance standards. Increasingly, high–corporate governance standards are viewed as a way to make their markets more attractive to international investors.
11.03: Global Investor Concerns
The 2006 ISS Global Institutional Investor Study identified three governance issues that consistently rank among the top three concerns of international investors:Global Institutional Investor Study (2006), p. 36.
• Better boards—the independence of the full board and key committees, the process of nominating and electing directors to ensure independence and the right mix of skills and qualifications, the accountability of boards, and their responsiveness to shareholders—defined the number one issue in all markets except Japan. Investors in four markets ranked board structure, composition, or independence as their number one priority, and investors in all markets except the United States included it in their top three issues.
• Executive pay—linking pay to performance, disclosing performance metrics, and demonstrating the links justifying executive compensation—was judged critical in all markets but Japan. Some of the strongest concerns came from investors in the United States and Canada.
• Financial reporting was a key issue in every market but Australia– New Zealand. More than 70% of investors surveyed cited improved disclosure as the most needed improvement. The lack of trust in current financial reporting extended across markets with distinctive approaches to financial disclosure. U.S. Generally Accepted Accounting Principles (GAAP) came under criticism for its rule-based, sometimes inconsistent or less than informative approach to accounting. The concern over financial reporting was hardly confined to the United States, however. Investors in other markets also voiced concerns, including those that take more of a principles-based approach. In developed markets, the principal challenge was seen to “make sense of the numbers, to see the forest for the trees.” In contrast, in developing markets like China, investors worried about obtaining reliable numbers in the first place.
A major conclusion of the survey was that institutional investors increasingly view corporate governance as a business imperative reflecting the recognition that their own business performance is largely driven by the bottom-line performance of the companies in their portfolios. They also signaled that corporate governance is likely to become an even more important factor in investment decisions in the future because of advances in the investment process, including global commercial databases on corporate governance ratings and the proxy voting records of institutional investors. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/11%3A_Epilogue_-_The_Future_of_Corporate_Governance/11.02%3A_The_Global_Convergence_of_Corporate_Governance_Practices.txt |
In 1999 the Organization for Economic Cooperation and Development (OECD) adopted the first multilateral set of guidelines. These “OECD principles” provide a conceptual framework for policymakers, companies, investors, and others to address corporate governance issues in terms that are commonly understood around the world.
The OECD principles define basic requirements a country must meet to be regarded as having an adequate corporate governance environment; they do not target harmonization, per se. Negotiated by lawmakers from 30 major developed economies with widely differing governance standards, they leave considerable room for country differences. They do insist all differences be made transparent, and thereby are a force for convergence. Since their adoption in 1999, the OECD principles have been explicitly used as a benchmark by a number of investor-related initiatives to set guidelines: the International Corporate Governance Network (ICGN)The International Corporate Governance Network (ICGN) is an association of large institutional investors from around the world with more than 10 trillion assets, under management whose aim is to promote better governance globally. For more details about the ICGN, go to their Web site, http://www.isgn.org guidelines on corporate governance; the guidelines of some of the largest institutional investors, such as the California Public Employees’ Retirement System (CALPERS) and the Teachers’ Insurance and Annuity Association–College Retirement Equities Fund (TIAA-CREF) in the United States; and Hermes Asset Management in the United Kingdom. In 2001 the International Institute of Finance (IIF), a grouping of the world’s most prominent financial institutions, also issued a set of global guidelines.
Convergence also does not imply a simple victory of one governance system over all others. Corporate ownership and control arrangements are deeply embedded in national laws and culture, and therefore will likely remain at least partly idiosyncratic. Rather, the focus of global alignment is on providing investors with a good understanding of how a company is governed in a particular country and the ability to fairly assess its performance and prospects. In other words, efforts to globally align governance systems and practices view the purpose of a high-quality corporate governance system in terms of generating trust in the investment community.
Convergence is principally occurring in three areas.
The first area concerns regulations, listing requirements, governance codes, and best practices. U.S. legislative changes have brought the American regulatory system closer to European norms, including
• the requirement that senior corporate officers must certify the fairness of corporate accounts or face criminal charges;
• the exposure of corporate executives and directors to criminal sanctions if they are found to have defrauded shareholders (the scope of criminal provisions on abuse of corporate property is broader in many continental jurisdictions, especially in France);
• a prohibition on company lending to senior executives (which is illegal in Germany).
Global convergence is also apparent in the new rule by the major U.S. exchanges requiring listed U.S. companies to adopt an internal corporate governance code and a code of ethics. Importantly, while the NYSE is not imposing its listing requirements on listed non-U.S. corporations, it does require them to explicitly comply or explain why they do not comply. This is another important way to stimulate convergence since many of the largest non-U.S. corporations in the world either have or aspire to have a NYSE listing. The new NYSE rules join a growing number of other “comply or explain” codes that have been adopted as part of listing requirements. This middle-of-the road approach between hard mandatory norms and purely voluntary market best practice was pioneered by the London Stock Exchange (LSE) when it integrated the various voluntary codes into a combined code that became a part of its listing requirements.
The second area concerns board independence and structure, the role and definition of independent directors, and shareholder representation. Board independence is also rapidly becoming a global benchmark. The new U.S. rules have set the independence bar high by requiring that a majority of directors be independent; that the audit, nominating, and compensation committees be comprised exclusively of independent directors and by tightening the definition of independence. But the main thrust of almost every code, whether international or national, is to enhance the independence of the board with regard to the controlling interests in a corporation: the managers in a widely held company or the controlling shareholder, where there is one. Almost all codes address this issue by requiring a “significant” number of independent, nonexecutive directors on the board. Most European codes do not specify a number; Korean listing requirements require that one fourth of the board should be independent; Malaysian listing requirements and the 2001 voluntary Singapore Code put the threshold at one third, following the example of the Vienot Code in France. According to the IIF guidelines, best practice consists in appointing independent directors to fill at least half of the board’s seats.
Convergence can also be observed in the opposite direction. Japan, for example, amended its commercial code in May 2002 to allow companies to choose their structure of governance. The choice is between the old company law scheme of a board of directors and a separate audit board, and a new, more U.S.-like structure that provides for an audit committee of the board with independent directors as a majority. Change will be slow; Japanese companies have shied away from instituting a clear board committee structure that would give real responsibilities to a largely ceremonial board.
In Europe, Deutsche Bank made a landmark change in the way its management board is organized, moving away from a focus on collective responsibility to a system that emphasizes individual responsibility of senior officers and the CEO, like that found in the United States. Siemens recently decided to establish an audit committee on its supervisory board (albeit not wholly independent) and to review its own corporate governance annually.
The third area concerns accounting, disclosure standards, and the regulation of the audit function. The convergence of financial reporting and accounting standards around the world is improving the ability of investors to compare investments on a global basis. It also facilitates accounting and reporting for companies with global operations and eliminates some costly requirements. Still substantially incomplete, it has the potential to create a new standard of accountability and greater transparency.
The goal is an improved reporting model built on principle-based standards. In Phase I of the convergence process (from 2001 to 2005), the European Commission decided on the use of a common financial reporting language (the International Financial Reporting Standards [IFRS]) and required the adoption of IFRS by more than 8,000 companies worldwide. Inaugurated by the February 2006 Memorandum of Understanding between the International Accounting Standards Board (IASB) and the U.S. Financial Accounting Standards Board (FASB), Phase II (from 2006 to 2009) is reserved for rigorous market and regulatory testing of the IFRS and for generating further proposals aimed at addressing significant differences. The objective is the substantial equivalence of IFRS and U.S. GAAP and the elimination of the SEC’s reconciliation requirement for foreign private issuers. Looking into the future (Phases III and beyond), the separate standard setters are expected to coordinate their actions and issue substantially identical standards. Longer term elements of FASB could be merged into the IASB structure to create a single, global standard setter (IASB) and accounting framework (IFRS) used worldwide.PriceWaterHouseCoopers ViewPoint (2007, April).
Thus, global convergence does not simply imply a movement to globally uniform corporate governance norms and behaviors. Rather, it signals the adoption of principles and practices that allow investors and corporations to increasingly operate on a basis of trust across national borders. Corporations around the world also are beginning to value good corporate governance and are adopting global best practices. In the end, however, the primary force behind global convergence will be investors’ demands for better governance and their willingness to value it. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/11%3A_Epilogue_-_The_Future_of_Corporate_Governance/11.04%3A_Global_Convergence_of_Systems_Requirements_and_Practices.txt |
Greater director independence to enhance accountability continues to be a major, if not the primary, focus of U.S. governance reform. A quick glance at the list of shareholder proposals of the most recent proxy season confirms this trend. The most popular shareholder resolutions filed concern issues, such as majority voting; access to the proxy statement; declassifying boards; “entrenchment” devices, such as classified boards, poison pills, supermajority vote requirements, and the right to call special shareholder meetings; and, of course, compensation alignment and disclosure. The latter issue, which Monks once called the “smoking gun” of U.S. corporate governance failure, is not only being targeted by shareholders but also by lawmakers.Monks (2005, March), p. 108.
Majority Voting
During the past year, many institutional shareholders have called on companies to adopt majority voting for director elections as opposed to what has been more common, plurality voting. Under the plurality model, directors who receive the greatest number of favorable votes are elected. Shareholders cannot vote against director nominees but can only withhold or not cast their votes. Thus, most nominees are elected, even if they receive very few favorable votes and even if many votes are withheld or not cast. Under majority voting, to be elected, a nominee must get a majority of the votes cast. The states in which most U.S. public companies are incorporated make either of these models available to corporations.
Companies faced with a majority voting proposal, binding or nonbinding, should pause before adopting the traditional approach of trying to defeat this kind of shareholder proposal. Clearly, investor, and increasingly regulatory, sentiment favors this proposal, and any victory is likely to be short-lived as the proposal will almost certainly be reintroduced every year until it prevails. Moreover, fighting the proposal will be a negative in the company’s “corporate governance rating” and may well lead to a new or reinvigorated campaign to withhold votes. Instead, boards would be wise to seize the corporate governance “high ground” by either adopting a modified plurality voting policy or a full-fledged majority voting regime.
Access Proposals
Another corporate governance issue that remains high on activists’ lists concerns shareholder proxy access in director elections. A few years ago, the SEC proposed rules that would have allowed certain shareholders to place the names of director nominees in the company’s proxy solicitation materials and proxy card. However, after reviewing the proposal, it decided against enactment. Arguments against proxy access included that, under current law, shareholders are free to utilize the proxy rules to solicit votes for their own nominees in director elections. Another argument was that proxy access might allow special interest groups to unduly influence the election process. Not all shareholders have the same interests. Arguments in favor of proxy access were that it would diversify boards and give shareholders a more prominent voice in decision making.
Elimination of “Entrenchment” Devices
Shareholders also continue to fight for the elimination of so-called classified or staggered boards, and the elimination of poison pills and related entrenchment devices. A staggered board of directors occurs when a corporation elects its directors a few at a time, with different groups of directors having overlapping multiyear terms, instead of en masse, with all directors having one-year terms. Each group of directors is put in a specified “class,” for example, Class I, Class II, and so on, hence staggered boards are also known as “classified boards.” In publicly held companies, staggered boards have the effect of making hostile takeover attempts more difficult because hostile bidders must win more than one proxy fight at successive shareholder meetings in order to exercise control of the target firm. Particularly in combination with a poison pill, a staggered board that cannot be dismantled or evaded is one of the most potent takeover defenses available to U.S. companies. Favole, in the Wall Street Journal, reported in January of 2007 that 2006 marked a key switch in the trend toward declassification or annual votes on all directors: More than half (55%) of the S&P 500 companies have declassified boards, compared with 47% in 2005.Favole (2007).
Compensation-Related Proposals
The 2008 proxy season “hot-button” issue was CEO pay, as evidenced by the large number of shareholder proposals calling for an annual advisory shareholder vote on executive pay, so-called “Say on Pay” proposals. Say on Pay is politically and emotionally appealing, attracts positive press, and, most important, is strongly supported by ISS (currently a part of RiskMetrics Group) and other proxy advisory firms. As with the issue of majority voting, given the strong national trend in favor of corporate governance activism and the obvious popular appeal of “Say on Pay,” momentum is building toward a pervasive “Say on Pay” regime for U.S. public companies.
The strong momentum for “Say on Pay” is, in part, explained by its international roots. As noted earlier, the concept originated in the United Kingdom in the early 2000s and was made mandatory for LSE-listed companies by an amendment to the Companies Act in 2002. Mandatory shareholder advisory votes on executive compensation have since been legislatively adopted in Australia and Sweden. “Say on Pay” has also been implemented in the Netherlands and Norway in the form of a binding annual “vote of confidence” on executive compensation.
As a practical matter, for a U.S. company, “Say on Pay” means that its executive pay policies and procedures will have to meet ISS guidelines on executive compensation or suffer a very strong risk of ISS recommending that shareholders vote “No on Pay.” Such a negative vote, if not addressed promptly by modifying executive compensation to fit ISS guidelines, will almost certainly lead to an ISS withhold-vote recommendation against the compensation committee and perhaps the entire board. The only clearly visible alternative to accepting ISS guidelines on executive compensation is for the board to negotiate exceptions with ISS based on particular facts and circumstances or with investors voting enough shares to overcome an ISS recommendation to vote “No on Pay.”
Looking ahead, there are indications that shareholders activists are shifting their focus to shareholder proposals for bylaw amendments to implement corporate governance reform in place of traditional nonbinding shareholder proposals that merely recommend board action. Two major reasons for this change in focus are the continued frustration with company boards that either fail to act in response to a successful nonbinding shareholder resolution or “water down” implementation of the proposal and a concern that boards can too easily amend or rescind board adopted policies under the umbrella of fiduciary duty obligations.
The continued focus of shareholder activists on director independence, director nomination and election, and issues of disclosure and transparency described above is useful and undoubtedly has substantively contributed to improving the U.S. governance system. At the same time, we should ask why they have not adopted a broader and even somewhat bolder agenda for change, especially since it now has been clearly established that increased director independence is not a panacea that will prevent future misconduct—or even managerial inefficiency. Moreover, the evidence in support of a positive relationship between independence and performance is also weak.
As Hinsey (2006) suggests, there are corporate governance issues that warrant greater activists’ attention. Separating the CEO and chairman positions is chief among them. In most U.S. boardrooms, the CEO continues to serve as board chair. As noted earlier, in this scenario the boardroom leadership responsible for independent directors’ oversight of management is the responsibility of none other than the corporation’s number one manager, a conflict of interest that is awkward at best.
The obvious solution is separating the two positions—the subject of only a handful of shareholder proposals filed in the last few years. The reason most often given against this idea is that having two leaders is confusing and does not work. The simple fact is, however, that it does work well, as demonstrated by the evidence from Great Britain. And rather than making the recently retired CEO the chairman of the board, outside directors should show their independence by filling the separate chair position with a nonexecutive boardroom leader of their own choosing.Hinsey (2006).
Another potentially productive debate concerns the issue of whether boards and shareholders should talk to each other. Most U.S. companies meet only (infrequently) with their largest shareowners and then only when threatened with resolutions or proxy contests. Resistance to increased communication between directors and investors is typically attributed to current SEC rules. It seems time, however, to test whether these regulations enhance or inhibit stronger corporate governance. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/11%3A_Epilogue_-_The_Future_of_Corporate_Governance/11.05%3A_Prospects_for_Further_U.S._Governance_Reform.txt |
A third major force that has already begun to change decision making in boardrooms all around the world is the push for social responsiveness and stakeholder relations. Societal considerations increasingly force companies to rethink their approach to core strategy and business model design.This section draws heavily on Rochlin (2006). Dealing more effectively with a company’s full range of stakeholders is also emerging as a strategic imperative.“Pressure grows on U.S. companies to act on climate,” Environmental Finance magazine, http://www.environmental-finance.com Historically, the amount of attention paid to stakeholders, other than directly affected parties, such as employees or major investors in crafting strategy, has been limited. Issues pertaining to communities, the environment, the health and happiness of employees, the human rights violations of global supply chains, and activist nongovernmental organizations (NGOs), among numerous other issues, were dealt with by the company’s public relations department or its lawyers.
For example, according to Ceres, a coalition of investors and environmental groups that helps coordinate shareholder filings, investors filed a record 43 climate-related resolutions with U.S. companies during the 2007 proxy season.See “Investors and Environmentalists for Sustainable Prosperity,” at http://www.ceres.org The resolutions sought greater disclosure from companies about their responses to the climate change issue, or called for companies to set greenhouse gas (GHG) reduction targets, and were filed by state and city pension funds and labor, foundation, religious, and other institutional shareholders, managing a total of more than \$200 billion in assets.
Fifteen of these resolutions led to positive actions by businesses, leading to shareholders withdrawing their resolutions. Among the companies that addressed investor concerns, oil company ConocoPhillips responded to its resolution by announcing its support for an aggressive mandatory federal policy to reduce GHG emissions, committing to spend \$300 million on low-carbon research, including alternative fuels, and agreeing to set a GHG reduction target.
Financial services company Wells Fargo committed to completing GHG assessments of key lending portfolios including agriculture, primary energy production, and power generation, while investment and insurance companies Hartford Insurance and Prudential Financial agreed to improve their public reporting and disclosure regarding the potential risks they face from climate change and strategies for mitigating those risks.
Seven resolutions were filed requesting that companies, including ExxonMobil, set specific GHG reduction targets from their operations and products. These resolutions received strong support, with more that 30% support at ExxonMobil, after investors raised concerns that the company is far behind competitors in addressing climate risks and investing in renewable energy. The increasing support for such resolutions shows that investors are looking for greater transparency about climate risks and information about how companies are preparing to meet the related challenges and seize the opportunities.
In this emerging environment, companies are finding that “business as usual” is no longer an option and that traditional strategies for companies to grow, cut costs, innovate, differentiate, and globalize are now subject to increased scrutiny by all stakeholders. Companies that accept, understand, and embrace this new reality will find that being a “good citizen” has significant, strategic value and does not detract but enhances business success. The late Milton Friedman might have had trouble accepting this new reality, but “good citizenship” has become “the business of business.” | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/11%3A_Epilogue_-_The_Future_of_Corporate_Governance/11.06%3A_A_New_Compact_Between_Business_and_Society.txt |
The Sarbanes-Oxley Act of 2002 imposes significant new disclosure and corporate governance requirements for public companies and also provides for substantially increased liability under the federal securities laws for public companies and their executives and directors. After it was adopted, the NYSE, NASDAQ, and AMEX adopted more comprehensive reporting requirements for listed companies, and the Securities and Exchange Commission (SEC) issued a host of new regulations aimed a strengthening transparency and accountability through more timely and accurate disclosure of information about corporate performance.
The most important changes concern director independence, the composition and responsibilities of the audit, nominating and compensation committees, shareholder approval of equity compensation plans, codes of ethics or conduct, the certification of financial statements by executives, payments to directors and officers of the corporation, the creation of an independent accounting oversight board, and the disclosure of internal controls.
12.03: Director Independence
New stock exchange listing requirements stipulate that the majority of directors of public companies be “independent.”An exception is made for “controlled companies”—those for which more than 50% of the voting power is held by an individual, a group, or other company. The rules further state, “No director will qualify as independent unless the board affirmatively determines that the director has no material relationship with the listed company” and require companies to disclose determinations of independence in its annual proxy statement or, if the company does not file an annual proxy statement, in the company’s annual report on Form 10-K filed with the SEC.
The rationale for increasing independence was that shareholders, by virtue of their inability to directly monitor management behavior, rely on the board of directors to perform critical monitoring activities and that the board’s monitoring potential is reduced, or perhaps eliminated, when management itself effectively controls the actions of the board. Additionally, outside directors may lack independence through various affiliations with the company and may be inclined to support management’s decisions in hopes of retaining their relationship with the firm. Requiring a board to have a majority of independent directors therefore increases the quality of board oversight and lessens the possibility of damaging conflicts of interest.
12.04: Audit Committees
Rule 10A-3 under the Exchange Act directs the stock exchanges and NASDAQ to require listed companies to have an audit committee composed entirely of independent directors. Subsequent stock exchange and SEC amendments further strengthened this provision by requiring the following, among other things:
• Each member of the audit committee is financially literate, as such qualification is interpreted by the board in its business judgment, or will become financially literate within a reasonable period of time after his or her appointment to the audit committee.
• At least one member of the audit committee is a “financial expert,” defined as someone who has
• an understanding of financial statements and generally accepted accounting principles;
• an ability to assess the general application of such principles in connection with the accounting for estimates, accruals, and reserves;
• experience preparing, auditing, analyzing, or evaluating financial statements;
• an understanding of internal controls and procedures for financial reporting;
• an understanding of audit committee functions.
• The audit committee has a charter that addresses the committee’s purpose and sets forth the duties and responsibilities of the committee.
• The audit committee obtains and reviews an annual report by the independent auditor regarding the firm’s internal quality-control procedures, discusses the audited financial statements with the independent auditor and management, and reports regularly to the board of directors.
• The audit committee is directly responsible for the appointment, compensation, retention, and oversight of the outside auditors. Additionally, the outside auditors must report directly to the audit committee.
• The audit committee has the authority to engage independent counsel and other advisers, as it determines necessary to carry out its duties.
• The audit committee approves, in advance, any audit or nonaudit services provided by the outside auditors.
The reasons behind these reforms are self-evident. Audit committees are in the best position within the company to identify and act in instances where top management may seek to misrepresent reported financial results. An audit committee composed entirely of outside independent directors can provide independent recommendations to the company’s board of directors. The responsibilities of the audit committee include review of the internal audit department, review of the annual audit plan, review of the annual reports and the results of the audit, selection and appointment of external auditors, and review of the internal accounting controls and safeguard of corporate assets.
12.05: Compensation Committees
New NYSE and SEC rules require that
• listed companies have a compensation committee composed entirely of independent directors;
• the compensation committee has a written charter that addresses, among other things, the committee’s purpose and sets forth the duties and responsibilities of the committee;
• the compensation committee produces—on an annual basis—a compensation committee report on executive compensation, to be included in the company’s annual proxy statement or annual report on Form 10-K filed with the SEC.
These reforms respond to the unprecedented growth in compensation for top executives and a dramatic increase in the ratio between the compensation of executives and their employees over the last 2 decades. A reasonable and fair compensation system for executives and employees is fundamental to the creation of long-term corporate value. The responsibility of the compensation committee is to evaluate and recommend the compensation of the firm’s top executive officers, including the CEO. To fulfill this responsibility objectively, it is necessary that the compensation committee be composed entirely of outside independent directors.
12.06: Nominating Committees
New NYSE and SEC rules stipulate that
• a listed company must have a nominating and corporate governance committee composed entirely of independent directors;
• the nominating and corporate governance committee must have a charter that addresses the committee’s purpose and sets forth the goals and responsibilities of the committee.
Nominating new board members is one of the board’s most important functions. It is the responsibility of the nominating committee to nominate individuals to serve on the company’s board of directors. Placing this responsibility in the hands of an independent nominating committee increases the likelihood that chosen individuals will be more willing to act as advocates for the shareholders and other stakeholders and be less beholden to management. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/12%3A_Appendix_A_-_Sarbanes-Oxley_and_Other_Recent_Reforms/12.02%3A_Overview.txt |
An equity-compensation plan is a plan or other arrangement that provides for the delivery of equity securities (including options) of the listed company to any service provider as compensation for services. Equity-compensation plans can help align shareholder and management interests, and equity-based awards are often very important components of employee compensation. New NYSE and SEC rules require shareholder approval for stock option plans or other equity compensation plans and any material modification of such plans. These rules are subject to a significant number of exemptions, however. Separately, new accounting rules have changed the accounting of stock options.For more on this subject, see Chapter 8 "CEO Performance Evaluation and Executive Compensation" in this volume.
12.08: Codes of Ethics and Conduct
New rules also require that public companies must adopt and disclose a code of business conduct and ethics for directors, officers, and employees; include its code of business conduct and ethics on its Web site; and each annual report filed with the SEC must state that the code of business conduct and ethics is available on the Web site. The code of conduct must comply with the definition of a “code of ethics” set forth in section 406 of Sarbanes-Oxley and provide for an enforcement mechanism that ensures prompt and consistent enforcement of the code, protection for persons reporting questionable behavior, clear and objective standards for compliance, and a fair process by which to determine violations.
12.09: Certification of Financial Statements
Sarbanes-Oxley requires the following:
• The principal executive officers and principal financial officers of public companies should provide a written statement with each periodic report that contains financial statements certifying (a) the report complies with the requirements of section 13(a) or 15(d) of the Exchange Act; and (b) the information contained in the report fairly presents, in all material respects, the financial condition and results of operations of the company
• The above certifications need to be filed separately with the SEC as exhibits to the periodic reports to which they relate.
• The principal executive officer and principal financial officer of the company must certify in each annual and quarterly report that
• the certifying officers have reviewed the report;
• to the certifying officers’ knowledge, the report does not contain any untrue statement of material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which the statements were made, not misleading;
• to the certifying officers’ knowledge, the financial statements and other financial information included in the report fairly present, in all material respects, the financial condition and results of operations of the company as of the dates of, and for the periods presented in, the reports;
• the certifying officers (a) are responsible for establishing and maintaining effective internal controls, (b) have designed such internal controls to ensure that material information relating to the company is made known to them, (c) have evaluated the effectiveness of the controls as of a date within 90 days prior to the filing of the report, (d) have presented in the report their conclusions about the effectiveness of the controls, (e) have disclosed to their outside auditors and audit committee any significant deficiencies in the internal controls and any fraud involving management or other employees who have a significant role in the company’s internal controls, (f) have identified for the outside auditors any material weaknesses in the internal controls, and (g) have indicated in the report whether or not there were significant changes in the internal controls that could affect those controls, including any corrective actions.
Any CEO or CFO who provides the certification knowing that the report does not meet the above-listed standards can be fined up to \$1 million, imprisoned for up to 10 years, or both.
12.10: Creation of the PCAOB
The Public Company Accounting Oversight Board (PCAOB) is a private-sector, nonprofit corporation created by Sarbanes-Oxley to oversee accounting professionals who provide independent audit reports for publicly traded companies. Its responsibilities include
• registering public accounting firms;
• establishing auditing, quality control, ethics, independence, and other standards relating to public company audits;
• conducting inspections, investigations, and disciplinary proceedings of registered accounting firms;
• enforcing compliance with Sarbanes-Oxley.
When Congress created the PCAOB, it gave the SEC the authority to oversee the PCAOB’s operations, to appoint or remove members, to approve the PCAOB’s budget and rules, and to entertain appeals of PCAOB inspection reports and disciplinary actions.
12.11: Disclosure of Internal Controls
As directed by section 404 of Sarbanes-Oxley, the SEC adopted a rule requiring registered companies to include in their annual reports a report of management on the company’s internal control over financial reporting. The internal control report must include
• a statement of management’s responsibility for establishing and maintaining adequate internal controls;
• a management assessment of the effectiveness of the company’s internal controls including disclosure of any material weaknesses;
• a statement identifying the framework used by management to evaluate the effectiveness of internal controls;
• a statement that the independent auditors have issued an attestation report on management’s assessment of the company’s internal controls over financial reporting. In addition, companies must provide disclosure about off-balance-sheet transactions in registration statements, annual reports, and proxy statements.
12.12: Payments to Directors and Officers
Sarbanes-Oxley and subsequent SEC directives stipulate that
• no public company may make a personal loan to a director or officer, and existing loans may not be materially modified or renewed;
• the CEO and CFO of a public company that restates its financial statements as a result of misconduct will have to forfeit any bonuses, incentives, equity-based compensation, and profits on sales of company stock realized during the 12-month period following the first public issuance of the financial document or report containing the inaccurate financial statements;
• the SEC has the authority to freeze any extraordinary payments by the company to any of its directors or officers while an investigation is ongoing;
• the SEC can bar a person who has violated section 17(a) of the Securities Act of 1933 or section 10(b) of the Exchange Act from serving as a public company director or officer;
• directors, officers, and 10% of stockholders of public companies are required to report changes in beneficial ownership within 2 business days after the relevant transaction;
• directors and executive officers are prohibited from buying or selling equity securities during a blackout period;
• nonmanagement directors are required to meet in regularly scheduled executive sessions without management present. | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/12%3A_Appendix_A_-_Sarbanes-Oxley_and_Other_Recent_Reforms/12.07%3A_Shareholder_Approval_for_Equity-Compensation_Plans.txt |
Analysis of corporations that have experienced major ethical and financial difficulties shows these companies have a great deal in common in terms of their corporate culture and management profiles, as well as their accounting and governance practices. On the basis of this knowledge, we can identify a number of early warning signals, or red flags, boards can use to spot the emergence of a corporate environment and culture susceptible to conflicts of interest and management abuse.This appendix is from Wood (2005).
Individually, these factors may not be predictive of future problems. In groups, however, they define a heightened risk profile and should be cause for additional scrutiny and objective analysis. For example, the combination of aggressive management practices creating rapid short-term revenue and stock price growth, coupled with weak board oversight, allowing the CEO to rapidly accumulate personal wealth through stock-based incentive compensation, has been present in a significant percentage of recent problem situations. Risk of rapid financial deterioration in such cases is exacerbated when the company also operates with aggressive financial practices and high leverage.
Specifically, audit committees would be well advised to monitor the following categories of higher risk characteristics based on their proven usefulness in identifying corporate environments that may be susceptible to rapid stock price and credit deterioration, as well as fraud:
13.02: Business Growth Strategy and Record
Business Growth Strategy and Record
• Aggressive pursuit of growth through acquisitions or through rapid expansion into new business lines, industries, or markets
• Major or frequent shifts or U-turns in business or operational strategy, including history of restructuring or sale of core business units or assets
• History of setting business growth targets, strategies, and projections that appear aggressive or overly optimistic, especially in comparison to peers
• Growth materially in excess of peers or broader market
13.03: Equity Culture- Stock Price Appreciation Strategy and Management Ownership
Equity Culture: Stock Price Appreciation Strategy and Management Ownership
• Aggressive positioning as a “growth stock”
• Overpreoccupation of management on short-term stock-price appreciation
• Low or no common dividend policy
• Rapid accumulation of ownership (stock and options) by senior management, at a rate and to levels materially in excess of peer group
• Long-established CEO and senior management team with significant ownership interest where structural complexity, leverage, or opaqueness are present
• Growth in price–earnings ratio, stock price, or market capitalization materially in excess of peers
13.04: Senior Management Character Compensation Composition Tenure Turnover and Succession
Senior Management Character, Compensation, Composition, Tenure, Turnover, and Succession
• Cult of a CEO (leader) personality or the high media profile of CEO
• Over-reliance on, excessive power of, or domination by the CEO, including unwillingness to delegate
• Heavy dependence on the CEO for corporate public, client, and government relations (e.g., when the CEO is the sole or main spokesperson)
• Weak or “domineered” senior management team below the CEO
• CEO incentive and/or total compensation materially higher than peer average
• Link between company financial performance and executive compensation primarily focused on short-term horizon
• Special payments or unusual fringe benefits or loans to executives without a clear purpose, or unconnected with any increase in performance (including “guaranteed” bonuses)
• Compensation plans or provisions that create perverse incentives (i.e., payouts that encourage excessive acquisition activity; payouts on reaching a certain share price trading level).
• Unclear succession plan and/or failure to name a successor
• High or unexpected senior management or board of director turnover or departures.
• Lack of credibility in company explanation of senior departure(s)
• Lavish CEO and senior executive lifestyle and corporate entertainment
13.05: Corporate Culture and Business Practices
Corporate Culture and Business Practices
• Lack of meaningful long-term corporate planning and focus
• Creation of a “culture of greed” and management self-enrichment: materially more generous compensation pattern for the CEO and senior executives than peers
• “Make the numbers!” corporate culture: untoward pressure on managers to achieve aggressive budgets
• Creation of a “culture of fear,” penalizing internal debate and independent or creative thinking; creation of environment where only “good news” is acceptable to corporate chieftains
• “Take no prisoners!” corporate culture: questionable or heavy-handed strategies and tactics with competitors, customers, employees, suppliers, accountants, bankers, business partners, and regulators or government authorities
• History of litigation in pursuit of business strategies and undue pressure on critics (e.g., lawsuits by company against company customers, employees, suppliers, accountants, bankers, regulators or government entities)
• Lack of transparency: history of lack of openness with external and internal constituencies, including independent directors
• Heavy use of lobbyists and lawyers
• Aggressive corporate communication and image building; heavy use of “spin”
• History of aggressive or questionable sales and/or marketing practices
• Cavalier attitudes toward internal control
13.06: Companys Legal Business Financial Ownership and Tax Practices
Company’s Legal, Business, Financial, Ownership, and Tax Practices
• Major changes in ownership, managerial, legal, regulatory, and operating structure
• Overfocus of management time and resources on creating complex corporate legal entity, operating, finance, and tax structures (particularly if this is accompanied by intercompany asset sales, transfers, or fee payments)
• Existence of seemingly excessive number of corporate legal entity vehicles (particularly those with limited or no clear operational mandates)
• Heavy reliance on tax shelters or similar devices to maintain or maximize profitability
• Management inability or unwillingness to explain reasons behind corporate-, finance-, tax-, or ownership-structure complexities
• Aggressiveness or complexity in financial leverage and structure, including
• high degree of leverage versus peers;
• stability of capital structure susceptible to refinancing risk;
• over-reliance on short-term debt;
• management inability to explain rationale for capitalization structure and financing sources and uses;
• complexity or untoward number of financing subsidiaries or other financing vehicles within the corporate structure;
• Overly structured financing arrangements.
13.07: Litigation Regulatory and Governmental Actions and Track Record
Litigation, Regulatory, and Governmental Actions and Track Record
• High or increasing incidence in litigation, or threat thereof, from customers, vendors, competitors, regulators, shareholders, creditors, or government entities
• Lawsuits suggesting the development of overly aggressive or illicit corporate culture in areas including management misrepresentations, product deficiency, excessive executive compensation and benefits or perks, company loans to executives, accounting and reporting irregularities, fraudulent or coercive sales, price fixing and illegal “market cornering” activities, or failure to supervise (management negligence)
• Sizable contingent liabilities exist or have material chance of developing; establishment of material reserves for future litigation costs/liabilities
• Increased incidence of regulatory scrutiny, actions, or penalties (including forced restatement, refiling of various reports or tax audits) | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/13%3A_Appendix_B_-_Red_Flags_in_Management/13.01%3A_Appendix_Overview.txt |
The recent wave of business scandals and threatening world events has fostered a greater awareness of the importance of risk management as a component of corporate governance. In 2004, the so-called Committee of Sponsoring Organizations of the Treadway Commission (COSO) released a comprehensive report titled “Enterprise Risk Management—Integrated Framework” to provide companies with a roadmap for identifying risks, avoiding pitfalls, and taking advantage of opportunities to grow firm value.
COSO defines enterprise risk management (ERM) as
a process, effected by an entity’s board of directors, management and other personnel, applied in a strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives.PricewaterhouseCoopers (2004). Principles-Based Framework for Managements and Boards to Comprehensively Manage Risks to Objectives (released by COSO, available at http://www.coso.org).
So defined, ERM assists in
• aligning risk appetite and strategy by explicitly considering the organization’s risk appetite in evaluating strategic alternatives, setting related objectives, and developing mechanisms to manage related risks;
• enhancing risk response decisions by providing rigor to identifying and selecting among alternative risk responses—risk avoidance, reduction, sharing, and acceptance;
• reducing operational surprises and losses by enhancing the capability to identify potential events and establish responses, thereby reducing surprises and associated costs or losses;
• identifying and managing multiple and cross-enterprise risks by facilitating integrated responses to multiple risks across the organization;
• seizing opportunities by considering a full range of potential events, which allows management to identify and proactively realize opportunities;
• improving deployment of capital by obtaining robust risk information, which allows management to effectively assess overall capital needs and enhance capital allocation.
Whereas traditional risk-management approaches are focused on protecting tangible assets shown on a company’s balance sheet and related contractual rights and obligations, the scope and application of ERM are much broader. ERM’s focus is enterprise-wide, and on enhancing as well as protecting the tangible and intangible assets that define a company’s business model. This widening of the scope of risk management reflects the fact that—with market capitalizations often significantly higher than historical balance-sheet values—the extension of risk management to intangible assets is critical. Just as future events can affect the value of tangible physical and financial assets, they can also affect the value of key intangible assets, such as a company’s reputation with suppliers, innovation record, or its brands.
ERM explicitly recognizes that risk may originate inside or outside the organization. For example, environmental risk originates outside the organization and can impair the viability of a particular business model. Process risk factors tend to be internal in origin and affect the ability of the firm to execute its stated mission. Information for decision-making risk threatens value creation because of its impact on the timeliness, quality, reliability, and comprehensiveness the information used to make key decisions.
Because risks do not always fall clearly into one category, the ERM philosophy encourages companies to develop a comprehensive risk-management plan in which the approaches to the various components of risk interact with and influence one another. In particular, ERM looks at eight sets of issues:
• Internal environment. The tone of an organization is set at the top of the organization. It is, therefore, important to ask what appetite its leaders have for risk and whether the company’s culture supports the chosen risk profile and risk-management and internal controls process.
• Objective setting. Companies typically set goals on many levels: strategic, operating, and financial. By clearly identifying its goals, management and the board can more clearly perceive the risks that the company may encounter.
• Event identification. The board should ask management how the company identifies new risks and opportunities. What risks and trends exist in the company’s industry? What risks are associated with new products, services, or acquisitions? With new competitors? How are the company’s risks interrelated? The board should also consider legal, ethical, and compliance risks that the company may encounter.
• Risk assessment. After identifying potential risks, management and the board should analyze and prioritize the risks in light of their likelihood and potential impact. Each business unit should be involved in the process and ask questions, such as, What adverse events has the company encountered in the past, and what lessons were learned?
• Risk response. Companies may chose to respond to risks by avoiding them or by accepting them and working to reduce their impact or dilute their severity by sharing risk with other parties. This raises questions, such as, What are the costs of these alternatives? Has management allocated sufficient resources to respond appropriately? Is the company adequately insured for its insurable risks?
• Control activities. The board should work with management to develop and implement well-structured policies and procedures in response to the company’s primary risks to ensure that responsive actions are carried out at all levels of the company.
• Information and communication. Relevant information should be well documented and communicated on a timely basis—vertically, up and down the chain of management, and horizontally, across divisions of a company—to ensure that all members of the organization carry out their responsibilities with respect to the company’s risk-management policies.
• Monitoring. The board should help management establish testing and evaluation procedures to monitor the company’s risk-management system. Modifications to the risk-management system should be made as needed in response to these evaluations.
Although the management of a company is ultimately responsible for a company’s risk management, the board must understand the risks facing the company and oversee the risk-management process. Board committees should incorporate risk management into their regular responsibilities. A company’s governance committee can ensure that the company is prepared to deal with risks and crises by evaluating the individual capabilities of the directors, nominating directors with crisis-management experience, and considering the time each director and nominee has to devote to the company. The governance committee should also work with management to establish an orientation program for new directors and succession plans for key executive officers.
While some companies prefer to involve the board as a whole in the risk-management process, corporate governance guidelines and charters of audit committees may delegate this responsibility to the audit committee. Alternatively, a company may appoint a risk-management officer, form a risk-management committee, or assign responsibility to a finance or compliance committee of the board. The responsible committee or group should meet regularly with the company’s internal auditor, the chief financial officer, the general counsel, and the head of compliance and individual business units to discuss specific risks and assess the effectiveness of the company’s risk-management systems.
Board committees should also incorporate risk management into their regular responsibilities. A company’s governance committee can ensure that the company is prepared to deal with risks and crises by evaluating the individual capabilities of the directors, nominating directors with crisis management experience, and considering the time each director and nominee has to devote to the company. The governance committee should also work with management to establish an orientation program for new directors and succession plans for key executive officers.
14.02: Questions Boards Should Ask About Risk Management
The NYSE listing requirements specify that, when addressing the audit committee’s duties and responsibilities, the committee charter should state that the committee must discuss management’s policies with respect to risk assessment and management. The ERM framework provides a context for such a discussion. Examples of questions the committee should ask include
with respect to strategy,This appendix is from Waller, Lansden, Dortch, and Davis (2005).
1. Is the board effectively engaged in strategic discussion of the company’s appetite for risk taking?
2. Does management involve the board when making decisions to accept or reject significant risks?
3. Is the company taking risks the board does not understand?
4. Are the risks inherent to the company’s business model fully understood? Managed capably? Monitored in a timely fashion?
with respect to policy,
1. How does management reward growth and innovation without creating unacceptable exposure to risk? Are there defined boundaries and limits that clearly specify behaviors that are off-limits?
2. Is there a proper balance between entrepreneurial and control activities? Are the risks associated with opportunity seeking clearly understood and managed?
with respect to execution,
1. Does management understand the uncertainties inherent in its strategies for the business?
2. Are there assurances that risk controls function properly?
3. Does the company have effective contingency plans to respond in event of a crisis?
4. What system of “early warning” signals does the company have?
5. Are there effective processes in place for identifying, measuring, and evaluating risk-management capabilities?
6. Has a risk officer or risk-management team been appointed?
with respect to transparency,
1. Is there an effective process for reliable reporting on risks and risk-management performance?
2. Does the company have an organizational structure in place to support enterprise-wide risk management? | textbooks/biz/Management/Corporate_Governance_(de_Kluyver)/14%3A_Appendix_C-_Enterprise_Risk_Management-_Ask_the_Board/14.01%3A_Appendix_Introduction.txt |
• 1.1: Criteria for Case Scenario Analysis
• 1.2: Topic 1- Professional Responsibility and Relationships Between Career Development Professionals and clients
Topic 1 provides scenarios that ask students to consider the role of professional responsibility and relationships when working as career development professionals. The differences in clients and/or workers must be considered at all times when providing professional services. Career development strategies and concepts changes along with workers and workplace policies.
• 1.3: Topic 2- Providing Career Services Online
Topic 2 provides scenarios that ask students to develop an understanding of how technology influences changes in ways to develop employees or potential employees in their careers. It also suggests that students consider the digital divide and how access to technology or lack thereof can effect their ability to provide appropriate career services.
• 1.4: Topic 3- Using Technology and Social Media in Human Resource and Workforce Development (HRWD)
As technology and social media have become essential to communication and collaboration among workers, Topic 3 provides scenarios that ask students to explore barriers that can occur when not all workers understand or feel comfortable using technology an social media. The rapid changes that occur with technology require HRWD professionals to remain diligent in their commitment to understanding both the effect and use of technology on people.
• 1.5: Topic 4- Supervising, Training, and Teaching Employees
Topic 4 provides scenarios where students can learn how motivational theories play a role in the development of employees. There are many motivational theories that play a role in supervising, training, and teaching employees. Understanding how to influence employees’ motivation is central to building successful relationships with employees for organizational success.
• 1.6: Topic 5- Ethics of Mentoring
Topic 5 introduces scenarios where mentoring and ethics can be explored and considered as complementary to each other. HRD professionals can develop competencies to complement the skills needed to successfully develop employees. Both the employees and HRD professionals should engage in continuous learning and development. Understanding historical context with integrity and honor helps HRD professionals be true to the career that they have chosen.
• 1.7: Topic 6- All Employees’ Access to Career Development, Training and Development, and Organization Development Activities
Topic 6 provides scenarios that ask students to examine their role in the access to training and development that HRWD professionals provide to all employees. Exclusionary tactics are common in organizations and their effect on organizational climate can determine the success or failure of developmental activities and initiatives. Having a well-designed, transparent strategy can help HRWD professionals in all aspects of employee development.
• 1.8: Topic 7- Power and Privilege Dynamics
Topic 7 provides scenarios that require students to acquire an understanding of how power and privilege can be misused and/or misunderstood. The appropriate use of power and privilege is essential for a healthy organizational culture where all employees feel valued. The contributions of all employees should collectively contribute to the success of the organization.
• 1.9: Topic 8- Authenticity of Allies
Topic 8 introduces students to the concept of allies for historically marginalized groups in the workplace. It can be argued that allies are supposed to be positive influences on the people they purport to help. However, there are fine lines that allies tend to cross when they covertly or overtly diminish the credentials of those they are seeking to help. One wonders if they even know the meaning of help and its purpose.
• 1.10: Topic 9- Ethics of Career Development and Training and Development Assessments
Topic 9 allows students to apply concepts to better understand how assessments can be both detrimental and positive to making successful hires and career transitions when used appropriately. HRWD professionals must consider all the consequences that can occur prior to using an assessment. Making the right hiring decisions influences employee morale. Hiring the wrong employee at any level of the organization can be problematic.
• 1.11: Topic 10- Protected Class Bias
Topic 10 requires that students have an understanding of protected class groups in the workplace and learn how discrimination of these groups is illegal and in many instances unethical. There are many real-life cases in the empirical research and professional literature of discrimination which have led to the creation of all the laws and mandates that protect these groups of employees in the workplace.
• 1.12: Topic 11- Covert Conditioning of Girls/Women Away from Male Dominated Fields
Historically, women and underrepresented in science, technology, engineering, and math (STEM) technical careers. The problems usually begin within the educational system. Without the proper educational foundation, it is difficult for girls to pursue higher education that will provide them the skills necessary to succeed as women in the workplace. Without women in technical positions both in school and the workplace, it is difficult for women to overcome barriers to entry in STEM careers.
• 1.13: Topic 12- Educational Opportunity Bias
Educational opportunity bias has long been a problem in throughout out the world, particularly for girls, minorities, and low income individuals. Education is sometimes seen as the great equalizer for opportunities in the workplace and society. Although education can be beneficial, the bias that exists in educational systems can create irreparable problems for individual students and society.
• 1.14: Topic 13- Occupational Segregation and Promotional Ceilings
Occupational segregation occurs in many ways. Topic 13 provides students with the opportunity to discuss ways that occupational segregation is used to derail the promising careers of employees. Without a cohesive work environment, where all employees feel integral to the organization’s success, organizations see high turnover among high potential employees.
• 1.15: Topic 14- Confidentiality
Topic 14 allows for the discussion of confidentiality and how the lack of maintaining confidentiality can be detrimental to organizational success. Building trust with employees is hard work that can be easily destroyed when confidentiality is violated. Inadvertent violations of confidentiality are still violations that are difficult to rectify.
• 1.16: Topic 15- Diversity, Equity, and Inclusion (DEI)
Topic 15 provides scenarios that provide students an opportunity to examine problems with diversity, equity, and inclusion in the workplace. There is no law that requires diversity in the workplace. There are laws that can lead to diversity, equity, an inclusion, but none that specifically requires diversity. Diversity just means difference. It must be defined in context to be applicable for use to achieve equity and inclusion.
• 1.17: Topic 16- Artificial Intelligence (AI) and HRD
Topic 16 allows students to discuss scenarios of how artificial intelligence (AI) and HRD are linked. The expertise of AI is not ethically sound, and the human expertise of HRD professionals can alleviate some of these concerns. Understanding the gap between HRD and explainable AI is important as technology becomes more integrated into workplace activities.
01: Chapters
Define the problem: Students should focus on defining the problem by determining the root cause, not the underlying symptom(s).
Develop reasonable alternatives: Students should develop three to four reasonable alternatives to deal with the problem. Most laws are written around the concept of what a reasonable person would do.
Evaluate each alternative: Generally, any alternative has both advantages and disadvantages. Students should provide at least two advantages and two disadvantages for each alternative.
Select the preferred alternative: Students should select one alternative or a combination of alternatives to resolve the underlying problem. Additionally, students should provide a reasonable and logical explanation as to why one alternative or combination of alternatives is better than another alternative.
Support the decision with empirical evidence: Students should support their decisions with empirical evidence as applicable. Not all empirical evidence is generalizable to every problem. | textbooks/biz/Management/Critical_Employment_Ethical_and_Legal_Scenarios_in_Human_Resource_Development_(Hughs)/1.01%3A_Criteria_for_Case_Scenario_Analysis.txt |
Abstract
Topic 1 provides scenarios that ask students to consider the role of professional responsibility and relationships when working as career development professionals. The differences in clients and/or workers must be considered at all times when providing professional services. Career development strategies and concepts changes along with workers and workplace policies.
Scenario 1: Coaching Responsibly
Regina is a mid-career, Black female supervisor for a multinational corporation. Regina would like to be promoted to an executive level position within her company. She realizes that the culture of her organization does not favor the advancement of Black professionals and less so Black women. Regina has decided to hire a career coach. She decides that she would like the perspective of a white male because, white males appear to be the only ones successfully reaching the executive suite in her organization.
After a few weeks of searching for a career coach, Regina finds Steve. Steve has been recommended by several white males in Regina’s organization who have used his services and have been promoted to the executive suite. Regina arranges a meeting with Steve. Steve advises Regina using the exact same resources that he has provided to her white male colleagues. After 6 months of career coaching from Steve, Regina has received no results from the changes that she has implemented after recommendations from Steve. Steve is baffled. He cannot begin to comprehend why his coaching is not working for Regina when he has seen phenomenal results in all of his other clients with the same information.
Discussion Questions
1. What are some of the potential problems that Steve is missing in his coaching of Regina?
2. Should Regina continue to seek career coaching from Steve? Why or why not?
3. Please find a real world example similar to this scenario. What happened and if resolved, how was the problem resolved?
Scenario 2: Professional responsibility of the career development professional
The country is trying to recover from a global recession. There are millions of people unemployed. However, the unemployment rate for Black workers is always double, if not triple, the rate of white workers with the same skills. There is a continuous stream of unemployed, skilled Blacks who come to meet with you in your role as career advisor at the unemployment office. You have access to information about jobs that you know the Black workers are qualified to do, but you also know that the employers with the most jobs do not like to hire Black workers.
Discussion Questions:
1. How do you help Black workers prepare to interview with employers who do not like to hire them?
2. What is your professional responsibility to these workers?
3. What is your professional responsibility to your employer?
4. What is your professional responsibility to the hiring organization?
5. What do you do with the information that you have about available jobs?
6. How do you help the Black workers obtain jobs?
Scenario 3: Career Development Expertise
Scotty is interested in changing careers. He schedules a career counseling appointment with a professional career development specialist, Carol. Carol meets with Scotty and documents his previous work history, education, and accomplishments to complete a professional resume for him. Carol tells Scotty that her fee is \$2,500. Scotty pays Carol because she assures him that the amount of money he pays her is miniscule in comparison to what he will earn on his next job. Carol offers Scotty no other service other than a sample cover letter. It has been a year since Carol met with Scotty. Scotty has not obtained a new job.
Discussion Questions:
1. Has Scotty been career counseled by Carol? Why or why not?
2. What more can Scotty do to obtain another position?
3. Is Carol obligated to further assist Scotty?
Supplemental Readings
Brotman, L. E., Liberi, W. P., & Wasylyshyn, K. M. (1998). Executive coaching: The need for standards of competence. Consulting Psychology Journal: Practice and Research, 50(1), 40-46.
Carter, R. T., Scales, J. E., Juby, H. L., Collins, N. M., & Wan, C. M. (2003). Seeking career services on campus: Racial differences in referral, process, and outcome. Journal of Career Assessment, 11(4), 393–404. https://doi.org/10.1177/1069072703255835
Chung, Y. B., & Gfroerer, M. C. A. (2003). Career coaching: Practice, training, professional, and ethical issues. The Career Development Quarterly, 52(2), 141-152.
Elliott, J. E. (1993). Career development with lesbian and gay clients. The Career Development Quarterly, 41(3), 210-226.
Feldman, D. C. (2001). Career coaching: What HR professionals and managers need to know. Human Resource Planning, 24(2), 26-35.
Feldman, D. C., & Lankau, M. J. (2005). Executive coaching: A review and agenda for future research. Journal of Management, 31(6), 829-848.
Hall, D. T., Otazo, K. L., & Hollenbeck, G. P. (1999). Behind closed doors: What really happens in executive coaching. Organizational Dynamics, 27(3), 39-53.
Hatala, J. P., & Hisey, L. (2011). Toward the development and validation of a career coach competency model. Performance Improvement Quarterly, 24(3), 101-122.
Kampa-Kokesch, S., & Anderson, M. Z. (2001). Executive coaching: A comprehensive review of the literature. Consulting Psychology Journal: Practice and Research, 53(4), 205-228.
Pearson, S. M., & Bieschke, K. J. (2001). Succeeding against the odds: An examination of familial influences on the career development of professional African American women. Journal of Counseling Psychology, 48(3), 301-309.
Richie, B. S., Fassinger, R. E., Linn, S. G., Johnson, J., Prosser, J., & Robinson, S. (1997). Persistence, connection, and passion: A qualitative study of the career development of highly achieving African American–Black and White women. Journal of Counseling Psychology, 44(2), 133–148. https://doi.org/10.1037/0022-0167.44.2.133
Thach, L., & Heinselman, T. (1999). Executive coaching defined. Training & Development, 53(3), 34-40. | textbooks/biz/Management/Critical_Employment_Ethical_and_Legal_Scenarios_in_Human_Resource_Development_(Hughs)/1.02%3A_Topic_1-_Professional_Responsibility_and_Relationships_Between_Career_Development_Professionals_and_cli.txt |
Abstract
Topic 2 provides scenarios that ask students to develop an understanding of how technology influences changes in ways to develop employees or potential employees in their careers. It also suggests that students consider the digital divide and how access to technology or lack thereof can effect their ability to provide appropriate career services.
Scenario 1: Limitations of OnlineCareer Services
Florine has been laid off from her job due to the effects of COVID-19. She is seeking to rejuvenate her career by exploring new opportunities. She can only receive career services through online processes due to the closure of government offices; however, the government offices in her county have limited technological resources, and the services cannot be viewed on cell phones. Florine has a smartphone but can no longer afford to pay for the data services. She can only receive text messages and phone calls. Florine also does not have a desktop, computer, laptop, iPad, or access to reliable internet services. She also does not have cable TV and without streaming services, cannot get a clear signal of public education channels.
Discussion Questions:
1. How can career professionals assist Florine?
2. Describe the best way(s) to improve Florine’s resources to access online career services?
Scenario 2: Rural Living and Technology Accessibility
Joseph recently graduated community college. While a student, he had access to a computer on campus and had a part-time job that allowed him free Internet access. Since his graduation, Joseph has lost his part-time job and his car. Living in a rural area of his community, Internet accessibility is inconsistent. All career services from his community college are online. Joseph desperately wants a new job, but he has no transportation or access to seek career support.
Discussion Questions
1. What can be done for individuals like Joseph who have limited Internet access ad need career assistance?
Supplemental Readings
Davidson, M. M. (2001). The computerization of career services: Critical issues to consider. Journal of Career Development, 27(3), 217-228.
Haberstroh, S., Rowe, S., & Cisneros, S. (2009). Implementing virtual career counseling and advising at a major university. Journal of Cases on Information Technology (JCIT), 11(3), 31-44.
Harris‐Bowlsbey, J., & Sampson Jr, J. P. (2005). Use of technology in delivering career services worldwide. The Career Development Quarterly, 54(1), 48-56.
Kettunen, J., Vuorinen, R., & Sampson Jr, J. P. (2013). Career practitioners’ conceptions of social media in career services. British Journal of Guidance & Counselling, 41(3), 302-317.
Kettunen, J., Sampson Jr, J. P., & Vuorinen, R. (2015). Career practitioners’ conceptions of competency for social media in career services. British Journal of Guidance & Counselling, 43(1), 43-56.
Kettunen, J., Vuorinen, R., & Sampson Jr, J. P. (2015). Practitioners’ experiences of social media in career services. The Career Development Quarterly, 63(3), 268-281.
Venable, M. A. (2010). Using technology to deliver career development services: Supporting today’s students in higher education. The Career Development Quarterly, 59(1), 87-96.
1.04: Topic 3- Using Technology and Social Media in Human Resource and Workforce Development (HRWD)
Abstract
As technology and social media have become essential to communication and collaboration among workers, Topic 3 provides scenarios that ask students to explore barriers that can occur when not all workers understand or feel comfortable using technology an social media. The rapid changes that occur with technology require HRWD professionals to remain diligent in their commitment to understanding both the effect and use of technology on people.
Scenario 1: Age Discrimination and Technology
The average age of employees in your division of the organization is 50. These employees have had limited use of any kind of technology or social media both at home and in the workplace. You are located in a rural community that has limited access to consistent, Internet service. You have designed training for them that includes examples about negative social media usage. As the training progresses, participants begin informing you that they have never used a computer outside of the workplace. They do not own a home computer and their telephone is not a smartphone; it is a flip phone. Despite holding this training in the computer lab, employees are having trouble accessing the Internet. They have never heard of Facebook, Twitter, Snapchat, Instagram, Netflix, Hulu, or the myriad other social media platforms. They absolutely do not know what an emoji is.
Discussion Questions:
1. How do you engage these participants without mentioning their age?
2. How do you change the session focus without offending participants?
Scenario 2: Social Class and the Digital Divide
The COVID-19 pandemic forced many employees to work from home. Across the world employees had little time to adjust. There has always been a digital divide between rural communities and urban areas regarding access to broadband Internet services. There is also a digital divide based on socio-economic status. Black families have the least access to broadband both in rural and urban communities. As human resource development and workforce development professionals seek to help workers facing the digital divide, they encounter many barriers. The majority of the activities require that they also work from home, so they do not have the resources to all of the technologies that they need either. Their Internet speed in many homes are slower than in the workplace and workers cannot apply for new jobs. Most of the required forms are no longer available in paper copies; therefore, more time is spent on the telephone to try and assist workers as opposed to virtual computing.
Discussion Questions:
1. How will workplaces sustain the careers of workers whose only limitation is access to broadband Internet?
2. How do HRWD professionals adjust their ability to use technology from home to meet the needs of workers?
3. What can be done to bridge the digital divide in Black communities?
Supplemental Readings
Benson, V., Morgan, S., & Filippaios, F. (2013). Social career management: Social media and employability skills gap. Computers in Human Behavior. 2013, 1-6.
Delello, J. A., McWhorter, R. R., & Camp, K. M. (2015). Using social media as a tool for learning: A multi-disciplinary study. International Journal on E-learning, 14(2), 163-180.
Hughes, C. (2010). “People as technology” conceptual model: Toward a new value creation paradigm for strategic human resource development. Human Resource Development Review, 9(1), 48-71.
Hughes, C. (2011, April). The five values of people and technology development: Introducing the value creation model for organizational competitive advantage framework. In American Institute of Higher Education 6th International Conference Proceedings,4(1), 180-189.
Maloni, M., Hiatt, M. S., & Campbell, S. (2019). Understanding the work values of Gen Z business students. The International Journal of Management Education, 17(3), 100320.
Oh, E. G., & Huang, W. H. D. (2018). A review of technology research in HRD from a design-based research perspective. Human Resource Development Review, 17(3), 258-276.
Osborn, D. S. & LoFrisco, B. M. (2012), How do career centers use social networking sites? The Career Development Quarterly, 60, 263–272.
Roberts, G., & Sambrook, S. (2014). Social networking and HRD. Human Resource Development International, 17(5), 577-587.
Sampson, J. P., Osborn, D. S., Kettunen, J., Hou, P. C., Miller, A. K., & Makela, J. P. (2018). The validity of social media–based career information. The Career Development Quarterly, 66(2), 121-134.
Shea, K., & Wesley, J. (2006). How social networking sites affect students, career services, and employers. NACE Journal. 66(4). 26-32.
Thomas, K. J., & Akdere, M. (2013). Social media as collaborative media in workplace learning. Human Resource Development Review, 12(3), 329-344.
Turner, J. R., Morris, M., & Atamenwan, I. (2019). A theoretical literature review on adaptive structuration theory as its relevance to human resource development. Advances in Developing Human Resources, 21(3), 289-302. | textbooks/biz/Management/Critical_Employment_Ethical_and_Legal_Scenarios_in_Human_Resource_Development_(Hughs)/1.03%3A_Topic_2-_Providing_Career_Services_Online.txt |
Abstract
Topic 4 provides scenarios where students can learn how motivational theories play a role in the development of employees. There are many motivational theories that play a role in supervising, training, and teaching employees. Understanding how to influence employees’ motivation is central to building successful relationships with employees for organizational success.
Scenario 1: Motivation Case Study
David was promoted to the position of Training Manager last week. His first project is to motivate the customer service representatives to provide better customer service despite the loss of three of their co-workers. The volume of work has not decreased, and no new employees will be hired. There will also not be any pay increases. Donna is the customer service supervisor, and it is her job to distribute the workload among the remaining 20 employees.
Donna has contacted David and requested cross-training of her employees as a motivational tool. She is hoping that the knowledge of new skills will be a motivation to the remaining employees so that they can obtain enhanced knowledge and skills for possible future promotions.
Discussion Questions:
1. In what way(s) can David motivate the customer service employees to learn new knowledge and skills?
2. In what way(s) can Donna motivate the customer service employees to apply the knowledge and skills obtained during training?
3. What key motivational theories are applicable to this case and why?
Scenario 2: Late to and Absent from Work
Monica started working at ABC Corporation five years ago. Monica recently married and now has an infant. Monica recently returned tow work after her pregnancy leave. Monica’s supervisor knows that she was previously an excellent worker; however, Monica has been late for work two times already and has also missed two days. If Monica is late or absent one more time, the supervisor will have no choice but to terminate her. The company policy must be followed and Monica signed the employee handbook agreeing to follow all policies.
Discussion Questions
1. Is there anything the supervisor can do to assist Monica? If so, what?
2. Should the ABC Corporation make changes to its late and/or sick policies?
Scenario 3: Performance-based Pay and Age
Marcus has been a team leader of his work group since he was 35-years old. He truly enjoys the leadership role, but now that he is 55-years old, his organization has decided to institute a performance-based pay system. Despite his documented, stellar performance, he is now required to attend mandatory classroom training. Marcus does not know how to read or write. He only attended school until 3rd grade.
Discussion Questions:
1. What will you do to ensure Marcus completes the required trainings?
2. Will you allow Marcus to continue to be a team leader? Why?
3. How do you counsel Michael without discriminating against him because of his age?
Supplemental Readings
Badura, K. L., Grijalva, E., Galvin, B. M., Owens, B. P., & Joseph, D. L. (2020). Motivation to lead: A meta-analysis and distal-proximal model of motivation and leadership. Journal of Applied Psychology105(4), 331-354.
Douglas, C. A., & McCauley, C. D. (1999). Formal developmental relationships: A survey of organizational practices. Human Resource Development Quarterly, 10(3), 203-220.
Eccles, J. S., & Wigfield, A. (2020). From expectancy-value theory to situated expectancy-value theory: A developmental, social cognitive, and sociocultural perspective on motivation. Contemporary Educational Psychology, 101859.
Geen, R. G., & Gange, J. J. (1977). Drive theory of social facilitation: Twelve years of theory and research. Psychological Bulletin84(6), 1267-1288.
Locke, E. A. (1968). Toward a theory of task motivation and incentives. Organizational Behavior and Human Performance3(2), 157-189.
Locke, E. A., & Latham, G. P. (1990). A theory of goal setting & task performance. Prentice-Hall, Inc.
Locke, E. A., & Latham, G. P. (2002). Building a practically useful theory of goal setting and task motivation: A 35-year odyssey. American Psychologist57, 705-717.
Porter, L. W., & Lawler, E. E. (1968). Managerial attitudes and performance. Richard D. Irwin, Inc.
Ryan, R. M., & Deci, E. L. (2020). Intrinsic and extrinsic motivation from a self-determination theory perspective: Definitions, theory, practices, and future directions. Contemporary Educational Psychology, 101860.
Schunk, D. H., & DiBenedetto, M. K. (2020). Motivation and social cognitive theory. Contemporary Educational Psychology60, 101832.
Taylor, J. A. (1956). Drive theory and manifest anxiety. Psychological Bulletin53(4), 303-320.
Van Vianen, A. E., Rosenauer, D., Homan, A. C., Horstmeier, C. A., & Voelpel, S. C. (2018). Career mentoring in context: A multilevel study on differentiated career mentoring and career mentoring climate. Human Resource Management, 57(2), 583-599.
Vroom, V. H. (1995). Work and motivation. Jossey-Bass. | textbooks/biz/Management/Critical_Employment_Ethical_and_Legal_Scenarios_in_Human_Resource_Development_(Hughs)/1.05%3A_Topic_4-_Supervising_Training_and_Teaching_Employees.txt |
Abstract
Topic 5 introduces scenarios where mentoring and ethics can be explored and considered as complementary to each other. HRD professionals can develop competencies to complement the skills needed to successfully develop employees. Both the employees and HRD professionals should engage in continuous learning and development. Understanding historical context with integrity and honor helps HRD professionals be true to the career that they have chosen.
Scenario 1: Training Mentor
Sheila has been certified as a mentor for employees in the workplace. She has worked in human resource development (HRD), specifically training and development for the past seven years. She believed that adding a mentoring certification as a competency would help her strengthen her ability to help the employees. Shelia has been asked to develop an employee who is very successful and currently enjoys her position. The employee’s supervisor has asked Sheila to counsel the employee and mentor her so that she will accept a different position. The supervisor has a friend who’s child needs a job and the only position the friend’s child can do is the one that the current employee enjoys.
Discussion Questions:
1. How should Sheila respond to the supervisor?
2. Is it ethical for Sheila to mentor an employee away from a job in which she is successful?
Scenario 2: Recruitment
Jeremy is a college recruiter for his company. His job is to primarily attend Historically Black Colleges and Universities (HBCUs) career fairs to recruit minority students. Unbeknownst to many people, students who attend HBCUs are not all Black. West Virginia State University, for example, is an HBCU whose students are now predominantly white. The student demographics as of 2018 were:
Student Profile in Fall 2018
74.2%-Caucasian
8.1% African American
3.1% Asian, Hawaiian/Pacific Islander, Hispanic or American Indian
4.9% Multiracial
8.4% undeclared race/ethnicity
1.3% non-resident alien
https://wvstateu.edu/about/administration/institutional-research/wvsu-quick-facts.aspx
Jeremy’s company wants Black applicants specifically because they are not meeting their Affirmative Action (AA) requirements. Yet, Jeremy knows that the company can meet its AA needs by recruiting white women instead. Jeremy misleads his company by requesting to go to WV State University. He recruits white females only and tells his company that he could not find any qualified Black applicants.
Discussion Questions
1. Do you believe Jeremy’s actions were illegal? Why or why not?
2. Do you believe Jeremy’s actions were unethical? Why or why not?
Supplemental Readings
Kram, K., & Isabella, L. (1985). Mentoring alternatives: The role of peer relationships in career development. The Academy of Management Journal, 28(1), 110-132.
McDonald, K. S., & Hite, L. M. (2005). Ethical issues in mentoring: The role of HRD. Advances in Developing Human Resources, 7(4), 569-582.
Moberg, D., & Velasquez, M. (2004). The ethics of mentoring. Business Ethics Quarterly, 14(1), 95-122.
Wright, C. A., & Wright, S. D. (1987). The role of mentors in the career development of young professionals. Family Relations, 36(2), 204-208.
1.07: Topic 6- All Employees Access to Career Development Training and Development and Organization Developme
Abstract
Topic 6 provides scenarios that ask students to examine their role in the access to training and development that HRWD professionals provide to all employees. Exclusionary tactics are common in organizations and their effect on organizational climate can determine the success or failure of developmental activities and initiatives. Having a well-designed, transparent strategy can help HRWD professionals in all aspects of employee development.
Scenario 1: Exclusionary Tactics
Rosalind arrived at her new job as a single mother. She received an invitation to attend, a yet to be scheduled, meeting between faculty and graduate students. She responded to the emailed invitation that she was interested in attending the meeting. Rosalind never received a follow-up email informing her of when the meeting was to be held and the location.
A few weeks later, Rosalind’s colleague, Robert, asked her why she did not attend the graduate student and faculty meet and greet the prior evening. Rosalind informed Robert that she had never received the official invitation after responding to the inquiry about attending. Robert said he did not understand what had happened and apologized.
Rosalind went to Karen who had sent the original email and asked her why she never received the official invitation. Karen informed her that she, as the administrative assistant, was informed by another faculty member, Kitty, that Rosalind probably wouldn’t have childcare and be able to attend.
Discussion Questions:
1. How should Rosalind respond to this situation?
2. How can this situation effect Rosalind’s relationship with the graduate students in her program?
3. How can this situation affect Rosalind’s ability to create collegiality with her peers?
Scenario 2: Strategic HRD Case Study
XYZ company is opening a new facility and does not have the resources to hire additional organizational development or training professionals. Mary, the training department manager has one organization development (OD) specialist and three trainers on her staff. She must maintain the implementation of an in-house performance-based pay system for 500 current employees and integrate the 300 new employees into the system. She must also manage all of the other trainings required for the new employees to meet mandated, federal requirements associated with occupational safety and health administration (OSHA) and other entities. Mary has three months to prepare a strategy to meet the new facility training needs.
Discussion Questions:
1. In what way(s) can Mary ensure that her training goals align with the organization’s goals?
2. What are the essential components that need to be included in Mary’s plan?
3. Identify the key stakeholders whose needs Mary’s plan must address?
Supplemental Readings
Ardichvili, A., & Jondle, D. (2009). Integrative literature review: Ethical business cultures: A literature review and implications for HRD. Human Resource Development Review, 8(2), 223-244.
Ardichvili, A., Jondle, D., & Kowske, B. (2010). Dimensions of ethical business cultures: Comparing data from 13 countries of Europe, Asia, and the Americas. Human Resource Development International, 13(3), 299-315.
Ardichvili, A., Jondle, D., & Kowske, B. (2012). Minding the gap: Exploring differences in perceptions of ethical business cultures among executives, mid-level managers and non-managers. Human Resource Development International, 15(3), 337-352.
Ardichvili, A., Mitchell, J. A., & Jondle, D. (2009). Characteristics of ethical business cultures. Journal of Business Ethics, 85(4), 445-451.
Arthur, W., Jr., Bennett, W., Jr. , Edens, P.S. , & Bell, S.T. (2003). Effectiveness of training in organizations: A meta-analysis of design and evaluation features. Journal of Applied Psychology, 88, 234 -245.
Baldwin, T.T., & Ford, J.K. (1988). Transfer of training: A review and directions for future research. Personnel Psychology, 41, 63 – 105.
Bartels, K. K., Harrick, E., Martell, K. & Strickland, D. (1998). The relationship between ethical climate and ethical problems within human resource management. Journal of Business Ethics, 17(7), 799-804.
Bunch, K. J. (2007). Training failure as a consequence of organizational culture. Human Resource Development Review, 6(2), 142-163.
Burke, L. A., & Hutchins, H. M. (2007). Training transfer: An integrative literature review. Human Resource Development Review, 6(3), 263-296.
Flores, L. Y., & O’Brien, K. M. (2002). The career development of Mexican American adolescent women: A test of social cognitive career theory. Journal of Counseling Psychology, 49(1), 14–27. https://doi.org/10.1037/0022-0167.49.1.14
Roberson, L., Kulik, C.T., & Pepper, M.B. (2003). Using needs assessment to resolve controversies in diversity training design. Group & Organization Management, 28, 148 – 174. | textbooks/biz/Management/Critical_Employment_Ethical_and_Legal_Scenarios_in_Human_Resource_Development_(Hughs)/1.06%3A_Topic_5-_Ethics_of_Mentoring.txt |
Abstract
Topic 7 provides scenarios that require students to acquire an understanding of how power and privilege can be misused and/or misunderstood. The appropriate use of power and privilege is essential for a healthy organizational culture where all employees feel valued. The contributions of all employees should collectively contribute to the success of the organization.
Scenario 1: Abuse of Training Power
You are the training and development department leader. You have not been able to keep the required two trainers who report to you for longer than 6 months at a time. The turnover in your department has been 100%, twice, in the past two years. None of the supervisors in other departments want you or your trainers to interact with their employees. The supervisors have expressed to organization leadership that you are misusing your power as a training department leader and are not listening to them as they try to explain to you that your training curriculum and processes do not align with how their employees do their jobs. They also complain that you try to use your power to force them to send their employees to training sessions. Their employees always come back from every training session angry about their experience with the training department leader and the trainer. There has also been no significant productivity improvement by workers after completing training.
Discussion Questions:
1. In what way(s) is power and privilege dynamics a problem in the above scenario?
2. What should the supervisors do?
3. What should the employees do?
Scenario 2: Privilege of a White Female to Openly Show Bias
Micah has been employed by his organization for five years. He is a white male, LGBTQ employee who has received mentorship and positive, biased treatment by his supervisor throughout his time within the organization. In fact, Micah is being mentored to become a supervisor by a white female who was mentored in the same way as she is providing mentorship for Micah.
Trevor is also a white male, LGBTQ employee. He has done much more work than Micah, but his work and achievements have never been publicized by the supervisor. In fact, she ignores all of Trevor’s work and pretends that he is not there. When asked if she thinks that it is appropriate to show favoritism towards Micah over Trevor and the other employees, she acknowledges that she recognizes her bias and said that she was told by her mentor that it was not a problem. Trevor subsequently left the organization.
Discussion Questions:
1. Do you think Trevor made the right decision? Why or why not?
2. How would you have handled the situation if you were Trevor?
Supplemental Readings
Hallett, T. (2003). Symbolic power and organizational culture. Sociological Theory, 21, 128 –149.
Hanscome, L., & Cervero, R.M. (2003). The impact of gendered power relations in HRD. Human Resource Development International, 6, 509—525.
Shipton, J., & McAuley, J. (1994). Issues of power and marginality in personnel. Human Resource Management Journal, 4, 1 – 13.
Steinbauer, R., Renn, R., Taylor, R., & Njoroge, P. (2014). Ethical leadership and followers’ moral judgment: The role of followers’ perceived accountability and self-leadership. Journal of Business Ethics, 120(3), 381-392.
Stevenson, W.B. , & Bartunek, J.M. (1996). Power, interaction, position, and the generation of cultural agreement in organizations. Human Relations, 49, 75—104. | textbooks/biz/Management/Critical_Employment_Ethical_and_Legal_Scenarios_in_Human_Resource_Development_(Hughs)/1.08%3A_Topic_7-_Power_and_Privilege_Dynamics.txt |
Abstract
Topic 8 introduces students to the concept of allies for historically marginalized groups in the workplace. It can be argued that allies are supposed to be positive influences on the people they purport to help. However, there are fine lines that allies tend to cross when they covertly or overtly diminish the credentials of those they are seeking to help. One wonders if they even know the meaning of help and its purpose.
Scenario 1: Diminishing the Credentials of Blacks by White Allies
Black people have been reporting incidents of discrimination in the workplace, that have been documented, since the inception of the Civil Rights Act of 1964. Prior to 1964, there were few Blacks in the formalized workplaces in the United States of America. Despite the ability of Blacks to communicate their lived experiences, they are often ignored until a white ally voices their story for them. They are only acknowledged because a white person said something. Instances of these occurrences have been chronicled by Black workers repeatedly; yet, very little has changed. The validity and credibility of what they report is ignored even if they are more highly credentialed than their white allies.
Discussion Questions:
1. Why does who tell the story matter for action to occur in support of Black workers?
2. Who determines the validity and credibility of Black voices and why?
Scenario 2: Controlling the Dialogue of Conversations Begun by Black People
Black people and Black scholars in America have been against racism (anti-racist) for at least 400 years. Yet, in 2020 white scholars are trying to introduce ant-racism as an emerging trend. White scholars are introducing the old ideas and attempting to control the dialogue of conversations begun by Black people.
Discussion Questions:
1. How and why is this acceptable?
2. In what way(s) does this diminish the credentials of Black people and Black scholars in America?
3. How do we get allies to research the scholarship of Black scholars and listen to the lived experiences of Black people?
Supplemental Readings
Alleyne, A (2004) Black identity and workplace oppression. Counselling and Psychotherapy Research, 4(1), 4–8.
Ashley, W. (2014). The angry black woman: The impact of pejorative stereotypes on psychotherapy with black women. Social Work in Public Health, 29(1), 27-34.
Bell, E. L. E., Meyerson, D., Nkomo, S., & Scully, M. (2003). Interpreting silence and voice in the workplace: A conversation about tempered radicalism among Black and White women researchers. The Journal of Applied Behavioral Science, 39(4), 381-414.
Delgado, R. (1990). When a story is just a story: Does voice really matter? Virginia Law Review, 95-111.
Ferree, M. M. (2004). Soft repression: Ridicule, stigma, and silencing in gender-based movements. Research in Social Movements, Conflicts and Change, 25, 85-101.
Griffin, R. A. (2012). I AM an angry Black woman: Black feminist autoethnography, voice, and resistance. Women’s Studies in Communication, 35(2), 138-157.
Kinouani, G. (2020). Silencing, power and racial trauma in groups. Group Analysis, 53(2), 145–161. https://doi.org/10.1177/0533316420908974
Newton, J. (2017). Anti-Black racism, resistance, and the health and well-being of Black bodies in public education. In New framings on anti-racism and resistance (pp. 45-64). Brill Sense.
Wingfield, A. H. (2007). The modern mammy and the angry Black man: African American professionals’ experiences with gendered racism in the workplace. Race, Gender & Class, 196-212.
Wingfield, A. H. (2009). Racializing the glass escalator: Reconsidering men’s experiences with women’s work. Gender & Society, 23(1), 5-26. | textbooks/biz/Management/Critical_Employment_Ethical_and_Legal_Scenarios_in_Human_Resource_Development_(Hughs)/1.09%3A_Topic_8-_Authenticity_of_Allies.txt |
Abstract
Topic 9 allows students to apply concepts to better understand how assessments can be both detrimental and positive to making successful hires and career transitions when used appropriately. HRWD professionals must consider all the consequences that can occur prior to using an assessment. Making the right hiring decisions influences employee morale. Hiring the wrong employee at any level of the organization can be problematic.
Scenario 1: Preparing for a Forklift Assessment
Helen arrived in the United States at the age of 18 as an international exchange student. In her home country of the Czech Republic, she did not have to learn much about the US language and workplace terminologies. Now that she has obtained her first job, she is excited to be working and enjoys the work that she does. There are changes occurring on her job and her supervisor has approached Helen about new training and assessment requirements for he to progress within her career path.
Helen wants to progress but is required to learn the classroom knowledge about operating a forklift, tow motor, and other mobile equipment inside the facility. During her first day of class, Helen realizes that she does not understand anything that the trainer is saying. She does not understand what a triangle is without being shown a picture. She absolutely cannot understand the concept of a stability triangle which is essential to understanding how to operate a forklift. Helen must be able to pass the written assessment about operating a forklift before she will ever be allowed to train to drive one.
Discussion Questions
1. What can the trainer do to help Helen?
2. What can the supervisor do to help Helen?
3. What can Helen do to help herself?
4. In what way(s) does this assessment have the potential to have an adverse impact on Helen?
Scenario 2: Biased Leadership Development Assessments
XYZ Corporation has introduced new hire assessments into their leadership development program. All new leaders must complete the assessment prior to participating in the second stage of the leadership program. No women or minorities have ever made it past the first stage of the leadership development program because there are gender and culturally biased questions on the assessment. Tricia has just been hired as HRD manager to oversee the leadership development program and upon discovering the bias in the assessment, it is her job to inform management, consisting of all white males, about the assessment bias.
Discussion Questions
1. How can Tricia help eliminate assessment bias against women and minority leaders?
2. Is it the role of HRD professionals to determine assessment bias?
Supplemental Readings
Bersin, J., & Chamorro-Premuzic, T. (2019). The case for hiring older workers. Harvard Business Review, 26, 2-5.
Boyer, E. P., & Webb, T. G. (1992). Ethics and diversity: A correlation enhanced through corporate communication. IEEE Transactions on Professional Communication, 35(1), 38-43.
Camara, W. J. (1997). Use and consequences of assessments in the USA: Professional, ethical and legal issues. European Journal of Psychological Assessment, 13(2), 140-152.
Johnson, L. E., & Potter, P. W. (1998). Information systems careers: The role of assessment centers. Career Development International, 3(4), 142-144.
Kim, S. (2003). Linking employee assessments to succession planning. Public Personnel Management, 32(4), 533-547.
Knight, R. (2017). 7 Practical ways to reduce bias in your hiring process. Harvard Business Review, 2-7.
Kuncel, N. R., & Hezlett, S. A. (2010). Fact and fiction in cognitive ability testing for admissions and hiring decisions. Current Directions in Psychological Science, 19(6), 339-345.
McGrath, R. E., Mitchell, M., Kim, B. H., & Hough, L. (2010). Evidence for response bias as a source of error variance in applied assessment. Psychological Bulletin, 136(3), 450-470.
McLagan, P. A. (1989). Models for HRD practice. Training & Development Journal, 43(9), 49-60.
Patton, W. D., & Pratt, C. (2002). Assessing the training needs of high-potential managers. Public Personnel Management, 31(4), 464-484. | textbooks/biz/Management/Critical_Employment_Ethical_and_Legal_Scenarios_in_Human_Resource_Development_(Hughs)/1.10%3A_Topic_9-_Ethics_of_Career_Development_and_Training_and_Development_Assessments.txt |
Abstract
Topic 10 requires that students have an understanding of protected class groups in the workplace and learn how discrimination of these groups is illegal and in many instances unethical. There are many real-life cases in the empirical research and professional literature of discrimination which have led to the creation of all the laws and mandates that protect these groups of employees in the workplace. As students examine these scenarios, it should be with the understanding that laws and mandates to do not eliminate discrimination. Only changed behavior and actions of leaders and employees can help eliminate workplace discrimination.
Culture of Disbelief
Ben arrives at least 20 minutes before his work shift. In his 15 years working for the company, he has never been late. He also has a spotless disciplinary record. Ben is the only Black male working in a lab full of women. There are only two Black women working in the lab, the remaining 10 women are white. Ben tries his best to keep a low profile because he understands the southern culture in the community where he works and does not want to be perceived as offending the white women with whom he works. He knows, from witnessing the experiences of other Black males, that the company where he works has a culture of disbelief when it comes to accepting the word of a Black male when he has to defend himself against the word of a white woman.
Ben would do anything requested of him, on the job, by his peers an supervisors. One day one of the white women told one of the Black women that she had observed Ben staring at the Black woman a little too long. Therefore, she decided to turn Ben into human resources and accuse him of sexual harassment through 3rd person sexual harassment. The Black woman never saw Ben looking at her inappropriately neither did the supervisor. HR representatives spoke with Ben about the report and Ben quit his job without saying anything to anyone. Upon hearing that Ben had quit, many of the employees were upset and angry at the woman that reported Ben to HR. The supervisor learned, from HR, that no negative action was taken against Ben.
Discussion Questions:
1. What can the supervisor do to improve the work environment?
2. Why do you believe Ben quit?
3. What could have been done to prevent Ben from quitting?
4. How can a company get eliminate a culture of disbelief?
Culture of Inaction
Mary and her colleagues have reported situations of covert racism through all avenues available to them throughout their organizations for the past 20 years. They have watched as those in positions of leadership note that they have been told of the situations, but there have been absolutely no visible changes in the treatment that Mary and her colleagues have received from their supervisors. In fact, the treatment has consistently worsened. None of the young Black employees will stay beyond a year with the organization beyond a year, if that long, because of the culture inaction displayed by leadership. It is futile to report anything perceived as discriminatory, so Mary and her colleagues have remained silent abut any ill-treatment. They have chosen to just go to work, do their job, and go home. The productivity in the company has significantly deteriorated because of the high turnover and low morale of employees. There is very little camaraderie among employees.
Discussion Questions:
1. What can an organization do to change the culture into a culture of action instead of inaction?
2. Why do you believe the younger workers are leaving and the older workers choose to stay?
Supplemental Readings
Bampton, R., & Maclagan, P. (2009). Does a ‘care orientation’ explain gender differences in ethical decision making? A critical analysis and fresh findings. Business Ethics: A European Review, 18(2), 179-191.
Banks, C. H. (2006). Career planning: Toward an inclusive model. In M. Karsten (Ed.) Gender, race and ethnicity in the workplace, (Vol. 3, pp. 99-116). Greenwood Publishing Group, Inc.
Barnes, C., & Mercer, G. (2005). Disability, work, and welfare: challenging the social exclusion of disabled people. Work, Employment and Society, 19(3), 527-545.
Bowe, F. G., McMahon, B. T., Chang, T., & Louvi, I. (2005). Workplace discrimination, deafness and hearing impairment: The national EEOC ADA research project. Work, 25(1), 19-25.
Brandt, A. M. (1978). Racism and research: The case of the Tuskegee Syphilis Study. Hastings Center Report, 8(6), 21-29.
Knapp, D.E., Faley, R.H., Ekeberg, S.E., & Dubois, C.L.Z. (1997). Determinants of target responses to sexual harassment: A conceptual framework. Academy of Management Review, 22, 687 -729.
1.12: Topic 11- Covert Conditioning of Girls Women Away from Male Dominated Fields
Abstract
Historically, women and underrepresented in science, technology, engineering, and math (STEM) technical careers. The problems usually begin within the educational system. Without the proper educational foundation, it is extremely difficult for girls to pursue higher education that will provide them the skills necessary to succeed as women in the workplace. Without women in technical positions both in school and the workplace, it is difficult for women to overcome barriers to entry in STEM careers.
Scenario 1: Covert Conditioning through Advising
Marsha is excited about the opportunity to major in engineering. She has dreamed of being an aerospace engineer since childhood. Her first day on campus, she meets with the advisor of the pre-engineering program, Cheryl. Cheryl politely tells her that there has never been a woman to graduate from the aerospace engineering program in the history of the institution, and she would advise her to go to the career center and talk to a career development specialist about what aerospace engineering is and what the men in that field do every day on the job. She further tells Marsha that women have struggled in that field because of all the time it takes to complete the work and she will not be able to go shopping or hang out with her girlfriends. She also tells Marsha that there is no female bathroom inside the lab, she will have to go outside of the lab into another area of the building to access the women’s facilities.
Discussion Questions:
1. What are some of the covert conditioning comments that Cheryl said to Marsha?
2. How can Marsha overcome those comments and achieve her goal?
3. What would you have done differently than Cheryl?
Scenario 2:
Maria is excited to have graduated with her doctoral degree in Chemistry. She wants to remain on the technical side of the business and progress through the technical management ranks. However, as the only Hispanic female, she is always given the least visible technical projects to work on and is provide very little mentoring to improve her visibility to executive leadership. Maria has been asked to move to the leadership side of the business where she has very little leadership knowledge. She would need to go back to school and/or spend a lot of time in leadership development programs before she could even begin to make progress. There is no guarantee that she could ever return to the technical side of the business.
Discussion Questions
1. What should Maria do to improve her visibility within the organization?
2. How can organizations better develop minority women into technical leadership positions?
Supplemental Readings
Bierema, L. L. (2009). Critiquing human resource development’s dominant masculine rationality and evaluating its impact. Human Resource Development Review, 8, 68-96.
Glick, P. (1991). Trait-based and sex-based discrimination in occupational prestige, occupational salary, and hiring. Sex Roles, 25, 351-378.
Miller, G.E. (2002). The frontier, entrepreneurialism, and engineers: Women coping with a web of masculinities in an organizational culture. Culture and Organization, 8, 145-160. | textbooks/biz/Management/Critical_Employment_Ethical_and_Legal_Scenarios_in_Human_Resource_Development_(Hughs)/1.11%3A_Topic_10-_Protected_Class_Bias.txt |
Abstract
Educational opportunity bias has long been a problem in throughout out the world, particularly for girls, minorities, and low income individuals. Education is sometimes seen as the great equalizer for opportunities in the workplace and society. Although education can be beneficial, the bias that exists in educational systems can create irreparable problems for individual students and society.
Scenario 1: Misadvised and Educational Progression
Serena is an undergraduate student in a field of study that requires a master’s degree in order to obtain sufficient employment. Serena is a first-generation college student, so she does not know much about the academic process to apply for the graduate program in her field. Serena is also the only African American student in her program. Serena struggles to complete her degree, but she does meet all the criteria to be admitted to the master’s program. Her advisor does not inform her that she must apply for the master’s degree program prior to a specific deadline because her advisor knows that there is a limit to the number of applicants who can be admitted each academic year. Serena finds out after the deadline that she will have to go to another institution or wait a year to apply for admission to her current institution.
Discussion Questions:
1. What can Serena do to ensure that what happened to her does not happen to other students?
2. Where should Serena complete her master’s degree? Why?
3. Do you think Serena was misadvised on purpose? Why or why not?
Scenario 2: No Recommendation
April has always loved math. She graduated with the highest math grade point average (GPA) in her high school and decided to pursue an advanced degree in physics. Because she likes a small school environment for learning, April decided to attend a small college and major in engineering. She wants to begin her education in a 3-2 transfer program so that she can establish a solid foundation prior to attending a major institution for her last two years. There is only one physics professor at April’s college, and he is the only person who can write April’s letter of recommendation as he manages the 3-2 program for the college. At the end of April’s second year, the physics professor tells April that he will not recommend her for the program even though her grades are just as good as the white male that he will recommend.
Discussion Questions:
1. What, if anything, can April do to stop this education bias?
2. Has the physics professor violated any laws by not recommending April?
Scenario 3: Educational Tracking
Robert is a first year college student, from a rural farming community and has no idea what he wants to do in his career. He is undecided but has expressed to his advisor his interests in business and/or journalism. Robert, faithfully, meets with his advisor as required each semester. However, his advisor never informs Robert that he must meet pre-core requirements for both his fields of interest or he will not be admitted because of space limitations. When Robert realizes the situation, he is required to wait another year to potentially be enrolled in his area of interest. Robert does not want to wait an extra year to complete his degree. He meets with his advisor and is told that there is always room in a particular degree program in agriculture for students like him. Robert feels betrayed and that he has been tracked away from his desired educational goal.
Discussion Questions;
1. Has Robert been misadvised? Why or why not?
2. Has Robert experienced educational bias? Why or why not.
Supplemental Readings
Alba, R. D., & Lavin, D. E. (1981). Community colleges and tracking in higher education. Sociology of Education, 223-237.
Ansalone, G. (2001). Schooling, tracking, and inequality. Journal of Children and Poverty7(1), 33-47.
Ansalone, G. (2010). Tracking: Educational differentiation or defective strategy. Educational Research Quarterly34(2), 3-17.
Berger, J., & Combet, B. (2017). Late school tracking, less class bias in educational decision-making? The uncertainty reduction mechanism and its experimental testing. European Sociological Review, 33(1), 124-136.
Cooper, C. W. (2003). The detrimental impact of teacher bias: Lessons learned from the standpoint of African American mothers. Teacher Education Quarterly, 30(2), 101-116.
Kershaw, T. (1992). The effects of educational tracking on the social mobility of African Americans. Journal of Black Studies23(1), 152-169.
Moller, S., & Stearns, E. (2012). Tracking success: High school curricula and labor market outcomes by race and gender. Urban Education47(6), 1025-1054.
Ozer, M., & Perc, M. (2020). Dreams and realities of school tracking and vocational education. Palgrave Communications6(1), 1-7.
Sadker, D., & Zittleman, K. (2007). Gender bias: From colonial America to today’s classrooms. In J. E. Banks and C.A.M. Banks (Eds.) Multicultural education: Issues and perspectives, (pp. 135-169). Wiley. | textbooks/biz/Management/Critical_Employment_Ethical_and_Legal_Scenarios_in_Human_Resource_Development_(Hughs)/1.13%3A_Topic_12-_Educational_Opportunity_Bias.txt |
Abstract
Occupational segregation occurs in many ways. Topic 13 provides students with the opportunity to discuss ways that occupational segregation is used to derail the promising careers of employees. Without a cohesive work environment, where all employees feel integral to the organization’s success, organizations see high turnover among high potential employees.
Scenario 1: Research Group Segregation
Peter has an advanced degree plus additional work experience. John has the same advanced degree as Peter but no work experience. Peter is an African American male and John is a white male. They are both hired on the same day. However, John is assigned to the most advanced research development team and allowed to manage his own project immediately. Peter is assigned to a less visible research team and assigned to work under several junior managers. Peter has noticed that there are no African American or other minorities in the group within which John has been assigned. If fact, there has never been any diversity within that group including white women. Peter feels that he and his minority group colleagues have been systematically segregated away from that particular research group despite their qualifications. Despite being equally qualified with John, Peter has only been hired for this position because his organization has been cited for occupational segregation violations.
Discussion Questions
1. Imagine that you are Peter, what would you do about the situation and why?
2. Peter has been asked by his minority group colleagues to file an official grievance and lead their efforts for change, should Peter agree to their request? Why or why not?
Scenario 2: Intentional Exclusion
Connie comes to work everyday wanting to be a team player. She is the least senior person on her team and realizes that the most important thing to success in her position is to be perceived by her peers and supervisor as a team player. Yet, every suggestion and contribution that Connie gives goes unacknowledged and unrecognized. Connie has also been bullied by her colleagues and is beginning to feel resentment. She has repeatedly asked to be reassigned, and her requests have been denied.
Connie realizes that if change does not occur, she may become bitter towards her manager and co-workers. She knows that she is the only person in her position who is being treated this way, and that she is being ignored on purpose.
Discussion Questions:
1. What can Connie do to ensure recognition of her contributions?
2. How can Connie be expected to feel included when she is consistently excluded?
3. How would you provide career coaching to Connie in this situation?
Scenario 3: Glass Ceiling
Margaret is a 45 -year old, 20-year employee of her organization. She has been with the organization since inception as a military subcontractor on government contracts. She has received stellar performance reviews on all of her assignments throughout her tenure with the organization. She has never missed a deadline, and she chose not to have children because she wanted to progress in her career. Yet, she has been denied promotion after promotion when every male employee that she has trained has been promoted ahead of her. Margaret perceives that she has been denied promotions because she is the only woman working for the organization and has recently learned that all of their partner organizations are led by former military, male leaders. Margaret has been told that if she pursues opportunities for advancement, she will need to leave the organization because she will be jeopardizing their opportunity to continue their lucrative partnerships.
Discussion Questions:
1. What should Margaret do if she wants to be promoted?
2. Is Margaret’s current employer being fair to her? Why or why not?
Scenario 4: Military Glass Ceiling
Susan graduated form the Naval Academy and has followed all military protocols. Despite, all of her dedication, Susan knows that she will never be able to ascend to the highest level in the military. The military has a seniority system and because of that system, the opportunities for advancement are extremely limited. One of Susan’s options for senior leadership within the government workforce is to retire from the military and take a civilian position. The only thing that makes the situation better is that there is more availability of senior positions.
Discussion Questions:
1. What should Susan do to improve her career options?
2. What can organizations do to help women ascend to higher levels and break through glass ceilings?
Supplemental Readings
Anker, R. (1997). Theories of occupational segregation by sex: An overview. International Labour Review, 136, 315-339.
Bergmann, B. R. (1974). Occupational segregation, wages and profits when employers discriminate by race or sex. Eastern Economic Journal1(2), 103-110.
Blau, F. D., Brummund, P., & Liu, A. Y. H. (2013). Trends in occupational segregation by gender 1970–2009: Adjusting for the impact of changes in the occupational coding system. Demography50(2), 471-492.
Coleman, I. (2010). The global glass ceiling: Why empowering women is good for business. Foreign Affairs89, 13-20.
Corsun, D. L., & Costen, W. M. (2001). Is the glass ceiling unbreakable? Habitus, fields, and the stalling of women and minorities in management. Journal of Management Inquiry10(1), 16-25.
Evertson, A., & Nesbitt, A. (2004). The glass ceiling effect and its impact on mid-level female military officer career progression in the United States marine corps and air force. Unpublished thesis, Naval Postgraduate School.
Finnigan, R. (2020). Rainbow-collar Jobs? Occupational segregation by sexual orientation in the United States. Socius6, 2378023120954795.
Glass, J. (1990). The impact of occupational segregation on working conditions. Social Forces68(3), 779-796.
Grassbaugh, J. (2013). The opaque glass ceiling: How will gender neutrality in combat affect military sexual assault prevalence, prevention, and prosecution. Ohio State Journal of Criminal Law11, 319-352.
Hodges, M. J. (2020, March). Intersections on the class escalator: Gender, race, and occupational segregation in paid care work. In Sociological Forum, 35(1), 24-49.
Hughes, C. (2014). American Black women and interpersonal leadership styles. Sense Publishers.
Hughes, C. (Ed.) (2015). Impact of diversity on organization and career development. IGI Global
Hunt, V. H., Rucker, L., & Kerr, B. (2020). Reconsidering sex-based occupational segregation and agency missions: An analysis of US state bureaucracies (1987-2015) using two different thresholds. Administration & Society, 52(3), 431-465.
Tesfai, R., & Thomas, K. J. (2020). Dimensions of inequality: Black immigrants’ occupational segregation in the United States. Sociology of Race and Ethnicity6(1), 1-21. | textbooks/biz/Management/Critical_Employment_Ethical_and_Legal_Scenarios_in_Human_Resource_Development_(Hughs)/1.14%3A_Topic_13-_Occupational_Segregation_and_Promotional_Ceilings.txt |
Abstract
Topic 14 allows for the discussion of confidentiality and how the lack of maintaining confidentiality can be detrimental to organizational success. Building trust with employees is hard work that can be easily destroyed when confidentiality is violated. Inadvertent violations of confidentiality are still violations that are difficult to rectify.
Scenario 1: Mental Health Confidentiality
Terrence had an unexpected death in his family. He has been diagnosed as suffering from anxiety and depression as a result of his inability to cope with his loss. He informed his supervisor Michael of his situation. Instead of Michael informing Terrence of the EAP services of the organization, Michael sent an email to all of Terrence’s peers asking them to be aware that Terrence is suffering from mental illnesses because of his recent loss and to be alert just in case they witness Terrence’s performance declining.
Discussion Questions:
1. Was Michael wrong to inform Terrence’s peers about his mental diagnosis? Why?
2. What can be done to solve this problem?
3. Should Michael be terminated? Why?
Scenario 2: Learning Ability Confidentiality
Carol is responsible for training all of the organization’s employees. She meets with all employees to ensure that the appropriate level of training is available for each employee. Employees share their anxiety and concerns about having to learn new skills to keep their jobs. These conversations are very sensitive to the employees, and they trust Carol to keep their learning confidence levels confidential.
Carol’s administrative assistant, Melissa, has been privy to many of Carol’s conversations with employees. Some of the employees have been made aware that Melissa has indiscreetly shared some of their personal information and comments with other employees. The employees whose information has been shared no longer feel comfortable seeking training from Carol.
Discussion Questions:
1. Do you think that Carol can win back the trust of the employees? If so, how? If not, why?
2. What should Carol do about Melissa’s violation of employee confidentiality?
Supplemental Readings
Huber, H. E. (2001). Privacy and confidentiality issues in corporate HRD practice. Advances in Developing Human Resources, 3(1), 75-77.
Hughes, C., Lusk, S., and Strause, S. (2016). Recognizing and accommodating employees withPTSD: Intersection of human resource development, rehabilitation, and psychology. New Horizons in Adult Education and Human Resource Development, 28(2), 27-39
Kuchinke, K. P. (2010). Human development as a central goal for human resource development. Human Resource Development International, 13(5), 575-585.
McDonald, K. S. (2001). Confidentiality issues in management development. Advances in Developing Human Resources, 3(1), 78-80.
Wiley, C. (2000). Ethical standards for human resource management professionals: A comparative analysis of five major codes. Journal of Business Ethics, 25(2), 93-114.
Woodall, J. (2001). Adventure training and client confidentiality. Advances in Developing Human Resources, 3(1), 21-25.
Wooten, K. C. (2001). Ethical dilemmas in human resource management: An application of a multidimensional framework, a unifying taxonomy, and applicable codes. Human Resource Management Review, 11(1-2), 159-175.
Zafar, H. (2013). Human resource information systems: Information security concerns for organizations. Human Resource Management Review, 23(1), 105-113.
Zinzow, H. M., Britt, T. W., Pury, C. L., Raymond, M. A., McFadden, A. C., & Burnette, C. M. (2013). Barriers and facilitators of mental health treatment seeking among active-duty army personnel. Military Psychology25(5), 514-535. | textbooks/biz/Management/Critical_Employment_Ethical_and_Legal_Scenarios_in_Human_Resource_Development_(Hughs)/1.15%3A_Topic_14-_Confidentiality.txt |
Abstract
Topic 15 provides scenarios that provide students an opportunity to examine problems with diversity, equity, and inclusion in the workplace. There is no law that requires diversity in the workplace. There are laws that can lead to diversity, equity, an inclusion, but none that specifically requires diversity. Diversity just means difference. It must be defined in context to be applicable for use to achieve equity and inclusion.
Scenario 1: Presentation of Diverse Employees throughout Organizations
Many organizations have minority themed activities to celebrate diversity of its employees. In many instances these activities are appreciated by minority employees representing these groups. However, if these activities are the only efforts exerted to “present” these minority groups to other organization employees, it may not be enough to increase understandings of diversity. Some non-minority employees may see these activities as entertainment while members of the minority groups value their cultural activities as sacred to the sustainability of their cultural heritage. The way these groups are presented is often perceived as an insult to their heritage.
Discussion Questions
1. How do you present your minority employees to the majority groups in the organization?
2. Do you value the cultural heritage of all employees within the organization?
3. Should cultural heritage be a part of diversity, equity, and inclusion efforts within organizations? Why or why not?
4. Does the cultural heritage of minority groups affect you in the workplace? How?
5. Is the cultural heritage of minority groups offensive to you? Why?
Scenario 2: DEI Leadership
Ray is a Black male who has been selected to lead his organization’s DEI efforts. His organization employees over 5,000 employees and less than two percent of them are from all minority groups combined. Ray does not have any specific DEI background because there is no known degree that prepares one to be a DEI leader. Ray has cultivated relationships with the senior leadership in his organization and because he has made it, he believes that other minorities can succeed within the organization too. Ray never meets with other minority groups in the organization. In fact, he has never sent an email to the minority employees in salaried positions, so those below the salaried ranks have even less of a chance at being heard by Ray. Ray’s DEI efforts are with external constituents of the organization so that these constituents will continue to invest with the organization. The organization’s brand must be perceived as promoting DEI regardless of the morale of internal minority employees. Ray is promoted because of his perceived DEI efforts.
Discussion Questions:
1. Should Ray have worked to improve the DEI situation for internal minorities of the organization?
2. Has Ray succeeded in meeting the DEI efforts of his organization?
3. Is organizational DEI branding more important to organizational success than the morale of workers?
4. How should DEI leaders be prepared to lead DEI efforts within organizations?
Supplemental Readings
Anderson, B. E. (1996). The ebb and flow of enforcing executive order 11246. American Economic Review, 86, 298–301.
Berg, R. K. (1964). Equal employment opportunity under the Civil Rights Act of 1964. BrooklynLaw Review, 31, 62-97.
Dover, T. L., Kaiser, C. R., & Major, B. (2020). Mixed signals: The unintended effects of diversity initiatives. Social Issues and Policy Review14(1), 152-181.
Elias, T., Honda, L. P., Kimmel, M., & Chun, J. (2016). A mixed methods examination of 21st century hiring processes, social networking sites, and implicit bias. The Journal of Social Media in Society, 5(1), 189-228.
Fine, C., Sojo, V., & Lawford‐Smith, H. (2020). Why does workplace gender diversity matter? Justice, organizational benefits, and policy. Social Issues and Policy Review14(1), 36-72.
Gutman, A., Koppes, L. L., Vodanovich, S. J. (2011). EEO law and personnel practices (3rd ed.). Routledge.
Hemphill, H., & Haines, R. (1997). Discrimination, harassment, and the failure of diversity training: What to do now. Quorum Books.
Hughes, C. (2014). American Black women and interpersonal leadership styles. Sense Publishers.
Hughes, C. (2016). Diversity intelligence: Integrating diversity intelligence alongside intellectual, emotional, and cultural intelligence for leadership and career development. Palgrave MacMillan Publications.
Hughes, C. (2018). Workforce inter-personnel diversity: The power to influence human productivity and career development. Springer International Publishing.
Hughes, C. (Preface). (2018). The role of HRD in using diversity intelligence to enhance leadership skill development and talent management strategy. Advances in Developing Human Resources, 20(3), 259-262.
Hughes, C. & Brown, L. (2018). Exploring leaders’ discriminatory, passive-aggressive behavior toward protected class employees using diversity intelligence. Advances in Developing Human Resources, 20(3), 263-284.
Hughes, C. (2018). Conclusion: Diversity intelligence as a core of diversity training and leadership development. Advances in Developing Human Resources, 20(3), 370-378.
Hughes, C. (Ed.) (2020). Implementation strategies for improving diversity in organizations. IGI Global.
Ng, E. S., & Sears, G. J. (2020). Walking the talk on diversity: CEO beliefs, moral values, and the implementation of workplace diversity practices. Journal of Business Ethics164(3), 437-450. | textbooks/biz/Management/Critical_Employment_Ethical_and_Legal_Scenarios_in_Human_Resource_Development_(Hughs)/1.16%3A_Topic_15-_Diversity_Equity_and_Inclusion_%28DEI%29.txt |
Abstract
Topic 16 allows students to discuss scenarios of how artificial intelligence (AI) and HRD are linked. The expertise of AI is not ethically sound, and the human expertise of HRD professionals can alleviate some of these concerns. Understanding the gap between HRD and explainable AI is important as technology becomes more integrated into workplace activities.
Scenario 1: AI and Data Analysis
Bethany started her new position two weeks ago and is excited to be doing data entry work. She has to analyze the human resource materials before inputting the content into the human resource information system (HRIS). Unbeknownst to Bethany, her organization has a plan to begin, in three months, using AI to replace the work that she does. Bethany has been asked to work with information system (IS) and information technology (IT) employees to make sure that the process that she is using to input the data is correct. Bethany does not discuss the way that she analyzes the data. She only informs IS and IT employees of the steps that she takes to input the data.
When the organization implements its new AI generated HRIS, sensitive confidential employee data is incorrectly inputted throughout the system. Bethany is asked to meet with leaders including her supervisor and leaders from IS and IT. When asked why the data is incorrect in the new system, Bethany informs them that she has an analysis process that she did not share because she did not know that AI would be used to input the data.
Discussion Questions:
1. What do you believe to be the main reason that data was incorrectly inputted into the HRIS?
2. How would you correct this situation and make amends to employees whose data was incorrectly distributed throughout the organization?
3. What could have been to prevent this situation from occurring?
Scenario 2: Fairness of AI in Promotion
Randy has been with his organization for 10 years and has been working towards a promotion on his job for five years. He has done everything that his supervisor has asked and has been proactive in leading new initiatives. Despite all of Randy’s hard work, his organization has determined that they can save money by using machine learning and AI to replace him. They also used AI to determine how much work Randy actually performed each day. The organization used AI data in its decision to downsize and has informed Randy that his position is being eliminated. They do let him know that should he want to apply for other jobs in other divisions of the organization, that opportunity is available. Randy is in shock and decides to meet with HR to find out why his position was eliminated. When told about his work being done by AI, Randy becomes angry.
Discussion Questions:
1. Do you think that it was a fair use of AI by the company? Why?
2. Pretend that you are Randy, would you seek another job with the organization?
3. Please find and share a real world example of how AI is being used to replace employees?
Supplemental Readings
Bellamy, R. K., Dey, K., Hind, M., Hoffman, S. C., Houde, S., Kannan, K., … & Nagar, S. (2019). AI Fairness 360: An extensible toolkit for detecting and mitigating algorithmic bias. IBM Journal of Research and Development63(4/5), 4-1.
Brougham, D., & Haar, J. (2018). Smart technology, artificial intelligence , robotics, and algorithms (STARA): Employees’ perceptions of our future workplace. Journal of Management & Organization24(2), 239-257.
Chermack, T. J. (2003). Decision-making expertise at the core of human resource development. Advances in Developing Human Resources, 5(4), 365–377.
Davies, J. (2016). Program good ethics into artificial intelligence Nature538, 291.
Etzioni, A., & Etzioni, O. (2016). AI assisted ethics. Ethics and Information Technology, 18(2), 149-156. https://doi.org.10.1007/s10676-016-9400-6
Githens, R. P., Dirani, K., Gitonga, J. W., & Teng, Y. T. (2008). Technology-related research in HRD publications: An analysis of content and metaperspectives from 2000 to 2006. Human Resource Development Quarterly, 19(3), 191–215. doi:10.1002/hrdq.1236
Hew, P. C. (2014). Artificial moral agents are infeasible with foreseeable technologies. Ethics and Information Technology, 16(3), 197-206.
Hirschi, A. (2018). The fourth industrial revolution: Issues and implications for career research and practice. The Career Development Quarterly66(3), 192-204.
Hughes, C., Robert, L., Frady, K., & Arroyos, A. (2019). Managing technology and middle and low skilled employees: Advances for economic regeneration. Emerald Publishing.
Ketter, P. (2017). Artificial intelligence creeps into talent development. TD Magazine, 71(4), 22-25.
Kim, P. T. (2019). Big data and artificial intelligence: New challenges for workplace equality. University of Louisville Law Review, 57(2), 313.
Kok, J. N., Boers, E. J. W., Kosters, W.A., & Van der Putten, P. (2009). Artificial intelligence: Definition, trends, techniques, and cases. In J. N. Kok (Ed.), Artificial intelligence (pp. 1 – 20). Encyclopedia of Life Support Systems.
McQuay, L. (2018). Will robots duplicate or surpass us? The impact of job automation on tasks, productivity, and work. Psychosociological Issues in Human Resource Management, 6(2), 86-91. http://doi.org/10.22381/PIHRM6220189
Raghavan, M., Barocas, S., Kleinberg, J., & Levy, K. (2020, January). Mitigating bias in algorithmic hiring: Evaluating claims and practices. In Proceedings of the 2020 Conference on Fairness, Accountability, and Transparency (pp. 469-481).
Rai, A. (2020). Explainable AI: From black box to glass box. Journal of the Academy of Marketing Science48(1), 137-141.
Robert, L. P., Pierce, C., Marquis, L., Kim, S., & Alahmad, R. (2020). Designing fair AI for managing employees in organizations: A review, critique, and design agenda. Human–Computer Interaction, 1-31. DOI: 10.1080/07370024.2020.1735391
Roy, V. V., Vértesy, D., & Vivarelli, M. (2018). Technology and employment: Mass unemployment or job creation? Empirical evidence from European patenting firms. Research Policy, 47(9), 1762-1776. doi:10.1016/j.respol.2018.06.008
Tzafestas, S. G. (2018). Ethics in robotics and automation: A general view. International Robotics & Automation Journal, 4, 229–234.
Upadhyay, A., & Khandelwal, K. (2019). Artificial intelligence-based training learning from application. Development and Learning in Organizations: An International Journal, 33(2), 20-23. doi:10.1108/DLO-05-2018-0058 | textbooks/biz/Management/Critical_Employment_Ethical_and_Legal_Scenarios_in_Human_Resource_Development_(Hughs)/1.17%3A_Topic_16-_Artificial_Intelligence_%28AI%29_and_HRD.txt |
The Strategic Leader’s New Mandate
The ability to hold two competing thoughts in one’s mind and still be able to function is the mark of a superior mind.
-F. Scott Fitzgerald
The meeting of two personalities is like the contact of two chemical substances: if there is any reaction, both are transformed.
-Carl Jung
Strategic leadersI distinguish between “strategic leaders” in this book who are in senior leadership positions at the strategic apex of the organization, and other “leaders” who can demonstrate leadership separate and distinct from their authority or position within the organization today are facing unrelenting pressures to deliver results. Indeed, whole books are being written based on the central premise that the purpose of leadership is to deliver results—on time and within budget. Ulrich, Zenger, & Smallwood (1999). In light of these withering pressures to deliver predictable short-term results, most leaders conclude that their only option is to react quickly to problems and opportunities as they arise and forget about long-term thinking.
This pressure to change is real and increasing. Ed Lawler and Chris Worley note,
An analysis of the Fortune 1000 corporations shows that between 1973 and 1983, 35 percent of the companies in the top twenty were new. The number of new companies increases to 45 percent when the comparison is between 1983 and 1993. It increases even further, to 60 percent, when the comparison is between 1993 and 2003. Any bets as to where it will be between 2003 and 2013?Lawler and Worley (2006), p. 1.
1.02: The New Mandate for Change Leadership
While executive leaders must react quickly to current problems and opportunities, they must also look to and prepare for the future. And while only a skilled few will have the ability to be “visionary,” one thing you know that the organization will need to do is to become more agile, flexible, and nimble. In other words, their long-term mandate is to build organizational capacity for change.
In the best-selling book titled The Seven Habits of Highly Successful People, Stephen Covey argued that all individuals must invest time and energy in balancing “production” with “production capacity.” Furthermore, Covey boldly states that “every production problem is a production capacity opportunity.”Covey (1989), p. 202. While this insight was directed to individuals and personal effectiveness, it also applies to strategic leaders and collective effectiveness.
One popular approach to making the organization more open to change is to resort to fear-based tactics in order to heighten the sense of urgency and productivity of the entire organization. For example, “burning platforms” is a popular phrase for many change programs—a metaphor for the notion that time is running out and we will all burn up and die if we don’t act immediately to move to or create an entirely new platform or organization.
In the short term, fear works. And in some cases, a fear-based “burning platform” is the most appropriate way to get the organization to quickly understand the need to change and to respond in new ways. By way of a painful recent illustration, Chief Electronics Technician Mike Williams really did have to jump 100 feet off the burning oil rig owned and operated by British Petroleum in the Gulf of Mexico on April 20, 2010, in order to live—he had to jump or else get consumed by the lethal flames, smoke, or explosions—it was literally a matter of life or death.Pelley (2010).
However, invoking the burning platform metaphor too often or for too long a period of time will lead to unhealthy “burnout” for the change champions, create Dilbert-like cynicism from middle managers, and lead to pathological resistance from frontline workers. In short, organizational change is painful, but if there is too much pain or the pain lasts for too long a period of time, the organization begins to break down.Abrahamson (2000).
Consequently, the new leadership mandate for the 21st century is delivering results in the short term while building change capacity for the long term. Capacity-building change initiatives take time, and short-term productivity sometimes suffers when the organization explores new organizational values, norms, systems, and routines. Capacity building requires trial, experimentation, and learning and these activities are not efficient in the short term. In general, learning is rarely efficient, but it is essential for organizations to be effective.
Michael Beer and Nitin Nohria, both organizational scholars at the Harvard Business School, argue for a more balanced perspective of leadership as well. Essentially, they assert that the two leading theories of organization are “Theory E,” where the firm pursues short-term results in order to elevate the enterprise, and “Theory O,” where the firm seeks to build long-term organizational capacity.Beer and Nohria (2000). Since much more is known about “Theory E” than “Theory O” approaches, this book will focus on the much newer and harder-to-execute theory.
Consequently, strategic leaders today need to be ambidextrous in their approach to leadership. This balancing act is much more challenging than pushing hard for short-term results or nurturing the organization so that new ideas and capabilities emerge in the long term. Because current pressures usually shove long-term objectives to the side, leaders are proving to be much more practiced in reacting to putting out brush fires in today’s organizations than in preparing the organization to be more change capable. Nonetheless, leaders must learn to fly the plane while rewiring it in flightJudge and Blocker (2008).—this is the mandate of the 21st century. | textbooks/biz/Management/Focusing_on_Organizational_Change/01%3A_The_Strategic_Leader's_New_Mandate/1.01%3A_Chapter_Introduction.txt |
The notion of the ambidextrous leadership mandate is clear and compelling in principle, but in practice, it can be quite challenging. First, individuals tend to be better at one skill than another. For example, leaders who thrive on generating short-term tangible results are often not as adept in building long-term organizational capabilities (and vice versa). Just as right-handed persons struggle with left-handed lay-ups in basketball, leaders often display a “handedness” in their leadership orientation. Of course, with awareness and practice, ambidexterity can be developed, but this is not a trivial endeavor. Hopefully, this book will offer compelling logic and some ideas as to how this ambidexterity can be cultivated.
A second complication is that sometimes the official leadership mandate is different from the unofficial one within a particular organization. When the official mandate does not align with the unofficial one, it can be devastating to leaders and organizations. Laurence Stybel and Maryanne Peabody are organizational consultants based in the Boston area. They coined the term “stealth mandate” and observed that it is very common for an executive to be given one leadership mandate while others in that same organization are operating with a completely different mandate.
Generally speaking, leadership mandates fall into one of three major categories: continuity, good to great, and turnaround. Continuity means business as usual: carrying on policies, procedures, and strategies. A typical example is the interim CEO, selected to maintain the status quo until a permanent CEO is found. Good to great refers to Jim Collins’s bestselling book of the same name. A good-to-great mandate is essentially this: We’ve been doing fine, but we can—and need to—do even better. Turnaround means dramatic changes are necessary: No business process, job, or strategy is sacred.Stybel and Peabody (2006), p. 11.
For example, CEOs are sometimes hired to move the organization from “good” to “great.” However, if the top management team or the board of directors or both are operating with a “continuity” mandate, the unofficial mandate clashes with the official one, and chaos often unfolds. When the official mandate is fundamentally different from the unofficial mandate, steps must be taken to bring them into alignment. Usually, this requires extraordinary conflict management skills and emotional maturity on the part of the leader.
A third complication that can challenge this ambidextrous approach to leadership is when the environmental context doesn’t allow the executive sufficient discretion to pursue short-term results while building organizational capacity for change. Some industries are in terminal decline, and the executive leader is not afforded the “luxury” of working for long-term survival. Some nations put employment ahead of productivity, and the executive leader is not allowed to challenge underperforming units. And some organizational cultures value stasis over excellence. All these constraints can conspire to limit executive discretion so that change capacity is not developed.
Fourth, and perhaps most importantly, organizations are built to perform within an established order, not to change. Managers are often rewarded for predictable results so organizational bureaucracy often gravitates to exploitation over experimentation, efficiency over effectiveness, and leveraging previous learning over generating new insights. Hence, it is a rare organization that is “built to change.”Lawler and Worley (2006).
1.04: The Leaders Pursuit of Multiple Objectives
In the fast-paced world that we live in with all its distractions, some might argue that it isn’t possible to pursue multiple objectives. Essentially, this is the logic behind pursuing shareholder value above all else. Indeed, there is some evidence to support this notion as some leaders pursue the stakeholder approach in order to avoid accountability, preserve self-interested behavior, or both. For example, a fascinating recent study found that the firms that were rated highest in corporate social responsibility were also the ones most likely to engage in earnings management—essentially using accounting tricks to deceive those outside of the firm.Prior, Surroca, & Prior (2008).
However, even “Neutron Jack” (Welch) understood that a myopic focus on shareholder value would threaten the very survival of General Electric. As such, even while he was laying off thousands of workers and shedding dozens of business units, he was working behind the scenes to build GE’s organizational change capacity, which emerged as his official focus in his later years as CEO. Which leads to a very important insight—the public objective or objectives announced to the rest of the organization do not have to be the same as the private objective or objectives pursued by the leaders of the organization.Welch and Welch (2005).
Louis Gerstner, the former CEO and Chairman of IBM who engineered a historic turnaround at that iconic firm, writes that leaders must be focused and they must be superb at executing a strategy.Gerstner (2002). For Gerstner, focus generated short-term results while execution was about building organizational capacity for change—both efforts were required to return IBM to its industry-leading role.
In summary, the leader’s mandate of the 21st century is to “avoid the tyranny of ‘or’ and pursue the genius of the ‘and.’”Collins and Porras (1994). Those who are entrusted with authority within an organization must pursue results and build organizational capacity for change (OCC). This book details just what organizational capacity for change is, and provides guidance as to how that capacity can be developed. I have been studying this capacity for over 10 years now and have developed a reliable and valid inventory for measuring OCC. With that inventory, I have amassed a considerable amount of data that has been helpful to other executive leaders as they seek to develop their firm’s OCC. This book helps to explain exactly what OCC is and to provide insights as to how executive leaders can pursue it. | textbooks/biz/Management/Focusing_on_Organizational_Change/01%3A_The_Strategic_Leader's_New_Mandate/1.03%3A_Leadership_Mandates_in_Context.txt |
This book seeks to assist leaders in building their organizational capacity for change. It is written for any executive who seeks to be more proactive toward change, and wants the process to be less painful and somewhat more predictable. In this first chapter, my objective is to challenge the conventional views about leadership and change so that you can begin to pursue the “genius of the and.”Collins and Porras (1994).
Chapter 2 "What Is Organizational Capacity for Change?" begins by examining what is organizational capacity for change, and why it is important. The one thing that you can be certain of in your future is that you and your organization will need to change. This chapter explores how some organizations do that well. In addition, you will learn that organizational capacity for change comprises eight dimensions, as summarized in Figure 1.1 "Eight Dimensions of Organizational Capacity for Change", and that each succeeding chapter goes into depth on each of these dimensions.
The first dimension of organizational capacity for change, trustworthy leadership, is the focus of Chapter 3 "OCC Dimension 1: Trustworthy Leadership". This chapter explains that authority is not enough to make an organization change capable; the strategic leaders must be perceived to be competent and looking out for the well-being of the rest of the employees in the organization. However, a strategic leader or leaders behaving in a trustworthy fashion are not enough; the followers within the organization must be favorably disposed to trusting their organization. In essence, you also need trusting followers to be change capable. Therefore, in Chapter 4 "OCC Dimension 2: Trusting Followers", we examine how important effective followership is within an organization in order to make it change capable. Together, these two human capital dimensions combine to yield the level of organizational trust that exists within the organization and throughout the organizational hierarchy.
Figure 1.1 Eight Dimensions of Organizational Capacity for Change
Chapter 5 "OCC Dimension 3: Capable Champions" explores the important role of capable champions within change-capable organizations. Change champions are those individuals within the senior executive group, the middle management ranks, or both who drive the change initiatives within an organization. These individuals are often mavericks and they don’t normally fit in well in bureaucratic structures. However, their misfit nature is exactly what is needed in order to drive change successfully.
Chapter 6 "OCC Dimension 4: Involved Midmanagement" examines the role that involved middle managers play in making the organizational change capable. In many organizations, middle management has been hollowed out, downsized, and replaced by computers. The remaining middle management group is often uninvolved with the strategy formation design initiatives. This is a mistake. Middle managers have a unique and important role to play in enhancing the change capability of the organization. When an organization comprises capable champions and involved midmanagement, then you have an opportunity for lateral leadership and effective influence without authority—a key ingredient for making your organization more agile.
Chapter 7 "OCC Dimension 5: Systems Thinking" focuses on systems thinking within the organization. Organizations are complex living systems that are not properly understood by linear thinking and analysis. In this chapter, we explore how systems thinking gets cultivated so that organizational learning is accelerated. Then in Chapter 8 "OCC Dimension 6: Communication Systems", the importance of effective communication systems is investigated. When an organization combines systems thinking with high-functioning communication systems, systemic knowledge is created and dispersed throughout the organization.
The final two chapters explore the role of organizational culture and change. Specifically, Chapter 9 "OCC Dimension 7: Accountable Culture" demonstrates the importance of having an accountable culture where there are consequences for employees that fail or succeed. However, this cultural attribute needs to be counterbalanced with an innovative culture, which is the focus of Chapter 10 "OCC Dimension 8: Innovative Culture". Together, these two dimensions of organizational change capacity—accountability and innovativeness—help to ensure that the organization efficiently marshals scarce resources while creatively looking to the future.
Chapter 11 "The Big Picture" provides a “big picture” perspective on organizational capacity for change, as well as guidance for assessing your organization’s capacity for change. Specifically, it provides ideas and suggestions for utilizing the survey listed in Chapter 12 "Appendix A: OCC Survey Instrument" to collect data and the benchmark data listed in Chapter 13 "Appendix B: 8 Dimensions and Factor Loadings for OCC", Chapter 14 "Appendix C: OCC Benchmarking", and Chapter 15 "Appendix D: OCC Benchmarking" that can be used for comparisons between your organization and other organizations that have already been assessed. Chapter 17 "References" contains the references cited in this book, and Chapter 16 "Appendix E: Resources" contains some simulations, readings, and cases that can be used to further explore the organizational capacity for change framework. Chapter 16 "Appendix E: Resources" also contains additional resources for teaching, researching, and learning about organizational capacity for change. | textbooks/biz/Management/Focusing_on_Organizational_Change/01%3A_The_Strategic_Leader's_New_Mandate/1.05%3A_Mapping_the_Chapters_of_This_Book.txt |
What Is Organizational Capacity for Change?
It is not the strongest of the species that will survive, nor the most intelligent, but the one most responsive to change.
-Charles Darwin
The only person who likes change is a wet baby.
-Price Pritchett
If the leader’s new mandate is to prepare for change in the future while delivering results in the present, then what specific preparation is required? My central thesis is that the strategic leader’s preparation for the future entails building organizations’ capacity for change, and that is the focus of the remainder of this book. In other words, this book is about helping executives fulfill the strategic leader’s new mandate.Bossidy and Charan (2002).
The business press is filled with many recent and ongoing stories of organizations that failed to adapt and change to an increasingly fluid and unpredictable environment. Indeed, a widely cited statistic is that “more than 70% of all organizational change initiatives fail.”Higgs and Rowland (2005), p. 121. Nonetheless, one of the arguments why senior executives are worthy of the lofty compensation packages that they currently command is based on the widely-held view that effective leaders and change agents are rare, but essential to cope with the volatile and hypercompetitive environments that many organizations find themselves in today.Kaplan (2008), p. 5.
In response to this pressure to change, scholars and consultants are increasingly focusing on the nature and dynamics of organizational change in an effort to distill lessons learned from previous successes and failures, and provide guidance to change agents to improve their future success rate. Notably, in a recent online search of articles written on “organizational change” in the last 20 years, I discovered that there were more than 25,000 articles published in a prominent online search engine named Proquest.ProQuest Research Library (2010). This suggests to me that the topic is of great importance to those seeking to change organizations, but that much that is written about organizational change by organizational scholars is not improving our success rate. In sum, there is more to be learned about this important subject and this book attempts to fill that gap.
2.02: Primary Reasons for Failure to Bring About Change
I believe that there are three primary reasons for our poor track record in changing organizations. One of the primary reasons for the failure of both scholars and practitioners to successfully develop and utilize a comprehensive yet parsimonious approach to organizational change is our collective failure to understand the systemic nature of change. Too often, organizational members operate in “departmental silos” that focus on local optimization at the expense of the entire system. Furthermore, the senior executives in charge of the overall organizational system (as well as the academics who study them) often fail to understand the interdisciplinary nature of their organizations as they are trapped in the myopia of their own backgrounds or disciplinary blinders.
Organizations are complex, interdependent social entities with relationships operating both within its boundaries and outside of its boundaries. Too many practitioners, in their “bias for action,” focus on a single dimension of organizational life or a single lever of organizational change. Change agents need to be reflective, as well as capable of influencing others. Organizational leaders need to be comprised of confident but humble CEOs and by well-functioning top management teams who collectively understand the entire organization, not a lone wolf with a reputation for individualism and boldness.
A second reason why so many change initiatives fail is that organizational change takes time, and time is one of the most precious commodities in the 21st century. In a recent article written by myself and a former doctoral student, we argued that organizations no longer have the luxury to go offline while the new information system is being built, the foreign venture is being launched, or the new technology is being analyzed. As such, change agents must “rewire” the plane while it is flying if the organization hopes to survive and perhaps prosper in the future.Judge and Blocker (2008), p. 915. Clearly, this is no easy task when everyone around you is arguing for you to “hurry up”!
A third reason why so many change initiatives fail is that our conception of what makes us human is overly mechanistic, narrow, and limited. Our traditional view of organizations is that they are hierarchies with power concentrated at the top with rational and logical employees operating throughout this hierarchy. While it is true that all organizations are hierarchical in some form and that organizational members are rational at times, this viewpoint is limited and not terribly realistic.
Organizational change is not only a rational activity but also an emotional one that challenges deep-seated human fears and inspires human hope. Indeed, John Kotter recently argued that change is predominantly about matters of the heart, not the head.Kotter and Cohen (2002). Organizations can operate in mechanical ways, but they also comprise living human beings who want meaningful work that allows them to “have a life” outside of work. As such, by assuming that all organizational change is rational and logical in nature where fear, political positioning, and turf wars rage, one wonders why any change initiative might work.
2.03: The Typical Reaction to Challenging Environmental Pressures
In my executive education classes and consulting projects, I ask my students and clients what their planning horizon is since strategic leaders are responsible for the long-term performance of their organizations. One response by the president of a major nonprofit medical center is instructive: “Ten years ago, my planning horizon was 5 years into the future. Five years ago, it was 2 years. In today’s environment, where health care reform is the flavor of the day, it is now down to 2 months.” Another CEO of a Fortune 500 chemicals company told me, “There is merciless pressure to deliver the financial results that Wall Street expects each and every quarter. Even though Wall Street denies this, our stock price often gets punished by looking beyond the next 3 months.”
Both of these quotations from CEOs, one from the nonprofit sector and the other from the for-profit sector, imply that the best that senior executives can do is to respond quickly to an increasingly volatile and demanding environment. While I agree that organizations today must be more “nimble” in reacting to such things as unexpected competitor moves, a seemingly short-term focus by the owners of the organization, and unpredictable “disruptive” technologiesChristensen (1997). that change the competitive dynamics of an industry overnight, this focus is overly narrow and too reactive. To succeed in the 21st century, organizations today must not only nimbly and flexibly respond to their changing environments but also build capacity for change. | textbooks/biz/Management/Focusing_on_Organizational_Change/02%3A_What_Is_Organizational_Capacity_for_Change/2.01%3A_Chapter_Introduction.txt |
Organizational capacity for change (OCC) can be conceptualized as the overall capability of an organization to either effectively prepare for or respond to an increasingly unpredictable and volatile environmental context. This overall capability is multidimensional, and it comprises three ingredients: (a) human skill sets and resources, (b) formal systems and procedures, and (c) organizational culture, values, and norms. As such, OCC is a dynamic, multidimensional capability that enables an organization to upgrade or revise existing organizational competencies, while cultivating new competencies that enable the organization to survive and prosper.
Peter Vaill argued that organizations increasingly operate in “white water” where executives have only partial control, yet effective navigation of a boat on the rapids requires everyone in the boat to react efficiently and effectively to the white water all around them.Vaill (1991), p. 2. While I like this metaphor, I would add that the navigator must also prepare the boat and the rest of the team for the oncoming white water.
Robert Thames and Douglas Webster use a different metaphor to describe the context in which firms operate today, namely—a hurricane or an earthquake. They state,
To many organizations, change comes like a hurricane season. Everyone knows it’s coming. It is the same every year. The only thing we don’t know is “Who will it hit this time?”…To other organizations change comes like the earthquake. We may never see it coming but have this nagging feeling that it is.Thames and Webster (2009), pp. 11–12.
Whether your industry or national economy seems like white water rapids, an oncoming hurricane, or a potential earthquake, organizations must prepare in advance, not just react when the “environmental jolt” is experienced. That advance preparation is what I am calling organizational capacity for change. Organizations with relatively high change capacity can successfully shoot the rapids, weather the hurricane, or continue operating during and after a devastating earthquake. Organizations with relatively low change capacity are at the mercy of their environment and much more subject to luck and chance.
I have been researching the nature of organizational capacity for change in hundreds of organizations in a wide variety of industries for over 10 years. In previous research I have found that the higher the aggregate organizational capacity for change is, the higher the subsequent environmentalJudge and Elenkov (2005). and financial performance.Judge, Naoumova, Douglas, & Koutzevol (2009). In other words, organizational capacity for change is positively correlated with, and is likely to lead to, superior financial and environmental performance.
In addition, I have also found that the importance of organizational capacity for change increases with the volatility of environmental uncertainty. In other words, common sense and systematic empirical research show that the more your environment is changing, or is about to change, the more important your organizational capacity for change is.
Finally, after reading literally hundreds of articles and dozens of books on organizational change, I have been able to distill the concept of organizational capacity to change down to eight separate and distinct dimensions.Judge and Douglas (2009). These dimensions are briefly described in the sections that follow, but they will be more extensively discussed in later chapters. | textbooks/biz/Management/Focusing_on_Organizational_Change/02%3A_What_Is_Organizational_Capacity_for_Change/2.04%3A_Organizational_Capacity_for_Change_Defined.txt |
Trustworthy leaders. No lasting, productive change within an organization ever happens without a modicum of trust between its members. As a consequence, the first essential dimension for OCC is the extent to which an organization is perceived to be led by trustworthy leaders. A trustworthy leader is someone who is not only perceived to be competent in leading the organization but also perceived as someone who has the best interests of the organization as their priority. This is why Jim Collins found that organizations that were changing for the better tended to be led by senior executives who were perceived to be humble servants of the organization, but were also passionate about ensuring a bright future for the organization.Collins (2001). Organizational change is risky. In order for employees to change their perceptions and behaviors, they have to trust their leaders. As such, a proven record of trustworthiness on the part of the leaders is essential to bring about experimentation with a new order of things.
Trusting followers. Leaders are only half of the equation when it comes to organizational change; the other half is the followers. I once worked with an executive at Alcoa who was perhaps one of the most trustworthy executives I ever met. He was honest to a fault, a first-rate engineer, who worked his way up through the executive ranks to a prominent leadership position. He had a deep and sound understanding as to where his business unit needed to change, but he had a problem—his plant was highly unionized and it had a long history of management missteps and labor union outrage. Interestingly, the union leaders did trust this particular plant manager, but they didn’t expect him to stay there long and they did expect corporate headquarters to replace him with someone who was not trustworthy. As a result, this business unit had a leader who was perceived to be trustworthy, but the ubiquitous lack of trust on the part of the rest of the organization prevented any major change initiative from progressing.
Psychologists tell us that all individuals have a “disposition to trust” others.Cook (2001). This disposition is influenced by such things as a person’s genetic background, family norms, and work-related experiences. When an organization is filled with a critical mass of individuals who are hopeful, optimistic, and trusting, it will be well positioned to experiment with new ways of operating. When an organization is dominated with a critical mass of individuals who are cynical, pessimistic, and not trusting, it will not be well positioned to engage with organizational change initiatives. In sum, a second key dimension of organizational capacity for change is the overall level of trust held by the employees of the organization.
Capable champions. Individuals, and hence organizations, tend to be inertial. In other words, change takes extra energy and it is much easier to keep doing things the way in which we are accustomed to. Consequently, organizations must identify, develop, and retain a cadre of capable change champions in order to lead the change initiative(s). Within small organizations, these champions are often the same as the head of the organization. Within medium and larger organizations, these champions are often drawn from the ranks of middle management.
Rosabeth Moss Kanter first identified this new breed of managers and she called them “change masters.” She defined change masters as “those people…adept at the art of anticipating the need for, and of leading, productive change.” Kanter (1983), p. 13. Professor Kanter’s central thesis is that if an organization is to change and innovate, power needs to be focused on or delegated to certain talented and energetic individuals, or both.
These “corporate entrepreneurs” are experts in building formal and informal coalitions to makes changes and get things done within an established organization. They know how to directly and indirectly handle political opposition. They often lead a group of “mavericks” and “bend the rules” in order to bypass bureaucratic obstacles. They are often very goal directed and know how to deliver on their promises. In sum, these change champions are often “sponsored” by top management to spearhead change initiatives. If an organization does not have capable champions, change initiatives often stall.
Involved middle management. Middle managers are those who link top executives to frontline workers. Department heads are classic examples of middle managers, but there are many other types of linkages. While it is undeniable that today’s organizations are flatter hierarchies with fewer middle managers than in the past, their role in helping to bring about change is still important. While change champions often come from the middle management ranks, middle managers can passively or actively block change initiatives due to their unique position within an organization.
Steven Floyd and Bill Wooldridge were among the first scholars to note the importance of middle managers when focusing on strategy formation and organization change. As they point out,
The capability-based model of competition puts managerial knowledge at the forefront of competitive advantage. The knowledge of middle managers may become crucial in recognizing an organization’s shortcomings and in broadening its capacity for change [italics added]. Perhaps even more important, the middle manager’s centrality in the information network creates the potential for them to become a driving force in organizational learning. Realizing this potential, however, demands a new set of management expectations.Floyd and Wooldridge (1996), p. 23.
Whenever any new organizational change initiative is announced, one of the first things that employees consider is “how will this affect me?” While every organization is going to have doubters and naysayers, one of the keys to enhancing organizational change capacity is to get a critical mass of the organization excited about the potential change. Middle managers are pivotal figures in shaping the organization’s response to potential change initiatives, so their involvement is crucial to organizational capacity for change.
Systems thinking. Organizational change capacity involves more than just the “getting the right people on the bus and the wrong people off the bus,” however. It also depends on a proper organization infrastructure. One of the key infrastructure issues that influence or retard an organizational change initiative is what is called “systems thinking.” These are the rules, structural arrangements, and budgetary procedures that facilitate or hinder an organization-wide—as opposed to a “segmentalist”—approach to organizational change. While segmentalism works quite well for routine procedures, it is anathema to the study of nonroutine events such as strategic decision making, organizational change, or both.Kanter (1983), pp. 28–35.
Peter Senge is a seminal author in this area. In his classic 1990 text, titled The Fifth Discipline, Senge wrote about how systems thinking can enhance an organization’s ability to experiment, adapt, and learn new ways of operating.Senge (1990). Systems thinking, according to Senge, focuses on how the individual being studied interacts with the other constituents of the system. Rather than focusing on the individual’s or organizational units within an organization, it prefers to look at a larger number of interactions within the organization and in between organizations as a whole. In sum, an organizational infrastructure that promotes systems thinking is another key dimension of organizational change capacity.
Communication systems. A second infrastructure dimension, and one that complements the systems thinking dimension, is what is called “communication systems.” This dimension involves such things as e-mail networks, face-to-face meetings, telephone calls, and corporate announcements all being focused on the conveyance of the value for and the means for implementing a proposed organizational change. Organizational change requires reflection and action. Too often, there is a gap between thinking and doing.Pfeffer and Sutton (2000). Consequently, many observers of failed and successful organizational change initiatives emphasize the importance of communication in order to convert knowledge into action.
For example, John Kotter argues that almost every change leader fails to accurately estimate the frequency, range, and amount of communication required to bring about change.Kotter (1996). Malcolm Gladwell argues that in order for organizations to “tip” in a new direction, convincing and persuasive communication is essential.Gladwell (2002). And Ed Lawler and Chris Worley argue that effective formal and informal communication systems are essential to the creation of organizations that are “built for change.”Lawler and Worley (2006). In sum, effectively designed and delivered two-way information about the change initiative is essential to building organizational capacity for change.
Accountable culture. A fourth and final infrastructure dimension is the degree to which an organization holds its members accountable for results. In my observation, most organizations generally excel on this dimension. However, when the organizational culture gets focused on innovation, accountability often gets ignored. While individuals need autonomy in today’s organizations to pursue innovative new ideas, they also need to be held accountable for delivering results on time and within budget. At the very least, they need to explain the failure to honor deadlines, resource constraints, or both.
Another term for an “accountable” culture is a “results-based” culture.Ulrich, Zenger, & Smallwood (1999). Accountable cultures do not focus on how the work is done, but they do help to carefully monitor the outcomes of results produced. As a result, accountable cultures track whether a deadline was reached or whether the activities were executed under budget or not, and seek to discern what teams and individuals hindered or facilitated successful change. Of course, change is inherently unpredictable so there must be some executive judgment involved with the evaluation of results. However, fostering innovation and change does not mean that innovators and change agents are given a blank check with no deadlines. In sum, organizational capacity for change is also dependent on effective reward and control systems.
Innovative culture. Tom Peters and Bob Waterman wrote powerfully as to the importance of an organizational culture “in search of excellence” in their classic text on America’s best-run companies.Peters and Waterman (1982). Similarly, John Kotter and Jim Heskett demonstrated a powerful correlation between corporate culture changes and subsequent firm performance improvements over 4 to 10 years of time.Kotter and Heskett (1992). And Clayton Christensen showed how corporate cultures often work to thwart innovation and change, particularly when the organization is a market leader.Christensen (1997).
The culture of an organization defines appropriate behavior, and motivates individuals and offers solutions where there is ambiguity. It governs the way a company processes information, its internal relations, and its values.Hampden-Turner (1992), p. 11. Some organizational cultures value innovation and change, while many others value stability and equilibrium. In sum, an organizational culture that emphasizes the importance of organizational change and innovation is a third infrastructure dimension that is critical to organizational change capacity.
2.06: Concluding Thoughts About OCC
In response to pressures to deliver short-term results, leaders and organizations often neglect building their capability to be productive. This book provides a description of how to overcome that purely reactive focus so that the organization can survive and prosper over the longer term.
This capability, or organizational capacity for change as I call it, contains eight different dimensions—four of the dimensions focus on critical human capital and four focus on social infrastructure. Many authors have written insightful books and articles about aspects of organizational capacity for change, but few have attempted to synthesize these writings into a coherent whole. Furthermore, this concept has been rigorously developed and researched in the organizational sciences, having undergone peer review of several scientific articles about it.
The remainder of this book elaborates on what the leader’s role is in creating organizational capacity for change, focuses on each of its eight dimensions in more depth, and provides practical ideas for diagnosing and enhancing your organizational capacity for change. In each subsequent chapter, I provide a detailed review of each dimension and discuss its relationship to organizational capacity for change. At the end of each chapter, seven actionable suggestions are made to help practitioners enhance this particular dimension of their organization. | textbooks/biz/Management/Focusing_on_Organizational_Change/02%3A_What_Is_Organizational_Capacity_for_Change/2.05%3A_The_Eight_Dimensions_of_OCC.txt |
OCC Dimension 1: Trustworthy Leadership
The glue that holds all relationships together—including the relationship between the leader and the led—is trust, and trust is based on integrity.
-Brian Tracy
The first responsibility of a leader is to define reality. The last is to say thank you. In between, the leader is a servant.
-Max De Pree
3.02: What Is Trustworthy Leadership
Trustworthiness can be thought of as the quality of someone being competent and benevolent so that others can safely be in partnership with that person. As Brian Tracy suggests earlier, trustworthiness is important to all human relationships, but it is essential for leadership effectiveness and the ability to prepare for and drive organizational change.
All change requires a partnership between leaders and followers. In any partnership situation, the leader must first demonstrate competence. After all, why should anyone follow the leader if the leader first does not demonstrate skill or competence in envisioning the future, making that vision a reality, or both? Certainly, followers are compliant every day with those in authority, but compliance is largely effective only in stable and unchanging situations. In unstable and changing situations, a trusting disposition among a critical mass of the employees is essential. If the followers’ disposition is largely compliant, change will be temporary or nonexistent. Indeed, it is foolish for anyone to follow a leader who is not deemed competent to lead. In other words, it is appropriate for followers to resist change when the leader has not demonstrated competence in leading.Kelley (1992).
But competence must be coupled with benevolence for one to have sufficient trust in a leader to agree to be led. Competence is a reflection of skill and followers want and need their leaders to be skillful, but what if the leader skillfully takes advantage of his or her followers? This implies that to be skillful or competent as a leader is necessary, but not sufficient grounds for leading change.
The popular press focuses on charisma as the mark of leadership, but history is replete with charismatic leaders who attracted lots of followers and then led them in self-centered and manipulative ways. Thus, the leader must benevolently care for his or her followers’ well-being, and they must be convinced that they are being cared for.
A metaphor that I like to use with executives when discussing the importance of benevolence is that of a knife. Knives are tools that can be handled with great skill, such as preparing food for a meal or defending from an attack. However, if the followers turn the knife over to the leader, they first want to be sure that the leader will not use the knife on them. The knife is a metaphor for power, and leadership involves the proper use of power. All knife-wielding leaders need to show that they know how to use a knife, and that they will not use that knife against their followers.
Some argue that those in authority positions within an organizational pyramid are the leaders of the organization, and that all that is needed to lead is for the followers to respect the authority of the position. This conception worked in the past, but works less and less in today’s organizations, as I will discuss later in this chapter. Indeed, many observers now argue that we are seeing the decline of authority and rise of trust as an organizing principle.Hardy (2007). Clearly, to be effective today, strategic leaders need to combine trust with authority. Authority is helpful, but it is not enough to lead others effectively. | textbooks/biz/Management/Focusing_on_Organizational_Change/03%3A_OCC_Dimension_1-_Trustworthy_Leadership/3.01%3A_Chapter_Introduction.txt |
Chester Barnard was one of the first writers who observed that trustworthy leadership yields trust and cooperation. Barnard was a rare individual who worked in a major corporation (New Jersey Bell) for 40 years and rose to a position of leadership; afterward, he wrote insightfully about that leadership experience. Barnard noted that the key to organizational survival and prosperity was cooperation, communication, and a shared sense of purpose. He further argued that leaders could only lead when they were perceived to be trustworthy by the rest of the organization. Even in the 1930s, Barnard argued that authority is completely a function of the willingness of subordinates to cooperate with the leader. Barnard was well ahead of his time.Barnard (1938).
Warren Bennis argues that the traditional idea of a “heroic” individual leading followers through sheer force of will is a myth. Instead, he argues for creative and productive partnerships among a group of individuals as being the only viable way forward. He emphasizes the importance of those in leadership positions needing to learn how to generate and sustain trust so as to enable organizations to survive the increasingly turbulent changes swirling around and within today’s organizations.Bennis (1999b).
Some argue that there is so much distrust in the workplace today that leaders can no longer rely on trustworthy leadership as an organizing principle. While it is true that there is very little trust in most of the organizations today, it is not true that mistrust on the part of followers cannot be diminished over time. For example, in a recent experimental research study, trustworthy players were found to be more effective in obtaining mutual cooperation than untrustworthy players, even given a history of distrust prior to engagement. Trustworthy players did this through signaling reassurance, rather than fearful messages, to the potential partner.Kydd (2000). In sum, trustworthiness is essential to change, and it can even overcome a mistrusting disposition.
Others argue that it is human nature to resist change, and that organizational changes are even more challenging than individual change. However, this viewpoint is too pessimistic, and both the empirical evidence and common sense suggest that human beings generally want to be part of something that is changing for the better, if there is trustworthy leadership driving that change and if they are involved in helping to decide the nature and pacing of the changes.Peus, Frey, Gerhardt, Fischer, & Traut-Mattausch (2009).
Dynamic stability is the new normal; static states of equilibrium are becoming rarer in organizations. Trustworthy leadership helps to reduce the pain associated with organizational change,Abrahamson (2000). and it yields increased employee engagement.Dittmar, Jennings, & Stahl-Wert (2007). Trustworthiness can lead to more creative work, and organizational innovation is impossible without trustworthy leadership.Littlefield (2004).
3.04: Trusting Cooperation Makes All Change Possible
Organizations can function for short periods of time where part or all of the top management team are viewed as untrustworthy. However, this will thwart the organization’s overall ability to change, and in the long term all organizations must change in order to survive. When in a crisis situation, however, trusting cooperation, and hence trustworthy leadership, is essential to survival.Booher (2002). It is a truism that when the ship is sinking, the captain of the ship must be obeyed in order to save the ship and its crew. If the ship’s captain is not viewed as trustworthy, the rational thing for the crew to do is abandon the ship, regardless of what the captain is urging.
Many if not most of today’s changes are complex and interrelated. For example, business process improvements typically cross multiple departments and multiple levels of an organization. Previous research has shown that preparing for change and the presence of trust can enable an organization to avoid “silo” thinking and focus on the organization’s well-being.Hall (2008).
Middle managers are the linkage between top executives and frontline employees. During all change initiatives, middle managers often feel torn between the changes urged by the “tops” against the resistance expressed or observed by frontline workers. Trustworthiness on the part of change agents enables middle managers to maintain the linkage between tops and the frontline, rather than actively or passively resisting the change.Weber and Weber (2001). In sum, all change requires trusting cooperation, and that is why trustworthy leadership is a critical dimension of organizational capacity for change. | textbooks/biz/Management/Focusing_on_Organizational_Change/03%3A_OCC_Dimension_1-_Trustworthy_Leadership/3.03%3A_Trustworthy_Leadership_Yields_Trust_and_Cooperation.txt |
To secure competitive advantages today, organizations need valuable and rare resources. Previous research has demonstrated that trustworthy leadership is not only valuable; it is also rare.Barney and Hansen (1994). For example, recent research has shown that trustworthy leaders are often able to establish trusting climates within organizations, and that the higher the trust level, the more profitable the organization is.Burton, Laurdisen, & Obel (2004). Furthermore, other research has demonstrated that trustworthy leadership speeds up the decision-making process as well as the implementation speed of new strategies.Roth (2008). This suggests that trustworthy leadership helps to assure not only the organization’s survival but also its future prosperity.
Fortunately or unfortunately, trustworthy leadership is relatively rare within today’s organizations. In a recent national poll, it was revealed that 80% of Americans do not trust the executives who lead major corporations. Even worse, roughly half of all managers do not trust the top executives in their own firms.Hurley (2006). In another national survey, 62% of all workers claim to have no aspirations to any leadership role within their organization because they perceive the leaders to be untrustworthy.Harris (2010). Clearly, having a trust gap between consumers and corporations is problematic, but it is even more challenging when middle managers and frontline employees lack trust.
There are many reasons given for the rareness of trustworthy leadership within today’s organizations. Clearly, many executives did not act in a trustworthy fashion in the aftermath of the Enron, Worldcom, and AIG scandals.Pellet (2009). Indeed, some observers even declare that “trust is dead.”Kempner (2009). While I personally do not believe that trust is dead, I do agree that the level of trust that Americans have for their leaders is not very high.
Another reason given for the lack of trust in today’s corporate leaders is the view that compensation levels are becoming excessive, and that executive leaders are greedy and self-serving above all else.Williamson (2008). While many workers have been laid off in recent years, or are assuming increasing duties with no pay increases, executive compensation has been increasing dramatically. Clearly, the perception of injustice and unfairness on the part of executive leadership is not conducive to fostering trust and cooperation among the rest of the organization.
A third common reason why it is getting harder to trust executives is because the shareholder value ethic is eroding the trust of the general public, especially in publicly held corporations. The consulting firm McKinsey notes that building trust among key stakeholders is a strategic concern for any corporation, and that generalized stakeholder trust is a major competitive advantage since it is so rare.Bonini, Hintz, & Mendonca (2008). In sum, trustworthy leadership is not only valuable; it is also rare. The good news here is that when the strategic leader is viewed as trustworthy, a noteworthy competitive advantage is generated.
3.06: Trustworthiness Is Becoming Increasingly Important
Notably, leadership trustworthiness is not only rare, but it is also becoming more important. Daniel Yankelovich tracks social trends throughout the United States, and he argues that a new social contract is replacing the old one. Yankelovich asserts that as we transition from an industrial to an information-based economy, the employment relationship is changing dramatically, and that these changes require that organizations be managed and led differently.Yankelovich (2007).
There are hints as to where these changes are all leading. Some note that organizations are evolving into federations and networks, and evolving away from pyramids and hierarchies.Bennis (1999a). When an organization is organized more as a network, then “lateral leadership” is more the norm than is vertical leadership.Kuhl, Schnelle, & Tillman (2005). If this assessment is correct, being at the top of the pyramid or hierarchy will be less critical to getting things done in future organizations.
Others note that the millennial generation now outnumbers the baby boom generation in today’s workforce. This new generation of workers, having seen their parents get laid off, outsourced, and downsized, is much less loyal to the organization than previous generations. As Marshal Goldsmith observes, this generation wants you to earn their trust; trust is not given automatically.Goldsmith (2008). Therefore, as millennials increasingly infiltrate our organizations, organizational leadership is going to have to earn their trust in order to be effective, and that trust is not easily earned.
Another trend in organizational life is the growing pervasiveness of virtual teams that are often spread out in a wide variety of time zones and countries. Since work cannot be directly observed or controlled, accountability systems must focus on outcomes and “control” is exerted through trusting partnerships.Henttonen and Blomqvist (2005). In general, the trend for future organizational life is clear: leaders need to rely more on soft power and persuasion than on hard power and control.Nancheria (2009). In sum, trustworthy leadership is not only valuable and rare, but it is also increasingly important. | textbooks/biz/Management/Focusing_on_Organizational_Change/03%3A_OCC_Dimension_1-_Trustworthy_Leadership/3.05%3A_Trustworthy_Leadership_Is_Valuable_and_Rare.txt |
There is no recipe or formula for building trustworthy leadership within an organization. Human beings are too variable for a recipe and human relationships come in all shapes and sizes. After all, leadership development is an “inside job” that requires character development, and character development was the focus of a previous book of mine.Judge (1999). However, there are some behavioral principles for those individuals and organizations seeking to make their organizations more change capable.
Practice 1: Become Skillful in Leading Others
Leadership takes skill and all skills can be developed over time. Without previous experiences in leading others through a change initiative, it is not possible to become a trustworthy leader.McCall, Lombardo, & Morrison (1988). Hence, anything that an organization can do to accelerate and enhance the leadership skills of its managers will yield long-term benefits in also enhancing the organization’s capacity to change.Tichy and Cohen (1997).
However, having a formal leadership development program is not enough to generate skillful leaders. In a recent review of these programs at eight major corporations, the differentiating factor that separated the successful programs from the unsuccessful programs was whether or not personal follow-up was part of the program or not. Personal follow-up involved such things as reminder notes to keep working on the development plan, one-on-one sessions with an executive coach or peer, and sufficient time and resources to work on important attitudes and behaviors unfolding in real time. In other words, leadership development is a contact sport.Goldsmith and Morgan (2003).
Practice 2: Learn How to Speak With and Listen to Associates
One of the problems with much that has been written about leadership and communication is that too much has been focused on telling the rest of the organization what the leader wants to do and helping to persuade the organization that resistance to change is a bad idea. This is only part of what is required. In order to build the leader–follower relationship, time and energy must be invested so that fears, concerns, and doubts can be expressed, alternative viewpoints can be discussed, and challenges to the vision can be articulated.
Most change initiatives fail because they do not consider the emotional aspects associated with change, and trustworthy leadership that communicates well can be an important antidote to counteract that obstacle to change. Indeed, noted author and change guru John Kotter argues that it is important to understand what people are feeling and to speak more directly to their anxieties, confusion, anger, and distrust.Kotter and Cohen (2002).
Interestingly, recent research reveals that the more communication that goes on between executives, the more trustworthy the communicators view each other to be. In a study of 50 senior managers within a multinational firm, it was reported that those executives who communicated more often were more likely to view others in the organization as more trustworthy.Becerra and Gupta (1999). Perhaps this is why interactive communication forums such as town hall meetings, online blogs, and two-way video sessions are becoming staples of organizational life.
Practice 3: Know Your Values and Act With Integrity
A key element of trustworthiness is consistency over time. The best way to be consistent is to know your values and act in concert with those values. If the leader or leaders are not clear about what their values are and what values they want to emphasize within the organization, they are likely to send out mixed messages to the rest of the organization.
Subordinates pay attention to what leaders say and do. When the message changes, or more importantly, when the message stays the same and the leader’s actions are not consistent with that message, trust is destroyed. One of the key factors noted in Ford’s recent success as compared to General Motors’s and Chrysler’s struggles was described as “talking the walk, and walking the talk.”Drickhamer (2004). In other words, Ford executives were able to build up more trust with their employees than executives at the other Detroit firms. Knowing your values and acting consistently with them is harder to do than one would think, but building trust in the absence of consistency between espoused and enacted values is virtually impossible.
Practice 4: Think “Win-Win” as Much as Possible
If employees are to trust their leaders, they need to know that their leaders genuinely care about them. This doesn’t mean that the leader must avoid conflicts and “play nice” all the time. It does mean that employees know that the leaders of the organization are not just in the game for themselves. Pragmatically speaking, leaders must seek win-win options as much as possible and employees need to know that the leader is looking to create a win for them.Covey (1989). In other words, followers want to know that you care about them before they are willing to trust you and follow you. Kouzes (2005).
Interestingly, organizations that went from being good to great were all led by relatively humble leaders who were more focused on building the organization than on their own well-being. Humility is not a traditional aspect used to describe effective leaders, but it is consistent with generating the organizational trust necessary to pursue a bold new vision, change initiative, or both. In sum, caring about the well-being of the entire organization and putting its well-being on a par with your own is essential for building organizational change capacity.
Practice 5: Be Authentic and Human; You Don’t Have to Be Perfect
Because the building of a trusting relationship takes time, it is not a one-time event. While we live in a society that is very unforgiving of mistakes, in order to build trust within an organization, it is more important to be authentic and human than it is to be perfect. When a mistake is made by a leader, it should be owned and acknowledged. Sometimes that acknowledgment needs to be made public; sometimes it needs to be private. The following quote is instructive in this regard:
Apologies can create the conditions for constructive change. An apology can also serve to strengthen an organization. Apologizing by admitting a mistake—to co-workers, employees, customers, clients, the public at large—tends to gain credibility and generate confidence in one’s leadership…To apologize is to comprehend and acknowledge one’s error, to act justly; it requires that the truth be told without minimizing or rationalizing the behavior.Stamato (2008), p. 1.
Part of authenticity is being candid and transparent. However, leaders should selectively reveal their weaknesses since too much disclosure can be inappropriate in certain times and places.Goffee and Jones (2000). In other words, it is possible to overdo this candor and undermine one’s trustworthiness.
Practice 6: Seek Respect, Not Friendship, From Your Subordinates
As this chapter suggests, organizational leaders need to earn the trust and respect of their followers. However, this does not mean that leaders need to be friends with their coworkers. Friendship at work is a wonderful thing, but far more important is the respect that others have for the leadership of the organization.
Respect is earned through being fair and just. And fairness applies to not only what the policy is but also how the policy is implemented. Indeed, recent research found that employee openness to change was even more influenced by how justly the policy was implemented than by how fair the policy was perceived to be in actual substance.Chawla and Kelloway (2004).
Practice 7: Trust Others a Bit More; Control Them a Little Less
Relationships are reciprocal in nature. There must be give and take for them to work properly. If leaders want the organization to trust them, then they must learn to trust the organization. While this prospect can be terrifying to some leaders with their fixation on control and predictability, it is an essential ingredient to building organizational capacity for change.
I personally had to deal with this issue myself recently. My 12-year-old daughter and a friend of hers and I visited the boardwalk in Virginia Beach where we live. The girls wanted to rent a four-person bicycle and so we did just that. Being the most experienced driver in the group, I assumed the steering role at the front left-hand side of the bicycle. However, after a few minutes, I offered to let my daughter steer the vehicle on the bicycle path. I made that offer with some trepidation knowing that her eye–hand coordination was not very developed and her ability to focus left much to be desired. Furthermore, the bikeway was quite crowded with other bicycles and many pedestrians nearby. However, I wanted her to learn to trust her driving ability and to know that I trusted her, so I made the offer. She readily accepted, and sure enough, the bicycle careened off the bike path into a bush in a few minutes when someone unexpectedly stepped in front. However, I kept my mouth shut and we did it again and she did much better the second time. Notably, my daughter said this was the highlight of our trip to the beach, and she seemed to walk a little taller and prouder after this little experiment.
Of course, the consequences of driving a bicycle off the path are not as bad as driving an organization off the path, so my personal example is rather trivial compared with trusting others to “step up” within an organization. However, the principles are the same and the outcome is illustrative. Overall, having a balance between trust and control is essential for building organizational trust. Figure 3.1 "The First Dimension of Organizational Capacity for Change: Trustworthy Leadership" contains a graphical summary of the first dimension of organizational capacity for change.
Figure 3.1 The First Dimension of Organizational Capacity for Change: Trustworthy Leadership | textbooks/biz/Management/Focusing_on_Organizational_Change/03%3A_OCC_Dimension_1-_Trustworthy_Leadership/3.07%3A_Practices_for_Cultivating_Trustworthy_Leadership_in_Your_Organization.txt |
OCC Dimension 2: Trusting Followers
Do not trust all men, but trust men of worth; the former course is silly, the latter a mark of prudence.
-Democritus
There are people I know who won’t hurt me. I call them corpses.
-Randy Milholland
Trust makes all change possible. Trust refers to a person’s belief that others make sincere efforts to uphold commitments and do not take advantage of that person if given the opportunity.Child and Rodrigues (2004). As discussed in the previous chapter, trustworthy leadership is an important ingredient to engendering a trusting organizational environment in which change can take place. However, effective leadership is incomplete unless there is effective followership.Kelley (1992). After all, leadership is a relationship, not a position. If the leader’s partners, the followers, are not sufficiently trusting, then organizational change capability will be impaired.
I came to this somewhat counterintuitive realization when working with a talented executive leader at Alcoa. This individual was a very strong and trustworthy leader—he had strong technical and interpersonal skills, had succeeded in every previous managerial role within Alcoa, was confident but humble, and he genuinely cared about his followers. Because of his strong track record and his considerable future potential to join the executive ranks, he was given increasingly difficult managerial positions within the company. When he was made the plant manager of a large but troubled and underperforming plant within the Alcoa system, he realized that the employees were not inclined to trust him or his leadership team. They were unionized, which gave them the power to stand up to management, and had been used and abused for many years. Previous plant leaders had tried all sorts of Machiavellian tactics to break or bend the union into submission. The end result was pervasive mistrust among most employees and within the overall plant. During his 5 years at the plant, the union gradually came to trust him. However, they told him that he would soon be promoted and replaced by “another untrustworthy jerk,” which is exactly what happened.
In general, it has been shown that there are three things that interact to build or tear down organizational trust. First, there is the trustworthiness of the leader or change agent. This was our focus in the previous chapter. Second, there is the propensity or disposition to trust those in authority positions. Finally, there is the risk associated with trusting.Mayer, Davis, & Schoorman (1995). The second and third determinants of organizational trust are the focus of this chapter.
4.02: Employees Collective Propensity to Trust
People differ in their inherent disposition to trust others. “Propensity will influence how much trust one has for a trustee prior to data on that particular party being available. People with different developmental experiences, personality types, and cultural backgrounds vary in their propensity to trust.”Mayer, Davis, & Schoorman (1995), p. 715. In other words, it takes emotional intelligence to follow as well as to lead well.Fitzgerald and Schutte (2010).
The central issue is whether those who are not driving change within an organization see change as an opportunity for growth or a threat to their well-being. There is considerable organizational research that demonstrates that the label of “threat” or “opportunity” is influenced by the perceiver as much as the actual event, if not more so.Hinduan, Wilson-Evered, Moss, & Scannell (2009).
Michael Maccoby, an organizational psychologist, helps us to understand why some employees are predisposed to follow the leader and why others are not. Using the Freudian concept of transference, Maccoby argues that transference is the emotional glue that binds people to a leader. When there is positive transference, employees trust their leaders, work hard, and are highly motivated. When there is negative transference, employees distrust their leaders, do just enough to get by, and are not motivated.Maccoby (2004).
In addition to an employee’s formative relationships, previous history also influences his or her propensity to trust. As the old saying goes, “Fool me once, shame on you; fool me twice, shame on me.” It has been my observation that bad management leads to the creation of unions; and when a union forms, everyone loses—management, employees, customers—everyone.
However, disposition to mistrust is not limited to blue collar laborers. One recent research study of salespersons is particularly telling. A global Fortune 500 firm agreed to partner with the United Nations philanthropic organizations, and some social scientists were asked to study employees’ perceptions associated with this partnership. Interestingly, if the employees perceived top management to be insincere, then the overall organization’s social responsibility initiatives were perceived to be “window-dressing” and not worthy of employee support. However, if the employees perceived their executives to be sincere, then the organization’s social responsibility initiatives were perceived to be “positive” and worthy of support.Vlachos, Theotokis, & Panagopoulos (2008). The key takeaway here is that the same overall corporate initiative was viewed differently according to the employees’ perception of executives’ sincerity.
4.03: Risk Associated With Trusting Others
Some proposed changes are relatively riskless, so it is relatively costless for employees to go along with a change initiative. However, many changes proposed by change agents carry relatively high costs for employees, and therefore it is rational for employees to be more cautious. In sum, when risk is evaluated to be “reasonable.” the employee is inclined to trust the change agent and “buy in.”Das and Tend (2004).
But the perceived riskiness of a current change proposal is not the only element that influences the risks associated with trusting the change agent. Another issue is the weight of history. Organizational trust evolves over time. Some have observed that it is slow to build and quick to be destroyed, as evidenced by the quick demise of Enron.Currall and Epstein (2003).
Another issue that is looming larger and larger for organizations is the rise of flextime, outsourcing, and virtual organizations. It has been observed that these efficiency-creating administrative realities of the 21st century make organizational trust more fragile since face-to-face interactions are a much more robust way to build and maintain trust.Ramo (2004). In other words, temporal and spatial distance between employees and their leaders makes trust that much more important, but also more fragile and risky.
4.04: Benefits of Pervasive Organizational Trust
When an organization has employees who are generally trusting of senior executives, then organizational trust is high. Previous research has shown a relationship between organizational trust and organizational learning,Jones (2001). hope,Ozag (2001). and organizational innovation and change.Jelinek and Bean (2010). Effective followership requires the proper organizational context as well as effective and trustworthy leadership.
As discussed previously, organizational trust is fragile and can be destroyed relatively easily. However, motivated followers can be a source of competitive advantage, and trusting followers is fundamental to becoming a change-capable organization. Furthermore, it is becoming more valuable over time. Organizational trust provides an anchor and some stability when everything else is changing. Having some predictability and psychological safety when everything is in flux and changing is a valuable resource.Grey and Garsten (2001).
And there is some good news about organizational trust within the context of the larger environment. Previous research has shown that it is possible to build organizational trust in low-trust societal contexts. For example, one study found that some of the highest performing firms in post-Soviet Lithuania in the 1990s were those where organizational trust was relatively high.Pucetaite, Lämsä, & Novelskaite (2010). Similarly, the J. Walter Thompson advertising agency survived and even prospered in the 1930s during the Great Depression in the United States due, in part, to the relatively high levels of organizational trust within that same organization.Mishra (2009). | textbooks/biz/Management/Focusing_on_Organizational_Change/04%3A_OCC_Dimension_2-_Trusting_Followers/4.01%3A_Chapter_Introduction.txt |
If you are interested in building organizational trust in order to make your organization or organizational unit more change capable, the following are some actionable ideas that you can pursue to make that a reality.
Practice 1: Know What the Propensity to Trust is Within Your Organization
It is important for executives to systematically collect data on the state of the overall organization, particularly with respect to organizational trust. After all, what gets measured gets managed. The easiest way to do this is through anonymous surveys of employees. However, it can also be done by watching for mistrust signals, such as employee sentiment that a new policy was unfair, or the firing of a manager was a mistake, or the launching of a new project was ill-considered. While there is no substitute for executive intuition, trust data can add precision and clarity to the situation. In a later chapter, we provide guidance as to how that data might be reliably collected and analyzed. Trend information is particularly important since comparisons over time tend to be the best indicator of how the current top management team is affecting organizational trust. Of course, knowledge and understanding of previous organizational events that damaged or encouraged trust is valuable information.
Practice 2: Dialogue With Employees; Don’t Just Talk to Them
People trust others who they believe understand them.Brownell (2000). How does an old-line manufacturer in a stagnant industry manage to grow 25% per year for 10 years? The answer, made in a recent Inc. Magazine cover story, is, by taking its employees seriously and listening to them. Atlas Container makes cardboard boxes. They also practice “open book management” and engage in workplace democracy.Case (2005). In another instance, the Ford Motor Company turned its poorest-performing plant operating near Atlanta to one of its best, simply by engaging in dialogue with the entire 2,000-member unit.Bunker and Alban (1997). Both of these anecdotes illustrate that a tremendous amount of employee trust and energy is liberated simply by engaging in dialogue, rather than in the more traditional top-down communiqués that occur throughout the business world.
Practice 3: Encourage Constructive Dissent From Subordinates
Robert Kelley argues passionately that leaders need constructive dissent from their subordinates in order to lead effectively. Clearly, this needs to be done with tact and diplomacy, but it can be done. Notably, the Intel Corporation trains each and all of its technically skilled employees in conflict management, and even goes so far as to identify its ability to surface and resolve conflict in the workplace as a distinctive competency.Thomas (2010). As such, the creation of an environment where constructive dissent is the norm is a valuable and rare organizational attribute.
Engaging in constructive dissent takes courage and willingness to incur the wrath of the rest of the organization. In general, organizations do not react well to those who disrupt the social harmony.Mercer (2010). Consequently, training and education as to how to respectfully disagree with a supervisor can be helpful. However, nothing replaces the importance of demonstrated examples. For example, when human resource directors constructively disagree with CEOs, their advice and contributions are taken more seriously.Stern (2009). In sum, constructive dissent is essential if you want to create trusting partnerships with your followers.
Practice 4: Be Fair and Consistent in Applying Corporate Policies
Inconsistencies and unfairness erode organizational trust very quickly. Individuals who vacillate, easily change their viewpoint depending on whom they are talking with, or refuse to make a decision because it may upset some people erode trusting partnerships.Brownell (2000), p. 11. While top executives are constantly confronted with exceptional circumstances and a continually changing environment, they must take care to avoid showing favoritism to one individual or group to the exclusion of other individuals or groups. Once again, this is easier said than done. What do you do when your star salesperson cuts corners with expense accounts? How fairly is affirmative action handled in your corporation? How do you handle requests by legitimately hurting subordinates who ask for exemptions from standard operating procedures? Sometimes, the manner in which these issues are handled are just as important as what is decided. In any event, follower trust is not possible in a work environment that is not generally seen to be fair and consistent.
Practice 5: Design Reward Systems to Support Trusting Partnerships
Most reward systems are focused on individual contributions, but collaboration and trust do not thrive in such a system. Rewards and accountability are important, and they earn a dedicated chapter in this book later on. However, their impact on organizational change capacity has a special power when it comes to engendering trust in the organization. Having said that, changing reward systems is very difficult to do. Simply recognize that it is a sheer waste of time to reward A (i.e., individual competition) while hoping for B (i.e., collaborative partnerships), as the classic article by Steven Kerr attests.Kerr (1975).
Practice 6: Remove Employees Who Repeatedly Destroy Trust
As Jim Collins suggests, you need to “get people off the bus who don’t want to go where you are going.”Collins (2001b). While creating trust is typically a “warm and squishy” idea, there is a hard side to trust that involves punishment and sanctions applied to those who are just not capable of creating trusting relationships, nor are they inclined to do so. The following is an excerpt by Jim Collins that explains why this is so important:
When it comes to getting started, good-to-great leaders understand three simple truths. First, if you begin with “who,” you can more easily adapt to a fast-changing world. If people get on your bus because of where they think it’s going, you’ll be in trouble when you get 10 miles down the road and discover that you need to change direction because the world has changed. But if people board the bus principally because of all the other great people on the bus, you’ll be much faster and smarter in responding to changing conditions. Second, if you have the right people on your bus, you don’t need to worry about motivating them. The right people are self-motivated: Nothing beats being part of a team that is expected to produce great results. And third, if you have the wrong people on the bus, nothing else matters. You may be headed in the right direction, but you still won’t achieve greatness. Great vision with mediocre people still produces mediocre results.Collins (2001b), p. 42.
Exceptional people build trust; mediocre people destroy trust. Avoid hiring and get rid of those who destroy trust in your organization. As Jack and Suzy Welch succinctly stated, “Send the jerks packing.”Welch and Welch, 2006.
Practice 7: Talk Straight and Be Transparent
There is considerable pressure on leaders to waffle and evade or just not be accessible. The belief is that the rest of the organization just does not understand the complexities and nuances of the information held at the senior-most level. There is a grain of truth to this belief; however, leaders need to understand that straight talk is essential for creating organizational trust. Recent research demonstrates that positive transparency on the part of leaders can greatly enhance followers’ trust disposition.Norman, Avolio, & Luthans, (2010).
Interestingly, Microsoft Corporation has a relatively high level of organizational trust. For example, 9 out of 10 employees at Microsoft Netherlands said they could “ask management any reasonable questions and get a straight answer.” This is particularly noteworthy since the organizational unit recently underwent a downsizing experience.Maitland (2008), p. 2. The same can be said for labor unions, which is not easy to do in this day of declining union strength. Clearly, straight talk and transparency are keys to enhancing organizational trust in all parts of the organization.
In summary, organizational trust is essential to be change capable. This requires both trustworthy leaders and trusting followers. Figure 4.1 "The Second Dimension of Organizational Capacity for Change: Trusting Followers" contains a graphic that summarizes these first two dimensions of organizational capacity for change.
Figure 4.1 The Second Dimension of Organizational Capacity for Change: Trusting Followers | textbooks/biz/Management/Focusing_on_Organizational_Change/04%3A_OCC_Dimension_2-_Trusting_Followers/4.05%3A_Practices_for_Building_the_Trusting_Followers_Dimension.txt |
OCC Dimension 3: Capable Champions
Nothing great was ever achieved without enthusiasm.
-Ralph Waldo Emerson
To be a great champion you must believe you are the best. If you’re not, pretend you are.
-Muhammad Ali
Top executives increasingly create cross-functional task forces comprised of respected middle managers to serve as a guiding coalition for major change initiatives. However, even when the top management team personally leads a change initiative, such as in life-or-death turnaround situations, individual change champions within the middle management ranks must “step up” if the change is to be successful. Consequently, the “vertical” chain of command, addressed in the previous two chapters (the hierarchical leader–follower relationship), is not enough to create a change-capable organization. Because organizations are removing layers of bureaucracy and because we are moving from an industrial economy to an information-based economy, “lateral” relationships and leadership are becoming more important. This chapter examines one essential part of that lateral relationship, namely, “capable champions.”
A capable champion is a middle manager who is able to influence others in the organization to adopt a proposed change without the formal authority to do so. In a systematic study of change champions conducted by McKinsey and Company, they found that these middle managers are different from the typical manager. While traditional managers always seek to make their numbers; change champions seek to satisfy customers and coworkers. Traditional managers hold others accountable; change champions hold everyone accountable, including themselves. In addition, traditional managers are fearful of failure; change champions are not afraid of failure and understand that they have career options outside of this job. In sum, traditional managers analyze, leverage, optimize, delegate, organize, and control with the basic mind-set that “I know best.” In contrast, change champions’ basic mind-set is to do it, fix it, change it, and that no one person knows best.Katzenbach (1996).
Clearly, organizations need to be both managed well and led effectively if they are to be successful over time. However, most organizations are overmanaged and underled,Bennis and Nanus (1997). and capable change champions are one of the best antidotes to this organizational imbalance. As Rosabeth Moss Kanter states,
Senior executives can come up with the most brilliant strategy in history, but if the people who design products, talk to customers, and oversee operations don’t foster innovation in their own realms, none of that brilliance will make a whit of difference.Kanter (2004), p. 150.
5.02: Influence Without Authority
Because organization-wide change and innovation frequently goes beyond existing organizational subunits and lines of authority, change champions often need to go beyond their existing authority in order to get things changed. To do this, they need power, which can be thought of as the capacity to mobilize resources and people to get things done. And just as absolute power corrupts, absolute powerlessness on the part of change champions also corrupts in the sense that those who are more interested in turf protection than in the overall organization are not challenged to think and behave in a bigger fashion.Kanter (2004), p. 153.
The advantage the change champions bring to the table is their deep knowledge of how things actually are and how things need to change to make the change vision a reality; the disadvantage that they have is their inadequate power base to influence those with whom they have no authority. Consequently, organizations that are “built to change” hire, retain, and promote change champions in sufficient numbers to counterbalance the equilibrium-seeking rest of the organization. In short, change champions are masters of influencing others without the authority to do so.
The first people change champions need to influence is their superiors and the top management team. Not all middle managers know how to “manage up,” but this talent is essential. There is a phenomenon operating to varying extents in all organizations known as “CEO disease.” This organizational malady is the information vacuum around a senior leader that gets created when people, including his or her inner circle, withhold important information. This leaves the senior leader out of touch and out of tune with the rest of the organization, its environment, or both.Arond-Thomas (2009).
Change champions are adept at selling strategic issues for senior managers to address. Change champions are also courageous enough to challenge senior executives when they are off track or misinformed. And change champions obtain the “sponsorship” of executives to act on the executives’ behalf. All of these behaviors require sophisticated political skills and the character to do this well.
In addition to influencing senior executives, change champions must also influence other middle managers to consider and adopt organizational changes. In this case, informal networks of influence must be created or expanded in order to bring about change, neutralize resistance to change initiatives, or both. One of the key ways that change champions do this is by the creation of alliances through exchanges of currencies.
Allan Cohen and David Bradford have written the seminal book on influence without authority, which is the ability to lead others when you do not have authority over them. These authors argue that many different currencies circulate within organizations, and that money is just one of those currencies. Those non-authority-related currencies include such things as inspiration-related currencies (e.g., vision, moral, or ethical correctness), task-related currencies (e.g., the pledge of new resources, organizational support, or information), relationship-related currencies (e.g., understanding, acceptance, or inclusion), and personal-related currencies (e.g., gratitude, comfort, or enhancement of self-concept).Cohen and Bradford (2005).
In particular, they emphasize the role of negotiations in creating win-win intraorganizational alliances and partnerships. To do so, they argue that you as a change champion must (a) know and communicate what your goals and intentions are to your potential ally, (b) understand your potential ally’s world and what his or her goals and intentions are, and (c) make win-win exchanges that prevent organizational changes from proceeding.Cohen and Bradford (2005).
Finally, change champions must influence frontline workers who are not under their direct supervision if the organization is to become change capable. Whenever change initiatives are launched, there are multiple “narratives” that flow through the organization because communication from the “top” is almost always inadequate, and listening from the “bottom” is often filtered. Change champions help to make sense of those often conflicting narratives so that frontline workers feel less threatened by the changes.Balogun and Johnson (2004).
Similar to other middle managers, change champions, in order to get changes adopted, can also trade currencies with frontline workers over whom they have no authority. Since frontline workers often feel oppressed and ignored within many hierarchical organizations, the softer skills—such as expressing sincere gratitude, including frontline workers in the change process, and understanding and accepting them—are particularly important to change champions if these alliances are to be maintained. | textbooks/biz/Management/Focusing_on_Organizational_Change/05%3A_OCC_Dimension_3-_Capable_Champions/5.01%3A_Chapter_Introduction.txt |
Geoffrey Bellman is an organizational development consultant who has written a national best seller about being a change champion. In his book, he says that in order to work effectively with other people over whom you have no authority, it is important to start out by being clear about what you want. Specifically, he states, “Clarity about your vision of what you want increases the likelihood you will reach for it.”Bellman (2001), p. 118.
He adds that “when we are not doing what we want to do, we are doing what others want us to do.”Bellman (2001), p. 21. In essence, he argues for the power of an authentic life over the power of organizationally backed authority. One of the implications of such a posture is that becoming a change champion within an organization requires that you be prepared to leave it when or if your life’s purpose cannot be pursued. Bellman states it well: “Worse that losing a job is keeping a job in which you are not respected, or not listened to, or not consulted, or not influential, or…you name it, it is your fear.”Bellman (2001), pp. 110–111.
Similar to other observers, Bellman argues that by keeping the combined interests of yourself and others in mind, you will get things done when not in charge. However, he further adds that many changes and change visions must wait for the proper time to act. In other words, change champions must be politically astute in their timing of change initiatives as they consider the evolving interests of others along with the evolving interests of themselves.
5.04: Rising Importance of Change Champions
Ori Brafman and Rod Beckstrom used a creative analogy from the animal kingdom to illustrate the rising importance of change champions within organizations. They argued that future organizations will function more like starfish, and less like spiders. They state,
If you chop off a spider’s head, it dies. If you take out the corporate headquarters, chances are you’ll kill the spider organization…Starfish don’t have a head to chop off. Its central body isn’t even in charge. In fact, the major organs are replicated through each and every arm. If you cut the starfish in half, you’ll be in for a surprise: the animal won’t die, and pretty soon you’ll have two starfish to deal with.Brafman and Beckstrom (2006), p. 35.
Illustrating their point, they argue that the organizations of the 21st century, what they call “starfish” organizations, are demonstrated by customer-enabled Internet firms such as eBay, Skype, Kazaa, Craigslist, and Wikipedia; “leaderless” nonprofit organizations like Alcoholics Anonymous and the Young Presidents Organization; and highly decentralized religious movements like the Quakers and al Qaeda.
With respect to this chapter, their insights about champions are particularly interesting. A champion is someone who is consumed with an idea and has the talent to rally others behind that idea. Brafman and Beckstrom argue that the passion and enthusiasm of champions attracts followers, and their persistence enables the group to endure all the obstacles to change. Classic champions of the past include Thomas Clarkson, a Quaker driven to end slavery, and Leor Jacobi, a vegan driven to end meat-eating. In the end, this book argues that change champions are as much if not more important to the future survival of the organization than even the formal leaders of the organization. | textbooks/biz/Management/Focusing_on_Organizational_Change/05%3A_OCC_Dimension_3-_Capable_Champions/5.03%3A_Getting_Things_Done_When_Not_in_Charge.txt |
To conclude this chapter, I once gain offer seven practices that can enable an organization to cultivate capable champions. As Ralph Waldo Emerson was quoted at the beginning of this chapter, nothing great ever gets accomplished without enthusiasm. Champions are passionate enthusiasts leading change initiatives.
Practice 1: Hire, Develop, and Retain Change Agents
Many senior executives confine themselves to looking only one level down from the top and conclude incorrectly that there are not enough people to lead change initiatives. As a result, they often hire newcomers or consultants too quickly and put them in influential change agent positions. While this is sometimes unavoidable, this approach has a major downside to it since it signals that the senior leadership does not trust existing managers to champion change.
A much better approach is to hire potential change agents to help ensure the organization’s future. However, change agents are mavericks by nature, and the hiring decision either consciously or unconsciously screens out individuals “who don’t fit in.” This is why hiring decisions are often better made by those who have actually led others to be superior to staff persons with no actual leadership experience or background.
Practice 2: Listen to Middle Managers, Especially Those Who Deal Directly With Customers
In the previous chapter, it was emphasized that senior leaders need to dialogue with and listen to their employees. This is especially true of change agents within the middle management ranks. For example, an organizational study of governmental agencies found that senior leaders of agencies that engaged in dialogue with the middle management ranks were much more successful in pursuing change than senior leaders of agencies that used a more top-down, one-way communication style. Change agents have unique and detailed perspectives on the entire organization as well as its customers. Senior leaders need two-way communication to tap this knowledge.
Practice 3: Identity Who Your Change Champions Are
Unusually effective middle managers are tremendous repositories of change champions. A recent Harvard Business Review article offers insights on how to identify who the change champions might be.Huy (2001). First, look for early volunteers. These individuals often have the confidence and enthusiasm to tackle the risky and ambiguous nature of change. They often feel constrained in their current duties, and are eager for more responsibility. Give it to them.
Second, look for positive critics. Change-resistant managers constantly find reasons why a change proposal won’t work, and they seldom, if ever, offer a counterproposal. In contrast, positive critics challenge existing proposals, suggest alternatives, and provide evidence to support their argument. Positive critics offer constructive criticism and positive criticism is essential to being a change champion.
Third, look for people with informal power. They are often middle managers whose advice and help are highly sought after by people all around them. They often have excellent reputations and a lot of “social capital.” They typically operate at the center of large informal networks, and know how to work with that network successfully.
Fourth, look for individuals who are versatile. Change champions need to be comfortable with change, and they often adapt more easily to previous organization change more readily and easily than others in the organization. Those who have endured in their career shifts, relocations, or both are more likely to be comfortable with change than those who have not undergone these professional changes.
Finally, look for emotional intelligence in your middle management ranks. Individuals who are aware of their own emotions and those of others, and actively take steps to manage their feelings, are more likely to adapt to an envisioned change. Emotional intelligence is much more important than traditional logical-mathematical intelligence. Using the vernacular of the day, change champions need “emotional” bandwidth.Davis (1997).
Practice 4: Recognize and Reward Effective Change Champions
Organizations are designed to reduce variation; change champions are oriented to creating variation. How can these two different orientations co-exist? Clearly, there needs to be a balance here. Unfortunately, most organizations only reward managers who reduce variation and punish or, more likely, ignore those who amplify variation.
Due to the messiness and uncertainty behind change, change champions are more likely to make mistakes. Organizations need to learn to find a way to reward effectiveness in addition to efficiency. Making mistakes is not efficient, but it can be effective. Does your organization recognize and reward an efficiently run organizational unit that hasn’t changed much in years as well as an organizational unit that has changed completely, but in the process angered some individuals along the way? Change champions make mistakes, but they learn from their mistakes and they ultimately succeed. As hard as it is for organizations, they need to be recognized and rewarded for doing so.
Practice 5: Train and Develop Middle Managers to Be Change Agents
Noel Tichy argues that effective companies build leaders at every level, and they do this by creating a “leadership engine.” This is especially true for the development of change champions. In Tichy’s view, the best leaders are “enablers” rather than “doers.” They work their initiatives through other people rather than doing it all themselves. They can only accomplish this, he adds, if they develop people sufficiently to ensure that proper execution can occur at all levels.Tichy and Cohen (1997).
In large organizations, a formal leadership development program is often created to identify and accelerate the development of change champions. In medium- and small-sized organizations, an informal leadership development program is often sufficient. Regardless of the formality of the program, the key notion here is the importance of “contextualized” training and development. Traditional training and development leads to new knowledge, but has little impact on organizational change. Training and development that is applied to actual work situations through such practices as action learning projects, leadership mentoring, and applied learning endeavors go hand-in-hand with organizational change.McCall, Lombardo, & Morrison (1988).
Practice 6: Use Cross-Functional Teams to Bring About Change
Organization-wide change requires cross-function teams to guide the change initiative. Without a cross-functional team, unrepresented organizational units are more likely to resist the change since it is assumed that their voice is not heard or considered. Ideally, the cross-functional team will comprise respected change champions from the various subunits. At a minimum, the team must be led by a change champion.
Cross-functional teams are different from the more traditional functional team. They can speed new product development cycles, increase creative problem solving, serve as a forum for organizational learning, and be a single point of contact for key stakeholder groups. Because of this unique structure and mandate, team leadership is different for a cross-functional team than for a functional team. Specifically, technical skills are relatively less important for these types of teams, but conceptual and interpersonal skills are more important. Hence, the creation and composition of cross-functional teams can be an excellent way to identify and develop your change champions.Parker (2002).
Practice 7: Understand the Nature and Power of “Sponsorship”
The sponsor of a change typically comes from the CEO or top management team. Senior leaders authorize change efforts and often provide tangible resources to make that change a reality. However, they also provide intangible and symbolic resources to change champions. If the sponsor announces a change initiative, creates a guiding coalition, and then disappears from view, the organization will notice and the change initiative will suffer. If the sponsor announces a change initiative, creates a guiding coalition, makes him or herself available to support and learn about progress to the team, and regularly voice support for the change initiative, then the change initiative has a much better chance of success.
The relationship between the senior leader and the change champion is particularly important. Since the change champion lacks the authority to get things done and some changes can only be brought about by formal authority, the sponsor must use his or her authority at times to keep up the change momentum. By the same token, change champions should never undertake leadership of a change initiative without solid support and sponsorship by senior leader(s). Without effective sponsorship, change champions are highly unlikely to succeed.
In sum, lateral relationships and influence without authority are as important to organizational change capacity as vertical relationships and authority are. This chapter discusses how creating a cadre of capable champions is essential for bringing about change. Figure 5.1 "The Third Dimension of Organizational Capacity for Change: Capable Champions" contains a graphical depiction of this third dimension of capacity for change.
Figure 5.1 The Third Dimension of Organizational Capacity for Change: Capable Champions | textbooks/biz/Management/Focusing_on_Organizational_Change/05%3A_OCC_Dimension_3-_Capable_Champions/5.05%3A_Practices_for_Cultivating_Capable_Champions.txt |
OCC Dimension 4: Involved Midmanagement
There is an enormous number of managers who have retired on the job.
-Peter Drucker
The Trojans lost the war because they fell for a really dumb trick. Hey, there’s a gigantic wooden horse outside and all the Greeks have left. Let’s bring it inside! Not a formula for long-term survival. Now if they had formed a task force to study the Trojan Horse and report back to a committee, everyone wouldn’t have been massacred. Who says middle management is useless?
-Adam Engst
6.02: The Evolving World of Middle Management
In the 1990s, many firms eliminated midmanagement positions and replaced them with computers.Stewart (1995). One of the most common terms for this was “delayering,” which is standard code for “eliminating all the nonproductive employees in the middle management ranks.” The result of all this turbulence is a very different role for middle managers in the 21st century as compared to the 20th century. Midmanagers now have more autonomy relative to the past, but experience much more monitoring. They have more job stress and are working longer hours. And there is less career progression within one firm, but more job hopping between firms.McCann, Morris, & Hassard (2008).
Meanwhile, there is a “war for talent” going on in the global economy. As such, there is intense and increasing competition for the top 10% of all MBAs and junior managers. As some have observed,
The unfortunate mathematical fact is that only 10 percent of the people are going to be in the top 10 percent. So, companies have a choice. They can all chase the same supposed talent. Or, they can do something even more useful and much more difficult to copy—build an organization that helps make it possible for regular folks to perform as if they were in the top 10 percent.O’Reilly and Pfeffer (2000).
While these trends and situations vary throughout the world, the overarching trend is for middle managers to be less secure in their jobs and less loyal to their employer.Hallier and Lyon (1996). While middle managers have always been torn and conflicted due to their key position in the organizational hierarchy, these feelings are particularly acute today.Hallier and James (1997). One of the ways of coping with this new reality is to avoid taking risks and making mistakes, or becoming more passive and less proactive. Perhaps this is why senior managers frequently perceive middle managers as one of the biggest obstacles to change in their organizations.Buchen (2005). As a result, middle managers are often not involved and engaged with the organization, or its substantive strategic reorientations. This clearly is problematic if the organization seeks to become change capable.
6.03: Middle Managers Contributions to Change
Middle managers have many opportunities to improve the overall change capability of the organization beyond championing strategic initiatives, which was discussed in the previous chapter. Systematic research suggests that middle managers not sponsored as change agents can take initiative on their own to sell ideas, make sense of the proposed changes, and provide essential stability during tumultuous change events. The end result is that “unsponsored” middle managers synthesize and accelerate information flow, facilitate adaptability, and are crucial implementers of deliberate changes.Floyd and Wooldridge (1996).
Selling ideas. In addition to the change agent(s), the senior manager(s), or both, “ordinary” or “unsponsored” middle managers must also sell change if the organization is to be change capable. The traditional selling of ideas is done from the middle manager to his or her subordinates and frontline employees, or “downward selling.” In most organizations, a major change initiative is announced by senior managers using lofty but vague visions and slogans. Unfortunately, the typical response of frontline employees is often hostility and fear. Rumors and disaster scenarios rush in to fill the gap. These negative reactions can only be challenged in private meetings between departmental managers after the formal announcement of a proposed change. If the middle manager can translate what the change initiative means to the unit as well as dispel myths and rumors, the organization becomes more change capable. If the middle managers are not sufficiently involved in the change design and objectives, however, this translation does not occur.Larkin and Larkin (1996).
In addition to selling downward, middle managers also sell ideas upward to their senior managers. Organizational change begins with the focusing of organization attention, and not all focusing must come from the top of the organization. Indeed, middle managers with their direct contact with customers and unique perspective within the middle of the hierarchy are well positioned for this activity. As recent research has shown, middle managers make formal presentations to top managers as well as bundle new ideas with established strategic goals or issues.Dutton, Ashford, O’Neill, & Lawrence (2001).
Finally, middle managers also sell ideas laterally. Organizational change typically cuts across multiple organizational units, departments, divisions, or all three. To bring about that change, middle managers across different units must collaborate and work together, without the formal authority to do so. Consequently, the ability to sell ideas laterally and negotiate influence across organizational units is a key contribution by middle managers.Cohen and Bradford (2005). In sum, middle managers can be essential salespersons for change initiatives for all those that they come in contact with. Senior executives and change champions are not the only ones to sell the change.
Making sense of change initiatives. Sometimes middle managers are called upon not to “sell” a proposed change, but just “make sense” of it. Organizational life can be confusing and hard to understand, and the emotional nature of change initiatives makes it that much more confusing and “senseless,” as Dilbert cartoons repeatedly remind us. Due to their integral role within organizations and the lofty perches of senior managers, middle managers can interpret messages and signals given by top executives to the rest of the organization, and this role can literally be the key factor that unlocks its potential so as to avoid unintended consequences. Indeed, this sense-making function on the part of middle managers has been shown to positively influence restructuring initiatives or an existing operation,Balogun and Johnson (2004). as well as the postacquisition integration process of merged operations.Nordblom (2006).
When middle managers are sidelined or blocked from being involved, they themselves can’t make sense of the change. This is true even in those instances when the middle managers have blind faith and trust in their senior leaders. Thus, it is harder if not impossible for them to make sense of proposed changes to others. Furthermore, even if they see the wisdom, logic, or both behind a change proposal, they will be less inclined to help others see the wisdom behind it if they have been uninvolved in the design and execution of a particular change.
Providing stability. As discussed previously, any successful change must preserve the core of the organization while changing its periphery. This stabilizing role is best handled by middle managers who are intimately linked with the rest of the organization. Sometimes, middle managers oppose ill-considered changes that violate the organization’s core values and norms. As such, not all resistance to change is bad, and middle managers can passively or actively preserve stability through resistance efforts.
However, even when the change initiatives are appropriate and well timed, middle managers can provide a stabilizing influence on the rest of the organization by directly addressing others’ fears and simply by listening. Indeed, there is even research to suggest that an essential skill set of middle managers is to act somewhat like an organizational therapist who pays attention to change recipients’ emotions and provides healthy perspectives in response to highly emotional reactions. As such, middle managers can provide an “emotional balancing” between organizational continuity and radical changes, and this balancing effect has a short-term and long-term impact on the organization’s health and survival.Huy (2002). | textbooks/biz/Management/Focusing_on_Organizational_Change/06%3A_OCC_Dimension_4-_Involved_Midmanagement/6.01%3A_Chapter_Introduction.txt |
New research suggests that middle managers are often missing in action when radical change is being pursued. However, when they are properly involved and engaged with the change initiative, the change process goes more smoothly and the outcomes are more positive. Four separate roles have been identified by researchers that middle managers fulfill in successful change initiatives, and each is discussed in the following paragraphs.
Entrepreneur. Middle managers are often more diverse than the senior executives are, and this diversity can be a source of creativity and entrepreneurship. A recent Harvard Business Review article describes this role well:
Middle managers are close to day-to-day operations, customers, and frontline employees—closer than senior managers are—so they know better than anyone where the problems are. But they are also far enough away from frontline work that they can see the big picture, which allows them to see new possibilities, both for solving problems and for encouraging growth.Huy (2001), p. 73.
So while middle managers are often viewed by senior executives as bureaucrats who constantly obstruct change, they actually are well positioned to be a source of creative entrepreneurial work, especially when it comes to bringing about change.
Communicator. Successful change requires information-rich transmission, such as face-to-face dialogue and observation of body language when discussing the change. Senior leaders simply don’t have the time or the energy to communicate one-on-one with employees or in small groups. However, this is what middle managers do on almost a daily basis. When they are properly involved and engaged with the change process (even as change recipients), communication can be improved and clarified, particularly by relying on established formal and informal networks of influence. “As they tap into their networks, middle managers use keen translation skills to communicate change initiatives throughout a work group or a company.”Huy (2001), p. 77.
Therapist. Middle managers do a host of things to make the workplace psychologically threatening or safe for an established organization. When the organization confronts change, strong emotions are stirred within employees, which can depress morale, trigger anxiety, and lead to distraction, absenteeism, turnover, depression, workplace violence, and other organizational maladies. If the middle manager is psychologically skilled and aware, many of these painful outcomes can be avoided or minimized during change initiatives. “Middle managers shoulder additional burdens during a period of profound change. Besides the already challenging daily tasks of operations and revenue generation, they provide far more hand holding, practical problem solving, and support than they usually do.”Huy (2001), p. 78. Clearly, if middle managers are involved and engaged with the change process, they are more likely to be able to fulfill this role.
Tightrope artist. Middle managers enable the organization to keep producing in the short term, while the organization positions itself for the future. They can slow down the change process when it becomes overwhelming to their unit, and they can speed it up when progress is too slow. They can obtain extra resources for their unit when necessary, and they can trim resources that are being wasted. They can support those in their unit who understand the purpose of the change but need personal support, and they can challenge those who fight the change due to self-interested behavior. In sum, successful organizational change requires attention not only to employee moral but also to the balance between change and continuity.”Huy (2001), p. 78. | textbooks/biz/Management/Focusing_on_Organizational_Change/06%3A_OCC_Dimension_4-_Involved_Midmanagement/6.04%3A_Middle_Manager_Change_Roles.txt |
As in previous chapters, we conclude with seven actionable ideas that can be pursued to increase this particular dimension of organizational change capacity. While not all employees will welcome change, ignoring middle managers can have a devastating effect on change initiatives. In essence, involved middle managers are essential for bringing along a critical mass of employees to adopt a proposed change. As a result, middle managers’ involvement in the design and execution of a change process is essential.
Practice 1: Accept the Differences Between Middle Managers and Change Champions
In any organization, there are “A,” “B,” and “C” players. The A players are the ones who regularly exceed performance expectations and often step into leadership roles for change initiatives. They are the rising stars who have inordinate ambition, take risks, and like to push the envelope. The C players are those employees who are not meeting performance expectations. And then there are the B players. These are the employees who are meeting performance expectations, but they act in a supporting role to the rest of the organization. They assume a more “ordinary” and “limited” but critical role within the organization.
Within the middle management ranks, A players are often given most if not all the attention by senior management because they are often similar in drive and impact to those in senior executive positions. Often, these players are the change champions within the organization. In contrast, B players are often ignored and taken for granted while C players are given remedial attention or removed from the organization. Ignoring B players is a mistake since they play such a vital complementary role within a corporation.DeLong and Vijayaraghavan (2003).
B players often place a higher value on work–life balance than do A players. B players may have second-rate educational backgrounds or technical skills compared with A players, but they compensate by developing extensive interpersonal skills or organizational memory. And B players often bring a depth of understanding to the organization and the unit in which they operate, since they have not progressed as quickly up the organizational ladder as have A players.DeLong and Vijayaraghavan (2003).
Organizations need stars (i.e., A players) and a strong supporting cast (i.e., B players) if they want to be change capable. Senior executives need to recognize the differences between these two groups of employees and respect the differences in ambition, motivation, training, and so on. By understanding these differences, B players will feel more respected and involved and the organization will more likely benefit from their contributions.
Practice 2: Invest in Middle Manager Skills, Especially During Slow Periods
When the economy is growing robustly and the organization is hitting its performance targets, investing in manager development initiatives is relatively easy to do. However, during slow periods, most organizations suspend all professional development initiatives, especially for middle managers. This is a missed opportunity.
During slow periods, investing in human capital is an ideal time to enhance the skills of your middle management ranks. Slow periods bring about fear within the employees’ ranks and present a unique opportunity to add new skills. By investing in management development initiatives for middle managers, the organization sends a signal that these employees are important, which reduces fear, and it generates loyalty. Furthermore, when the pace picks up, middle managers can sometimes rejuvenate their careers and display a burst of creative energy, become better supporting actors, or both. Management development is not a luxury during slow times, it is a necessity.Krishnamurthy (2008).
Practice 3: Tailor Rewards to Things That Middle Managers Value
Not all middle managers want to become senior managers. Not all middle managers want to move every 2 to 3 years. Not all middle managers want to make huge sums of money. Not all middle managers want to tackle extremely challenging problems that have defied solution by others. Some middle managers are content with the way things are.
Most reward and recognition systems are designed to motivate and reward the A players. This needs to change. Change-capable organizations recognize the differences between A and B players and revise their reward systems to align with these differences. For example, rather than offering more compensation, sometimes the gift of time is valued as much if not more by some employees. Rather than offer a single career track, multiple career tracks should be considered since not all managers want the same careers and stress as do A players. In sum, recognize the differences between change champions and middle managers, and adjust your organizational systems to reward both types of management.DeLong and Vijayaraghavan (2003), p. 102.
Practice 4: Don’t Ignore the Plateaued Middle Manager
Some middle managers provide solid and consistent performance, but they have plateaued in their careers. As a result, these plateaued managers are often older and less energetic than the change champions. However, with age sometimes comes wisdom and proven social networks and these individual capabilities are invaluable when the organization is confronted with large, transformative change initiatives. Perhaps this is why a recent research study found that the most effective managers in engaging with transformative change were the older, plateaued middle managers, as compared with the younger, rising stars.Spreitzer and Quinn (1995). Again, traditional middle managers can play a major supporting role and sometimes even a leading role in any change initiative.
Practice 5: Involve Middle Managers in the Strategy Formation Process
In today’s increasingly information-based economy, successful strategy is more about learning faster than the competition than it is about exquisite and detailed deliberate strategic planning. Therefore, it only makes sense that involving the middle managers engaged with day-to-day operations as well as the customers can be a valuable source of learning and testing of strategic change ideas. Indeed, more and more research suggests that high-performance organizations regularly involve their middle managers in the substantive development of organizational strategy, as well as in its execution.Floyd and Wooldridge (1996). This involvement can be as formal and expensive as an organization-wide strategy conference, or as informal as a hallway chat with middle managers about the organization’s external threats and opportunities. Whatever form it takes, engaging middle managers in forming the strategy as well as executing it will enhance their knowledge and commitment to future change programs.
Practice 6: Create a “Leadership Engine”
Adaptable and innovative organizations grow leadership at every level, and create a wide and deep array of internal talent to call upon in times of need. Leadership is not the preserve for a select few, but for as many in the organization as possible. This is especially true of middle managers who are not champions of change. Innovative organizations develop a “teachable point of view” on business ideas and values, and this can accelerate knowledge creation and transfer within the firm. Middle managers are not just “doers,” they also are “thinkers.” And if given the chance and the right circumstances, middle managers can also be “leaders.”Tichy and Cohen (1997).
Practice 7: Enable Middle Managers to Constructively Challenge Senior Leaders
Many significant organizational disasters—such as the British Petroleum oil rig explosion or the Bernie Madoff Ponzi scheme—could have been prevented or mitigated if those in the middle management ranks were allowed to voice constructive criticism. Middle managers need to have access to the senior leaders and they need to be allowed to deliver news that is not flattering. As one organizational consultant puts it, “Followers and leaders both orbit around the (organizational) purpose; followers do not orbit around the leader.”Chaleff (2009), p. 13. In other words, organizations must cultivate courage in the middle management ranks to speak “truth to hierarchy,”Chaleff (2009), chap. 7, pp. 179–204. and senior leaders need to be focused more on the well-being of the organization than on their own personal well-being.Judge (1999).
In sum, some of your middle managers need to be involved in helping to bring about change, even if they are not the change champions. Organization-wide change is complex and affects everyone. Middle managers can make a major contribution to actively bringing about change or passively assure its demise. Figure 6.1 "The Fourth Dimension of Organizational Capacity for Change: Involved Midmanagement" contains the fourth dimension of capacity for change.
Figure 6.1 The Fourth Dimension of Organizational Capacity for Change: Involved Midmanagement | textbooks/biz/Management/Focusing_on_Organizational_Change/06%3A_OCC_Dimension_4-_Involved_Midmanagement/6.05%3A_Practices_for_Increasing_Midmanager_Involvement_in_Change.txt |
OCC Dimension 5: Systems Thinking
A system must have an aim. Without an aim, there is no system. A system must be managed. The secret is cooperation between components toward the aim of the organization.
-W. Edwards Deming
No problem can ever be solved with the consciousness that created it. We must learn to see the world anew.
-Albert Einstein
7.02: A Primer on Systems Thinking
What Is a System?
W. Edwards Deming, the guru of total quality management, defines a system as “a network of interdependent components that work together to try to accomplish a common aim.”Deming (1986), p. 32. A pile of sand is technically not a system since the removal of a single component (i.e., a grain of sand) does not change the functioning of the collectivity (i.e., the pile). Furthermore, there is no “aim” designed into or emanating from the pile.
In contrast, a car is a system that comprises thousands of parts that all work together to provide transportation to a driver. If you remove the gasoline tank, then the car fails to perform its aim properly. In this case, the aim is designed into the car by the automobile design team, so the car is a mechanical, not a living, system.
Living systems are the most complex forms of systems. What makes them unique is that they interact with their environment and are self-organizing. As a result, the aim is not designed in but constantly evolving over time. Living systems can be something as simple as a cell, to something as complex as the European Union. Therefore, one of the ways of determining whether a collectivity is a system or not is (a) the interacting parts possess a central aim or purpose and (b) the removal of a component changes the functioning of the overall system.Miller (1978).
What Is Systems Thinking?
Systems thinking builds on our understanding of natural and man-made systems. It emphasizes that we need to understand how the whole affects its parts and how the parts affect the whole. This is different from traditional thinking, which assumes that the parts are independent of the whole. It is a set of techniques and an overarching mind-set that “problems” can best be solved by considering the component’s relationship to the overall system and its environment.
This type of thinking is revolutionizing many fields of study. For example, we now know that the pain that you have in your back may be caused by one leg being longer than the other so that the skeletal subsystem is skewed. In other words, close examination of a person’s back will reveal the symptoms (i.e., back pain), but not the causes (i.e., leg length differences). In traditional thinking, diagnosis of back pain focuses exclusively on the pained area of the body.
Systems thinkers tell us that there are two types of systems—closed and open systems. Closed systems function as systems relatively independent of their environment; open systems are constantly exchanging material, energy, and information with their environment. An example of a closed system is the circulatory system of a fish versus mollusks. In fish (and other vertebrates), the blood circulates within vessels of different lengths and wall thicknesses, so its circulatory system is relatively closed to the rest of its body cavities. In mollusks (and most invertebrates), there are no vessels and the blood circulates within the tissues of the entire body cavity. The key notion for our purposes is the fact that system openness is a relative state, not an absolute state.
Sometimes the components or elements of a system function as subsystems within a larger system. A subsystem is a collection of components or elements with a smaller aim within the larger system. Hence, there are various levels of systems that operate interdependently. A prime example here would be the financial subsystem’s impact on and relationship with the larger national economic system.
The Organization as a Living System
Systems thinking is revolutionizing the organizational sciences, just as it is challenging all the other sciences. If we consider the organization to be a living system, then organizational problems and opportunities are viewed in an entirely new way. For example, a high-performing individual might be creating dysfunction within his or her work group. Similarly, an award-winning department might be the cause of organizational decline. And a financially successful organization could be polluting its natural environment.
Interestingly, systems thinking can lead to principles that transcend a particular area of study. For example, the Japanese often study natural systems (i.e., a river) to guide them in the design and improvement of interorganizational systems (i.e., a supply chain). Similarly, Margaret Wheatley has used systems insights from the study of quantum mechanics to better understand the proper functioning of organizational systems.Wheatley (2006).
Systems thinking requires us to consider the subsystems and components within an organization, and the organization as a subsystem within its larger environment. Organizations vary in terms of their levels of openness to the environment, and systems thinking suggests that a balance must be struck between maintaining some boundaries with the environment and assuring that those boundaries are somewhat porous. A classic systems problem is that the organization is not listening enough to its current customers (it is too closed), or that it is listening too much to its current customers, or what Clayton Christensen calls the innovator’s dilemma.Christensen (1997).
Systems thinking also requires us to consider the aim of the system and to what degree the members of the organization, or larger society, align with the overarching aim. Chris Argyris eloquently describes how individuals often have both espoused aims and actual aims; and how the key to individual health and productivity involves minimizing the distance between what is espoused and what is actual.Argyris (1993).
The stakeholder versus stockholder perspective of organizations also deals with the aim of the organizational system. For some managers and theorists, maximizing shareholder wealth is the sole purpose of the corporation, and by doing so the overall economic system, of which the organization is a part, benefits. However, other managers and theorists suggest that there are multiple social actors inside and outside the organization with a “stake” in the functioning of the organization, and that no one stakeholder is more important than any other. Systems thinking enable managers to sort out this difficult, value-laden issue. | textbooks/biz/Management/Focusing_on_Organizational_Change/07%3A_OCC_Dimension_5-_Systems_Thinking/7.01%3A_Chapter_Introduction.txt |
Peter Senge was a pioneer in helping us to apply systems thinking to organizational change. He emphasized the central role of organizational learning, and created frameworks and tools for diagnosing organizational dysfunction and enhancing organizational functioning. In particular, he emphasized some of the organizational learning disabilities, or delusions, that must be acknowledged if the organization wants to change and survive.
The Delusion of Mental Models
Senge emphasizes that we all have mental models of how things work. When our organizations are not functioning properly, he suggests that we need to reconsider our individual and collective mental models. This is not easy to do because
mental models are deeply ingrained assumptions, generalizations, or even picture or images that influence how we understand the world and how we take action. Very often, we are not consciously aware of our mental models or the effects that they have on our behavior.Senge (1990), p. 8.
Therefore, change-capable organizations are conscious of their shared mental models, and are adept in revising those mental models when they no longer work properly.
The Boiled Frog Delusion
The boiled frog delusion is a commonly told story, but rarely do living systems learn from its message. If you place a frog in a pot of boiling water, it will immediately hop out. But if you carefully place the frog in a pot containing room-temperature water, and gradually raise the temperature of the water, the frog will not notice the temperature increase and will stay in the water even though he is free to jump out. The reason for this is that the frog’s internal mechanism for survival is geared to deal with sudden changes to his environment, not gradual ones. The same applies to our organizations.Senge (1990), p. 23.
In many ways, our organizations change dramatically and well when the environment shifts in radical ways. Think of how individuals and organizations in New York City demonstrated magnificent performance in the advent of the 9/11 terrorist attack, which was violent and sudden and dramatic. However, creeping problems like slowly eroding market share, insidious environmental pollution, steady quality declines, and turnover by some of the key employees of an organization are often not noticed. The environment is turning up the heat slowly but surely on many of our organizations, but it is happening so gradually that we do not notice or take action to correct this trend.
The Delusion of Learning From Experience
Most learning for individuals, organizational units, and overall organizations comes from reflection on the experienced effects that are the result of certain actions. For example, a common lesson learned within organizations is “When I deliver requested results on time and within budget, my project continues being funded.” Or at the subunit level, “When our sales unit aggressively pursues new customers, sales grow for the company.” And at the organizational level, “When our organization hits its earnings per share goal, our stock price rises.”
However, what happens when there is not a direct effect of our actions on organizational outcomes? Many individuals recognize that they can do their best, but the project gets canceled for other reasons. And some sales units pursue customers aggressively and sales still fall. And some organizations hit their earnings guidance, but the stock price still continues to fall. When learning from direct experience doesn’t work, Senge suggests that we need to think more systemically about cause and effect. He states, “Herein lies the core learning dilemma that confronts organizations: We learn best from experience but we never directly experience the consequences of many of our most important decisions.”Senge (1990), p. 25.
The Delusion of Individual Initiative Within a System
When an individual or subunit within an organization is not meeting performance standards, the traditional response by the individual or subunit is to “work harder.” Sometimes this works; often it does not. When this does not work, Senge points out that often the system is the problem, rather than the individual or individuals who are working within the system. Specifically, he states,
The systems perspective tells us that we must look beyond individual mistakes or bad luck to understand important problems…We must look into the underlying structures which shape individual actions and create the conditions where types of events become likely.Senge (1990), pp. 42–43. | textbooks/biz/Management/Focusing_on_Organizational_Change/07%3A_OCC_Dimension_5-_Systems_Thinking/7.03%3A_Systems_Thinking_and_Organizational_Change.txt |
As in previous chapters, this concluding section lays out seven practices that are consistent with the chapter’s focus, systems thinking, which can make your organization more change capable.
Practice 1: Try to Anticipate “Ripple Effects” of Change Initiatives
Unintended side effects are common with pharmaceuticals, so why should we be surprised when the same thing happens during or after an organizational change initiative is launched? Organizations are complex, interdependent social systems. Like a water balloon, when we push on one part of it, another part changes. While anticipating the side effects of a change initiative is not easy to do, some effort should be made to envision what those ripple effects might be.
Similar to scenario analysis of future environmental states,Schwartz (1991). by envisioning potential outcomes in advance we are more prepared to deal with the outcomes that may result. Furthermore, by trying to anticipate future unintended consequences, sponsors of the change and the change agents are more attentive to the unfolding nature of the change initiative and more likely to learn from the experience.Schriefer and Sales (2006). It is important to remember, however, that cause and effect are often not closely related in time and space when trying to change a complex system. Consequently, analogies can be a useful tool for anticipating unintended consequences of change. Another tool for anticipating the effects of a change initiative are computerized simulations.Ziegenfuss and Bentley (2000).
One systems thinking tool that can be instrumental in anticipating ripple effects are causal loop diagrams.Hebel (2007). Diagrams help us to visualize how the change might unfold. Causal loops remind us that there are feedback linkages within systems that can dampen or amplify the effects of initiatives. In sum, anticipating ripple effects is more art than science, but the effort will ensure that unintended side effects are avoided and will deepen the change sponsors’ understanding of the systemic nature of change.
Practice 2: Small Changes Can Produce Big Results; Search for Optimal Levers
There are no simple rules for finding high-leverage changes, but there are ways of thinking that make it more likely. Learning to see underlying “structures” rather than “events” is a starting point…Thinking in terms of processes of change rather than “snapshots” is another.Senge (1990), p. 65.
Malcolm Gladwell wrote a best-selling book on this very topic and it was given the graphic term “tipping points.” Gladwell argues that “the world may seem like an immovable, implacable place. It is not. With the slightest push—in just the right place—it can be tipped.”Gladwell (2002), p. 259.
Gladwell also asserts that ideas, products, messages, and behaviors can spread just like viruses do. Similar to how the flu attacks kids in schools each winter, the small changes that tip the system must be contagious; they should multiply rapidly; and the contagion should spread relatively quickly through a population within a particular system. Learning how your system has tipped in the past, and understanding who or what was involved can be an invaluable insight into thinking systemically about your organization.
Practice 3: Identify Feedback Loops and Multiple Drivers of Change
Systemic change often involves multiple feedback loops and drivers of change. As such, focusing on a single causal variable is often not helpful. For example, I often hear executives argue that “it is all about the right reward systems—get your rewards right and everything falls into place.” While reward systems are very important and a key part of organizational change capability, they are a subsystem within a larger system that has many complex and interacting parts.
Barry Oshry writes insightfully about “spatial” and “temporal” blindness within an organizational system. Spatial blindness is about seeing the part without seeing the whole. Temporal blindness is about seeing the present without the past. Both forms of blindness need to be overcome in order to better understand cause and effect within a system. Oshry recommends that people from various parts of the system need to periodically take time out to reflect collectively so as to transcend their blind spots.Oshry (1996), p. 27.
Practice 4: Align Change Initiatives Around an Inspiring Vision of the Future
Change is difficult and often painful. People generally will not give up an idea, behavior, or mental model without latching onto something to replace it. The something that they need to hold onto is the shared vision of the future. In their analysis of over 10,000 successful change initiatives in organizations, Jim Kouzes and Barry Posner found that the creation of an inspiring vision of the future was always present.Kouzes and Posner (2003). As Peter Senge notes, “When there is a genuine vision (as opposed to the all-too-familiar ‘vision statement’), people excel and learn, not because they are told to, but because they want to.”Senge (1990), p. 9. And Jim Collins and Gerry Porras point out that “a visionary company doesn’t simply balance between idealism and profitability; it seeks to be highly idealistic and highly profitable.”Collins and Porras (1994), p. 44. In sum, a compelling and well communicated vision is key to bringing about change within an organizational system, and this principle is central to systems thinking.
Practice 5: Seek to Change Associates’ Mental Models
The definition of insanity is applying the same approach over and over again, and expecting new results—the same is true about mental models. When organizational changes don’t work or when an organization repeatedly fails to meet its performance expectations, sometimes the dominant mental model, or paradigm, within an organization is to blame. Changing this dominant mental model is not easy since political capital is often tied up with particular models. First-order systems changes involve refinement of the system within an existing mental model. Second-order systems changes involve the unlearning of a previous mental model, and its replacement with a new and improved version. These changes do not occur on their own—second-order learning requires intention and focus on the history and identity of the overall system.Gharajedaghi, 2007.
Barry Oshry writes poetically about the “dance of the blind reflex.” This reflex is a generalization of the mental models of various parts of the organizational system. Oshry argues that top executives generally feel burdened by the unmanageable complexity for which they are responsible. Meanwhile, frontline workers at the bottom of the organizational hierarchy feel oppressed by insensitive higher-ups. Furthermore, middle managers feel torn and fractionated as they attempt to link the tops to the bottoms. Furthermore, customers feel righteously done-to (i.e., screwed) by an unresponsive system. Interestingly, none of the four groups of players mentioned see their part in creating any of the “dance” described here.Oshry (1996), p. 54. However, there is a way out of this problem. As Oshry notes,
We sometimes see the dance in others when they don’t see it in themselves; just as they see the dance in us when we are still blind to it. Each of us has the power to turn on the lights for others.Oshry (1996), p. 123.
Peter Vaill uses the metaphor of “permanent white water” as an analogy for the learning environment that most organizations currently find themselves in. He argues that “learning to reflect on our own learning” is a fundamental skill that is required for simple survival. Vaill argues that learning about oneself in interaction with the surrounding world is the key to changing our mental models. He further suggests that the personal attributes that make this all possible are the willingness to risk, to experiment, to learn from feedback, and above all, to enjoy the adventure.Vaill (1996), p. 156.
Practice 6: Engage in Vigorous Dialogue Around the Welfare of the System
Dialogue aimed at understanding the organizational system is fundamental to enhancing systems thinking. This dialogue should involve top executives, middle managers, frontline workers, and customers at repeated intervals. Organizational systems gurus, such as Deming, Senge, and Oshry, all agree that the key to systemic thinking is to involve a wide variety of voices within the system talking and listening to each other. Town hall meetings, weekend retreats, and organizational intranets are a common and increasingly popular means of engaging in dialogue about the system.
Practice 7: Work to Maintain Openness to the System to Avoid Entropy
When an individual or group within the system engages with another individual or group within the system that is “not normal”; new information is created within that system. External to the system, when an individual or group engages with individuals, groups, or other organizations that are not normal, new information is created between the systems. This new information can lead to energy and matter transfer that counteracts systemic entropy.
Intrasystemic openness occurs when two departments agree to collaborate on a project that contains mutual benefits to each. “Open door” policies are clearly a step in the right direction. Even a simple act of going to lunch with someone you have never dined with before can reduce system entropy. Extrasystemic openness occurs when new employees are hired, when external consultants are engaged, and when individuals attend trade association meetings or external training sessions. The human tendency to stick with the known and familiar and maintain routine must be challenged by the continual creation of new connections.
In sum, a systemic perspective is essential for making your organization change capable. Systems thinking is an infrastructure within which all change takes place. Figure 7.1 "The Fifth Dimension of Organizational Capacity for Change: Systems Thinking" contains a graphic summarizing this fifth dimension of organizational capacity for change.
Figure 7.1 The Fifth Dimension of Organizational Capacity for Change: Systems Thinking | textbooks/biz/Management/Focusing_on_Organizational_Change/07%3A_OCC_Dimension_5-_Systems_Thinking/7.04%3A_Practices_for_Building_Systems_Thinking_Into_Your_Organization.txt |
OCC Dimension 6: Communication Systems
The single biggest problem in communication is the illusion that it has taken place.
-George Bernard Shaw
Good communication is as stimulating as black coffee, and just as hard to sleep after.
-Anne Morrow Lindbergh
8.02: Communication Challenges in Modern Organizations
All communication involves the transmission of a message from a sender to a receiver. Communication is central to organizational effectiveness and survival because the essence of organizations is cooperation, and no cooperation is possible without effective communication.Barnard (1938). While communicating effectively has never been easy to do in organizations, there are some special challenges to communication in today’s organizations.
Information Overload
Every organization must solve the problem of what pattern of communication shall be instituted, and what information shall be directed to what offices. One issue in establishing such a pattern is information overload. There are limits to the amount of communication that can be received, coded, and effectively handled by any one individual.Katz and Kahn (1966), p. 257.
John Kotter has an interesting anecdote that illustrates this problem. He asserts that the typical employee receives approximately 2,300,000 words or numbers communicated to him or her in a 3-month period. He estimates that the typical communication of a change vision over 3 months is one 30-minute speech, one hour-long meeting, one 600-word article in the firm’s newspaper, and one 2,000-word memo, which amounts to about 13,400 words. Consequently, roughly one-half of one percent of all the words or facts that an employee receives over 3 months will be focused on the change vision.Kotter (1996), p. 89. Clearly, routine information can easily overwhelm change messages.
Sterility of Electronic Communication Technologies
We live in a time of disruptive electronic technologies, some of which have led to new and powerful information and communication technologies. Data-based reporting systems, e-mail, voice mail, intranets, bulletin boards, Websites, and video conferencing are cost effectively breaking down large distances and providing information to huge numbers of people in relatively inexpensive but fast ways. Unfortunately, these mediums of communication are rather sterile and impersonal, and not as powerful or meaningful to people as more personal modes of communication.
Because change initiatives can arouse strong and passionate emotions within an organization, these marvelous information and communication technologies are often not up to the task. Since visual cues are so important in all human communication, non-visual mediums disconnected from context, such as e-mail, just don’t communicate well. Since human relationship is so important to communication, mediums that do not add to the relationship, such as electronic bulletin boards, can convey different messages to different receivers. And since impersonal “digital” communication is relatively fast and easier to do than more personal communication forms, senders are often not as practiced or as skilled in the more personal modes. In sum, electronic communication systems are invaluable to today’s organizations, but they have considerable limitations when it comes to bringing about change.
8.03: Organizational Communication and Change
Due to the aforementioned reasons, as well more traditional communication problems such as sender arrogance or receiver resistance to change, change initiatives often fail to meet their objectives. For instance, John Kotter flatly states that ineffective communication of the change vision is one of the primary causes of failed organizational transformations.Kotter (1996). T. J. Larkin and Sandar Larkin, two noted communication consultants, assert that change-oriented communications are too often lofty, vague, and impersonal so the message is never really understood and therefore change initiatives founder.Larkin and Larkin (1994). And Rob Goffee and Gareth Jones observe that most change communication lacks authenticity, so the rest of the organization doesn’t trust what is being said and consequently the change effort stalls or goes in unintended directions.Goffee and Jones (2006).
Unfortunately, there is much more written about how communication fails to support change than what works. Consider the title of one article arguing for more communication within organizations: “If communication isn’t working, nothing else will.”Taylor (1998). In another article, a leadership expert states,
Transformation is impossible unless hundreds of thousands of people are willing to help, often to the point of making short-term sacrifices. Employees will not make sacrifices, even if they are unhappy with the status quo, unless they believe that useful change is possible. Without credible communication, and a lot of it, the hearts and minds of the troops are never captured.Kotter (1995), p. 60.
Also, many change consultants point out how pervasive rumor and innuendo are within organizations today due to the ineffective communication at work. For example, Jeannie Duck states, “In the absence of communication from the leaders, the organization will seek information from other sources, whether those sources know what they are talking about or not. Your silence does not stop conversation; it just means you are not participating in it.”Duck (2001), p. 143.
Unfortunately, many if not most of the communication prescriptions made tend to be overly simplistic or overly complex. On the simplistic side, some observers argue that all change communications simply need to be face-to-face, frequent, and informal.Anastasiou (1998). While these practices have merit, they do not consider such contextual factors as the organization’s size and geographic diversity, the urgency of the change initiative, or the availability of communications technology.
On the other hand, some change communication prescriptions are overly complex. For example, one change consultant recommends that a formal change communication action plan be developed for every change initiative. These action plans were recommended to include (a) careful consideration of change targets, (b) deliberate change messages, (c) prespecification of change messages, (d) timing and frequency of the message(s), (e) establishment of ownership for the communication, and (f) measurements planned for the change. Of course, then the change leaders are supposed to execute this plan and iterate as necessary.Bennett (2000). One wonders if the change leaders will have any time to do anything other than communicate to the rest of the organization! | textbooks/biz/Management/Focusing_on_Organizational_Change/08%3A_OCC_Dimension_6-_Communication_Systems/8.01%3A_Chapter_Introduction.txt |
One of the primary reasons why communication within organizations tends to be fragmented is that the organizational leaders think of it as a collection of tools rather than an overall system.Katz and Kahn (1966). An organization’s communication system consists of a particular message, the change leader(s) personal attributes, the change targets’ collective readiness to change, feedback loops between leader(s) and target(s), and the variety of channels of communication operating within an organization. Robust organizational communication systems are essential for bringing about organizational change. The following section discusses each aspect of the communication system.
The Change Message
When communicating with others, it is important to consider the nature of the message in order to make sure that it is heard. For example, downsizing and layoff messages evoke strong and often powerful emotions within organizations. Consequently, the timing and medium of that message should be tailored to address the delicate nature of the information intended. Similarly, the message must be clear and direct if there isn’t much time to make the change. And if the message is complicated, such as the need to replace an old technology with an entirely new one, then the communication system must take this into consideration.Kotter (1996).
Change Leader Attributes
If the change leader is perceived to be honest and authentic, then the message is likely to be heard—no small task in our information overload world. Authentic leader(s) display their true selves throughout the changes of context that require them to play a variety of roles. Authentic leaders also nurture their relationship with followers by highlighting their strengths, while revealing human weaknesses; they maintain their individuality while conforming enough to hold the organization together, and they establish intimacy with followers while keeping enough distance to command respect.Goffee and Jones (2006).
Related to the notion of authenticity is the ability of the change leader to listen well. Warren Bennis and Bert Nanus state, “A leader must be a superb listener, particularly to those advocating new or different images of the emerging reality. Many leaders establish both formal and informal channels of communication to gain access to these ideas.”Bennis and Nanus (1997), p. 96.
A third and final characteristic of the change leader is his or her credibility with the rest of the organization. As we discussed in the trustworthy leadership dimension, credibility brings trust. What we add in this chapter is that this credibility-induced trust also facilitates communication and information sharing.
Followers’ Readiness to Change
Employees within an organization vary in their readiness to change. Some individuals just don’t like any change, while others will leap at the opportunity to try something new. Most individuals vary between these two poles of readiness depending on the perceived costs and benefits of a particular proposed change. In other words, if the employee perceives a change as relatively easy to adopt (i.e., low cost), and the change brings about many advantages or solves existing problems (i.e., high benefit), then the employee will be relatively open to the change.Armenakis, Harris, & Mossholder (1993).
Another way to think about the employee’s readiness to change is to consider all change proposals as a diffusion-of-innovation problem. Everett Rogers devoted his lifetime to understanding how innovations diffused within social systems, and he discovered a very interesting fact: When confronted with a particular change, individuals tend to sort themselves out into a normal distribution in terms of readiness to change. In other words, roughly 16% of all employees will be early adopters of proposed changes; 34% will then follow the early adopters. Next, another 34% of employees will be late adopters. And finally, 16% of the employees will resist the proposed change as long as possible.Rogers (1983). In sum, when attempting to communicate to an entire organization, it is very helpful to know something about the nature of the change targets before, during, and after a change initiative is launched.
Feedback Loops
Most systems have feedback loops, and communication systems are no exception. Just because a change message is issued is no guarantee that the message is heard. Furthermore, even if the message is heard at the time that it is issued, it may not be remembered later on. And even if the message is remembered, it may not lead to new behavior. Hence, feedback loops are essential for uncovering what was heard, what was remembered, and what new behaviors, if any, have resulted.
In addition to message assessment, feedback loops are also helpful in improving the change initiative, for a variety of reasons. First, the change designers may not see the entire situation, and feedback loops help them to broaden or refine their perspective. Second, some change initiatives are just wrong-headed, and the communication system should enable the rest of the organization to weigh in on its overall worth and efficacy. Finally, new things are learned as change initiatives are rolled out, and these lessons need to be distributed to the rest of the organization so that the lessons can be leveraged.
Barry Oshry points out that most feedback loops within organizations are “filtered” so that the established reality perceived by senior management, middle managers, or frontline workers goes unchallenged. Furthermore, in complex social systems, such as an organization, feedback loops often provide conflicting information. When this happens, most social systems tend to ignore the information because sorting out the discrepancies can be difficult, upsetting, and time consuming.Oshry (1993). Effective communication systems have many feedback loops, and the information conveyed as feedback is weighed and considered.
Channels of Communication
There are a wide variety of communication channels possible within organizations. Communication channels involve both formal and informal mediums of information exchange. Formal mediums include such things as town hall meetings, newsletters, workshops, videos, e-mail, bulletin boards, manuals, roadshows, and progress reports.Balogun and Hailey (2008), p. 195. Informal mediums include such things as hallway discussions, one-on-one meetings, departmental briefings, and having senior leaders walking the talk. In both cases, the invisible social network within the organization plays a powerful role in interpreting the message.Farmer, 2008.
While most organizations tend to prefer using certain communication channels in all situations, the selection of the channel should be based on the specific change context. The reason for this is that communication channels vary in their efficiency and information richness. Rich communication channels are typically interactive and face-to-face, and they provide an abundance of contextualized information. Some channels, such as e-mail, are extremely efficient but not information rich at all. Other channels, such as one-on-one private meetings, are not efficient at all, but extremely information rich. In general, the more complicated and emotionally charged the change initiative, the more communication channels will be needed, and they need to be information rich, particularly in the beginning of the change program. | textbooks/biz/Management/Focusing_on_Organizational_Change/08%3A_OCC_Dimension_6-_Communication_Systems/8.04%3A_Using_the_Communication_System_to_Bring_About_Change.txt |
Once again, we conclude our chapter discussion with seven action items that can be pursued to develop this particular dimension of organizational capacity for change. These suggestions are not comprehensive, but research and common sense suggest that they can work to enhance your communication system.
Practice 1: Hire, Develop, and Retain Effective Communicators
In a 1998 survey of 480 companies and public organizations by the National Association of Colleges and Employers, communication abilities are ranked number one among personal qualities of college graduates sought by employers. Work experience and motivation are second and third.Bennett (2000), p. 73. Clearly, one of the reasons why communication skills are so important is that these skills are essential for facilitating organizational change. A less obvious reason why good communicators are essential is that these individuals understand how to design and enhance the communication systems within an organization so that information flows more effectively.
For example, Rob Goffee and Gareth Jones argue that effective leaders “communicate with care.” Communicating with care means that the leaders choose their channels of communication strategically, tailor their message to the aims of the change initiative, authentically disclose intimate details when appropriate, and are very sensitive to the pace and timing of their communications.Goffee and Jones (2006). Clearly, any employee with this subtle set of skills is a rare and valuable human resource, and the organization does well to enhance this skill set in as many individuals as possible, since their skill can be leveraged into improved communication systems for the entire organization.
Practice 2: Invest in Information Technologies and Experiment With New Formats
The number one capital investment for most organizations is in information technologies; the primary new means of communicating within organizations. By some accounts, information technologies account for 35% to 50% of all business capital investment in the United States.Anonymous (2010). There are several obvious reasons for this high level of investment—the clear benefits of productivity gains due to improved information, the transition from an industrial to an information-based economy, and the declining cost of information technologies coupled with increasing capabilities.
However, information sharing is the essence of communication, and so effective information technologies are an essential ingredient to making an organization change capable. Information is being shared more extensively with not only senior executives but also with the entire organization. Examining trends in information sharing in trying to understand organizations that were “built to change,” Ed Lawler and Chris Worley reported that of the five common types of information within an organization, all were being shared with a wider range of employees. The five typical types of information being shared were (a) corporate operating results, (b) unit operating results, (c) new technologies, (d) business plans and goals, and (e) competitor’s performance. Interestingly, more than half of all employees in all organizations received regular information in these five areas in 2005; whereas in 1987, only corporate and unit operating results were reported to half of the employee base.Lawler and Worley (2006), p. 123.
Effective information systems do the following six things for an organization to make it more change capable. First, they provide comprehensive data on key processes. Second, these systems integrate data across departmental boundaries. Third, they monitor organizational capabilities as well as performance. Fourth, they are linked to goal setting and reward systems, which are central to organizational change. Fifth, they include information on customer and competitors. And finally, effective information systems make measurements visible throughout the organization.Lawler and Worley (2006), pp. 125–126. Clearly, good communication is not likely to occur without good information, and effective information technologies are a necessary ingredient to make that happen.
Practice 3: Talk the Walk and Walk the Talk
There is nothing more devastating to change initiative and overall change capability than for the senior leaders to espouse the benefits of change and then not act in alignment with those espoused benefits. In other words, when the behavior from prominent people within an organization is inconsistent with the change vision, then all other forms of communication are disregarded.Kotter (1996), p. 90. In short, “walking the talk” is an essential part of the communication system within an organization.
This process begins with the chief executive of the firm modeling the behavior being sought by the change vision. Next, it requires the top management team to police themselves to act congruently with the change vision. And if there are sponsored change agents by the senior executive team, these individuals clearly need to “walk the talk” as well. Change leaders are in a fish bowl, and they must be as if not more willing than the rest of the organization to change their behaviors. As Mahatma Gandhi stated, “Be the change you wish to see in the world.”
Practice 4: Use Stories, Metaphors, Analogies, and Pictures as Much as Possible
Effective communication systems connect the hearts and minds of the rest of the organization. Stories, metaphors, and analogies are powerful ways to communicate complex information in compelling ways. John Kotter emphasizes that this is particularly important for communicating the change vision. He restates the truism that “a verbal picture is worth a thousand words.”Kotter (1996), p. 90.
However, figurative communication in the form of verbal pictures or graphic depictions is also essential for building confidence in the change program. Stories are pithy narratives with plots, characters, and twists that are full of meaning. Leaders are discovering that the telling of actual “success stories” can often be the catalyst for momentum behind a change initiative.Denning (2007). Metaphors and analogies are inferential techniques to transfer the meaning of something that is known to another thing that is unknown. For example, Plato compared our perception of reality to shadows on the wall of a cave. Darwin used diagrams of trees to help explain his theory of evolution. And Shakespeare saw the world as a stage.Wormeli (2009). Organizational change, by definition, requires employees to try something new and move into the unknown. Communication systems that rely on stories, metaphors, and analogies can make the unknown future state more attractive and understandable.
Practice 5: Repeat the Message Many Times in Many Forums, but Keep It Fresh
It is common for change leaders to announce a new change program and pull out all the stops to communicate it to the rest of the organization in the early part of the change initiative, only to move onto other pressing issues after it has been launched. This is a mistake, and it leads to the change cynicism that pervades many organizations today. Furthermore, organizational changes take time to adopt, often years, and this requires focused attention on the part of the rest of the organization.
Consequently, the change message must be repeated many ways in many different contexts using multiple communication channels.Kotter (1996), p. 90. However, this does not mean that daily e-mails with the same message need to be sent out to the entire organization. It does mean that creative and different versions of the same message need to be distributed periodically in various channels. For example, the change vision could be communicated to large and small groups in formal and informal ways at the launch of a major change program.
Furthermore, forums for listening to the employees’ reactions to the change need to be set up, and sometimes the change initiative needs to be adjusted. Furthermore, progress reports on implementing the change program can be circulated electronically or visually. Paycheck stuffers might provide factoids that related to the proposed change. And town hall meetings can be used to discuss the change initiative to those who have complaints to voice, are curious, or both. As Marshall MacLuhan noted, “the medium is the message,”McLuhan (1964). so repeated, pervasive, and fresh change messages help to gain the attention, interest, and eventual adoption of an information overloaded workforce.
Practice 6: Seek to Discuss the Undiscussable
In every organization, there are undiscussable issues. An undiscussable issue is a taboo subject, something people in an open forum don’t talk about in order to avoid an emotionally charged discussion. These issues are undiscussable because people are fearful of releasing “negative” emotions that could jeopardize working relationships. (What some people express colorfully as “naming the elephant in the room.”) Common undiscussables are challenging an existing reality, questioning those in power, sharing concerns about an idea that is being sold as “perfect,” or simply agreeing to disagree when perspectives clash.Hammond and Mayfield (2004).
In addition to emotionally charged undiscussables, there are also logical inconsistencies that need to be addressed by the communication system. Organizational change is complicated and there are often inconsistencies when moving from one organizational state to another. If the communication system does not address these inconsistencies, then the credibility of the entire change initiative is called into question.Kotter (1996), p. 90. Furthermore, it is much more honest and productive to discuss undiscussables.O’Toole and Bennis (2009).
There are a wide variety of ways to successfully discuss the undiscussables, but it all starts with having an attitude of seeing everyone as being in partnership around the success of the overall system.Oshry (1996). Therefore, blaming leaders or employees is usually not constructive, but structuring in debate and conflicting viewpoints is. Being defensive is rarely helpful, but being curious is. Avoiding discussions of delicate issues will hold back progress, but playful and humorous treatments of tricky issues can help. Emphasizing individual responsibility to the exclusion of collective responsibility clearly leads to an imbalance. Sometimes enabling anonymous discussion of undiscussables using Web-based technologies can shine a light on “the elephant in the room.”Hammond and Mayfield (2004).
Practice 7: Leverage Informal Social Networks
A social network is “the structure of personal and professional relationships you have with others. Social capital is the resources—such as ideas, information, money, and trust—that you are able to access through your social networks.”Carpenter (2009), pp. 5–6. Social networks and capital exist inside and outside of the organization, but the internal organizational networks can be most powerful in dealing with organizational issues. Informal social networks consisting of simple things like friendships outside of work or regular lunch gatherings during work can have a major influence on change implementation success. Unlike the formal organizational structure, the informal social network is nonhierarchical, constantly evolving, and essentially based on trust, reciprocity, and common values. The informal social network complements the formal organizational structure of an organization.
It is a mistake to communicate only through the formal organizational structure. Indeed, Peter Drucker observed that in more than 600 years, no society has ever had as many competing centers of power as today. In addition, he noted that as we move to a more knowledge-based economy, informal social networks are increasingly important to organizational success and survival.Drucker (1992).
Informal social networks in the form of ad hoc peer groups can spur collaboration and unlock value as well as thwart collaboration and destroy value. If internal social networks are ignored, they can be a source of role conflict, rumor mongering, resistance to change, and conformity of thought and action. If they are successfully leveraged, they can complement the formal organization, be more fluid and responsive, and magnify the impact of advocates of change. Consequently, in order to leverage the social network, the first order of business is to be aware of it, and the second priority is the attempt to influence it so that the organization can more effectively enhance its communication system.
In sum, effective communication systems are an essential element of any change capable organization. These systems complement the systemic thinking dimension in such a way that the knowing-doing gap is bridged.Pfeffer and Sutton (2000). Figure 8.1 "The Sixth Dimension of Organizational Capacity for Change: Communication Systems" contains a graphical summary of this sixth dimension of OCC.
Figure 8.1 The Sixth Dimension of Organizational Capacity for Change: Communication Systems | textbooks/biz/Management/Focusing_on_Organizational_Change/08%3A_OCC_Dimension_6-_Communication_Systems/8.05%3A_Practices_of_Good_Communication_Systems.txt |
OCC Dimension 7: Accountable Culture
It is not only what we do, but also what we do not do, for which we are accountable.
-Moliere
Only entropy comes easy.
-Anton Chekhov
9.02: What Does It Mean to Be Accountable
Accountability refers to an obligation or willingness to accept responsibility for one’s actions. When a person accepts responsibility, that person is committed to generating positive results, what some people call “taking ownership.” Sometimes responsibility is obligated by assuming a specific role within an organization. For example, the chief financial officer of a corporation is obligated for knowing about and protecting the financial well-being of the firm. However, lots of work gets done within organizations for which the person is not obligated. For example, that same chief financial officer might demonstrate concern for the natural environment even though he or she is not formally responsible for it.
When individuals are accountable, they understand and accept the consequences of their actions for the areas in which they assume responsibility. When roles are clear and people are held accountable, work gets done efficiently and effectively. Furthermore, constructive change and learning is possible when accountability is the norm. When roles are not clear and people are not held accountable, work does not get done properly, and learning is not possible.
In highly litigious societies, such as the United States, accountability is often hard to assign or constructive to assume since there is a lot of societal downside to being responsible and not much upside. This is particularly true for organizational actions whereby an individual does not have full control over the outcomes. For example, individuals are often eager to serve on a board of directors as it is a prestigious position that can lead to new learning and an expanded network with other elites. However, board members are often quick to disavow responsibility for many organizational dysfunctions when class action lawsuits get filed. Avoidance of accountability is not only bad for society; but it is also devastating for organizations. And since accountability can be the container in which organizations change occurs, it is essential to organizational capacity for change.
9.03: Organizational Culture and Accountability
Clearly, supervisors are the ones who possess the authority to hold employees accountable for results; and the board of directors is the group responsible for holding the senior-most executive accountable. However, managers and directors vary in their interest and ability to do this. Consequently, cultivating an organizational culture that supports and encourages accountability within an organization is fundamental to organizational change.
What Is an Organizational Culture?
While there are many definitions of organizational culture, I think that one of the clearest was offered by Edgar Schein. He defined organizational culture as
a pattern of basic assumptions—invented, discovered, or developed by a given group as it learns to cope with its problems of external adaptation and internal integration—that has worked well enough to be considered valid and, therefore, to be taught to new members as the correct way to perceive, think, and feel in relation to those problems.Schein (1985), p. 9.
Schein argued that there are three levels of culture in any organization. The most visible level of culture is where observable organizational artifacts such as technology, art, dress, pictures, architecture, and audible behavior occur. A cultural artifact is a term used to refer to any observable item or action created by humans that gives information about the collectivity of the creators, the users, or both. The intermediate level of organizational culture is the values and beliefs about what the purpose of the organization is, and what gives meaning to its existence. Usually, there is a social consensus as to what values and beliefs matter most within an organization. And finally, at the deepest unconscious level within an organization, there are assumptions about human nature, human relations, time, and the organizational and environmental interface. Schein argued that these assumptions serve as the foundation for the values, norms, and beliefs within all organizations, and are hardest to change.Schein (1985), p. 14.
Some observers argue that organizational culture can be a “social control” mechanism that is more efficient and effective than more formal and traditional control mechanisms due to its fluid pervasiveness.Ouchi (1980). However, a more common view is that organizational culture is the “social glue” that makes organizational life meaningful.Alvesson (2002), p. 32.
In recent years, organizational culture has emerged as a key source of competitive advantage for many firms. Since resources can be easily obtained by new entrants, technology can be easily copied by competitors, and employees are now highly mobile, traditional ways of generating competitive advantage through industry positioning are less relevant today. Furthermore, it has been increasingly observed that a strong set of core values and beliefs often leads to competitive advantages and superior performance for many firms. Since performance above industry norms is a common indicator of competitive advantage, organizational culture is getting more attention by strategists. Finally, since culture is relatively hard to imitate, the competitive advantage is often sustainable.Barney (1986).
How Cultural Norms Influence Accountability Behaviors
In many organizations, there is not a cultural focus on being accountable and getting results. Indeed, five “crippling habits” deeply embedded in an organizational culture are (a) absence of clear directives, (b) lack of accountability, (c) rationalizing inferior performance, (d) planning in lieu of action, and (e) aversion to risk and change.Prosen (2006).
There are many explanations for these negative habits. One is that senior executives consciously or unconsciously neglect their responsibility for executing the strategy well. Forming a brand new strategy is exciting, garners attention from external stakeholders, and happens rather quickly. In contrast, executing an existing strategy requires attention to detail, is often not noticed outside of an organization, and takes a long time to manifest an effect. Hence, making an organization accountable is often not “sexy” to senior leaders.Bossidy and Charan (2002).
Another reason why organizational cultures do not hold members accountable is what is known as the “smart talk trap.” This phenomenon refers to organizational cultures that emphasize talk over action, looking good over getting results, and sounding intelligent rather than delivering results. Managers sometimes let talk substitute for action because that is what they have been trained to do. In addition, there is a human propensity to assume intelligence for those who talk with complex words and focus on hard-to-understand concepts. Unfortunately, complex words and concepts are often difficult to execute. And finally, studies have shown that individuals who criticize ideas are often judged to be smarter than individuals who attempt to be helpful and constructive. While critical thinking is clearly needed in organizations, it often does not lead to constructive action.Pfeffer and Sutton (1999).
Whatever the reason for lack of accountability within an organization, organizational cultures are central to making the organization change capable. Indeed, there is a “hard side” to change management and it centers on keeping people accountable and getting organizationally important results. Prescribing desired results, clarifying responsibility, measuring performance, rewarding those who meet or exceed expectations, and challenging those who do not are all integral to an organization’s norms, values, and assumptions about the way things get done. Accountability is a cultural mind-set, and accountable behaviors emerge from organizational cultures that value it.
9.04: Cultural Accountability and Organizational Capacity for Change
Two books have become popular tomes on the relationship between cultural accountability and organizational capacity for change. The first book, written by Larry Bossidy and Ram Charan, talks about the importance of creating a culture focused on executing strategy well. Bossidy and Charan note that execution must be a core element of an organization’s culture and that execution is a discipline that is essential to strategic success.
Larry Bossidy quickly rose through the management ranks at General Electric, and then inherited a turnaround situation when he became CEO at Honeywell International. He states,
My job at Honeywell International these days is to restore the discipline of execution to a company that had lost it. Many people regard execution as detail work that’s beneath the dignity of a business leader. That is wrong. To the contrary, it’s a leader’s most important job.Bossidy and Charan (2002), p. 1.
Bossidy goes on to say, “Organizations don’t execute unless the right people, individually and collectively, focus on the right details at the right time.”Bossidy and Charan (2002), p. 33. Since Bossidy led Honeywell through a very successful and dramatic turnaround, his words carry special weight.
The second major book devoted to creating accountability was written by three change consultants—David Ulrich, Jack Zenger, and Norm Smallwood. They argue that many leaders and leadership training courses neglect the fact that leadership is about getting desired results. In their own words,
Results-based leaders define their roles in terms of practical action. They articulate what they want to accomplish and thus make their agendas clear and meaningful to others. Employees willingly follow leaders who know both who they are and what they are doing. Such leaders instill confidence and inspire trust in others because they are direct, focused, and consistent.Ulrich, Zenger, & Smallwood (1999), p. 21.
Furthermore, they argue that accountability is the primary means for achieving those results. They state,
Organizations may learn, change, and remove boundaries, but if they lack accountability and discipline, success will elude them over time. Accountability comes from discipline, processes, and ownership. Discipline requires getting work done with rigor and consistency, meeting scheduled commitments, and following through on plans and programs to deliver promises. Process accountability may require reengineering how work gets done, reducing redundant efforts, and driving down costs at every level. With accountability comes ownership, as individuals feel responsible for accomplishing work. Leaders who foster accountability continuously improve how work gets done, deliver high-quality products and services, and ensure commitment from all employees.Ulrich, Zenger, & Smallwood (1999), p. 97.
In sum, change-capable organizations benefit from cultures of accountability. In the next section, I provide some ideas for making your culture more accountable. | textbooks/biz/Management/Focusing_on_Organizational_Change/09%3A_OCC_Dimension_7-_Accountable_Culture/9.01%3A_Chapter_Introduction.txt |
Organizational cultures are very difficult to change and it takes considerable time to do so. The organizational founder and previous experiences of an organization help to establish “how things get done around here”; and these norms, values, and assumptions are often not conscious or easily changed.
However, cultures are particularly sensitive to the behaviors and attitudes of senior leaders. Therefore, senior leaders do have a special interest and responsibility in reinforcing positive and productive aspects of a culture, and replacing negative and unproductive aspects. Furthermore, due to the intangible and relatively intransigent nature of culture, productive cultures can be a source of sustained competitive advantage. The following are seven different things that can be done to make your culture more accountable. Since a culture consists of the artifacts, values, and assumptions that drive organizational action, changing a culture needs to involve change in all three areas. Listed below are seven principles that can assist you in making your culture more accountable for results.
Practice 1: Begin With a Focus on Results Being Sought
Effective accountability means that there is a clear understanding of the results being sought throughout the entire organization. This requires intense thought and ongoing dialogue about what the organization’s purpose is, and what it is trying to achieve. It starts with a clear understanding of the overall mission of the organization and then cascades down into performance standards expected for each and every individual within that organization. Without asking the question as to “what is wanted” before deciding how to do it, organizational members who act without full knowledge of the results required may work harder but accomplish less.Ulrich, Zenger, & Smallwood (1999), p. 21.
Accompanying this clarity on results is the clarity of the goals being sought. Sometimes, organizational goals are ambiguous and unenforceable, what some call “resolutions.” While resolutions may sound good, the actions required are often not clear and the results being sought can be up to interpretation. Clear goals, on the other hand, specify what is desired and by when. And when individuals commit to clear goals, positive outcomes emerge.Heath and Heath (2008).
Practice 2: Assign Responsibility for Results to Everyone in the Organization
If your organization has difficulty assigning responsibility for results, consider responsibility charting. This technique is essentially a matrix with results desired in one column, and individuals in an organizational unit in the other columns. Matrix entries specify who is responsible for what and, if possible, when results are expected. With this relatively simple approach, responsibility and clarity is much more clear, especially if there is a review of the results achieved when compared with the results desired.
But not all responsibility can be assigned in advance. Sometimes individuals volunteer to be accountable for certain results in special circumstances. Stories are an effective tool for eliciting volunteers to become more accountable, particularly when the story involves a previous member of the organization who overcame overwhelming odds to deliver extraordinary results. Success stories are part of every culture, and success stories about accountability help to make the culture more accountable as well as encourage volunteerism.Wines and Hamilton (2009).
In your attempt to be clear about responsibility, effective communication is essential. Sometimes leaders know exactly what they want, but they don’t communicate clearly what is desired. Sometimes leaders have a vague idea of what is wanted and dialogue needs to be conducted with subordinates to help clarify matters. When the dialogue is open, candid, and informal, clarity ensues and accountability results.Bossidy and Charan (2002), p. 102.
Practice 3: Leaders Should Demonstrate the Behaviors That Align With the Proposed Change
Culture change starts and gains momentum with changed behavior on the part of the leaders of that organization or organizational unit. Nothing kills a change initiative faster than leaders who espouse certain behaviors and attitudes, but demonstrate different ones. For example, if a leader announces the importance of controlling costs more carefully, but then he or she arranges for a lavish executive retreat or decorates his or her office in excessive ways, the rest of the organization takes notice. Hence, leaders need to exercise care in the behaviors they exhibit.Bossidy and Charan (2002), p. 105.
In addition, leaders need to be careful as to behaviors that they tolerate. If results are being stressed and their subordinate does not deliver results, then there needs to be demonstrable consequences. This applies to both meeting the numbers and behaving consistently with the organization’s values. Indeed, it has been observed that if a nonperformer gets high enough in the organizational hierarchy and is not held accountable, that person can literally destroy the organization.Bossidy and Charan (2002), p. 115.
Practice 4: Measure the Right Performance Standards and Do It Rigorously
It is a skill to link desired results and goals with standards and metrics of performance. If a performance standard is done well, achievement of that standard will realize the results being sought. Designing realistic timetables and appropriate performance standards is not easy to do well, and it is particularly difficult for large, complicated projects. And for those change initiatives that have an extended time horizon, intermediate milestones must be set with care. Nonetheless, rigorous standard setting is an essential activity if an accountable culture is being sought.Osborne (1993).
Clearly, performance measures need to be balanced or else the organization risks becoming unbalanced. Consequently, this suggests that multiple performance standards are required. However, if the performance standards are too numerous, then assessing performance is no longer possible. Overall, focusing on a relatively few, balanced performance standards works best for making the organization more accountable.Ulrich, Zenger, & Smallwood (1999).
When designing performance standards, it is sometimes helpful to distinguish between ends and means standards. When the strategic goals are established and measureable, then metrics that focus on the end result are most appropriate. However, when the strategic goals are changing and not easily measured, then metrics that focus on the means for bringing about the change are most appropriate. In either case, however, measurements can and should be applied.Melnyk, Hanson, & Calantone (2010).
Finally, most people assume that utilizing performance standards implies a bureaucratic organization; however, this does not have to be the case. Accountability can be achieved in nonhierarchical organizational structures when it comes from within the employee or is reviewed in nonbureaucratic ways.Ulrich, Zenger, & Smallwood (1999), p. 97.
Practice 5: Make Sure That Cultural Artifacts Support Accountability
As discussed previously, cultural artifacts are the visible expressions of the underlying values and assumptions that pervade an organization. When changing a culture, changing the visible artifacts makes a conscious and unconscious impression on the organization’s members. There are at least five types of cultural artifacts: (a) normal behavior, (b) myths and sagas, (c) language systems and metaphors, (d) symbols, rituals, and ceremonies, and (e) physical surroundings including interior design and physical equipment.Shrivastava (1985).
One cultural artifact surrounding accountability is who gets celebrated and who gets ignored. Clearly, celebrating and promoting individuals who deliver results on time and within budget is one way to support movement to more accountable culture. Also, individuals who don’t deliver results on time or within budget need to be privately confronted, coached, and sometimes removed from the organization.Bossidy and Charan (2002).
The transformation of Continental Airlines is a prime example of how important changing artifacts are to making a culture more accountable. To change behavioral norms that had been associated with low productivity, the leaders instituted a bonus system that rewarded high levels of productivity. In order to align the culture with the new business strategy, the leader’s next act was to reduce the corporate policy manual from 800 pages to just 80 pages and then conduct a ritual where the former manuals were burned by the employees. In addition, the catch phrase “from worst to first” was used to focus employees’ attention on the desired results. Whenever key milestones were achieved, corporate celebrations were arranged. And executives were required to work on holidays so that “we are all in this together” in Continental’s effort to become more accountable and productive. And the repainting of the jets, renovating of the gateways, and purchasing of state-of-the-art information technology all contributed to the turnaround initiative.Higgins and McAllaster (2004).
Practice 6: Discuss Assumptions Underlying Actions Dealing With Accountability
The fastest but perhaps most challenging way to change an organizational culture is to change the assumptions underlying that culture. Since culture is the “taken-for-granted” way of doing things within an organization, this is not an easy task. However, change-capable organizations are adept at naming the assumptions underlying organizational actions and changing those assumptions when they no longer serve the organization.
Surfacing and debating assumptions is the means by which cultural change is achieved, and paying attention to assumptions around accountability is a key way to make your organization more change capable. Larry Bossidy and Ram Charan note,
Debate on assumptions is one of the most critical parts of any operating review—not just the big-picture assumptions but assumptions specifically linked with their effects on the business, segment by segment, item by item. That’s a key part of what’s missing in the standard budget review. You cannot set realistic goals until you’ve debated the assumptions behind them.Bossidy and Charan (2002), p. 236.
Practice 7: Make Sure That the Reward System Focuses on Accountability
A key aspect of accountability means that there are consequences to meeting or not meeting performance standards. This suggests that the reward and recognition system needs to celebrate and reward those who consistently deliver results and develop a reputation for accountability, and it needs to confront and punish those who consistently fail to deliver results.Kerr and Slocum (2005).
Many organizations do a good job celebrating and recognizing good performance. Very few organizations deal with nonperformers well even though this is a key process for any organization that takes accountability seriously. Most employees like knowing where they stand in terms of performance, and the performance evaluation system is central to making an organization accountable. It is particularly important that the performance evaluation system is based on hitting predefined targets and standards as much as possible. However, care must be exercised in selecting the right standards, not just those that are easiest to measure.Kerr (1975).
In the absence of rigorously defined standards, performance evaluation becomes more focused on nonperformance criteria. Since each organization is unique, customized reward and recognition systems are becoming the norm for organizations seeking greater accountability.Heneman, Fisher, & Dixon (2001).
In sum, creating and maintaining a culture of accountability is essential to bring about a change-capable organization. This does not mean that organizations need to measure everything and become more mechanical. If thoughtfully developed, however, measurements and responsibility assignments can aid in organizational learning and adaptability. This dimension, and the previous dimensions discussed, is graphically depicted in Figure 9.1 "The Seventh Dimension of Organizational Capacity for Change: Accountable Culture". | textbooks/biz/Management/Focusing_on_Organizational_Change/09%3A_OCC_Dimension_7-_Accountable_Culture/9.05%3A_Practices_for_Making_Your_Organizational_Culture_More_Accountable.txt |
OCC Dimension 8: Innovative Culture
The achievement of excellence can only occur if the organization promotes a culture of creative dissatisfaction.
-Lawrence Miller
Everything that can be invented has been invented.
-Charles H. Duell, Director of U.S. Patent Office, 1899
10.02: What Does It Mean to Be Innovative
Organizations in all developed economies (and increasingly many developing economies) want to be innovative. While cost control, cost parity, or both are important to be competitive, organizations in developed economies simply cannot compete with the low cost advantages that developing economies offer. As a result, more and more organizations voice or attempt to embrace the 21st-century mantra, “Innovate or die.”Peters (2006).
Many people equate creativity with innovation, and while this is understandable it is also a mistake. Creativity is the process of generating something new; while innovation is the application of creativity to a new product or service that has value. Product innovations add direct value to customers; process innovations add indirect value to customers by lowering costs, increasing the quality of new or existing products, or both. Value is generated by taking a creative new idea and moving it through a series of stages in order to yield a practical new innovation. Therefore, creativity is a necessary, but not sufficient condition for innovation.
Another misconception about innovation is that it is effortless and just happens. The philosopher Plato observed that “necessity is the mother of invention.” This observation suggests that problems are the stimulus for creativity and innovation and that persistence is required. Perhaps this is why T. S. Eliot, the highly creative American writer, stated, “Anxiety is the hand maiden of creativity”; and Andy Grove, the highly successful CEO who guided the Intel Corporation through an amazing streak of innovative activity, insists that “only the paranoid survive.”Grove (1996). In sum, creativity and innovation are essential for just about any organization today, but they are different concepts and neither comes easily.
10.03: What Makes an Organizational Culture Innovative
In this chapter, I argue that the key to making an organization innovative is to cultivate an innovative culture, our eighth and final dimension of organizational capacity for change. There are many reasons why creative ideas and innovative projects are killed within organizations. Notably, almost all of them have to do with an overweighting of the risks to existing operations, and an underassessment of the returns associated with new ideas based on the overarching organizational culture. Clearly, not all ideas should be pursued and the pursuit of new ideas needs to be selective. However, very few organizations know how to fully explore new ideas and develop the best ideas into innovative new ventures. Perhaps that is why the stock market values Apple so highly, due to its rare ability to keep coming up with a steady stream of innovative new products and services year after year.
“The creative process is social, not just individual, and thus forms of organization are necessary. But elements of organization can and frequently do stifle creativity and innovation.”Florida (2002), p. 22. Organizational cultures become creative and innovative when they encourage “combinatorial play.”Shames (2009). In other words, employees need to imaginatively combine ideas in new ways and then play with them to see how the new combination works in reality. In most organizations, however, imagination and play are not valued, getting work done on time and under budget is; pursuing ideas with unproven merit is frowned upon; and extrinsic rewards are emphasized over intrinsic rewards. All of these traditional cultural norms and values thwart the development of innovation since creative employees usually value imagination and play and pursuing new ideas into unknown realms, and are highly motivated by intrinsic rewards.
A second aspect of organizational culture that is fundamental to creativity is the cultivation of diversity of thought. Although many organizations pay lip service to the need to diversify their workforce, diversity of observable demographic traits is typically the emphasis, not diversity of thought. When the workforce is highly diverse, then misunderstandings are likely, conflict often ensues, and productivity can decline. Clearly, none of these outcomes is a pleasant experience and they do not automatically lead to innovations. However, if diversity of thought is welcomed in an organizational culture, creativity and innovation are more likely.Basset-Jones (2005).
A third aspect of organizational culture that can facilitate innovation is the ubiquity of weak ties. Strong ties are relationships we have with family members, close friends, and longtime neighbors or coworkers. They tend to be ties of long duration, marked by trust and reciprocity in multiple areas of life. In contrast, weak ties are those relationships that are more on the surface—people we are acquainted with but not deeply connected to. Research has shown that creative individuals have many “weak ties” inside and outside their work organizations.Granovetter (1973). Consequently, organizational cultures that encourage flexible working conditions and external networking make innovation more likely. Hence, there is a spontaneous and serendipitous aspect to innovative cultures.
A fourth aspect of organizational culture that nurtures creativity and innovation is an organization-wide ability to look long term. Today’s organizations are very lean and short-term focused. They are so busy exploiting existing markets, they don’t have the time or resources or capacity to explore new markets. However, organizational cultures that enable the organization to both exploit and explore markets make it possible for its leaders to “fly the plan while rewiring it.”Judge and Blocker (2008).
A fifth aspect of organizational culture that makes creativity and innovation possible is the tolerance of ambiguity and failure. As Woody Allen states, “If you are not failing every now and again, it’s a sign you’re not doing anything very innovative.” Clearly, not all new ideas will work out as hoped, so ideas that lead to dead-ends are an inevitable part of the innovation process. Unfortunately, most organizational cultures seek to blame individuals who fail, rather than accepting occasional failures and attempting to learn from the experience.
A sixth aspect of organizational culture stems from the reality that most innovations come from collaboration within and across teams, not the genius or perseverance of a single individual. For example, in a scientific study of R&D units in the biotechnology industry, Judge and associates found that the most innovative units operated more like goal-directed communities than as a collection of big-name scientists.Judge, Fryxzell, & Dooley (1997). Nonetheless, many organizations seek to hire employees who are extremely intelligent, come from prestigious universities, or both, and these are often the individuals who have the most problems collaborating with others.
10.04: Innovative Cultures and Capacity for Change
Some executives believe that the key to being innovative is all about investing heavily in a Research and Development unit; others argue that all innovation stems from hiring the right leaders; still others assert that innovation is largely a matter of luck and serendipity. However, the research consensus is that organizational culture is the primary source of comprehensive and sustained innovation.Garvin (2004). The primary reason for this is that innovation is a teachable discipline that involves many different people in collaboration.Drucker (1993).
There is a wide variety of cultural typologies in the organizational sciences, but one of the most popular is the “Competing Values” framework advanced by Kim Cameron and Robert Quinn. According to these authors, there are four classical types of organizational cultures: (a) hierarchy, (b) market, (c) clan, and (d) adhocracy. These four organizational cultures vary in their relative emphasis on flexibility and discretion bestowed upon individuals and their external focus on variation and differentiation. The “adhocracy” culture is reported to be the one cultural type that is most conducive to innovation since it emphasizes flexibility and discretion over stability and control and external differentiation over internal integration.Cameron and Quinn (1999).
As Cameron and Quinn point out, some cultures are more open to innovation and change than others, but the reason for this is that there are competing values tugging the culture in multiple directions. The “hierarchy” culture, with its inward integration coupled with a stability and control focus, is the exact opposite of the adhocracy culture. Indeed, hierarchical cultures are useful for addressing matters of accountability, as discussed in the previous chapter. However, too much emphasis on control and an overly inward focus will limit the overall capacity for change of the organization. In sum, there must be a balance struck between innovation and accountability for those organizations that seek to expand their capacity for change.
Innovation is fostered by information gathered from new connections, from insights gained by journeys into other disciplines or places; from active, collegial networks and fluid open boundaries. Innovation arises from ongoing circles of exchange, where information is not just accumulated or stored, but created.Wheatley (2006), p. 113.
Clearly, the more open the culture is to new ideas and connections, the more likely that it will be innovative and capable of change.
In 2004, Fast Company magazine nominated W. L. Gore and Associates as “pound for pound, the most innovative company in America.” They argued that their impressive string of innovations were a direct result of their culture, which was designed specifically to be innovative. What is striking is how nonhierarchical Gore’s culture is. For example, they emphasize the power of small, interdisciplinary teams over formal organizational structure. There are no ranks, no titles, and no bosses to report to. The firm takes the long view as much as possible; and it emphasizes the importance of face-to-face communication. Associates are encouraged to spend up to 10% of their time pursuing speculative new ideas. And the culture celebrates failure in order to encourage risk taking.Deutschman (2004). | textbooks/biz/Management/Focusing_on_Organizational_Change/10%3A_OCC_Dimension_8-_Innovative_Culture/10.01%3A_Chapter_Introduction.txt |
Similar to previous chapters, we conclude this chapter with a discussion of seven practices that can be used to enhance your organization’s capacity for change in this particular area.
Practice 1: Make Innovation Everyone’s Responsibility
In too many organizations, innovation is assumed to be the responsibility of the top management team, or the research and development unit.Hargadon and Sutton (2000). While these two groups of people are essential, this emphasis will fail to capture the “wisdom of the anthill.”Hamel and Prahalad (1994). Innovation is essentially a collaborative endeavor, where collective imagination yields new business opportunities.Hammer (2004).
According to Peter Drucker, innovation and entrepreneurship are capable of being presented as a discipline. In other words, it can be learned and practiced. Most important for us in this chapter, Drucker asserts that it can be fostered and encouraged throughout an entire organization.Drucker (1996). One of the keys appears to be to create a collaborative, “information-rich” environment in which all employees are invited to contribute.Kanter (2006). Commenting on the success of the Sundance Film Festival, Robert Redford stated, “If you create an atmosphere of freedom, where people aren’t afraid someone will steal their ideas, they will engage with each other, they will help one another, and they will do some amazingly creative things together.”Zades (2003), p. 67.
Practice 2: Hire and Retain Creative Employees
All innovation depends on the generation of new ideas, but no new ideas will be generated in the absence of human creativity. Consequently, the hiring process needs to emphasize the importance of selecting individuals who have creative potential. More importantly, the human resources system needs to focus on developing that creativity and retaining individuals who show creative promise.Mumford (2000).
However, creative individuals aren’t the only ones required to cultivate a more innovative culture. Other individuals, such as “knowledge brokers,” are also essential. Knowledge brokers are individuals who constantly collect ideas and combine them in unique and valuable ways. They often are not the originators of the ideas, but they have a skill at keeping new ideas alive and seeing where they lead. Hargadon and Sutton (2000). Sometimes older workers lose their creative spark but serve as knowledge brokers to keep the spark alive.
Most organizations are uncomfortable with “mavericks” who shake up the status quo and display irreverence for accepted wisdom. However, mavericks play a vital role in making an organization more innovative, especially larger organizations.Stringer (2000). For example, Jack Welch, a relatively famous maverick who led General Electric through a very innovative period, stated, “Here at GE, we reward failure.”Farson and Keyes (2002). Indeed, there is scientific research that demonstrates that when the reward system recognizes and retains creative employees, the organization behaves more innovatively.Chandler, Keller, & Lyon (2000).
Practice 3: Put as Many Promising Ideas to the Test as Possible
A popular but controversial mantra in innovative organizations is “fail fast, fail cheap.” The idea here is that it is important to get your new ideas in rough form out into the marketplace, and learn from your customers. This is in contrast to the “go–no go” approach where companies want new ideas to be 95% right before taking any action.Hall (2007). Perhaps this is why IBM’s Thomas Watson, Sr., once said, “The fastest way to succeed is to double your failure rate.”Edmondson (2002), p. 64.
However, fast and cheap are not enough; the innovative organization also needs to learn from the experience in order to make the “failure” pay off. This is where testing comes in. Hence, a key ingredient to becoming more culturally innovative is the importance of designing relatively small-scale, but rigorous tests or “experiments.” For example, Capital One, a highly successful retail bank, was founded on experimental design where new ideas were constantly tested. Tests are most reliable when many roughly equivalent settings can be observed—some containing the new idea and some not.Davenport (2009). Similarly, IDEO, perhaps the most innovative design firm in the world, is a staunch proponent of encouraging experimenters who prototype ideas quickly and cheaply.Kelley and Littman (2005). In sum, innovative cultures fail fast and fail cheap and learn from their failures.
Practice 4: Use Your Human Resources System to Create Psychological Safety
Organizations operate in increasingly competitive environments. The concept of “winning” is an important one, and being labeled a “winner” is usually a key to organizational advancement. Unfortunately, failure is an integral part of innovation, so innovative cultures need to create the psychological safety whereby failure in certain circumstances is acceptable.Edmondson (2008).
Some mistakes are more lethal than others, so mistakes that do not jeopardize the survival of the organization need to be accepted, even welcomed by leaders. Relatedly, it is more important to focus on the ideas rather than the individuals behind the ideas so that failure is not personalized. And “failure-tolerant leaders emphasize that a good idea is a good idea, whether it comes from Peter Drucker, Reader’s Digest, or an obnoxious coworker.”Farson and Keyes (2002), p. 70.
Once again, the human resources system can be instrumental in helping to create the psychological safety to enable innovation. In this case, the system can be designed to permit and even celebrate failure.Bowen and Ostroff (2004). Clearly, this involves a balancing act between rewarding success and tolerating failure. Consequently, the key is to create sufficient psychological safety within a culture so that the organization can “dance on the borderline between success and failure.”Wylie (2001).
Practice 5: Emphasize Interdisciplinary Teams Throughout the Entire Organization
In the 1970s and 1980s, many organizations tried to create specialized subunits where their mandate was to make the organization more innovative. This structural approach to innovation largely failed, either immediately or in the long term. For example, General Motors created the Saturn division as a built-from-scratch innovative new way to produce and sell cars. At first, Saturn had spectacular success. However, the lessons learned from Saturn never translated to the rest of the organization and recently the Saturn division was eliminated.Hanna (2010). Similarly, too many large organizations try to rely solely on their research and development units for innovation, which greatly constrains the idea production and development process.Stringer (2000).
Innovation is clearly a team sport, one that should pervade the entire organization. As a result, ad hoc interdisciplinary teams appear to be the proper structural approach to fostering innovation. Today, IDEO is one of the most innovative firms in the world, and their approach to business is centered around interdisciplinary teams.Kelley and Littman (2005). In sum, the ad hoc interdisciplinary team appears to be the structural solution to innovation, not a self-contained innovative subunit as some suggest.
Practice 6: Change Cultural Artifacts and Values to Signal Importance of Innovation
Recall from the previous chapter that one key way to change a culture is to intentionally shift the cultural artifacts in the direction of the desired change. When creativity and innovation is desired, it is important to be more flexible in the work environment. So flexibility in working arrangements, dress codes, and organizational titles becomes important.
New myths and rituals are required that focus on creativity and innovation. For example, some organizations celebrate failed experiments based on imaginative new ideas. Other organizations promote individuals who took a risk on a promising new idea that did not work out. And changing the formal values statement to incorporate an explicit statement about creativity and innovation highlights its new importance. Still others change the metaphors used in the organization. For example, creating a “blank canvas” culture evokes an image of artists operating without artificial constraints.
Fundamentally, cultures are not changed by new thoughts or words, they are changed by new behaviors that reinforce the cultural attributes that are desired. For example, GM’s automobile plant in Fremont, California, transformed its culture by adopting the lean manufacturing behaviors advocated by its new venture partner, Toyota Motors. For example, nothing was as transformative at this particular plant as the “simple” act of empowering frontline employees to stop the productive line at any time due to quality concerns. This new policy had dramatic impacts on the revitalization of this unionized plant.Shook (2010).
Practice 7: Change Cultural Assumptions to Signal Importance of Innovation
Culture change does not occur until the underlying assumptions that pervade the organization are challenged and replaced with some new assumptions. Therefore, ordering new behaviors isn’t enough. The organization must thoughtfully identify what the old assumptions are and work to instill new assumptions that support the culture desired. Consequently, contemplation and reflection are essential to any culture-change initiative. Perhaps this is why Gary Hamel and C. K. Prahalad note that “true strategy is the result of deep, innovative thinking.”Hamel and Prahalad (1994), p. 56.
Some observers call for “disciplined reflection”;Edmondson (2008). while others urge leaders to identify “constraining assumptions.”Hammer (2004). Whatever the term that is used, organizational members need to think deeply about where their culture limits innovation, and to identify what cultural assumptions are the limiting factor. This requires a collective perspective; very rarely can a single leader come to this realization. Since most organizations have a bias for action, this reflection can be especially difficult. However, organizational learning often requires unlearning old and harmful assumptions and this is especially true for cultivating innovativeness.Senge (1990).
In conclusion, the eighth and final dimension of organizational capacity for change is an innovative culture that fosters and celebrates creativity and innovation. This dimension is an essential counterbalance to accountability systems. Together, these two dimensions complete our understanding of how to make your organization more change capable.
Figure 10.1 The Eighth Dimension of Organizational Capacity for Change: Innovative Culture | textbooks/biz/Management/Focusing_on_Organizational_Change/10%3A_OCC_Dimension_8-_Innovative_Culture/10.05%3A_Practices_for_Making_Your_Culture_More_Innovative.txt |
We live in an organizational society today. All of us have memberships in multiple organizations, and the effectiveness of these organizations probably varies greatly. Ralph Kilmann, an astute academic and organizational consultant, captures these sentiments well:
Organizations are the greatest invention of all time. They enable people to transcend their own limitations of both body and mind in order to manage the problems of natures and civilizations. Without organized activity, all the other great inventions either would not have been created, or would have been brought to the marketplace. It is hardly an overstatement to suggest that economic prosperity and quality of life for the people of the world are largely determined by the functioning of organizations and institutions.Kilmann (1989), p. ix.
Since organizations are so central to our lives and since they are so important to the fate of humanity, it is imperative that they function well. However, the organizations of the 21st century are not agile enough to deal with the unpredictable and increasingly volatile nature of the environments that they occupy. We need organizations that are more capable of change. This book is dedicated to that premise.
11.02: Four Organizational Attributes of Change-Capable Organizations
Two Human Capital Attributes: Organizational Trust and Lateral Leadership
Recall that there are eight dimensions of organizational capacity for change. The first four dimensions focus on the human capital within your firm. These dimensions focused on your human capital are depicted in Figure 11.1 "The Human Capital Required for Organizational Capacity for Change". The first two dimensions, trustworthy leadership and trusting followers, are oriented toward producing organizational trust to the greatest extent possible. Organizational trust refers to the ability of members of an organization to put their lives and well-being at risk in service to the well-being of the overall organization. Hence, it refers to how much frontline workers trust middle managers and senior executives to watch out for their interests. Similarly, it addresses how much top executives trust middle managers and frontline workers to do their jobs well. Trust suggests that we perceive the other as not only competent but also genuinely concerned about the general well-being of others.Gilbert (2005).
The second two dimensions, capable champions and involved midmanagement, are oriented toward unleashing the power of lateral leadership. Lateral leadership is concerned with getting things done across organizational units and functional areas of expertise.Fisher and Sharp (2004). The hierarchical organization will always be with us, but the power of hierarchical authority is diminishing. In its place is the power of influence without authority, in other words, lateral leadership. Crisis situations demonstrate this power quite clearly. When a crisis occurs, people often self-organize into social groups that do amazing things in inexplicably short amounts of time. The trick here is to enable the organization to self organize. In this book, I have emphasized the importance of creating change champions and involving middle management in the change process so that lateral leadership can occur. Figure 11.1 "The Human Capital Required for Organizational Capacity for Change" contains a graphical depiction of the two organizational attributes dealing with human capital in change capable organizations.
Figure 11.1 The Human Capital Required for Organizational Capacity for Change
Two Social Infrastructure Attributes: Systemic Knowledge and Cultural Ambidexterity
Organizations also require adequate social infrastructure in order to be change capable. Social infrastructure is the means by which organizational members come to understand and deal with the life of the overall organizational system. One key attribute that is part of the social infrastructure is the level of systemic knowledge within the organization. Systemic knowledge is the degree to which members of an organization understand and are focused on the overall organizational system. Too often, members focus on just their careers or just their organizational subunit. When a critical mass of the organization becomes focused on the overall life of the organizational system, the organization becomes much more open to the environment. This openness translates into more agility and flexibility within the system.Oshry (1996).
The fourth and final organizational attribute that is fundamental to change capability is cultural ambidexterity. Many observers note the powerful role that organizational culture plays in facilitating or thwarting organizational change. What is often missed, however, is that change-capable organizations balance accountability with innovation. If the organization overemphasizes accountability, innovation suffers. And if innovation is the sole focus, accountability is ignored. Change-capable organizations optimize on both of these seemingly contradictory cultural virtues.Quinn (1991). Hence, the organization needs to become ambidextrous culturally, using the right-handed accountability norms in balance with the left-handed innovation norms.Judge and Blocker (2008). | textbooks/biz/Management/Focusing_on_Organizational_Change/11%3A_The_Big_Picture/11.01%3A_The_Centrality_of_Organizations_in_Our_Lives.txt |
If you are now convinced that organizational capacity for change is an important capability that you want to develop in your organization, this final section contains some ideas for assessing your organization’s capacity. There are two ways that your organization’s capacity for change can be assessed. First, you can do this qualitatively by interviewing individuals at various levels of the organization and attempting to characterize it along these eight dimensions in narrative format using anecdotes and stories to illustrate where the organization stands. Second, you can do this quantitatively by administering an anonymous survey to the entire organization and aggregating the numerical results.
Chapter 12 "Appendix A: OCC Survey Instrument" contains a reliable and valid instrument that you can use to quantitatively assess your organization’s change capacity.This survey instrument can also be used as an interview protocol for qualitative interviews. This instrument can be administered online or via paper and pencil to any strategic business unit within your organization.Sometimes organizations are so large, and comprise so many organizational units, that it does not make sense to assess capacity for change for the entire organization. Hence, meaningful assessments are made at the strategic business unit level. A strategic business unit is an organizational subunit with profit and loss responsibility, or a cost center within an organization. For smaller, single-business organizations, the strategic business unit is the entire organization. It is best if you administer the survey to your entire organization since a census provides the clearest picture of where the overall organization stands. However, sometimes a census is just not feasible. In these cases, it is necessary that a random sampling approach be taken. Chapter 13 "Appendix B: 8 Dimensions and Factor Loadings for OCC" illustrates that these items are reliable as shown through the relatively high factor loadings across the eight dimensions derived from a statistical factor analysis. For further reading about the reliability and validity of this instrument, please consider reading the publication that covers this issue.Judge and Douglas (2009). In previous research using this instrument, I have discovered that it is important to sample sufficient numbers of senior executives, middle managers, and frontline employees within the organization. The reason for this is that, in general, top management often has the most optimistic view of the organization’s capacity for change, and frontline workers have the most pessimistic viewpoint. Interestingly, the middle managers’ viewpoint is typically in between these two assessments, and the gap between the midmanagement and senior-level perspective tells you how much work is required to enhance the change capability. Therefore, it is important to collect a representative sample of individual perceptions from the top, middle, and bottom of the organizational hierarchy.
Once you have collected the data from tops, middles, and frontline workers, it is useful to aggregate that data by the three levels and for the overall organization. If you are graphically minded, it can be helpful to construct a radar chart depicting the eight dimensions of organizational capacity for change by adding up the mean score for the four items in each dimension. Since a minimum score would be 4 across the four items and a maximum score would be 40, your organizational score will be somewhere between these two extremes. As can be seen in Chapter 14 "Appendix C: OCC Benchmarking", descriptive statistics are provided for each of the eight dimensions for the over 200 strategic business units that have been previously assessed using the instrument in Chapter 12 "Appendix A: OCC Survey Instrument". Notably, Communication Systems is often the lowest evaluated dimension of the eight, and Trustworthy Leadership is typically the highest evaluated dimension. This suggests that improving your communication before, during, and after change initiatives offers the biggest opportunity for improvement. In addition, it is interesting to point out that the coefficient of variation is highest for systems thinking and communication systems, which suggests that strategic business units vary the most on these two dimensions.
Chapter 15 "Appendix D: OCC Benchmarking" contains the mean values across the three hierarchical subgroups of employees required to assess organizational capacity for change. As might be expected, senior executives consistently rate the organizational capacity for change the highest, and frontline workers consistently rate it the lowest. In all cases except for accountable culture, middle managers rate the dimensions of organizational capacity for change in between these two subgroups. Overall, this benchmark data can be used to compare your organization to a wide variety of organizations operating in a wide variety of industries throughout the world.
A final worthwhile assessment is to track your organizational capacity for change over time. This can be done by administering the instrument at one point in time, and collecting data at a later point in time. Some organizational leaders choose to do this at regular intervals (e.g., every year, every quarter); other organizational leaders choose to do this after a major intervention event (e.g., following a postacquisition integration program or a major training program). Armed with longitudinal data, you get a perspective as to whether your organization is improving in its overall capacity for change.
11.04: Concluding Thoughts
Organizations in the 20th century were built for stability and predictability. Organizations in the 21st century need to be both stable and change capable, what some refer to as “dynamically stable”.Abrahamson (2000). As a result, many organizations today tend to be overmanaged and underled as we transition to a global, information-based economy. This book provides insights, research, practical suggestions, and an approach to systematically assess your organization’s capacity for change using a valid and reliable survey instrument. Both management and leadership are essential skills required for 21st century organizations. This book provides some insights that can enable your organization to survive and prosper in the new millennium.
Figure 11.2 The Social Infrasctructure Required for Organizational Capacity for Change | textbooks/biz/Management/Focusing_on_Organizational_Change/11%3A_The_Big_Picture/11.03%3A_Assessing_Your_Organizational_Capacity_for_Change.txt |
Item # Question Almost never Sometimes Always
Do the unit leader(s)
01 protect the core values while encouraging change? 1 2 3 4 5 6 7 8 9 10
02 consistently articulate an inspiring vision of the future? 1 2 3 4 5 6 7 8 9 10
03 show courage in their support of change initiatives? 1 2 3 4 5 6 7 8 9 10
04 demonstrate humility while fiercely pursuing the vision? 1 2 3 4 5 6 7 8 9 10
Do we have an organizational culture that
05 values innovation and change? 1 2 3 4 5 6 7 8 9 10
06 attracts and retains creative people? 1 2 3 4 5 6 7 8 9 10
07 provides resources to experiment with new ideas? 1 2 3 4 5 6 7 8 9 10
08 allows people to take risks and occasionally fail? 1 2 3 4 5 6 7 8 9 10
Does information flow effectively
09 from executives to workers? 1 2 3 4 5 6 7 8 9 10
10 in a timely fashion? 1 2 3 4 5 6 7 8 9 10
11 across organizational units? 1 2 3 4 5 6 7 8 9 10
12 from customers to the business unit? 1 2 3 4 5 6 7 8 9 10
Do middle managers in this organizational unit
13 effectively link top executives with frontline employees? 1 2 3 4 5 6 7 8 9 10
14 show commitment to the organization’s well-being? 1 2 3 4 5 6 7 8 9 10
15 balance change initiatives while getting work done? 1 2 3 4 5 6 7 8 9 10
16 voice dissent constructively? 1 2 3 4 5 6 7 8 9 10
Do frontline employees
17 open themselves to consider change proposals? 1 2 3 4 5 6 7 8 9 10
18 have opportunities to voice their concerns about change? 1 2 3 4 5 6 7 8 9 10
19 generally know how change will help the business unit? 1 2 3 4 5 6 7 8 9 10
20 generally view top management as trustworthy? 1 2 3 4 5 6 7 8 9 10
Do employees throughout the organizational unit
21 experience consequences for outcomes of their actions? 1 2 3 4 5 6 7 8 9 10
22 meet deadlines and honor resource commitments? 1 2 3 4 5 6 7 8 9 10
23 accept responsibility for getting work done? 1 2 3 4 5 6 7 8 9 10
24 have clear roles for who has to do what? 1 2 3 4 5 6 7 8 9 10
Do change champions recognize the
25 interdependent systems implications of change? 1 2 3 4 5 6 7 8 9 10
26 importance of institutionalizing change? 1 2 3 4 5 6 7 8 9 10
27 need to realign incentives with desired changes? 1 2 3 4 5 6 7 8 9 10
28 value of addressing causes rather than symptoms? 1 2 3 4 5 6 7 8 9 10
Do we have change champion(s) who
29 command the respect of the members in the unit? 1 2 3 4 5 6 7 8 9 10
30 possess good interpersonal skills? 1 2 3 4 5 6 7 8 9 10
31 are willing and able to challenge the status quo? 1 2 3 4 5 6 7 8 9 10
32 have the will and creativity to bring about change? 1 2 3 4 5 6 7 8 9 10 | textbooks/biz/Management/Focusing_on_Organizational_Change/12%3A_OCC_Survey_Instrument/12.01%3A_Section_1-.txt |
Item # Question Factor loadings
Do the unit leader(s) Factor 1: Trustworthy leaders
01 protect the core values while encouraging change? 0.708
02 consistently articulate an inspiring vision of the future? 0.738
03 show courage in their support of change initiatives? 0.709
04 demonstrate humility while fiercely pursuing the vision? 0.718
Do we have an organizational culture that Factor 2: Innovative culture
05 values innovation and change? 0.509
06 attracts and retains creative people? 0.693
07 provides resources to experiment with new ideas? 0.726
08 allows people to take risks and occasionally fail? 0.691
Does information flow effectively Factor 3: Communication systems
09 from executives to workers? 0.745
10 in a timely fashion? 0.772
11 across organizational units? 0.787
12 from customers to the business unit? 0.734
Do middle managers in this organizational unit Factor 4: Involved midmanagers
13 effectively link top executives with frontline employees? 0.565
14 show commitment to the organization’s well-being? 0.660
15 balance change initiatives while getting work done? 0.727
16 voice dissent constructively? 0.676
Do frontline employees Factor 5: Trusting followers
17 open themselves to consider change proposals? 0.773
18 have opportunities to voice their concerns about change? 0.609
19 generally know how change will help the business unit? 0.712
20 generally view top management as trustworthy? 0.535
Do employees throughout the organizational unit Factor 6: Accountable culture
21 experience consequences for outcomes of their actions? 0.697
22 meet deadlines and honor resource commitments? 0.717
23 accept responsibility for getting work done? 0.780
24 have clear roles for who has to do what? 0.668
Do change champions recognize the Factor 7: Systems thinking
25 interdependent systems implications of change? 0.676
26 importance of institutionalizing change? 0.790
27 need to realign incentives with desired changes? 0.806
28 value of addressing causes rather than symptoms? 0.639
Do we have change champion(s) who Factor 8: Capable champions
29 command the respect of the members in the unit? 0.776
30 possess good interpersonal skills? 0.804
31 are willing and able to challenge the status quo? 0.797
32 have the will and creativity to bring about change? 0.667
Source: Judge and Douglas (2009), p. 648.
14.01: Section 1-
Table 14.1 Descriptive Statistics for Strategic Business Units
OCC dimension Mean value Standard deviation Coefficient of variation
1. Trustworthy leadership 27.1 4.7 0.17
2. Trusting followers 24.7 4.3 0.17
3. Capable champions 26.1 4.9 0.19
4. Involved midmanagement 26.2 4.5 0.17
5. Systems thinking 25.9 4.1 0.21
6. Communications systems 23.4 4.8 0.21
7. Accountable culture 26.0 4.3 0.17
8. Innovative culture 24.6 4.6 0.19
Overall organization
Aggregate scores: 204.0
Source: These data represent the descriptive statistics on organizational capacity for change across the eight dimensions for 5,124 employees assessing their organizational capacity for change within 205 strategic business units for firms operating in North America, Europe, and Asia during 1999 to 2006. The coefficient of variation is the standard deviation divided by the mean value. The higher the coefficient of variation, the more variation or volatility is experienced with this particular organizational attribute.
15.01: Section 1-
Table 15.1 Mean Values for Hierarchical Subgroups Within SBUs
OCC dimension Senior executives Midmanagers Frontline workers
1. Trustworthy leadership 29.2 27.9 26.4
2. Trusting followers 25.6 25.0 24.7
3. Capable champions 27.8 26.7 26.0
4. Involved midmanagement 27.6 27.0 25.8
5. Systems thinking 27.1 26.2 25.6
6. Communications systems 25.8 24.2 22.6
7. Accountable culture 26.8 26.2 26.5
8. Innovative culture 27.0 26.0 25.0
Overall organization
Aggregate scores: 216.8 209.2 202.6
Source: These data represent the descriptive statistics on organizational capacity for change across the eight dimensions for 5,124 employees assessing their organizational capacity for change within 205 strategic business units for firms operating in North America, Europe, and Asia during 1999 to 2006. | textbooks/biz/Management/Focusing_on_Organizational_Change/13%3A_8_Dimensions_and_Factor_Loadings_for_OCC/13.01%3A_Section_1-.txt |
Judge, W., & Hill, L. (2010). Change management: Power and influence. Retrieved from hbr.org/product/change-management-harvard-managementor- online-modu/an/6789E-HTM-ENG?Ntt= change%2520management%2520power%2520and%2520influence
In this single-player simulation produced by Harvard Business Publishing in Boston, students play one of two roles at a sunglass manufacturing firm and face the challenges associated with implementing an organization-wide environmental sustainability initiative. The initiative seeks to change raw material inputs in order to make the company’s products more “green” and also to address environmental waste issues. The simulation includes up to four scenarios with different combinations of two important factors for creating change: the relative power of the change agent and the relative urgency associated with the change initiative. In each scenario, students choose among different change levers in an attempt to persuade key members of the organization to adopt the change initiative. Students are assessed on their ability to achieve the greatest percentage of adopters within the company while simultaneously using the fewest resources. Appropriate for use in undergraduate, graduate, and executive business programs.
ExperiencePoint. (2010). Experience change simulations. Retrieved from http://www.experiencepoint.com/
In this single-player simulation produced by ExperiencePoint in Toronto, students play the role of a change agent in four different organizational contexts. For the GlobalTech simulation, players lead change in a siloed organization that needs to be more customer focused. For the SkyTech simulation, players lead a corporate social responsibility initiative in a global corporation. For the Lakeview simulation, players implement lean practices to reduce patient wait times in a hospital emergency department. For the Central-Valley view simulation, players balance the needs of internal and external stakeholders as they lead the merger of two hospitals.
16.02: Section 2-
Beer, M., & Eisenstadt, R. (1994). Developing an organization capable of implementing strategy and learning. Human Relations, 49, 597–620.
Bennett, J. L. (2000). Leading the edge of change: Building individual and organizational capacity for the evolving nature of change. Mooresville, NC: Paw Print Press.
Bethune, G. (1998). From worst to first: Behind the scenes of Continental’s remarkable comeback. New York, NY: Wiley.
Bishop, C. (2000). Making change happen one person at a time: Assessing change capacity within your organization. New York, NY: AMACON.
Collins, J., & Porras, J. (1994). Built to last: Successful habits of visionary companies. New York, NY: HarperBusiness.
Dell, M. (2000). Direct from Dell: Strategies that revolutionized an industry. New York, NY: HarperBusiness.
Fullan, M. (2008). The six secrets of change: What the best leaders do to help their organizations survive and thrive. San Francisco, CA: Jossey-Bass.
Gardner, H. (2004). Changing minds: The art and science of changing our own and other people’s minds. Boston, MA: Harvard Business School Press.
Gerstner, L. (2002). Who says elephants can’t dance? New York, NY: HarperBusiness.
Hock, D. (2005). One from many: VISA and the rise of chaordic organization. San Francisco, CA: Berrett-Koehler.
Judge, W., & Blocker, C. (2008). Organizational capacity for change and strategic ambidexterity: Flying the plane while rewiring it. European Journal of Marketing, 42(9/10), 915–926.
Judge, W., & Douglas, T. (2009). The evolution of the organizational capacity for change construct. Journal of Organizational Change Management, 22(6), 635–649.
Judge, W., & Elenkov, D. (2005). Organizational capacity for change and environmental performance: An empirical assessment of Bulgarian firms. Journal of Business Research, 58, 894–901.
Judge, W., Naoumova, I., Douglas, T., & Kouzevol, N. (2009). Organizational capacity for change and firm performance in Russia. International Journal of Human Resource Management, 20(8), 1737–1752.
Lawler, E., & Worley, C. (2006). Built to change: How to achieve sustained organizational effectiveness. San Francisco, CA: Jossey-Bass.
Lengnick-Hall, C., & Beck, T. (2005). Adaptive fit versus robust transformation: How organizations respond to environmental change. Journal of Management, 31(5), 738–757.
Price Waterhouse. (1996). The paradox principles: How high performance companies manage chaos, complexity, and contradiction to achieve superior results. Chicago, IL: Irwin.
Seidman, D. (2007). How: Why how we do anything means everything in business (and in life). Hoboken, NJ: Wiley
Staber, U., & Sydow, J. (2002). Organizational adaptive capacity: A structuration perspective. Journal of Management Inquiry, 11, 408–424.
Thames, R., & Webster, D. (2009). Chasing change: Building organizational capacity in a turbulent environment. Hoboken, NJ: Wiley.
16.03: Section 3-
AT&T: The Dallas Works
Case ID: HBS 492023
Trustworthy leadership: Ken Weatherford
Trusting followers: Union turmoil
Capable champions: Sandy Ward
Involved midmanagement: Ad hoc teams
Systems thinking: Guiding coalition
Communication systems: Multichannel
Accountable culture: Avoid plant closing
Innovative culture: Products and processes
Cisco Systems
Case ID: HBS 409061
Trustworthy leadership: John Chambers
Capable champions: Customer champions
Systems thinking: IT systems
Accountable culture: Customer focus
Citigroup (A)
Case ID: HBS 308001
Trustworthy leadership: Chuck Prince
Systems thinking: Merger challenge
Communication systems: Problem area
Accountable culture: Problem area
Innovative culture: Problem area
Digital Chocolate
Case ID: HBS 401049
Trustworthy leadership: Trip Hawkins
Capable champions: Problem area
Involved midmanagement: Problem area
Systems thinking: E-mail, meetings
Communication systems: Venture burn rate
Accountable culture: Growth potential
EBay
Case ID: HBS 401024
Trustworthy leadership: Meg Whitman
Involved midmanagement: Fully engaged
Systems thinking: Acquire Krause?
Accountable culture: Problem Area
Innovative culture: Customer focus
Hindustan Lever
Case ID: HBS 410002
Trustworthy leadership: Biswaranjan Sen
Trusting followers: Union turmoil
Capable champions: Suchita Prasan
Systems thinking: Problem area
Communication systems: Problem area
Accountable culture: Extreme downsizing
Innovative culture: British hierarchy
Merck (A)
Case ID: HBS 499054
Trustworthy leadership: Ray Gilmartin
Capable champions: Mgt. committee
Involved midmanagement: Functional silos
Systems thinking: Merger challenge
Communication systems: Problem area
Accountable culture: Problem area
Innovative culture: Drug creation
Northwest Airlines
Case ID: HBS 491036
Trustworthy leadership: Steve Rothmeir
Trusting followers: Union turmoil
Capable champions: Dr. Ken Myers
Involved midmanagement: Merger integration
Systems thinking: Merger challenge
Communication systems: Problem area
Accountable culture: Problem area
Innovative culture: Problem area
Oticon
Case ID: IMD 079
Trustworthy leadership: Lars Kolind
Trusting followers: Relocation Resistance
Capable champions: Sten Davidsen
Involved midmanagement: Problem area
Accountable culture: Problem area
Innovative culture: Problem area
P&G in the 21st Century
Case ID: MBS 309030
Trustworthy leadership: A. G. Lafley
Trusting followers: Problem area
Involved midmanagement: Walk the talk
Communication systems: Problem area
Accountable culture: Global integration
Innovative culture: Problem area
Renault-Nissan
Case ID: TB 0047
Trustworthy leadership: Louis Schweitzer
Trusting followers: Downsizing
Capable champions: Carlos Ghosn
Involved midmanagement: Cultural differences
Systems thinking: Merger challenge
Communication systems: Problem area
Accountable culture: Problem area
Innovative culture: Mavericks elevated
Siemens Nixdorf
Case ID: HBS 396203
Trustworthy leadership: Gerhard Schulmeyer
Capable champions: Mark Maletz
Involved midmanagement: Problem area
Innovative culture: Global expansion
Walt Disney’s Dennis Hightower
Case ID: HBS 395055
Trustworthy leadership: Dennis Hightower
Trusting followers: Country Managers
Capable champions: Problem area
Involved midmanagement: Problem area
Systems thinking: European integration
Communication systems: Group vs. individual
Accountable culture: Problem area
Innovative culture: Growth potential
Wyeth Pharmaceutical
Case ID: SGBS L-15
Trustworthy leadership: Micahel Kamarck
Capable champions: Guiding coalition
Systems thinking: Learning teams
Communication systems: Multichannel
Accountable culture: Cut costs 25% in 1 year | textbooks/biz/Management/Focusing_on_Organizational_Change/16%3A_Resources/16.01%3A_Section_1-.txt |
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