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A code of malpractice

Sun, 11th Nov 2012
This week the City has been congratulating itself on 20 years of UK corporate governance codes. Since the original Cadbury guide to boardroom practice in 1992, the UK has taken pride in its role as a world leader in the field, and the codes as a successful export. Seventy countries around the world have followed the UK example and drawn up similar guidelines.
 
There’s just one problem. Could it be the wrong kind of governance? The day the FT carried the story, Incomes Data Services was reporting that FTSE100 directors took home a median 10 per cent pay increase last year, continuing a soaraway trend that has continued year-in, year-out over the same period. And would this be the same governance, that has given us the RBS meltdown, LIBOR and PPI mis-selling to the tune of £18bn, the biggest rip-off in financial history? That failed to stop phone-hacking or BP taking dangerous short cuts? And that has sanctioned the wholesale offloading of risk on to everyone else, whether individuals (pensions, careers) or collective (global and financial warming), at the same time rejecting any responsibility of its own except to shareholders? 
 
So lop-sided and jerry-built is the corporate economy erected on the scaffolding of the current governance codes that it can’t even deliver the material progress by which it justifies its many privileges: even with a return to growth, living standards for lower or middle earners may be no higher in 2020 than in 2000, according to the Resolution Foundation.
 
The truth is that much vaunted UK corporate governance has neither headed off major scandal nor nurtured good long-term management. In fact it has done the opposite. 
 
The irony is that by now we know pretty well what makes companies prosper in the long term. Organisations are whole systems and have to be managed as such – you can’t optimise whole systems by optimising the individual parts. Pace Beecroft and Osborne, good people management pays dividends: fear makes people stupid and cussed, not clever and entrepreneurial. 
 
We know that incentives and targets are dangerous (and sometimes lethal) things, all too often taking people’s eye off the real job and focusing it instead on the incentives themselves, damaging intrinsic motivation and undermining performance. Companies work better when pay differentials are less wide (ie, when we really are in this together). Lasting success comes from the hard work of organisation-building and devising products and services that please customers, not from doing deals, which mostly destroy value. 
 
Lastly, it’s obvious except to themselves that in the long term companies can’t thrive unless they have society’s interests at heart as well as their own.
 
So why do so many boards and managers, sicced on by politicians, systematically do the opposite – run companies as top-down dictatorships, opt for mergers and financial engineering over pleasing customers, destroy teamwork with runaway incentives, attack employment rights and conditions, outsource customer service, treat their stakeholders as resources to be exploited, and refuse wider responsibilities to society? 
 
The answer is that management in the 1980s was hijacked by an opportunistic alliance of impatient shareholders, corporate raiders and ambitious business school academics. The formula that they came up with cast management as a sub-branch of Chicago economics, based on an ideologically inspired view of human nature (homo economicus) needing to be bribed, whipped or both to do their exclusive job of maximising returns to shareholders. It is these assumptions, untested and hidden from view, that are at the heart of the governance codes and have taken on the aura of unchallenged truths ever since.
 
The consequences of the hijack have been momentuous, over time remodelling society as well as business. The first consequence was to align managers’ interests not with their own organisations but with financial outsiders – shareholders. This triggered the explosion of senior managers’ pay that continues to this day. 
 
At the same time, focusing outside rather than in made them less sensitive to the real-world needs and capabilities of their organisation and encouraged them instead to turn to deals as the preferred short cut to growth (and their bonus targets). This signalled the second major consequence, the switch from the previous policy of retaining and reinvesting profits for the benefit of all stakeholders, to ‘downsize and distribute’, contracting out as much as possible and cranking up dividends and share buybacks to shareholders.
 
The crowning irony is that this stealth revolution progressively undermined the foundations of the shareholder value under whose flag the activists had ridden into battle. Along with corporate welfare and customer service, one of the prominent victims of downsize and distribute was R&D. Innovation has stalled since the 1980s, prompting some economists to query whether the era of growth itself is over
 
But it’s not economics, it’s management, stupid. Unsurprisingly, downtrodden and outsourced workers, mis-sold-to customers, exploited suppliers and underpowered innovation do not make for rising shareholder value despite ever more ingenious financial engineering.
 
When the Canadian academic Roger Martin crunched the numbers, he found that shareholders had done less well in the the shareholder value era since 1980 than in previous decades when lazy managers were supposedly feathering their own nest. The crash of 2007-8 stripped away any remaining doubt: the economic performance of the last 30 years was a sham. Overall, there were no profits – as Nassim Nicholas Taleb wrote in The Black Swan, they were 'were simply borrowed against destiny with some random payment time.’
 
To sum up: what the City was congratulating itself on last week is a wonderful example of the wrong thing done righter. The 'success' of the governance codes is a triumph of bureaucratic process over substance. Never mind that we have a financial system that has lost both purpose and moral compass, an economy that  is failing most of the population and an increasingly unequal society, look how well we tick the governance boxes! The truth is that governance has recreated management as a new imperium in which managers and shareholders rule, and the real world dances to finance's tune. A worthier anniversary to celebrate is the death seven years ago this month of Peter Drucker, one of the architects of pre-code management. Austrian by birth, Drucker was a cultured humanist one of whose distinctions was having his books burned by the Nazis. In The Practice of Management in 1954 he wrote: ‘Free enterprise cannot be justified as being good for business. It can be justified only as being good for society’. 
 

 


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