By Mihnea Moldoveanu and Richard Nesbitt
How impactful can simplexity gap be in corporate boards? In this article, the authors show how such gap undermines the role, function and integrity of the board by making it impossible for boards to ratify decisions on the basis of all of the information that is valid, reliable and relevant to the case at hand, as well as how the design and execution of the right board communication process can help boards bridge the gap and restore agency and accountability to the board.
A Widening Chasm. A growing chasm separates corporate boards from the competent exercise of their duties of care and diligence. It threatens to make boards everywhere into no more than ineffectual rubber-stampers that do not fully understand what their management teams do and why they do it and end up sanctioning the wrong actions for the wrong reason at the wrong time. It is a gap in knowledge rather than information; in expertise rather than evidence; and in understanding and comprehension rather than judgment.
On one side, you have top management teams leading organisations whose technological, operational and social complexity has grown momentously during the past decade – the ability to deal with complexity is cited by most CEO’s as the greatest challenge to their businesses.1 Their recommendations to the board are based on detailed analyses of dense, changing, uncertain information. They are informed by expert analyses couched in technical language systems that are opaque and are easily misunderstood by untrained board members. Their reasoning and arguments are complex – and scarcely intelligible to those who have the obligation to audit and understand them.
On the other side, you have directors who typically spend less than 100th of the time that management does on the intricate details of the business they are entrusted with. They expect the information, analysis and recommendations management presents them with to be intelligible, valid, easily auditable and immediately actionable. In a word, simple. They expect to be able to understand Web 2.5 product launch plans with the technical skills of Web 1.0 – and in no more than the two or three hours they schedule for reading management’s decks; to be able to monitor risky asset allocations using dated techniques developed before the Financial Crisis of 2008 – the ones they know about; to be able to ratify outsourcing plans involving remote R&D teams working in countries with different legal systems and social cultures on the basis of rationales simple enough to lay out in 10 minutes’ worth of discussion at a board meeting. Boards rely for their decisions on what information management provides – and legal statutes and practice actually encourage them not to go beyond that information: failures arising from ignorance are far less culpable than failures arising from knowing-but-not-doing.
The simplexity gap is the yawning space between the simple expectations of board members and the complex predicaments, problems and rationales of management. It leads to failures arising from not understanding enough to ask the right question at the right time – an effect too subtle to be picked up by legal status, at present. It opens up whenever consequential communications about critical decisions or events occurs between management and the board. Boards that do not heed and proactively deal with the simplexity gap are flying blind – unable to exercise the duties it has accepted as its charge. And whether things go well or not, they do not do so on account of the board, because the board could not have understood the rationale for the decisions it ratified – and cannot, thus, properly monitor them.
How Boards Actually Promulgate the Simplexity Gap by Trying to Deal with It: Three Tendencies and Two Traps
While they may not have a name for their pain, most boards feel inadequate. They think it’s a miracle they have not been yet witnessed cataclysmic event caused by a managerial decision they signed off on. They instinctively guard against the asymmetries of expertise and sophistication between themselves and management by methods committees have used for decades to avoid being “snowed”.
1. They centralise: the chairman or CEO becomes the central node in the information flow network. S/he talks to each board member privately and aggregates all the information into agendas and critical action items. As a result, board members know only what the central node tells them and none know what the others know or don’t know. As a result, their dominant MO is often to defer to the chair or CEO or the management team in board meetings;
2. They segregate: Boards fan out into cliques that are “in-the know” about particular issues on the basis of more frequent interactions with the chairman/CEO and with one another. In each clique, everyone knows what everyone else knows.2 But, the clique usually has to keep in the chair’s or the CEO’s good graces to maintain privileged access to information. They often become yes-committees that perpetuate rather than mitigate the simplexity gap.
3. They specialise: Board members form go-to groups for certain kinds of issues (HR, compensation). They come to be recognised as experts by other board members. As board-recognised experts they are expected to understand more about their topic area than others on the board. But their opinion is often confused with that of real experts, which they are not. They are simply the most knowledgeable – on a particular topic – members of a group that is typically not very competent on that topic to begin with. Moreover, they are often structured into committees to deal with general, catch-all issues (finance, audit, risk) – that cannot easily deal with large-scale problems that cut across boundaries.
Information Traps: Making Sense of “Board Culture” Using Information Flows in Networks
The simplexity gap is not a run of the mill informational asymmetry,3 where management keeps things they know or do from their boards to avoid censuring, sanctioning or the costs of having to report frequently, tediously, annoyingly or strenuously in the future. In fact, a management team wishing to exploit the simplexity gap is likely to be utterly forthcoming with any and all information about the business: accounts, customers, technologies, products, operations, trans-border negotiations…. If the information is encoded in ways that are too complicated for board members to decode in the time they have, then it does not matter how much information the board has: it just does not have the right decoder and therefore cannot tell right from wrong, true from false, costly from beneficial and sense from nonsense.
Decoding what management says and does in time to do something about it is the capability that sets boards paralysed by the simplexity gap from those that are not. But board members alone cannot provide this decoding function: they must act together, cooperatively and collaboratively. Board culture plays a critical role in turning a group of people who are confused into a team that works together to push management to greater levels of transparency and auditability.
Unfortunately, there are as many approaches to quantifying culture as there are social psychologists, sociologists and culture theorists: everyone has (had) his or her say. We can think of describing board culture by its embodied or espoused norms, its principles, its values, the beliefs and commitments everyone has and knows everyone else shares, its dominant emotions, its patterns of talking….What are boards to do? How to choose from among all of the expert opinions? If you are smiling, you are likely right: this is an example of the simplexity gap at work.
As board members and executives reporting to boards for decades, we have found the most causally potent way of describing board culture is by looking at how sensitive and material information flows: who knows, what does she know, when does she know it? Each board is many things, but one thing all boards are is an information flow network. Each board develops patterns of communicating sensitive material information – patterns its members are often oblivious of – even if and when management knows of and exploits it. The structure of the board’s information flow network is its culture – and it entraps the board, often unwittingly, into accentuating and accelerating the growth of the simplexity gap.
Taking Hold of Process: What Boards Can and Should Do to Address the Simplexity Gap.
The origins and causes of the simplexity gap are numerous. They range from technology savviness gaps between management and boards, to the counterproductive pursuit of “independent” board members who are often ignorant and oblivious of the intricate dynamics of the industry and business, to the oft-bemoaned incentive gap between board members paid low fees and very small equity grants and management – which frequently makes the former unwilling to put in the time and work to truly understand and monitor the decisions, behaviours and rationales of the latter; to the undue reliance on outside experts, advisors and consultants whose residual liability in making recommendations to the board is limited to weak reputational effects.
But contrary to popular opinion, dealing with the simplexity gap need not involve addressing all of its root causes. Just like putting out a forest fire has a lot more to do with understanding wind patterns and aerial water distribution patterns rather than the details of who started it, when, and how, dealing with the simplexity gap has more to do with understanding the what, how and when of information flows than with the specific who and why of its origins. And these are problems that can be addressed by changing the process by which the board handles, questions, conveys, interprets and deliberates on information.
Bridging the simplexity gap requires a structured, disciplined, incisive and proactive approach to undo habitual and counter-productive information flow patterns on boards.
Serendipitous Discovery via Prospective Foraging: first, board members should be (and consider themselves to be) free, encouraged and incentivised to seek information from management and employees without having the feeling they are sabotaging or mistrusting the CEO or Chair. This allows them to aggregate information that they do not know and become aware of issues they would not know they did not know without the benefit of “roaming the organisation”;
Making Each Communication Count: second, information exchanged among board members, CEO and Chair, as well as information exchanged within smaller cliques and committees of the board should become common knowledge among board members: each all must know it and each all must know that each and all know it. This turns the entire board into a clique and breaks up clique traps and hub and spoke traps. The sense of knowing all there is for a board member to know (without being wary of power-based informational asymmetries) empowers each board member to focus on her responsibility for diligence and care without worrying about signalling ignorance, bias or special affiliation. No board member will feel she cannot ask a question in a board meeting because she fears it has already been asked and answered, unbeknownst to her; or on account of fearing it is not the right question to ask, given the CEO’s current interests and motivations.
Inquiry and Deliberation: Building Conversational Capital: third, board meetings should make inquiry (questions and challenges, publicly asked and answered) a central point of board meetings and pre-meeting communications. Rather than seeking “consensus on ways forward”, chairs should seek consensus first on critical questions that need to be answered and challenges to be addressed.
But, not all questions and challenges are created equal. Some are weak. Most are fuzzy and reticent. Some are rhetorical. Boards need to build, develop and safeguard their conversational capital – the stock of questions and challenges that probe the core of the credibility of a statement and of the person that makes it. Top management teams make statements of all kinds – about the way things are, about the way they should be, about what the company should do given the way things are. Very often, the interrogatory repertoire of board members – the questions they ask and the challenges they raise – is limited and weak. The questions themselves are too polite, too loose, too general, too deferential and too fuzzy. Challenges are raised pro forma: they lack teeth. Boards need to practice the repeated posing of sharp questions – questions that cut rather than mend. To get there, we spoke to dozens of board members and executives, as well as professionals and experts who depend for their livelihood on making credible diagnoses and prognoses – usually based on information received from other people: physicians and surgeons, judges and litigators, foreign intelligence professionals – along with cognitive psychologists, linguists and analytic philosophers – and boiled their insights down to a minimal list of maximal powerful questions – the ones that allow you to figure out if someone’s integrity and competence can be trusted:
The resulting “question battery” can function as a guide for board conversations – a common canon of sound board deliberations aimed at placing deeper, tighter scrutiny on statements management makes. Once they are publicly asked, they become common knowledge among board members: everyone knows that everyone knows they are in play. And if the chair functions as the arbiter and scorekeeper of inquiry in a board meeting, then each question publicly asked must be publicly answered – and minuted or even transcribed – which means answers become discoverable and common knowledge as well. No set of questions can by themselves supply boards with the “chops” to test the credibility and competence of their management teams – which is why they must be supplemented with direct challenges that further press managers to substantiate claims, corroborate facts, and develop arguments and reasons for their proposed courses of action.
The Instant Replay. How would a VW or Wells Fargo board have fared if they had taken an inquiry-based rather than ratification-based approach to the information top management presented? One can only guess – but a detailed guess can be informative for other boards facing similar predicaments (see Diagram 9). The right set of questions – asked at the right time in the process – could have set in motion discovery paths (follow on questions that must be answered and challenges that must be addressed) that would have let the company as a whole to avoid the debacle, ensuing disaster and resulting loss of money, credibility, trust and market share.
In closing. The social technology for bridging the simplexity gap is at hand: we can design and engineer a board’s culture (its informational sharing practices and its conversational capital) even if it is not the ideal board and even if it does not have the right committee and authority structure. Boards can choose to act on this knowledge, but do not have to. Quite likely, the future of the single share class public corporation hangs in the balance.
About the Authors
Mihnea Moldoveanu is Professor of Economic Analysis, Desautels Professor of Integrative Thinking, Director of the Desautels Centre for Integrative Thinking and Vice Dean of Learning, Innovation and Executive Programs at the Rotman School of Management, University of Toronto. He is also a Visiting Professor at the Harvard Business School. He is the Founder, past CEO of Redline Communications, Inc. (TSX:RDL), a leading manufacturer of broadband wireless networking equipment.
Richard Nesbitt is CEO of the Global Risk Institute and Adjunct Professor of Management at the Rotman School of Management at the University of Toronto. He is also a Visiting professor at the London School of Economics and Political Science. He is past Chief Operating Officer of the Canadian Imperial Bank of Commerce (TSX: CIBC) – a leading commercial, retail and investment bank in Canada and globally. He is also past CEO of the Toronto Stock Exchange (TSX: TMX).
The authors would like to thank Mr. Corey Li for his sharp, proficient and diligent research assistance.
References
1. IBM. (2013). Capitalizing on Complexity: Evidence from Fortune 1000 CEO’s.
2. Moldoveanu, M.C. and J.A.C. Baum. (2014). Epinets: The Epistemic Structure and Dynamics of Social Networks, Stanford: Stanford University Press.
3. … which are the basic building blocks of economic models of communication between principals and their representatives (boards) and agents (managers) – see, for instance: Gibbons, R., H. Matoushek and J. Roberts. (2012). Decisions in Organizations, in the Handbook of Organizational Economics. Princeton University Press.
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