The Leadership Crisis

By Nancy A. Doyal
President, The International Forum
July 2002

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We are experiencing a major crisis and failure in leadership. It is evident in all aspects of society but particularly in corporations.

This failure is a result of two decades of dramatic changes in the global capital markets and the role of the leader in this system. While the crisis is most public in the United States with recent scandals such as Enron, WorldCom and Tyco, it is also evident in other parts of the world as well including Japan, Korea, Europe and South East Asia.

The crisis in the United States is particularly worrisome because it involves companies and leaders who defined a system of capitalism, which was believed to have had the greatest integrity. The system was successful at generating tremendous return on investment and it was distinguished by its reliability and transparency in compensation and financial reporting. Driven primarily by the success of this Anglo-American shareholder capitalist system, the rest of the world struggled to emulate its principles of transparency, efficiency and capital allocation while trying to make it fit with their own cultural values and societal norms.

While the controls in the system were to ensure that the types of corruption that has taken place in other systems of capitalism did not in fact happen here, they did not take the place of personal values and integrity. The collapse of the Chaebol in Korea and the banks in Japan and the corruption of individuals involved were catastrophic for those economies and the region. But because the Anglo-American system of shareholder capitalism has been regarded as the system that works best in a global arena and after which other systems should be modeled, its failure at both an institutional and individual level is particularly critical. How will this change the environment in which the company operates?

At the core of the debate now is the merit of the capitalist system itself and whether or not it is fundamentally a system built on greed and personal gain at the expense of others, the natural environment and the societies in which it operates. As such we should ask, in what way must it be permitted to proceed? How should it be re-regulated and controlled? What role should it play in the greater society?

The strengths of shareholder capitalism are evident. To grow a company needs capital and this system is an efficient means by which capital is allocated. Those companies, which create something the market values, generate profits, which can be used to finance growth or attract additional capital by increasing returns to shareholders. Good work is rewarded with good opportunity.

Most companies were originally created to generate wealth by accomplishing a greater objective, determined by its owners. In the middle of the 20th century the ownership structure changed and with it the purpose of the company changed. Ownership of companies shifted from individual owners, investors and managers to financial institutions and pension funds. By the 1990ís over 60% of the equity of publicly traded companies was in the hands of "fiduciary agents" or institutions acting on behalf of others (primarily individual retirees, future retirees or individuals) instead of founders and active owners. This form of "fiduciary capitalism" created agents for the owners of capital who were legally bound to take only those actions which a prudent person would take to further the best interests of the beneficiary.

Many of these fiduciary agents were institutional investors, who were evaluated on short-term financial returns by individual investors. This accelerated an emphasis on short-term performance and the emergence of individual personalities who could make the right investment picks. It de-emphasized the greater purpose or the role for the company in the longer term.

Concurrently, American corporations, in response to their apparent "loss of competitiveness" in the 1980ís, re-engineered not only their operations, but also their compensation structures. The explosion of stock option compensation plans was based on the premise that if a large part of an individualís compensation was based directly on the stock price of the company, they would be more motivated make decisions that contribute directly to profits, thereby increasing shareholder value. This was one of the solutions that enabled American companies to become lean and competitive again, but it also lead to great temptations, short-term thinking and potential for abuse.

While the shareholder capitalist system was going through this transformation, the role of leader was thrown into chaos. Individual superstar corporate leaders emerged as knowing how to do it all and getting it all done. With a ruthless focus on creating shareholder value, companies competed globally and created enormous wealth. Leaders were touted personally as the engineer of this enormous success. The pressure to deliver results in the short term was immense and in many cases caused overwhelming conflict between personal and organizational values. The pressure on boards to deliver short-term shareholder value increased CEO turnover rates and M& A activity. Less job security at the CEO level and increased demand for "good" CEOís drove the creation of enormous compensation packages including contracts and parachutes to offset the risk taken by an incoming CEO when the average tenure dropped to 18 months.

The combination of these factors in addition to the opening up of global capital markets, declining trade barriers, lower transportation and shipping costs and technology created a host of new Problems:

  1. Short term demands on institutional investors forced them to put pressure on corporate CEOís to deliver extraordinary results in the short term
  2. Tenure of corporate CEOís (an average of 18 months) motivated them to make decisions such that they could take their benefit from stock options in the short term
  3. Increasing pressure to create profit in the short term took priority over the longer-term benefits to other stakeholder ie. Employees, communities, environment, customers

At the root of this crisis was the role of the individual leader. Their decisions and actions have influenced greatly the outcome of recent events. Their actions have been governed by their own personal values or lack thereof and their ability to strike balance between those values and the values and purpose of their companies.

Will societies now continue to tolerate the choices that corporate leaders have had to make?

Is the next generation of CEOís any better prepared to assume the role of leader? How can we ensure that they become better prepared for this?

How should we re-consider the role of the corporation and its part in supporting the broader goals of the societies in which it operates?

 

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