Frank Timmons’ Blog

I drafted this article in late 2005. Once finalized, I intended to submit it for consideration by one or more regional publications. Hopefully I’ll have some time to properly and carefully edit this article to make it more suitable for professional publication.

 

Corporate Governance: HSE Leadership Model
By Frank Timmons
 

So, you have provided your workers with all the best safety equipment, procedures, and training. You explained that safety is your highest priority, and that nothing is worth doing unless it can be done safely. Everyone in the factory knows the rules, can quote the procedures, and has all the required PPE. You have done everything possible to create a safe work environment. However, when you walk around your shop, 30% of the people are not wearing their safety glasses, and 50% are not wearing the correct PPE for their job!

How can we get our Thai employees to follow our HSE rules?

Over the past few years, Corporate Governance has become a popular discussion topic. Everyone can name at least a few of the companies made famous by their bad Corporate Governance: Enron, Tyco, Parmalat, Worldcom, Global Crossing. Most professionals can list at least the most common features that supposedly demonstrate good Corporate Governance: A majority of Independent Directors comprising the Board of Directors, Independent Directors leading the Compensation Committee, Compliant Accounting and Audit Standards, Transparent Executive Renumeration, etc. It would certainly seem that more than enough time and ink has been devoted to covering this topic.

I hereby solemnly swear that when I become CEO or MD, I will faithfully implement these golden rules of Corporate Governance. Unfortunately, I don’t expect to be offered the top job for at least a little while longer.

In the meantime, does Corporate Governance, and its underlying principles, have any relevance to those of us toiling away day by day in our middle level management positions?

Foundation Principles
The popular press would have us believe that Corporate Governance is something that is applicable only in the boardrooms of major corporations. We hear the golden rules, but never learn the underlying principles.

Corporate Governance is actually based upon a few economic principles which primarily deal with the behavior of individuals seeking to maximize their self interest, and strategies to align that self interest with the fundamental interests of the company. These economic principles, which include Agency Theory and the concept of Utility, are somewhat beyond the scope of this article. Fortunately, we can satisfactorily describe the general features and application of Corporate Governance without delving too deeply into the underlying theories.

All of the rules and recommendations of Corporate Governance are derived from three simple principles. Perhaps not surprisingly, these three principles are equally valid to good management as practiced at all levels within organizations, large or small; public, private, or government.

Performance Measurement and Evaluation
Good (or great) performance never happens by accident. Performance depends on the ability to successfully identify the key value drivers for your organization or department, and to actively quantify, measure, report, and evaluate performance. If you can’t measure it, you can’t manage it.

It is very important that performance measurements include short and long term performance parameters, and financial as well as operational parameters. Example, if the CEO sets a single goal to significantly cut fixed costs, the organization could most effectively achieve this objective by slashing preventative maintenance activities and deferring plant improvements. Short term business performance may improve, but over the long term such a narrow strategy might destroy the valuable plant assets required for operational and financial success.

Allocation of Decision Rights
It should go without saying that people cannot achieve performance targets without adequate resources. Resources include tools, equipment, and materials. Resources must also include the ability to make decisions and take actions.

Managers generally receive a formal list of Authorities – how much money he / she is authorized to spend, value of contracts that can be signed, hiring / firing rights, etc. However, many organizations fail to recognize that a significant amount of organizational performance depends upon the people working out on the factory floor. They must also have the ability to make decisions, take actions, enact / request changes, in order to drive performance.

You expect your team to complete a certain quantity of work each shift, keep the plant and shop clean, complete work orders with minimum rework, prevent defects, continuously improve quality, etc. Reality check: managers set standards, but it’s the guys on the floor who get their hands dirty to reach and exceed those standards. They cannot be successful if they lack the ability to make decisions, take actions, and implement change.

Reward System
The reward system is a system of financial and non-financial compensations that motivate performance to achieve goals.

Imagine an organization that measures a broad range of short and long term, financial and operational performance parameters. This organization also has a carefully designed set of authorities that empowers action at all levels of the organization. However, this organization pays everyone equally, with wages simply indexed to inflation. What incentives exist for these employees to take actions to drive performance measurements?

To drive performance, an organization needs to have a reward system that actively encourages employees to take actions consistent with their Decision Rights to maximize Performance Measurements. Employees in such an organization thereby seek to maximize their utility (the combination of financial and non-financial rewards) by taking actions to maximize measured performance.

What are rewards? Obviously, traditional compensation such as salary and benefits are included. Other rewards include peer recognition, praise from management, career advancement. Individuals seek to maximize total rewards; this also involves avoiding undesirable compensation, such as punishment, that subtract from total utility. Other undesirable compensations could include boredom (a more rewarding job is more valuable than a boring job), an unsafe or unhealthy environment, a general lack of advancement opportunities, etc.

A manager’s goal should be to create a reward environment wherein employees are highly motivated to maximize measured performance by using all of the tools / resources / rights provided by management. At the middle manager level, the manager might not have the opportunity to raise salaries or change the system of annual employee performance review. However, all managers, supervisors, foremen, and other team leaders have the opportunity to alter the reward environment for their direct reports through non-financial incentives. Use praise and punishment effectively, create a clean, safe, healthy environment, adjust job assignments to promote professionalism and minimize boredom. Be sure that each employee has the opportunity to go home at the end of the day convinced that he / she made a solid and valuable contribution to the team’s performance.

The Continuum
These three principles are not linear in nature, but rather are circular. No one principle comes before another, each principle supports the others, such that collectively they create an environment of continuous action. Having authority to take action enables an employee at any level to make decisions and facilitate action. Measurements define how the employee’s actions will be evaluated, so he can make decisions that are positively reflected by the measurements (or conversely to make decisions knowing that the results will not be noticed because they are not measured). Rewards are the means through which the employee maximizes his self interest through taking actions to optimize / maximize the value of measured parameters.

Note that these principles are rather simple in concept, but very powerful in effect. As with most powerful tools, these principles can create great value for the organization when thoughtfully implemented, and are equally capable of destroying value, or even the organization itself, if carelessly implemented.

The Golden Rules of Corporate Governance are created in the hopes of creating an environment within the Board of Directors wherein these three principles will be thoughtfully implemented, with prudent and effective oversight to preserve majority and minority shareholder interests. Unfortunately, I must observe that by focusing primarily on a set of rules, the power and promise of Corporate Governance Theory has, in many cases, failed to be realized. The “rubber meets the road” on the factory floor, in the accounting office, in the HR department, and within the sales group. The managers who guide these teams could extract maximum value from the Corporate Governance Principles, if only they were familiar with them.

Balanced Approach
To realize the full promise of Corporate Governance in generating value for the organization, it is very important to develop a carefully balanced system of measurements, decision rights, and linked rewards. Corporate Boards of Directors that choose to compensate their CEO’s and Top Management almost exclusively on quarterly stock price performance create an environment wherein management maximizes their self interest through short term actions, exposing the corporation to long term damage and potentially disaster. Tyco and Enron are far from the only corporations who made this fundamental mistake in judgment.

Deep within the organization, we must also achieve a balance of short and long term goals, operational and financial goals, if we are to maximize shareholder value.

Economic Environment Evolution
It is equally important to recognize that the economic landscape through which we guide our organization is ever-changing. The perfect set of goals last year might be far from perfect this year and actually harmful to the organization next year.

The need to change goals to match a changing economic landscape can be clearly shown by the classic example of a new product launch. A company launches a new, innovative product that is enthusiastically received by consumers. Demand is high, supply is low, and the plant has trouble keeping up with orders. Consumers are thus willing to pay a premium for the product, even if quality isn’t particularly high. In this environment, an organization might create a set of measurements and rewards focused on maximizing production throughput. Unit cost and quality may not be particularly important parameters in this environment. After a year or so, competitors launch competing products, supply catches up with demand, consumers become more price and quality conscious, and the plant finds itself with excess capacity. In this new environment, maximum throughput at all cost is no longer a value – maximizing strategy. The company must change its measurements and rewards to focus on producing high quality products at low unit cost to extract maximum value out of this evolving market. The organization that can keep its strategy in sync with its changing operating environment can produce maximum returns for shareholders.

Implementation on the Factory Floor
How can Corporate Governance Theory be applied to achieve superior performance on the Factory Floor, or in the Accounting Office, or within the Sales Team?

First, don’t call it Corporate Governance. You won’t generate much enthusiasm for a program with such an ominous sounding title. Perhaps just call it a “Performance Checklist”.

1.            Measurements

a.            What are the goals for our team? Be sure to define short term and long term goals, operational and financial goals. If we are a factory team, we might want to achieve certain safety targets, production performance, efficiency targets, unit costs, breakdown hours, preventative maintenance tasks, measurable housekeeping standards achieved, etc.

b.            How will we measure these goals? Safety: No incidents, high level of training completion, minimum number of Job Observations, etc. Production Performance: Units produced, quality target achieved. Efficiency targets: material and utility unit consumption within accepted limits – too low may indicate customers are being cheated, too high means input factors are being wasted.  Housekeeping: objective measurements defined and routinely observed and recorded.

c.             Don’t be afraid to share financial performance with the team. If you are privately held, perhaps shareholders wish to keep certain financial measures confidential. This is reasonable. However, shareholder value cannot be maximized if all financial measures are held confidential. Strongly consider reporting key decision-making parameters such as Unit Contribution Margin, or at least put a monetary value on units of downtime, so the team can make decisions to maximize margin or minimize downtime costs.

2.            Decision Rights

a.            What power will we give to our team members to achieve these goals? Will operators have a budget to buy tools, or at least a convenient way to request tools and materials? How about providing them with a catalog of available tools, so they can select those that best meet their needs? Will they have the opportunity to contribute to safe work procedures, to recommend changes to work practices, to request repairs or modifications to machines? Will they be given direct access to performance parameters, such as monthly unit consumption figures and historical trends, so they can directly evaluate their ongoing performance?

3.            Rewards

a.            Will their performance be based on objective measurements of these goals? Will the performance of individuals be rewarded, or will performance be based on collective team accomplishments? Will compensation be progressive, rewarding achievements that meet or exceed goals, or will it only be punitive, punishing failures to reach targets?

b.            Non-financial rewards are very powerful, and must never be overlooked. Seek opportunities to give praise, to say thank-you. Never avoid punishment, but always try to make constructive comments rather than criticism, and be sure to recognize and reward improvements. Be a good listener, and be sure to recognize and reward positive staff recommendations.

c.             Provide a good work environment. Safe, bright, healthy, friendly. You don’t need to replace the old factory, just take care of the old factory. You’ll be surprised what a coat of paint can accomplish.

As you can see, such a program could be implemented and maintained by supervisory staff on the factory floor, or in most other departments, given a reasonable level of support from Management.

And you can take pride in having successfully introduced Corporate Governance Principles into your organization. Congratulations, you are one step closer to becoming a CEO.