I was talking with a colleague this morning about common threads in businesses that need to be turned around. One of the common threads we discussed briefly was that of risk and agency costs. It should come as no surprise that in the privately-held business, estimating $50M and under in annual sales, one of the elements that is least managed and yet represents real harm to the business is that of agency cost – the ability of a key employee or an owner or partner to engage in activities that are personally beneficial but hurt the organization at-large.
In an interesting article published by Deloitte within the frame work of the Wall Street Journal, they suggest that owners take responsibility to build a “risk intelligent” culture – one in which each employee takes “personal responsibility for management risk in their work every day”. Costly errors often occur when well-intentioned employees make decisions without regard to the risks involved. For example, John was a fairly competent controller for his $9M/year company. But when the company started to experience cash flow problems due to declining sales, he became behind in making small tax payments to various states. None of these payments were over $100, but over time, as he ignored the repeated demand notices, the fines and interest costs levied by the various states grew to a collective payout of several thousand dollars. While sales continued to decline to less than half of what they were, John’s inactions came to light. Needless to say, John was fired. On his way out, in his own defense, John commented on how he didn’t have any money to pay the taxes in the first place, so “what was I supposed to do?” This statement was revealing on several levels, but at a minimum, it reveals that John didn’t have any appreciation for the risks involved in not paying taxes when they are due.
While John’s example (a real case scenario, I might add) is a bit extreme, it does illustrate the point that employees should understand and appreciate the core risks inherent in their decisions. John didn’t even connect what he was doing (or not doing) to any risks he was creating for the company. And since his CEO had too much trust in his person and work (another risk that the CEO himself only saw in hindsight), it made for the perfect storm. So at a time when the total tax bills would have been less than $1000, John’s actions created a total tax bill of nearly $5000 as well as incurring another ~$2500 in legal fees.
Cultivating a risk intelligent culture would have meant that John would have known and understood the risks he was creating and instead of being silent, he would have informed the CEO of his decisions and discussed them with him. In addition, it would have meant that the CEO would have trusted less and verified more the quality of John’s work. Early detection would have saved the company thousands of dollars.
So, take a look at the Deloitte article. I recommend it to you for your consideration.
Bill English, CEO