The Philosophy of Liquidity: Diversity, Decision-making and Governance

DMHoweBy Donna Howe

One of my personal pet peeves is the way people often say one thing but do another. This seems to bother others as well, since there is a lot of conversation on the web about adding diversity to corporate Boards of Directors. However, there is equally a lot of complaining that Boards are not in fact, becoming more diverse. There is plenty of literature indicating that better decisions are made when a diverse group of persons combine to make a decision rather than a homogenous group. So why might a firm act in a suboptimal fashion?

Anecdotally, this lack of follow-through may be caused by a reluctance to change the established process. The reasons why have multiple explanations. Is the process considered to be “good enough” as it currently exists? Is increasing diversity at senior management or the Board perceived as increasing a firm’s risk? Or is it due to uncertainty in how, exactly, to execute the goal? Is the driver to less diversification of decision-making bodies perhaps due to an inability to quantify the term? How exactly, should one think of diversity?

I recently started reading The Atlas of Economic Complexity, by Richard Hausmann, with colleagues Hidalgo, Bustos, Coscia, Simoes and Yildirim published by the MIT Press last year. They define economic diversity of a country as the number of product types it produces. They then tie complexity into the ease of replacement of those products. Perhaps we can take a clue from them in structuring a solution for modeling diversity. If we instead substitute educational background for products, and business experience for ubiquity we can build a corporate model for diversity that does not depend on physical or cultural definitions. In this model, a diverse group would be one where the group contains actors with multiple approaches to problem-solving. As well, some of those approaches would be specialized to the business’ risk taking. As an illustration, let’s look at the process for setting the annual strategic goal and the budget for a corporation.

In a financial firm, there are numbers of analysts and modelers with physics and engineering degrees. And often, the top companies recruit in similar quantitative disciplines – math, economics, physics, and engineering are the top four families. While these are reasonably commonplace in some roles, the skill sets are “clumpy” rather than homogeneously spread throughout our hypothetical company. There are growing numbers of statisticians in the industry, fewer actuaries outside of insurance, and few biologists or those from the social sciences. As we advance up the foodchain into the senior management arena, there are few of these quant types in the room. Mostly, the decision-makers are business people by education. The most ubiquitous experience types include strategy specialists and sales – the rain-makers of the firm. So perhaps that’s the management challenge. How should a firm add the input of employees and staff that add diversity of problem-solving to the mix? What key problem-solving approaches need to be treated as a priority addition?

In finance, given that there have been significant regulatory risk developments in the past few years, one might surmise that experience with risk management, regulatory compliance, and data (both elements and architecture) would be the most scarce. If the enterprise operates in the retail markets, including health-care providers and pharmacies, one could add experience with social media, identity privacy, and demographics as well as IT security. In the current low interest rate and tight credit spread economic environment, capital assessment and capital adequacy are hot topics, creating a need for statisticians and predictive analysts. On the predictive front, demographers and economists can provide input.

Regardless of the type of experience and skills, the model can be used to establish a governance framework for diversity in decision-making. If you have 10 people on the board, perhaps no more than 3 individuals should have educational backgrounds exclusively in business. Alternatively, a Board could set a self-governing rule that sets experience criteria for new members to most effectively flesh out the current team. If the senior team is stable, a low risk approach might be a brain-storming session with identified staff having the less-common educational or business experience types. Results could go directly to the CEO, thereby incentivizing employees. It might also work to create career paths and experience internships for those with the most desired educational backgrounds – but make sure you also reach out to different schools for that education.

In summary, this type of model could provide a firm with a more quantitative and less biased way of determining diversity – both within the management team and at the Board. Further, it can be implemented and governed appropriately and may well be valuable in ways well beyond improving a firm’s decision-making and problem-solving.

Donna Marie Howe, CFA is a risk management and finance professional with more than 25 years industry experience in the financial services sector. With the ability to combine high-level quantitative skills with qualitative management excellence she has held a variety of senior risk management roles in some of the world’s largest banks including Deutsche Bank, UBS, ABN-AMRO, and Santander. Acting as a force for change to improve standards of practice, she has broad experience across both the buy-side (retail banking, commercial banking, insurance, hedge funds) as well as sell-side. Her product expertise includes liquidity management, client analytics, derivatives use, clearing and prime brokerage and incentives management. Well-known within the North American risk community she served for 10 years on the Board of the Global Association of Risk Professionals (GARP). Currently she is providing consulting services in governance, data, and enterprise risk management including Basel III, Dodd-Frank Act and CCAR while completing her PhD in International Economics & Finance at Brandeis University.

Interactions with senior regulators on capital adequacy and risk governance range from Large Bank OCC to SEC and FRB, as well as international regulators including the ECB and Banco de Espana. Current projects include design of a forward-looking model for operational risks with greater predictive capability and establishing a framework for systemic risk assessment of the health-care and pharmaceutical industry.

 

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