While much has been written and much policy developed on the issue of banks that are “too big to fail”, have we ignored a bigger problem? I think that too big to manage may be a good candidate.
The idea that too big to fail actually means too big to regulate has been floated before[1]. Indeed Michael Mainelli and Bob Giffords have described the too big to manage problem[2]. Adam Smith himself raised concerns about the problem of too big to manage, so it has a long history. So, why hasn’t it gained more traction since 2007-8?
Inequality is now on the agenda globally for the first time in a generation. The ratio of top pay to workforce is at historically high levels and increasing.
The conventional wisdom is that top talent needs commensurate awards for the great responsibilities that they have in managing these giant organisations. Yet there is a growing body of evidence that high pay does not translate into high achievement, certainly from a shareholder perspective.
Importantly, when anything goes wrong, the “top talent” frequently denies knowledge of what is going on within their own organisation. How can you claim to be in charge of a large organisation when you don’t know what’s going on? Furthermore, it’s often hard to pin down who it was that actually knew.
The erosion of trust in business, commerce and finance is long established in the UK and many other countries. The recent administration of Phones4U had that bastion of revolution, The Daily Telegraph, complaining in terms that a generation ago would have been seen as hard left.
This is not confined to finance. We have examples of editors who don’t know how their papers get stories. The black hole in Tesco’s accounts is the latest in a line of such misdeeds. The principle that “ignorance of the law is no defence” is interesting when applied to Corporate Governance. It is widely accepted that the culture of an organisation is set by the top team. My reading of a number of accounts of corporate failings is that it is not that the top team is actually “covering up” misdeeds that they are in reality aware of. Rather, the major issue that I find across different sectors is that organisational leadership does not fully understand the consequences of the culture they create.
When hitting numbers, targets and getting the business done regardless of how these are done becomes the dominant culture, who is responsible? Is ignorance a realistic defence? Also, when the economy or a specific sector is undergoing structural, as opposed to cyclical, change, as with Tesco, the time to turn around these giant organisations is often a decade or more with little guarantee of success.
For all stakeholders, be they shareholders, employees or customers do we need to see too big to manage as the cause and too big to fail as the symptom?
This is particularly important in the context of the recent changes in the regulation of the Eurozone and the recent banking stability tests. Imagine two banks, one which marginally passed and the other marginally failed the resilience requirements of the stress tests. Which is the more risky? I would argue that if the failed bank had a governance structure which made it able to react quicker to turbulence that the successful one, then it could carry more risk without being, in principle, riskier.
For me, the evidence is increasing that the economies and efficiencies of scale arguments increasingly look flawed in a turbulent and changing global economy.
How might we apply the “ignorance” principle to corporate governance and create trust between those at the top and wider society?
If organisational governance is arranged so that the leadership is assumed to be knowledgeable UNLESS they can demonstrate that the next tier has the knowledge and has not passed it upwards, then it seems to me that the reward system could be better designed to align risk and reward at every level of an organisation.
We appear to be seeing a slowdown of the economy before most people have recovered from the last downturn. The increasing inability for mainstream politics to offer ways forward must concern us all.
If business and finance is to flourish, I’m not sure that fixing the “too big to fail” problem will be enough. I offer as my candidate for the next “big thing” will be “too big to manage”.
Over the last 50 years we have seen a move away from vertically integrated organisations to flexible supply chains in many sectors. These in turn are morphing to supply networks or “ecosystems”. My suspicion is that we can reduce systemic risk and improve resilience if we look at the problems with fresh thinking on governance. That Adam Smith recognised the problem centuries ago is helpful. I find it fascinating that some of the most passionate advocates of Free Markets are so loathe to understand the checks and balances that he thought necessary.
I have seen it argued elsewhere that the mainframe age of computing made it possible to build giant global organisations. In the era of networked IT will the giants turn out to be dinosaurs?