When Good Turns to Bad

8/13/2019 When Good Turns to Bad

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When Good Turns to Bad: An Examination

of Governance Failure in a Not-for-Profit

EnterpriseIntroduction

Governance failures in the private sector have received significant attention in recent years. The

banking crisis has highlighted the lack of controls on institutional risk-taking which has echoesin earlier cases such as Enron where creditors and shareholders alike were misled (Clarke !!"#.

Those involved in the governance function in the for-profit sector now effectively find

themselves guilty until proven innocent. In contrast$ the not-for-profit sector retains a superiorreputation despite enduring its own problems with financial mismanagement. This behavior

tends to be analy%ed as almost accidental rather than willfully unethical (&unn and 'iley !!#.

Therefore$ although deficit in board ability does feature in the not-for-profit.

)iterature (*b%ug and Galaskiewic% !!+, rown !!#$ there is little in the way of apresumption of unethical behaviors being prevalent within the sector. This divergence in

assessing and analy%ing governance in the for-profit and not for- profit sectors is echoed in

academe. The literature on organi%ational governance suggests that organi%ations in each sectoreist in parallel worlds. Corporate governance /ournals tend to have few articles focusing on not-

for-profit governance (e.g.$ art and &eal !!0, Turnbull !!1#. 2ost research is published in

dedicated not-for-profit /ournals such as 34onprofit 2anagement and )eadership5. Therefore$ as

a conse6uence of this separation$ papers seeking to compare governance in these different sectorsare 3virtually non eistent5 (art and &eal !!0$#. The analysis of governance in each sector is

driven by two distinct theoretical approaches. They can be broadly identified as shareholding and

stockholding ()et%a et al. !!#. 7or-profits tend to receive an analysis that has a shareholdingframework at its foundation. This is guided by the assumption that shareholder interest is the

primary aim of a firm8s eistence (Child and 'odrigues !!#. The stakeholder model of

governance$ by contrast$ views the organi%ation as a means to serve the interests of numerousparties (ecovich !!"#. This in turn re6uires the board to focus on 3co-ordination with a fairly

broad array of constituents5 compared to private sector boards which preoccupy themselves with

3securing access to capital and enhancing co-ordination5 (2iller-2illesen !!9#. *lthough somescholars believe that the stakeholder model applies e6ually to for-profits and not for- profits

(ouckaert and :andenhove +;;


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hese demands is the key challenge of governance within the stockholding model ()et%a et al.

!!, )ow and Cowton !!#.

Stakeholder Involvement

'esearchers make both a moral and an instrumental case for stakeholder involvement ingovernance (&onaldson and Areston +;;", *b%ug and Galaskiewic% !!+#. The moral view is

that not-for-profits have a democratic ethos that places a duty on them to take into account a

broad range of community interests (Iecovich !!"#. To facilitate this$ the board membershipshould be diverse and composed in a way that reduces the likelihood of it being dominated by

long-serving local elites (Aarker !!1#. The instrumental case is more pragmatic in that the claim

is made that there will be gains in the efficiency and effectiveness of decision making ifstakeholders are involved in governance ()et%a et al. !!#. This view has been critici%ed on the

grounds that involving stakeholders is not feasible and nor is it desirable (Bternberg !!!#. Even

stockholding advocates accept that there are difficulties in meeting stakeholder needs

simultaneously (Goodpaster +;;9, 2ason et al. !!1#. *s *b%ug and Galaskiewic% (!!+# note$

3there is no one community interest, there are many5.

&iversity of board membership has also become a prominent issue in for-profit studies. The

ob/ective of such diversity is different though. It is primarily concerned with how the conduct of

boards might be improved by ensuring that there is a reduced likelihood of the 3cost boardroomties5 (=ayden !!0# that have been linked to a lack of attention to shareholder interests. There is

also an e6uality dimension to this agenda. *s =iggs (!!9# noted$ 6uestions will be asked of an

organi%ation8s commitment to diversity if the board itself appears to be homogenous. 7urtherstudies have attempted to evaluate progress on the etent to which board membership has been

opened up to broaden the gender and ethnic mi ('uigrok et al. !!1, Grosvold et al. !!1#.

The preceding section has identified two issues to eplore within the research contet? agency$which is dominant within the shareholding model$ and involvement$ which is a preoccupation of

the stockholding model. The case study that is eamined in the net section offers a not-for-

profit research contet in which each of these issues is to be eamined. * brief description of the

methodology employed is followed by the case study. The two issues are then eamined and

conclusions drawn



Enterprise

Case Btudy? *C


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This case study was compiled based on the eperiences of a participant within *C$ the focal

not-for-profit organisation. It is acknowledged that participant observation may not provide an

entirely unbiased perspective on organi%ational processes and events (Bilverman !!!#.=owever$ the position taken here is that an insider can help to reveal dynamics that would go

undetected by an independent researcher using more ob/ective methods such as surveys (Aarker

!!1#. 2ore specifically$ in this instance$ board processes and director behaviors were capturedand analyses (Bamra-7redericks !!!#. The data collection eercise took place over five years

and included participant observation alongside the ac6uisition and conse6uent analysis of

internal documentation such as the organi%ation8s written constitution.

This methodological approach was not the result of a planned and purposive eercise. It was theproduct of the participant conducting a rigorous retrospective analysis in the light of the

organi%ational failure which resulted in the company8s bankruptcy in !!0. 4o claims are made$

therefore$ that this case should be viewed as one that is ehaustively validated. It is offered in thespirit of presenting an opportunity to begin a discussion of the possibility of connections being

made between governance practices in different sectors.

ABC

*C was established in =uddersfield$ England$ in Dctober !!! as a not-for-profit company

limited by guarantee. It lasted si years and was formally wound up in !!0. It was created toprovide opportunities for young people to access creative arts activities. The young people it

focused on were those ehibiting anti-social behaviors. *lthough *C was constituted as a

worker co-operative$ it did not have provision to act as a member benefit organi%ation. It wasspecifically organi%ed to proscribe members receiving personal rewards$ as embodied in the

constitution which stated that.

the surplus of the Co-operative shall be applied as follows$ in such proportion and in such amanner as the General meeting shall decide from time to time? to a general reserve for thecontinuation and development of the Co-operative.

The assets of *C were similarly locked in to maintain community ownership through a further

clause?

If on the winding up or dissolution of the Co-operative any of its assets remain to be disposed ofafter its liabilities are satisfied$ these assets shall not be distributed among the 2embers$ but shall

be transferred instead to some other common ownership enterprise$ or some other non-profit

organi%ation$ as may be decided by the members. Driginally the organi%ation was run by four

staff whose positions were supported by funding from the > government through anemployment creation scheme. Foung people were referred to *C by local schools as well as

parts of the criminal /ustice system such as youth offending teams. *C subscribed to a model

of anti-social behaviors that linked it with low educational attainment$ unemployment$ andcrime. They believed that they could reduce the incidence of social eclusion by offering

positive alternatives to the usual activities of drug-taking$ alcohol$ and criminal behaviors. These

alternative activities were predominantly workshop-based sessions in music technology$ break-


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dancing$ and drama. These sessions were designed to increase confidence and motivation by

providing young people with transferable skills.

Initially *C focused on *fro-Caribbean young people. There is a si%eable community withinthe =uddersfield area. Dver time the organi%ation epanded its reach and engaged with white

and *sian youths who were also ehibiting anti-social behaviors. ithin one year *C was in aposition to establish its own premises within =uddersfield. They ac6uired space which enabled

them to create a number of dedicated facilities including a recording studio$ dance studio$training rooms$ and office space. Btaff was recruited on the basis of their creative talents and

their proimity to the organi%ation. )ocal artists$ musicians$ and dancers became mentors who

were seen by *C to be capable of acting as positive role models for the young people on theirprogrammers.

*C gradually became more established and received recognition for their work. 7or eample

they won a regional award in !! for being 3Dn the p5. etween !! and !!$ annual

turnover grew sharply from H9


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seek financial sustainability against the taking of reasonable risks to secure this sustainability.

*nother interpretation is to view this venture as the board allowing their own personal interest in

the music industry to cloud their /udgment. This demoted the social ob/ectives of the companyinto second place. This behaviors can be defended to some etent and suggest agency failure

without 6uestioning the ethics of the board8s conduct. =owever$ the evidence from the following

section on stakeholder involvement suggests a different conclusion.

Involvement

Btakeholder involvement is enshrined legally in the constitution of a co-operative. In theory at

least$ it is possible for anyone to become a member. 7rom there$ any member is then entitled to

put themselves forward for board membership. Therefore$ any stakeholder can become involvedin the governance function. This is illustrated within *C8s *rticles of *ssociation?

9. 2embership will be open.

The *rticles also show their support for the involvement of employees with the clausestating$

. *ll employees on taking up employment with the Co-operative shall be admitted to2embership of the Co-operative$ ecept that the Co-operative in General 2eetings may

by ma/ority vote decide to eclude from the 2embership?

a. persons under eighteen years of age,

b. newly appointed employees during such reasonable probationary period as may be

specified in their terms and conditions of employment, provided that any such criteria for

eclusion is applied e6ually to all employees.

These ecerpts from the constitution suggest that *C intended to offer the opportunity to new

employees to become members of the organi%ation and$ further$ to become involved in

governance if they so desired. This opportunity was to be available unless there were eceptionaland transparent circumstances which would be determined through a ma/ority vote by the

eisting membership. =owever$ this clause was used to limit membership and keep it eclusive

to the founding members. This was achieved by etending the 3reasonable probationary period5detailed in the clause to beyond the length of any eisting employee8s service. This had the effect

of keeping membership perpetually out of reach. The other implication of this was that there was

no opportunity for an employee to /oin the board.

Eventually$ the situation did become the sub/ect of a challenge from staff within the organi%ationas they became more aware of their legal entitlements. Employees began to insist upon the right

to membership and hence also pushed for full voting rights at *nnual General 2eetings. pon

gaining these rights$ the membership decided to remove a director from his role against hiswishes. =is conduct was 6uestionable not least because he had appointed himself both 2anaging

&irector and 7inancial &irector. =e had also been identified by members as one of the key

barriers to any inclusive practices being fully implemented. The other members of the board


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received more favorable treatment and were granted the right to continue in their roles for

another year before being sub/ected to a membership vote.

Dnce the inclusive policy was in place$ *C had an open route to membership. This continuedfor the si months that remained of the organi%ation8s eistence. The company continued to

struggle in spite of these improvements being made to employee involvement in the governancefunction. y the autumn of !!"$ the organi%ation was no longer financially viable and was

effectively on the verge of collapse. The price was being paid for previous decisions by directorsto award themselves hefty pay raises while their new ventures$ as with the eample above$

singularly failed to achieve business success. It fell to the newly elected board members to honor

their legal obligation to instigate li6uidation proceedings following the holding of an EmergencyGeneral 2eeting of the membership. This decision was not supported by the original directors

who demonstrated little understanding of the legal implications of trading whilst in the full

knowledge that the organi%ation is insolvent. 7ortunately$ the newly empowered membershipwas able to impose their will over the old guard and administration and winding-up duly

followed.



Enterprise

&iscussion

This case analysis has attempted to support the central argument of this paper$ namely that for-

profit and not-for-profit governance should not always be viewed in isolation of one another.Governance in these two sectors may actually ehibit very similar behaviors in certaincircumstances and so there is value in being open to this possibility. =owever these behaviors

will only be identified by researchers if theoretical insights from research in each sector are

combined in any framework adopted. &espite a handful of eceptions (2iller-2illesen !!9,art and &eal !!0, Aarker !!1#$ there is still a tendency to focus on issues that have been

revisited many times in the same sector. The case detailed here has focused on agency and

involvement$ two key challenges of governance that are prominent within the for-profit and not-for-profit literatures respectively. y making a link between agency failure and a desire by the

board to restrict stakeholder involvement$ the case has shown how not-for-profits can be sub/ect

to unethical conduct by directors who can undermine governance and so impact negatively on

operational decision-making.

*lthough the agency failure detailed above can be viewed as incompetence$ it takes on a more

unethical character when taken together with the board8s behaviors with regard to involvement

and governance. The willful eclusion of employees took place through undermining the spirit ifnot the letter of the constitution of the company. ouckaert and :andenhove (+;;


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the company5. There is little evidence of this 3due regard5 in the case of *C. This fact raises

doubt around whose interests the board members were serving in their decision-making. &irector

self-interest may be more common within the for-profit sector but it should not be ruled out inthe not-for-profit arena (=ayden !!0#.

It is not the intention to suggest that this case indicates a widespread malaise in the not-for-profitsector. It simply highlights that an organi%ation that is founded on a social principle may still

display behaviors that is more usually associated with the for-profit sector. The organi%ation maystill trumpet its values throughout its communications while acting in a way that undermines its

claims. etter governance procedures within the not-for-profit sector aim to balance eperience

with new ideas (+ Aarker !!1#. The case of *C shows how this can be stifled by protecting thecost arrangements already in place (=ayden !!0#. )ack of openness to new board members may

pose a threat to the 6uality of decision-making ()et%a et al. !!# alongside being an issue of

ethics. The agency failure of *C may or may not have been avoided with a more diverse boardmembership. ut at least the adoption of a more pluralistic approach would raise the probability

of a more informed approach to the decision-making process. It becomes more likely that the

board will be made more sensitive to the demands of stakeholders$ including potential consumersand contractors (*b%ug and Galaskiewic% !!+#.

This field re6uires conceptual development alongside additional studies eamining governance

failure within the not-for-profit sector. It is assumed that the current preference will continue

amongst governments for the not-for-profit sector to epand in its provision of public services

(Aarker !!1#. Therefore$ it is not unreasonable to posit that the incidence of financial collapse

will increase$ thereby presenting more research opportunities for research. hile increased

failure is not a desirable scenario$ it re6uires greater scrutiny. ithout such scrutiny it is likely

that future failures will continue to happen. Greater attention must be paid to the impact of the

role played by director conduct and motivation in not-for-profit organi%ations. The for-profit3scandal5 literature does a very good /ob of analy%ing this. To help bring this about$ more

syntheses of the two literatures are needed (e.g.$ 2iller- 2illesen !!9#. This would then offer

the possibility of developing a framework that builds upon the tentative model put forward in

this paper

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When Good Turns to Bad