The ongoing scandal regarding big banks’ manipulation of LIBOR is just the latest chapter in a depressing litany of stories of once highly-reputed organizations which have been revealed in the past few years to be both ethically-challenged and poorly controlled. Whether the manipulation was done to manufacture trading profits or to conceal the weakness of a bank’s credit standing, the practice was obviously illegal, harmful to the bank’s customers, and inevitably damaging to the reputation of both the banks involved and the industry of which they are a key part. J.P. Morgan’s “hedge” gone wrong to the tune of $6 bn and counting is another example of the sort of corporate misbehavior which used to be rare, and on a much smaller scale than it now is. The industry has been under a political microscope since the Great Crash and bailouts of 2008. Yet the scandals keep arriving.
One possible explanation is that banks have now grown so large and complex that no one can adequately manage them. Another is that personal morality throughout our society has become so weakened that more and more individuals feel that they can cheat without getting caught. A third is that the industry as a whole has become hopelessly corrupted by the markets’ attitude that anything goes so long as investors can make a fast buck from a bump in corporate profits, no matter how ephemeral this may prove to be. (And lest the bankers feel unfairly singled out, I must add that scandals of this same general type are by no means limited to the financial services industry.) There is a common thread running through all of these possible explanations: the collapse of unique corporate cultures.
Corporate cultures do not have to be positive forces, of course. There have been companies characterized by a tendency to cut corners from their inception, there have been companies which have historically been risk-averse to a fault, there have been companies which have tended to inbreeding and a reluctance to embrace or even acknowledge any innovation in their own industry. But such maladaptive cultures have usually limited the growth of a company, or doomed it to an early demise, unless they were counterbalanced by other strengths—either of culture or market position—which more than compensated for harmful internal tendencies. So if we’re dealing with companies which at least have been successful in the past, which is usually the kind whose disasters which make front page news and wipe out billions in investors’ equity, there is not only a defective corporate culture at work, but usually a previously-hidden flaw exposed, or even the collapse of a once-strong culture. And the question is: if this is becoming more prevalent, and it seems to be, why?
One manifestation of this is that if one mentions the term “corporate culture” to the majority of active investors today one is likely to be met with a snort of contempt. The model which so many fund managers depend upon today is completely mechanical. The company is a black box into which one feeds the proper growth ingredients, and—bingo!—an unexpected earnings increase jumps out, accompanied by a sharp rise in the share price. This accomplished, the investor moves on to the next black box. The human element does not usually figure into these calculations, unless perhaps it is some mystical belief in the identity of the CEO who supposedly controls all the processes taking place within the box. Keep the CEO (at least until the market becomes disenchanted with him) and the profits will continue to spurt out. If problems emerge, and the machine becomes less reliable at producing the requisite returns, a change in CEO is expected to rectify all problems, at least those not fundamental to a declining industry. There is something about the quantitative mind which refuses to believe in human variables (just as, of course, there is something in the humanistic mind which refuses to believe in quantitative constraints.)
Thus, very little investor attention is given to the cultural elements which have made some companies reliable growth engines for many years, even in industries with thin margins and significant cyclicality, or those of others which have been proven again and again to be capable of developing and exploiting innovations, even if they could not always sustain their profits once others joined in on the new trend. There are companies which seem to manifest a ‘manic-depressive’ tendency, with extreme profit rises in every boom and exaggerated falls in every bust, yet, beyond the structure of the balance sheet, few analysts and fewer PMs ask, “Why?” There are companies which may manifest a significant degree of paternalism towards their employees and in any case are known to be good places to work for, and others which are known to churn through their staffs like a giant thresher moving through a field of wheat. Any effect this might have upon a company’s ability to execute a new strategy, manage a difficult transition, or escape from difficulties tends not to find its way into brokers’ reports.
Behind this cultural context, there is often the phenomenon that some companies have a history of producing a positive ‘alpha’ for their shareholders, and others for which the alpha tends to be negative. Again, there is not enough introspection upon this effect, particularly in boardrooms, where it is often taken for granted. Especially in the U.S., and increasingly in the U.S.-modeled business culture of the City of London, this sort of factor tends to be ignored whenever a company faces a problem, or simply finds itself in an industry in a state of rapid evolution. New managers are brought in, these import colleagues, veterans are laid off, not necessarily because they resist changes but simply because they represent the “old way,” star performers are recruited, sometimes at a huge premium to whatever their co-workers are being paid, and the assumption is that nothing positive will be lost, and an element of greater dynamism will be added to the company at no cost. Very few directors worry that the changes may destroy the culture which has heretofore enabled the company to survive and reach the present, because the status quo is always taken for granted.
The problem is that it is much easier to destroy a strong corporate culture than it is to create it. Once any sort of cultural incoherence sets in—as when a new crop of managers is brought in to ‘transform’ a business thought to have become too hidebound or set in its ways—it is very easy for the morale and internal behavior of the employees to degenerate into the sort of anomie where there are no longer any points of reference, ‘anything goes,’ and the most important criterion becomes reporting ever-rising results to one’s superiors, and especially to the new leadership, because suddenly everything is in a state of flux.
The cult of executive mobility, and especially the journeyman CEO, who makes his mark in one company, and moves on to pastures new before any of the problems he might have created manifest themselves, has exacerbated the trend to greater fragility of positive corporate cultures. Yes, it is bad for companies to become too inbred, and to become complacent, timid with respect to necessary innovations, and impregnated with a “not-invented-here” mentality. But unless the company has become totally dysfunctional, necessary changes must be made with regard to the existing culture, lest the best elements be cast aside along with the perceived problems. No one should take the fact that a corporation has lasted for as long as it has for granted: something probably made it tick, and that something may still be essential to the survival of the business.
Boards must take much of the blame for this sort of development. All too frequently, they give little thought to succession issues until the retirement of the incumbent CEO is immanent or there is a major crisis. Then, they are apt to reach outside for the antithesis of whatever has been wrong with the previous regime. Instead, there should always be at least one—preferably more than one—viable internal candidate who would provide cultural continuity, as well as presumably knowing anything that has been going wrong from the inside, before the board begins to look at external candidates as well. The idea of making a ‘clean sweep’ may appeal to the executive mind, but rarely is this done without inflicting considerable damage upon a company’s culture and employee morale.
The result of this sort of demolition of a collective culture is usually the creation of an individualistic, atomized culture. Individualism is a tremendous asset in certain fields of endeavor—pure science and research, the arts, new and entrepreneurial businesses with a truly separate balance sheet—but as a general mindset in a large corporation, it is dangerous any time individuals may jeopardize others at little cost to themselves, or with a disproportionate ratio of rewards to punishments. This is exactly what we have seen in the financial services industry.
Old-line, relationship-oriented investment banking firms suddenly became transaction-driven, and it ceased to matter if a banker sold a “dog” to a corporate client. The most highly-regarded institutional stockbrokers began to publish and promote research meant solely to push a new issue the house was involved in, or to unload a big position they were stuck with on their own book. No matter if they “blew up” some longstanding institutional clients in the process. After all, as P.T. Barnum said, “There’s a sucker born every minute.” With fewer and fewer brokers to deal with, to whom else could the clients turn, anyway?
As these firms, newly public and therefore awash with cash which was no longer the principals’ own, merged into ever-larger entities, the cultures of the various components cracked wide open. The issuers went looking for retail networks to aid in their distribution, the brokerage houses went looking for traders to leverage up their relationships with institutional clients, and the combined firms sought out commercial banks to provide ever more capital to finance larger and larger positions. The trading side of these firms became more and more dominant, and an increasing number of the firms were being run by individuals who had risen through the trading desks of the firms. The firms became less and less risk-averse, and more inclined to take short-term views of their markets. Once they had begun to play with investors’ capital, some trading firms had already tried their hand at market manipulation. Now it became possible on a much larger scale. Is there any surprise that some traders would try to move their benchmark in order to make their performance look better? That desks would double down and double down again on losing positions, and try to misreport the mess to risk managers and senior executives?
Until atomized, individualistic cultures can be re-molded into more social, cooperative ones—or segregated from the rest of financial activity entirely—these “accidents” will continue to happen, and with increasing frequency. Individual employees can never be made responsible for the potential losses of a joint-stock corporation which has made a ‘mistake’: the consequences are in the billions. “Too big to fail” means that the taxpayer is ultimately on the hook for any outsized losses. And the taxpayer cannot afford to be bankrolling a collection of individuals, each of whom is looking out only for himself. The only solution is to pay more attention to the corporate culture, and not backstop any culture which is fundamentally anti-social.
“Lots of luck,” as the cynics would say. Until markets begin to care about the culture of the firms they invest in, there will always be more capital for any hot new synergistic models of business combinations. “A serious crisis is a terrible thing to waste,” President Obama’s then-chief advisor repeatedly said in 2008. Well, folks, this crisis was totally “wasted,” and it still goes on.