Freek Vermeulen took a look at some recent financial events and found an overlooked element. He offers an analysis and suggests a new ...
Freek Vermeulen took a look at some recent financial events and found an overlooked element. He offers an analysis and suggests a new priority as a solution.
When you compare the 2008 banking crisis with the Enron debacle, with Ahold’s demise or even with the Union Carbide disaster in Bhopal in 1984, some surprisingly clear parallels emerge. Various explanations have been offered for each of these crises, ranging from top management greed and failing watchdogs to insufficient government regulation and inappropriate accounting and governance structures. Yet, there is one common cause underlying all these symptoms and triggers, and that is the structural failure of management. How did it happen? There were several key factors:
One central element in each of these disasters, including the banking crisis, is the degree of division of labour and specialization within and across organizations. In the case of investment banks, financial engineers drew up increasingly complex financial instruments that, among other factors, incorporated assets based on the American housing market. Yet, the financial engineers didn’t quite understand the situation in the housing market; the people in divisions and banks participating in the instruments didn’t quite understand the financial constructions or the American housing market; and all the way to the level of departments, groups, divisions and whole corporations, top managers had no clue what they were exposed to and to what degree.
Similarly, Enron managers did not quite understand what its energy traders were up to; Ahold’s executives had long lost track of the dealings of its various subsidiaries scattered all over the world; and the managers at Union Carbide’s head office had little knowledge of the chemical plant in faraway Bhopal. In all these cases, the organization, both within and across participating corporations, had outgrown any individual’s comprehension and surpassed the capacity of the traditional control systems in place.
Another crucial role was played by the myopia of success. Initially, the approach by the companies involved was limited and careful, while there often were countervailing voices that expressed doubts and hesitation; there certainly is evidence of all of this in the case of Enron, Ahold and Union Carbide. Yet, when financial returns began to be realized, as in the case of the banks, the usage of the complex instruments increased, sometimes dramatically, and they became bolder and more far-reaching. Iconoclasts’ countervailing voices ceased to be raised or were dismissed. For example, in Ahold and Enron, the financial success of the firms’ approaches suppressed all hesitation towards their business strategies.
This happens when “do the wrong thing” becomes the way of the day. It actually became improper not to follow the approach that brought so much success to many. In other words, to be good became bad. In the case of investment banks, other banks and financial institutions that did not participate to the same extent received criticism for being too conservative and oldfashioned. Investors, analysts and other stakeholders joined in the criticism, and watchdogs and other regulatory institutions came under increasing pressure to get out of the way and not hamper innovation and progress.
Similarly, in the 1990s, Enron was hailed as the modern way of doing business, while analysts (whose investment banks were greatly profiting from Enron’s success) recommended the company stock as a “buy” till days before its fall. Similarly, Ahold’s CEO, Cees van der Hoeven, continued to receive awards while the company had already started its freefall. All of these organizations’ courses of action had turned into an irreversible trend supported by the various parties and stakeholders in its business environment.
All of the organizations and individuals involved in the current banking crisis seemed to have let short-term financial gain prevail over common sense and good stewardship. But in all these cases, greed was not restricted to the few top managers who ended up in jail or covered in tar and feathers. Ahold’s shareholders initially profited as much as its executives. Investors, politicians and customers shared in equal measure from the early-day benefits of Enron; likewise in the investment bank situation. Even the Church of England made big bucks on the financial practices they so heavily criticized in the days following the collapse of the system.