Opinionista Roger Stewart 13 June 2019

How to improve the smell of the boardroom

Business is in society’s sin bin and all the corporate governance in the world is not changing this. But mandatory compliance with codes of corporate governance and the distrust spawned by the unproven agency theory have changed the boardroom climate. Empirical evidence has revealed that self-governance, grounded in trust, values and purpose-driven mission is superior to both authoritarian and rules-based control in determining company performance gauged by a range of financial and non-financial measures.

The late Sumantra Ghoshal, a leading management academic, used evocative metaphors to describe the workplace climate and argued that corporate change efforts should shift from widely unsuccessful attempts at changing people to changing the organisation context: ‘The smell of the place’.

The oppressively hot, humid atmosphere of Kolkata (AKA Calcutta) in summer represented an enervating organisation workplace climate of “constraints, compliance, controls and contracts”.

By contrast, the crisp air of Fontainebleau’s forest in spring represented an energising workplace climate of “stretch, self-discipline, support and trust”. A Kolkata workplace suppressed and Fontainebleau climate fostered creativity, innovation, co-operation and quick decision-making … and it showed in companies’ performance.

Since the early 1990s, many societies and their stock exchanges have opted for governance of corporations through ever-increasing “constraints, compliance, controls and contracts”. Unfortunately, Ghoshal died before he could link “the smell of the place” metaphor specifically to his concern for corporate governance; nevertheless, his comments on management implied that the pervasive boardroom climate was downtown Kolkata in summer, not Fontainebleau’s forest in spring.

Ghoshal lamented developments in corporate governance inter alia: bad management theories were causing bad management practices. He objected to the agency and transaction cost economic theories, which underpin contemporary governance, for their pessimistic view of human nature. Today this is reflected in more trusted “independent” directors “policing” their non-independent colleagues. Ghoshal argued persuasively and presciently that widely accepted social theories, such as agency theory, become self-fulfilling: the behaviours of directors’ and managers’ eventually will conform to the theory.

Ghoshal’s concern about self-fulfilling social theory has been realised. We continue to witness high profile corporate governance failures and examples of grossly immoral behaviours of some boards, individual directors and executives. The consequences for companies and society have been devastating. Furthermore, there has been no widespread change in corporate survival rates or performance levels, yet we have an ever-expanding executive remuneration bubble.

There are usually many interconnected causes in the complex dynamics that lead to corporate and economic system failures. It would be simplistic and wrong to suggest that the failure of corporate governance codes is the “root cause” of these ongoing governance problems.

The response to corporate and economic system failures has been a clarion call for more strictly regulated governance by way of more constraining codes, even legislation, and more detailed disclosure. Ghoshal suggested that a positive moral framework and view of human nature and intent was necessary, albeit not sufficient, for companies to be a “force for good”: we should focus our efforts on changing the micro-climate of the boardroom from downtown Kolkata in summer to Fontainebleau’s forest in spring.

Directors and managers have a fiduciary duty – a duty of trustworthy behaviour, of competent stewardship underpinned by probity. This implies that trust, not distrust, should be the basic principle underpinning governance. Thus, shareholders should appoint and retain directors primarily for their trustworthiness, which includes their proven combination of appropriate business expertise, acumen and self-disciplined morality. Trust these directors to trust each other; to adopt or develop governance processes that are based either on the evidence of what does and does not work or designed for their specific context; and to exercise good judgment in the best interest of the company (their fiduciary duty, after all).

Perhaps then directors will work energetically, creatively and morally towards their companies’ purpose, with the joint outcomes of economic success and good standing in society.

What does the evidence reveal? Empirical evidence from 18 countries and 36,280 employees, in the How Project, revealed that self-governance, grounded in trust, values and purpose-driven mission is superior to both authoritarian and rules-based control in determining company performance. A Fontainebleau-smelling boardroom had a compellingly positive impact on behaviours within companies and on a variety of corporate measures such as financial outcomes, employee engagement and loyalty, innovation, customer satisfaction, ethical behaviour and reputation in society.

Ghoshal recommended that we should shun agency theory, which is dismally rooted in distrust, and abandon futile attempts to control the behaviours of people who are appointed to a position of trust. There are no guarantees in trust, however. There will always be a few delinquent executives, directors and boards; and we continue to be reminded that codes, regulations and laws do not constrain those who will disappoint. The challenge is an improvement of director selection, not control of deviants when they are already on the board, and the creation of a positive, energising “smell in the boardroom”.

Constraints, compliance, controls and contracts” create a dystopian boardroom environment like Ghoshal’s oppressive Kolkata in summer. It saps the energy of trustworthy directors: they expend too much of their energy on unproductive dehydrated talk, compliance and reporting, instead of supporting management in their quest along the uncertain path to corporate success and social recognition.

Ghoshal suggested that a positive moral framework and view of human nature and intention was necessary, albeit not sufficient, for companies to be a “force for good”. The evidence and thinking from Ghoshal and the HOW project suggest that corporate governance can be revitalised and companies can be “a force for good” if trustworthy and competent directors work in a boardroom climate like the invigorating air of Fontainebleau’s forest in spring. Business is in society’s “sin bin”; perhaps we should use the opportunity to reconsider how we think about companies and their governance by way of mandatory compliance with codes. BM

Roger Stewart is a truant from medicine and academia. He has served on corporate boards in southern Africa, Europe and the USA. He is a Fellow of the Institute of Directors. He applies systems and value thinking to complex problems such as governance. He writes on corporate governance in his personal capacity.

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