Owning up to integrity

AUTHOR: Deborah Tarrant   DATE: 06.09.07   ISSUE 1, 2007

For all the debate about talent wars, escalating labour shortages and the vital importance of employee engagement, most Australian businesses are overlooking a powerful means of encouraging employees to be loyal and productive, says Dr Shann Turnbull, a lecturer in the School of Organisation and Management at Australian School of Business.

Network governance can protect directors from conflicts of interest and being "profoundly misled" as happened in recent major corporate failures.

Illustration: Alison Wallace

Employee ownership schemes have been used conventionally to motivate employees by aligning their interests with owners, according to Dr Turnbull. Just a few years ago Employee Share Ownership Plans (ESOPs) were touted as a major solution to the employee engagement dilemma. However, Australian employers’ interest has flagged, in part due to a lack of the right incentives to promote shared ownership.

What’s more, the sudden upsurge of private equity activity in Australia – and globally – seems set to further stymie interest in starting or growing employee ownership in organisations, he observes.

The Federal Government is closing down its employee ownership support unit that was set up to increase ownership by employees from 5.9% of workers in 2004 to 11% in 2008. “There would appear little possibility of this objective being achieved, especially as private equity acquisitions are reducing employee ownership,” says Dr Turnbull.

Current levels of employee ownership in Australia prove difficult to measure. Dr Turnbull estimates less than one third of the companies listed on the Australian Stock Exchange (ASX) have employee shareholders, while evidence of employee ownership in private companies is not available. Many companies that boast ESOPs are running them as bonus or profit incentive schemes, but do not involve the employee-owners in decisions on how the companies are run or by whom, he says.

In the US, where tax incentives encourage private firms to share ownership with employees, around 10,000 firms have some form of employee ownership.
Undoubtedly, employee share ownership attracts controversy. “Some trade unions see ESOPs as undermining their role with some union leaders and politicians disparaging them as a ‘tax dodge’,” reports Dr Turnbull.

The case for multiple boards
Overseas studies have shown the most competitive and sustainable firms in the world are employee-owned and run using 'network governance'. The study of organisations governed by more than one board – a network of control centres – was the topic of Dr Turnbull’s PhD research. In his prior career as a serial entrepreneur, Dr Turnbull used the principles of network governance to set up and run two successful commercial enterprises. Earlier this year he delivered a paper, Capturing Competitive Advantages Through Employee Ownerships, at the Australian Human Relations Institute’s National Convention. His presentation outlined the effectiveness of network governance compared to command-and-control governance which forms the basis of most management systems today.

Firms that have multiple boards create “network governance” and have proved their competitiveness and sustainability over generations of management in comparison with investor-governed firms, says Dr Turnbull.

Different models of network governance exist in the interlocking relationships and shareholding in Japanese keiretsu, in France where state-controlled companies have a corporate senate watchdog and in Germany where, in addition to shareholder boards, companies have supervisory boards of outsiders and employees.

Iconic examples of employee-owned firms that use network governance can also be found in the American Cast Iron and Pipe Company, some US plywood firms, the UK-founded Scott Bader Commonwealth and The John Lewis Partnership.

It is the co-operatives of Mondragón in the Basque region of Spain that show network governance functioning optimally. Dr Turnbull cites the example of the Mondragón Corporacion Cooperativa that has 60,000+ employee owners, 12 relationship groups and more than 150 primary co-operatives. The Mondragón example runs on a compound board with input from a watchdog board, a supervisory council (which appoints the management board), a management board (to allocate resources), a social council (taking care of employee welfare) and a work group (to look after production).

While the model for this entity appears complex, the roles of individuals on various boards and councils is actually simplified, Dr Turnbull says.

Comparative figures show typically around 75 percent of investor firms fail in their first five years whereas less than five percent of Mondragón firms fall over in the same timeframe.

Network imperative
Research indicates competitive pressures force network governance on businesses in the fastest, most dynamic industries. Italy’s ephemeral fashion industry, for example, is comprised of thousands of small firms that specialise in different products and processes and form different networks every six months according to what’s fashionable. The high tech players of Silicon Valley and those in the biotech industries also often leverage network relationships.
Dr Turnbull's research explains how network governance introduces "distributed intelligence" that can outsmart the most gifted board of company directors.

“The board in a traditional company has to look after all management, finance, compliance and the shareholders, which means the directors need to focus on what’s happening internally, externally, long term and short term. In network governance, the decision-making is decomposed into control centres with specialised functions.”

Network governance can protect directors from conflicts of interest and being "profoundly misled" as happened in recent major corporate failures. “Competing channels of information provide a more creditable basis for directors to perform their fiduciary duties as required, with due care, and to monitor and control a business with diligence,” Dr Turnbull reports.

“Under the traditional or Anglo structure, the purpose of having outside or independent directors on a board is to monitor and direct management, but the more independent they are, the less knowledge and authority they have. Evidence indicates other stakeholder boards are needed to tell directors what’s going on.”

CEO information flow
There’s also the irony that directors of listed companies appoint and control the chief executive, and, at the same time, receive the information on company matters from the chief executive, he says.

More widely distributed power in organisations also takes care of whistleblowing, a topic of increased interest since the major corporate collapses of the past decade have focused attention on the need for employees to speak out. A recent development in a number of large US companies, Dr Turnbull notes, is the introduction of ‘external ombudsmen’ to protect the careers of people within.

Dr Turnbull pointed out that is in the interest of shareholders, creditors and other stakeholders to improve the governance integrity of firms – and employee ownership in tandem with network governance can deliver a more democratic means. It also offers a solution to succession issues.

Typically the architects of corporate governance have been lawyers who provide expertise without taking into account the strategic competitive advantages of business. “As an entrepreneur, I had the privilege of being able to write the corporate constitution – and I wrote checks and balances into it,” says Dr Turnbull. Those power-sharing checks and balances shared risks with investors, and ensured as the CEO, he could not strip assets or over-borrow the business and consequently protected his own reputation.

Such arrangements dissolve the boundary between management and governance and, as Dr Turnbull told the AHRI convention delegates, may turn human resources managers into "governance architects" determining the effectiveness of directors and helping to define the competitive advantages of the business.