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A code of malpractice

This week the City has been congratulating itself on 20 years of UK corporate governance codes. Since the original Cadbury guide to boardroom practice in 1992, the UK has taken pride in its role as a world leader in the field, and the codes as a successful export. Seventy countries around the world have followed the UK example and drawn up similar guidelines.

There’s just one problem. Could it be the wrong kind of governance? The day the FT carried the story, Incomes Data Services was reporting that FTSE100 directors took home a median 10 per cent pay increase last year, continuing a soaraway trend that has continued year-in, year-out over the same period. And would this be the same governance, that has given us the RBS meltdown, LIBOR and PPI mis-selling to the tune of £18bn, the biggest rip-off in financial history? That failed to stop phone-hacking or BP taking dangerous short cuts? And that has sanctioned the wholesale offloading of risk on to everyone else, whether individuals (pensions, careers) or collective (global and financial warming), at the same time rejecting any responsibility of its own except to shareholders?

So lop-sided and jerry-built is the corporate economy erected on the scaffolding of the current governance codes that it can’t even deliver the material progress by which it justifies its many privileges: even with a return to growth, living standards for lower or middle earners may be no higher in 2020 than in 2000, according to the Resolution Foundation.

The truth is that much vaunted UK corporate governance has neither headed off major scandal nor nurtured good long-term management. In fact it has done the opposite.

The irony is that by now we know pretty well what makes companies prosper in the long term. Organisations are whole systems and have to be managed as such – you can’t optimise whole systems by optimising the individual parts. Pace Beecroft and Osborne, good people management pays dividends: fear makes people stupid and cussed, not clever and entrepreneurial.

We know that incentives and targets are dangerous (and sometimes lethal) things, all too often taking people’s eye off the real job and focusing it instead on the incentives themselves, damaging intrinsic motivation and undermining performance. Companies work better when pay differentials are less wide (ie, when we really are in this together). Lasting success comes from the hard work of organisation-building and devising products and services that please customers, not from doing deals, which mostly destroy value.

Lastly, it’s obvious except to themselves that in the long term companies can’t thrive unless they have society’s interests at heart as well as their own.

So why do so many boards and managers, sicced on by politicians, systematically do the opposite – run companies as top-down dictatorships, opt for mergers and financial engineering over pleasing customers, destroy teamwork with runaway incentives, attack employment rights and conditions, outsource customer service, treat their stakeholders as resources to be exploited, and refuse wider responsibilities to society?

The answer is that management in the 1980s was hijacked by an opportunistic alliance of impatient shareholders, corporate raiders and ambitious business school academics. The formula that they came up with cast management as a sub-branch of Chicago economics, based on an ideologically inspired view of human nature (homo economicus) needing to be bribed, whipped or both to do their exclusive job of maximising returns to shareholders. It is these assumptions, untested and hidden from view, that are at the heart of the governance codes and have taken on the aura of unchallenged truths ever since.

The consequences of the hijack have been momentuous, over time remodelling society as well as business. The first consequence was to align managers’ interests not with their own organisations but with financial outsiders – shareholders. This triggered the explosion of senior managers’ pay that continues to this day.

At the same time, focusing outside rather than in made them less sensitive to the real-world needs and capabilities of their organisation and encouraged them instead to turn to deals as the preferred short cut to growth (and their bonus targets). This signalled the second major consequence, the switch from the previous policy of retaining and reinvesting profits for the benefit of all stakeholders, to ‘downsize and distribute’, contracting out as much as possible and cranking up dividends and share buybacks to shareholders.

The crowning irony is that this stealth revolution progressively undermined the foundations of the shareholder value under whose flag the activists had ridden into battle. Along with corporate welfare and customer service, one of the prominent victims of downsize and distribute was R&D. Innovation has stalled since the 1980s, prompting some economists to query whether the era of growth itself is over.

But it’s not economics, it’s management, stupid. Unsurprisingly, downtrodden and outsourced workers, mis-sold-to customers, exploited suppliers and underpowered innovation do not make for rising shareholder value despite ever more ingenious financial engineering.

When the Canadian academic Roger Martin crunched the numbers, he found that shareholders had done less well in the the shareholder value era since 1980 than in previous decades when lazy managers were supposedly feathering their own nest. The crash of 2007-8 stripped away any remaining doubt: the economic performance of the last 30 years was a sham. Overall, there were no profits – as Nassim Nicholas Taleb wrote in The Black Swan, they were ‘were simply borrowed against destiny with some random payment time.’

To sum up: what the City was congratulating itself on last week is a wonderful example of the wrong thing done righter. The ‘success’ of the governance codes is a triumph of bureaucratic process over substance. Never mind that we have a financial system that has lost both purpose and moral compass, an economy that is failing most of the population and an increasingly unequal society, look how well we tick the governance boxes! The truth is that governance has recreated management as a new imperium in which managers and shareholders rule, and the real world dances to finance’s tune. A worthier anniversary to celebrate is the death seven years ago this month of Peter Drucker, one of the architects of pre-code management. Austrian by birth, Drucker was a cultured humanist one of whose distinctions was having his books burned by the Nazis. In The Practice of Management in 1954 he wrote: ‘Free enterprise cannot be justified as being good for business. It can be justified only as being good for society’.

The real leadership crisis

If quantity of ink were the criterion, we’d know everything there was to know about leadership and more. The last time I looked there were 64,000 titles on the subject listed at Amazon (UK) – with another 2,000 added to the groaning shelves each year.

Yet it’s one of those topics that the more you read and talk about, the smaller the area of certainty becomes (‘I’m still confused, but at a higher level’, as Goethe said after reading Hegel). What’s more, the higher the pile get, the more confused thinking and practice become, triggering yet more effusions on the subject. No wonder there’s a ‘leadership crisis’, even though it’s not the one that most people think it is.

It was hard not to reach this conclusion at a fascinating recent symposium on the subject at Gresham College, London. It was illuminated by two dazzling lectures by Liz Mellon, executive director of Duke Corporate Education, and ex-headhunter Douglas Board, npw visiting fellow at Cass University, talking respectively of the way leaders think and the way they are appointed.

Reverse-engineering leaders, says Mellon, author of Inside The Leader’s Mind: Five Ways to Think Like a Leader, by breaking leadership into its component competencies and then finding (or forcing) candidates to fit the template, is doomed to failure. You might as well try to create a butterfly by pulling one to bits and using the parts as a blueprint for a new one. It’s only slightly less crude than the Frankenstein myth. What’s missing – what gives leadership life – is the way leaders think, and without it what you get is robots and clones: the exact opposite of what is needed for a world of ambiguity, few precedents, and incomplete information.

This error is made worse by the extraordinarily lackadaisical way senior leaders are chosen, according Board, whose book Choosing Leaders and Choosing to Lead: Science, Politics and Intuition in Executive Selection, came out in the summer. Despite spending enormous amounts on headhunters – a search for a US CEO can easily cost upwards of $1m – candidates for top jobs almost never get the grilling they deserve (and that more junior executive would undergo) from either board or search officers. The role of politics and intuition is rarely taken into account. As a result, those who get appointed to the top jobs are those who are firmly convinced by search’s rituals of deference that unlike other mere mortals they are already equipped for and deserve them. Hence, perhaps, the hubris, sense of entitlement and narcissistic display that is in evidence in boardrooms almost every day.

But what if leadership, like happiness and even profits, is best looked at as an epiphenomenon – a by-product of doing something else? Here’s a quote on captaincy by Martin Corry, a former captain of the England rugby team: ‘It’s a simple matter of making sure everyone knows what he’s supposed to be doing, and then letting them do it. After that, it’s about maintaining your own standards, which is the most effective way of winning the confidence of those around you. It’s obvious to me that you can’t have a captain the majority of the dressing-room think is a tosser. How can you stand up and say your piece in a team meeting if you’re playing like a fairy every weekend? Your performance carries the weight of everything. That’s all you need to remember, basically.’

‘Your current performance carries the weight of everything’. Given the arid competency approach, it’s not surprising, as Mellon notes, that the hottest leadership courses du jour are on ‘authenticity’ – ‘being yourself’ – in other words, another fruitless attempt to pin down an abstraction that doesn’t exist in isolation from the behaviour itself. But how can anyone be ‘authentic’ when they are simultaneously being expected to conform to the same competency framework as everyone else? You can convincingly have one or the other, but not except in the very rarest cases both.

So perhaps we should stop searching for a mythical particle called ‘leadership’ and instead start looking at character and values as a predictor of behaviour under pressure. ‘Leaders must be true to themselves, but they also have a role to deliver that demands that they should rather bring the best of themselves to every situation’, says Mellon. ‘I believe we should ask leaders to get straight how they think about their role – and then trust that the right behaviour, across a broad spectrum, will follow’.

The proviso here, though, is that our current management model demands that leaders march their troops in the wrong direction. Take corporate governance arrangements, at the heart of which is financial alignment of top management with shareholders’ interests. Yet as überguru Gary Hamel has noted, while managers boast of their alignment with shareholders, ‘My guess is that… shareholders would have been better serviced if their chairman could have bragged about being aligned with employees and customers. It seems to me that a CEO’s first accountability should be to those who have the greatest power to create or destroy shareholder value’. Would there be £18bn claims on the banks, the worst banking scandal in history, for PFI mis-selling if CEOs were aligned with customers and employees rather than shareholders?

So, to sum up: the ‘leadership crisis’ does not consist of a dearth of great leaders (or rather, the unrealistic desire for great leaders is the wrong solution to a problem that does not exist in the form most people think it does). It is that senior leaders are poorly chosen, against mis-specified qualifications, and given a job that is designed to make them do the wrong thing.

On second thoughts, perhaps we do need a few more books on leadership after all.

Morality or growth – managing shades of grey across cultures

‘Morality’ isn’t as clear cut as we sometimes assume. Read my report for The Foundation here

Unblocking the arteries of innovation

As if we weren’t in enough trouble, among the wreckage thrown up by the still-receding economic tide is a crisis of innovation. It may be hard to credit in an era of apparently ubiquitous technology, but the innovation that has powered the rise of the western economies has stalled. Tyler Cowen in his 2011 book called it ‘The Great Stagnation’. ‘The American economy has enjoyed… low-hanging fruit since at least the 17th century, whether it be free land,… immigrant labor, or powerful new technologies’, he notes. ‘Yet during the last 40 years, that low-hanging fruit started disappearing, and we started pretending it was still there. We have failed to recognise that we are at a technological plateau and the trees are more bare than we would like to think’.

Robert Gordon’s provocative paper, ‘Is US Economic Growth Over?’, goes over similar ground. In Gordon’s account, growth and progress have been driven by the pervasive uptake of General Purpose Technologies, or GPTs, that have fuelled three ‘industrial revolutions’ based on respectively steam and the railways, then electricity, the internal combustion engine, chemicals and petroleum, and finally, already 50 years old, communications in the shape of semiconductors, computers and the internet.


But productivity growth in the third wave has been much lower than in the second industrial revolution which reached its apogee in the decades after the Second World War. Both Cowen and Gordon attribute this to the fact that many of the advances in the first two rounds were one-offs, the magnitude of whose effects become progressively harder to reproduce. This may be true. But the incidence of innovation is also falling. Not only is the effort less effective, there is less of it about. Why should this be?


One important clue is in the dates. To anyone approaching the problem from the corporate end, the fact that the innovation began to falter in the late 1970s is a tell-tale sign. To see why, we need to look at the ecology of innovation, which is much more complex than the conventional picture of a couple of nerds tinkering in a garage allows.

Entrepreneurial inventors – Steve Jobs, Jeff Bezos, Sergey Brin and Larry Page – are the photogenic face of innovation. But iPhones, Amazons and Googles don’t spring from nowhere. For innovation to have systematic effect, would-be innovators need two other elements to be in place. With the great corporate labs (AT&T, Xerox) a thing of the past, one is state support for the fundamental blue-skies research that provides the seedcorn for long-term innovation. It is well known that the internet came out of the US Defence Research Projects Agency (DARPA); perhaps less so that Google’s search algorithms, some of Apple’s iPhone technologies and the whole US biotech industry also emerged from publicly funded research. Historically the US administration has been responsible for 60 per cent of the country’s R&D effort, and particularly the fundamental part.

The second element is finance. As Gordon Pearson notes (see his excellent The Road to Cooperation), the modern finance sector and the public limited liability company developed together as a means of managing the risks of bringing innovations to market. Finance supported corporate innovators by raising the capital necessary for the uncertain process of exploiting technological development, benefiting the economy as a whole.

But in a triple whammy, over the last three decades all three of innovation’s components have broken down, and for the same reason – the cult of shareholder primacy. In the corporate sector, innovation is a prominent victim (along with pensions, wages and long-term investment generally) of the ‘downsize and distribute’ policies that have been adopted since the 1980s to maximise short-term gains for stockholders (and thus also CEO bonuses). Companies are more concerned with protecting and extracting rents from existing positions than developing new ones. At the same time, finance has turned from means to end, and a predatory end at that. The roles have been reversed. Instead of supporting industry in the patient work of real-world value creation, finance has dedicated itself to value extraction. Instead of creative destruction, taking economies to a higher plane of efficiency, finance has pursued destructive creation, in Mariana Mazzucato’s phrase. Companies that innovate and invest for the long term are particularly vulnerable to the City and Wall Street raiders. For their part, governments in thrall to the same benighted notions of efficiency as the private sector have cut back on support for long-term research in favour of more applied projects. Austerity has just reinforced this tendency.

The result is a monument to perversity, a market failure of world-endangering proportions. On the one hand sits a financially and environmentally overheating real world in desperate need of a bundle of green GPTs to drive a fourth industrial revolution centred on sustainability. On the other are corporates stuffed with cash that they don’t know what to do with, while capital markets not only do nothing to connect the two but actively siphon off for their own ends the money that governments have printed to kickstart their economies. Thus the phenomenon noted by Mazzucato of ‘poverty (underfunding) in the midst of plenty (tens of trillions of dollars of wealth in search of high returns)’; venture capital retreating progressively from innovative startups; and b-school graduates whose entrepreneurial ambition is limited to founding social-media firms that can be flipped to Google, Facebook or Microsoft without the bother of establishing a business model capable of making money from real customers.

Instead of handing out yet more money to an unreconstructed finance sector, governments should be looking to unblock the arteries of corporate innovation by protecting companies from financial predation, speeding up City reform and setting careful incentives for long-term investment in green technologies – preferably before rather than after the lights go out.

Devil in the detail

Read my piece for FT Business Education, 15 October 2012, on the promise and perils of ‘big data’, here

George Osborne’s shares-for-rights scheme doesn’t add up

Read my piece for The Guardian, Comment is Free, 9 October 2012, here goo.gl/d2z3H

Size matters

The cult of bigness is so ingrained that we barely think about it. It’s become axiomatic that big is efficient because of the ability to standardise, specialise, and spread the management overhead. It underpins regulation, management thinking and political solution-seeking alike.

The bigger/better conflation contains a grain of truth. In the early 20th century the discovery that things became cheaper to make as quantities increased was ably exploited by Henry Ford and other mass-production pioneers to invent the consumer market and make their fortunes. Scale economies live on in some areas of manufacturing. But except in limited cases, the Fordist idea of scale economies has been superceded by Toyota’s discovery of the superior economies of flow. In services it is an irrelevance. ‘There is no longer any reason to rule out localisation of economic activity on the grounds of scale economies. Scale economy, beyond very small volumes, is a concept that should be discarded’, declares accounting professor Tom Johnson.

Why then is the hold of scale economies so powerful? One reason is that it harks back to a simpler mechanical world where a large problem could be addressed by taking it apart and ‘solving’ the individual parts. So even when the big retailers control the vast bulk of the UK grocery market, have screwed the local supply chain into the ground and reduced the High Street to a dreary sameness whereno one wants to shop, competition authorities repeatedly find in their favour on the narrow economic grounds that competition between them benefits consumers in terms of price. They take no account of the effects on the system as a whole.

We should know better. As the Bank of England’s director for financial stability Andy Haldane has pointed out, a large contributory factor to the financial meltdown in 2007-2008 was the astonishing failure of anyone in the system to think in terms of the resilience of the structure as a whole. The banks were too big, too interconnected and too similar not only for their own good but also for the resilience of the entire financial system – and we are still paying for the consequences today.

As the banks might suggest, and Vanguard’s John Seddon has formally proposed, in services economies of scale are an optical illusion. The reliable rule of thumb is that the bigger the organisation, the worse the customer service. It should be no surprise that while outsourcing, shared services and specialised call centres have achieved the promise of lower unit costs from size and specialisation, the price has been the wrecking of flow, worse service and soaring overall costs. W. Edwards Deming instructed 50 years ago that optimising the parts necessarily underoptimises the whole and vice versa. And so it has proved. Companies, like regulators, have lost sight of the wood for the trees; which is why everything touted as an ‘improvement’ from their point of view is always the reverse from ours.

But at last people are beginning to query the cult of size. John Kay notes that in the case of big projects, returns to scale do not increase but diminish. In 1908 the London Olympics cost £20,000 and in 1948 £750,000. The estimated 2012 total of £11bn is out of all proportion to previous amounts, even with inflation. This seems to be a phenomenon of the last 50 years, and it holds for tube lines, IT projects and military spending, to name but three. ‘Perhaps technological advance has reduced rather than increased productivity, by offering enhancements that do not represent value for money,’ suggests Kay. ‘The result is that major projects cannot be afforded or, if they are afforded, squeeze out smaller advances that would add more to human welfare’. More is less.

In the case of the banks, even the market is having second thoughts. Haldane recently observed that many banks are currently valued at less, sometimes much less, than the sum of their parts. In other words, he writes, ‘there are market-implied diseconomies of scale and scope. The problem for investors appears to be not so much too-big-to-fail as too-complex-to-price’. The banks would be more valuable broken up. Unbundling would not only create financial value. It would also make the system more resilient and simpler to regulate, both of which would reduce risk.

Yet don’t count on this impeccable logic prevailing in the short term. For it runs up against the most potent reason for the persistence of defunct scale ideas, which is self-interest. There is one area where returns to scale are enormous and increasing: power. CEOs now find they get a better return on their time and effort lobbying legislators than working to please customers. This is one reason why acquisitions continue to be such an important part of corporate strategy despite their dodgy record.

Consider the much-discussed merger of European high-tech manufacturers EADS and BAE Systems. EADS makes civil airliners (Airbus) and BAE weapons; no manufacturing economies of scale there, then. As the crash and events since should have made clear, claims for economies of scale in management or HR also need to be taken with a sack of salt. The truth – and the only possible justification for BAE and EADS getting together – is that both companies are hoping that the added clout the combined company can bring to bear in Washington and Brussels will make up for strategic and operational failings in the past. In short, it can make itself too big and politically troublesome to fail. Other merger bonuses (for them, not us) are pricing power (eg Glencore-Xstrata) and, literally, more bunce for top managers (Glencore-Xstrata again).

Adam Smith famously wrote that ‘People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices’. Now they’ve got politicians to do their conspiring for them. ‘Conservatives in both the US and the UK now represent vested over public interest, big business over small, international over national capital. They typify and defend an economic system that serves the minority rather than the majority…. narrowing opportunity, concentrating wealth and protecting monopoly interests’, writes Phillip Blond sorrowfully. As Blond suggests, size isn’t a technocratic issue, it’s political. It’s time to nail down the zombie’s coffin and put a stake through its heart.

Better business

How do we get more responsible, ethical business? In order to answer that, we have to ask ourselves why we have so much unethical, or to be more accurate, a-ethical business (as by and large we do), in the first place.

The answer is very simple: that’s the way it has been designed. People seem constantly surprised by the fact that business can and does behave badly, but they shouldn’t be. I’ll spell it out: business is an amoral, ethics-free zone because that’s what it’s been set up to be.

Generations of managers have learned at business school, from consultants, their peers and the business press that:

Actually, all these propositions are false. Shareholders don’t own companies – they own shares which give them certain rights, a very different thing. In law, diirectors have to have regard for shareholders, as they do for employees and customers, but their direct fiduciary duty is to the company itself, for the benefit of all its members over time. As for purpose, Dave Packard, one of the founders of HP (who must be writhing in his grave at the moment), put it like this: the purpose of management is not profit, it’s profit that makes the proper ends and aims of management possible. And all the evidence is that incentives simply teach people to take their eye off the job and pay attention to incentives: except for the very simplest and most direct tasks (which emphatically does not include running a company) incentives are more likely to do harm than good, by wrecking teamwork and cooperation, for example.

Nonetheless, this is what managers have absorbed with their mother’s milk, and it’s no surprise that many of them behave accordingly.

So in survey after survey, managers say that despite the talk of ethics and corporate social responsibility, they would engage in dodgy practices if it benefited shareholders, because that’s what their pay structures encourage them to do. So even when behaviour isn’t illegal or criminally reckless, as much of the behaviour of the banks clearly was, it’s often irresponsible to the point of endangering sustainability.

To take a small example from retail (for which thanks to that wise observer, John Carlisle): in 1990s the farm gate price of potatoes was 9p a kilo and the retail price 30p; a mark-up of already more than 200 per cent. Ten years later the shop price per kilo had gone up to 47p, which the farm gate price at 9p hadn’t budged. The mark-up was no 425 per cent: not a penny of the extra profit had gone to the farmers. That’s not fair profit: that’s predatory rent-seeking.

Or Apple, a company which gets so much right for customers. How could Apple be caught out imposing indefensible conditions on subcontractors building $600 iPhones on which it makes a 70 per cent marging? Because its managers believe, or at least act on, the myths that I listed a few moments ago, in particular the imperative to maximise returns to shareholders. Prominent among whom, of course are Apple’s own managers. When he became CEO last year, Tim Cook was awarded nearly$400m-worth of stock options to vest over the next 10 years, and last time I looked they were worth more than double that. That’s a pretty strong incentive to go on screwing your suppliers, whatever the ethics might look like.

The Apple example of course illustrates exactly how and why executive pay keeps on going up and up as it does. It’s an integral part of the same nonchalantly ethics-free dynamic, which has a massive weight of vested interest in theory and practice behind it, not least among the top-level managers who stand to gain from it above all.

Given all this, the surprise is not that much business should display so little concern with ethics, but that there is any that is ethical at all. We should be even more grateful for such stand-outs than we are.

So how do we level the playing field?

The first thing is that we need some politicians brave enough not just to talk vaguely about responsible capitalism but to recognise that this is a crisis, more particularly a crisis of what has been the engine of capitalism up to now, the public limited company; and that since the mess we’re in is squarely man made, the result of faulty design, it shouldn’t be beyond the wit of man to put it right by designing a better system.

This isn’t chiefly a matter of regulation or law change: you can’t regulate to make people better. If you could, Sarbanes-Oxley would have prevented the financial crash. Instead, as John Kay says, we need simple structures that foster resilience. It’s not just the banks – in obsession with economic ‘efficiency’ we have allowed far too many companies of all kinds to grow too big – too big to manage, too big to fail and too powerful for the good of the rest of us. So competition policy should be reframed in the light of sustainability concerns, and that probably means breaking up some of the larger concentrations of corporate power, again, not just the banks. Will Hutton’s Ownership Commission has argued that instead of the current overreliance on the public limited company, we should encourage a plethora of other corporate forms – mutuals, cooperatives and social enterprise, for example, and that’s an important part of the equation. We could make a start on diversification, as suggested by Oxford’s professor of global economic governance, Ngaire Woods, by reincorporating the investment banks with unlimited liability – which is not as far-fetched as it sounds, since as partnerships that’s how most of them effectively operating until as late as the 1990s. Seriously, why not?

But the biggest change has to be internal. This goes far beyond the figleaf of corporate social responsibility. Business needs to acknowledge, explicitly and directly, what is abundantly clear to everyone else: that it can only prosper in the long term if it simultaneously pays attention to the interests of customers employees, shareholders and the communities it is embedded in. That needs to be written into the corporate governance codes, which ironically, and with the most earnest of intentions, have congealed into the bastions of the current corporate social irresponsibility.

But I sense the grain of an opportunity here. Interestingly, there is no empirical evidence that current governance ‘best practice’ – independent boards, splitting chairman and chief executive roles, aligning management with shareholder interests – has any beneficial effect on performance. In fact, the whole enterprise of making business morals-free doesn’t even benefit shareholders in whose name the privilege is claimed. Over the last 30 years, companies have done less welly by shareholders than they did in the previous period when shareholders weren’t put first in the same way. Ethics-lite shareholder capitalism fails even in its own terms.

That means that for once we’re in that rare situation where we have nothing to lose and everything to gain by doing the right thing. So who’s up for it?

A big problem

Read my column in FT Business Education, 16 September 2012, on goats and power here