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Tussling for corporate control: reconciling owners' and managers' interests

Dr Jack Jacoby
DBA, MBA, BA, CMC, MIMC, AFAIM
Managing Director - Jacoby Consulting Group

It is increasingly common to hear shareholders and directors talk about the difficulty they face in maintaining control over their organisations, particularly ensuring that their organisations deliver what their owners expect. The consequences of the excesses of the 1980s have drawn attention to the importance of this issue and reinforced the need for a mechanism to ensure that organisations more reliably reflect the interests of shareholders and directors.

Business has undergone many changes in style and practice during the 20th Century. Most of the changes have promised increased effectiveness and efficiency.

The focus has traditionally been on management, because management has been perceived as the controller of corporate destinies. When most business was small and operated with the daily involvement of its owners, this was a relevant perspective as the distinction between owners and managers was minimal.

However, the face of industry has changed. and the average corporation has grown in size and complexity. The relationship between owner and manager has changed. Owners, particularly owners of large corporations, are rarely the same individuals who make the daily management decisions which impact on the performance and destiny of organisations.

It is not uncommon for directors of medium-to-large corporations to complain that management has "hijacked" the organisation and that the direction management has set is not consistent with the Board's vision, even though the board is the final arbiter of organisational policy and direction.

There are many reasons for this disparity in owners' and managers' interests. For example, directors are generally part-time. While management has a range of specialist skills to call on when making decisions that it presents to the board for ratification, it is difficult for the board to verify in detail the assumptions, calculations and the conclusions made by management, because they do not benefit from the same resources.

A director's call for a second opinion or detailed questioning on assumptions and figures, is perceived by management as a vote of no-confidence, or distrust, even though management will concede that it is the directors' responsibility to question and probe.

The dilemma facing directors is real. Directors are there to protect and further the interest of the shareholders, and are seen in law as having this responsibility. Yet they are not always fully in control of the information flows and deliberation processes, which makes their responsibilities difficult to execute and, in certain circumstances, fraught with risk.

What then is the appropriate relationship between the owners of a corporation and the managers they appoint to operate it? Is it possible to identify a solid relationship between the two groups that enables both to fulfil their roles and perform to expectations? How do we divide their responsibilities?

The planning process is the starting point in delineating the relationships between owners and managers. Within the planning process, the structure, orientation and commitment to an organisation's future is made. It is against plans that an organisation's performance is managed and measured. And it is against the skill sets identified within plans that personnel are retained, recruited and rewarded. An integral part of the planning process - the expected and actual performance of organisations - attracts or repels investors and financiers.

An organisation is ultimately assessed by what it has achieved and what and how it is striving to achieve. The business/corporate/strategic plan therefore, is the document that encapsulates organisational striving - the process which tells employees, owners and other interested parties how past and current difficulties will be overcome and how future goals will be achieved. It should be the definitive reference for assessing an organisation's performance against its promises, and for assessing its skill in pre-empting and determining its future.

Those who control the planning process are inevitably those who control the destiny of the organisation. Owners want a plan that enables their needs to be satisfied while managers want a plan which enables them to manage the business and control its resources.

A planning paradigm: causality and dependence

People who run organisations often assert that organisations are only after profit, asset growth or dividends. Similarly, many business leaders site contemporary managerial themes - like TQM, process re-engineering, team building, quality circles, sustainable competitive advantage, world's best practice and benchmarking - as the driver of organisational performance.

These themes appear in the mission statements of many of the world's major corporations. "We will become the biggest", or the "best", or have the "largest market share", or "we adopt TQM principles", "we are here to maximise customer satisfaction", and so on. These are all admirable pursuits, but only when they are in context, and then only when they are seen as enablers to achievement rather than the purpose for striving.

It is a truism that not all organisations are alike; they all have different needs and aspirations and the expectations of their owners are different. Therefore the adoption of a management theme is not equally appropriate for all organisations.

The key dilemma facing owners and managers is when strategies chosen by management conflict directly with the owner objectives. When management chooses to adopt TQM, for example, it usually does so at a considerable cost. If owners have specific short-term optimal dividend objectives, then the investment in TQM, as legitimate as it may be to the longer-term benefit of the organisation, is clearly to the short-term disadvantage of the owners. What is the correct path? Satisfy the owners at the expense of the longer-term health of the corporation, or satisfy the organisation's needs at the expense of owner objectives?

To reconcile this dilemma, it is necessary to deal with the issues of causality in organisations. What within an organisation causes other things to happen and where does this chain of events start?

If, for example, a decision is made to re-engineer a major process in an organisation, what was the principal stimulus for the decision? Was it the desire or need to establish or maintain competitive advantage? Was it a need for lower costs? Where does the organisation get its bearing from?

Many would argue that these decisions are based on being able to fulfil the organisation's objectives. Indeed most corporate behaviour should be rationalised by a desire to fulfil corporate objectives. In practice, however, there are many examples of business decisions made in spite of and in conflict with corporate objectives.

For example, I have worked with many organisations which based their corporate planning on existing structures because it was always done that way or because of internal political expediency. When the structure pre-empts all else, however, objectives are distorted and optimal results rarely achieved. In a recent project I was asked to undertake a strategic review of a high-technology telecommunications division of a major organisation. The division was facing strong threats from emerging technologies. The project sponsors requested that the strategic review assess only structural and organisational issues. Yet nowhere in such an assessment was there the latitude to ask the question "is this division contributing to corporate and owners' objectives and should this business unit continue", particularly since the most optimistic projections fell well short of satisfying owner objectives.

I recently worked with a major insurance company which asked its Information Technology Manager to formalise his group's business plan. The manager objected because his group was a cost centre and was there to provide I.T. support to the rest of the organisation. He was also unaware of the product, service, sales and human resource plans upon which his group reacted and therefore was unable to develop a meaningful plan. His C.E.O. insisted, and an I.T. plan was produced. Millions of dollars were spent on computer tools based on the manager's ill-informed perceptions of the needs of his internal clients. Not only were the millions of dollars poorly committed, but the I.T. plan had to be reworked.

Ultimately, organisational dependency must start somewhere. This point of initial stimulus is often regarded as an organisation's principal objective or mission statement, which in many cases is taken for granted and receives relatively little attention despite it supposedly being the organisation's reason d'etre. If an organisation's mission or corporate objectives are recognised as the initial stimulus, then what gives them life?

My experience strongly suggests that an organisation's initial stimulus extends outside of the organisation itself, and that it rests with the owners and their reasons for establishing the organisation. Owner motivation ultimately should be the force which moulds and shapes organisations.

The paradigm of initial stimulus and functional interdependency

Drawing on experience with scores of organisations, their operations, cultures, planning systems, performance, internal structures and operating styles, I have formulated a set of succinct corporate "laws" which dictate relationships and dependencies in a rational organisation.

Each step of the paradigm is dependent on the preceding step.

1. The organisation exists to fulfil owner objectives. (The initial stimulus of all organisations).

2. The organisation chooses to exist within specific economic, social, cultural, regulatory and economic parameters within which it must be active in order to fulfil its owners' objectives - an organisation's market.

3. Within this market, the organisation must choose what it will offer (products and services) so that owners' objectives can be realised.

4. Once an organisation's products and services have been identified, it must choose the methods by which the market will become aware of its offerings and how these offerings will reach their market, (ie. the four "Ps" of classical marketing)

5. Once the market and product mix strategies have been determined, it is then necessary to assess their impact on the organisation's product and service delivery capability, particularly human resources, information technology and financial resources.

6. Only when these tasks have been effectively completed, can an organisation pull together these divergent (and often conflicting) elements and call it a business, corporate or strategic plan.

This paradigm reflects the internal mechanics of organisational and inter-functional dependence. It establishes the relationships between events in the decision making process and allows planners to ensure an appropriate and logical flow of managerial decision making.

The fundamental characteristic of the paradigm is the recognition that the initial stimulus of all organisations is the satisfaction of owner needs. This is equally true of public and private, large and small organisations. Corporate objectives therefore must reflect owner objectives.

From there, the owners choose the market in which to participate in order to extract the benefits sought by owners.

Once the market has been defined, a choice is made about the tools needed to extract the benefits from it - an organisation's product and service offerings.

The market and product/service decisions will open up a number of distribution and delivery options. How does the organisation get the products and services into the market while still satisfying our core objectives. What channels of distribution, service delivery systems and marketing communication strategies are available?

These higher level decisions will significantly determine decisions on human resources, information technology and processes required to make it happen. A decision to manufacture versus a decision to retail will cause massive changes to H.R., I.T., organisational structure and process strategies. The higher-level decisions determine the mechanistic needs of the organisation.

After the higher level decisions have been made, an organisation can develop a holistic financial picture. Only then can an organisation determine whether it will satisfy owner objectives. If after progressing through this planning process, the financial analysis reveals that the probable benefits do not match desired benefits, then some of the assumptions and decisions made during the process need to be questioned and the plan needs to be reworked.

Diagram 1 illustrates the logical flow of the key elements within the planning process which supports the decision-making dependencies implicit in the paradigm. Looking at it, it is easy to see the inappropriateness of organisational or I.T. structures as the principal determinants of an organisation's planning process. Structure and I.T. are determined by what needs to be done and how it is to be done - they are corporate enablers.

Entrepreneurial organisations often provide good examples of how it should work. They have driving ambitions which are realised with the aid of a range of additional enablers. If resources are not available, the entrepreneur finds them through flexible strategies such as franchising, licensing, out-sourcing, sub-contracting and virtual corporations.

 

Interrelationships chart

Diagram 1

Organisations must always be prepared to question the basic fundamentals of what they do and why they do it in order to provide on-going compatibility between what the owners of the corporation want and what the organisation is doing.

For example, computer mainframe manufacturers historically assumed that their organisational structure, culture, size and skill base provided them with the competitive advantage they needed to remain dominant and profitable. But the mainframe manufacturers' shareholders stopped receiving the dividends they had grown accustomed to. Owner dissatisfaction forced a paradigm shift and the mainframe manufacturers had to change their structure, size, skill base and culture.

Organisations which recognise that they exist solely as an enabler of their owners' aspirations, remain flexible, dynamic and able to cope with challenges. If an organisation has an internal legitimacy and structure that is not aligned directly to owner needs, it is difficult to question the prevailing operational paradigm, and likely that that organisation's culture, structure, skill mix and size will dictate its direction.

Recommendations for owners and managers

There are a few golden rules that enable owners to ensure that their organisations satisfy their objectives. The rules are summarised in Diagram 2.

1. If you are an owner operator, be honest with yourself about what you want your organisation to do for you - what benefit do you want and when do you want to achieve it? Many people who are owners, directors and managers simultaneously lose sight of their own objectives because of short-term operational imperatives. Do not forget to place a value on the degree of satisfaction you are getting from your organisation.

If you are getting everything you want, great. If not, why not? What is the root cause of your dissatisfaction? Deal with the root cause and not with the symptoms. Can you honestly say that based on reasonable probability and your management ability, you are likely to satisfy your objectives through your organisation? If not, seriously consider alternatives. If so, what do you have to do as an owner (not as a manager) to ensure their fulfilment? This may involve firing yourself as a manager and appointing a new one.

 

Chart

Diagram 2

If you are an investor, match the organisation's historical performance with the core benefits you wish to extract from your association with it. Have you been satisfied in the past? Look at the strategies and direction the organisation is adopting. Ask yourself the same questions as the owner operator. If you are not getting what you want, look for another investment where your ambitions are better served and where you have a greater probability for satisfaction. If you are in a position to take control, ask yourself whether it is worth it. What do you have to do to the organisation to achieve what you want? Are you capable of doing it? Control does not mean success, you also need ability, judgement and credibility. After all, you don't want to take control only to find your suppliers and staff desert you.

If you are a director, make sure you understand what the owners want. Get to know the investors/owners and maintain regular communications. Do not assume that owner objectives remain fixed. Do not assume that management will always have the owner's best interest at heart - that is your role and responsibility. Do not accept management plans and strategies at face value. Always question their assumptions. Only approve initiatives that enhance owner objectives.

If you are a manager, learn what makes your owners happy and learn to manage to satisfy their needs. Become ruthless in assessing opportunities and initiatives against the owner- needs. Get board/owner buy-in to your planning processes and assumptions.

2. No matter what your relationship to the organisation, adopt a planning process that recognises the inter-dependencies and inter-relationships between the elements within it as illustrated in Diagram 1.

Adopt a "trickle down" planning process in which high-level decisions are the basis for further iteration down the organisation. This trickle-down process has a number of characteristics:

a. Clarify what the owners' objectives are and adopt these as the corporate objectives.

b. Clarify all corporate-wide planning assumptions - GDP growth rates, disposable incomes, employment rates, exchange rates, freight costs, global market trends, etc.

c. Have all personnel responsible for planning affirm their agreement to the objectives driving the organisation and the planning assumption within which they operate.

d. Once affirmed, request a short synopsis of the marketing assumptions that are peculiar to each planning unit. What are the trends and characteristics of these markets? What are the characteristics of the market environment that will enable that unit to contribute to the satisfaction of owner objectives.

e. All market synopses should be ratified by a planning steering committee composed of the CEO, the CFO, the Director of Marketing and at least two members of the board. Where interpretations and assumptions are in conflict with committee understanding or with other planning units, then the overview statement(s) need to be revised.

f. The unit planners should then provide a high-level synopsis of the products and services they intend to offer in their defined market. They should also outline the demand, supply and competitive characteristics of the market, and provide broad revenue and profit/benefit projections for their product and service offerings.

g. These synopses are again ratified by the planning steering committee for congruence and compatibility.

h. Planning units are then instructed to develop detailed product/service plans including channel, service, marketing communication strategies supported by HR, IT, process and administration resource specifications. This necessitates detailed discussions with other functional areas of the organisation.

i. Then one needs to wrap an "organisational skin" around the product and service plans. This will involve forming or adapting those functions that impact all or most functional units such as management and organisation structure, corporate HR function, marketing and executive and support needs.

j. Only then can financial projections be accurately developed and assessments made as to whether the chosen strategies will fulfil corporate objectives. If not, then assumptions and decisions are revisited and different options considered. When the best fit is formulated it is formalised into a business, corporate, strategic or marketing plan.

3. Ensure that the performance measures your organisation adopts reinforce corporate/owner objectives. Do not measure the effectiveness of your organisation and its CEO by generic measures. Use measures that apply in your context and relate to satisfying owner objectives.

Owners have no one to blame but themselves if their organisations do not delivering owner objectives. There are many tools available to owners and investors to achieve better alignment between corporate and owner objectives. If this article strikes a chord, I suggest you pursue one of them.

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