CIO —
My favorite post-Enron cartoon, by Dan Wasserman, has two captains of industry discussing what to do about the fallout from corporate scandals. "We are seen as ethical disasters," says one of them. "How are we going to rebuild public trust?" In a flash of brilliance, the other answers: "We could outsource it!"
Behind the sarcasm there lies an interesting question: When a company sheds operations through outsourcing, does it also shed its responsibility—ethical and otherwise—for how those operations are run? Companies today rely more and more on partnerships with third parties for everything ranging from supplies and manufacturing to product design and distribution. In this so-called extended enterprise, where does management’s responsibility for good governance begin and end?
Lawyers and accountants will surely have an answer (or several) to this question, based on their reading of Sarbanes-Oxley and other regulations. But top management’s answer should go beyond current laws and professional practices, as the question also relates to performance, reputation and, yes, even ethics.
Corporate governance, writ large, means how and to what ends top management exercises its authority and influence. But authority over what? The financial statements of a company begin and end at the legal boundaries of the company’s property. What it owns or controls is included; what it doesn’t, is not. The problem is that partnerships and outsourcing often fall in a gray zone—they are not usually owned or controlled by the company, but they can be critical to its economic performance.
In effect, the economic boundaries of the company stretch well beyond the legal boundaries. And it is this broader economic scope of operations that companies should govern well, not just the legally defined core. Those who don’t, risk suffering penalties—perhaps not legal penalties, but penalties no less in their performance, their brand reputation, or in the public’s perception of their ethical integrity. A few examples will illustrate what I mean.
Auto Alliances: Turbocharged or Stalled?
Compare the tales of two automotive joint ventures. Such ventures are common ways for automobile companies to extend their reach into new markets, share manufacturing costs and source technology abroad. Toyota, the world’s second-largest auto company, is often cited for the critical advantages it derives from its well-managed network of external suppliers.
Not so for General Motors. While GM has had foreign joint ventures and sourcing arrangements since the 1970s, somehow it never got the hang of how to govern assets it did not fully own and control. Its recent failed investment in Italy’s Fiat is only the latest example to prove this point. In 2000, GM paid $2.4 billion for a 20 percent stake in Fiat, with the aim of gaining access to Fiat’s diesel-engine technology and sharing manufacturing costs in Europe. But their efforts in managing this joint venture were ineffective, and within two years, Fiat was hemorrhaging money. After difficult divorce proceedings, with a court battle looming, GM agreed to pay $2 billion to terminate the deal in 2005. Moody’s Investors Service cited this costly settlement as a reason for downgrading GM’s credit rating.
