Corporate Behavior

Insanity

“Insanity: doing the same thing over and over again and expecting different results.”
Albert Einstein

When we examine the headlines, this oft-quoted phrase becomes increasingly relevant. We accept public policy errors with barely a whimper. We are either too comfortable with the status quo or paralyzed by fear of the unknown. Worse, perhaps we have lost our ability to question critically. Maybe all the aforementioned are true at once. Let’s examine some of the current insanity.

Living on Flood Plains

Our family was raised near the Passaic River in New Jersey. In high school in 1970, my brother did an in-depth study of flooding in the Passaic River Valley. Even then, after relatively modest storms, flooding of the towns of Lincoln Park and Wayne, NJ, was all too common. My brother interviewed then State Senator (later Governor) Thomas Kean. Kean was well aware of the problem and had worked with the Army Corps of Engineers to devise a plan to stop the flooding. A new dam was needed, but the project withered from political opposition. Now, more than forty years later, the area routinely floods in these and other Passaic River towns. No dam has been built. Worse, overbuilding since the seventies has intensified, leaving more families in harm’s way. Now, with full media drama, we are treated to heroic emergency rescues, and heart rending scenes of home evacuations and lost possessions.

My guess is that many of these homeowners will receive sizeable checks from federal flood insurance programs. We the taxpayers are subsidizing the choices of individuals to build homes on flood plains. Although I believe there is a role for a federal emergency response, Ron Paul was right to question the need for a federal response to Hurricane Irene. Even the liberal Huffington Post recognized the insanity in some of these programs.

Federal disaster relief programs have their faults. The National Flood Insurance Program, originally designed to force homeowners to take financial responsibility for living in flood plains, has encouraged development in unsafe areas. So too have federal levee and flood control programs. See A Natural Disasters History Lesson for Ron Paul

Insanity is to encourage overbuilding in flood plains, watch hurricanes and lesser storms destroy houses, and then having taxpayers reward reckless builders and homeowners with monies from the Treasury. We need to at least begin the process of requiring our citizens to acknowledge the risks they take in their choices. Financial responsibility should reside with the homeowner not the taxpayer.

Boards and CEOs

Much hoopla surrounds the naming of a new CEO for a major American company. Too often, we find out later that the Board of Directors never fully investigated the candidate to explore the “soft issues” such as management style. And then comes the consequences for the company and its shareholders. We have two recent cases of high profile executive terminations: Jeffrey Kindler at Pfizer and Robert Kelly at Bank of New York Mellon.

In both instances the Board discovered after the CEO was ensconced that his abrasive management style was alienating other key senior managers. The result was dysfunctional management decision making.

This woeful tale occurs quite often. The Board becomes enamored of a brilliant, seemingly charismatic executive. But if the Board did its homework, it would discover that sometimes an executive is a brilliant individual contributor, but a mediocre or too often a terrible manager. Given the hierarchical nature of corporations and the fear of losing one’s job, subordinates do not speak out about their bosses. Or if the rare employee has the courage to speak out, the Board rationalizes complaints: such employees are disaffected complainers, or sore losers in the climb to the top.

When corporate performance inevitably founders, the mass exodus of senior talent or the disclosure of a scandal catapults the Board into action. Horrors! All those complainers may have been correct. Secret sessions occur, the Board develops some backbone and fires the executive, but tells the world that the executive is retiring or resigning to spend more time with their family. Worse, Boards do not deal harshly enough with a mistake in hiring: they reward the offending executive with a large severance package and a proclamation of gratitude for taking the company to a new, higher level. The end result: a cynical group of employees and shareholders.

See Inside Pfizer’s Palace Coup, Robert Kelly: Bank Fired Him Because of His ‘Abrasive’ Management Style Lowered Morale

QE3

Wall Street continues to beat the drums for a third round of quantitative easing from the Federal Reserve. Peter Tchir of TF Market Advisors debunks the effectiveness of QE2. The stock market may have gone higher but that may have been related to the problems in Europe that lowered the value of the dollar or the lower stock price levels then (1050 S&P 500) versus now (1215 S&P 500). The “wealth effect” related to rising stock prices did little to improve the lot of the average American. Unemployment remained high, house prices did not recover and wages stagnated. Finally, there were dramatic increases in commodity prices raising the cost of key items such as food and energy. Yet, the Federal Reserve continues to hint at QE3 and major investment banks view it as a given. See QE3, What’s not to Like?

Repeating Insanity

What has happened to critical questioning of key institutions: Congress, the Executive Branch, the Federal Reserve and even corporate boards of directors? Policy initiatives are floated every day in the press, one crazier than the next, and few pundits ask why? As crises seem to occur without respite, my guess is that this obtuseness will not serve us well.

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3
Aug 11

The Meal Was Great; Our Outlook, Not As Good

I had dinner the other day with two close friends, both former colleagues. We are, in parlance, “men of a certain age:” baby boomers, children of the sixties, sons of World War II veterans. We all began our work lives in our twenties, worked for giant corporations, and turned jobs into long-term careers. When first hired by our companies, we planned to stay just a couple of years and then move on to another company. With the benefit of hindsight now, and the need for false humility ended, we can each gratefully admit that we enjoyed significant professional success, although none of us thought we would rise to the senior executive levels that we did.

We now occasionally get together for dinner and discuss our families, our current pursuits, how our former employer is doing and the general state of things. Last time, we discussed what went wrong with America generally, why our children will not have long careers with large companies, and why they likely will not be as financially successful as we were.

We spoke about our fathers and the norms of their generation. They fought in the War, returned and worked hard, and had few expectations about success or wealth. They kept their noses to the grindstone and rarely complained.

We discussed the landscape of the corporations we went to work for. When I was hired as a junior attorney, the General Counsel barely made five times my salary. Bonuses were stingy and a modest number of stock options (in the hundreds of shares) were offered to a handful of our most senior executives. Interestingly, it was generally a harmonious and engaging work environment. In contrast, by the time I retired, the Chairman and CEO made more than 400 times what an average employee made. Employees were not nearly as engaged or happy.

The immediate catalyst for our wondering what has gone wrong with America was the current debate over the US debt ceiling. I started to think back to the blogs I had written and tried to put together some hypotheses. I caution the reader this is not a rigorous, but rather an impressionistic view of sociological, political and economic trends which shape the current state of affairs. If it is insightful, I give tribute to good dinner conversation and fine friendship:

Loss of Shared Sacrifice – Perhaps it was the “Me Generation” of the 1960’s, but America has lost its sense of shared sacrifice; that is, the notion that we are all in this together and we rise or fall as one nation. Instead we have an ethic of greed: I want what I want and I want it now, everyone else be damned.
Out of Control Military Spending – Too much of America’s resources are spent in our defense budget. Compounding this problem is a series of seemingly endless wars. While we deploy hundreds of thousands of troops to Iraq and Afghanistan, our allies deploy hundreds. Note that the German, Canadian, and Australian economies boomed, while ours stagnated.
The Volunteer Army – A volunteer army allows wars to be fought by other people’s children. Thus, the popular outcry against wars or military spending is diminished because our own (privileged) sons and daughters are less likely to be involved.
Too Many Laws – The Wall Street Journal highlighted the growth in federal criminal law. We over-criminalize too many areas of society. One commentator archly noted that someone violates some law each day, often unaware of his lawbreaking conduct. See As Criminal Laws Proliferate, More are Ensnared
Unequal Enforcement of the Law – Perhaps since the OJ Simpson trial, our citizens cynically believe that if one hires a good enough lawyer, one literally can get away with murder. This carries over to the belief if a corporation is big enough, especially a “too big to fail” financial institution, it will never be prosecuted.
Socialism for the Rich, Capitalism for the Poor – When the “too big to fail” institutions became insolvent, the Bush Administration, Congress and the Federal Reserve rushed in with a comprehensive program of TARP and zero interest rate lending. The Obama Administration has continued these policies from the beginning. Insolvent homeowners have been evicted from their homes, and many unemployed workers have exhausted their unemployment benefits.
Reckless Lending and Borrowing – The Federal Reserve was a major culprit in the growth of both public and private credit. Instead of accepting the economic consequences of the internet bubble crash, Alan Greenspan reduced interest rates to below market levels to encourage real estate lending. Subprime lending further inflated the housing bubble. Based on an inflated residential and commercial real estate market the economy boomed. Assuming that this was permanent prosperity, debt was taken on at all levels: states and municipalities, corporations, homeowners and the federal government. Now we cannot repay that debt.

While my dinner with friends continued all in one evening, Part Two will continue this discussion.

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6
Jul 11

Recycling Losers

A curious feature of institutional behavior is the tendency to hire or retain executives who have failed in their jobs. A prime example of such behavior is the hiring of baseball managers. Baseball is enthralled with the familiar. So it seems the best way to get a manager’s job is to be fired from one. Despite their undistinguished records, managers like Jim Fregosi (win/loss record 1028-1095); Jerry Narron (291-341); Grady Little (385-290); Dallas Green (454-478) and a host of others were fired by one club, and then hired by another. Many were given veteran clubs with proven stars, and yet they could not win championships. Anecdotally, baseball was often accused of recycling old white men. But recent reforms in baseball have demonstrated an equality of mediocrity if you will, as baseball has recycled minority managers with losing records.

The same dysfunctional thinking occurs in American business. After being fired in the wake of the Bank of America merger, John Thain went from leadership at Merrill Lynch to head the CIT group. Robert Rubin remained as Chairman of Citicorp after the financial crisis (although he resigned in 2009). Lloyd Blankfein at Goldman Sachs and Jamie Dimon at J.P. Morgan continue in their positions.

President Obama assembled his financial team and shamelessly recycled flawed people: Ben Bernanke (Federal Reserve Chairman); Timothy Geithner (Secretary of the Treasury); Lawrence Summers (Head of the Council of Economic Advisers); Robert Rubin (economic adviser) and Jeffrey Immelt (President’s Economic Recovery Advisory Board). Without cataloging their financial sins, clearly each of them contributed in a major way to the near collapse of the American financial system.

Failing Upward

In an aptly named article, Failing Upward, Yves Smith highlights the hiring of Madelyn Antoncic as Treasurer of the World Bank. Ms. Antoncic’s previous position was Chief Risk Officer of the bankrupt Lehman Brothers:

The World Bank has appointed Madelyn Antoncic as its new vice president and treasurer.

Ms Antoncic served as Lehman Brothers’ chief risk officer from 2002 to 2007 and following the collapse of the bank, stayed on for a year as managing director and senior advisor at the Lehman Estate, helping to maximise value for creditors….

Commenting on the appointment, World Bank Group president Robert B Zoellick, says: “Known for her forthrightness, I am delighted Madelyn is taking up this important role.” See Failing Upward

Ms. Smith concludes that large financial institutions are comfortable hiring familiar people for big jobs, no matter how poorly they have previously performed.

Forthright but Ineffective

Robert Zoellick praises Ms. Antoncic’s forthrightness. Another analyst comments that she “was likely the only person on Lehman’s executive committee who had any sense.” See World Bank Taps Ex Risk Officer as Treasurer. But we then learn that senior management knew that the firm was taking on too much risk. What was Ms. Antoncic’s role in controlling risk; indeed what did she know? Was not controlling risk essentially her job?

So where was Antoncic to reign in such risk during that time? Well, she was being kicked out of executive meetings where risk was being discussed. Antoncic, with her PhD in economics and a prior 12 year stint at Goldman Sachs, might have know Lehman was taking too much risk but her opinion was blatantly disregarded when she was removed from Lehman’s executive committee in 2007. See World Bank Taps Ex Risk Officer as Treasurer

So Ms. Antoncic, the lonely voice of reason, was kicked off the executive committee. I do not know Ms. Antoncic, but her behavior raises important management questions. Did she resign from Lehman? Did she inform the Board of Directors or government regulators that the bank was taking on too much risk and might collapse? No, she continued to collect her paycheck, a monument to her ineffectiveness and her questionable ethics. If she was one of my employees, I would have fired her. Forthright but ineffective just does not cut it.

Too Comfortable

Executives become too comfortable. Instead of hiring a challenging subordinate who can bring fresh ideas, they are more likely to hire a loyal unchallenging stalwart who can maintain the status quo. In a more cynical view of things, I would suspect that Mr. Zoellick found the right employee in Ms. Antoncic. She would be beholden to him, be loyal to a fault and never challenge his decisions. Unfortunately, these are valued traits in corporate America and in government and can be summarized: “go along and get along.”

In my own experience I watched poor performing executives fail and then be promoted to a larger assignment. I once quipped that you could not be promoted until you made at least a $500m dollar mistake. That would demonstrate that you were a real player. Obviously, Ms. Antoncic was a “real player.” It took a real talent to be part of team which bankrupted a major investment bank and nearly crashed the entire economy.

The financial crisis will remain intractable as long as we continue to recycle the same financial players and government advisers who got us into this mess. We need smart people with new ideas and different energy who can get us out this quagmire. It is going to take the truly exceptional Board of Directors, CEO or US President to get rid of the wrong people, locate and hire the right people, and break with the past. Perhaps it is time to afflict the too comfortable.

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3
Jul 11

All Millionaires are Not Created Equal

In Is Debt Ever Good? we contrasted productive debt and non-productive debt. There is a duality with millionaires as well. Some are productive and some are not.

At his Wednesday press conference, President Obama adopted what he figured would be the populist stance, and he vilified millionaires as a group:

Mr. Obama repeatedly mocked tax breaks that he said were for “millionaires and billionaires, oil companies and corporate jet owners,” saying that voters would not look kindly on Republican lawmakers who defended such breaks at the cost of cuts in popular programs like health care, education and food safety….

“If you are a wealthy C.E.O. or hedge fund manager in America right now, your taxes are lower than they have ever been. They are lower than they have been since the 1950s. And they can afford it,” Mr. Obama said. “You can still ride on your corporate jet. You’re just going to have to pay a little more.” See Obama: Republican Leaders Must Bend on Taxes

The financial press immediately declared this as “class warfare.” See e.g. Obama’s Case Against the Rich Rings Hollow. I would conjecture that the American public can distinguish between the good millionaire, who creates jobs and real wealth, and the bad millionaire, who becomes wealthy through political maneuvering or illegal activity.

The Productive or “Good” Millionaire

Americans applaud individuals from all backgrounds who have an innovative idea and are able to execute and create real wealth. Bill Gates (Microsoft); Sergey Brin and Larry Page (Google); Steve Jobs (Apple); Jeff Bezos (Amazon); Pierre Omidyar (EBay); Mark Zuckerberg (Facebook) and a host of other entrepreneurs identified a business need, created a new product or service, raised private capital and became wealthy. Even in the much maligned financial industry there were pioneers such as Charles Schwab who brought discount brokerage and other financial services to the average investor. These are thriving enterprises, which need no government assistance or special tax breaks to make money and create jobs.

The Non-Productive or “Bad” Millionaire

Unfortunately, we have too many examples of this type of wealthy interloper:

Failed Bankers – Richard Fuld (Lehman), Charles Prince (Citicorp) and Ken Lewis (Bank of America) are examples of bankers who drove their institutions into bankruptcy or made them wards of the state. Each of these individuals secured great wealth and suffered no compensation “clawbacks” or criminal prosecution.

Failed Corporations – During the financial crisis, companies like General Electric almost went bankrupt. When they should have diluted shares and jeopardized their own stock-based compensation through equity and debt offerings, crony capitalists such as Jeff Immelt called on their Washington “friends” to extend large, below market rate, irresponsible loans to GE.

Under- performing Corporations – Legions of CEOs collected large compensation packages while their businesses, employees and shareholders suffered. Instead of amassing their personal largesse at company expense, many an under-performing CEO should have been dismissed.

Criminal Enterprises – Ken Lay and Jeff Skilling of Enron and Scott Sullivan and Bernie Ebbers of Worldcom, among a long and undistinguished list of corporate malefactors, were able to deceive shareholders and bankrupt their businesses. And worse, each amassed a large personal fortune.

Defense Contractors – A small, tight knit cadre of defense contractors feed at the Defense Department trough. Many of these contractors have been accused of violating various bidding and other contracting rules, but are never disqualified from bidding on future contracts. Cost overruns, delays and malfunctioning systems occur far too often.

Why Are Americans Angry?

We are angry at millionaires who game the tax code, misrepresent the financial status of their businesses, and seek government bailouts while continuing to pay themselves outsized compensation packages. We resent non-performing CEOs who continue to be richly rewarded. We oppose government contractors with cozy Washington relationships. To the average American, these millionaires win because the game is rigged.

Americans applaud the honest entrepreneur because he or she fills a real societal need. Further, these individuals are the best examples of the American spirit and ethos of creative imagination, perseverance and hard work yielding a valuable result. Americans do not want to destroy these individuals; they want to be these individuals. Obama is overreaching when he paints all millionaires with the same brush. What Americans want is an end to the bailouts and special deals that destroy incentives for honest entrepreneurs and both create and protect the undeserving rich. Americans want a level playing field so they can compete and become wealthy, too.

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21
Jun 11

Corporations: The Good and the Bad

In Are Corporations Really the Devil? we examined the concept of corporate profit maximization. Corporations are essentially amoral in nature, pursuing economic efficiency for the benefit of shareholders. In this pursuit they exhibit both good and bad behaviors. Since Charles Hugh Smith conflates corporations with the “work of the devil,” let’s begin with his thesis of the evil corporation.

The Bad

Having worked for thirty-plus years within the bellies of these beasts I can indeed report lots of bad stuff:

Greed – Executive compensation often dominates the corporate agenda. It is a costly diversion, consuming the efforts of attorneys, consultants, accountants and senior management. Management is often diverted from the more important job of running the business. In the end neither shareholders nor the executives are satisfied. The result of the process is that there are too many overpaid executives. Few if any executives demonstrate the management acumen justifying such overly generous compensation packages.

Lack of Foresight – I could excuse large pay packages, if a senior executive had true foresight and talent in matters relating to the business of the corporation itself. The record of too many CEOs? They stayed in businesses which should have been sold, missed investing in and deploying new technologies, made horrendous hiring decisions, laid off employees when they should have been hiring, and were late in removing poorly performing executives. A corollary truth to this realization: many executives can competently perform their jobs, but few are visionary. Few executives can follow hockey great Wayne Gretzky’s advice: “…skate to where the puck is going to be, not to where it has been.”

Careerism and Promotions – Many executives put their own career advancement over the good of their employees, fellow executives and the corporation. And worse, business ethics and simple interpersonal courtesy and manners were routinely and very sadly lacking. Bad corporate behavior includes: withholding of critical information, undercutting colleagues’ efforts, and wasteful projects for self aggrandizement. Many times bad behavior leads to ethical lapses and legal shortcuts that subject the company to expensive liability.

Many times the wrong person is promoted into a higher level job for all the wrong reasons. The tireless self-promotion and undercutting of colleagues that some executives made their modus operandi sent terrible messages to good performing employees when these behaviors were rewarded with inappropriate promotion and aggrandizement.

Abnegation of Responsibility - When something in a corporation goes wrong, executives who accept blame and responsibility are few and far between. It is the rare executive who accepts blame for a decision gone awry and takes responsibility for the cleanup.

Job Insecurity – When I began my professional life in 1977, there was excellent job security in corporate America. Starting in 1981 and each and every year thereafter until I retired in 2009, my corporate employers and many others had work force reductions either through early retirement or layoffs. It was a fact of life. Accepting this fact, my belief is that one is paid up to date, and the corporation does not owe the employee lifetime employment.

Bureaucracy – A corporate hierarchy by definition is a bureaucracy. Myriad layers of corporate approval always slow innovation. In the wrong environment, bureaucracy is a sure condition for good ideas to go nowhere.

The Good

Wealth Accumulation – Given the current state of our tax laws, corporations provide the average employee with a means for wealth accumulation. Many companies have 401k savings plans, often with generous matching contributions, health spending accounts, defined benefit pension plans, employee stock purchase plans, and medical, dental, vision and life insurance plans. In my experience a frugal secretary who took advantage of stock purchase and savings plans would be able to accumulate substantial wealth, often times in excess of a million dollars.

Freedom from Discrimination – With our wide range of equal employment and anti discrimination laws, employees of big corporations are largely free of discrimination. Although much maligned, the human resources department does ensure that employees are treated in accordance with the law and that the workplace is essentially fair.

Training and Promotions – Corporations provide their employees valuable formal and informal training. Further, many large employers pay for college and advanced courses, thus enhancing resumes and promotional opportunities, notably promotion from within, which increases seniority while maintaining job stability for an employee. I worked with many secretaries and paralegals who completed college and master’s programs, and then were promoted into management.

Ethical Conduct – Corporations promulgate codes of conduct. Corporations are serious about enforcing these codes of conduct, as ethical infractions could lead to criminal penalties and fines. While everyone can point to Enron and WorldCom as counter examples, by and large corporations are ethical bastions with numerous controls in place (internal and external auditors, compliance and legal departments) to deal harshly with violators.

Balancing It All Out

Regulators – Mr. Smith believes that large corporations can bend compliant regulators to their will. And yes, corporations are profit maximizers in any way they can be. They are going to try everything within the law to shape the regulatory environment in their favor. Mr. Smith fails to realize that this is not a one-handed game. Industry competitors, consumer groups and other activists are also lobbying regulators to bend the rules in their favor. One corporation cannot entirely shape a regulatory agenda.

Taxes – Commentators lambasted GE for investing in a huge tax department to avoid paying any US income tax. In law school one of the strongest mantras is: no taxpayer has an obligation to pay one cent more than is due. If one does not like GE’s tax avoidance, change the tax laws.

Technology – Much has been made of layoffs, outsourcing and the dispensable employee. Little thought has been given to the role of technology which has eliminated the need for many jobs. High speed communication innovations and faster, larger modes of transportation have made outsourcing of manufacturing and other jobs feasible. Are corporations supposed to retain employees when the job no longer exists or is uneconomical to perform in the US?

Man versus Machine

Corporations are a legal construct. They are created by humans and are flawed like humans. On balance, they probably do more good than bad. To particularize the current state of affairs, we live in a highly competitive, financially short sighted world. And knowing that means that the days of guaranteed employment, lush compensation and benefit packages, and benevolent corporations will not be returning in our lifetimes. In the end I guess no one likes to contemplate the thought that we are all dispensable.

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19
Jun 11

Are Corporations Really the Devil?

Charles Hugh Smith, a thoughtful, insightful and creative blogger, comments on economic, social and political issues. However, last Friday he departed from his usual fare, and launched into a corporation bashing diatribe:

Scrape away the Human Resource Department rah-rah about “our mission” and how much your loyalty is “valued,” and what’s left? A paycheck and a sucking sound.

Let’s state the heretical obvious: Corporate America, you suck. We could count the ways–subverting democracy via your lobbying and campaign contributions, your sabotage of competition via regulatory capture, and so on–but what really matters is how you treat your employees.

We know: you really care about your employees. Really. The propaganda would be laughable if it wasn’t so bald-faced. Do corporate managers really believe in the Big Lie theory, that the bigger the lie, the easier it is to sell? Corporate America Really Cares About Its Employees (Really)

For 32 years, I worked for two major corporations and had business dealings with scores more. While it would be easier to agree with Smith, a little balance is needed before falling into the growing populist past time of corporation bashing.

The Role of Corporations

Corporations have a simple mission: maximize profits for their shareholders. The rest is mere commentary. The public, our politicians and even the corporation’s own employees often have a difficult time understanding this concept or simple mission. These and other constituencies would like corporations to meet a number of additional Social Objectives: provide work to minorities, females, veterans and the handicapped; improve the environment; publicly eschew support for certain racist or totalitarian countries; refrain from the defense business; donate generously to charities; support local educational efforts; provide job training and help reduce unemployment.

These Social Objectives may have their foundation in law (anti discrimination laws, affirmative action), shareholder activism (restrictions on investment in certain countries), or social pressure (donations to local hospitals, arts initiatives and civic pursuits).

Maximizing Shareholder Value

A corporate CEO has many ways to maximize shareholder value. An enlightened CEO may embrace Social Objectives because they are good business. He or she may publicly embrace affirmative action, which may help the corporation hire more talented and diverse individuals. The corporation then can become an “employer of choice” for talented and progressively thinking individuals. When executives provide community service and make donations to local charities it burnishes the corporation’s image. This approach is especially helpful if the corporation makes or sells a consumer product or service; consumers then think of the corporation as caring and concerned when they go to buy a product. In the same vein, an enlightened CEO may wish engage in socially conscious investments: avoiding racist countries (South Africa when apartheid was practiced) or investing in environmentally friendly projects. Such foresight may limit shareholder complaints, encourage stock investment and again remove a barrier in the consumer’s mind to the purchase of the company’s goods and services.

A less enlightened CEO may adopt a different approach. He or she may decide on a ruthless cost cutting approach: no charitable contributions, and constant layoffs and firings to “keep the workforce on their toes.” Usually in this paradigm, executives serve on the boards of charitable organizations on their own time, and adherence to the equal opportunity laws is more marginal, or at best a lower priority,

Corporations and their Employees

Much of the anguish over how corporations treat employees is based in nostalgia and memory of how employees were treated half a century ago. Since I worked on employee benefits and compensation issues, I was privy to this history and the evolution of human resources and benefits practices.

After World War II, there was no better place to work than a large corporation. The War had effectively destroyed competition and America produced 50% or more of worldwide production. With large manufacturing firms such as GM dominating the economic landscape “30 and out” became a rallying cry to retain employees for a long period of time and then permit them to retire early. Thus, companies provided cradle to grave job security in the form of no layoff policies, free active and retiree medical insurance and lush pensions. When I first started work in 1977, if a manager needed an employee, he or she just filled out a requisition and called human resources to find a candidate. There was little or no questioning of a request to hire. Raises and promotions were plentiful. The role of human resources was to keep the workforce happy.

The world has changed. We have new technologies which have made the skills of many employees obsolete. We have foreign competition which has made the American worker seem expensive and unproductive compared to cheaper Asian employees. Finally, we have a financial sector which has glorified short term performance, over long-term investment in employees and the business.

Smith inveighs against the current notion of “dispensability” of American employees. But corporations were at their inception a legal invention designed to perpetuate themselves beyond the life of any one employee. Their essence is that all employees are dispensable, from the CEO to the loading dock worker. Even in the halcyon post-World War II days employees were terminated. Why is Mr. Smith surprised that corporations fire and lay off employees to maximize profits?

This more recent profit maximization formula has made the early post World War II era look extravagant and the current environment look harsh. But were corporations good then and bad now? Can we paint this picture in such stark terms? My next blog will explore this further.

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30
May 11

Wildfires and the Economy

Sometimes very wise things are also very simple: like a story for children. I am a mentor volunteer for local disadvantaged fourth graders. This week’s reading assignment was to read and discuss Wildfires, a short children’s book written by Seymour Simon.

The author’s theme seemed contradictory: wildfires are not always harmful. Rather, they are part of the natural cycle of forest life. They occurred well before man populated North America. Extended droughts provided the necessary environment so that when lightning storms arose, wildfires ensued. No firefighters or park rangers impeded the natural order of things. Eventually, enough rain fell to extinguish a fire, or a fire would run out of fuel.

In elegant language understandable to fourth graders, Mr. Simon advocates a controversial and grown up point. The US Forest Service actually did a disservice to the long term health of our forests. Our ecosystem needs fires to allow light to reach the forest floor, to remove kindling which could cause even larger conflagrations, to permit certain animal species to reproduce, and to allow tree seeds to travel and reproduce. New and natural growth cannot occur without the cleansing effect of a wildfire. We now understand that aggressive firefighting was poor governmental policy that actually damaged the environment.

An Economy Managed Like a Wildfire?

The economic analogy is obvious. When the 2008 great financial crisis occurred the Treasury and the government overreacted. Treasury pleaded with Congress to create bailouts: TARP, TALF and an alphabet soup of other programs. The Federal Reserve aggressively lowered interest rates to zero and made bank purchases of distressed mortgage-backed securities and other poorly-rated assets. Finally, the Administration went on a policy and public relations campaign to save GM, Chrysler, GE, AIG and other large private companies. Government chose to aggressively fight the financial wildfire.

Policy makers forgot that, like a healthy forest, capitalism requires “creative destruction.” Coined by Joseph Schumpeter in his work entitled “Capitalism, Socialism and Democracy” (1942), this term denotes a “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.”

In a properly functioning capitalist economy, old or dysfunctional businesses must be discarded and replaced by more dynamic enterprises. If not, we would still be powering computers with vacuum tubes instead of advanced generations of semiconductors.

Killing the Business Cycle

On Friday, David Goldman’s blog Inner Workings pointed out the fallacy of aggressive governmental steps to arrest the financial crisis. His prediction: we will be mired in a little or no growth mode for years.

I’ve been on Larry Kudlow’s CNBC show arguing that the US will have 2% growth indefinitely–no real recovery, no double dip, no banking crisis, but no bank stock rally. Today’s depressing numbers are in line with my depressing expectations. We’ve got a creative-destruction economy, without the creation: the startups, the venture capital, the entrepreneurship. MySpace and LinkedIn don’t count: they are a faddish extension of old technology, a means by which Americans who bowl alone can pretend to have lots of friends. The People’s Republic of America Reports 1.8% GDP Growth (or: Why this is NOT a Business Cycle)

Lending to create new businesses has evaporated. In fact, credit creation is moribund. Banks are happy to borrow at low interest rates and reinvest at higher interest rate government securities without undertaking the riskier business of lending. New business formation is harmed. Multinational corporations are satisfied with earning profits outside the United States, which means we have anemic job growth. We are mired in a non-recovery recovery.

Let the Light In

In our wildfire analogy, the largest trees are the ones that most need to be eliminated. These are the ones that block growth on the forest floor. Government may have temporarily arrested financial decline, but at what cost? I grant you that it will be painful to permit the creative destruction of our “tallest trees”: poor performing banks and industrial companies. The pain would be sharp but not prolonged. Using another analogy, we needed to rip the economic band aid off quickly to minimize prolonged pain.http://www.prophetwithoutprofit.com/wp-admin/post-new.php

Mr. Simon in Wildfires pointed out another flaw in aggressive fire fighting: putting out smaller fires too early. Dangerous residual undergrowth became tinder for more destructive, larger, out of control wildfires. Similarly, our government did not fix the financial problems of 2008; they only postponed our date with a larger financial conflagration.

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American Society / Corporate Behavior / International Finance / Political — 0 Comments
21
May 11

Abusing the Public’s Trust

Have national and internal political leaders had all their internal governors removed? We have had more sordid revelations of leaders’ sexual misconduct than we can turn into television dramas. And it doesn’t seem to matter whether these scurrilous doings are coming from leaders who lean to the left or the right. 1. John Ensign, US Senator from Nevada resigns in disgrace over an affair with a member of his campaign staff. 2. Arnold Schwarzenegger, former California governor, admits to fathering an out of wedlock child while married to Maria Shriver, mother of his four other children. 3. Newt Gingrich plans a run for President after admitting to various sexual indiscretions with Congressional aides while he was married. The list of figures is long and undistinguished, going back to Bill Clinton, John Edwards, Gary Hart, Ted Kennedy, and others.

Dominique Strauss-Kahn

Dominique Strauss-Kahn, President of the International Monetary Fund (“IMF”), was arrested in New York last week on charges of a criminal sexual act, attempted rape and unlawful imprisonment. He was alleged to have brutally attacked a maid in his $3000 a night suite at the Sofitel in mid-town New York. Mr. Strauss-Kahn was apprehended in his airplane seat (Air France First Class) as he prepared to return to Paris. See I.M.F Chief, Apprehended at Airport, Is Accused of Sexual Attack

Mr.Strauss-Kahn claims the sex with the maid was consensual. The investigators and the courts will sort it all out. More interesting is why there is not more of a public uproar about the extravagant lifestyle of this public servant. The IMF, an intergovernmental organization, oversees the world financial system and stabilizes exchange rates. Financial support comes from its 188 member nations. The United States provides over 16% of its financial support. As IMF President, Mr. Strauss-Kahn is paid approximately $420,000 tax free, with a $75,000 expense allowance.

Why is Mr. Strauss-Kahn staying in a $3000 per night suite? Why is he flying first class to Paris at public expense? The Air France website lists a first class round trip from Paris to New York at over $15,000. You think Mr. Strauss-Kahn could have crossed the Atlantic in business class or, heaven forbid, coach? Ironically, Mr. Strauss-Kahn is a leading figure in the French Socialist Party. Perhaps his personal socialist credo does not extend to travel arrangements.

An Overweening Sense of Entitlement

Our political leaders have anointed themselves modern day royalty. They bombard us with speeches about fiscal prudence, austerity and the sanctity of family. But their behavior speaks volumes as to what they really think of us: the rules are for us, not them. We are useful dupes to be manipulated and lied to, or at the very least soaked financially for our ability to enhance their lifestyles. How insulting that in the midst of an economic depression we get to pick up the bill for their personal extravagance.

Some Rules to Live By

It is not such a far distance to extend this criticism to our business leaders as well. As a former business leader, I felt a responsibility to my company and my employees. As a senior manager, I had great leeway in selecting hotels, restaurants and transportation. Except for air flights where I often could not obtain an advance purchase discount ticket, my basic rule was that I would not charge the company for any travel arrangement I was not prepared to pay for in my personal life. Thus, I would not take a limo to the airport, but used a local taxi service for one third the price. I stayed in modest hotels and chose a standard room. [Note: I stayed at the same Sofitel as Mr. Strauss-Kahn on a business trip, and the bill for a very nice standard room with tax was less than $300. Those suites must be something!] Dinner out was at a type of restaurant that I would take my family. I wanted my employees to understand that we were part of a profit making business. Our jobs were not in existence to enhance our lifestyle at company expense. Rather, we were fiduciaries of corporate funds and we needed to do our part to control expenses.

While sexual misconduct gets the headlines, it is the rape of the taxpayer (which does not get the headlines) which should be drawing equal public ire.

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Banking / Corporate Behavior / Executive Compensatio / Justice System / Political / The Federal Reserve — 0 Comments
22
Apr 11

Over Compensating

Executive compensation is a “hot button” issue. Corporate executives argue the need for a free hand in setting compensation: we must attract and retain high performing executives. They further argue that correctly tailored compensation creates appropriate incentives to increase shareholder value. According to this thinking, this aligns management and shareholder interests.

Shareholder activist groups strenuously disagree. Management over compensates itself, and awards senior executives hundreds of times the average worker salary. Equity compensation (options, restricted stock grants) richly rewards management at the expense of diluted shareholders. Even more egregious are executive compensation increases even when the corporation has a bad year or underperforms its industry peers. Boards of Directors, who should be guardians of shareholder interests, are often too aligned with ineffective management. True confession: executive compensation issues comprised much of my career. Generally, I agree with keeping the government out of the executive compensation process. In my view, management knows its own business and knows the market for top talent. With Board of Directors’ review, advice and consent, let management set compensation and let the chips fall where they may. Internal safeguards and shareholder activist groups inevitably punish bad or greedy managements.

However, there is one industry where the government needs to take an active role in setting executive compensation.

Is Goldman Sachs Allowed To Fail?

Simon Johnson, former IMF chief economist, asks the question: if another financial crisis appears would Goldman Sachs be permitted to fail and follow the Lehman Brothers bankruptcy route? See Could Goldman Sachs Fail? Johnson polled leading experts who unambiguously stated that Goldman would be bailed out again. Goldman’s balance sheet at $900b would be just too big to permit bankruptcy. Dodd-Frank legislation which has resolution authority to handle a large bankruptcy would be ineffective because of the international scope of Goldman’s operations.

While Goldman is one case study, Mr. Johnson could ask the same question about JP Morgan, Citibank, Wells Fargo or a number of other large American financial institutions. I believe he would get the same answer: they are too big to fail. Thus, the experts agree that these institutions have a favored position in the market place: they borrow at below market costs, and benefit from the full faith and credit guarantee of the US government.

A Modest Proposal or a Proposal for Modesty

Mr. Johnson posits that the only solution is to “press hard for higher capital requirements for Goldman and all other big banks.” More capital would permit absorption of more losses in the event of a financial crisis. Allow me to propose an alternative.

Goldman and other large banks pay out nearly half their revenue in compensation: amazing that this practice has not received more government scrutiny. As we know from Untimely News That’s Unfit to Print, the government is afraid to prosecute these banks for their financial misdeeds. How about severely limiting executive compensation?

I can hear the howls from Wall Street now. How can we attract the best talent? This is antithetical to the principles of the free market! Our work would not be properly valued!

When a bank accepts bailouts from the government (TARP), when it enlists the government to make good on derivative bets (AIG and Goldman), when it is subsidized by American savers through a zero interest policy, and when it receives a full faith and credit guarantee of the US government, that bank is no longer a free market enterprise. That bank is a ward of the state. As such, its compensation should look more like the federal civil service pay scale.

Controlling and changing bank top management pay scales in this way would be hugely beneficial:

Banks would be able to retain more earnings, and immediately improve their capital base.
Shareholders would benefit as more cash would be available for dividend payments.
The productive economy could successfully compete for the best university graduates.
Wall Street firms would shrink.
Systemic risk of too big to fail institutions would diminish as would rent seeking behavior.
The real economy would flourish.

Perhaps we should start a new campaign: Government Service Levels (GS) for Goldman Sachs (GS). Put more simply: GS for GS.

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Business / Consulting / Corporate Behavior — 0 Comments
22
Mar 11

Exposing the CULT in ConsULTant

Yves Smith of Naked Capitalism uses the insider trading accusations against Rajat Gupta, former managing director of McKinsey and former Procter & Gamble and Goldman Sachs board member, as a springboard to analyze the role of business consulting. See McKinsey, the Insider Trading Scandal, and the Problems with Consulting. Ms. Smith, a McKinsey veteran, catalogs the rise of her former firm and its current state:

McKinsey at the Beginning

Originally a time and motion study firm, McKinsey evolved to a premiere business consulting firm, selling its high quality, professional studies to large business clients. These studies purported to be fact based, objective analyses, “telling the clients the truth even if they might not like it.” A partner’s goal was relationship building and repeat engagements.

The intellectual heavyweights of the firm were top of the class MBAs from leading business schools.

McKinsey Now

Partners now consult on a specific problem and maintain relationships with the senior hiring executive to earn repeat business. Does the client now receive unvarnished truth or “leading edge conventional wisdom?”
Does the firm “add value” or ever change client behavior? On the contrary, I suspect the firm is serving as a kind of corporate therapist, only the patient never gets any better. Again, a great way to earn repeat business.
With a constant need to perform studies, keep young employees productive and cost effective, McKinsey gravitates to troubled client firms with weak management.
Despite efforts to maintain consistent professional standards and quality, the McKinsey product has varied widely by partner, with embarrassing episodes of falsified data and poor advice. Ms. Smith points to the AOL-Time Warner merger, Swissair bankruptcy, Enron collapse and other bad business strategies and outcomes as examples of poor consulting work.
To meet Wall Street competition for MBA’s, McKinsey raised rates and became an aggressive marketer of its services.
The Rajat Gupta allegations of insider trading undermine the expected trusted relationship between consultant and client.

See McKinsey, the Insider Trading Scandal, and the Problems with Consulting.

The Cult of the Expert

Ms. Smith expertly analyzes McKinsey’s rise and current path. She and I agree McKinsey’s current problems are emblematic of management’s over reliance on outsiders for analysis and decisions appropriately made in-house. At one time or another, my former employers have retained a number of the name brand consulting firms. A couple of first hand observations:

How naive to believe that freshly minted MBAs with little or no practical business experience can add real value. These neophytes write well, dazzle with mathematical formulas and research, but are short on wisdom, judgment and usable advice.
Most of consultants’ research studies can be replicated by sending one’s own very bright employees to a corporate or local university library. In fact, I routinely turned down hiring a consultant and used my own staff to research business problems. The results were excellent and very practical. [Note: my staff should produce quicker, better cost-effective results; they know the business and are not billing by the hour.]
Insecure or weak managements are the target client base for business consultants. Insecure management lacks confidence in its own judgment, thus creating a need for consultant validation.
The corollary to “insecure management” is “cowardly management.” Unfortunately, many times management demonstrates both traits which opens the door to long-term consulting engagements. Consultants provide “air cover” for this folly: McKinsey is the business version of a “Good Housekeeping Seal of Approval.” In response to internal or external criticism of a business decision, management can respond that “I was merely following McKinsey’s recommendation.”
McKinsey can also be the CEO crutch to convince a skeptical or spineless Board of Directors to approve an important corporate decision: spin off a division, merge with another company, discontinue a pension plan, increase debt to equity ratios, or other corporate level actions implicating the fiduciary duty of the director to the shareholders. An Ivy League-trained senior consultant, speaking in well modulated tones with multi-industry experience, backed by a wealth of data and analysis, can serve as the “closer” to convince the Board to ratify management’s strategy.

Human Nature

In narrow specialized areas, the cult of the “expert” may be useful. An expert can diagnose a cancer or heart disease and in many cases successfully treat it. Alas, business is not like medicine. Rather, it is a blend of art, science, psychology, economics, mathematics, marketing, law, accounting, finance, experience, and old fashioned common sense. Rarely is there only one right answer. But we are all entitled to our own levels of insecurity. And yes, it is good to have facts and rigorous analysis.

I worked for organizations that over used consultants to the point of undermining and neutering their own senior management. I also worked for an organization that used virtually no consultants; their reluctance reinforced the insularity in their own management group. A well-defined and limited role for a consultant indeed exists. A good consultant can help with areas of uncertainty or in house inexperience or lack of resources. Importantly, a good consultant will even provide a new perspective and derail unproductive in house “group think.”

One of the eternal truths is that no one can guarantee the perfect answer to a business problem. In the end it is a CEO or senior executive who must decide and be held accountable. Jean Francois Revel wrote about the European cult-like infatuation with communism in “Without Marx and Jesus.“ Perhaps we need to debunk the cult of the all-knowing business consultant. Maybe we could prepare a study entitled: “Without McKinsey or the Boston Consulting Group.”

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