Cross-posted from System Viability and Corporate Governance blog
A common feature of much recent malfeasance is the construction of
highly complex corporate structures, apparently beyond the legitimate
demands of Requisite Variety.
Complexity – whether requisite or
otherwise – adds to investment risk. Dodgy management practices may
cause a continuous erosion of corporate value, or they may trigger a
sudden collapse of value (Enron, Parmalat). Some companies have a
sufficiently robust business model that they remain viable even with a
certain level of malfeasance. Other companies turn out to be merely
pseudo-viable – only remaining solvent thanks to dodgy accounting. Some
investors may be willing to tolerate erosion, but do not wish to be
confronted with sudden collapse.
Complexity is (or should be) a
warning sign. The purpose of complexity is what it does. If it doesn’t
serve a legitimate purpose, then it is surely reasonable to assume it is
there to serve some other agenda.
Using the theory of
complexity, we should be able to construct geological maps of the
corporate world, showing (probabilistically) where it might be worth
drilling for the next accounting black hole.
For example, it now
seems that Parmalat was non-viable, only sustained in pseudo-viability
by paper cashflows from a non-existent bank account. But such
transactions can only be concealed by having lots of apparently genuine
intra-company transactions. There is therefore a control mechanism that
forces complexity onto the company at the operational level, and a
higher level mechanism that manages the smoke and mirrors. It might not
be easy to detect the fraud by looking at the operational company
alone; it may be the existence of the control mechanisms that gives the
Conversely, if a management is obliged to construct
and present evidence of its bona fides, this evidence needs to include a
properly grounded account of the control mechanisms, including a
justification of the degrees of complexity and intracompany coupling.