Rotman Management, Winter 2017 by Rotman School of Management

How to Deal With Activists

Walmartâ&#x20AC;&#x2122;s Approach to Sustainability

Smart Power Personified

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MANAGEMENT WINTER 2017: SMART POWER

While the last wave of globalization focused on accessing foreign markets and creating low-cost global supply chains, the next wave could follow a very different pattern. GE CEO Jeff Immelt—shown speaking at a forum on African innovation—has said it will be more cognizant of social impact and the importance of building capabilities rather than exploiting labour cost differentials. For its part, GE will invest about $2 billion in Africa by 2018 to expand in what Immelt calls “one of the world’s most promising markets.”

Features

Shareholder Activism: This Changes Everything!

Tackling Inequality: The Challenge for Corporate Leaders

by David R. Beatty

by Rich Lesser, Martin Reeves and Johann Harnoss

By embracing three principles, directors and executives alike will be better prepared to navigate the challenges posed by activist shareholders.

If business leaders don’t step up to shape a more positive future, they risk a backlash that will limit their ability to create value going forward.

Walmart’s Journey to Sustainability by Sarah Kaplan

Walmart’s Chief Sustainability Officer describes the retailer’s (somewhat surprising) journey to leadership in the sustainable business arena.

Investing for a Sustainable Future by G. Unruh, D. Kiron, N. Kruschwitz, M. Reeves, H. Rubel and A. Meyer zum Felde

MIT and BCG present findings from their 2016 Global Executive Study, showing that sustainabilityrelated data has become a rationale for investing.

Collaborative Innovation: How to Avoid the Four Traps by Alessandro Di Fiore, Jonas Vetter and Devan R. Capur

Successful B2B collaborations demand a co-designed problem statement, agreement around time horizons and — above all else — empathy.

The End of Accounting? by Baruch Lev and Partha Mohanram

In The End of Accounting, Baruch Lev makes some bold statements about the future of financial reporting. Rotman Professor Partha Mohanram responds to some of his more provocative statements.

Health

Sustainability

Housing

Education Agriculture

Environment

Managing Conflict Constructively by Karen Dillon

Most disagreements in the workplace stem from one of three sources: different agendas, different perceptions and different personal styles. Here’s how to work through all three.

Youth Unemployment: Confronting the Elephant in the Room by W. Seldon, K. Smith Milway, S. Morfit and B. Bills

A number of well-known companies are developing innovative approaches to address high rates of youth unemployment.

Winning the Brain Game: Fixing the Seven Fatal Flaws of Thinking by Matthew E. May

Toyota’s former creative advisor explains how to re-frame problems and avoid seven common—and sometimes fatal — thinking flaws.

Impact Investing: Tracking the Adoption of a Financial (and Social) Innovation by Roger Martin and Rod Lohin

If impact investing can address current barriers to adoption and play up its key strengths, it will be one of the breakthrough innovations of our time.

When Expertise Becomes a Liability

Introducing Catalytic Governance

by András Tilcsik and Juan Almandoz

by Patricia Meredith, Steven Rosell and Ged Davis

Although domain experts are often touted as being invaluable to decisionmaking groups, when uncertainty exists, they can actually increase the likelihood of failure.

‘Catalytic Governance’ provides rich opportunities for participants to learn from one another and construct a common vision for collaborative action.

Rotman Management Winter 2017 Rotman Management is published in January, May and September by the Rotman School of Management, University of Toronto. ISSN 2293-7684 (Print) ISSN 2293-7722 (Digital)

In Every Issue

Editor-in-Chief Karen Christensen

Contributors Steve Arenburg, David R. Beatty, Claire Celerier, Craig Doidge, Alexander Dyck, Ole-Kristian Hope, Sarah Kaplan, Rod Lohin, Roger Martin, Partha Mohanram, András Tilcsik

From the Editor

Thought Leader Interview: Mark Wiseman (MBA ‘96)

Sales & Circulation Associate Lori Mazza

by Karen Christensen

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Idea Exchange “When power is used poorly, it exacerbates the distance between the top and the bottom.”

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QUESTIONS FOR Jesse Sostrin

QUESTIONS FOR Ann Kaplan (MBA `05)

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FROM THE EDITOR

Karen Christensen

Smart Power UNTIL RECENTLY, THE MODEL OF INFLUENCE in society was based on the belief that the interests of those in power were connected to those of the broader public — and that if someone worked hard enough, it was possible to ‘climb the ladder’. But today, rising income inequality, high-profile corporate blunders and the democratization of media have flipped the classic pyramid of influence — to a point where people now trust their peers more than they trust those in power. That according to the 2016 Edelman Trust Barometer, which asked 33,000 people worldwide how much trust they have in four institutions — government, business, NGOs and the media — to ‘do what is right’. The results: in more than 60 per cent of countries, the general population’s trust in institutions is below 50 per cent. What exactly do people expect from today’s business leaders? A whopping 80 per cent of respondants expect them to increase profits while at the same time, improving economic and social conditions. Among the ‘most critical’ issues for business to address: access to education and training, healthcare, the environment, human rights, income inequality, maintaining infrastructure and reducing poverty. A new breed of CEO has emerged to embrace this challenge. They include Paul Polman at Unilever, with his focus on the environment; Howard Schultz at Starbucks, who is working on youth employment; Cyrus Mistry of Tata, who is making strides in education; and Jack Ma of Alibaba, who is tackling inclusion. In this issue we put the ‘smart power’ displayed by these and other leaders in the spotlight, and present some of the key approaches and mindsets that are fueling this trust-enhancing movement. We kick the issue off on page 6 with, Shareholder Activism: This Changes Everything!, where the head of the Rotman School’s Clarkson Centre for Business Ethics + Board Effectiveness, David R. Beatty, argues that a revolutionary phenomenon in global capital markets is about to change everything in the boardroom — and no publicly-traded company is immune. Societies the world over are being fundamentally challenged in ways we have not seen for decades — with nationalis-

tic rhetoric and agendas from the far right and a deep distrust of business, globalization and technology from the far left. On page 20, Boston Consulting Group CEO Rich Lesser and his co-authors look at the road ahead in Tackling Inequality: The Challenge for Corporate Leaders. If Walmart were a country, it would rank 28th in the world in GDP — right behind Norway and ahead of Austria. Its stores use five times as much electricity as the state of Vermont, and emit more CO2 than the 50 lowest-emitting countries combined. On page 26, Rotman Professor Sarah Kaplan interviews Walmart’s Chief Sustainability Officer Kathleen McLaughlin, to see what the retail giant is doing about it. Elsewhere in this issue, we feature Rotman MBA alumnus Mark Wiseman in our Thought Leader Interview on page 12; and our Idea Exchange features PwC leadership expert Jesse Sostrin, good-governance pioneer Claude Lamoureux, and Rotman faculty members Claire Celerier, Craig Doidge, Alexander Dyck and Ole-Kristian Hope. As Dan Markovitz points out on page 126, when power is used poorly, it exacerbates the distance between the top and the bottom. The good news is, many of today’s leaders want to exercise smart power. Increasingly, they recognize that trust will no longer be granted automatically on the basis of hierarchy or title. In today’s world, trust must be earned. Whether you are just getting started on this path or are on your way to making it a reality, we hope you will find some useful tools and ideas in this issue.

Karen Christensen, Editor-in-Chief editor@rotman.utoronto.ca Twitter: @RotmanMgmtMag rotmanmagazine.ca / 5

SHAREHOLDER ACTIVISM:

This Changes Everything! A revolutionary phenomenon in global capital markets is changing everything in the boardroom; and no publicly-traded company is immune. by David R. Beatty

ON THE EVENING OF OCTOBER 28, 2011, Canadian Pacific Railway Vice-President Paul Guthrie and a senior team were travelling across Canada, touring the company’s facilities, when Paul received a call. CP’s legal advisory firm had heard a rumour: activist hedge fund Pershing Square Capital Management (‘Pershing’) was buying up CP stock — and had surpassed the five-per-cent threshold requiring it to notify the Securities and Exchange Commission (SEC) of its activity. Headed up by William Ackman, Pershing was a private, U.S.-based hedge fund that took positions in companies it considered to be under-valued. With US$7.78 billion in assets under management, it had already made investments in Target, Kraft Foods, J.C. Penney, Citigroup and Wendy’s — where Ackman had forced the sale of its Tim Hortons operations. Unbeknownst to CP’s senior team, earlier that year, a group of 20 portfolio managers from different firms had assembled at an upscale Manhattan restaurant to discuss “financial opportunities in the transportation sector”. At the dinner, one of the attendees had initiated a tirade against CP’s CEO, Fred Green, suggesting that he was incompetent, and that an activist

investor should pressure the Board “to do what it should have done long ago.” An associate of one of the attendees that night was Paul Hilal, a partner at Pershing who knew a lot about CP. Through a flurry of subsequent phone calls and discussions, Pershing gathered key information, numbers were crunched and a battle plan was set in motion. By fall of 2011, Pershing was ready to make its biggest play ever: a $1.4-billion bet on CP, including a plan to replace Green with retired industry legend Hunter Harrison, former head of CP’s rival, Canadian National Railway Co. Pershing’s focus was on CP’s performance over the last few years, as reflected in a simple statistic: the operating ratio (operating costs as a percentage of revenue) as a measure of efficiency. In 2011, CP’s number was 81, in contrast with CN’s, which was 63 — a target that Pershing believed CP could achieve, under Harrison’s leadership. During the fourth quarter of 2011, various members of the CP Board met with Ackman to discuss his interest in CP. They even offered him a seat on the Board on the condition that rotmanmagazine.ca / 7

Today’s activist campaigns are often based on an alternative view of corporate strategy.

Pershing did not increase its share ownership beyond the approximately 14 per cent that it already held. As reported by The Globe and Mail, on January 4, 2012, John Cleghorn — former chairman/and CEO of the Royal Bank of Canada and director of several large Canadian corporations, including CP — received the following e-mail from Ackman: From: William A. Ackman Sent: Wednesday, January 04, 2012 7:22 AM To: John Cleghorn Subject: War and Peace John, I woke up early this morning thinking about my favourite Canadian railroad and it is causing me to become more interested in military history. We have had what the historians would likely call a border skirmish. It is not clear who fired the first shot, but a few people have been hurt, some egos have been bruised, and the arms dealers (the media) are calling for and attempting to gin up a fight. When a border skirmish takes place, sometimes it leads to full out war and other times, things die down, borders are redrawn and peace can remain in both lands. The choices as I see them are (1) representatives from our side and your side sit down and work this out promptly. Working it out, in my view, means the quick addition to the Board of two representatives from our side, and Hunter’s hiring as CEO. The second alternative is that we will be forced to launch a proxy contest for the upcoming annual meeting, where we will seek to replace a greater number of the existing directors with extremely highly regarded business executives who share our belief that management and board change is necessary at CP. In the proxy contest, as a first step, we will take the largest public hall you have available in Toronto and will make a presentation to shareholders and the public (which will be simulcast on the Internet) about management and board failure over the last 10 years at CP. This proxy contest will not go well for the Board and Fred. The track record is very poor, shareholders are disgruntled, and we are offering an alternative with a legendary reputation. We will win the election, likely by a landslide vote. 8 / Rotman Management Winter 2017

War is also not inevitable. I would like to resolve this situation amicably in the best interest of shareholders as I am sure you would. To throw out alternative ideas, I am open to not serving on the Board as long as I am comfortable that we are adequately represented by directors that we designate (that of course you have to approve) and we are comfortable with the composition of the rest of the Board. Let’s avoid having a border skirmish turn into a nuclear winter. Life is too short. Please call me when you can. While Pershing had not launched a formal proxy fight, the email clearly indicated that it was prepared to do so unless CP met Ackman’s demands. Following is Cleghorn’s response: From: John Cleghorn Sent: Wednesday, January 04, 2012 05:47 PM To: William A. Ackman Subject: CP Bill, Thank you for your email and for your phone message. Let me reiterate that we would like to reach an agreement which advances the best interests of the company. As you will appreciate, I will be discussing your email with my board. Best regards, John The end result: without having to resort to a proxy fight, Ackman’s crew became directors. At the time of writing, CP’s operating margin had dropped to below 60 per cent and its share price had approximately tripled. The Origin of the Species

In the 1980s and 90s, funds that attacked publicly-traded companies were known as ‘corporate raiders’, and their tactics involved shin-kicking and mudslinging. These attacks were brash and brutish, and usually linked to the ‘slash and burn’ style of transformational change. Fearing the reputational risk of being associated with a ‘raider’, both passive and active asset managers tended to stay clear of such nasty attacks. At the time, the money managers likely didn’t believe that any activist fund had

Tracking Activist Campaigns Half-year (blue) and full year (pink) number of companies subjected to activist demands:

637 548 473 405 338 done more than a cursory study of the target and its competitors to determine what might be done differently. Today, these funds are called ‘activists’ or ‘constructivists’, and they have gained respectability, as their campaigns are most often based on an alternative view of corporate strategy — developed with significant investments of time, talent and money. Indeed, it is estimated that Ackman spent ~US$20 million studying CP before approaching other investors, and ultimately, the company. The approach to the publicly-traded company is a debate centred on, ‘How should this business move forward?’, rather than being carried out with public acrimony. As a result of these changes in behaviour, previously aloof fund managers are now taking an interest in these ‘alternative strategy’ points of view. Willing to listen, they might well agree that the performance of their mutual funds and exchange-traded fund shares could well be advanced by such thinking and action. This has resulted in a number of huge funds getting involved in some transformative campaigns. The game-changing result: trillions of dollars — yes, trillions — are now being mobilized to improve the strategies and the performance of publiclytraded companies. The convergence of activists with formerly passive investment funds has created what the markets call ‘wolf packs’, hunting together to bring down their prey or transform a company’s strategy. Whether executives and board members like it or not, hedge fund activism has become a characteristic of the corporate landscape. Last year alone, some 637 campaigns were mounted worldwide, and pundits expect in excess of 700 this year. And these are just the campaigns that are made public: there are probably at least as many that never see the light of the press due to a settlement between the activist and the target company’s board. As a result, the media has been increasingly referring to the current era as the ‘golden age of activist investing’. There are now estimated to be approximately 400 ‘activist funds’ around the globe, mainly centred in the U.S., and new firms are sprouting up in local markets. In Australia, there is Sandon Capital, which is probably the biggest activist in terms of the number of companies it targets. Additionally, funds such as Thorney Opportunities and Allan Gray have targeted multiple Australian issuers since 2010. In Canada there are the likes of West Face Capital, Front Four Capital Group, Jaguar

2014

2015

2016

Companies subjected to activist demands in 2015 by market cap:

23.0% 23.0% Nano-Cap Large-Cap 15.4% Micro-Cap

22.3% Mid-Cap

16.4% Small-Cap Charts courtesy of Activist Insight Monthly. FIGURE ONE

Financial Corporation and Smoothwater Capital, all of which are regarded as activists and frequently adopt an activist stance. Hong Kong-based companies are a little harder to determine, as a lot of the activities are typically taken by smaller firms which have adopted an activist position on a ‘one-off ’ basis. The most frequent activist here is Elliott Management, which has publicly subjected three Hong Kong-based companies to activist demands since 2010. rotmanmagazine.ca / 9

Last year alone, some 637 campaigns were mounted worldwide, and pundits expect in excess of 700 this year.

Big Fund Involvement $5.1 trillion

8 Campaigns

$889 billion

9 Campaigns

$487 billion

8 Campaigns

$414 billion

8 Campaigns

FIGURE TWO

Hedge fund activists have sought a wide range of changes to the strategy and management of companies — ranging from divesting assets, to changing executive compensation to replacing the CEO. Of course, developing strong opinions on such matters requires first acquiring a substantial amount of company-specific information. Activists often hold a significant stake in the targeted company and hope to benefit from the appreciation in its value that they believe would result from implementing the change. In addition to seeking such ‘operational’ changes, activists often seek governance changes in how the company is run or personnel changes in its leadership. Critics of hedge-fund activism express concerns about certain types of changes that might be induced by ‘myopic activists’. 10 / Rotman Management Winter 2017

They worry, for example, that activists will pressure companies to make cuts in research and development expenses, market development, and new business ventures, simply because they only promise to pay off in the long term. Former Medtronic CEO Bill George has stated that the essential problem is that activists’ real goal is a short-term bump in the stock price: they lobby publicly for significant structural changes, hoping to drive up the share price and book quick profits. Then they bail out, leaving corporate management to clean up the mess. To escape from activists and also from rampant short-termism in public markets — a phenomenon attacked by McKinsey global leader Dominic Barton and former Canada Pension Plan Investment Board CEO Mark Wiseman — many companies are going private. A classic example is DELL, whose CEO Michael Dell has said : “As a private company DELL now has the freedom to take a long-term view: no more pulling R&D to make quarterly numbers; no more activists hijacking our strategy; no more short-term trade-offs for long-term health.” His recent $63.4 billion bid for EMC was “only possible [because we were] private.” But as indicated by the CP example, the end result of activism can also be positive. The fact is that activist firms come in all shapes and sizes, with some orienting themselves to short-term turnarounds — i.e. ‘slash and burn’ — and some to longer-term transformations. An example of the former would be Agrium in Canada, which successfully fought off Jana Partners, arguing that it would destroy billions of dollars of shareholder value. On the other hand, a significant investment of 10.8 per cent in the British firm Rolls Royce was made by ValueAct after a series of profit warnings seriously weakened its stock. In March of 2016, ValueAct COO Bradley Singer was appointed to the Rolls Royce Board. Its Chairman, Ian Davis — the former global head of McKinsey & Co. — declared that there would be “no change in strategy.” Another recent blockbuster case occurred in December of 2015, when DuPont declared its intent to merge with Dow and then split into three pieces. The driving forces behind the decision to merge two of America’s most venerable firms (DuPont was founded in 1802 and Dow in 1897) were Nelson Pelz’s

Tracking CP’s Operating Ratio 90

Hunter Harrison CP CEO

95 80

62.1%

Hunter Harrison CN COO

Hunter Harrison CN CEO

65 60 ‘96

61.0% ‘97

‘98

‘99

‘00

‘01

‘02

‘03

‘04

‘05

‘06

‘07

‘08

‘09

‘10

‘11

‘12

‘13

‘14

‘15

FIGURE THREE

Trion Fund on the Dupont side, and Daniel Loeb’s Third Point Fund on the Dow side. The announcement to merge was made by the two CEOs, Edward Breen (newly-appointed DuPont CEO) and Dow’s Andrew Liveris; but the decision to merge and then split was most likely made behind the scenes by Pelz and Loeb. It’s not just large corporations that need to pay attention: in addition to extending their global reach, activists are also drilling down into smaller and smaller market-cap companies. Indeed, over the last 18 months in the U.S., activists have been interested in all sizes of market caps — right down to ‘nano-caps’. Three New Realities

Not surprisingly, the increase in hedge-fund activism has met with intense opposition from public companies and their advisers, creating a heated debate: is such activism a catalyst of beneficial changes that legal rules and corporate arrangements should facilitate? Or are activists short-term opportunists that are detrimental to long-term value creation and that legal rules and corporate arrangements should discourage? In my view, the answer lies somewhere in the middle. Between the two extremes of ‘slash and burn’ and ‘long-term investment’, there are many stops. Two things are clear: this revolutionary phenomenon in global capital markets is changing everything in the boardroom; and no publicly-traded company is immune. Board members and CEOs alike must embrace three new realities as operating principles, as they will have a transformative impact on the traditional workings of every board of directors.

1. Investor Relations Is Now a Board Job

All medium and large public companies have Investor Relations departments who report regularly to the board about shareholding levels and shareholder concerns. But few, if any, directors would actually visit a shareholder to discern their views. Now, as a direct consequence of activism, boards and management constantly review their largest shareholders and then decide on a subsequent visitation strategy that might well include an independent director visiting a shareholder without any management being present. Mary Jo White, the current Chair of the Securities and Exchange Commission, has even publicly stated that shareholder relations are now a Board duty: “The Board of Directors is — or ought to be — a central player in shareholder engagement.” Companies are taking notice: Andy Bryant, the independent Chair of Intel, meets with four of Intel’s largest shareholders quarterly, sometimes with the CEO and/or other senior managers present, and sometimes with other independent directors; Larry Fink, CEO of the world’s biggest asset manager, BlackRock (with an estimated US$5.1 trillion in assets under management), wrote an April 2015 letter to all 500 S&P500 CEOs, requiring that they have “consistent and sustained engagement” with their shareholders; Vanguard CEO, Frederick William McNabb III (with an estimated US$3 trillion in assets under management) has proposed that companies establish a new board committee to focus on engagement; and Tempur Sealy International has now created a Stockholder Liaison Committee of its board. Meanwhile, giant oil company Exxon has explicitly stated that its board has a policy that ‘no independent director will rotmanmagazine.ca / 11

speak to an investor’. But Anne Simpson, governance leader at the well-known pension fund CalPERS, has told the media that “Exxon is an outlier: a minority of one.” A new advisory industry has already sprung up to help boards cope with these new shareholder relations responsibilities. For example, The Shareholder-Director Exchange (SDX) was formed by leading advisors to corporations and their directors: Cadwalader, Wickersham & Taft LLP for legal strategy and governance analysis; Teneo for communications and strategy; and Tapestry Networks for governance and multi-party problem expertise, with additional support from investor communications firm Broadridge Financial Solutions. 2. Corporate Strategy Must Be Examined by Third-Parties

Most, if not all, corporations hold an annual strategy off-site to deeply examine the company’s competitive context. Typically, these are two-to-three day meetings, with carefully thoughtthrough agendas and senior managers leading the effort. According to a recent McKinsey survey, boards have significantly increased the amount of time they spend on strategy, and this is not surprising given the ever-increasing complexity of the world we live in. Corporate strategy is tougher to hone and of shorter duration than ever before, and increasing number of companies now insist that it be on the agenda of each and every board meeting, so that directors can be assured that they are investing time in their most important function: helping to navigate the road ahead. The traditional off-site provides a real chance to go back to the basic roots of company competitiveness and re-examine assumptions and past approaches. This is almost always led by the C-suite team, but can include external speakers with specific firm knowledge. If you, as a director thinking about the next strategic review, were reasonably certain that one, two or perhaps even three external activists were closely examining your company, why not get their insights? Wouldn’t this be threatening to management, you might ask? Of course: but today, it is also necessary. In terms of current norms and expectations, having an external party report to the Board on their view of ‘alternate corporate strategies’ is awkward at best: but it is essential. As we have seen, failure to understand alternate strategies to maximize corporate performance might well lead to an open proxy fight. To look at the matter in a less threatening way, instead of having to spend millions on a consulting review, you can now get one for free! 12 / Rotman Management Winter 2017

3. Board Relationships with Management Must Become Much More Transparent

Relationships between directors and the CEO and C-suite executives depend upon many things, perhaps particularly, the level of trust that exists between the Chair (or Lead Director) and the CEO. These relationships have always evolved over time as a company progresses or fails to progress, and as the CEO grows into his or her position. But today, the presence of activists in the market transforms these relationships. The Board must constantly take these considerations into account and question the top management team accordingly. The equilibrium between directors — who usually get fed what is put on the table — and managers is now under intense new stress. Failing to see ‘behind the door, into the kitchen’ might quickly lead to hostilities that can be damaging to the company, its employees and its customers. Sir David Walker, the former Chair of Barclay’s Bank, was recently quoted as saying: “Despite the benefit of being entrenched and knowing the business well, a charismatic chief executive may become an increasing problem after three or four years in the job. The inevitable tendency is for him or her to become less ‘challengeable’ in the executive committee and in the boardroom and — potentially more seriously — to lose self-doubt. Accordingly, shareholders should have an increasing presumption that a chief executive who is successful should move on after five or six years”. In closing

The challenges for corporate boards just got a whole lot tougher. Just as every company is different, so is every activist fund, and while boards might like to ignore them, they are here to stay. By embracing the three principles outlined herein, directors will be prepared to navigate the choppy waters ahead. The bottom line for boards is simple but stark: adapt or die.

David R. Beatty, C.M., O.B.E., is Conway Chair of the

Clarkson Centre for Business Ethics + Board Effectiveness at the Rotman School of Management. Currently, he serves as a Director of FirstService Corporation, Walter Energy and Canada Steamships Lines. Over his career he has served on over 35 boards and been Chair of eight publicly-traded companies. He was the founding Managing Director of the Canadian Coalition for Good Governance (2003-2008).

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The former head of Canada’s biggest pension plan recently joined the world’s largest asset manager. BlackRock’s new Global Head of Active Equities talks about long-term investing, shareholder activism and the new challenge he has taken on.

Thought Leader Interview:

Mark Wiseman by Karen Christensen

It all started with an article Dominic wrote for Harvard Business Review [“Capitalism for the Long-Term”] back in 2011. In it, he argued that, if we didn’t shift to more long-term thinking — and start producing greater prosperity for citizens — capitalism could be at risk as an organizing principle for society. Dominic made this point extremely well in the article, but because he’s a good friend of mine, I called him up and said, ‘Dom, you’re being a typical consultant — pointing out all these issues, but not doing anything to find solutions. What are you going to do about it?’ He came right back at me — as he is apt to do — and said, “The question is, Mark, what are we going to do about it?’ That’s how our Focusing Capital on the Long-Term initiative started out. 14 / Rotman Management Winter 2017

‘FCLT’, as it is now known, recently became an official organization. Tell us more about it.

The founding partners include BlackRock, Mackenzie, the Canada Pension Plan Investment Board (CPPIB) and corporations including Dow and the Tata Group. Others, like GIC, Unilever and BP joined shortly thereafter. Together, we are working to create meaningful reform — not just sitting around talking about the problem. I like to think of FCLT as a do tank, not a think tank. The main source of the problem, we believe, is the continuing pressure on public companies to maximize short-term results. We’re really trying to change the way markets operate, so we can be in a position to create greater long-term value for shareholders and ultimately, for the owners of assets, which are individual savers around the world. If we can achieve that, we believe it will create a greater degree of prosperity for everyone.

ILLUSTRATION BY CHERYL CHALMERS

Along with McKinsey’s Dominic Barton, you have been closely involved in the quest to focus investors' mindsets on the long term. Describe how and why you became involved.

Are we willing to make the hard decisions and trade-offs that a long-term perspective demands? I don’t think we’re seeing evidence of that yet.

Findings from McKinsey-Canada Pension Plan Investment Board Survey • 63% of respondents said the pressure to generate strong short-term results had increased over the previous five years. • 79% felt especially pressured to demonstrate strong financial performance over a period of two years or less. • 44% said they use a time horizon of less than three years in setting strategy. • 73% agreed they should use a time horizon of more than three years. • 86% agreed that using a longer time horizon to make business decisions would positively affect corporate performance in a number of ways.

We also believe that the single most effective way to move forward is to change the strategies of the biggest investors out there. They include asset owners and managers like pension funds, mutual funds, sovereign wealth funds and insurance firms, all of whom invest on behalf of long-term savers. Today, they own 73 per cent of the top 1,000 companies in the U.S. That is a huge increase over the 47 per cent they owned in 1973. The good news is, these players have both the scale and the time horizon to focus their capital on the long term. You have noted that, eight years after the global financial crisis, we have yet to see meaningful reforms in this arena. Talk a bit about the progress made to date.

This issue has gotten a lot of traction in business circles, as well as in political and regulatory circles — so I do think it has entered into the consciousness of business people on a global basis. As to whether or not we are willing to make the hard decisions and trade-offs that a long-term perspective demands — I don’t think we’re seeing evidence of that yet. There is still a tremendous 16 / Rotman Management Winter 2017

amount of short-termism in public markets: public companies continue to manage to quarterly earnings cycles, and investors continue to be relatively short-term in the way they measure and reward performance. So, although we’ve helped to raise consciousness about the issue, there is still plenty of work to be done in terms of getting people away from short-term thinking. The challenge is, this involves doing something that is extremely difficult: changing human (and corporate) behaviour. That includes changing the way boards operate, changing the way asset owners and managers operate, and changing some of the regulatory structures that we have in place. It’s going to require a long-term effort—but I do believe we can make a meaningful impact. Shifting to a longer-term mindset will mean changing many of the traditional ways companies have been governed. What are some of the key elements of this?

A number of things have to change in corporations. One thing we are focusing on at FCLT is, ‘What is the role of the Board?’ All of this begins with having the right people on your board, and having them focus on the right things. Today’s boards spend far too much time looking in the rear-view mirror — doing things like reviewing financial statements. But that only tells you what happened in the past: it is not going to help you with the future. We need board members who are engaged in ensuring that management has a long-term strategy in place, and who encourage management not to focus on things like quarterly earnings. But if we expect board members to be proactive in creating longterm shareholder value, they have to be properly incented. It might seem counterintuitive, but we actually believe that board members should be paid more, because they need to be more engaged and financially aligned with a firm’s long-term outcomes. We strongly recommend that companies stop giving quarterly guidance, because we don’t see it as being particularly useful. But one should not confuse that with the need for ongoing transparency, generally. Boards need to demand and then report on the long-term metrics that are relevant to their company. What role does shareholder activism play in all of this?

People hear about a shareholder activist forcing a board to pay out more dividends, or to break up a company, and they say, ‘These activists are pushing companies to be more short-term.’ But my view is that activists aren’t the real issue here. I actually believe that — as in any other occupation — there are good

activists and bad activists. Some of them truly want to make value-creating changes, while others are only in it for short-term gains. By and large, activists are a symptom rather than a cause of short-term thinking and behaviour. If companies and investors undertook some of the measures that we have suggested [see sidebar] to get longer-term thinking into their investment value chain, there would be less room for activists to have influence. The fact is, shareholders have to start acting like owners. Here’s a simple example: an activist buys two or three per cent of a public company’s shares, and soon after, starts to put all kinds of demands on the company. My question is, where are the other 97 or 98 per cent of the owners of that company? Why aren’t they speaking up to protect their own long-term interests? Rather than blaming activists, we should instead blame some of these companies for not being clear enough about the long-term strategic outcomes they are trying to achieve, and for not having metrics in place to measure those things. I also blame the institutional-investment community and the asset-management community, who quite frankly aren’t acting like owners, and are allowing someone with two or three per cent of a company’s stock to have disproportionate influence. They are partly responsible for the rise of shareholder activism. Like anything else in life, sometimes activists are right and sometimes they’re wrong. If you look at Pershing Square Capital Management’s involvement in the Canadian Pacific Railway situation, I think most observers would agree that they had a point — and certainly, CP’s subsequent performance confirms that; but that same group has been involved in other situations where it’s difficult to argue that they created any long-term value. I really think we’re spending too much time thinking that activists are the problem. The root causes of this issue are short-term behaviour by boards, and investors failing to act like owners. It has been said that up to 80 per cent of the market value of the modern corporation lies in intangible assets. If this is the case, what needs to change in terms of financial reporting?

I think it very much depends on the company. I’m sure there are some companies where 100 per cent of the value rests in intangible assets; and there are others that are more traditional in terms of owning tangible assets — like real estate, for example. At the end of the day, I don’t think changing financial reporting standards is as important as figuring out how to value something like ‘goodwill’, for example. To me, as an investor,

Four Long-Term Approaches for Institutional Investors 1. Invest the portfolio only after defining long-term objectives and risk appetite. 2. Unlock value through engagement and active ownership. 3. Demand long-term metrics from companies to change the investor-management conversation. 4. Structure institutional governance to support a long-term approach. -From “Focusing Capital on the Long Term” by Dominic Barton and Mark Wiseman, Harvard Business Review, JanuaryFebruary 2014

what is most critical is having complete transparency of information, so that I can understand the intangible aspects of a company’s enterprise value. Investors should never value a company based solely on the shareholders’ equity showing up on the balance sheet. At the end of the day, you have to value a company based on its ability to generate cash in the long run — and cash can be generated by both tangible and intangible assets. It’s not just about intangible assets — it’s also about the other side of the equation, which is liabilities. Take something like litigation risk or climate risk. Companies need to do a much better job of disclosing their long-term risks, and things that may affect their sustainability — from environmental impact to labour practices to supply chain management. If we had better disclosure around these sorts of things, it would allow investors to be more accurate in valuing a company. The work that Bob Eccles and others have done on creating ‘sustainable accounting standards’ may be a bit too prescriptive, but I believe there is something to it. The idea of a greater degree of transparency and better reporting by companies — not just around traditional metrics — is very important, going forward. For example, the Carbon Disclosure Project has been quite successful in enabling investors to make better decisions. rotmanmagazine.ca / 17

At CPPIB, a ‘quarter’ meant 25 years, not 90 days. That is probably pretty close to a general definition of 'long term'.

It has been said that as an initial step, all parties involved need to agree on the definition of ‘long term’. How do you define it?

That’s a really good question, because there are a lot of different definitions out there. I think it’s interesting to look at Canada’s Indigenous peoples’ definition: the Iroquois Nation has this concept of ‘seven generations’, whereby whenever they made a decision, the elders had to be thinking about the impact that it would have seven generations down the line. There are similar philosophies in Chinese culture. I’m not suggesting that our corporations need to be thinking seven generations ahead of time — and again, it’s somewhat dependent on the business. I don’t think you can necessarily measure it in every context in the same way — so it’s okay for different companies to think about it differently. Of course, if your business activities impact the environment, you have to think about your environmental practices over a much longer term. In that case, it might actually be seven generations. But in terms of your technology strategy, if you always thought seven generations ahead, you couldn’t progress. So, there is no single definition of ‘long-term’; but by and large, it’s probably close to the approach I used at the CPPIB: I always said that for CPPIB, a ‘quarter’ meant 25 years, not 90 days. That is probably pretty close to a general definition of long term. For example, if you look at the decision of some major companies to move into China — Volkswagen, Procter & Gamble, Walmart, Starbucks — in each case, those decisions did not pay off for over a decade. Each company experienced a long period of investment and losses; but if they had not made those decisions, I would argue that their entire business model might now be in peril — given how important the Chinese market is, and will be, going forward. In each case, they were thinking at least a decade or more out, and the benefits of being early movers are still paying off — and will continue to do so. It is critical for each and every corporation to define what it means by long-term. Then, set a long-term strategy, define a set of metrics, and report on their success. Of course, you can't just ‘set it and forget it’. It’s not like you’re going to have the same long-term strategy for the next 25 years; if something isn’t working, you have to adjust it. Also, just because you have a long-term strategy, that doesn’t mean you shouldn’t pay any attention to the short-term. It’s about keeping your investment eye fixed on the horizon rather than staring down at the cracks in the sidewalk in front of you. 18 / Rotman Management Winter 2017

You recently embarked on a new phase in your career at BlackRock, the world’s largest investment company. What do you foresee as your greatest challenge ahead?

Clearly, BlackRock’s business is very different from what I was doing at CPPIB, so I’ve got a lot to learn. For example, CPPIB had the rarefied position of not having to raise capital: it came to us through the operation of Canada’s national pension plan. But at BlackRock, everyone — including me — has to get out there and prove themselves, each and every day. It’s also a much larger organization, both in terms of its assets under management and its employee base. I’m very excited to learn all about it. That has actually been a constant throughout my career: whether I was practicing law, working at the Ontario Teachers’ Pension Plan or at CPPIB, I have always made it a habit to learn something new every single day. I plan to continue to do that.

Mark Wiseman (Rotman MBA ’96) is the Global Head of Active Equities

for BlackRock and Chairman of BlackRock Alternative Investors. He also serves as Chairman of the firm’s Global Investment Committee and on its Global Executive Committee. He joined BlackRock in 2016 from the Canada Pension Plan Investment Board, where he served as President and CEO since 2012. Mark is a member of the Advisory Council on Economic Growth, which advises the Canadian Finance Minister on policies to achieve long-term, sustainable growth. He is also the Chairman of the Focusing Capital on the Long Term initiative, which he co-founded, serves on the boards of several non-profit organizations and is a certified member of the Canadian Institute of Corporate Directors.

O T 19 C HE -2 TO DAT 1, BE E 20 R 17

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TACKLING INEQUALITY:

The Challenge For Corporate Leaders If business leaders don’t step up to shape a more positive future, they risk a backlash that will limit their ability to create value going forward. by Rich Lesser, Martin Reeves and Johann Harnoss

THE WORLD HAS NEVER BEEN MORE PROSPEROUS than it is today. People around the world live longer, healthier lives than ever before. In emerging markets, billions of people have moved out of extreme poverty, and in the developed world, we enjoy better medicines, education, information, connectivity, and mobility than most of us could have imagined a quarter century ago. These achievements have many fathers and mothers. Human inventiveness, political leadership, social activism and entrepreneurship have all contributed to what Nobel Prize winner Amartya Sen described as ‘human freedom’. Carefully-crafted policies for the free exchange of goods, services, capital and labour — commonly known as globalization — and the march of technology have also played essential roles. These two forces have increased productivity, opened up markets, and created opportunities for billions of people to improve their lives. We also live in a time of growing inequality and uncertainty. Societies are being fundamentally challenged in ways we have not seen for decades — with nationalistic rhetoric and agendas

from the far right and a deep distrust of business, globalization and technology from the far left. Many worry that such a polarization of public opinion and policy making could introduce new risks and uncertainties that would deter investment — which is already far too low, judging by current interest rates — and undermine the basis for future prosperity. Why this polarization? While there are many causes, and they vary from country to country, it reflects in large part widespread and growing dissatisfaction with entrenched economic and social inequality and greater personal uncertainty in a fastchanging global economy. It also reflects people’s mistrust of political and corporate elites, who are seen as the architects of this state of affairs. Economic inequality within our societies is a by-product of the way we have managed the past three and a half decades of global economic integration. At the same time, technology — in particular, recent advances in robotics, machine intelligence, and distributed ledgers (The Blockchain) — could replace human rotmanmagazine.ca / 21

The growing divide between winners and losers has become a specter that haunts both business and society — and it is time to confront it.

labour in many areas, further compounding dislocation, inequality and discontent. The division between those who have captured the vast majority of the benefits from global integration and technological progress and those who haven’t runs between major cities and smaller communities, between young and old, and between people with different levels of education. Seventy per cent of the U.S. workforce has experienced no real wage increase in the past four decades, and similar patterns can be observed in Canada, Germany and other European countries. Wealth concentration has also increased globally, with one per cent of people controlling 50 per cent of the world’s assets. What if Brexit was only the beginning? In polls, sizable majorities in the United States and key European countries now demand a reorientation around narrow national interests, proclaiming, “Let other countries deal with their own problems.” As more people feel left behind by economic progress, this sentiment could grow and percolate into politics and then policy. And such policies could prove to be contagious across nations. As a result, firms could soon find themselves in an environment of escalating political risk in terms of trade, access to talent, regulatory rules and constraints, and restrictions on new technologies. Political uncertainty could become the major business risk, compromising firms’ ability to innovate, to access markets and talent, and to invest and create wealth. In short, it appears that many people are so dissatisfied with the current game that they are threatening to end it, even at significant cost to themselves, thereby jeopardizing two major drivers of global economic prosperity: globalization and technological progress. The Root Causes of Inequality

Today’s economic inequality is a direct result of how we have managed globalization and technology. These two drivers have always been latent fault lines. Wealth creation does not automatically result in a fair distribution of rewards. Freedom of trade, capital, and labour movement creates winners and losers, as does the advent of new technology. Popular support for globalization has always rested on the premise that most would benefit, many could succeed through their own efforts, and a social safety net would protect temporary losers. Traditionally, it has been government’s role to provide equality of opportunity (particularly through education), an effective safety net, societal balance, and political and economic stability. Meanwhile, business 22 / Rotman Management Winter 2017

could focus on generating growth, productivity, innovation and, ultimately, societal wealth. Governments now find it harder and harder to play their role. Reshaping policies to help struggling individuals and communities in times of transition requires political stability and consensus — both of which are lacking right now. Broader economic realities are not helping, either. The ability of governments to intervene is constrained by feeble macroeconomic growth in the U.S. and Europe, which greatly limits the scope of fiscal and monetary policy. The cracks are beginning to show. Many people now think the game is biased: two-thirds of Americans say that the economic system is ‘not fair’. Some conveniently blame immigrants and foreigners for their woes, while others appeal to moral notions of fairness and demand distributive justice. Moral questions aside, addressing the distributive challenge in our societies is in business’s best interest. It is hard to imagine that business has anything to win from ending today’s game and replacing it with one characterized by restricted trade and access to talent, a backlash against technology, and persistent political and economic uncertainty. Searching for practical solutions to hard challenges is precisely the forte of business. Yet business leaders have traditionally shied away from controversial societal issues like the sustainability of the current economic system, preferring to entrust them to government. In this environment, corporate leaders can no longer afford to stand by as observers. A Corporate Leadership Agenda

Our societies need the voices and efforts of corporate leaders in order to tackle the inequality and social dislocation caused by technology and globalization. An incremental extension of corporate social responsibility activities will not be sufficient. The growing divide between winners and losers has become a specter that haunts both business and society — and it is time to confront it. Business leaders need to balance two apparently conflicting objectives. First, they need to secure the sustainability and prosperity of their own companies. This remains a CEO’s prime responsibility, and it has become much harder in an era defined by lower growth, impatient investors, geopolitical uncertainty, and extremely rapid technological change. Second, they need to shape the conditions for continued and more inclusive economic prosperity and, in particular, for global economic integration and

Seven Opportunities for Corporate Leaders to Improve the Economic Landscape

Economic inequality Unequal

Technology Economic benefits Globalization

Distribution

1. Shape the next wave of globalization 2. Support entrepreneurial business ecosystems 3. Leverage technology from front to back 4. Invest in human capital

Broad

5. Apply a social business mindset 6. Rebalance and align rewards

Shared prosperity

7. Renew and own the narrative

FIGURE ONE

technological progress. To achieve those ends, we propose that business leaders embrace a new agenda comprising seven areas of opportunity. It will not be easy, and it will entail unfamiliar and uncomfortable choices, including, in some cases, de-emphasizing short-term returns in order to support economic and societal progress and strengthen the enterprise for the longer term. But we see this as a trade-off worth making. 1. SHAPE THE NEXT WAVE OF GLOBALIZATION.

Globalization has been fluid across its several centuries of development and will almost certainly continue to evolve. Whereas the last wave centered on accessing foreign markets and creating low-cost global supply chains, the next wave could follow a very different pattern. In his 2016 commencement speech at New York University, GE CEO Jeff Immelt described what this could look like: more decentralized, more geographically differentiated, more digitally interconnected, more cognizant of social impact and the importance of building capabilities rather than exploiting labor cost differentials. Business leaders can take an active role in shaping the next phase of globalization, looking beyond cost-based offshoring and emphasizing the benefits of trade and technology across a wider geographic and demographic base. Technology will be crucial. For example, the use of analytics and robotics could bring manu-

facturing closer to target markets. We already see companies shaping the next wave of globalization by re-shoring time-sensitive and highly customizable forms of production, particularly in the fast apparel and automotive industries, thus turning global supply chains into two-way streets. 2. SUPPORT ENTREPRENEURIAL BUSINESS ECOSYSTEMS

Several decades of economic progress have resulted in a concentration of economic activity in larger enterprises and a decline in startup activity. Depending on how we harness it, further technological progress could either exaggerate or ameliorate this divide. The emergence of platform businesses, which facilitate the collaboration of thousands of individuals and enterprises in dynamic ecosystems, could help to restore balance and sustainability. Such ecosystems would make it possible for individuals and small firms to participate in technological progress, catalyzing both employment and innovation. As corporations rethink their global supply chains and business models, creating ecosystems of suppliers and aspiring entrepreneurs could be part of the journey. Take, for example, providers of cloud-based web services, which give young companies access to scale benefits and flexibility previously unavailable to them. Such ecosystems are not just the purview of web-based companies. Leading energy companies are investing in decentralized energy grids, demonstrating the broad feasibility of such rotmanmagazine.ca / 23

The ‘elites’ of business and government are increasingly mistrusted. In this vacuum, stories appealing to instinct, fear and emotion take hold.

approaches. Toyota’s integrated and highly collaborative supply network — much celebrated for both its leanness and resilience — illustrates that ecosystems are also important for traditional manufacturing companies. 3. LEVERAGE TECHNOLOGY FROM FRONT TO BACK

Technology’s effect on humans depends on how we choose to develop and use it. If we leverage it from the back-office forward, focusing mainly on increasing efficiency and optimizing internal processes, then our use of technology will result primarily in the displacement of labour. We will miss opportunities not only to enhance value for customers but also to create innovative jobs and improve people’s lives. Instead, businesses should start from the front, with a clear focus on solving unmet customer needs and delivering tangible new value. Using technology to spur innovation and give people more fulfilling lives is an opportunity in nearly every sector of the economy. But this inclusive approach may require some uncomfortable choices. Take emerging blockchain technology applications, which could have vast potential in financial services (currency, payment solutions, digital assets), insurance (contract and identity management), entertainment (performing rights management) and many other sectors. The benefits could be extracted either primarily through efficiency enhancements — by eliminating intermediaries and probably shedding many jobs in the process — or through the creation of valuable services and markets. Could we even imagine that those who originate and develop new technologies take some responsibility to apply them in an inclusive manner, creating new benefits and services while addressing transitional frictions? 4. INVEST IN HUMAN CAPITAL

An increase in the dynamism and diversity of business environments means that people need to adapt their skills at a faster pace. This includes their ability to take part in the production as well as the consumption of new goods and services. Finding effective and affordable ways to help people acquire transferable skills during their careers — not just before they start out — is a large social challenge. Education is critical in creating career mobility and equality of opportunity, which are at least as important as—and closely tied to — income gaps. But it takes too long for new work skills to become codified and for the education system to deliver them. Firms can help to close the loop — for example, by working 24 / Rotman Management Winter 2017

with online education providers or taking direct responsibility for re-skilling. As new tools become available to build or rebuild human capital more effectively and efficiently, corporations could seek to broaden their mandate in this area, both with their own staff and in the communities where they operate. We also see it as paramount that business leaders be consistent, passionate advocates for improving access to high-quality education for all ages and income levels. 5. APPLY A SOCIAL BUSINESS MINDSET

To contribute to society, and to gain its support, businesses must be deeply embedded in it. One way corporate leaders can achieve this is to establish ‘social businesses’ that are adjacent to their core business models. This puts corporations in a position to solve some of society’s most fundamental problems by leveraging their core skills, rather than making tangential and ultimately unsustainable philanthropic contributions. Nobel Prize winner Muhammad Yunus has been a passionate champion and advocate of social business and its ability to create sustainable value for challenged communities. He defines social businesses as those that provide clear benefits to under-served populations, return the initial invested capital, and reinvest dividends to create sustainable enterprises. Social businesses founded by Danone (small, low-cost portions of vitamin-enhanced yogurt produced in small community factories) and Essilor (affordable vision care for millions of low-income individuals around the world) show the feasibility and potential of such approaches. Social businesses can also build capabilities inside the sponsoring corporation and surface innovations that can be deployed more broadly. Financial inclusion is often pivotal in making social business models work. Giving under-served groups access to payment and money transfer services, deposit accounts, credit and other financial tools can have a far-reaching impact on well-being. It has been cited as an important factor not only in poverty reduction and economic growth but also in gender equality. While governments can lay the groundwork for financial inclusion, the private sector can play a major role in driving rapid innovation and expanding access in a sustained and scalable way. Just four years after telecom company Safaricom launched the mobile-phone-based money transfer service M-Pesa in Kenya, for example, 70 per cent of adults had adopted it. A social business mindset can also lead to meaningful progress on hard-to-crack issues, like long-term youth unemployment.

In Europe, business-led alliances work closely with public agencies, thousands of volunteers, and employers to offer structured education and skill building programs. These social business vehicles have been three to four times more effective than standard programs in re-integrating young Europeans and immigrants into labour markets, thus helping companies tap into new pools of talent.

supporting economic and societal progress, many pointed out the challenging context in which they operate. Between boards, major investors, activists and potential acquirers, there is tremendous pressure to focus on short-term profitability and value maximization. The regulatory frameworks in many markets do not make a broader focus any easier. In closing

6. REBALANCE AND ALIGN REWARDS

People’s sense of self-worth is closely linked to the nature of their work and their relative compensation. This is especially true when we consider not only wages and benefits but also career mobility, merit-based recognition, and the intangible value of purpose (often related to some higher social goal) in work. Mismatches between rewards and performance along the entire pay scale, from entry-level workers to leaders, undermine perceptions of fairness and faith in the system. Aligning performance with rewards presents an opportunity for corporate leaders to directly shape people’s perceptions of self-worth, fairness and access to opportunity. Many companies are starting to increase remuneration and support for lower-paid employees. In the years ahead, more will be needed.

Business leaders are beginning to see the plausible endpoint of the current political polarization in our societies. Many privately confide that they don’t like what they see, and they are open to considering novel measures to address the new challenges. The opportunities we propose herein are intended to soften globalization’s and technology’s sharpest edges, thereby perpetuating a more balanced game that creates broader prosperity and greater societal openness to change. This is not an easy mandate. But if we, as business leaders, don’t step up to shape a more positive future, it is increasingly clear that we risk a backlash that will limit our ability to create value in our own enterprises and for our customers. Now is the time to take on this broader agenda.

7. RENEW AND OWN THE NARRATIVE

The current crisis is as much about inspiration and ideas as it is about economics. The case for globalization is a hard sell if it doesn’t address the obvious distributive side effects of overall economic advancement. The same goes for technology, in which the absence of a more inclusive narrative has already sparked vigorous backlash (for example, taxi strikes in France and elsewhere). What’s more, the storytellers — the ‘elites’ of business and government — are increasingly mistrusted and have lost their audience. In this vacuum, stories appealing to instinct, fear and emotion take hold. This matters, because narratives shape perceptions and political reality, which in turn shape economic reality. Business leaders have traditionally avoided broader societal issues and have focused on their narrower role. In the coming years, we believe that they will need to take a more active stance — to play offense and not just defense. It is time for a credible, inclusive and trust-inspiring narrative, both for the direction of our societies and the sharing of benefits and opportunity within them. Defining what needs to be done is a first logical step, but it is only a start. In conversations with CEOs about their role in

Rich Lesser is President and

CEO of The Boston Consulting Group. Martin Reeves is a Senior Partner and Managing Director at BCG and Director of its Henderson Institute. Johann Harnoss is a Project Leader at BCG. For more from BCG, visit bcgperspectives.com. rotmanmagazine.ca / 25

WALMART’S JOURNEY TO SUSTAINABILITY Walmart’s Chief Sustainability Officer, Kathleen McLaughlin, describes the retailer’s (surprising) journey to leadership in the realm of sustainability. Interview by Sarah Kaplan

How did you come to see Walmart as a possible change-maker in the world?

Let me start out with a pretty simple proposition that is, nevertheless, somewhat contentious: business exists to serve society. The question is, how do companies interpret that, and what do they do to fulfill that promise? The most obvious way is to look at what your business does from day-to-day, to serve its customers. Three years ago, soon after I joined Walmart, I travelled to Soweto, South Africa, where we run our stores under the Cambridge banner. I was in one of the stores with our management team, as they coached the person behind the deli counter about food safety — making sure raw chicken didn’t touch the vegetables, and other important procedures. I stood there for a few minutes, just watching people: entire families were coming in to shop together; mothers had babies on their backs, and were putting rice, vegetables and meat into their baskets. I had been to that part of Africa many times before, working

on HIV/AIDS and maternal health issues — but it suddenly occurred to me that this store was enabling a whole different kind of development. The approach is slightly different in each of the 28 countries Walmart operates in, but essentially, it’s always about bringing affordable food, apparel and general merchandise to people to make their lives better. The value of that clear purpose was made crystal clear to me that day. For much of the past several decades, the mantra has been, ‘Business exists to serve shareholders’. How did Walmart come to embrace ‘Business exists to serve society’?

It all started ten years ago, with Hurricane Katrina. Walmart has stores in that part of the world, so many of our associates were affected — along with millions of our customers. When the hurricane hit, our people just started jumping in and trying to do whatever they could to help. There were some amazing stories of heroism: Our people were commandeering bulldozers, knocking rotmanmagazine.ca / 27

F. Lee Scott—our CEO at the time—said, ‘What if we could be that kind of company every single day?’

down walls to our stores and giving out products, and creating shelters for people. They would call in to Home Office every 30 minutes or so, asking, ‘Can we get permission to do this? Can we get permission to give this away?’ Finally, F. Lee Scott — our CEO at the time — said, ‘You know what, don’t ask for permission: just go ahead and do what you need to do. We’ll figure out later how much it all costs.’ That event was so cataclysmic that it literally changed the way our leadership team thought. In the weeks that followed, they sat back and asked themselves, ‘What if we could be that kind of company every single day? What would that be like?’ Lee had a personal epiphany: ‘We are the largest retail[er] in the world — we are truly driving consumption on a global basis; maybe we should figure out a way to make this all circular.’ That fall, he gave a speech titled, “21st Century Leadership”, and in it, he set three broad goals for Walmart: to be supplied by 100 per cent renewable energy, to create zero waste and to sell sustainable products. At the time, I was, like, what? Walmart? It was a great surprise. One thing I’ve come to appreciate since joining the company is that, when Walmart says it’s going to do something, it does it. It’s a very execution-oriented company. For ten years now, this is what people have been working on. The whole system has changed, and it’s just getting better and better, as our people develop these programs and work closely with hundreds of suppliers, other retailers, government agencies and non-profits.

sustainability and community building. These pillars are ‘evergreen’: they will not change from year-to-year — but what we do within each pillar might change from year to year. Economic opportunity was a natural focus for us, given our ability to provide jobs and sign purchase orders all around the world. We can play a significant role in creating upward economic mobility not only for our associates, but also for lots of people in global supply chains, so that is a huge priority for us. The second pillar is sustainability. Ultimately, we’re a supply-chain company that sources products from around the world and gets them to consumers. So, how can we do that in a way that is truly restorative? Walmart is known for talking about ‘everyday low cost’; but we now talk about ‘true cost’: what is the true cost of something, from a social and environmental perspective? This is so important, because the price tag doesn’t always reflect that. Ultimately, we want this approach to create more of a ‘circular economy’, with a restorative approach to developing products, delivering them, and then addressing what happens postconsumption. This enables us to address the climate, waste, food security, natural capital — and more. Our third pillar is community building. We’re in 28 countries and thousands of communities. The question is, what role should we be playing in each of these communities, from day to day? And what should we be doing in times of crisis? Ever since Hurricane Katrina, we’ve focused on developing disaster preparedness and response capabilities throughout our organization.

Describe the three pillars of Walmart’s approach to serving society.

The latest Walmart Global Responsibility Report outlines your ‘whole systems’ approach. Why is this important, and what triggered the move in this direction?

Our first principle is about creating shared value, a term developed by Harvard’s Michael Porter and Mark Kramer. What we like about this concept is the recognition of overlap between societal impact and business impact, and the effort to try to find and operate in that sweet spot between the two. We achieve this by first engaging stakeholders to understand which societal issues are most affecting them; then we ask ourselves, what should Walmart be doing about that? Is there a role for us to play? Last year, we worked with Sustainalytics and our key stakeholder groups to identify some priority issues. We then formed an agenda around three pillars: economic opportunity, 28 / Rotman Management Winter 2017

We don’t think about corporate social responsibility in terms of philanthropy that we do on the side — removed from the core business. Instead, we are trying to shift systems as a whole. We might look at a particular employment system, or an agricultural system, and ask, How can we work with others to reshape this system, to make it more sustainable? Cashew production is one example. As you can imagine, we source a lot of cashews. In western Africa there is a pretty big cashew-growing region, in Ghana. The challenge is that, historically, the yields and quality have not been good. So, the product

gets grown there — but then it is shipped off to Asia for processing; and then, it is flown back to the UK, where we sell it through Asda supermarkets. Clearly, this system is not great for the Ghanian farmers, and it’s not great for emissions to be carting cashews around the world. So, we’ve looked at how we can strengthen the Ghanian system locally, to create, better quality and a local processing infrastructure, which would also create more of a margin pool for local farmers. This would also mean fewer miles travelled, because you could then take the product from there straight to the UK — or wherever else people are going to consume it. If we can start showing up in Ghana and saying, ‘Look, we will buy X amount of cashews over this time frame, for this amount of money’, we see that as a development asset. There was some work done recently, comparing foreign aid to foreign-direct investment from the private sector. If you think of purchase orders as ‘development assets’, they are pretty significant. Walmart spends billions each year buying things, and that represents a huge capital effusion. A long-term purchase order from us provides the security for other capital to come in and invest in processing infrastructure. It also provides the base for someone like USAID to come in and provide technical assistance around agricultural practices, and so on. All of these things work together to strengthen the overall system. Of course, before we take anything on, we have to believe that we have some unique assets to bring to the situation. Take hunger relief. The main way we address hunger is by providing affordable food in our communities. In many cases, these consumers haven’t previously had access to food in this way. But by serving them, we end up with a lot of excess food that we can’t sell; that’s just part of retail. So, we donate approximately $1 billion worth of food every year to food banks, mostly in North America, but in other markets as well. This is great for the business, because it lowers the amount of material going to landfill (which we have to pay for) and it lowers waste; but it’s also fantastic for the community — especially if we are donating fresh food. Ultimately, we want to create a much healthier charitablemeal system that flows healthy food into the pipeline, which is so much better for the people who need these services.

You also run a Women’s Economic Empowerment Program. What are you trying to achieve with this effort?

In Canada, we’ve increased the number of female store managers by more than 50 per cent in the last few years, and globally, 31 per cent of our corporate officers are women. That’s compared to 15 per cent in the Fortune 500 and about 18 per cent in the retail industry. We also have 22 per cent people of colour in the [U.S.] officer rank. So this is something we work hard at — but we wanted to go beyond that and look at how we could use our purchaseorder clout to empower women. As a result, we’ve committed to sourcing $20 billion worth of product from businesses owned by women for our U.S. operations. Why is collaboration so important to the model of change that you’re working on?

A wide range of things needs to happen to bring about societal changes — from policy changes, to business action, to philanthropy, to consumer action. As indicated, our goal is to shift entire systems, like the cocoa production system, the way row crops get produced or the way people get their first job and get skills to progress in life. All those things involve systems with a lot of moving parts. We work with the leaders of those systems to establish a shared vision of what the improvements will look like, and then we work on achieving them together. For example, we couldn’t have supported training for close to a million women to date without working with CARE, World Vision, Swasti, USAID and the Gates Foundation. In addition to training these women, we now have a model for doing this that anybody can use to do the same — and we want to share it; that’s part of our theory of change. If we were just off on our own doing these things, we would probably produce some benefit—but we wouldn’t really be shifting the system. In the last decade, there has been an explosion in the number of platforms to facilitate collaboration. As an example, we’ve brought together about a dozen companies — other food and consumer products manufacturers — for pre-competitive collaboration to work on a couple of things. One is around recycling infrastructure in North America. We supported the creation of a fund to invest in municipal infrastructure for recycling — because we all have an interest in driving that. And the other is emissions rotmanmagazine.ca / 29

We always ask, what is the true cost of something, from a social and environmental perspective? The price tag doesn’t always reflect that.

reduction and agricultural chains. These companies have fields where they’re growing wheat or rice or soy or corn, and they’re now bringing more sustainable management to those operations to reduce emissions and runoff into watersheds. The CEOs involved have committed to that. Walmart is famously hard-nosed about business operations. When there is a goal you want to achieve from a sustainability or social standpoint that does not have a ‘business case’, how do you handle that? What informs the kinds of tradeoffs you might have to make?

Ideally, there is a Venn diagram of ‘value for business’ and ‘value for society’, and the overlap is pretty big — so there is a lot of scope to make a difference. But as you indicate, that is not always the case, and that’s one reason why we still have a robust philanthropic program through the Walmart Foundation. With any of these systemic changes we’re trying to enable, business can only go so far, so we have a whole suite of grants that we give out that go way beyond what the business can do. For example, as part of our Women’s Economic Empowerment Program, we have made a commitment to training one million women in our supply chains. That’s not something that would make sense for our business alone to do. So we work through the Walmart Foundation, which has supported training for about 760,000 women in farms and factories. It’s all about women in emerging markets getting their first formal job. That’s an example where philanthropy can really push things further. Where it gets tougher is on the other end: are there business practices that are not creating immediate social value? A good example is animal welfare. If you look at issues like gestation crates in the pork industry, or cage-free eggs, these are production systems that have evolved over time, and that are not unique to Walmart. They’re part of the food industry’s efforts to satisfy rising consumer demand — but many people are not comfortable with them anymore. Changing those systems is going to require problem solving to create better systems, and that will require capital and operating expense, and so on. How that will evolve — in a way that doesn’t increase the cost of the end product — is a real challenge that we need to work through. 30 / Rotman Management Winter 2017

We can’t do any of this by ourselves; for instance, we actually don’t own any chickens — we buy eggs from other people, so, clearly, addressing this requires collaboration. The way we come at it is, ‘Let’s use the same problem-solving ability that we would apply to any business problem’, because these are business problems, too. They require innovation in production approaches and collaboration with suppliers and other retailers. You hold two jobs at the same time – President of the Foundation and Chief Sustainability Officer in the Corporation. Why is it important to have one person hold both jobs? What does that allow you to do that you wouldn’t be able to do otherwise?

As indicated, we lead these efforts through the business, primarily, but we use philanthropy to fill in the blanks — where the project isn’t creating business value, but something needs to happen in the system for it to move forward. It is important to integrate your philanthropic efforts with what your business is doing — particularly if you’re trying to address something specific, like accelerating economic opportunity or taking chemicals out of products, because as indicated, there’s only so much we can do through the business. The Walmart Foundation is a 501(c)(3) — a tax exempt nonprofit organization — and as such, we abide by strict rules and regulations in terms of the nature of the grants we make towards societal improvements. These improvements are not directly connected to Walmart, but they are intended to improve the overall systems that we all work within. What happens if different social goals are at odds?

This can definitely happen. Take deforestation, for example. We’ve been doing a ton of work around palm oil, soy and Brazilian beef, and we feel really good about these initiatives; but we haven’t made as much progress with paper production. It’s just capacity. We had to start somewhere, so we started with those commodities we were most worried about. But, we also thought that, given some of the actors involved, we’d have better luck getting people on board and making progress in those areas. Some things take more time.

Fortune’s 2016 Change the World List

GlaxoSmithKline (Pharmaceuticals)

11.

Coca-Cola (Beverages)

IDE Technologies (Industrial Machinery)

12.

Intel (Semiconductors)

General Electric (Industrial Machinery)

13.

Munich RE (Insurance: Property & Casualty)

Gilead Sciences (Pharmaceuticals)

14.

Fibria Celulose (Forest & Paper Products)

Nestlé (Food Consumer Products)

15.

Walmart (General Merchandisers)

Nike (Apparel)

16.

Bank of America (Banks)

MasterCard (Financial Data Services)

17.

Crystal Group (Apparel)

United Technologies (Aerospace & Defense)

18.

Ito En (Beverages)

Novozymes (Specialty Chemicals)

19.

PayPal (Financial Data Services)

First Solar (Energy)

20.

Skandia (Insurance: Life & Health)

10.

FIGURE ONE

Who would have thought, 20 years ago, that a company like Walmart would be publishing a global responsibility report? How did we get to this moment?

Whether it’s the impact of climate change or rampant inequality, I think everyone can see the effects all around us, and that’s a big part of it. Years ago, at McKinsey, I was working in the social innovation space, and I got involved in this thing called the Sustainable Food Lab, which was the first of its kind. At the time, it was viewed as a bit of a lunatic fringe experiment. We met every quarter for two years to look at making sustainability more mainstream in our supply chains. Over time, as these things started to hatch and spawn, we started to feel some real pressure on these issues. Today, these efforts are far from the lunatic fringe. PricewaterhouseCoopers did some research tallying up how many S&P 500 companies have sustainability programs or reports. In 2011 it was 25%, and in 2014, 75%. I would guess we’re getting close to 100% now. It doesn’t mean that these are

all great programs — but it does mean that everyone is thinking about this and trying do a better job of addressing the full suite of issues in what they do day-to-day. The bottom line is, business leaders can no longer separate economic, environmental and social issues. They are deeply interrelated, and to solve any one type of issue, you have to address the others.

Kathleen McLaughlin is the Chief Sustain-

ability Officer at Walmart and President of the Walmart Foundation. Sarah Kaplan is the Founding Director of the Institute for Gender and the Economy and a Professor of Strategic Management at the Rotman School of Management. This interview took place live at the Rotman School. For a list of upcoming public events, visit rotman. utoronto.ca/events rotmanmagazine.ca / 31

Investing for a Sustainable Future The authors of MIT and the Boston Consulting Group’s 2016 Global Executive Study present their findings, showing that sustainability is becoming a key rationale for investment decisions. by G. Unruh, D. Kiron, N. Kruschwitz, M. Reeves, H. Rubel and A. Meyer zum Felde

IN GENERAL, IT IS ASSUMED that every company’s top executives and its board of directors possess a keen understanding of investor priorities. Indeed, most would agree that this is one of their key responsibilities. Based on their understanding of investor interests, a leadership team will often focus corporate strategy and behaviour in one direction rather than another. For instance, if executives believe that their investors prioritize short-term profits, they will tend to organize sales, cost management, and research and development activities to maximize such profits rather than make certain long-term investments. Today, many executives continue to embrace the conventional wisdom that mainstream investors care very little about an organization’s performance on environmental, social and governance (ESG) metrics. Investors won’t shift their investments, the thinking goes, based on ESG performance. For the seventh consecutive year, MIT Sloan Management Review, in partnership with The Boston Consulting Group (BCG), conducted a global survey of managers about corporate sustainability. The response set included 7,011 respondents from 113 countries. Our resulting report, The 2016 Global Executive

Study, is based on a smaller sub-sample of 3,057 respondents from commercial enterprises. Within this sample, 579 respondents self-identified as investors: most were strategic (39%), institutional (24%), or retail (11%) investors. Few identified themselves as ‘mission-oriented’ or ‘socially responsible’ investors. Our findings, which we will summarize herein, serve as a wakeup call: the time has come for corporate leaders to recognize that an increasing number of shareholders are (literally) invested in whether a company’s ESG activities connect with its financial success. At least three factors are driving this growing interest in sustainability. BIG DATA. Analytics and sophisticated modeling can now show how and when sustainability investments create shareholder value, and these models are meeting growing investor demand for data on corporate sustainability efforts that can be included in corporate valuations and comparative analyses. Large firms like Bloomberg and Thompson Reuters collect data on sustainability issues, and most big investment firms, including BlackRock, have specialized departments examining these issues. rotmanmagazine.ca / 33

Today, a fossil fuel company is out of the investment picture nine times out of 10.

Organizations from accounting firms to the United Nations are developing and offering models that can assess and calculate the impact of ESG factors on a company’s performance and future prospects. ACADEMIC RESEARCH. Research from academic institutions and investment firms increasingly links effective management of material sustainability issues to strong financial performance. In a study of the world’s 500 largest companies, for example, Harvard Business School Professor George Serafeim and Bethesda, Maryland-based Calvert Investments found that strong ESG performance has a high correlation with strong valuations, expected growth and lower costs of capital. The study also found that high ESG performance correlates strongly with lower credit default swap spreads. And in 2015, investment management firm Arabesque Partners and researchers from Oxford University released the findings of their analysis of more than 200 sustainability studies and reports: nearly 90 per cent concluded that solid ESG practices drive improvements in operational performance. MINDSET SHIFT. We are seeing a shift in attitude within the investor community about the connection between strong sustainability performance, value creation and risk reduction. While it may have been the case at one time that only activist investors saw a connection between these activities, today, 75 per cent of investment community respondents see improved revenue performance from sustainability as a strong reason to invest. In addition, more than 80 per cent of investor respondents indicate that good sustainability performance increases a company’s potential for long-term value creation. Walking the Walk

In 2014, according to the Forum for Sustainable and Responsible Investment (SIF), $1 of every $6 invested was put into sustainability investment strategies — a jump of 76 per cent since 2012. “2016 is set to be the year of green finance,” says Achim Steiner, executive director of the United Nations Environment Programme. “Across the world, we are seeing a growing number of countries aligning their financial systems with the sustainability imperative.” Agreements reached during the 21st session (2015) of the United Nations Framework Convention on Climate Change are a prime example: the agreement heralded a decisive shift to low-carbon economies and mobilized financial institutions and regulators around the world. For a decisive majority of the investors we surveyed — more 34 / Rotman Management Winter 2017

than 70 per cent — sustainability is now central to their investment decisions. “In the last two or three years, sustainability has been gaining momentum among mainstream investors,” says Antoni Ballabriga, global head of responsible business at international banking group Banco Bilbao Vizcaya Argentaria S.A. (BBVA), based in Bilbao, Spain. “In the past, we might have received a few inquiries from socially-responsible investors; now there are many more events focused on socially-responsible investment, and attendance by mainstream investors has gone up considerably.” “Companies have been complaining that nobody cares about sustainability,” comments Robert Eccles, chairman of Arabesque Partners and professor of management practice at Harvard Business School. “But investors care, and companies need to up their game.” In the past, investors who cared about sustainability had data and information to develop only exclusionary strategies — identifying ‘bad apple’ companies that harmed the environment. “Exclusionary criteria led investors to see their choices as binary,” comments Pamela Styles, founder and principal with Next Level Investor Relations, a Virginiabased investor relations and corporate communications consultancy. “They either loved or hated you.” More sophisticated data and analytics are broadening investors’ fields of vision by including more inclusionary factors. According to SIF, assets invested with inclusionary sustainability strategies now exceed those under exclusionary approaches. Styles believes that new indicators are revealing nuances that allow investors to include companies that they traditionally viewed as outcasts. “Today, a fossil fuel company is out of the investment picture nine times out of 10,” she says. “But with more sophisticated analytics, an investor might put capital into a fossil fuel company because there are better performance indicators and the company is improving on many or all of them.” Integrating ESG indicators into investment models is the crux of these inclusionary performance indicators. The integration has been difficult in the past because, as BBVA’s Ballabriga puts it, “Sustainability types speak in PowerPoint, and investors speak in Excel.” A number of organizations are starting to bridge this gap. The UN Global Compact and the Principles for Responsible Investment Initiative, for example, have created a tool that companies can use to assess and communicate the financial impact of their sustainability strategies. The model assesses return

on invested capital by adding sustainability into growth, risk, and productivity calculations. Some companies are developing models that estimate the impact of sustainability-related actions on future earnings based on market dynamics and what regulators and stakeholders might do. Arabesque has developed a similar model that it uses to identify the top 1,000 responsible equities (out of approximately 77,000 listed globally) based on ESG and business metrics. In 2014, the company’s Prime Fund outperformed the MSCI AC World Index by nearly three per cent, while its Systematic Fund outperformed the index by five per cent. “Right now, there are very few investment products out there,” says John Buckley, global head of the corporate social responsibility program at Bank of New York Mellon Corporation. “But I believe there will be more in the future, because many buyers will want them.” Poor Performance Can Be a Deal Breaker

Nearly half of all surveyed investors — 44 per cent — told us that. They simply won’t invest in a company with poor sustainability performance. Further, nearly 60 per cent of investment firm board members said they would be willing to divest from companies that have poor sustainability performance. Consider divestments in the fossil fuel industry, especially coal. Although low returns have muted investor interests in the sector, sustainability concerns are also important. To date, more than 400 institutional and 2,000 individual investors in 43 countries have committed to divesting more than $2 trillion in assets from fossil fuel companies. According to a 2015 study by Arabella Advisors, the divestment trend has moved far beyond mission-driven institutions. Large pension funds and private companies now account for 95 per cent of the assets slated to be sold. Norway’s largest pension fund, Kommunal Landspensjonskasse, or KLP, is indicative of the trend, having divested all of its investments in coal companies. Instead, KLP will invest those funds in renewable-energy production companies in emerging economies. As Bevis Longstreth, former U.S. Securities and Exchange commissioner under President Ronald Reagan, put it: “Fiduciaries have a compelling reason on financial grounds alone to divest these holdings before the inevitable correction occurs.” Elsewhere, in 2015, Corporate Knights, a Toronto-based media and research company, launched its Decarbonizer Tool, where any investor can see what effect a divestment in 2012 from

fossil fuels would have had on a fund or index performance in 2015. The Bill & Melinda Gates Foundation, for example, would have been nearly $2 billion ahead had it divested from fossil fuels. Another example comes from a different side of the mining industry, where the ‘Aiming For A’ coalition of some 100 European investors is demanding that mining companies Anglo American Glencore and Rio Tinto demonstrate that they are working to lessen the impact of climate change on their businesses. The investor coalition includes Aviva, Amundi and Schroders, which manage more than $4 trillion in assets. Mis-managing a sustainability issue can also send investors running. In 2007, after lead paint was found in toys it manufactured in China, Mattel Inc. had to recall more than 20 million products. To help stem declines in the company’s stock price and help its relations with China, Thomas A. Debrowski, Mattel’s executive vice president for worldwide operations, publicly apologized to everyone affected by the recall, including the Chinese people. China was by no means a new market for Mattel. It had been doing business there since 1959, and was known for scrutinizing its manufacturing partners. But in this case, its efforts fell drastically short. More recently, Lumber Liquidators Inc. — one of the largest and fastest-growing flooring retailers in North America — found itself on CBS’s 60 Minutes and the target of short sellers banking on the fallout of a sustainability fiasco. Yonkers, N.Y.based Lumber Liquidators sells hardwood and laminate flooring that is manufactured in China. The company allegedly fell significantly short of U.S. health and safety standards governing the amount of formaldehyde that can be used in products, putting thousands of people at heightened risk of respiratory irritation, asthma and cancer. Lumber Liquidators had once been a darling of investors. Its stock price rose from $13 per share in 2011 to $119 per share in 2013. In November 2015, a few months after the 60 Minutes report aired, the share price plunged to less than $15. On the other hand, managing sustainability well can attract investors. Mitsubishi Corporation is a case in point. In 2015, the company announced that it was making a $1.1 billion investment in Olam International, an agricultural trading company based in Singapore. Many believed that the purchase was driven by Mitsubishi’s desire to capitalize on growing incomes and consumption in emerging markets. But Mitsubishi was particularly drawn to the company’s sustainability footprint and its expertise rotmanmagazine.ca / 35

Nearly half of surveyed investors simply won’t invest in a company with poor sustainability performance.

in working with small farmers and producers in remote areas of Asia and Africa. Olam’s sustainability footprint drove a 29 per cent premium over the company’s 2014 average share price. Richard Liroff, founder and executive director of the Investor Environmental Health Network, points to organic-grocery retailer Whole Foods Market Inc. as an example of corporate learning. In the 1990s, scientists began identifying hazards associated with plastic bottles made with bisphenol A. In 2004, Liroff ’s organization approached Whole Foods to address the issue that the retailer was selling baby bottles made with the chemical. But the company was already aware of the issue, which had been raised by some of its stockholders. In 2004, Whole Foods pulled the bottles from its shelves. “Fast-forward to 2008,” says Liroff. “The government said there might be risks, and suddenly major retailers were stumbling over themselves to pull these plastic bottles from their shelves. Businesses that were on top of those issues benefited tremendously.” However, the experience of Whole Foods also points to the bigger picture of what investors are pursuing — sustainability’s impact on the business. A diligent focus on ESG initially helped Whole Foods gain its reputation among consumers and investors. But as the retailer’s competitors started offering organic products at lower prices, they profited from organic products as well, and investors started criticizing Whole Foods. Increasingly, the measure of sustainability is its impact on the bottom line and as indicated, that focus is being aided by a new generation of analytics tools.

Sustainability Strategies are More Prevalent in Some Industries Chemicals, industrial services, and conglomerates have the highest concentration of companies with sustainability strategies. As in past years, the media and entertainment industry has the lowest percent of companies with a sustainability strategy. Does you organization have a sustainability strategy? Chemicals

84%

2% 14%

Industrial services

79%

21%

78%

Conglomerates/Multi-Ind. Energy and utilities

73%

Consumer products

71%

Automobiles

70%

Commodities

69%

Technology & Telco

57%

Healthcare

56%

Financial services

53%

Construction

53%

Media and entertainment

45% 52%

Other

At the same time, sustainability indices are losing their luster. Although they have been a mainstay for many years (Dow Jones & Company has offered a sustainability index since 1999 and the Financial Times has produced its FTSE4Good Index since 2001), corporate executives seem to care more about these lists than investors do. Consider the responses from managers in public companies: 32 per cent say that their company is listed on a sustainability index, while 36 per cent didn’t know if their company was listed or not. Investors care far less about a company’s inclusion in a sustainability index, especially when making an investment decision: only 36 per cent of investors say that a company’s inclusion in a major index is an important factor in investment decisions. 36 / Rotman Management Winter 2017

Yes

18%

23%

17% 3%

65%

Industrial goods & mach. retail

Sustainability Indices Are Declining in Value

10% 12%

9% 15%

13%

28% 27% 28%

20% 18% 8% 15% 14%

Don’t Know

24% 27% 39% 40% 34%

FIGURE ONE

One reason is that data in many sustainability indices is selfreported and usually vetted for completeness, not accuracy. German automaker Volkswagen Group spotlights the issue. Before its diesel emissions-control scandal, the company held the top automotive industry spot on the Dow Jones Sustainability Index. Corporate leaders may care about their rankings on sustainability lists, of course, for reasons that have an indirect

connection with investors. For example, they may believe their place on these lists or indices has intangible brand-reputation value that carries weight with consumers. Even so, the sheer number of reporting frameworks and sustainability indices that now exist is raising questions about whether the time and resources spent filling out these questionnaires is worth the corporate effort and cost. Fifty thousand companies are annually subject to ESG evaluations by 150 ratings systems on approximately 10,000 performance metrics. The diversity of organizations and systems, ratings and metrics has led many sustainability managers to the verge of ‘survey fatigue.’ According to Ann Klee, vice president of environment, health, and safety at General Electric Co., the company responded to more than 650 individual questions from ratings groups in 2014. The process took months to complete and required more than 75 people to finish. And it provided virtually no value to the company’s customers and stakeholders. “The profusion of metrics and ratings is just creating more noise in the environment,” says Chris Pinney, president and founder of High Meadows Institute, a Boston-based research organization focused on business and the global economy. “For most investors, the ratio of signal to noise is just impossible.” The materiality movement — an effort to promote corporate reporting that integrates both financial and non-financial material issues — is driving efforts to simplify matters. Atlas Copco AB — a manufacturer of industrial tools and equipment, based in Stockholm, Sweden — is a case in point. In 2016, Atlas announced that it would no longer apply for inclusion in the RobecoSAM Dow Jones Sustainability Index. Instead, the “Group will use a materiality driven approach and the GRI G4 guidelines to disclose environmental, social, and governance information to investors.” In the U.S., the Sustainability Accounting Standards Board is working to develop rules governing public disclosure of financially material corporate sustainability information. Project Delphi, an initiative between the European Business Network for Corporate Social Responsibility and State Street Global Advisers, is convening investors and financial analysts to develop quantitative sustainability indicators that can predict overall company performance. “With the maturing of the field, there’s better information,” says BNY Mellon’s Buckley. “And with better information, there is better thinking.”

Investors Care About Good Sustainability Performance for Many Reasons Why is a company’s good sustainability performance important to your firm when making investment decisions? Company’s increased potential for long-term value creation

51%

31%

12% 4%

Company’s improved revenue potential

38%

37%

15% 7%

Company’s better operational efficiency

38%

36%

17% 5%

40%

19% 6%

Company’s compliance with market expectations

32%

Signals effective management

30%

42%

18% 6%

Company’s enhanced employee productivity, retention and attraction

31%

39%

21% 6%

Company’s increased innovation potential

37%

33%

18% 8% 4%

Company’s higher community acceptance

36%

33%

Company’s lower risk Company’s lower costs of capital Very important

Quite important

30% 23%

Somewhat important

36% 33%

Slightly important

21% 22% 27%

Not at all Important

8% 8%

9% 5%

Don’t know

FIGURE TWO

Developing a Value-Creation Story

A clear business case is the crux of every robust sustainability strategy. However, only 25 per cent of our respondents said that their companies have developed such a business case. “Many companies still base sustainability efforts on values,” says Cary Krosinsky, a former advisor at the Principles for Responsible Investment network, sponsored by the United Nations. “But it is the business case that really matters if we’re talking to the investment world.” GE is a case in point. In 2004, the company embraced sustainability as a growth driver by establishing Ecomagination brands, focused on environmental safety. During the recent global economic crisis, these brands were GE’s only source of growth, growing by 12 per cent while other revenues shrank by rotmanmagazine.ca / 37

two per cent. In 2010, Ecomagination products drove $85 billion in revenue. By 2014, the number had jumped to $200 billion. Based in Costa Rica, Florida Ice & Farm Company SA, is another example. In 2005, the company responded to Costa Rica’s looming water access crisis by investing in water-saving measures. Within two years, the organization had decreased its use of water in production by an eye-popping 82 per cent. The reduction drove down production costs and helped sustain 20 per cent annual growth between 2010 and 2014. Pharmaceutical and healthcare companies are also making the case for sustainable business: Deerfield, Illinois-based Baxter International Inc. estimates it earns $3 for every $1 invested in environmental initiatives; and Johnson & Johnson is achieving a 19 per cent internal rate of return on its CO2 projects. Perhaps most important, sustainability strategies where business models change are the most likely to generate profit. For example, only about one third of respondents say that sustainability-related actions and decisions in their company have increased profits. But if the organization has made a sustainability-related business model change, the percentage of respondents who report profit from sustainability jumps to 60 per cent. Consider Papua, New Guinea-based New Britain Palm Oil Ltd., a leading producer of sustainable palm oil. As activists drew attention to the social and environmental impacts of palm oil production, the company altered its business model by developing a fully traceable supply chain and reducing the use of petrochemicals such as fertilizer. The change enhanced the company’s reputation and drove superior financial performance, including profit margins that are 79 per cent higher than the industry average. Once a business has developed a strategy and business case, it is ready to tell its story. According to Ballabriga, the story should focus on material sustainability challenges that, almost by definition, a sustainability strategy will address. “At the end of the day, investors want to know about growth, efficiency and risk,” he says. “Sustainability is central to each.” Accounting and standards boards in the U.S. and Europe are grappling with the essentials of what sustainability issues must be disclosed to investors. Perhaps most important, investment firms such as Generation Investment are demonstrating that attention to non-financial material issues can produce favourable returns. As indicated by our research, there is no one-size-fits-all solution for businesses to meet the needs of the sustainabilityfocused investor. But companies should prepare to capitalize on this trend. To do so, leaders can take the following steps: • Build awareness of sustainability challenges and programs — both within the company and among stakeholders, including investors. 38 / Rotman Management Winter 2017

• Identify and analyze material issues and create alignment within the organization to ensure an integrated response. • Invest in and focus on tangible and measurable sustainability outcomes instead of positions on ratings lists. • Formulate a strategy once tangible sustainability measures are established. • Incorporate the sustainability strategy into the overall corporate strategy, including a clear business case or proof of value. • Engage investors, and a broad range of stakeholders, to discuss the company’s sustainability strategy and progress. In closing

As investor interest in sustainability mounts, sustainability laggards need to pay attention. Companies such as Walmart and Marks & Spencer are beginning to give preferred shelf space to sustainable products, and manufacturers are taking notice. A similar trend is brewing in the investment community. As major investors refine their models and prove the value of sustainability, companies such as Vanguard and Fidelity may do for retirement savings what Walmart has done for consumer products: shift the focus squarely onto businesses with solid sustainability performance. Lest one think that idea is far-fetched, few would have thought 20 years ago that Walmart would become a beacon of corporate sustainability. Executives across all industries should take notice — and action.

Gregory Unruh is the Arison

Group Endowed professor at George Mason University in Virginia. David Kiron is the executive editor of MIT Sloan Management Review’s Big Ideas Initiative. Nina Kruschwitz is MIT Sloan Management Review’s managing editor and special projects manager. Martin Reeves is a senior partner and managing director in the Boston Consulting Group’s New York office and head of BCG’s Henderson Institute. Holger Rubel is a senior partner and managing director in the BCG’s Frankfurt office and a global sustainability lead. Alexander Meyer Zum Felde is a project leader for sustainability in BCG’s Hamburg office. This article is an adapted excerpt from the joint MIT Sloan Management Review/BCG report, Investing for a Sustainable Future. The complete report can be downloaded online.

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COLLABORATIVE INNOVATION:

How to Avoid the Four Traps

Successful collaborations demand a seemless process, a co-designed problem statement, value generation across multiple time horizons, and above all, empathy. by Alessandro Di Fiore, Jonas Vetter and Devan R. Capur

MOST LEADERS RECOGNIZE that they need to take proactive steps to break down the silos within their organizations, so that people can work together more easily and innovate across departments. They also know that in today’s innovation-starved environment, they need to collaborate externally with their customers and others in their ecosystem to create new products and solutions. This sort of collaboration has been well-documented in the business-to-consumer (B2C) context, but less so in the businessto-business (B2B) space. In our work with clients, we have seen first-hand that, when done right, B2B collaborations can generate benefits in four distinct areas:

Collaborations allow a business to closely explore the ‘context of use’, giving it a more in-depth knowledge of end-user needs; LOWER MARKETING COSTS. Market research costs can be lowered dramatically via collaborations, as businesses can develop a concept jointly and share the costs of testing it out;

• DEEPER KNOWLEDGE.

•

As a business innovates directly with target customers, risk goes down and the end result is more likely to fit the needs of the marketplace. INCREASED TRUST. Close ties with collaborators can lead to improved relationships and trust within an industry ecosystem.

• DECREASED RISK.

•

Consider the case of Italcementi, a US$4 billion Italy-based cement company. Italcementi decided to target ‘Archistars’ — architects so famous that their projects inspire the works of countless other architects and real estate developers — as their collaborative innovation partners. Their initial project was with contemporary architect Richard Meier, who designed the Dives in Misericordia church in Rome, commissioned by the Vatican. Meier wanted a white cement surface that could stay brilliant for years — even in a city filled with pollution. Italcementi had been working on a self-cleaning cement in its lab, but had never developed it fully until the collaboration with Meier. rotmanmagazine.ca / 41

Full agreement on the nature of the problem you plan to tackle together is critical.

Having seen first-hand the value of such collaborations, Italcementi institutionalized the approach to support the development of its ‘specialized cements’ line of business. The company went on to collaborate with Giampaolo Imbrighi on ‘transparent cement’, which lets light through and is a more sustainable building material, for the Pavilion at the Shanghai 2012 EXPO. They then repeated the exercise with another archistar, co-developing a so-called ‘biodynamic’ cement — a material that has both air-purification as well as extreme malleability characteristics — for the Italian Pavilion in the Milan 2015 EXPO. Italcementi benefited in a variety of ways from these collaborations: they enabled it to position itself as an innovator in a commodity industry; and it received significant publicity, while minimizing the risk of getting its innovations to market. And it all paid off: Italcementi managed to grow its specialty cement business from by five per cent in three years — and is targeting 20 per cent growth by 2018. While this case clearly illustrates the benefits of collaborative initiatives in the B2B space, the fact is, these innovations often fail to yield the expected results. We have seen numerous cases where resources and time are wasted on initiatives that die on the vine. On the bright side, we have also witnessed successful collaborations. Following are two examples. VentureMed + Surgeons + Biomedical Device Manufacturers:

VentureMed group successfully facilitated a process of collaborative innovation between end-user surgeons and bio medical device manufacturing suppliers to create the FLEX Scoring Catheter®, an innovative device that enhances the effectiveness and safety of angioplasty to help clear blood vessel blockages. The process it embraced included iterative safety-centered discussions and simulations, resulting in an extremely promising device. BASF + Daimler Buses: In another successful collaboration,

BASF and Daimler Buses got together to imagine ‘the bus of the future’. The initiative was triggered by BASF under its global co-creation program, Creator SpaceTM, which aims to connect innovation-minded companies and stakeholders to discover solutions for key challenges. Our exposure to these initiatives enabled us to identify four common traps of collaborative innovation—as well as four related solutions that can enable their avoidance. 42 / Rotman Management Fall 2017

TRAP 1: Treating Collaboration as an ‘Event’

Organizing and executing a successful innovation workshop with a new partner is a challenge unto itself, but leaders often invest too much effort in bells and whistles to present their companies in a good light. Remember, this is not a sales pitch. Fostering innovation requires careful planning, before and after the workshop; selection of ideas through a jointly-agreed upon process; intellectual property management between the two parties; resources allocation; and a clear governance structure. Recently, a well-known telecommunications company launched an initiative with a key business customer to jointly innovate the customer data management system. While the subsequent innovation workshop was set-up professionally, the two companies failed to plan for governance and resources to properly follow-up on the generated ideas. Furthermore, the key resources were owned by another function, which was not involved in the process, and its manager didn’t provide the required support because his managing-by-objectives priorities were pointing in a different direction. Not surprisingly, that first wave of effort was not followed by a second one. SOLUTION: Manage it Like a Seamless Process

From the first day onwards, it was clear to BASF and Daimler that the initiative would not be an event unto itself, but a shared journey aimed at shaping the future of urban mobility by innovating Daimler’s bus of the future. The initiative was planned by the two companies well in advance — eight months before the event. The kick-off happened at a joint workshop, attended by Daimler Buses’ head of strategy and the coordinator of BASF’s automotive industry group. Here, BASF presented to Daimler Buses its goals, as well as the suggested co-creation approach. In an atmosphere of joint excitement, first milestones were agreed upon and key roles defined. BASF appointed a full time project coordinator — an experienced sales employee with strong ties to the automotive industry. The BASF project coordinator and a cross-divisional BASF team of highly-motivated experts went through a dedicated training session on collaborative innovation methods. Daimler Buses, for its part, assigned the head of design as internal coordinator for the collaboration. Then, the joint coordination team set-up a proper governance structure involving technical and research staff as well as senior management of the two companies. Both

Archistar Innovative Collaboration System • Focus on Archistars... • ... while developing flagships

• Push the bar of architectural creations • Emotional value of recognition 1

companies leveraged their structures. BASF, for instance, used its automotive steering committee — a committee consisting of divisional heads with significant business in the automotive industry — as the project’s steering committee. Daimler Buses’ team, on the other side, was sponsored directly by the board of the bus division. The Creator Space team provided methodological support and facilitation along the journey. Having secured both management endorsement and methodological support, the coordinators planned the preparation phase, the innovation workshop and the follow-up phase. A legal intellectual property agreement was put in place, clearly regulating the use of the jointly developed ideas based on BASF technologies. After the workshop, ideas were seamlessly integrated into the existing companies’ decision making and resource-allocation processes. At Daimler Buses, the screened ideas went through the initial stage of their innovation process and received the required resources. At BASF, the project manager presented the selected ideas to its automotive steering committee. After obtaining the go-ahead, he did a road show through the respective business units in order to get the required support from the experts, R&D staff and line managers of each division. TRAP 2: Defining the Problem Statement Alone

In this context, full agreement on the nature of the problem you plan to tackle together is critical. While this might sound obvious, this is not always the case. We saw one such initiative unfold at a company we will call ‘WhiteCo’ — a parts supplier for the white-goods industry (refrigerators, washers and so on). WhiteCo had put huge efforts into convincing a key customer to participate in a collaborative project and had done its best to properly plan the event. They had picked a location designed to spark people’s imagination, and both parties had sent representatives from multiple functions that included experts and key executives from each. A top-flight facilitator had been invited to lead the discussion. Commitment and expectations were high, but despite these efforts, the workshop flopped. The issue, it turned out, was that the problem they were trying to solve through the exercise was only relevant to WhiteCo, and not to its customer — so the customer’s representatives soon disengaged. In an attempt to salvage things, WhiteCo switched to a problem that it knew was important to its

Contributors

Value

Platforms

Interactions

• Archistars pampered during the experience cycle • Joint ideation with R&D staff

• Creation of a physical space... • ... showcasing R&D capabilities

FIGURE ONE

customer, but it soon became apparent that this didn’t work either, because it really wasn’t relevant to the WhiteCo participants. Both sides ended up disappointed and will be unlikely to repeat the experiment. SOLUTION: Co-Design the Problem Statement

At VentureMed group, the problem statement was progressively refined through a collaborative process among three key entities: the founder and chief science officer of VentureMed; the physician surgeons (end-users); and multiple biomedical device companies (suppliers). This helped to filter and evolve the portfolio of questions to address in developing an optimal solution. After some initial informal discussions, VentureMed implemented a structured process of three successive working sessions. An external facilitator was selected and the sessions focused on uncovering the unmet needs of patients and physicians to craft a clearly articulated problem statement. The team also involved venture capitalists for input at this early stage. rotmanmagazine.ca / 43

An emotional understanding — obtained through touching, seeing and feeling—of the business issues at hand will drive empathy among collaboration partners.

Battery concept

New coatings

Innovative surface materials Novel seating solution

Ozone to oxygen catalyst coating

Part of the visualization exercise in the BASF-Daimler collaboration.

leaders do not invest time in creating a shared understanding of their time-horizon thresholds, and this misalignment can undermine the appetite for ongoing resource allocation. For example, a supplier in the packaging industry, which we will call ‘GlobalPack’, was focusing on a one-year time horizon to find new applications for its existing materials. The customer, a global multi-brand original equipment manufacturer in the fast-moving consumer goods industry, targeted long-term innovations enabled by new materials. The customer became disillusioned by his supplier’s approach, while the GlobalPack people — many with a sales background — were frustrated by the lack of tangible business impact of the initiative. Even during the innovation workshop, the two companies were speaking different languages. SOLUTION: Generate Value Across Multiple Time Horizons

A portfolio of questions to address was then honed by their impact on unmet needs and their clinical relevance, which led to the deeper dive session focused on design. At BASF and Daimler Buses, the co-design of the problem statements was kicked off though a professionally facilitated brainstorming session at Daimler’s Neu Ulm site six months ahead of the innovation workshop. At the session, selected engineers and managers but also ‘unbiased’ young employees gave their views on the future challenges for Daimler Buses and its end-users. After this initial brainstorming, the items were clustered by BASF which then returned a list of potential problem statements to Daimler Buses, which circulated the list through its own organization. Having received inputs from a larger circle of people, the list was returned to BASF with an order of preference. Finally, BASF organized the problem statements into agenda themes, resembling the joint work teams at the innovation workshop. This process ensured that the final topics represented the actual pain points of Daimler Buses and its customers, which were at the same time aligned with BASF capabilities. TRAP 3: Diverging Time Horizons

In some cases, innovation partners might be aligned on the problem statement, but their time horizons for the innovation cycle and expected financial returns can be quite different. Too often, 44 / Rotman Management Fall 2017

BASF had very dispersed time horizons for the project, ranging from short-term targets in its coatings and fluids businesses, to mid-term horizons for plastics to long-term prospects for research projects. Daimler Buses, on the other side, works with a firm development cycle of 10 years for buses, with little need and space to bring new innovations into existing product lines. To by-pass the third trap, both companies agreed to aim at a balanced distribution of short, medium and long-term project ideas — i.e., a ‘forced’ portfolio able to bridge different expectations. To achieve it, up-front transparency and openness regarding the two companies’ financial goals and time horizons — and within each organization of the different stakeholders—was key. For example, the two project managers knew that only a few quick wins would make a large scale implementation of ambitious ideas possible. As businesses tend to be evaluated along shortterm economic results, there needed to be a monetization able to bridge the time span until the realization of the grand innovations. In fact, BASF realized additional sales of existing products during the initial months of the journey. This quick win catalyzed even more support and resources from the varied stakeholders of the company. The BASF team also used another lever to catalyze internal interest and support at the company: they integrated the most salient potential joint projects with Daimler Buses into a vehicle rendering for internal use only. The rendering provided an integrated vision of how the individual projects of the variegated

BASF divisions could contribute to the desired ‘bus of the future’. This visualization helped people understand the big picture and was used as communication collateral at the BASF Automotive Steering Committee to move forward with several hypothesized joint innovation task forces with Daimler Buses. TRAP 4: A Failure to Generate Empathy

‘Take a walk in the customer’s shoes’ is an old saying, but practicing it during a collaborative innovation process is an imperative. Only if business leaders understand and ‘feel the pain’ of their customer or partner, can they be truly creative in their ideation process. An emotional understanding — obtained through touching, seeing and feeling — of the business issues at hand drives empathy among collaboration partners. It also enables intimacy and trust — key ingredients for a sustainable collaboration. The trap here is to rely on jargon, Power Point presentations and engineering-requirement lists to indicate empathy. These elements create an environment where people are not able to perform at their best, because they have not emotionally understood how their partner and end user are thinking and feeling. SOLUTION: Empathize Throughout the Process

VentureMed’s process focused on ‘empathy touch points’ for the patient and the physician. Illustrative cases were created of patients before and after the procedure, along with powerful testimonials. In the case of the physicians, a constant voice of the clinician end-user was part of the process in the design of the handle for the device. Ease of use was emphasized: awareness of the gloved hand, slip resistance and simplicity led to an ergonomic, intuitive handle for the device. Likewise, the BASF innovation workshop was planned to embed emphatic design techniques. The participants went through each other’s site visits, a ‘day in the life of ’ each company aimed to build emotional understanding and recognition of the pain points of the respective production processes. In addition to workshop participants, other key decision makers and stakeholders of the two companies needed to ‘see and feel’ the atmosphere and results of the workshop. BASF found a good way of handling this: they invited a professional movie maker who developed a vibrant short video able to capture the emotions and the collaborative innovation environ-

The end result of Venture Med’s collaboration: the FLEX Scoring Catheter®.

ment of the workshop. This video helped stakeholders of the two companies to understand the human element and the value of the collaborative process. In closing

Collaborative innovation is an increasingly common organizational challenge — and opportunity. We can attest to the fact that, even when the outcome is successful, barriers will be encountered and mistakes made along the path. However, as indicated herein, a robust and long-term commitment to this new way of doing business can lead to significant value creation.

Alessandro Di Fiore is

the founder and CEO of the European Centre for Strategic Innovation (ECSI), based in London. Jonas Vetter is a consultant at ECSI in Milan. Devan R. Capur is a Strategic Advisor to ECSI in Boston. rotmanmagazine.ca / 45

The End of Accounting? TWO EXPERTS GO HEAD-TO-HEAD

NYU Professor Baruch Lev’s latest book, The End of Accounting, makes some bold statements about the state of financial reporting. Rotman’s Partha Mohanram responds to some of his more provocative statements.

Illustrations by Cheryl Chalmers.

PROESSOR BARUCH LEV ON FINANCIAL REPORTING, THEN AND NOW:

“Surprisingly, with all the advances in information technology, communication, and investment analysis affecting capital markets — as well as the substantial changes affecting the strategies and operations of businesses — the structure and content of corporate financial reports to investors didn’t change during the past century. Investors, 110 years ago, received similar balance sheets and income statements as do their present counterparts. This would suggest a constant decrease in the role of financial information.” “[Comparing 1902 with 2012,] Amazingly, there are absolutely no differences in the structure and information items provided to investors by [U.S. Steel’s] two financial reports. Seriously, a struggling enterprise, like the 2012 U.S. Steel, providing the same information as the booming 1902 company? Shouldn’t today’s investors be told what aspects of the business

model failed in 2012 or before? Informed about manufacturing setbacks? Specific marketing challenges? And told, backed by data, about the remedial steps taken by management? Shouldn’t a 21st-century corporation reporting about its operations and economic condition systematically convey such strategic information, rather than report what it paid years ago for buildings and machinery or questionable assets like goodwill? Really informative financial reports — rather than those frozen in time—are essential to investors and the public at large.” PROFESSOR PARTHA MOHANRAM’S RESPONSE:

Prof. Lev makes some compelling arguments supporting his view that financial reporting has remained relatively static. However, there are at least three caveats to his arguments. First, it’s not as if this is unique to the arena of financial reporting. Consider the roads we drive on, and the traffic signals that abound at major intersections. Outwardly, they appear to have rotmanmagazine.ca / 47

remained essentially the same, while cars have changed beyond recognition over the past century. Looking deeper, one realizes that a vast number of changes have occurred in road design, synchronized traffic signals etc. Second, while the nature and format of financial statements may not have changed, their mechanism of delivery has undergone radical transformation due to the emergence of company investor relations websites, availability of financials on the SEC EDGAR database, searchability using XBRL etc. This means that one can, in a matter of seconds, acquire information about virtually any firm from literally anywhere. Finally, while it is true that none of information that Prof. Lev desires is mandatory, many firms do report this information voluntarily, either in the discussion of business risk or in their footnotes. Allowing this kind of disclosure to be voluntary allows firms to make their own trade-offs between the benefits of transparency and the costs of releasing proprietary information. PROF. LEV ON CASH FLOW vs. EARNINGS:

“Predicting companies’ cash flows would have yielded an eight per cent higher return annually than predicting earnings over 2009–2013. And, predicting cash flows is more straightforward and considerably less time-consuming than predicting earnings, because you don’t have to forecast the numerous non-cash items (accruals) that affect earnings, such as the bad-debt provision, pension and stock options expenses, and depreciation.” “Nowadays, reported earnings are largely detached from reality and don’t really matter much. It is hard to argue with the evidence. Memo to investors: don’t take it seriously when companies occasionally miss or beat the earnings consensus. Much more consequential are changes in the business fundamentals, like decreases in new customers or in policy renewals at insurance companies, same-store-sales changes, or the size of nonperforming bank loans.” PROF. MOHANRAM’S RESPONSE:

I do not view predicting earnings and cash flows to be a horse race. Indeed, nowadays it is increasingly common for analysts to forecast earnings and cash flows. In fact, there is considerable research showing that the best analysts are those who forecast both. Predicting cash flows is much more difficult than predicting earnings — for the plain and simple reason that cash flows are much more volatile. Indeed, most of time, forecasts of cash flows are created from earnings forecasts by backing out the accruals implicit in earnings. Finally, it must be noted that while firms manipulate earnings 48 / Rotman Management Winter 2017

to meet benchmarks, they also manipulate cash flows. This is the ‘new frontier’ in earnings management, referred to as ‘Real Earnings Management’ — where firms defer projects, cut discretionary expenses like R&D and change the timing of transactions. These actions affect earnings and cash flows. The bottom line is that firms will ‘manage’ whatever they are being evaluated on — whether it be earnings or cash flows. Rather than abandon earnings for cash flows, a better approach is to pay closer attention to the numbers. PROF. LEV ON THE ROLE OF INTANGIBLES AND SUBJECTIVITY:

“The constant rise in the importance of intangibles in companies’ performance and value creation, yet suppressed by accounting and reporting practices, renders financial information increasingly irrelevant.” “The emergence of intangibles is not the only factor adversely affecting accounting usefulness. Successive accounting regulations have increased the role of managerial subjective estimation and forecasting in the calculation of financial items (asset write-offs, fair valuing of assets and liabilities), further diminishing the integrity and reliability of financial information and distancing it from reality.” “Three factors — intangibles, the proliferation of managerial estimates, and delays in recognizing important business events— all on the rise in recent decades, combine to strip currently reported financial information of much of its value.” PROF. MOHANRAM’S RESPONSE:

Prof. Lev is correct to note the growing importance of intangibles in the knowledge economy, which he says is suppressed by the current accounting system. He would like to recognize activities like R&D that create intangibles as assets on the balance sheet and not as expenses on the income statement. This, however, contradicts his earlier point regarding earnings and cash flows. The current approach treats R&D on a cash-flow basis: all we know is that money is being spent. The benefits will accrue sometime in the future, when the R&D, if successful, leads to future revenues, income and cash flows. Creating an R&D asset would defer the expenditure to the future, even though the cash is being spent now. Prof. Lev is also correct to note the growing role of fair-value accounting in financial statements. However, I have to disagree with his assertion that managerial subjectivity has increased. Recent accounting pronouncements have in fact reduced managerial discretion over key aspects of financial accounting—especially accounting for restructuring and M&A.

PROF. LEV ON WHAT FINANCIAL REPORTS CONVEY:

“The deterioration is actually worse than it looks: the amount of new or relevant information conveyed today by corporate financial reports is much less than 40 to 50 per cent; it is more like five per cent. Yes, five per cent.” “Over the past 60 years, the role of corporate earnings, book values, and other key financial indicators in setting share prices diminished rapidly, and in terms of information timeliness, or relevance to investors’ decisions, financial report information (not just earnings and book values) is increasingly preempted by more prompt and relevant information sources. “Our conclusions could be challenged on the grounds that they are drawn from two moving parts: share prices and financial information. What we have essentially shown is that the link between the two has been seriously eroding over the past half century, representing a rapidly widening chasm between accounting information and investors’ decisions.”

PROF. MOHANRAM’S RESPONSE:

This is a common assertion, and the chain of logic goes something like this: Accounting has become increasingly ‘conservative’, as we don’t measure things like R&D, which have increased in importance. At the same time, the ‘value relevance’ of Accounting has declined. Hence, it must be the case that this increased conservatism is responsible for the declining value relevance. In a paper I published with my Harvard classmate Sid Balachandran [“Is the Decline in the Value Relevance of Accounting Driven by Increased Conservatism? “, published in the Review of Accounting Studies in 2011], we explicitly disprove this. We show that if one examines the data closer, there is no decline in the subset of firms where conservatism in accounting was high — i.e. precisely the firms that Prof. Lev is most concerned about. The main reason for this perceived decline is the increasing heterogeneity among firms. In the 1950s and 60s, the number of publicly-listed firms was less than a quarter of what it has been since the 2000, and most firms were profitable. Prof. Lev’s regressions are trying to fit General Mills and Twitter into the same multiple of earnings and book value. If one re-runs these regressions with controls for industry and profitability, this decline disappears. His other point — that the real explanatory power is only five per cent — ignores an important development: the rise of the Internet and social media for investor relations. Firms are constantly communicating with investors through their IR websites, Facebook pages and Twitter feeds. Firms are also increasing their guidance of earnings, so that investors are less likely to be surprised when the actual performance numbers are revealed.

PROF. LEV ON CREATING SUSTAINABLE VALUE:

“How, then, to achieve sustained competitive advantage? The essence is to create sustained economic profits, namely, the residual that remains after subtracting from revenues all operating and financial costs, including cost of equity capital. This is, of course, a far cry from the routinely-reported quarterly accounting earnings, which are subject to myriad biases, mix expenses with investments (R&D, brands), mismatch costs with revenues (restructuring charges), and ignore altogether the company’s cost of equity capital — that is, the alternative return shareholders could have gained on the funds, including retained earnings, they invested in the company.” “Accounting earnings are relatively easy to ‘achieve’; economic profit is a challenge. How can a company achieve it? By efficiently operating its resources and assets. But not just any resources; office buildings, production machinery, airplanes, inventory or drilling equipment — all those assets that populate corporate balance sheets cannot create competitive advantage. They are just ‘commodities’ available to all competitors, and therefore, their use cannot distinguish the user from its rivals. The resources enabling value creation are different from accounting-recognized assets. They share three attributes: 1. They are valuable: they create a stream of benefits, exceeding costs, such as the patents underlying profitable products or services; 2. They are rare: a limited amount of these assets is generally available, like wireless spectrum or airlines’ landing rights; and 3. They are difficult to imitate: competitors cannot easily acquire or produce these resources; quickly mimicking valuable brands (i.e. Google) is practically impossible. Enterprises owning and efficiently operating such strategic assets are able to consistently implement value-creating strategies that their present or potential competitors cannot put into effect and thereby gain a sustained competitive advantage. End of theory.”

PROF. MOHANRAM’S RESPONSE:

I agree wholeheartedly with Prof. Lev that one ought to evaluate firms based not on their net income, but rather on their residual income, which includes a charge for equity capital. Indeed, in another of my papers with Prof. Balachandran [“Using Residual Income to Refine the Relationship between Earnings Growth and Stock Returns”, published in the Review of Accounting Studies in 2012], we show that growth in net income is truly valuable only when rotmanmagazine.ca / 49

accompanied by growth in residual income. We also show in related papers that this important fact is ignored by the markets, by boards while setting CEO compensation, and by most institutional investors. Where we disagree is the role that financial statements are supposed to play. Are financial statements supposed to provide information or analysis? Much of what Prof. Lev suggests would fall into the latter categorization. This is something that is best left to the users of financial statements, who can apply their own judgments. Mandating the disclosure of such information will either open a Pandora’s box of opportunities for manipulation (discount rates, amortization schedules for internally generated intangibles, valuation and revaluation of intangible assets). Fixing this would only add to the large volume of accounting standards as regulators come up with new principles and rules. PROF. LEV ON ACCOUNTING COMPLEXITY:

“Accounting is complex because business is complex, is the standard answer. But this is faulty logic. Consider a company’s sales: when should a sale be recorded as such in the books? It is hard to believe, but this question led to a 15-year (!) project by the Financial Acoounting Standards Board (the ‘revenue recognition project’), and despite having been presumably concluded in 2014 with the production of a 700-page rulebook, it was soon delayed for another year because it wasn’t ready for prime time. Why the complexity? Primarily because regulators strive to incorporate in the rules any known or conceivable transaction and agreement between parties, even when remote and inconsequential.” “Sadly, current financial reporting has deteriorated into a compliance activity, where managers and auditors ‘check the (very detailed) regulatory boxes’. There is no room for managers to decide whether the reported item fits the specific aspects of the transaction and the surrounding economic circumstances. Accounting rules should accommodate, even encourage, managers and auditors to fit the reporting of unusual and specific events to reflect the surrounding business and economic circumstances, with full disclosure, of course. Accounting will advance by experimentation more than by dictation.”

PROF. MOHANRAM’S RESPONSE:

I think Prof. Lev makes an important point about complexity. The standard-setting process — while allowing opportunities for feedback and consultation — is largely opaque. However, flawed as it may be, standard setting generally follows the needs expressed by users

50 / Rotman Management Winter 2017

and preparers of financial statements. Consider the standards for hedge accounting (FAS 133 and its revisions); these came as a result of a fallout from Procter & Gamble losing billions over its unaccounted-for speculative hedging activities. Prof. Lev is absolutely correct in his observation that much of the accounting standards were indeed written with the ‘oldeconomy’ conventional firm in mind. But, it’s also fair to say that most of the changes also reflect the growing complexity in industrial organization over time. Much of the complexity affects revenue recognition. For instance, when a software firm makes a sale, is it selling a product (‘recognize revenue upfront’) or is it selling a service (‘recognize across time’)? Overall, Prof. Lev makes many astute observations regarding the current state of financial statements. However, his recommendations suffer from at least three problems. First, they are not internally consistent. Consider his desire to focus on cash flows but at the same time, not treat R&D as an expense; or his statements that accountants should not value assets, but still figure out the value of intangible assets. Secondly, his recommendations will either increase the tools that firms have at their disposal to manipulate their financial performance or will increase the rules that they need to conform to. And finally, while he outlines the benefits from his proposals, he is largely silent on the costs. I’ll just mention one: auditors who are responsible for providing assurance about financial statements will now have to vouch for the veracity of the assumptions used to value intangible assets. I think the current system is fine as it is. Let the firms disclose the information they are required to in their financial statements and any additional information they wish to in their voluntary disclosure. Users of financial information can use this mosaic of information in the way that they wish to. PROF. LEV ON REVITALIZING ACCOUNTING:

“How can historical-based accounting and financial reporting be restructured and rejuvenated? The gradual, fine-tuning approach of accounting regulators to enhance information effectiveness failed. But don’t take our word for it: a recent exhaustive examination of the Financial Accounting Standards Board’s 40-year regulatory record corroborates our verdict. Four accounting researchers examined the impact on investors of 147 accounting regulations enacted between 1973 and 2009 — many of them with extensive implications on how assets, liabilities, revenues, expenses and cash flows should be accounted for and publicly disclosed — and reported sobering results: a whopping 75 per cent of the regulations had no impact on investors whatsoever.”

“A new direction for accounting and financial reporting is obviously in order: we propose 1) Accepting reality, that the value-creating resources of business enterprises are increasingly intangible assets that have to be recognized as such in accounting; 2) That accountants shouldn’t be in the business of asset valuation, which by its nature is subjective and speculative; and 3) Internalizing the fact that financial information’s increasing complexity and obscurity is diminishing its usefulness to investors. Essentially, financial reporting should predominantly be about facts, and facts that matter. A return to fundamentals, so to speak.” PROF. MOHANRAM’S RESPONSE:

Points 1) and 2) contradict each other: if accountants should not be in the business of asset valuation, how will they value intangible assets, which by their very nature and definition are much more difficult to value than physical and financial assets? I agree with Prof. Lev that financial reporting should be about the facts. But the facts are themselves based on assumptions. Consider R&D expenses. Could a firm say something like “Our CEO spends 40 per cent of his/her time thinking about R&D and meeting with our R&D teams, so we include 40 per cent of CEO compensation in R&D, which by the way, we don’t expense but capitalize”? Assuming for a moment that the actual amount a firm spends on R&D is a fact, the value of the associated intangible asset is often a fiction based on many assumptions, some of which undoubtedly will be made opportunistically. There is potential for manipulation when an asset is created, and also when an asset needs to be written off. Can we expect firms to be completely transparent and timely when they realize that their R&D ‘asset’ is not worth what it says on the balance sheet? Who will hold them accountable? The auditors, who may not be technical experts? Investors, who may not have the in-depth information necessary to question the assumptions made? Boards of directors?

as a company’s future cash flows, products, or market share?” PROF. MOHANRAM’S RESPONSE:

I am interested! In my research and teaching, I show that financial statements still play a crucial role in business analysis and valuation. I am not in any way arguing that financial statements are perfect and cannot be improved. Yet, an intelligent user with a sound knowledge of accounting, finance and strategy will be able to read financial statements, make adjustments for any accounting issues and use the information effectively. In addition, many users who rely on other sources of information to analyze and value firms may still find financial statements useful, as they use them as a reliable and dependable source of information. While Prof. Lev’s proposals may increase the ‘relevance’ of financial statements, they will undoubtedly reduce their ‘reliability’. Many of the changes that Prof. Lev advocates so passionately for are neither necessary nor costless. Shifting our attention to cash flows instead of earnings will simply mean that firms will shift to ‘real earnings management’ instead of the traditional ‘accruals-based’ earnings management. Following through on his proposal to recognize intangible assets would only add to the arsenal of tricks that CEOs and CFOs have to manipulate financial statements.

PROF. LEV ON MOVING FORWARD:

“So, why is anybody interested in corporate financial reports? After all, they are purely historical documents, describing, not very accurately or with great timeliness, the firm’s performance (sales, earnings) and financial position (assets, liabilities), as of the prior year or quarter. What relevance can such backward-looking information have for investors’ decisions, which are based on prospective outcomes, such

Baruch Lev is the Philip Bardes Professor of Accounting and Finance at NYU’s

Stern School of Business, and the author of The End of Accounting and the Path Forward for Investors and Managers (Wiley 2016). Partha Mohanram is the CPA Ontario Professor of Financial Accounting and Professor of Accounting at the Rotman School of Management. He is an Editor of Contemporary Accounting Research and sits on the editorial boards of The Accounting Review and Review of Accounting Studies. He is also the Director of the India Innovation Institute at the University of Toronto.

Rotman faculty research is ranked #3 globally by the Financial Times. rotmanmagazine.ca / 51

MANAGING CONFLICT CONSTRUCTIVELY Most workplace disagreements stem from one of three sources: different agendas, different perceptions and different personal styles. Here’s how to work through all three. by Karen Dillon

WHEN WE THINK ABOUT CONFLICT, what often comes to mind is war: factions diametrically opposed over a significant issue. But not all conflicts are struggles for power or property or people. Lines are often drawn at work, too — and just because a workplace is civil and quiet doesn’t mean it is devoid of conflict. Consider this story. Robin and Eli worked together on a joint project virtually, from different time zones. Robin spent her mornings drafting the piece of the project she’d be working on that day with Eli. When Eli came online several hours later, he wouldn’t read what Robin had done; instead, he wanted to work together in real time to create a bullet-point outline. This practice annoyed Robin. Why had she spent hours getting a head start if Eli was going to ignore her work and control the conversation later in the day anyway? She fell in line, ceding to his way of working — but she also started getting grumpy with him, growling at his suggestions or

huffing her way through his re-creation of work she’d already done. This passive-aggressive dance went on for weeks, until finally, Robin quit doing any work on the project. Eli didn’t even notice that she had stopped contributing until Robin broke and flagged it for him. Sometimes, conflict is quiet. It’s also widespread. In fact, employees at all levels spend 2.8 hours a week dealing with unproductive conflict, according to a 2008 study by CPP Global. That adds up to more than $350 billion a year in wasted wages. Unproductive conflict might be as simple as experiencing a perceived slight or misunderstanding a process, as was the case with Robin; or it could be as complicated as locking horns in a client presentation. Either way, we waste company time and money either entrenched in these fights or avoiding a confrontation. Worse yet, work disputes also likely bleed into your personal life, consuming your precious free time with worry, dumping rotmanmagazine.ca / 53

Employees at all levels spend 2.8 hours a week dealing with unproductive conflict.

misplaced frustration on your family, and placing unwelcome stress on you. So why don’t we just have the argument and then move forward? In general, we avoid addressing uncomfortable issues because very few people like to deal with conflict head-on. “People have a basic need to be liked,” says leadership consultant Ron Ashkenas. “As soon as you get into a conflict, there’s this discomfort that the relationship is going to be broken.” On top of that fundamental human need, there are layers of complicated reasons that make it difficult to confront someone. Perhaps you’ve tried, and failed, to resolve clashes in the past, or you fantasize that your boss will notice and intervene. But conflict is seldom resolved through avoidance or wishful thinking. Even the most conflict-averse of us can develop productive ways to confront — and resolve — thorny issues. The following guidelines will help you manage conflict more constructively. GET MORE COMFORTABLE WITH CONFLICT. First, you need to recognize that not all conflict is bad. In fact, it can be healthy, leading to creativity, collaboration and problem solving. Consider the classic tension between sales and product teams: aggressive reps make customers promises that the product teams can’t possibly deliver. Or so it seems — until the drive to satisfy the customer and meet expectations leads to innovations in manufacturing, product design — and sometimes, completely new offerings. “Teams composed of high-performing individuals are naturally subject to contradictory tensions and rivalry,” suggests Mark de Rond, an associate professor of strategy and organization at the Judge Business School, University of Cambridge. But these tensions should not necessarily be ‘managed away’: de Rond has found that they boost productivity and help teams perform better, because they stem from the same diversity of skills, approaches and opinions that help the group build a complete big-picture view. SEPARATE EMOTION FROM OUTCOME. Consciously separate how you feel about the conflict from how it is affecting your work. It’s possible that even though a situation seems tense to you, it’s not actually interfering with excellent results. For example, participating in an after-action review of a failed product launch may raise 54 / Rotman Management Winter 2017

your blood pressure, but this discussion may also yield useful process changes to avoid such disasters in the future. To help disentangle your feelings from your output, ask yourself whether your struggles with a colleague have actually had a negative impact. Have they made the project schedule slip or jeopardized a client relationship? It’s not uncommon for work that feels difficult while it’s under way to actually be stellar in the end — and recognizing this can help you see how tension is an integral part of the creative process. DON’T MAKE IT PERSONAL. You may also feel uncomfortable with conflict because you don’t like the idea of ‘attacking’ someone. But you can confront someone without shredding their character. When you focus on the problem at hand — instead of the person involved — you can challenge a colleague without it sounding like — or being — an attack, advises Ashkenas. Asking probing questions and challenging assumptions, for example, and using language such as, ‘Have you thought about X or Y?’ can go a long way toward shifting the conversation from ‘attack’ to a calmer exploration of an issue. IDENTIFY AND RESOLVE YOUR CONFLICT. No matter what the source of conflict is, the key to resolving it is not to struggle in silence, says Ashkenas, but to bring your concern out in the open. “Try to make the implicit, explicit,” he says. Identify it for yourself first, and say it out loud: “Nicolas and I have fundamentally different priorities on this project.” A problem that is never articulated is unlikely to be solved. When you’ve collected your thoughts and cooled down from any annoyance you were feeling, go see your colleague, privately, to discuss what’s bothering you. In essence you’re asking for his permission to have a discussion, advises organizational development and HR expert Susan Heathfield. You can do this by e-mail or by popping by his office. If your colleague isn’t ready to have a discussion, he’s likely to beg off: “Not today, I’m swamped.” But try again the next day. Don’t go in with guns blazing: have your key points ready about your view of the differences, and be prepared to listen. Although situations vary, there are three universal pieces of advice for having a productive disagreement:

Understand and be able to clearly express what the clash is about. • Empathize. Consider your colleague’s point of view. • Have courage. An honest conversation that recognizes your different perspectives will propel you both forward. • Articulate.

Sources of Disagreements

Most disagreements stem from one of three sources, says Jeff Weiss, a partner at Vantage Partners and an expert in conflict management. SOURCE 1: Different Agendas

When it comes to conflicts born of different agendas, we often see well-intentioned people working toward different and legitimate aims who allow a situation to turn into a black-and-white dispute: ‘I want X. You want Y. We can’t agree; one of us has to lose for the other to win’. This is the most common source of workplace disputes, and it isn’t personal, Weiss says. You simply have different roles and goals. How can you find common ground despite these different goals? You need to sit down to talk with the other person to figure out what you’re each driving toward. THE WRONG WAY TO HANDLE IT: Suppose you’re a salesperson trying to close a large deal with a customer to meet your monthly goals. You’ve decided to offer a substantial discount and forgo the customary 25 per cent deposit in advance of any work. This is a longtime customer, and you don’t want to risk losing them to an aggressive new competitor. You try to slip the paperwork under the legal department’s nose on a busy Friday, so that it won’t hold you up. But your colleagues are used to such frenzied month-end tactics. They know well the high price of poorly-outlined terms that make it painful or impossible for finance to collect. They intercept the documents — calling out the deviations from standard contracts — and return a redlined nightmare that prevents you from closing the deal, serving your customer, and meeting your target. A BETTER WAY: Explain what you’re trying to achieve: ‘This is a long-time, reliable customer, and we’ve never had a problem with payment. I’m really worried that we’re at risk of losing this

customer to a competitor who is offering far more favourable terms. I’m trying to take some of the bureaucracy out of our agreement here to close a deal quickly and edge out our competitors.’ Empathize with your colleagues. What were they trying to achieve? ‘May I ask why you’re leery of putting the contract through as it is? What concerns are you trying to address with your edits?’ Get beyond accusations and ultimatums such as, ‘You can’t do that’ to discover what is motivating the behaviour you don’t like. The key to a productive outcome here is coming to an understanding of what is driving each other’s agendas, says Weiss. When you learn more about why someone has a different view than you do — and you have a chance to explain your own — you are far more likely to find a creative solution that works for both of you. Your goal isn’t to ‘win’, but to find a better way forward based on your increased comprehension of each other’s interests. It may be that the legal department doesn’t want a culture of one-off contract terms to become the norm; or you may discover a new law that exposes your company to unseen liability if a particular clause is excluded from a contract. With an open conversation and brainstorming, you’ll likely find a path that is better for your company. SOURCE 2: Different Perceptions

In conflicts that arise due to different perceptions, the basic facts are not in dispute, but what you think about those facts varies based on your personal filters. Two people can be in the same meeting and walk away with completely different ideas about what the next steps are. You just see the world differently. Resolving differences in perception, de Rond says, requires an explanation from both parties. Understanding your colleague’s point of view — and how she came to it — and sharing how you came to yours will help you create a shared view. THE WRONG WAY TO HANDLE IT: Say you and your colleague Rohit are asked to join the team that will redesign your company’s website. The CEO’s mandate is to create a high-quality web presence using the best internal resources possible. You think that entails targeting resources — getting internal buy-in on key aspects related to function. As such, you’re willing to risk delaying the launch so that finance, sales and marketing are happy with the shopping rotmanmagazine.ca / 55

Teams composed of high-performing individuals are naturally subject to contradictory tensions and rivalry.

cart functionality. But Rohit seems to be interpreting ‘best internal resources possible’ to mean that everyone needs to weigh in on the look and feel of the new site. Rather than giving formal presentations to keep folks up-to-date, he’s conducting one-onone sessions with random people — for instance, asking finance colleagues what they think about colour palettes or fonts. His feedback-collection strategy threatens to delay the schedule, and for what purpose? Needless niceties of tapping a group that has no expertise in this area? The CEO put you both on the team because you’re known for bringing difficult projects in on time. But you’re steaming over Rohit’s approach, whereas he thinks the approach you’re advocating excludes employee input. You confront him: ‘Enough with the cube-by-cube tour of wireframes! You’re more concerned with looking like a ‘project manager of the people’ than you are about the impact all this feedback will have on the people who actually need to act on it.” He is genuinely shocked and hurt; the way he sees it, he’s been following the CEO’s orders. How did you get to such different places? A BETTER WAY: Assume that your colleague has good reason for his different opinion. Ask him to explain how he sees the issue, and then you should have the same opportunity. Digging into what you each think something means (i.e. what does ‘best use of internal resources’ look like to you?) will help you both better manage your expectations and future behaviour. ‘Can you help me identify which presentations you thought were important, and which ones you decided to pass on?’ Listen to his reply. It could be, for example, that Rohit’s informal conversations with people in the finance department suggested that they’d rather not sit through an hour-long PowerPoint presentation and preferred to offer their recommendations in a more ad hoc format. You don’t have to agree with his view, but you should acknowledge it: ‘I can see why you wound up chatting with the finance folks one-onone, given their schedule constraints.’ Then share what’s behind your perspective: ‘Let me explain why I think it’s important to consult people from different departments only on their area of expertise.’ It may be that neither of you is able to agree with the other person’s perspective, but at least you’ll know why you disagree. And your conversations may 56 / Rotman Management Winter 2017

then lead to an alternative view. Together, you can craft a productive solution: the two of you could co-host town-hall-style meetings to targeted groups, but make attendance voluntary. You could then send summary briefings to the core team members for their feedback before they finalize decisions — all well within the bounds of your schedule. SOURCE 3: Different Personal Styles

Type A personality versus creative maverick; deadline-driven person versus ‘schedules are only guidelines’. Conflicts born of different personal styles can be the most difficult to navigate, because at their core, it might be that you and your colleague are completely different. But as with the other two sources of disagreement, your primary goal is to see where your colleague is coming from and what is motivating his behaviour, says Weiss. Understanding, appreciating, and trying to take advantage of your different views will help you move forward. THE WRONG WAY TO HANDLE IT: Say you’re a punctual person. You make a point of being on time or early to every meeting you attend or facilitate. You come prepared, you’ve put away unnecessary electronics, and you don’t get caught up in small talk that eats away at meeting time. Your colleague Alan, on the other hand, routinely turns up to meetings 10 minutes late. He breezes in, all apologies, and then looks expectantly at you as facilitator to bring him up to speed. Everyone who arrived on time endures a rehashing of material they covered only minutes ago. The people in the meeting roll their eyes at you for not being sensitive to their time, and you’re mentally throttling Alan. Everyone’s frustrated, and now you’re behind on your agenda, too. The next time Alan turns up late for your meeting, you dramatically stop the discussion and make a spectacle of his tardiness: “Alan, how nice of you to join us!’’ Or perhaps you begin overloading his inbox with excessive meeting reminders, hovering near his desk when it’s time to head to the conference room. You’re so focused on your annoyance with him, you don’t pay attention to the five other people who consistently turn up for your meetings on time and prepared. A BETTER WAY:

Take a moment to remind yourself that people

who are different from each other can still get along. Think about what’s really bothering you. When you’ve collected your thoughts and emotions, meet with your colleague to learn more about where he’s coming from and to find a way to work together. You might say, “Alan, I’m frustrated when you’re late, because I feel that we either can’t start without you or if we do start, we’ll need to pause and bring you up to speed. Is there something I can do to schedule meetings in a way that works better for you?” He may reveal a very good reason for consistently being late: perhaps he has seen from the agenda that the first five minutes will be an overview of the project — really for the benefit of morejunior employees — and that his contributions won’t be needed until later in the agenda. Once you’ve both shared your perspectives, you can work toward a solution. For example, you might conclude that Alan will take a narrower role in the meeting: perhaps he joins the group at an agreed-upon time to serve as an expert on a key issue. Or you could let him know when it’s particularly important that he attend a meeting so that he can rearrange his schedule or commitments to be on time.

This is not an opportunity to complain about the other person — either directly or through passive-aggressive language (such as ‘John seems to think that it’s worth risking losing a key customer in order to keep the historic blueprint of all our contracts intact’). Instead, state the issue clearly, focusing on the problem, not the personalities: ‘We’re stuck, and we need your help thinking this through.’ Frame the conflict by describing its impact on the organization. ‘This customer is worth $10 million to us annually. We want to be careful not to establish a bad precedent for overlooking important legal protections — but if we can’t agree on the right language for this contract quickly, we risk the customer looking elsewhere.’ Briefly explain what you’ve tried thus far. Your neutral airing of the issue, your united front in appearing at the meeting, and your demonstration of how you’ve tried to solve the problem will make your boss more willing to work with you both. She may know of other internal resources — such as in-house mediation services or organizational guidelines for conflict. Or she may just make a judgment call that you both have to live with. In closing

Know When to Bring In the Boss

As a last resort, it’s okay to escalate a problem with a colleague to your boss, says Weiss — but only after you’ve given some real thought to why you haven’t been able to resolve the issue on your own. Most managers aren’t interested in fighting your battles for you, but if everything you’ve tried has failed, enlist the other person involved to avoid looking as if you’re ‘tattling’. In a calm moment, go to your colleague and see if you can at least jointly define the problem and diagnoses for it to better help your manager help you. Acknowledge that you’re both trying to do the right thing; you just happen to disagree on what that is, and admit that you’re at a standstill. ‘John, I don’t think you and I are getting anywhere trying to resolve this issue. Would you be willing to go with me to ask Lydia for her help in finding a solution?’ Such transparency builds trust. It’s in your mutual interest to avoid being seen as difficult to work with or unwilling to compromise. When you meet with the boss, explain that you seem to have different objectives (or work styles, or perceptions) and that you’ve come to at an impasse.

Finding productive ways to work through conflict with your colleagues offers tremendous benefits: a unified front for working with customers and suppliers, faster and better internal decision making, reduced costs through sharing resources and expertise, and the development of more innovative products and solutions. In the end, choosing to be effective involves working through conflict, and it’s a skill that can help drive your own performance and career to a much better place.

Karen Dillon is a contributing editor at Harvard Business

Review. She is the co-author of several best-selling titles, most recently Competing Against Luck: The Story of Innovation and Customer Choice (HarperCollins, October 2016). The preceeding is an adapted excerpt from her HBR Guide to Office Politics (HBR Press).

Winning the Brain Game: Fixing the Seven Fatal Flaws of Thinking

Former Toyota Creative Advisor Matt May explains how to re-frame problems and avoid seven common — and sometimes fatal — thinking flaws. Interview by Karen Christensen

You believe today’s leaders should keep the following mantra in mind at all times: ‘What appears to be the problem, isn’t.’ Please explain.

That’s the first part of a longer mantra, which goes on to say, ‘What appears to be the solution, isn’t. What appears to be impossible, isn’t.’ It’s something I learned from working with Toyota for eight years. Here’s the thing: we solve dozens of problems every day, but the vast majority of them don’t require deep thinking; they are routine in nature and demand nothing more than a reactionary work-around — one we’ve undoubtedly used in the past. But because we solve so many challenges this way, we tend to use the same approach when tackling more complex problems. We mistakenly pose the question ‘What should we do next?’ before asking ‘What is possible here?’ We want a solution, but we don’t have the patience to wait for the optimal one, so we favour implementation over incubation. We might throw some resources at the problem and move on, or tweak a

previous solution and fit it to the current situation; but we fail to look more holistically at the challenge, and the result is that we often miss out on the best, most elegant solution. Complex problems are, by nature multidimensional, and they resist obvious, surface solutions. As MIT’s Peter Senge has said, “Human endeavours are systems. We tend to focus on snapshots of isolated parts of the system, and wonder why our deepest problems never get solved.” You have identified seven ‘fatal flaws’ of thinking, and the first three are the most common: leaping, fixation and over-thinking. Please describe how they play out.

I group these under the heading ‘Misleading’, because the lazy part of our brain can lead us into comfortable ruts and mental roadblocks that prevent the kind of mindful thinking that allows us to solve problems creatively. Leaping is when we immediately jump right to solution mode. By far, this is the most prevalent thinking flaw I see. We have been so conditioned through formal rotmanmagazine.ca / 59

We have been so conditioned to seek the right answer as quickly as possible that it has become a hard-wired behaviour.

education to seek the right answer as quickly as possible that it has become a hard-wired behaviour. All of those ‘Why?’ questions we incessantly asked when we were younger lose priority over the years. Unfocused brainstorming has become our go-to creative problem solving process; the problem is, it almost never works, and does little more than produce top-of-mind ideas—nearly all of which fail to solve the problem. Fixation is my umbrella term for our general mental rigidity and linear thinking — our ‘go-to’ mindsets, blindspots, paradigms, biases, mental maps and models — that make it easier for us to make it through the day, but harder for us to flex and shift our perception. The term itself comes from what psychologists call ‘functional fixedness’. Our brains are amazing ‘pattern machines’, constantly making, recognizing, and acting on patterns developed from our experiences and ‘grooved’ into our brains over time. While following those deep grooves makes us more efficient, it also makes it tough to — as the Apple tagline goes — ‘think different.’ Over-thinking is at the other end of the thinking spectrum from leaping. It can be thought of as our knack for creating problems that weren’t even there in the first place. Over-thinking is a rather deep bucket filled with a host of variations on a theme: over-analyzing, over-planning, and generally complicating matters by adding unnecessary complexity and cost. Based on your work with Toyota and other organizations, you have developed a fix for leaping: ‘framestorming’. Please describe how it works.

The difficulty with the Leaping flaw is that not enough time is devoted to properly framing whatever issue you’re grappling with. If I have learned anything from facilitating problem-solving sessions, it is that we will be largely unsuccessful in attempting to shut off the deeply-embedded Leaping impulse, and we should not even try. We will make far more progress if we redirect and channel the ‘instinct to act’ into behaviour that feels like 60 / Rotman Management Winter 2017

brainstorming — but actually involves generating questions instead of answers. In practice, framestorming is just that: simply injecting a step into the problem-solving effort focused on quickly generating multiple ways to frame the problem, using prompts such as Why?, What if?, and How might we? In other words, instead of seeking answers right away, you come up with questions right away, before launching into ‘solutioning’. Describe the role of ‘attention density’ in all of this.

I was especially keen to understand the underlying causes of Over-thinking and why it is so prevalent, so I spent time with a well-known neuropsychologist, Dr. Jeffrey Schwartz, who uses mindfulness to treat Obsessive Compulsive Disorder. He gave me a catchy primer that I could use to understand how patterns are formed in the brain: ‘neurons that fire together, wire together’. What turns that neural spark into a brain pattern is focused attention, referred to as ‘attention density’. The denser your attention is, the more likely a specific habit will be wired into your brain. Repeatedly focusing your attention on something strengthens brain circuits — which explains how learning to ride a bike becomes automatic, and why many habits are so hard to break. The fact is, attention can work for or against you. When you focus your attention on a strong and enduring brain circuit, it can slow you down — or even shut you down. Athletes and other performers experience this as ‘choking’: what has become automatic through years of practice can suddenly become crippling under pressure when too much attention is focused on it. In other words, thinking too much can indeed be detrimental. Whether we want to admit it or not, we all make assumptions. What is the best way to surface them?

Every solution — no matter how perfect it first appears — carries with it certain assumptions, leaps of faith or implicit conditions

for success. If these are not attended to — teased out, made transparent and tested — they can turn out to be the Achilles heel in your great idea. In my experience, simply making a list of assumptions doesn’t work for most people, for a few reasons. First, our assumptions are so ingrained in our thinking and thus so hard to identify (this is the Fixation flaw at work) that it takes a good tool to lend a bit of objectivity. Second, most people tend to list ‘known’ things for the sake of ease and to avoid the risk of looking uncertain. But an assumption, by definition, is something unknown and un-tested — a guess. And that’s scary for most of us; we fear the unknown, and we are reticent to bring it up and make it public. I learned the most powerful technique for not only surfacing assumptions but also turning them into an advantage from [former Rotman School Dean] Roger Martin, who I consider a mentor. His approach amounts to a single but powerful question: What must be true? This question is a real mind-opener, which explains why Roger has used it for over 20 years. Answering it produces a fairly robust set of conditions for success, which represent educated guesses about the future. The task then becomes one of identifying the things that you’re most worried might not be true — and thus represent obstacles and barriers — and constructing experiments to test the guesses. Tell us a bit about the two flaws of mediocrity: satisficing and downgrading.

These two are close cousins. Satisficing is a term Nobel laureate Herbert Simon coined in his 1957 book, Models of Man. It’s the combination of satisfy and suffice, and refers to our natural tendency to glom onto what’s easy and obvious and stop looking for the best or optimal solution — the one that resolves the problem within the given goals and constraints. Too often, we over-compromise and sub-optimize, accepting the halfway solution and relying on our ability to push it forward. Unfortunately, when

it comes to complex problems, that usually amounts to a rather Herculean but useless effort, akin to pushing water uphill. By thinking less, we end up working more. Downgrading is my term for when we formally revise our stated ambition in a distinctly downward or backward direction, committing what amounts to pre-emptive surrender, which, in a kind of perverse way, enables us to do what we really want to do — which is declare victory. No one likes to lose: we all love to win. But by definition, there is only one true winner. So, in order to feel like a winner, we will back off the original goal and tell ourselves a happy but fictional story of triumph. Politicians are masters of this, but unfortunately, it happens all the time in business too, and it can result in wholesale disengagement, which is detrimental to any effort. How does the downgrading flaw manifest itself in the workplace?

I see it all the time in project teams. When things get a little more difficult than anticipated, they would rather revise a goal downward or backward — and sell themselves and others on those revisions — than embrace and master the creative tension that always exists in a significant gap between where you are and where you want to be. Downgrading comes naturally and far too easily, and when we do it, we unconsciously sell short our capabilities. The fact is that you can’t possibly know your true limits until you put your capacity on trial. Immunity from downgrading is founded in good old-fashioned ‘grit’, as author Angela Duckworth terms it. Tell us about the ‘Not-Invented-Here’ flaw (NIH), and your fix for it: ‘Proudly Found Elsewhere’ (PFE).

NIH is defined as an automatic negative perception of, and visceral aversion to, concepts and solutions developed somewhere else — somewhere external to the individual or team — often rotmanmagazine.ca / 61

‘Not-invented-here’ is defined as an automatic negative perception of concepts and solutions developed somewhere else.

resulting in an unnecessary reinvention of the wheel. It means ‘If I/we didn’t come up with it, I/we won’t consider it,’ and ‘I/we can do anything you/they can do, better.’ The expression of NIH is always the same: shutting out another person’s or group’s idea immediately and without due consideration, merely because they came up with it. The next time you’re in a lobby waiting for the elevator to go up to your office or hotel room, count how many people hit the Up button even though they can see that you’ve already pushed it. That’s NIH in action. PFE is the term Procter & Gamble’s innovation group came up with to refer to the executive mandate by then-CEO A.G. Lafley to source fully 50 per cent of P&G’s innovation from outside or external entities: startups, small companies, researchers, inventors, etc. Steve Jobs never suffered from NIH. If he had, he might never have even considered visiting the Xerox Palo Alto Research Center (PARC) in 1979 and seen what he almost immediately recognized as the future of personal computing: a graphical user interface PARC had developed, designed to look like a desktop and convert traditional computer command lines and DOS prompts into icons of folders and documents that a user could point to and click open by using something Xerox called a mouse. In fact, Jobs openly embraced PFE, to the point of quite literally adopting Pablo Picasso’s quote that “good artists copy, great artists steal.” When he took the Xerox interface for Apple’s use, he later boasted that “we have always been shameless about stealing great ideas.” Tell us a bit about the ‘outsider effect’ on creative problem solving.

Most people find other people’s problems much easier to solve than their own, and psychologists believe this may be due to simply being too close to our own problems. Studies exploring the impact of mentally distancing the imagination from the immediate context have shown what’s now called the ‘outsider 62 / Rotman Management Winter 2017

effect’ as playing an important role in our ability to creatively solve problems. In one of the more recent studies, researchers gave two different groups of undergraduate Psychology students a creative generation exercise which they termed a ‘linguistic skills task’: list as many examples of modes of transportation as you can think of. There was no time limit, the instructions emphasized that there were no right or wrong answers, and responses could be “as commonplace or as creative and out of the ordinary as you like.” They split participants into two groups: ‘spatially distant’ and ‘spatially near’. The spatially-distant group was told that the task was designed by students enrolled in an Indiana Universitysponsored program called Study Abroad Program in Greece. The spatially-near group was told that it was designed by local Indiana University students. This seemingly irrelevant twist made a world of difference: the group that was told the task originated in Greece generated significantly more, and more original, examples of transportation modes than did the group that was told the task originated nearby. “Furthermore,” write the study authors, “relative to those who believed the generation task was from Indianapolis, participants exhibited greater cognitive flexibility when they believed that the task was from Greece.” In other words, those who imagined themselves in a distant and foreign land weren’t limited by what they knew to be true of local transportation, and were free to list chariots, carriages, Vespas and the like. Thinking about getting around Greece instead of Indianapolis opened their minds and invoked the outsider effect. The researchers concluded that mentally distancing oneself from the source of the problem can have a dramatically positive influence on creative performance. The good news is, there’s a simple technique you can use to flip on the outsider effect: talk to yourself in the third person, as if you were in fact someone else: ‘Matt, don’t over-think it.’

The Seven Fatal Flaws of Thinking 1. Leaping Leaping to solutions, jumping to conclusions or brainstorming in an instinctive or reflexive way almost never leads to an elegant solution to a complex problem. 2. Fixation Fixation is the umbrella term for our deeply-grooved thinking patterns—mental models, mindsets, biases, assumptions—that can make it hard for us to ‘think different’. 3. Over-Thinking Over-thinking is the art of complicating matters, and causing problems that weren’t even there to begin with, which we tend to do because our brains abhor uncertainty. 4. Satisficing Satisficing is Nobel Laureate Herbert Simon’s term for our tendency to glom onto solutions that are easy and obvious, but mediocre, thus failing to solve our problem in a creative way.

As researchers at the University of Michigan Self-Control and Emotion Lab explain it, using the third person engages the cerebral cortex, which is your centre of thought. Meanwhile, using the first person engages the amygdala, which is where fear emotions reside. Toggling between the two moves you towards or away from your sense of self and its myriad emotional attachments. The greater the psychological distance, the more self-control you have, in turn enabling you to think more clearly, objectively and creatively. Harvard’s Ellen Langer’s once said to you, “As soon as you realize that an issue looks quite different from a another perspective, take that perspective.” Why are these words so powerful?

As you know from interviewing her several years ago, Ellen — who literally wrote the book on Mindfulness — is a brilliant researcher, writer and artist. I happen to believe that her advice to me holds the very key to winning the ‘brain game’, which I define as the interplay between the biological brain and the conscious mind. The essence of her message is that there is always another way to look at any situation, and failing to override the brain’s mental inertia by consciously looking for those perspectives is not only a loss in the ‘brain game’; it is utterly mindless.

5. Downgrading Downgrading is a close cousin of satisficing and is a formal revision of a goal in what amounts to preemptive surrender, simply so that we can declare victory. No one likes to fail. 6. Not-Invented-Here (NIH) NIH means ‘if we didn’t come up with the idea, it won’t work’. We naturally reject, stifle and dismiss ideas simply because we didn’t think of them ourselves. 7. Self-Censoring Self-censoring is the mindless act of rejecting our own ideas, usually out of fear, before they ever see the light of day. It is the deadliest of the fatal thinking flaws, because it stifles creativity. —From Winning the Brain Game: Fixing the 7 Fatal Flaws of Thinking

Matthew May spent eight years as the creative advisor to Toyota, an experi-

ence that enabled him to write a book about its innovative methods and launch a speaking career. His most recent book is, Winning the Brain Game: Fixing the Seven Fatal Flaws of Thinking (McGraw-Hill Education, 2016). He hold an MBA in Organizational Design from the Wharton School of Business. rotmanmagazine.ca / 63

Health

Sustainability

Housing

Education Agriculture

Environment

IMPACT INVESTING:

Tracking the Adoption of a Financial (and Social) Innovation If impact investing can address barriers to adoption and play up its key strengths, it will be one of the breakthrough innovations of our time. by Roger Martin and Rod Lohin

IMAGINE A WORLD IN WHICH it is possible for a financial innovation to generate solid returns alongside positive social and environmental impact. This is the promise of an emerging investment approach called ‘impact investing’ that is gaining the attention of pioneering investors: big institutions, foundations and high net-worth individuals are moving quickly into this new market. However, in order to succeed, impact investing will need to grow beyond these pioneers and reach a broader set of investors. In The Diffusion of Innovations, Everett M. Rogers proposes that five attributes influence the spread of any innovation: • its relative advantage over alternatives; • compatibility with the values, experiences and needs of adopters; • simplicity; • trialability; and • visibility.

Applying these principles to impact investing in its current state, it clearly fails on more than one of these measures. However, if impact investing can address barriers to adoption and play up its key strengths, it may well continue to grow and deliver on its promise: better investing and a better world. What is Impact Investing?

Impact investments are one type of socially-responsible investment (SRI). Among the more familiar SRI approaches are ‘screens’ (to filter out unwanted companies, such as tobacco or oil) and environmental, social or governance risk analysis (to reduce exposure to risks relating to specific firms). However, only impact investments include a specific intent to create a measureable social or environmental impact and simultaneously produce a solid return on investment. Impact investing is one of the fastest-growing areas of the capital markets. Globally, there were over US$77.4 billion in rotmanmagazine.ca / 65

Globally, there were over US$77.4 billion in assets under management in 2015 and by 2025, this may grow to US$2 trillion.

assets under management in 2015 and by 2025, this may grow to US$2 trillion. In Canada, CAD$4.1 billion in 2014 is expected to grow to about $30 billion by 2023. Impact investments have already been made across a range of asset classes, in both the private and public markets. Figure One provides a snapshot of the global market in 2015. In Canada, as in other developed markets, a range of impact investment products are being developed and offered to investors. Private debt — primarily in the form of bonds issued by companies or governments — comprises the largest segment of assets. For example, Canadian fund SolarShare has issued CAD$46 million in five- and 15-year bonds to fund solar power generation projects. The scale of private debt and private equity investment shows the importance of early-stage capital to what, in many cases, are growing organizations that cannot yet access public markets. For example, InvestEco has several funds investing in expansion-stage private companies. According to its website, “Our goal is to generate strong financial returns for investors by investing in companies that promote health and sustainability in the food and agricultural sector.” Real estate and other ‘real assets’ are a significant part of the mix, making up almost 12 per cent of current investments, globally. In Canada, Vancouver-based New Market Funds runs the NMF Rental Housing Fund, which invests in multi-family affordable rental housing in partnership with local non-profit organizations. The Fund’s first four investment commitments total 358 rental units of family, workforce, elderly, and specialneeds housing, which are affordable to households earning 70 per cent or less of the area’s median income. More projects are under development. Elsewhere, the Centre for Social Innovation (CSI) wanted to expand its co-working space for social enterprises. With the help of a CAD$2 million bond, available to both institutional and retail investors, they were able to buy and refurbish another building. Investors could expect a promised return of 4.5 per cent based on its rents and with the additional security of the underlying real asset — the building itself, which has appreciated in Toronto’s hot property market. Another type of impact investment is ‘pay-for-performance 66 / Rotman Management Winter 2017

instruments’ — sometimes called ‘social bonds’ or ‘social impact bonds’. In recent years, a number of these projects have begun in the UK and the U.S., with mixed results. In Canada, the Province of Ontario is exploring this concept. Nevertheless, it remains one of the most complex forms of impact investments and represents less than one per cent of the total spectrum of such investments globally. Who is Making Impact Investments?

Currently, the largest participants in the impact investing market are major institutional investors, who are using the stable base of their large asset pools to try it out. They see these investments as experiments that provide both diversification and potential reputational upside. BlackRock, Prudential and RBC Financial Group have all made major commitments to impact investing recently, and others like J.P. Morgan and BNY Mellon are signalling their interest by publishing research on the topic. More and more philanthropic foundations are also participating in impact investments, increasing alignment between their investments and their missions. Every indication is that this trend will continue. The Rockefeller Foundation was one of the early innovators and has committed US$50 million to building the field (over and above investing its own assets). In Canada, the Canadian Task Force on Social Finance and the National Advisory Board to the Social Impact Investment Taskforce have encouraged foundations to shift 10 per cent of their assets into impact investments by 2020. Upping the ante considerably, the Inspirit Foundation has committed to shifting 100 per cent of its assets into impact investing over time, to ensure that its entire investment portfolio is consistent with its mission of pluralism in Canada. To date however, individual investors have found few retail investment opportunities. In Canada, of a total of $4.1 billion in impact investments, only about $400 million was available to individual investors. This represents just 10 per cent of the market to date — indicating that retail products are a significant potential growth area. Nevertheless, impact investing remains at an early stage in its adoption. Given the rapid growth expected over the next decade (almost 25x in the U.S. by 2025) and the increasing interest

Total Assests Under Management by Investment Full Sample

Excluding Outliers

35%

Private debt

25%

Real assets

17%

Private equity

Public equity

Equity-like debt

Public Debt

Deposits & cash

0.2%

Pay-for-performance instruments

Other

2% 0.2% 2%

6% 35% 9%

6% 7%

3% 0.3% 3%

4% 44% 21% 17%

12%

25% FIGURE ONE SOURCE: GLOBAL IMPACT INVESTING NETWORK, ANNUAL IMPACT INVESTOR SURVEY, 2016

and capacity of millennials and women investors, impact investing may very well be approaching an inflection point. What is Working—and What Isn’t

Clearly, impact investing offers new opportunities to investors. But does it have what it takes to generate widespread interest? A quick analysis based on Rogers’ five attributes of successful innovations suggests that impact investing has much to offer — but that there are also significant challenges to address. We will now discuss Everett Rogers’ five aspects of successful innovations as they apply to impact investing. RELATIVE ADVANTAGE. At first glance, adding measurable social or environmental benefits to financial returns make it notionally a superior substitute — both to other types of investment and to philanthropy. Without clear social or environmental benefits, other investments will be less attractive to some investors. Similarly, philanthropy can improve social and environmental conditions, but without any direct return to the investor. Impact investments are intended to do both. There is no doubting investors’ interest in achieving this dual objective: recent research by Cap Gemini and RBC demonstrates that 90 per cent of high net-worth individuals globally, and 86 per cent in Canada, agree on the importance of contributing to social impact. Presumably, major institutional investors are similarly attracted, and may even see the reputational benefits of experimenting in this arena. The relative advantage of impact investing depends on three things:

1. Impact

investments must generate a substantial history with identifiable indicators of financial success, allowing investors to assess their likelihood of generating solid returns with acceptable risks and costs. 2. Positive impact on social problems must also be demonstrated — and while measurable results are a hallmark of impact investing, this remains one of the fuzziest and most challenging aspects of this type of investment. 3. There is also a relatively unclear regulatory landscape. As with earlier forms of responsible investment, it’s not entirely clear that impact investing complies with the fiduciary responsibility of institutional investors — which may limit the market significantly. It may also open the door to unscrupulousness or misrepresentation of products that are not, by definition, impact investments. Over the past decade, the UK has developed clearer regulatory opportunities for impact investing, and U.S. regulators recently ruled that foundations and pension funds can take positions in these investments. These steps — and clearer compliance standards — may well be necessary across more jurisdictions, including Canada. WHAT IS NEEDED: 1.

A track record of financial success at acceptable risk levels and costs; 2. Clear measurement standards and assurance systems; 3. Clear (and supportive) regulation and compliance standards. rotmanmagazine.ca / 67

Globally, 90 per cent of high net-worth individuals agree on the importance of contributing to social impact.

COMPATIBILITY. As indicated, impact investments are already attracting the interest of sophisticated pioneers, such as major financial institutions and fund managers. However, it’s not immediately apparent that this new approach is compatible with key aspects of modern portfolio theory. First, impact adds a vector of ‘social variables’ beyond return and risk, and this complicates how potential investments might be selected and tracked. Second, given that impact investments exclude other types of investments, it can be argued that there is a loss of the benefits of diversification. Third, there are real challenges in terms of liquidity, particularly in private markets, which may not be fully appreciated by less experienced investors. These problems are often played out in the conversations between investors (even committed, sophisticated individuals) and their advisors. Traditionally-trained advisors rarely know much about impact investing and guide investors back to more familiar investments — fearing that investors will lose financial returns, diversification and/or liquidity. There is also a challenge in terms of compatibility with existing investment practices and systems. As many impact investment products are new and are offered through unusual intermediaries — or even as direct investments — it is tricky for investors and advisors to find and adequately assess them. For traditional investments such as publically-traded equities, there is a massive, well-established set of resources, information tools, trading systems and analysis available to investors and advisors. There are even clear compensation practices to help and incent advisors. Furthermore, resources to help select products are scarce: there are few public databases of products internationally — and none in Canada. In general, advisors have no idea how to find these products or how they’ll be compensated, as they’re not built into their internal trading systems. There is also no common framework to conduct analysis, and limited publicly-available analysis of existing products. The lack of these resources and tools needs to be addressed to improve compatibility. WHAT IS NEEDED: 1. Deeper

theory.

research on consistency with modern portfolio

68 / Rotman Management Winter 2017

2. Dissemination

of research to advisors and, ultimately, investors. 3. Clearer public and advisor-focused resources, information tools, trading and compensation systems. SIMPLICITY. Investing is an already-complex universe laden with its own theories, jargon, institutions and systems. Impact investing adds another element: social and environmental benefit, which may be intuitively and emotionally attractive, but does nothing to simplify matters. Add to this the complexity of finding information about such investments and the challenges faced by advisors and investors in buying them. These issues may be overcome by clearer proofs of success and better integration with financial theories and systems. However, for the short term, it is likely that impact-investing advocates should continue to focus on its greatest strength: the virtually universal belief that impact is a good thing. WHAT IS NEEDED: 1.

Simplify through proof.

2. Appeal to the human desire for impact.

TRIALABILITY. As noted, impact investments are still relatively new, are challenging to access, and there is simply not enough product. Most impact investments to date have been made by major institutional investments, foundations or ‘accredited investors’ — people with investable assets in excess of $1 million. Although institutional investors have taken the largest positions, even they have relatively few choices, as large new products are rare and bought rapidly. According to David Borcsok of the RBC Generator Fund: “Relatively large-scale institutional grade impact investment opportunities — such as the Government of Ontario’s recent CAD$750 million Green Bond issue — have been, until now, outliers due to their considerable size, and as such, get snapped up by the big firms with responsible investment mandates very quickly.” Foundations find it challenging to find opportunities that relate directly to their mandate and regional interests. For example, Canada’s Inspirit Foundation found few products that suited its interests, and has gone so far as to develop its own direct

The Diffusion of Innovation In his classic, The Diffusion of Innovation (1962, updated 2003), Rogers proposed that: “Individuals in a social system do not all adopt an innovation at the same time. Rather, they adopt in an over-time sequence.” He describes this sequence as a distribution on the basis of ‘innovativeness’ — “the degree to which an individual… is relatively earlier in adopting new ideas than other members of a social system”. The most likely to adopt an innovation are Innovators (2.5% of the population), followed by Early Adopters (13.5%), and so on.

investment opportunities as private equity investors. Liquidity is also a potential challenge in these types of investments. For those seeking to make small investments, there are very few options to date. Our research study for RBC in July 2015 found 22 retail investment products available, worth about $1.25 billion, up from about 16 in the previous year. For all of these reasons, it is difficult to ‘try out’ impact investing. There is also increased potential for loss (or even fraud) by unsophisticated investors — particularly when delving for the first time into private equity and direct investment, all of which could hamper the growth of impact investing. WHAT IS NEEDED: 1.

Speedier development of new products for large and small investors. Funds of funds? Mutual funds? 2. Caution in direct investments. 3. Some way to allow for cost-free trial.

VISIBILITY. To date, few impact investors (or advocates) have

gained prominence, with the possible exception of key leaders like Sir Ronald Cohen and Bridges Ventures in the UK and the Rockefeller Foundation in the U.S. This is a remarkable oversight — and opportunity. Impact investors not only have the opportunity to do good — but to be seen doing it. With an appropriate level of promotion, they can be seen as ‘virtuous’ investors, bringing personal, professional goodwill to their firms, families and to themselves; and they can be seen to be creating value that exceeds what can be done through philanthropy. Or both. Of course, this strength is insufficient by itself. Other challenges (such as proof of returns and impact, more product, and better resources) must be addressed. However, if impact investing can continue to grow and prove its value to investors, then promoting the virtuous success of innovative investors may be an important strategy to generate even wider adoption. WHAT IS NEEDED:

Promote successful impact investments and investors to ensure they are seen to be ‘doing good’.

2.5% Innovators

34% Early Majority 13% Early Adopters

34% Late Majority 15% Laggards

The key to the success of an innovation is that it crosses the ‘chasm’ between early adopters and laggards into the majority—in other words, that it achieves critical mass. In order to succeed, an innovation must be perceived to have the following attributes by potential adopters: 1. Relative advantage (over comparable ideas, products or services); 2. Compatibility (with the values, experiences and needs of adopters); 3. Simplicity (easy to understand and use); 4. Trialability (easy to try out at low risk/cost); and 5. Visibility (seen to be used by others).

In closing

Impact investing holds tremendous promise to connect our capital markets to social and environmental benefit. Given today’s stronger democratic institutions and civil society, more powerful and inventive capital markets, and a greater inclination among investors than ever before to address social and environmental challenges, it is entirely possible that impact investing will be one of the breakthrough innovations of our time.

Roger Martin, C.M., is director of the Martin Prosperity Institute and Premier’s Research Chair in Productivity and Competitiveness at the Rotman School of Management. He is the author of eight books, most recently, Getting Beyond Better: How Social Entrepreneurship Works (Harvard Business Review Press, 2015), with Sally Osberg. He is ranked as one of the top 10 management thinkers in the world by the Thinkers50. Rod Lohin is executive director of the Michael Lee-Chin Family Institute for Corporate Citizenship at the Rotman School of Management. rotmanmagazine.ca / 69

YOUTH UNEMPLOYMENT:

Confronting The Elephant in the Room

As the jobless rate for young people continues to inch upward, youth unemployment has become a global concern. A number of companies are developing innovative approaches to address the issue. by Willa Seldon, Katie Smith Milway, Simon Morfit and Brian Bills

IT’S NOT A GOOD TIME to be young and in the job market. After a period of modest improvement, the global youth unemployment rate worsened in 2016. Globally, joblessness among 15- to 24-year-olds reached 13.1 per cent, just shy of the 20-year peak in 2013, according to a report from the International Labour Organization. In raw numbers, 71 million young people can’t find work. Some regions are in worse shape than others. Youth unemployment in the Arab States is highest, at 30.6 per cent, and lowest in East Asia, at 10.7 per cent. In the European Union — still suffering the residual effects of the 2009 global recession — it totals 19.2 per cent. The report also finds that even where jobs are available to young people, they often fail to provide living-wage incomes.

Concern about youth employment extends well beyond ‘keeping track of joblessness’. Large numbers of unemployed young people can have serious consequences for a country’s economic security and political stability. Not surprisingly, the United Nations has included youth employment policy goals in its 2030 Agenda for Sustainable Development. Lowering youth unemployment and improving access to stable job opportunities is a policy goal for developing and developed countries alike. In the U.S., where unemployment has fallen from a Great Recession high of 10 per cent in October 2009 to 4.9 per cent more recently, the youth unemployment rate remains more than twice the overall unemployment rate. Yet, as the U.S. economy has rebounded, employers are increasingly struggling to fill rotmanmagazine.ca / 71

Some 5.5 million 16- to-24-year-olds are both out of work and out of school, presenting a huge pool of untapped talent.

entry-level positions. This mismatch between demand and supply will likely continue for some time. Between now and 2022, Bureau of Labour Statistics data project that nearly six million entry-level jobs suitable for young people will be created across a range of industries. Companies unable to fill these positions will face lower productivity and revenue. The solution for this worker shortage is hidden in plain sight: today, some 5.5 million 16- to-24-year-olds are both out of work and out of school, presenting employers with a huge pool of untapped talent available to fill entry-level positions. But developing that raw talent won’t be easy. Many of these so-called ‘opportunity youth’ have survived family strife, struggled to stay in school, and even had run-ins with the law. Preparing them for successful work experiences will take innovative forms of collaboration between employers, non-profits and government. A recent Bridgespan study found a number of global corporations that have embarked on this mission in their U.S. operations, including State Street Corporation, Starbucks, CVS Health, Walmart and JPMorgan Chase. They joined with more than a dozen other large U.S. companies in 2015 to launch the 100,000 Opportunities Initiative — the largest employer-led coalition focused on hiring opportunity youth. Today, nearly 40 employers use the initiative to offer internships, training programs, and jobs for 16- to-24-year-olds who are out of school and unemployed. The biggest challenge these employers face? Matching young people to the right jobs.

customer service. In addition, Year Up helps youth develop soft skills, from professional dress to conflict resolution, placing its participants with 250 other partner companies, where they gain work experience. Throughout their year-long participation in the program, (six months of training followed by six months spent as interns), participants receive a stipend, college credit, job recommendations and ‘wrap-around supports’, such as one-to-one mentoring and assistance with transportation, childcare and housing. Eighty-five percent of Year Up’s interns are later hired either by host companies or enroll in college: more than two-thirds of the interns Year Up has provided to State Street have become fulltime employees and stayed an average of 45 months — almost triple the average time 20- to 24-year-olds stay with an employer. Other fast-growing workforce intermediaries in the U.S. include BankWork$, which trains opportunity youth for banking jobs, and iFoster, which trains youth aging out of foster care for careers in retail and other industries. In Canada, intermediaries such as Social Capital Partners (SCP) — a social finance organization focused on matching employer demand for workers with the needs of disadvantaged people — are developing new approaches to youth employment. SCP, for example, helped Virgin Mobile launch its initiative to provide homeless youth with the skills employers need, including IT, digital print, and construction skills. SCP has also structured an innovative partnership between banks and government to offer low-interest loans to businesses that hire disadvantaged employees.

Matchmakers Step Up

‘Matchmaking’ is a role often played by non-profit intermediaries. Bottom Line, which helps low-income and first-generation students gain entry to college and careers, is one of several organizations helping Boston-based State Street Corporation, a financial services provider to institutional investors. A few years back, State Street faced stiff competition for entry-level hires, as Millennial college graduates flocked to high tech. At the same time, it wanted new employees to better reflect the diversity of its customer base. State Street turned to Bottom Line, Year Up and other workforce development partners for help with preparing and recruiting a diverse group of entry-level applicants. Year Up’s interns spend six months developing job skills in information technology, operations, finance, sales, marketing or 72 / Rotman Management Winter 2017

Adopting Youth-Friendly Policies

While non-profits have demonstrated their value as matchmakers, employers have honed policies and practices tailored to helping opportunity youth succeed. Three stand out: 1. SCREENING CANDIDATES IN VERSUS OUT

Human resources teams need to evaluate the competencies young people bring to the job. Rather than screening applicants out for lack of diplomas or experience, this approach screens people in for skills and aptitudes. A study conducted by Innovate + Educate — which uses research-based strategies to address the U.S. national skills gap — shows how this approach increases the number of qualified

applicants. The study found that while only one per cent of unemployed New Mexican young adults met the criteria for jobs that required a college degree, 33 per cent cleared the hurdle when measured by skills and aptitude. Pharmacy chain CVS Health has made ‘screening-in’ part of its hiring process for entry-level workers. The company hires roughly 1,000 such employees each week to help staff its 9,600 retail pharmacy locations with cashiers, shelf stockers and pharmacy technicians. CVS’s apprenticeship program, which currently operates in four states, is designed to train and retain young workers. While the program varies from state to state, it is expected to spread to 10–15 states by 2017. The company’s efforts include a ‘training store’, located in a technical high school in Lowell, Massachusetts, where threequarters of students are classified as low income. Students who excel get job offers for part-time work in local CVS locations, with full-time job offers on graduation. Those who may aspire, for example, to become a pharmacy technician or to pursue a business degree can continue part time through post-secondary training. When evaluating young job applicants, managers have been coached to look past a candidate’s limited prior experience or short resume and instead, focus on whether candidates have the attributes to take care of customers and commit to working their way up. 2. MENTORING ON THE JOB

Although the notion of apprenticeships may conjure up craftsmen of yore, many modern professions — from doctors to electricians — still grow talent by matching entry-level employees with skilled mentors. Mentoring conveys learning in the way that cognitive research tells us is the most effective: experientially. The Center for Creative Leadership recommends that 70 per cent of training occurs on the job. Not surprisingly, companies successful in hiring opportunity youth are also committed to mentoring. One is SK Food Group, a U.S. food manufacturer and wholesaler with more than $300 million in annual sales. A supplier to café chains and retailers, SK opened a new sandwich plant in 2014 just outside of Columbus, Ohio, which became a pilot site for LeadersUp, a youth employment intermediary founded with support from Starbucks. SK needed hundreds of employees for this new facility, but

faced hiring in one of the nation’s tightest regional labour markets. LeadersUp convinced SK that opportunity youth offered a talent pool that could address the challenge. Like CVS Health, SK screened candidates in for competencies and ultimately hired 220 young people. SK asked managers to interact closely with these young employees and to look for ‘teachable moments’. One such hire, Jeffrey Duran, advanced from line worker to forklift driver after his production manager helped him overcome shyness. “He gave me the opportunity to become a lead and work with people in all kinds of situations,” said Duran. “I’m not afraid of talking anymore.” From young employees and managers alike, we heard again and again about how much this kind of day-to-day, informal support meant to young workers’ advancement. SK’s training and support also includes basic workplace skills, such as communicating clearly and getting to work on time. It asks managers to acknowledge unavoidable employee setbacks, such as transportation failures or child-care crunches. Even so, those who fail to forewarn supervisors of impending absences face consequences on an escalating scale — from warning to docked pay or even dismissal. 3. EMPATHY, ACCOUNTABILITY AND PEER GROUPS

Turnover of entry-level workers — which ranged up to 70 per cent in a Bridgespan-Rockefeller Foundation workforce study — is a big concern for employers. Among low-income workers, nearly three-quarters experience a personal challenge that can disrupt job performance during any 12-month period. But organizations we visited found ways to engage entry-level workers from day one and help them rise within the company, with resulting retention rate improvements ranging from 20 to 200 per cent over traditional hires. The most successful companies create a ‘career-development culture’ that offers a blend of accountability and empathy and lowers barriers to employee success. SK, for example, grants time off for employees to handle personal business and reassigns employees who struggle with morning child care to later shifts. SK’s career-development culture helped Tori Lamont past a difficult moment. Lamont, a college dropout, came to SK three years ago from LeadersUp, starting out as a line worker and quickly rising to team lead — becoming a poster child for the rotmanmagazine.ca / 73

Among low-income workers, nearly three-quarters experience a personal challenge that can disrupt job performance during any 12-month period.

program. One day, she wandered off in the middle of a shift. Instead of dismissing her, Lamont’s supervisor took the time to understand what had happened: it turned out Lamont wanted to see what others did at the factory and what other jobs she might aspire to. Her supervisor docked that day’s pay, but the company reassigned her to the maintenance systems group, where she could issue work orders across many factory functions and broaden her purview. Lamont also has peers to guide and support her at work. That’s because LeadersUp helped deliver a group of new hires who could bond and learn together on the job. SK has found that young people in cohorts encourage and support each other as they confront challenges — something that would be much less likely in the traditional one-by-one hiring process. SK has partnered with local companies to address logistical challenges faced by its young workers, such as funding a better bus service from Columbus’s city centre to the factory in Groveport, 12 miles south of downtown, and increasing the availability of child care. Of the 220 opportunity youth who joined SK since 2014, 80 are still there — a retention rate 23 per cent higher than other SK entry-level hires. Approximately two dozen have been promoted. “You have to be patient through some significant challenges,” said Steve Sposari, SK’s president and CEO. “But it’s paid off for us because these young people have battled through and are great contributors.” From CSR to Core Business Strategy

Many companies would view hiring opportunity youth as a demonstration of corporate social responsibility. A smaller number have evolved their thinking to embrace opportunity youth as strategic to their business success. Our research shows that this evolution in thinking takes dedicated personnel and corporate champions committed to continuously improving the onboarding, mentoring, and development of entry-level workers. Bridgespan’s 2015 youth employment study with the U.S. Chamber of Commerce Foundation found that the most successful opportunity youth programs had a champion in the Csuite — like Sposari at SK Food — and a champion closer to the front lines and in regular contact with young workers. At American Express — which began hiring opportunity youth in small numbers in 2007 through Year Up, support came 74 / Rotman Management Winter 2017

from the top. CEO Ken Chenault proclaimed on 60 Minutes that the Year Up relationship was a win-win for the company and the urban communities it served. But it was Destin Dexter, American Express’s vice president of technology, who scaled the company’s efforts to meet business objectives related to hiring entrylevel IT talent in a highly competitive market. As a 165-year-old Fortune 50 company, American Express has a reputation as a traditional financial institution — not necessarily a place to which recent computer science graduates gravitate. “It’s not that we didn’t offer great IT jobs,” said Dexter. “They just weren’t interested.” Would opportunity youth be more favourably inclined? After a successful pilot at American Express’s Fort Lauderdale offices, Dexter launched an eight-week software engineering boot camp with Year Up and Gateway Community College in Phoenix, a major technology hub for the company. They screened candidates for comfort with logic and numbers before bringing them to class. “The Year Up interns loved it,” said Dexter. “They came to work with smiles on their faces and really ‘leaned in’. They brought aptitude, and they were ready to learn.” Today, Dexter brings on from 80 to 100 Year Up interns annually for tech jobs ranging from software engineering to customer service. The interns have a 72 per cent conversion rate to full time, versus about 60 per cent for interns from traditional hiring pools. Year Up candidates also stay an average of 44 months, versus 18 months for traditional hires. Under the arrangement, interns earn their Year Up stipend the first six months, while Dexter tests potential hires and develops a deep bench of future talent. Successful initiatives like those of American Express, SK and others are chipping away at matching opportunity youth with entry-level openings. But it will take more than non-profit matchmakers and in-house initiatives to put millions of young people to work. One approach to ramping up the matchmaking process involves an innovative use of technology. Today, talent-analytics software locates key words on resumés to quickly identify formal education or experience across thousands of applicants. Unfortunately, the algorithms that power this software likely screen out many capable young people. To address this problem, Knack, an analytics firm supported by the Rockefeller Foundation, piloted game-based talent analytics to compare the aptitudes of a group of opportunity youth and

Calculating the ROI on Youth Employment Although youth employment efforts often start as a way for an employer to give back to the community, the business leaders showcased in this article have all come to see youth employment as a good investment. While there are up-front costs to consider, the benefits more than make up for it.

current job holders at four companies. Of the 600 opportunity youth who participated, 83 per cent scored at or above the level of average employees on aptitudes required for succeeding at one or more roles. While still in development, such new aptitude-analytics software offers potential for identifying and hiring more young candidacies who typically get passed over. The Payoff for Companies and Young People

Investments in opportunity youth tend to produce loyal, enthusiastic, skilled workers who stay. Grads of Life, an organization that helps businesses build career pathways for opportunity youth, has documented employer returns in increased retention, faster onboarding, stronger morale, access to government incentives, and improved corporate image. It calculates that CVS Health, for example, invested $2.9 million to hire opportunity youth, earning a return of 79 per cent based on tax credits alone. While investing in opportunity youth has cut new-hire turnover, the real payoff comes in creating a talent pipeline for internal promotions and in nurturing individual careers. CVS Health, for example, has a strong culture of promoting from within and thinks several steps beyond entry level when hiring. American Express’s technology team uses a framework that maps career paths from entry-level software engineer up through engineering director and beyond. And State Street, which has one of the most evolved strategies, has ramped up its program by identifying business units that have roles that best fit the skills and talents of potential recruits, and where managers have strong commitments to mentoring. Corporations at the forefront in hiring opportunity youth have been generous in sharing their experiences, making it easier for other companies to follow, find workforce partners and match candidates to entry-level needs that are mission critical. At the same time, companies like American Express, which are new to bringing on large numbers of opportunity youth, are asking why they didn’t think bigger sooner. “We initially approached the Year Up partnership as a great way to support the local communities where we live and work,” said Dexter. “But over time, it became clear the program could be a breakthrough way to source entry-level talent.” As companies in the U.S. seek to fill nearly six million entry-

Benefits

Costs

• Increases employee retention • Improved employee performance • High-quality employee sourcing partners decrease hiring and training costs

• Staff time spent coordinating the program and mentoring employees • Wages and benefits for interns • Payments to partner organizations

For example, consider these statistics about retail sales employees. The average employee makes $21,000 per year, and costs about $3,400 to replace. Turnover is five per cent per month, or 60 per cent per year, on average. So for a company with 5,000 entry-level retail employees, annual turnover costs will be just over $10 million. If this company can cut turnover in half by paying a workforce intermediary $5,000 per worker to source and train each, it would save $2.5 million per year. And that doesn’t account for all the other benefits: a more veteran workforce has higher productivity and better morale; improvement in corporate image in the community increases brand loyalty and customer retention; a more diverse staff meets workforce targets and better represents the customer base; and a stronger community and local economy creates a better business environment.

level positions suitable for young people by 2022, opportunity youth present an unexpected solution, and one that other nations may learn from. Indeed, while every nation committed to lowering youth unemployment must chart its own course, the lessons learned by U.S. firms show what can be accomplished when business, non-profits, and government work together.

Willa Seldon is a partner with The Bridgespan

Group in San Francisco. She is the co-author of “Making Youth Employment Work” (U.S. Chamber of Commerce Foundation, 2015) and “Youth Hold the Key: Building Your Workforce Today and in the Future,” (Bridgespan.org, 2015). Katie Smith Milway is a Bridgespan partner in Boston and co-founder of youth entrepreneurship program One Hen, a unit of America SCORES Boston. Simon Morfit is a Bridgespan consultant in San Francisco. Brian Bills is an associate consultant in San Francisco. This article was adapted from “Hidden Talent: How Smart Companies Are Tapping into Unemployed Youth,” published by Stanford Social Innovation Review in September 2016. rotmanmagazine.ca / 75

WHEN EXPERTISE BECOMES A LIABILITY Domain experts are often touted as being invaluable, but when uncertainty prevails, they can actually increase the likelihood of failure. by András Tilcsik and Juan Almandoz

THE MOST CRITICAL FUNCTION of every board of directors — and more broadly, of every executive team — is to make decisions that benefit an organization in the long term. Therefore, one would imagine that the more domain experts involved, the better: their extensive collective knowledge of risks and opportunities in a particular industry will surely lead to more effective long-term decision making, the thinking goes. However, recent evidence suggests that this reasoning is flawed. The fact is, in certain circumstances, decision-making groups that are dominated by domain experts may exhibit several harmful tendencies that actually detract from effective decision making. In this article we will explain why and summarize our recent research, which suggests that the proportion of domain experts in a decision-making group can be a key determinant of organizational success or failure.

Domain Expertise vs. Diversity

To date, research on the composition of decision-making groups has focused on diversity in group members’ professional backgrounds. The degree of diversity, however, is conceptually distinct from that of domain expertise. To illustrate, consider two simple examples. First, a manufacturer of solar panels has a board of directors that includes five solar energy experts, two lawyers, and two bankers. Second, the board of another firm in the same industry includes two solar energy experts, five lawyers, and two bankers. Thus, both boards include nine directors from three occupational categories, such that the largest category includes five directors, while the other two categories include two directors each. In the literature on team diversity, these two boards would be typically coded as equally diverse in terms of professional background. rotmanmagazine.ca / 77

Groups with a greater proportion of domain experts are less likely to alter their perspectives as the environment changes. But these boards differ substantially in the proportion of domain-expert directors: while the majority (56 per cent) of the first board is composed of solar-industry experts, such directors are a minority (22 per cent) in the second board. Most previous studies on board and executive team diversity have not distinguished experts from non-experts within a given domain, and hence cannot answer the question of how domain experts affect a firm’s performance. Previous research indicates that when the level of decision uncertainty is high, three negative characteristics of domain-expertise are more likely to be present and to undermine effective decision making: COGNITIVE ENTRENCHMENT. Decision-making groups with a greater proportion of domain experts are less likely to recognize, interpret, and integrate new information or to alter their perspectives

as the environment changes. In the solar energy industry, for example, management teams in which the majority of executives were domain experts were found to be less flexible than other teams in implementing technological changes to respond to environmental shifts. Consistent with this finding, scholars have highlighted a tendency of individual domain experts for ‘cognitive entrenchment’ — that is, a high degree of stability in their framing of problems and issues. If domain experts dominate the collective framing and discussion of problems and opportunities in a decision-making group, this tendency for cognitive entrenchment can make it more difficult for the group to recognize and flexibly react to new information. OVER-CONFIDENCE. A greater proportion of domain expertise has also been associated with a higher level of group over-confidence.

How Group Dynamics Affect Decisions By Paul Rogers and Todd Senturia One big factor affecting the quality of decisions is whether a decision involves a group. That’s because group dynamics can lead otherwise sensible individuals to make (or agree to) decisions they might not come to on their own. At times the effects are positive, as when some group members help others overcome prejudices. But the dynamics of a group often have negative consequences. Since nearly every company relies on collective decision making in some contexts, executives need to be on the lookout for group biases and their undesirable results. Following are four common manifestations of the ‘group effect’ and some suggestions about how to counter them: Conformity. Many people go along with the group regardless of what they themselves might think as individuals. A famous experiment by psychologist Solomon Asch showed how powerful this effect is. Asked to choose which of three lines was the same length as a prototype line, nearly every subject chose correctly when acting alone. But then Asch put each subject into a group of several confederates, all of whom had been instructed to pick the wrong line on one of the ‘tests’. Sure enough, almost 75 per cent of the subjects agreed with the group at least once — even though many later confessed they knew the group’s answer was wrong. In business, the tendency to conform often persuades dissenters to shut up rather than speak out. Warner Brothers, for example, invested $50 million in the film adaptation of Tom Wolfe’s best seller The Bonfire of the Vanities. The result: a

78 / Rotman Management Winter 2017

hugely expensive box-office bomb. “Many people involved … had doubts about the casting choices and changes in the storyline, but they never voiced these doubts to the director,” wrote Cabrillo College professor J. Dan Rothwell in a book on smallgroup communication. Meanwhile the director also had doubts “but because no dissent was voiced, he convinced himself that he had made the correct decisions.” Group Polarization. You’d think that a group would tend to moderate individual points of view. In fact, the opposite often occurs: in a phenomenon known as group polarization, deliberation can intensify people’s attitudes, leading to more extreme decisions. A study of U.S. federal judges, for example, found that judges working alone took a relatively extreme course of action only 30 per cent of the time. When they were working in groups of three, this figure more than doubled, to 65 per cent. The business implications? Imagine a company’s investment committee. If it’s composed of people with a generally cautious outlook, the group may make decisions that avoid risk altogether — or vice versa. Or imagine a go/no-go product-development decision. If group members making the decision are inclined toward innovation rather than conservatism, they may collectively decide to throw caution to the winds. A public example of group polarization may have occurred in 2013 in the U.S., when opposition to the Affordable Care Act led a group of Republicans in the House of Representatives to shut down the government in hopes of forcing negotiations over the Act’s implementation.

Over-confidence leads to a tendency to overestimate the accuracy and precision of one’s judgments and predictions; that is, to assume overly narrow confidence intervals around one’s estimates of unknown probabilities. Group over-confidence refers to the same tendency at the level of a decision-making group: an inflated sense of confidence in the precision and accuracy of group judgments and forecasts. At the individual level, scholars have noted a tendency of domain experts for over-confidence in the accuracy of their professional judgments and predictions. In fact, over-confidence has been described as one of the most common and serious problems in expert judgment in studies of physicists, economists, doctors, psychologists, intelligence analysts and other experts. At the group level, the overconfidence of domain experts who have similar assessments of a situation because of shared ‘domain schemas’ can substantially affect group decisions, espe-

cially because of the high degree of status and authority granted to experts in decision-making bodies. Moreover, group polarization can further increase the effect of overconfidence in decisionmaking groups with higher proportions of experts. In the context of corporate boards, group polarization implies that board decisions will reflect the amplification of directors’ average initial positions.

“From decades of empirical research, we know that when likeminded people speak with one another, they tend to become more extreme, more confident and more unified — the phenomenon known as group polarization,” wrote Harvard Law School Professor Cass R. Sunstein in an analysis of the shutdown.

cues from other people whenever possible. The bystander effect crops up in a variety of business contexts. Employees might be expected to report safety violations, for example — but if some people ignore a dangerous situation, others are likely to do so as well. Barings Bank was brought down in 1995 by the unauthorized trading of head derivatives trader Nick Leeson in Singapore. Afterwards, investigators found that several internal and external reports had drawn attention to the fact that someone in Leeson’s position could conceal losses. Yet “individuals in a number of different departments failed to face up to, or follow up on, identified problems,” according to an MIT Sloan Management Review article. Nobody can put an end to group dynamics, but companies that actively compensate for the negative effects described here will make better decisions, on average, than those who fail to do so.

Obedience to Authority. Every Psychology 101 student learns of Stanley Milgram’s classic experiment in which test subjects obeyed instructions to administer electric shocks to other ‘subjects’ — actually confederates pretending to be shocked — even when the harm seemed extreme. Though businesses depend on employees to carry out their supervisors’ instructions, executives should find this particular group dynamic disturbing. A company suffers when subordinates never challenge their superiors’ decisions. Take the worst commercial aviation incident in history: In 1977 a KLM plane attempted to take off from Tenerife airport while a Pan Am plane was on the runway. Official investigation concluded that the senior KLM pilot had taken off without clearance as a result of communication problems, including the reluctance of other crew to challenge his decision to go. The ‘captain was always right’ effect was cited as a principal cause in the official report on the incident. The Bystander Effect. As social psychologists have long known, people are far more likely to aid a victim in distress or report an apparent emergency if they are alone than if other people are around. One reason: If you’re uncertain what to do, you’re likely to take your

LIMITED TASK CONFLICT. A higher proportion of domain experts might also reduce the level of task conflict in a group. Task conflict, or ‘cognitive conflict’, involves disagreements about the content of the tasks being performed, including differences in viewpoints, ideas and opinions. In corporate boards and other decision-making groups, some level of task conflict is critical for effective decision making because it results in investigative interactions and the consideration of more alternatives.

Paul Rogers is the Managing Director of Bain & Company, Middle

East & Turkey, and founder of the firm’s Global Organization practice. Todd Senturia is a Bain partner based in Los Angeles.

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A higher proportion of domain experts on a board, however, might make non-expert directors less willing or less able to challenge experts to justify their assumptions. Of course, a reduced level of task conflict might also be expected whenever a board has a high proportion of directors from any given profession, even if that profession is not identified with the focal domain. But, given the high level of status that domain experts enjoy in decision-making groups, a high proportion of domain experts is especially likely to reduce task conflict. Our Research

In recent research, we set out to show that cognitive entrenchment, over-confidence and limited task conflict are most likely to be damaging when a company veers off the beaten path and faces decision uncertainty. We felt there were three reasons for this: 1. The higher the degree of decision uncertainty, the greater the likelihood that cognitive entrenchment will undermine the effectiveness of decision making. In contrast, in routine situations with a relatively high degree of stability and predictability, entrenchment might be unproblematic, or even advantageous, as it can produce reliable responses to commonly encountered problems. Consistent with this idea, there is evidence that inflexibility in modifying corporate strategy and structure is more detrimental to a firm’s survival chances under uncertain conditions than in predictable situations. 2. Under increased levels of decision uncertainty, expert overconfidence is both more likely to occur and more likely to become problematic. Prior research suggests that overconfidence regarding one’s professional judgment is more likely when a decision environment is nonrepetitive or ambiguous. For example, while meteorologists do not systematically overestimate the accuracy of their predictions when forecasting rain, they do exhibit overconfidence when predicting tornadoes — that is, when they lack a sufficient number of repetitive and unambiguous prior observations to help calibrate judgment. Similarly, the greater the level of market uncertainty, the higher the degree of overconfidence that financial professionals exhibit. 80 / Rotman Management Winter 2017

3. The lack of task conflict among board members is more likely to have negative consequences under greater decision uncertainty. Because task conflict fosters more effective and critical consideration of information and alternative courses of action, it is particularly important to the quality of decisions under uncertainty. By contrast, under more stable and predictable circumstances — and when dealing with commonly encountered problems — the critical and investigative interaction processes that result from task conflict are less essential for effective decisions. This suggested to us that the relationship between the proportion of domain experts on a board and the risk of organizational failure is contingent on the level of decision uncertainty. We tested this hypothesis in the context of the U.S. banking sector, focusing on the board composition of new and recently established local banks between 1996 and 2012. Local banks, or ‘community banks’, have their own legal charter, total assets below $1 billion, and a business model focusing on the county or counties located around their headquarters. This is a useful research setting because a local bank’s board is an active strategic decision-making group rather than simply an oversight body. The banking executives we interviewed identified three conditions that can lead to a decision-making environment of heightened uncertainty — and thus risk falling prey to the negative characteristics of domain-expert-heavy groups: RAPID ASSET GROWTH. In such cases, because asset growth involves new lending, the bank is probably operating in an unfamiliar market territory with unknown borrowers, lending areas, and sources of loans. Fast asset growth entails greater uncertainty because it involves rapidly expanding the pool of potential borrowers and, at the board level, having to manage the approval and oversight process for a large number of loans for such borrowers. THE NATURE OF LENDING MARKETS. The bankers we interviewed noted that a high degree of uncertainty is associated with lending markets that involve non-standard real estate loans — for example, loans for real estate other than ordinary family residential properties. Such non-standard loans include land, construction and development loans, farm loans, large multifamily residential loans, and other commercial real estate loans. The boards of

A greater proportion of domain expertise has also been associated with a higher level of group over-confidence.

banks that are heavily involved in non-standard real estate lending markets face uncertainty because clients in such markets tend to be highly heterogeneous, often with uncommon profiles. Thus, in decisions about major loans in such markets, boards have limited access to past trends, historical performance, or other systematic information that could reduce the uncertainty about the associated risks and potential profits. This is in stark contrast to banks that are primarily involved in standard real estate markets focused on regular family residential properties, which create less uncertainty because detailed information about past patterns and risk factors is available.

high number of other local banks in the area — a higher proportion of domain experts on a board was associated with a bank’s higher risk of failure. And this relationship is not driven by a tendency of riskier banks to appoint more domain experts; in fact, banks that engaged in observably riskier practices did not have more domain experts on their boards. It is important to remember that the boards we studied included at least two banking experts. So, our results don’t imply that having no experts at all is the best approach: instead, they suggest that it is helpful to have several people whose main expertise may be in another field — especially if the Board is likely to face a great deal of decision uncertainty.

OPERATING IN A GEOGRAPHIC AREA WITH MANY OTHER LOCAL BANKS.

Local banks compete for deposits, loans, and investor capital most intensely not with large regional or national banks, but with other local banks, which offer similar ‘relationship-based’ local services. Having a large number of direct competitors, in turn, can increase environmental complexity, which makes it difficult to anticipate rivals’ actions and creates uncertainty for decision makers. To identify domain experts on local banks’ boards, we obtained biographical data on directors from three sources. The first source was the regulatory form Interagency Charter and Federal Deposit Insurance Application — a filing of prospective banks that is necessary to receive required deposit insurance guarantee from the Federal Deposit Insurance Corporation (FDIC) and to receive federal or state charter approval from such regulators as the Federal Reserve, the Office of the Comptroller of the Currency, or state-level regulators. Our second source was the Annual Report of Bank Holding Companies form, which includes information about the bank subsidiaries of holding companies. Both of these forms include biographical statements of board members at the time of founding, describing their prior professional experiences and other relevant qualifications. The third source of biographical data was SNL Financial, a research organization providing news and data about U.S. banks. Of the 1,307 banks in our final sample, 124 (9.5 per cent) failed during the 1996-2012 period. Under conditions associated with decision uncertainty — fast asset growth, involvement in non-standard real estate lending markets, and a

In closing

The idea that expert-dominated boards can have serious negative consequences defies conventional wisdom. Nevertheless, our research suggests that the proportion of domain-expert directors is an important variable to consider in board design. Although domain experts are often touted as being invaluable, we found that — under conditions of decision uncertainty — higher proportions of domain-expertise can actually lead to poor decision making and a greater likelihood of organizational failure.

András Tilcsik is an Assistant Professor of

Strategic Management at the Rotman School of Management and a Fellow at the Michael Lee-Chin Family Institute for Corporate Citizenship. He was named to Poets & Quants’ ‘40 Under 40’ list of outstanding business professors globally in 2016. Juan Almandoz is an Assistant Professor of Managing People in Organizations at Spain’s IESE Business School. This article summarizes their recent paper, “When Experts Become Liabilities: Domain Experts on Boards and Organizational Failure,” which appeared in the Academy of Management Journal (Issue 59(4), 2016). Rotman faculty research is ranked #3 in the world by the Financial Times. rotmanmagazine.ca / 81

Introducing

CATALYTIC GOVERNANCE If leaders fail to engage a wide range of stakeholders in meaningful dialogue, they risk developing solutions that drive mistrust, disengagement and resentment. by Patricia Meredith, Steven A. Rosell and Ged R. Davis

WITH THE OPINIONS of countless thousands only a tweet away, it has never been easier for decision makers to engage and consult. The like-minded can now organize with ease, and as a result, more groups and organizations are demanding a voice in governance. Yet, at the same time as people are becoming more determined to have their voices heard, our problems are becoming more difficult to solve. This is the era of overload: a world of information and misinformation, interconnection and openness; a world in which people know more, share more and aspire to have greater influence on the forces that shape their lives. In the face of such radical transformation, why would we assume that our old methods of governance would still serve us best? The traditional, top-down model of governance — in which a few render judgments and the masses fall in line — is

increasingly being rejected, and we are seeing an exertion of influence by people and groups who feel excluded from traditional governance structures. Just think of the Brexit vote and the unlikely triumph of Donald Trump — a thumping rejection of the party line as pronounced by members of the Republican establishment. The result: those who were once voiceless now have a voice; the infrastructure now exists for them to have their say; and frankly, they expect to be heard. How can political and corporate leaders steer — confidently and effectively — with so many hands reaching for the wheel? How can they leverage this new reality to the benefit of citizens, companies and communities? A new approach to governance is required — one that is more inclusive, dialogue-based, forward looking and action-oriented. We call it Catalytic Governance. rotmanmagazine.ca / 83

Task Force for Payment Systems Review Achievements • Acceleration of electronic payments and invoicing • Creation of a mobile ecosystem • Development of a digital identification and authentication regime • Passed legislation to overhaul the governance of the Canadian Payments Association (established FinPay)

Origin of the Species

Our development of the Catalytic Governance process originated with the Task Force for the Payments System Review, which was established in 2010 by the Canadian Finance Minister of the time, the late Jim Flaherty. Given our experience leading change in complex, multi-stakeholder environments, one of the authors [Patricia] was named Chair of the Task Force; while the other two [Steven and Ged] consulted on the initiative. The issue at hand: for years, there had been stakeholder complaints about the high cost of the Canadian payments system — especially with regard to the fees charged by credit card companies. There was also a pressing need to address the complex challenges of managing the transition to online payments, updating regulatory structures, improving security and protecting privacy in the digital age. Given the complexities and uncertainties of the payments environment, the Task Force recognized that a traditional approach — consisting of research, consulting with experts and making recommendations — was inadequate. Further, we recognized early on that, despite our individual insights and experiences, none of us could solve the problem on our own. To deliver change that would ‘stick’, we would need to bring together the best of each of our fields: dialogue, scenarios and implementation. Bringing together consumers, banks, networks, tech companies, retailers, small and medium sized enterprises, governments and more — stakeholders with very different perspectives and interests — the Task Force led a dialogue to explore different possible futures and look for common ground. Building on this work and the trust it created, a coalition emerged: leaders from across all of the groups involved who were ready and willing to build the preferred future they had envisioned together. In the end, the Task Force delivered a community-supported action plan that enabled government and industry to act on all four of the Task Force’s recommendations [see sidebar] within two years. Because the action plan had such broad buy-in among a wide range of stakeholders, it prompted a number of tangible advances and improvements to the payments system. 84 / Rotman Management Winter 2017

None of this was easy. There were moments at the outset when it felt like everyone at the table was singing from a different hymn book. There was even some open hostility. But over time, participants began to trust the process and continually widen the circle of engagement. People began to see things they hadn’t seen before, or hadn’t fully appreciated. Areas of common ground emerged, and from this, an action plan that participants were eager to lead. For us, this was truly a revelatory experience, and one that proved the power of what we have come to call Catalytic Governance. Models of Public Decision Making

The word ‘governance’ derives from the Greek kybernan (to steer) and kybernetes (pilot or helmsman). Simply put, governance is the process by which an organization or a society ‘steers itself ’. While government is central to this process in society, in the Information Age, it is increasingly only one helmsman among many, as more and more players — voluntary organizations, interest groups, the private sector, the media, and more — become involved in the process. In the Information Age, effective leadership and governance depend less on traditional, top-down approaches and more on creating shared meanings and frameworks. Given this ‘new normal’, traditional models of public decision making have several serious drawbacks: they are non-democratic, lacking public participation, dialogue, or debate; they are prone to bias, as the views of those not sharing the political opinion or ethical values of policymakers are frequently dismissed; and they ignore the perspectives of those outside the circle of insiders and experts. Following are three traditional models of public decision making. THE DECISIONIST MODEL. Usually ascribed to Max Weber, the Decisionist model assumes that public policymakers are the group most competent to make judgments around policy ends. Experts provide advice about how best to achieve these policy ends, and politicians then act on that advice. The Decisionist model

predominates, for example, in Westminster systems of government (such as Canada’s) based on the principle of ministerial responsibility. A prime example is the development of a government’s budget. THE TECHNOCRATIC MODEL. This model can be traced back to Henri de Saint-Simon and Francis Bacon. Its proponents argue that most policy problems are so complex and unprecedented that politicians alone cannot determine policy ends. Instead, experts are needed to make judgments as well as the most effective means of achieving them, and politicians should act based on these recommendations. A good example of this approach is national regulation of health or environmental standards. THE PRAGMATIC MODEL. This model represented an important step towards a more inclusive and dialogue-based approach to public decision making. Drawing on the work of John Dewey, George Herbert Mead, Charles Sanders Pierce and other Pragmatist philosophers, Jürgen Habermas introduced this model in 1981, arguing that policy ends and means can be effectively determined in a rational discourse among experts, policymakers and the public. The Pragmatic model supports pluralism, ‘deliberative democracy’, and a more democratic control of expertise in policy.

The Catalytic Governance Process

While the Pragmatic model represented progress in the public decision making arena, today, an even wider range of stakeholders needs to be involved. Research shows that when different perspectives are not proactively engaged, decision-makers are less likely to challenge their own assumptions — or even to be aware that others may hold very different assumptions about the question at issue, limiting the scope for learning and dialogue. Catalytic Governance entails clearly defining the rules of engagement and encouraging stakeholders to explore different perspectives and alternative futures, looking for common ground

from which to build a shared plan for action. So, what does this mean for governments and boards? What is their specific role in this new process? They need to make room for a much wider range of stakeholders — and to empower those players to operate at a higher level. Governments and boards must relax their day-to-day control — or the illusion of such control — and shift to a catalytic approach. That means: • Framing the issues and the agenda; • Ensuring a full range of stakeholders are engaged; • Defining the rules of that engagement; • Encouraging stakeholders to explore different perspectives in search of common ground; and • Participating in the learning process — and acting on the emerging strategic direction. It is important to note that under Catalytic Governance, the core roles of government and boards remain as important as ever. Government continues to protect and advance the public interest and boards continue to ensure that actions are taken in the best interests of the corporation. What changes is how these responsibilities are pursued and achieved. The Catalytic Governance process has five steps: Step 1: Frame the Problem and Set Boundaries for Solutions

The first step is for groups with policy responsibility to determine whether the process is needed in the first place. Simpler issues will not require such a large investment of time and resources, and can be addressed through traditional approaches. But when the nature of both the issues and the possible responses is unclear — that is, when the issue at hand is a ‘wicked problem’, and when people with very different beliefs, problem definitions, values or traditions must find common ground as a basis for collaborative action — a catalytic governance approach is required. In these circumstances, governments or boards take the initial step of framing the problem and the agenda, defining the process to be followed and the range of stakeholders to be included, and setting the boundaries for acceptable solutions. Above all, rotmanmagazine.ca / 85

Those who were once voiceless now have a voice; and they expect to be heard.

they need to be prepared to trust the process, and to place the onus on the stakeholders involved to deliver an acceptable outcome. Step 2: Begin Engagement and Dialogue

The second step is to begin to engage a wide range of stakeholders around the issue, embedding the ground rules of dialogue and engagement in all conversations from the outset. Governing bodies need to ensure that all key stakeholder viewpoints are included in the process, including those normally under-represented. The stakeholders should be selected to be a microcosm of the system at issue. In a true dialogue, participants need to be free to speak for themselves, not as representatives. When engaging stakeholders through a face-to-face process, participants should be drawn from a wide spectrum of backgrounds and sectors, represent a range of viewpoints, and include many who are in a position to change things. They must be prepared to work with other stakeholders to develop a better understanding of the issue and potential solutions. Throughout the process, engagement should be open and transparent so that all stakeholders are aware of the work and face minimal barriers to participation. At present, face-to-face engagement is still the most effective approach. While social media and other communications technologies excel at raising awareness of an issue and canvassing initial opinions, they cannot yet replicate the intense dialogue, learning, and community building offered by the Catalytic approach. Once stakeholders are engaged and the ground rules are understood, participants need to work together to confirm and further develop the initial framing of the issue. This recognizes that when it comes to wicked problems, the definition of the core issue is often unclear, contested and organic. Step 3: Explore Alternative Perspectives/Futures

The third step in the process is to explore, in detail, a variety of perspectives on the issue and alternative possibilities for how it may unfold. From the beginning, it is important to challenge stakeholders’ assumptions and ingrained thinking — for example, by including presentations by outside experts. Familiar as86 / Rotman Management Winter 2017

sumptions often act as blinders, providing a false sense of security and making it more difficult to perceive changes. Successfully challenging assumptions and biases can open up and energize the learning process. Scenario planning offers a powerful and tested methodology for doing this. By focusing on alternative futures, it takes the spotlight away from current controversies and creates more opportunities to find common ground. The fact is, many people find it easier to discover areas of agreement when talking about what they want to see in the future. A dialogue-based process of learning and exploring alternative perspectives and futures can build a community and develop shared mental maps, language, norms, and expectations for that community. Scenarios are an especially effective means of doing this. Scenarios also offer an opportunity to widen the dialogue and expand the community. Through this process of learning and exploration, participants come to recognize that the status quo is not likely to persist and that a number of alternative futures are plausible — some attractive and others less so. This awareness lays the groundwork for participants to define and work to realize a desired future. Step 4: Co-Create the Desired Future

The fourth step in the process is for those stakeholders who are willing to define their desired future to come up with practical action steps to realize that future. To be effective, such a coalition needs to include stakeholders who are in a position to bring about change and willing to take concrete action. These coalitions must first identify those initiatives that will have the largest impact on the future, and then work to make change happen. Often this will require a process of ‘action learning’ — taking experimental actions and learning from the result. We can no longer separate planning and action in the traditional way; instead, in the words of Donald Schön — one of the earliest analysts of this world of rapid change: “We must act before we know in order to learn.” Governments, boards and others responsible for policy have an important role to play at this stage. First, they need to participate in the dialogue to the degree possible, or at least monitor it

closely enough to quickly understand the outcome, anticipate problems, and respond promptly. Without that participation, important initiatives can lose momentum. Just as important, governments or boards can encourage stakeholders to work together and find common ground by stating early on that they will act on any approach to agreed by the participants, provided it meets certain conditions; but they will develop their own solution if participants cannot reach agreement. Step 5: Ratify and Disseminate the Desired Future

In this fifth step, governments, boards, or others responsible for policy play a leading role, first by ratifying and disseminating the results of the process, and then by acting and encouraging action on the emerging strategy (including legislating, if necessary), and monitoring the results. This step is not a simple end point; it is itself a process of ‘action learning’ — an approach to solving problems that involves taking action and reflecting upon the results. Decision-making bodies retain the authority not to ratify — and even to veto — the outcome; however, given the degree of stakeholder engagement and investment in the process to this point, any such veto requires a clear explanation and rationale. Once an outcome is ratified, the next step is to build widespread support for action — support that goes beyond the stakeholders who have been directly involved in the process. While governments and boards have always had this responsibility, now they should be able to count on the active support of a cadre of engaged stakeholders. The government, the private sector, and the social sector need to work together to create and test the new institutions, roles, and practices required to realize the desired future, as well as make the changes necessary to move towards the desired future within their own organizations. When more is needed (e.g., when the basic framing of the issue is overtaken by events), governments or boards can also use the results as a starting point for reassessing the issue and for a new cycle of problem framing, engagement and dialogue, exploring alternative perspectives/futures, co-creating a desired future, and acting/encouraging action to realize the desired future.

In most cases it will not be necessary to repeat the full process; instead, simpler variants can be used that build on the work already done. Another variant is to focus on updating the desired future and the actions needed to realize that future. In closing

Catalytic Governance empowers leaders to better engage stakeholders, find common ground and build trust to take on wicked challenges, providing rich opportunities for participants to learn from one another, frame and re- frame issues, and construct a common plan from which to take collaborative action. The shared mental maps constructed by Catalytic Governance enable people to communicate and work together across boundaries and to organize and govern themselves. In a world of rapid change, a society or organization’s ability to prosper will depend, in no small measure, on its ability to develop these new capacities.

Dr. Patricia Meredith is a Director of many public, private and not-for-profit organizations. She also served as Executive Vice-President and Chief Strategy Officer at CIBC and as Senior Strategy Advisor to financial services and technology companies at Monitor Group. Dr. Steven A. Rosell is President and co-founder of Viewpoint Learning, where he leads the development of innovative dialogue-based techniques and their application in both business and the public sector. Ged R. Davis is Executive Chair of Scenarios at the World Energy Council and President of Forescene S.A., a scenarios and strategy boutique consultancy. They are the co-authors of Catalytic Governance: Leading Change in the Information Age (Rotman-UTP Publishing, 2016), from which this is an adapted excerpted. rotmanmagazine.ca / 87

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Idea Exchange

JESSE SOSTRIN

CLAUDE LAMOUREUX

CLAIRE CELERIER

101 CRAIG DOIDGE + ALEXANDER DYCK

105

109 DAVID WEISS + TED CADSBY

112

ANN KAPLAN (MBA ’05)

115

OLE-KRISTIAN HOPE

118

HATEM JAHSHAN (MBA ‘12)

121

126

on your ‘margin of power’

DAN PONTEFRACT

on governance lessons learned

on finance salaries and inequality

on the power of Purpose

on decision-making under complexity

on ‘shadow banking’

on the value of Accounting

on surviving the Dragon’s Den

ELLEN AUSTER + LISA HILLENBRAND

DANIEL MARKOVITZ

on institutional investors

on being strategic+agile

on bridging the gaps in hierarchies

QUESTIONS FOR

Jesse Sostrin, PhD, Leadership Expert, PricewaterhouseCoopers

Q &A

A leadership expert and author talks about closing the gap between managerial capacity and increasing demands. Interview by Karen Christensen

90 / Rotman Management Winter 2017

You believe that one of the most overlooked factors in effective leadership is capacity. How do you define ‘leadership capacity’?

A leader’s capacity is the time, energy, resources and focus that she needs to effectively address her priorities and responsibilities. Simply put, it’s the ‘fuel’ that every leader needs in order to accomplish what matters. Deficits in capacity are among the most common factors responsible for breakdowns in a leader’s performance and overall impact. You have found that leaders at every level — including most executives — do not possess enough capacity to meet their demands. Why is this?

There are two factors, and the first is external and largely out of our personal control: structural forces in the economy have literally baked-in the conditions for severe and sustained capacity deficits. As far back as 1981, Harvard Business Review began publishing articles that dealt with the growing concerns of managers who were overwhelmed by the struggle to cope with rising demands and rapidly changing conditions. Fast forward after a quarter century of cutbacks, downsizing, and increased competition, and the great recession of 2008 was simply an inflection point that reinforced acceptance of the premise that the inverse equation of shrinking resources and increasing demands is business as usual.

When someone is operating with a capacity surplus, things get done when they say they’ll get done.

‘Doing more with less’ is a corporate mantra linked to several alarming trends: 80 per cent of managers say that the demands they face are increasing; 66 per cent say that their workload is the leading cause of their stress; about half say that they struggle with a lack of focus and clear direction; and 61 per cent say they are working below their optimal level. Beyond the numbers, this translates into adverse impact on performance, engagement and well-being. That’s the big-picture piece. On the individual side, I have found that many professionals lack proficiency when it comes to assessing their priorities and saying Yes and No, accordingly. While we can’t personally shift those external economic forces, we can regain a measure of influence by using our available capacity more intelligently. We can avoid behaviours that unnecessarily drain our time, energy, resources, and focus while becoming more consistent and effective in how we determine what is truly important. How do you define an individual’s ‘margin of power’?

The theory of margin is based on the work of Howard McCluskey — who, in my view is an overlooked powerhouse of a thinker. In the 1970s, he conducted research on adult education to explain why some people could successfully start and finish new projects, goals, or initiatives while others became overwhelmed and unable to succeed. He created a formula that expresses the relationship between the ‘load’ a person carries (the demands placed on them by their family, work, etc.) and their available ‘power’ to carry it (their own energy, competence, etc.). His original formula was presented as a ratio, which can be confusing, so I decided to apply his concept as a straightforward subtractive equation. To put it in simple terms, your margin of power is what is left over after you use your available resources to address the demands you face. When you have a surplus, or ‘available margin’, it’s because you’ve got more fuel in the tank to deal with what’s on your plate; and when you’re operat-

ing at a deficit or a ‘negative margin’, your load is already too much to carry — so any new or unexpected challenges (i.e. your boss drops a new project on your plate, a colleague quits unexpectedly and now you have to cover, etc.) mean that you’re likely to be unsuccessful. What does it look like when someone has a ‘surplus’ of power?

It shows up differently from person to person, but typically you’ll see behaviours in line with traditional high-performance indicators: things like confidence, and a keen focus on the job at hand — both of which lead to timely and effective execution. When someone is operating with a capacity surplus, things get done when they say they’ll get done, and they get done in a way that adds value for the organization. When you can get the right things done with the resources you have, you don’t ever feel exhausted or behind. Instead, you feel invigorated. The literature on experiences like ‘flow’ and ‘peak performance’ at work shows that when you can see the results of your investment of capacity, the incremental achievement creates positive momentum and personal satisfaction. This, in turn, creates a virtuous cycle. Unfortunately, what I see in most cubicles and corner offices is quite the opposite. It seems like this concept of ‘margin’ and available capacity is fluid. How does this play out in organizational life?

It is definitely fluid, but if you hope to do something about your own capacity gaps, it’s important to honestly assess your available margin on a regular basis. Imagine this scenario: You’re getting your work done and you’re getting it done well. There is a nice rhythm to your days and you feel satisfied about your overall contribution. Out of the blue, there is a leadership change and now you have a new boss. The change itself is not taxing, in fact it’s full of opportunity, but you have to invest unbudgeted time and energy to absorb new expectations, educate your boss about how your rotmanmagazine.ca / 91

Many people lack proficiency when it comes to assessing their priorities and saying Yes and No, accordingly.

projects are going, and prepare differently for team meetings and planning sessions. This new, unexpected load has just tilted your margin close to zero, but you’re still holding on. Perhaps you’re getting a little less sleep and taking a few shortcuts here and there, but no major decline in your performance is noticeable. Then it happens: It could be something in your personal life, a health issue, or even something positive — maybe you finally start that MBA program you always wanted to complete. Whatever the circumstances, you suddenly have zero margin and can no longer keep up. You get stuck in ‘firefighting mode’ and inadvertently begin to work against yourself with counter-productive behaviours that further drain your capacity. The manager’s dilemma has set in.

after you’ve pushed past your limits for just a little too long. When you can no longer mask these affects, those around you begin to take notice as you start to inadvertently ignore certain things. Perhaps your communication becomes terse and infrequent, or you compensate by taking charge and inadvertently steamrolling others. Or, maybe you retreat inward and stop asking for help from others at the very moment you need it most. Whatever form it takes, your dilemma can threaten your performance in the shortterm and erode your well-being and professional brand over time.

Tell us more about ‘the manager’s dilemma’.

Sometimes I’ll hear an over-worked leader say, ‘I just can’t afford to recharge right now; things are way too busy.’ Just think about how counterproductive that is. Or a manager might say, ‘If we had more time, we could do better; but we just have to move on to the next issue.’ Imagine being the customer about to receive this compromised product or service. Statements like these are indicators that somebody has really gotten stuck. I relate that to losing judgment because of a quote from one of my favourite writers, Wendell Berry: “If one’s judgment is unsound, their expert advice is of little use.” Whether you’re trying to influence people, projects or strategic priorities, your judgment is at risk the minute you get stuck in the manager’s dilemma. Unfortunately, the dilemma has a way of blinding us to our own routines. When you’re stuck in its grasp, everything looks like a zero-sum game, where you can either do this or you can do that. Which fire of the day will get extinguished, while others are left to burn becomes there is simply not enough capacity to deal with them? It is precisely that dichotomous thinking that keeps us stuck. On the bright side, if we can become students of our own behaviour, we can

It’s the easy improvement you don’t have time to make. It’s the good advice you don’t have the energy to follow. It’s the obvious solution you’re too distracted to notice. When the gap between the demands you face and the resources you have to meet them widens past the point of no return, selfdefeating actions like these take hold. It’s not intentional; when you’ve exhausted your capacity and feel behind, you just want to catch up in order to regain that feeling of confidence and positive contribution. But the harder you struggle to meet the impossible demand, the more you lose the very performance edge that you need to break the cycle. This is why I call it a ‘dilemma’: once you’ve started to think and act differently, you just can’t resolve the issue with conventional solutions. You have to think about your own thinking and see your own pattern of behaviour for what it is. For most people, their dilemma emerges subtly. It may be fatigue from the lack of rest during constant activity, or increasing irritability from waking up tired day after day. For others it could be the frustration from missed workouts, the bit of extra weight from poor diet, the disorientation from excessive travel, or that predictable sore throat that comes 92 / Rotman Management Winter 2017

You have said that the moment a manager loses her judgment is the moment her impact begins to decline. What are the signs that this has happened?

learn to notice these subtle thought patterns before they become entrenched. What is your advice for managers who read this and realize that they are operating at a power deficit?

The first thing I would suggest is to create more situational awareness around what your own personal ‘capacity gap’ looks like. You can use three questions to determine this: First, have the demands on you increased over the past several days or weeks? Second, are those demands likely to stay elevated — or even continue to increase? And third, do you have the time, energy, resources, and focus required to address them? If your answers are Yes, Yes and No, you are likely close to the zero margin effect. These three questions are the doorway to self-awareness. If you’re already stuck in the manager’s dilemma, embrace it and study the way it shows up in your interactions with others. What we are unaware of controls us, so focus on it until you can predict how you’ll respond to difficult demands. Then, do what you can to regain your influence to preserve your capacity. Start by attentively evaluating every demand that comes your way and look more closely at the contributions that you are most skilled at making. To requests that draw on this talent, you say, Yes. To requests that are not aligned, you say, ‘Yes, if …’ and you identify other ways of accomplishing the goals without setting yourself up for failure. This discerning approach forces you to address your capacity problem head-on. The second thing I would say is, take a leadership perspective on capacity gaps. Many of your readers are already in the ranks of emerging and established leadership, so it’s imperative to take a wider vantage point and look out for evidence of capacity gaps within the organization’s culture. If people are being rewarded for trying to do more with less, bragging about how much they’re doing and how little sleep they got last night, or comparing worth by how many e-mails are in their inbox — these are clear evidence of capacity

gaps. If you can start to identify these things and invoke honest conversation about them, you’ve positioned yourself to both understand and produce a credible response. As I said earlier, we can’t change the macro, structural factors that we face as leaders — but we can certainly influence our organization’s culture by making it permissible to name capacity gaps as legitimate performance deficits. Then, the goal is to figure out what you can do differently to actually increase peoples’ capacity for the things that really matter.

Jesse Sostrin, PhD, is a Director in the U.S. Leadership Coaching

Center of Excellence at PricewaterhouseCoopers and the author of The Manager’s Dilemma (Palgrave MacMillan, 2015). He has served on the adjunct faculty of the Orfalea College of Business at the California Polytechnic State University and has lectured at the University of Arizona and the University of California, Santa Barbara, among others. rotmanmagazine.ca / 93

QUESTIONS FOR

Claude Lamoureux, Co-Founder, Canadian Coalition for Good Governance

Q &A

A pioneer in the quest for best-in-class corporate governance in Canada describes his journey.

Interview by Karen Christensen

When you interviewed for the CEO’s role at Ontario Teacher’s Pension Plan, you told then-chair Gerald Bouey that if you took on the job, you would ‘run it like a business’. What did you mean by that?

It could be that I had a negative view of government organizations at the time, but what I meant is that in a corporation, the CEO is given a clear mandate: he or she draws up a plan and determines objectives, and makes sure that they are followed. I’m a big fan of management by objectives, so I wanted to make sure that if I took on the role, this would be a result-oriented organization. I needed to communicate this, because I had worked in a corporation for many years — and I knew that in many cases, you are a captive of your history. Running Teachers’ ‘like a corporation’ would also mean having an incentive plan in place, and having the CEO be transparent with the Board — but not having to check with them on every decision. If we were not meeting objectives, there should be consequences. I would expect the Board to get rid of us. What really surprised me is that Gerry — who had spent many years with the Bank of Canada and was very familiar with government operations — never even flinched. I quickly realized that we would get along. Before you joined Teachers’, it was highly conservative, investing only in non-marketable Government of Ontario debentures. Before long, it was investing in Canadian and foreign equities, income-producing real estate and hedge funds. Describe how this change of direction came about.

When I started in 1990, the board was brand new. Before that, it had been composed of mid-level civil servants and top executives from the Ontario Teacher’s Federation. The new board knew that big changes had to take place. Initially, they thought we should only invest the new cash flow. Probably the best decision I made was to hire Bob Bertram 94 / Rotman Management Winter 2017

Good governance should not be viewed as an end unto itself: it is a means to an end — and that end is great performance.

as Chief Investment Officer. When Bob started, I realized I was working with someone who spoke the same language. We basically inherited a portfolio of non-marketable, non-assignable, non-negotiable Ontario debentures. I said to Bob, ‘We’ve got to diversify this portfolio’. And he said, ‘Why don’t we try swaps?’ This was a first in Canada. One of our early swaps was for a billion dollars. Obviously the Board wanted to know what our intentions were. I have to give them credit, because after we explained the thinking behind it, they understood that this bold move made sense. In order to do new things, you need to have a board that understands your strategy. From day one, I always believed that we should invest 80 per cent of our funds internally, and this happened very rapidly. We hired a few outside money managers, but we also proceeded to hire really good people for our internal investment team. By 1991 — our second year — we were already doing private equity transactions, internally. In addition, we created partnerships with private equity firms. One early partner was Barings Capital, as it was called then. George Engman was in charge of private equity at the time, and he told Barings that we wanted to co-invest with them. Essentially they said, ‘Yeah, yeah, yeah. Everybody says that, but nobody does it.’ Our answer was, ‘Try us.’ They gave us an opportunity, and we were able to react rapidly and proceed together with a fairly large investment. Looking back, it was all about having good people with great ideas, and a board that understood what needed to be done. In my view, if you have these things in place, you have a recipe for success. Is there one fundamental difference between the corporate governance at Teachers and other pension plans?

Probably the most distinguishing factor was the independence of the Board — independence from the two organizations that appointed it, i.e. the Ontario Government and the Ontario Teachers Federation. This was a fundamental principle from the start. Board members knew they were there to represent all the members of the plan, and that their mission was to hire and supervise management and act in the interest of all members — even if this was not in the interest of

the two sponsoring organizations. Today this is even more important because the plan’s members are participating in its financial risks. How would you describe your approach to risk at that time?

In 1990 we had one class of assets: Ontario Government debentures, so diversifying was a priority. A consulting firm had been hired to determine how to proceed, and their recommendation was to determine an ‘efficient frontier’ for the portfolio — i.e. the optimal mix that would offer the highest returns for the lowest risk and a level of expected return. It seemed odd to us that the consultants were only looking at the asset side of the balance sheet and not taking something very important into account: liabilities. When Leo De Bever joined Teachers’, we started to do things the right way. He did a great job of including liability, and from that point on, we developed a really good process that Barbara Zvan has been overseeing for a number of years now. She’s done a terrific job of developing a really robust efficient frontier, through stochastic modeling. We were one of the first funds to do that kind of work. Since its inception, Teachers’ has earned an average return on investment of 10.3 per cent. What has been the key to achieving this?

Again, my answer is simple: great people, a great board and a strong strategy. Thanks to these elements, we’ve had a fairly low turnover over the years. Of course, you also have to have some luck. If you look back at 2000 to 2009, the annualized S&P total return was below -2%. We didn’t face any of that in the early 1990s: we were buying real estate in ‘92 and ‘93, at a time when doing so was not popular. Obviously, with hindsight, we can see that this was the right thing to do — but at the time, many investors didn’t want to venture into real estate. Cadillac Fairview was one of our largest investments ever. It had gone bankrupt, so we invested in it along with two private equity funds, and then eventually we bought the whole thing. This definitely required a long-term outlook, and that is how we approached real estate. rotmanmagazine.ca / 95

I always made sure that people were paid, not just for their work, but for teamwork, because when you invest, you’re part of a team.

Another thing we did was improve the service to our members and school boards. In 1990 this aspect was far from adequate, so from day one, we put a lot of effort into delivering top notch service. Again, the key was having the right people and setting high standards. You are widely recognized as a pioneer in the quest for better corporate governance. What do you make of all the shareholder activism we are seeing?

To me, good governance should not be viewed as an end unto itself: it is a means to an end — and that end is great performance. It has to help you perform better, and for a pension fund, that means good long-term performance and best-in-class service. I’ve been on a few boards over the years, and I began to realize that many pension funds, for instance, have a governance division that is not involved in the investment process. At Teachers’, we made sure that governance was always involved. For instance, if the governance team voted No on something, there were always three senior people who had to agree. The activism we’re seeing today is not necessarily bad, but it has to serve a purpose — and the purpose is making sure that corporations perform. Do any of the boards you have served on personify your definition of good governance?

I’m currently on the board of Industrial Alliance, which is a mid-sized insurance company, and in my view, they come pretty close. They’ve got a strong CEO in place and there is good chemistry with the people on the Board. As a result, difficult questions are sometimes raised, and management tends to listen to the suggestions that are made. But at the end of the day, they are the ones deciding. I was also on a board in the UK for a water company called Northumbrian, which is now private. That, too, was an excellent board. Again, there was great chemistry, and people weren’t afraid to ask tough questions. Management was very transparent. They didn’t even have offices — they all sat in one big room together with their assistants, and it was interesting to see the chemistry between these people. The Board was the same: people were very open; 96 / Rotman Management Winter 2017

there were no secrets. Also, Xstrata, which is now owned by Glencore, is a company that grew very fast and has excellent governance. Again, it is very open, essentially performance-oriented and at the same time, very concerned about the environment in the communities where it was operating. For instance, if they are working in a remote area, they participate in building hospitals and schools. They recognize that when you run a mining company in a remote area — or anywhere, for that matter — you are part of the fabric of society. Describe the incentive system you set up at Teachers’, to help people focus on long-term investing.

This goes back to my initial conversations with Gerry Bouey. From the start, I said that we would have to have the right incentives. Our approach was low base pay and good incentives for people, especially in the investment area, because good people can — and do — make a huge difference. I wanted the incentives to be for both the short term and the long term. But unfortunately in Canada, we couldn’t extend the long-term for more than four years, for tax reasons. If I had my druthers, I would have extended it to five or six years. In addition, I always made sure that people were paid, not just for their work, but for teamwork, because when you invest, you’re part of a team. If you’re a portfolio manager, you’re part of a small group so, yes, you will be rewarded for your results — but you will also be rewarded for the team’s results. And if you are a senior person, you were rewarded not just for your results, but for how the overall organization did. You need to make sure that people help each other and collaborate, as opposed to becoming too focused on their own results and forgetting that the rest of the organization exists. On many occasions, we did very well when we had two or three teams working together and helping each other, as opposed to trying to out-earn each other. You founded the Canadian Coalition for Good Governance in 2002. Based on your work with the Coalition, are you optimistic about the future of good governance?

I am optimistic. In general, I think Canadian companies do

New from Rotman-UTP Publishing fairly well on governance, and the Coalition has done some really good work; for instance, we’ve been able to separate the roles of Chair and CEO. I don’t think this is an ‘absolute’ rule, but to me, it’s a much better way to organize a board. The Coalition has also done great work in the areas of majority voting for director elections, say-on-pay, and compensation structure and disclosure. When Steve Jarislowsky and I started the Coalition, it was important to include people who knew about performance. If you look at the members of the Board of the Coalition, most of them have senior positions in investing. Of course, they also know that governance is important, but their focus is on making sure that they provide a good return for their investors. Governance is an area where we will never achieve perfection, but we can always take steps to make it better. For instance, if you look at compensation today, many corporations still do not pay based on performance. It’s mostly fixed remuneration, and as a result, the correlation between good performance and compensation is not always there. We have improved — but there is still plenty of room for improvement.

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Claude Lamoureux, FCAI, ICD.D., O.C., is co-founder of the Canadian

Coalition for Good Governance. He served as President and CEO of Ontario Teachers’ Pension Plan until December 1, 2007. Between 1990 and 2007, he led its development into one of the world’s leading pension plans, with more than CAD$ 100 billion in net assets. Today he is Chairman of Orbite Technologies Inc. and a Director of Industrial Alliance Insurance and Financial Services, Inc. He also serves as a Director of St. Michael’s Hospital.

utppublishing.com

rotmanmagazine.ca / 97

FACULTY FOCUS

Claire Celerier, Professor of Finance, Rotman School of Management

Finance Salaries, Returns-to-Talent and Inequality Interview by Karen Christensen

Many people believe that the finance sector is contributing disproportionately to income inequality in our society. Do you agree?

I do. Ever since the 1980s, compensation in finance has been higher and more skewed than in other sectors. It has been shown that the ‘finance wage premium’ — the degree to which finance salaries exceed those in other industries — is, on average, 50 per cent. That is why the sector has been criticized as one of the sources of growing income inequality. My colleagues and I felt that this public debate called for an improved understanding of the drivers of bankers’ pay. Our intuition told us that one of the key drivers is the competition for talent. For our research, we defined talent as, ‘the aptitude to reach an objective in a competitive environment’. In this definition, talent encompasses not only cognitive skills, but also personality traits such as motivation, self-discipline, low cost of effort, and ability to perform in a competitive environment. We set out to answer two questions: Are wage returns to talent relatively high in finance compared to the rest of the economy?; and, Do talent effects drive the cross-section of wages observed in finance? 98 / Rotman Management Winter 2017

Our main finding was that the finance wage premium has indeed been disproportionately allocated to the most talented individuals in this sector: returns to talent were three times higher in finance than in the rest of the economy. We also discovered that, while wages have increased a lot in the finance sector overall, they have increased even more for the top percentile in the sector. The most talented individuals in finance have thus received most of the available wage increases in recent decades. We believe these significant returns are also associated with an increasing share of talented individuals choosing to go into finance occupations. Our results contribute to the overall understanding of the well-documented rise in income equality. While these outcomes may be both meritocratic and economically efficient in the short run — they might not be socially or politically sustainable in the long run. Within finance, you found that returns-to-talent for ‘front-office’ jobs are even higher when compared to back office or ‘support’ departments. Please discuss this finding.

We found that indeed, returns to talent are higher for frontoffice jobs like traders or quants, relative to ‘back-office’

Banks may be competing for talent based on short-term performance, so there may be negative externalities involved.

roles such as risk managers, and there are two possible reasons for this. The first is that talent is more scalable in front-office jobs. If you are a highly talented trader, the cost of managing a portfolio of ten million dollars is not much higher than the cost of managing a portfolio of two billion dollars. The work itself is very scalable: depending on how talented you are, you can adjust the size of your portfolio with relatively low cost. Whereas, if you are a risk manager, you can’t suddenly start analyzing three times as many securities without taking a lot more time, which costs more. It is also easier to measure your short-term performance as a front-office worker, because you can measure the performance of your portfolio and how many securities you have sold; but when you are a risk manager or any other back office job, the focus is more on long-term performance. In short, the more transparency there is around confirming great performance, the higher the competition for talent. In a world where finance wage returns to talent are more than three times higher than in the rest of the economy, what is your message for finance executives?

As indicated, banks may be competing for talent based on short-term performance, so there may be negative externalities involved — in the sense that the long-term risk of certain types of behaviour may not be taken into account. As a manager of finance talent, you should be looking at the long-term impact of your decisions. In your view, should bankers’ pay be regulated?

I don’t think that is the answer, because a cap on wages would only encourage the development of a more opaque and complex system. Also, if these sky-high wages result from competition for talent — which we believe they do — banks will just find other another way to pay these people. They might just provide them with fancy cars or bigger bonuses; or, more people might just go abroad to work. There have actually been some laws putting a cap on bonuses, but that has only resulted in higher fixed wages. I would like to do more research on this, because quantifying the negative externalities of higher returns to talent — if indeed they exist — is difficult. In addition, any answer could create new distortions. For example, higher taxes

could be considered as part of the solution. The government could take income inequality into account when setting tax rates; but increasing taxes could also lead to a brain drain to countries with lower tax regimes. In other research, you looked at the ‘unbanked’ population, to investigate whether the finance sector is meeting the needs of poor families. What were your key findings?

People might not recognize that this is a huge chunk of the population: in the U.S., 35 to 45 per cent of low-income households are ‘unbanked’ — which means that they possess neither a chequing nor a savings account. We were interested in whether this is driven by supply- or demand-side factors. The ‘demand-side’ view attributes the unbanked phenomenon to cultural determinants (i.e. the poor may distrust financial institutions or may not have a ‘culture of saving’) or to a lack of financial literacy. Alternatively, the ‘supply-side’ view suggests that standard bank practices create hurdles for the poor: minimum account balances, overdraft fees, a large distance between branches and the proliferation of formal steps to open an account result in costs that may be too high for poor households to manage. Furthermore, bank services may not be tailored to low-income households. Of course, these two polar explanations have different policy implications. The demand-side view would require interventions at the household level, through financial literacy programs, for example, while the supply-side view suggests that giving banks incentives to change their behaviour towards these customers may reduce the share of unbanked households. We found clear evidence of a supply issue. In our study, an increase in the density of bank offices in poor counties had a positive impact on the share of low-income households with a bank account. We also found that interstate branching deregulation is associated with a significant drop in the rate of unbanked households among low-income populations. We observed a significant increase in the share of banked households following deregulation. We also found that having access to bank accounts improves wealth accumulation, but does not translate into higher levels of indebtedness. We showed that deregulation impacts neither the probability to incur debt nor the rotmanmagazine.ca / 99

IMAGE: GETTY IMAGES

There are two theories of the determinants of security design: first, risk sharing; and second, banks catering to yield-seeking investors through complexity and shrouding (i.e. concealing) information. The results of our study are consistent with financial complexity being a by-product of banks catering to yield-seeking investors: we found that products offering high headline rates and products exposing investors to complete losses are more complex. Second, the spread between product headline rates and interest rates increases when interest rates are low, as do product complexity and risk. Third, both products offering a high headline rate and more complex products yield higher markups to the banks that issue them. These higher markups translate into lower performance for more complex products.

In finance, the long-term risk of certain types of behaviour may not be taken into account.

debt-to-income ratio of low income households, which mitigates the fear that banking competition fosters ‘predatory lending’. You also studied the sale of complex financial products; what were your key findings?

Since the end of the 1990s, European financial institutions have designed, marketed and sold more than two trillion euros worth of complex financial products to households — socalled ‘retail structured products’. The marketing for these products typically focuses on the return they offer under the best-case scenario, which is known as the ‘headline rate’. In parallel, in the U.S. and in Canada, the market of structured deposits, which are a sub-category of retail structured products, is becoming increasingly popular. In our study, we documented three basic facts about the retail market for structured products. First, product complexity increased significantly from 2002 to 2010, with no discernible drop during the global financial crisis. Second, the fraction of products exposing investors to complete losses increased significantly over our sample period. Third, headline rates departed more from the level of interest rates when interest rates were low. 100 / Rotman Management Winter 2017

Complexity is often said to go hand-in-hand with financial innovation. Do you agree?

No, I don’t. I think the perfect innovation would improve risk sharing, complete markets and better match consumer needs, without any complexity. I would actually love a world where financial innovation comes without complexity! What are you working on these days? I have a few projects underway. I am continuing my work on complexity in finance — looking at who exactly is buying all of these retail structured products. I also have another project on the go related to unbanked households, where we look at the effect on these individual financial situations of having access to health insurance. Then I have projects that are more related to bank regulations in general. In one, we’re looking at the effects of an exogenous shock on bank credit, and what the effect is on employment. How do firms react? It’s still quite preliminary — but I will be happy to share my results with your readers in the near future!

Claire Celerier is an Assistant Professor of Finance at the Rotman

School of Management. Before joining Rotman in July 2016, she was an Assistant Professor at the University of Zurich. Rotman faculty research is ranked #3 in the world by the Financial Times.

FACULTY FOCUS

Craig Doidge + Alexander Dyck, Professors of Finance, Rotman School of Management

Institutional Investing 101 Interview by Karen Christensen

KC: Describe how corporate ownership has been transformed over the last few decades by the emergence of institutional investors. Craig Doidge: In The Modern Corporation

and Private Property (1932), Berle and Means warned that with the separation of corporate ownership and control, the interests of shareholders and managers may diverge, and that “no shareholder is in the position to place important pressure upon management.” Back when that was written, there was ‘The Corporation’ and there were a bunch of passive shareholders, and their paths rarely crossed. The picture is much more complicated today. While ‘dispersed ownership’ is still largely the case in the U.S. (and to some degree, in Canada), there are lots of large shareholders who now have significant influence on management. Of course, there are exceptions, like family firms and dual-class firms. We also now have entities like hedge funds — which have a big enough stake to get a seat at the strategy table.

Alexander Dyck: For me, the biggest

change from the time when Berle and Means were writing is the movement away from individuals buying shares in specific firms. At the time, that was the predominant form of non-insider ownership. What we have seen — since World War II, and particularly in the last 20 years — is the rise of institutional ownership. For years now, we’ve taught our students that they should not buy shares in individual firms. We tell them they’d be better off buying through an institution that accumulates shares for them — and this is what has happened, on a broader scale. It’s now at the point where there are a few very large institutional investors, each of whom might own three-to-five per cent of a firm’s shares — which is enough to get the attention of management. KC: How do you define the term ‘institutional investor’? AD: When you look at institutional money, there are three

different types in Canada that account for the bulk of rotmanmagazine.ca / 101

Poor governance leads to poor decision making, which can destroy value; so implementing positive governance changes should lead to value creation.

invested capital. First, we have large pension plans like the Ontario Teachers’ Pension Plan (‘Teachers’), which has around $170 billion in assets and invests on behalf of its beneficiaries, sometimes buying significant stakes in individual firms. Second, there are the mutual funds. Jarislowsky Fraser is a well-known mutual-fund company that an individual can invest in, and then the firm decides which companies to invest in, on clients’ behalf. A third category would be the bank-based asset managers at the big Canadian banks. CD: I think a generic definition would be that institutional

investors pool the funds of individual investors or entities. That can include insurance companies, hedge funds, pension funds, mutual funds or bank-based asset managers. The largest percentage comes through bank-based asset management companies. Then you have independent mutual funds — but their number is shrinking. Thirdly, you have pension funds. And then, finally, you have smaller investors like hedge funds, who can choose — for a small period of time — to assemble relatively large stakes. We can’t ignore them, because they can be prominent investors. KC: Can you provide an example of an institutional investor having significant influence on a company’s strategy? CD: A nice example is Bill Ackman’s hedge fund, Persh-

ing Square Capital Management, which had a significant influence on the strategy of Canadian Pacific Railway. After buying up a significant number of shares, Ackman and company basically forced their way onto the CP Board, and proceeded to replace CEO Fred Green with former Canadian National Railway chief Hunter Harrison. This actually turned out well for CP: at last count, its share price had tripled. But it should be noted that Ackman had a similar de102 / Rotman Management Winter 2017

gree of impact on the strategy of Valeant Pharmaceuticals — and not in a positive way. AD: It used to be the case that, if an investor didn’t like what

was going on, they had to buy the company outright and make the changes. As indicated by the CP example, one of the most interesting developments over the last decade is the possibility for investors to essentially take control of a board and make significant changes, without taking over the firm entirely. Another example is Teachers’, which had a large stake in Petro-Canada, but believed that it would be better off selling itself to Suncor. Teachers did a 13D filing and, within a matter of weeks, Petro-Can sold itself off to Suncor. So it’s not only hedge funds that can affect a company’s strategy. For me, there are two different categories of shareholder engagement: in the first, the shareholder wants to come in and change the strategy in light of changed circumstances. They may think management is missing a huge opportunity or that the right people are not in place, and that a corporate restructuring is in order. The institutional investors that engage in this kind of activity, by and large, are not the ones who hold a very small stake. Only hedge funds or giants like Teachers’ tend to do this, because they might have a five or ten per cent stake in the corporation. Then, there is a second type of engagement — which is the focus of our recent paper — and that involves taking steps to change governance practices at a firm. It is now recognized that poor governance leads to poor decision making, which can destroy value, so the ability to implement positive changes to governance should lead to value creation. Hedge funds are largely absent from these sorts of discussions as each small change in governance will not have a big impact — so it is hard for them to generate returns by focusing solely on

CCGG has influenced the adoption of three key governance improvements: majority voting, say-on-pay advisory votes, and improved compensation structure and disclosure.

these smaller changes. Larger investors that have a portfolio of investments, and that have a longer time horizon are more involved in this type of engagement. KC: As part of your research, you studied the inner workings of the Canadian Coalition for Good Governance (CCGG) between 2005 and 2013. Do you consider CCGG to be a ‘shareholder activist’? AD: It depends on how you define ‘activist’. They are cer-

tainly part of the trend of shareholders becoming more vocal in trying to get their concerns listened to. They call themselves ‘the voice of the shareholder’, and for a certain set of issues, they have absolutely been the voice of the shareholder. But then there are the classic shareholder activists, such as hedge fund activists, who want to address specific strategy weaknesses at individual firms. That is not CCGG’s mandate. CD: If the opposite of active is passive, there are still a lot

of passive shareholders who invest in a firm, and that’s the extent of their engagement. Clearly, CCGG is more than passive: they have a clear agenda to improve governance — and they’re actively engaging firms on that front. So in that sense, yes, they are activists. KC: Can institutional investors drive improvements in governance? AD: We found that the answer is Yes. CCGG has been able to

influence firms’ adoption of three key governance improvements: majority voting, say-on-pay advisory votes, and improved compensation structure and disclosure. We chose to focus on these issues for our research because they aren’t required by any regulation, they are prominent, and there was good data available. But beyond what we studied, they have

done lots of other things to improve governance. For instance, one of the first things they tried was to get boards to be better performing, by encouraging a process that was already in place: making the Chair of the Board separate from the CEO. Canada is quite different from the U.S. in this respect: almost all of our corporations — aside from controlled corporations — have separated those roles, and the CCGG definitely played a role in that. To be clear, CCGG is like an umbrella group for the largest and most motivated institutional investors in Canada — who, as indicated, own the preponderance of the country’s institutional shares — to identify issues that they think are important and address them. Each year, they get together and the Board agrees on what the most important issues are at that time. There are two kinds of ‘leakage’ in this process. First, there are some issues for which there will be insufficient consensus. Some people will view them as being extremely important and others won’t, so they will not be pursued. And, second, there are issues that are important, but not quite as important as others — and given the CCGG’s scarce resources, they cannot tackle everything. For example, take the issue of dual-class shares, which are relatively common in Canada compared to the U.S. This has not been as much of a focus for the CCGG as you would think. If you look at the academic literature, most of it says that a separation of power from economic interest is a bad setup for creating value for the long term. A second illustration would be issues around environmental and social issues, and the extent to which boards are paying attention to these—which may not have an immediate bottomline effect. Some shareholders think firms should be paying attention to these issues; but others aren’t quite sold that doing so is a value-enhancing move. As a result, we have yet to see the CCGG make environmental and social issues a rotmanmagazine.ca / 103

The Institutional Investment Ecosystem REGULATORS Public entities which set and enforce the rules of the marketplace Asset Managers Fund managers that invest on behalf of clients, as agents

Asset Owners & Benefiaciaries Institutions that own the assets under their management, and invest as principals

AD: Broadly speaking, the opportunities for institutional

investors to improve governance abroad are much bigger— simply because the governance problems outside of Canada are so much bigger. For example, there has been a lot of interest in investing in Asia, where a variety of governance issues have arisen. Even a small effort to improve things in these settings can generate a lot of value. Already, some of our major institutional investors are trying to find channels there, to introduce some of the changes that have already been introduced in Canada. So, the focus may very well move away from Canadian firms.

Intermediaries Institutions that act as middlemen and consultants for other investors

SOURCE: WORLD ECONOMIC FORUM

priority. Right now, a topic that people are interested in is proxy access; and CCGG has been working on this for a while. KC: Describe the challenges that lie ahead for institutional investors in a world with increasingly large crossborder capital flows. CD: As we continue to have more foreign investors owning

shares in Canada, and more Canadian investors taking their money outside of the country, our biggest investors will have smaller stakes in Canadian firms — and their incentives to invest time and money into advocating for good governance for Canadian firms may decline. Outside of Canada, there are a few other loose coalitions of institutional investors like CCGG, but they tend to do several things, of which governance is just one, and they tend to be reactive rather than proactive. Whereas CCGG says, ‘Look, we think these are important issues: let’s try and be ahead of the pack and get this fixed’.

104 / Rotman Management Winter 2017

Craig Doidge holds a Professorship in Corporate Governance, is the Finance Area Coordinator and a Professor of Finance at the Rotman School of Management. Alexander Dyck holds the Manulife Financial Chair in Financial Services and is a Professor of Finance and Business Economics at the Rotman School of Management. He is also director of the School’s Capital Markets Institute and Academic Director of the Director’s Education Program, jointly developed by the Rotman School and the Institute of Corporate Directors. Their working paper, “Can Institutional Investors Improve Corporate Governance Through Collective Action?” can be downloaded at ssrn.org.

Rotman faculty research is ranked #3 globally by the Financial Times.

QUESTIONS FOR

Dan Pontefract, Chief Envisioner, Telus

Q &A

Telus’ Chief Envisioner describes the critical role of purpose in building a stronger societal

ecosystem. Interview by Karen Christensen

The importance of ‘having a purpose’ is not a new idea; it has been discussed since the time of the ancient Greeks. Why write a book about it now?

Quite frankly, society has lost its way, and there is no better time than the present to start bringing up the concepts of what the Greeks — along with Peter Drucker, Charles Handy and many others — have been writing about for years: what are we here for? Are we here to serve ourselves — or, in the case of a publicly-traded company, our shareholders? Or, are we here to serve all of society’s stakeholders? Since Milton Friedman came on the scene in the early 1970’s, for the better part of the past 46 years, our for-profit organizations have steered towards a very selfish manifestation of why the organization exists. Meanwhile, not-for-profit and public sector organizations have morphed into a very bureaucratic, ‘power-monger’ model, which doesn’t serve their true purpose, either. I honestly believe we need a reset. You have said the ‘ecosystem way of thinking’ is key to enabling prosperity going forward. Please describe it.

The definition of an ecosystem is ‘an interconnection of organisms’. When applied to our purpose in life, it is the idea that our actions and our decisions are all interconnected. As a result, when we decide to do something within an organization, we ought to be thinking about each element of the ecosystem that will be impacted. Put simply, we should always be thinking in terms of our interconnectedness. This rotmanmagazine.ca / 105

No matter who you are, you are responsible for finding or creating your own ‘sweet spot’.

is critical for the prosperity of future generations. You have defined three distinct categories of purpose. Please describe them.

The first type is personal purpose, and it revolves around three Ds: an individual who seeks a sense of purpose in life is constantly developing, defining and deciding their values, priorities, attributes and general ways of conducting themselves from day to day. It is a perpetual cycle of self-discovery. The second type of purpose is organizational purpose. In Fixing the Game, former Rotman Dean Roger Martin argues that every organization should be placing its customers at the centre of the firm and focus on delighting them. I extended Roger’s argument to create the Good Deeds Model, which I would encourage every organization to embrace: Delight your customers, Engage your team members, be Ethical within society, Deliver fair practices and Serve all stakeholders. No organization is an island unto itself. It is important that companies recognize their responsibility as an integral partner in society’s ecosystem. The third type of purpose is role purpose. Roles are created by an organization to fulfill a mission or purpose, and an individual’s role-based mindset is the result of whether their personal purpose is in alignment with the organization’s purpose — as well as with the duties required to perform in the role itself. In terms of role purpose, tell us about the 3 mindsets that employees can adopt.

Every individual is always operating with one of three mindsets: the job mindset, the career mindset or the purpose mindset. We all employ each of them at one time or another throughout our careers — maybe even during a particular week. The important thing is to be in the purpose mindset for most of the time. The job mindset is very transactional. It’s a paycheque mentality: ‘I’m here because I need to pay my mortgage and make my car payment’. It can also pertain to the things you don’t like doing in your role. But remember, we all have aspects of our roles that we don’t like doing. 106 / Rotman Management Winter 2017

The career mindset is about ‘ladder climbing’ and what I refer to as seeking ‘career girth.’ When you are in this mindset you are quite selfish and are only in it for yourself. It’s like that old hockey adage, ‘you’re playing for the name on the back of your jersey, not the crest on the front’. In this mindset, people are obsessed with power — and whether it’s salary, title, team size, or budget size — their quest is more. People stuck in this mindset can really create havoc in an organization. Lastly, there is the purpose mindset. This is the Holy Grail, where there is alignment between what you do for a living and your personal purpose: you are contributing, you feel engaged and can be creative — everything clicks. When you hear that clicking sound, you’ve arrived at the ‘sweet spot’ — where you will make your optimal contribution to the organization — and to yourself. What is ‘purpose misalignment’, and what are its effects?

This can manifest itself in several ways. On an individual level, it occurs when people have not asked themselves the three-D questions: Are you developing yourself? Are you defining yourself? And are you deciding how to show up every day? If they’re just going through the motions, they’ve entered the ‘valley of apathy’, as I call it. The sad truth is, no matter what data point you look at, roughly 70 per cent of us are disengaged at work. There can also be purpose misalignment within the organization itself. This is usually a direct result of the C-suite — but the Board also gets implicated. Is the organization’s purpose to serve corporate interests and maximize shareholder return, or is it to serve all stakeholders? If the organization has defined its purpose as ‘maximize shareholder return’, to me, that’s purpose misalignment, and today, society is becoming increasingly intolerant of organizations that maintain such a purpose. Describe the relationship between an organization’s culture and its purpose.

Deloitte LLP has unearthed evidence suggesting that a

Whenever we decide to do something, we need to think about every element of the ecosystem that will be impacted.

The Purpose Effect Model culture of purpose in an organization directly creates shortand long-term growth as well as an improved internal culture and financial benefits. Based on this research, Deloitte’s Global CEO, Punit Renjen, has said that an organization’s culture of purpose answers the critical questions of who we are and why we exist through a set of carefully-articulated core beliefs. He contends that an organization that instills a sense of purpose — permeating all stakeholders, including team members, customers and society — not only builds business confidence, but fosters a thriving business community. His definition closely aligns with my beliefs.

Personal Purpose

DEVELOP

DECIDE

CAREER

Can you share your own personal ‘purpose journey’ with us?

First, I want to say that we all own the shovel, and it’s our responsibility to pick it up each and every day to dig our own path. Far too often, people feel as though this is the duty of their leaders; but that could not be further from the truth. No matter who you are, you are responsible for finding or creating your own sweet spot. It’s not going to happen unless you take action. For me, I went to university thinking I wanted to be a doctor. That didn’t work out, because as it turns out, I’m not very fond of blood. But I still wanted to help people, so instead, I went into the education program to become a teacher in the K-12 space. I did that for two years — and essentially lost my mind: I had fallen into this world of apathy where all the teachers sat around the staffroom in a daze and were essentially ‘mailing it in’. I thought to myself, this cannot be it for me. So, I quit and then I had an epiphany that higher education was where it’s at: I could work with people who already had the mental mindset that they wanted to improve upon themselves. So I got into some post-graduate work at the British Columbia Institute of Technology. I had a great time there, but again, I knew that there was a ceiling, and that if I was going to become a better person, I had to go and find some greater purpose, to complement all that I had learned to date.

The “Sweet Spot”

DEFINE

ENGAGE DELIGHT

JOB

ETHICAL

PURPOSE SERVE

Role Purpose

DELIVER

Organizational Purpose

I joined the corporate world in 2002 and had a wonderful six years at a company called BusinessObjects, which was then bought by SAP. For those six years, we were knocking it out of the park when it came to purpose, culture and engagement. The company was doing all kinds of philanthropy and community investment, and it was so great to be a part of it. When BusinessObjects was acquired, for about a year I tried to help the leaders at SAP see that our way of operating — with an open, transparent and collaborative culture and a rotmanmagazine.ca / 107

purpose mindset — was something they might want to consider. Sadly, they didn’t agree, so there was no happy ending there: I walked out on June 30th of 2008, because I was not going to let myself operate with a job mindset. No pun intended, but soon after that, Telus called and said, ‘We want you to come help us change our culture.’ I joined Telus in December of ‘08, and for five years as Chief Learning Officer, I had a wonderful time: the organization, its board, its C-suite — everybody was unified under a mission to put customers first, aided and abetted by instilling an engaged, open, transparent and collaborative culture. Our employee engagement scores went from 53 per cent to 87 per cent. But knowing that there is a shelf life to every work role, I said to myself, I really love what I do, but if I’m going to continue on my own purposeful path, I’ve got to grow even more. So I pitched our senior leaders this idea that, maybe Telus could help other organizations with their own culture, engagement and purpose needs. A year and a half later, in May of 2014, I was lucky enough to be able to launch a small outfit and say, ‘Let’s go help our customers.’ And that’s what I’ve being doing for the past two years.

‘We’re not here to see through each other; we’re here to see each other through’. That statement constantly makes me think about why I’m here. Whether it’s in relation to my kids, my wife Denise, my friends or my colleagues, why am I here? Am I here just for me — or am I here to help other people get through their day in a positive way? Hopefully, that has ripple effects — and becomes contagious.

What are the first steps towards embracing purpose?

First, you have to look in the mirror and ask yourself those three hard questions — how you’re developing, how you’re defining yourself and how you’re deciding to operate each day in the world. There are also things you can do in the workplace, like try a job rotation, or getting involved in cross-departmental projects. I encourage people to never assume that there aren’t other ways for them to learn, develop, grow and prosper. Many of us have not yet defined what former Medtronic CEO Bill George calls our ‘true north’ — our declaration of purpose. Each of us should have a two or three line personal mission statement that defines us — and determines how we continue to develop and how we ‘show up’ every day. Back in 2007, I defined my own declaration of purpose — though I didn’t call it that at the time. It’s quite simple: 108 / Rotman Management Winter 2017

Dan Pontefract is the Chief Envisioner at Telus, based in Victoria, B.C.

He is the author of The Purpose Effect: Building Meaning in Yourself, Your Role and Your Organization (Elevate Publishing, 2016).

POINT OF VIEW

David Weiss and Ted Cadsby, Authors and Decision-Making Experts

Decision-Making for Complex Situations WHEN LEADERS FACE COMPLEXITY, ineffective deliberations and decision making are often the result. In our experience, this occurs because they fail to differentiate complex situations from complicated ones. As a result, they engage in superficial team discussions often relying on one perceived expert opinion — and they take shortcuts in the decision-making process. The fact is, complex situations are materially different from complicated ones — and increasingly common in today’s environment: building earthquake-resistant towers is complicated; tackling climate change is complex. Managing inventory is complicated; mapping out corporate strategy is complex. Diagnosing a machine’s performance is complicated; assessing a CEO is complex. Complicated situations are characterized by many moving parts, whose interactions may or may not be immediately obvious, but whose consequences are decipherable and predictable. The signals that allow us to unravel complexity, on the other hand, are more deeply buried, ambiguous and inconsistent from one situation to another. When we interact with complex systems, the feedback we get is indirect, delayed and even distorted. Such ambiguous patterns and feedback make predicting complex phenomena very difficult and expertise nearly impossible to develop. Based on our work with clients, we have identified four distinct stages for handling complex situations. Each is

designed to avoid the decision-making mistakes that leaders and their teams are vulnerable to when confronting complexity. 1. Differentiate complex problems and opportunities from complicated ones, so that they can be handled differently; 2. Shepherd competing arguments to bring contradictions and unspoken assumptions to the surface, while avoiding the recognized traps to which groups are vulnerable; 3. Integrate various perspectives by synthesizing insights into a coherent plan. In our experience, it is this dynamic process of integrating disparate views that distinguishes an effective leader of complexity from an ineffective one; and finally 4. Learn how to respond to the unpredictable feedback of complex systems, by continually fine-tuning your plan. The four stages in our model contain eight decision strategies. We will now take a closer look at each stage in the complex decision-making process. STAGE 1: DIFFERENTIATE COMPLEXITY

Strategy 1: Disaggregate the complex from the complicated. Some issues are obviously complex, while others are obviously just complicated. But today’s leaders often face more subtle distinctions because many of their challenges and opportunities have both complicated and complex aspects to them. That’s why it is so important to work with rotmanmagazine.ca / 109

Leaders must cultivate a culture of question-asking in order to ensure that silent voices are heard.

diverse teams to disaggregate these hybrid situations by first identifying their complex aspects those elements with a high degree of ambiguity and uncertainty. Strategy 2: Unravel causal complexity. As indicated, it is the multiple, interacting causal and stakeholder factors that define complexity and demand a distinct approach, but tackling complexity depends on first recognizing it. ‘Systems thinking’ is the essential tool for separating ‘noise from signal’ in complex situations, because deciphering complex causality relies on hunting for the missing information that lurks within a system. Effective systems analysis takes time, patience and perseverance. Leaders and teams need to account for hidden and ambiguous causal relationships and a lack of predictability. Then, they must allocate sufficient time in their meeting agenda to explore the entire system of causal factors that are contributing to make a situation complex. STAGE 2: FACILITATE DIALOGUE

Strategy 3: Foster deep question asking. Leaders must cultivate a culture of question-asking in order to ensure that silent voices are heard, unspoken assumptions are surfaced and latent concerns are identified. They can do this by limiting their own explicitly-stated opinions and by spending a disproportionate amount of their ‘talking time’ asking questions to ferret out the missing information that characterizes all complex situations. They can also encourage question asking within their teams by signaling greater enthusiasm for incisive questions than for shallow opinions. Strategy 4: Encourage constructive dissent. High-quality dialogue is not self-generating. It requires a certain skill in facilitation to engender constructive dissent—the hallmark of generative conversations. To generate divergent ideas and solutions, leaders need to leverage the diverse perspectives on a team in order to surface implicit assumptions and contrary viewpoints. They need to celebrate and validate alternative viewpoints and proactively seek out contrary 110 / Rotman Management Winter 2017

opinions, rather than dismissing voices of dissent. This entails watching out for the following red flags: unanimous views, reticent or frustrated participants, dominating personalities that overwhelm others, and extreme positions that can limit creativity. STAGE 3: SYNTHESIZE INSIGHTS

Strategy 5: Integrate perspectives. Leaders must coach their teams to resist the instinct to draw premature conclusions when facing complexity. They must recognize that solutions to complex issues usually result from integrating multiple solutions that represent a synthesis of many alternatives. The best solutions are rarely the initial ones proposed but, instead, are a blend of different perspectives that represent the best parts of a number of ideas and solutions. In other words, complex problems demand solutions that are ‘artful tapestries’ of varied components. Strategy 6: Assess outcome probabilities. Leaders need to cultivate ‘probabilistic thinking’, rather than leaning towards dichotomous (i.e. black-and-white) thinking. They can do this by keeping themselves and their teams honest with a simple but powerful question: What probability should we assign to...? The probability question should be applied to the likelihood that (a) all the relevant information has been surfaced and discussed, (b) the interpretation of the information is accurate, and (c) the outcome of the decisions will unfold as predicted. With complex situations, the only type of ‘truth’ that is useful is the provisional kind, represented by subjective probability estimates. STAGE 4: REFLECT AND REFINE

Strategy 7: Establish ‘pre-mortem’ plans. Because complex situations defy perfectly-accurate predictions, alternate ‘pre-mortem’ or back-up plans (‘Plan Bs’) are essential to mitigate the risk that the chosen solution will not fulfill its promise. The higher the assessed probability of risk of failure (strategy #6), the greater the need for a Plan B. Leaders and their teams need to engage in ‘pre-mortem’

Decision-Making for Complex Situations COMMON ERRORS:

Treat complexity as if it were complicated.

DECISION STAGES:

Stage 1: Differentiate Complexity

DECISION STRATEGIES:

Fail to maximize benefits of cognitive diversity.

Stage 2: Facilitate Dialogue

Stage 3: Synthesize Insights

Fail to plan for unintended consequences.

Stage 4: Reflect and Refine

1. Disaggregate complex from complicated

3. Foster deep question asking

5. Integrate perspectives

7. Establish “pre-mortem” plans

2. Unravel causal complexity

4. Encourage constructive dissent

6. Assess outcome probabilities

8. Course correct gracefully

examinations of ‘what might go wrong?’ and identify, in advance, the agreed-upon indicators of whether or not the complex solution is unfolding as anticipated. Strategy 8: Course correct, gracefully: Leaders and their teams need to keep a watchful eye on how a complex solution is unfolding in reality by seeking customer feedback and scheduling early and regular assessments of their implemented decisions. Because the feedback about complex issues is often uneven, there is great danger in over-reacting to ‘noise’ as well as in under-reacting to signals that indicate a course correction is required. Leaders and their teams need to be disciplined in analyzing their learnings and ready to shift direction by gracefully moving to predetermined backup plans, or modified versions of them. In closing

Conclude prematurely.

Successful navigating today’s complex environment demands that leaders embrace complexity and view it as a core characteristic of their ongoing deliberations. Leaders need to unravel and fully understand the unique elements associated with complex situations, gain insight by asking deep

questions and encouraging constructive dissent, discover innovative solutions by integrating perspectives and assessing outcome probabilities, and then course correct as reality unfolds. These four stages of decision-making for complex situations can make the difference for an organization during these challenging and uncertain times.

David S. Weiss, PhD, ICD.D, is the President and CEO of Weiss

International Ltd. and visiting faculty at three universities. Previously, he was an Affiliate Professor of the Rotman School of Management and the VP & Chief Innovation Officer of a multi-national consulting firm. David has authored or co-authored six books, including Innovative Intelligence (Wiley, 2011). Ted Cadsby, MBA, CFA, ICD.D, is a corporate director with experience on a number of public, private and non-profit boards. Previously, he was executive vice president of Retail Distribution at the Canadian Imperial Bank of Commerce (CIBC), where he led 18,000 employees in Canada and internationally. He is a best-selling author of three books, most recently Closing the Mind Gap: Making Smarter Decisions in a Hyper-Complex World (BPS Books, 2013). rotmanmagazine.ca / 111

QUESTIONS FOR

Ann Kaplan (Rotman MBA ‘05), CEO, iFinance Canada

Q &A

One of Canada’s leading entrepreneurs describes her management style and how her business model has evolved over 20 years.. Interview by Karen Christensen

112 / Rotman Management Winter 2017

What prompted you to launch Medicard Finance (now iFinance Canada) 20 years ago, and how has your business model evolved over the years?

In 1996, the indications were that Canada would be moving towards a two-tiered healthcare system, and as a result, more people would be paying for things out of their own pockets. If someone wanted to get, say, laser eye surgery, how would they finance that procedure? I founded Medicard to fill this gap. This was also right at the beginning of the cosmeticenhancement boom. Certain cosmetic procedures were just coming on the market and were now acceptable to talk about. Initially, cosmetic surgery was our biggest line of business. A few years later, we expanded our model and moved into Petcard, which finances pet procedures (anyone who has a pet knows how expensive these can be); and then Dentalcard, for elective dental procedures. We then moved into other verticals such as home improvement loans and ‘payday’ lending.

You have to earn your stripes in order to be included at the negotiating table, and I don’t think that’s different whether you’re male or female.

Based on three-year revenue growth, you were recently named—for the 10th time—to the PROFIT/Chatelaine W100 ranking of Canada’s top female entrepreneurs. What key practices have kept you on this list?

It is unusual for a corporation to see the continual growth that we have seen: for 10 of our 20 years, we have grown astronomically. But the fact is, we don’t try to achieve a specific level of growth; instead, we concentrate on being agile and making whatever changes are needed to accommodate our customers. We really focus on our core business and on providing great service. At the moment, this means we are spending a lot of time looking at expanding our online and digital services. We already offer a very fast turnaround on loan approvals via our App. Our goal is to keep making it easier for our clients to get loans. What key challenges—if any—have you faced as a female leader in a male-dominated industry?

It’s true that finance is an extremely male-dominated business, but I don’t think it’s different from any other type of business: when you reach a certain level in the size of transactions you are dealing with — whether you’re male or female — you have to know what you’re doing. You have to earn your stripes in order to be included at the negotiating table, and I don’t think that’s different whether you’re male or female. Of course, you have to bring as much to the table as any male would, and you have to gain the respect of your peers, just like everyone else. I tend to ignore — or choose not to see — any prejudice. You have been described as being ‘deadly serious’ about business. How would you describe your management style?

I have a great management team working with me. I hire people based on their skills, obviously — but they also have to share the values that I have built this company on. Then,

once they have been with me for a period of time, I make it a habit to never override their decisions. They run their departments. If someone is considering how to address an issue, I trust that their mind is always attuned to what is best for the company. Tying all decisions to a clear value set is critical. It’s often very tempting to make quick decisions, but you always have to ask, Is this really the best thing for our company? Not, Is this good for me, or Is it good for the doctor who is loaning us money? I have found that, if a decision is right for the company, it turns out to be right for everybody involved. Personally, before I sign off on something important, I always run it by a few trusted people who are not ‘yes people’. It’s important to have people around you to say, Have you thought of this? Your mentors or critics shouldn’t be in your life because they’re checkpoints; they should be there to help guide you. Tell us about your role as co-chair of the G-20Y’s Alternative Investments Committee.

I’ve been involved with the G-20Y for a few years. I was originally asked to chair a jobs committee, but I decided not to accept that position. I told them I would prefer to cochair their Alternative Investments Committee — a lesser position in an area that I am passionate about, and they made the offer. The Alternative Investments Committee pushes initiatives forward globally, to different financial institutions and other stakeholders. My company is what is referred to as a ‘shadow bank’, which simply means that we work ‘in the shadow of the big banks’. The problem is, we are not regulated in the same way as the banks are, and I believe that needs to change. My argument, and I believe many share it, is that financial institutions such as ours borrow from the banks, so there is a trickle-down effect. There should be some type of framework in place that ensures transparency rotmanmagazine.ca / 113

I tend to ignore—or choose not to see— any prejudice against female leaders.

to the consumer, because ultimately, the consumer can be affected. If there’s a big crash like the one in 2008, ultimately, it’s the government and taxpayers that have to pay. People often ask me, Why are you pushing for more regulation? I tell them, ‘Because we need it!’ When a company like mine is borrowing almost $100 million per year from a bank, clearly, we could end up having a big impact if we’re not complying. Of course, I want to see everybody following the rules — not just us. If I’m going to leave any type of legacy, hopefully it will be that I have contributed in some small way to maintaining the reputation of Canadian finance. People around the world have a comfort level of investing and doing business in Canada, in part because we have such strong regulations. Tell us about the research you’ve been doing for your PhD.

I did years of research on the correlation between the level of spirituality in an organization and employee happiness within that organization. Then, a few years ago, I was taking a Statistics course for my Master’s of Science, and I had to learn — once again — how to run a regression model using data of my choice. I told my professor that I had collected about 50,000 data points at work, and that I wanted to use them for this project. The idea was to figure out whether we can predict whether someone will default on a loan. My professor said, ‘You have all this data, and yet you’re doing your thesis on spirituality in business?’ This led to an offer from the University to support me if I changed the focus of my research. After carefully considering this, I decided to start all over with this new research proposal. I have now completed my thesis and derived an alternate credit score (similar to a FICO-based score) — in other words, an algorithm that determines the likelihood that a consumer will default on a loan. 114 / Rotman Management Winter 2017

In addition to running your business, you have eight children. You’ve probably been asked this a thousand times—but how do you do it?

A while ago, I told the children that the reason I get interviewed so often is because I’m filming a show called Eight is Too Many, and that we would be deciding to eliminate one child at a time. So, my kids are extremely well behaved. In all seriousness, I am exhausted at the end of each day, and I also have a very demanding husband who needs my time. When you have that many people drawing from you, you need to be very focussed in the moment. When I’m at work for an eight-hour day, I am totally focussed on my job. But when I go home, it is all about the kids and my family. Whether you have two children, eight children or no children, you need to be organized in your personal life because ‘stuff happens’, and if you’re not organized, when it happens you’ll be stuck trying to put out fires that you should have put out a long time ago. I strive to be prepared at all times: I like to have all the predictable stuff done before I walk out the door each morning — so I can start dealing with all the unpredictable stuff that comes at me throughout the day.

Ann Kaplan (Rotman MBA ‘05) is President & CEO of iFinance

Canada, which provides small-ticket consumer loans. She was named to the 2016 PROFIT/Chatelaine W100 ranking of Canada’s top female entrepreneurs, for the 10th time.

FACULTY FOCUS

Ole-Kristian Hope, Professor of Accounting, Rotman School of Management

The Economic Usefulness of Accounting Interview by Karen Christensen

In a recent paper, you examined the ‘economic usefulness’ of accounting for private firms. What did you find?

For some privately-held firms, the costs of providing high-quality, accrual-based financial statements outweigh the benefits of accommodating the demands of their stakeholders — who may rely more on cash flows or have direct access to management. But for other private firms, greater stakeholder demand for their financial information necessitates highquality accounting. Using a large sample of U.S. private firms, we confirmed that accrual quality in private firms is associated with the ability of accruals to predict future cash flows; next, we found that accrual quality increases with the demand for monitoring by equity investors, lenders and suppliers. Overall, our evidence suggests that for private U.S. firms, accrual quality is useful, has economic consequences, and varies predictably with certain firm characteristics. Why did you focus on private firms?

I’ve been interested in private firms and their accounting issues for some time now, for several reasons. Most impor-

tantly, if you look at the main drivers of economic growth, private firms are surprisingly important. I say surprisingly because we always hear in the media about publicly-listed companies. Yet, if you aggregate the economic activity in private firms, they have, in total, four times as many employees; three times the total revenue; and twice as much in total assets and scale as publicly-listed companies. Second, primarily due to limited data availability, there is very limited prior research on private firms, especially in the U.S. and Canada. Only in Europe can you find extensive data on private firms. That is explained by the fact that, in Europe, firms’ filing requirements are independent of their listing status. So, if you’re a limited-liability company, whether you are public or private, you have to file certain documents such as annual reports, and these are made publically available. Anyone can access them, as they’re available in large databases. The third reason for my interest in private firms is that they face different issues. By definition, these firms are more tightly controlled. Family firms tend to have a lack of dispersed ownership, and are focused on things besides equity markets and the next quarterly results. They also face different ‘agency costs’, because of the connections between rotmanmagazine.ca / 115

One way to assess the ‘quality of earnings’ is to compare income to cash flow from operations.

management and the owners — which are often one and the same. How do you define ‘accrual quality’?

This is a hotly-debated topic in accounting. My colleagues and I define it as, ‘the extent to which accruals and cash flows map onto each other, and whether there is a natural relation between the two’. Simply put, today’s accruals should either reflect tomorrow’s cash flows or yesterday’s cash flows. If there is no connection between the two, either way, it is likely that management is intervening, which could indicate some form of earnings management. Talk a bit about the indirect costs of preparing financial statements.

The most commonly-cited indirect cost is that you don’t want to give away more information than you have to. Researchers call this ‘proprietary cost’. And within the realm of private firms, there is significant variation in terms of reporting. Some of these firms are huge, so they’re not that different from public firms. In Canada, we have a few of these, including McCain Foods, which is ‘quasi-public’, in that it often has publically-traded debt. These companies clearly have different user groups around the world who are interested in their financial statements for a variety of reasons, so they have to address different end users. The key is to figure out, ‘Who are the main users of our financial statements?’ Describe the renewed focus on cash flows in accounting.

Cash flows have always been important, for the simple reason that you can buy things with cash; you can’t buy anything with an accrued account. There is a very large literature in accounting on what helps predict future cash flows best. There are, literally hundreds of studies and different facets of this, but I think it’s fair to say that accrual accounting predicts future cash flows better than cash flows alone. You can say net income is a better predictor of future cash flows than current cash flows; but that doesn’t mean that accrualbased earnings won’t have their deficiencies. Clearly, we’re all aware of that. Part of the ‘renewed focus’ on cash flows is that they serve as a check on repeated earnings: one way to assess the ‘quality of earnings’ is to compare income (or some other earnings number) to cash flow from operations. 116 / Rotman Management Winter 2017

There should be, at least over time, some natural relation between the two. If you go back in time, companies primarily provided earnings-per-share forecasts; but now, they tend to broaden their forecasts to include things like sales, and in many cases, cash flow. The idea behind our testing for this is, if there is no evidence that accrual accounting is important in some sense, then why should we be interested in examining the variations in the accrual quality of our financial reporting quota? That was our motivation for the research. Clearly, there are different ways to measure the economic usefulness of accounting, and our approach is just one of them; but it is one that is well motivated, because it comes directly from the conceptual framework of both the Financial Accounting Standards Board as well as the International Accounting Standards Board, where both conceptual frameworks basically say that ‘accrual accounting earnings are important if they can help us predict future cash flows’. In an earlier version of this paper, we looked at some other aspects of economic usefulness. For example, we considered whether higher quality accounting had a positive association with investment efficiency. In other words, are firms that have higher quality accounting able to make better investment decisions? We found evidence consistent with that. If you have one owner of a hot dog stand, then you don’t have any demand for accounting information from equity investors. But with more dispersed owners, the further out you are, and the less involved in management, the more you’re relying on accounting information to assess what’s going on. You can call that proper governance, stewardship, monitoring — whatever you want. Accounting is a very important element of that. The more dispersed ownership you have, the more demand there is for quality accounting. In another recent paper, you and your colleagues looked at the influence of ‘blockholders’—shareholders who own at least five per cent of a company’s shares. What did you find?

Recent studies suggest that blockholders exert governance control through the ‘threat of exit’. Simply put, blockholders have strong incentives to gather private information and sell their shares when managers are perceived to underperform. To prevent them from doing so — and the firm from

In The End of Accounting, NYU’s Baruch Lev notes that 110 years ago, investors received nearly identical balance sheets and income statements to those received by their present counterparts. Does this suggest a decrease in the role of financial information?

It’s a provocative statement; but it’s only an assertion unless he backs it up with evidence. My answer to your question would be yes and no. Let me say why. If you’re just focusing on net income, the balance sheet, income statements, etc. — the elements that have existed for a hundred years — then I would conjecture that his belief is correct. I would expect these things, for example, to explain less variations in equity prices and stock returns than they did 50 years ago. However that, to me, does not imply that accounting has become any less useful. Nowadays, much bigger packages of financial information are made available by firms. So, unless you include the entire package in that assessment, in a sense, it’s not a fair comparison. We’re talking about all kinds of things here, but the length of the annual report is the simplest thing: over time, it has just gone up and up. And equally important to me, firms, nowadays, compared to say 50 years ago, tend to provide much more voluntary disclosure. There is a lot more transparency, in general, and this can take a number of forms — certainly not limited to, but including, manage-

IMAGE: GETTY IMAGES

suffering a stock-price decline — managers have begun to align their actions with the interests of these shareholders. As a result, managers’ actions are more likely to be in shareholders’ best interest, and consequently there is less need to manipulate earnings. We also found evidence that as exit-threat increases, firms have higher financial reporting quality. Simply put, blockholders play an important role in a firm’s reporting outcomes through their actions as informed investors. Presumably, blockholders’ influence extends to other aspects of financial reporting as well. For example, the threat of exit could improve the transparency of firms’ financial disclosures, increase managers’ willingness to issue (accurate) forecasts, possibly limit the demand for conditional conservatism in reported earnings, and reduce other forms of earnings management that occur through classification shifting. We believe these are interesting avenues for future research.

Today’s accruals should either reflect tomorrow’s cash flows, or yesterday’s cash flows. If they don’t, earnings management might be at play.

ment guides and earnings forecasts. All of these things provide some information about what you should expect future performance to look like. If you only focus on one aspect of disclosure, it’s not surprising to me that it comprises a small portion of the overall ‘value relevance’. There’s actually quite a lot of research directly related to Lev’s assertion. The main reason for declining value relevance over the last few years is that you have different composition of firms on the stock exchange. They are less mature, and they are smaller, relatively speaking, and so on. And of course today, there are many more intangibles in the mix. So, it’s a bit of an unfair comparison just to compare one time period to another. But saying that financial information, in general, has reduced in its relevance — that, to me, is a gross exaggeration.

Ole-Kristian Hope is the Deloitte Professor of Accounting and

the PhD Program Coordinator for Accounting at the Rotman School of Management. His papers, “Stakeholder Demand for Accounting Quality and Economic Usefulness of Accounting in U.S. Private Firms” and “Blockholder Exit Threats and Financial Reporting Quality” can be downloaded online. Rotman faculty research is ranked #3 in the world by the Financial Times. rotmanmagazine.ca / 117

QUESTIONS FOR

Hatem Jahshan (Rotman MBA ‘10), CEO, Steeped Tea

Q &A Turning tea parties into big business.

Interview by Sharon Aschaiek

118 / Rotman Management Winter 2017

By many measures, Hatem Jahshan (Rotman MBA ’10, B.Eng, ’99) and his wife Tonia are enjoying stratospheric success. Their 10-year-old loose-leaf tea company, Steeped Tea, has 9,000 ‘consultants’ across Canada and in every U.S. state who directly sell up to 300 types of tea to their family, friends and neighbours by hosting tea parties in people’s homes. In the last five years, the Ancaster, Ontario-based company has seen its revenues grow 3,500 per cent, and last year, it pulled in $20 million. Earlier this year, Tonia scored the top spot on the 2016 PROFIT/Chatelaine W100 ranking of Canada’s top female entrepreneurs. But one business milestone stands out from the others — both because it happened on national television, and involved the kind of pressure that can crack even the most self-assured entrepreneur: they scored a deal on the CBC reality show, Dragon’s Den. Here, Hatem explains why they chose to go ‘investment hunting’, and what it was like to tangle with the Dragons. When you and your wife appeared on Dragon’s Den in September 2012, you were already six years into your business, with 500 ‘consultants’ on board and $1.3 million in annual sales. How did your company evolve to that initial level of success?

My wife Tonia started Steeped Tea in 2006, as a hobby. We had taken a trip to Nova Scotia and were served loose-leaf Earl Grey tea for the first time, and she fell in love with it: the taste, the flavour, the colour. Loose-leaf tea was pretty unknown back them, so she saw a business opportunity. She began putting together packages of loose-leaf teas and trying to sell them through open houses, but didn’t get very far with that approach. One day, someone asked if she would host a tea party at their home. The event was very successful, and the guests wanted to throw their own tea parties. From that first event, she booked eight more tea parties. Selling tea as an ‘experience’ instead of a product has been an incredibly effective approach. By the end of the third

All of a sudden we were getting recognized, and we had a stamp of approval from the Dragons. year, she had hit half a million dollars in sales. During that time, I was operating a few Subway sandwich franchises, and doing my MBA at Rotman. After completing my MBA, I joined the company as CEO and began handling operations and finances. You decided to audition for Dragon’s Den because you wanted support to expand your operation into the U.S. How did that decision come about?

Our business is very much geared to North American society, where people love to get together socially in each other’s homes. There was a huge potential for us to tap into the U.S. market. Everything we’ve done, we’ve automated: from the consultant signup process to shipping to ordering, everything can be done online. So, we had the economies of scale, and the U.S. was the next best logical market for us. Our number one goal for going on the show was to get a partner who understood franchising and trade in the U.S. Number two was publicity. We knew we had an awesome product, and we wanted as many people as possible to know about it. The third reason was credibility. The Dragons don’t tie their name to something that is vague or potentially harmful to consumers, so their stamp of approval would be worth a lot. Finally, the cash would help. What was the audition process like?

We stood in line and waited all day — along with hundreds of others — to present to a panel of producers. They gave us 15 to 20 minutes to pitch our business; then they asked questions. They were looking for two things: the viability of the business, and whether it was ‘TV quality’. Was there a real story behind it that viewers would connect with? I think what really drove it home was our sales numbers: at that time, we had $1.3 million in annual sales. Second, our story would be watchable: Tonia was pregnant with our third child at the time, and by the time we would appear on the show, she would be just a month away from delivering — so I’m sure that helped. What went into preparing your pitch for the Dragons?

The biggest issue on the show is always valuation. You’ve got to go in with a valuation for them to bid on, basically. We had a proven concept, and I had come up with a figure. However, the show had connected us with an advisor, and she said, ‘I just want to give you one piece of advice: you have maybe

three minutes in front of the world. You need to make a choice about whether you want to spend those three minutes defending your valuation, or talking about how wonderful your company is.’ She was right, because our valuation had too many variables and was open to interpretation. So we decided to just present our one-time annual sales. For our pitch, we reviewed past episodes and learned about the Dragon’s hobbies, likes and dislikes. Tonia created a customized tea for each of them. We prepared answers for potential questions an investor would ask — everything from top-line sales to earnings to operational efficiencies. We also prepared to answer questions like, Why are you on the show? Why do you want to go into the U.S.? Who do you want to partner with, and why specifically that person? We also discussed what were we willing to part with and for how much. In the end, we decided to ask for an investment of $250,000 in exchange for 20 per cent of our company. How did your experience match up with what everyone saw on TV?

What you saw on TV was almost seven minutes that was edited from a 50-minute session. It takes time, because the Dragons don’t know anything about your company in advance. They gave us half an hour to set up our backdrop, which looked like a living room. The whole idea was to create ‘a tea party in the living room’. After our five-minute elevator pitch, there were a lot of questions. They were asking about the scalability of the business and about direct sales, because direct sales is a bit of a niche method; it’s not retail or wholesale. Kevin [O’Leary] said, ‘Hey, I can get you into Costco.’ But we said, ‘We can’t sell wholesale. We have made a commitment to our consultants that we will only sell through them.’ Then they asked about our sales, and as soon as they heard it was $1.3 million, that changed everything. They put on their technical hats. What are your margins? What are your cost of sales? How do you recruit? What does that cost you? What is your bottom line? What are your efficiencies of scale? Then they started asking about our business and educational backgrounds. Are you the right fit for running the company? What did you do before this? Also, have you ever defaulted on any loans or had a bankruptcy? Basically, they want to know, If I give you money, will you squander it and screw this all up, or will you take it and do something right with it? rotmanmagazine.ca / 119

The post-Dragon’s Den ribbon-cutting.

You ended up getting three offers: David Chilton and Jim Treliving jointly matched your terms of $250,000 for 20 per cent of your company; Arlene Dickinson offered $250,000 for 18 per cent; and Kevin O’Leary proposed $300,000 for 30 per cent. How did it feel to get that kind of interest?

We were over the moon. Tonia loves Arlene. She said to me, ‘Here is a female entrepreneur leading the charge, representing women in the field: I really want her to be part of this company!’ My perspective was, yes, that’s true, but her marketing experience didn’t fit our niche model. As a representative of the company, Arlene would have been awesome; but I didn’t feel she added value in any other respect. Jim, on the other hand, brought both public value, credibility and functional operational value. He understands every aspect of a real business that produces something. He understands how to network, moving product around the entire continent and to the U.S. market, manufacturing and franchising. In a way, our business is kind of similar to a franchise where you’ve got other people carrying on your business on your behalf. Dave, meanwhile, was the only one that really got direct sales. It was very clear that he understood what we did, and would bring some insight. So while Arlene came in with the best offer from a financial perspective, that wasn’t our main motivator. What happened after the show, in terms of sealing the deal with the Dragons?

We got whisked away by the show’s lawyer and accountant, who asked us to sign a few documents to make sure the information we presented on the show was verifiable and real. We also had to sign a non-disclosure document, because we had to keep our lips sealed until the show aired. Then signed off, then the due diligence process started. Regarding our financials, they asked a ton of questions. They talked to our accountants. They looked at our sales, payroll, business taxes, even personal income and taxes. They wanted to make sure that our story added up. Next was arguing the shareholder agreement. Jim and Dave ended up saying, ‘We don’t want to take a piece of your company, we just want a small royalty, forever.’ I told them, 120 / Rotman Management Winter 2017

‘I don’t care how we do this, but your names have to go on my door. You have to be principals in this company. That’s the only way this deal is going to go through.’ This back and forth went on for a month. I made them an offer so attractive that they couldn’t refuse: they would get all their money back in the first three years. We signed the paperwork the night before the episode aired. How did being on the show affect?

All of a sudden we were getting recognized, and we had a stamp of approval from the Dragons. We struggled to get all the orders out the door. The phones were ringing off the hook, with consultants joining left, right and centre. We even ran out of products for the kit that our consultants use to start their business and sell our products. Our growth rate went from 300 per cent the day before it aired, to 600 per cent the day after it aired. We invested in inventory, infrastructure and attracting and training consultants. We’re now in every U.S. state, and the growth has been very organic. We haven’t really pushed advertising, because the U.S. is such a big market, that if our growth ‘hockey sticks’ there, we would have a very big problem. So, we’re taking it step by step. For the next two to three years, we will be completely focused on the U.S.; but we also have our eyes on Australia and England. What kind of role do Jim and Dave play in the business today?

They have been wonderful. They are ‘hands-off ’ investors who do not interfere in the day-to-day operation. They know that, as the folks who have gotten it this far, we know what we’re doing. But we report to them like any other investors. We have president’s statements and yearly board meetings. And they’re there for advice anytime we need it. Hatem Jahshan (Rotman MBA ’10, U of T BEng ‘99) is the CEO

and Co-Founder of Steeped Tea alongside his wife, Tonia. In 2013, the Direct Sellers Association’s ‘Journey to Success’ award was presented to Steeped Tea in recognition of an up-and-coming direct selling company that has dedicated itself to achieving a high standard of excellence in its business operations.

QUESTIONS FOR

Ellen Auster, Professor, York U, and Lisa Hillenbrand, Former Head of Marketing, P&G

Q &A

Two strategy experts discuss ‘stragility’ — their term for being strategic + agile at the same time. Interview by Karen Christensen

Jack Welch once said of businesses, “If the rate of change on the outside exceeds the rate of change on the inside, the end is near.” Describe the significance of this statement for today’s leaders. Ellen Auster: It’s certainly true that change is everywhere.

In today’s hyper-competitive and fast-paced business environment filled with disruptive technology, fierce global competition and shifting customer expectations, change is the new normal. There are periods when we’d all like to slow it down, but the fact is, most businesses need to be continually changing to stay ahead of the curve. Those like Blockbuster who don’t adapt fast enough risk getting blindsided by game changers like Netflix. You believe today’s leaders require a specific new skill in order to thrive. What is it? Lisa Hillenbrand: Given the accelerating rates of organiza-

tional and market upheaval, the skill that all leaders need today , at all levels, the ability to successfully navigate change. We call this skill ‘stragility’ — our term for strategic, agile, people-powered change. Sadly, over 70 per cent of change efforts fail, leaving organizations crippled and derailing promising careers. The good news is that change skills can be learned and turned into a powerful and sustainable competitive advantage for both individuals and organizations. Learning these skills doesn’t require capital or big R&D investments, and they will never become obsolete. rotmanmagazine.ca / 121

Disruption nearly always occurs at the margins of current businesses.

Stragility entails four core skills. Please summarize them. EA: The first skill is sense and shift. Locking and loading on a

strategy is tempting, but is not the best course of action when the world is always changing. We need to stay ahead of competitors and constantly monitor the periphery for disruptive forces. Sense and shift is about proactively being attuned to external game changers and course-correcting as we go. The second core skill is embracing our inner politician. Politics are often considered taboo in organizations and most of us would rather avoid them. However, embracing our inner politician is critical for successful change. We need to identify key influencers — both supporters and skeptics —who can help us understand various points of view and customize action steps to build ownership. The third core skill is inspire and engage. As time-starved leaders, we often default to telling people what to do and expecting them to embrace the change. Instead, we need to create a compelling why that tells a story, helping the change resonate with those impacted. A tight business case that provides the logical rationale for change is also essential. In addition — a mantra that captures the spirit of the effort while instilling passion throughout the organizational hierarchy helps anchor the change. The fourth skill is cultivating change fitness, which centers on avoiding burnout and exhaustion. Business can be transformed by bundling change initiatives together, running pilots, conducting ‘pre-mortems’, optimizing personal energy and learning from what we do, so we don’t repeat mistakes. In an environment of constant change, it is increasingly important to select the right metrics to measure success. What is the best way to go about this? LH: As we formulate new strategies, we also need to alter our

metrics to focus on those that drive desired outcomes. We recommend organizations think about three types of mea122 / Rotman Management Winter 2017

sures: outcome-focused measures (e.g. market share, profit); lead measures that indicate we are on the right track (e.g. inquiries, orders, shipments); and employee engagement measures (satisfaction, retention). Many companies have too many measures or stop at activity measures that distract them from the outcome measures — which are, of course, the most important. How can leaders learn to anticipate disruption? LH: Disruption nearly always occurs at the margins of cur-

rent businesses. For example, the photography market was disrupted not by better cameras, but by cell phones. The best way to avoid this is to stay externally connected: read a wide range of material, attend conferences outside of your field, meet with leading-edge experts, and immerse yourself in the lives of your customers. We recommend that you allocate some funds to ‘moonshot’ type projects, like Google does. These projects have the potential to be huge, have some fully dedicated staff to work on them and allow people to experiment and learn. Based on our experience, failure often leads the way to future breakthroughs. Can you provide an example of what it looks like to ‘embrace your inner politician’? EA: Our favourite example of this is the transformation of

Samso Island in Denmark. They say, ‘no man is an island,’ but change leader Soren Hermansen found himself alone, trying to persuade a whole community to become the first 100 per cent renewable-energy island in the world. His most powerful tool turned out to be what he called ‘coffee and beer diplomacy’ — a series of meetings with key individuals and groups to build support for the change. Local plumbers learned they could have a new revenue source by installing and servicing heat pumps; residents were helped to get tax credits; even the local golf course found a new way to get

IMAGE: GETTY IMAGES

Samso Island in Denmark, the first 100 per cent renewable energy island on the planet.

involved by using solar powered lawn mowers. Slowly, more and more people embraced the new approaches, the island met its goal, and Hermansen now runs an energy academy, teaching others his political skills. This story shows the power of engaging people by listening to different stakeholder needs and building ownership. Describe the key role played by influencers — particularly skeptics — in achieving stragility. EA: Influencers are essential for change, but are often over-

looked. Key influencers typically fall into three major categories: supporters who see why the change is needed and offer their resources to help; ‘fence-sitters’, who look to others to decide how engaged they will be; and so-called skeptics who are resistant to the change. Most leaders avoid skeptics, but we have found that engaging them can be very beneficial. First, skeptics often push back because they see flaws that need to be addressed. Second, involving them sends a powerful signal to the rest of the organization, that input and alternate points of view are valued. Lastly, if you engage skeptics and build ownership, that often brings fence-sitters on board.

parking lot attendant suggested offering carts to passengers embarking. These ideas and many others — propelled by aspiration and inspiration — led the port to win new business and exceed its goals. Stragility is not just important for senior managers. How can it be fostered, organization-wide? EA: In our work with companies, we have found that people

throughout the organization are eager to strengthen their stragility skills. Building a compelling case for change, using political and engagement strategies, asking for input sooner rather than later, prioritizing, and pacing each effort to avoid ‘change fatigue’ enables those in the organization to feel ownership for the change. Those wins then fuel people’s interest in further building their skills and capabilities so that they are better equipped to take on the challenges of tomorrow. Before long, everyone begins to see the power of stragility as perhaps the ‘ultimate’ competitive advantage, because it enables the organization to win at change every time.

What are some of the key steps involved in combining aspiration and inspiration? LH: Aspiration and inspiration fuel each other. Before peo-

ple will truly engage in anything, they need to understand the ‘why’ of change. For example, one global port was losing business to similar ports and needed a new competitive advantage. The senior team realized that it could become ‘the most hassle-free port in the world’. So, the team created a ‘Smooth Sailing’ mantra, to ensure the entire organization understood the aspiration. With that end in mind, everyone was asked for ideas to contribute. The logistics manager suggested flying paperwork via helicopter to boats before they docked for quicker turn around; and the

Ellen Auster is a Professor of Strategic Management at the Schulich School of Business, York University. Lisa Hillenbrand is President

of Lisa Hillenbrand & Associates and the former Director of Global Marketing for Procter & Gamble, a position she held for 11 years. They are the co-authors of Stragility: Excelling at Strategic Changes (Rotman-UTP Publishing, 2016).

rotmanmagazine.ca / 123

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POINT OF VIEW

Daniel Markovitz, Lean Enterprise Institute

Smart Power Personified THE OCCUPY WALL STREET MOVEMENT. Donald Trump’s unexpected presidential victory. The popularity of the TV show Undercover Boss. The stunning pay gap between CEOs and front-line workers. What do these things have in common? They are evidence of the increasing disconnect between people at the top and people at the bottom — or even the middle — of society. When transferred to a corporate environment, they are evidence of a misuse of power and, frankly, a lack of leadership. By contrast, ‘smart power’ seeks to minimize the distance between the top and bottom ranks of an organization in the service of greater cohesion and superior performance. Let’s be clear: this is not a Marxist, anti-capitalist screed arguing for total equality of all employees. CEOs bear an enormous burden. They carry broader responsibilities and toil for longer hours than most employees, and therefore, should be better compensated than the average worker. But it’s precisely the higher salaries, along with the isolation fostered by the perks and benefits of the office, that compromise a CEO’s leadership. Smart power involves fighting that isolation and creating greater bonds and identification between the top and bottom of a hierarchy. Most CEOs would never admit to being elitists, deserving of special treatment just by virtue of their title. And yet, many CEOs, wittingly or unwittingly, behave in that manner due to the nature of the office. It’s not just the 350-to-1 ratio of CEO-to-unskilled worker pay in the U.S., either—the 126 / Rotman Management Winter 2017

perks and benefits of the office fundamentally change behavior and undermine the ability to exercise smart power. As Warren Buffett wrote in his 2010 shareholder letter, Winston Churchill once said, “You shape your houses and then they shape you.” That wisdom applies to businesses as well. Bureaucratic procedures beget more bureaucracy, and imperial corporate palaces induce imperious behavior…. At Berkshire’s ‘World Headquarters’, our annual rent is $270,212. Moreover, the home-office investment in furniture, art, Coke dispenser, lunch room, high-tech equipment — you name it — totals $301,363. As long as Charlie and I treat your money as if it were our own, Berkshire’s managers are likely to be careful with it as well. Legendary management consultant Russell Ackoff alluded to the same phenomenon in a 1994 panel discussion on the legacy of W. Edwards Deming when he pointed out that there is a fundamental disconnect between what corporate executives preach and what they practice: A corporation says that its principle value is maximizing shareholder value. That’s nonsense. If that were the case, executives wouldn’t fly around on private jets and have Philippine mahogany-lined offices and the rest of it. The principle function to those executives is to provide themselves with the quality of work life that

You can see this kind of behaviour in the old General Motors. Prior to its bankruptcy in 2009, GM executives kept themselves in almost total isolation from front-line workers: they ate catered meals in a private dining room and used a special elevator that took them directly from the garage to their offices on the 14th floor. It’s probably unnecessary to mention that entrance to that floor was by invitation only. It is this distance between the CEO bubble and the daily life of ordinary workers that leads to the popularity of television shows like Undercover Boss. The premise — force a CEO to do the menial work of the lowest-paid frontline workers and film it — is a magnificent exercise in schadenfreude. Viewers revel in the CEO’s struggles with the job, and gloat at his or her epiphany that the work is both really hard and poorly paid. It feeds into the perception that there’s a fundamental inequality in the workplace (and society at large), and that compensation isn’t appropriately calibrated to the work that ordinary people do. When power is used poorly, it exacerbates the distance between the top and the bottom. When it is used wisely, it diminishes that distance to the benefit of both the workers and the organization. Controlling executive pay, perks, and benefits is one way to demonstrate smart power. Ken Iverson, the late (and legendary) CEO of Nucor exemplified this approach. In his book, Plain Talk, he writes: Inequality runs rampant in most business corporations. I am referring now to hierarchical inequality which legitimizes and institutionalizes the principle of ‘We’ vs. ‘They’. The people at the top of the hierarchy grant themselves privilege after privilege, flaunt those privileges before the men and women who do the real work, then wonder why employees are unmoved by management’s invocations to cut costs and boost profitability. When I think of the millions of dollars spent by people at the top of the hierarchy on efforts to motivate people who are continually put down by that hierarchy, I can only shake my head in wonder. To fight this inequality, Iverson installed pay-for-performance bonuses for frontline workers, not just executives. He insisted that in bad times, top management takes a pay cut before anyone else — a practice that’s common at many large Japanese companies. Moreover, all executives flew economy class on business trips and rented regular cars. Everyone in the organization even had the same insurance plans.

IMAGE: GETTY IMAGES

they like. And profit is simply a means which guarantees their ability to do it. . . . If we are going to talk about values, we’ve got to talk about what the values are in action, not in proclamation.

Former Costco CEO Jim Sinegal made $325,000 a year; his successor demanded ten times as much.

Bob Chapman, the CEO of Barry-Wehmiller, embraces a form of smart power that he calls ‘people-centric leadership’. As with Iverson’s insistence that top management take pay cuts before workers, Chapman believes that everyone in Barry-Wehmiller is part of a family that thrives together and struggles together. In 2008, the company suffered a 40 per cent drop in customer orders. Most leaders would deal with the downturn by laying-off workers. Not Chapman. He had everyone share the burden: he suspended the company’s 401K match, and asked all workers — including management — to take four weeks of unpaid time off. Chapman describes the result this way: The reaction was extraordinary. Some team members offered to take double furloughs, stepping up to ‘take the time’ for their co-workers who could not afford the loss of pay. Many associates welcomed the time off, scheduling it so they could spend the summer home with children or participate in special volunteer projects. Our business emerged from the downturn well ahead of the curve and, once orders picked back up, our performance increased faster than ever before. Why? Because our actions during a time of great distress didn’t damage the cultural fabric of the company — like layoffs so often do — but rather, strengthened it. Our decision to use furloughs to save jobs made our associates proud and profoundly touched by the realization that they worked for a company that truly cared about them. Even though they had lost out on one-twelfth of their income, they embraced the furlough program because it meant saving someone else’s job. It’s true that Iverson and Chapman — and all CEOs, for that matter — make more money than frontline workers. But workers don’t object to pay differentials; rather, they object rotmanmagazine.ca / 127

First-hand experience with the jobs that employees do on a regular basis provides executives with a different kind of authority: smart power.

to differences that seem both obscene and unwarranted. Indeed, respondents in a study by Sorapop Kiatpongsan and Havard Business School Professor Michael Norton show that people feel the ‘ideal’ pay gap between CEOs and unskilled workers should be from 2 to 1 (Denmark) up to 20 to 1 (Taiwan). At Costco, former CEO Jim Sinegal made $325,000 a year. His successor, Craig Jelinek earned $650,000 in 2012, plus a $200,000 bonus and stock options worth about $4 million, based on the company’s performance. By contrast, Walmart CEO Mike Duke’s 2012 base salary was $1.3 million; he was also awarded a $4.4 million cash bonus and $13.6 million in stock grants. Smart power isn’t all about foregoing money, however. It means learning and appreciating the work that gets done at the front lines—and not just when the Undercover Boss cameras show up. In my experience, that is most effectively done by adopting the philosophy that Toyota calls genchi genbutsu, or ‘go and see’. ‘Go and see’ is fundamental to the philosophy of lean and continuous improvement that has made Toyota the most successful automaker in the world. It means that executives (and anyone, for that matter) must go to where the work is done and see for themselves what’s happening. When leaders do this on a regular basis, they close the distance between their offices and the shop floor, and they build a foundation of trust and understanding that leads to superior performance. Art Byrne, former CEO of Wiremold, understands how essential it is for executives to participate in the daily work processes of the front lines. In 10 years under his leadership, Wiremold quadrupled sales, raised gross profit from 38 to 51 per cent, and increased the value of the company by nearly 2500 per cent. But he didn’t do it through empty slogans issued from the executive suite or motivational posters tacked to the walls. He did it by ‘going and seeing’, by joining with his workers on the front lines. Byrne says that “You can’t just send a memo. You’ve got to lead it. Show them by example, do it on the shop floor.” John Toussaint, the former CEO of Thedacare, a community-owned health system, said much the same thing. Despite eye-popping increases in the cost of medical care, Toussaint dramatically improved hospital performance 128 / Rotman Management Winter 2017

during his eight-year tenure, doubling revenue and operating margin, all while receiving numerous awards for quality of patient care. When asked why other hospitals struggle to follow Thedacare’s lead, Toussaint replied: The biggest mistake that is made is that the senior leaders or the CEO delegates this work to somebody from a department or a [six sigma] black belt and says, ‘Here, you just go do lean. And then come back and report to me.’ This is about everyone’s engagement, from the CEO to the front line nurse and everyone in between. That doesn’t mean that the CEO has to clean and oil the drill press, or empty bedpans in the ICU everyday—although once in awhile, it wouldn’t be a bad idea. All employees understand that CEOs have their own responsibilities. But first-hand experience with the jobs that employees do on a regular basis provides executives with a different kind of authority: smart power. In closing

In Leaders Eat Last, Simon Sinek points out that if you go to any Marine Corps mess hall, you will see the Marines lined up in rank order, with the most senior person at the back of the line and the most junior person at the front. The order represents the belief that it’s the leader’s job to ensure people’s safety and performance. This belief is at the core of smart power in the corporate world, as well. It’s the understanding that the CEO actually works for the employees — not the other way around. The traditional trappings of power — high salaries, extraordinary perks and benefits, a disconnect from the daily work of the organization — all serve to obscure that fundamental understanding, and weaken the bonds between the top and bottom of a hierarchy. So, give up the trappings of privilege, and reap the benefits of smart power.

Daniel Markovitz is the author of Building the Fit Organization:

Six Core Principles for Making Your Company Stronger, Faster, and More Competitive (McGraw Hill Education, 2015) and the principle of Markovitz Consulting. Earlier in his career, he held senior positions at Adidas, CNET and Asics Tiger.

Upcoming Events Complete details are available at rotman.utoronto.ca/events January 9, 5:00-6:00pm Speaker: James Dewald, Dean and Professor, Haskayne School of Business, University of Calgary; Author Topic: Achieving Longevity: How Great Firms Prosper Through Entrepreneurial Thinking (Rotman-UTP Publishing, 2016)

March 28, 5:30-6:30pm Speaker: Barbara Zvan, Senior Vice-President, Strategy & Risk and Chief Investment Risk Officer, Ontario Teachersâ&#x20AC;&#x2122; Pension Plan; Director, Global Risk Institute Topic: tba

January 11, 5:00-6:00pm Speaker: Eugene Soltes, Professor of Business Administration, Harvard Business School; Author Topic: Why They Do It: Inside the Mind of the White-Collar Criminal (Public Affairs, 2016)

April 3, 5:30-6:30pm Speaker: Anjuan Simmons, Software Developer, Speaker and Author Topic: Being an Ally and Lending Privilege

January 12, 5:00-6:00pm Speaker: Rory Capern, Managing Director, Twitter Canada Topic: Social Media: Positioning Canada as a Hub for Digital Innovation January 16, 5:00-6:00pm Speaker: Gary Taubes, Co-Founder and Senior Scientific Advisor, Nutrition Science Initiative; Science and Health Journalist; Author Topic: The Case Against Sugar (Knopf, 2016) February 1, 5:00-6:00pm Speaker: Fareed Zakaria, Host, Fareed Zakaria GPS, CNN; Editor-at-Large and Columnist, TIME magazine; Author Topic: tba March 21, 8:00-9:00am Speaker: Clare Morneau, Grade 12 Student, Havergal College; Intern, Global Humanitarian Lab; Author Topic: Kakuma Girls: Sharing Stories of Hardship, Hope and Joy from Kakuma Refugee Camp (Barlow Books, 2016) March 27, 5:00-6:00pm Speaker: Joann Lublin, Management News Editor, The Wall Street Journal; Author Topic: Earning It: Hard-Won Lessons from Trailblazing Women at the Top of the Business World (Harper, 2016) March 28, 5:00-6:00pm Speaker: Scott Sonenshein, Professor of Management, Jones Graduate School of Business, Rice University; Author Topic: Stretch: Unlock the Power of Less - and Achieve More Than You Ever Imagined (Harper, Feb. 7, 2017)

April 10, 5:00-6:00pm Speaker: Amanda Lang, Producer and Anchor, Bloomberg North on Bloomberg TV; Author Topic: The Beauty of Discomfort (Harper, Apr. 4, 2017) April 11, 5:00-6:00pm Speaker: Richard Florida, University Professor and Cities Director, Martin Prosperity Institute, Rotman School of Management, University of Toronto; Author Topic: The New Urban Crisis: How Our Cities Are Increasing Inequality, Deepening Segregation, and Failing the Middle Class-and What We Can Do About It (Basic Books, Apr. 11, 2017) April 19, 5:00-6:00pm Speakers: Emanuela Heyninck, Pay Equity Commissioner for Ontario Topic: What Needs To Be Done To Close the Gender Wage Gap in Ontario? April 21, 5:00-6:00pm Speaker: Michael Tushman, Professor of Business Administration and Chair, Program for Leadership Development, Harvard Business School; Author Topic: Lead and Disrupt: How to Solve the Innovatorâ&#x20AC;&#x2122;s Dilemma (Stanford Business Press, 2016) May 11, 5:00-6:00pm Speaker: Angela Duckworth, Professor of Psychology, University of Pennsylvania; Author Topic: Grit: The Power of Passion and Perseverance (Harper, 2016) May 26, 8:30am-5:15pm 19th annual Rotman Life-Long Learning Conference Theme: The Business of Creativity in the Workplace

PM: 40062461

Short Talks by Thought Leaders Public talks by experts take place frequently at Rotman. These 15 smart people and many others will speak at the School from January to June. Dates, times and topics for their talks and many others are at rotman.utoronto.ca/events JAMES DEWALD, Dean and Professor, Haskayne School of Business, University of Calgary; Author

CLARE MORNEAU, Grade 12 Student, Havergal College; Intern, Global Humanitarian Lab; Author

AMANDA LANG. Producer and Anchor, Bloomberg North on Bloomberg TV; Author

EUGENE SOLTES, Jakurski Family Associate Professor of Business Administration, Harvard Business School; Author

JOANN LUBLIN, Management News Editor, The Wall Street Journal; Author

RICHARD FLORIDA, University Professor and Cities Director, Martin Prosperity Institute, Rotman School of Management, University of Toronto; Author

RORY CAPERN, Managing Director, Twitter Canada GARY TAUBES, Co-Founder and Senior Scientific Advisor, Nutrition Science Initiative; Science and Health Journalist; Author FAREED ZAKARIA, Host, Fareed Zakaria GPS, CNN; Editor-at-Large and Columnist, TIME magazine; Author

SCOTT SONENSHEIN, Professor of Management, Jones Graduate School of Business, Rice University; Author BARBARA ZVAN, Senior Vice-President, Strategy & Risk and Chief Investment Risk Officer, Ontario Teachersâ&#x20AC;&#x2122; Pension Plan; Director, Global Risk Institute ANJUAN SIMMONS, Software Developer, Speaker and Author

EMANUELA HEYNINCK, Pay Equity Commissioner for Ontario MICHAEL TUSHMAN, Professor of Business Administration and Chair, Program for Leadership Development, Harvard Business School; Author ANGELA DUCKWORTH, Professor of Psychology, University of Pennsylvania; Author