The future of corporate governance and the role of directors

The current corporate governance models of today’s organizations are unfit for organizations of the future, and even today. What does this mean for directors and the management? Let’s have a look into the future, divided into long-term, middle-term, and short-term future lenses. Don’t hesitate to contact me to receive the full version of this essay.

We live in a world which is changing at dramatically high pace, and where the development of new technologies and scalability of these new technologies like artificial intelligence, the blockchain, bots, quantum computers, … is exponential. Because of this evolution entrepreneurship is being democratized. Look for example to Uber and Airbnb that are creating possibilities for everyone to become a real estate entrepreneur or cab driver when it fits in your lifestyle. Organizations are adapting to this new reality and change how they work, behave and create value to stay relevant in the future.

Because of the invention of the internet. entrepreneurship is being democratized. Time and space have become irrelevant. Because of this paradigm, new models (online platforms, communities, …) are invented on the foundations of the internet.

Because of that, the invention of the blockchain was made possible, Trust is being democratized. Laws, rules, control has become irrelevant. Because of this paradigm, new models (blockchain based platforms, communities, …) are invented on the foundations of the blockchain.

Because of these evolutions and rise of new technologies, the current corporate governance best practices and legislation have the potential to be threatened and become irrelevant. Because of all these paradigms, new models (platforms, communities, …) like DAO’s, so-called Decentralized Autonomous Organizations are invented on the foundations of exponential technologies.

“The current concept and discourse of corporate governance seem to be disconnected from the needs and realities of organizations today, and, if anything, is at risk of making the situation worse.”

This story asserts that the governance models of today’s organizations — which are based on standards and best practices of corporate governance over the past 30 years — are unfit for organizations of the future, and even today. And what does this mean for directors and the management?

Corporate governance is the hygiene of an organization, not the health. It is determined according to complexity, not according to size. And taking into account the corporate social responsibility. A balance (power distribution) is a challenge for every organization. Anyone who in any case represents shares automatically has a conflict of interest (shareholder, director, and management roles in one). Decisions should be made in a consensus and collegiality, not on the basis of votes.

“Corporate governance is doing the right things, doing things right … at the right time”— Tim Melville-Ross, 1996

 

The traditional hierarchical corporate structure and tripod works, but it has debilitating limits when it comes to information processing. Not referring to the typical financial and operating metrics to construct dashboards and KPI’s, but rather information such as unique ideas, employee morale, the objective value of a specific output, how one outcome impacts others, and so on.

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As a centralized organization grows, it encounters challenges as the amount of important information in the system, and the distance that information has to travel grows exponentially. Traditional practices of delegating responsibility are not enough. There is still too much data, most of it gets lost along the way, and the people on the receiving end can’t adequately interpret, and act on, all of it.

In response to this problem, innovative companies have increasingly embraced more decentralized frameworks such as Holacracy, Sociocracy 3.0, Agile & Lean methodologies. The thesis of these models is that complexity is manageable when small teams are empowered to autonomously make “on the spot” decisions, which improves both the speed and quality of decision making. These systems also build in explicit communication protocols that improve the transmission of essential information from one team to another. Questioning classical governance models is a challenge for every board of directors to recognize & acknowledge new and innovative corporate governance models.

Decentralized Autonomous Organizations

What?

“A decentralized autonomous organization, or just DAO, is an organization model whose decisions are made electronically (digital) by a written computer code or through the vote of its members. In essence, it is a system of hard-coded rules that define which actions an organization will take. Some features of a DAO are:

  • Flexibility and agility
  • Decentralized trust
  • Fast and autonomous
  • Always accessible
  • Open, transparent and secure

Presently a DAO structure could completely replace the functions of companies such as Dropbox, Kickstarter, Uber, and Amazon and get rid of their “inefficient” human managers. Former Bitcoin contributor, Mike Hearn, believes that “30 years from now, Blockchain will be the structure to power organizations without leaders”. The creator of Ethereum, Vitalik Buterin said: “There is a lot of intermediaries that end up charging 20–30%, if the concept of decentralization takes off and does well, those fees are going to decline to almost zero”. Not all humans are in agreement with this possible change but it is undeniable that a DAO powered by blockchain technology is a governance model of the future. But not for every situation, this scheme gives a quick assessment of blockchain, beyond the hype:

Governance and funding?

Dash is the first DAO powered by a Sybil proof decentralized governance and funding system. Decentralized Governance by Blockchain (DGBB), often referred to simply as the “treasury system” is a means of coming to a consensus on proposed network changes and funding development of the Dash ecosystem. Ten percent of the block rewards go to this “treasury” in order to pay for projects that benefit Dash. Funding from the treasury system has been used to hire additional developers and other employees, to fund attendance at conferences, and to fund integrations with major exchanges and other software providers.

Each master node operator receives one vote. Proposals are eligible for funding according to the following formula: (YES VOTES — NO VOTES) > (TOTAL NUMBER OF MASTERNODES * 0.1). If there are more proposals that meet that criteria than there are budget funds for the month, then the proposals with the highest number of net votes will be paid. Community interaction with proposal submitters is done through the dash.org forums, or through community-driven websites, like DashCentral. These websites allow proposal submitters to provide multiple drafts, then lobby for community support before finally submitting their project to the network for a vote. After the submitter has enough support, the network will automatically pay out the required funds in the next superblock, which happens monthly.

The funding system has seen revenue growth. In September 2015, the treasury system provided $14,000 in funding per month. Due to increases in the value of Dash, the treasury system provided about $574,000 per month in funding. The treasury system has created a positive feedback loop, whereby additional development increases the value of Dash, which increases the amount of funding provided by the budget system.

Risks?

DAO, as it stands today, comes with some risks and vulnerabilities. Risk of hacking is one of them. Another risk is a lack of voting participation. Also, the legal status of this type of organization has not yet been decided on by lawmakers. Currently, the term for a DAO is a “general partnership” which means that every participant is liable for any legal actions and debts the organization may face. Another hardship that arises is the difficulty of changing the code of a DAO or the smart contracts once deployed in the blockchain. On one hand, this is good because one single entity cannot change the rules, but the disadvantage is that debugging cannot be done. “This is what happened with The DAO company, attackers slowly drained all funds by simply exploiting a bug in the system. The head coders of Ethereum reversed all transactions but the best way to handle such an event in the future is up for debate.

“Blockchain is here and it has the power to do great things. But, Technology has never been about what it can do, but rather, what we can do with it… and therein lies the important point ” — Human & Humanity first

The hacking risk and legal issues that come with this DAO are not insurmountable as with any innovation. They will solve it selves over time. There is still an important role for committees with independent advisors that can take into account the different risks and communicate their suggestions and ideas to all stakeholders by forums and other, new communication channels to take this into account and cover and reduce risks. Just like an audit committee in the “classical” corporate governance model.

DAO Examples:

There are already some use-cases and organizations like Siemens AG Hutten-DDO: “The first Fortune 500 company using the DAO Framework, Siemens AG has implemented an internal DAO, dubbed the “Hutten-DDO”. Hutten stands for the street Huttenstraße in Berlin, where Siemens has its Gas Turbine Plant located, and DDO is an acronym for “Decentralized Digital Organization”. The DDO works almost exactly as per the DAO Framework specifications. A few modifications were made to the framework to accommodate Siemens needs. The Siemens internal social network invited all employees to choose their favorite general purpose of the DDO:

  • Social initiative: Supporting of SOS Children’s Villages
  • The build-up of a creative lab at the Huttenstraße offices
  • Open-DDO without a specific purpose”.

The Siemens employees voted for the “SOS Children’s Villages” in nearby Berlin-Moabit, an NGO dedicated to helping socially disadvantaged children and raised a funding-round from Siemens employees.

On einc.io you can create and build up your own DAO without or almost no technical knowledge, your einc is automatically a global digital organization based on cryptographic proof of the blockchain instead of trust, that can operate borderless, permissionless, democratically and transparently with the consensus of its shareholders, without the need of a trusted third party and/or costly intermediaries.

There is a quick rise of DAO initiatives, and facilitating platforms like harbourproject.io, colony, governX, DAOstack and many more.

Artificial Intelligence

What?

Just as artificial intelligence is helping doctors make better diagnoses and deliver better care, it is also poised to bring valuable insights to corporate leaders — if they’ll let it.

Part of what’s driving the use of AI in healthcare is the fact that the cost of bad decisions is high. That’s the same in business, too: Consider that half of the Fortune 500 companies are forecasted to fall off the list within a decade, and that failure rates are high for new product launches, mergers and acquisitions, and even attempts at digital transformation. Responsibility for these failures falls on the shoulders of executives and board members, who concede that they’re struggling: A 2015 McKinsey study found that only 16% of board directors said they fully understood how the dynamics of their industries were changing and how technological advancement would alter the trajectories of their company and industry.

The reality is that organizations become too complex and are moving too rapidly for Boards and CEOs to make good decisions without intelligent systems. A solution to this complexity will be to incorporate AI in the practice of corporate governance and strategy. This is not about automating leadership and governance, but rather augmenting board intelligence using AI. Artificial intelligence for both strategic decision-making (capital allocation) and operating decision-making will come to be an essential competitive advantage, just like electricity was in the industrial revolution or enterprise resource planning software (ERP) was in the information age. For example, AI could be used to improve strategic decision-making by tracking capital allocation patterns and highlighting concerns — such as when the company is decreasing spending on research and development while most competitors are increasing investment — and reviewing and processing press releases to identify potential new competitors moving into key product markets and then suggesting investments to protect market share. AI could be used to improve operational decision-making by analyzing internal communication to assess employee morale and predicting churn, and by identifying subtle changes in customer preference or demographics that may have product or strategy implications.

According to research from WEF “Nearly half of respondents expect the first AI machine to be on the board of directors of an organization by 2025, while the first transplant of a 3D-printed liver is likely to become reality by 2024,” found the survey of 800 executives by the World Economic Forum’s Global Agenda Council on the Future of Software and Society.

Risks of AI?

What are the risks of using an AI? The most important thing is to have ethical debates (also in the boardroom)… Why? Ethics is like physics The greatest challenge we face today are moral questions about exponential technologies (like AI) and their impact. Just like with physics, we need to invest time and resources to research the ethical implications of these technologies and their effect on how we are governing organizations.

Since we are building artificial intelligence in our own image, it is likely to be both as brilliant and as flawed as we are as humans… Kevin Kelly wrote: “the myth of a superhuman AI” which brings clarity and a broad view on this. And as for DAO’s the legal aspect of artificial intelligence has still to be decided.

The role of directors

While the importance of non-executive directors, and sometimes executives is still well established, it is also being questioned considering the technological advancements highlighted in this essay, while there is still a mismatch between the executive and non-executive roles. The NIFO (Nose-In Fingers-Out) principle for non-executive board members is not always established or embedded yet. The future role of directors is uncertain because of new technological evolutions that could have an impact on the established corporate governance codes and best practices.

There is a mismatch between the capabilities that are required on board of directors and the challenges organizations face. Executives are unprepared for their role and most of them don’t have expertise with those new, exponential technologies.

Director pay is very important in recruiting and retaining qualified people. It is also symbolically important as a representation of the company’s attitudes towards corporate governance but there is a need for fairness in paying board members (executive and non-executive) and fair doesn’t necessarily mean equal.

Diversity is a very hot topic in the field of corporate governance, it is logic to embrace diversity and to have a mix of different board members. Gender, age, origin, … in order to have different views on challenges and topics in the board. Also directors and the management should embrace innovating ideas within the organization and bring them to the board of directors to debate, elaborate and take decisions.

So there is no question of executives just looking in the rear-view mirror (naturally). No question either of limiting themselves to the financial risks of today and tomorrow as the threats to the survival of the organizations of tomorrow will be technological (r)evolutions. Directors (executive or non-executive) must therefore proactively and methodically address the potentially disruptive consequences of technological upheavals.

Impact

New, exponential technologies could be used as a leverage to have a significant, potential positive impact on the corporate governance of organizations and solve challenges to create a better future for our society. It rather is a question of what speed organizations will adapt and/or new innovative ventures will use these technologies and search, explore and experiment with all these new possibilities and evaluate the outcome.

Key Learnings

Some key learnings and quick takeaways:

  • While technology is growing exponentially, leaders and boards are only changing incrementally, leaving many legacy organizations further and further behind. It’s time for leaders to courageously admit that, despite all their years of experience. AI belongs in the boardroom.
  • As long as the use of artificial intelligence is not widespread with respect to business decisions, the duty to delegate information processing to such devices is therefore unlikely to be established. In the long run, however, the rapid development of artificial intelligence may even give rise to the question of whether artificial intelligence cannot only assist, but even replace, human directors. The legal admissibility of such a replacement depends on the rules governing the appointment of directors. According to many jurisdictions, these rules require directors to be “natural persons”. Some jurisdictions are less restrictive, allowing legal entities to have a seat on corporate boards. If corporate law also offered possibilities for the creation of company structures that provide legal housing for artificial intelligence, these devices might indeed be able to be appointed as directors in the legal sense. Consequently, corporate law will face the fundamental question as to whether the legal strategies designed for human agency relationships are also suited to robo-directors. We have seen that some of these strategies are likely to either miss the mark or to become redundant if robo-directors act on different incentives to human directors. Since those incentives depend on the algorithms of robo- directors, the legal strategies of corporate law will change. They will focus on the ex-ante control of algorithms instead of the ex-post control of directorial behavior. If state agencies are entrusted with that control, then this shift has the potential to undermine private autonomy and entrepreneurial freedom. Designing legal rules for robots in the boardroom is, therefore, a delicate task, and it is likely to affect the anatomy of corporate law in a very fundamental way. After all, corporate law is not only highly relevant for the use of artificial intelligence in corporations; it will also need to be adapted to the challenges posed by that technology.
  • Organizations of the future: No CEO, no boss, fully managed by blockchain. “Instead of a board of directors or senior executives, the token holders (aka shareholders) of a DAO have the right to vote “yay” or “nay” on any and every proposal facing the organization.”
  • Directors must prepare for the future and question themselves, and there is a need for fairness in paying board members (executive and non-executive).

Conclusion

As always, everything depends on the context. Some new, exponential technologies have reached the potential to create significant change, value and bring different solutions to future-oriented corporate governance challenges. But a changing in mindset requires time so this is likely to happen in waves:

  • Long-term: New corporate governance models (DAO’s) which are fully blockchain based and requires a totally different mindset of governing organizations.
  • Middle-term: An AI-powered director with a seat on the board to assist human directors to take better decisions.
  • Short-term: Embracing innovating ideas within organizations and bring them to the board of directors to debate, elaborate and take decisions.

I believe adapting to these evolutions and seeing, the waves in reality, will require to embrace and merge the DAO model, AI, exponential technologies and new creative ways of thinking with a more traditional leadership-based model and have a dualistic approach as a symbiosis.

Context said it all

Different type of organizations, rather is an ecosystem, network, corporate, SME, a non-profit or a for-profit organization, … requires a different approach. Now and especially in the future.

All organizations should embrace innovating ideas within the organizations and bring them to the board of directors to debate, elaborate and take decisions.

End note

This story is based on the essay: the future of corporate governance and the role of directors. I used insights of different organizations and use-cases, and more specifically the context of three organizations (TechventuresForcitValpeo) where I personally have a specific, relevant role. And the agreement to use background information and details for this essay.

Some people I would like to give a special thanks: Abigail Levrau, Erik Van den Begin, Guy Wollaert, Benjamin Rieder. All my colleagues at Forcit and other ventures where I’m involved (some as a board member).

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