Hony.
Editor |
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Dr.
Bindi Mehta
(Director,
Research at ICSI - CCRT, Formerly, Chief economist, CRISIL
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Succession
Games and Corporate Governance
By
Dr. YRK Reddy
Founder Trustee, ACG
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In
history and mythology, succession was often by capture,
if not chance. If the princess or the elephant does not
favour with a garland as in the Puranas, it had
to be through violence as in history. The Mughal dynasty,
the Quli-Qutub Shah dynasty and even the Roman empire
give us vivid stories on how it was easy to succeed by
brute force including patricide and fratricide. However,
democratic institutions and the concepts of efficiency
and common good have demanded a better system of succession
- a system that is predictable, transparent, objective
and effective. Succession, in this ideal, requires to
be planned well and transparently. It forms an important
part of corporate governance.
Good
governance entails planning for an effective succession
to the CEO so that the organization grows in the direction
and with the pace and in a manner that will benefit the
community of shareholders and the important stakeholders.
Such a Chief Executive is required to not merely understand
the wishes of the controlling groups but even convince
them, inspire a new vision, reinvent the strategy and
motivate all the resources to be able to implement the
new strategy. Such a succession can be achieved by an
iterative sequence and a due process that evokes the best
of every one’s judgment and an objective perspective keeping
the long-term interests of shareholders and the important
stakeholders.
In
an ideal world, such succession planning would have been
done far in advance by undertaking leadership development
projects, meticulously among the senior management. There
are several companies, which have an on-going leadership
development programme and succession matrices for all
contingencies and for all critical positions. In such
progressive companies, succession planning and leadership
development would not be disparate but integrated (for
an inspirational argument on this particular point, see
Developing Your Leadership Pipeline, by: Conger,
Jay A., Fulmer, Robert M, Harvard Business Review, Dec2003,
Vol. 81, Issue 12). In the absence of a strong leadership
development program, there will be more and more recourse
to external recruitment.
In
the eventuality of external requirement, theory has given
us some indication as to how an iterative sequence can
be documented and followed. It involves three important
steps, the first one being a close study of the
job and the competencies required to perform and meet
the objectives of the job. While the job specifications
and competencies may remain constant through the stable
period of an organization, there are occasions when new
competencies may be required. For instance, if the company
is facing aggressive competition in the market, some degree
of competitive strategy from the marketing perspective
may be a dominant competence required in the CEO. On the
other hand, if the challenge is technology and its innovative
absorption and new products, the competence that is relevant
for leveraging technology will be more important than
financial management.
Such
competencies obviously are inclusive of generic personal
attributes such as honesty, and integrity. If it is an
academic institution, competences must include the ability
to inspire research, assuming academic leadership and
inspiring confidence in the potential “market”. A CNR
Rao, a Mashelkar, a Abdul Kalam show us the importance
of these competences. Where the CEO is assisted by a strong
team of senior management and working directors, the specifications
might be different than in a structure that is essentially
led by the CEO and less by the other members of the senior
management or the non-executive chairman.
After
understanding the competence required, the next step involves
generating a field of candidates by appropriate
use of communication. Increasingly the announcement for
CEOs is becoming transparent and well broadcast to generate
a wide range of possibilities. The call may provide for
both direct applications and referrals/nominations, should
the position be so sensitive that eminent people are reluctant
to apply. In recent times, positions which were considered
as a prerogative of the Chairman or Board of Directors
or the government are increasingly broadcast widely to
generate a wider catch. An example often cited as a measure
of transparency and wide canvassing is the advertisement
by the Bank of England for a Non-Executive/Independent
Director. It is only when the current CEO is required
to be replaced silently through a coup that secrecy is
adopted. Otherwise, it does not make sense that the field
is narrow. Placement agencies are also a preferred route
for the corporates in view of their long standing, the
database they maintain and importantly, their ability
to reach, communicate, and convince candidates to evince
interest.
The
third step obviously is the process of ascertaining,
evaluating, and ranking the competencies amongst the candidates
including the personal attributes. These, obviously
are to be juxtaposed with the requirements determined
in advance. Often, a selection team of seasoned and mature
interviewers who can judge these competencies well are
engaged in this process. Innovative companies even try
not only the Assessment Centre methods but also hand-writing
analysis, palmistry, and astrology! A let up at this stage
might result in filling a hole in the organogram than
selecting an inspiring leader. In the absence of seasoned
analysts and a scientific approach, selections could become
victims of irrelevant criteria including that of the so
called “chemistry”, which often means conformance, sub-servience,
cultural predictability that includes symmetry in region,
religion, idiosyncracies, and prejudices. If chemistry
is an argument, one has to go beneath to discover as to
why it exists or does not exist in the candidate and whether
it can be interpreted in terms of competencies.
In practice, the sequence can be tweaked to suit the interest
of the controlling owner or a board member. One can rediscover
competencies breaking away from the records and the manuals
of job descriptions, and job specifications to tailor-make
them for the candidates in mind. Better still, as it happens
in many organizations, ensure that that there is no job
description or job specifications, or competence profile
at all. This will give enormous scope for those in control
to massage them around to meet their own agenda. Show
me the man and I will tell you the competence required
for the job! If one is constrained at this stage for any
reason, a second lever is in selecting the media or mode
of announcements for recruitment i.e. by limiting the
knowledge of vacancies so that levels of competition are
controlled to make it comfortable for the pre chosen one.
If
the controller were “deprived” at this stage, there is
still a chance to design a selection team that will use
intuitive methods than close discovery of competencies,
their evaluation, analysis, and ranking. Such intuitive
methods help in making sweeping judgmental statements
in favour of those who need to be short-listed and a set
of totally asymmetrical statements in respect of those
who need to be shot down. Mute specialists can be used
for form sake and to flavour the process with the requisite
reputational characteristic.
The
last resort, of course, is to dissuade the short listed
candidates from accepting the offers by one means or the
other or extracting statements that can be twisted around
to meet ones desired conclusion. This process can be continued
till the pre-chosen one emerges as the candidate.
In
feudal regimes there is little need for masquerading.
The feudals are the controllers and they can nominate
whoever they desire. In the case of publicly traded companies
which are truly widely spread with an active, transparent,
and independent board of directors and assertive shareholders,
the iterative sequence is followed well and the due process
is also applied diligently. Such a process is also evident
in some of the progressive not-for-profit organizations
including hospitals, cooperatives, societies and public
trusts where a detailed manual is adopted by the activist
board and transparency is assured so that no particular
stakeholder or the management is able to tamper with it
to appoint one’s kith, kin, regents, underlings and related
parties. It is apparent that the less transparent and
less iterative the process is, the greater has been the
need for exercising undue control and betraying the trust
and fiduciary duty. The process of selection of the CEO
could indeed be a proxy measure of the quality of corporate
governance. If the CEO’s appointment is faulty, everything
else that flows from him should obviously be warped to
benefit a few.
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When
the Spare Tyre Gets Bald
by
Dr. YRK Reddy
Founder Trustee, ACG
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Alan
Greenspan had perceptively argued the importance of a
diversified and sophisticated financial system, particularly
the capital markets, with less concentration on banks.
He advocated the need for a spare tyre alluding to cases
in the US, Japan, Germany and Sweden among others. Referring
to the Asian financial crisis, he remarked:
“Before
the crisis broke, there was little reason to question
the three decades of phenomenally solid East Asian economic
growth, largely financed through the banking system,
so long as the rapidly expanding economies and bank
credit kept the ratio of nonperforming loans to total
bank assets low. The failure to have backup forms of
intermediation was of little consequence. The lack of
a spare tyre is of no concern if you do not get a flat.
East Asia had no spare tyres.” (Addressing the World
Bank/IMF Group in 1999).
However,
what may not have been reckoned at that time is the
possibility that the spare tyre itself has turned bald
or flat! This can happen in many ways as we had noted
in the case of the distresses, not only in capital markets,
but also in Urban Cooperative Banks and deposit taking
non-banking finance companies. A more recent happening
is probably by way of transfer of credit risk from banks
to other entities, particularly the insurance companies.
Thus,
as the Economist (August 16-22, 2003) noted in the case
of the US, that it is no wonder that despite the collapses
of several companies including Enron and WorldCom, the
leading bankers to these companies continued to register
profits. This was achieved by transferring the risk
to insurance companies and other entities and also resorting
to credit derivatives which are reportedly experiencing
nearly 100 per cent growth per annum. The trading in
these credit derivatives have reportedly exceeded the
gross credit outstanding and is poised to follow the
trends in share options, commodity futures and margin
trading. There is nothing surprising in this, as in
the very same speech Alan Greenspan reflected that once
capital markets and traded instruments came into existence,
they offered banks new options for hedging “their idiosyncratic
risks and shifted their business from holding to originating
loans”. However, there are issues of risk transfer to
connected businesses than their mitigation on the one
hand and on the other, transparency and corporate governance.
In
line with the prophecy, there has been some movement
of risk transfer in the Indian case too, to the recently
created Asset Reconstruction Companies, insurance companies
and foreign NBFIs. For instance, the Asset Care Enterprises
Ltd was set up by PNB, LIC, Bank of Baroda, United Bank
of India, and IFCI. A management team is reportedly
not yet in place for this ARC but decisions to off-load
assets worth over Rs. 1000 crores have been taken. It
is likely that foreign players like GE Capital, CDC,
Morgan Stanley, and Merrill Lynch will, in turn, take
an active interest in the transfer of risky and dud
assets.
Spreading
of risk should be desirable especially when it is taken
by those entities which not only have large appetites
but by those who know what it would imply to themselves
and their shareholders in the long run. But there are
justifiable fears that such risk taking may not be matched
by abilities to manage risk but only benefit from the
lack of transparency and the lag effect in showing up
the illness. Even the BIS has acknowledged that the
markets lack transparency about the ultimate distribution
of credit risk.
The
problem is that some of such transfers may actually
turn out to be a transfer of a problem than its mitigation.
These “assets” may get accumulated in the transferee
entities which are promoted and partly owned by the
transferors themselves. Such entities may have the immediate
advantages of lower cost of capital, less effective
regulation, and most importantly, the ability to escape
public disclosure and reporting through opaque means.
Such entities enjoy multiple advantages in the short
run primary of which could be weaker supervision and
corporate governance standards.
Managing
such risky assets actually require more skills and hands-on
effort than the takers may have. The challenge becomes
hefty in the absence of a secondary market for these
assets. Some of these entities such as our insurance
companies and ARC’s, have presumably lesser ability
as yet to evaluate risks and manage them by themselves.
They may have to further off-load them at a discount
to those, who can cherry-pick better or resort to external
advice which may not necessarily be independent or objective
due to potential inter-linkages among analysts, advisors,
brokers, and investors.
Credit
risk transfer, if not managed diligently at the policy
end, may actually lull us into complacency that could
hurt us three ways. Firstly, to believing that the spare
tyre is actually in good shape and can avert the systemic
risk. The fact, however, could be that while the wheels
appear to be in good shape, even if due to periodic
re-treading / restructuring if not ever-greening, the
spare tyre may have got bald. Secondly, the situation
may lead to the prospect of a moral hazard for the banks
themselves especially under conditions of feel-good
factor. The banks which have been risk averse in the
recent years, to a degree of being at a fault to be
reminded of their primary task of lending to industry,
might actually tend to splurge, if there is a well developed
market to spread credit risk. (Such splurging may, in
fact, boost industrial growth till such time as nemesis
catches up). Thirdly, such risks may actually get concentrated
with people or entities whose capacity may be determined
not necessarily by virtue of better management of credit
risks and recoveries but purely their resilience to
endure the problem silently and patiently till it shows
up with a lagged effect.
The
task before the policy makers – fortunately, it is still
early days - is to figure out a method and means by
which such transfer of risk is more transparent and
motivated by the skills to manage such assets than for
tidying up books. Concurrently, a good secondary market
and a good pool of specialists in managing such risks
must be developed and put in place, as eventually, it
is the taxpayer who is carrying the risk most, without
his knowing.
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© 2001 Academy of Corporate Governance
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