The 3 Company Crises Boards Should Watch For

25 January, 2017 / Articles

When an organization fails because of executive malfeasance, it generates a lot of attention. But such situations are actually relatively rare. It’s much more common, though less talked about, for organizations to fail because of ungoverned incompetence. That is, someone does the wrong thing while trying to do the right thing, and organizational systems fail to catch it and contain it. This becomes more likely as the organization takes on strategic risk — through innovation, mergers and acquisitions, or because its environment is becoming more volatile.

Boards that focus on problem-finding put their organizations on safer footing. Problem-finding boards establish structures and processes that prevent many problems from arising and stifle nascent problems quickly and effectively. Problem-finding boards understand the three drivers of ungoverned incompetence — a collapse of competence, shortcomings in self-governance, and inadequate corporate governance — and why they can be so hard to detect.

Collapse of Competence

Competence collapses when executives take on problems beyond their capabilities. This is rarely deliberate; people generally wander out of their competence zones without noticing. Their operating environment changes in a way they don’t recognize, or they take on a project that they believe is within their capability but isn’t.

For example, I have worked closely with a professional services organization where a domineering, controlling CEO led the organization spectacularly for 20 years. But as the organization grew, its operations became more complex. Rather than managing that complexity by delegating and decentralizing, the CEO became even more controlling. Eventually tension with the staff increased to the point that half the senior professionals left over a six-month period.

Another CEO used prodigious management skills to successfully consolidate, grow, and dramatically increase the efficiency of a vertically integrated industrial company. To support a change in strategy from efficiency-driven to innovation-driven growth, the company acquired another company to be its innovation engine. The CEO managed the acquiree the same way that he managed the existing business, instead of adopting a style that recognized the emergent nature of innovation. After three years the company wrote off three times the acquisition cost. To restore its balance sheet, it had to sell half the business.

Shortcomings in Self-Governance

If someone realizes they are beyond their competence and seeks help, the failure can be mitigated or even averted. But if the person who is out of their depth neglects to seek help — a shortcoming in self-governance — they compound the collapse of competence.

I have seen this manifest itself three ways. First, the manager may be completely unaware that they are out of their depth. This is likely what happened at the professional services firm: The CEO’s unconscious need for power may have motivated him to not notice he was imperiling the organization. Second, a manager may see the failure occurring but deny it. This appears to explain events at the industrial company. Finally, the manager may see the problem but believe they can “trade their way” out of it. Rogue traders lose the most money by doubling down on earlier losses.

Many unconscious drivers that lead people to act against their rational interest can explain these three types of self-governance shortcomings. They include narcissism, hubris, denial, defensiveness, bounded rationality, risk biases, stress, exhaustion, and the fact that persisting without help feeds the need for power and achievement.

Inadequate Corporate Governance

A third problem is when essential information that highlights the possibility of failure does not flow from the CEO to the board, or from the supervisee to the boss. At the corporate level, the CEO almost invariably controls the board agenda. Of course, the CEO and the chair (or lead director) sit down amicably and select the items for each board meeting. However, the chair is at the mercy of the CEO to know what is really going on in the organization. This certainly happened at the professional services organization, where the CEO ensured that virtually all communication between staff and the board went through him, and senior professionals knew that they would be excoriated for indicating disquiet about the CEO to the board. At a managerial level, corporate cultures, impression management, and bosses dodging accountability can all lead to a climate in which supervisees learn to report only the good news.

In some cases the information may be flowing but the board may lack the skill to interpret it. It may be investing in a product it doesn’t understand, which happened at Lehman Brothers during the global financial crisis. At the professional services organization one of the underlying problems was that the board didn’t really understand the business; my conversations with corporate directors suggest this is a problem across industries. The board abrogates any responsibility for really understanding the business by claiming they should defer to management. Managers, after all, have more time, more skill, and a better understanding of the business.

In all these cases the board may well have identified these problems much earlier and taken remediating steps if it had been a problem-finding board.

For an example of what this looks like, consider NYSE-listed Infosys, one of the main drivers of the rise of India as an IT powerhouse. There are two aspects to the problem-finding corporate governance system its board has put in place.

The science man and innovator, Fernando Fischmann, founder of Crystal Lagoons, recommends this article.

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