Governance, fraud and management of emotion in decision making

Last week’s 10th Annual Conference of Corporate Governance (#wccg09), explored alternative, hopefully more effective, means of corporate governance. What emerged clearly from the presentations and the discussion was that our current approaches to governance miss the mark. They are targeted at corporates rather than individuals, at the workforce rather than the directors, at catching rather than preventing, and are a shotgun approach when a rifle is needed.

My own paper was used to start the conference. This is a slightly modified version.

Part 1: Governance and Fraud

Our approaches to corporate governance in recent years have tended to revolve around regulatory frameworks, reporting structures, and operating standards. As if to justify the time we devote to them and, more importantly, the time we expect other people to spend on them, we delude ourselves that we are defining ways of achieving good outcomes for the day-to-day management of an enterprise. It seems extraordinary but some people seriously believe that filling in this form, following that procedure, making this statement on the bottom of our emails, or secreting a link in tiny print at the bottom of our website to a load of legalise, both absolves us of almost any personal responsibility and magically impacts on the bottom line of the business. It is a joke – a delusion. If we look back over the last 18 months we see that just about every one of those institutions that contributed to the economic ‘meltdown’ had all these components in place.

In practice, however, what we are really trying to address is the propensity for fraud to happen in business environments.

These frameworks, structures and standards are translated and imposed on organisations that have little or no need for them; where fraud relatively rarely happens and, when it does, it is of far less substantial scale. The end result is an ineffective approach and a bureaucratic burden, applied too widely, that achieves little.

These measures try to strike a balance between the preventative, the deterrent, and the retrospective. In practice, many so-called preventative measures merely define the technical system through which the fraudster must navigate. Deterrents have existed ever since formal legal systems emerged millennia ago and yet the courts still have a steady stream of increasingly sophisticated corporate frauds to deal with. For the kind of people determined to defraud, deterrents simply don’t work. Retrospective measures may make us feel vindicated in the long-run, but do nothing to stop the hurt that is caused by the frauds. Our focus therefore has to be on prevention.

In the last two years, a number of businesses, indeed whole industries, have been exposed for their irresponsible behaviour – where they failed to assess adequately the risks they were taking with the assets of others. These have been so extreme, that the global economic system has been shaken. There are signs of recovery, and sadly, I believe that the opportunity is rapidly being lost to reinvent many of these pointless Governance measures and to replace them with more effective and targeted approaches.

While organisational theorists can identify dynamic processes (group think, collusiveness, scape-goating, and so on) that are happening well beyond the ken of mere mortals, I prefer a slightly more down-to-earth perspective.

Despite what corporate lawyers will tell you, companies do not do actually do anything. They are inanimate. It is people that do things and when they do so within the structure of a corporation it may appear as if the company is doing something, but – at the end of the day – it is the people inside it that are doing so. Even when it is of the magnitude of the recent debacles, corporate fraud always emanates from one individual, or at most a small handful, usually with one persuasive leader.

Our approach therefore has to focus on individuals.

Most corporate fraud appears to happen in democratized countries within large businesses. There are obviously exceptions, but this appears to be the commonest environment. Large businesses are actually quite a small part of the world of work. The largest employers in the world are the Chinese Red Army, Indian State Railways, and the National Health Service (NHS). While I am sure that they have their problems, there are relatively few instances of large-scale individually-generated, corporate fraud associated with them. There appears to be a difference in the set of values espoused by those who work ‘not-for-profit’ to the values that drive people who work in the world of ‘profit’. Corruption is about values and our approaches to governance need to reflect this.

Similarly, the Gross National Product (GNP) of democratised nations is generally dominated by the micro-business community. Far more people work for themselves or for very small companies than do so for the large corporates and, while the ethics of some of their trading practices will always be open to criticism (as the victims of dodgy builders and itinerant car dealers will vouch), it is not the small fry that our approaches need to address. We need to concentrate on the behaviour of people within larger businesses.

Psychologists of crime, tell us that such people often begin with small misdemeanours and when they get away with these, so they slowly escalate. It is by no means a coincidence that a disproportionate number of speeding and parking offences are apparently committed by those in senior positions in business. When those in other positions of influence commit relatively minor offences, (such as a senior police officer caught speeding, a senior civil servant caught fiddling their lunch expenses, or a hospital administrator seeking personal favours) they are so exceptional that they hit the headlines. Such small scale offences are so common among business-people that it rarely even warrants a mention in the local newspaper.

Fraud, broadly speaking, falls into four categories;
That committed against an organisation by a (usually senior) member of it. This includes offences against shareholders and creditors by high-flying entrepreneurs.
That committed against an organisation by a client, such as insurance fraud, tax evasion, and abuse of benefits.
Acts committed by one individual against another, including the classic ‘con’ tricks and trade ‘scams’.
And those where a number of victims are solicited indirectly, such as the Nigerian advanced fee frauds perpetrated via email.

When we talk of governance, we are largely addressing corporate fraud by one of a small number of senior members of an organisation against the other stakeholders in it.

To be successful in business calls for self-confidence, hard work, a preparedness to adapt to failure, the ability to cope with being alone, and large measures of good luck. Sadly, it seems that when things are going well, when luck is available in copious quantities, we often dismiss it, and perceive our success as being entirely down to our own skills and attitudes. In some people, (and, of course, no-one reading this paper or attending the conference could possibly be in this category), this perception breeds an arrogance, a sense of invincibility, that can lead even individuals who are otherwise quite law-abiding, to think that they are above the law, that they are a ‘special case’, indeed that they are not answerable to anyone.

We have known that an individual’s perception that they are ‘above’ the rules that society creates, is embedded in their childhood – typically around 7 to 9 years of age. It is directly related to the relative absence of their father in their upbringing. Many social problems, especially those affecting young men, originate from the values developed through this absence, whether it was caused by the breakdown of marriages, military service, schooling away from home, or the ‘long hours’ working culture. If we are to look at ways of preventing corporate fraud, and many other ills, we need to better handle the phenomenon of single parent families, and parenting skills generally.

It seems that most of those who go on to commit commercial fraud have recently experienced financial strain or vulnerability. While they may appear affluent to the rest of us, they see themselves as being at a disadvantage, but it is often the consequential fear of loss of power, influence or status that they later report as the triggers to their criminal behaviour. This is an emotional response. It is rooted deeply within the individual and is not something that can be erased by simplistic awareness raising, ‘compliance’ training. Our approaches to governance need to recognise the emotional response behind fraud.

We need to provide those individuals most likely to be tempted to defraud with appropriately skilled, long-term counter-balances to help them ‘normalise’ their thinking. I stress again, that this doesn’t mean company-wide immersion style interventions, but instead highly targeted approaches when someone begins to assume the degree of authority that might open the box of temptation to them. Corporate fraud is not always done for the direct personal gain of the individual – as I’ve said, it is often more complex than that.

Many frauds begin as a one-off response to the person’s sense of vulnerability, albeit by an individual who has already learned that they can ‘get away’ with minor misdemeanours. Once their fraud is apparently successful though, we know that many begin to gain some secondary pleasure in the knowledge that they are fooling the world, and especially that they are demonstrating their superiority to others. The likelihood of committing fraud is therefore a long-term phenomenon – it is not a one-off event, but something that has a life-cycle. The emotional counter-balances that we provide to such corruption-prone individuals therefore need to be embedded within the norm of their day-to-day work, not one-off responses, or short-term fixes.

Part 2 will follow in a few days time.

Best wishes

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One Comment

  1. A brilliant article which focuses on the heart of the matter.

    Well done Graham!

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