What’s the Future of Corporate Governance?

by James Heskett

Summing Up

Future Corporate Governance: Different, But More Effective?

Shann Turnbull suggests that the world of corporate governance will benefit from the establishment of "a new type of corporate information and control architecture.”

Speculation on the future of corporate governance in response to last month's column suggests both a conclusion and a question: It will be different, but will it be more effective?

First, the differences. Corporate governance in the future will, according to Devdip Ganguli, reflect an increasing emphasis on customer satisfaction as a way of measuring the adaptability of the organization over time. As he put it, "By focusing too strongly on financial records (and audit committee work), we lose sight of the fact that departments like operations and human resources are very important components (in forecasting future success). (Phrases in parentheses are mine.)

Shann Turnbull suggests that the world of corporate governance will benefit from the establishment of "a new type of corporate information and control architecture." In fact, he goes beyond this to propose that a network of more specialized board groups and "advisory stakeholder councils" comprising employees, lead customers, suppliers, and others offers a useful solution to the governance vacuum that exists in many large corporations today.

Not so fast, says Gopi Vaddi. While agreeing that "customer and employee satisfaction and loyalty are indeed good predictors for (the) future success of a company," he suggests that these measures have to be viewed with a long-term lens, one that accommodates the fact in the short-run, managements may take actions to reduce costs and the size of the labor force to achieve long-term success—actions that could adversely affect non-financial indicators used as inputs for corporate governance.

Vaddi provides a list of questions that need to be answered if a "public" balanced scorecard of non-financial information is to be created. "Who will perform the audit? What are the guidelines? Who pays for it? Should there be an independent firm that is appointed by the SEC?"

What do you think?

Original Article

Observers such as Jay Lorsch, in his book Pawns and Potentates, has argued that boards of directors often have insufficient information with which to perform their duties. Some don't invest the time necessary to provide effective oversight of management activities. And many are reluctant to tread too closely to the line between oversight and management. This may help explain why boards are accused of acting far too slowly in discharging their ultimate duty, insuring proper leadership for an organization.

Robert Kaplan and David Norton, in their books, The Balanced Scorecard and The Strategy-Focused Organization, have argued for performance measures and reward practices that reflect predictors of future success as well as a continued almost-total reliance on largely historic financial measures. In a book that I wrote with Earl Sasser and Len Schlesinger, The Service Profit Chain, we discussed the mounting evidence that customer and employee satisfaction and loyalty are far better predictors of future financial success than are measures of past financial success. They would be strong candidates for inclusion in any organization's balanced scorecard.

Among board committees, the audit committee has historically received the most attention. Not only are boards expected—and in case of publicly financed organizations required—to have one, independent, so-called "outsider," director membership on the audit committee has been strongly prescribed. Increasingly, audit committees are called to task for their responsibilities and required to co-sign important communications to shareholders.

While all of this is going on, of course, governance continues to go astray. An organization's books may be in order, but its performance may be going down the tubes. What's to be done?

Should the growing number of governance committees require management to establish certain measures—in this case, measures disclosing trends in customer and employee satisfaction and loyalty—that help predict future performance? Should they be responsible for the regular auditing of such measures? Should the measures be made available to investors on a regular basis? In fact, should the SEC or another organization require the disclosure of such information, just as it now requires the disclosure of somewhat meaningless (at least for future investors) historic financial information? What do you think?

    • Devdip Ganguli
    • Sri Aurobindo International Centre of Education (Pondicherry, India)

    Although historic financial performance can be a factor in predicting future success, it is far from being the most important one. A financial scorecard gives the prospective investor an idea of the financial health and reliability of the company. But it is not a reliable yardstick to measure future performance for the simple reason that we see that now, more prominently than ever before, market trends don't stay in tune with past performance alone. Today's economy demands performance complemented with dynamic change. A way to measure adaptability is sustained customer satisfaction.

    What, therefore, becomes important in a volatile economy is how happy the customers are. After all, it is they who decide the fate of a company. Perhaps it makes more sense today to talk about customer/employee satisfaction than sheer financial performance. Companies like Lucent and Kodak (both part of the list of America's Worst Boards as compiled by Business 2.0) would benefit if their directors kept their ears open outside the boardroom.

    As for the issue of corporate governance in the broader sense, what is honestly lacking today is common-sense perspective. While audit books are a necessary aspect of an organization, the importance allotted to them alone defeats the purpose of progress in the organization, both outwardly and in terms of customer/employee satisfaction. By focusing too strongly on financial records, we lose sight of the fact that departments like Operations, and Human Resources are very important components in the amalgamation of an organization.

    Leadership that is bold, willing to listen and adapt, young at heart, and endowed with common-sense priorities will be at the helm of tomorrow's leading companies. It's about time we realized that.

    • Gopi Vaddi
    • Engineer, Avici Systems

    Customer and employee satisfaction and loyalty are indeed good predictors for future success of a company. This should be viewed in conjunction with historical financials and future development strategies of the company. Also, since this is valuable information, it should be binding on the company to release such data.

    But we need to answer a few questions. Who will perform the audit? What are the guidelines? Who pays for it? Should there be an independent firm that is appointed by the SEC?

    Employee satisfaction should be viewed in conjunction with the state of the company. Consider a big company trying to stage a comeback and reducing operating expenses by laying off some of its employees. Remaining employees go through a bad phase and their morale in such situations is low. But this move is for the ultimate benefit of the company. This is also true in cases where the employees are investors (by way of stock options or otherwise) and there is a general market correction. The employee is effected. There is little that the management can do about this.

    • Raul Bantug Tan

    Interestingly enough, I just attended a talk given by one of our professors at the AIM (Asian Institute of Management) regarding the correlation of corporate governance and banking performance.

    While I may not have subscribed to all of her conclusions, I do feel that corporate governance is a necessary evil in today's corporation.

    Why a necessary evil? Well, first of all, there are no hard and fast rules regarding its role as a major factor in profits. In fact, in less developed countries, it may be a hindrance. However, it all goes back to the basic question of human nature and ethics, and the conflict to be found between them.

    Human nature, as such, would more likely flout the rules (or tell a white lie) in the face of a windfall. Ethics, however, nags our consciousness (well, most of the time anyway) into doing the right thing. In the absence of a conscience, it is really up to the internal and external systems to keep the balance.

    It is from this point of view that I believe we should look. Public policy should work with private interest groups (or industry associations) to ensure that audits are carried out—independent of the company—on a regular and random basis. Internal auditors tend to be loathed and can be powerless in the face off a powerful board of directors.

    Professional and experienced auditors should be recruited by the concerned regulatory body to work hand in hand with the private sector and reach a platform of understanding that subscribes and prescribes professionalism in all aspects of the corporation.

    • Shann Turnbulln
    • Honorary Associate, APRIM, Macquarie University

    Future corporate governance will mitigate the problems identified by you and Jay Lorsch by establishing a new type of corporate information and control architecture. A network of boards and advisory stakeholder councils will govern sustainable competitive corporations.

    Network governance provides the only way to mitigate the information overload introduced by a unitary board through decomposing decision-making labor. Network information and control systems can also provide requisite variety of information feedback and control from strategic stakeholders to provide competitive advantages. This will require employees, lead customers, suppliers, and members of the host community to be organized into self-appointed advisory councils in order to bond and integrate their interests with the corporation's. Network boards remove and use the conflicts of interest between stakeholders who Michael Porter recommended be integrated into corporate governance in his 1992 Research Report on Capital Choices.

    Network boards introduce "distributed intelligence" and specialize in decision-making labor in a way similar to M-Form firms. Watchdog boards take over the compliance roles of auditing and governance boards take over the role of nominating and remunerating directors. This greatly simplifies the duties of the executive board to increase shareholder value. In addition, non-executive directors become politically independent of management and can obtain information independent of management from the stakeholder boards to evaluate management and the strengths, weaknesses, opportunities, and threats of the business.