Risk: A Game of Thrones

HBO, the producer of ”made for TV” award-winning shows, is renowned for its high-quality programming, documentaries and event TV.  One of HBO’s hit shows, A Game of Thrones, is based on the A Song of Ice and Fire series of fictional novels by George R.R. Martin, the first installment of which was published in 1996.  The title of the show comes from a proverb that the Queen Cersei quotes in the novel: “When you play the game of thrones, you win or you die.  There is no middle ground.”

The series has more plot twists than a murder mystery and captures the imagination.  There is no shortage of drama, intrigue and, of course, obligatory gratuitous sex.  But what does this have to do with risk management?

A Game of Thrones is a great metaphor for how human behavior can radically change the course of events, including the downfall of empires (oops, I meant to say corporations).  Fiction is a reflection of real human behavior.  In fact, “conduct risk” may be the hardest risk to manage simply because it permeates every aspect of business life.  Conduct risk is the manifestation of every decision an employee of a firm makes to either act ethically or take advantage of opportunities for self-indulgence.  Given the temptations of wealth, power and access to resources only available to senior executives, it should not be surprising that fraud occurs.  Yet each time it happens, we sit back in awe and judgment, condemning bad behavior.  Seldom is this behavior condemned, though, before it causes catastrophic failure.

Economists have a coined a phrase, “agency risk,” for corporate bad behavior.  Agency risk is the risk of senior executives seeking their own self-interest over the fiduciary duties and best interests of the firm, employees and shareholders.  This risk has become prevalent in society and may often be the main source of financial failure.  Agency risk is not isolated to the C-Suite or middle management, it exists wherever someone is appointed to look out for the affairs of others and the “agent” decides to pursue a course of actions to enrich themselves.  Behavioral science research on these topics is only now becoming mainstream as a theoretical framework for explaining how and why this happens and the cognitive dissonance of such behavior.

Organizations are well aware of these risks; however, the real challenge is what to do about it.  In fact, regulatory agencies have attempted to address these risks through increased enforcement action.  The United Kingdom’s regulatory body, the Financial Services Authority (FSA), has drafted guidelines for conduct risk.  Martin Wheatley, CEO designate of the FSA, said “firms need to ensure that they are putting the consumer and the integrity of markets at the heart of their business models and strategies. This includes making cultural changes that promote good conduct, establishing oversight around the design and innovation of products and services and ensuring they are transparent in their dealings with consumers.”

Yet there is very little evidence that the threat of enforcement or financial penalties has curbed this behavior or served as a deterrent to those who commit financial fraud.  Numerous examples exist as a reminder that conduct risk is pervasive and remains a huge challenge for every organization.  Why does it take a firm like General Motors 10 years to come forward to recall defective cars?  Another example is SAC Capital Advisors’ Stephen Cohen, who lost his license to manage outside money as a result of alleged insider trading.  The examples are numerous and may exist within each firm with varying degrees of harm.  But we still haven’t answered the obvious question of how is conduct risk addressed.  What is the root cause of conduct risk and what realistic actions can be taken?

Our modern-day princes and princesses are paid handsomely for running large and complex businesses, and most do so with a great deal of integrity.  But some have adopted the proverb of Queen Cersei, “when you play the game of thrones, you win or you die.  There is no middle ground.”

Adam Smith’s foundational teachings in “The Wealth of Nations” was built on his earlier work, “Theory of Moral Sentiments.”  Smith, a Scottish professor and philosopher, was profound in his treatment of morality and laissez-faire.  Many have turned these phrases to their own benefit and completely ignored Smith’s work on ethics and jurisprudence.  Self-interest did not mean self-indulgence.

There are no easy answers, yet A Game of Thrones may provide the guidance we need to avoid the pitfalls of conduct risk. Here are a few that Boards may consider:

1. Bad behavior should not be tolerated, even in small indiscretions.  Small lies become big lies and can always be justified.  Create an environment where people can call a spade a spade without the threat of career-ending repercussions.
2. Concentrating power or access to critical information within small groups of senior executives seldom benefits anyone except these individuals.  Openness and transparency has become cliché, yet everyone admires the leader who leads by this example in life and in business.
3. Financial incentives should be based on long-term outcomes, not short-term results.  Anyone can “manage” financial performance in the short-term; however, long-term results require sustained good behavior.  Today’s instant gratification and star treatment has institutionalized a “win at all costs” mentality to the detriment of business and society at large.
4. Don’t ignore internal talent.  Often the “best” person for the job is overlooked because of a bias to find a proven leader who has moved from opportunity to opportunity.  The myth of the super star executive is just that, a myth.  Your best talent is the person who knows the weaknesses and strengths of the firm.  Surround them with talent and develop the leadership team that you need.

The vast majority of firms today don’t exhibit the behavior of the characters in A Game of Thrones, but even so, these lessons are a reminder that a major failure can happen in any firm.   An honest assessment should not be undertaken after it occurs.  Assume that it can happen and create the environment that you believe will lead to the best outcomes long-term.