Organisation Effectiveness & Top Executive Pay by Corporate Research Forum

Organisation effectiveness and top executive pay DISCUSSION PAPER, NOVEMBER 2013 David Creelman & Andrew Lambert

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Contents About the authors and PARC

Introduction

Executive Summary

What is organisational effectiveness?

Models of organisational effectiveness

Building and assessing effectiveness

Incentives – truths and half-truths

Recommendations – linking pay to organisational effectiveness

Appendix 1 – Stakeholder perspectives

Appendix 2 – Effectiveness and ownership

Appendix 3 – Posing questions about effectiveness

Appendix 4 – Organisational health checklist for boards

10 References and further reading

About the authors David Creelman

David Creelman

Andrew Lambert

About PARC PARC was founded in 2004 to provide a centre of excellence for the development and management of high-performing organisations. Through the provision of informative and challenging research and briefings, PARC enables HR and Reward Directors to engage with leading thinkers, expert practitioners and each other on the key issues affecting today’s organisational performance, reward and governance agenda. To find out how membership of PARC can benefit you and your organisation please contact info@parcentre.co.uk.

Acknowledgments We offer thanks to the many contributors to this study, many of whom preferred to remain anonymous. Those we can name included Ed Lawler, Henri Servaes, Jordi Canals, Mike Haffenden, Simon Patterson, Ken Hugessen, Elisabeth Haas Edersheim, David Clifford, Michael A Thompson, Phil Wills, Mike McInerney, Pete Donovan, Diane MacDiarmid, Duncan Brown, Kevin Abbott and Fred Whittlesey. Thanks also go to Artisan for report lay-out and design.

David has a distinguished record as an independent researcher, writer and consultant on human capital management. He works with a wide range of think-tanks, academics, consultants and HR vendors in the US, Japan, Canada, the EU and the Middle East. He collaborates regularly with leading experts in HR such as Dave Ulrich, Norm Smallwood, John Boudreau, Henry Mintzberg and Ed Lawler. He is also a partner in Creelman Lambert, an international research company focusing on the effective governance of human capital. This includes the responsibilities of boards, executive management and HR, and the working relationship between them and with investors. Creelman Lambert was awarded the 2012 Walker prize by the Human Resource Planning Society for the ‘most state-of-the-art contribution to HR thinking or practices’. Andrew Lambert Andrew is a partner in Creelman Lambert. He has been a management consultant for 35 years, leading consultancies responsible for developing the fields of employer branding and internal communications, and also heading corporate functions in two UK banks. More recently, as cofounder of the Corporate Research Forum, he has published research and guidance on areas such as the future of HR, people risk, employee engagement, performance management, HR evaluation and measurement, the management of coaching and mentoring, employee surveying, the management of global organisations, innovation and creativity, the impact of technology on learning and work, strategic workforce planning, and the role of HR in mergers and acquisitions.

INTRODUCTION While PARC has examined many aspects of organisational and individual performance since its inception, this is the first study to address 'organisational effectiveness' (OE) directly. We posed three questions in this research. • What is organisational effectiveness? • How best do you assess it? • How should it influence rewards for executives who lead organisations? We consulted well-placed people in a wide range of roles – from boards to HR functions, financial markets specialists, different flavours of business professor, experts in OD and in reward. PARC studies and debates hitherto, including contributions from Sir Andrew Likierman and Bob Cowell, have provided useful insights. PARC members already know that there is more to effectiveness than financial results, and that undue focus on short-term financial results can undermine long-term performance. The growing of mistrust of boards and Remuneration Committees (RemCos) about governance and pay has resulted in the threat of discretionary powers being curtailed, in favour of mechanistic regulatory approaches. This threatens to make a difficult situation worse. Our thought is that organisational effectiveness may provide some tools to tilt the balance back towards use of judgement. We started in the knowledge that definitions of OE are a little vague. However intuitively we know it relates to having a solid, capable organisation – like a healthy person or a well-engineered machine, an entity that will do well over time under a variety of conditions. We set out therefore to explore whether and how measures of organisational effectiveness might provide better insight into future success than financials do on their own. They might also be useful in assessing the difference that organisational leaders make, including the value they generate, in the context of the debate about performance and reward. They may help specifically in meeting the requirements of the UK's new remuneration reporting regulations. Our purpose, in this report, is to stimulate thought and debate, rather than resolve every issue in a sprawling topic. To that end we will pose as many questions as we present answers.

EXECUTIVE SUMMARY 1 There is unease that organisations focus too much on short-term results, often due to investor pressures. Might placing more importance on organisation effectiveness alleviate this? 2 There is unease that executive pay is poorly related to performance. Would including an assessment of contribution to enhancing organisation effectiveness improve matters? 3 Multiple stakeholders now make demands on organisations, and assess whether they are doing a good job in many other ways than just shareholder return. How willing and capable are boards in responding to these pressures, thus guarding reputation and pre-empting regulation? 4 Organisation effectiveness is best thought of as the ability to deliver sustainably good results. It is behavioural and future focused, unlike the financial results – intrinsically rearward looking – commonly used to judge performance.

• clarity – purpose, direction, identity, values, strategy and objectives • governance and alignment – is there robust oversight to keep us on track, and are the right questions being asked? • capabilities – what do we need to succeed on a continuing basis, whatever the challenges? • results and resilience – how good are we at assessing and learning from our results so that we enhance our resilience, including through the way we reward performance? 8 Moving from assessing organisation effectiveness to executive pay design is difficult, because the public debate on executive pay contains some half-truths.

5 Our consultation identified that mostly organisational performance and executive reward are assessed in terms of financial results. Other data – eg customer or employee – are presented, but generally carry far less weight. Risk registers are used mainly to assess threats rather than opportunities. Effectiveness per se is rarely assessed formally, although it does get discussed.

• Pay for failure: critics (especially the media) fail to recognise that boards are right to hesitate to punish a good CEO where poor financial performance was not his or her fault.

6 To facilitate deeper consideration, we identify various debates on how to approach organisation effectiveness.

• Equity based pay is THE way to align interests: all forms of equity based pay have significant drawbacks; there is no magic formula that always and reliably reveals added value and makes managing executive remuneration painless.

• Planning vs emergence: do we focus on a defined strategy or let strategy emerge? • A few drivers vs a value creation model: do we identify just a few key drivers of success or have a comprehensive, balanced scorecard style, model. • Reputation management vs deep values: do we pay attention to corporate responsibility as part of reputation management or because we truly believe in values that go beyond profits? • Strengths vs sickness: should we focus on our strengths or simply make sure we avoid the many common dysfunctions of organisations? • Key performance questions vs key performance indicators: should we focus on asking the right questions or be more hard-nosed and stick to looking at the numbers? • Sustainability versus resilience: should we focus on the ability to sustain the current business model or on the ability to re-invent the organisation? • Three vs ten(+) year time horizon: should we focus on the reasonably ‘knowable’ three year future or set our sights on doing the right things with a 10+ year time horizon?

7 An organisation can assess its effectiveness by tough, systemic evaluation of its

• Pay motivates performance: the conventional belief that incentive pay is essential to motivate CEOs is highly questionable. Most are already motivated, and don’t need bribing.

9 Boards need to • be clearer about what organisation effectiveness means both to them and to important stakeholders; and have a well structured way to assess it , just as they have a reasonably structured way to think about risk – past results alone guarantee nothing • have deep insight into how to enhance organisational performance and develop long-term resilience; they need to make time and use systems thinking to deepen their understanding. 10 There is no neat formula that ties organization effectiveness measures to pay. However, pay decisions should be rooted in a board’s deep understanding of what drives the organisation’s performance over time, and how key executives have added lasting value to its capabilities, not just its financial value.

1 WHAT IS ORGANISATIONAL EFFECTIVENESS?

WHAT IS ORGANISATIONAL EFFECTIVENESS? Understanding effectiveness starts by simply asking 'are you doing a good job?'. This applies both to the present and the foreseeable future – the expectation is that you continue to deliver, and thus can be trusted. Our definition of effectiveness is 'the ability to deliver sustainably good results'. Thus effectiveness is both behavioural and future focused. Past results – personal, financial or operational – can influence confidence about future delivery, but actually guarantee nothing.

Common sense suggests that effectiveness represents a large part of understanding and assessing both organisational and individual performance. The trickiness in performance assessment starts with defining 'good', especially in determining linkage with reward. Nonetheless, this trickiness must be mastered in order for any sensible judgements to be made. We argue that reaching a shared view of what is effective is key to tackling many of the complexities that we will now briefly refer to.

'Good' is in the eye of the beholder It is important to recognise that effectiveness is judged not just by your own criteria, but by others. You may think you are doing a great job, but it's for others to be convinced – which can be hard because organisations have a wide range of stakeholders to satisfy.

Friedman vs Packard (et al) "There is one and only one social responsibility of business – to use its resource 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.” Milton Friedman, 1962 "I want to discuss why a company exists in the first place.....many people assume, wrongly, that a company exists simply to make money. While this is an important result of a company's existence, we have to go deeper and find the real reasons for our being. ....The real reason for (Hewlett-Packard's) existence is that we provide something which is unique, that makes a contribution to society." Dave Packard, 1960

Stakeholders (see Appendix 1) fall into three categories. • Those with an economic interest – owners, customers, employees, business partners. • Those who may be impacted by operations – eg communities, special interest groups. • Regulators and governmental bodies – in theory seeking to balance stakeholder interests. Within a single type of stakeholder there can be highly varied perspectives. For example ownership has many forms – public and private companies, charities, public or state-owned bodies – and many behavioural types. Even if we narrow ourselves to public companies there is wide divergence between different shareholders’ goals; level of interest in and understanding of the organisations they invest in; and their stock-holding time-frames. See Appendix 2.

A question of purpose Another common sense observation is that it is hard to be effective without first having a clear sense of purpose. As it happens, there is a continuing and increasingly fractious debate about what organisations are for, particularly as regards large public companies providing goods and services that society needs. Where they fail – eg banks, transport systems – governments come under pressure to take control, generating fresh arguments about what is effective or not. The debate about purpose is linked to differences between stakeholders and their expectations, for example between owners and many other types of stakeholder whose views on what is effective do not start with return to shareholders.

1 WHAT IS ORGANISATIONAL EFFECTIVENESS?

“People want to work for a company that makes a difference, a company that's doing great things in the world.” Jeff Immelt, GE, 2004

Disparate contributor viewpoints We found our interviewees' responses depended considerably on their background and core discipline, and where their particular interests lie. • Finance specialists – practitioners and academics – focus most on how to assess value generated for shareholders, and what kind of financial numbers are valid. All other stakeholders and associated metrics are secondary. • Various organisational experts cleave by contrast to a broader narrative – about HOW value is created, and about how different stakeholders' needs should be recognised because they interconnect. They support a mix of financial and nonfinancial performance measures. • HR contributors tend more to the latter than the former, but commonly comment regretfully about the dominance of financial measures, particularly in determining executive reward. Concern was also expressed about measuring what is easy, eg past results, rather than what is predictive. Note that most financial indicators commonly used to assess performance are 'lag measures', yet effectiveness is intrinsically indicative of future outcomes – surely more useful for investors.

Within companies as well as society there is palpable tension between the Milton Friedman/ Chicago School perspective – maximise profits and shareholder return by all legal means – and the 'moral purpose' and 'societal good' standpoints. This is reflected currently in fierce arguments about the tax status of multinationals – generating employment and providing customer benefits are cited by low corporate tax payers, but critics are not mollified. Some leading CEOs have become vocal advocates of having to do good in order to be considered 'great' – including Jeff Immelt of GE and Paul Polman of Unilever – echoing earlier philanthropic or values-led entrepreneurs such as the Cadburys and Dave Packard. Among recent academic commentators, Professor Jordi Canals of IESE extensively explores the linkages between doing good and economic success in his book ‘Building Respected Companies.’ (See References section.) No organisation can be regarded as effective unless it has a clear promise, and then delivers on it. Not doing what you said you’d do undermines the trust of shareholders and anyone transacting with the organisation. Beyond that, many surveys have indicated that employees, customers and society in general will not regard any organisation as truly effective and trustworthy unless it has laudable values and lives up to them. That is a test that many struggle to achieve. Contributors to this study had quite varied perspectives about this – see the column.

A question of comparison While doing better than you did before – ‘absolute performance’ – does suggest increased effectiveness, mostly judgements require comparison to be robust. An organisation’s effectiveness will automatically be in doubt if it does not display toughness and ambition in choosing comparators. • Often that means thinking harder than just measuring yourself against obvious rivals. • Other stakeholders have their own view of who you compare with, whether you like it or not. • Choosing ‘soft’ and narrow comparators does not win respect, nor aid self-improvement – and stokes the controversy about assessing performance, and top level executive reward in particular. That is not to say comparison is easy. Competitive organisations seek to differentiate themselves partly to increase their attractiveness. Others may just be complex. However, stakeholders who know what they want – and most do – will certainly find their own criteria for comparison.

Context shapes viewpoints What is judged as effectiveness varies greatly in different sectors, market cycles and cultures.

1 WHAT IS ORGANISATIONAL EFFECTIVENESS?

The UK Companies Act 2006 requires that directors need to have regard where appropriate to long term factors in promoting the success of their company. (S.172, CA 2006)

Core competences Organisations need to be clear about their ‘core competence’ to talk sense about effectiveness. That includes clarity about shifting that competence to what is relevant to the future – something Kodak and DEC failed to do. Also, the leadership should know what good looks like in all the various functional disciplines that a modern organisation needs to be effective – eg finance, people management, technology, marketing, distribution, law, communications etc. Frankly, in some organisations one observes more assumption than science in this respect – see the column. Lifecycles Different performance measures are appropriate to different stages of maturity – in terms of product/service type or geographic market; from high growth 'gazelles' to declining industries, and recovery scenarios. Large organisations mostly contain a mixture of types and life-stages of business. Head offices must understand what effectiveness looks like in each scenario, avoiding simplistic one-size-fits-all measures. And owners and investors too must understand the parts of the organisation if they are to evaluate the whole. "Just looking at us at group level tells you little", observed a conglomerate's HR director. Industry dynamics differ Pace and dynamics vary from industry to industry, and therefore so does the period over which effectiveness and return on investment can be judged. Take the fierce debate about the 'tyranny' of quarterly reporting – described by the highly respected Chairman of Novartis Daniel Vasella as poisoning the relationship between shareholders and managers, driving short-term profit maximisation at the expense of long-term value. Serial board member Baroness Kingsmill is just one of many voices calling for a norm of half-yearly reporting. Yet in fast-moving technology sectors there is impatience at the infrequency of quarterly updates, and even calls for real-time reporting – for example by Mark Schneider, CEO, Fresenius Group. Although one might wonder when exactly a CEO would get time to be strategic if subject to continuous reporting, it helps to make the point that one size does not fit all when choosing the right timescale for assessing effectiveness.

Board effectiveness – depth and breadth Financial services boards have been particularly in the firing line for not understanding their own businesses. Neither the organisations nor their supervisory boards have been effective. The regulatory response – eg through the UK's FSA (as was) – has been to strengthen further the financial expertise of board members through their appointments approval process. However, knowledgeable insiders reveal that oversight failures are largely due to lack of strategic breadth, understanding of psychology and tough enquiry. Insufficient challenge is in part due to having an un-diverse group of financial specialists as board directors, and partly due to group-think – with these being interconnected. Ultimately the failings were behavioural, not technical. In any case, there is a danger that NED specialist knowledge is, frankly, no longer cutting edge. As advised in The Board and HR, board effectiveness requires taking talent management seriously within the board itself, building a diverse and well-balanced group. The mixture of directors needs to optimise authoritative understanding of what good, and bad, looks like both across organisations in general and within technical specialisms. Good oversight is about persistently asking the right questions rather than knowing more than executives.

To summarise, we should not expect a single model of organisational effectiveness to work everywhere. Someone sitting on multiple boards may find the definitions and measures will vary considerably between organisations. Furthermore within complex organisations there will be more than one model.

Our focus is on the board's perspective In conducting this study, we focus primarily on what boards and RemCos in publicly-quoted companies – working with executive management – understand and do about organisational effectiveness. Boards’ stance will depend on who they truly represent – see the column (p.10). We contend that their overarching governance responsibility is to focus on the future and what will create lasting value. Directors should aim to create a great legacy.

1 WHAT IS ORGANISATIONAL EFFECTIVENESS?

“The entrepreneur always searches for change, responds to it, and exploits it as an opportunity.” Peter F. Drucker

Who do boards represent? The UK’s Companies Act requires Boards (and RemCos) to protect the company’s assets, promote its success and work in the best interests of all its ‘members’ ie shareholders as a whole, not favouring any particular ‘owner’. The Act also suggests (rather than requires) that ‘success’ factors include the interests of company employees; fostering good business relationships with suppliers, customers and others; and the impact on communities and the environment. But in practice many questions arise. • Are directors also ‘cheerleaders’ for the organisation? Can that represent a conflict of interest? • Should boards primarily assess strategies, or should they get involved in forming them? If the latter, can this compromise their role of oversight? • How should boards avoid the common suspicion that they are too prone to selfinterest and/or control by executive management, including on pay – especially if there is a combined Chairman and CEO? • To what extent are they conflicted by different types of owner represented on the board? • How much should boards formally owe responsibility to non-owner stakeholders? How should they define that, including how they resolve differences of interest? • In the UK, does the stewardship code genuinely help boards in their 'piggy in the middle' position? What lessons are there for other jurisdictions? Boards need transparently to resolve these kinds of balancing conundrums if they are to be able to assess both their own effectiveness and that of the organisation they are responsible for.

1 The board wants to know how the organisation will stay successful. What tells us if the organisation is healthy enough to thrive in a VUCA world? An organisation may be doing well financially, but has it invested in the capabilities to succeed in the years ahead? Conversely, organisations that are not making money now may be doing all the right things for future success. Understanding organisational effectiveness helps the Board see clearly. 2 Remuneration committees should assess and reward executives on factors that shape future success. If the Board understands which internal factors are important for future success, the remuneration committee should want to tie those to incentives. Wouldn't using robust measures of organisation effectiveness help to avoid some of the problems that currently engulf executive pay? When we probe about how boards of quoted companies actually discuss performance, we find generally that • most of the reporting to and by boards/RemCos focuses on financial measures • that is partly because of the relative priority given to investors and share price • 'effectiveness' is not usually addressed as a defined topic , with supporting metrics – in the way that, say, risk would be • however, in reviewing strategy and progress, there is usually plenty of discussion that relates to aspects of effectiveness beyond the purely financial • the two most prominent non-financial or risk measures regularly reviewed are employee engagement – widely – and, more occasionally, customer net promoter score; useful as these are, there are more dimensions to consider than these. Meeting strategic goals and generating economic value are justifiably the principal tests of success, and boards are right to concentrate on these. Our question is whether this sufficiently focuses on the qualities to achieve excellence and capabilities to achieve lasting resilience – which a robust discussion about effectiveness should do. We concluded that there is considerable room to improve how boards and RemCos do their job by helping them better to assess organisation effectiveness. Yes, this is challenging, in that there are potentially a thousand and one perspectives on effectiveness, with plenty of conflicting views. To have any chance of their organisation being assessed fairly, boards need constantly to educate key stakeholders on their organisations' performance and prospects, and the basis for variable rewards.

We feel that boards should first be clear in their own minds about the dimensions of effectiveness that help them do that. It is particularly appropriate to be considering this now, in the UK jurisdiction at least, given the more demanding requirements of new remuneration report requirements.

1 WHAT IS ORGANISATIONAL EFFECTIVENESS?

“When the rate of change inside the company is exceeded by the rate of change outside the company, the end is near.” Jack Welch

Reward effectiveness We all know the context – steady growth in reward disparities, public anger about 'rewards for failure' and corruption at the top, exacerbated by erosion of employment, pensions and support mechanisms – albeit that both the level of disquiet about top pay and degree of economic pain varies quite considerably across economies and cultures. Undeniably, shareholder pressures have increased, and on CEO pay in particular. Martin Sorrell and Stephen Hester are among those who have experienced wearisome personal attention. The CEOs of Aviva, Astra Zeneca and Trinity Mirror departed in quick succession in 2012 following shareholder revolts about compensation and performance. As regards incentive plan design, the main pressures are • calls for less opaquely complex packages, which fuel latent suspicions • unease about formulae in common use, purely equity-based approaches, and TSR in particular. Surely it would help boards and RemCos to achieve more transparent, simpler-tounderstand performance-linked formulae if it can be demonstrated that executives had made a material difference to the effectiveness of their organisations, through their own efforts and not by luck or share price manipulation? However, we have already identified that effectiveness per se does not tend to be formally on board agendas and in metrics packs. It may or may not figure as part of discussing strategic goals. When it comes to measures, and relationship to reward, we found that what counts is financial results, and rarely much else. It is uncommon for other board-debated metrics, such as engagement or net promoter scores, to have any impact on pay at all. Missing personal targets can be important for future prospects, but only some organisations include this as a proportion of bonus.

Try paying bonuses in advance? Recent research led by Harvard professor Roland Fryer experimented with bonusing teachers. 8% of salary would be on offer for achieving improved student performance in maths tests, payable on results. This had no effect on outcomes, supporting the view that pay for performance has little impact if teachers already intrinsically care about student learning. However, one group of teachers were paid the bonus in advance, on the basis that they would have to re-pay if targets were not reached. Their students improved significantly, to the tune of nearly 10 percentiles. The researchers point to loss-aversion: the prospect of a loss yields greater pain than the comparative pleasure of a gain. Professor Adam Grant of Wharton added the comment that "doling out a bonus in advance communicates trust and high expectations, which are known to encourage greater effort and better results.”

This seems to us to offer plenty of room to design reward packages with more lasting organisational benefit.

In summary... In our research we found • some major areas of debate about purpose and role that need resolution before a clear perspective on performance can be formed • very few examples of formal focus on effectiveness in board discussions • frequent examples of top executive pay linked only to financial results • at the same time, most recognise the pressures to form a broader view of what constitutes making a beneficial difference – both as organisations and as corporate leaders. Therefore in Chapter 2 we explore a variety of debates and frameworks concerning effectiveness. And in Part 4 we discuss reward, and in particular highlight some half-truths about incentives.

2 MODELS OF ORGANISATION EFFECTIVENESS

MODELS OF ORGANISATION EFFECTIVENESS Using the BBS (or not) Our consultation found that • use of the full Kaplan & Norton Balanced Business Scorecard is limited • some respondents have developed variant scorecards • other contributors commented that the financial element outweighed all others. The BBS is only as useful as the rigour with which it is used – “often it’s just a case of high level generalising”, observed one Group HR director.

The current state Organisations are already awash with performance measures of different kinds. Additionally, everywhere you turn a consultant has some model of organisational effectiveness. The most common framework is Kaplan and Norton's Balanced Business Scorecard (BBS), but there is also McKinsey's ‘Beyond Performance’ framework, Galbraith’s Star model, Total Quality, high performance organisation models and many more. It is a bit like being in a tapas bar with too long a menu – each item looks tasty, but it is hard to know what to select. Despite the wide range of frameworks we could not identify any serious debates raging on organisational effectiveness – no divergent poles of opinion to ground one’s position against. This is where the tapas bar metaphor fails; instead of diverse choices all the frameworks seem much the same. A walkthrough of three or four or a dozen frameworks would be a remarkably dull activity. Perhaps this is why these models do not figure much in board discussion. To bring something new to understanding organisational effectiveness we need to pry open some areas of controversy.Seven debates “If we always agree, one of us is redundant.” – Bob Sutton, Stanford University Board members should have serious disagreements about substantial matters. It is only through disagreement, and probing for the assumptions underlying those disagreements, that a comprehensive understanding of what is right and wrong with the organisation will arise. We now examine seven conflicting assumptions about - the nature of organisations that drive divergent views of how to assess organisational effectiveness.

Planning vs emergence

Point

Counterpoint

We need a strategic plan. We need to be clear about the direction we want the organisation to go in, what we are trying to achieve, and how we are going to get there. We need to plan the work and work the plan. Furthermore, we need congruence about that direction – everyone on the same page.

Strategy emerges in an unplanned way and often we do not know where we are going until after we get there. If we just work the plan we will be narrow minded and miss opportunities. Furthermore, if we have too much consensus we will not thoroughly explore ideas and reveal blind spots.

For the rational mind it is obvious that unless you plan where you are going you will never get there. Yet a dispassionate analysis of how things actually work in the world shows that success is often opportunistic, emergent rather than planned. Take the UN. When founded its primary goal was ‘to save succeeding generations from the scourge of war,’ but it has had its greatest successes with agencies like the World Health Organisation and the UN High Commissioner for Refugees. Too much focus might have squashed those successes. The UN did not know what it would be capable of doing when it was formed; those strengths had to emerge from a good deal of trial and error.

2 MODELS OF ORGANISATION EFFECTIVENESS

“Effective strategy gets you better performance using less resources.” Professor George Yip, China Europe International Business School

Another famous example of emergence is Honda’s successful entry into the US automotive market. Its principal strategy of selling big motorbikes was an abysmal failure. It succeeded by selling small motorbikes, reacting in desperation to a market opportunity they had not foreseen. If Honda’s board had been pressuring the CEO to achieve the sales targets for big bikes it would have been hindering the company's success. There are some points of compromise. Those promoting emergent strategy do not deny that planning can be helpful; and one can plan that the company strategy should be emergent. Nonetheless there is a rather stark distinction between those wishing to plan the work and work the plan, versus those who are happy to try lots of things and learn as they go. • For the board believing in planning, achievement of milestones would be the main way to assess organisational effectiveness. Intermediate variables, like process efficiency, would be identified based on how they contributed to those milestones. • A board believing in emergence would support experimentation, helping management to be flexible, adaptive and purposefully opportunistic. For this kind of board, an effective organisation is one that is constantly trying things and learning what it is good at.

A few drivers vs a value creation model Point

Counterpoint

We need to focus on a few key drivers of organisational performance.

It is not enough just to cherry-pick a few factors. We need a model that describes all the elements that lead to value creation.

Some CEO perspectives "Our primary goal is to double shareholder value every three years.” Sir Brian Pitman, former CEO of Lloyds Bank "The lens of sustainable living is helping us to drive brands that have strong purpose in people’s lives, to reduce costs and take waste out of the system and to drive innovation that will make a positive difference to the environmental and social challenges facing us all. The Plan pushes us to think ahead, reducing risk and making the business more resilient for the long term." Paul Polman, Unilever CEO report, 2012. “Your most unhappy customers are your greatest source of learning.” Bill Gates, Microsoft “Surviving a failure gives you more selfconfidence. Failures are great learning tool, but they must be kept to a minimum.” Jeff Immelt, GE

It is popular among some leaders to talk about focusing on just a few key issues and not overly worrying about anything else. An extreme example is real estate agents with their three KPIs of location, location, and location. A contrasting school of thought proposes that organisations need a comprehensive valuecreation model. Phil Wills commented to us that “most business models are complex – and organisational performance cannot be reduced to a few key drivers.” The Balanced Scorecard, in its most complete manifestation, is intended to be a strategy map showing how various elements come together to drive the organisation forward. Both the Japanese and German approach to reporting on intellectual capital starts with a model of how an individual organisation takes tangible and intangible assets and uses them to create value. The latest incarnation of this thinking is provided by the International Integrated Reporting Council (www.theiirc.org), which is attempting to reform corporate reporting. Its ambitious goal is to fashion “a concise communication about how an organisation’s strategy, governance, performance and prospects lead to the creation of value over the short, medium and long term.”

2 MODELS OF ORGANISATION EFFECTIVENESS

Some CEO perspectives (continued)

• A board believing in a few key drivers would argue that value creation models are hard to use and maintain, generate more information than they can handle, and lead to lack of focus.

“The man who will use his skill and constructive imagination to see how much he can give for a dollar, instead of how little he can give for a dollar, is bound to succeed.” Henry Ford

• A board believing in value creation models would argue that picking a few measures is simplistic, and that just tracking a handful of things would blind them to important contributors to organisational effectiveness. These boards want the kind of rigour, and the comprehensiveness promised by a value creation model.

“Management is nothing more than motivating other people.” Lee Iacocca, Chrysler

Reputation management vs deep values

“Give individuals the tools they need, outline some parameters to work within, and then just let them get on and do their stuff.” Richard Branson, Virgin “No enterprise can exist for itself alone. It ministers to some great need, it performs some great service, not for itself, but for others, or failing therein, it ceases to be profitable and ceases to exist.” Calvin Coolidge, US President “A lot of issues in business are the same – they’re about management, people, recruiting, vision and strategy, clarity of direction, driving revenue and IT.” Carolyn McCall, CEO Easyjet

Point

Counterpoint

Our mission as a corporation is to maximise shareholder wealth. Fortunately being a responsible corporate citizen is compatible with that.

A true multi-stakeholder focus means that we do not just consider environmental and social goals when they happen to support profits. We live our values first and foremost and will not sacrifice them in the name of profitability.

The multi-stakeholder perspective has largely won the day over the pure Chicago school of economic theory, arguing that businesses should only focus on shareholder value. Companies are comfortable talking about the Triple Bottom Line (TBL) or Environmental, Social, and Governance (ESG). Most large companies now prepare sustainability or corporate responsibility reports. However, is the reason for embracing corporate responsibility mainly economic, or does it derive from a genuine devotion to good behaviour? Some boards care about ESG only because reputation affects profits and share price. Their concern is about shareowners and management – relationships with other stakeholders are only means to that end. Other boards embrace deep values and truly balance the concerns of various stakeholders. We found that some now resist the acronym CSR, seeing it as tainted. Which approach is right? • A board believing in reputation management would want to see an ESG scorecard with results similar to others in their industry, and would be willing to sacrifice some ESG points when the profit opportunity was compelling. They would be sceptical of any proposals to go beyond the norm unless there was an obvious public relations win. Interest in CSR is thus extrinsic. • A board believing in deep values would focus on measures of how they were living those values, and that discussion would precede the discussion of financial results. They would not consider potentially profitable ventures that violated those values, even if there was unlikely to be any reputational damage. Finally they would keep management centred on the belief that if we are true to our values then economic success will follow. Here, devotion to CSR is intrinsic.

2 MODELS OF ORGANISATION EFFECTIVENESS

“The expectations of life depend upon diligence; the mechanic that would perfect his work must first sharpen his tools.” Confucius

Strengths vs sickness

‘Doing good’ with whose money?

Point

Counterpoint

We should play to our strengths – that means organisational effectiveness measures should focus on relentlessly tracking the things we need to excel at. “We want our race car tuned to perfection.”

The board’s role is to ensure the organisation is not sick. Organisational effectiveness is mainly about preventing breakdowns. “We want our car running normally with nothing broken.”

There is a powerful school of thought that individuals and organizations should focus on strengths rather than weaknesses. While no board would argue for ignoring sickness, a strength-based approach would discourage fretting over weaknesses and encourage time being spent ensuring the organisation is playing to its strengths. The alternative view is perhaps more jaded. It sees organisations as subject to many sorts of dysfunction, and feels the special value the board brings is the perspective and experience to detect these and get them corrected before they do serious harm. Furthermore the sickness-oriented view is somewhat uncomfortable with the ‘pat ourselves on the back’ nature of a focus on strengths – this could be a hostage to fortune. Such a board is more like a home inspector, looking for cracked foundations, not an estate agent thinking how lovely the kitchen could be. Note that either of these is preferable to the kind of board, all too frequently pilloried in the press, that springs into action just when something goes wrong – either to fix the problem, conceal it, or shift the blame.

Large sums can get spent, particularly in ‘good times’, which on closer inspection seem to be a mixture of misplaced brand advertising and somewhat vainglorious grandstanding by top executives. CSR and marketing, particularly sponsorship, are uneasy bed-fellows at the best of times, and should not be confused with business acting responsibly. • ‘Fig-leaf spending’ can backfire, and fuel cynicism or worse among stakeholders and commentators. • The Milton Friedman school has a point when it argues that shareholders should be deciding what good causes they do or don’t spend their money on, not companies – taxpayers can feel the same about governments. • What impresses, by contrast, are projects where there is clear purpose, long-standing commitment, involvement of staff, and learning as well as reputational benefits for the organisation.

The strengths advocates think the board should help the organisation do as well as it possibly can; the sickness advocates think the proper role of the board is to help the organisation avoid falling into traps. Can boards do both? Perhaps, but in the limited time available one perspective is likely to dominate the other. • A board with a strengths perspective would see organisational effectiveness as those factors that lead to developing and deploying strengths. • A board with a sickness perspective would instinctively review a checklist of illnesses and seek measures that would warn of these illnesses. Just as with human illness, the list of common organisational diseases is quite long, and perhaps in a somewhat unsavoury way, rather entertaining – see Appendix 4.

Key performance questions vs key performance indicators Point

Counterpoint

We need robust key performance indicators (KPIs).

We don’t need KPIs as much as we need KPQs: key performance questions.

2 MODELS OF ORGANISATION EFFECTIVENESS

“The most serious mistakes are not being made as a result of wrong answers. The truly dangerous thing is asking the wrong question.” Peter F. Drucker

The value of sensing • Alongside any formal performance information, most people form a gut feel view of how effective an organisation is based on what they see, sense and experience of the organisation and how it compares. • In an era where social media dominates, those cumulative experiences are quickly shared and often reacted to. • Although there is potential for misleading information here too – rumour, innuendo, prejudice, malevolence – in aggregate the 'word on the street' is likely to be as reliable an indicator of effectiveness as any formal internal or third-party source, and must be taken at least as seriously.

There is near universal agreement on the need for key performance indicators (KPIs) and similar consensus that the KPIs we have do not tell us nearly enough – while perversely there is a tendency to generate too many. Bernard Marr of the Advanced Performance Institute suggests asking key performance questions (KPQs) rather than obsessing on KPIs. While KPIs are much more talked about than KPQs, leaders and consultants often say they approach organisation effectiveness by asking questions. For example, Elisabeth Haas Edersheim, founder of New York Consulting Partners and a former McKinsey partner, says that as a board member she asks the following. • Identity. Do we have a clear identity? Are we living it? What is our identity from the customer perspective; from the employee perspective? • External orientation. Are we constantly looking outside and adapting? Does that orientation show up in our strategy process? Does it show up when you talk to employees about their work? • Integration. Are the different dimensions of the organisation pulling together or pulling apart?

• Social media trawling is by now already part of recognised (big) data analysis.

None of these KPQs are particularly suited to be answered with KPIs. Elisabeth Haas says the tension between KPIs and KPQs is partly “do you want answers or do you want to think? The real leverage comes from the thinking.”

• When they are right, gut or instinctive views exemplify the effectiveness of human intuition and innate analytical ability. When they are wrong, it is usually because conscious or unconscious biases cloud judgement.

Phil Wills, referring to the need for rigorous discussion of strategic alternatives, quoted the old advertising slogan “it’s the fish that John West rejects that makes John West the best.” KPIs will help to tell you what is working now. However, probing questions are what is needed to trigger enquiry into what may work better in the future. Again it is easy to say that boards should do both – be balanced and ask KPQs and review KPIs. The question is, in reality, where does your board spend the bulk of the precious little time it has? • A board leaning toward KPQs would be sceptical of what they will learn from KPIs in resolving complexity and ambiguity; prefer to pose tough questions and have serious dialogue on the answers; prefer to avoid narrow discussion about how numbers are calculated and dispute about the interpretation. • A board leaning toward KPIs might by contrast be impatient with chatter that does not quickly reach a firm conclusion, and potentially skirts around hard facts ostensibly given by the data.

Sustainability vs resilience

Point

Counterpoint

Organisational effectiveness is about being a well-run, efficient organisation that can sustain the existing business model.”

How you operate today is less relevant than how you need to operate in the future. An effective organisation is one that can dynamically reinvent the business model.

2 MODELS OF ORGANISATION EFFECTIVENESS

“How do hidden champions deal with downturns and crises? The majority seem to actually profit from difficult conditions.” Hermman Simon, author, Hidden champions of the 21st Century

In a 2007 PARC meeting Professor Sir Andrew Likierman noted the difference between sustainability, an ability to sustain the existing model in uncertain times, and resilience – the ability dynamically to reinvent the business model to anticipate change. Related ideas have appeared from a variety of thinkers. Nicholas Nassim Taleb, author of Black Swan and Antifragile says organisations can be fragile, robust, or antifragile. • In the worst case, fragile organisations focus so much on being efficient, and exploiting the current business model, that they collapse when faced with a serious shock. • Better organisations build robustness, including a deep talent bench, solid culture and conservative balance sheet so that they can bounce back after a shock. • Taleb favours the novel idea of antifragility where organisations are designed so that they benefit from shocks and volatility. This notion is similar to Likierman’s idea of resilience, but envisions an organisation thriving on change by being faster and more adaptable than competitors. The ideas of Likierman and Taleb are quite profound, and perhaps we do them a disservice in summarising them in a few paragraphs. What they have in common is that they are attuned to the uncertain, ambiguous, unstable and complex. They all warn us that viewing an organisation as a well-ordered machine executing the chosen business model is often unrealistic. Given that management is often up to its neck in fire-fighting and keeping the business 'ontrack', we argue that the board has particular responsibility for looking over the horizon and ensuring the organisation can thrive in an unpredictable world. Major behavioural tensions to understand and cope with include • how to be an early adopter without losing large sums on misfiring projects • becoming adept at operating in a ‘beta’ world, running with ideas and technology that are still part-formed

Some contributor observations “At the board level everything is framed in terms of risk, so discussions of organization effectiveness revolve around issues like is there a weakness in some capability that could derail the organization.” Mike McInerney , Board member “Most CEOs in Canada do have some organizational effectiveness measures built into their pay formula.” Mike Thompson, Exec comp consultant “For us economic volatility is not a risk, it’s an opportunity because we can move faster than bigger companies. In that sense we are antifragile. One way we assess our organizational effectiveness is how good we are at finding new niches.” Pete Donovan, Managing Partner, Top Gun Ventures “The main way I assess organization effectiveness is whether we are achieving our goals and whether in a general sense people are competent. In particular I want to see that the leaders are forward looking, that they know where the organization needs to go.” Diane MacDiarmid, board member

• failing fast, often and profitably – because on balance the benefits of being experimental outweigh the cost. Nonetheless, some boards will feel that keeping the organisation robust is best done by sustaining the current business model – sticking to what we know, not speculating about complex systems and unknowable risks. Observing rivals who are early adopters – and thus learning what to avoid – is a potentially prudent and cost-effective strategic approach. • Boards content with sustainability will focus on conventional measures of organisational effectiveness – are we achieving our goals, are our processes efficient, are our customers loyal, and so on. They will seek robustness by making sure no single risk will sink the company before things ‘get back to normal’. • Boards who believe in resilience will examine how well the organisation responds to changing conditions relative to both old and new competitors. They may push to broaden the range of products and markets to reduce dependence on any one area, and to position the firm to capitalise on new opportunities. They may favour a structure of loosely connected units, rather than a tightly controlled centralised structure, because the ‘nodal’ design is inherently more adaptable. 17

2 MODELS OF ORGANISATION EFFECTIVENESS

“It is not the strongest of the species that survive, nor the most intelligent, but the one most responsive to change.” Charles Darwin

Human capital vs tangible measures We should also mention a debate that often engages HR leaders – human capital vs. tangible measures. • Some argue “human capital is our greatest cost and biggest asset. We cannot discuss organisational effectiveness without assessing human capital.” • Others say “attempts to measure human capital have achieved little; the board needs to focus on tangible measures.” Where does your board stand on this debate?

Note that the concept of ‘sustainability’ is increasingly being used with a different meaning, ie designing and operating organisations to support environmental and socio-economic health, and thus more akin to CSR. For example, this has now become the ‘signature’ theme of Unilever’s strategy and organisational development – which is consequently requiring a rethink of LTIP design.

Three vs ten(+) year time horizon Point

Counterpoint

We look three years ahead, anything beyond that is unknowable.

Many bad decisions do not show up for five to ten years. The board has to have a time horizon approaching ten years or more.

As the pace of technological advance and market evolution has quickened and operating conditions become more volatile, many organisational leaderships experience increasing tensions about how far they can plan ahead. • It is commonplace to find strategies that have a firm plan for one year, and look forward 'strategically' three years, but become sketchy further out. This now applies to organisations in historically more predictable sectors – of course, in faster-moving arenas, strategy necessarily must be more 'emergent' and fluid. • Yet at the same time many organisations still have to make investment decisions that can have 10-30 year or more life-spans, eg manufacturing plants, property purchases and leases, mines. Investments in geographies – especially China – pose questions about length of commitment to achieve viability and scale. • Then there are the debates we have mentioned about investment short-termism and the adequacy of the conventional 1-3 year time-frame for vesting top executive rewards. Boards and RemCos must ask themselves whether sticking to relatively short time-frames is about lack of courage or wisely avoiding brio and bravado. Have they really invested sufficient time in brain-storming future possibilities, are they being fatalistic, or have they genuinely created an organisation so agile that it is anti-fragile? Certainty may be tough, even unrealistic, to aim for. Yet, however it can be achieved, it remains the key ingredient in generating confidence amongst key stakeholders – workforce, customers, partners and investors.

In conclusion.... Our intention has been to stimulate thought about the kinds of debate corporate leaderships are, or should be, engaged in about what makes their organisations effective. Our enquiries tell us that there is certainly debate, but that that quality, depth and focus on what matters can be quite variable. Absence of thorough debate at the top, including about inappropriate reward policies, lie at the heart of many major corporations’ falls from grace – see Anthony Salz’s review of Barclays’ business practices for a chilling example, including his conclusions about HR, while also noting there are many worse examples than this that could be mentioned. Credit is due to Barclays for its relative transparency. In the next Chapter we give some pointers on how to frame such discussion. 18

3 BUILDING & ASSESSING EFFECTIVENESS

BUILDING & ASSESSING EFFECTIVENESS While articulating the importance of getting to grips with organisational effectiveness, we have also identified various cautionary points about any single model.

Bob Cowell’s yardsticks

• One size does not fit all – requirements and contexts vary greatly, even inside an organisation.

These are the main performance measures investors should use, says Bob Cowell of Makinson Cowell.

• Comparison between organisations is important but can also be complex – circumstances differ and need to be understood. • Effectiveness is in the eye of the beholder – stakeholder understanding and parochial interests are varied and can be conflicting. • Frameworks offer pointers, but are never 'the answer'.

Quantitative • Growth – revenue / earnings / dividends • Cash – cash conversion / free cash flow

• Numbers can be highly illuminating yet also simplistic and misleading. So it is naturally with caution that we nonetheless offer a framework for boards and top executives to consider. We propose the factors in the diagram as

• Financial position – ratios / covenants / debt headroom / maturity profile • Returns vs cost of capital

• reasonably universal foundation stones for both achieving and assessing effectiveness • a sound basis for agreeing more detailed factors that are tailored to organisations' needs

Qualitative

• things that many organisations do actually struggle with, at a cost to their effectiveness.

• Strategic clarity • Management strength

Oganisational effectiveness – critical health factors

• Competitive advantage • Risk management

Clarity of purpose, direction, identity, standards

Governance and alignment – future focus, investment, organisation design & development, objective setting, accountabilities, culture & behaviour, reward

capabilities

Results

Development of skills, talent

Operations

• Communication with shareholders/markets • Governance

Engagement, commitment

Risk management

Finances

Teamwork, collaboration

Change improvement & innovation

Stakeholder satisfaction

Efficiency of processes and delivery

All of these are about organisational effectiveness – firstly financial, and then a range of other dimensions, some of which could be supported by numerical data.

Reputation

Resilience

About the model All serious stakeholders – starting with the board and leadership team – need to recognise that an organisation is a 'system'. In particular it is a human system, not a machine; physical assets are worthless until intangible assets turn them into value. This model principally focuses on intangible assets, and views effectiveness in terms of health.

3 BUILDING & ASSESSING EFFECTIVENESS

“Who measures OE well? From what I’ve seen even the widely admired companies like Google and Apple don’t look so good on the inside.” Group HR director

Observations on 'clarity' Even organisations with a reputation for effectiveness have to focus continually on clarity, especially as the world evolves rapidly and expectations change. However, clarity alone is not enough. Ryanair prides itself on the clarity of its proposition and its operating efficiency. Yet the contrast with Southwest Airlines, whose model it largely copied, is striking – and illuminating in terms of true effectiveness. • Southwest is consistently in the top 10 of most admired Fortune 500 companies – the only airline in the top 50 – and a byword for employee engagement while being 80% unionised. Its philosophy is ‘if people truly participate, you don’t need control.’ It scores highly in brand 'forgiveness' ratings, inter alia. • Ryanair is anti-union, antagonistic to regulators, highly controlling, purely transactional with little commitment to customers or staff. Its rates of pay and customer satisfaction are low whereas Southwest's are relatively high. Standard Chartered, one of the few banks to emerge with some honour from the recent financial crisis, is very public in its devotion to running a good business. Yet senior executive Tim Miller – who has a doctorate in employee engagement – comments that it is a perennial challenge to ensure that employees are clear about what they are doing. And the bank has since been penalised, like other banks, for 'unapproved' processes. However it retains considerable goodwill from its stakeholders.

• It's not about whether you are doing a good job but whether you can keep doing it. • Regular and rigorous self-examination is advisable. Middle-aged men, notoriously, tend not to do this much for themselves. And that is a familiar phenomenon when observing organisational leaderships, and the quality of their self-questioning (including board self-evaluations). • It is unwise either to obsess about or neglect health. • Maintaining good health, and treating problems, requires systems thinking – appreciating interconnected factors. An organisation can potentially live for longer than any human provides it continually reinvests in its health. Only a minority do this well. The model comprises groups of factors which build one upon the other. To be resilient requires the right kind of results over time, which depends on capabilities, which in turn need to be orchestrated and aligned through good governance, which cannot be achieved without initial clarity of purpose. While the model does not attempt to address every facet of performance, assessment of effectiveness will provide comprehensive insights.

Using the model Boards and leadership teams should use the model as a basis for posing tough questions relevant to their circumstances. Investors and other core stakeholders should ask similar questions if they really want to understand the potential of the organisation. 1 Clarity The starting point for generating trust and confidence is clarity of purpose and direction, and about who you are (identity) and the standards you work to. Pertinent questions include • how well are these articulated – eg in vision, mission and values statements – and then communicated and acted upon? What does the evidence show? • what is distinctive, different and memorable about what we offer and do? • is what we say and do inherently attractive to stakeholders? We may feel we are efficient in what we do, but how do others understand and value us? What is our brand appeal to customers, employees, investors etc? What investors and other stakeholders want thereafter is 'no surprises', unless they are nice ones. Consistency is prized, as long as it does not develop into rigidity. To be effective, strategies must be distinctive and memorable – tactics can vary, but there is a sense of contract-forming that comes with strategic promises. 2 Governance and alignment We use the word 'governance' in its broad, Cadbury-defined sense, with the addition of 'alignment' – a critical objective for good governance and a fundamental factor in determining effectiveness. As an overarching requirement, serious attention should be paid to systems thinking, and in particular to human systems as much as any other system type.

3 BUILDING & ASSESSING EFFECTIVENESS

“A company is only as good as the people it keeps.” Mary Kay Ash

Thus governance needs to apply • laterally as well as vertically through organisation structures – ie mutual responsibility, not just 'control' • to both 'hard' and 'soft' dimensions of managing • to networks as well as formal structures, ie to the realities of how now a large proportion of work is done and decisions taken. These are important areas to probe. • How future focused? In forming strategy, in anticipating opportunities and risk, in adapting to new technologies and associated behaviours. Willingness to re-invent business models, and discard potentially redundant ones. • Investment? Quality and depth of decision-making process. • Organisation design and development? Depth of understanding of OD and organisation behaviour/psychology; skill in steering all aspects of structural change – organic, acquisition, divestment – and product/process/market change; minimising surprise and knee-jerk. • Objective-setting? Quality of both top-down and bottom-up decision-making; ability to co-create with stakeholders, enhancing both relevance and commitment. • Accountabilities? Even in complex structures, always being clear about who is accountable for what. If delivery falls short, or mistakes are made, being open and clear about rectification. • Culture and behaviour? Clarity about, and orientation to do, both what is 'right' and what is promised. Maximising transparency in order to win trust and avoid misunderstanding. Role-modelling good behaviour at the top. • Reward? Clarity about what is 'good' behaviour and achievement and recognising it appropriately – whether financially and/or by other means – fairly and consistently; and similarly for sub-standard achievement and behaviour. 3 Capabilities Central to board oversight of the executive should be the question ’do we have the capabilities to enable our strategy to succeed?’ This starts with the top team but should extend throughout the delivery chain – employees and also contractors and business partners. Here are six groups of capabilities that between them shape effectiveness. Note that, particularly for commercial organisations, an overarching question is 'how do our capabilities provide distinctiveness and competitive advantage?' This should run like a thread trough all discussions. • Skill and talent development. What specific core and generic capabilities will enable the organisation to excel over time? How good is it at developing people and processes, and attracting and retaining talent? How effective is it developing and using diverse talent? • Risk management. How good is the organisation at recognising and exploiting opportunities as well as anticipating/minimising potential for harm? How well is this embedded, from top to bottom (including contractors)?

Organisation design and effectiveness Organisation design expert Susan Mohrman argues that some 80% of organisations and their leaders persist with the hierarchical, functional model that emerged in the 1920s. Yet conventional structure charts do not now reflect the way work is done – ie through lateral rather than vertical/hierarchical processes. Projects, networking and collaboration are increasingly the way value is generated. Rapidly evolving communication technology offers remedies to combat the inefficiencies of silos. Yet considerable constraints on effectiveness derive from a management ethos wedded to control, and backward in adapting personally to both technology and social organisation. This offers great opportunities for smaller organisations to undermine legacy-burdened behemoths. Stu Winby cites the pace of change in areas like Silicon Valley, where “silo thinking loses you money fast. Open sourcing, rather than proprietary development, has become key to the socio-economic system. It’s about what you share as much as about what you know.” This underlines the reality of effective organisation design, which is more about human systems and dynamics than organagrams. Some large organisations are thinking more radically. IBM’s attempt to become a ‘social organisation’ helps a 450,000 strong organisation be connected and agile; and Unilever is organising its products and processes around global sustainability. Ambidexterity is an important attribute – being able to encompass different business models, including small entrepreneurial teams to provide the ideas that larger distribution structures can exploit. Key to success in developing new businesses is discarding conventional rule-books that kill motivation and innovation at birth.

3 BUILDING & ASSESSING EFFECTIVENESS

“Success comes from learning faster than your competitors. Past success breeds future failure.” Professor George Yip, China Europe International Business School

Effectiveness in managing change GlaxoSmithKline’s board identified inadequate strategy execution and change management as a critical risk. A dedicated team was created to 'change the way we change'. The aim was to embed culture and processes so that smooth and purposeful business improvement would become a natural way of doing business, enhancing short and long-term performance, agility and resilience. The approach adopted sought to • blend the best of 6 Sigma, OD methods and rigorous project management, underpinned by good understanding of organisation design, development and adult learning models • use the GEMBA principle that focuses on building change capability where the work is done, rather than the top-down and 'expert' dominated style of many change processes.

• Change, improvement and innovation. How smoothly and thoroughly does the organisation achieve change, continuing improvement and the innovation it needs to stay ahead? How well does it involve stakeholders, facilitate idea flow, welcome feedback and take positive action, recognise and profit from mistakes? Does it manage innovation cycles well? How adaptable, flexible, agile is it? How ambidextrous – able to accommodate different business models and degrees of entrepreneurship? How well trained and empowered are managers to play their part? How able is the organisation to operate in an increasingly ‘beta’ world? • Efficiency of processes and delivery. How well do processes help customers and employees to achieve what they need? Do the processes consistently deliver what is promised? How well are hassle and bureaucracy minimised? Does automation truly enhance user experience? • Teamwork and collaboration. Does the organisation pull together, avoid silo behaviour, ensure the left hand knows what the right is doing, and use the collective strengths of employees, partners and customers? • Engagement and commitment. How well does the organisation manage stakeholder relationships to maximise productivity and retention of value over time? Does it demonstrate the kind of authenticity, empathy and honesty that builds trust and mutual benefit creation? A pre-requisite is that an organisation is proficient and honest in assessing its capabilities. Only then will it begin to know what to develop, what to discard, and how to make strengths scalable.

Four years on, all parts of the organisation have been involved in transformation projects using this approach. Embedding of change capability is estimated at 30% – close to a tipping point. Many hundreds of staff are now formally accredited as 'change practitioners'.

How much can a board reasonably know about the organisation? How much should the limits on what is knowable determine how it tracks organisation effectiveness? In our report The Board and HR, we discussed issues such as the limitations of board packs and how best busy board members can gain insight despite clouds of data. The art to develop is that of incisive questions, identifying pressure points much as an acupuncturist does, so that information providers are induced to be honest and open.

Weekly evaluation and review enables a core network of qualified change facilitators – supported by a top executive team steering group – to learn, adjust and problem-solve continuously. See References for more detail.

Appendix 3 therefore includes some useful additional questions about areas of effectiveness, and Appendix 4 lists examples of organisational health conditions of which boards should beware.

OUR COMMENT – Might the CEO be in a position eventually to claim this as a distinctive competitive advantage and reason to invest long-term in the company? We are not privy to his thoughts. But would the shareholding community be able to appreciate the significance of this type of investment?

Note that while these questions are intended for organisations to ask themselves, the canny external stakeholder can have a truly powerful effect on the health of board and leadership priorities by probing insightfully in these areas. 4 Results and resilience Obviously an organisation that consistently does not achieve good results – delivering what it promises to do, avoiding nasty surprises – will acquire a lousy reputation. That will be compounded if it is evasive and poor at engaging with stakeholders, regulators and critics. We know that the way results information is presented ranges from usefully revealing to totally misleading. Third party and 'independent' performance information is therefore often perceived to be more credible. Here are some pertinent questions.

3 BUILDING & ASSESSING EFFECTIVENESS

• How robust and self-challenging is the organisation's use of comparators in analysing and presenting performance information?

Judge us by this...

• What results information specifically tells us most about the capability to achieve lasting value – absolute and comparative?

Many organisations make ambitious promises to deliver. John Lewis’ ‘Never knowingly undersold’ is a good example. Ryanair reneging on its promise of free flights for life to its millionth passenger is more infamous.

• What cause-and-effect relationships have been established between operational and financial achievement and types of stakeholder satisfaction (eg employee/customer engagement)? • How honest and open is the organisation in sharing and reacting to third-party performance information, whether complimentary or critical? • What tells us how the organisation can be resilient in the face of potential future challenges and shocks? • What performance data yields credible information about who deserves being rewarded for what?

In conclusion.... As we have said, any model or check-list is only good as the way it is used, and applied to specific circumstances. And as OD expert Mee-Yan Cheung-Judge frequently states at CRF workshops, it is important to ‘scavenge’ different models – such as Jay Galbraith’s ‘Star’ framework or the 70/20/10 principle – for their strengths in building an accurate picture, and analysing and resolving issues. Our model is specifically intended to be a platform for developing robust questioning and data collection about organisational effectiveness. “The key to effectiveness lies in a rigorous strategy process, used for constant review and judgement of performance”, observed a Group HR Director. So the real test is in developing the ancillary questions that relate to a particular organisation's challenges, and which are probing enough to give genuine insight to whether, where, why and for how long that organisation will be effective. Boards will generally find that people who in aggregate know most about those questions are at or near the front line of where work gets done – whether working for or being served by the organisation. “Commitment to effectiveness from the top will serve to inspire. Measures of effectiveness devised at the top very often have the opposite effect”, observed one experienced reward and OD expert.

Many also make fine claims about their strengths and their values – although the somewhat samey language tends to inspire ennui rather than admiration. And that’s before one tests the reality. Organisations are less keen to put details of their business strategy up for examination to all and sundry. Some certainly fear that by doing so they will cede competitive advantage. Yet investors, particularly those who are not ‘professionals’, need to know why an organisation will continue to deliver. In our review, Standard Life stood out, particularly within its sector, in terms of clarity and consistency in articulating the parameters whereby the performance of the organisation can be judged. What it states very publicly on its website you also hear in person talking to its top executives – in itself unusual, as these often appear disconnected. It was one of few organisations that told us it uses the balanced business scorecard rigorously. Note that it has an unusually high proportion of private shareholders – over 50%. (See http://www.standardlife.com/about/ strategy.html) Do you have other good examples?

Finally, organisations tend to measure what’s easy rather than the right things. Behaviours and capability aren’t always easy to assess, but they are what makes for lasting difference.

4 INCENTIVES – TRUTHS AND HALF-TRUTHS

INCENTIVES – TRUTHS AND HALF-TRUTHS CEO pay – sea-change or just a few waves? One of the few CEOs to speak publicly on pay has been Andy Street of John Lewis (a former HR director). In 2012 he told the BBC that CEO pay was "out of control", in the context of a 50% rise in CEO reward during a recession where general wage levels have been static. He explained his company's fixed ratio between top and bottom pay levels – a mechanism few organisations use, and 'still too high at 75 times but half the FTSE 100 average'. He felt the issue was now important enough for RemCos to make a stand and achieve a tipping point. Was he being over-optimistic? The heat may be getting to some. A recent incoming CEO very publicly accepted a far lower package than his predecessor. Ross McEwan, the internal appointee succeeding Stephen Hester at RBS, was said by his Chairman, Sir Philip Hampton, to prefer to “start life as RBS CEO with as little pay drama as possible”, although he added that he could expect to earn a “good commercial package” in future. Our view is that this is a mere and localised ripple, and that more energy will be devoted to better justification of rewards than reducing their level.

We started this paper suggesting two uses for organisational effectiveness. One was helping the board know how the organisation will stay successful. The other was helping remuneration committees identify factors that shape future success – and hence better design incentives. However, it is difficult to have an intelligent discussion about CEO incentives because the subject is littered with half-truths. Before discussing how organisation effectiveness measures should affect reward we need to clear away particular three half-truths: • that CEOs should not be paid for 'failure' • that pay motivates performance • that equity-based pay is THE way to align CEO and shareholder interests.

Half-truth 1: CEOs should not be paid for 'failure' Consider this comment from Patterson Associates. “Under-performers generally made up for their performance by paying higher salaries, with the average salary for winners (or those delivering 10 per cent or more value appreciation) being £3.8m, against £4.5m for under-performers.”The implication is that lousy CEOs are getting around reductions in variable pay by inflating salaries. This is the dreaded ‘pay for failure.’ If CEOs fail, then what should boards do? Punish them by withholding their bonus? No, they should replace the CEO. If the board is not taking decisive action, that is a problem with governance not remuneration design. Boards should recruit a CEO – and pay well – because they think he or she is the best person for the job. The issue is not whether the organisation is performing poorly or well; it is whether it would perform better or worse without that CEO. If the organisation needs that CEO, then the board is absolutely right to pay • what is needed to attract or retain the leadership required for the situation • rewards that reflect a real positive difference being made. If the Board feels they need to find a way around a compensation scheme that is not paying out – a compensation scheme they approved – then shareholders are right to fear the Board is going soft on management. • The challenge is partly one of communication, explaining to shareholders that the CEO’s performance actually is good (if that is indeed the case). • However the bigger issue is boards approving incentive schemes that will only work if business conditions are good. If the Board knows they need to pay a substantial bonus regardless of business conditions then that should be explicit. • Too often it seems easier to pretend the bonus is for good financial results, when in reality the Board simply wants to pay a CEO at a certain level. A closely related form of reward that annoys stakeholders is ‘luck’, eg when a reward scheme pays out handsomely to the CEO or top team due to external circumstances such as a sector surging in value. Simon Wolfson, CEO of Next, recently waived such an increase in a way that drew some admiration. However, arguably again this is a result of poor reward design.

4 INCENTIVES – TRUTHS AND HALF-TRUTHS

“The focus on purely financial performance measures drives short-term feathering of the nest. Frankly, organisational effectiveness becomes a secondary issue, or worse.” Group HR director

The problem of ‘pay for failure’ and ‘pay for luck’ lies is the Board’s pretence that CEO pay is all about financial results when it actually is driven by other 'windfall' factors.

It's not all about one person

The pressure is on RemCos to be able robustly to demonstrate that their judgement is both fair and contributory to business success. We would argue that a soundly constructed set of effectiveness parameters would help to ensure that rewards were justifiable and balanced

• when analysing how comparatively well an organisation and its executives have performed.

The nature of the individual at the top is often a major determinant of the style and atmosphere in an organisation. Change the boss and it's all change – arguably a sign of organisational immaturity, indicating a lack of embedded value.

The insidious factor that can lie behind unjustifiable decisions is that of the relative power of the CEO. Good governance requires facing up to this reality and dealing with it. See the box.

However how much does the CEO really impact effectiveness?

• whatever is happening with general market prices, and also

CEO power, RemCo chairs and HR leaders CEOs need to be powerful to be effective, and make the organisation effective. However, good governance requires a balance of power, avoiding over-mighty chairmen as much as dominant executives. Regarding pay, the issue is about the perceived value of an executive to the organisation. Particularly with CEOs, that value is inflated the more irreplaceable they seem. Just being in position for a long time can stimulate both unhealthy deference and reward inflation. It’s not necessarily driven by an overbearing personality. Bluntly, some contributors referred to greed as a factor – hardly a surprise. Again this is not just a question of the CEO’s proclivities. “They’re all at it” commented one Group HRD, referring to ExCo members. Of course there has also long been suspicion about a broader conspiracy, including HR being in league with pay consultants – who Warren Buffett famously referred in 2005 as ‘Ratchet, Ratchet and Bingo’ – and not forgetting the self-interest of highly paid fund managers. All are deemed by critics to make their contribution to soft deals.

"In a complex global organisation, a lot of strategy and performance is determined a lot more locally than investors realise", argues one Group HRD we spoke to. "The sheer diversity is too much for anyone central to control. Performance dashboards should be shaped closer to the action. Too much importance gets attached to CEOs and boards as regards performance and reward – I guess it's convenient for investors to look for someone identifiable to blame. What they should look for is the leadership's ability to pick and grow people through the organisation, and create the right conditions."

‘The market dictates what we must pay’ is a good point to debate. On the one hand, whatever the limitations of pay as a motivator, few people want to take or stay in a job that is comparatively poorly paid. No one likes to feel undervalued, and for most CEOs pride and ‘face’ are important factors. However, it is a feeling that the market is rigged that makes many stakeholders distrust this argument. To remedy all this, a legacy of poor visibility and transparency must be overcome. • Stephen Cahill of Deloitte told a recent PARC meeting that there is vastly increased demand for more pro-active, skilled and resilient RemCo chairmen than ever before, at least in countries such as the UK where high pay is a hot public issue. • Meanwhile the hurried departure of the BBC’s HR director has very publicly spotlighted the position of HR leaders in sanctioning ‘indefensible’ rewards. • Both can find the challenge to be particularly thankless if it means standing up to a powerful CEO, especially if the chairman is ambivalent. Can creating – and propagating – a better general understanding of what creates organisational effectiveness help RemCos and HR leaders to achieve a game change? Do they actually want that?

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“Management is nothing more than motivating other people.”Lee Iacocca

Bonuses and motivation

Half-truth 2: Pay motivates performance How might incentives improve CEO performance?

Variable pay has long been a minefield. On the one hand there is a widespread supposition that it is a fair method to recognise achievement as well as a way to motivate higher performance. On the other hand, • engagement principles tell us there are many better motivators of discretionary effort than money • psychologists and neuro-science explain how short-term the effects of inducement are, in contrast to intrinsic motivators, and ironically – in the context of debating longer LTIP vesting periods – that the further in the future rewards are placed, the less effective they are • a recent Towers Watson pulse survey of 121 UK companies reveals that bonus automaticity is widespread – any incentive effect is largely nullified when bonuses become regarded as salary top-ups and entitlements, with pro-rata payments even being awarded to departed employees • this study also reported 24% of respondents awarding some incentive payout to employees even if failing to meet performance expectations; nearly 20 % didn’t set differences in target payouts based on employee performance • in reality, the difficulty of getting bonusing right can do more damage than good, engendering perverse effects, resentment, distraction and general disaffection. The reality is that attraction and retention are often more important factors than performance recognition in shaping pay deals – for CEOs as much as anyone.

One way might be to encourage effort – if our CEO likes to sneak out early perhaps the right bonus scheme would get him/her to work harder. This is obviously not a reasonable justification for incentives. If we hired a lazy CEO then that is a mistake in selection, not pay design. If incentives cannot motivate CEOs to work significantly harder, can they motivate them to work on the right things? This is a half-truth. If we select CEOs who are not inclined to do the right things then again we should fix selection rather than try to solve the problem with incentives. If the CEO is going off-course, it is the role of the board to correct that, not the role of incentives. Former Shell CEO Jeroen van der Veer famously said "You have to realise, if I had been paid 50% more, I would not have done it better. If I had been paid 50% less, then I would not have done it worse." BBC business editor Robert Peston observed that this statement of the obvious would be greeted among other CEOs as "the worst possible heresy.” Why? We leave that for the reader to discern! And what are the ‘right things’? In short, there are two important dimensions. • The ‘right’ strategy. How to determine this of course is a major topic, as is how to assess it. Clearly it is often easier to judge what was right in retrospect – especially for big, bold calls. Deferred rewards is the remuneration ‘answer’ to the question – with the debate now centering on whether a 5-10 year spectrum is appropriate, rather than 1-3 years. • The ‘right’ behaviours – this is the Cinderalla dimension that needs serious attention. Arguably it is more predictive of success and effectiveness than just coming up with the right strategy, since it powerfully effects strategy execution, which is widely accepted and 9/10ths of the game. Articulating leadership competency frameworks is a start, but only just that. One of the very few in-depth (and longitudinal) studies of what leadership characteristics impact productivity offers boards/RemCos a clue about what they should be rewarding – and indeed recruiting in the first place. Hitherto they will have probably given big pay awards to powerful leaders who seem to have all the right knowledge. Actually it is their ‘engagement ability’ that is far more predictive of beneficial impact than, say being a ‘visionary leader’ or having a good bundle of ‘leadership capabilities’. (See the AlimoMetcalfe reference at the end of this report.) Note that the message that CEOs will not do their duty without being ‘bribed’ to do the right things is scarcely one that an aspiring role model should adopt. • It puts them in the doubtful company of salesmen, mercenaries and hard-line trade unionists. • It also relates to a fundamental issue about using bonuses – are they really about exceptional performance at all? • The large proportion of employees who are expected to achieve objectives as part of their job can only look on askance.

4 INCENTIVES – TRUTHS AND HALF-TRUTHS

What do RemCos themselves think? A 2011 study by Professor Brian Main for Towers Perrin interviewed 15 RemCo chairmen who collectively sat on 28 boards. Only seven felt that pay drives behaviour, but noted that poor LTIPs produce perverse outcomes. Three felt it did not, and the rest were described as 'equivocal'. Nonetheless, the discussion of goals that should accompany incentive plans does represent a ‘contracting’ exercise where the board and CEO come to agree on what is important and what targets are appropriate – knowing there is a carrot if a particular target is achieved can certainly focus the CEO's attention, as it does a salesman’s. There remains a serious problem – the dangerous asymmetry of incentives. If CEOs are doing their best then incentives cannot do much to improve that. There is limited upside. However, incentives can motivate CEOs to the wrong thing. The downside is unlimited. Usually the intense focus on incentive design is because incentives have encouraged an otherwise good CEO to do the wrong things. We can address this by trying to improve the design, and certainly including organisational effective measures is relevant here. However, a more potent answer might be to reduce the importance of incentives; this will leave the essential contracting exercise intact while reducing the motivation to misbehave.

Length of LTIPs Fidelity found that in 2012 that only 14 FTSE 350 companies had LTIPs extending to 5 years. Head of equities Dominic Rossi commented that “extending holding periods ....will result in a far better alignment between executive compensation and the longer-term performance of the company.” Some companies replied that reduced flexibility would make it harder to recruit talent. See Fidelity challenges companies on longterm incentives, Financial Times, 22 September 2013

Half-truth 3: Equity based pay is THE way to align interests There is a faith that just the right type of equity based compensation will seamlessly align executive behaviour with shareholder interests, and that this will obtain good, and avoid poor, organisational performance. PARC readers are familiar with the ins and outs of equity-based pay. Despite its theoretical attractiveness, in practice equity pay can encourage risky behaviour, result in undeserved windfalls or punish high performing CEOs. A lot of effort has gone into trying to find the magic formula; that effort has not been rewarded. Here are two opposing views that highlight the issues. Roger Martin, the Dean at the Rotman Business School at the University of Toronto, savages faith in equity compensation in his book Fixing the Game: Bubbles, Crashes and what Capitalism Can Learn from the NFL. • He draws the distinction between the real market (cash, revenue, profit) and the expectations market (the share price). • If investors pay a high price for shares because they think a superstar CEO will achieve brilliant profits, anything less than superstar performance will lead to a loss in the expectations market. • In the end, you can never win in the expectations market because the better you do in the real world, the higher expectations get until failure is inevitable. Martin feels this problem is destroying American capitalism. • CEOs should be rewarded only on real world measures like revenue, market share and any relevant organisational effectiveness measures. A related critique of equity compensation is that pumping up the share price is good for the owners selling their shares, but bad for the new owners who bought the shares – systemically encouraging managers to serve today’s owners by betraying tomorrow’s. 27

4 INCENTIVES – TRUTHS AND HALF-TRUTHS

“Even with the new (UK) regulations in place, the awkward truth remains that no one has much idea how much remuneration is worth when it is handed over.” Peter Montagnon

In contrast, Phil Wills (former reward head at Reed Elsevier, ICI and Diageo) points out that • ‘real world’ measures like revenue, profits, customer satisfaction are even easier to manipulate in the short term than share prices, and • most institutional investors want top management rewards to be inextricably linked to their own investment gain – put simply, “if I don’t make money, you don’t make money.” We may see the latter as a poor decision, but it is easy to understand why they think that way – and if they do, then TSR is the best measure of performance. Where TSR goes wrong is not the concept but the period of time (ie they should reward gains over the long haul, not just 3 years); and the peer group against which relative TSR is compared (an ‘easy’ peer group will over-reward executives). Note that simply extending the period before LTIP pay-out occurs is not in itself a ‘golden bullet’ solution. As one group HR director observed, “if you ask CEOs and the like to keep shares for longer, they’ll just want more. RemCos need somehow to extend the period without triggering reward inflation.” TSR – bad formula or bad implementation? Total Shareholder Return became the metric of choice for many companies during the 1st decade of the 21st century for LTIPs. Shareholders are commonly felt to have placed particular faith in this to align top executive behaviour with their interests. Yet we found spreading dissatisfaction with TSR, particularly among HR leaders. Compensation specialists have penned numerous articles demonstrating faults and perverse results. However Phil Wills argues that where investors insist that executive rewards mirror their own then they naturally will want to use TSR – defined as the aggregate of share price appreciation and dividends – and that what messes up TSR as a performance measure is not the concept, but bad decisions in respect of choices of time periods (too short ) and peer group comparisons (too soft). He adds that "relative TSR measured over rolling 3-year periods has to be one of the worst possible metrics for rewarding relative management performance" because, among other flaws, it rewards extremes more than steady performance. We observe that TSR tells us nothing about what particular difference a CEO and/or executive team has made and why, and thence how to generate future organisational effectiveness and value.

In the heat of this debate we can lose sight of the fact that the design of executive pay is unlikely to be at the root of poor organisational performance. However, protracted debate about reward can certainly distract leadership and the board from running the company – and hardly sets a good example for employees who actually do the work.

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Will we ever learn?

Tough times show when pay is deserved

In conclusion, some of the common arguments about CEO pay are at best half-truths that distract us from the real dynamics of how they are, and should be, paid. Here is a summary of perceived problems and suggested solutions.

Problem Incoming CEOs command an eye-watering price

Solution Be rigorous in considering alternative candidates – prices are high when the choice is slim. Be very clear about what is expected in terms of difference to be made (value, organisational effectiveness). Ensure transparency, so that key stakeholders can have confidence.

In-situ CEOs can demand disproportionately high pay increases

Change the power balance so that boards and investors can push down pay levels. And/or have a tough discussion about the ROI, and what justifies the negative example being set. If the power balance cannot be changed then learn to live with high CEO pay, and consider appointing a more responsible CEO in future.

Company is performing poorly, CEO is good

There is nothing more to be done, reducing the CEO's pay involuntarily will make things worse. (However he/she can choose to do this to set a good example.)

Company is performing poorly, CEO is no good

Replace the CEO – reducing his/her pay is not a solution.

CEO is not motivated to work hard

Replace the CEO – adding an incentive is not the right solution.

CEO is working on the wrong things

The board needs to provide direction. It also should correct any perverse incentivisation that rewards the CEO for doing the wrong things.

Martin Morrow, a partner in KPMG Australia, comments in an article that “it is when conditions turn down that good CEOs and their executive teams can show what they are really made of. • They are more likely to follow their own instincts rather than seeking the security of the broader view. • They will pick up on changed conditions quickly, make the appropriate responses (including the unpleasant ones), guide the organisation through the worst of the situation, and position it to make the most of opportunities. • They will not be overly concerned about reduced revenues and profits, but will be tenacious and uncompromising in defending the firm’s core markets and competencies and in preserving its solvency. • They will understand that it is just as important to know when to sell as it is to know when to buy. • They will have the courage to tell their board what they need to know, not just what they want to hear. None of these qualities is easy to measure, but they are the competencies that will be deserving of recognition and reward.”

Good CEOs are capable, driven people who mostly work very hard for the long term good of the organisation. We get good CEO performance through good governance, which means selecting good CEOs, replacing bad ones, and helping set direction. Reward can be supportive of this, but it cannot play a lead role. Clever incentive schemes cannot substitute for smart governance.

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“If you don’t get your team right, you’re done for.” Carolyn McCall (Director magazine 10.13)

Ken Hugessen, one of Canada’s top executive compensation consultants, reminds board members that designing an excellent reward package is not a positive job. It is more about avoiding the big negatives and big irritations than driving high performance. The board creates high performance by selecting the right CEO and having robust discussions about performance, including lively debates on organisation effectiveness. If there is a problem with the CEO about pay, this will be probably a proxy for other issues that need probing. Pay complexity There are many complaints about the complexity of pay packages at the top. Here are a few reminders. • Bob Cowell has explained to PARC how professional investors place much blame at the door of reward consultancies. • Both they and head-hunters are seen to have an intrinsic self-interest in high-paying and opaque deals. • Warren Buffett sees RemCos and HR leaders as weak or complicit in accepting these • Peter Montagnon argues that “anecdotal evidence suggests (executives) undervalue the options and performance shares that come their way, one reason why they are always asking for more.” Phil Wills observed to us, however, that everyone should realise that incentive plans are not simple to get right. "They are like marriages in that they require constant attention and effort." There are at least eight different elements, all of which should be reviewed regularly. • A rigorous definition of performance • The right performance measures and targets, including weighting • The right performance period • The right quantum – at both ends of the performance scale • A rigorous and independent measurement process • Understanding what behaviours aggravate risk – and developing controls • Open and clear communication – internally and externally • Constant review and tweaking of the rules In our view, logic dictates that it is for boards and RemCos to take ultimate responsibility for reducing or explaining complexity, rather than their hired advisers.

5 RECOMMENDATIONS – LINKING PAY TO ORGANISATION EFFECTIVENESS

RECOMMENDATIONS – LINKING PAY TO ORGANISATION EFFECTIVENESS If your top team and board already • demonstrably satisfies all its key stakeholders regarding their organisation’s continuing effectiveness, in all aspects of its operations • balances successfully any conflicts between stakeholder demands • has established clear, transparent linkage between how its senior executives personally drive achievement of effectiveness and how they are rewarded • avoids complacency and has built sufficient resilience to withstand any future challenge or shock ....then congratulations. You will be one of a rare band of organisations, and you are probably not reading this report. For very many other organisations, there will be work to be done. Here we summarise some simple recommendations about how to proceed. Defining performance At the beginning of this report we made it clear that, while performance and effectiveness are not synonymous, effectiveness represents a large part of understanding and assessing both organisational and individual performance. In many organisations the battle for clarity starts with knowing what good performance looks like. Put simply, organisations need to be sure that everyone knows what they are aiming at, in terms of targets and standards, and in terms of both desired outcomes and ways of behaving in achieving those outcomes. That is easy to say, and harder to do – see the column. The concept of effectiveness serves as a lens to describe what is needed to enable good performance to be achieved repeatedly. Addressing effectiveness Effectiveness goals should focus on building organisational capability and resilience, and leaving a lasting legacy rather than just a short-term performance boost. • Reflect on existing articulation of standards and related measurement. Are the frameworks clear? Are the measurements helpful? Could these be improved to sharpen focus and align around what really matters? What gets in the way? What should we do less of?

Effective performance discussions Close examination of under-performing organisations will typically identify lack of internal clarity and alignment around how best to meet (and balance) stakeholder needs consistently and well. Simply put, they don't discuss performance issues effectively. The old notion of ownership – central control, telling people what to do – is no longer fit-forpurpose. Instead the critical capability is being able to discuss performance and improvement maturely, openly and in an informed way – up, down and across the organisation – respecting the contribution of everyone who is part of a value-creating human system. Robust discussion of what good looks like should happen at all levels of the organisation, but with the example set at the top, and involving continual adjustment to changing operating conditions and challenges. Alignment is good when achieved after entering discussion with open minds and abandoning pre-conceptions; after serious discussion of alternatives; and taking account of diverse views. Group-think and views imposed by powerful personalities do not generate good alignment or decisions, nor motivate good performance. Additionally, in contrast to the experience of many, individual and team performance reviews should pass a simple test. Do they both motivate and guide the parties to achieve improved results?

• Examine what effectiveness looks like to stakeholders – based on evidence, not mere assumption. (We have in mind going rather deeper than typical investor discussions, market research and employee surveys.) • Preferably engage with stakeholders directly, in order to build confidence and achieve mutual education about what is important – from purpose to delivery; this also provides a way to establish consensus where expectations conflict. • In particular, engage open and honestly with managers and staff at all levels. They both know most about what works and doesn’t and have to deal with the consequences. Keep them in the picture regarding external stakeholders’ views, market predictions and future plans. 31

5 RECOMMENDATIONS – LINKING PAY TO ORGANISATION EFFECTIVENESS

“Performance is the clear identification and the delivery of the sources of strategic competitive advantage.” Phil Wills

Pay debate angles

• Choose robust comparators – not just obvious competitors – and explore how to create lasting and winning difference.

• The number of UK charity managers paid over £100k has risen 72% since 2010. 66% of respondents to a One Poll survey in 2013 said they would be less willing to donate to such charities.

• Build a framework tailored to the organisation for targeting and measuring action to improve/sustain effectiveness. Use our debates and high level framework as a starting point, if that helps, for pinpointing the important pressure points, as an acupuncturist would.

• The pay of FTSE 100 chiefs has grown from 47 times their employees’ average earnings in 1998 to 133 times in 2012, according to Manifest/MM&K. • A Deloitte survey of FTSE 100 companies (publicised in September 2013) indicates reduced bonuses; two thirds of bonus plans now contain measures based on the company’s KPIs; 80% include clawback and malus provisions, and 85% operate bonus deferral arrangements. • (Elevated pay levels) “inevitably distort culture, tending to attract people who measure their personal success principally on compensation”, giving employees a sense of entitlement. Anthony Salz • “Financial incentives fill up your entire thinking space, preventing you from focusing on other things or being open to ideas.. There is no evidence that massive financial incentives attract the best talent,” Professor Philippe Jacquart, EMLyon business school. • “People may be paid higher amounts in North America, but they generally have to perform at the top level to get them.” Simon Patterson • “Accounting rules already require (UK) companies to put a value on share schemes, but this figure lacks credibility.” Peter Montagnon

• Develop tough questions for self-examination in each critical ‘delivery’ area – as per Chapter 3 and our examples in Appendix 3. This includes team effectiveness at board and executive committee level. • Analyse the linkage between the various dimensions of effectiveness and financial health. • Focus risk management/measurement on the capability sustainably to deliver future results, not just on risk minimisation. • Envisage trends and examine ‘what if’ scenarios. How may expectations shift? • Build these perspectives into business strategy, such that examination of progress in achieving strategic aims is always informed by being viewed through an organisation effectiveness lens. • Make effectiveness part of the organisation’s promise, once it is capable of delivering. Linkage to reward • Identify for each area of effectiveness ‘delivery’ the actions that senior executives should take. Use this analysis to devise genuine stretch targets. • Identify where the linkage relates to individual accountability and/or collective team accountability, and build this into the performance and reward framework. • As achieving organisational effectiveness is mostly about working vicariously – ie influencing others – incorporate this into how leadership performance is assessed and rewarded. • Build ‘lasting effectiveness’ into the time-frame for vesting of long-term rewards. • Reward design needs clearly to link to behaviour as well as results – boards and CEOs need to be mature enough to talk about behaviour openly and toughly. • Ensure that how results are achieved is fully understood and built into performance reviews at the top – performance quality not just quantity. (Avoid reference to meeting the ‘values’ becoming mere lip service, hence undermining role modelling.) • Use effectiveness measures to underpin fair rewards in tough times as well as good. Reward design should prevent ‘lucky’ windfalls, and also unduly punitive reductions that could inhibit the organisation’s ability to attract and retain talent.

5 RECOMMENDATIONS – LINKING PAY TO ORGANISATION EFFECTIVENESS

“Boards’ reluctance to venture out of ‘the area of comfortable debate’ is a real problem.” Professor Murray Steele

Ancillary actions

Some contributor observations

• Lasting effectiveness and how to achieve it should be to the forefront when recruiting or on-boarding business leaders – particularly if, as often, recovery or new direction is part of the brief.

“It’s important to understand the dark side of targets.”

• Address any power imbalances that might allow unhealthy deals to be struck. This includes ensuring Chairman and board support for RemCo chairmen in standing up to pressures on pay. • This also includes, when recruiting/selecting top executives, being explicit about how their package is tied to achieving organisational effectiveness. (“Whenever you leave the organisation, X should have happened.”) • Good performance management disciplines should be at least as rigorously deployed at top team level as elsewhere in the organisation, and arguably should be setting an example. • Ensure that RemCo chairmen are equipped with the skills to play a leading role in linking organisational effectiveness to reward design, and to articulate the business justification of reward judgements to multiple and potentially sceptical stakeholders. • Ensure that the Board takes full responsibility for reward design – including any issues concerning complexity – in its dealings with reward consultants. Hire reward consultants for their ability to provide healthy challenge as well as technical experience.

Concluding words The vast majority of boards and leadership teams do care about the long-term effectiveness of their organisation – some with evident passion, not just because of pecuniary reward or exercising power. That concern shows up in risk management, investment in infrastructure, talent reviews, and a general alertness to what is going right or wrong within the organisation.

“The acid test for effectiveness is, would anyone care if the company disappeared?” “There’s often confusion between terms such as OD and OE. Effectiveness is not just about ‘lean’ either.” “The CEO’s personal proclivities tend to make a huge difference to how effectiveness is seen. That can’t be right.” “Round here reward does drive behaviours and what gets measured gets done – they interrelate, for right or wrong.” “Who in our boardrooms will stick their neck out and ignore short-termist pressures? It’s tough to break the cycle.” “Smart finance people will ask you ‘what profit do you want to declare’. Profit figures are endlessly misleading, particularly in financial services.” “If you spend your whole time sticking to rules and keeping your nose clean, you won’t be thinking much about effectiveness.”

However, our enquiries indicate that it is rare to find • leaders or board members with an explicit framework for assessing OE • sharp debates about different ways to view OE. Indeed, boards can be so busy with their workload and current challenges that they can struggle to play the role of a farsighted body calmly ensuring the organisation is prepared for the long-term. The raging debates on CEO pay are often framed around the idea that if only we ‘properly’ measured performance and properly paid for it – especially not paying for ‘failure’ – then everything would be fine. This debate is hampered by half-truths, and the danger that back-lash regulatory action will be circumvented and counter-productive.

5 RECOMMENDATIONS – LINKING PAY TO ORGANISATION EFFECTIVENESS

“Adaptability requires a willingness to abandon routines. In most industries there are few incentives to do so – hence change tends to be trivial or traumatic.” Gary Hamel

Some contributor observations (continued) “Rather more energy and ingenuity goes into ensuring bonus schemes pay out than into seeing how the organisation benefits.” “People in banks who turn down risky opportunities tend not to be rewarded.” “RemCos are now on the back foot all the time, defending every decision, trying to get nothing wrong. Yes, it would help if they could be on the front foot.” “There’s too much dashboard creation that takes place in head offices by people who are not close to the action.” “Search companies are conflicted, along with reward consultants. They benefit from appointees getting large pay packages, so why wouldn’t they use that in advising on ‘market rates’?!” “Companies aren’t oriented to hire reward advisers who argue with them. The truth is that shapes the way consultants do business.” “Organisations tend to measure what’s easy rather than the right things. Behaviours and capability aren’t always easy to assess, but they are what makes lasting difference.”

We argue that OE measures can and should play a role in executive pay. This is not necessarily about reducing pay but about demonstrating value for money – particularly when so many people’s pensions and livelihoods are under pressure. By transparently tying pay to objectives and outcomes that the vast majority would regard as beneficial – whether as an investor, customer, employee or neighbour – today’s corporations and their leaders could do much to diffuse the cloud of suspicion, and worse, that surrounds capitalist structures. This is not so much about finding clever formulae or particular KPIs as about honest dialogue on deliverables with stakeholders. This is now a social world which very quickly shares information, forms views and takes action – and unresponsive organisations are intrinsically in the firing line. Of course many organisations do indeed aim very publicly for excellence, and build stakeholder relationships into the way they manage and improve themselves. Yet statistics on organisational longevity show that only a minority manage to maintain standards and trust over the long-term, and stay true to sound founding principles. And we all observe and experience daily organisations that fall well short of expectations, and avoid making commitments whether out of fear or just evasion. Making it more the norm that organisations should be explicit about effectiveness – with their leaders putting their money where their mouth is – looks to us like good business sense. It might even help increase the pressure on many unsatisfactory state-administered organisations to do better.

6 APPENDIX 1 – STAKEHOLDER PERSPECTIVES

APPENDIX 1 STAKEHOLDER PERSPECTIVES Perspectives on effectiveness depend on what a particular stakeholder wants from the organisation. The chart below identifies the most common relationships a typical listed company will have.

Stakeholder relationships – listed companies ‘External’ owners

‘Internal’ owners Board, executive and employee shareholders

Active institutional investors

Private shareholders

Computer traders, hedge funds

Banks

Organisation

Governing board & RemCo Clarity of purpose, direction, identity, standards Executive leadership

Customers Local communities

Public

Government – local, national

Lobby groups

Employees

Industry regulators

Owners of organisations, logic would suggest, should be particularly interested in ensuring that they are effective. However, the nature of ownership and associated behaviours vary hugely (see Appendix 2). Customers. Increasingly vocal, demanding and flexing collective muscles, aided by social media. Interest/lobby groups. Growing sophistication in tracking and commenting on organisations' behaviour, for example regarding environmental performance and social impact, deploying performance indices and targets that are used to drive public commentary. Regulators. Can require organisations to behave in ways that – rightly or wrongly, wittingly or unwittingly – inhibit effectiveness. Regulators are created to encourage or enforce a conception of ‘good’. Yet we heard much about how concern to comply skews priorities and mentalities away from serving shareholders and customers well, even where regulators like to think they are striking a fair balance between interest groups. Public. Growing antipathy across society towards perceived 'self-serving capitalism', top executive greed and absence of social conscience, spurred by bad bank behaviour but spreading wider – and stimulating debate about organisations' core purpose. 35

6 APPENDIX 1 – STAKEHOLDER PERSPECTIVES

“Shareholder value is a dumb idea. Shareholder value is a result, not a strategy . . . It is the product of your combined efforts – from the management to the employees.” Jack Welch (FT 12.3.09)

Stakeholder pecking order For many years there has been discussion about which of three key stakeholders is the most important to satisfy in creating value – shareholders, customers or employees. • Famously Jack Welch of GE claimed that he started by placing shareholders first, then switched to customers, and finally focused on employees first. • This view of the value generation chain is certainly supported by advocates of employee engagement as a productivity and quality driver. • There are certainly some prominent CEOs who advocate a 'customer first' approach. • However we find widespread, continuing adherence at board level to the primacy of shareholder interests.

Business partners/contractors. Outsourcing and collaborative arrangements are commonplace. With customers not necessarily knowing whether they are dealing with an employee or not, the onus is on the organisation to ensure that it is effective and 'in control' whoever delivers its brand.

Shifting balance The impact of the media revolution on the world of work is changing the balance of stakeholder power. • Organisations are no longer in control of their own brand – they are on the defensive. Stakeholders are now interconnected as never before. • Reputation – positive or negative – could always have an impact on the financial health of the organisation. However, the breadth and speed of connectivity has expanded that potential impact considerably. • CSR has been for some organisations an optional extra, a nice-to-have. It is now increasingly risky not to be proactive and authentic, and harder for any business to stay out of the limelight. Trust has become a critical organisational asset, hard to win, easy to lose – internally and externally. An organisation that has not built a reputation for effectiveness will already be in deficit, particularly when trouble looms.

7 APPENDIX 2 – EFFECTIVENESS AND OWNERSHIP

APPENDIX 2 EFFECTIVENESS AND OWNERSHIP There is much talk of getting their executives to think/behave like owners – which feeds directly into debates about performance and reward. What are 'owners' like?

Some contributor observations

Let's look first at ownership of listed companies. We can observe considerable tension about how ‘value’ is maximised from the perspective of different owner types.

“Shareholders use blunt measurement instruments, lagging measures and imperfect information.” Simon Patterson

• Institutional investors, our contributors commented, with few exceptions have little interest in non-financial measures; they either don't believe, or understand how, the latter contribute to long-term sustainable value. Meanwhile the pressure on CEOs and boards constantly to address their share price is widely and strongly felt – and is criticised as short-termism. • Activist investors, eg Carl Icahn, aggressively challenge management teams to maximise value, chiefly by re-structuring. Their primary interest is to enlarge their own funds. There is little evident consideration of collateral damage eg to workforces or any sympathy for notions of long-term purpose. They argue that they target complacency and weakness, not sound companies. • Computer-based trading and hedge funds are felt to be disconnected from any serious estimation of organisational effectiveness – they are betting on share price movements. There is growing fear that algorithm-driven trading is moving beyond human control. It is hard to see how any of this relates to the concept of responsible stewardship. • Private shareholders, who ironically have less access to performance information, are on average more likely to hold stocks long-term. Some of that is inertia, but commonly it is also a sense of sticking with what they feel to be a well-managed asset – and thus more like the Warren Buffetts or Terry Smiths of this world than how many institutional fund managers are perceived. • Executive shareholders have 'skin in the game', an inside track, and direct responsibility for effectiveness. Yet to what extent are they thinking about their pockets rather than any organisational legacy? Employee shareholders' attitudes depend on whether they feel they have real influence – perhaps yes, in the case of John Lewis, but generally not in listed companies. • There are many styles of ownership and governance other than the UK and US models. For example in Germany, banks are active long-term investors, rather than transactional capital providers, and employees and trade unions are represented on supervisory boards – both should be interested in understanding effectiveness.

“The relentless focus on short-term results and share price clouds our view of organisational effectiveness.” Global head of organisational effectiveness. “Personal stakes drive decisions, but not always good ones.” Senior HR VP in private equity owned firm. “I believe that a company needs to act right, be that in relation to its employees, shareholders, partners, suppliers or the wider environment... I do not believe that profits and proper behaviour are mutually exclusive in business." Mark Smith, Co-founder & Chief Executive Officer, Quercus. “Anyone buying shares on a punt is not thinking about organisational effectiveness” Head of organisation effectiveness, global company. “Thousand of equity managers are under the cosh to achieve results. Only the exceptions, like Warren Buffett, are forgiven for a bad patch.” Head of reward, global company.

While much of the terminology and concepts about performance and pay relates primarily to large listed companies, rather more economic activity globally resides under other forms of ownership. • Family firms and partnerships include many organisations admired for their effectiveness over long periods, and typically have less issues about reward at the top. • Private equity has also been much lauded for inducing focus on the bottom line, although a 'them and us' approach to reward and focus on pay-out points can undermine long-term value. • Charities by their nature have to use resources efficiently, and the best of them are complex, professionally-run organisations that inspire commitment well beyond commercial firms. • Public sector organisations range hugely in form and quality, and are prone to suffer from poor governance – especially where politicians are involved – and tenuous commitment to serving the public. Similarly, reward policies range from the admirable – great work done without any bonus required – to shockingly poor, from vast overpayment to exploitative low rates that foster corruption. 37

8 APPENDIX 3 – POSING QUESTIONS ABOUT EFFECTIVENESS

APPENDIX 3 POSING QUESTIONS ABOUT EFFECTIVENESS Board committees and organisation effectiveness Organisational effectiveness is a subject that cuts across the business of all board committees. Here are just a few examples we have selected – there will be many more. • Audit committee – are our measurement systems sound and honest? • Risk committee – how does our risk framework underpin and monitor taking the right kind of risks to both drive and protect our business health? • Nominations Committee – how have we built effectiveness into our recruitment /selection of key executives, and in our talent strategy? • RemCo – how does effectiveness link to the design of rewards? How does reward policy interrelate with culture and risk? • HR Committee (common in the US) – how well does our human capital strategy and organisational effectiveness interrelate?

To add to the high level questions posed in our OE model in Chapter 3, here are some examples of more detailed questions that organisations boards and executive teams can devise to provide sharpness to their self-examination. There are many more topics that may be relevant to your organisation, but these may be helpful as a start – or, if relevant, a prompt to look again at the kind of questions already used in effectiveness reviews. Strategic scanning – are we effective in… • insights, not just data – seeing beyond the numbers the management team presents us? • keeping our finger on the pulse of the organisation? • seeing the competitive landscape beyond the lens that the organisation has traditionally used to view the world? • understanding the perspective of external stakeholders? Not just what they want now, but looking beyond to what they might want in future? • asking and persisting with tough questions, including about known unknowns and unknown unknowns? • translating the results of scanning into the way we plan and invest? Leadership depth – are we effective in… • identifying pivotal roles that have a big impact and are hard to fill? • taking action to build a deep bench for those pivotal roles? • taking action when leaders underperform or misbehave?

Note that some boards show they take certain subjects seriously by creating dedicated committees. For example, Standard Chartered Bank and 3i have Brand & Values Committees, concerned with reputation behaviour and standards, inter alia. AT&T has a ‘Public Policy & Reputation’ Committee with a somewhat similar remit. But why do so few boards give these important issues that degree of focus?

• actually building leadership, not just going through the motions? • developing all kinds of talent, so that we achieve healthy diversity all the way to the top? • matching types of leaders with different business scenarios and challenges – through the life cycle from start-ups to disengagement? • achieving leadership mastery of attributes that match the future of both organisations and their generation Y and Z employees – eg more social, democratic and agile? Culture – are we effective in… • assessing what aspects of our culture we must protect? • assessing what aspects of our culture could get us into trouble? • moving our culture in the direction we want it to go? • enabling our culture to be the powerhouse for lasting and continually updated effectiveness?

8 APPENDIX 3 – POSING QUESTIONS ABOUT EFFECTIVENESS

Customer orientation – are we effective in…

Is there rigour in the numbers?

• aligning culture, processes and performance measurement around customer satisfaction? • building a bank of good will and trust in our products and services? • anticipating customers’ future needs? • rewarding great customer service performance? Brand management – are we effective in... • investing in our corporate, customer and employer brands? • building trust across key relationships? • being proactive in managing our identity and reputation, and adapting this to the digital age? Investment effectiveness • Do we model the variability of potential returns rigorously, using 'triangulation' – eg a variety of analysis methods including DCF, sensitivity analysis, opportunity cost (of investing or not), depreciation etc – see the column • Do we factor in human systems issues, and other non-financial opportunities and costs?

Professor Henri Servaes challenges how rigorous some major companies are in valuing projects and assessing investment returns. He observes • Weakness in deploying assessment methods, including discounted cash flows (DCF) • too much ‘shading’ the numbers – adding something to gloss or expand the picture • over-optimistic rates of return – “they may want 25% rate of return, but such opportunities rarely exist; they make up the numbers to fit the goal.” Bluntly, he advises boards to beware ‘made-up numbers’, and to look for robust comparisons and scenario analysis.

• Do we fully scope out 'what if' factors in advance, and re-assess these periodically? • Do we conduct full and honest post-event reviews to learn what worked and what didn't? Learning – are we effective in... • knowing the capabilities we need for continued success and continually enhancing these? • seeking and using feedback to enhance our business? • maximising learning from experimentation, successes, failures and mistakes? • sharing knowledge to enhance productivity and innovation? • developing our ability to learn and improve as a source of competitive advantage? • measuring the quality, depth and speed of our learning, particularly in relation to the competition? Managing change – are we effective in... • smooth change: avoiding rushed, knee-jerk and disruptive decisions – and their harmful effects on productivity and stakeholder commitment? • anticipating the future in the way we design and develop the organisation? • supporting and empowering managers and employees to maximise improvement and the benefits of change? • shaping the collective capacity to regard change as both normal and intrinsically desirable? • developing leaders with both EQ and IQ, who can set the company up to compete and challenge both emotionally and technically? 39

8 APPENDIX 3 – POSING QUESTIONS ABOUT EFFECTIVENESS

Boards and the ‘difficult stuff’

Risk management • How clearly do we articulate risk appetite?

In addressing effectiveness, does your board skate over issues that get at the heart of the matter? “The real problem is boards’ reluctance to venture out of ‘the area of comfortable debate’”, comments Murray Steele, Professor of Business at Cranfield. He says they typically spend 97% of their time on “the easy stuff” – takeovers, new strategies, new products and new geographies – and just 3% in “the area of uncomfortable debate”, discussing more dangerous challenges such as underperformance, conflict and individual incompetence. Some aspects of pay clearly fit in this ‘difficult’ category. Research by fellow Cranfield professor Andrew Kakabadse across 12,000 European boards revealed an average of under 5 hours a month devoted by non-executives to any one board. Apart from anything else, this means they don’t know each other or the company well. “Most understand the critical issues facing them; they are just unable to tackle them head on.” Whatever the reasons for inhibitions on board debates – eg size, dynamics, power imbalances – inadequate checks and balances at the top means ultimately that the effectiveness of the whole organisation is liable to be impacted, sooner or later. The last five years has seen an explosion of guidance on board effectiveness. Has it permeated your board?

• Do we focus principally on creating the right risk culture or on controls? • Do we understand risk management as being as much about judgement of good opportunities as preventing bad things? • Do we enable the first line of risk defence – front-line managers and staff – to play their full and responsible part in managing risk? Or do we try to manage it just from the ‘centre’? • Are our risk experts as attuned to human systems and behaviour as they are to measurement and procedures? Innovation – are we effective in... • creating the right environment for ideation? • developing skilful leadership of innovation – eg inspirers, facilitators, talent managers? • our process of selecting potential winners (products, services, processes, investments)? • exploiting and maximising the potential or innovation? • structuring the organisation to foster continuing innovation? • collaborating successfully with external sources of ideas and innovation? Digital competence – are we effective in... • anticipating and adapting to new technologies in terms of their impact on strategic choices, ways of working ? • developing common data platforms that also allow flexible, tailored usage, in order to support productivity, collaboration and innovation? • managing different generations and orientations to technology in order to align behaviour? • managing security challenges without undermining productivity? • integrating and enhancing our ability cross-functionally in using data to achieve powerful competitive advantage, business enhancement and cost savings?

9 APPENDIX 4 – ORGANISATIONAL HEALTH CHECKLIST FOR BOARDS

APPENDIX 4 ORGANISATIONAL HEALTH CHECKLIST FOR BOARDS For boards seeking to detect and address organisational illness, here are some systemic failings that cripple effectiveness. • Bloat – the organisation adds layers and head-count, for example as a result of empire building by individual managers. • Sloth – the organisation has been comfortable in its niche and moves slowly; tendency to maintain the status quo, uninterested in new ideas or challenge. • Loss of focus – diminishing alignment of activity to purpose, complexity replaces clarity, multiplication of disparate initiatives, becoming subject to fads and enthusiasms • Lost Mojo – the organisation loses energy, drive and direction. In some industries – eg technology – this means you are in trouble long before you can become slothful. • Bureaucracy – rules, guidelines and norms become about prevention not enabling; processes for processes' sake; petty power and/or fear undermines service to both internal and external customers; risk prevention displaces good risk-taking and entrepreneurialism. • Over-confidence – companies may interpret a run of good luck as evidence they can do no wrong. Rigour in self-analysis evaporates. Thence they develop hubris and arrogance, take on undue risks, or bite off more than they can chew – eg M&A, new market entries, IT projects. • Non-delivery – once standards are allowed to slip, for whatever reason, the rot can spread into the culture, and not caring becomes more normal. In truly competitive scenarios, this quickly translates into organisational damage; in imperfect markets, less so. It always indicates management who are out of touch, or who themselves don’t care – so why should anyone else. • Waste – excessive losses of various kinds. Causes include employee disengagement, or alternatively getting ‘soft’ due to too much success; also over-straining the system, or overly ambitious targets can drive up attrition of people, goods, and money. • Corruption – where unethical behaviours become tolerated, organisations can fall prey to endemic corruption. Bad behaviour in banking and pharma is currently in the spotlight. What looks like waste can also turn out to be ‘a little bit on the side’. • Leadership vacuum – CEOs, to protect their own power, or simply out of personal style, create a power vacuum below them, weakening the organisation and creating a potentially dangerous position when they need to be replaced. • Leadership toxicity – when leaders become too powerful. Some may indulge in narcissism, bullying and other abusive behaviour. Simply being in situ for a long period can generate toxic 'follower' behaviour, through over-deference, fear of replacement (even on boards). • Leadership clash – powerful leaders develop personal dislike to the point it impedes effectiveness, which leads to division and paralysis. • Baronries – local power structures build local silos, due to natural human tendencies for individuals to create power bases, and also due to lack of a clear central purpose, drive and personal leadership example. Such silos often start within the top team itself. • Loss of transparency – attempts to control, not facilitate, information flows; slow and obfuscatory leadership communication, building sense of 'them and us'; people can't speak frankly about issues; feedback unwelcome; ideas don't get shared, collaboration and teamwork suffers; mistakes get hidden and bad news buried. What would you add? 41

10 REFERENCES AND FURTHER READING

REFERENCES AND FURTHER READING References Alimo-Metcalfe, B & Alban-Metcalfe, J – The ‘need to get more for less’: a new model of ‘engaging leadership’ and evidence of its effect on team productivity, Chartered Management Institute Management Articles of the Year, 2012 Buffet, W – Berkshire Hathaway Shareholder letter, 2005 Cowell, R– Looking from the outside in – investors and performance, PARC private meeting notes, 23 March 2011 Deloitte – Directors remuneration in FTSE 100 companies – the story of the 2013 AGM season so far Financial Times– Shell boss calls for pay reform/ Executive rewards, for what, 9 June 2009 Grant, A – An upfront bonus pays over the long term, Financial Times, 5 August 2013 Immelt, J – Money and morals at GE, Fortune 64-8, November 2004 Jacquart, P – quoted in High pay does not equal high quality, Financial Times, 19 May 2013 Main, B – What makes remuneration committees effective, Towers Watson, 2012

Ghoshal, S and Bartlett, CA – The individualized corporation, Harper Business, 1997

Pitman, B – Leading for value, HBR magazine, April 2003

Hamel, G – What matters now - how to win in a world of relentless change, ferocious competition, and unstoppable innovation, Jossey-Bass, 2012

Polman, P – Unilever annual report 2012 Salz, A – An independent review of Barclays’ business practices, April 2013 Schneider, M – Quarterly reports come too late for modern investors, Financial Times, 22 July 2013 http://www.ft.com/cms/s/0/5e1a44a6-e7d5-11e2babb-00144feabdc0.html#axzz2e13Izh98 Street, A – BBC interview 2012, http://news.bbc.co.uk/2/hi/programmes/hardtalk/9 710913.stm Taleb, NN – Antifragile – things that gain from disorder, Random House, 2012 Towers Watson – Talent Management and Rewards Pulse Survey 2013 Vasella, D – Fortune 67-71, 18 November 2002 Winby, S – Perspectives from Silicon Valley, presentation to CRF international conference, Madrid 2013

Manifest/MM&K, Remuneration Survey 2013