Out of the Economic Quagmire
History has a way of repeating itself, even in “once in a century” financial crises. A mere 20 years ago, the markets also faced rapidly escalating oil prices, a credit crunch and calls for deregulation. In 1987, virtually overnight, the tide came back with a vengeance. The Federal Reserve, concerned about inflation, cranked up interest rates. The oil market took a huge drop. Real estate tanked.
While Mellon Bank Corp. had profited from a market fueled by real estate speculation, swelling oil demand and access to cheap credit, large investments that it made in Louisiana, Texas and Ohio were suddenly worth a fraction of the money lent. Payments on junk bonds that financed everything came due - and the bank faced the first loss in its 120-year history.
But within a few years, the money management giant pulled itself out of a downward spiral and became healthy enough to acquire mutual fund services firm Boston Co. and merge with asset manager Dreyfus Corp. The key to Mellon’s rebirth was another lesson from history: A company cannot successfully pull itself out of trouble without assiduously applying transparency and honesty.
At Mellon, an insistence on transparency came from a new CEO: financial industry veteran Frank Cahouet. From the outset, the strategic approach at Mellon was what has become called a “good bank-bad bank” strategy. The bank publicly created a subsidiary that would hold all of the “toxic” assets and whose staff would be dedicated to selling them - a move that eventually helped improve the quality of the bank’s portfolio. The rest of the institution focused on rebuilding and moving forward. But what made the whole operation work were principles, coming from Cahouet himself, of complete transparency and honesty, according to Michael Bleier, a partner in the law firm of Reed Smith who served as the bank’s general counsel at the time.
“Frank put his stamp on everything,” he says. “He wanted to know what was going on and be involved. He would have staff meetings starting at 5:30 in the morning. If there were problems, he wanted to hear them so he could get on top of them. But he didn’t shoot the messenger.”
There in a nutshell was the philosophy: Face trouble head-on so you can know what to do, and never punish the people who have to deliver the bad news.
From the top, the push for transparency spread throughout the organization. The management team held extensive series of meetings with staff - back before email could disseminate information easily - and explained exactly what it was doing and why. “It was very critical,” Bleier says. “People could exhale, finally, and focus on moving the company forward.”
For example, as part of its strategy, Mellon had to create the “bad” bank - Grant Street National Bank -to take on the bad debt from Mellon, liquidate those assets and then go out of business when the notes were paid off. Without honesty and trust in the operations, the employees who transferred over to undertake the liquidation might have panicked, thinking that they would lose their jobs at the end of the exercise. Instead, they had Cahouet’s word that they would have jobs with Mellon again after Grant was shuttered.
There would be no hiding by anyone. “[Cahouet] even told me once that if I ever saw him doing something wrong … to take it to the board of directors,” Bleier remembers.
Holding the CEO to that degree of accountability may sound bold, especially now as people point fingers at each other, trying to identify the scapegoat for the current economic fiasco. But it is a basic necessity to put a company on a path toward corporate health in tough times.
Lessons for Today
“The financial crisis sprung from the fact that executives were free to lead their companies into risks they did not understand and could not manage,” says Robert W. MacDonald, former CEO and chairman of Allianz Life and author of “Beat The System: 11 Secrets to Building an Entrepreneurial Culture in a Bureaucratic World.” Only “disclosure and transparency in all financial services activity [can] create the international-level playing field that will allow the strengths of a true, entrepreneurial open market to re-emerge and grow.”
Many businesspeople talk about transparency as a single thing, but it actually comprises four types of transparency: to markets, to employees, to managers and to customers, experts say. Each type of stakeholder has its own needs and concerns. But to pull out of trouble, a company needs the cooperation of each. Any single one can block any progress - and will, if it feels that the company is lying or hiding information.
Investors are nervous when they see their money at risk. Most are willing to have a management team take necessary steps to turn a company around, but only when they get a real appraisal of the circumstances. When executives say one thing and then contradict themselves, investors lose confidence.
“I think if the CEO stands up in front of investors and says the big news at the end of this quarter was, ‘I didn’t know what was going on,’ then that is clearly a reason for the investors to run for cover,” says Mark Collinson, a partner with CCG Investor Relations, a financial communications firm.
But it’s not just investors - employees lose confidence as well when management isn’t being open and honest about the health of the company. When employees don’t trust management, it drags down the morale and pierces a hole in the core of the corporate culture. This is why the standard advice to businesses is to discuss all necessary changes up front and not drag them out.
In May, Wawa Inc., a mid-Atlantic chain of convenience stores and gas stations, followed this advice after it was hit by the current economic downturn. Management calculated what steps all would need to take - and then communicated the plans to enlist the cooperation of employees.
“We went through and shared with our associates the things we are going to do from a cost-reduction standpoint, an employee standpoint and pricing,” says Blyth McGarrie, who serves on Wawa’s board and is also the CEO of management consulting firm LIF Group. “A vacuum needs to be filled. It’s up to senior management and the board to communicate the facts and the story. If you don’t, people will make their own up, and it’s usually much worse [than reality].”
A management team that proceeds without transparency loses control of the situation. “What are [employees] telling your customers?” asks Guido Quelle, managing partner of Mandat GmbH, a German management consultancy. Customers pick up on the uncertainty and dissatisfaction of the employees. Those customers have their own interests to consider. When they sense distrust in the air, they are likely to take their business elsewhere, making recovery next to impossible, says Quelle.
Often the most difficult part of the process for rebuilding a company is the third part of the equation: management’s need for transparency. After all, these are the people who see the unvarnished information and who should know what it going on.
But that’s not always true - executives often have an incomplete or warped view of their operations. A recent study by management consulting firm the Hackett Group found that two-thirds of corporations cannot predict earnings for the next quarter with accuracy and are from six to 30 percent off in their calculations.
“It’s saying that a lot of companies in the forecasting process for many years have just been going through the motions,” says Bryan Hall, Hackett’s finance advisory practice leader.
Companies largely use the same forecasting approaches they have for decades; only today’s increased financial volatility has underscored their weakness. Look at the instability in financial institutions. Executives had put their entire belief in risk management models that only approximated reality. Decision makers then pushed the bounds, Hall says, changing underlying assumptions so they justify bigger risks until institutions were vastly over-leveraged without reserves to cover their positions.
“Nine out of 10 companies do not know what their gross profit is,” says Neil Goldstein, a principal of Management Services Consultants LLC. “They think they do, but they’re wrong.” For example, they will forget to take bad debt, discounts and allowances into account when looking at sales prices. His view may be partly formed by working with troubled companies, but there is other supporting evidence.
Why don’t executives face facts? “Reason No. 1, No. 2, and No. 3 is denial,” Goldstein says. “The leader of the company … is denying that Joe can’t sell, that his people can’t collect, that he has the wrong inventory and products. He needs to let go of his ego and see [what's actually there].”
Ego was apparently not a problem for Cahouet. He always refused to let reality take a back seat to his self-image, says Bleier. “I really respect him for what he did,” Bleier remembers. “He wanted to know what was going on and be involved. He felt that was his job and his responsibility, ultimately. There’s nobody like Frank.”
*Erik Sherman has been writing about business and technology for more than a dozen years, with articles in such publications as Newsweek, Fortune, the New York Times Magazine, the Financial Times, Chief Executive and Advertising Age. He has also worked a business consultant and spent years in corporate management. He is the co-author of “The Everything Leadership Book” (Adams Media Corp., 2008).
Last 5 posts by Erik Sherman
• Truly Saying, 'I'm Sorry' - April 30th, 2009
December 12th, 2008 at 7:53 pm
Excellent article - I am still dumbfounded by the company leadership that invested in (or insurance) financial instruments for which they knew or should have known. they could not properly value.
June 16th, 2009 at 11:26 am
[...] After a humble start in 1869 in Pittsburgh, Mellon Bank became a powerful and prosperous industry leader in wealth management for millions of investors. But by 1987, it was facing its first loss in nearly 120 years. The bank’s stock price slipped, and Frank Cahouet was brought in as the new CEO. [...]