LEADER’S EDGE UPDATE: SUMANTRA GHOSHAL ON LEADERSHIP, MANAGEMENT AND GOOD GOVERNANCE

Sumantra Ghoshal is one of the most influential business academics in the world, and is, in fact, ranked 12th on the Financial Times’ list of Top Fifty Thinkers. The co-author of important books such as Managing Across Borders: The Transnational Solution, and The Individualized Corporation.

This Leader’s Edge interview was originally published in the September/October 2004 issue of Ivey Business Journal. It is being re-issued now as an update for March/April 2004 to help commemorate Professor Ghoshal’s death a few weeks ago.

Within the context of governance, have debacles like Enron and WorldCom revealed any systemic problems with the way that managers manage?

There are clear pathologies of behaviour where one person or more, individually or collectively, did things that are not in shades of grey but in the domain of black and white, who just did some things that are illegal. And we can start from there and say, well, managers have done illegal things that have incurred a huge cost for lots of people and what do we need to do to prevent this in the future. But I think the deeper problem lies in the system that we have created out of which such behaviours emerge over time. So yes, there is a systematic problem. Basically, I think we’ve created a system where management is the real problem. Management, particularly in the large public corporations, is excessively constrained.

Excessively constrained?

Yes, excessively constrained. There are very powerful forces that are constantly pushing management. On one side, and perhaps the strongest force of all, are the capital markets. And the capital markets operate like an unending thumbscrew. Constantly, quarter by quarter, there are expectations, and the expectations of the future being built into the current stock price create an enormous pressure to make those expectations happen, not just for progress but just to protect what appears to be the current state of affairs. The demands of the capital markets, on a free-market basis, are relentless.

On the other side, there’s the pressure of talent. Increasingly, the labour market, particularly the market for talented people, is becoming freer and freer. It is taking on a character somewhat similar to the capital markets. There’s a constant pressure not just to hire but also to retain existing employees. That’s a huge pressure that management has to constantly respond to. Then there are the pressures of customers. We are all saying that customers are becoming more and more knowledgeable and more and more discriminating. There are essentially more intense demands from customers and more intense demands from competition. If you put all of these things around management, I think you will find that there is no space, no space for breathing, no space for discussion.

There’s a case at Harvard Business School where a young guy takes over as the president of a small division of a large company, the Elton Corporation. He squeezes, and performance improves and so on, but you begin to suspect that the guy is doing something wrong. You realize that the guy was actually fudging the books and cooking the numbers. And you say, “Who’s responsible?” Of course he’s responsible. He has fudged the books. But then, as you really understand what was going on, you begin to see how the nature of the corporate control processes and expectations, and the way they were being managed, was gradually pushing this person. Now that doesn’t exempt the person, the person is still at fault. But nevertheless, that doesn’t deny that the corporate officers were really pushing people. It shows that the weaker people at the margin will get pushed into cooking numbers. I think we are playing out Elton on a grand scale today.

One of the jobs of the chief executive is to create more space for the company, space for discretion, and push back against these forces, whether it’s the capital markets, talent, customers or competition. And I think what we have is no space, nothing in between. That is a big problem.

Could you elaborate on the “space for discretion”?

A company that’s continuously growing and managing change needs space, an area within which it can consolidate, take a breath, reflect, within which it can live. A company is an institution and that institution needs its own sphere of discretion, and increasingly given these diverse pressures, there is no space for discretion, space for taking a breath. And it’s like you get onto a tiger and you’re riding a tiger and if you fall down the tiger will eat you. Capital markets, particularly in the context of all these other pressures, have become like a tiger, and I think the demands are becoming unreasonable. No company can keep growing at 10 per cent or keep earnings per share growing at 10 per cent. But even knowing that, there is the constant, day-to-day demand for more every time. And I think part of the pathologies we’re seeing is a response of some weak individuals, undoubtedly, to this environment of constant pressure.

What’s it going to take for a CEO to stand up and say “no” to that intense pressure?

It is a manager’s job to manage the resources efficiently and provide adequate returns. Any manager who doesn’t do it needs to be replaced, and both an efficient capital market and corporate controls have been extraordinarily powerful instruments in improving productivity and efficiency. My point is not that the capital markets are like a devil. Not at all. But at the same time, we must ask what a CEO can do. A very strong CEO can stand up and tell the truth. People like John Browne at BP. Now, once you build a track record, you can give a forewarning of tough times. Then you manage expectations. In some ways Jack Welch managed that, John Browne is managing that, and Andy Grove of Intel has managed that. But whether it’s a new dot-com that goes IPO or somebody like Enron that creates a new business model which has a spiralling effect, it’s very hard to manage that, because there is no stability against which it can be managed.

Also, we’ve created this notion that when it comes to growth that more is better. But this is not necessarily so. At what rate should a company grow? I think this is a very important issue for senior management. When you talk about sustainable development, it does not apply only to society and the planet. Issues of sustainable development that apply to a company’s growth. I think that many of the management practices that have evolved over the last two-and-a-half decades have had little regard for concepts like sustainable development. I think they need to be brought back in. If all you want is the superstars, if all you want is the highest-priced earnings ratios and the like, then you create a system that is inherently unstable and will be more likely to unravel in one form or another, whether it unravels the Enron way, because of individuals’ accounting pathologies, or as some of the dot-coms did. Then, looking back, we will say, “This was a strategic mistake.” But they will ultimately unravel because of a systemic fault in the structure within which they had found themselves trapped.

Let me move down the chart a little, to senior managers or even middle managers: What is their ideal relationship with directors?

You can never overcome the fact that there is information asymmetry between managers and directors. Full-time managers will have information that is more relevant and significantly richer and superior to anything that a part-time director may have, no matter how many board meetings you have or how involved the director is and how well he or she reads the reports that are sent up or other ways of collecting information. No matter what you do, at the end you will not overcome a fundamental problem of information asymmetry between directors and managers.

There is an increasing debate between the merits of a director-centric model of governance and shareholder centric model. In the latter, directors are not representatives of the shareholders, but referees in the game in which customers—everybody—are involved. And I think that is not an inappropriate model, because ultimately the notion that shareholders own the company is wrong. Shareholders own shares. They don’t own the company, because shares in the company are a different thing, and that is the core of the financial model of capital markets. Everybody who has any understanding of what capital markets are and what companies are knows that. But in a loose sense, and I think people and the capital markets have been guilty of it, they’ve kind of simplified it by saying that shareholders own the company. But they do not, and if that is the case, seeing directors as referees in the game actually makes more sense.

But I will go a step further. I ask myself, to whom is a manager responsible? In the end, managers are responsible to the institution they manage, the company, not to shareholders, not to employees, not to customers. They are required to protect the integrity of the institution. And I think that’s the rule of management. It is responsible ultimately for protecting the integrity of the institution. And when I mean integrity, I mean it in all senses of the word. Integrity means it’s holding together. Integrity is what lies at the core of the management profession. Now, integrity cannot be maintained unless shareholders are satisfied, because they will withdraw capital. Integrity cannot be maintained until the employees are satisfied, because they’ll withdraw their labour, or customers or other “stakeholders,” which is a word I don’t like.

I would argue that managers are ultimately responsible for protecting and maintaining the integrity of the institution they manage, and that all the other responsibilities and obligations flow from this basic and primary responsibility. Then the directors become the referees that will ensure that the managers are indeed doing their job of protecting the integrity of the corporation.

There’s considerable criticism of managers who have ties to directors. Should managers have no ties to directors?

The notion that says that everyone should be independent is based on a very atomistic notion of the world. But the world is a social world; it operates by social relationships and networks and linkages. How is the board to be constructed and who will construct it? Ultimately, it will be through some form of relationships, whether they’re direct relationships established socially, maybe they play golf together or they’ve heard about somebody because he’s a good guy and you put him on the board. But ultimately it is not an atomistic, fragmented world where each individual is an island unto himself or herself. It’s social processes that drive the decisions.

In all of these discussions we sort of have a very cognitive, rational model, which totally denies the role of emotions. But that’s not true. If there’s somebody you’re working with regularly, at the end of two years he or she is likely to become a friend or an enemy. There’ll be an emotional content in that relationship no matter how hard you try to avoid it. So there will be this relationship between managers and directors, no matter what. That doesn’t prevent objectivity to the extent you can in terms of the reporting.

I think it’s possible to really look at — and I think a business school should play a role in this — the kinds of reports that management should provide to directors. That would emerge out of talk, reflection and research, saying these kinds of information provide minimum, or in some instances adequate, data for people to make their inferences and judgments. I think we haven’t done such a process with regard to directors. The meeting agendas are rather ad hoc. I think there’s an opportunity for academics and practitioners to work together to devise systems of information that will maintain some objectivity. There should be a process of qualifying board members in a manner that they can have the ability to access that information. So I think we can do a lot to define and improve the relationship between management and boards.

Institutional shareholders, especially pension funds, are becoming increasingly active in the affairs of companies. Is there something managers can do, by way of being proactive, to accommodate—in fact, to manage—the claims of institutional shareholders?

It is just like managers are responsible for ensuring that employees have proper information about the company, because they are investing their human capital in the company. I think managers have an absolute responsibility to ensure that shareholders have appropriate and adequate information about how their resources are being used, how effectively they are being used, what the prospects are, so that they can decide whether they wish to continue to allocate their resources to that particular institution or move them somewhere else. That’s the responsibility for providing adequate, timely information to the best of a manager’s ability and it is an integral part of a capital market process, no question.

Second, I think everybody knows that some customers are more important than others, simply because they buy more or whatever. Similarly, some investors are more important than others. If a major pension fund is holding 10 per cent of your equity, that investment is more important than others and deserves a greater level of information with greater frequency than the others. Managers can avoid a lot of pressure by realizing that some investors are more important than others and keeping those investors fully informed.

On the other hand, some institutional investors have been very macho. The reality is that many institutional shareholders or the managers of those funds have destroyed enormous amounts of their own value and they too don’t inform their owners very well. The pensioners whose fund it is actually are not being kept very well informed by the pension fund manager who is focused on the next quarter, because his or her incentives are tied to that quarter’s performance. I think there will be a lot of push-back. The capital markets and particularly these large funds are as much responsible for many of the so-called scandals as the managers themselves. So far, the funds are standing on the sideline and pointing fingers at management. I think it is already beginning to happen more and more, that the fingers will be pointed at them too. And there needs to be far more responsibility, far more maturity within those institutional groups, as an inherent counterpart to the responsibility and maturity that’s wanted on the managerial side.

Okay, Sumantra. I thank you very much.

Ghoshal: My pleasure.