When a plane crashes, a thorough investigation ensues and, as we have just seen in the case of the Boeing 737 max 8, sometimes aircraft are grounded until the cause of the accident is properly understood. When a patient dies unexpectedly on the operating table, the case is analysed in a Morbidity and Mortality conference. When a public company destroys shareholder value by making poor strategic decisions, society shrugs and says that’s the risk of being an equity investor.
It appears that the extent to which mechanisms for ensuring quality are defined and entrenched is in proportion to the perceived proximity and scale of risk. But, are strategic decisions being under-recognised in respect of their risk?
Let's look at this more closely by considering two dimensions:
1. the perceived proximity and scale of risk.
2. the quality assurance mechanisms applied.
For a pilot commanding a passenger aircraft, the perceived proximity and scale of risk is very high since not only are all of the passengers at risk, but so is the pilot who truly has "skin in the game". The airline industry has built in quality assurance mechanisms and these are stringently enforced. These include initial and ongoing certification for pilots, checklists on every flight, and comprehensive incident reviews.
For a surgeon operating on a patient, the perceived proximity and scale of risk is high, but not very high (as above) since the surgeon's own life is not at risk, but the proximity is as close as it gets. And the scale is also not as high as in the airline case, although it is significant since an error in procedure could be replicated by thousands of surgeons. The medical profession has stringent certification requirements and has built in quality assurance mechanisms like Morbidity and Mortality conferences [1] and, more recently, the use of a surgical checklist, although this is not yet as strictly enforced as the pilot's checklist.
For an engineer building a bridge, the perceived proximity and scale of risk is perhaps medium compared to the cases above. Proximity is less, both in time and in space, i.e. if a bridge were to collapse, the engineer is typically not there to witness it. However, the scale is high since multiple people might lose their lives. The engineering profession also requires certification and has a range of technical quality assurance checks for the design, the materials being used, etc. In addition, engineers apply safety factors to their designs. In rare instances of failure, thorough incident reviews follow.
For a chief executive leading a public company, let's consider two types of risk. The risk of fraudulent behaviour and the risk of poor strategic decision making. Both of these risks can significantly erode shareholder value.
Fraud risk has been recognised for decades and corporate governance has been the response. Like everything in life, corporate governance is not perfect and events like those at Enron [2], VW "Dieselgate" [3], and more recently Steinhoff [4], demonstrate how much damage can result. So, while lives are not at risk, the scale of the risk is significant. Under current corporate governance regulation, guilty executives could be held personally liable and could be sent to prison. So too can the auditors, who are certified professionals. In South Africa, we have seen increasingly stringent quality assurance mechanisms being applied, starting with King I in 1994 and most recently King IV in 2016. Probably because of the threat of fines and prison, large scale fraud in public companies is now quite rare.
What about the risk of poor strategic decision making? Paul Nutt, a leading researcher in the field, suggests that half of strategic decisions are failures [6]. Nutt also says that "failure does not generally stem from things beyond a manager's control" [7]. In other words, the failure rate is high and needn’t be so. In fact, "when decision makers followed best practices, success doubled" [6]. With the rate of creative destruction expected to increase [Why care NOW about strategic decision making], the imperative to make good strategic decisions is intensifying. Not doing so means putting jobs and shareholder funds at risk.
What is the perceived proximity and scale of risk when making strategic decisions? The "perceived" risk from the perspective of the chief executive is lower than in the fraud case.
Although chief executives don’t risk prison, they do risk their reputation and a portion of their wealth. However, the outcomes resulting from strategic decisions often take years to be realized and are confounded by numerous other factors and luck, making it exceedingly difficult to determine whether a good or poor decision was made. In other words, except in the most blatant cases, the passage of time and the complexity of the context obscure the truth. Furthermore, when challenged to explain a decision that happened years ago, even an honest chief executives’ narrative will typically include elements of hindsight bias and memory failure. So, convincing explanations, a complex context, an inability to directly link outcome to decision quality (see [Judge decision quality on process, not outcome]), make it extremely difficult to hold a chief executive accountable for a poor strategic decision.
What quality assurance mechanisms are in place? No certification is required to be a chief executive. Board sign-off is required on strategic decisions, but what standards does the board refer to and/or what quality assurance mechanisms does the board apply? Since there are no generally accepted standards of what constitutes a high quality strategic decision, boards rely on the judgment and experience of the board members. And how reliable is that? Well, half of strategic decisions are failures!
So, given the frequency and scale of value destruction, shouldn’t shareholders demand more of public companies in terms of quality standards for strategic decisions?
References:
[1] https://en.wikipedia.org/wiki/Morbidity_and_mortality_conference
[2] https://en.wikipedia.org/wiki/Enron
[3] https://en.wikipedia.org/wiki/Volkswagen_emissions_scandal
[4] https://mg.co.za/article/2018-01-29-holes-in-steinhoffs-management-led-to-corporate-scandal
[5] https://en.wikipedia.org/wiki/King_Report_on_Corporate_Governance
[6] "Why decisions fail", Paul Nutt
[7] "Surprising but true: Half the decisions in organizations fail", Paul Nutt
[8] https://www.linkedin.com/pulse/why-care-now-strategic-decision-making-wayne-borchardt/
[9] https://www.linkedin.com/pulse/judge-decision-quality-process-outcome-wayne-borchardt/