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Reputability LLP are thought leaders in the field of reputational risk and its root causes, behavioural risk and organisational risk. Our book 'Rethinking Reputational Risk' received excellent reviews: see www.rethinkingreputationalrisk.com. Anthony Fitzsimmons, one of its authors, is an authority and accomplished speaker on reputational risks and their drivers. Reputability helps 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.

Monday, 23 June 2014

Character, Trustworthiness and Incentives

Charlie Munger isn't as well known as Warren Buffett, but he is Vice Chairman at Berkshire Hathaway and, among other interests, a business philosopher.

A recent paper from the Rock Center for Corporate Governance collected Munger's ideas on corporate governance.  His thinking is worth summarising.

Munger starts from the premise that companies need a governance system because individuals working for a firm are inevitably self-interested and may therefore tend to act in their own interests rather than those of the firm.  To anyone with a background in behavioural risk that is a good place to start.

Having noted the current trend for ever more control systems, Munger rows in the opposite direction.  He advocates a governance system based on "a seamless web of deserved trust".  This requires recruitment for character, something that was also emphasised in 'Leadership on Trial', a research report from the Richard Ivey School of Business in Canada. 
"Good character is very efficient.  If you can trust people, your system can be way simpler.  There's enormous efficiency in good character and dis-efficiency in bad character."
But can you trust the people?  That, as Munger acknowledges is a key question.  You can only rely on a trust-based system to the extent that you can rely on the people not to put their self-interest above the corporate interest.

Munger sees the lynchpin as a high calibre CEO who can be trusted to put his firm above himself.  As the researchers observe, the trust based systems that Munger uses as his examples, such as James Sinegal, the founder and former CEO of Costco, are founder-led organisations.  This is an important observation.  Founders of integrity who understand the value of integrity have the power to recruit others of integrity.

Warren Buffett unsurprisingly has a similar approach to hiring CEOs.
“Somebody once said that in looking for people to hire, you look for three qualities: integrity, intelligence and energy. And if they don’t have the first, the other two will kill you. You think about it; it’s true. If you hire someone without integrity, you really want them to be dumb and lazy.”
A different basis for a trust-based system is recognised in a recent academic study of the community who trade at Lloyd's, the insurance market.  

Lloyd's is ultimately a community of people who, by and large, like the work they do, are proud to be working in Lloyd's and have much of their social life connected to Lloyd's.  Participants know that the long-term well-being of Lloyd's is vital to their future well-being, both financially and socially.  And they know that their own social position in Lloyd's depends on adhering to widely accepted standards of behaviour.  This state of affairs gives participants strong incentives to good behaviour and a strong self-interest in the future well-being of Lloyd's.  Munger would probably recognise that strongly aligning personal self-interest with the long-term interests of Lloyd's should encourage trustworthy behaviour towards Lloyd's within Lloyd's.  (Afficionados of Lloyd's structure will recognise that there is another axis, the relationship between individuals who trade at Lloyd's and their employers.)

Add recruitment for character, often at a young age, and a reinforced memory of near-death in the early 1990s and you have a powerful combination of history, culture and incentives that should help to keep behaviour within widely acceptable limits. 

But the world of companies that have emerged from their founders' aura onto competitive stock markets seems different.  CEOs are under many short-term pressures.   These are amplified by the 'Agency' issue and the fact that a CEO's expectancy of tenure is a small number of years.  It is much harder to remain a paragon under such conditions.

Anthony Fitzsimmons 
Reputability LLP
London
www.reputability.co.uk



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