Are Organizations Too Complex to Govern Effectively

Norman Marks, CRMA, CPA, was a chief audit executive and chief risk officer at major global corporations for more than 20 years. The views expressed in this blog are his personal views and may not represent those of The IIA.

 

When you look at many of the organizational disasters of recent years (such as the Deepwater Horizon explosion, fire, and oil spill that embroiled BP, Halliburton, and Transocean in billions of dollars in cost, even before reputational damage and business disruption), people ask where top management and the board were.

Is it reasonable to believe that the CEO of BP should have known about the risks and potential compliance problems on a single oil rig?

Is it reasonable to expect the board to be able to ensure that top management has the processes, people, and systems in place to manage risks at far-flung corners of the enterprise?

A discussion on a National Association of Corporate Directors (NACD) site on the topic of The Elements of Effective Board Governance between Robert Guido (retired EY vice chairman) and Mary Ann Cloyd (leader of PwC’s Center for Board Governance) starts with Mary Ann asking “Do you think that corporations today have become too complex to be governed effectively?”

I think this is an excellent and insightful question. It’s not only that corporations are increasingly global, with less reliance on revenue and operations in their home country, that these are turbulent times and business conditions and risks are changing all the time, but organizations are increasingly adopting so-called matrix reporting. In this set-up, a manager or senior executive may have multiple bosses; each could be demanding different priorities and execution, and no one person has total responsibility for key areas. For example, while one executive may be responsible for sales and marketing in Europe, different executives may be responsible for each of the various products and services he is charged with selling. I saw this extensively at my former employer, SAP. While it has some advantages, it can lead to individuals being given accountability for an area without the authority and power to obtain results. In the example I described, the executives responsible for each of the products do not have any authority over the executive running Europe. In addition, managers can be left focusing on the goals and objectives they were set at the beginning of the year even though conditions on the ground have changed. Why? Because their compensation is based on those numbers, not necessarily what some of their matrix managers are demanding as they try to adapt today’s environment.

If I continue to think about SAP, a corporation that has been immensely successful and continues to build innovative and disruptive products, its portfolio of software solutions must number in the thousands. Is that too complex for any management team to manage? Are they making the best decisions when it comes to which solutions to invest in, which to divest or close out, and when to move them to cloud/mobile/in-memory? I will let the SAP insiders make their own assessment.

How did Robert Guido reply to Mary Ann? He made some interesting and correct points.

“Large and complex organizations need strong leaders and an organizational structure that is properly aligned. Strong leaders set the proper tone, develop talent, set realistic expectations, and encourage communications and transparency. Therefore, with proper leadership, I don’t believe that organizations have become too big or complex to manage. I believe these organizations can be grouped into business segments to manage. This will assist in building strong leaders, with the proper lines of communication and a clear understanding of reporting relationships among operating and functional leaders.

“I have worked with large, complex companies with various organizational structures, i.e., centralized versus decentralized, and have seen most to be effective. I believe certain core functions, however, need to be linked (dotted or solid-line reporting) among the business segments and the corporate center. Strong leaders develop and implement the proper measurements to manage large, complex organizations.”

While there is some level of validity to Guido’s answer, it strikes me as naïve. Relying on strong leaders, even when there are (as he continues to say), strong core functions like Human Resources, is simply not enough.

Rupert Murdoch is a very strong leader. While his newspaper group has been very successful for a number of years, it still suffered a highly embarrassing disaster and his reply was that he relied on his managers. Was that acceptable?

BP’s former CEO appeared to be a strong leader, but that didn’t prevent the Gulf incident. His response was basically that it was unreasonable to expect the CEO to know about every potential problem and how it was addressed. He relied on the managers responsible for each area. Was that acceptable?

Now I am not saying that Guido is himself naïve. I don’t know him. All I know is that he was a senior partner with EY and never worked as a manager or executive within a corporation (unless you count EY, and I would suggest that a public accounting firm is not the same species). His assertion that you can hire strong people and then you are OK is naïve.

Strong management is simply not enough. You need the right corporate culture — and let’s not forget that a CEO who is too strong can destroy a corporate culture, or create a culture of greed and disregard for risk or compliance.

You need reliable information that provides insight into the entire organization and its critical points, teamwork among the executives, and strong risk management practices and processes.

I also believe you need an effective, independent and objective internal audit function that has the courage to speak up when things are not as they seem or should be — even when the CEO is the root of the problem.

Add an effective board that provides skeptical oversight of management and not only demands of internal audit a formal assessment of governance, risk, and related internal control processes but listens actively to what they have to say.

Are organizations too complex to govern and manage effectively? I think we are getting close, but actions such as I have described limit the risk.

I welcome your comments!

Posted on Aug 12, 2013 by Norman Marks

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  1. Mr. Norman, I found your article very interesting. I am not an expert in corporate governance, however, a few points I would like to mention which I am sure you have considered. I think the globalization of organizations has been at a much faster pace then the actual transfer of corporate culture, corporate ethos, instilling of management style, definition of BAU, SLA in home country vs international branches. Even bigger element is the Human Factor. Our destination might be the same but our path might be different. Even during the process of organic growth the effects of the above elements are given less importance. The policy of "if its not broken don't try to fix it" fails as soon as the process being carried out moves out of home country. I believe in catch it before it breaks. During inorganic growth the due diligence carried out focuses more on merging of business rather than people. Again the human factor is given less importance. Ultimately, organizations are only as complex as the sharp gradient of their cultural spectrum. Thank you again for your article. Best regards Mohammed Osmani
  1. I agree that it's a very perceptive question and that Guido's answer, while good advice, misses the point of the question.  Complexity inevitably breeds unmanageability in the form of unpredictable major events caused by the random confluence of disparate smaller events that, as Leonard Mlodinow (The Drunkard's Walk) said, "you can usually afford not to worry about" in isolation.  Chaos theory and "normal accident theory" address these phenomena.  There are not only limits to what strong leadership can actually accomplish but also to what micro-controls can accomplish.

    That's life!  You do the best you can, but it helps if you know you're riding a tiger.

  1.  I'd say you nicely summed up the solutions to the problems in the last few sentences.

    Considering American corporate management's tendency to "manage up" for short term bonus fulfillment and career politicking I'd say Norman's recommendations are the only cure.

     

    Having never served on a board, their apparent hesitancy to require what Norman suggests is confusing to this Texan raised to "call a spade a spade."

  1. Norman, I just aught up with this one.  My comment would be that I've felt for a long time in the world of financial services, the real issue was not "too big to fail"  but "too big to manage."  The size and complexity of many of the financial services giants puts them in this category of too big to manage.  This applies also to their boards. I believe that if you look at some of the financial disasters, you see this issue as a root cause issue.  Unfortunately, the further consolidation in the industry after the meltdown has only heightened the risk of this issue.  The "London Whale" problem is a good example of failures at both the management and board level.

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