Why boards need to take action on power-hungry leaders

Leaders who consolidate power through retaining decision-making rights are willing to sacrifice their organisation’s expected earnings in order to retain control

From Enron and Tyco through to WorldCom and Lehman Brothers, the world’s biggest corporate collapses usually have one thing in common: a centralised organisational structure that concentrated power into the hands of executives who stifled the free flow of information and retained the right to make critical business decisions. In such cases, there was often a whistleblower at a local level who knew something was going horribly wrong, but when they raised the alarm, they were ignored or overruled and effectively silenced by those higher up in the organisational food chain.

This kind of behaviour on the part of executives can manifest itself in a not inconsiderable number of problems for organisations and their boards. In particular, executives' desire to maintain control and hoard the “rights” to make decisions can have potentially significant and far-reaching consequences, according to a new research paper, Organisations with Power-Hungry Agents, co-authored by Richard Holden, Professor in the School of Economics at UNSW Business School, and Wouter Dessein, Eli Ginzberg Professor of Finance and Economics at Columbia Business School.

“I’ve seen plenty of folks hoard decision rights,” states Prof. Holden, who puts this kind of behaviour down to a variety of factors. “Part of it can be put down to more or less nefarious explanations. There is one group of people who might have some kind of narcissistic personality disorder, and we can all probably think of examples of that. And there are other people who have ‘rules of thumb’ that got them where they are in order to be successful. And then some people just don't trust others and like to do things themselves; there’s nothing that’s necessarily or deeply profoundly psychologically problematic about that – it’s just the way some people are,” he explained.

What are the commercial implications of power-hungry leaders?

While “power hungry” sounds like a value-laden term (and to some degree Prof. Holden says it is), he explains that the evidence discussed in the research paper is from carefully designed and executed laboratory experiments, and these found that the hoarding of decision-making rights among organisational leaders is a fairly widespread phenomenon.

Furthermore, the hoarding of rights to make decisions tends to be most severe at the top of organisations – and this has potentially significant commercial implications for organisations. Chief among these is that leaders who retain decision-making rights are willing to sacrifice their organisation’s expected earnings in order to retain control. In addition, organisations with power-hungry leaders tend to be too centralised in their structure, while the presence of such managers also results in a flattening of the organisational hierarchy and smaller, less integrated firms.

As a result, Prof. Holden said organisations are unable to harness and take advantage of the power of local information, where employees and managers at the coalface tend to know more about local operating and market conditions. “Power hungry leaders are kind of anti-hierarchy, in the sense that they tend to keep decision-making rights centralised, but in doing so they tend to make poorer decisions as they give up on the use of local knowledge. That's a considerable problem in practice,” he said.

Read more: Employees behaving badly: how high CEO pay can encourage wider wrongdoing

“If you can think back to a time when banks had branches with local managers, it has been very well-documented that they are much better at assessing credit risks than people back in head office, for example. Similarly, people in an academic department at a university probably know more about who the best people are in their particular field (such as a certain branch of anthropology or a certain branch of mathematical number theory) than people in the central administration of the university. This principle is roughly true in almost every organisation throughout the economy.”

Prof. Holden said multinationals are more likely to experience this problem, and he gave the example of a study of 100,000 IBM employees across 50 countries in the 1970s which documented substantial variation in cultural attitudes toward hierarchy and authority. This study found that the larger and more dispersed an organisation is (either geographically or based on industries), the more likely it will have leaders who tend to centralise decision-making rights.

What should boards do about power-hungry leaders?

As part of their study, Prof. Holden and Prof. Dessein developed a framework that models answers to a number of important questions for organisations, such as:

• What is the optimal number of layers in an organisational hierarchy?
• When do middle managers destroy value?
• What is the optimal scope of a firm?

While the answers to the above questions will differ for each organisation, Prof. Holden said the implications for boards (and the actions they should take) around power-hungry leaders are more consistent. “This is a job for the board,” said Prof. Holden, who explained the first and most important consideration is to be careful who they choose as CEO.

“Is the candidate they have in mind a ‘power-hungry decision-rights hoarder’? That could be bad news for the organisation. When it comes to making decisions, are they a hoarder or not? Are they a good delegator or not? And since there's an underappreciated downside or drawback to having a hoarder in charge, you may want to think carefully about that dimension of who you're choosing.”

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Another solution for boards to power-hungry leaders providing direct rewards or incentives for delegation. These rewards might come in different forms, including benefits that come from structuring the organisation in a certain way.

“At the board level, they need to be quite explicit about the kind of formal authority that is delegated to say, divisional managers, or the amount of authority that is delegated below the CEO. Obviously, the CEO has to be in charge and you can't undercut their authority. But there are ways that you can think about financial delegations for example, in that can be they can be decisions that can be made at the board level,” said Prof. Holden.

These might be decisions about limits on capital expenditures, acquisitions or divestitures, for example, which place formal thresholds on certain kinds of decisions and the potential impact they could have on an organisation. “So those are the things that boards can do, and it’s really a challenge for board directors to take up,” Prof. Holden concluded.

Richard Holden is a Professor of Economics at UNSW Business School, director of the Economics of Education Knowledge Hub @UNSWBusiness, co-director of the New Economic Policy Initiative, and President-elect of the Academy of the Social Sciences in Australia. His research expertise includes contract theory, law and economics, and political economy. For more information please read Organisations with Power-Hungry Agents or contact Prof. Holden directly.