Success breeds success, so the saying goes. But successful companies can also breed behaviour that creates risk to the business. And if it goes unchecked, such behaviour can lead to spectacular failure
Take a snapshot of success, fast forward a few years, and you discover how ephemeral it can be. On the 10th anniversary of the publication of Built to Last, for example, seven of the 18 companies selected by Jim Collins and Jerry Porras as exemplars of their principles either no longer existed or had experienced a major failure.
Success, while better than failure, creates its own risks. Some of those risks are based on the inevitable failure of successful companies to scale their risk management processes and systems to cope with a bigger and broader business. Many, though, stem from the response of employees, managers and investors to success. Here is a small selection of those risky behaviours.
1 Delivering the numbers becomes the strategy
Success creates inflated expectations of quarterly sales numbers. “Organisations become so focused on meeting next quarter’s earnings-per-share targets that manipulation is going on,” says Dean Kreymeyer, executive director of the Institute for Corporate Ethics.
WorldCom is the best example. When internal auditor Cynthia Cooper questioned the numbers, management warned her to “stay away” from her investigation. She worked secretly to expose the financial engineering that departmental heads were incentivised to put in place to make their numbers. For example, $771m of unused network was reallocated as “construction in progress”. When one departmental head refused to change his reported numbers to the satisfaction of his manager, general accounting did it for him – behind his back.
2 Banishing negativity
Success can weaken the position of the risk management function if its processes are seen to impede growth. After the £28bn merger of Bank of Scotland and Halifax Building Society, the entrepreneurial zeal of Halifax came to dominate. It created an organisation in which head of regulatory risk Paul Moore could be told by one employee that “we’ll never hit our sales targets and sell ethically”. Moore reported the failure of risk management to the board, and soon after was made redundant with no remedial action taken.
The culture can lead to “opinion shopping”, where the business will look for someone, anyone, to support destructive or dishonest behaviour. Thus Lehman Brothers reported its “Repo 105” loans as sales after an opinion offered by external UK counsel. US counsel had already rejected this course of action. After Lehman’s bankruptcy the court appointed examiner called the decision “actionable balance sheet manipulation”.
3 It worked last time
The concentration of influence in a small group of managers who have delivered success can create a single-strategy company that gradually becomes exposed to massive risk from rare events. Northern Rock wrote mortgages for customers who were acquired by brokers. Its growth targets demanded that it borrowed wholesale money to lend as new mortgages. It securitised the loans and sold them to other banks. The bank was incentivised to offer ever-riskier products (125% mortgages) with fewer checks (self-certified mortgages). It became a giant one-way bet based on inter-bank wholesale lending remaining available.
4 Whatever works culture
Success driven by strong management can lead to failure driven by the same force. At Bear Stearns, ‘Ace’ Greenberg hired recruits who were ‘PSDs’: poor, smart and with a deep desire to get rich. These PSDs not only set the tone but could push through day-to-day decisions with devastating results, because they enjoyed the confidence of the management. This eventually led to a trader, Ralph Cioffi, creating a fund that was leveraged 35 times and blew up. His response? Create another fund, leveraged 100 times. When that also blew up, he tried to salvage it by creating a listed company to contain the toxic debt.
5 You recruit to win, not to manage risk
Dr Doug Hirschhorn, who trains traders for investment banks, is surprised that only 10% of the banks he works for give potential recruits a personality test. So many take on the sort of behaviour displayed by traders: a tendency to over-trade, a lack of appreciation of real-time risk/reward outcomes, and an inability to accept that losses are sometimes inevitable.
Allied with traders’ expertise in hiding these problems, and formal risk management practices are impossible to either teach or to implement. “A lot of behaviour is driven by how many people are watching,” Hirschhorn warns.
Tim Philips is the author of Fit to Bust, published by Kogan Page and available at bookstores and online
