SUCCESS IS NOT ALL ABOUT PERFECT DECISION-MAKING
▶ Good CEOs know which decisions to take to have maximum impact on performance
Your idea of success is completely wrong
There is this idea that success is 100 per cent correct decision-making. For some people, they understand this to be 90 per cent or even 80 per cent correct decision-making. This idea is completely wrong. A success rate of 56 per cent, implying 44 per cent incorrect decisions, is a great result. Here’s why.
Let’s simplify things. Assume that you are the chief executive of a company and that each decision you make has, on average, an equal impact on the company performance. Let’s say that if you make a good decision you increase profit by Dh1 million and if you make a bad decision you decrease profit by Dh1m.
What does this mean in terms of the company performance? Imagine, if you will, that as CEO you have to make one of these decisions every working day and that there are 240 working days a year. A 56 per cent success rate means that out of the 240 decisions, about 134 are successful, which generates Dh134m in profit. That means 106 decisions are failures, decreasing profits by Dh106m. The result is an annual profit of Dh28m. Most people would never believe that a 56 per cent success rate, on a uniform distribution of the effect of decisions on P/L, could result in an Dh28m profit. In fact, most people would consider a 56 per cent success rate as a failure for a chief executive.
The absolute return of Dh28m needs context in terms of the total equity of the firm. If the equity is Dh10 billion, then this is an insignificant contribution to performance. If the equity is Dh100m then it is a major contribution to performance.
The way to think of this is what types of decisions should a chief executive be taking? As a simple example, why not assume that if a decision has less than a 1 per cent impact on return on equity (RoE) then the CEO delegates it, but the as soon as it reaches 1 per cent of RoE, the CEO takes the decision. This gives us a way to think of the impact of decisions on the RoE of the company. In this scenario, a chief executive with a 56 per cent success rate, implying a 44 per cent failure rate, will generate a 56 per cent- 44 per cent = 12 per cent RoE. If the success rate is just 60 per cent in this scenario, then the RoE will be an extraordinary 20 per cent.
Some might question the flat
1 per cent per chief executive decision. Although the actual level at which a chief executive takes the decision can vary, it makes no sense for a chief executive to take a decision on matters that have a large variance on RoE impact. A chief executive who takes decisions that have a 10 percentage point impact on RoE would not be rational to also take decisions that impacted RoE by only 2 percentage points. This is a chief executive who doesn’t understand how to take the critical decisions and delegate the sometimes big but not critical decisions.
What does this mean in looking at a business? If a chief executive talks about having an 80 per cent success rate then they better have an RoE of around 80 per cent - 20 per cent = 60 per cent. My participation in our markets shows CEOs in general claiming greater than 80 per cent success rates but they have RoEs of far less than 60 per cent. Far less than 20 per cent even. In this scenario this means that either the chief executive is taking decisions at extremely low levels of importance to the company, ie incompetent, or the chief executive is dishonest.
Why corporate governance fails
I am taking my annual break from writing to refresh and energise. It reminds me of the summer holidays I used to have as a child at school. The first school I attended was The British School – Al Khubairat in Abu Dhabi. I was one of a handful non-British students. I remember the class covering the children’s tale The Emperor’s New Clothes by the legendary Hans Christian Andersen. If you haven’t read it here is Wikipedia’s summary:
[The tale is about] two weavers who promise an emperor a new suit of clothes that they say is invisible to those who are unfit for their positions, stupid or incompetent. When the emperor parades before his subjects in his new clothes, no one dares to say that they don’t see any suit of clothes on him for fear that they will be seen as “unfit for their positions, stupid, or incompetent”. Finally, a child cries out, “But he isn’t wearing anything at all”. And everyone starts laughing and pointing at the naked emperor.
In the class discussion afterwards my British classmates focused on the question of how people can be manipulated.
It says something that all I could think about is “What happened to the child who exposed the manipulation?”
It was decades later that I understood the relevance of this child’s tale to business. The formal theory is called the “spiral of silence theory”. It explains how boards, executive management teams and other commercial groups, which although made of individually decent people, can act in a fraudulent or corrupt manner.
The site Mass Communication Theory has a useful definition:
Spiral of silence is the term meant to refer to the tendence [sic] of people to remain silent when they feel that their views are in opposition to the majority view on a subject. The theory posits that they remain silent for a few reasons including:
Fear of isolation when the group or public realises that the individual has a divergent opinion from the status quo.
Fear of reprisal or more extreme isolation, in the sense that voicing said opinion might lead to a negative consequence beyond that of mere isolation (loss of job, status).
If this theory is correct then any committee-style decision-making body, such as a board of directors, might have a majority of decent people but still act in a way contrary to the values of this majority. In other words, this theory predicts that a single person can control the whole board. This needs to be addressed if we are to evolve our economy. Growth comes from good decision-making, and good decision-making comes from the whole board freely engaging in the decision-making. One idea is to have board voting anonymous. You could take it further by having anonymous virtual meetings on a specific topic if 30 per cent of the board requests it. Anonymously of course. There are other potential solutions.
One-minute round up
A quote from Dana Gas from an article from The National this past week: “The final outcome of the ongoing litigations in UAE courts [regarding the sukuk issued by Dana Gas] would likely result in a significant liability for the sukuk holders to repay the company excess ‘on account profit payments’ based on a lawful reconciliation of the matter”.
Translation: Dana Gas is refusing to honour its sukuk and it wants to force its creditors to pay back money. A question that comes to mind is: Does this not expose Dana Gas to liability for issuing a sukuk that it marketed as Sharia-compliant but now is no longer Sharia-compliant?
Dana Gas defends itself against the question of whether investors would lose confidence in the company by stating: “The fact that share prices have increased significantly over the past three to four months is an indicator that people view Dana Gas positively”. It should be noted that a single shareholder bought a large percentage of Dana Gas, which clearly contributed to an upward spike in the price by around 60 per cent, in the two weeks before the statement by Dana Gas regarding its intent in invalidating its sukuk.
Any committee-style decision-making body might have a majority of decent people but still act in a way contrary to the values of this majority