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How Organisational Stress Affects Corporate Governance

by AppliedCG

In our Applied Corporate Governance methodology, we have Five Golden Rules to guide us towards establishing good corporate governance.

The first three rules of good corporate governance are about an ethical approach to business, a clear and sensible goal which represents an appropriate balance of the collective wishes of the key stakeholders, and a strategy process which reflects the stakeholder approach to the business. The fourth rule is about organisation.

Organisation must follow strategy

Clearly, in order to implement the strategic plan which has been developed to achieve the agreed goal, the organization (that is, how the company is structured) must emerge from the first three rules. This is our fourth Golden Rule. The fifth is a system of communications to the stakeholders which provides effectively for accountability and transparency.

The prime objective of organisational design is therefore to ensure that there is an organisation in place which:

  • reflects and protects the interests of the key stakeholder groups
  • ensures efficiency and effectiveness in delivering business goals

Bad organisation leads to bad corporate governance

With an inappropriate organization in place, the goal will not be achieved, and the approach to business will be vulnerable to a falling short in ethical behaviour. Furthermore, any relationship between the way the business is being run and the expectations of the various non-managerial stakeholders will be purely coincidental.

Let’s look at how two world leading companies in very different fields have recently approached the issue of organisation after having had to reassess their global strategies under pressure from events.

Google’s reorganisation in February 2015

Previous organisation matches market strategy

Google’s operations in the EU, while headquartered in Ireland for tax reasons, had been fragmented across the EU. This apparently originated in an early organisational policy decision that this arrangement would motivate sales teams to compete with each other, for the good of the greater Google.

As the company has grown very much larger, however, it has had to wake up to the fact that the European Commission’s Brussels bureaucracy makes policy which it aims to roll out across the single market as uniformly as it can. The result is that Google has been facing the same sorts of issues in all the EU countries within which it operates, but having to deal with these through a fragmented operation.

Market strategy faces challenge to governance model

Some of these issues are now becoming potentially very serious for Google – the right to be forgotten is an example, originating in Spain but being taken up by the European Court of Justice in Luxembourg and immediately applied across the EU. This rendered a common response necessary in all 28 countries of the EU. But Google didn’t have a unified organisation across the 28 countries, causing inefficiencies in its response and potentially much greater danger from inappropriate or inadequate actions.

Google is also facing the re-opening of the Commission’s anti-trust case and a long-drawn out battle of the kind that Microsoft had to fight for years.

The conclusion was that Google had to approach the EU like other well-established large organisations, through a unified structure.

Strategy is modified and organisation follows

Hence it recently reorganised to put a new CEO in charge of the whole of the EU operation. This unified the southern and eastern group with the northern and western group whose head, Matt Brittin, will now take charge of the whole region. Mr Brittin puts a positive spin on this by saying that it enables Google to respond appropriately to the plans of the recently elected new head of the Commission, Jean-Claude Juncker, to create a “single digital market”. It also provides a single point for negotiations between Google and the Commission in the key anti-trust negotiations.

Corporate governance reflects interest of key stakeholder

This neatly illustrates how strategy changes lead quickly to appropriate organisational changes in a fast-moving business. Clearly, the prospects for good corporate governance have improved through the response to the interests of the major stakeholder, the regulatory authority in Brussels.

HSBC’s recent problems

By comparison, let’s look at the organisational changes that may be required in a very large but slow-moving organisation, HSBC.

Previous organisation reflects historic approach to governance

HSBC was run in a historically devolved way, as seemed appropriate for a geographically widely spread bank with its origins in colonial corresponding banking relationships.

Sir William (“Willie”) Purves, ruled the bank as CEO in the early 1990s, with a canny Scot’s eye for detail. An acquaintance of the author, who was working in the bank’s venture capital arm, was once berated by Purves, in a furious personal phone call for making a poor investment which had lost £5m of “his” money.

Change of strategy did NOT result in change of organisation

In 1993, John Bond, as he was then, took over leadership of HSBC. Sir John Bond’s approach was rather different. He led HSBC on a big expansion drive which included buying the US credit card and sub-prime mortgage lender Household International for $14bn in 2002 (even after questions were raised about its allegedly dubious lending practices). In 1999, he had also previously bought the New York private banking business of Edmund Safra, which included a Swiss banking arm.

This meant that, without organisational change, the huge expansion would have left the newly acquired banks with a much greater degree of freedom and much less detailed supervision than might otherwise have been expected. But the organisational approach didn’t change, and managements of these new acquisitions appear to have been left with a great degree of autonomy, despite the great increase in size and complexity of the bank.

Inappropriate organisation leads to failure of strategy and bad corporate governance

When the financial crash came in 2008, all the potential problems lurking in Household came to the surface and HSBC was faced with huge write-offs and fines for the wrong-doings of its acquired business in the US.

It was also hit by failings in its US compliance department when it had to pay huge fines for money laundering in its Mexican operation, after it transpired that they had been providing these services to customers who turned out to be local gangsters.

Most recently, following the attempt by an ex-employee of HSBC to sell customer records stolen from its Swiss bank, the outcome has been a world-wide crack-down on tax evasion and aggressive tax avoidance schemes, and widespread criticism of HSBC for allowing these things to go on in its banking business.

Organisational failure still not recognised

When its chief executive, Stuart Gulliver, was hauled before the UK Treasury Committee to account for the bank’s behaviour, he asked “How can I know what every one of 257,000 people is doing? Clearly I can’t.” This remark, while attracting some sympathy, also provoked scorn. Prof. Henry Mintzberg was quoted as saying that “You can’t excuse (scandals) by saying that you have so many employees. You…have to be on the ground to have a sense of what your organisation is all about”. This recalls our remark, above, about “Willie” Purves, Gulliver’s predecessor but four as CEO, twenty years earlier. He was hands-on, he had his ear to the ground, and everyone knew it.

Clearly HSBC’s organisational style of devolved responsibilities has been proved most inadequate to the grand strategy of global expansion, to the point where questions are raised as to whether HSBC has simply got too big to manage and ought to be broken up.

How can governance be improved with wrong organisation?

The same questions have, of course, been raised about the other large banks following the 2008 financial crisis. Unfortunately, the rescue of some of the failed banks has resulted in fewer, larger organisations, rather than the smaller, simpler ones that are being called for. Indeed, the massive new regulatory wave that is spreading round the globe will arguably require possibly still larger organisations to support the vastly increased compliance functions which will be required to serve the gargantuan demands of the regulatory agencies. To fulfil the expectations of improved corporate governance in this new global world will require some very imaginative organisational thinking.


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