By Byron Loflin, Global Head of Board Advisory, Nasdaq
A key skill of a high-performing board of directors—which adds value to both management and the company—is its collective ability to understand and anticipate risks and opportunities. Each board member contributes insights, skills, knowledge and perspectives drawn from experiences that inform and facilitate the board’s decision-making processes in carefully identifying and assessing key risks and opportunities inherent in the various options under consideration. The potential unintended consequences of those options should also be included in the board’s considerations. Failure to do so can lead to those unintended consequences being actualized.
Regulatory rules and decisions, new technologies, market opportunities, disruptors and sustainability-focused initiatives can fundamentally affect how a financial-services company operates. Decisions made in the boardroom can have lasting impacts on the company, its customers and employees, the communities in which it operates and the industry itself. While short-, mid- and long-term risks and opportunities are at the forefront of decision-making processes, unintended consequences—which are harder to predict because they are more likely to be realised in the longer term and result from factors outside the control of the company—tend to lie beyond the decision-makers’ risk lens. For example, how will artificial intelligence (AI) alter banking, and what new risks will emerge? Effective risk oversight must include assessments of such potential unintended consequences.
Expanding the board’s risk-oversight lens to focus on possible unintended consequences requires that the board go beyond “routine” risk assessment and engage in rigorous tabletop exercises that include scenario planning for worst-case events. Recent bank failures in the United States have had far-reaching global impacts and should create an impetus to enhance how all boards approach risk oversight. It is not an exaggeration to say that failing to engage in scenario planning, in addition to not taking full advantage of the resources available to the board (directors’ experience, management’s data, etc.) and the lessons learned from the oversight failures of others, may expose companies to their own potential existential crises.
The law of unintended consequences, capitalism and shareholder primacy
As a formal concept, the term “law of unintended consequences” was first discussed as an economic theory around 1759, when economist and philosopher Adam Smith offered his explanation of the “invisible hand”. Smith posited that while individuals pursue business activities to promote profitable self-interest, those actions also have unintended consequences, such as the advancement of an enterprise delivering benefits beyond what was intended. In a profit-oriented system, board decisions are made to maximise shareholder value above all. Beyond that immediate goal, unintended consequences are often not part of the board’s calculus.
As a high-level example, Apple is one of the world’s most profitable businesses and has achieved Greenpeace status—or the world’s “most environmentally-friendly technology company”.1
Since the 1950s and the advent of modern theories of business management and leadership, chief executive officers (CEOs) and boards have wrestled with the corporation’s purpose. The wrestling match is between shareholder primacy, derived from Milton Friedman’s 1970 article “The Social Responsibility of Business Is to Increase Its Profits”,2 and stakeholder capitalism, a philosophy of capitalism that purports that long-term growth is maximised by incentivising seven key stakeholder groups. Recently, this wrestling match has become more like a cage fight. Both groups are capitalists, differentiated by their prioritisations of shareholders versus stakeholders. At present, shareholder-primacy supporters are on the ropes because they are thought to be indifferent toward workers and hold more short-term investment perspectives.
“Since 1946, when his book, Concept of the Corporation, redefined employees as a resource rather than a cost, [Peter] Drucker’s works have become an ever-growing resource for leaders in every major culture… A goodly share of productive organisations worldwide are led by men and women who consider Drucker their intellectual guide, if not their personal mentor.”3
Certainly, one could argue that aligning with the shareholder-primacy objective with its narrow focus on shareholder value increases risks of unintended consequences being overlooked in the boardroom.
However, a more stakeholder-oriented approach to business and decision-making implicitly heightens the importance of the board’s ability to apply a rigorous approach to risk assessment and scenario planning to balance the potential benefits.
A new era of corporate governance in the United States
For our economic system to succeed and evolve, capitalism, democracy and justice must be inextricably linked. Trust in our financial systems is critical to the future of capitalism and democracy. The last 23 years have brought significant changes to the corporate-governance landscape. Business failures have magnified corporate-governance failures, prompting changes and codifications of governance efficacy globally. The King IV Code in South Africa and the UK Corporate Governance Code (Revised 2018) are primary examples.
“As a dog returneth to his vomit, so a fool returneth to his folly.” – Proverbs 26:11
In the United States, there are many unintended consequences of shareholder primacy. While significant financial rewards of innovation and business growth have benefitted a few, there has been a significant rise in income inequality, including relative decreases in the incomes of the lower and middle classes. The current “war for talent” has exposed the steady decrease in worker loyalty and positioned purpose and culture as keys to employee satisfaction.4 Employees are not a cost center; they are an innovation center.
A stakeholder-capitalist view provides boardroom leaders with a framework for evaluating risk on a forward-looking basis. The seven key stakeholders who create long-term corporate value are:
- The employees and contract workers on whom it depends,
- The customers it serves,
- The communities it touches,
- The suppliers and vendors with which it works,
- The environment it impacts,
- The shareholders for whom it provides,
- The corporation itself.
Too often, the shareholder-primacy view has focused on cutting costs to increase profitability, resulting in shrinking businesses. Peter Georgescu, chairman emeritus and former CEO of Young & Rubicam Inc. (Y&R) and author of Capitalists, Arise!: End Economic Inequality, Grow the Middle Class, Heal the Nation, emphasised that “people are the secret sauce to success”.5 An unintended consequence of cost-cutting through workforce reduction is the loss of valuable institutional knowledge and potential innovators, as well as the subsequent disruptions created by former employees who have leveraged their insights to successfully develop new platforms or products that can compete with and eat into the market shares of their former employers.
As of January 2023, the US banking system comprised approximately 5,000 banks and credit unions. Many of these provide important liquidity and lending to small businesses and homeowners. Often overlooked is that small business is the foundation of a healthy, free-market capitalist system. According to March 2023 data published by the United States Small Business Administration Office of Advocacy, there are 33.2 million small businesses (under 500 employees) in the United States, accounting for 99.9 percent of all businesses and roughly 44 percent of US economic activity.6
An unintended consequence of shareholder primacy has been the tendency to focus on the short-term investment horizon, the quarter-to-quarter timeline of analysis, versus the longer-term perspective of the average superannuation (UK version) or 401(k) (US) investor, whose funds are typically invested in long-term mutual funds and exchange-traded funds (ETFs) through the institutional-investment community.
“Those who cannot remember the past are condemned to repeat it.” – George Santayana
The wrestling match between shareholder primacy and stakeholder capitalism continues to bring to the surface several significant issues on the front pages of financial periodicals, within political halls and inside boardrooms. An important aspect of the law of unintended consequences is that we learn lessons and build better models to understand the impacts of past decisions.
“The law of unintended consequences is the only real law of history.” – Niall Ferguson, Historian and Milbank Family Senior Fellow at Stanford University’s Hoover Institution
When level heads do not prevail
ESG (environmental, social, and governance) has become a three-letter punching bag. Certainly, ESG priorities are unique to each company, and each should be free to develop its approach to sustainability respective to its strategy. The “E” and “S” priorities and goals of a fossil-fuel explorer differ greatly from the “S” and “G” priorities of a business-services firm.
For the forward-looking board, considering the “what if” scenarios and the intended and unintended consequences with respect to “E,” “S” and “G” should be a priority.
“You can blow out a candle,
But you can’t blow out a fire.
Once the flames begin to catch,
The wind will blow it higher.”
— “Biko” by Peter Gabriel
ESG is a holistic approach—a movement, in a sense—to address risk management. One or a few or all? Level heads are collaborating and actively innovating for positive impacts on “E,” “S” and “G”. These “heads” are diverse, with different career experiences, political backgrounds, races, genders and more. Simply put, innovation is happening. The intended consequence of stakeholder capitalism is incentivising innovation by diversifying creativity and solution-making. An unintended consequence of “debunking” ESG is failing to understand the existential threat to a company that one or more of these areas could pose to its profitability and sustainability.
“Great strategy is more than an aspiration, more than a dream: It’s a system of value creation, a set of mutually reinforcing parts.” – Cynthia Montgomery, The Strategist: Be the Leader Your Business Needs7
So, how should boards monitor strategy and the law of unintended consequences today? Management and boards should regularly consider a dashboard of key performance indicators (KPIs), risks and possible consequences of significant actions and conduct regular reviews of possible scenarios and black swans. The time has come for a chief scenario planning officer who manages the scenario dashboard and reports to management and the board. The banking challenges of early March could have been mapped and predicted. For an industry that was built on mathematical spreads and actuarial-type predictive analysis, the failures were especially shocking. Does the absence of a chief risk officer contribute to the collapse of a company? Among the board’s risk oversight responsibilities is assuring that key risk personnel are in place and that the board is aware of risk possibilities well in advance.
The journey forward: anticipating unintended consequences
Seeking to better understand and acknowledge unintended consequences and their possible implications fosters self-awareness, bias recognition and continuous improvement on the leadership journey. It is also an antidote to denial and failure to acknowledge how a board’s decision today could lead to diminished value in the future.
One of the single most important periods in a board’s lifecycle is CEO succession. The typical approach to CEO succession has been likened to king-making. A better approach is the use of an enterprise risk management (ERM) framework. The intended consequence is a more organised and holistic approach to CEO-succession planning.
Learning from unintended consequences:
- An unintended consequence of the global pandemic was that it magnified the fact that we are universally, more similarly vulnerable than different.
- An unintended consequence of dramatic CEO pay ratios is the increasing distrust of stakeholders in business leadership.
- An unintended consequence—and lesson learned—from the bank crisis of March 2023 is that a few social-media comments may have generated increased attention to bank failures that aroused broader banking-sector concerns.
We will never anticipate all black or gray swan events; however, scenario planning and tabletop exercises applying an ERM approach will help boards and management model the possibilities of unintended consequences, anticipate the variables and develop better-informed solutions that improve both total stakeholder and shareholder returns.
In uncertain and challenging times, the more consistency, self-reflection, and robustness in the company’s—and the board’s—corporate governance arrangements, the better. The Nasdaq Board Advisory team partners with boards to administer evaluations that provide transparency into board composition, so directors can operate as effectively as possible and work together at peak performance. For more information, visit here: nasdaq.com/solutions/governance/board-evaluations.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
1 One Grid Energy Solutions: “Greenpeace Declares Apple ‘Greenest Tech Company’ for Third Year Running.”
2 SpringerLink: “The Social Responsibility of Business Is to Increase Its Profits,” Milton Friedman, Corporate Ethics and Corporate Governance, Pages 173-178.
3 Harvard Business Review: “The Post-Capitalist Executive: An Interview with Peter F. Drucker,” T George Harris, May-June 1993.
4 World Economic Forum (WEF): “Employee loyalty is declining. Here’s how to build it back,” Ana Kreacic, Lucia Uribe and Simon Luong, November 16, 2021.
5 Leaders: “Stakeholder Capitalism An Interview with Peter Georgescu, Chairman Emeritus,
Young & Rubicam, Inc.,” October 4, 2022.
6 U.S. Small Business Administration Office of Advocacy: “What’s New With Small Business,” March 14, 2023.
7 Harvard Business School: Cynthia A. Montgomery (Timken Professor of Business Administration, Charles B. [Tex] Thornton Chair of the Advanced Management Program), The Strategist: Be the Leader Your Business Needs, New York: HarperCollins, 2012.