It’s time to reboot the way we do business

December 1, 2010, 4:44 PM UTC

When your computer system crashes or a virus hijacks the network, there’s no easy alternative: you need to upgrade the whole system, maybe rewriting the code from the bottom up. That’s where we are with management.

By Simon Caulkin, contributor

Most of the time, you take your office computers for granted. Okay, there’s a niggle or two, but generally the IT folks can sort it out.

Occasionally, though, it gets serious. When the system crashes regularly or a virus hijacks the network, there’s no easy alternative: you need to upgrade the whole system, maybe even rewrite the code from the bottom up.

That’s where we are with management.

When Vince Cable, the UK’s business secretary, suggested in September that capitalism wasn’t — ahem — actually functioning too well, he was roundly booed by the press and business leaders who seemed to think his job was cheerleading rather than criticizing.

Yet for anyone not living on some other planet — anyone, for instance, who has lost a home, a job or pension rights, or had their salary frozen in the last couple of the years — Cable’s remark was a statement of the blindingly obvious.

Here are three things to chew on:

Exhibit A is the banking crash. This was a crisis of management. Not only was the peripheral applications software (mortgage generation, derivatives) buggy — the whole banking OS was incorrectly designed and specified. It collapsed under stress, nearly bringing the entire world economic system with it.

As is now becoming apparent — Exhibit B — none of the conventional internal safeguards kicked in to stop things from going awry. According to recent academic research from the American Accounting Association, the worst stock market performance by financial firms during the crash was suffered by those with the most independent boards. How much financial expertise the board had, whether the CEO also served as board chairman, even if there was a risk committee — none of these governance nostrums made a blind bit of difference.

What did make a difference, though, was the amount of company stock owned by institutional investors, with — wait for it — greater institutional ownership translating into poorer stock performance.

That takes a bit of digesting. Why should this be so?

Well, we’ve learned that it’s pointless to try to optimize computer software in isolation from the hardware, or vice versa. Once again, the analogy holds for companies.

That brings us to Exhibit C: Shareholders have done worse when companies were optimized in their interest than they did in the years when managers were supposedly running the show for their own benefit.

Compound annual returns from the S&P 500 dropped from 7.6% in the four decades up to 1976, to 5.9% in the subsequent 30 years when companies were nominally being run for the exclusive benefit of stockholders, according to data provided by Roger Martin, who is dean and professor of strategic management at the Rotman School of Management, for Harvard Business Review.

That’s a significant fall — but no surprise to those familiar with the conclusions and reasoning of Jerry Porras and Jim Collins, the authors of Built to Last, who found that companies with a purpose beyond stockholder value gave massively better returns to stockholders than their financially-focused peers.

System crashes, failed governance and unimpressive performance on the measures held most dear — Exhibits A, B and C — aren’t trivial glitches in an otherwise well-functioning system. They are linked and fundamental failures: nature’s way of saying that our present company OS is not only unfit for purpose but a clear and present danger to everyone who depends on it.

The technology has moved on, and so have our demands as workers and consumers, but we’re locked in an operating model that was frozen in the 1980s. So let’s get coding, guys. And that means all of us: no disrespect, but it’s far too important to leave to our friends in the IT department alone.

Simon Caulkin is a writer and editor who for 16 years was the Observer’s management columnist, writing on subjects ranging from rock ‘n’ roll to the banking crisis. He has contributed to the Economist, the Financial Times, and many national and international business magazines.