A response to Sir David Walker's report

August 2009 - Could science-based due diligence of management teams be the key to preventing a future repeat of the near collapse of the financial sector?

Sir David Walker’s government-commissioned review of corporate governance in UK banks and other financial industry entities was published for consultation on 16 July 2009. Its publication prompted conflicting opinions about what measures can be put in place to prevent a future repeat of the near collapse of the banking sector. Ali Gill, CEO of Crelos, offers her view on why science-based due diligence of management teams is crucial.

The near collapse of the banking sector in 2008 has resulted in significant ongoing restructuring and M&A activity amongst the UK’s largest financial institutions. The many reasons for its near demise have been widely discussed, critiqued, and in late July Sir David Walker released his much awaited report, looking at the issues that have troubled the beleaguered banking sector. The report makes various recommendations about what measures should be put in place to prevent a future repeat of its near collapse.

The Report calls for bank directors to have ’greater skills, more experience and demonstrable independence‘. It also emphasised the need for boards to be equipped with the right skills and for investors to be ’active and engaged in scrutinising business strategy‘.

Additionally, Sir David recommends that non-executives reduce the number of appointments they take on and spend 50% more time getting to know the businesses they work with. Other recommendations include that non-execs should systematically challenge chief executives to stop the institutions from assuming too much risk and from paying top bankers excessively.

Despite the recommendations made in the Report, there is conflicting opinion about what measures should be put in place. For example, Keith Boyfield, Chairman of the Adam Smith Institute’s Regulatory Evaluation Group has called for a return to old-style boardroom structures for investment banks (where partnership arrangements meant that it was the boards own money they were risking).

We at Crelos believe that returning to old-style boardroom structures would be a step backwards and one which could result in more harm than good. While it would be wrong to suggest that it was the lack of skills of some high ranking bankers which was wholly responsible for the near collapse of the UK (and indeed global) banking system, Crelos believes that a complete overhaul of the way management and boards are appointed and evaluated is required.

Now more than ever, in a very busy M&A climate, Crelos believes that it is crucial to perform science-based due diligence on management teams. 40% of a company’s superior ROI and 35% of its income growth stem from the strength of the CEO and the management team, yet they are rarely fully professionally assessed to ensure they are capable of delivering. Indeed, at this level, many non-executive directors are still ’recruited‘ via the old boys network. Currently, the number of CEOs removed from businesses for poor performance is around 35% a year.

Crelos believes that a combination of Sir David Walker’s recommendations mixed with yearly rounds of science-based due diligence of management teams running investment banks and financial institutions, would ensure that they are more appropriately skilled to take these institutions forward.

Crelos and the Institute of Chartered Accountants in England and Wales have just released the first ever set of formal Guidelines on performing management due diligence: “Due diligence: The assessment and development of management teams - specifically designed for investors, private equity houses and venture capitalists. The Guidelines explore how modern business psychology practices can be used to select a board and top team that are fit for purpose and use Crelos’ precise psychological measurement model which can predict the performance of management teams.

There is a widely held myth that it is difficult to "prove and measure" the capability of a management team. However, the precision of the psychological measurement of people, organisations and performance has evolved immensely over the past ten years. This should be good news for Corporate Financiers and Investors, who can now use such techniques to significantly enhance the predictability of business performance.

Crelos’ measurement model provides a precise assessment of management teams using proven psychological tools and techniques, leading to investors understanding how the members of the management team will behave in a wide range of different future situations. The model also provides team development roadmaps and actions tightly woven into the business plan, thereby helping to significantly enhance the management control of the business, to underpin the investors' decision making and to deliver significant return on investment.

To be successful boards need to be schooled in the behaviours required to effect proper strategic or ’Integrated Thinking“. This requires them to truly understand the mental processes and necessary behaviours to maximise the intellectual horse-power of the Group. A proportion of any board’s time should be committed to enhanced awareness of inadequacies, weaknesses and strengths. Using its expertise in team dynamics and behaviour and drawing from the information generated during the assessment phase, Crelos enables boards to make use of the assessment information and learn to interact in a very efficient manner so as to turn the team into a high performing one.

In the past 12 months Crelos has noticed a timely increase in the number of companies requesting professional assistance with management due diligence, particularly from the banking sector.

Whilst it is the responsibility of the board to choose non-executive directors with the right mix of skills and abilities, research shows that they are often appointed because of who they know and because they may already have a non-executive position. However this might not be in the same sector. In order to truly know whether boards have the right mix of skills they need to be thoroughly assessed by an independent third party at least every other year. Sir David proposes that non-executives should work 30-36 days per year. We would propose that 8 of these should be dedicated to the purpose of review and active development.

If you would like to discuss any of the above, email Ali