Is there a better way to fail?

In some instances of corporate scandal or failure, it seems clear who is to blame. Greed and incompetence are simple to attribute and, when punishment does not follow, outrage does. The outrage is usually addressed by promises of systemic change.

The pendulum signifying deficient behaviour swings between three poles. If the board of directors is at fault, we are told that we need improved corporate governance - more independent and diverse boards. If the auditors are at fault, we are told that we need to break up the big 4 to make the audit market more competitive. If the shareholders are at fault, it seems that we need to make them take more active interest in their investee companies and behave as owners rather than traders.

None of this makes a great deal of difference. Part of the problem is due to the process of corporate accountability. The reporting framework was devised in the nineteenth century and has not adapted sufficiently to changes in business activity, business structure, information requirements and communication channels.

There is also a problem of expectation. The literature on audit long ago identified the expectation gap between what people think auditors should do and what they are actually required to do. (I remember being taught that the auditor is "a watchdog, not a bloodhound" which may seem like a useful metaphor.. but don't they both bark?)

But there is also a very wide expectation gap between what the general public believe that companies should do and what they actually do. No corporate accountability system can work without some clear idea of what companies are for and what can be expected of them. This discussion is happening in various places:  for example, The Future of the Corporation, The Purpose of the Corporation, Tomorrow's Company Whether the insights from these different groups can be brought together and synthesised in any useful way remains to be seen but such thinking is needed to underpin policy and regulatory decisions which, at present, work on an ad hoc basis, selecting what appear to be the most pressing issues and tinkering with the system to try to address them.

Companies fail for all sorts of reasons. Risk is inherent in business and can't be managed out of existence. Honest and competent boards and management may make bad business decisions. Covering up may lead to incompetent and dishonest behaviour but no system can prevent that. The new focus on corporate culture assumes that a "good" culture will inhibit such behaviour but evidence of this seems very sparse.

We need to accept that companies will fail, even those that tick all the boxes. More boxes to tick won't change this. As well as identifying causes, perhaps we should be looking more closely at how the failure process is managed and how those caught in the fallout can be better protected.

Transparency?

This recent publication by Larcker and Tayan caught my eye: "Netflix Approach to Governance: Genuine Transparency with the Board".  It's a short descriptive account of the "highly unique practices" (can "unique be qualified?) of the Netflix board. 

I'm a fan of Netflix (love "The Crown") but I'm not convinced that what is described represents "genuine transparency", whatever that means.  We are told:

"The Netflix approach incorporates two highly unique practices: (1) board members periodically attend (in an observing capacity only) monthly and quarterly senior management meetings, and (2) board communications are structured as approximately 30-page online memos in narrative form that not only include links to supporting analysis but also allow open access to all data and information on the company’s internal shared systems, including the ability to ask clarifying questions of the subject authors. This quarterly memo is written by and shared with the top 90 executives as well as the board."

I do think that distance from management is a problem for boards, now that executive directors and NEDs don't sit around the boardroom table together. But attending management meetings? Reed Hastings, the CEO, says:

 “I don’t want the management meeting to be any different because they’re there.” 

Really? Has he heard of the Hawthorn effect? I can't believe that management won't behave differently if observed by the board. I also find it difficult to believe that board members could keep their mouths shut if they think that mistakes are being made. Transparency? The cynic in me whispers that meetings can be stage managed to avoid difficult issues and important discussions can take place outside management meetings. Just like board meetings, in fact...

The board memo could be a good idea. Maybe this is transparency. The ability to drill down and ask direct questions could be very valuable. But how much time would this take out of a director's day? Would they bother?  We are not told how long the Netflix board has been operating in this way, although it implies that the practices were in place at the time of the Qwikster debacle which was in 2011. So the directors interviewed could have been asked about the actual use they make of this facility and how much of their time they devote to it.

"Hastings cautions that directors granted this level of access to management discussion and documentation need to exercise self restraint about influencing decisions outside the boardroom." You bet!

At a broader level, these practices raise an issue about the boundaries of corporate governance. The challenge is to provide board members with information that enables them to fulfil their oversight duties but not so much that they are tempted to become de facto management.  Or at least that is the received wisdom: the discussions I have had with NHS NEDs suggest that the boundary could be permeable under some circumstances.

We need to know much more about information flows around the board. It's quite possible that other companies use similar - or even more innovative - methods. Some rigorous research into this would be very valuable.