What price a lost reputation? In the aftermath of high-profile corporate collapses, businesses are finding out just how much it has cost, and pondering how to recover. By David James & Leon Gettler
William Shakespeare’s character famously comments: “He that filches from me my good name, robs me of that which not enriches him, but makes me poor indeed.” This insight is a good place to start when considering current management challenges. Polls show that the recent spate of monumental bankruptcies has shattered the reputation of business. In one United States poll, 35% of the community said it had no real confidence that business was fulfilling its responsibilities. This was up sharply from 21% four months before. Another poll found that people had more faith in politicians than in business leaders.
The issue for corporations is how to go about restoring trust. David Hale, chief economist for Zurich Financial, says the current divergence between the US equity market and the US economy is the greatest in memory, because of shock stemming from accounting fraud and other corporate governance abuse at several large companies. Hale says there is a risk that the new regulatory mood will cause accounting firms and corporate management to become highly risk averse, thereby hampering the growth of corporate profitability.
The only way Hale’s pessimistic scenario can be averted is to restore trust. Without greater trust, investor confidence will not return. And greater evidence of enforcement will be needed. At the moment, the reputation of business leaders is low: the evidence indicates that senior managers have been helping themselves under the guise of “showing leadership” and “doing business in a different way”. It is as though the degree of abuse and greed has been directly proportionate to the level of hyperbole emanating from self-aggrandising business leaders. The problems have not been as severe in Australia, probably because the possibilities were fewer, but excesses at Harris Scarfe, One.Tel and HIH have done harm to the wider reputation of business and shaken investor confidence.
Who owns what?
One of the first issues to consider is the mantra that corporations are there only to maximise shareholder value. This is not to imply that shareholders are unimportant. Strong capital markets underpin strong economies and solid returns for investors underpin strong capital markets.
In recent years, however, questions have been raised as to whether the pendulum has swung too far, that other stakeholders, such as customers and employees, have been sacrificed in the name of shareholder returns.
These criticisms overlook a fundamental shift in the market, a development that makes any re-alignment more difficult. The nature of ownership has been redefined because of the growth and institutionalisation of markets underpinned by mandated superannuation.
The booming funds-management sector has sophisticated systems for benchmarking managers against indexes and peers that in turn put pressure on managers to toe the line. This creates tensions, because corporations operate in different time-frames and strategies take much longer to pay off. Hence the blurring of definitions as to what constitutes ownership.
Companies are now more aware about the need to rebuild franchises with customers, employees, suppliers and communities. But because of these tensions, few seem to know how to do it. An Ernst & Young global survey has found that companies are embracing corporate social responsibility (CSR) strategies but few seem to know what it means. According to the survey, 71% said they had strategies, or were developing some, for dealing with ethical, social and environmental issues. Only 9% said they understood how CSR was relevant to their business.
Charles Handy, one of the world’s leading management philosophers, believes that the concept of ownership will be redefined with more power going to key stakeholders in the form of the talent in the company. Handy says: “We talk about shareholders owning the company but they don’t really. They are actually betting on it, rather than owning. So, they don’t have any of the responsibilities of ownership. If they don’t like the company, they can just go away.
“What I think is going to happen is that the owners of the intellectual property will become more powerful because they will have more bargaining power with the board and with management.”
Management specialist Henry Mintzberg believes that the underlying problem is in the way that management language has been skewed and forced in a certain direction.
Mintzberg said in an interview in the New Scotsman: “It can be a kind of legal corruption: a corruption of values; a corruption of attitudes; a corruption of responsibility. The system is sick right down to its roots. Call it shareholder value or whatever, but the obsession with narrow performance and economics skews the way that people think and act. Businesses can’t function without some degree of social responsibility.
“Companies have to balance the social with the economic for their own good as well as for society’s good. But even CEOs are just cogs in the machine. How are they going to stand up to a board that sees shareholder value as the only important dimension? Solzhenitsyn said a society that has no rules, like the communist society, is abhorrent; but a society that only stays within the letter of the law – he had the United States in mind – is not much better.”
David Maister, regarded as the world’s leading authority on professional services firms, has put some of the blame on business schools. Put simply, they have failed to produce better managers.
A former faculty member at Harvard Business School, Maister also holds degrees from the University of Birmingham and the London School of Economics, and a doctorate in business administration from Harvard Business School.
Maister says: “The pure MBA doesn’t have a great track record, because the secret of success in business is not the analytics that they teach you in MBA school. The real talent in management lies beyond the analytics. There are too many MBAs who come out like me: smart, educated, know all the analytics and can’t manage their way out of a paper bag. In the end, management is fundamentally human. It’s interpersonal, it’s personal, it’s social.”
Maister highlights two recurring problems: one structural and one moral. The structural issue is the misunderstanding of client relationships. “The auditors problem, as I see it, is that they have recently, meaning the last 30 and 40 years, taken the view that the companies they are auditing are their clients; which, by definition, is idiotic. The whole purpose of an audit is not to view the company as the client. Their public obligation is to be an outside observer. It is rather like imagining that a restaurant hires its own health inspector, chooses the health inspector, retains him and fires him. An audit should be that the obligation is not to the company but to the shareholders.”
The moral issue is familiar enough: who wants to be a whistleblower? “If you see someone about to commit a crime, then you have not only a moral but also a legal obligation to report it. The question then becomes, how many consultants would do that? Most consultants, including me, if they saw their client doing shady stuff, would resign. I would walk. I am not sure I would be the whistleblower to turn them in. I am not proud of saying that. But the honest truth is that I don’t have the legal obligation to be a whistleblower and I do not know if I have the amount of personal courage – I am not sure I would do the right thing.”
Who’s a crony capitalist now?
The problems may go deeper, to the heart of what constitutes the best way of conducting business. The US-style of capitalism until recently was thought to have won the day over Asian corporatism and the European “social market” model (high levels of bureaucracy and imposed social responsibility). It is now seen more as an exercise in theft. Many business leaders, once lionised, are seen as little more than self-appointed robber barons. US ideas enjoy great currency in Australia, so the effect of this ideology has been felt here, although few Australian business people have engaged in comparable excesses.
At heart is an uncertainty about the best way of leading companies for an economy and a society. Should entrepreneurs be encouraged to be selfish, in the belief that the effects of that selfishness will ultimately create a dynamism that leads to a greater good: more wealth, more innovation? Or should business leaders be subject to constraints from the outset and encouraged not to think just of themselves but of their wider social responsibility?
Until recently, dramatic stockmarket growth in the US seemed to imply that selfishness was good, if not for the individual, then at least for the wider economy (and, by extension, society). It was also believed that corporatism and social-market structures encouraged corruption or, at least, cronyism, that caused great harm to the societies involved.
The picture is now not so clear. Yes, corporatism has its dangers, as demonstrated by Japan’s decade-long squandering of national wealth and its political inaction. But other Asian economies, such as Malaysia and South Korea, have recovered economically without changing their corporatist styles fundamentally.
China’s emergence, regarded as one of the most sustained wealth-creation achievements in history, has been undertaken within a communist-style corporatism.
Yes, the rigidity of European social-market capitalism is unimpressive, as evidenced by the absurd and damaging Common Agricultural Policy, which punishes poorer countries and threatens to bankrupt the EU. The level of European bureaucracy also can be damaging.
France, for example, spends half its GDP on government. But Europe has not experienced the kind of recent shocks that have beset the US, and it is at least trying to develop a balance between social and economic goals.
The US does not have an unambiguously superior style, either. Or, more accurately, the latest version of American “greed is good” is not really US-style capitalism at all, which in the earlier part of the century had a deeply moralistic character.
Working hard, creating wealth and developing civic responsibility were all aspects of the same thing: being a good citizen. There was little need for corporate social responsibility charters because they were to some extent assumed. The “man in the grey flannel suit” – the mythical management emblem of the 1950s and 1960s – may have been dull, but he did have a sense of civic responsibility.
See selfishness, dump stock
Maister says the guideline is simple enough: if it is clear that business leaders are concerned only with themselves rather than the enterprise, then run a mile: “Ray Kroc, the founder of McDonald’s, said ‘You must be able to see the beauty in a hamburger’. Most people would laugh at that. But a moment’s reflection would tell you that it has got to be right because you can’t become the dominant player in your industry if your view of what you do is that ‘this is junk for idiots’. The way you make the most money is that you cannot take a cynical, detached money-based view of what you do.”
Maister says the people who make the most money have an ideology: “[Those] who go from good to great, are led by managers who are not personally selfish but are ambitious for their organisations. You don’t create Microsoft by concentrating on making money.
“The data is clear. There is no generational divide. There are no systematic effects. The superstar managers, by which I mean people creating double the growth rates, are not a demographic. It wasn’t gender specific, it wasn’t age specific, it certainly wasn’t across firms worldwide. Just individuals. They were men and women of conviction – interestingly enough, not the same conviction.”
Greed is nothing new – investor disappointment may represent a healthy dose of realism after one of the longest bull markets in history – and finding the best way of balancing entrepreneurialism and social responsibility is a problem that admits no obvious solution. It could be argued that the current pessimism is just a rebalancing of forces perpetually in opposition.
But for managers faced with the need to improve reputations, what is required? In a public environment in which people are increasingly aware of the tricks of public relations and “spin”, just hiring some image experts will not be sufficient. The key to restoring reputations is the management of expectations.
Tom Copeland, a finance consultant with Monitor Group, a consultancy co-founded by Harvard academic Michael Porter, says the evidence suggests that share prices reflect changes in the long-term expectations of a company’s performance (putting paid to the idea that the sharemarket is oriented to the short term). “The expectation is that the long term is always from today forward. When we get new information, the new information may cause us to revise our expectations about long-term growth.
“Management doesn’t just send a signal; it sends that signal with clarity or with noise. A signal is the difference between actual earnings per share and expected earnings per share (eps). Take a company whose expected eps is $1 and the actual eps is $1.25; the earnings surprise is a signal of 25 cents. The noise is the standard deviation of analysts’ forecasts. If the signal is that earnings are up 25 cents and analysts agree that it should have been a $1, then analysts all revise upwards. But, if the range of analysts’ forecasts was $1 to $2, then some will go up and some will go down. We say, first of all, that you want to exceed expectations, because that is what increases the value of the stock. Second, you want to set expectations in an unbiased manner. That is surprising.”
Copeland says honesty and realism are also important in setting expectations with staff. “Setting expectations happens not only externally but internally. That means the budgeting process has to be done well. If the budget is a paper exercise, you haven’t set expectations. And compensation that is based on exceeding expectations doesn’t mean anything. Internally, setting expectations provides an incentive to lie, because every junior manager tries to sandbag every senior manager – this is a terrible idea. “As I become better informed, I can have a better-informed dialogue, so I can set a reasonable target. Traditional performance measures simply say, here is the cost of capital, go earn the cost of capital. Some business units earn more than the cost of capital perpetually. They have barriers to entry and so forth. They earn 30% a year and the cost of capital is 10%. Beating the cost of capital is a slam dunk and doesn’t create value. They beat the cost of capital perpetually. Expectations-based management requires an informed dialogue internally and externally.”
Restoring reputations is thus not so much a matter of being an ethical or well-intentioned person – although that will certainly help. It is a matter of improving relationships with the markets, with staff and with the wider community. Maister says: “It turns out that the essence of a managerial job is inter-personal skills. Can you motivate large numbers of people? Yet we very rarely choose managers based on social skills. We don’t train them.”
By James Kirby
As corporate Australia undergoes an adjustment to a new era of tighter regulation, maybe it is also time to stamp out hypocrisy in high office.
There is no better place to start than the banking sector. The banks already have a record in this area, the outstanding precedent being a decision by the Australian Bankers Association to pay Sydney radio commentator Alan Jones for positive comment on air.
More recently Chris Corrigan, the joint owner with Richard Branson of the Virgin Blue airline, has launched a bruising campaign against Macquarie Bank in a contest to get access rights to the former Ansett flight terminal in Sydney. Corrigan, the chief executive of Patrick Corporation, has vented most of his spleen against banks.
Corrigan fails to mention he is a banker himself and rose through the ranks at Bankers Trust Australia before launching into the transport industry. John Symond, who became a member of the Order of Australia in the New Year’s honors list last year, has made a career of “beating the banks”. Symond’s Aussie Home Loans has always pitched itself against the banking industry. Symond touts the business as the home-loan shop for the “Aussie battler”. Yet PUMA, the mortgage securitisation arm of none other than Macquarie Bank, heavily financed the Aussie Home Loan operation from the beginning.
One of the benefits of a recession is its purgative quality. Investors go back to basics. They want five-year profit records, they want profit forecasts not profit projections, and they want leadership not hype or hypocrisy. Every recession reveals the buccaneers, who at first are held to be business leaders. Ten years ago it was Alan Bond and John Elliot. This time round it is Jodee Rich and Rodney Adler.
Yet, to be fair to the fallen, the hypocrisy at high levels of business is by no means local. The worst perpetrators have been overseas. Bernard Ebbers at World-Com is a standout this year. Ebbers put pressure on workers at WorldCom not to sell their company stock even as the now bankrupt group’s shares were in freefall.
But first prize goes to Percy Barnevik, the former head of Asea Brown Boveri. Regularly voted the most admired business leader in Europe in the 1990s, Barnevik forgot to give his board the details of his $160 million pension payout. Earlier this year, the company launched an internal inquiry to review the pay-out at a time of losses and a decimated share price. Barnevik’s name has no doubt been quietly removed from the business-school case studies. Perhaps before lauding the next generation of business leaders, the business schools (and journalists) should look a little harder at the history of their heroes.