Slide 1

Michael Mainelli, The Z/Yen Group

[A version of this article originally appeared as "Wither the FD? Hello Risk/Reward Director!", Handbook of Risk Management, Issue 30, Kluwer Publishing (12 July 1999) pages 5-7.

Each new management fad generates a new call for board representation.  Why not risk management?

The composition of a typical corporate board reflects the composition of the typical problems facing organisations.  First, some one needs to be in charge; so there is a CEO, President, Managing Director, what have you.  Second, some body needs to bring in the bacon; so there is a sales and marketing director.  Third, some one must ensure that real work is done and, although the type of work varies significantly from organisation to organisation, we expect to see production directors or operations directors or something similar.  Fourth, some body needs to ensure that the finances are taken care of, and quite a few other things besides - information, facilities, payrolls, legal work.  This fourth role is the finance director.

These four roles are quite ingrained.  Virtually every start-up attempts to reassure prospective investors that these four areas are covered, yet the management press is full of articles about the need for organisations to have a variety of other directors - information technology directors, human resource directors, change management directors, re-engineering directors, culture directors, knowledge management directors, research directors.  These press articles ignore the difficulty of having too many people around a table 'directing things'; nothing gets done.  There is genuine, and constructive, tension between board representation of an issue and the human need for a manageable group.

Of the four director roles - managing, sales, operations and finance - by far the most confused is the finance director's.  At first glance, it looks the most defined role.  The finance director is almost always qualified professionally for what he or she does on the accounting, which is not common with the other directorships.  However, there are two big problems with the role, other tasks and systemic implosion.  The "other tasks" problem is straightforward.  In many, if not most, organisations the finance director has responsibility for a host of things outside of the accounting and finance.  In the absence of a clear description we call this "the infrastructure".  Computing and computers started in most companies, somewhat sadly, at the tail end of it all, doing invoicing and payrolls.  Three decades on we struggle to get sensible sales and marketing or contact systems, but plenty of people believe the natural home for computers and networks is somewhere in finance.  So it goes for buildings, security, reprographics, legal departments, intellectual property departments, insurances, mergers & acquisitions, strategy units.  It all seems so natural - the finance director is the obvious 'catch-all' role.

The other problem with the finance director's role, systemic implosion, is a bit more involved.  Large, modern organisations are complex systems.  The modern organisation needs to be managed through its systems, not direct tinkering.  A design engineer looks at a recurrent problem and tries to design it out, not pretend that a change of parts will do the trick.  When a problem occurs more than once in an organisation, systemic managers wonder why the system is failing to deliver, not who is to blame.  The systemic organisation requires seven separate bits - governance (the board), feedforward (strategy), feedback (results), monitoring (target setting and budgets), inputs (sales and marketing), processes (operations), outputs (logistics and delivery).  Because of the need to provide the infrastructure, the finance director has become involved in all seven areas.  The system needs to exploded, so that the key roles are clearer.

The biggest systems design problem in large organisations today is that there is only one measure used for control, finance, when organisations increasingly need to measure other things, both required by law and crucial for the business.  The dominance of financial measurement means that it is paramount in managers' minds.  When financial inputs and measures are inaccurate, e.g.  the source of most cross-charging debates, the myriad decisions made by managers at all levels of the organisation are slightly inaccurate.  The cumulative systemic results can be catastrophic.  Other 'measurement' systems are played with - customer satisfaction, employee satisfaction, ISO9000 - and sometimes succeed, but too often the only measurement system the board has faith in, and the system the board spends 90% of its time poring over, is the financial system.  It might be nice to talk about a corporate currency other than dollars, pounds or euros, for instance borrowing the shmoolean currency from our cartoon friends, but we do start with existing systems (and board representation) for financial measurement.  In part, the need to measure on different axes simultaneously, combined with the immense difficulty of doing so well, leads to calls for board representation.  If information technology finds it difficult to measure its value in financial terms, but is still crucial, why not give it board representation to ensure it gets attention? On the other hand, why not ask the finance director to ensure that the financial systems and the internal cross-charging systems promote the correct use of information technology? Future finance directors face a large challenge, either tackle the problem of moving all the axes of measurement into financial terms or move aside for other measurement systems.

The confused role of the finance director leads to confused expectations.  Often the poor state of the infrastructure or internal services is holding the organisation back.  Who monitors the finance director when his or her role has grown to large operational proportions? Who are the finance director's customers? Who is responsible for measurements other than finance - quality, health & safety, environmental, stakeholder satisfaction, return on knowledge? Simpler measures of success, e.g.  profit, are giving way to more refined measures incorporating risk, e.g.  shareholder value or risk-adjusted rates of return.  What's a poor finance director to do?

Some speculation can be made from trends observable today.  These trends certainly include the increasing importance of risk management (see Patrick Bentley's "The Renaissance of Risk Management", Kluwer Issue No 29, 11 June 1999), but also the outsourcing of non-core areas and the rise of non-financial accounting systems such as quality management.  Financial accounting systems are backward-looking, command-and-control systems.  Large organisations are moving, or groping, towards management systems which do incorporate future probabilities.  Despite some heavily technical efforts, e.g.  Monte Carlo modeling, these future probabilities are armchair exercises of little meaning to a budget-holder with a task to do.  Moving from command-and-control to local empowerment is even trickier.  Notwithstanding attempts at local budgets, flex budgets, etc., most large organisations find it impossible to design systems which empower people locally because the local managers are not getting accurate inputs for their decisions.  These inputs need to incorporate the concepts of risk and reward probabilities - stochastic thinking.  Ideas are being grabbed from a variety of areas, most interestingly combinations of complexity theory and economics.  It is refreshing to note that while many organisations fail to design control systems which they trust, the people in those organisations leave the office and jump into the largest system of all - the market - a system which evolved without design.  One senior executive in a large multi-national said that his job was "to ensure the orderly functioning of our internal market - the market from which we generate returns to shareholders."

My speculation is that the role of the finance director will evolve over the next few decades into a role where he or she is responsible for an internal market incorporating risks and rewards.  Moving from today's largely health & safety or insurance-based risk management, some large organisations already have risk management functions within the finance department which set organisational prices for risks local managers run and build these prices into internal premia which affect managers' performance measurement.  The mirror image of risk management is reward management.  The reward management of the future may be quite sophisticated, rewarding managers through a system which can place a value in advance on things such as improved quality results, a new product line, a new region, return on customers as assets or improved employee motivation.  This evolution may be smooth as finance directors, among all the other tasks, are often responsible today for remuneration and commission schemes as well as personnel.  As for the infrastructure tasks, well they will still exist, but their location will matter less as more and more is outsourced.

This internal market will give an organisation the ability to measure its results more accurately, more richly and more honestly.  Rather than dishing out targets, the board will alter the pricing of risks and rewards to encourage the behaviour it seeks.  Risk managers, and dare I say reward managers, have an increasingly important role in a scenario such as this providing the evaluations needed to translate risks and rewards into numbers.  The finance director role will have to change markedly to incorporate some of the probabilistic, stochastic thinking behind risk management rather than the deterministic, reflective finance model.  He or she will also have to provide the systems and information which make the internal market function.  In the end, the finance director will be the person who guards the internal currency of the internal market, the central banker who translates organisational risks and rewards into one measure which managers can use for decisions about non-financial things.  So the finance director returns to providing values.

Perhaps, the times they are a-changin.