The Secret Life of the CEO: Is the Economy Just Built to Flip?

Here's the truth: The problem isn't the market's rise or fall. The problem is people who react to events, rather than seek to create something great.

During the go-go days of the late 1990s, when many business thinkers found themselves seduced by the idea that everything is new in the new economy, Jim Collins marched to a different drummer. Hiding away in "monk mode" at his management laboratory in Boulder, Colorado, he continued his lifelong quest to discover the timeless principles that make enduring great companies.

The former Stanford faculty member takes a data-driven, long-term view of the arc of business. His two best-selling books, Built to Last: Successful Habits of Visionary Companies (HarperBusiness, 1994) and Good to Great: Why Some Companies Make the Leap . . . and Others Don't (HarperBusiness, 2001), are both products of years of painstaking research. Collins insists that we need to look at performance over time in order to evaluate a leader's lasting contribution.

In a transcribed conversation, which Collins then edited, Fast Company asked the key questions about CEOs, companies, and our own work lives: How did we get into this mess in the first place? Are all CEOs crooks? What will it take to get business back on track? And what can each of us do to make a difference?

Jim Collins answers below.

The problem: the built-to-flip economy
Sitting in my rocking chair, reading in the New York Times and USA Today about the latest round of corporate scandals, I found myself confronted with a problem: Under what heading should I file all of the articles piling up on my floor? I'm an incorrigible clipper, with cabinets full of articles taken from papers dating back 100 years.

I had problems with my clippings. At first, I filed them under company names: Enron, WorldCom, Qwest. But then there were articles about the widespread abuse of executive compensation, failed acquisitions, deposed CEOs, and dotcom hangovers. Finally, I started labeling most articles under the simple word "Flip" -- a file I created after my "Built to Flip" article appeared in the March 2000 issue of Fast Company.

Here's what I realized: All of those stories were connected by one underlying theme: the built-to-flip ethos. I began to see that the dotcom IPO bubble was just one particular strain of a larger pattern, a reflection of a deeper trend in American corporate culture. We didn't just have a built-to-flip IPO bubble; our entire business culture had become a version of built to flip. We became a built-to-flip economy, perhaps even a built-to-flip society.

Consider Enron in this light. I view Enron as the blue-suit, corporate-America version of built to flip. Just like the dotcom excesses, Enron used the capital markets to increase the price of a share -- independent of the underlying value of that share -- so that a few people could cash out at that inflated price before the markets pounded the price back down to the true value of the share. It's essentially the same idea as starting a dotcom that has minimal current value, taking it public, and cashing out before the game is up -- albeit with more nefarious overtones.

The issue here isn't just one of fraud and corruption. The issue is an entire built-to-flip mind-set: opportunists who created a significant delta between short-term share price and long-term share value and then cashed out before the gap could close.

It was popular to speak about the 1990s as the greatest wealth-creation moment in history. In reality, it was just as much a period of wealth transference on a grand scale. One group of people simply transferred wealth to themselves at the expense of another group of people. A whole generation saw it as a once-in-a-lifetime opportunity to get in, get theirs, and get out before the bubble burst. They saw it not just as an opportunity, but also as an entitlement. And we are paying the price today.

The driver: a disproportionate number of conscious opportunists
A confluence of historical events made all of this possible. We had a 20-year bull market that moved huge amounts of capital into retirement accounts. Multiply that change by the baby boom, and you've got two big variables compounding each other. Now add in the vastly increased use of equity and stock options, and it all adds up to a bull-market bubble -- and a huge opportunity. But businesspeople responded to that opportunity in four different ways.

At one end of the continuum were the self-directed people. For them, none of this was important. They just went about the daily tasks of building a successful enterprise: trying to build sustainability, create innovations that make a contribution, and add value. They were out there in places like Minnetonka, Minnesota, quietly going about their work. These were also the people who, when confronted with an environment that asked them to breach their values, refused to participate (akin to those who refused to shock the "learner" with intense electrical jolts in the famous Stanley Milgram experiments, despite the fact that 65% of the test subjects did so).

A bit further along the continuum, we encounter the malleable masses. These were the people who, in the presence of an opportunity to behave differently, got drawn into it, one step after another. If you told them 10 years ahead of time, "Hey, let's cook the books and all get rich," they would never go along with it. But that's rarely how most people get drawn into activities that they later regret. When you are at step A, it feels inconceivable to jump all the way to step Z, if step Z involves something that is a total breach of your values. But if you go from step A to step B, then step B to step C, then step C to step D . . . then someday, you wake up and discover that you are at step Y, and the move to step Z comes about that much easier.

Social psychologists call this process "commitment and consistency." In Milton Mayer's essay, "They Thought They Were Free," he explains the process this way: A farmer never notices the corn growing minute by minute. But if he stays in the field long enough, he wakes up one day to discover that it has grown over his head. The people who make up the malleable masses weren't bad at the outset. But through a series of gradual steps, they ended up in bad situations -- in over their heads.

The third category consists of the conscious opportunists. An ex-student of mine told me, "I knew it was a momentary gold rush that would someday come to an end and that I had one chance to get in and out before the whole thing crashed." But here's the litmus test: If it weren't for all of the spectacular opportunity, how many people would have been drawn into doing what they were doing? It might be accurate to call something a "once-in-a-lifetime opportunity," but that does not make it a reason to participate. Creative, passionate people who invent work of real value will have many once-in-a-lifetime opportunities.

At the far end of the continuum were the architects of evil. Just as there are heroic leaders who elevate others to a higher level, there are also evil leaders who take people into darkness. They understand the power of A to B, B to C, C to D, and Y to Z, and they use that psychological mechanism to create situations where otherwise-good people participate in awful things. Those people are frequently charismatic characters whom people want to believe. And that only serves to make them more dangerous.

The group that grew disproportionately in the 1990s was not the architects of evil, but rather the conscious opportunists. The architects of evil have always existed in our economic system, and -- given the right circumstances -- they will emerge again. We cannot legislate them out of the system; we can only throw them in jail when they emerge. (And they should certainly go to jail for an amount of time that is proportionate to the scale of their damage to society.) But we shouldn't design our economic system in lurching reaction to the architects of evil.

One change that would certainly help would be to index stock options to the market and to prohibit stock options from being cashed out for at least 10 years after they are issued. That one change would get many of the problem executives off the bus -- the flippers would choose to leave, the builders would stay -- and help alleviate the destructive confusion between the concepts of share price and share value. It would also help eliminate the destructive sense of entitlement that infected our economic system: Too many people got the idea that they "deserved" entrepreneurial rewards without taking entrepreneurial risks.

The way out: creators vs. reactors
Here's the essential truth of our current situation: The real problem has stayed the same, regardless of the direction of the market. First we went through a spiraling-up phase, and people lost their bearings as they got caught up in the great melee of opportunity. Now we're in a downward spiral, and people have lost their bearings in a scramble of uncertainty. It's the exact same pattern in reverse: people merely reacting to circumstances, rather than doing anything fundamentally creative.

The distinction isn't between a market that's going up and a market that's going down. It's between people who are fundamentally creators and people who are only reactors, who take their cues from the outside world.

If you did a word search across my research materials on the greatest company builders of the past 100 years, you would find almost no mention of "competitive strategy." Not that those builders had no strategy; they clearly did. But they did not craft their strategies principally in reaction to the competitive landscape or in response to external conditions and shocks. Without question, they kept a wary eye on the brutal facts.The fundamental drive to transform and build their companies was internal and creative. It didn't matter whether they faced a crisis (as did Thomas J. Watson Sr. at IBM, who never resorted to layoffs in the Great Depression) or whether they faced calm (as did Walt Disney when he conceived of Disneyland). The leaders who built enduring great companies showed a creative inside-out approach rather than a reactive outside-in approach. In contrast, the mediocre company leaders displayed a pattern of lurching and thrashing, running about in frantic reaction to threats and opportunities.

If I could bring all of my students back into the classroom, I would remind them of David Packard's admonition that in the long run, "more companies die of indigestion than starvation." If a company focuses on making creative contributions that fall in the middle of three intersecting circles -- what it is passionate about, what it can be the best in the world at, and what best drives a sustained profitable economic engine -- then growth will likely follow.

The research that went into my books showed that mediocre companies tend to focus on growth for growth's sake, whereas truly great companies focus on making creative, profitable contributions that are squarely focused on those three circles. Regardless of whether the market is up or down, great companies that adhere to those circles are, in the long run, likely to have more growth than they can handle -- indigestion, not starvation. The same holds true for creative people who discover what they are passionate about, what they are genetically encoded for, and how they can build an economic engine based on their contributions. Those who operate at the intersection of all three circles are more likely to face the problem of too much opportunity in their lives, not too little.

The Important Distinction The stock market may go up - or down. But according to Jim Collins, that isn't the key distinction. Regardless of the market, what matters is whether you are a creator who is internally driven or a reactor who takes cues from the outside.

Creator
Internally driven, externally aware
Pursues creative strategy
Discovers genetic talents and applies them
Builds an economic engine to get things done
Many once-in-a-lifetime opportunities
Growth follows from creative contribution
Ambitious first and foremost for the work
Focuses on building relationships
Values self-improvement for its own sake
Sets 10-to-25-year audacious goals
Core values inform all efforts
Seeks self-actualization
Reactor
Externally driven, without intrinsic passion
Pursues competitive strategy
Agenda of competence set by the outside world
Gets things done to make a lot of money
Few once-in-a-lifetime opportunities
Seeks growth for growth's sake
Ambitious first and foremost for self
Focuses on transactions
Driven largely by comparison to others
Five years is long-term
Nothing is sacred; expedience rules
Seeks success

The question: Which side are you on?
Abraham Maslow defined self-actualization as the process of discovering what you were made to do and making a commitment to do it with excellence. That is what the three circles are all about: making self-actualization work in a capitalist society. No one ever reached self-actualization simply by seizing a bubble moment to get rich and retire. Similarly, no one ever self-actualized by taking the cockroach strategy of just hunkering down and trying to survive until difficult times passed.

There are, of course, no guarantees. Luck is always a factor, and the dice can roll against you. But that does not change the fact that those who go about their lives and work with the passion to create and build in pursuit of self-created goals are the only ones who will find meaning in the end -- regardless of whether the dice roll their way. The fact of the matter is that life is short, and we only carry to our graves the inner integrity of our efforts. Only we know how we lived our lives, whether we cut corners, whether we did anything of value -- or whether we took the built-to-flip approach to life.

Sidebar: The Journalist: Everyone Has Been Discredited

Meet Charles Lewis
In 1989, Charles Lewis left the world of high-profile broadcast journalism to invent the world of what he calls "public-service journalism." Lewis, who was awarded a MacArthur Fellowship in 1998, founded the Center for Public Integrity in 1990 to pursue investigative projects that the major media were neglecting. During the past 12 years, the center has produced 10 books and more than 100 reports documenting the often-sordid ties between big money and big politics.

Isn't the problem limited to a few bad apples?
Not unless the whole world is your orchard. That's a lot of apples, folks! More companies are restating their earnings now than at any time in U.S. history. And by the way: They have dumped hundreds of millions of dollars into the political process to weaken any laws that might exist to curb the excesses.

So Washington is complicit in this?
You can't look at Wall Street without looking at Washington. They're joined at the hip. Congress and the politicians were the enablers for those scandals. They needed the campaign cash. The corporate executives needed certain favors. Everyone got what they wanted -- except, of course, investors and the public. Ninety-six percent of Americans don't contribute to political campaigns at all. The wealthiest elements of this country are sustaining and sponsoring the political process and its actors. What that means is that you get a government that's essentially bought and paid for by the powerful interests affected by those decisions.

If that's right, where's the outrage?
The outrage is muted, because you don't know who to trust. In 1994, we had Newt Gingrich's Contract with America and a new Congress coming to Washington to turn the city on its ear. In their first six months in office, those new members took more campaign money than any previous freshman class in the history of the Congress. We know what happens to Mr. Smith Goes to Washington. It becomes a Stephen King movie.

Do people not want to hear the truth?
Sometimes it does feel like we're trying to force people to drink castor oil. People don't really want to get bad news. But information is power. Until you find out the truth, you can't dig yourself out of the mess.

Who can people trust today to tell us the truth?
It's a very short list. Everyone has been discredited. We have a situation where we don't trust our government or our capitalist system. The level of distrust right now is probably unparalleled since the 1930s.

Is there a way to rebuild that trust?
You set tough standards, and you actually -- what a concept! -- enforce them. You have transparency. You have openness. You have a set of rules. You enforce those rules. I'm sorry if it sounds old-fashioned, but it's time for leadership. In the boardroom. In the Oval Office. On Capitol Hill. Our leaders can't think it's just a few bad apples. They have to take this very seriously and exert new standards in our society. In that sense, it's an exciting moment. We didn't talk like this a year ago.
by Daniel H. Pink

Sidebar: The Investigator: People Will Be Going to Jail

Meet Eliot Spitzer
New York attorney general Eliot Spitzer fits the part of the crusading cop. Last May, his crusade won national notoriety when Merrill Lynch agreed to pay a $100 million fine to atone for the misleading recommendations made by its research analysts.

Spitzer's office is still sniffing out conflicts of interest among Wall Street's analysts and bankers, focusing for the moment on the analysts who are covering failed telecom companies such as WorldCom and on bankers' practice of allotting initial-public-offering shares to favored clients.

What kind of financial crimes are you investigating?
There are two sets of crimes. One is the gamesmanship of CEOs with the numbers. That is elementary fraud. That crime originated in the field, driven by CEOs who wanted to trigger their options or hit unrealistic numbers. They fabricated numbers. That's old-fashioned stuff. The crime that originated on Wall Street was a result of the conflicts and tensions that exist when you have that many decision makers and that much money floating around. The analysts, the investment bankers, the underwriters -- there was an ease with which money could be shifted and markets could be pumped.

Wall Street's stock research has been corrupt for years. Why hasn't anything been done before?
When the market was going up, there was less pain, so there weren't as many complaints. Plus, there were checks and balances that used to exist in the corporate context. You had outside auditors, directors, regulators, shareholders. Every one of those checks fell prey to the notion that things were going so well, no one needed to pay attention. The ease with which people made money masked the underlying tensions. It's when everything falls apart that people start questioning the system.

So the solution is for those people to pay attention?
The solution must involve all market participants. It requires a renewed sense of ethics at every level. It means that CEOs can't simply tell their investment bankers, "Fire this analyst," if a report isn't favorable. It means that the president of the investment bank has to have the willpower to say, "We're not going to change our analyst report just because you're significant banking clients." And mutual funds have to tell their investment bankers, "We expect more of you." I've been telling the trustees of pension funds, "Hey guys, it's your money. You are ultimate fiduciaries, and you have the capacity because of your leverage to set the rules." I think we'll see an awakening on the part of all of those overseers and an end to the era of the imperial CEO.

Where will all of this stand a year from now?
People will be going to jail. Individual criminal liability will be found. Just as important, there will be a rewriting of the rules. Our inquiries and those of others will continue, and the new rules will emerge as a function of individual settlements. Ultimately, we'll see a new structure within which analysts have to operate and new rules about IPO issuances.

Do the people who run Wall Street realize now that they've been doing something wrong?
I'm not sure. I do believe there is a renewed attention to the underlying ethical problems posed by the conflicts of interest on Wall Street. But I don't know whether there is any sense of remorse for wrongdoing.
by Keith H. Hammonds

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