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November 18, 2003

Corporate Governance: The Elusive Balance

Regulatory compliance is now a fact of life for nearly all businesses. The critical question for many organizations has become: How can we prevent this policy focus from unduly hindering the viability of strategic business processes?

by Frank J. Bernhard

Oversight of surreptitious dealings within the walls of Corporate America has rarely come under such intense scrutiny. First came the Enron story, which occasioned the auditor's fall from grace. Then came the troubles experienced by whistle-blowers at the FBI and other agencies: their frustration was uncovered during the Los Alamos laboratory spying case and analysis of agency behavior leading up to the Sept. 11, 2001 terrorist attacks. Hardly a boardroom today is unaffected by directors feuding over the extent to which security and corporate governance policies must protect the business and its stakeholders without simultaneously damaging productivity.

Businesses and government regulators share a precarious position. Too much handcuffing will lead to a morass of bureaucracy and idle business resources. Too little guidance from regulators could lead to harmful exposure. Where is the boundary between sensible policymaking and unreasonable enforcement? Will policy and procedure edicts weighing slightly less than a standard dictionary satisfy business enterprise leaders? Avoiding pitfalls is a difficult task as organizations try to allay security and governance fears while continuing to function competitively.

Behavioral economics — a social science that aims to measure the effect of choices and outcomes — sheds light on the subject of policy gone awry. In the late 1980s, regulators tightened policy in response to the savings and loan scandals. The worst S&L managers were dragged into the public spotlight as case examples of poor accountability — and the reason for strong policies to prevent future fraudulent investment schemes. Fast-forward to 2002: that year alone saw more corporate executives dethroned and hauled into courtrooms than during the entire S&L scandal era. Auditing standards and reporting policies proved impotent. Inadequate compliance cost investors billions. Strike that: the failure continues to cost investors extraordinary sums, thanks to restated earnings and a shrunken population of confident shareholders.

Policy proves to be no safeguard without a strong desire to achieve a clear outcome. At the end of the 1990s, nefarious executives comfortably stood by, watching day-to-day operations run their companies aground. Equally deluded dot-commers tended to their wanton appetites ahead of investors' interests.The naive public lost much of its retirement savings in the process. Where were the policies and enforcement when the money was flowing so freely? By most accounts, they were nowhere. Regulation became secondary to the pursuit of empires of wealth. It took eroding asset values to bring the issue back to center stage.

Seeking Homeostasis

Corporate giants today squirm uncomfortably as hindsight into circumstances becomes clear. However, they must now worry about what might lie ahead given what has happened previously when industries fell prey to Draconian policies. Take the quasi-regulated airline industry, for example — an industry that was actually deregulated more than two decades ago but has since succumbed to steadily increasing oversight by the U.S. Department of Transportation. In the wake of Sept. 11th, government "help" has come in the form of the Transportation Services Administration (TSA). TSA is focused on the implementation of security directives, while the airline industry desperately tries to maintain focus on the business of moving people and goods at a respectable pace and price. Dragged down by the cost and procedural accountability involved in providing a secure infrastructure and passenger experience, some airlines are suffocating from policy overload and may not survive.

At what point do companies in airline, education, healthcare, telecommunications, and other industries dealing with sometimes heavy-handed policy bureaucracy hit the danger point? We see it when customer service breaks down and companies struggle to perform basic business fundamentals. It is difficult for most organizations to balance between serving policy rules and regulations that often deliver marginal risk mitigation, and pursuing strategic business objectives that lift productivity. The balancing equation is elusive.

A prominent healthcare service provider in California recently grappled with this challenge. The executive in charge of HIPAA compliance noted that it was tough to meet the ultimate goal of member service and privacy protection with so much of the firm's attention focused on interpreting and complying with regulations. Not all sides agree on the issue of patient privacy when balanced with the critical ability to share and deliver medical information. The provider found that knots in the rope between connecting pertinent medical data and assuring member privacy developed quickly when trying to comply with current regulations.

Governance and policy are major balancing issues in mergers and acquisitions. A good example comes from one of the dominant events of recent times in the computer industry: Hewlett-Packard's merger with Compaq Computers. Amid the millions of human hours and thousands of decisions that went into forming the merger, both sides had to execute on policy and governance. According to Jeff Clarke, executive vice president of Hewlett-Packard's Global Operations, "we were racing against time and the factor of making decisions that would ultimately impact a much larger organization when all was finished. But the truly amazing part of this effort was our execution on policy — taking the best of both sides and leaving the rest on the sidelines." This meant taking a close look at accounting, process maps, and the future direction of the new company to set the tempo for how the pieces would fit together harmoniously. Governance had to be strict to ensure integrity and the highest level of accountability: but process functionality weighed equally heavily as employees focused on the goal of putting together an innovative, market-nimble organization.

HP could not afford a malaise of cumbersome policy, which would filter down to how it treated customers. The master plan had to result in a business built to flex in response to market dynamics, yet maintain a rigid core of strategy, clear decisions, governance, and policy adherence.