The demise of Audit?

It is clear from today's FT at  that the big four accountants fear collapse to the extent that they are discussing contingency plans.  The discussions centre on how to re-boot a new company as a phoenix from the ashes of the old.

As the demise of Arthur Andersen illustrates, any sign of 'rotten' sends clients running elsewhere - what is the value of an audit certificate from a malodorous firm?  The suggestion from John Griffith-Jones of KPMG, that 'regulators might need to compel clients to stay with a stricken auditor temporarily', is therefore particularly striking. 

But the discussion should not just be about whether and how a big audit firm can rise like a phoenix from its own ashes.  It should include whether audit as we know it would survive as a business after the destruction of a Big 4 audit firm.  That one has been filed under "Too Difficult". 

Update: See also Lex on 24 February 2011

Anthony Fitzsimmons
www.reputability.co.uk

Are civil service leaders competent?

Are the Civil Service's top mandarins competent?  Two strong pieces of evidence suggest that they have a reputation for incompetence among those who deal most closely with them.  Another suggests that this reputation is deserved.  Re-visiting Lord Fulton's seminal 1968 report on civil service competence suggests why.

The UK Commons Public Accounts Committee reports on the civil service.  At its last review, the Committee concluded: "The confidence reported by staff in departments’ boards and senior leadership has been improving but is still low."  Those who know the mandrins best have little confidence in their leaders.

Coalition ministers clearly arrived thinking mandarins lack management skills.  Despite resistance from senior civil servants, one of the coalition's first acts was to try to bring experienced private sector leaders into the so-called boards of government departments in order to inject management skills into the top of the civil service. 

Now there is evidence that this reputation for incompetence is justified.  It comes from a recent lecture by Professor Van Reenen of the LSE, as reported by Tim Harford.  Van Reenen evaluated management competence in a double-blind survey based on 8000 interviews.  A striking conclusion was that government-run companies rank right at the bottom of management quality tables.  As Tim Harford put it, "David Brent is alive and working in Whitehall".

Depressingly, this is not a new phenomenon.  As long ago as 1968, the Fulton Report characterised the upper reaches of the civil service as based on the cult of the clever, classically educated amateur. 

Lord Fulton made two important recommendations.  The first was to provide management training for the civil service's policy-makers.  Whilst civil servants do get management training, the evidence suggests there is a continuing systemic failure of the civil service to deliver good management.

Secondly, the Report recommended that scientists and engineers should be given more training and responsibility in management and policy spheres (Chapter 1 para 17 on page 12).  

There has been a total failure here.  Over forty years on, only two of the 42 permanent secretaries that lead the UK's Civil Service have science or engineering degrees.  Only two more have degree level numeracy.   The nearest the UK Treasury's policy-making Executive Management Group has to a scientist is one person with a maths degree.  (Source: Cabinet Office and Treasury FoI answers).  

This failure explains two weaknesses in government policy-making.  Firstly, senior mandarins as a class are scientifically ignorant to an extent that should make them blush.  This makes them vulnerable to stupid mistakes because they have no independent basis for knowing where to probe any subject that has scientific content.  A cadre of specialist scientists is no substitute for mandarins who, collectively, are not scientifically ignorant.

Secondly, the lack of science training amongst mandarins has excluded the scientific culture and way of thinking from the civil service leadership.  The civil service leadership is deprived of the evidence-based culture and rigour that imbues those with a good science education.  This evidence-seeking rigour can be uncomfortable, but it is highly desirable.  

It seems clear that the Civil Service has no intention of developing scientists and engineers to fill the highest levels. This is probably because it does not recognise its own weakness.  A recent FoI answer states "There is no strategy or policy that has been pursued by the Civil Service (either at present or in the last five years), to ensure that current and potential permanent secretaries are selected to ensure a certain distribution of academic backgrounds amongst this group." 

The civil service leadership needs to improve.  Its is notoriously resistant to change as the abiding image of Sir Humphrey reminds us.  It will take a determined government to change civil service culture.  

Political leaders could do worse than resurect Lord Fulton's report because forty years on, its diagnosis still seems to fit. They should commission a small group, well balanced between science and arts graduates, to revisit the Civil Service's culture and competence.  

And in the meantime, they should set the Civil Service Commissioners the objective of making scientific ignorance as embarassing to mandarins as ignorance of literature, history, politics or the rhetorical arts.

Postcript: You will find a recent piece by Richard Bacon MP here.

Anthony Fitzsimmons

www.reputability.co.uk


Anthony Fitzsimmons is Chairman of Reputability LLP and, with the late Derek Atkins, author of “Rethinking Reputational Risk: How to Manage the Risks that can Ruin Your Business, Your Reputation and You”

Do boards live in a rose-tinted bubble?

Are boards living in a rose-tinted bubble?  Roffey Park's latest survey suggests they are.  This matters because any disconnection of a board from reality is dangerous and can wreck the organisation.

Roffey Park carries out an annual survey of managers and directors.  Apart from looking at trends, this year's statistics were analysed by seniority.  The 2011 results showed board members to be more confident both in themselves and in the future than lower echelons. 

There are two obvious explanations for this.  It may be that board directors have a better view of things from their elevated position.  Alternatively, board members are poorly informed about what is going on at the coal face, for example because lower level staff try to avoid telling their bosses bad news.

It is extremely easy to create a system of incentives that discourages the flow of bad news up a hierarchy.  The result is that some problems will be widely discussed below a certain level in the organisation but will not communicated upwards.  A typical example seems to have occurred at BP.  Before the Deepwater Horizon exploded, the Mocando well was being described among engineers as a "nightmare well", but the US House Energy Committee found  "no trace of that news reaching senior management".

This matters doubly.  First, the lack of 'bad news' means that management does not have all the organisation's know-how available when making decisions.  This means decisions are made on the basis of information that is unnecessarily incomplete.

But worse happens when a disaster opens top management to public scrutiny.  Outrage and severe reputational damage frequently follow when it is discovered that top mangement has made a bad decision because it did not have access to the organisation's collective knowledge.  The history of disasters is littered with cases where top management was lambasted - and sacked - for not knowing what was really going on lower down their organisation.  

Poor communication within an organisation is an operational and reputational risk.  These results from Roffey Park's are more evidence that poor internal communication is a common problem.

Anthony Fitzsimmons
www.reputability.co.uk

Whither Goldman Sachs?

These are torrid times for Goldman Sachs despite weathering the 2008 financial crisis better than most. The least of it was reports of its advice to investment clients to short Californian state bonds that it had helped to sell and of its help to the Greek government to 'mask' the size of Greek government debt.  More serious were the Massachusetts investigation of sub-prime mortgage sales in the state (settled for $60m) and CDO issues, which include a fraud case launched by the US SEC in April 2010 and settled by payment of a $550m fine.

All this has taken place against the background of a witch hunt against bankers by politicians who have persuaded themselves and the public that only bankers, not politicians or voters, are to blame for the financial crisis.  The result is that Goldman's currently excites a mix of emotions ranging from admiration and fear to scorn and hostility, packaged with a back-story that has a toxic potential that begins to rival BP's.
 

So at last May's AGM, Goldman's chairman, Lloyd Blankfein, announced Goldman's new Business Standards Committee (“BSC”). “Questions have been raised that go to the heart of this institution’s most fundamental value: how we treat our clients. ...There is a disconnect between how we as a firm view ourselves and how the broader public perceives our role and activities in the market”.

A good start.  It got better.  The BSC's mandate was to “ensure the firm's business standards and practices are of the highest quality; that they meet or exceed the expectations of clients, other stakeholders and regulators; and that they contribute to overall financial stability and economic opportunity”.

The BSC report  was published on 10 January 2011.  Referring to Goldman's Business Principles it correctly recognises Goldman's reputation as one of its most important assets and that reputation risk is important.  It admits that clients see some some shortcomings at Goldman's – questioning “whether the firm has remained true to its traditional values” and suggesting that “in some circumstances the firm weighs its interests and short term incentives too heavily”. But from that encouraging start, and despite its 39 recommendations, the report does not engage with the fundamental issues. Why?

The first clue is BSC membership.  Plenty of senior bankers and bank functionaries, a seasoning of lawyers - but who is the obvious omission?  Goldman's Chief Risk Officer, Craig Broderick.  Why exclude Goldman's most senior risk professional from the BSC, whose report mentions reputational risk more than 20 times?

Secondly, the report's focus is primarily on clients.  "The cornerstone of the [BSC]'s recommendations is the relationship between Goldman Sachs and its clients, and a deeply rooted belief that if our clients are successful, our own success will follow."  All beliefs, especially the deeply rooted variety, should be questioned regularly, and this is no exception.  Their client' success probably is important to Goldman's; but it is quite different to believe that client success necessarily leads to success for  Goldman's.

Looking back at the report's introduction reveals a third clue.  The report coyly refers to Goldman's recent “considerable scrutiny” and the arrival of an “opportunity to engage in a thorough self-assessment” and to “consider how we can and should improve”.  At best this is deliberate understatement driven by lawyers; at worst, it represents self-delusion, never the best starting point for recovery.

Against that background, it is no surprise that the BSC's 39 recommendations focus primarily on what its members understand well – clients, governance, committees, training, procedure and good intentions.

Whilst reputational risk management is mentioned 16 times, there is no reference to the importance or place of systematic reputational risk analysis or reputational strategy, without which reputational risk management is unlikely to be effective.  Avoiding these subjects may have been due to tactical coyness, but if so it has been taken to the degree of suggesting ignorance.  

Whither Goldman's?  Predicting the future is a mug's game, but without focus on these areas, Goldman's will remain perched uncomfortably close to the edge of a reputational abyss.  And Goldman's will miss a rare, valuable opportunity to become the world's most respected bank, set in a class of its own.  Since reputational capital can represent as much as 40% of market capital for a well respected company, its shareholders would be happy - and the more so if Goldman's improved reputation was built on rock-solid foundations.

Anthony Fitzsimmons
www.reputability.co.uk

Lessons from BP's collapse

When BP's share price fell, shareholders' pockets felt lighter by up to £58 billion. Much, probably most, of the drop in share price reflected the collapse of the value of BP's reputation, once a huge asset even if it did not appear in BP's balance sheet.

Good corporate reputations are built on the assumption that management is sound so that, for example, it joins up knowledge, culture and behaviour across the entire organisation and learns systematically from the many small mistakes that do not cause a disaster. 

 

Anything that undermines this assumption is an important risk to reputation.  In a view that summarised the new perception of BP, Professor David Green suggested "the painful truth is that BP may not have been very well run."  Perceptions like this were important reasons for BP's reputational collapse.  

The first release from the final report of the US President's National Commission Report into the Deepwater Horizon blowout seems to confirm (at page 90) that the perception was in fact justified even if the management deficiencies were not known to BP's board at the time.

“But most of the mistakes and oversights at Macondo can be traced back to a single overarching failure—a failure of management. Better management by BP, Halliburton, and Transocean would almost certainly have prevented the blowout by improving the ability of individuals involved to identify the risks they faced, and to properly evaluate, communicate, and address them.”

Few companies systematically analyse risks to their reputation. As a result, there is a large, widespread lacuna in management - and board - knowledge of risks to reputation in this important area, among others.

This is the result of history. As originally conceived, classic risk management and Enterprise Risk Management (“ERM”) were not designed to find reputational risks. Even state-of-the-art risk management and ERM miss large and important areas of risks to reputation. The lacuna is made worse because traditional approaches do pick up some risks to reputation, lulling practitioners into a false sense of security.

The consequence is that many – from my own sample of observations I believe most – well-regarded companies have large and important gaps in their risk analysis as regards reputational risks.  This leaves potentially catastrophic risks and risk combinations unrecognised.  As a result, the opportunity to manage this huge area of risk to shareholder value is lost.

Boards - particularly Chairmen and Chief Executives - need to recognise this lacuna and set strategy to deal with it.

Anthony Fitzsimmons 
Reputability
London
www.reputability.co.uk

Only 5% of top civil servants have degree level science education

Only two of the 42 permanent secretaries that lead the UK's Civil Service have science or engineering degrees.  Two more have degree level numeracy.   And the nearest the UK Treasury's policy-making Executive Management Group has to a scientist is one person with a maths degree.  (Source: Cabinet Office and Treasury FOI answers)

Yet the seminal 1968  Fulton Report  recommended professionalisation of the civil service's cult of the clever (typically Oxbridge) amateur.  Apart from recommending training in management (though why is No 10 drafting in top businessmen to bring management acumen to all government departments?) Fulton specifically recommended that scientists and engineers should be given more training and responsibility in management and policy spheres (Chapter 1 para 17). 

It is clear that the Civil Service has not developed scientists and engineers to fill the highest levels; and a FOI answer states "There is no strategy or policy that has been pursued by the Civil Service (either at present or in the last five years), to ensure that current and potential permanent secretaries are selected to ensure a certain distribution of academic backgrounds amongst this group."

Two questions remain:

1. Why has the Civil Service leadership not implemented the Fulton recommendation on scientists and engineers over the last 40 years?
2. What are the consequences of their failure to do so?

Anthony Fitzsimmons
www.reputability.co.uk


Anthony Fitzsimmons is Chairman of Reputability LLP and, with the late Derek Atkins, author of “Rethinking Reputational Risk: How to Manage the Risks that can Ruin Your Business, Your Reputation and You”

RNIB risks undermining its reputation

In a move that will increase risks to its reputation, the RNIB is taking a line that supports Genentech and Roche, drug companies that market and make Avastin.

Avastin is a drug licensed for treatment for bowel cancer.  It has been discovered that Avastin can also stem wet macular degeneration, a condition that condemns many elderly people to blindness.  And Avastin is much cheaper than alternative treatments.

Nice is considering appraising Avastin as a treatment of macular degeneration because it is more cost-effective.  Genentech and Roche are resisting NICE's efforts to appraise Avastin for this use.  The RNIB is reportedly running the same argument as the drug companies, essentially that NICE should not seek out cheaper treatments by using existing drugs for new purposes.

This argument seems counterintuitive but for one additional fact reported by the Guardian.  Both drug companies give money to the RNIB.

Whatever the truth, many will perceive that the RNIB is dancing to its donors' tune.  Whilst this episode on its own is unlikely to cause serious damage, the accumulation of episodes like this will erode the reputation of RNIB as a trustworthy advocate for blind people. 

This is a common problem for charities.  Big business likes to buy their endorsement and the charities like the money.  The danger for charities is that they come to be seen as just another advocate of their commercial sponsors.  With that comes the loss of a valuable reputation that has taken decades to build.

Anthony Fitzsimmons
www.reputability.co.uk