Corporate Governance 07 April, 2011

While management is about directing activities, governance is about setting the conditions within which activities can be directed. Formally defined, corporate governance is about management and the board of directors enforcing policy that:

• Balances the interests of shareholders
• Forces responsibility, accountability, and transparency
• Challenges management to achieve high performance

Agency Theory

Agency theory is one way of looking at the problem of controlling the performance and ethics that a business’s influence carries. In agency theory, there are two actors. One actor is a principal, which is thought of as a stakeholder (someone who is affected by an entity). The other actor is an agent, or someone managing the entity. It is often the case that the principal and the agent do not have the same goals. For example, although the principal may have a monetary stake in the entity and the agent is an employee of the entity, the principal and agent may not share the same work ethic for company success or the same notion of what appropriate risk is.

Given these differences in how the principal and agent think about an entity, it may be difficult for a principal to monitor the actions of the agent. When active monitoring does not take place, it is easy for the gap between a principal’s and an agent’s desires to grow wider and conflict. Corporate governance can help close this gap.

Who is Involved?

Although everyone should act responsibly, the board of directors has the explicit responsibility for overseeing corporate governance. The board is usually broken up into several committees who each have one or two main objectives. The responsibilities of the board of directors and its committees include:

• Nominating other board members
• Auditing and determining who performs the audits
• Setting the tone for ethical behavior and high performance
• Approving budgets
• Ensuring availability of financial resources
• Setting salaries and compensation for executives
• Watches out for a “if it is legal, it is okay” attitude
• Questions executive decisions
• Allows the outside to see success
• Looks out for shareholder equity
• Balances stakeholder interests

Stakeholder Analysis

Being aware of all stakeholders that are affected by the company and balancing their needs can cover much of what corporate responsibility is meant to do. The following list outlines basic stakeholder analysis steps:

• Identify all stakeholders and their relationship to the company
• All stakeholder needs must be identified (time, quality, cost)
• An organization must understand how well stakeholder needs are being met
• Gaps in providing for needs must then be weighed and necessary changes made

Independence

The executives of a company are responsible for following guidelines and rules, but it is the board of directors that should have the last say in questionable matters. Given all the decision making and analytical power that the board possesses, an important caveat in structuring a board of directors is the degree to which they are independent. Independence in a board of directors will determine how easy it is for a company to become unethical or underperform.

The degree to which a board of directors is independent directly affects how equitable it is with shareholders as well as how it balances stakeholder needs. When a board is independent, it can act without bias. When a board is not independent, conflicts of interest arise. To help ensure the independence of board members, they must:

• Not have any conflicts of interest
• Not be afraid to speak out
• Be trained to ask the right questions

Making sure that an annual meeting calendar with topics exists, and making a distinction about what decisions the board should make can help the board operate effectively.

Companies must pay the price to help ensure that conflicts of interest do not exist, that boards are independent, decisions are transparent, and that auditing is done correctly. If they do not, more regulations will be put in place and fewer overall benefits will be garnered by stakeholders.

Deciding in Light of Uncertainty and Risk 05 April, 2011

Decision making can be difficult because there are often many options to chose from, and varying levels of risk are built in to these options. Many times, when people talk of managing risk, they simply mean transferring the risk elsewhere. Decision and risk are necessary issues that must be dealt with, simply because business is a competitive environment. Conservatism can work for a period of time, but it opens the door for others to leapfrog a business that is unwilling to take some risks or make decisions involving uncertainty.

Risk and uncertainty often are the result of incomplete information, ambiguous information, or time constraints. Sometimes, they are a result of people interpreting the same information differently. A representative sample may be necessary from which to base a decision.

Another reason that this subject warrants attention is because common solutions for dealing with risk and uncertainty have become flawed. History is not an indicator of black swan events. Although using historical data to analyze current situations can be useful, it should probably be used as a last resort in many scenarios. The following set of generic and specific frameworks will help identify what a correct decision should be, regardless of the uncertainty level.

Decision Making Steps

• Recognize the need for a decision
• Generate alternatives
• Assess alternatives
• Choose among alternatives
• Implement the chosen alternative
• Learn from feedback

You may be able to narrow alternatives by removing those that are not:

• Legal
• Ethical
• Economical
• Practical

Risk Matrix

A risk matrix simply interpolates and visualizes what risk may be associated with familiarity of products/technology, as well as what risk may be associated

with familiarity of markets.

Reality Check

Simply asking the following questions can provide a person with a reality/sanity check and as an initial feasibility test. An entire Harvard Business Review article was written on this:

• Is it real?
• Can we win?
• Is it worth doing?

Cynefin Framework

A decision is categorized into one of four levels of order/organization, and then dealt with accordingly:

• Simple - Clear cause and effects -> Use best practices
• Complicated - Multiple right answers exist -> Use expertise
• Complex - No visibly right answer -> Look for patterns
• Chaos - No right answer, no pattern -> Establish order

Uncertainty Framework

Three academics (Courtney, Kirkland, and Viguerie) established a model for identifying levels of uncertainty and dealing with them.

• Level 1 - Basic uncertainty -> Learn the required information
• Level 2 - A few possible outcomes exist -> Use a decision tree
• Level 3 - No discrete number of outcomes -> Use scenario planning
• Level 4 - Even variables are discrete or unknown -> Use analogies to simplify

Decision Styles

Subordinates are all on a spectrum of needed supervision. When others cannot or will not decide, you decide for them. Otherwise, responsive, intellectual, and participative decision styles should be used.

Decision Trees

If a few requirements are met in a given scenario, it is possible and useful to use decision trees to narrow down and grasp options. The following steps outline how to create and use a decision tree:

Prerequisite - You must know all the alternatives, be able to assign probabilities to them, and have clear objectives.

1. State your decision
2. Draw branches for any intermediate results that could occur
3. Draw branches any decisions that should be made at that stage
4. Repeat steps 1 & 2 until no more intermediate results or decision points exist
5. End each final branch with a outcome result ($ for example)
6. Multiply probabilities and outcome values where it makes sense
7. Based on all probabilities and final objectives, choose the best outcome

Example Decision Tree

Avoiding Decision Making Pitfalls

• Don't form an immovable hypothesis from the piece first information you get
• Don't justify decisions simply from historical data
• Don't use the status quo as a benchmark for success
• Get an outside point of view
• Phrase the problem differently to see other sides
• Be mindful of over emphasis by individual sources
• Watch out for assumption padding on multiple levels

One of the most important things that can be done to improve decision making abilities is to receive quick and clear feedback after a decision has been made and results are available.

Leadership vs Management

Leadership vs Management

The words management and leadership both describe ways of dealing with people, but they underscore two very different ideals. At a high level, management deals with complexity by breaking up work. Leadership deals with change by applying a vision to everyone’s work.

A higher level of leadership would normally be found in the executive ranks of organizations. A higher level of management is usually found in the middle ranks of an organization. Finding the best mix of management and leadership for a person is extremely important. One reason for this is that the amount of supervision needed theoretically changes as you look higher towards C-suite positions. When less supervision is needed, there exists in subordinates attributes needed to make decisions. They need to be led more than they need to be managed.

Peter Drucker said “There is nothing more wasteful than becoming highly efficient at doing the wrong thing”. I would add that “There is nothing more frustrating than knowing you are on the right path, but getting nowhere”. Management is doing a thing right. Leadership is doing the right thing.

Although managing complexity can be hard, changing can be harder. John Kotter outlines an eight step change process that can help:

• Create urgency
• Form a group of advocates
• Get the vision right
• Communicate to get buy in
• Empower action
• Create short term wins
• Don’t give up
• Make change stick

Here is a comparison of leadership and management goals:

Can anyone be a leader?

Kouzes and Posner say that a leader must be able to:

• Find your voice (your words must be consistent with your actions)
• Affirm your values (what you care about – determined by how you spend your time)
• Express yourself in your own way (others follow authenticity)
• Challenge the process (experiment and grow)
• Enable others to act
• Encourage optimism

Formally, there are several academic frameworks for understanding leadership

Trait approach

This approach goes in and out of style every few years. It says that there are specific traits that define whether or not a person is a leader. Research shows that most of these traits can be learned. These traits drive decision making and generally include:

• Drive
• Extraversion
• Integrity
• Self-confidence
• Knowledge of the business
• The ability to read others

Behavioral approach

This approach is simply to focus on both project goals as well as team relationships. Finding the right balance of these two items determines the effectiveness of the leader. This approach can be seen in many aspects of the situational approach.

Situational approach

This approach to leadership says that universal leadership traits and behaviors don’t exist and you must look at the situation before deciding what to do.

Three popular situational models include the Vroom model, Fiedler analysis, and the Hersey/Blanchard theory.

1 - The Vroom model looks at situational attributes such as decision significance and where subjet matter experts are, assigning each one a status of high or low. A funnel method is then used to narrow down how the decision should be made (on a spectrum of autocratic to democratic). If more than one option seems to fit, use the one that will take the least amount of time.

2 - Fiedler analysis asks three questions and uses a funnel model similar to that of Vroom’s to determine if a leader’s decision should favor project goals or personal relationship maintenance. The three questions include the following:

Is the leader to other relationship good?

Is the task understood?

Does the leader have power?

3 - The Hersey/Blanchard theory looks at the maturity of individuals involved and decides whether to focus on project goals or personal relationship maintenance. It simply states that if a person or group has a low or high maturity, a focus should be placed on project goals. If, however, the person or group is of moderate maturity, a decision should focus on personal relationship maintenance.

With knowledge workers, helping everyone to exemplify a shared leadership is critical. It is often difficult to do everything by oneself. After all is said and done, I think one of the easiest ways to act is based on a statement I once heard “Help others fall into the pit of success”. Although oversimplified, this very well may sum up the way managers and leaders should act.