Theranos and the wake-up call for ethics

If you have been following the story of Theranos, a $9 billion blood testing company that was built on a lie, you have probably come across the newly released documentary, The Inventor, and podcasts detailing the scandal. While there are many lessons and takeaways (for example, the fact that the pressure to succeed and oversell is a reality for many startups), the deep, dark game of deception played by Theranos should be a wake-up call for investors and boards everywhere.

In the podcast, The Dropout, co-workers discuss how founder and former CEO Elizabeth Holmes had carefully crafted her image and deceptively ran the company. She adopted Steve Jobs' iconic turtleneck sweater and allegedly faked her deep baritone voice. Co-workers would catch Holmes occasionally falling out of character and speaking with a higher pitched voice after drinking.

Holmes knew what she needed to do to get noticed. As research suggests, when men or women, deliberately lower their voices, they are perceived as more dominant. She composed a board of government veterans instead of doctors or scientists, knowing that they wouldn't challenge her on the feasibility of the technology. She also made sure the board didn’t have a regulatory or oversight function, giving it merely had an advisory role, which made it ineffective at detecting the massive fraud that was occurring right under its nose.

Theranos claimed they were working on a device that could perform a traditional blood test with just a single drop of blood, analyzed almost instantly. However, due to the complex machinery required to perform a blood test, including robotic arms and needles, it was physically impossible for it to work properly in such a small box. This led to wildly inaccurate testing results, and people being falsely diagnosed with serious diseases. Holmes and her team then worked on creating an illusion – diluting the finger prick blood tests and manually running them on common, commercially available Siemens machines in a secret basement lab. One employee recalls her experience, saying “I don’t feel like I was scammed. It started off as one lie, and snowballed into this really crazy situation.”

Holmes created a culture of paranoia so that her own staff couldn’t piece together the puzzle of the lies. Although few questioned the ethical ramifications of their work, given Holmes' celebrity-like reputation at the time, many employees began to feel as if they were the ones missing something. She would prevent teams from communicating, leading to duplicated work and misdirected initiatives. This exacerbated the problems with the devices and stunted progress.

Theranos has become a case study, leaving directors and investors alike contemplating the red flags others may have missed. According to an article by Inc., investors and potential board members should verify company claims with external sources, audit financial statements, discuss what process of due diligence others have done before joining, and conduct a character check by talking with the CEO’s former colleagues or investors.

While Theranos was a wakeup call for companies in the Valley, reflecting on the ethical consequences of the “move fast and break things mentality”, it ultimately serves as a warning to investors and board members about the destructiveness of unethical behavior left unchecked.


Author

Stephanie Law, Viewpoint Research Team

What Did Michael Cohen’s Testimony Teach Us About Ethics?

On Wednesday, Michael Cohen, President Trump’s former lawyer, was brought before a congressional hearing to testify about his involvement with Trump’s various dealings, including his alleged collusion with Russia and the hush money paid to Stormy Daniels. The hearing broke the seal for Cohen, where he revealed the darkest depths of his time alongside Trump, proclaiming “He is a racist. He is a con man. And he is a cheat.”

Driven by power and ambition, Cohen explained that “being around Mr. Trump was intoxicating” and he had been persuaded into doing unsavory work without being directly asked. “Mr. Trump did not directly tell me to lie to Congress. That's not how he operates.”

What would compel Cohen to jeopardize his future without being instructed to do so? What frame of mind would an established, successful professional have to be in to needlessly risk (and ultimately lose) his freedom?

Parallels in the business world could help us understand Cohen’s motives. As Harvard Business Review explores “Despite good intentions, organizations set themselves up for ethical catastrophes by creating environments in which people feel forced to make choices they could never have imagined.” Trump’s “unspoken” desires created an environment that pressured Cohen to live up to his expectations of him, similar to when employees of thePhoenix Veterans Administration felt forced to manipulate their hospital wait times in order to meet targets without being specifically directed to do so, ultimately leading to the death of 40 veterans waiting for care.

There have been a number of studies that suggest power corrupts everyone in one form or another. If Cohen was “mesmerized” by the power he gained working with Trump, why would he suddenly come clean now about Trump’s wrongdoings? According to Harvard Business School research, people can behave unethically in situations that favour them, without even realizing it. Studies also show that people who believe they share bonds with others, real or imaginary, will mimic other’s behaviours. For example, people are more prone to litter in areas covered in litter, but also likely to be more environmentally conscious when told other people are doing the same. Based on this these studies, there is a chance that Cohen’s case could have been the result of his environment, if indeed his allegations turn out to be true.

However, it is worth noting that individual autonomy still exists. Our individual dispositions can predispose us to be unyielding to pressure to act unethically. An example of such an individual disposition is “honesty-humility”, a personality trait. Being high in “honesty-humility” means you’re more willing to rise above a high-pressure environment to make the right choices. Perhaps the recent events involving former justice minister Jody Wilson-Raybould might suggest that she is high on honesty-humility. She stood up to the Liberal Party and Prime Minister Trudeau when asked to “help out” SNC Lavalin and skirt around the rule of law. At the end of the day, a toxic environment may urge us down a dark path, but our individual dispositions and convictions are what ultimately saves us from walking it.


Author

Viewpoint Research Team

How to Keep Control When Employees Start Crossing the Line

Ignoring health and safety procedures, incivility between employees, fraudulent reporting of hours worked – these workplace deviances can be the death knell for the culture and finances of any business. Although these may be signs of endemic issues within an organization, it can still be difficult to identify these problems before they manifest. What is the cause of workplace deviance and incivility, and what can be done to prevent it?

A study from 2016 concluded that unsatisfied workers use these deviances as a form of protest against their employers if faced with harsh working conditions, high periods of anxiety or stress, and limited opportunities for social interactions. In particular, these workers skirted proper procedures and paperwork in order to accumulate more free time for themselves. However, the workers in the study still understood the importance of being seen as a “valuable employee”, so they would be subtle in their deviances. “The study suggests that workers were far more likely to game the system rather than slack off. So rather than resist work entirely, workers were resisting the negative and precarious aspects of work.”

Working on “auto-pilot” may be leading some employees to break company policies. In one study, workers at a Japanese bank who were given a wider variety of tasks were found to adhere to the company’s strict break times better than those who had less variety in their tasks. Additionally, studies have shown that people are less likely to cheat on tests that have different types of questions interspersed with each other, as opposed to tests with long sequences of similar types of questions. Thus, keeping workers cognitively stimulated can help keep them mindful of company policies.

Anti-social behaviour (e.g., yelling, destroying property, and stonewalling) is also becoming an increasingly pervasive issue“According to a study that was reported by Fortune magazine, U.S. firms spend 13 percent of their time addressing the incendiary fallout of workplace incivility.”  However, research shows that in most cases of incivility, the victim is likely to be of lower status than the perpetrator. In other words, most incivility is an abuse of power. To make things worse, employees who witness their leaders’ distasteful behaviour can see it as a signal to what is acceptable in the workplace, and can end up propagating further incivility and creating a malicious work culture. It takes mindful and engaged leadership to ensure the self-feeding cycle of incivility never takes root. One suggestion is to implement zero tolerance policies and reward acts of cooperation between employees and leaders. By upholding cooperation as a core principle at your organization, you can plant the seed for a more inclusive, empathetic culture where every employee understands the impact of their actions.


Author

Viewpoint Research Team

Of Purpose and Profit

This month in Davos, Switzerland, CEOs from around the world were talking about one thing: a letter sent by Larry Fink, CEO of BlackRock. It stirred controversy among many attendants at the World Economic Forum, proselytizing that pursuing purpose over profits is the key to unlocking the full potential of any business. Why should businesses need to worry about anything other than profit? Many would argue that financial growth is all that should drive a business. What could be more important?

It’s a question that’s been asked many times by our founder, Mac Van Wielingen, most notably in his 2017 speech at the Fraser Institute, where he proposes that long-term success depends on much more than just profit. “We are not maximizing one variable, we are combining, making choices, trading off and optimizing among four variables: profit, risk, time, and human experience.”

In a recent study by Deloitte, 40 percent of millennials “believe the goal of businesses should be to ‘improve society’.” As millennials will soon make up about 40 percent of all consumers, it is imperative that organizations examine how long-term sustainability, purpose-driven business decisions, and community investment fit into the bigger picture. Nothing states this louder than the fact that “64% of people globally expect CEOs to lead on social change rather than waiting for government intervention.”

Society needs corporate champions to lead the way down this untested, unfamiliar path. In his letter to CEOs, Larry Fink talks about the intimate relationship between purpose and profit in business. “Purpose is not the sole pursuit of profits but the animating force for achieving them. Profits are in no way inconsistent with purpose – in fact, profits and purpose are inextricably linked.”  He then encourages CEOs to lead the charge on making a positive impact on society. “One thing, however, is certain: the world needs your leadership. As divisions continue to deepen, companies must demonstrate their commitment to the countries, regions, and communities where they operate, particularly on issues central to the world’s future prosperity.” More and more leaders are realizing the interdependency of purpose and profit. If you need proof, read Baupost’s Davos letter orSeth Klarman’s interview regarding the leaders at Davos.

How can your organization prepare itself for a world that increasingly scrutinizes purpose? As Mac Van Wielingen proposes, corporate strategy is the key driver. At every turn in the strategy, ask if unnecessary short-term risk, social value, and environmental sustainability have been taken into account. By infusing the core of your organization with a culture of long-term thinking and social awareness, purpose-driven decisions will be made unconsciously, and social license will come naturally to your business.


Author

Viewpoint Research Team

State of the Nation: Canada’s 2019 Outlook

With trade wars, polarized politics, and big business shakeups across the world over the past year, many observers would opine that the political and economic state of many nations is in flux. With this in mind, it’s time we step back and take a big-picture view of Canada from a political and economic standpoint, as well as theorize what could be in store for 2019.

According to Edelmen’s 2018 Trust Barometer, Canadians' trust in institutions (government, business, media, and NGOs) did not change between 2017 and 2018, staying at a relatively low level of distrust from the general public (49 on a trust scale of 100) and a low level of trust from the “informed” public (62 out of 100). The US saw the steepest drop in trust by the informed public, from 68 in 2017, down to 45 in 2018. Canadians also have an increased trust in authority figures compared to 2017, choosing to believe academic experts, technical experts, and financial industry analysts above “people similar to themselves”.

On the business side, Canadian companies are the most trusted globally, beating Switzerland, Sweden, and Australia to claim the number one spot. However, trust in most business sectors within Canada is declining, except for the energy industry, which actually saw a 4 percent increase between 2017 and 2018, reversing a three-year downward trend. The top trust-building mandates for businesses in Canada is to drive economic prosperity, invest in jobs, and innovate, whereas the top trust-building mandates in the US are to safeguard privacy, investigate corruption, and ensure equal opportunity.

As for Canada’s 2019 economic outlook, the Business Development Bank of Canadafocuses on five analyses: 1) the Canadian economy is expected to grow by 2 percent, 2) trade tensions won’t affect the global economy with US-imposed tariffs expected to be removed, 3) the US is expected to lead most countries on economic growth, 4) a strong US economy will put downward pressure on the Canadian dollar, and 5) Canadian businesses will continue to struggle in hiring the people they need, stifling growth.

Additionally, a study by the International Institute for Sustainable Development shows Canada’s economy on shaky ground, with the growth of the nation’s “comprehensive wealth”, composed of five different types of capital (produced, natural, human, financial, and social), to be drastically behind other developed countries, and is in fact the only G7 nation undergoing a contraction of comprehensive wealth per capita. The risks to Canada’s economy include unprecedented levels of household debt, over-dependence on market-sensitive industries, zero growth in human capital, and climate change events (floods, wildfires, and storms).


Author

Viewpoint Research Team

Good Governance or a Coup D’état? What Ghosn’s Board Can Teach Us About Corruption

Carlos Ghosn was once a legend of the automotive world, pulling Nissan back from the grave to become one of the world’s most iconic brands. In an economically battered 1990s Japan, Ghosn became a kind of folk hero, a symbol of hope and restoration. With his brash personality and stylish character combined with his skill for streamlining business operations, he quickly rose to celebrity status, even being drawn into Japanese comic books. In-step with his larger-than-life presence, he was the chairman for Renault, Nissan, and Mitsubishi Motors simultaneously.

That all came crashing down when it was discovered he’d been underreporting $44 million in income and misappropriating company funds from Nissan. Although it has been debated that the publicity of the scandal could be part of an internal coup d’état to separate Nissan from Renault, Ghosn has been lambasted by Nissan’s CEO (who Ghosn himself hand-picked), calling on the board to remove him as chairman.

Scandals like this aren’t uncommon – but what is surprising is how Nissan’s CEO and board of directors reacted to his crimes by immediately, and publicly, turning on him.
Contrast this with Steve Jobs’ options backdating scandal, where Apple’s General Council took the fall for Jobs, or Elon Musk promoting a fraudulent $420-per-share private sale with minimal backlash from Tesla, or the absence of charges against any executives of Kobe Steel when they lied to customers about their quality data. What makes Ghosn so different that his board would immediately oust him? Could be this be an example of ethics and good governance on behalf of the board?

Although this could be a case of good governance in action, it may be difficult for critics to imagine that an active, engaged board would not be aware of Ghosn’s illegal activities, which were taking place since at least 2010. However, the problem may lie with boards themselves. It has been suggested by researchers that boards are ineffective at their monitoring duties due to the principal-agent problem, knowledge barriers, management tactics, time demands of their other jobs, firm complexity, and a culture of deference. Echoing the ideas of our founder, Mac Van Wielingen, there is an imperative need fordirectors to become more active and more assertive with corporate governance, or we can expect to see more cases like Ghosn’s and corruption continue to thrive.


Author

Viewpoint Research Team

Machines and Morality: How and Why We Should Make AI More Human

We are entering what some call the “fourth industrial revolution.” Whereas the first industrial revolution mastered the power of the steam engine, the fourth will flourish on the backs of big data, artificial intelligence and robotics.

China has recognized the importance of these three keystone technologies and have committed to creating a $150 billion AI industry in the hopes of becoming the global leader by 2030. However, China’s vision for AI may be at odds with the vision of Western democracies, “AI in China appears to be an incredibly powerful enabler of authoritarian rule” with face scans, citizen databases and censorship taking centrestage, while Western AI is focused on the monetary potential - mapping consumer behavior, making cities more efficient and improving consumer technology.

So with the world accelerating towards an AI-dependent future – it leaves us to ask one question: What role does morality play with AI? Can AI itself be programmed with the concept of morality and hold itself accountable?

Interestingly, yes - AI can be as moral as the humans who code it. By crowdsourcing ethical decisions from subjects around the world, scientists have been able to create a morale framework to help self-driving cars make decisions in difficult moral dilemmas. If a malfunctioning self-driving vehicle is barreling towards an elderly couple or a young child, how should it react? The results may surprise you – and they depend on your cultural background. For example, in China, Japan and South Korea, the elderly are held in high esteem, so subjects were less likely to save the child. According to an MIT review of the study“countries with more individualistic cultures are more likely to spare the young”. As dark as the prospect of AI out-competing human productivity and creativity, the future may not look so bleak if it can adhere to a human-based moral code.


Author

Viewpoint Research Team

Massive Retailers Are Failing, Could They Have Been Saved?

The sudden wave of retail bankruptcies this year have been startling for shoppers and analysts alike. Whether they’re electing to pursue online-only retail strategies or shutting up shop completely, the “retail apocalypse” may have finally descended upon us. With Sears announcing its Chapter 11 bankruptcy to restructure, President Trump has come out publicly claiming that Sears “has been dying for years” due to mismanagement (which is ironic, as the US Secretary of Treasury, Steven Mnuchin, was also on Sears’ board of directors).

Sears was once the USA’s largest employer – the Walmart or Amazon of yesteryear. Toys R’ Us was once the Mecca for children’s toys. How are such high-profile retail outlets succumbing at such an alarming rate? Are shoppers simply moving online? Although ecommerce is an easy scapegoat for many retailers, it is likely not the main culprit. The evidence points to something deeper – systemic flaws within the culture of these retail monoliths that leave them no ability to adapt or re-invent their businesses, short-sighted management with little strategic planning, and huge debt levels from unmotivated private equity owners. “If you are going to run your business like most businesses, it is only reasonable to expect that you will end up like most businesses” – most likely out of business within five years.

This leaves us one question: where does the responsibly lie? Could the boards of these organizations have ultimately prevented these performance failures?

As we’ve seen, in their current state, it is too easy for boards of directors to overlook deep-rooted performance issues. This point is something Mac Van Wielingen has drawn on multiple times in his work – that the board needs to take a more active, vigilant approach to guiding the performance of their companies, escaping the gravitational pull that leads to“most directors [playing] a role akin to spectators…versus real players in the game, sharing in the responsibilities for outcomes.”


Author

Viewpoint Research Team

Is Canada Losing the Battle Against Corruption?

Corruption has a high price. Globally, corruption has been estimated to total to 2% of the global economic output, which is around $1.5 – 2 trillion. How is it so rampant? Bribery and unethical behaviour can be contagious- “competitors that offer better products lose out in an unfair marketplace and this triggers a race to the bottom..." This is already happening in some regions, with Amazon employees allegedly leaking data for bribesNovartis embroiled in controversy over bribing Chinese healthcare professionals to boost sales in 2016, and the Danske Bank found to have laundered over $234 billion between 2007 to 2015.

Just having anti-corruption laws might not be enough.

Canada signed the OECD convention to stop white-collar crime more than two decades ago. However, a new report suggests that Canada is losing ground in the battle against corruption, with active enforcement of foreign bribery laws declining. “Canada is at the ‘back of the pack’ of OECD countries when it comes to clamping down on the bribing of officials abroad,” with only four foreign bribery cases being initiated and one concluded in three years.

Though law enforcement and policy makers play a big role, there are things businesses can do to take a stand against corruption. There needs to be focus from the inside out; corporate boards and top management must focus on aligning strategy, embedding a culture of compliance, and providing consistent processes on monitoring and reporting unethical behaviour. Mac Van Wielingen, founder of Viewpoint and Canadian philanthropist, has advocated that corporate boards should take a more active role. “As leaders who oversee the most important decisions in an organization, directors have an unshakeable and implicit responsibility to ensure management pursues a path of ethics and legitimacy, through embedding a culture of compliance and ethics, and “ethical performance” through culture, strategy and accountability systems.” Directors cannot afford to be bystanders; instead, they must be actively responsible for the outcomes.


Author

Viewpoint Research Team

Are We Heading Towards Another Financial Crisis?

Our founder, Mac Van Wielingen, often refers to the 2008 financial crisis as a critical point, as it “exposed significant corporate governance failings and led many to question the role of business in society.” There was a failure in strategic risk management and oversight due to a loss of focus on client interests, obsessive short-termism, and excessive financial leverage. In 2010, Viewpoint Research Partners was founded to explore the challenges through conducting and curating research. A decade has passed since Lehman Brothers filed for bankruptcy, launching the world into a global financial meltdown. In a single day, more than $600 billion USD in assets were wiped out, and 25,000 employees lost their jobs.

So what has changed since then?

The road to recovery has been a tough one. It has taken years for unemployment to return to pre-recession numbers, which has increased disparity in wealth. Middle-class income in the U.S. has only recently reached $61,000 USD, the level before the recession. Policy changes and new regulations have been implemented in response to the instability and the abundance of financial fraud that occurred, resulting in more global bank stability.

Are we at risk of stepping down the same path again?

It seems that there are similar conditions brewing, with increasing public polarization, and the increasing trade tensions and corporate debt. “Ten years on from the 2008 meltdown, the global banking systems seems more resilient to shocks, corporate profits are generally strong, and the bull market trudges along. But that in itself is a dangerous situation.” While there is no punchy one-line answer, organizations can protect themselves from repeating history by focusing on long-term performance and sustainability, and being open to new ways of governing business.


Author

Viewpoint Research Team

How Passive Investors are Influencing Corporate Governance

Disclaimer: For the purposes of this blog we refer to BlackRock, Vanguard and State Street as passive investors and reference their use of index strategies within this context. This language is meant to provide a generalized descriptor to explore how the corporate governance landscape is evolving as the result of the dramatic growth in index investing. However, we acknowledge that the use of this language is overly simplistic in understanding the wide variety of index strategies (which are not synonymous with passive management), and in differentiating the distinction between passive an active management. Many have appropriately argued that no investment activity is truly passive. To learn more about how index strategies can be active where it counts visit Viewpoint Investment Partners.

“I’d Say Traditional Index Funds Are The Last, Best Hope For Corporate Governance.”
— JACK BOGLE (FOUNDER & FORMER CEO OF VANGUARD)

Passive investment vehicles have experienced tremendous growth in recent years. Today, reports suggest the combination of the top three firms in the space, BlackRock, Vanguard and State Street, constitute the single largest shareholder in over 40% of listed companies in the U.S.[1] Recent reports are predicting continued exponential growth in index investing, with research from Ernst & Young forecasting that over the next three years exchange traded funds (ETFs) will grow by a compound average growth rate of approximately 18%.[2] In the first six months of 2017, net flows out of actively managed funds and into passively managed funds accounted for US$500 billion.[3] Much of these gains have been on the back of a growing body of research showing that the vast majority of active managers fail to beat their stated benchmark.[4]  This research, in combination with low fees, enhanced transparency and increased diversification offered by passive vehicles have contributed to their rise in popularity. 

As passive investments and index strategies continue to gain popularity, new questions are being raised on the overall impact and influence on market systems and efficiencies. Corporate governance is one such area where pundits for and against, are weighing in on unintended consequences and the opportunities brought about by increased dollars in such strategies. This blog explores this debate, starting first with framing both sides, then outlining the unique governance position of leading indexers, and concluding with a look into the how influence is being exercised by these investors. For our purposes we will mainly focus on actions and data involving the three largest passive investment firms, BlackRock, Vanguard and State Street – whom we collectively refer to as the “big three.” [1]

Before exploring the debate surrounding passive investment vehicles and any governance implications, let’s briefly review how such strategies work. Most passive vehicles are designed to replicate the performance of a specific index or benchmark. As they are passively managed, the expense ratio is generally low. Importantly, passive managers, unlike active managers, are not stock pickers. While there is a vast array of strategies implemented by passive investors, the general premise is based on a buy-and-hold strategy, where investors are not trying to beat the market by profiting from short-term swings, but rather to create maximum value over a long-term investment horizon. This means that passive investors are in the unique position of being essentially “long only” in the basket of stocks they are invested in – an important point which we will revisit later.

THE DEBATE

The foundation of healthy corporate governance is based on shareholder rights and voice in the decision-making of management. Systems of corporate governance, such as annual general meetings and proxy voting, function as a check and balance on managers, dissuading self-serving decision making that is not in the best interest of shareholders. In terms of index investing, concerns have been raised that these investors will leave companies unchecked and therefore corporate governance standards and, ultimately, company performance will weaken. This assertion is based on managers of indexing strategies being unable to vote with their feet and sell underperforming stocks; as well as concerns that due to the sheer number of stocks held in any one index the proper care and due diligence cannot possibly be taken to effectively flag issues and vote on proxy matters.

Additional concerns have been raised with what is essentially an index oligopoly, as BlackRock, Vanguard and State Street dominate the industry. This concern is tied to a worry that as the big three control a growing ownership block in stock markets that competitive forces will erode and oligopolistic practices will emerge. Bill Ackman, hedge fund manager and shareholder activist, has compared the growing dominance of index funds with the Japanese keiretsu systems of cross-corporate ownership, which has been widely blamed for corporate underperformance in the country.[5] The keiretsu system is a loose network of businesses, often across industries, who may have stakes in each other’s business or operate in a manner that is beneficial to the others in the group. The system is criticized for creating inefficient market practices.

Passive Investors have argued that, as inherently long-term investors, they place greater weight on sound governance strategies than their active counterparts. Bill McNabb, Chairman and CEO of Vanguard, explains their unique governance position in a 2015 speech at the Harvard Law School:

“We’re going to hold your stock when you hit your quarterly earnings target. And we’ll hold it when you don’t. We’re going to hold your stock if we like you. And if we don’t. We’re going to hold your stock when everyone else is piling in. And when everyone else is running for the exits. That is precisely why we care so much about good governance.”[6]

In effect, because of the inability to ‘vote with their feet,’ the big three have had to find other ways to influence corporate action. This influence is being exercised in three ways: corporate engagement; public influence or voice; and proxy voting.

EXERCISING INFLUENCE

Corporate Engagement
Dialogue between investors and companies is seen by the big three as an important component of their fiduciary responsibility to shareholders, as well as a method to help management better understand the needs of their investors and make more informed decisions. According to a company report, during the 2017 proxy season Vanguard held 954 company engagements and voted on over 171,000 proxy proposals.[7] State Street reported a similar large volume of activity, conducting 611 corporate engagement meetings in 2016.[8] Such engagements give investors the opportunity to flag issues and to discuss priorities with company leadership. To manage their expanding number of engagements, BlackRock and Vanguard have both reported that they are bolstering their corporate governance teams. Critics have argued that the increase in manpower is not enough to effectively cover the big three’s large universe of diverse holdings. Chances are most firms won’t hear from the likes of the big three unless they have serious governance concerns. For many C-suite and investor relations professionals it is an uncomfortable reality that you can’t put a face to some of your largest investors, and opportunities for outreach are limited or non-existent. 

Environmental, social and governance (ESG) issues have been a major focus of corporate engagement among the big three,  dominating their stewardship agendas. In 2015, BlackRock teamed up with Ceres, an investor advocacy group with a sustainability focus, to produce a guide providing strategies for investors to incorporate ESG considerations into corporate interactions.[9] The 68-page document reads as a “how to guide,” covering multiple facets of engagement from writing shareholder proposals, to divestment, to influencing public policy. Additionally, BlackRock, Vanguard and State Street all publish annual stewardship priorities on their websites. While the communications of these priorities serve to focus the agenda of corporate engagement, they are also creating influence beyond the hundreds of physical engagement meetings that the big three hold each year.  

Voice
Passive investors have been actively shaping the conversation around ESG issues through channels such as annual letters, website content, media interviews and conferences. A recent example is BlackRock’s 2018 Letter to CEOs, from its CEO, Larry Fink. The letter asserts that a new model of governance is required stating[10]:

"Society is demanding that companies, both public and private, serve a social purpose. To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society."

Similarly, Vanguard’s McNabb is a supporter of The CEO Force for Good (CECP), which brings together over 150 CEO’s with the goal of empowering corporations to be a force for good in society. In February of this year, McNabb co-authored an open letter from CECP, which re-states the need for long-term strategy and suggests questions for corporates to consider when presenting publicly-disclosed, investor-facing long-term plans. Both examples demonstrate a clear push that is seen by all the big three towards long-term strategic frameworks and the affirmation of board oversight on these plans. This is a departure for the investment industry which many have argued, including Fink and McNabb, has become dangerously focused on the short-term and the quarterly cycle.

The focus on long-termism can be understood as one of the foundational, perennial governance issues which the big three have pressed with companies. Others include: board compensation and effectiveness; alignment of executive compensation with the long-term strategy and shareholder interests; and promotion of governance structures that encourage increased accountability. BlackRock explicitly asks companies to provide information on how board effectiveness and performance is assessed. Vanguard and State Street have vocalized similar requests. The combination of these focus areas indicates a move from the big three towards governance models that go beyond oversight and compliance and to one focused on enhancing long-term sustainable performance. 

The big three have also taken leadership in the development of ESG integration and reporting.  The world of ESG reporting has struggled over the past decade to find a common reporting framework and language, such as those that exist in financial reporting with GAAP or IFRS. Against this backdrop, the high-profile publications and campaigns of the big three, together with collaborations such as BlackRock and Ceres, have served to provide direction for corporates and standard agencies, alike, and to give us all priorities we can begin to wrap our arms around. Further, BlackRock has publicly supported the Financial Stability Boards’ Task Force on Climate-related Financial Disclosure (TCFD) reporting standards, while Vanguard has aligned with the Sustainability Accounting Standards Board (SASB). These steps help provide companies with more insight into what types of information and in what format investors are looking for, and ultimately to help teams better communicate both performance and strategy.

Proxy Voting
Of course, all investors (passive or not) have proxy voting as a direct tool of influence, and the big three have certainly not shied away from exercising this power. While the big three are unlikely to initiate a proxy battle, their shares can become an important vote that can swing results. This was reportedly the case in the 2017 proxy fight at Procter & Gamble, where BlackRock and State Street supported activist Nelson Peltz in his bid for a board seat, and Vanguard voted with management. The voting was so close that a recount of the preliminary tally was required, and Peltz was eventually appointed to the board. [11]Another well-cited example is the 2016 ExxonMobil proxy battle. In this case, BlackRock and Vanguard jointly led a shareholder resolution to force the company to publish an annual assessment of the business impact of climate change policies, such as the 2-degree Celsius scenario ratified by the Paris Agreement.[12]

UNDERSTANDING INFLUENCE

The big three’s public campaigns have grabbed headlines and spurred discussion, however, is there evidence of meaningful influence on corporate governance practices? Analysis of voting results provides one tangible view on influence. As documented in recent research from the University of Amsterdam, the big three are seen to exercise consolidated voting practices across all funds held within a firm’s universe – supporting the view of structural power through ownership and voting influence.[1] Analyzing behavioural voting practices, the researchers found that the big three voted with management 90% of the time – suggesting a hesitancy to exercise power. However, proposals where the big three voted against management typically related to ESG issues, which given their nature are mainly proposed by activist shareholders.

These findings are further supported by a 2016 study which found that an increase in passive investment is associated with greater support for shareholder-initiated governance proposals.[13] The same study identified three corporate governance changes that are thought to be influenced by increased passive ownership. These are: increased board independence; removal of takeover defenses; and lower likelihood of unequal voting rights. The findings of the report suggest passive investors are conscience owners, and that managers today, face a more contentious and active shareholder base, despite an increase in passive investment and decrease in activism. While results provide compelling evidence for real influence exercised by the big three, additional research is required to understand if the influence of voice, and public campaigns by leaders such as McNabb and Fink are being internalized by management teams who are not in direct contact with governance teams or facing the big three in proxy battles.

One thing is clear, the big three are taking actions to engage with companies and vocalize their expectations in the realm of corporate governance in an effort to increase the long-term value of their holdings. In this way, good corporate governance is seen not as a matter of compliance, but rather as an indicator a quality of leadership and ultimately an enabler of better performance. 


Author

Viewpoint Research Team

 


[1] J. Fichtner, E. Heemskerk, J. Garcia-Bernardo. Hidden power of the Big Three? Passive index funds, re-concentration of corporate ownership, and new financial risk. Business and Politics. Retrieved at: https://www.cambridge.org/core/journals/business-and-politics/article/hidden-power-of-the-big-three-passive-index-funds-reconcentration-of-corporate-ownership-and-new-financial-risk/30AD689509AAD62F5B677E916C28C4B6

[2] EY. (2017). Reshaping around the investor: Global ETF Research 2017. Retrieved from: http://www.ey.com/gl/en/industries/financial-services/asset-management/ey-global-etf-survey-2017

[3] C. Stein. (December 4, 2017). Active vs. Passive Investing. Bloomberg. Retrieved from:  https://www.bloomberg.com/quicktake/active-vs-passive-investing

[4] A.M Soe., R. Poirier. (September 15, 2016). SPIVA U.S. Scorecard. S&P Global. Retrieved from: https://www.spglobal.com/our-insights/SPIVA-US-Scorecard.html

[5] Perishing Square. (January 26, 2016). Letter to Shareholders. Retrieved from: https://assets.pershingsquareholdings.com/2014/09/Pershing-Square-2015-Annual-Letter-PSH-January-26-2016.pdf

[6] W. McNabb. (June 24, 2017) Getting to Know You: The Case for Significant Shareholder Engagement. Harvard Law School Forum on Corporate Governance and Financial Regulation. Retrieved from: https://corpgov.law.harvard.edu/2015/06/24/getting-to-know-you-the-case-for-significant-shareholder-engagement/

[7] Vanguard (August 2017) Investment Stewardship 2017 Annual Report. Retrieved at: https://about.vanguard.com/investment-stewardship/annual-report.pdf

[8] http://www.statestreet.com/content/dam/statestreet/documents/values/StateStreet_2016_CorporateResponsiblityReport.pdf

[9] BlackRock (2015). 21st Century Engagement. Retrieved at: https://www.blackrock.com/corporate/literature/publication/blk-ceres-engagementguide2015.pdf

[10] BlackRock (2018). A Sense of Purpose. Retrieved at: https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter

[11] CNBC (2017). P&G appoints Peltz to board despite losing proxy battle. Retrieved at: https://www.cnbc.com/2017/12/18/pg-appoints-peltz-to-board-despite-losing-proxy-battle.html

[12]S. Mufson. (May 31, 2017). Financial firm lead shareholder rebellion against ExxonMobil climate change policy. The Washington Post. Retrieved at: https://www.washingtonpost.com/news/energy-environment/wp/2017/05/31/exxonmobil-is-trying-to-fend-off-a-shareholder-rebellion-over-climate-change/?utm_term=.79aa059f441c

[13] I. Appel, T. Gormely, D. Keil. (February 2016). Passive Investors, Not Passive Owners. Journal of Financial Economics.

Mac Van Wielingen Explores Drivers of Performance

Early in December 2017, Mac Van Wielingen addressed a small group of senior business leaders in Calgary. His talk titled, Advanced Governance: Strategy and the Imperative of Performance, explored the performance challenge facing most companies, critical drivers of performance and how they relate to strategy. The talk concluded with a selection of Advanced Practices aimed at assisting leaders in the development of great strategy. This blog recounts the key ideas and themes presented in Van Wielingen’s talk from my point of view as an audience member. A summary powerpoint presentation is also available​ here

THE PERFORMANCE CHALLENGE

Central to the discussion of performance is the empirical reality that most businesses eventually underperform and fail. Research shows that half to two-thirds of newly formed companies statistically disappear within their first five years.1 However, this performance challenge is not only a threat to newly formed companies, as numerous mature and once leading companies have also hit the wall of underperformance and/or experience high profile corporate meltdowns (i.e. Blackberry, Nortel, Lehman Brothers, etc.). 

“I focus on the point of performance, because I am always asking myself: What is the typical experience for a management group or board of directors? The evidence points to a typical experience of a serious, everyday performance challenge.”

Van Wielingen points to research exploring the theory of positive skewness, which has been shown to be prevalent in public equity returns, as well as private equity and venture capital.2 Positive skewness centres on nonsymmetrical distributed returns of a portfolio, as a result of numerous frequent small losses and a few extreme gains. Therefore, such a distribution, tells us that a small number of companies drive the overall value creation of a portfolio. Recent research from the University of Arizona,3 further supports the theory of positive skewness. Reviewing lifetime returns (listing to delisting) of 26,000 stocks over a 90-year period in the U.S., the study found that six out of 10 stocks did not outperform low-risk treasuries. The study points to the fact that as the overall stock market has outperformed low-risk treasuries – this performance can be attributed to a small number of companies.  Given this evidence, Van Wielingen cautions, “If we are going to run our businesses like most businesses are run, it is only reasonable to expect that you will end up like most businesses.”

However, do not pass this viewpoint off as an unduly pessimistic outlook. For, as Van Wielingen highlights, understanding the facts, allows us to ask ourselves“What can we do differently to increase the probability that our companies will survive?”

DRIVERS OF PERFORMANCE  

A copious number of business books and guides to corporate strategy have been written that promise to provide the secrets to success. Van Wielingen shares, “In my business career, I have been continuously searching for the one big driver of performance.” In his quest, he studied numerous drivers from vision to capital structure to culture (view a more complete list of performance drivers in the accompanying presentation.)  

“There is no silver bullet. There are multiple drivers. Each is essential; each offers the opportunity to create a competitive advantage. If any one of the fundamentals is missing, your organization may be in peril.”

The conclusion is that comprehensiveness is an essential ingredient for good strategy. Simple. All you must do is do everything, and it all well. Van Wielingen, himself admits that this is no easy task, it is hard work. Further, many executive leaders have told him that it all sounds too complex and overwhelming. To aid overwhelmed leaders, Van Wielingen points to the foundation of the Governance of Performance and a selection of Advanced Practices, which can help pave the way to integrate comprehensiveness into strategy. 

GOVERNANCE OF PERFORMANCE

Governance of Performance looks at the respective roles of management and the board of directors, and the structure of responsibilities and authorities within an organization. This is critical as it addresses how the board’s role links with organizational performance. The board has authority over all material fundamentals of an organization. This includes, but is not limited to, issuance of debt and equity, CEO selection and performance management, capital spending and material transactions. In Van Wielingen’s view, the role of the board goes beyond passive compliance and advisory, stating, the Board and Management are a partnership, sharing in the leadership responsibility of an organization – the board can be seen as the control partner and management is the executive partner.”

In this way, management has the responsibility to develop and implement strategy, but the board has the ongoing responsibility for essential due-diligence and, ultimately, the decision if the strategy is good/great and justifies the commitments of the organization. It is with this mindset that boards can move towards operating at an optimal level and fulfilling duties relating to performance.

FIVE ADVANCED PRACTICES

To conclude his talk Van Wielingen offers five Advanced Practices, all of which he has used, and seen to generate success. However, Van Wielingen stresses that this is not a complete list and there are many more that could be addressed.

  1. Vision - Find a way to describe your vision that is compelling and that is moving towards what is viewed as a leadership position in your industry.

  2. Strategy - Strategy creates coherence and rationale for the commitment of an organization’s resources. It must be integrated into the purpose of an organization. The most important condition is that strategy is comprehensive. Ask yourself if you can put a checkmark next to each driver of performance, and if there is internal consistency? What you are trying to achieve is broader than one variable it goes beyond solely profit. In addition to profit, purpose also needs to include a perspective on risk, timeframe, and quality of human experience.

  3. Organizational Competencies - We are generally well-aware of technical and functional competencies, but not as much of organizational competencies (i.e. leadership and communication), such as: priority setting; determining what is material; workplace coordination; and clarity and direction on values. An effective way to assess this is 360 performance reviews.

  4. Accountability - Accountability is the acceptance of responsibility and the willingness to be answerable for progress towards a desired outcome within a particular domain of responsibility. It is often a proxy for performance. A method to build a performance-based culture with high accountability is to implement self-evaluated progress monitoring reports.

  5. Culture - A large body of research tells us that there is a link between strength of culture and performance. (See: Predicting Corporate Performance from Organizational Culture[3] and Organizational Culture: Can it Be a Source of Sustained Competitive Advantage?[4]).

For a more detailed description please view the accompanying presentation.


IN SUMMARY

Highlighting the realities of pervasive underperformance, Van Wielingen makes a strong case for a need to re-envision how strategy is developed and how performance is managed. Central to his argument is the need for comprehensiveness within strategy, which embraces all key performance drivers both in how they are integrated into the purpose and internally managed. In Van Wielingen’s view, a critical component of sustained performance is the role of the board in strategy development and performance management. This role must go beyond the traditional passive, compliance-based role to include the sharing of leadership responsibilities in the organization. Providing insight on five selected Advanced Practices, Van Wielingen offers a path forward to leaders striving sustain performance of their organizations.



Author

Viewpoint Research Team


References

1) Parsley, C., & Halabisky, D. (2008). Profile of growth firms: A summary of Industry Canada research. Ottawa: Industry Canada, March 2008. 

2) Buchner, A. (June 2016). Dealing with non-normality when estimating abnormal returns and systematic risk of private equity: A closed-form solution. Journal of International Financial Markets, Institutions & Money. 45 (2016) 60–78. Available at https://www.sciencedirect.com/science/article/pii/S1042443116300488?via%3Dihub

3) Bessembinder, Hendrik. (November 2017). Do Stocks Outperform Treasury Bills? Journal of Financial Economics, Forthcoming. Available athttps://papers.ssrn.com/sol3/papers.cfm?abstract_id=2900447   

3) Gordon, G., & DiTomaso, N. (1992). Predicting Corporate Performance from Organizational Culture. Journal of Management Studies. 29. 783 - 798. 10.1111/j.1467-6486.19

4) Barney, J. (1986). Organizational Culture: Can It Be a Source of Sustained Competitive Advantage? The Academy of Management Review, 11(3), 656-665. Retrieved from http://www.jstor.org/stable/258317



Power, Politics, and the Dangers of a Narcissistic Leader

The beauty of me is that I’m very rich”1

“My IQ is one of the highest – and you all know it! Please don’t feel so stupid or insecure; it’s not your fault.”2

“I think I am actually humble. I think I’m much more humble than you would understand.”3

- President Donald Trump


Hearing these statements made by President Donald Trump, one might wonder how such a person was elected as the leader of the United States? Donald Trump has elicited concerns due to his comments on TV programs, his behavior at political debates and press conferences, and impulsive tweets. This has prompted some psychologists to attribute his behavior to the personality trait narcissism.4​

Narcissism ranges in severity from being an undesirable trait to a clinical disorder. Those who are highly narcissistic tend to have a grandiose sense of self and have an impaired ability to understand reality. Researchers have found that those who are high in narcissism take credit for the success of others while blaming others for failure,5 and are openly and publicly abrasive in interpersonal interactions with people that they dislike.6 Though high narcissism may be an undesirable personal trait, this blog explores if it has an impact on the effectiveness of leadership.

Research has found that high narcissism interferes with the ability to be supportive and facilitative of followers, which are core components of effective leadership. Leaders high in narcissism tend to possess a strong sense of entitlement and exploitiveness,7 which may lead to the manipulation of followers and impede the effectiveness of leadership.

In a study of 500 CEOs, narcissistic CEOs were also found to be more likely to engage in fraud and other negative behaviors.7 This increased tendency to engage in unethical behavior may be problematic in all leadership positions, but we would argue that even more so when that leader is in a government agency where high ethical standards and integrity are fundamental.

Knowing that narcissism relates to negative outcomes, how does a narcissistic leader gain support in the first place? 

Those high in narcissism typically have high self-worth and self-sufficiency. They tend to possess a strong sense of ego, which enables them to be viewed in a leadership position.8 Furthermore, studies have found that in a crisis, people may gravitate towards candidates with strong policies towards reducing the crisis.9 This is called terror management theory,10 which is a motivational driving force that causes humans to minimize risks to increase survivability. The central focus is on self-preservation, and thus all other needs are pushed aside to focus on this main motive. This may explain why voters felt compelled by the radical points of President Trump’s platform to protect U.S. citizens from external threats, such as his promises for “extreme vetting” to screen out potential threats.

SO, WHAT MAKES A GOOD LEADER?

In contrast to narcissism, humility has been regarded as a “critical strength for leaders and organizations possessing it, and a dangerous weakness for those lacking it.”11 There are three main traits of humility. First, leaders high in humility have self-awareness of their strengths and weaknesses. They also are open to new ideas and to sharing personal limitations. Finally, they can see the larger perspective and transcend goals of personal gain for those that benefit others. These traits allow humble leaders to empower their followers to focus on growth and learning, which has been shown to result in longer periods of sustained organizational performance relative to organizations with leaders who are low on humility.11

​Humble leaders are also likely to engage in transformational leadership, which is an effective leadership style centered on inspiring and motivating followers through a shared common goal. Transformational leadership has been related to a host of positive outcomes, such as follower satisfaction and increased organizational performance.12 Using power to help others is at the core of transformational leadership. If a leader is only interested in leadership for personal power, they may appear to be transformational, but fail to elicit the benefits of transformational leadership because they are engaging in self-promoting behaviors to exploit others.13

Humble leaders may excel in another effective form of leadership - ethical leadership.

Ethical leadership involves role modeling integrity, and setting the cultural norms and behaviors that trickle down to all levels of the organization. This trickledown effect was evidenced in a study involving 63 CEOs, 327 top management members, and 645 middle managers. 

The study showed that humble CEOs were effective at empowering the top management members, which subsequently influenced the organizational climate. The positive environment then empowered middle management and bolstered their performance.14 

Moreover, in a study involving 105 small to medium sized firms, humble CEOs were found to positively impact organizational performance15. Firms with humble CEOs were more likely to have effective communication processes, a strong shared vision, and better strategic planning. Such processes not only contribute to an overall stronger bottom line, but also often result in a positive experience for employees.16

 These findings suggest that for effective leadership, a leader should demonstrate high humility, such that they act with integrity and role model ethical behavior to the organization. Though leaders could be selected based on high humility as a personal trait, some actionable changes that any leader can engage in to practice humble leadership, include increasing communication with employees, empowering them in their day-to-day tasks, and involving them to some degree in the decision-making process. Humble leaders lead by focusing on the improvement of others, while narcissistic leaders focus on the improvement of themselves. By shifting the focus to the needs of the organization, leaders can practice more effective leadership.


Author

Stephanie Law, Viewpoint Research Team


References
1) King, N., Jr. (2011). Wall Street Journal.
2) CBS News. (2017). 
3) Stahl, L. (2016). The Washington Post.
4) Hosie, R. (2017). Malignant Narcissism: Donald Trump Displays classic traits of mental illness, claim psychologists. Independent. Retrieved from http://www.independent.co.uk/life-style/health-and-families/donald-trump-mental-illness-narcisissm-us-president-psychologists-inauguration-crowd-size-paranoia-a7552661.html
5) Gosling, S.D., John, O.P., Craik, K.H., & Robins, R.W. Do people know how they behave? Self-reported act frequencies compared with on-line coding by observers. Journal of Personality and Social Psychology, 1998, 74, 1337–49.
6) Kernis, M.H. & Sun, C.-R. Narcissism and reactions to interpersonal feedback. Journal of Research in Personality, 1994, 28, 4–13.
7) Vera, D., & Rodriguez-Lopez, A. (2004). Strategic Virtues: Humility as a Source of Competitive Advantage. Organizational Dynamics33(4), 393-408.
8) Paunonen, S. V., Lonnqvist, J., Verkasalo, M., Leikas, S., & Nissinen, V. (2006). Narcissism and emergent leadership in military cadets. The Leadership Quarterly, 17, 475 – 486.
9) Landau, M. J., Solomon, S., Greenberg, J., Cohen, F., Pyszczynski, T., Arndt, J., & Cook, A. (2004). Deliver us from evil: The effects of mortality salience and reminders of 9/11 on support for President George W. Bush. Personality and Social Psychology Bulletin30(9), 1136-1150.
10) Greenberg, J., Solomon, S., & Pyszczynski, T. (1997). Terror management theory of self-esteem and cultural worldviews: Empirical assessments and conceptual refinements. Advances in experimental social psychology29, 61-139.
11) Morris, J. A., Brotheridge, C. M., & Urbanski, J. C. (2005). Bringing humility to leadership: Antecedents and consequences of leader humility. Human relations58(10), 1323-1350.
12) Wang, G., Oh, I., Courtright, S. H., & Colbert, A. E. (2011). Transformational leadership and performance across criteria and levels: A meta-analytic review of 25 years of research”. Group & Organizational Management, 36, 223-270.
13) Chatterjee, A., & Hambrick, D. C. (2007). It's all about me: Narcissistic chief executive officers and their effects on company strategy and performance. Administrative science quarterly52(3), 351-386.
14) Ou, A. Y., Tsui, A. S., Kinicki, A. J., Waldman, D. A., Xiao, Z., & Song, L. J. (2014). Humble chief executive officers’ connections to top management team integration and middle managers’ responses. Administrative Science Quarterly59(1), 34-72.
15) Ou, A. Y., Waldman, D. A., & Peterson, S. J. (2015). Do humble CEOs matter? An examination of CEO humility and firm outcomes. Journal of Management, 0149206315604187.
16) Pettit, Jr, J. D., Goris, J. R., & Vaught, B. C. (1997). An examination of organizational communication as a moderator of the relationship between job performance and job satisfaction. The Journal of Business, 34, 81-98

Is Ethical Culture in Banks an Oxymoron?

Canadian banks have had the bragging rights of not following in their southern neighbors’ footsteps during the financial collapse of ‘08/’09. However, recent allegations from employees of Canada’s five major banks of intense pressure to meet sales goals, even at the unethical expense of misleading clients, sounds eerily similar to the recent Wells Fargo scandal.

The toxic sales culture in Canadian banks was brought to light after “Go Public” (an investigative news segment of the CBC) reported that staff at TD were experiencing intense sales pressure, with the threat of dismissal should they not meet quotas. Over 1,000 emails from employees at the other four major banks(Scotiabank, BMO, CIBC, and RBC) detailing the same issues followed shortly after that initial report.

Even though the Financial Consumer Agency of Canada (FCAC) has started a business practices probe that will look at sales practices and whether guidelines on express consent and fee disclosure are being followed, there is still the question of how it was allowed to get this bad in the first place. 

WHAT’S HAPPENING IN THE STATES

In America, a similar ethical dilemma is being fought in the courts, with Wall Street continuing to fight for brokers’ right to give unregulated advice to retirement investors. Currently, it is legal for financial professionals to recommend higher-cost investment products that provide them with a higher commission but their clients with lower returns. Investors choose these options because they are endorsed by their advisers, believing that they are receiving advice that suits their best interests. 

This is happening at an expedited rate, given that the fiduciary rule set into motion by the Obama Administration that would require the protection of investors welfare, was supposed to be implemented earlier this month. However, on April 5, the Department of Labor delayed implementation of the rule until at least June 9. 

This process was first started in 2010, but action was delayed so that stakeholders could be consulted, the current version of the rule was proposed in 2015. A press release from the Economic Policy Institute states that, “Every seven days that the rule’s implementation is delayed will cost retirement savers $431 million over the next 30 years. All told, the proposed 60-day delay will cost workers saving for retirement $3.7 billion.”

IT ALL BOILS DOWN TO CULTURE

Culture and ethics need to be an ingrained and put into practice, instead of having policies in place that tick off all the right boxes, but are only reviewed during training or predetermined reviews. This matters in banking just as much as it does in other industries. 

“the risk management failures at so many leading global financial institutions were not merely isolated events—a rogue trader here and a deviant employer there—but rather reflections of systematic breakdowns in corporate culture.”
— Anjan Thakor (2016) 

Other major events such as the financial crisis did bring culture to the forefront of important topics for bank executives and regulators, it doesn’t seem to have made a lasting impact. How a company explicitly outlines their culture, versus how it is embodied in the day-to-day can often be two very different things. It is a driving force behind how an organization operates, and needs to be distributed top down, rather than just a statement in the employee handbook to become pervasive. 

A successful culture supports how a business executes its growth strategy, and positively influences all aspects of decision-making. Additionally, when an employee feels engaged with, and a part of the business in a positive way, there is less of a need to rely on incentives, or job security, to bring about a desired behavior or outcome.

So even though the intention behind selling more products to clients may have started out as an innocent way to increase revenue, it certainly didn’t remain so. And while Canada’s banks haven’t reached the level of scandal that Wells Fargo did, they appear to have been on their way. Enabling employees and consumers to hold institutions accountable to their promises and policies of an ethical way of doing business can go a long way towards achieving long-term success.


Author

Viewpoint Research Team


Sources used for this post:

Bradshaw, J. (2017). Federal watchdog to review banks’ sales tacticsThe Globe and Mail. Retrieved 17 April 2017, from http://www.theglobeandmail.com/report-on-business/canadian-watchdog-to-review-banks-sales-tactics/article34309072/

Burne, K. (2016). Bankers, Regulators Find No Easy Answers at Bank Culture WorkshopWSJ. Retrieved 22 April 2017, from https://www.wsj.com/articles/bankers-regulators-find-no-easy-answers-at-bank-culture-workshop-1476998844

Edwards, B., & Lazaro, C. (2017). Investors Pay If Wall Street Wins a Fiduciary-Rule DelayBloomberg View. Retrieved 20 April 2017, from https://www.bloomberg.com/view/articles/2017-03-28/investors-pay-if-wall-street-wins-a-fiduciary-rule-delay

Ernst & Young. (2014). Shifting Focus: Risk Culture at the Forefront of Banking. Ernst & Young. Retrieved from https://webforms.ey.com/Publication/vwLUAssets/ey-shifting-focus-risk-culture-at-the-forefront-of-banking/$File/ey-shifting-focus-risk-culture-at-the-forefront-of-banking.pdf

Johnson, E. (2017). Bank call centre staff reveal pressure to turn customer inquiries into salesCBC News. Retrieved 11 April 2017, from http://www.cbc.ca/news/business/banks-sales-tactics-call-centres-go-public-1.4030981

Ligaya, A. (2017). Watchdog reports surge in bank complaints in wake of high-pressure sales tactics allegationsFinancial Post. Retrieved 10 April 2017, from http://business.financialpost.com/news/watchdog-reports-surge-in-bank-complaints-in-wake-of-high-pressure-sales-tactics-allegations

Linnane, C. (2017). Are Canadian banks headed toward a Wells Fargo–style scandal over sales tactics?MarketWatch. Retrieved 27 March 2017, from http://www.marketwatch.com/story/is-there-a-wells-fargo-like-bank-selling-scandal-breaking-in-canada-2017-03-15

McGee, S. (2016). Wells Fargo's toxic culture reveals big banks' eight deadly sinsthe Guardian. Retrieved 13 April 2017, from https://www.theguardian.com/business/us-money-blog/2016/sep/22/wells-fargo-scandal-john-stumpf-elizabeth-warren-senate

Salinger, T. (2017). Fiduciary rule to spawn thousands of low-fee mutual fund shares: Morningstar. Financial Planning. Retrieved 21 April 2017, from https://www.financial-planning.com/news/morningstar-fiduciary-rule-boosts-offerings-of-low-fee-mutual-funds

Thakor, A. (2016). Corporate Culture in Banking: Why It MattersOxford Law Faculty. Retrieved 15 April 2017, from https://www.law.ox.ac.uk/business-law-blog/blog/2016/10/corporate-culture-banking-why-it-matters

Trump delay of the ‘fiduciary rule’ will cost retirement savers $3.7 billion. (2017). Economic Policy Institute. Retrieved 27 March 2017, from http://www.epi.org/press/trump-delay-of-the-fiduciary-rule-will-cost-retirement-savers-3-7-billion/

Wursthorn, M. (2017). Billions Gush Into Merrill’s Fee Accounts as Obama-Era Rule LoomsWSJ. Retrieved 20 April 2017, from https://www.wsj.com/articles/billions-gush-into-merrills-fee-accounts-as-obama-era-rule-looms-1492531169?tesla=y

Decision rights: Who has the authority?

Our previous blog post discussed the pros and cons that are associated with distributed leadership. One of the facets of distributed leadership promotes, initiative and leadership responsibilities at all levels of a firm. In order to do this, everyone from front-line workers to upper management must have a clear understanding of what decisions they do, and do not have authority over.

This post delves more deeply into understanding why this concept of so called “decision rights” is important, and examines the methods and practices behind successfully establishing, and implementing the authority behind a person’s decision rights.

Job titles and the ladder of corporate hierarchy have been traditionally linked with decision rights, with the assumption being that the higher the pay grade, the more empowered a person is to make decisions. However, even if your organization does not subscribe to the idea of distributed leadership, there are still going to be instances in which your employees will need to make decisions.

They need to have a clear understanding of which decisions and actions to take the lead on themselves, and which to bring to the attention of their superiors. 

Decision rights is a difficult practice to get right. Michael C. Jensen and William H. Meckling (1992) state,“allocating decision rights in ways that maximize organizational performance is an extraordinarily difficult and controversial management task.” Often leaders either do not want to relinquish decision-making power because they see it as theirs. Or, it is their own cognitive bias that distorts their judgments and knowledge as being superior to others. However, it is important to overcome these barriers, because the benefits of doing so have been linked to profound improvements in employee satisfaction, the everyday operations of the business, and the bottom line.

One of the most important benefits of decision rights is encountered in its absence and a decision is moved away from the frontlines of an organization, resulting in the unnecessary time that is added to how long it takes to execute the answer. Because of this, in order to be effective and efficient in executing business strategies, accomplishing goals, and mitigating risks, decision authority needs to be put in the hands of the person who possesses the most relevant information.

When this is not implemented correctly, and upper-management or executive level leaders are involved in decisions that are not aligned with their knowledge base, a huge amount of wasted time, money and resources are incurred. Not every problem or judgment is appropriate to bring to the attention of the CEO.

“Decision rights are closely related to governance… [but] go beyond the standard approach to governance, cataloguing critical decisions that must be made, identifying who is closest to the relevant information that will help them make these decisions, and documenting who will ultimately be accountable for the decisions that are made.” 

-Deloitte (2011)

Another benefit to distributed leadership is that an employee’s satisfaction increases when they have higher levels of purpose through understanding what is expected of them, these expectations can then be worked towards and delivered on a regular basis.

CREATING A FRAMEWORK FOR DECISION RIGHTS ALLOCATION

  • Have a comprehensive inventory of the key decisions that are made most commonly by your firm

  • Clearly define the weight of the cost that each decision carries

  • Plainly establish the procedures of the decision-making process (e.g. problem and tracking tools, escalation processes etc.)

  • State explicitly the ownership of each decision

  • Outline the hierarchy of decision makers or decision-making groups

  • Have a set review schedule and update the distribution of decision authority accordingly should there be any changes

  • Don’t mix up the outcome with the decision process (if the decisions authority has been well allocated then changing it based on a less favourable outcome will make the problem worse next time)

Decision rights are important in companies of all sizes, but even more so as the size and complexity of an organization increases. Peter Jacobs (2005) argues that “how effective an organization is at making high-quality decisions consistent with its mission and objectives… is a prime determinant of its ability to compete in the marketplace.” Finding the right balance between standardization and agility is critical.

Decision making authority is a constantly changing aspect of a firm. Below are examples of when a company should examine and potentially change their framework and policies.

TRIGGERS SIGNALLING THE NEED FOR CHANGE

  • Growth strategies

    • New markets, products, and organizational structures

    • When companies go global, communication lines are stretched and leaders are removed even further from the action


  • New executive team

    • New leaders may have different ideas about decision making

    • Making sure all employees are on the same page regarding decision making authority is crucial


  • Mergers and acquisitions

    • Each company has their own culture and way of doing business

    • If decision making authority does not match once the firms have combined then there will be redundancies, inefficiencies and mistakes


  • Strategy or operating model changes

    • When any aspect of the business changes, decision rights need to be reassessed


  • Quality focus and regulatory changes

    • Global regulations impose new decision making criteria

    • Managing these new requirements and confirming compliance necessitates new processes, procedures, and means of oversight


  • Need for increased speed to market

    • The key is finding quality data, which often requires working across hierarchies and locations to achieve a broader view of opportunities and risks

    • Decision rights can help overcome the tendency towards risk avoidance and subsequent delays in decision making by enabling business leaders to quickly identify and analyze the required information acquired by those on the frontline

In almost any enterprise, in order to achieve effective and fast execution, collaboration and collective decision-making is essential.

Having decision rights that are clearly defined will help drive an organization’s efficiency, accountability, and empower employees at all levels of the firm to make the best decisions possible when necessary.  

When executed correctly, there seems to be no end to the benefits of properly allocated decision rights. A company’s human capital is arguably one of its most valuable assets, and utilizing this competitive advantage to its fullest extent helps enable companies to thrive in the marketplace.


Author

Viewpoint Research Team


Sources used for this post:​​​​

Athey, S., & Roberts, J. (2001). Organizational design: Decision rights and incentive contracts. The American Economic Review91(2), 200-205.

Deloitte, (2011). It's Your Decision. Deloitte.

Jacobs, P. (2005). Decision Rights: Who Gives the Green Light? [online] HBS Working Knowledge. Available at: http://hbswk.hbs.edu/item/decision-rights-who-gives-

the-green-light [Accessed 7 Apr. 2016].

Jensen, M. C., & Meckling, W. H. (1992). Specific and general knowledge and organizational structure

Success: Ethical Failure in Leadership

The topic of success’s dark-side was recently brought up, and the more that it was explored, the more facets it seemed to have. Facets such as, in-fighting among top executives or family members in successful companies, the never ending battle to find the next big talent, and the loss of ethics that lead to scandal, all of which deserve to be explored fully in their own posts.

The recent scandals that have been dominating news feeds this past year, along with the questions of how and why leaders with well-established integrity and leadership track records come to engage in unethical practices.

ETHICS (OR LACK THEREOF) AND LEADERSHIP ACROSS SECTORS

Reports that detail ethical violations by managers and executives continue to occur despite ethics being considered pivotal to organizational success, and receiving increased attention by firms and business schools. Trust in corporations and how they are run has never before been subjected to the level of public scrutiny that it is now. Advances in technology, the internet, and social media make it increasingly easy to check up on businesses and their practices.

Leaders at all levels can talk the talk of ethics all they want, but unless they are also walking that ethics walk it becomes meaningless.

This is not only seen in business, but in other arenas where ethics and honour are held in high esteem such as sports. The scandals surrounding FIFA, the Olympics, and other elite athletic competitions such as the Tour De France, are but a few examples of where the ethics talk certainly does not match up with the walk.

Spectators and athletes who compete fairly are becoming increasingly disillusioned with the competitive culture of sports and how it is getting out of hand. It is more and more common for those who win at any cost through corruption, and monetary advantages to be met with public derision and harsh penalties.

Politics is another area where ethics is ideally a key piece of the foundation on which individual politicians and their platforms run. However as the news so continuously, and delightedly informs us, this is often not the case. This seemingly endless American federal election has provided countless examples of this.

And while America’s larger-than-life presence often dominates, this is a world-wide phenomenon and Canada has had its fair share of ethical failures.

HOW SUCCESS AND ETHICAL FAILURE ARE CONNECTED

Ludwig and Longenecker suggest that competitive pressure can certainly be a factor behind why some leaders abandon their principles and commit ethical violations. This notion that the ethical failure of leaders – in all sectors – is largely due to lack of personal principles, or the state of the climate of the market, is argued to be only half of the story.

“The media, politicians, and the general public frequently characterize these leaders as bad people, even calling them evil. Simplistic notions of good and bad only cloud our understanding of why good leaders lose their way, and how this could happen to any of us.”— George, 2011

Success and lack of preparedness in dealing with personal and organizational success is actually the issue. Our society places a high priority on being successful, yet there is little attention placed on preparing people to deal with the aftermath of success once it is achieved.

There were a number of reasons discussed in the literature that outline why success can lead to ethical failure:

  • Success can lead to complacency and loss of focus

    • Attention is diverted away from the management of their business, and teams are left unchecked

  • Personal and organizational success can lead to privileged access to information, people, or objects

    • Information can be used to the leaders advantage (i.e. insider trading)

  • Success often includes increasing control over organizational resources

    • Resources can be diverted to areas more focused on personal interests rather than to what is best for the organization

  • Success can lead to an inflation of a manager’s belief in their personal ability to manipulate outcomes

    • External factors that may also be influencing the organization’s performance are discounted (See previous post on bias)

  • Leaders who are successful can lose their ability to gain satisfaction from what they have already achieved, and what they have becomes not enough

    • This can translate into greed which can lead to a loss in perspective and unethical behaviours being rationalized

    • Not initially getting caught in this cycle can increase the feeling of invincibility and the likelihood of additional unethical choices being made in the future

  • Personal isolation and a lack of intimacy with family, friends, and colleagues can become an issue

    • Not being able to discuss problems, and long hours spent away from home can cause a loss in a valuable source of personal balance

While none of these reasons should be looked at as excuses for those who experience ethical failure, the issue is not as simple as labelling someone good or bad. Anyone can fall into the trap of success if they are not properly prepared for all of the stresses that are associated with said success.

MITIGATING THIS RISK

There are a number of ways in which you can prepare yourself, your leadership team, and your organization for success.

The first and most obvious should be that ethics must be an ingrained characteristic in those that you hire. Building a team who is ethical helps to inspire those around them to lead by example.

Your company’s board should also be actively aware of your management team’s personal and psychological balance. Before anyone is appointed to a leadership role they need to understand and express why it is that they want to lead, as well as what the purpose of their leadership is, and what it will achieve for the company, and for themselves personally. If the answers to these questions honestly revolve around concepts such as money, power, and prestige, then these candidates run the risk of primarily considering external gratification as their measure of fulfillment, and are most at risk of ethical failure.

While there is nothing wrong with placing value on these visible external symbols of success, they must be “combined with a deeper desire to serve something greater than oneself” (George, 2011) in order to maintain a firm grip on the high standard of ethics that most leaders start out with.

Regularly scheduled audits of critical organizational decisions, processes and resources, clearly established ethical codes of conduct, and a strictly enforced policy that protects employees who report unethical behaviour heighten both awareness and compliance.

In both the VW and Wells Fargo examples that were linked to at the beginning of this post, there was evidence that employees who tried to go against the grain of established unethical practice were fired for either not meeting the excessively unrealistic criteria, or, for bringing unsavoury information to light – to either leaders, or the public.

If we are able to reframe our perception of leaders from hero to servant of the people they lead, the psychological challenges listed above may be easier to mitigate due to fact that these expectations that people often have of what they deserve once success is achieved will not be as prevalent. 

No matter what sector you are looking at – sports, politics, or business – an organization whose leadership team is entirely composed of members who are the physical embodiment of ethics and fully capable of wise decision-making, can still become a victim of the temptations that are offered to – or seen to be deserved by – the powerful and successful.

The dichotomy of good versus bad in our current portrayal of scandals in the media is not representative of the underlying issues. If this continues, and the root of the problem is not addressed, then no matter how much effort, time, and money, business schools and firms put towards ethics education, scandals will continue to happen.

The negative aspects of success are not always obvious, but they are nevertheless present. It is how well we understand ourselves, and are able to see these dangers to effectively diminish them that count.


Author

Viewpoint Research Team


Sources used for this post:

Brimmer, S. (2007). The Role of Ethics in 21st Century Organizations - Leadership Advance Online, School of Business & Leadership, Regent University, Virginia Beach, VirginiaRegent.edu. Retrieved 21 November 2016, fromhttp://www.regent.edu/acad/global/publications/lao/issue_11/brimmer.htm

de Botton, A. (2013). Business and PhilosophyThe Huffington Post. Retrieved 28 October 2016, from http://www.huffingtonpost.com/alain-de-botton/business-and-philosophy_b_4170623.html

George, B. (2011). Why Leaders Lose Their WayHBS Working Knowledge. Retrieved 17 October 2016, from http://hbswk.hbs.edu/item/why-leaders-lose-their-way

Ludwig, D. C., & Longenecker, C. O. (1993). The Bathsheba syndrome: The ethical failure of successful leaders. Journal of Business Ethics12(4), 265-273.

Mellahi, K., Jackson, P., & Sparks, L. (2002). An exploratory study into failure in successful organizations: The case of Marks & Spencer. British Journal of Management13(1), 15-29.

Poulsen, A. (2015). Why Future Business Leaders Need PhilosophyBig Think. Retrieved 26 October 2016, from http://bigthink.com/experts-corner/why-future-business-leaders-need-philosophy

When Information Asymmetry is Found Between Board Members and the Management Team

Running a company and ensuring its continued success is no easy task.

All hands must be on deck with up-to-date information to make the best decisions possible. This ideology is often called into question when directors feel as though they are at a disadvantage because they are not as involved in the day-to-day operations of the company like managers are. When this breakdown occurs it is known as “information asymmetry.”

There is an abundance of both scholarly and popular work done on this topic. In general, information asymmetry occurs in relationships where one party has more - or better - information than the other. This imbalance typically creates outcomes that are either unfair, or achieve poor results. In this case, information asymmetry refers to the perception that boards have less information about the organization than the management team they are meant to monitor and advise.

In situations where this occurs, management-board information asymmetry presents as a problem when there is a breakdown in communication. If there is an absence of trust, or worse yet, the presence of deception between the board and management, the board’s role as a critical governance mechanism is undermined, and poor decisions are made due to the lack of information, or the presence of inaccurate information.

The reading that I have done for this blog post examines how information asymmetry affects businesses, and how the relationship that exists between managers and directors is important to the organization’s overall success.

CAUSES OF INFORMATION ASYMMETRY

The causes of information asymmetry are numerous, and can range from innocent to disreputable.

On the innocent side of the spectrum, the issue revolves around time. Many directors often hold not just multiple other directorships, but also full-time positions at other corporations – which then creates extremely tight time constraints on how much attention they are able to put towards each role.

Because non-executive directors have limited involvement in the day-to-day decision making processes of the company, their ability to monitor the quality of top management’s strategic decisions is often limited to board interactions. Because of this, they then rely on the CEO to provide them with relevant firm-specific information, which may not always be given voluntarily. The resulting information asymmetry may hamper their ability to properly fulfill their monitoring duties, which in turn negatively affects firm performance. 

The paradox of managers wanting advice and counsel from board members, but not wanting to be monitored or influenced too heavily is another common reason information asymmetry is a persistent problem for companies. Perhaps because of the board’s lack of on-the-ground experience at the firm, their advice can be seen as more of a guiding tool than actual decisions on strategy that are to be implemented. The disreputable component of this paradox is that the information is not being voluntarily provided because the boards monitoring could uncover fraudulent behaviour, or mismanagement.

The paradox is a particular risk for two types of firms. The first is one that has numerous independent board members. This is because an independent board is typically viewed as a tougher monitor, therefore, the CEO may be reluctant to share information with them. The second is one that is a family run organization that has multiple family members on its board. The information that is shared runs the risk of being skewed in the family's favour, but may not be what the board needs to know in order to make the best decisions for the company overall.

IS INFORMATION ASYMMETRY ALL BAD?

In all of the doom and gloom that the majority of the articles that I read regarding this topic, there were a couple shining lights that advocated its often overlooked positive attributes in board effectiveness.

While independent board members may not have detailed knowledge of the business, their external role, knowledge and professional experience allows them to view the company objectively, from alternative perspectives, and through different lenses than managers. This allows them to be critical in their advisory and monitoring roles. This external knowledge should be seen as complementary to the manager’s internal knowledge rather than out-of-sync or asymmetric.

Those who viewed information asymmetry as positive saw the negative issues surrounding it to be based on the breakdown in communication between management's implicit (primary direct experience) and the board's explicit (secondary sources such as papers, reports, and presentations) knowledge and information. Acknowledging the two types of knowledge or information sources as different rather than superior versus inferior made for healthier organizations as a whole.

“The very existence of the board as an institution is rooted in the wise belief that the effective oversight of an organization exceeds the capability of any individual and that collective knowledge and deliberation are best suited to the task.”
— Brennen & Redmond, 2001

WAYS TO COMBAT THE NEGATIVE EFFECTS OF INFORMATION ASYMMETRY

There are a number of steps that you can take to curb the presence of negative information asymmetry in your leadership teams:

  1. Independent directors – Having the appropriate balance of independent directors on your board is key to getting the level of voluntary disclosure of corporate information needed to make educated decisions for your company’s strategy. A compromise must exist between independence and competence in order to create a group that is optimally efficient.
     

  2. Audit committees – Having an audit committee as part of your board is significantly and positively related to the extent of voluntary disclosure. They ensure the quality of financial accounting and control systems. They can also influence the reduction of the amount of information that is withheld from the board.

Directors with expert knowledge in financial control can affect the transparency of their companies through the creation of more accurate information and better audited financials. A director who qualifies for financial expertise has the following:

  • Is a graduate of a business school or university in the field of management, with accounting or finance

  • Has experience in dealing with finance (financial managers, financial inspectors, auditors, lawyers with an accounts specialization etc.)

  1. Transparency - To improve transparency and accountability there should usually be a separation of the CEO and board chairman roles, and (in the case of family run businesses) a limit to the number of family members involved on the board.
     

  2. A well-defined schedule for meetings - To ensure efficiency and good communication, a set board meeting schedule should be established. There were varied answers when it came to the optimal number of meetings boards should be having every year – ranging from quarterly to every 2 months. However, there was consensus that the higher the frequency of meetings, the higher the level of quality in voluntary information sharing and financial reporting.

Board directors require deep background knowledge and timely updates about firm activities and results. A higher meeting frequency puts greater pressure on managers to provide supplementary information. Because these meetings are often the only time board members get together with each other and the management team, having a high attendance rate at each meeting is seen as a way to decrease information asymmetry between all parties and promote more effective functioning of the board and management team overall.

Information asymmetry between board and management is a fact. The management team does have more firm-specific knowledge, and board members do depend on management for much of their information. It is also a fact that external board members have alternative perspectives and expertise to bring to the table.

The solution to the negative aspects of management-board information asymmetry is based on managers engaging with boards and being required to account for their actions and to make explicit what otherwise would be implicit and inaccessible. Keeping lines of transparent communication open will enable differing individual experiences to work together.


Author

Viewpoint Research Team


Sources used for this article:

Adams, R. B., & Ferreira, D. (2007). A theory of friendly boards. The Journal of Finance62(1), 217-250.

Ajina, A., Sougne, D., & Laouiti, M. (2013). Do Board Characteristics affect Information Asymmetry?. International Journal of Academic Research in Business and Social Sciences3(12), 660.

Brennan, N. and Redmond, J. (2001). Boards, Management and the Information Asymmetry Paradox.

Cormier, D., Ledoux, M. J., Magnan, M., & Aerts, W. (2010). Corporate governance and information asymmetry between managers and investors.Corporate Governance: The international journal of business in society,10(5), 574-589.

Ho, S. S., & Wong, K. S. (2001). A study of the relationship between corporate governance structures and the extent of voluntary disclosure. Journal of International Accounting, Auditing and Taxation10(2), 139-156.

Karamanou, I., & Vafeas, N. (2005). The association between corporate boards, audit committees, and management earnings forecasts: An empirical analysis. Journal of Accounting research43(3), 453-486.