Case Study: ABC in Corporate Governance and Business Ethics

This case study was compiled based on the experiences of a participant within ABC, the focal not-for-profit organisation. It is acknowledged that participant observation may not provide an entirely unbiased perspective on organizational processes and events (Silverman 2000). However, the position taken here is that an insider can help to reveal dynamics that would go undetected by an independent researcher using more objective methods such as surveys (Parker 2007). More specifically, in this instance, board processes and director behaviors were captured and analyses (Samra-Fredericks 2000). The data collection exercise took place over five years and included participant observation alongside the acquisition and consequent analysis of internal documentation such as the organization’s written constitution.

This methodological approach was not the result of a planned and purposive exercise. It was the product of the participant conducting a rigorous retrospective analysis in the light of the organizational failure which resulted in the company’s bankruptcy in 2006. No claims are made, therefore, that this case should be viewed as one that is exhaustively validated. It is offered in the spirit of presenting an opportunity to begin a discussion of the possibility of connections being made between governance practices in different sectors.

ABC

ABC was established in Huddersfield, England, in October 2000 as a not-for-profit company limited by guarantee. It lasted six years and was formally wound up in 2006. It was created to provide opportunities for young people to access creative arts activities. The young people it focused on were those exhibiting anti-social behaviors. Although ABC was constituted as a worker co-operative, it did not have provision to act as a member benefit organization. It was specifically organized 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 a manner as the General meeting shall decide from time to time: to a general reserve for the continuation and development of the Co-operative.

The assets of ABC 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 of after its liabilities are satisfied, these assets shall not be distributed among the Members, but shall be transferred instead to some other common ownership enterprise, or some other non-profit organization, as may be decided by the members. Originally the organization was run by four staff whose positions were supported by funding from the UK government through an employment creation scheme. Young people were referred to ABC by local schools as well as parts of the criminal justice system such as youth offending teams. ABC subscribed to a model of anti-social behaviors that linked it with low educational attainment, unemployment, and crime. They believed that they could reduce the incidence of social exclusion 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-dancing, and drama. These sessions were designed to increase confidence and motivation by providing young people with transferable skills.

Initially ABC focused on Afro-Caribbean young people. There is a sizeable community within the Huddersfield area. Over time the organization expanded its reach and engaged with white and Asian youths who were also exhibiting anti-social behaviors. Within one year ABC was in a position to establish its own premises within Huddersfield. They acquired space which enabled them to create a number of dedicated facilities including a recording studio, dance studio, training rooms, and office space. Staff was recruited on the basis of their creative talents and their proximity to the organization. Local artists, musicians, and dancers became mentors who were seen by ABC to be capable of acting as positive role models for the young people on their programmers.

ABC gradually became more established and received recognition for their work. For example they won a regional award in 2004 for being “On the Up”. Between 2002 and 2004, annual turnover grew sharply from £38,000 to around £300,000. This was the result of trading, funding awards, and contracting with one government contract alone being worth £150,000. These contracts require an organization to create formal systems that can deal with monitoring, evaluation, and progression of participants. This meant that a perception grew within ABC that they were meeting the needs of their contractors rather than maximizing their effectiveness with regard to users of their service. This formality was making them less flexible and so less responsive to the young people on their programmers. Accountability appeared to be moving away from the community which ABC were set up to serve as they had to meet the increasingly onerous demands of their contractors. After a series of events that shall be described in the following sections, by January 2006 the organization was in voluntary liquidation. To identify which factors may have contributed to this swift decline, agency and stakeholder involvement from the earlier theoretical discussion will now be explored in the context of the case material.

Agency

A contributory factor to ABC’s failure was the agency problem which emerged in the establishment of a subsidiary trading arm focused on the music industry. This venture aimed to nurture those talented youngsters that had been discovered while attending ABC’s creative programmers. These local music artists were given recording opportunities and management support in return for a guaranteed share in future revenues from sales and performance commissions. This artist development programmed would therefore be financially supported by commercial trading income. Any profit margin generated could then be invested back into ABC to help subsidies their main social purpose activity. A large amount of working capital was needed to set this programmed up and was raised through accessing the company’s reserves. After two years, and with the support of two full-time members of staff, it had still failed to generate any income.

Directors failed in their role as agents of both the organization and the community. It is not uncommon for these types of venture to fail. The music industry is a notoriously difficult one in which to succeed due to its competitive nature. However, the decision-making bears further analysis. Perhaps the venture illustrates the difficulty of balancing the need for not-for-profits to seek financial sustainability against the taking of reasonable risks to secure this sustainability. Another interpretation is to view this venture as the board allowing their own personal interest in the music industry to cloud their judgment. This demoted the social objectives of the company into second place. This behaviors can be defended to some extent and suggest agency failure without questioning the ethics of the board’s conduct. However, the evidence from the following section on stakeholder involvement suggests a different conclusion.

Involvement

Stakeholder involvement is enshrined legally in the constitution of a co-operative. In theory at least, it is possible for anyone to become a member. From there, any member is then entitled to put themselves forward for board membership. Therefore, any stakeholder can become involved in the governance function. This is illustrated within ABC’s Articles of Association:

    3. Membership will be open.

    The Articles also show their support for the involvement of employees with the clause stating,

    4. All employees on taking up employment with the Co-operative shall be admitted to Membership of the Co-operative, except that the Co-operative in General Meetings may by majority vote decide to exclude from the Membership:

    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 exclusion is applied equally to all employees.

These excerpts from the constitution suggest that ABC intended to offer the opportunity to new employees to become members of the organization and, further, to become involved in governance if they so desired. This opportunity was to be available unless there were exceptional and transparent circumstances which would be determined through a majority vote by the existing membership. However, this clause 4 was used to limit membership and keep it exclusive to the founding members. This was achieved by extending the “reasonable probationary period” detailed in the clause to beyond the length of any existing employee’s 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 join the board.

Eventually, the situation did become the subject of a challenge from staff within the organization as 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 Annual General Meetings. Upon gaining these rights, the membership decided to remove a director from his role against his wishes. His conduct was questionable not least because he had appointed himself both Managing Director and Financial Director. He 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 received more favorable treatment and were granted the right to continue in their roles for another year before being subjected to a membership vote.

Once the inclusive policy was in place, ABC had an open route to membership. This continued for the six months that remained of the organization’s existence. The company continued to struggle in spite of these improvements being made to employee involvement in the governance function. By the autumn of 2005, the organization was no longer financially viable and was effectively on the verge of collapse. The price was being paid for previous decisions by directors to award themselves hefty pay raises while their new ventures, as with the example above, singularly failed to achieve business success. It fell to the newly elected board members to honor their legal obligation to instigate liquidation proceedings following the holding of an Emergency General Meeting 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 organization is insolvent. Fortunately, the newly empowered membership was able to impose their will over the old guard and administration and winding-up duly followed.



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