Monday, May 13, 2013

Great Men + Weak Governance = Bad Decisions

The on-going JP Morgan Chase, London Whale drama about striping Jamie Dimon of his joint CEO-Board Chairman title, along with the replacement of some directors, raises interesting governance lessons. These lessons are not just limited to JP, Dimon and banking. They apply to most major decisions, good and bad, including M&A.

Dimon is a strong willed, successful, confident leader, some would say over confidant, AKA a great man. He runs a large complex organization operating in a challenging industry undergoing rapid change. As the Whale incident demonstrates, he operates with limited board oversight. JP’s board is large, has a long tenure, and was handpicked by Dimon, who controls the selection and nominating process.  The board has limited industry technical experience in key areas like risk management. Hence, it is deferential to the CEO/Chairman’s wishes and decisions. This is reinforced by his relatively successful navigation of his bank thru the financial crisis.

As Douglas Hubband notes, never attribute to malice or stupidity that which can be explained by moderately rational individuals following incentives in a complex system of interactions. The purpose of board governance is to protect the institution from being driven by the narrow interest of an individual, the great man. Absent this governance check, Warren Buffett’s Institutional Imperative takes hold.

Institutional Imperative involves (1) resisting change, (2) staff support of leadership desires and actions regardless of merit using all means available including complex financial models and detailed strategic plans prepared by expensive and high profile advisors and (3) slavishly following peer behavior. It is very difficult to challenge great men decisions and desires. This is probably best summed up by former MGM head Louis B. Mayer’s comment that “….he admired men who were unafraid to speak their mind even if it cost them their jobs.”

Some possible control mechanisms include:
1)     Spliting the CEO and Board Chairman roles
2)     Obtaining a strong lead director capable of challenging the great man
3)     Smaller boards
4)     Independent experienced directors - no more museum directors on the bank board!
5)     Proper incentives for both management and the board

Perhaps most importantly, a culture which encourages professional challenge of senior management decisions is needed. JP’s management discussion in their 2012 annual report in which they discuss the London Whale problem provides some interesting points - albeit learned the hard way after a $6B loss.  Some of the more important points are as follows:

1)     Fight complacency: do not assume tomorrow will look like today. Question others and let others question you-especially after a long period of when thing have gone well.
2)     Overcome conflict avoidance: ask hard questions.
3)     Controls must match the activity being conducted. This means for big ‘bet your company type’, major acquisitions use a rigorous independent review process.
4)     Trust but verify: the board should not micro manage executives. Neither, should it blindly assume they are correct. Make them verify their plans.
5)     Do not shoot the messenger: encourage everyone to quickly surface problems so they can be fixed before they become fatal.

Even great men have bad days and make bad decisions. Good governance can help minimize the damages of those bad decisions on their organizations.


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