By Roy C. Smith
VW is facing an
existential moment, one like BP’s after the Deepwater Horizon oil spill that
cost its shareholders $70 billion in market value.
Surely, someone on VW’s Supervisory Board must have asked “what could we have
done to prevent this from happening?”
The same question must have been asked by the Boards of
Directors of the dozen of so major banks who between them have paid out
approximately $200 billion to settle lawsuits brought by the US Department of
Justice, the Federal Housing Authority, the SEC, the CFTC, State Banking
Regulators, and British and European regulators since 2008.
These various and numerous regulatory offenses leave the
impression that today’s Big Business firms ignore or deliberately flaunt laws
and regulations intended to contain their power and influence. Observers must wonder whether anyone
has ever asked the question of any large corporate board members.
There is, alas, little evidence that anyone has.
Boards are the bodies charged under the law with looking
after the interests of the shareholders of private corporations. They are required to appoint CEOs, but
otherwise their duties are unclear, having to do with “monitoring” things,
making sure takeover offers are handled fairly, looking after social
responsibilities, and, of course, avoiding the existential moments.
How to prevent those moments from occurring is of utmost
importance to their shareholders, so boards need to consider some different
approaches to doing so. Here are four ideas:
Challenge Strategies
Boards not only appoint CEOs, the CEOs establish business
strategies that boards must approve and fund. This may include VW’s strategic initiative
to use its diesel engine performance to rise to the top of the auto
industry. If people independent of
management had challenged this idea rigorously then the plan’s Achilles heel (they
can’t do it without violating emissions standards) might have been revealed. But it wasn’t.
After the merger of Citicorp into Travellers to form Citigroup,
there were dozens of other mergers of big banks. None were seriously challenged by their boards, all of whom
seemed to go along with the idea that being bigger was always better, even when
it plunged them into a realm of new businesses and risky activities they knew
little about. Almost all of the
litigation settled by the major banks is the result of missteps in trading,
underwriting, mortgages, or other activities the banks were not in a decade
before. More pushback from the
independent board members (supported by their own experts and advisors as
needed) might have made a difference. At least they could have focused
attention on the difficult implementation of the strategy that proved to be their
Achilles heels.
Rethink Middle Management
Goldman Sachs became a public company in 1999 after 130
years as a partnership. It wanted
to preserve some of the uniform cultural and managerial aspects of the
partnership, so it devised a different kind of management structure from other
banks, one that put a lot of emphasis on middle management to enforce
professional standards for the whole firm. Today, Goldman Sachs has about 34,000 employees, of whom
2,100 or so are Managing Directors, the firm’s principle culture carriers. Of these, approximately 20% are
Partner-Managing Directors, a senior position that is entitled to partner-like
compensation based on a share of the whole firm’s annual income. Managing
Directors are selected based on their performance as middle and upper mangers
responsible for revenues, risks, costs and legal exposures. The units they supervise are under
constant surveillance to maintain high standards, and to detect and prevent any
form of misconduct or wrongdoing. Things fall through the cracks sometimes, but
with 2,100 of these guys continuously roaming the halls, there are fewer
accidents than might occur otherwise.
Learn from Mistakes
Every legal or regulatory settlement that occurs can be a
teaching moment. There is something to learn from a thorough discussion of the
events that ended in lawsuits, especially by the standards-enforcing middle and
upper managers of a firm. The need to know what motivated the troublesome events,
why they went undetected and what the outcome of the litigation was, but can
only do so if someone prepares the information (from the extensive legal
proceedings) on the cases and enables a full discussion of them by the entire
middle management cohort group, however large, though the discussions must be
held in small groups overseen by someone in touch with top management.
Few firms do this – they don’t want to highlight their own
settlements, or take the time necessary to send everyone to school periodically
on such matters. They should. It
would improve everyone’s understanding of what happened, what was wrong with
it, and to clarify for everyone’s benefit how such things should be handled at their
own firm should they crop up.
Pay and Promote Differently
Increasingly, it seems necessary to replace “you-eat-what-you-kill,”
pay-for-performance compensation programs with ones that are more holistic and
take into account defensive and preventive measures taken by managers. If the
word gets out at the mid-manager level that performance is to be judged by
several factors, not just profits contributed, including how well one’s unit
performs over time and what managers have done to prevent harm, things will
change quickly. Boards should be willing to pay well for good managers that do
these things well. They are scarcer than good engineers or traders.
Pay, of course, also needs to be increasingly in company
shares as managers rise in the firm, and always subject to “clawback”
provisions, including in cases in which a subordinate is charged with
wrongdoing. The firm should also make it clear that individuals charged by
regulators may not be reimbursed for legal expenses, and the firms will
cooperate with prosecutors in their prosecution of the individual.
Existential events are not often fatal, but few companies
escape the years of lackluster performance that follow the thumping that the
events engender. Boards of Big Business companies need to wake up and recognize
that they can lower the probability of such events in the future by reshaping
the cultures and middle management cadres that have enabled them.
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