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Reputability LLP are pioneers and leaders globally in the field of reputational risk and its root causes, behavioural risk and organisational risk. We help business leaders to find these widespread but hidden risks that regularly cause reputational disasters. We also teach leaders and risk teams about these risks. Here are our thoughts, and the thoughts of our guest bloggers, on some recent stories which have captured our attention. We are always interested to know what you think too.

Wednesday, 16 October 2013

Values in the City

Bankers were painted in varying shades of amorality and incompetence after the banking crisis.  The City Values Forum has spent two years trying to re-set and restore standards of integrity among London bankers.

The Forum's conference, on 15 October, publicised their progress. They have plenty to say on what integrity might look like.  With help from the City HR Association, they have produced a 'Gold Standard' for 'Performance linked to values'.

But they have ducked two important issues, raised by Anthony Hilton. The first has to do with implementation.  How do you ensure that the desired values are lived consistently from top to bottom of the organisation?

Andrew Hill in the FT has highlighted the importance of behavioural change programmes, but a vital part of the answer is leadership: as John Griffith-Jones of the FCA commented, "If [tone] comes from  halfway down… it just doesn’t have the same impact”.  It is even worse if the leaders set the tone but don't live by it - what Philippa Foster Back pithily calls the "say-do" gap.  Who has the means or authority to bring top leaders back into line - assuming that their double standards are recognised for what they are?

The second problem has to do with bonuses, a complex and poorly understood subject.  It is easy to announce that incentives will reflect not only success but also how success was achieved. But there is an important information asymmetry.  It is hard for leaders reliably to know how success was actually achieved - whereas it is easy for peers to know the truth.  Thus a high achiever, known by his peers to be cutting corners, may be rewarded by leaders who think he is 'doing the right thing'.  The effect will be as corrosive as leaders' double standards.

This highlights a broader problem of implementation missed by the Forum.  All organisations run on people power, and it is the behaviour of people, collectively and individually, that typically makes and breaks organisations.  However, few if any organisations systematically capture, let alone manage, people risks whether from the leadership or elsewhere.  This is a clearly identified hole in risk management systems.  As Anthony Hilton put it, "The ... issue for boards having set a culture is how to know with confidence that its values really are being lived throughout the organisation. What does success look like and how do they measure it?"

The City Values Forum's latest proposals are blind to this fundamental problem of implementation even though it was drawn to their attention two years ago.  That is a missed opportunity.

Anthony Fitzsimmons
Reputability
London
www.reputability.co.uk






Thursday, 3 October 2013

Bonuses and Beyond

Are bonuses damaging economic growth?  Anthony Hilton suggests they are.  We think this is part of a much larger, and pernicious, problem.

We have been pioneers in showing how unintended incentives can destroy companies.  In 'Deconstructing failure - Insights for boards' we went on to discover that it was a root cause of failure in 40% of cases, 60% in the financial sector.

But Anthony Hilton's latest column discusses how bonuses can distort national and corporate growth and probably will.   The piece is based on based on Andrew Smithers' latest book "The Road to Recovery: How and Why Economic Policy Must Change".  If you haven't heard of Smithers, he is one of the rare economists who "can reasonably claim to have predicted the financial crisis in its full gruesome detail long before it happened".

The central point is that the design of most bonus schemes has two effects on the C-team's behaviour.

  • First, sacrificing greater long-term growth by not investing now produces bigger and more certain bonuses in the short term.  So that is what too many C-Suite teams do.  
  • Second, if you have a cash pile, the most reliable way to a bigger bonus short-term is buying back shares in an attempt to increase earnings per share - though it doesn't always work.

This behaviour makes sense to CEOs who understand about discounting cash flows on large future bonuses - and the grim statistic that the average CEO tenure is usually below 4 years.    It is the obvious route to the probability of larger bonuses under many bonus schemes.

But don't blame the C Suite.  They are only human and are behaving just as all humans can be expected to behave.  The risk that they will respond to bonuses in this way is a ubiquitous, if largely unrecognised, board vulnerability.

So who is to blame?  The answer lies between Remuneration Committees, who set the bonuses, the professional remuneration advisers who advise Remuneration Committees and Institutional Investors who fail to challenge Remuneration Committees that set flawed incentives.  (I have left Chief Risk Officers and Risk Directors off the list because whilst they might have the know-how to see the risk, their hierarchical status below the C-suite makes it impossible to raise the subject without putting their careers in jeopardy.)

The largest part of the blame, however, probably attaches to remuneration consultants.  How many have taken the time to explain to Remuneration Committees how short term bonus schemes risk generating short termism in the C-Suite?  And which remuneration consultant has explained how larger bonuses actually seem to work.  As Dan Ariely has discovered, bigger bonuses seem to produce worse performance, not better, when it comes to mentally demanding work (as opposed to mechanical or manual tasks).

This is part of a bigger problem, the hole in the "three lines of defence" approach to risk control.  The name has a reassuring ring about, but the concept isn't designed systematically to find, let alone deal with, risks related to how humans actually behave.  Nor is it a remotely suitable concept to deal with board-level vulnerabilities.  No-one below board level can deal with them.

Anthony Fitzsimmons

Reputability LLP
London
www.reputability.co.uk