Executive Deterrent

There is a lot of research that tells us that rewards work better than sanctions and if the risk of reward outweighs the risk of sanctions and their proportionate effects, then coupled with the concepts of limited liability and the fact that rewards structures are based on the same principles of shareholder wealth, you can quickly understand why the risk of reward out plays the risk of sanctions. What would be the worst that can happen to inappropriate behaviour of individual executives, even if it leads to a corporate collapse? In the UK we have guidelines on executives behaviour and also criminal offences under Companies Act for supplying false information to Auditors, but these sanctions are little used, even in the US under Sarbanes Oxley, there are provisions for clawing back remuneration where eecutives have been at fault , again little used. Going back to UK experience, the deterrents for bad behaviour seem to be ignored and leads to high risk behaviour, we have had high profile cases where pension rights have been adjusted (voluntarily) in the RBS example and (Sir) Fred Goodwin’s poor decision making, but nevertheless his executive pay levels and existing pension rights appear to leave him comfortably off, even if he is no longer a Knight of the realm. In the case of Kids Company, executives would appear to now be more likely to be disqualified for holding office, yet other high profile collapses appear to be treated differently and we have many examples of confidential pay offs by companies who appear loathe to use the ‘gross misconduct’ reason for terminating an executive’s contract of employment or indeed just plain ‘irrational’ decision making. There is an argument that says that more publicity should be given to errant director’s behaviour with details of sanctions in order to highlight the unacceptability of inappropriate behaviour. Directors justify their actions through the above model of shareholder wealth and corporate results, so short termism rears its head and trade-offs come into play. It is almost as if executives have their own personal strategy to exact the best deal for themselves, such behaviour is therefore motivated by a reward system and a ‘rational’ decision making process. In terms of corporate and personal wealth, there is a common interest in reaching outcomes that are mutually worthwhile. What therefore would ‘ deter’ an executive from making a potentially high risk and high reward decisions which may not sit comfortably with shareholders who ante hoc, may not share the same view of risk. Criminal proceedings could be used but what happens when there are differences in risk aversion and there is no clear line in the sand when any executive actions become at variance with shareholder wishes? Can deterrents help avoid these situations? There appears to be no known theories about deterrent models of corporate behaviours that take into account such ideas as these 1 the kind of internal sanctions to be imposed on errant executive behaviour, 2 the differences between the shareholder’s and executive’s value system 3 the asymmetric emphasis on reward structures 4 the shareholder’s ability to identify misconduct 5 the clarity in employment contracts about authority and decision making levels 6 the tolerance levels for ‘mistakes’ 7 the flaws in employment contracts to specify performance criteria. For deterrence to be relevant there needs not only to be a defined relationship and common interest between the parties involved but also a degree of trust, latitude and areas open to interpretation which inevitably will lead to compromise and possibly conflict, with executives testing the boundaries to see what is acceptable. Fundamentally we are talking about a values based contract for both shareholders and the executive with some form of reward or payoff, but can any deterrence work within a relationship that is both defined and open to (mis)interpretation? This lack of deterrence is key to understanding the difference between Stewardship and Agency theories because there are no warning signs when perimeters and parameters are nearing breach points. Clearly there are some lines to be drawn when we have recourse to legal cases, criminal behaviour and the threat of imprisonment, but before we get to these lines, there is a whole continuum of behaviour between concurrence and conflict. At some stage we have to get to threat levels of sanctions and ultimately sanctions themselves which will, in an ideal world, be agreed upon at the outset and the choice of alternative courses of action should there be a disagreement. If we go straight to sanction mode then there is a failure of relationship, if we have a threat of sanction at an early stage the possibility of disaster can be averted. In such situations we get to brinkmanship and blinking. This all presupposes we are dealing with rationalists who behave logically. We know that under pressure executives don’t always behave rationally, especially when their personal income is under threat and definitions of stewardship and agency become muddled. You can imagine a scenario where even a threat of a sanction would be taken very personally by an executive and we get into areas of personal principles and reputations and a reluctance to enforce agreed disciplinary processes by the company because the Board would be reluctant to take that path on behalf of the shareholders and shareholders do not have such direct contractual and detailed arrangements with individual executives. If the current model of limited liability and capitalism is to survive, there needs to be a better understanding of the contractual relationship between the shareholder, the company as a separate persona at law, the Board (acting on behalf of the shareholders) and the errant executive. Some sanctions or threat of sanctions are required to act as checks and balances on these relationships which should be contractual based on clearly defined positions of power, authority, democracy and rank.

Inspiration- The Strategy of Conflict- Schelling