What drives people to become CEOs
Eliminate the perversion
Mr. Larcker, Mr. Tayan, the vice president of investment holding Berkshire Hathaway and best friend of Warren Buffet, Charles Munger, claims that an in-house system based on trust is much more efficient than a compliance-based system. The prerequisite, however, is that the CEO has a "good character". But at a certain point, people's actions become unpredictable. So how do you solve the CEO election problem?
The CEO's job is more than developing corporate strategy and running the business. He or she also sets the tone for the entire organization. If a company wants to introduce a trust-based system in the company, this must be emphasized again and again with the "tone from the top". And that has to come from the CEO. As you put it yourself, making the right CEO choice is key and any honest assessment of the CEO candidate must include an impartial review of his or her character. Is the person righteous, hardworking, and righteous? Or is the person cornering their employees, putting a lot of pressure on their subordinates, and is it all about sales? Boards of directors develop their reputations over time. It is up to the board of directors to find out what reputation the person has before hiring them.
But the "good character" approach is a little nebulous. In our regulated world, it may be seen as too easy or inappropriate for the realities of the business world ...
This approach may not be widely used, but it plays an important role. The scientific literature has pointed out time and again that people who are dutiful, who are dedicated to a higher purpose, who don't compromise on results, and who are willing to wait for a reward do better than both people and leaders . This trait described is certainly rare, but it also brings a rarely good result for the company in which such people work.
Mr Munger's ideas may be suitable for a holding company, but would it also be suitable for a normal, internationally active industrial company? There is, for example, the UK Bribery Act, FCPA and many other regulations around the world that force international companies in particular to have a compliance organization.
There are two barriers to implementing a trust-based system in today's businesses. First, there is the in-house bureaucracy that at some point takes hold in most companies. The workers develop routine, corporate groups develop into bunkers and processes are then established in such a way that they are thoughtlessly accepted by everyone. A CEO has to find ways to break this so that working efficiently can develop in the first place. And employees have to be constantly reassured that they will be rewarded and not punished when they develop new work processes.
Second, as you pointed out, there are laws and regulations that govern the behavior of companies. These laws should be obeyed, both letter and spirit. However, this means that compliance officers and legal departments still have a choice of how to implement their programs and how much they burden the employees with. If the corporate culture is based on ethical behavior, then the compliance officer also has the flexibility to develop leaner systems.
Mr. Munger describes a corporate structure as "perverse" which leads good people to do wrong. But doesn't this approach lead to passivity or even moral disenfranchisement among employees? Where does the individual responsibility end and where does the responsibility of the management or company owner begin?
The opposite is the case. Active employee participation is crucial to the success of the company. After all, the employees are not just the ones who do the company's work, they are its culture. If the CEO sets the right "tone from the top" and develops the right processes, he also signals which type of employee will be successful in the company. So there is a large selection process taking place at the employee and management level. The companies get a certain reputation and it has a lot to do with the type of person who works there and who can be successful in this company.
Would you say that it is also the responsibility of the compliance officer to change this “perversion” of a company structure that Mr. Munger spoke of? And what can the compliance officer do?
Absolutely. But here, too, the success of every compliance officer depends on how they are supported by the board of directors and management. Some companies see compliance as a necessary evil. In such companies, it will be very difficult for the compliance officer to do more than just implement the rules.
But there are also other companies that consider compliance or risk management in general to be an important part of corporate strategy. In these companies, the compliance officer will have a much more interesting challenge: How should one support ethical behavior and following the rules without putting too much strain on the employees? This also implies an active discussion with the executives on how to develop compliance and risk management in such a way that they support the company's success and not hinder it.
What is your position as a scientist on this? Would the system as Mr. Munger imagines it even work in a normal company?
Yes, we think it would work for an average company, but such a system would not be widely used. There is simply not enough of such a special type of business leader who would be willing and able to introduce something like this. On the other hand, Munger's system would give you a real competitive advantage. This is proven by the results of his company.
Which compliance practices do you consider necessary in today's large companies and when do you overdo it with compliance? I'm referring to Walmart's example here. The company improved its compliance system after the ongoing FCPA case, spent hundreds of millions of dollars on it, and hired more than 2,000 compliance people worldwide. They are currently in the process of developing a tight network of control and compliance structures. So what's the right amount?
Some industries have stricter regulatory requirements than others. You then have to map this accordingly in the compliance organization. Companies must take the opportunity to review their control and monitoring mechanisms as well as the daily approval processes. When is management countersigned really necessary? What really needs to be approved by the compliance department, or by the finance or HR department? A really efficient system allows managers and employees to make decisions independently and to be responsible for the consequences. As far as possible, you should develop a system that allows them to do so and that they are rewarded for it. Up to the limit, of course, at which you can individually rely on the employees in question to be able to make such decisions.
What are the compliance officers doing wrong?
The greatest opportunity for the compliance departments is to integrate their work into the ongoing business process. The same also applies to all other “support functions” within the company. What are the working relationships like between compliance and the employees who fight on the front lines, such as in sales or marketing? Do they get along or are they constantly fighting with each other? How “healthy” these relationships are will tell you how the corporate culture is and whether the compliance department will really be successful with its mission.
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