When you work with senior executives and boards of directors as long as I have, troubling behaviors that directly affect corporate performance become all too clear. And a number of major corporate failures we’ve all seen in the news can be traced back to these behavioral characteristics. I’ve coined names for these bad habits. Worst is “keeping up with the Joneses” syndrome, followed by its two corollaries: “best practices” and “groupthink.”
We know that businesses must take risks to carry out their missions and to drive toward achieving growth and profit. We also know that competition is inherently good, bringing out the best in capable people and organizations. Similarly, benchmarking against high-performing organizations is a useful tool for measurement and improvement. All that is obvious.
Where organizations have failed (often spectacularly) is when a healthy competitive desire turns into an obsessive need to match peer performance, regardless of extraordinarily high risk and possible ultimate cost. The result in such circumstances can mean betting the ranch, and then losing the bet. Some examples immediately come to mind where trying to keep up with the Joneses had disastrous results.
Among the more recent is the implosion of major investment banks such as Bear Stearns, Lehman Brothers, and Merrill Lynch, among others. There are a number of reasons for their demise; senior executives looking greedily at the vast amounts of money being made in the collateralized debt obligation market by their competitors is one of them. When regulatory restraints were lifted and leverage soared, a seemingly insatiable appetite developed to grab, package, and resell the securitized assets. Yes, these companies used value-at-risk models and other risk-management procedures (see my prior columns for how “well” they were applied). But with compensation programs motivating behavior and what many are calling inadequate oversight by boards and regulators, senior managements were driving at breakneck speed toward the goal of “more and more.”
We saw similar behavior at Countrywide Financial, Washington Mutual, and other banks, and mortgage brokers and others generating the NINJA (no income, no job, no asset) and “liar” loans, and other mortgages where borrowers had little chance of keeping up with payments unless the market values of their homes continued to rise. Here greed, with up-front payments to these institutions and managers, was a driving force. Money was made hand over fist with little effective oversight.
In the early part of the decade Arthur Anderson, one of the (then) Big 5 auditing firms, which was held in high esteem both within and outside the profession, was brought to its knees and ultimately folded. The failure had many causes, but one stands out in my mind: Having lost its consulting arm in a major court case, Andersen’s management was hell-bent on rebuilding the firm’s advisory practice. One of management’s fateful decisions was to let audit decisions be made closer to the client, in the context of developing better client relations. Then the Enron debacle came along, where one individual—the engagement partner—overruled the better technical knowledge and business judgment of the national office, and made the final decision to approve Enron’s financial statements and then engaged in the fatal document destruction.
During the dot-com years, telecommunications companies watched in awe at WorldCom’s tremendous growth. They modified their strategies to keep up, investing heavily in the quest for more broadband capacity. It turned out, however, that much of the so-called growth touted by competitor WorldCom was the result of fraudulent financial reporting. That didn’t help the companies that poured their dollars into capacity nobody needed.
More recently, managers investing college and university endowment funds were looking enviously at the returns of the likes of Harvard’s and Yale’s funds. Trustees and alumni were asking, “Why can’t we do that?” Well, soon more and more of these institutions’ money was poured into a slew of alternative investments, generating higher returns—but with increased risk. Many of these funds have since been devastated, and the schools now need to cut their offerings to students dramatically. The same goes for state and municipal pension funds, which also invested in higher-risk investments and are now suffering extreme shortfalls.
And of course there are those investors seeing colleagues and friends earning 10 to 12 percent returns year after year, in good markets and bad. Despite some difficulties in getting a piece of the action, they persevered and finally succeeded in gaining entrée to participate in this outstanding investment vehicle. Unfortunately, the mastermind was a guy named Bernie Madoff. We all know what happened to those investments.
While each of these situations described above has their particular sad details, a common thread does connect all these disastrous business decisions: a driving need to keep up with competitors or friends, regardless of whether they were running like lemmings off the edge of a cliff.
Mistake No. 2: Best Practices
How can anyone argue with “best practices?” After all, isn’t “best” unquestionably the ultimate? Unfortunately, this term (and others like it, such as “leading” or “leading edge” practices) too often is used to describe what really are common practices, or practices that successful organizations use with little evidence that those practices actually drive success. While following so-called best practices can be viewed as learning from the successes of others, there’s also a potential trap of blindly following what others are doing.
At the risk of being immodest, I’ll point to a book titled Corporate Governance and the Board—What Works Best, which I spearheaded in 2000. By way of background, the project initially focused on a broad-based survey of board practices. When I took over responsibility for the book’s development, it became clear that examining what were in reality “common practices” wouldn’t benefit the corporate director community. There was already too much focus on surveys and peer comparisons, so we shifted tacks.
Instead, as noted in the preface, the book was
“… developed with face-to-face input from some of the most experienced, savvy directors anywhere on the globe. With that, along with ideas of corporate governance thought leaders, a survey of board members and PricewaterhouseCoopers’ own experience with leading companies and their boards, we’ve put together the best of the best. It might be called “best practice,” but indeed no board, even those of successful companies with the largest capitalizations, is utilizing everything suggested here. To be clear, this report does not set a common standard, and certainly not a minimum one … It sets the bar at the highest level to make a board most effective in enhancing shareholder value … Accordingly, some boards will find they need to jump much higher to measure up, whereas the best boards can reach the goal of broad-based excellence more easily and quickly.”
Indeed, this publication has stood the test of time because it was forward looking, grounded in what were truly the most successful practices and extending to what was needed to further enhance board performance.
The point here is that truly successful managements and boards, while certainly aware of what others are doing, do not fall into the trap of following the herd. They recognize common practices for what they are, and operate in more effective ways that drive success.
Consider CEO compensation. We know that many board compensation committees were following what was called a “best” practice but in reality was merely a common practice of using peer comparison as a central feature in determining CEO compensation. Among the results was the Lake Woebegone effect, where every CEO had to be above average. The thought was if a board was doing its job well, then the company’s CEO must by definition be “above average.”
Well, while peer comparison done with the right peer group can be a useful tool, the more effective boards directly link compensation to the company’s strategic plan. Relevant performance metrics motivate not short-term revenue but long-term return and shareholder value. While reflecting marketplace realities, compensation is geared to achievement of specified performance measures, aligned with board-approved risk appetites. And of course, change-of-control and other severance arrangements are well thought out and tested in advance to avoid the kinds of outlandish payments we’ve seen all too often.
Similarly, years ago it was common for compensation committees to rely on compensation consultants engaged by the company’s management. Some knew even then that it makes a lot more sense for the committee to hire its own compensation consultants, avoiding potential conflicts. What was once seen as a “best practice” now is shunned; the use of independent compensation consultants is now widely viewed as superior. In these and other cases, there’s little doubt that the so-called “best practice” sometimes is anything but the best.
Groupthink
You’ll remember at the outset of this column I mentioned two corollaries to keeping up with the Joneses. We’ve addressed one here, the concept of so called “best practice.” Next month I’ll describe how boards and managements can get into trouble with something called “groupthink,” and how they can break themselves from that bad habit. Please stay tuned.
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