Best Buy and Organizational Rationality

 Richard Schulze, the founder and largest shareholder of Best Buy, the “big box” electronic retailer, has announced his intention to buy back the firm by leading a leveraged buyout (LBO). Analysts are skeptical that he can attract the necessary venture capital. He is offering about $25 a share, but the stock is currently trading at about $18. It is unclear why investors would want to pay such a premium. Should he succeed, the company would have to take on an additional $7 billion in debt. If successful, the leveraged buy-out would mean that costs would have to be cut significantly. Moreover, Best Buy is in trouble. While its chief competitor, Circuit City, went bankrupt at the beginning of the Great Recession, it now faces competition from Amazon with its online sales capability, and Apple with its boutique retail outlets. It lost $1.7 billion in the first quarter of this year.

The proximate stimulus for Schulze’s leveraged buyout offer was his forced resignation as the chairman of the board. As the New York Times notes, “Late last year, Mr. Schulze, now 71, received a written statement from an employee “containing specific allegations about a possible inappropriate relationship” between Brian J. Dunn, the 51-year-old chief executive, and a 29-year-old female employee, according to a report by the company’s audit committee. Mr. Schulze confronted Mr. Dunn, who “adamantly denied any inappropriate conduct or romantic relationship with respect to the female employee.” Mr. Schulze accepted his word and viewed the matter as settled. He did not tell any of his fellow board members as was required by the company policy.”  In addition, he told Dunn who had filed the written statement.

The audit committee of the board, commissioned an investigation of Dunn’s behavior. The report concluded that, “The CEO violated Company policy by engaging in an extremely close personal relationship with a female employee that negatively impacted the work environment. He also violated Company policy by soliciting from a vendor a complimentary ticket for the female employee. His relationship with the female employee demonstrated extremely poor judgment and a lack of professionalism, but the inquiry revealed no misuse of Company resources… In addition, as part of the investigation, it was determined that the Chairman of the Board of Directors (the “Chairman”) acted inappropriately when he failed to bring the matter to the Audit Committee of the Board of Directors in December 2011, when the allegations were first raised with him.”

It is worth asking why the board took the extreme step of dismissing its chair and founder. He was the architect of the firm’s success, had appointed every prior CEO, was the major shareholder and, as his plan for the LBO suggests, he could create trouble. Indeed, one analyst described the board’s action as a “palace coup.” One hypothesis is that the board’s decision about Schulze was colored by the nature of Dunn’s faulty decision, namely, a decision to conduct a "close personal" relationship that “negatively impacted the work environment.”

The use of the term “close personal” is suggestive. I want to propose that the foundation for a psychologically secure work setting is paradoxically impersonal. In such a setting, a person is only as good as his or her past effectiveness, and should it prove wanting, the organization can fire the person. The organization is obligated to meet customers’ needs, not employees’ needs. To be sure, organizations should not be brutal. But this ethic of impersonality means that there is an element of indifference that shapes the psychological climate of the modern performance organization.

How can such an ethic possibly create a sense of psychological security? Because it also means that supervisors cannot “play favorites” based on personal preference, and people in authority cannot act arbitrarily in allocating tasks and rewards. Personnel decisions should be based only on what contributes best to the organization’s performance People experience such an organizational climate as rational, and this rationality is a partial compensation for the indifference. The climate may be challenging and the setting unkind, but it is not arbitrary. The organization’s rationality is the analogue of civil society’s “rule of law.”

This is an ideal of course. Informal social networks, through which people provide advantages to others who share the same social background, shape organizational life. Personal preferences can matter. But it is a measure of some progress that executives in authority are held accountable for minimizing the impacts of such preferences. This is the basis for most human-resources policies, and for anti-discrimination laws. When a discrimination claim leads to a legal suit, the rule of law and the ideal of organizational rationality are joined.

Yet, there is no reported evidence that Dunn favored the woman with career opportunities or company resources. Moreover, office romances are strikingly common. As one survey of 7,800 workers reports, “Nearly 40 percent of employees say they’ve dated someone at work, and of those almost 30 percent say they’ve hooked up with someone above them in company rank.”

This suggests that there was something egregious or unseemly about Dunn’s behavior. What could that be? The audit committee's report notes that Dunn and the unidentified woman had numerous private meetings and exchanged “hundreds of text messages and phone calls.” Moreover, as the audit committee’s report notes, he had asked a vendor to provide the woman with a free ticket for a concert. One explanation, buttressed by the report, is that what was unseemly was not simply or only his behavior, but his obvious lack of discretion and poor judgment. After all, as the audit committee’s report suggests, people knew about the pair’s relationship, and it is likely that some people observed moments when the couple sought out a setting for a private meeting. Perhaps what upset people the most is that Dunn allowed a sexual attraction, which is never reasoned and is always arbitrary, to undermine his good judgment.  

Why is this upsetting, why does it create a negative work environment? According to this line of thinking people did not imagine that the woman was being favored. Rather, they saw the CEO succumb to sexual impulses, strong enough that they ruled out discretion. As a result he became a poor representative of organizational rationality. As the saying goes, he “fell head over heels.” Of course, there are many times when a CEO may give way to his or her impulses, for example in fits of anger. But these instances are often linked to the tensions of the work itself. In this sense they can be explained, even if they are unreasonable. Succumbing to a sexual attraction has no such explanation. 

This account provides a plausible explanation for the board’s willingness to be so bold as to stage a “palace coup.” They saw Dunn’s behavior and Schulze’s behavior as cut from the same cloth, as part of a single episode.  Just as Dunn failed to represent organizational rationality, Schulze violated it. He did not follow company policies and board rules. Instead, he failed to report the complaint against Dunn to the audit committee, and told Dunn the name of the employee who had lodged the complaint. It is a cardinal rule of organizational rationality that people who lodge complaints against senior executives have the right to remain anonymous. Otherwise they might be punished for their truth telling. Dunn’s poor judgment and lack of impulse control colored the board’s estimation of Schulze’s behavior, which in other circumstances they might have forgiven with a reprimand.  

In this context it is no accident that Schulze wants to take the company private. As a private company Schulze would be less shackled by the “rule of law.” The company would become his private domain. It is also likely that his decision to attempt an LBO has some of the same impulsive qualities that shaped Dunn’s behavior. After all analysts are very skeptical he can succeed. Moreover, taking on too much debt could jeopardize Best Buy, just when it has to restructure its entire operation to remain competitive.  Schulze may be trying “to get even,” a sorry basis for a rational investment decision. One wonders if board members experienced Schulze as increasingly impulsive even prior to the Dunn affair.

There has been a tendency in management literature to poo-poo organizational rationality, as if it were an ideological description of the organization that bears no relationship to real organizations.  Of course there is much irrationality in organization life, as this very case suggests. But that does not mean that the ideal of rationality, when conceived of as the “rule of law,” should be dispensed with.