Pervasive Collusion. The Elephant in the Room

by John Berling Hardy

In today's corporate world the unthinkable has become the commonplace. The nightmare scenario for any outside stakeholder in a corporation - pervasive collusion extending to include the executive and board levels - has become the elephant in the room.

Our classic approach to risk management focuses upon placing adequate controls in place to address each identifiable individual risk. These controls are then meticulously tested and monitored on a regular basis. With this done, we are free to go about our business, secure in the knowledge that we are protected. But are we? Events over the last two years have demonstrated how flawed this thinking can be.

There is a set of conditions under which tight controls are in place, yet malfeasance runs rampant at the high levels within the organization. I refer to this in my literature as the Hidden Game Algorithm.

All control structures effectiveness depends on a single presupposition - the absence of pervasive collusion at the top. In the cases where it exists, the controls are not only ineffective, the inhibitor becomes the enabler, and the controls are actually enlisted in concealing the fraud.

The assumption in the past as being the pervasive collusion was an anomaly, a kind of perfect storm that was so unlikely that it was not worthy of serious concern. I would argue that this presupposition is not only unfounded, it has been instrumental in blinding us to what was right under our noses.

Collusion exists in small towns, in social groups, in religious organizations, etc. I suggest that pervasive collusion is the stasis towards which all social systems gravitate in the absence of specific safeguards being in place to prevent it. The notion that this was an anomaly ensured that these safeguards were not put in place, creating the ideal conditions for collusion to progress unimpeded.

The best example of this is the way in which corporate malfeasance has been effectively legitimized in today's corporate governance paradigm. Executive remuneration packages have been designed in such a way that no matter what the roll of the dice, regardless of how catastrophic the economic fall-out from their decisions, the executives come out the winners. Bonuses, stock options, and golden parachutes have had the combined effect of indemnifying the executive against their own incompetence, and given them a Carte Blanche to use the company as their personal proxy. This could not have taken place without complicity at the board level, implying that the role of the boards of corporations, as the check on the performance of management, has been completely compromised.

This means that the outside stakeholders are left holding the bag, multiplying the risk to equity holders, creditors, regulatory bodies etc. The only way to address this Hidden Game Algorithm is to identify the conditions that are likely to support it, and implement safeguards that are specifically designed to address this issue. These controls would need to be independent of the corporate governance system in order to be effective. No longer can the board be relied upon to protect stakeholder's interests. It is time they became more proactive, taking positive steps to ensure the security of their investments.

John Berling Hardy,

CEO, The Hidden Game

http://www.johnberlinghardy.com

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Filed under Business Growth and posted on 10 March 2010