Corporate Eye

Corporate Governance, Ostriches and Black Swans

Simply put, a Black Swan event is one that has a low chance of happening but if it does the impact could be catastrophic. The most current example is the BP oil spill in the USA.

Underpinning Black Swans are some interesting philosophical and psychological factors of human frailties.

A black swan is a highly improbable event with three principal characteristics: It is unpredictable; it carries a massive impact; and, after the fact, we concoct an explanation that makes it appear less random, and more predictable, than it was. The astonishing success of Google was a black swan; so was 9/11. For Nassim Nicholas Taleb (author The Black Swan: The Impact of the Highly Improbable), black swans underlie almost everything about our world, from the rise of religions to events in our own personal lives.

Why do we not acknowledge the phenomenon of black swans until after they occur? Part of the answer, according to Taleb, is that humans are hardwired to learn specifics when they should be focused on generalities. We concentrate on things we already know and time and time again fail to take into consideration what we don’t know. We are, therefore, unable to truly estimate opportunities, too vulnerable to the impulse to simplify, narrate, and categorize, and not open enough to rewarding those who can imagine the “impossible.”

Black Swan: Strategy Execution for the “Outlier”

When Black Swan events occur, shareholders can suffer significant losses. Forbes magazine in their article, Of Brown Pelicans And Black Swans chronicled the financial impact of various corporate Black Swans–

Company

Start Date

End date

Market cap
(start date, in millions)

Market cap
(end date, in millions)

Money Lost

XOM

Exxon Mobil

3/24/89

4/10/89

55,275

52,170

3,105

MS

Morgan Stanley

9/10/01

9/17/01

45,171

39,259

5,912

BAC

Bank of America

9/10/01

9/17/01

92,439

87,147

5,291

MAR

Marriott International, Inc

9/10/01

9/17/01

9,996

7,892

2,104

BID

Sotheby’s

9/10/01

9/17/01

636

550

85

AXP

American Express Company

9/10/01

9/17/01

40,563

35,048

5,515

BK

The Bank of New York Mellon Corporation

9/10/01

9/21/01

27,269

22,555

4,714

XOM

Exxon Mobil

8/29/05

10/21/05

368,346

349,115

19,231

COP

Conoco Phillips

8/29/05

10/21/05

87,791

80,943

6,848

SCGLY

Societe Generale SA (ADR)

1/18/08

1/28/08

58,192

49,014

9,178

TM

Toyota

1/21/10

2/4/10

155,884

123,749

32,135

DLAKY

Deutsche Lufthansa AG

4/15/10

4/28/10

8,207

7,395

812

BAIRY

British Airways

4/15/10

4/28/10

4,338

3,952

386

BP

BP

4/22/10

6/17/10

186,431

99,273

87,158

The costs of Black Swans can be daunting.

ostrich heads

For Corporate Governance, dealing with Black Swans is risk management. The Board is responsible for oversight and the strategic direction of the company— not execution. This means Board members should take on a devil’s advocate role by asking C-Level managers questions such as–

  • How will you make the strategic direction come alive?
  • Have you considered all financial, strategic, ethical and risk issues?
  • What is the worst that could go wrong and how will you manage the outcomes?

More insights for dealing with Black Swans are covered in the report Black Swans Do Exist published by International Federation of Accountants–

  • Directors should increase their focus on risk, and engage more in detailed appreciation and understanding of the risks in their company’s products and service areas. For the financial services industry, a solution could be for boards to establish a specialized risk committee, and consider the employment of an external risk specialist.
  • Black swans do, and will always, exist. Therefore, be much more alert to the fact that, even at the extreme end of risk possibility, things do actually happen.
  • Executive remuneration should be better aligned with the longer-term real performance (in terms of profitability, not sales volume) of the organization—for example, via deferred remuneration in the form of shares.
  • Governance issues are probably best tackled with a mixture of regulatory, investor, and board responsibility. To only look to investors being more active is unlikely to be effective.

What do you think? Would this help companies deal with the arrival of a Black Swan event – and avoid the ostrich ‘head in the sand’ syndrome?

Coming soon: How Shell Uses Scenarios To Manage Risks.

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Ed Konczal has an MBA from New York University's Stern School of Business (with distinction). He has spent the last 10 years as an executive consultant focusing on human resources, leadership, market research, and business planning. Ed has over 10 years of top-level experience from AT&T in the areas of new ventures and business planning. He is co-author of the book "Simple Stories for Leadership Insight," published by University Press of America.
 
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