Board, Governance and Sales Incentives scheme

Wells Fargo and the Slippery Slope of Sales Incentives

even a strong compliance function can’t counteract a compromised culture.

Get on Board the proper people, culture and behaviour….this is the primary interest to serve the shareholders as well, MALTAway is ready to serve you BOARD GOVERNANCE AND NON EXECUTIVE DIRECTOR (NED)

board-compensation-committee

In early September Wells Fargo agreed to pay a $185 million fine and return $5 million in fees wrongly charged to customers. The settlement stems from the bank’s employees allegedly opening more than 2 million bank and credit card accounts without customers’ permission. The CEO of Wells Fargo, John Stumpf, apologized in front of a congressional panel Tuesday, saying in a statement, “I accept full responsibility for all unethical sales practices.”

That speaks to why they did this in the first place: To meet sales quotas and earn incentives.

 

This is certainly not the first time that a high-profile sales scandal like this has hit the press. In the early 1990s Sears sought to restore its reputation with $46 million in coupons because some employees of its automotive repair division (who were paid a commission on sales of parts and services) had allegedly enticed customers into authorizing and paying for needless repairs. In 2005 the world’s largest insurance broker, Marsh Inc., paid $850 million in fines in the aftermath of accusations that it had received kickbacks from insurance companies for steering business their way — a scheme at odds with Marsh’s commitment to finding the best deal for customers.

Beyond the fines, Wells Fargo has fired at least 5,300 employees for “inappropriate sales conduct,” and the bank is making changes to its quota system. Stumpf said in an earlier statement: “We are eliminating product sales goals because we want to make certain our customers have full confidence that our retail bankers are always focused on the best interests of customers.” Politicians, predictably, have railed against the leadership at Wells Fargo and have called for Stumpf’s resignation. One of the intriguing facts to come to light is that the fraudulent account openings continued even after the bank was aware of it and had fired employees for it starting in 2011.

That suggests that firing employees was not enough to curb the actions. Will eliminating sales goals do it? Before answering this question, it is useful to understand why and how such sales practices begin and spread within an organization.

In these and many other similar (but often less high-profile) cases, much of the blame gets placed on the sales goals and incentives. Salespeople are offered a large monetary reward linked to the achievement of sales goals — goals that employees perceive as excessively high. Sales managers, too, are rewarded for goal achievement, so they put pressure on salespeople to deliver. Salespeople are enticed by the promise of the large reward, or perhaps they are fearful of losing their jobs. Either way, they do whatever it takes to make sales goals.

But large rewards tied to challenging sales goals do not have to be a deadly combination. Many companies have great success using incentives and stretch goals to motivate the sales force and drive revenue. The culture in such sales forces may be sales-oriented and even competitive, yet salespeople still behave ethically and remain focused on meeting customers’ needs.

What differentiates sales teams that play by the rules from those that break them?

Large-scale unethical sales practices often begin with minor ethical compromises. Things escalate and spread from there. Consider the following sequence:

A bank account manager, under pressure to make a sales goal, pushes a customer to add a credit card, even though the account manager knows it’s not in the customer’s interest
Still short of the goal, the account manager asks his friends and family to open accounts. (The accounts are to be closed shortly thereafter.)
With the goal still not achieved, the account manager opens accounts without asking customers and transfers a small amount of money. (The accounts are closed shortly thereafter and the money is transferred back.)
As soon as the account manager gets away with the first unethical act, it’s not a big step to the fraudulent ones. The justification moves from “it’s legal” to “no one is harmed” to “no one will notice.” When such practices are tolerated, they escalate in severity and spread throughout the organization.

 

To prevent that, the sales culture has to stop the first level of compromise, because the slippery slope begins there. As Wells Fargo has discovered in the last five years, even a strong compliance function — one that began firing people in 2011 — can’t counteract a compromised culture.

 

When things escalate to such a scale, the problems won’t stop with salespeople. Managers and leaders may be looking the other way, or aiding and abetting the behaviors.
What’s most insidious is that managers and leaders may be engaging in similar behaviors in their spheres and domains — in how they deal with other people inside the company, with partners, and with suppliers. Often, bringing about change requires going right to the top of the sales organization and bringing in a new leader who isn’t connected to the history of what’s happened. This individual can build a new culture based on appropriate values and the right workstyle.

Though not a question for customers and regulators, companies such as Wells Fargo have to ask how they can succeed in a sales world without heavy reliance on goals and incentives.

In 2011, about the same time that Wells Fargo began firing employees for questionable sales practices, we wrote a piece for HBR.org addressing that very issue. We called it “Is Your Sales Force Addicted to Incentives?” As we wrote back then, the key to success will be a new culture built around a more balanced approach to managing sales. This new approach will require using tools other than incentives — for example, interesting work, enhanced processes for selecting salespeople and managers, training and coaching, information sharing, empowerment, teamwork, manager assistance and supervision, and improved performance management systems — to motivate salespeople and guide and control sales behaviors.

If the bank is successful in transforming to this balanced sales culture, then perhaps the money it once used for employee incentives can instead go to customer incentives — for example, a no-fee credit card or a better interest rate for opening a new high-balance account. Other companies would be wise to take the time to examine their own sales culture and ask whether incentives might be clouding otherwise good judgment.

https://hbr.org/2016/09/wells-fargo-and-the-slippery-slope-of-sales-incentives

Bank digital credit risk management

Bank digital credit risk management

To withstand new regulatory pressures, investor expectations, and innovative competitors, banks need to reset their value focus and digitize their credit risk processes.

External and internal pressures are requiring banks to reevaluate the cost efficiency and sustainability of their risk-management models and processes. Some of the pressure comes, directly or indirectly, from regulators; some from investors and new competitors; and some from the banks’ own customers.

The impact is being felt on the bottom line. In 2012, the share of risk and compliance in total banking costs was about 10 percent; in the coming year the cost is expected to rise to around 15 percent. Overall, return on equity in banking globally remains below the cost of capital, due to additional capital requirements, fines, and lagging cost efficiency. All of this puts sustained pressure on risk management, as banks are finding it increasingly difficult to mitigate risk through incremental improvements in risk-management processes.

To expand despite the new pressures, banks need to digitize their credit processes. Lending continues to be a key source of bank revenue across the retail, small and medium-size enterprise (SME), and corporate segments. Digital transformation in credit risk management brings greater transparency to risk profiles. With a firmer grip on risk, banks may expand their business, through more targeted risk-based pricing, faster client service without sacrifice in risk levels, and more effective management of existing portfolios.

Incumbents under pressure

Five fundamental pressures that relate directly to risk management are being exerted on banks’ current business model: customer expectations for digitally managed services; regulatory expectations of a high-performing risk function; the growing importance of strong data management and advanced analytics; new digital attackers disrupting traditional business models; and increasing pressure on costs and returns, especially from financial-technology (fintech) companies (Exhibit 1).

Customer expectations. Traditionally reliant on physical distribution, banks are finding it difficult to meet changing customer needs for speed and simplicity, such as fast online credit approvals.

Regulatory and supervisory road map. Regulators are expecting the risk function to take a more active role in the context of new, digitized business models. New regulations are being put in place to address cyberrisk, automation of controls, and issues relating to risk-data aggregation. Directives pertaining to the Comprehensive Capital Analysis and Review, BCBS 239, and asset-quality reviews specify requirements for data management and the accuracy and timeliness of the data used in stress testing.1

Data management and analytics. Rising customer use of digital-banking services and the increased data this generates create new opportunities and risks. First, banks can integrate new data sources and make them available for risk modeling. This can enhance the visibility of changing risk profiles—from individuals to segments to the bank as a whole. Second, as they collect customers’ personal and financial data, banks are mandated to address privacy concerns and especially protect against security breaches.

Fintech companies and other innovative attackers. The digitally savvy segments have responded to innovative offerings from new nontraditional competitors, especially fintech companies and digital-only banks. These start-ups are extending innovation throughout the digital-banking space, creating a competitive threat to traditional banks but also potentially valuable opportunities for partnerships (Exhibit 2).

Pressure on cost and returns. The new competitors are beginning to threaten incumbents’ revenues and their cost models. Without the traditional burden of banking operations, branch networks, and legacy IT systems, fintech companies can operate at much lower cost-to-income ratios—below 40 percent.

Fighting back

Banks are beginning to respond to these trends, albeit slowly. Over the past several years, leading banks have begun to digitize core processes to increase efficiency—in particular, risk-related processes, where the largest share of banks’ costs are typically concentrated. Most banks started with retail credit processes, where the potential efficiency gains are most significant. Digital approaches can be more easily adopted from well-established online retailers: mobile applications, for example, can be developed to enable the origination of tailored personal loans possible instantaneously at the point of sale. More recently, banks have begun to capture efficiency gains in the SME and commercial-banking segments by digitizing key steps of credit processes, such as the automation of credit decision engines.

The automation of credit processes and the digitization of the key steps in the credit value chain can yield cost savings of up to 50 percent. The benefits of digitizing credit risk go well beyond even these improvements. Digitization can also protect bank revenue, potentially reducing leakage by 5 to 10 percent.

To give an example, by putting in place real-time credit decision making in the front line, banks reduce the risk of losing creditworthy clients to competitors as a result of slow approval processes. Additionally, banks can generate credit leads by integrating into their suite of products new digital offerings from third parties and fintech companies, such as unsecured lending platforms for business. Finally, credit risk costs can be further reduced through the integration of new data sources and the application of advanced-analytics techniques. These improvements generate richer insights for better risk decisions and ensure more effective and forward-looking credit risk monitoring. The use of machine-learning techniques, for example, can help banks improve the predictability of credit early-warning systems by up to 25 percent (Exhibit 3).

Good progress has been made, but it is only a beginning. Many risk-related processes remain beyond the digital capabilities of most banks. Significant effort has been expended on the digital credit risk interface, but the translation of existing credit processes into the online world falls far short of customer expectations for simple digital management of their finances.

There is plenty of room for digital improvement in client-facing processes, but banks also need to go deeper into the credit risk value chain to find opportunities to create value through digitization. The systematic mapping and analysis of the entire credit risk work flow is the best way to begin capturing such opportunities. The key steps—from setting risk appetite and limits to collection and restructuring—can be mapped in detail to reveal digitization opportunities. The potential for revenue improvement, cost reduction, and credit risk mitigation for each step should be weighed against implementation cost to identify high-value areas for digitization (Exhibit 4).

Some improvement opportunities will cut across client segments, while others will be segment specific. In origination, for example, most banks will probably find that several segments benefit from a digitally connected, paperless credit underwriting process (with live access to customer data). At the stage of credit monitoring and early warning, furthermore, advanced analytics and fully leveraged internal and external data could improve risk models for identifying issues across different segments. Back-office and loan-administration tools such as straight-through processing and automated collateral valuation are also cross-cutting improvements, as are the automation and interactivity of risk reporting.

On the other hand, in credit analysis and decision making, banks will likely find that instant credit decisions are mostly relevant in the retail and SME segments, while the corporate and institutional segments would benefit more from smarter work-flow solutions. The application of geospatial data, combined with advanced analytics, for example, can yield a high-performing asset-valuation model for mortgages in the retail segment. For collection and restructuring, automated propensity models will match customers in the retail and SME segments with specific actions, while for the corporate segment banks will likely need to develop debt restructuring-simulation tools, with a digital interface to identify and assess optimal strategies in a more efficient and structured way.

How digital credit creates value

Several leading banks have implemented digital credit initiatives that already created significant value. These are a few compelling cases:

  1. Sales and planning. One financial institution’s journey to an interactive front line involved the construction of a digital workbench for relationship managers (RMs). The challenges to optimal frontline performance were numerous and included the lack of systematic skill building, customer-relationship-management (CRM) systems with a fragmented overview of clients, and difficulty gathering relevant client and industry data. Onboarding, credit, and after-sales processes required many hours of paperwork, drawing frontline attention away from new client meetings. By engaging RMs with the IT solutions providers, the bank’s transformation team created a complete set of frontline tools for a single digital platform, including best-practice CRM approaches and product-specialist availability. The front line soon increased client interactions four to six times while cutting administrative and preparation time in half.
  2. The mortgage process. This presents a large opportunity for capturing digital value. One European bank achieved significant revenue uplift, cost reduction, and risk mitigation by fully automating mortgage-loan decisions. Much higher data quality was obtained through exchange-to-exchange systems and work-flow tools. Manual errors were eliminated as systems were automated and integrated, and top management obtained transparency through real-time data processing, monitoring, and reporting. Decisions were improved and errors of judgment reduced through rule-based decision making, automated valuation of collateral, and machine-learning algorithms. The bank’s automated real-estate valuation model uses publicly known sale prices to derive the amount of real-estate collateral available as a credit risk mitigant. The model, verified and continuously updated with new data, attained the same level of accuracy as a professional appraiser. Recognized by the regulator, it is saving the bank considerable time and expense in making credit decisions on actions ranging from underwriting to capital calculation and allocation. Losses were further minimized by automated monitoring of customers and optimized restructuring solutions. The digital engine moved decision making from 5 percent automated to 70 percent, reducing decision time from days to seconds.
  3. Insights and analysis. By making machine learning a part of the effort to digitize credit risk processes, banks can capture nearer-term gains while building a key capability for the overall transformation. Machine learning can be applied in early-warning systems (EWS), for example. Here it can enable deeper insights to emerge from large, complex data sets, without the fixed limits of standardized statistical analysis. At one financial institution, a machine learning–enhanced EWS enabled automated reporting, portfolio monitoring, and recommendations for potential actions, including an optimal approach for each case in workout and recovery. Debtor finances and recovery approaches are evaluated, while qualitative factors are automatically assessed, based on the incorporation of large volumes of nontraditional (but legally obtained) data. Expert judgment is embedded using advanced-analytics algorithms. In the SME segment, this institution achieved an improvement of 70 to 90 percent in its model’s ability accurately to predict late payments six or more months prior to delinquency.

The approach: Working on two levels

While the potential value in the digital enablement of credit risk management can be significant for early movers, a complete transformation may be required to achieve the bank’s target ambitions. This would involve building new capabilities across the organization and close collaboration among the risk function, operations, and the businesses. Given the complexity of the effort, banks should embark on this journey by prioritizing the areas where digitization can unlock the most value in a reasonable amount of time: significant impact from applying digital levers can be tangible in weeks.

Rather than designing a master plan in advance, banks can in this context develop a digital approach to one area of credit risk management based on existing technology and business value. Each bank may develop initiatives based on their specific priorities. Banks that most need to increase regulatory compliance and the quality of their execution may begin with initiatives in process reengineering to reduce the number of manual processes or to build a fully digital credit risk engine. Those looking to improve customer value from greater speed and efficiency might implement such initiatives as a state-of-the-art digital credit-underwriting interface, a digitally enabled sales force, data-driven pricing, or straight-through credit decision processing. Banks needing to mitigate risk through better decision making may develop initiatives to automate and integrate early-warning and recovery tools and create an automated, flexible risk-reporting mechanism (a “digital-risk cockpit”).

A credit risk transformation thus requires banks to work on two levels. First, look for initiatives that are within easy technological reach and that will also advance the core business priorities. Launching initiatives that bring in savings quickly will help the transformation effort become self-funding over time. Once a first wave of savings is captured, investments can be made in building the digital capabilities and developing the foundation for the overall transformation. Based on what has been learned in early-wave initiatives, moreover, new initiatives can be designed and rolled out in further waves. Typical first-wave initiatives digitize underwriting processes, including frontline decision making and reporting. Risk reporting is another likely candidate for early digitization, since digitization reduces production time and leads to faster decision making.

Building digital capabilities: Talent, IT, data, and culture

The experience of specific initiatives will help shape digital capabilities for the long term. These will be needed to support the overall digital transformation of credit risk management and keep the analytics and technology current. To begin, banks can examine their current capabilities and assess gaps based on the needs of the transformation. The talent focus in risk and across the organization will likely shift as a result toward a greater emphasis on IT expertise and quantitative analytics.

In addition to enhancing their talent profiles, banks will have to shift the direction of their IT architecture. The target will likely be two-speed IT, a model in which the bank’s IT architecture is divided into two segments. Accordingly, the bank’s core (often legacy) IT systems constitute a slower and reliable back end, while a flexible and agile front end faces customers. Without a two-speed capability, the agility needed for digital credit risk management would not be attainable.

Along with the supporting IT architecture and analytics talent, improved data infrastructure is an essential digital capability for the credit risk-management transformation. The uses of data are disparate throughout the bank and will continually change. For big data–analytics projects, great quantities of data are needed, but how they should be structured is not usually apparent at the outset. The construction of separate data sets for each use, furthermore, creates as many data silos within the organization as there are projects.

For these reasons, some leading companies are moving toward utilizing a “data lake”—an enterprise-wide platform that stores all data in the original unstructured form. This approach can improve organizational agility, but it requires that each project has the capability to structure the data and understand data biases. All types of data infrastructure also pose security risks, moreover, which can be addressed only by IT experts. Finally, the reconfiguration of the data infrastructure needs to be done using methods that carefully respect legal privacy barriers and meet all regulatory requirements.

Last, building and maintaining a strong digital-risk culture will be of critical importance in ensuring the success of the risk function of the future. A shift in culture and mind-set is needed among employees, top executives, and regulators, as they acclimate themselves to the new digital credit environment. Here, machines and automation have a much greater role, while human capabilities are developed to support the continual improvement of the risk culture. The focus shifts from executing a risk process to managing true control systems that continuously detect, assess, and mitigate risks.

Toward a flexible digital-risk end state

From data input and management to decision making, from customer contact to execution, the initiatives should build step by step toward a seamless and interactive digital-risk function. The initiative-first approach builds in the capability of agile adaptation to changes in customer demand or the competitive and regulatory environments. The digital opportunities and the way banks address them, in other words, will continually evolve, and the digital end state must support such changes while maintaining enhanced risk-management and client-service capabilities.


The digital transformation of existing credit risk tools, processes, and systems can address rising costs, regulatory complexity, and new customer preferences. The digital enablement of credit risk management means the automation of processes, a better customer experience, sounder decision making, and rapid delivery. Digital-risk management will be the norm in the industry in five years, and banks that act now can attain enduring competitive advantage.

http://www.mckinsey.com/business-functions/risk/our-insights/the-value-in-digitally-transforming-credit-risk-management?cid=other-eml-alt-mip-mck-oth-1608

Corporate Bureaucracy Is Costing the U.S. $3 Trillion Per Year

Excess Management Is Costing the U.S. $3 Trillion Per Year …. being much more bureaucratic it is much worse for Europe and Asia

66a05-global-unemployment

MALTAway your Board and Governance Advisor

More people are working in big, bureaucratic organizations than ever before. Yet there’s compelling evidence that bureaucracy creates a significant drag on productivity and organizational resilience and innovation. By our reckoning, the cost of excess bureaucracy in the U.S. economy amounts to more than $3 trillion in lost economic output, or about 17% of GDP.

Here’s the arithmetic. According to our analysis of occupational data provided by the U.S. Bureau of Labor Statistics, there were 23.8 million managers, first-line supervisors, and administrators in the American workforce in 2014. (This figure includes both the public and private sectors but does not include individuals in IT-related functions.) That works out to one manager and administrator for every 4.7 employees. Overall, managers and administrators made up 17.6% of the U.S. workforce and received nearly 30% of total compensation.

How many of these 23.8 million overseers do we actually need? We can get an answer by looking at the management practices of a small but growing number of post-bureaucratic pioneers. Their experience suggests it’s possible to run complex businesses with less than half the managerial load typically found in large companies.

Among the vanguard are Nucor (America’s most profitable steel maker), Morning Star (the world’s largest tomato processor), W.L. Gore (a $3 billion high-tech company famous for its Gore-Tex fabrics), Svenska Handelsbanken (a Stockholm-based bank with more than 800 branches across Northern Europe and the UK), Sun Hydraulics (a class-leading manufacturer of hydraulic components), Valve (a pioneering developer of online games), and General Electric’s jet engine plant in Durham, North Carolina.

The case of Svenska Handelsbanken is illustrative. Its return on equity has surpassed that of its European peers every year since 1971. In the organization of 12,000 associates, there are only three levels. Operating decisions are almost entirely decentralized. Each branch makes its own loan decisions, sets its own pricing on loans and deposits, controls its own marketing budget, runs its own website (on a shared platform), and serves all customer segments — from individuals to multinationals — within its catchment area. Nearly all of these practices run counter to conventional banking wisdom, which holds that to be efficient a bank must consolidate operational activities and centralize decision making on matters like pricing and lending. Svenska Handelsbanken has consistently posted industry-beating cost-to-income and loan-loss ratios.

The average span of control in these and other vanguard organizations is more than double the U.S. average. GE’s Durham plant, to take a dramatic example, employs more than 300 technicians and a single supervisor: the plant manager. The facility is more than twice as productive as its sister plants in GE Aviation.

The experience of the vanguard suggests it should be possible to double the ratio of employees to managers and administrators, from 4.7:1 to 10:1. Doing so would free up 12.5 million individuals for other work that is more creative and productive.

There would be indirect savings as well. A myriad of studies have documented the time lost to low-value management processes, from budgeting to theperformance review. On the basis of this evidence (further discussed here), it’s reasonable to assume that as much as 50% of all internal compliance activity is of questionable value. If we assume that the 111 million Americans workers who are not managers, supervisors, and administrators (or unincorporated self-employed) are spending roughly 16% of their time on internal compliance (an estimate from a Deloitte Economics study) and that half of that time is wasted, this translates into an annual waste of about 8.9 million worker years.

In total, then, there are 21.4 million employees in the U.S. workforce — 12.5 million managers and the equivalent of 8.9 million individual contributors, who, through no fault of their own, are creating little or no economic value. This means the U.S. could achieve current levels of economic output with 15% fewer people in the labor force. That would, in effect, boost GDP per worker from $120,000 to $141,000.

The goal, of course, isn’t to put 21.4 million people out of work, but to redeploy them into value-creating activities. If these individuals were contributing an average of $141,000 each to economic output each year, rather than adding nothing, U.S. GDP could grow by $3 trillion — and the actual figure would likely be higher. Managers and administrators tend to be better educated than the workforce at large and typically possess technical or functional skills. Given that, we should expect them to deliver better than average output per capita once reassigned to more productive, and potentially more satisfying, work.

Then there are the large but difficult-to-quantify benefits that would come from a newly empowered workforce that is no longer paralyzed by process. More freedom and responsibility would mean more initiative, innovation, and institutional flexibility — which would further boost productivity. These side benefits are far from trivial. For example, a number of highly respected leaders in the pharmaceutical industry have argued that the only way to raise R&D productivity, and thereby reduce the soaring costs of drug discovery, is to dismantle bureaucracy. Roger Perlmutter, the president of Merck Research Laboratories, suggested that a good start would be to “scrape off the top five levels of management, including myself.”

Three trillion dollars represents 17% of U.S. GDP. If this burden was reduced by half over the next 10 years, productivity growth would increase by a compounded rate of 1.3% annually, essentially doubling the post-2007 productivity growth rate.

The productivity bonanza would be even larger outside the U.S. In 2014 the combined GDP of the 35 countries that make up the OECD amounted to $49.7 trillion, of which the non-U.S. share was $32 trillion. If bureaucracy is as ubiquitous in these economies as it is in the U.S., and there’s little reason to believe it isn’t, cutting the number of managers in half would save another $5.4 trillion — an amount that exceeds the value of the entire Japanese economy.

Many of the world’s largest economies are in a prolonged productivity slump. In Europe and the U.S., stagnating incomes and diminished economic hopes are feeding a growing appetite for protectionism and spawning divisive, us-versus-them political forces. While some hold out hope that robots, genomics, and the internet of things will one day yield a productivity bonanza, we believe a concerted effort to reverse the rising tide of bureaucracy offers a more immediate and less speculative route to enhanced economic performance.

https://hbr.org/2016/09/excess-management-is-costing-the-us-3-trillion-per-year

Investors’ Reading Habits Influence Stock Prices

Investors’ Reading Habits Influence Stock Prices

murakami

A cornerstone of efficient and transparent markets is freely available information. Information drives financial activity, and ensuring equitable access to that information is seen as critical to a well-functioning marketplace.

But does the mere action of placing a piece of financial news in the public domain make it readily seen and efficiently reflected in stock prices? According to my and others’ research, not necessarily.

MALTA way BANKS & INVESTMENTS

INVESTMENTS in Malta: The Complexity of Simplicity

Corporations, Entrepreneurs, Families, HNWIs, Individuals, with our advice and support, find in Malta a dedicated, professional and safe Banking and Finance system within legal, tax, financial regulations suitable for business environment and wealth & assets protection

These Finance Services’ solutions for Investments in Malta, meet the clients’ needs in a stable, safe and growing economy country, member of Europe and Commonwealth as well

Behind these words , there are three basic concepts :

  • wealth protection
  • asset growth
  • income from capital

In 2001 professors Gur Huberman and Tomer Regev of Columbia University drew attention to a peculiar sequence of market reactions to news regarding a cancer research breakthrough licensed by biotech firm EntreMed. The initial news release, printed as a scientific piece in Nature and reported in the popular press in November 1997, was accompanied by a 30% increase in EntreMed’s stock price. In May 1998, over five months after the initial breakthrough, the New York Times published a front-page piece with almost identical information. EntreMed’s stock price surged by over 300%. Whether the initial reaction in November was insufficient, or the frenzy in May was irrational, one thing was clear: The positioning of news, not just its newness, plays a pivotal role in how financial markets incorporate information.

In my research, I find that similar instances of too much and too little attention to financial news persist today. For instance, I find that news articles placed on the front page or at the top of news websites garner more reads. Readers also pay more attention to news about larger and better-known companies, to news published earlier in the week, and to negative news. And reprints of old news continue to spur market reactions. This might not surprise journalists or news junkies, but it challenges the idea that financial markets absorb all news equally, based only on financial relevance.

These pitfalls of news consumption emerge predictably from human psychology. A sizable literature documents the role that distraction plays: When faced with multiple competing cues, people have difficulty focusing their attention on the relevant information. The more complex the network of signals, the more difficult it is to extract pertinent information. For example, professors David Hirshleifer, Sonya Lim, and Siew Teoh of the University of California and DePaul University show that the market is less efficient in processing earnings announcements when a large number of releases occur at the same time. In “When Can the Market Identify Stale News?” James Hodson and I suggest that reactions to reprints of old news are likewise driven by complexity. Market participants are much more likely to mistake old news for new when the old information is drawn from multiple sources than when it is directly reprinted from a single previous story.

But although the market as a whole displays a variety of biases in processing financial news, not all finance professionals consume news in the same way. Some are faster, more active, and more sophisticated in identifying novel news. In “News Consumption: From Information to Returns,” I compare the news consumption patterns of different finance professionals. Broker dealers and hedge funds are much quicker, on average, to click on any given piece of news than banks or large investment management companies.

Hedge funds are also much more likely to be the first to get a piece of news. Hedge funds are only 8% of all financial professionals reading financial news. However, for 27% of all news articles, the very first click comes from a hedge fund reader. That means that even when a piece of information is public, hedge funds are more likely than other investors to find it first.

Hedge fund readers, along with family offices, private equity firms, and some broker dealers, are also among the least likely to read a piece of news that reprints old content. And they read far more news than any other group of finance professionals.

Does the more sophisticated consumption of news translate to more impact on the market? Yes. Increased attention by the more-active news readers like hedge fund investors is more predictive of stock price moves and trading volumes than increased attention by other investors, including large investment managers and pension funds. A one-standard-deviation increase in hedge fund attention corresponds to a 30 basis point larger return over the next day and a 3–4% higher trading volume.

These market swings occur because news consumption creates disagreement among investors about an investment’s prospects. In general, there are two main sources of trading volume: liquidity needs, where investors need to trade due to flows or portfolio rebalancing, and disagreement, where traders who hold different opinions make bets against each other. Since news releases (such as earnings announcements) do not systematically coincide with liquidity shocks, increased trading around news is attributed to disagreement. But why would public news increase disagreement?

In “Disagreement after News: Gradual Information Diffusion or Differences of Opinion?” I show that a large portion of disagreement around news is driven by people getting the news at different times. An investor who has not yet seen the news forms a willing counterparty to a trade put on by someone who has. A large portion of market activity is driven by something as simple as some people taking longer to read and process public news releases than others. In fact, moving from perfect information flows to perfect dispersion of readership causes trading volumes to surge by an additional 160%.

Bringing information into the public domain is extremely important. But so is sophisticated processing of the public information, especially given how quickly the news environment is changing.

As Tom Glocer, former CEO of news and financial information provider Reuters Group PLC, puts it: “A huge amount of time and effort is devoted by public companies to managing the divide between public and private potentially market-moving information. I can envision a future in which we abandon concepts like 10-Qs and 8-Ks in favor of a continuous stream of relevant performance data. This would be quite harrowing at first for public company executives, and contribute to daily volatility; however, over the long term, investors and managements would adjust.”

Such a future is exciting but could raise its own challenges. Modern-day proliferation of news, including reprints or repackaging of old articles, makes the market’s task of processing information ever more complex. Publishers exercise discretion over which news to print and where; investors read and trade on these public releases. Both sides are vitally important for financial markets’ stability and efficiency, especially at a time when daily news releases number in the millions.

Thx to Anastassia Fedyk is a Ph.D. Candidate in business economics at Harvard Business School. Her research focuses on finance and behavioral economics.

PE Mistakes Picking CEOs Portfolio Companies, short-termism backfires

The Mistakes PE Firms Make When They Pick CEOs for Portfolio Companies, short-termism backfires

board-member-short-termism

MALTAWAY BOARD GOVERNANCE AND NON EXECUTIVE DIRECTOR (NED)
Even here in Malta this issue arises with relevant importance and validity , partly because the high number of foreign companies present in Malta, in order to be compliant with international standards for tax purposes (see the case of dummy company and tax inversion) , must have a board of directors with directors and NON EXECUTIVE DIRECTOR , residents in Malta, supporting and providing clear and convincing evidence that the foreign company is effectively managed from Malta.
Furthermore having a NED with international experience in the BOARD, reinforce widely the diversity, independence and compliance requirements for a better Corporate Governance, Leadership and Business results
30+ years Board, Governance, Investment’s experience and practice for YOUR BOARD needs and solutions


When a private equity firm adds a new company to its portfolio, analysts rigorously size up its financial, operational, and competitive condition. Yet even with all that knowledge and effort, many private equity companies still don’t do a good job when it comes to deciding whether to keep the CEO in place or select a new CEO.

In fact, management consultancy Bain & Co. has found that almost half of the private equity firms it studied replaced the CEOs who ran their portfolio companies, and in 60% of those instances the PE firm hadn’t planned to make the change at the start.

Since 2009 we have interviewed and surveyed 181 executives who run PE-owned companies, as well as eight to 15 people who work with each of these 181 executives (supervisors, board members, director reports, and others). From looking at the qualities of the CEOs at the best-performing of these firms, we have found three fundamental CEO qualities that drive growth in the most successful PE investments:

  • Systems thinking (the capacity to understand how a change in one aspect of the workings of an operation affects the others)
  • Building alignment and commitment to the firm’s strategy (in particular, by emphasizing empathy as much as urgency)
  • Selectively developing top team members to accomplish the strategy

Too many CEOs fall short of these skills. Here are the most common CEO selection mistakes we see.

Mistaking quick thinking for systems thinking. Being a quick study is not the same as being a deep thinker. Running a smaller, entrepreneurial firm is very different from scaling that same company for rapid growth. The job becomes far more complex, requiring a deep understanding of how to make the parts of the organization function together.

What’s more, the demand for rapid growth often comes with a push from investors to enter new markets or ramp up product innovation. CEOs need to know how a change in strategy (a new target market, say, or a new product) will affect manufacturing, marketing, selling, servicing, and other processes. In addition, excellent strategic and systems thinkers have a gift for identifying the underlying causes of problems and troubleshooting in a collaborative way that increases the odds of finding an effective solution that others are on board with.

But in our work with PE firms over the last 20 years, we’ve seen how easy it is for investors to overlook these skills in a CEO. That’s what led a PE firm astray when it evaluated the founding CEO of a company it had just acquired. He was very smart and polished but didn’t see how his pointed words and micromanaging ways were affecting his management team. Morale was terrible, and important initiatives were flagging. The PE firm tried for six months to get the CEO to become more of a systems thinker and a real leader, but he resisted. With the firm’s once-rapid growth having slowed to a crawl, the PE company decided the best course was to sell the firm. It got a much lower price than it would have if it had more rigorously evaluated the CEO right after it bought his company and then replaced him.

Not seeking CEOs who value talent development. Because of the short timeframe in which they hold their portfolio companies (typically five to seven years), investors may view executive development as a luxury. But CEOs at the best-run PE-owned firms we’ve worked with emphasize both recruiting and talent development. And they are quite selective of which individuals and which skills to invest in. Indeed, they may even temporarily overlook the development of entire layers of management, so that they can focus on employees whose development will have the greatest business impact over the period in which the PE firm plans to own the company.

Consider the case of Surgical Care Affiliates (SCA), a provider of surgical facilities based in Deerfield, Illinois. A private equity group led by TPG bought the company in 2007; at the time SCA had suffered more than four straight quarters of declining profits. That year TPG hired a new CEO, Andrew Hayek, to rebuild SCA. He quickly recognized that he had to institute a new strategy and culture. He offered development opportunities to those who were short on the skills needed to execute the strategy.

However, Hayek didn’t push training on them. Rather, he created a “pull” scenario by continually raising the bar on executive performance year over year. He held them accountable for meeting sizable improvements, but he also supported the team during challenging periods. Leaders who were internally driven to improve themselves stayed with the organization while others opted out.

The impact began to show in the first year, with an 11% increase in profits. And it has continued to this day. From 2008 to 2015 SCA’s revenue rose 88% (from $690 million to $1.3 billion) and net income more than doubled (from $73 million to $170 million).

Believing CEOs who emphasize urgency are far better than those who stress empathy. A recent Harvard Business Review article on hiring CEOs for PE-owned companies argued that “urgency outranks empathy.” There’s no time for coddling — or so goes the conventional wisdom. CEOs must focus on getting things done rapidly, rather than making sure everybody is happy doing it.

We believe this is a false and harmful dichotomy. The best leaders, including those at PE-owned companies, recognize that urgency and empathy are not mutually exclusive. A CEO who leads with great urgency and zero empathy will produce followers who are afraid to get it wrong and thus become overly cautious and hesitant. Meanwhile, urgency delivered with empathy greatly increases the odds that critical work gets done on time and according to expectations. PE firms need CEOs who know how to use empathy to generate a highly positive sense of urgency, thereby generating greater momentum toward strategic and financial goals.

The CEO that PE firm Founders Equity Inc. hired to run one of its portfolio companies shows the power of leaders who exude equal amounts of urgency and empathy. In 2012 Founders brought on Richard Hall to run Oncology Services International, a Montebello, New York, company that is the largest independent service provider for radiation therapy equipment. After making numerous changes in the way the company was led (including shifting from an engineer-driven to a professionally managed organization and replacing some members of the top team), Hall learned after his first six months on the job not to run roughshod over his direct reports. “When I joined the organization, I was so intense that I’m sure I intimidated some of my managers,” he told us. “In the early days, I was probably too intense and too much of a taskmaster.”

But Hall soon caught himself after realizing he was charging too hard, especially with OSI’s field service engineers — the people who fix the machines OSI sells. They represented the firm’s largest fixed expense, and Hall wanted to track their productivity. But that set off the field engineers’ alarm bells. “If one of those machines is down and we can’t treat patients, that’s a big deal,” Hall says. After understanding just how critical these employees were to OSI and its customers around the clock (they were always on call), Hall knew he had to better appreciate their role and measure their productivity more delicately. In other words, Hall realized he had to exude both urgency and empathy, and that the latter could not come at the expense of the former. Driving OSI from a place of urgency alone would have been very bad for business.

OSI’s revenue are 65% higher than they were in 2012, and its valued has doubled. This July Founders Equity sold OSI to Jordan Industries. Hall and OSI’s leadership team have coinvested with Jordan and will continue with the company.

PE firms these days are often under pressure to close a deal quickly, as competition for portfolio companies has increased, forcing the acquirer to position itself as an attractive buyer. That makes it difficult to ask potentially awkward questions about the CEO. PE executives can also perceive such a careful assessment to be slowing their deal-making process. But a thorough CEO assessment can be done in six to eight weeks in parallel with the traditional PE firm due diligence process, and in a nonintrusive way.

You can learn a great deal about a leader’s approach by talking to people who have worked with him or her, as well as with other stakeholders.

None of this is easy for PE investors, given the tall demands of sizing up acquisitions rigorously yet expeditiously while other potential buyers are typically in contention; however, neither is being saddled with a CEO who can’t deal with the complexities of a turnaround or rapid growth. PE firms that conduct the right evaluations of leaders for their portfolio companies go a long way toward reducing the risks of their investments.

https://hbr.org/2016/09/the-mistakes-pe-firms-make-when-they-pick-ceos-for-portfolio-companies

Too Many Experts of the same arena on the same Board, no diversity Backfires

Too Many Experts of the same arena on the same Board, no diversity Backfires

CRITICAL ISSUES

  1. The first factor is what psychologists call “cognitive entrenchment.”
  2. The second factor is overconfidence,
  3. The third factor has to do with the level of “task conflict”

 

maltaway_balattiboardmember_BoardEngagement

 

MALTAWAY BOARD GOVERNANCE AND NON EXECUTIVE DIRECTOR (NED)

Even here in Malta this issue arises with relevant importance and validity , partly because the high number of foreign companies present in Malta, in order to be compliant with international standards for tax purposes (see the case of dummy company and tax inversion) , must have a board of directors with directors and NON EXECUTIVE DIRECTOR , residents in Malta, supporting and providing clear and convincing evidence that the foreign company is effectively managed from Malta.

Furthermore having a NED with international experience in the BOARD, reinforce widely the diversity, independence and compliance requirements for a better Corporate Governance, Leadership and Business results

30+ years Board, Governance, Investment’s  experience and practice for YOUR BOARD needs and solutions

best-practice-corporate-board-governance-2-728

 


 

 

Why boards succeed or fail and how to make them better are critical questions for corporate governance. We know that board composition—who the directors are and what backgrounds and perspectives they represent—can influence important outcomes like firm value and sales growth. But the full spectrum of these relationships is far from fully understood.

We conducted a study, recently published in the Academy of Management Journal, to learn more about a neglected dimension of board composition: the proportion of domain experts. That is, the percentage of directors whose primary professional experience is within a firm’s industry. Though companies can easily manipulate the proportion of directors with domain expertise when building a board or appointing new directors, we know virtually nothing about its effects on corporate performance.

Common sense might suggest that the more experts, the better. Domain experts know the ins and outs of an industry and are highly skilled at assessing risks and opportunities. But our interviews with board members and CEOs in the banking industry—and decades of research on experts and teams—point to three factors that can compromise the effectiveness of expert-dominated boards, at least in some circumstances.

The first factor is what psychologists call “cognitive entrenchment.” As we gain deeper expertise in an area, we acquire more accurate and detailed knowledge but also become less flexible in our thinking and less likely to change our perspective. So expert-dominated boards might be less effective in responding to new information or unfamiliar situations. Indeed, related research shows that executive teams made up of many industry experts are less flexible in responding to changes in the competitive environment. Our own interviews also confirm this idea. Many of our interviewees emphasized the “baggage” that domain experts bring with them to a board. Domain experts “brought with them habits from the other institutions and perhaps those habits were not always good,” one CEO explained.

The second factor is overconfidence, a common problem in expert judgment that affects experts in a wide range of fields, from doctors and physicists to economists and CIA analysts. In banking, for example, one board member explained, “a board which has got a lot of bankers on it, they are going to tend to reach for loans a little bit more because they believe that they have got a little bit more background and experience. Whereas other people who aren’t bankers tend to be a little more cautious.” As another director put it, non-expert directors “often play the role of devil’s advocate, taking the situation to its worst conclusion.” This means that boards with several non-expert directors tend to be more skeptical. They “demand more reporting and analytics” and often respond to proposals by saying “We are not going to make a decision today because you didn’t give us enough information to make the decision.”

The third factor has to do with the level of “task conflict”—the extent to which board members have different viewpoints, ideas, and opinions about the decisions they face. Some amount of task conflict is essential because it allows the board to explore and discuss more alternatives. But research suggests that a high proportion of domain experts can suppress task conflict because non-expert directors may defer too much to the judgment of experts. When non-expert directors are just a small minority on a board, it is difficult for them to challenge experts to justify their assumptions and consider alternatives. In such boards, a CEO told us, “there could also be some egos involved—here is the way I have done it all my life and that’s the way we are going to do it. And everybody respects each other’s ego at that table, and at the end of the day, they won’t really call each other out.” In contrast, in a board with fewer domain experts, “when we see something we don’t like, no one is afraid to bring it up.”

Our research shows that these three problems of expert-dominated boards are most likely to be damaging when a company veers off the beaten path and faces uncertainty. Dealing with changing, unfamiliar situations requires flexible thinking and a healthy dose of disagreement. And when conditions are novel or ambiguous, expert overconfidence is especially severe.

We studied 17 years of data on roughly 1,300 community banks—banks that have their own legal charter, aggregate assets below $1 billion, and a locally focused business model. The boards of some community banks include mostly domain experts, that is, directors whose primary background is in banking, typically as executive vice presidents or above. Other boards include a few banking experts but also directors with backgrounds in law, insurance, medicine, the public sector, the military, and other fields.

In our sample as a whole, there was no clear relationship between the proportion of domain experts and a bank’s financial performance or survival chances. At first glance, whether a bank’s board had many domain experts or just a few didn’t seem to matter for profits, growth, or the likelihood of bank failure.

But then we looked specifically at banks that faced heightened uncertainty for some reason—for example, because they were growing rapidly in an uncharted market territory or because they were operating in a lending market with unusual loans and atypical, heterogeneous clients. In such situations, there was a clear link between the proportion of domain expert directors and the probability of bank failure. The more banking experts on the board, the greater the likelihood that a bank would go out of business.

Our findings persisted even when we controlled for a host of other factors, including functional diversity, and they weren’t simply driven by banks appointing more experts in response to financial trouble or uncertainty.

At the same time, it’s important to note that most boards in our sample included at least two banking experts, or roughly 20% of board members. So our results don’t mean that having no experts at all is optimal. What they suggest, instead, is that it’s important to appoint a non-trivial number of directors whose primary expertise is in another industry—especially if the board is likely to face significant uncertainty.

It also may seem obvious, but it’s worth remembering that high proportion of domain experts is not the same as the absence of professional diversity. For example, a board of a telecommunications company that includes five telecommunications experts, two lawyers, and two bankers is exactly as diverse in terms of professional backgrounds as a board of another firm in the same industry that includes two telecommunications experts, five lawyers, and two bankers. But these boards differ greatly in the proportion of domain expert directors—five versus two, out of nine board members.

This is just the first study on this issue. It will require further research to confirm that the link we found is causal and that it exists in other industries as well. But it’s an important first step in gaining a deeper understanding of how boards work—and how companies can make them stronger.

https://hbr.org/2016/08/when-having-too-many-experts-on-the-board-backfires

Political Affiliation Shapes U.S. Boards

Political Affiliation Shapes U.S. Boards

Are corporate boards as polarized politically as the general population? That’s one of the questions we asked ourselves as we conducted a survey of directors of public and private companies headquartered in the United States.

MALTAWAY BOARD GOVERNANCE AND NON EXECUTIVE DIRECTOR (NED)

Even here in Malta this issue arises with relevant importance and validity , partly because the high number of foreign companies present in Malta, in order to be compliant with international standards for tax purposes (see the case of dummy company and tax inversion) , must have a board of directors with directors and NON EXECUTIVE DIRECTOR , residents in Malta, supporting and providing clear and convincing evidence that the foreign company is effectively managed from Malta.

Furthermore having a NED with international experience in the BOARD, reinforce widely the diversity, independence and compliance requirements for a better Corporate Governance, Leadership and Business results

30+ years Board, Governance, Investment’s  experience and practice for YOUR BOARD needs and solutions

maltaway_balattiboardmember_digital-age

 


We and our research partners found that Republicans are more highly represented on boards than in the general population: they were 50% Republicans, 24% Democrats, and 26% Independents, while the American public, according to Gallup, is 28% Republicans, 31% Democrats, and 39% Independents. But affiliation doesn’t guarantee enthusiasm, as this sample of survey comments reveals: “On sabbatical from the Democratic party”; “Republican, unless they keep acting like goofballs”; and “Independent (especially this year!).”

W160809_GROYSBERG_PARTYAFFILIATION

 

As with the general public, we found differences among demographic groups. Female directors are much more evenly split between the two main political parties. By comparison, male directors are more than twice as likely to identify as Republicans than Democrats. Our limited sample sizes suggest that African American/Black and Asian/Pacific Islander directors are more likely to be Democrats than their white (not Hispanic) counterparts, and single directors are more likely to be Democrats than their married counterparts. We did not find any notable differences by age group or education.

W160809_GROYSBERG_PARTYDEMOGRAPHIC

 

We also found that industry matters. Boards of companies operating in the consumer discretionary industry have a disproportionately high representation of Democrats, while boards operating in the industrials and energy and utilities industries skew more Republican. The proportion of Democrat and Republican directors does not substantially differ between public and private firms.

W160809_GROYSBERG_PARTYINDUSTRY

 

We found that directors of all political stripes care a lot about the economy and cybersecurity, and that Republican and Democrat directors are aligned in their concerns about political instability and healthcare costs, even though they may have conflicting views on how these costs should be contained. Alongside these commonalities, we also found some notable partisan differences. Democrats are less pessimistic about the economy: 10% of Democrats expect a global economic slowdown in the next three years, compared to 18% of Republicans. Democrats care more about economic justice, environmental sustainability, and equal rights for women. Republicans care more about corporate tax rates, the national budget deficit, and regulation. The ideological divisions we’re seeing in the political arena have permeated the boardroom. The disparities in the perceived importance of these issues could affect how directors prioritize and choose to address risks to the company.

W160809_GROYSBERG_TOPPOLITICAL

 

Directors are also consistent in their views of the key challenges to achieving their companies’ strategic objectives: attracting and retaining top talent, the regulatory environment, and domestic competitive threats top the list for directors from both parties.

Our limited sample suggests that both groups agree that board leadership should serve as champions of board diversity, but they differ on the policies they advocate to increase board diversity. Republicans generally favor developing a pipeline of diverse candidates through director advocacy and mentorship, while Democrats are more likely to favor requiring that every director slate include diverse candidates, or that boards implement targets for diverse membership. Democrats are also more strongly in favor of boardroom quotas for diversity, and Republicans are strongly against disclosure requirements on steps taken to seat diverse director candidates.

W160809_GROYSBERG_HOWDIVERSITY

 

We found differences in how Republican and Democrat directors view the performance of their boards. Both Republicans and Democrats say the most effective board committee is audit/finance. However, Republican directors are more likely to identify the compensation committee as the least effective committee. Interestingly, Republican directors think the compensation level of the CEO of their company is “too high.” Directors of both political views rate their boards similarly on processes, dynamics, and effectiveness as a whole, but differ on the question of compensation.

Democrat and Republican directors diverge on the skills they think are most important for board service today. Republicans prioritize industry knowledge, financial and audit expertise, and international expertise more than their Democrat counterparts. Meanwhile, Democrats place greater importance on technology expertise and risk management. It’s important to note that the representation of Democrats on risk committees is disproportionately high. These differences can manifest themselves when boards identify and select candidates for open board seats or when evaluating other directors.

W160809_GROYSBERG_WHATSKILLS

 

We also looked at how Democrat and Republican directors diverge on their self-evaluations. More Republicans consider themselves to be very good at negotiation, while more Democrats consider themselves to be very good at building teams. Overall, directors from both sides are bringing diverse strengths to the table.

W160809_GROYSBERG_HOWRATE

 

Why does all this matter? Boardrooms are not insulated from the widening rifts in political ideologies in the United States. Democrat and Republican directors differ in their economic outlooks, evaluations of the most pressing political issues, approaches to increasing board diversity, and even in their assessments of their own skills and strengths. Political affiliation is another form of board diversity–one that is rarely discussed, but could have profound implications on how corporate boards function and set priorities. Having directors with a range of political philosophies can invigorate board discussions and ensure that a wide array of issues and solutions reach the boardroom. Maintaining a diversity of political perspectives is an important consideration to ensure that boards are equipped to anticipate and tackle the multitude of challenges that confront companies today.

 

HBR