Review: Governance Reimagined – Risk Capital as Commons

Governance Reimagined: Organizational Design, Risk, and Value Creation (Wiley Finance) by David R. Koenig envisions a fundamental redesign based on a networked/distributive model centered around risk capital viewed as a “commons.”  Like Guns, Germs, and Steel: The Fates of Human Societies by Jared M. Diamond, Koenig weaves together ideas from a wide variety of sources, exploding many myths along the way. 

Traditional economics approaches markets by “making simplifying assumptions that do not square with reality in order to prove a theory to be correct.” Typically, we have to assume cost-free, full, and perfect access to relevant information and that economic decisions are made instantaneously. Koenig illustrates several fallacies by imagining the purchase of an apple and the various factors that go into our decision. “If the assumptions are not reality, then you are solving the wrong problem,” he concludes.

Nonlinear dynamic systems are explored to better understand real behavior. There is sensitivity to initial conditions, path-dependency, punctuated equilibria, etc. We look at how enterprises are influenced, from within and without, and at the value of utility, learning that most studies show a preference for avoiding losses that is as much as two-and-one-half times as big as the preference for receiving large gains.

Biases are everywhere and Koenig examines the well known groupthink bias and fourteen other lesser known varieties. One important relatively new finding is that a “tit-for-tat” strategy in playing an iterative game of Prisoner’s Dilemma pales in comparison to a strategy aimed at distinguishing “friends” from “enemies” and cooperating with them. Success is built on the durability of relationships and finding ways to elicit cooperation.

Central to Koenig’s emerging model is the role of trust in networks and the connections between agents. Motivation are also key. Heavy use of options-based compensation “brings about more large losses than large gains, negatively skewing results.” Intrinsic rewards are explored. Will CEOs be satisfied with autonomy, mastery and purpose? Fundamentally, much of Koenig’s new paradigm depends on applying the principles from Elinor Ostrom’s counter to Garrett Hardin’s The Tragedy of the Commons to pools of capital and building estimates of risks from the ground up, in reciprocal feedback loops.

Koenig endorses a varient of the Carver Model of distributive governance, where control “is not viewed as the issuance of orders but as defining by policy a structure that increases the self-control of various subdivisions,” and Shann Trunbull‘s consultative and supervisory committees, as well as watchdog boards with veto power.  Koenig also draws from Geoffrey West’s The Surprising Mathematices of Cities and Corporations concerning how corporations, which grow like organisms, can cheat death by learning from the relatively mobile and self-organizing social networks of people living in cities, which can remain robust for millenia.

… self-governance structures are extermely successful in increasing returns, not depleting the resource. They are substantially more efficient than those overseen by some centralized governor that is distant and remote to the users of the resource.

Nested enterprises increase the likelihood of long-term survival where each has clear boundaries, can adapt to local conditions, can make collective choices within their own framework, the condition of the resource pool is monitored both from within and from outside, where such nested enterprises incur graduated sanctions for rule violations, and where there are low cost conflict resolution mechanisms and recognized rights.

Koenig’s risk governance infrastructure could bring much more business intelligence to bear by more fully engaging employees and stakeholders. It depends, in part, not only on markets but also on monitoring by stakeholders necessitating a new level of transparency, which would also reduce the overall cost of the firms economic capital.

Adoption may depend on whether or not key power figures wish to enlarge the domain of mutual influence of their organizations. How many are willing to redistribute even a modicum of power to substantially reduce risk?

In Silicon Valley the other day I heard well respected directors say they wouldn’t join a board unless insiders retained a controlling interest through a dual class voting structure. They don’t want the interference of proxy voting agencies, stakeholders or shareowners.

Even though Facebook’s stock took a pounding out of the gate, I’d bet more founders are intent on cashing out a substantial portion of their interest, while retaining power, than they are for building companies structured to last forever. Too many are driven by greed and the next quarter.

Of course, I hope I’m wrong. The habitability of Earth for future generations may depend on extending the concept of the commons to capitalism itself. Unless our businesses adopt a sustainable model how can we expect to address our larger commons? Businesses are in the driver’s seat. Adoption of Koenig’s ideas could keep us from going off a cliff.