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Three Things You Need to Know About Trust: Part 2

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There are really only three things you need to know about trust. You can pretty much deduce the rest. The three parts are:

  1. Trust is a Two-player Game
  2. Trust Requires Risk
  3. Trust is Reciprocal

Part 2: Trust Requires Risk.

First, there is no trust without risk. Second, only one player takes the risk; this sets up a particular dynamic.

No Trust Without Risk

Ronald Reagan was blowing smoke when he famously said, “Trust, but verify.”  The truth is, if you have to verify, it’s not trust. If it’s trust, then it’s not about verification. (Tellingly, Lenin was fond of the same phrase).

At one extreme, trust is bordered by blind faith, which is unbounded by data or reason. At the other, we have statistics, where risk is strictly a matter of probabilities and assumptions, governed by the rules of mathematics.

Trust lies curiously in between faith and probability – and a little off the straight and narrow of the continuum as well.  A psychological relationship, it involves one party willingly putting itself in harm’s way of the other, with a significant but not perfectly quantifiable chance that the other may abuse the situation. No wonder we speak of it often with metaphors.

People say trust mitigates risk. That’s true, but it’s also true that risk creates trust. Without risk-taking, there can be no trust. We forget this when we try to create trust by eliminating risk.

Why is this important? If you remove temptation or risk, you create an artificial dependence outside of the critical trust relationship. For example, if you render financial institutions completely non-risky by over-doing tick-box compliance, you will also choke off trust. Trust eats risk for breakfast, and becomes stronger for so doing.

As with many things trust-related, this is paradoxical. Trust reduces risk, but it also thrives on risk. Robotic safety and predictability are components of trust, but small ones. A completely mechanical world may be risk-free, but it’s also trust-free.

One Player Takes the Risk

In its pure form, one party trusts, while the other is trusted. In my classes, it’s a running joke I play: would you rather get better at trusting? Or at being trusted? So far, every class has opted to get better at being trusted. Doh! That’s the non-risky choice.

It’s human nature to wish others to take the risk. Sometimes, we’re lucky. The other person asks us out first; the customer shows their hand first, reducing our fears about price; the interviewer shares something personal about themselves, setting us at ease.

If you’re willing to run your business dependent on the kindness of strangers, that’s fine. But if you prefer to make your own luck – or trust – you’re going to have to learn to take risks. As Wayne Gretzky said, you’ll never miss a shot you don’t take; but of course, you’ll never score a goal either.

One of the biggest barriers to trusting is the cult of trustworthiness. The professions in particular like to cloak themselves in the idea of a Trusted Advisor that is strictly about trustworthiness – but not about trusting.  Such ideas include the high-minded virtues of integrity, tell-it-like-it-is courage, and a professional remove. But they frequently don’t encompass vulnerability and emotional risk-taking.  They should.

———–

In the third part, I’ll talk about the reciprocity of trust – how the role of trustor and trustee gets traded back and forth, and what that means for the development of trust.

HBS’s Bill Sahlman on the Financial Crisis: Why it Happened, How to Fix It

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Few people are more qualified to explain what went wrong in the financial industry than Harvard Business School’s Bill Sahlman.  His resume covers just about every aspect of the industry.

In an HBS Working Knowledge paper titled Management and the Financial Crisis (We Have Met the Enemy and He is Us …)  he gives us a very special view of what happened—broad and deep, and holistic to boot. He also gives us an idea of what should be done.

He gets an A+ for the explanation; for the recommendation, maybe not so much.

My summary cannot do his paper justice; but to whet your appetite, I’ll touch a few bases.

Managerial Incompetence Was the Driving Factor

Black swan theory fans notwithstanding, Sahlman argues this meltdown was not unique except in scope and scale. What we had was a massive failure of five largely managerial systems: Incentives, Control and Information Technology, Accounting, Human Capital, and Culture.

Sahlman also flatly says “Greed played a role but the bigger problem was incompetence.” What he means by competence largely comes down to managers. I find this hugely commonsensical, and rare at the same time. In other words, I think he’s very right.

He is inclined also to give a bye to some of the usual suspects: accounting firms, boards of directors, and regulators, to some extent. His reasoning is hard to argue with: the complexity of the products engaged in ran far beyond the relatively meager abilities of those in the aforementioned roles.

Sahlman singles out Goldman Sachs and JPMorgan Chase’s Dimon as examples of good managers who clearly avoided most of the damage caused by their inept competitors.
His diagnosis, refreshingly, puts the blame squarely at the feet of business itself—particularly management. A management that runs the company through over-leveraging and over-optimism is a management team that is grossly incompetent. Even they wouldn’t have generally wanted the results they ended up with.

What I also like about Sahlman’s view is that it treats impersonal tools like incentives not as exogenous dehumanizing variables, but as things completely within the realm of management—and he makes management squarely responsible for their use. As far as I’m concerned, this is the best of HBS talking; the old-school HBS that assumes managers have a responsibility to run organizations holistically, for the long run, and in the interest of stakeholders–not slavishly to a few slanted metrics.

The Solution–an Overseer?

After such a great analysis, I’m left a little cold with Sahlman’s solution. It is to have a sort of outside observer—not a government interveener, since Sahlman is not sanguine about government intervention, but a new kind of monitor. This monitor would have a scope to cover the five broad areas Sahlman outlined at the outset.

The problem is not with having a holistic view; I’m all for it. And while Sahlman is rather vague about the statutory authority of the “monitor,” I figure that could be figured out.

My concern is that, in the end, Sahlman sounds like the consummate insider; his specific knowledge of the situation runs the risk of blinding him to the system’s flaws.
In this case, the one flaw that worries me is the belief that one more systemic overview will finally get it right. It’s the idea that our problem is the lack of a comprehensive enough model; that if we just had a little more data and a better model, we could finally model the world.

Here I have to agree with Taleb’s Black Swan theory: the problem with models is that they never model what hasn’t been envisioned. And while you won’t get a better dose of commonsense in business than what Sahlman serves up, I’m still sceptical about this part.

A Different Idea: Management by Values

So do I have a better idea? Well, I do have another idea. And it lies in the one area Sahlman puts least emphasis on—culture. While Sahlman talks about ethical cultures, he seems generally to mean a focus on long-term risk management and an aversion to illegality. Necessary, but not sufficient, for a good culture.

Those traits are jacks for openers. We need to be cultivating belief systems, not just management control systems.  We need mental models that talk about relationships, that actually live out the idea of long-term relationships instead of relegating them to the thin air of risk management managers.

We need baked-in beliefs about the role of business in society, that get promulgated not by monitors and smart managers, but by high school teachers and b-school profs, by bloggers and journalists and marketing managers and bankers alike, and in the most mundane areas of business. That’s a culture: a set of beliefs that people unconsciously share about ‘big’ things like fairness, relationships and the value of one’s word.

One of the best insights I ever got from HBS could easily have been articulated by Sahlman himself, I suspect: as things get more complicated, you’re better off managing by values than by policies.
 

Is Trust a Substitute for Risk Management?

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Some financiers say the current financial crisis is a risk management issue. Unwarranted risks were taken; better risk management tools are needed.

They misunderstand the difference between risk management and trust.

Risk management is when we contract that you’ll staff my project with the best people, you’ll use best practices, charge me a fair rate, that I can terminate with 30 days’ notice, and so forth. And if you don’t do those things, you’ll be in violation of a legally enforceable agreement.

Trust is where we look each other in the eye, shake hands, and say, “we’re going to do right by each other, including changing whatever else it takes to do so.”

Risk management is for hurricanes—things, events. Trusting the weather won’t change it one whit, and can be suicidal.

But treating people like hurricanes actually increases the risk. The more you give employees lie detector tests, the more they’ll lie—“someone must be getting away with it, why else would they keep testing us?” More fine print just leads to gaming the system.

Conversely, when you trust people, you increase their trustworthiness. A client once cut short my praise of a proposed subcontractor. “Charlie, enough–if you say he’s good, he’s good—I trust you,” the client said. I instantly felt the weight of the burden of trust.

When people are involved, risk management partially raises risk. Trust lowers it. Why do the financiers have it wrong? Because they think our crisis is about securities capable of being evaluated in absolute terms. It’s not–it’s about people relationships, capable of being evaluated only in subjective terms. It’s not a crisis of derivates valuation–it’s a crisis of trust.

Trust won’t eliminate risk. Some people steal from honor boxes, and take advantage of others. I commonly hear, “Charlie, you’re naive. You need to legally enforce legal rights to copyright, employee behavior, or pricing. There are no sanctions with trust.”

In fact, there are sanctions, both carrot and stick, and they can be more powerful than contracts.

Suppose I trust a French contractor with my intellectual property. I could get a legal contract stating sanctions. If violated, I could enforce it in France. But at what cost in euros, time spent, and time elapsed?

Here’s the trust carrot. “Pierre, think of the great business you and I can do together—new markets, products, opportunities; as long as, of course, you continue to respect my property rights, we can do this again and again. This can be the beginning of a beautiful friendship.”

And the trust stick? “In the inconceivable event that you, Pierre, were to violate this agreement—not that you ever would, of course—then I would be forced to make that fact public. In a blog. In letters, emails, articles, public websites, aimed at your other business partners and potential partners, your customers, your employees. That would be most harmful to your reputation for trustworthiness, Pierre, and we both know that, so we needn’t speak more of such terrible things, now do we? We understand each other, oui?”

The common way to manage risk is with lawyers and contracts. The better way is often to create trust–over a fine French meal and a bottle of wine.

One of those ways is cheaper, faster, stronger, more pleasant. Why would I want to use lawyers when I can use trust? Why manage “people risk” like you manage hurricanes, when you can use trust instead?

(The usual pushback is how to scale trust: more on that soon).