I consult, write, and speak on running better technology businesses (tech firms and IT captives) and the things that make it possible: good governance behaviors (activist investing in IT), what matters most (results, not effort), how we organize (restructure from the technologically abstract to the business concrete), how we execute and manage (replacing industrial with professional), how we plan (debunking the myth of control), and how we pay the bills (capital-intensive financing and budgeting in an agile world). I am increasingly interested in robustness over optimization.

Thursday, October 31, 2013

Can we stop misusing the word "Governance"?

The word "governance" is misused in IT, particularly in software development.

There are two popular misconceptions. One is that it consists of a steering committee of senior executives with oversight responsibility for delivery; it's responsibilities are largely super-management tasks. The other is that it is primarily concerned with compliance with protocols, procedures or regulations, such as ITIL or Sarbanes-Oxley or even coding and architectural standards.

Governance is neither of these things.

The first interpretation leads us to create steering committees staffed with senior managers and vendor reps. This is an in-bred political body of the people who are at the highest levels of those expected to make good on delivery, not an independent body adjudicating (and correcting) the performance of people in delivery. By extension, this makes it a form of self-regulation, and defines governance as nothing more than a fancy word for management. This body doesn't govern. At best, it expedites damage control negotiations among all participants when things go wrong.

The second interpretation relegates governance to an overhead role that polices the organization, searching for violations of rules and policies. This does little to advance solution development, but it does a lot to make an organization afraid of its own shadow, hesitant to take action lest it violate unfamiliar rules or guidelines. Governance is meant to keep us honest, but it isn't meant to keep us in check.

Well, what does it mean to govern?

Let's look at corporate governance. Corporations offer the opportunity for people to take an ownership stake in a business that they think will be a success and offer them financial reward. Such investors are called equity holders or stockholders. In most large corporations, stockholders do not run the business day-to-day. Of course, there are exceptions to this, such as founder-managers who hold the majority of the voting equity (Facebook). But in most corporations, certainly in most large corporations, owners hire managers to run the business.

The interests of ownership and the interest of management are not necessarily aligned. Owners need to know that the management they hired are acting as responsible stewards of their money, are competent at making decisions, and are running the business in accordance with their expectations. While few individual stockholders will have time to do these things, all stockholders collectively have this need. So, owners form a board of directors, who act on all of their behalf. The board is a form of representative government of the owners of the business.

Being a member of a corporate board doesn't require anything more than the ability to garner enough votes from the people who own the business. An activist investor can buy a large bloc of shares and agitate to get both himself and a slate of his choosing nominated to the board (Bill Ackman at JC Penney). People are often nominated to board membership reasons of vanity (John Paulson has Alan Greenspan on his advisory board) or political connections (Robert Rubin at Citibank).

Competent board participation requires more than just being nominated and showing up. Board members should know something about the industry and the business, bring ideas from outside that industry, and have experience at running a business themselves. (As the financial crisis hit in 2008, it became glaringly obvious that few bank directors had any detailed understanding of either banking or risk.) Good boards also have independent or non-executive directors, people who have no direct involvement with the company as an employee or stockholder. Non-executive directors are brought on principally to advise and challenge on questions of risk, people, strategy and performance.

A board of directors has three obligations to its shareholders: to set expectations, to hire managers to fulfill those expectations, and to verify what management says is going on in the business.

The first - setting expectations - is to charter the business and approve the overall strategy for it. In practice, this means identifying what businesses the company is in or is not in; whether it wants to grow organically or through acquisition (or both), or put itself up for sale. The CEO may come up with what she thinks a brilliant acquisition, but it is up to the board to approve it. By the same token, a board that wants to grow through acquisition will part ways with a CEO who brings it no deals to consider. The board may choose to diversify or divest, invest or squeeze costs, aggressively grow or minimize revenue erosion, or any number of other strategies. The CEO, CFO, COO and other executives may propose a strategy and figure out how to execute on it, but it is the board who must approve it.

The second - hiring and empowering managers - is the responsibility to recruit the right people to execute the strategy of the business. The board is responsible for hiring key executives - CEO, CFO, President - and possibly other executive roles like Chief Investment Officer, Chief Technology Officer, or Chief Operating Officer, depending on the nature of the firm. The board entrusts those people to build and shape the organization needed to satisfy the expectations set by the board. They serve at the board's discretion: they must perform and demonstrate competency. The board also approves the compensation of those executives, providing incentives to executives to stay and to reward them for the performance of the firm under their leadership. These divergent interests and obligations is why it is considered poor governance to have the same person be both Chairman of the Board and Chief Executive Officer.

The third - verification - is the duty of the board to challenge what they are being told by the people they have hired. Are management's reports accurate and faithful representations of what's going on in the business? We tend to think of business results as hard numbers. But numbers are easily manipulated. Informal metrics such as weighted sales pipelines are easily fluffed: 100 opportunities of $100,000 each at a 10% close probability yields a sales pipeline of $1,000,000 - but any opportunity without signature on paper is, from a revenue and cash flow perspective, 0% closed. Formal (regulated) metrics such as profitability are accounting phenomenon; it's easy to flatter the P&L with creative accounting. There is an abundance of examples of management misrepresenting results - and boards that rubber stamp what their hired management feeds them (e.g., Conrad Black's board at Hollinger).

Compliance questions are relevant to fulfilling the duty of verification. Management that plays loose and fast with regulatory obligations create risks that the board needs to be aware of, correct, and prevent from happening again (whether a rogue trader at UBS or violation of the Formula 1 sporting rules by employees of McLaren). But compliance is a small part of what Nell Minow calls a "duty of curiosity" that each board member has. The board - acting as a representative of investors - cannot take reported results at face value. It must investigate those results. And, the board must investigate alternative interpretations of results that management may not fully appreciate: an embedded growth business who's value is depressed by a slow-growth parent, a loss leader that brings in customers to the big revenue generator, a minor initiative that provides a halo to a stodgy business.

The confusion about governance in IT is a result of too narrow a focus. People in technology tend to be operationally as opposed to financially focused, so most cannot imagine a board consisting of people other than those with super-responsibilities for delivery, such as executives from vendor partners. Tech people also tend to be more interested in the technology and the act of creating it, rather than the business and it's non-functional responsibilities. Regulations tend to take on a near mystical quality with technology people, and are subsequently given an outsized importance in our understanding of governance.

Good corporate governance requires that we have an independent body that sets expectations, hires and empowers a management team, and verifies that they are delivering results in accordance with our expectations. Good IT governance requires the same. We'll look at how we implement this in IT in part 2.