Most of the corporate governance debate focuses on corporate accountability, yet a company is, by definition, a group of people and as such, personal accountability should have primacy. How and why is it, then, that companies are fined (which affects all employees), yet very few individuals (especially directors) are actually held personally responsible for their action (or lack thereof)?
Are current regulations punishing the wrong people?
A few years ago, I penned an article for our website about accountability, and what it meant in today’s world. We looked at who should be held accountable for exactly what in the corporate field, who should hold them to account, and how would we at ACG approach the task of monitoring accountability.
Since then, the focus in regard to accountability has shifted towards the issue of personal versus corporate accountability. In particular, is it right that, following egregious corporate behaviour, companies are being held responsible while the individuals who led the companies into this bad behaviour seem to get off scot free? At any rate, very few former directors seem to suffer any major personal loss, whether of job or wealth, let alone of personal freedom.
A company is run by human beings
Our Five Golden Rules, or principles, of good corporate governance require an ethical approach to the business, a goal representing the balanced interests of the key stakeholders, with an innovative approach focused on the long term future, and an organisation structured and resourced to deliver the goal, within an ethical framework. Furthermore, good governance demands a recognition that in addition to the key stakeholder groups (customers, owners and employees) the public interest must be recognised as a stakeholder vital for the perceived legitimacy of that business.
However, we must remember that a company is an impersonal being and requires the involvement of real human beings to be able to function. These real humans, led by the board of directors, are responsible for what the company actually does. Hence, the principles of good governance that we demand apply to running the company must require the executives and directors to implement them. And the culture that is created in the company by those executives and directors is the direct outcome of the actions by those individuals. So if the company is found to have transgressed, it must be those same individual executives and directors who have transgressed.
Individuals create culture
Thus, when a company accounts for its activities and results to its stakeholders (our Fifth Golden Rule) the responsibility for those activities and results must lie with the executives and directors. That is, those individuals are themselves accountable for the behaviour of the company, regardless of the details in their employment contracts.
Attempts to shift the responsibility from the directors and employees (a prime stakeholder group) on to the shareholders as owners (another prime stakeholder group), ought to be judged dispassionately. Clearly a company effectively controlled by a group or groups of shareholders would imply shared responsibility for bad actions. But there would still be no excuse for the directors and executives who connived in, or accepted the requirement to behave badly.
So good corporate governance requires good personal governance by the people involved, and judgement of their personal performance is a key part of measuring the governance of the company itself. And this is how accountability should be judged, and how rewards should be granted and punishment inflicted.
What happens currently? How is accountability executed and how are rewards and punishments distributed? Let’s look at some examples from the past few years, of businesses being driven by leaders who seem accountable and others where the leaders seem to have avoided proper accountability.
A good place to start is perhaps Berkshire Hathaway which has been run by Warren Buffett and his friend Charlie Munger for over fifty years. Since the early days, Buffett has led from the front, openly taking the long view, issuing an annual report in which he readily admits to having made mistakes, and meeting his (adoring) investors at an annual meeting which he and Munger address as if to relatives and friends. Famously, when Buffett, as a big investor and director, was persuaded to act as interim chairman of Salomon in 1991 when it was on the verge of collapse, he put his own reputation on the line. His approach was to apply his own personal code of behaviour and to purge the firm of what he saw as an unacceptable culture which had caused the problems. To the staff of Salomon, his message (as quoted in the wonderful biography by Alice Schroeder) was:
“Lose money for the firm and I will be understanding. Lose a shred of reputation and I will be ruthless”
“I want every employee to be his or her own compliance officer”.
In successfully turning round the firm, he hugely enhanced his own reputation, but the commitment he had made was absolute. The senior officers whose wrong-doing or poor management had brought the firm to this pass were fired or resigned and the shareholders’ wealth and employees’ jobs were saved.
In doing this, Warren Buffett made himself personally accountable to all the key stakeholders: the other shareholders, the employees, the bank’s clients and, not least, the regulatory authorities.
Warren Buffett’s personal ethics shine through his business career. And surely this is what stakeholders should be looking for. For instance, a recent example of personal commitment towards others taking precedence over pure commercial gain is the action of French entrepreneur Xavier Niel, who made his fortune in telecoms. He has launched a project in Paris called Station F, backed by Silicon Valley investors, to help small tech companies from round the world. He is quoted by the FT as saying:
“I earned a lot of money in this country, but I have too much money…Station F is the idea of supporting this country by creating something big…by helping people coming mostly from poor suburbs to do something for their life…”
Let’s compare this with the case of BHS (about which we wrote last year). After Philip Green acquired the company, he is estimated to have taken well over a billion pounds out of a business which had clearly started to lose its way and had a pension deficit which was growing. After some initial investment, which proved unrewarding, he subsequently cut back on capital expenditure and allowed the pension deficit to grow five-fold. Ultimately, he sold the business for a notional one pound sterling to a buyer who was so ill-suited to the role that the company went bust a year later.
Far from taking steps to safeguard the business, for instance by finding a genuinely suitable buyer, or, if the business was truly beyond rescue, by executing a plan to mitigate the impact on employees and put the pension scheme on a sounder footing, the owner of BHS ran for cover. One assumes he hoped that he would be over the hills and far away before it folded, and no-one would point the finger at him. This the man whose expenditure on his new private yacht alone would have done wonders for the solvency of the pension scheme. Well, he certainly shredded his own reputation, but he can hardly be said to have suffered much as the acquisition cost of BHS was covered many times over by the charges and dividends he was able to draw in the subsequent years.
To whom did Philip Green make himself accountable? To himself alone, it would seem.
In the case of BHS, the company itself was not accused of wrong-doing, and hence there was no question of directors escaping punishment for actions for which their company paid a penalty. But there are lots of recent examples where exactly this seems to have happened, or where punishment is very late in coming and often hardly seems to match the scale of the disasters that gave rise to it. Here are just a few:
Royal Bank of Scotland (RBS), the biggest bank in the world at the time, measured by assets, messed up its strategy so badly that it had to be bailed out by a huge government investment. The board approved the strategy and monitored its execution. After everything went wrong, RBS was subsequently hit with huge fines by regulators for failings in its various businesses, the shareholders’ wealth was hit very badly and many employees lost their jobs. But what about the board which presided over this mess? The CEO had a reduction in his huge pension pot and lost his knighthood, and had his name taken off the waiting list of the prestigious golf club he wanted to join but that was about it.
Volkswagen, about which we wrote earlier, has been hit with huge fines for installing devices to cheat emissions testing. The CEO resigned, while denying any culpability, but, while there are on-going investigations, they have so far been limited to a relatively few specialist engineers, well below board level. This may be changing as the authorities grope their way towards evidence implicating people higher up the hierarchy, but as of now, it’s the shareholders who have taken the hit as their company forks out these huge sums.
Well Fargo built a huge business, and reputation for highly effective cross-selling, which went horribly wrong when it emerged that employees were so strongly motivated (or threatened) by the incentive scheme in place, that they resorted to setting up sham bank accounts for customers. The CEO resigned, and the incentive scheme was scrapped, but the big hit was taken by the shareholders.
Two more examples are the selling of unnecessary Payment Protection Insurance by most of the UK banks which benefited employees on incentives but cost the banks’ shareholders huge sums in fines, and sloppy operational execution leading to a BP oil rig blow-out in the Gulf of Mexico, causing deaths and large scale damage, and resulting in huge fines hitting the BP shareholders, but minimal financial impact on the board and senior management.
There seems to be a basic asymmetry of punishment here. How does accountability get served in these cases? Surely something is wrong?
Who should carry the can?
We have to ask ourselves: what are the directors accountable for, how should they be monitored and what should happen when they fall short? Surely it can’t be right that the shareholders take the hit through enormous fines on the company, when it is the failings of the people managing and operating the company which have caused the transgressions.
Currently, it seems, when things go right, employees get the credit and the rewards, disproportionately, compared with the company’s stakeholders. When things go wrong, individuals get blamed, but not apparently punished at a senior level, except being fired in extreme cases, whereas the company’s stakeholders get hit by fines on their company. In the past few years the regulatory authorities in the UK have made attempts to nail down personal responsibility in the financial services area, which is already highly regulated, through something called the Senior Managers Regime. This aims to define the responsibilities of all senior people in an organisation and require the organisation to ensure that these roles are filled with fit and proper people. It is then hoped that if problems occur, it will be easier to point to the person responsible and punish them accordingly. One wonders how these large and generally mature companies ran their businesses without such procedures being in place already. The sceptical conclusion is that they generally did have such procedures in place and they didn’t prevent disasters from happening which resulted in the shareholders being hit, and that adding a layer of regulatory supervision will make no practical difference apart from adding to the costs of running the business.
We probably have to separate two things here: punishment for wrong-doing and compensation for injured parties. Clearly, a class action to compensate a large group which has suffered loss as a result of a company’s wrongful actions would achieve very little from suing the directors and top managers, even if they were covered by insurance and the insurance paid out. However, it is clearly unfair if the individuals whose management actions gave rise to the corporate offence escape without due punishment when the accountability rests clearly with them rather than the impersonal being which is the company.
Transparency not regulation
Coming back to accountability, a very important part of the ACG approach to corporate governance is that the company should be transparent in accounting for its activities to its stakeholders. This needs to be extended to the accountability of its directors and top managers in terms of the culture which they have created and maintained. Hence, the key element in the ACG approach which requires a regular, independent survey of stakeholders to ascertain their perception of the company needs to include an assessment of the top people governing that company.
Since the company’s culture is determined by the top people, they should be judged accordingly. And if it proves difficult to assess any or all of these people, what does that say about the transparency of the regime that they are running. A survey of Berkshire Hathaway stakeholders would have no trouble in eliciting informed perceptions of Warren Buffett and Charlie Munger.
The answer to the problem of lack of accountability doesn’t lie in yet more regulation, but in exposure to the light of day. Maturing blockchain technology (a secure distributed ledger system that guarantees authenticity) could be the key to this. With such transparency, people can make their own judgements about the riskiness or otherwise of involvement with the company and its directors and management.