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May 24, 2016

Theranos: A Hard Lesson for Innovators

Summary:

Silicon Valley often thinks it can live by a different set of rules than corporate America because it is innovating. Wrong.

Photo Courtesy of TechCrunch

The Theranos saga hit another low when the company informed regulators that it was voiding two years of tests from its Edison blood testing devices and sending of tens of thousands of revised test results to doctors. This means thousands of patients received incorrect results and were likely given incorrect treatments. 

These doctors and patients trusted Theranos, relying upon the brand value of the gilded names the company promoted as its governance oversight, presuming somebody truly conducted some genuine, diligent reviews. These names included diplomatic and military titans such as two former U.S. secretaries of state (Henry Kissinger and George Schultz), former U.S. senators (Sam Nunn and Bill Frist), a former U.S. secretary of defense (William Perry) and, surprisingly, the tough-minded former CEO of Wells Fargo, Richard Kovacevich.

Didn’t Theranos CEO Elizabeth Holmes and her executive team realize they were risking lives by using unproven and faulty equipment? Didn’t the all-star board ask tough questions about the workings of the technology? Didn’t the leaders understand that ethics is a slippery slope, that once you compromise there is no turning back?

Sadly, we have seen too many  ethical lapses and too much lack of disclosure to shareholders in the technology world. We have written about Silicon Valley’s careless and arrogant frat-boy culture; warned Uber’s CEO he risked being known as a modern-day robber baron for his dubious business practices; and battled tech titans who pay children to drop out of school before they have developed important social skills and ethical values.

See also: The State of Ethics in Insurance

We can list more than 50 tech firms that died when their governance failed long before their technology. One example was Informix — a fallen star of Silicon Valley and a darling of Wall Street. Founded in 1980, it towered over its rivals Oracle and Sybase as the first of the database giants to offer object relational database support with superior multi-media storage built in. Nonetheless, its poor governance drowned out its technological triumphs, as misstated revenue recognition and accounting fraud led to the imprisonment of celebrity CEO Phil White and to the firm’s ultimate collapse.

Silicon Valley often thinks it can live by a different set of rules than corporate America because it is developing world-changing innovations and because start-ups need the freedom to innovate. Yes, we need to allow entrepreneurs to take risks and break some rules so they can do their magic. But these rules cannot be ethical ones. The lines on ethics are usually clear, as they were with Theranos, and there can be no compromise.

Profiteers are always ready to exploit markets fueled by hope, hype and emotion.  Here are some lessons:

1. Question the over-hyped founders.

Theranos’s CEO notoriously chased testimonial media appearances and self-aggrandizing promotional materials and strutted before cheering and unquestioning audiences of wannabe disrupters at TED talks. Instead, look for leaders who engage in debate with people who understand the core technology and may fortify or enhance the original concept. If you look at some of the biggest and most successful companies, some of the most vital names — Robert Noyce at Intel; Paul Allen at Microsoft, Steve Wozniak at Apple, David Filo of Yahoo; Sergey Brin of Google; etc. — are not the names attached to the company by the media, but, of course, they were crucial in each firm’s future technical, commercial and moral trajectory. The wisdom of Abraham Lincoln’s Team of Rivals has value beyond politics.

2. Beware of leaders who hide behind the cloaks of marquee names.

Celebrity roll-ups are used as governance smoke screens from substance. It seems too obvious to state what must yet still be stated, that boards must be recruited from the ranks of those with relevant skill and knowledge, not from the gossip pages. The three board members who seemed to understand Theranos’s technology quit en masse three years ago.

3. Dissent is not disloyalty.

Tech leaders should embrace outside critics and listen to internal challenges rather than disparage — and even threaten — dissenters. The chief science at Theranos killed himself, after reportedly telling his wife that the technology did not work. Frustrated internal whistleblowers revealed to The Wall Street Journal that the firm’s celebrated systems were no longer even used for most of the several types of tests they ran.

The boards of start-ups must also be held to higher standards. When they join a board, venture capitalists have a fiduciary duty to represent the interests of all shareholders, not only their funds. While Theranos is not a publicly listed enterprise, members of the board still staked their good names to reassure investors, strategic partners, employees and the public — in this case not just verifying financial health but also physical health.

During the dizzying days on the eve of the dot-com crash, many innovative firms skyrocketed as they disrupted the defensive old order. Anyone who questioned the hype was trashed as a neo-Luddites defending the past. Prominent governance apologists celebrated “e-board governance,” a self-righteous term replacing traditional diligent governance. Such new-age board oversight encouraged venture capitalist service on scores of boards, misleading pro forma financial reports, backdating stock options, illegally booked barter deals and following other reckless practices while waving away oversight through marquee names. Two decades later, “the Valley” should ascend from such governance lowlands.

Jeffrey A. Sonnenfeld, a professor at the Yale School of Management, is the co-author of this article.

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About the Author

Vivek Wadhwa is a fellow at Arthur & Toni Rembe Rock Center for Corporate Governance, Stanford University; director of research at the Center for Entrepreneurship and Research Commercialization at the Pratt School of Engineering, Duke University; and distinguished fellow at Singularity University.

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