Using the Leadership Capital Index to Improve Key Organization Processes

With the leadership capital index in use, many organization processes of interest to key stakeholders could be refined. In particular, leadership capital has a significant impact on the core processes of risk, governance, social responsibility, and reputation.

RISK

Risk has become a central topic and concept in decision making and organization action. At its basic level, risk deals with uncertainty and the ability to predict the future in the present, or the probability something will happen. It also deals with variability, or the range of potential difference in an activity. When control processes reduce uncertainty and variability, risk is reduced and organizations more predictably accomplish their goals.

Enterprise risk assessment occurs when a governing committee identifies the major risks, then filters these risks against the criteria of uncertainty and variability to prioritize the ones that call for management attention. To guide this risk assessment, frameworks have been provided that help predict categories of risk. For example, the Committee of Sponsoring Organizations of the Treadway Commission (COSO), a joint initiative of five private-sector organizations dedicated to providing thought leadership about risk management, has developed a framework with four major risk domains: strategic, operational, financial, and compliance (see Figure 2.4).

Leadership capital is missing from this framework, as it is from others. Nonetheless, in a business environment of increasing complexity and change, quality of leadership becomes even more important as a source of success. Leaders make decisions that affect strategic, operational, financial, and compliance risks, and leaders build control mechanisms to manage these risks. Leadership risk is the extent to which leadership throughout an organization possesses individual competences and builds organization capabilities to predictably deliver expected results. An enterprise risk assessment should consider the predictability and variability of leaders throughout an organization both to demonstrate personal competencies and to build organization capabilities. The leadership capital index provides a governing committee charged with assessing risk with a tool to determine leadership risk.

GOVERNANCE

Corporate governance deals with the control mechanisms that an organization adopts to keep self-interested managers from engaging in activities detrimental to key stakeholders. These control mechanisms include managing decisions about firm strategy, enterprise risk assessment, executive compensation, acquisition of other companies, and shareholder interests. Governance clarifies who has authority to make what decisions, from the board of directors through the CEO to the senior leadership team and the frontline leaders. The topic is of wide interest, with auditors, customers, suppliers, regulators, media, analysts, creditors, and investors all monitoring governance. Investors pay a premium for a firm’s assets when they perceive good governance.

In the discussion of governance, leadership capital should play an increasingly central role. David Larkin, a thought leader in the study of governance, suggests that governance currently misses out on organization design, culture, the personality of the CEO, and the quality of the board. The individual competencies of the CEO and other leaders should become a predictor of good governance. Leaders who demonstrate the five factors of individual competence (personal proficiency, strategy, execution, talent, and brand) will be better able to provide governance to their organization. When leaders demonstrate the ability to develop organization capital by attending to the factors of culture, people, performance, information, and work, they will also improve governance processes. The leadership capital index allows those interested in governance to recognize and improve both individual leadership and organization capital as a source of improved governance.

SOCIAL RESPONSIBILITY

Organizations exist to serve multiple stakeholders, both internal and external. In recent years, the concept of a triple bottom line—people, profits, and planet—has become a catch phrase referring to the stakeholders an organization serves. Under the "planet” umbrella, a host of corporate social responsibility initiatives can be articulated.

In 1973, the United States established the Financial Accounting Standards Board (FASB) to establish and monitor GAAP on behalf of the SEC. In 2011, the Sustainability Accounting Standards Board (SASB) was established to create and disseminate sustainability accounting standards and to disclose material sustainability issues to investors and other stakeholders. SASB attempts to turn corporate social responsibility aspirations into measurable initiatives so as to inform investors about sustainability commitments. The framework for tracking sustainability highlights six areas for attention: employee, supply chain, environmental, governance, community, and customer. My colleagues and I propose that, similar to enterprise risk assessment and governance, understanding the quality of leadership would complement this framework. Leaders make decisions that influence sustainability issues in each of the six areas. Defining and determining leadership capital at the personal and organizational levels will increase the sustainability of the work on sustainability itself.

The implications are significant. Organizations that manage sustainability will become better citizens, attract better employees, and improve their customer service. Responsible investors have begun to create funds that highlight these socially responsible organizations. Sustainable capitalism occurs when organizations not only profit from but also serve their people and the planet. Including a leadership capital index as a component of this sustainability movement ensures that the aspirations for social responsibility are embedded in the fabric of the enterprise.

REPUTATION

Organizations seek a positive reputation in their marketplace. This is more than a matter of personal satisfaction; a positive reputation leads to an estimated 5% increase in sales growth and better attraction and retention of valued employees. Investors also monitor a firm’s reputation to determine how well it manages its public image. Firm reputations have directly influenced shareholder value—for example, after the Gulf oil spill of 2010, British Petroleum’s stock dropped from about $62 to $27, a market loss of more than $80 billion. As of May 2015, five years later, the stock was around $42 a share, still not fully recovered.

While most discussions of reputation deal with the firm’s identity, image, social media presence, branding, and public affairs, the reputations of leaders at a firm have a dramatic impact on the company’s overall reputation. In private enterprises, the values and demeanor of the CEO (or the founders) generally reflect the organization’s values. In public enterprises, the actions of a CEO can have a major influence on the company’s reputation. Enron’s downfall was not just bad business judgment; it was the reputational nosedive as leaders lost the confidence of their employees, customers, and communities. But it is not just the CEO who makes the difference. Leaders throughout an organization become identified with the organization, and their behavior shapes the organization’s reputation.

The leadership capital index should give stakeholders increased confidence in the reputation of leadership. In the personal proficiency factor, investors pay attention to values and integrity, but beyond this baseline for positive reputation, the leadership index also examines the breadth of leaders' personal skills and the ability of leaders to replicate those skills through the organization factors. Leadership capital becomes a critical aspect of building a strong reputation.