Responsible governance and Human Resource Management: the connection
Responsible governance and Human Resource Management: the connection Russell Connor Lehman Brothers, Royal Bank of Scotland and Northern Rock fulfilled their fiduciary duties without abuse or corruption. However, the truth is that they lost vast amounts of money entrusted to them. It seems that even in regulated markets with overseeing bodies and largely ethical, if misguided executives, it is possible to destroy investment, savings and assets on a scale vastly greater than those that set out to rob and defraud. These companies may have been compliant with all the necessary regulation and legal duties, but no one could really say that their highly risky actions amounted to responsible governance. For many, the wholesale value destruction that we have seen in the credit crunch is an inevitable consequence of riding the waves of change. Boom and bust is just inherent in the system.
organisational design can weave corporate citizenship, purpose, personal ownership of accountabilities and responsibility into the very fabric of the organisation. With good organisation design, governance can move from a focus on compliance with external standards to responsible self-governance. Here there are direct parallels with Quality Management. Quality control was a cost until the 1960s and 1970s when the Japanese showed how to make it a very positive sales point/benefit, and revolutionised their companies in the process. Those which had excellent quality, survived; those that didn’t, disappeared. Today, there is a way of moving away from compliance as simply a rule-based exercise to excellent governance. This provides a strong point of differentiation and a way of maximising the opportunity for corporate survival through the uncharted waters of the future.
For others, the answer is that responsible governance of vital institutions is impossible and, as such, it will be necessary to nationalise these, or at least exert such control that risks are managed very tightly.
Emerging lessons from the credit crunch
However, responsible governance is achievable and HR’s remit to design and build fit-for-purpose organisations is absolutely central to the task.
Major corporations reviewed their governance structures and developed departments covering corporate and social responsibility. Industry watchdogs such as the Financial Services Authority (FSA) were given extensive resources and powers to ensure compliance. The roles of non-executive directors were reviewed and board sub-committees were established to address important matters such as executive remuneration.
Is there a connection between HR and governance? The connection between HR and governance may not be obvious; there is though a direct link. It is our contention that behaviour is a by-product of organisational design. Good
With the bursting of the dotcom bubble and the subsequent fall from grace of many large institutions, the management of risk and corporate governance became the name of the game.
However, the credit crunch seemingly makes the dotcom crash look like the froth on the top of a derivative trader’s daily cappuccino. The inquest has yet to fully establish how, with all this governance, there could have been such wholesale value destruction. If the inquest seeks to apportion blame, it will come up against a major stumbling block. What makes governance so difficult in public limited companies is that the ultimate body for holding people to account for the actions and outcomes of companies is the shareholders. However, in the case of most banks and publicly owned financial institutions, this was the body least likely to ask the searching questions that needed to be asked before the crunch. If there were people pointing out that debt was too cheap and assets too pricey their voices were drowned out by the stampeding hooves of investors hungry to get to the watering-hole. In the cases where shares have joined the 90% club (ie were worth less than 10% of their peak) investors are keen to point the finger. Yet this illustrates the dilemma with accountability in public limited companies. Accountability is not just cascaded from the board to the executive and then on down through an organisation, along with appropriate authorities. Accountability
Developing HR Strategy July 2009
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Responsible governance and Human Resource Management: the connection
can also be seen as “rolling-up”. This upward cascade is rarely considered. Accountability for managing the assets of any public company moves up to the CEO, then to the board, then to the pension and mutual-fund trustees and finally to the investor beneficiaries who provided the capital to fund their retirement living. Just as in the dotcom boom and bust, the accountability for setting the appetite for high risk strategies has to rest with the individuals and bodies that were sending the message to the CEO (sometimes by omitting to voice a concern) that risking everything for a high return was acceptable. The pressures that shareholders exerted are evident in the creditcrunch. In the months before the onset of the present troubles no-one questioned the rise of Northern Rock. Certainly not the FSA! However, Lloyds TSB had begun to come under fire for its old fashioned approach of taking in savings and recycling them as loans, ie normal banking business. Other banks had aims to significantly increase shareholder value through more speculative means and Lloyds TSB was considered by many to be failing its shareholders through timidity. Investors need to be careful about pointing the finger. Remember, when you do so four fingers point back at yourself.
A microcosm A thorough investigation of the failure of Northern Rock is likely to reveal a microcosm of wider issues. Such an analysis is likely to show a range of problems that together could only end in one outcome. These include the following. • The breaking of the link between profit generation and longterm value. • Performance plans and incentive schemes promoting only short-term gains. • Business models that only worked in growth periods not being balanced by risk assessment. • Investors that asked very few difficult questions as they were happy to see rapid share-price gains. Formerly a Building Society, Northern Rock was formed as a bank in 1997 when the society floated on the London Stock Exchange. Northern Rock joined the stock exchange as a minor bank. By the year 2000, having taken a much more aggressive position in the market, it gained promotion to the FTSE 100 index. By 2006 the bank had moved into sub-prime lending via a deal with Lehman Brothers. Whilst all the signs proved to be positive when the economic waters were rising, clearly the falling of the tide has exposed one bank, among many, as swimming without any trunks on. The highest value that a company’s board can add is to ensure the long-term viability of the organisation in social and economic terms. However, clearly this was not uppermost in the minds of those steering the passage of Northern Rock. Making profits and improving shareholder value (ie keeping shareholders happy) in the short term seems to have been the ultimate goal. This is evidenced by the business model itself. This was based on
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“borrowing short and lending long”. Such a strategy works when money is cheap and plentiful but would always run into trouble if and when conditions changed. The short-term nature of the strategy is reflected in the compensation plans for the senior executives. CEO, Adam Applegarth was paid £1,364,000 as stated in the 2006 accounts, of which £660,000 was bonus related. These same accounts made much of the new long-term incentive plans which were largely geared to total shareholder returns over a three-year performance period. Northern Rock achieved what it set out to achieve, namely spectacular short-term profits. One of the lessons is clear — you get what you pay for. Another is that investors are not the best body to ask the difficult questions except post melt-down and that is a tad too late. It is clear that short-term thinking and an obsession with increasing the share price is potentially a self-destructive combination.
What is missing? What of responsible governance? Many, especially those hurt by the recent events, will say that greed is inherent in the very fabric of the system and that the only way to control this is through external measures, regulatory bodies and statutory changes. Their argument is made more powerful when combined with an analysis that the ultimate sanctioning body, ie the shareholders, are complicit in the wholesale destruction of value and livelihoods. However, control and red tape does not seem to have worked in the past, and large-scale nationalisation is also a failed concept. So, before we throw the baby out with the bathwater we had better quickly discover other means to ensure responsible self-governance.
July 2009 Developing HR Strategy
Responsible governance and Human Resource Management: the connection
A great deal of focus has been given to how public institutions conduct public affairs, manage public resources, and guarantee the realisation of human rights. Professor Mark Bovens of the University of Utrecht, among many others, has written extensively and well on the subject. His analysis starts with understanding what is meant by “responsible”. “To be responsible” — the term, both in its Germanic and Romance origin, suggest the notion of giving an answer, respondere. It is an answer in the sense of giving account, justifying oneself or defending oneself against an accusation. The core of responsibility is that I can be asked the question, “why did you do it” and be obliged to give an answer. Responsibility therefore, as expressed in terms of being held to account, has a backward looking quality to it. What is also inherent in the word responsibility, but is so often lacking, is the expression of holding accountability as a virtue — of being responsible. Being responsible is not an isolated event. It has to be intricately woven together with a sense of purpose and a value-system. Professor Bovens has drawn on areas of political philosophy, sociology and law and has developed frameworks that are particularly suited to the governance of public bodies. Through his thorough analysis he suggests that responsibility could be a by-product of organisational design. Unfortunately for those studying the subject there is something vital missing in social and management science; namely, a commonly held best practice that encompasses sound and universal principles of good organisational design.
What can be put in place Surprisingly, a complete theory regarding organisation design and the setting of responsibilities and allocating accountabilities is available. We just have to start using it. The lineage of this theory goes back more than 30 years to the original work of Elliott Jaques and Wilfred (Lord) Brown. The now late Professor Elliott Jaques, who founded the Brunel Institute of Organisation and Social Studies (BIOSS), described work in terms of complexity and defined a series of valueadding levels. The late Wilfred Brown as head of Glacier Metals provided the opportunity for these principles to be tested and they continue to be tested in pockets to the present day. The evidence from the implementation of the theories gives weight to Jaques’s assertion that; The most far-reaching, dramatic and rapid changes in the behaviours of individuals in organisations can be achieved by changes in organisation structures, the setting of appropriate accountabilities and creating the right space in which people can express rational and trustful behaviour.
Summary Making the distinction between responsibility as being held to account and responsibility as a virtue as Professor Bovens does is not just semantics. Utilising the distinction is the corner-stone
Developing HR Strategy July 2009
of good governance and working this through can act as the counter-weight to the obvious knee-jerk reactions aimed at preventing future collapses. Most, if not all, of these reactions are expensive options that are likely to impede wealth generation rather than simply managing-out the risk. Setting up expensive regulatory bodies and introducing red tape is not going to cure the problems caused by a focus on shareholder value and the short tem. What is needed is the clear allocation of executive responsibilities, accountabilities and balanced measures that enable the long-term success of an enterprise. Good organisation design provides the basis for a move from compliance to responsible self-governance. This transition can use as its model the move from quality control to Total Quality Management that Japanese companies so effectively implemented. Product quality used to be maintained by strict control and checking functions. Total Quality Management taught companies how to weave quality into all processes and quality control was effectively made redundant. When corporate citizenship, purpose, personal ownership of accountabilities and responsibility is woven into the very fabric of the organisation, boards and CEOs can even start to educate their shareholders! Investors need to know that there is not a simple and direct relationship between profit and long-term value and that an obsession with minute share-price movement is like any other obsession – pointless and potentially self-harming. Through this the investors may begin to understand that if they demand good governance, the share price will look after itself. Once accountabilities, together with a balanced set of measures, are clear, boards and shareholders can then hold executives to account for the decision-making process and the cascade of strategic intent into operational reality.
References Bovens M, (1998) The Quest for Responsibility, Accountability and Citizenship in Complex Organisations. Cambridge University Press Jaques E, (1998) Requisite Organisation. Cason Hall
Points to ponder • To what extent are people held to account for their actions in your organisation? • How can HR contribute most effectively to good governance in your view?
Russell Connor is the Managing Director of Dynamic Link (www.dynamic-link.com). Dynamic Link uses a Levels-of-Work framework to help build organisations that last.
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