Thursday, March 12, 2009

Financial Meltdown and Governability

I was watching a BBC discussion moderated by Nik Gowing at Davos. The eminent panel included a vice-chairman of AIG, a Berkeley Professor (also a board member in a major investment bank), the Guyanese head of state and the Swedish Finance Minister. The moderator and the audience were after the major banks, which had caused the meltdown, while the representatives from AIG and the investment bank were defending their position. The AIG vice-chairman (who is actually not on the board of AIG) said that the $85 billion bail-out of AIG was actually a bail-out of the financial system rather than the bank, much to the amazement of the moderator and the audience! The professor denied that the board members of the bank were to blame, and attributed the crisis to a systemic failure.

While it was amusing to watch the show, it set me thinking on some deeper issues around the meltdown that didn’t seem to have received the attention they deserved – the entire idea of ‘Governability’. The hundreds of billions in bail-out have gone largely into salvaging troubled mega corporations, with their toxic assets, and not to the smaller banks and other financial institutions. In fact, the smaller banks seem to be wooing away business from the big banks because of their stability and proximity to customers.

The question is: has the growing diversity of business under a single umbrella since the repeal of the Glass-Steagall Act in 1999 made governance difficult? Has the complexity of the various financial and derivative products made it impossible for executives and the board to manage the inherent risks in the business? Is there a size beyond which no company can be governed or managed effectively?

Expectations from the board and management

It is expected (and justifiably so) that the CEO and the executive leadership team are in complete control of all aspects of the operating and financial performance of a company. It is also expected that the board has the ability to oversee and govern the company at a sufficient level of depth to assure itself that it is well managed, that the business and financial risks are attended to and that the organization is legally and ethically above board. I would look at this as the basic fiduciary responsibilities of the executive team and the independent board members.
However, as a company becomes large and more complex, there is bound to be a point where the board and management are unable to provide the requisite executive attention and governance oversight to all critical aspects of the business. It is at that point that the company becomes too big to be governable.

How big is too big?
As always, there is no universal definition of appropriate size. It is for the board and the management to determine the point at which they feel they’ve lost control of all critical aspects of the business.
Just imagine the plight of independent board members at any large bank with hundreds of different lines of business, countries of operations, products, exposures and risks. Are they really capable of understanding and overseeing the various aspects of the business they have undertaken a fiduciary responsibility to govern?

Clearly, a Bear Sterns and Lehman, which could not predict their own fall a few weeks ahead of the actual occurrence, were too big. The management and the board were clearly not in control of the business. It is likely that a Bank of America, which looked solid but had to seek a government fund injection soon after its Merrill acquisition, may also be too large to be governed.

There are many factors that have contributed to the meltdown. The pursuit of growth and market dominance at any cost have led companies to bite off more than they can chew.; This has led not just to indigestion, but death or near death. To maintain the integrity and health of our financial systems, it is critical for the regulators to apply themselves to the aspect of governability.

Bringing governability into sharp focus
To bring governability and manageability into focus, we must clearly define the accountabilities of the CEO, his leadership team and the independent board members. We need to clearly distinguish between the corporation, as a distinct legal entity, from its management and board.
When someone is appointed as a CEO or as a senior executive in a corporation, there is an implicit understanding that he would perform his function with diligence. Similarly, it is expected that every independent board member will discharge his or her role with the same level of diligence and professionalism.

It is the responsibility of the management and the board to ensure that the company does not become unmanageable and ungovernable in any way – either in terms of size and / or complexity. This can be enforced by making the executives and board members personally accountable for negligence and misconduct in the discharge of their responsibilities. This is similar to the professional liability carried by any other professional, like a doctor, lawyer or accountant.

While Sarbanes-Oxley brought a level of individual accountability at the executive and board level to the accuracy of financial reporting, it could not prevent the failure of these mega corporations. The need, therefore, is for regulations to go beyond reporting accuracy to adequacy of management supervision and board oversight to the critical aspects of a corporation’s functioning.

The meltdown has brought out the shocking realization that the current form of capitalism is far from perfect and that free market mechanisms can create global havoc. While the economic repercussions have been quite severe for employees and investors, one of the few positive outcomes could have been to take a fundamental relook at the current financial system and subject it to a major overhaul. We have lost a significant part of this opportunity because of government interventions and bail-outs. It is now imperative for regulators and corporations to do what it takes to avoid a repeat of this fiasco. Ensuring manageability and governability is one necessary step in this direction.

Sudhakar Ram
CMD Mastek Ltd

Wednesday, March 4, 2009

Making the most of the downturn

At the recent NASSCOM conference, the presentations and conversations were mostly about the downturn and how the industry should cope with it. It was clear that the impact has been unprecedented and few firms have been spared this onslaught. What was particularly concerning was that many CEOs expected the slowdown to last beyond the next two years!

We need concerted efforts along two broad streams to buck the trend and make the most of the downturn – increasing agility and discovering new opportunities.

Increasing Agility
One of the unique trends over the past year or two has been the increased variability of the external environment in both directions. As an example, gas prices went from $60 per barrel to $140 and back to $40 all in a matter of two years. The dollar, which had weakened considerably against the rupee, suddenly gained 28% against the rupee in under 12 months. In our own case, we saw a growth of 34% last year and we are now looking at less than half that number.
The level of variability is likely to continue in the future. The challenge for companies like us, then, is to respond to a downturn with the same speed and poise as taking advantage of an upturn or a special market opportunity. To illustrate, suppose we expect to make $16 of profits on a planned revenue of $100, we should be equally able to maintain that $16 profit if the revenue drops to $85 or take advantage of some sudden market opportunity and raise revenues to $115. Such variability of demand requires a lot more variability on our delivery and support side than we have today. I’d like ideas from all of you on how we can become far more agile as an enterprise – since this could be a significant competitive advantage for us in the future.

Discovering new opportunities
We know that the opportunities for new solutions and new platforms will grow exponentially as the markets revive. However, we still need to grow in the interim. We have made substantial investments in bringing in new leadership, in UK and US.

Our hypothesis is that there will always be visionaries and early adopters who will embrace new platforms ahead of the curve, and we need the leadership bandwidth to identify and capitalize on these opportunities. We are also expanding into Canada and parts of Europe to discover new opportunities within our existing verticals. I must mention that John and the North American team had a great turn out of prospective customers and partners when we did our Canada launch early February.

We need more ideas from all of you on new approaches to discover these opportunities. For instance, when I addressed Mastekeers in Pune, one person came up with the idea that we could leverage the virtual bench by training them in highly specialized, niche technologies / applications so that we can go after these market opportunities. I’d like our sales teams to figure out whether we have such possibilities within the insurance, wealth management or healthcare vertical – where we can bring in special expertise in some rare technologies / applications. Many more such ideas are required for us to buck the trend and grow faster than the industry in the next year.

These are uncertain times for businesses as well as individuals. Just as enterprises need to go the extra mile to emerge stronger from crises, so do professionals. This is the time for all of us to -- individually and collectively -- reflect on what we can do to make ourselves more relevant in the current context. This is the time for us to go beyond our existing skill sets and acquire new capabilities and knowledge to grow as individuals and professionals.

I invite suggestions and ideas from all of you on one can do to stay relevant and make a difference to themselves, their company and its customers.

Responding to Terrorism

How should we handle the impact of the Mumbai terror attacks on our global clients, employees and partners? We can have an effective mechanism to thwart terrorism, or at least contain the damage, only when all of us, as responsible citizens and corporations, plan for and demand a coherent response from the various security forces.

Bottom-Up Approach
In our internal discussions it came out that as a company we had no systematic process to deal with a terrorist attack. It became clear that we need a larger plan to cover the Business Parks that we operate in. At our SEEPZ facility, therefore, we called a meeting of all the companies operating from there along with the Commissioner. We were glad to note that the Commissioner had already received a directive from the Ministry of Commerce to beef up security within the zone.

However, we realized that this was important but inadequate. We require a Level 1 plan that involves not just the SEEPZ security personnel but also the security officers of each company. The plan would have to address various possible attack scenarios and how each company would be alerted, what response measures they would need to take and so on.

Further, we need to work out a Level 2 plan with the local police station, fire brigade, ambulance services etc. to handle situations that escalate beyond the ability of the SEEPZ security forces. Similarly, we need higher levels of escalation to the appropriate forces. We are planning to involve these agencies in our future meetings.

We are looking for NASSCOM and other industry groups to contribute to this process, even involving specialists from India and abroad who can advise us. It is important that every company, industrial park or zone, or residential colony gets together to formulate its own plan of response.

Top-Down Approach

The events in Mumbai have clearly brought out a lack of preparedness in responding to terror in a systematic fashion. It would be pragmatic to have systematic approaches to responding to these attacks.

I envisage that a systematic response plan will involve the following:
- Classification of locations / building based on potential risk – high-risk buildings to low-risk buildings
- Prescribing different levels of security preparedness based on the nature of risk
- Coherent response strategies for different risk scenarios
- Close coordination with the security personnel in the location as well as proximate security forces
- Clear definitions of escalation levels, response times and processes, and handing over charge to forces of higher caliber at appropriate junctures

It will definitely be worthwhile to collaborate with the security agencies of other countries to learn and share best practices. It’s only with sustained, concerted efforts between governments and the public that humanity will discover the means not just to thwart terrorism but to eliminate it from the face of the earth.

Looking forward to other ideas from all of you.