New Normal, Radical Shift

Changing Business and Politics for a Sustainable Future

Neela Bettridge, Philip Whiteley

• Publisher: Routledge
• Year: 2016
• eBook ISBN: 9781317088295
• Topic: Business
• Subtopic: Business General
• Index: Business

Our traditional ways of looking at economics, business and politics are not fit for purpose. The causes of the recent crisis were behavioural and international, but our measures are superficial and financial, recorded at a national or company level. This is combined with a fervent quest for endless 'growth', no matter how unsustainable. Theory has to catch up with reality. Many books chart different courses for economic and business management but New Normal, Radical Shift is different. Using examples from international organizations around the world, it analyses not only the business model that failed, but challenges wider economic and political beliefs that employees' interests always conflict with those of managers and business owners. Neela Bettridge and Philip Whiteley argue that the right messages about good practice in business struggle to be heard, not because of indifference or inertia, but because dysfunctional philosophies are still supported not only within business and business schools, but also within political circles and by trade unions, NGOs and others campaigning for workers' rights. The central belief of the 'old normal' is that profits are made by exploiting workers and the environment. In this book the authors' arguments - all supported by exemplary case studies -demonstrate that this belief is false, opening up enormous possibilities in a 'new normal' of enhanced working lives, environmental protection and business success.

CHAPTER 1 REFRAMING

DOI: 10.4324/9781315598017-2

On 20 April 2010, the Deepwater Horizon oil rig, owned by Transocean on behalf of BP, exploded with the loss of 11 lives. Two days later, it sank. Oil began gushing into the Gulf of Mexico, and the spill was not capped until 15 July, following some unsuccessful attempts, while permanent closure was announced on 19 September. The total leakage was estimated at nearly five million barrels. The direct cost to BP was over $3 billion; the reputational damage was incalculable.

The Deepwater Horizon disaster serves as a perfect metaphor for the conventional approach to organisational governance. We are often out of our depth, handling complex entities that can explode without warning, with tool-kits that are inadequate, where risk is incalculable and unexpected consequences far-reaching and unpredictable.

There is also paradox: an apparent emphasis on cost-cutting ended up being more expensive to the company than a more cautious approach to oil drilling and to safety. The disaster also placed a question mark over BP's strategy, as its plans for growth have depended upon extracting oil from difficult-to-access locations. The drama also illustrated the delicate interdependence of ourselves and the environment; and of different industries. Fishing and tourism in the southern USA have obviously been badly affected, and the consequences are likely to last for years. The oil industry cannot operate as though other industries do not exist; and all enterprises have to acknowledge that respect for the environment is a business as well as an ethical concern.

This tragedy came at the end of a decade punctuated by organisational and economic crises of increasing magnitude, though with recurring features. The accountancy scandals; the credit crisis; mismanagement of mergers & acquisitions (M&A). This begs some big questions. What is the nature of these events? Were they avoidable? Why did they take most of us by surprise?

If you look at the core features of these dramas, they are behavioural and international. There has been herd-like behaviour among investors, deception by executives (in the case of the accountancy scandals), decisions to minimise cost and boost quarterly figures, greed that led to risky levels of leverage and securitisation; all of these activities taking place in a global context, with limited capital controls and free trade, and deep interconnectedness of different constituencies.

Yet if you look at the information sources that we use to assess performance and risk, they are neither behavioural nor international. They are superficial, at company or national level, financial and historic.

In later chapters, we will discuss reporting methodologies and leadership approaches that better meet contemporary challenges, based on our joint experience, and numerous examples from successful organisations. There is perhaps not so much a need to develop new thinking; the thinking exists. The challenge is to convert it from the fringe to the mainstream. It is about communication.

We pretend we rely on data, but actually we buy stories. Enron was a story, securitised mortgage debt was a story, Bernie Madoff peddled a story. We know frighteningly little about the organisations that we invest in or report on. It is difficult to be fully informed on organisations; even the executives themselves cannot know everything about a large enterprise's activities and risks.

At which point, we ourselves have to observe a cautionary note. The case studies that we shall present in this book are not – indeed cannot – be based on full information. We cannot guarantee that Westpac or Marks & Spencer won't hit problems or even crises at some point in the future, but we have sought to base our reports on descriptions of the real company's activities, not just a checklist of financial indicators. In our case studies we attempt to portray some of the features of enlightened leadership; not claim that everything can be perfect.

We do not intend to produce a simplistic Good Company/Bad Company league table. Many of the corporate casualties of the past decade, such as Anglo Irish Bank and Arthur Anderson, had teams of high-integrity people delivering valuable services, but who were let down by excessive risk-taking or fraud elsewhere in the organisation. No amount of reform can offer a complete safeguard against malpractice.

The point of the cautionary tales in this chapter is to seek to learn from them; to enquire deeply into how misleading an apparently positive narrative can be. Above all, it is to highlight the common point that we systematically misread a situation owing to the dislocation referred to: the most common ways of seeking to understand, monitor and manage organisations and economies are not even in the same dimensional frame as the context in which they take place. At best they are proxy measures; at worst they are misleading or irrelevant.

Specifically, the over-reliance on quarterly financial information, and demand for a continual narrative of quarter-by-quarter ‘growth’, defined at company or national level, heightens risk and limits the kind of insight required to understand the behavioural dynamics that actually determine performance. Developing a broader approach to governance that seeks to understand and report on complexity and interconnectedness is not a guarantee against problems, but it is an approach that increases the sources of intelligence that can guard against error or excessive risk.

It helps if we redefine the organisation or the economy. Accountancy and formal economics have so completely captured this area that we can forget that their terms of reference are arbitrary, subjective and narrow. Within this orthodoxy, the organisation is defined as a set of assets and financial indicators; the economy appears as little more than output. If, instead, we redefine them as human communities, dependent upon the nurturing of skills and wise stewardship of finite resources, the terms of reference are transformed. The question of ‘sustainability’, which is core to the discussion in this book, becomes central, rather than the favoured subject matter of a few interest groups or environmental enthusiasts. This definition of sustainability covers multiple dimensions: environmental, societal and organisationally. It has, moreover, become an inescapable challenge, not an optional extra.

It has often been asserted that an approach to business that focuses on short-term maximisation of shareholder value, reducing workers to disposable human resources, and regarding natural resources as no more than a cost on the bottom line, is unethical. It is now clear that it is impractical also; bad for business as well as society and the environment.

ENRON ET AL.: JUST AN HORS D'OEUVRE

For six consecutive years, 1995–2000, the US energy giant Enron was named as Fortune's ‘Most Innovative Company’. Everyone knows what happened subsequently, as details of the gigantic fraud began to emerge in 2001: the company went into liquidation and its leaders to prison. There has even been a play on the subject in London's West End. We do not wish here to indulge in Schadenfreude at the expense of the good people of Fortune; nor can we claim that we saw it coming. The point here in referring to this scandal is to make a case that the lessons have still not been learned. The context in which the key Enron executives, Kenneth Lay, Jeff Skilling and Andrew Fastow, operated encouraged this type of behaviour, and remains largely unreformed. Investors and business journalists believed the story because they wanted to, and would have reacted negatively to a more honest portrayal of company risk had it been presented to them at an earlier date.

The responses to Enron and similar cases have been to tighten financial regulation. This is understandable and necessary, but insufficient. There has been little critique of the primacy of financial reporting: judging an organisation primarily on its quarter-by-quarter profit figures. This habit creates a clear incentive for executives, many of whom have no long-term stake in the business, to boost profits figures in unsustainable ways, without a care to the long-term health or even viability of the enterprise. The Financial Times investigation into Enron concluded:

Enron bolstered profits by booking income immediately on contracts that would take up to 10 years to complete. It shifted debts into partnerships it created and in effect controlled, even though defined by auditors as off balance sheet. It used such entities to manipulate its accounts at the end of each quarter and employed financial derivatives and other complex transactions aggressively to the same end. It masked poorly performing assets with rapid deal-making.

As an example, one of the many ‘arm's-length’ entities created by Enron, controlled by the corporation but effectively off balance-sheet, was LJM2 CoInvestment. In a company presentation in October 2000 it listed 24 investments since formation in December 1999. Half came in the final month of a quarter and nine in the last week of the accounting period. After the truth came to light, in 2002, the report by the special investigative committee commissioned by the Enron board said the rapid reversal of many of these deals and the fact that LJM partnerships ‘made a profit on every transaction … call into question the legitimacy of the sale’.¹

1 Enron: Virtual company, virtual profits, Financial Times special report, 3 February 2002.

The chief measure that companies have employed over the past few decades to guard against executives acting against the interest of the company and shareholders is based on something called ‘agency theory’, which will be discussed in more detail in Chapter 3. Proponents of agency theory recommend that executives build up significant stockholdings in the company. In the case of Enron, this simply further encouraged them to shore up the stock price by any means available, and then offload their personal holdings before the bad news hit the wires.

The policeman that the architects of the contemporary governance structure devised, agency theory, ended up as complicit in the crime. Despite this, there has been little fundamental inquiry into the flawed nature of this theory and the damage it has wrought; and inadequate initiatives at ideological renewal. The formulaic and superficial stipulations of successive codes of conduct in governance miss the point. They consider structures of committees; create a bogus, and actually unlawful, concept of ‘independent’ board directors; and ignore behavioural dynamics altogether. Again, we shall discuss this further in Chapter 3.

There is an irony: the more that individuals insist that they follow ‘hard’ financial data rather than a qualitative narrative, the more susceptible they become to a misleading story. The more they deny their emotions, the more prone they are to irrational exuberance.

The scandal at Enron, which occurred at a time of similar frauds at WorldCom, Global Crossing, Tyco and others, had the following characteristics: excessive focus on short-term financial growth; reliance on superficial economic indicators; an unsustainable bubble in asset prices; a sudden collapse in price, with a few insiders reaping huge rewards while many investors lose billions of dollars.

What if such a pattern were to repeat itself, not at a corporate level, but across entire economies? Step forward the credit crisis. In the multi-course feast of gluttony, waste, ruin and stupidity in the first decade of the twenty-first century, Enron et al. were just the hors d'oeuvres.

COLLATORISED DEBT OBLIGATIONS, HOUSING BUBBLES AND ECONOMIC ‘GROWTH’

A marked feature of Enron was its aggressive use of financial engineering, especially derivatives to bring forward profit, or at least the appearance of profit, and reliance upon optimistic forecasting as justification for the reported results. As the fraudulent use of such activities became apparent, a similar derivative was becoming popular in the banking industry. Collatorised Debt Obligations (CDOs) were a form securitising mortgage debt. The intention was to spread risk among lower-grade debts, but the practice soon became divorced from the underlying assets, and excessive optimism took over, sending the trading value of such derivatives higher, even though the traders had no way of knowing the viability of the debtors involved. Meanwhile, aggressive sub-prime lending in many nations: especially the USA, Spain, Ireland and the UK, sent house prices higher and increased the hidden risk within CDO trading. In Spain and Ireland in particular, property companies piled in, building excessively on the strength of the upward march of real estate prices. It was a classic ‘bubble’, but cheered on by the financial pages, finance ministers and the banks.

Economic theory exacerbated the problem in CDO trading. Excessive reliance on financial data has tempted economists and investment banks down some dangerous paths. As Nassim Nicholas Taleb observed in Black Swan,² economic orthodoxy has clung to the pretence that economics observes Newtonian, predictable properties. The generation of so much data meant that advanced calculus could be used to ‘plot’ the behaviour of asset prices as a means of assessing risk. The fact that such plotting has no relation to real life has never deterred such economists. It is unlikely that calculus has a valid role at all in economics, because there are no constants. In the time it takes to complete the calculation, the operating assumptions used to inform it have altered, rendering it useless.

2 Taleb, Nassim Nicholas, The Black Swan: The Impact of the Highly Improbable, Random House, 2007.

Taleb anticipated the crisis in 2007, just before it hit:

The giant firm JP Morgan put the entire world at risk by introducing, in the 1990s, RiskMetrics, a phony method aiming at managing people's risks … A related method called ‘Value at Risk’, which relies on the quantitative measurement of risk, has been spreading. Likewise, the government-sponsored institution Fanny Mae, when I look at their risks, seems to be sitting on a barrel of dynamite, vulnerable to the slightest hiccup. But not to worry: their large staff of scientists deemed these events ‘unlikely’.

The dynamite did indeed explode just a few months later. Here is a paradox: an individual who eschews prediction was more correct in his anticipation of events than those who pretended you could predict with accuracy.

At a political level, it is alarming that the same superficial indicators that have proved so misleading and inadequate at corporate level should also be applied at national level, where the complexity is even greater and the stakes even higher.

The definition of recession as two quarters of successive negative growth creates a huge incentive for politicians to maintain the illusion of ‘growth’, especially in the run-up to an election, even if this is in unsustainable ways. News media feed into this illusion, putting fierce pressure on politicians to come up with ‘growth’ by any means. By this measure, reckless state borrowing and debt-fuelled consumption binges look as positive as growth based on the development of an innovative engineering sector.

The behavioural pattern is identical to that of CEOs bolstering short-term profits figures. To take one example, Ireland was dubbed the ‘Celtic Tiger’ because of continuous GDP growth, and insufficient attention was paid to the levels of risk. House price rises are assumed to be beneficial to an economy even when they soar far above a reasonable level of affordability for the real economy. In the mid-2000s in Ireland, leading economist Morgan Kelly of University College Dublin began warning of dangerous levels of deb...

Table of contents

• Cover Page
• Half-Title Page
• Title Page
• Copyright Page
• Table of Contents
• New Normal – Introduction
• 1 Reframing
• 2 A Multi-polar World and a Finite One
• 3 The Myths That Hold Us Back
• 4 Beyond the Balance Sheet
• 5 Into the Future – the Leadership Challenge
• 6 Beyond Left and Right
• 7 Conscious Leadership: The Personal Agenda
• 8 New Populism and the Dangers
• 9 From Supply Chain to Supply Circle
• Conclusion
• Index