Replacing intrusive regulation with self-governance

Tuesday, 01 August 2017


    Dr Shann Turnbull argues that more needs to be done to encourage entities to effectively self-govern.

    The wellbeing of individuals, organisations and society is improved as self-governance of all these three entities are improved. However, effective self-governance is only possible when the governors of organisations are denied absolute power in identifying and managing their own conflicts of self-interest.

    Single decision-making committees or boards of directors governing organisations in the private, public and not-for-profit sectors obtain absolute power in this regard.

    Absolute power can lead to the absolute corruption of the individuals involved, of organisations and of society. Absolute power creates toxic governance. The solution is well known and is widely practised in democratic societies that introduce a division of power with checks and balances.

    However, such a simple solution is not adopted by modern organisations, including those publicly traded on stock exchanges. It is irresponsible of stock exchanges and government regulators to allow corporations with a unitary board – with absolute power to corrupt its members, the firm and others absolutely – to become publicly traded.

    Appointing a unionist or other stakeholders to a unitary board does not solve the problem. It creates a decision-making organ responsible to everyone, and so accountable to no one.

    It also creates negative relationships with each stakeholder constituency suspecting that their board nominee has been captured or even bribed to represent others, while each board nominee suspects that their colleagues are sharing sensitive information with their potentially competing stakeholder constituencies.

    Toxic Governance Practices

    Without a division of powers, upgrading regulations and codes of so-called good governance does not remove the kind of toxic governance that created the 2008 Global Financial Crisis (GFC).

    The cause of the GFC is typically attributed to excessive risks in sub-prime mortgages. While such risk existed it was not the key cause of the crisis, according to the US Financial Crisis Inquiry Commission of 2011. A core expertise of banks is analysing risk. This led the commission to conclude a key cause of the crisis was “dramatic failures of corporate governance and risk management”.

    US financial institutions were tightly regulated so the cause of failure was not that they did not comply with regulations, but because they did comply. Governance codes and regulations that accept toxic governance are the problem, not the solution. Is it evidence of an inability to admit mistakes when experts keep repeating or reinforcing mistakes expecting a different result.

    The UK 2016 Corporate Governance Reform Green Paper provided evidence of this problem. While Prime Minister Theresa May’s introduction recognised the need for the right checks and balances, the paper nominated the opposite, stating a unitary board system was a key requirement.

    This denied the Parliamentary Inquiry reporting in 2017 the opportunity to consider replacing toxic governance with processes to allow entities to survive and thrive in a dynamic, unknowable and complex environment.

    Such processes would minimise the risk of external regulators acting in a costly, delayed, reactive manner rather than a proactive, sensitive, nuanced and low-cost manner. However, the theory and practice of self-governance represents an intellectual blind spot for management gurus, policy experts, regulators and legislators.

    Centralised power is so toxic that venture capitalists (VCs) typically require both shareholders and directors to relinquish their powers to govern the business and vest these powers with the VC. This practice proves there is no commercial reason for not establishing a separation of powers, even in highly precarious enterprises starting up in dynamic competitive environments.

    Today, scientists and engineers have acquired the knowledge of how to design self-governing automobiles and space probes. However, lawyers, economists and other social scientists that draft legislation or regulate or manage organisations are mostly not educated in the science of governance.

    Mathematicians and natural scientists identified governance science in the middle of the last century. Yet the theory and practice of self-governance is not taught at graduate management schools. The word management implies centralised, hierarchical control.

    Dysfunctionality of hierarchies

    Hierarchies reduce wellbeing by introducing dysfunctional subservience, blind obedience, alienation and conformity. Conformity is dysfunctional because organisations require a dynamic, rich menu of behavioural responses to survive and thrive in novel, complex and ever changing environments, just like autonomous vehicles and humans. Hierarchies are dysfunctional in other ways:

    • They lack the requisite variety of independent communication channels to cross-check the integrity of the data, information, knowledge and wisdom of what is being reported.
    • They lack the requisite variety of control channels to counter the complexity of disruptive variables.
    • They lack the requisite variety of decision-making centres to reduce data processing overload or for cross-checking decisions.
    • They inhibit the contrary nature humans need to generate a variety of responses to survive and thrive.

    Network Governance

    The human brain is the most complex system known. Like the brains of all other self-governing entities, it has no chief executive neuron. Different parts of the brain make different decisions according the physiological and environmental context. Likewise, many large businesses are created with hundreds of boards within a single business entity. Each board possesses absolute power over one function or operating region.

    Hierarchies simplify complexity by filtering out data, information, knowledge and wisdom at each level, exposing the organisation to undetected operational costs and existential survival risks. Network organisations like The John Lewis Partnership removed toxic governance with a separation of powers to simplify complexity by localising decision making.

    Network governance introduces distributed intelligence with a division of power, allowing internal contestability to provide cross-checking decision making with multiple cross-checking communication and control channels. The result is improved wellbeing for stakeholders and society with a business that obtains competitive advantages with resilience.

    Without a division of power, the ability of stakeholders to improve business operations and resilience while protecting and furthering stakeholder interests will be lost. Meaningful stakeholder involvement can provide a much cheaper, direct, nuanced and economic way to bypass the need for government regulations while enriching the quality of democracy on a bottom-up, participative basis.

    Instead, regulators and governance experts are now becoming obsessed with trying to regulate the very slippery concept of culture and tone at the top. Changing board behaviour is very much dependent on power relationships. The simplest, most straight-forward, certain and effective way to change the culture and tone at the top is to change the power relationships between shareholders, directors and stakeholders.

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