We are standing on a precipice, teetering between growth and decline.
Are the initial signs of recovery the fore tidings of a full economic expansion, or are they rather, as many economists think, the small upswing in the center of a “W” as opposed to the unbridled growth of a “V”?
Certainly, there are conditions that for most of us who are not senior officers of large financial institutions and government agencies; or those who have the misfortune to be influential government leaders can control. But it has always been the case that policies come and go, and regardless of which political party is calling the shots, as business leaders we choose where our attention goes, where we allocate resources, and our commitments.
So in this context, the pertinent questions are:
Are you focusing on finding ways to move your organization forward, creating new pathways for success and discerning new opportunities for growth, or are you hunkered down waiting to see if you will survive this downturn?
Are you actively working to recruit the best leaders, providing your people access to resources that will make a difference in their own growth and development while positively impacting the business, or are you waiting to see which way the wind is blowing?
Where is your attention? Where are you allocating your resources? What actions are you taking that will make a difference?
I believe that our future depends on the answers to these questions. This is the Want Ad I believe needs to be posted on the internet and in the newspapers:
Wanted:Bold and Courageous Business Leaders
Experience: Proven track record of success in forwarding new initiatives and ideas, taking calculated risks, recruiting top leaders and focusing personal and organizational resources on the development of people.
Personal Values: Intestinal fortitude, straight talk, humor, willing to think big and act bigger.
To apply, I suggest you start looking within your own organization.
Segway is known for its zero emmision personal transport vehicle seen in shopping malls, airports and many city streets. However, their recent agreement with GM has them entering the next generation electric car marketplace and attempting to dramatically alter the paradigm of transportation in the process. Our most recent Leadership Interview is with Brian Cohen, Segway’s Chief Financial Officer. Brian has over 20 years of high-tech financial leadership in rapidly growing early stage and publicly traded companies. In his role as CFO of Segway, Cohen is responsible for managing the finance, information technology, legal, operations and human resources functions of the company. Since joining Segway he has already realized significant achievements for the company, including completing a new round of financing and playing a major role in the negotiations of Segway’s recent agreement with GM.
Prior to joining Segway, Cohen served as CFO for PHT Corporation, a provider of advanced information technology solutions for the pharmaceutical industry. His background also includes CFO positions at technology companies , including Telebit, Yantra and WebLine Communications. He managed the merger and acquisition process of Telebit and WebLine by Cisco Systems, Inc. He began his career at Price Waterhouse. Cohen is a certified public accountant and holds a bachelor of science in accounting from the State University of New York at Oswego.
We are pleased to present our latest Leadership Interview with Brian Cohen in which he talks about Segway and the overall future of the automotive industry:
Greg Selker: Brian, I’ve known you for over ten years. I’ve always admired you and I’m thrilled to have this opportunity to interact with you in this context. So let’s talk Segway.
Brian Cohen: All right, great.
Greg Selker: Segway is just such a fascinating story. The first personal transporters were introduced in 2001, then in 2006 – the second model, and the company has raised a very significant amount of venture capital.
There were the predictions by John Doerr in the early stages that Segway would be the fastest venture-backed company to reach $1 billion in sales, and clearly a lot has gone right although you haven’t reach $1 billion in sales yet. You’ve continually had great publicity and great product placement in the media. You see Segway on TV and in movies; and sales have experienced significant growth, but not to the levels envisioned.
And now you’ve introduced PUMA, the Segway platform that migrates to multi-passenger, zero emission, urban automobiles, and Segway has taken the bold move of establishing a partnership with GM. What do you see that needs to happen, both internally within Segway, and externally within the marketplace that will have PUMA be as successful as you all hope that it will be?
Brian Cohen: Well, John Doerr is probably one of the greatest venture capitalists, and a very enthusiastic supporter of all his companies. When I first met John during the interview process, I asked him what caused him to make the statement that he thought Segway would be one of the fastest VC backed companies to reach $1 billion in sales?
And at that point in time, the company was well on its way to completing a number of contracts that would have resulted sales of many, many PT’s (Personal Transporters). Unfortunately for a variety of reasons, the contracts were not completed.
But nevertheless, the company has been refocused on growing it’s market, growing its segments, and we have continued to experience great growth. And a lot of our efforts have been focused on finding new market segments – one of those would be the police and security market. If you walk through many major airports throughout the world today, you’ll see security workers using the Segway units.
Greg Selker: Absolutely. Segways are increasingly being seen as the transportation vehicles for security personnel. In face, you’ve got the recent Kevin James movie – “Mall Cop”, where he is riding a Segway PT.
Brian Cohen: So it’s been a great platform, but every company in the technology industry needs to have multiple avenues, and technology is a means for creating additional products. With the technology that we possess, and it’s really technology that’s focused on electric transportation, we have been looking at potential partnerships to expand our product portfolio. We believe one of the best ways to do this is with strategic partners.
We were approached by General Motors with a goal of trying to create a much smaller electric vehicle, but much larger than a PT. Something that would have the ability to carry two individuals, be able to go up to about 35 mph, clean, green, very maneuverable, but with the footprint one-third the size of a traditional smaller vehicle. We were challenged by GM to forward our initial concepts and design of this vehicle in approximately a 90 day period. They wanted to see what we could build as a potential prototype to be able to move into the small electric vehicle market.
And to their surprise within 90 days we built the prototype that was revealed approximately this past April and shown to the world. And again, that was something we built within 90 days to demonstrate to GM the flexibility of the technology that we possess for electric transportation.
That ultimately led to a relationship with General Motors to build prototypes, and those prototypes will be revealed over the next 6 to 12 months. We’re very excited to have a great partnership with General Motors – have their experience, and to be able to work with them to help create a significant new transportation alternative that is primarily focused on very large congested cities. These vehicles are not designed for highways; they’re really designed for congested cities such as Paris, or Rome. A city where it’s very difficult to park, and more often than not you probably can’t go any faster than 10 or 15 mph anyway.
Greg Selker: So you just named two European cities. Where do you see this two-person vehicle, the PUMA, playing a role in major US cities?
Brian Cohen: I think the initial rollout would be in countries including China, India and many of the more congested European cities. I think it’s probably in a phase two or a phase three of the vehicle that we would address the US marketplace.
Greg Selker: Why is that?
Brian Cohen: There are a couple of reasons. One, is I look at the environment in which I live and operate. I live approximately 30 miles from my office. I’d have to go via freeway in order to get to the office. I would not be able to drive the PUMA on a highway.
Greg Selker: Right, that makes sense, but why not New York City?
Brian Cohen: New York City represents a potential opportunity, but at the same time it would require some regulatory approvals. You would not want to put these vehicles on the road next to a large SUV, or a large semi. So it may require separate lanes, and I think some European cities are already well on their way to changing the regulations for transportation. London is a great example of this. There are now tariffs imposed to drive within the city limits.
I believe that the Europeans are a little more advanced at this point in time in their desire to consider alternative forms of transportation. And I think while the US is becoming more aggressive in that regard, I still believe that there’s some catching up to do. I have no doubt that we will catch up eventually, but from a company perspective we’re focused on large market opportunities. We want to establish a foothold in some initial markets and then expand from there. And the interest has already been expressed by a number of European cities and governments.
Greg Selker: Well I know there are multiple factors which have contributed to creating the situation you just described in that European and Asian cities are more amenable to embracing this kind of technology. But from your perspective as the CFO of Segway, why do you think that the American automobile manufacturers, the legislature and the public have been so reticent to move forward and embrace this new technology and be in a leadership position as opposed to now playing catch-up?
Brian Cohen: That’s a great question Greg. If you look at the US automobile industry, many of the US manufacturer’s profits were driven by the sales of large vehicles. They just have not been able to create the same level of profitability from smaller vehicles.
The price of oil is significantly cheaper in the US than it is in Europe, and as a result people want, and can afford the comfort of a large vehicle. Plus, it’s not as difficult to park and navigate in many US cities as it is in Europe. I think that with the recent increases in the price of oil, and even though the costs per gallon of gas is cheaper than it was a year ago, I think it’s just a matter of time before we’re going to see significant increases in the price of oil.
The US automobile industry is now being forced to reconsider changes in its strategies, and there is a greater emphasis on smaller transportation, electric transportation, and cheaper transportation. I think the US government is doing a great job in trying to promote programs now that are going to force the hand of both the manufacturers and the public at large to consider alternative means of transportation. There’s a greater concern about the environment, which also is influencing consumer preferences.
So I think that we have been a little bit slower to move in the US than overseas, because we haven’t had to deal with some of the factors here that they’ve had to deal with in other parts of the world. But I think the playing field is starting to level, and the US will become increasingly more aggressive in pursuing other forms of transportation and smaller vehicles in general.
Greg Selker: Given the financial issues confronting the overall automotive market and GM in particular, how does this impact both Segway’s future, and the future of our country in moving towards greater fuel efficient and economically more impactful transportation?
Brian Cohen: I think that the manufacture and sale of large vehicles have disguised a problem within the US automotive industry for many years. And the US automotive industry has not been forced by the government to necessarily focus on the most efficient forms of transportation. Pollution, while it’s been a concern; hasn’t been the utmost concern.
Greg Selker: Right. Emission controls have been fought and have been slowed down within Congress and the legislature.
Brian Cohen: Now there’s a global focus on the environment and on emissions which is dovetailing with the US government becoming very involved in bailing out and supporting the US automotive industry. With the cost of gasoline expected to rise in the years to come, I think we’re going to see the automotive industry in the US become extremely aggressive in pursuing transportation alternatives that will require fuel efficient vehicles. I don’t know exactly what those requirements are going to be, or the dates in which they’re going to be implemented, but there is no doubt that the government focus in this area will speed the process.
Segway is extremely pleased to be a partner with GM, and one of the things that we’ve learned from this partnership is that the US automotive industry has not been avoiding the issue of moving towards more fuel efficient vehicles and smaller vehicles. It’s just a matter of how they do it. And I give GM a lot of credit in that they thought about the issues that any automotive manufacturer would face in going from a dominant focus on larger vehicles to smaller vehicles, and especially to electric transportation. Ultimately they decided, you can either take the existing form of transportation and try to go through the process of bringing the cost down and reducing the size; or, as GM has preferred, you try to partner with someone like a Segway, where technology and an entirely new platform is the key.
You take the Segway core technology, and you figure out what you need to do in order to make, for instance, a new Segway PT that now can go faster than the current PT at 12.5 mph. What can you do to make it more flexible and comfortable? I think it’s just a matter of time before the automotive industry in general starts to introduce more cars like the Chevrolet Volt.
I just saw that Ford is going to coming out with their own electric vehicle, and I think there are many upstarts including Tesla, that are starting to put a lot of pressure on the US transportation industry, and from this pressure, the US automotive industry will change.
Greg Selker: Well that’s almost hopeful Brian.
Brian Cohen: It’s hopeful and optimistic. It’s also something that says change is well on its way. You can’t necessarily go out and purchase all these vehicles today, but there will be a significant shift. And I think if we look forward ten years from now, the era of the large gas-guzzling vehicles will be a thing of the past.
Greg Selker: I actually agree with you, and am as equally optimistic and hopeful as you are. Because I think that it’s necessary for us. it’s not even a “like to” transition, it’s a “must make” transition.
Brian Cohen: We cannot continue to be dependent upon foreign oil.
Greg Selker: That’s really the bottom line isn’t it?
Brian Cohen: It’s a very dangerous position to be in.
Greg Selker: So let’s shift the conversation now towards leadership and the future, looking at not only products that need to come on line, but both existing and younger companies that now need to transition into delivering these new products. What do you see are the leadership qualities that are really going to be required from this next generation of companies – whether it’s existing companies or new companies, to deliver products and solutions that meet this very optimistic and hopeful future that both you and I are envisioning?
Brian Cohen: For a long time many of the more traditional established companies have had a “not invented here” syndrome, and I think one of the greatest challenges is in being flexible. If you’re a large manufacturer, you have to look at your core competency. One of the greatest challenges that the automotive industry faces today, is developing low-cost, long-range batteries. I don’t believe that the automotive companies of today are going to necessarily be the people to do that. But there isn’t any reason why today’s automotive companies can’t develop strategies that take advantage of this technology.
But in order to do this, you have to have the ability to develop new strategies, to look at what your core competencies are, figure out where can you partner to determine how to navigate from the current vehicles in production to these new vehicles which are dramatically different. In many cases, you might not have mechanical brakes. You will probably see, just as the computer industry is focused on digital media, the same thing will apply to an automobile.
So there will be less mechanical parts, and the entire automotive industry will go through a transition. It’s going to require companies to be creative, to be flexible, to understand how to partner, and also to be very quick on their feet. These changes are occurring as we speak. They are occurring throughout the world, and it’s important to understand that there aren’t many companies out there where their core competency is in battery technology.
And it’s an interesting paradigm shift where it could be that the companies that are the future of the automotive industry are the ones that are starting to strategize on how I build a car around a battery, as opposed to putting the battery into the car? It’s that type of thinking and the aggressive mind set to focus on change that will be key for the success of automotive companies in the future.
Greg Selker: So if I summarize the characteristics that you just said, I think flexibility and being pro-active, and then bringing these qualities to think differently about the problems that we have today.
Brian Cohen: Absolutely, and I think that if you look at many automotive companies today, their focus is on manufacturing. And manufacturing may not be the key to the automotive company of the future. It may be something that is out-sourced. Again, it’s thinking about what do you do best, and how you really add value, and what are non-value-added functions.
Greg Selker: So if we take these qualities of flexibility, proactive analysis of what your core competencies are, and applying this to thinking differently about today’s problems, where do you see some great examples of that kind of behavior and leadership today in the automotive industry?
Brian Cohen: That’s a good question. The automotive companies today are focused on largely restructuring their existing businesses. At the same time, they are trying to work on advanced technology initiatives. And I think these companies need to get through the restructuring phase, make sure that they are going to be viable, and at the same time, there are a lot of initiatives within these companies that are not publicly disclosed that do represent the qualities we’ve been discussing.
There are new forms of energy that are being considered, including hydrogen. But for a paradigm shift in the automotive industry to be real, it means that there also needs to be a paradigm shift in our general society. For instance, if you’re utilizing hydrogen, or electric batteries as fuel, there aren’t hydrogen re-fueling stations or battery recharging stations. It’s going to require, not only developing the vehicles of the future, but figuring out all the logistics and other aspects that are related to the maintenance and support of those types of vehicles.
It’s going to require companies to be able work within the legislative system and figure out how they can partner, not only to build great vehicles, but how they are going to power them, support them and maintain them for many years to come.
Greg Selker: Well as you look at Segway and moving the company forward, what are the qualities that you are continually seeking in hiring, building and developing the leadership and management team so that you’ve got an organization that is primed to be one of the major companies delivering on this potential future?
Brian Cohen: It’s interesting. I actually believe that the qualities haven’t necessarily changed over the past decade or two. Of the qualities we look for, number one is confidence. I can recall that when we first started discussions with General Motors, there were a number of people who didn’t believe that we could consummate a deal with them. General Motors was such a large company, and we’re a much smaller company. They have much greater resources. Many people just thought that it couldn’t be done. A lot of what we are able to accomplish came down to confidence.
So we’re looking for people who have confidence, who have a passion to succeed, to do things that have not been done before. People who want to grow, and who have a proven track record of getting into a company, starting in a position, being very successful in that role and taking on additional responsibility.
Attitude is extremely important. It’s an attitude that “I will find a way to get it done.” It might not be easy, it may take a little bit longer than I thought, but there is a way to get things done. I think ultimately when you have an attitude like this; it leads to creativity and innovation. When I look at the future it’s clear to me that we’re going to be operating in a much different world. It’s going to be much more focused on global activities, on partnerships, and it’s going to be focused on solving problems that we have not dealt with in the past.
And doing these things requires a great deal of creativity, and as many people have said, “thinking is free.” Take advantage of it, but ultimately have the confidence that you can succeed. People want to be around people who believe that things can be done. I think there are some great opportunities for many companies in the electric transportation industry, and in technology in general to continue to build great value for their shareholders.
Greg Selker: As you build out the management and leadership team at different levels within Segway, what do you do as a company to make certain that the people that you’re hiring have behavior that is truly reflective of those qualities that you just named?
Brian Cohen: So we’ll do what I would describe as more traditional type processes including reference checks. But I think the most important thing is, not necessarily asking people about their experiences, while that’s an indicator of success in the future, I think a lot of it is about sitting down with them one on one and asking them questions about problems that you’re anticipating you’re going to have to solve.
Then determine whether you would feel comfortable working with them, and to what degree can they think creatively? Do they exude the confidence, and ultimately if you believe you’re going to partner with them, do you believe that that person sitting across from you is going to make you and your company successful? It’s very similar in some respects to dating, where you don’t want to necessarily rush into anything, it takes time, and it takes both parties to communicate with one another to make sure that you’re forming a bond that’s going to be lasting.
Greg Selker: Got it. Let’s talk about the challenges that you’re confronting as the CFO of Segway in this current environment and economic downturn. With Segway’s commitment and focus, not only on innovation and the future of green mobility, what are some of the ways that you can instill this culture of innovation and creativity while balancing rewarding successes and also tight-fisted financial control?
Brian Cohen: Well in this environment that’s a great question, and the capital markets are extremely difficult at this point in time. A company like Segway has a great technology platform and multiple opportunities to bring new products to market. We realize that while we have tremendous opportunities, we cannot do it all ourselves, and continuing to raise capital is extremely dilutive. We’re taking an approach that’s focused on partnerships. General Motors is the first major partnership we announced, and that’s for the PUMA prototype. At the same time, we’re also talking to a number of other very large transportation companies. We’re trying to figure out how we can work together so that we can bring our core competency to them. There are many attributes these companies possess, including distribution. There’s a large potential market opportunity that we should be able to structure a relationship, where each one of us leverages the other and neither of us has to go it alone or raise a significant amount of capital in order achieve success.
So I believe in this environment, even though it’s not necessarily easy, if you have the opportunity to partner, this offers the quickest road to success. But it’s most important to make sure as you enter these partnerships, that you have a clear understanding and clear expectations established upfront so as you continue to move down the path of partnership, you avoid surprises.
Greg Selker: If you could be a little bit more specific. As you structure these partnership agreements, what kind of surprises are you trying to avoid?
Brian Cohen: So for instance, it could be cost overruns. So it’s making sure that you understand up front, what are we trying to achieve and how we are going to monitor it. If we get to a point where we believe we’re not going to achieve the milestone at the intended cost, what do we do?
Greg Selker: So here we’re cutting to the heart of keeping the financial controls in place, or putting financial controls in place that will allow the true measurement of creativity and innovation.
Brian Cohen: The financial controls are always important, but if we ultimately have to look to numbers on a piece of paper, it may be too late. It’s just not getting an agreement done that’s important. I ultimately believe that you should take the agreement, sign it, and you hopefully put it in the drawer and never have to pull it out. It’s then the relationships that you’ve built, the processes that you administer and how you work with one another that are going to be the key to success. And every partnership will encounter a problem, at which point you need to figure out how to work together and not against each other to move forward and get beyond the issue and achieve the goals of the partnership.
Greg Selker: Got it. So as we look forward again to this hopeful and optimistic future that has unbridled success with Segway and other companies that are delivering these innovative solutions through partnerships, and through rethinking existing problems from a new perspective within a new paradigm, what do you see the leadership of existing transportation automotive companies doing that will contribute to this kind of shift in consciousness?
Brian Cohen: I think to a large degree, some of it is not necessarily a natural shift. Some of it has been forced by government regulation, and more recently, the government forcing the automotive industry’s hand in making some long-needed changes. Some of it has been forced by competition, and ultimately it’s forced based upon financial models for companies. And the models of yesterday as well as the models of today, are largely becoming history.
In order to be able to play in the new era of transportation representative of this future we’ve been discussing, companies will have to establish footholds in the market. And while there are many opportunities for this– there are all types of vehicles today that are either powered by gasoline or diesel etc., there are many alternatives. As I mentioned, electric is one, hydrogen is another, and it’s looking at the market opportunity and understanding the regulatory hurdles that you’re going to have to deal with. The PUMA vehicle is not designed to drive on a sidewalk, there are no regulations that allow that. At the same time, it is not designed to be driven on your traditional roads.
Greg Selker: Right.
Brian Cohen: So it’s going to require significant shifts in many aspects of the business, including how you work with governments, not only in the US, but throughout the world to accept these new forms of transportation and make them safe. And our core infrastructure will have to shift as well. The roads of the future may be dramatically different then the roads that we’re accustomed to today. The vehicles of the future will be much lighter, and so they won’t necessarily require the infrastructure of today. If you look at these smaller vehicles, there may be changes in how they inter-operate with another. There may be communication systems that manage the distances and the speeds of these vehicles, and there may be systems that will allow you to automate getting from Point A to Point B. There may be systems that will re-route you based upon traffic patterns.
But I think a lot of our challenges we’re going to face in creating new forms of transportation will be focused on trying to anticipate these and similar issues. And while it’s often times easier to build a vehicle, I think the more difficult problem is how to make sure that this new type of vehicle is going to be safe? How do you make sure that there’s a market available to you, and especially, how do you deal with the regulatory issues so that you can develop and bring these products to market and know that this is going to be a market opportunity available to you?
Greg Selker: You’re right. I think this gets back to thinking of things very, very differently. And as we look into this future, many of the ways in which we do things today won’t be the way in which we do things in the future.
Brian Cohen: The change is already happening, and we have to embrace it.
Greg Selker: Yes, I believe that. So that leads me to the last question, which is looking back on your career, what’s the best piece of leadership advice that you’ve ever received and why?
Brian Cohen: Well, I’ve had a little pink pig that’s been with me, it’s plastic. A pink pig that’s been on my desk for probably at least 15 years. I don’t recall where I got it from. Business is always about negotiation. You negotiate internally, you negotiate externally. Everything you do really comes down to negotiation.
The reason the pig is on my desk, is to always remind me never to be a pig. If you’re involved in a deal and you’re holding out for that last percentage or that last dollar, what if you don’t get it? What if the partner on the other side of the table, whoever it may be, decides that you know what, you’re too difficult to work with. I think I’m going to go work with your competitor.
Greg Selker: Yes.
Brian Cohen: Did you really achieve your goal? So ultimately the best advice I ever received, is “don’t be a pig.” Always focus on the big picture. Make sure you achieve your goal, and make sure the other person or other company feels good when the day is done.
Greg Selker: Well that is sound advice to live by my friend. Brian, thank you so much for speaking with me. I’ve enjoyed this conversation very much.
Brian Cohen: Greg, this has been great and it’s always a pleasure speaking with you and working with you. And I will look forward to the next opportunity.
Greg Selker: Marc, I’m interested in your thoughts on what you think is the ideal role a Board of Directors can take in bringing about a higher level of accountability across their company’s executive ranks?
Marc Morgenstern: Let’s go back to my first proposition which is understanding “the mission”. If we’re talking about a Board holding an executive team to a higher level of accountability, my first question is – “what did the Board ask the executive team to do?” Some Boards don’t actually ask their executive leadership to do anything. The executives’ goals are translated as this year’s budget. That’s not a lot of direction.
Now I will also tell you that I have lots of maxims that I have developed through the years, and one of“Morgenstern’s Maxims” is, “an expectation unarticulated is a disappointment guaranteed”. The core of that is that you obviously have articulation and expectation.
So what’s the desired corporate outcome? Is it change or is it innovation? Is it de-leveraging the capital structure? Is it getting more liquidity or driving higher profits? Is it increasing market share? Is it a 3 year or a 5 year goal?
Pretend for a moment that you had ten simultaneous Boards for each public company. Even if each Board was very responsible, you might still have ten legitimately different views of what the goal of the company should be; and therefore, different views on the goals the executives should be held accountable for producing.
So when you say, “holding a team to a higher level of accountability”, I’m not quite sure what that means. Does it mean that if they don’t reach the desired goal, they should be fired or have their pay reduced?
The consequences of that would be that executive teams would be fighting with Boards all day long to make sure that the budget and goals were lower so they didn’t fail on their assigned tasks.
Greg Selker: Well, Marc first of all, I would say that a base level of accountability would be that a Board seriously engages their executive team in having this kind of discussion. Fundamentally starting with, “what are we committed to as a company?” And secondly, I would say that established goals are not only defined in financial and budgetary terms, but that they encompass values and behavioral areas as well.
Marc Morgenstern: And I agree with that. I guess part of my point is that it’s a two-way street. Boards can’t hold executives to a higher level of accountability until executives can hold Boards to a higher level of accountability.
Greg Selker: I agree with you 100%. And I think that we could probably forward a pretty solid argument that says that today, a Board for a complex global company that meets on a quarterly basis does not actually have enough insight into the business to even hold their executive team accountable.
Marc Morgenstern: Yes. In fact the problem is that much of corporate behavior is still driven by models that were created in the 1890’s, worked in the 1950’s and maybe even the 1970’s, but may not work today. This is very true of the concept of quarterly Board meetings. In the 1950’s or 60’s, the world moved at a pace where certainly much less happened in any 3 month period than in any 3 month period now.
Greg Selker: The rate of change has accelerated not only because of our global nature, but also with the speed of decisions and actions that are being taken given our communications networks.
Marc Morgenstern: Yes. It makes sense to ask ourselves, ‘what was the quarterly meeting a proxy for?’ To me it was a proxy for, ‘we meet often enough that we’re not likely to be tremendously surprised by information that we do not know.’
And you almost have to assume that if a quarterly meeting worked in 1960, quarterly meetings do not work in today’s world. And then the question becomes, “What is the right model today? Is it six times a year; twelve times a year?”
Again, the answer, depending on the nature of the company, could be different. Maybe it makes sense to go to a 2-day board meeting quarterly, and a one to three hour update every month. I think there are lots of perfectly viable alternatives. But they all depend on greater frequency of Board and management interaction, and achieving greater Board involvement. It’s funny, because the Boards of many public companies still meet four times a year. This is always a surprise to me, because most of the privately-held emerging growth companies I’m involved with meet monthly.
Greg Selker: Right, and there is greater contact between the CEO, the executive team and Board Directors.
Marc Morgenstern: This also means that Directors are then more a part of pro-active planning than commenting on something that has already happened.
Greg Selker: Right.
Marc Morgenstern: So in my opinion, a critical area to talk about is how the role of the Board of Directors needs to change, but it needs to change both from a business perspective and a legal perspective.
If we look at the statutory words about Boards of Directors going back to the late 1800’s and early 1900’s, a Board is spoken about as a body that manages the company and oversees the executive team.
Well this was a time when businesses were all located in one city. Remember, there were no multi-state businesses until Henry Flagler figured out, on behalf of John D. Rockefeller, how to do interlocking trusts. This was in the 1860’s and 1870’s and represented the first time you had businesses that crossed state lines. Though for many years post this, 50-80 years, most businesses in one way or the other were local or regional. They simply weren’t national. And they were smaller.
Let’s translate this into today’s world. If you’re a really conscientious Director of a company doing $10 million dollars a year, I would bet you know an awful lot about the business, down to very small decisions being made, and you can impact these decisions and the company.
Now let’s take the opposite end of the spectrum, and by the way, my observation is not driven by recent events. I’ve been saying this for several decades. How can anybody suggest that a Director of a company like Citibank could conceivably know what was going on in the myriad businesses, even if they spent every day, all day, talking to the CEO? How could you ever know what was going on in a business doing a billion dollars a day?
And so with scale, this means there is an inability for a Director to perform the duties charged. You’re simply too far removed. In a company like Citibank, there are so many layers between a Director and the operational reality, that they’re reading paper of a paper of a paper of a paper of a paper. Their data is tremendously filtered. Not because someone is trying to do something malevolent. It’s filtered because you’re ten thousand miles away from the operation geographically and organizationally.
And so as that separation between a Director and an asset gets farther and farther away, what do we all really think those nice people could do? They’re sort of left with the only thing they can do, which is to try to do a lot of talking with senior management, and maybe the management layer below that. And after that, what else could they do?
Maybe a company like Citibank should have ten Boards of Directors as an example. You know, why is there a concept of only one Board? Why is it only at the top? Maybe we need to find a different definition? Maybe there should be three Directors for any division that’s greater than a billion dollars? I can think of lots of alternatives.
But what I believe is that no matter how many people are on the Board, no matter how often they meet and how well meaning they are, there is no way that a Director of Citibank could ever really claim to have the same knowledge and involvement of the company than a Director for a $10, $50 or $100 million business. And yet it’s the same statutory word, it’s the same legal charge, and it’s the same mission. And I simply don’t think that works.
Greg Selker: Well, this makes sense to me. How do we go from this philosophical discussion of trying to alter the corporate reality of Boards, to putting it into action? What are some of the suggested steps that you believe could be taken to bringing about change, besides broadening this conversation to include more people?
Marc Morgenstern: I guess that first you’d have to get a fairly broad consensus that the overall concept of a Board of Directors is outdated. It is a buggy whip manufacturer in the automobile age. And then, we need to engage in a serious discussion knowing that this is not a one day discussion and it’s not a simple answer.
Greg Selker: No, not at all. And as you said, there could be multiple, valid structures each depending upon the company and the context.
Marc Morgenstern: So the classic American approach for this would be to default to the fact that it is State law, and not Federal law, that overall governs Boards of Directors. It is the State law of the corporation that says what the Director’s charges are.
And in general, different States have taken different approaches to the same problems. Over a period of time, you have enough data to say, – “You know what? The State of Maryland had what seemed like a great idea when in 1990 they passed this law. But now that we’ve had a chance to look at it in the real world for ten years plus, we see a lot of flaws with it.”
Then Montana passed a law approaching this problem differently, and at the time we thought it was a bad idea. But you know what? Fifteen years later we’ve seen how it works, and it’s really a good idea.
This state by state approach often leads to consensus that the three good things in the Maryland law and the two good things in the Montana law should be combined and evolve to a common standard.
But what’s unsatisfying to people about this approach is that it’s messy, and it takes time. And you have to allow things to play themselves out so that you can see what things work, what things don’t work, and what things work okay but could be better. And that’s a 5 to 20 year process.
At the end of the day, there will be a tremendously improved society, but along the way you may have had a lot of very bad individual experiences. And so we come back to the whole concept of risk and reward, but at a societal and governmental level. And to me, the benefits of that sort of experimentation justify the risk.
I think over an extended period of time to end up with the best answer to this dilemma by permitting state variation creates a very acceptable risk-reward ratio. Other people could comfortably disagree and I would understand that.
But still, almost everything in life comes down to risk-reward or cost-benefit. I’m prepared to live with short-term uncertainty and short-term failures, if in the longer run we produce a much better legal and business foundation for the next hundred years of our society. Some people would not be okay with that.
Greg Selker: Marc, you’re on a number of Boards. Have you brought some of these concepts of restructuring, rethinking the core definition of what the Board of Directors is, to the companies in which you’re a Board Director?
Marc Morgenstern: The short answer would be yes. But not necessarily because it was driven by me, but because I tend to be on Boards and involved with Boards of people who are at least like-minded enough that what I’m saying is not emotionally or intellectually dissonant to them.
And so what I would tell you is that I think that really smart CEO’s are changing Board behavior because in theory, while it’s the Board that calls the Board of Directors meeting, in the real world it’s the CEO.
So number one, good CEO’s attract and recruit good Boards. And good CEO’s, for either offensive or defensive purposes, want more relationship between the Board and management. And I say relationship rather than meetings, because meetings are just a proxy for information exchange and relationships.
So I’m not involved with any public companies that literally only have four meetings a year. Whether they have four or six formal meetings varies. They almost all have extended phone conferences in-between meetings. They almost all provide monthly information packets that are very intelligent and well designed by management and the Board through an iterative process where management says, “I think this information or format is what’s helpful”. And the Board looks at it and says, “yeah that’s great, but we’d like this report prepared differently”, or “we’d like two more reports or whatever it is the Board thinks they need to see to get good information.
Board meetings are much longer today than in the past. There are many more off-site meetings to make sure that management isn’t distracted. There are many more meetings that take place at an operating headquarters or operating division. Because that’s one of the ways that a Board can get a much better feeling of the person managing a large division; we’ve only ever heard their name a hundred times – let’s go meet the person. And let’s go meet the person who’s their number two or number three person.
And by the way, let’s make sure that the division knows that the Board of Directors was there – that there really is a Board of Directors and they really are paying attention, and Directors are real people. And so you de-mystify some of the concepts of a Board of Directors. As opposed to what usually happens, which is, the Board of Directors is usually only “real” to about a handful of people: CEO’s, General Counsel, CFO’s, COO’s, and the Treasurer. All the people who typically directly and routinely interact with the Board.
The Board of Directors needs to be real to many more people. The Board can go to the people, which is a very good solution. Or, what many companies are doing is that at every Board meeting, they bring in the next three officers in a division, or the head of Sales and Marketing. People who do not ordinarily appear in Board rooms. And this person prepares and gives a presentation and is available for Q and A.
This sort of interaction creates the potential for open-ended questions and immediate management responsiveness, almost like a built-in stress test. Can this person stand up to that kind of inquiry? If they succeed, that’s great. If they don’t, do they go away determined to improve now that they have a better sense of how a Board of Directors thinks? Hopefully, they will.
Greg Selker: One of the best corporate practices that I’ve run across when it comes to Board and executive interaction, was a $3 billion company that had an annual retreat to which the executive team, plus the next layer down of the folks who were identified as high potential succession candidates, were invited.
There were group presentations made to the Board, and different Directors were paired up with executives on a rotating basis throughout the weekend, and from one year to the next. This meant there was real interaction that occurred over a 2 or 3 day period between a Director and an executive or junior executive, not just the typical two to three hour presentation..
Marc Morgenstern: I think whatever venue and whatever the format, more interaction is better than less interaction.
Greg Selker: I would agree.
Marc Morgenstern: There is real benefit to informal one-on-ones. Some people are not particularly comfortable presenting to a group that’s very formal – it’s not what they do all day long. But sitting talking to a human being one-on-one, is normal and comfortable, and they’re much more likely to - not that they would be dishonest in the Board environment - but they would be more open and honest in a different way in a one-on-one environment.
Greg Selker: Yes, that is a different kind of interaction that’s invites a deeper level of conversation and communication.
Marc Morgenstern: And the development of individual trust and intimacy. This also sets the stage for a Director to call two months later and say, “You know, I’m hung up on something we discussed, can we talk about it?”
Greg Selker: Yes, absolutely. It becomes an opportunity for mentorship for a Board Director who has more experience and knowledge to be able to impart that to a younger executive, while at the same time enabling the Director to provide some insight into who that person is to the CEO and the senior team.
Marc Morgenstern: Another benefit is that you’ve really both talked and listened to somebody one-on-one. If you’re getting reports from them later on, you’ll always read the reports differently because you’ll have a better understanding that when Jane uses the word “must”, she may mean it would be helpful. If John uses the word “must”, he may mean this is absolutely a condition precedent. So understanding people and therefore, understanding their vocabulary, simply lets Directors listen and gather data more efficiently and effectively.
Greg Selker: So you are saying that part of the redesign of a Board of Directors is taking its mandate seriously of directing a company and become more involved, however that is structured or constituted.
Marc Morgenstern: Well, not necessarily. Because more could also be meddling. A Director can’t be a micro-manager. And you probably couldn’t have five Directors each calling the same person, and then each reporting back to the Board, – “Gee, I had a discussion and the person said “X”, and another Director says no they said “Y”. Because the Directors probably asked different questions, thinking they’re asking the same question. You have to manage against disconnects.
Greg Selker: Absolutely, right. I didn’t mean that the Board should begin to be engaged in the management of the operations of the company.
Marc Morgenstern: Yes. You know, there’s a fine line between a Board having greater involvement, on the one hand, and end-running the CEO on the other. And you know there’s a reason why, in effect, people always come to a single cusp point at which a CEO is talking to a Board. Some of that’s very good, because there’s a monolithic management voice saying something.
Some of that’s very bad, because there’s a lack of permeability between the Board and the rest of the company. So I don’t think there’s a simple balance, or even by the way, a balance that is true of the same company across time.
It’s always changing. Probably the single greatest problem facing people generally today is the rate of change. What was a good answer yesterday…
Greg Selker: …isn’t a good answer today or tomorrow.
Marc Morgenstern: And if you extended that to laws, it’s the same thing. This is truly the most fundamental disconnect as we talk about Boards, regulation and accountability. The length of time it takes to put laws in place and the bureaucracies, regulatory environment and people to manage them. No matter what change you make, by the time it’s spun through a system, the stimulus that caused the change, in today’s world, by definition has changed. And so the final managerial or legislative response, if not inadequate, was responding to a different stimulus.
This is the same issue with a Board of Directors. Anything that we’re saying right now is probably directionally accurate. But a year from now there could be a technology that would totally alter the way in which the problem is looked at, and what the best response is. This is one of the things we really haven’t touched on with respect to where we began our conversation, the under-utilization of technology by the SEC, Boards of Directors and many other groups.
Why don’t most Boards of Directors have (in effect) a LinkedIn equivalent with the top 50 executives in a company, or the top 10? Why isn’t there an open-ended online forum? Why aren’t documents being exchanged more frequently and annotated in that fashion rather than by hard copy? If you have companies that are increasingly not in one place, however the phrase “not in one place” is defined, you really have “distributed teams”. Then you have to find a way to work more collaboratively.
There are so many evolving forms of collaborative software, annotation software, and community and communication software. There are devices like Skype. Most people do so much better if they’re looking at someone’s face while talking to them. We communicate words, and we communicate with words, gestures and body language and many other things. I don’t want to call the CEO – I want to see the CEO. And yet I will just tell you that many company’s IT infrastructures, including most major law firms, don’t accommodate Skype. Most companies are more concerned about the security of their IT system, the risk side of the equation, than the reward side, which is better communication. So people’s personal technology access may be greater at home than in the workplace. That’s a problem.
For many companies the risk-reward ratio is focused on security. That’s largely driven by MIS and IT people. The discussion isn’t driven by senior management and the Board focusing on the reward side of the question with the degree of priority it deserves. If somebody gives you the answer, “We can’t do Skype”, not too many Directors say, “Well then we’ve got a problem with our network infrastructure and we better change it so you can do Skype.” They just accept it. This is disturbing and a very common pattern and something that I think needs to be talked more about.
Greg Selker: Marc, we’ve talked about board accountability in terms of the board’s responsibility to give guidance to and develop a successful relationship with executive management; let’s talk about board and corporate accountability in a different context. I’m interested in your thoughts on what you think constitute best practices around measuring, reporting and compensating performance, and in particular, if whether or not the pressures around quarterly reporting unduly influence both executive and board behavior.
Marc Morgenstern: Now we could say that quarterly measurements are good or bad. I tend to think they’re bad. But as long as it is what it is, then you’re going to have executive and Board behavior that are tremendously influenced by this. Even though people always decry the measurement of short term profits, the fact is, that’s what is rewarded in the market place.
So if the driver of behavior is reward for short term profits, why would anyone expect a different result from rational people dealing in a known universe? And I think the answer is, you really can’t.
If the Board says, we don’t care what the market place thinks – we want you to do A, B and C, and the executive does exactly what the Board wants, and the Board really believes this course of action is in the best long term interest of the company over five years, the Board truly sets compensation based on its desired outcome. But in those five years, the market says, “We’re not interested in these things. We don’t have the patience for that, and we’ll take your stock from $100 to $8.” What happens then? Employee stock options are worth nothing and you can’t attract or retain the best and the brightest. People say, “They’re a fallen angel – they used to be good, but now they’re bad.” There’s tremendous negative reinforcement – and by the way, danger.
Because if the stock price is $8, and a long term strategic buyer says, “Boy that company is worth $100, I’ll go in and offer $16 and I’ll tell the Board you have to take it because it’s in the best interest of the shareholders because it’s a 100% premium over current trading price” What Board of Directors is going to turn down a 100% premium? That’s pretty tough. Make it a 200% premium on $8, I’ll pay you $24. It’s still worth $100.
So if it’s worth more to the private market place than the public market place, guess what – it will end up in the private market place. So a lot of the behaviors we see are the self-defense of public companies who perform in the arena in which they’re placed and act in accordance with the way in which they’re judged.
Greg Selker: So it seems we may need to radically change both the communication mechanisms and those in which results are reported and evaluated and considered by shareholders and by the public market place.
Marc Morgenstern: Yes, but you can’t do this from inside – you can only do this from outside.
Greg Selker: Well this basically brings us back to the SEC, but certainly other kinds of agencies or regulatory commissions or committees that could look at and address these issues at a more systemic level.
Marc Morgenstern: And, I could put an outrageous proposal on the table. As soon as I say it, you’ll recoil - Instead of quarterly results from a public company, why don’t we just give annual results?
Greg Selker: I don’t recoil at all. Personally, I think that is a good idea. Because I believe wholeheartedly in the principles in which you’re describing and have believed them myself for years. Short-term reporting tends to skew executive behavior to the short-term.
Marc Morgenstern: Yes, but here’s why the world would recoil. They would say, “Well, transparency is the current God”. And if you only report once a year, I don’t have any transparency. So I equate transparency with animmediacy of data. And as soon as people value immediacy of data over information, then you’ve lost the whole battle.
And so the world says more reporting (and more reporting in granularity) is a good thing because that’s what they think transparency is. And particularly again – going back to a world that changes so quickly. If a company went a year without reporting, it could be a completely different company. But if you’re a truly long term investor, a private investor, you couldn’t care less about the quarter. It’s an absolutely arbitrary, meaningless measurement. It’s no more logical than once every four months – or once every two months. It’s just what’s existed for a very extended period of time.
Let me say just one more thing. The shorter the measurement period, the more the data and less the information.
Greg Selker: Got it. So if a company has systems in place that allow accessibility and transparency of data, the difference between quarterly reporting would be a management report that consolidates that information, and says, here’s what it means.
Marc Morgenstern: You know right now we have sort of a hybrid which says that it’s okay to give people information quarterly, which if you’re a public company, you do with the 10-Q. But there are a fair number of things that if they happen, we can’t wait for a quarter to learn about them.
So for instance, you have the 8-K’s which are used to report major events. If you’ve made an acquisition, a director resigned over disagreement on major policy, major changes in compensation, changes in the share ownership of Executive Officers and Directors, all these things go under the 8-K or Form 4 filings.
So there’s a mechanism now for things in between quarters. There’s a tremendous amount of work involved in a 10-Q. Outside of the filing there is the whole internal management discussion and analysis, and the external public reporting of the results with the accompanying analysis and discussion. And if you think about it, part of the obligation of public companies is to discuss trends. If I’ve got a year to report something, I’ve got a year’s data to observe – I could probably tell you what a trend is or isn’t. However, the shorter the period of time I’m looking at, if I look at only three months of data, it’s much harder to discern what is and is not a trend. Is a “change” the effect of seasonality, is it an aberration? Is it a result of a currency fluctuation? I don’t know. And to pretend that I could magically report once a month, what does one month’s data really mean?
You know last year at this time, the company had 22 shipping days in January while this year, January only, we had 19 shipping days. I mean variables like that produce incredible differences. If you’re a retailer looking at comparable quarters, did Easter fall in the second quarter or the first quarter? Was Christmas a six week selling season or a four week selling season?
And so it’s very hard to actually give an analysis or provide information that is more than just data. I can give you the data – the sales last year were $10, and this year they were $9 – that’s a $1 difference; that’s data. But what does it mean? I don’t know. It could simply mean a shorter selling season. It could mean I had the same level of inventory and orders to be shipped, but three trucks broke down and so the shipment was delayed. Or the last shipping day of the month last year was a Friday, and this year is a Monday.
So the shorter the time period – no matter how conscientious you are, the harder it is to really give an analysis that is a genuine analysis.
Greg Selker: So in the spirit of trying to deliver accessibility and transparency, how would a company go about doing this to provide not only the immediacy of information, but also some sense as to a consolidated, kind of high level view of what this information means?
Marc Morgenstern: Well, let me address some of this at a philosophical level. As an example, every company that I’ve ever been involved with as a director or lawyer that has gone through the IPO process, upon their public offering, I have encouraged them to make a blanket policy statement that they do not endorse analyst earnings, nor do they make their own projected earnings. Just a flat out statement.
This frequently causes a lot of aggravation with the underwriters of that process. They say, ‘Your stock price won’t be rewarded and people won’t follow you.” But if you don’t put yourself under the pressure of the system of projected/reported quarterly earnings, then you don’t have to engage with your own projection. And every quarter if something is wrong, you don’t have to say – “Oh gee, we projected 12 cents – now we think it’s going to be 9 cents”. And so you simply can avoid an enormous amount of aggravation by doing it this way and ultimately, it creates a safer environment.
Again, reasonable people can disagree. Some people will say, “They’re not getting 20 analysts to follow me.” Well maybe, maybe not. But generally, if you’re a profitable, good company, analysts will follow you. But you will have reversed the game on them by refusing to play the way they want to play. They will still make their own estimates. There’s nothing you can do about that. But it will be theirs, not your estimates. So you won’t have an obligation to amend, modify and update your own disclosures. And you will make the task of being a public company much easier.
By the way, if 500 public companies all said collectively “We’re not going to provide projected earnings”, you would almost immediately change the whole global investment evaluation process. But that’s what it would take – it would probably take 10 or 20 of the top 50 companies. If AT&T,IBM or several other large companies just said, “We’re not going to project earnings. We’re comfortable enough that you’re going to follow us anyway.” In my view, you’d create an enormously better environment because you would take the betting aspect out of it, and truly make it much more like long-term investing.
Greg Selker: So it would have a ripple effect to much smaller companies?
Marc Morgenstern: Yes, if $50 to $100 million dollar companies did the same thing on their own, it’s largely irrelevant.
Greg Selker: Right.
Marc Morgenstern: This is a place where scale matters – mass matters – and branding matters.
So as is true of many things – it used to be that if it’s good for General Motors, it’s good for the country. I’m not so sure GM is the right metaphor anymore, but you get my point.
Greg Selker: Right. Well this kind of brings us to really talking about enlightened leadership, because I believe that’s what it would take in order to bring some of these changes about. What do you see needs to happen in order to bring about this level of enlightened leadership?
Marc Morgenstern: Well I think it’s a combination of enlightened leadership at an individual and a company level. But I think there are also lots of organizations like business roundtables, for example, where those leaders gather together, and that’s one of the places where you can reach an agreement across 20 companies of what you think a recommended course of action is. So if an umbrella organization of enlightened leaders says to its enlightened leaders – “this is what we recommend”, then you can really get change.
Greg Selker: Yes.
Marc Morgenstern: And by the way, Why don’t you see activist shareholders, if they’re so concerned about short term profits, why don’t you see them demanding longer term goals and less reporting and fewer projections? And you know why. Most activist shareholders want more projections and more data allowing them to make shorter term decisions, rather than more information.
But there is no reason why genuinely enlightened shareholders shouldn’t be involved in pushing for these kind of changes, as well as enlightened leaders and Boards. In fact, if the pressure for change exists from each of these perspectives, that will increase the likelihood of change actually happening.
Greg Selker: Well Marc, this has been a fascinating conversation and I know that we could talk for several more hours on additional topics. Thank you so much for your insights.
Marc Morgenstern: You’re welcome Greg. This was fun and a good dialogue.
Marc Morgenstern is the Founder and Managing Partner of Blue Mesa Partners. He serves as a Senior Advisor and/or Board member for growth companies in industries as diverse as telecom, enterprise software, social broadcasting, specialized steel service centers, printing and imaging, and solutions for protection and renewal of residential and municipal infrastructure.
Over his 25 year plus career as a nationally prominent corporate and securities lawyer, he has been a director of numerous public and private companies, and a principal advisor at hundreds of public and private companies board meetings advising about corporate governance, mergers and acquisitions, executive compensation, public and private equity financing, financial statement restatements, Sarbanes-Oxley compliance, and hostile takeover defenses.
Prior to devoting his full-time efforts to entrepreneurial activities, Mr. Morgenstern was the leader of the West Coast Corporate and Securities Group for a national law firm, and previously had been the long-time Managing Partner and CEO of a midwest regional law firm focused on entrepreneurs and emerging growth companies (public and private).
His observations have appeared in national media, including CNBC’s Squawk Box (private equity), The Deal (private equity and hedge funds), CFO magazine (Sarbanes-Oxley), Wall Street Journal (cost of being public), Los Angeles Times (Blackstone IPO), Tech Republic (strategic planning), New York Times (how a good board helps grow companies), Compliance Week (stock option expensing), Entrepreneur Magazine (problem investor syndrome), San Francisco Chronicle (Sarbanes-Oxley and IPO’s), and the San Jose Mercury News (sale of restricted securities).
We are thrilled to present this Leadership Interview with Marc Morgenstern.
Greg Selker: Marc, thank you for participating in our on-going series of leadership interviews.
Marc Morgenstern: My pleasure.
Greg Selker: I’m looking forward to talking with you in this context. We’ve known each other for a number of years, but our interactions have generally been about specific projects, rather than a more broad philosophical conversation on these particular issues.
Marc Morgenstern: Indeed.
Greg Selker: Marc, you have developed an expertise and have written extensively about the SEC, and specifically how the regulatory environment affects both the IPO process and privatization of companies.
In your recent article published on The Huffington Post, you wrote about the U.S. capital markets regaining their once world-renowned reputation for safety, transparency and liquidity. To me the necessary ingredients to bring this about are the SEC creating rules that are designed to balance long-term results, as opposed to short-term profits, their enforcement of these rules, and the degree to which an executive team is held accountable by a Board of Directors for behaving in accordance to these rules.
Do you agree with my categorization of these three major areas?
Marc Morgenstern: Well I think the short answer is that I sort of agree in part, and don’t agree in part. I think you’ve described very closed ended categories, and I think the real answers lie in a more open-ended way of thinking about our current condition.
As a starting point, it makes sense to try to understand where we are in the context of looking at the dynamics that drive behavior as a very broad concept. In other words, what do people believe that their mission is and how does their behavior match up?
If you talk about the SEC, the first thing that everyone needs to understand is that the SEC has a dual mandate. On the one hand, their very clear mandate going back to 1933 is that they’re supposed to protect investors.
Now starting with Reagan in 1980 or 1981, the rules changed and an additional mandate to the SEC was added, (and by the way I think it is quite a sensible one) and that is that the SEC is also responsible for capital formation.
These are absolutely counter-cyclical charges from the government. They’re supposed to protect toward safety, which generally means driving farther away from capital formation. Or enable capital formation, which generally means driving further away from safety. I don’t know really what Congress intended, but I’m going to assume that these dual mandates reflect a fundamental characteristic of the capital market place, which is striking the balance between risk and reward.
So the goal of the agency is to achieve this balance. Now I don’t think that the balance is there, and there are many reasons for this.
Greg Selker: Well, regardless of the reasons for this imbalance, how would you describe it?
Marc Morgenstern: Let’s talk about it philosophically first, and this get’s back to my response to your categorization of the possible solutions to regain our transparency, safety and liquidity. What is the SEC’s long standing mandate and how do they regulate things? The answer is that there’s a very sharp distinction between how the Federal government historically is regulated, and how state governments are regulated.
The Federal Government operates in a disclosure driven securities model which assumes that the marketplace is grown-up and sophisticated. The role of the SEC and the Federal Government is to make sure that investors have the facts that they need in order to make informed, rational investment decisions. That’s a disclosure system.
The States have always had a sharply different, very paternalistic view to protect investors from things that the regulators don’t think they should invest in. It’s substantive regulation. As an example, in the tax shelter days of the 1980’s, many states had leverage ratios governing investments. You couldn’t invest in an oil and gas deal if the leverage ratio was more than 3 to 1 or 5 to 1.
The SEC’s view was different saying, “You can do whatever you want to as long as investors are aware of the leverage ratio. We’re not here to tell you whether or not to make the investment. We’re just here to make sure that you know what you’re investing in.”
So part of what has happened over the last couple of years, particularly around Sarbanes-Oxley, is that I think the Federal mandate has gotten quite confused. And to me the tipping point was Sarbanes-Oxley when the legislation said that a public company cannot make a loan to one of their Executive Officers or Directors. That moved the Federal Government into regulating the substance of what a company can or cannot do. Previously, these kind of substantive regulations were always governed under State (corporate) law.
Greg Selker: As opposed to Federal law and the SEC, which was really more focused on transparency and full disclosure?
Marc Morgenstern: Yes, and my comment at the time was - well, if the SEC can regulate that aspect of compensation, because that’s what loans tend to be, why can’t they say that you can’t have more than six weeks or three weeks vacation or a limit on your bonus?
Greg Selker: Little did you know that you were being prescient.
Marc Morgenstern: Well actually I did know, because it was just a little thing, but sometimes little things lead into very big things. And although I didn’t know exactly what it would lead to, it changed Federal philosophy from disclosure to substantive regulation.
And unfortunately, much more troubling to me was the fact that this outcome is so frequently true of well-intended, but ultimately self-defeating rules. New rules were implemented because people were outraged. You may remember the scandals from the 80’s where people had taken loans from their companies and didn’t repay them?
Greg Selker: Yes, absolutely.
Marc Morgenstern:And the fact of the matter was that those loans were fraudulent and illegal, all conduct which was subject to State law. You know, Boards of Directors did not authorize $100 million dollar loans. That was a violation of all corporate law.
Those loans were concealed from the Board of Directors. There were 50 statutes on the books that would have recovered the money, but instead of acknowledging that the laws were perfectly okay and enforcement was needed, populist outrage moved to eliminate the variable. That, by the way, is the consistent pattern of human behavior and regulation over time. And it is happening again today for very predictable reasons. People are angry about things and the legislative response is to say, “Let’s look at the variables and make them go away.” And that never works.
Greg Selker: This is why you said you both agree and disagree with my categorization of the solution to our crises?
Marc Morgenstern: Yes. If we automatically default to more rules and regulations, which is where many people want to go, the first question is, how many laws will the SEC inherit? Congress passes a law and the SEC is then charged with enforcing it.
And the second question is, what does enforcement mean when you’re the SEC? And that answer takes us right back to compliance. Public companies have to file their annual reports and their quarterly reports, and the SEC is charged with going through them and saying, “it’s ok or it’s not ok”. And every three years – and notice it’s only every three years - they must review the 10-K for every public company. Well, think how much happens in a three-year period.
Greg Selker: Right, an enormous amount.
Marc Morgenstern: Anybody who really believes for a second that this represents active enforcement is foolish. Of course, it isn’t. But the SEC has only so many resources, and the three-year review was again, a very consistent regulatory response. Which is to say, ‘We’ll make a rule and assume that it fits all categories across all public companies.’
What possible sense does that make? Because with finite resources, doesn’t it make more sense to allocate resources on a risk adjusted basis so that SEC personnel spend the time where it counts the most? So the SEC’s charge shouldn’t be to review 10-K’s every three years. The charge should have been: the SEC will evaluate where risk is, and review most often the disclosure documents that it thinks represent the highest level of risk - and review least often the documents that they think represent the lowest level of risk. Recognizing that it’s not perfect – that perfect is not one of the alternatives.
Many years ago in response to a question about Sarbanes-Oxley and the regulatory environment in general, Irwin Federman, the founding partner of US Venture Partners said, that in his experience, “one-size-fits-all only works with muu-muus and athletic socks.” I thought that was a really telling observation.
So you have to give the SEC a much more flexible approach to managing risk. And if you think about it, this approach is completely consistent with how the largest accounting firms conduct their audits.
A Big 4 audit report typically would say, “We know our audit isn’t perfect. We concentrated our efforts on identifying and auditing the riskiest components of this business. And we are telling you, the Board of Directors and the people reading the financial statements, what we think are the greatest levels of risk, and then what we believe is the best approach to disclose and mitigate this risk.”
And to me this kind of audit says, mathematically, we can’t do everything.
A Big 4 audit report says, “What we can do is tell you what we did and how we did it. You can agree with our methodology or not. You can question our assumptions. But you can’t question our transparency.”
Transparency doesn’t mean perfect – and transparency doesn’t mean you go down to the smallest variable on someone’s balance sheet. And that’s where I think people consistently have a very serious misperception. Because the goal cannot be perfection. The goal can only be progress.
Greg Selker: So in the spirit of progress – and also given what you described as the reality both of human nature and the tendency to default to ruling out a variable as the path of least resistance, what do you think would be a new way of looking at the SEC that would help bring back transparency, safety and liquidity, but also increase accountability?
Marc Morgenstern: Well, I think maybe the easiest way to start (oddly enough) is with SEC operations rather than with the SEC’s mission. Because if you give somebody a mission that they cannot accomplish with their personnel or their tools, then it’s doomed to fail.
So to me the right question is – what’s the best thing you can do to improve the SEC? And it has nothing to do with rules. It has to do with the people who are there, and the tools they have to do their job.
This is fairly straight-forward. When you have relatively inexperienced people, and many of the staff at the SEC are lawyers who have 2-6 years experience, they’re going to be, intentionally or unintentionally, unarmed and inadequately prepared to deal with the people they’re investigating who have been in business for 30 or 50 years and who have much greater capital and technology resources. That is an unfair fight to begin with.
So the first thing to do is to make the SEC a place that highly compensates its employees, and will therefore attract highly skilled and experienced individuals. And for some reason, paying people what they’re worth is an unpopular view in Congress. But the simple truth is you need to pay more to get the best people. And this may be more than a Congressman or Senator makes – I can’t help that. The marketplace sets compensation, not me.
Greg Selker: Agreed. And what would you say about the revolving door between the SEC and financial institutions?
Marc Morgenstern: I don’t have a problem with it and I’ll tell you why. When I first started practicing law, the best and the brightest worked at the SEC. They were an astounding agency in the 60’s, 70’s and 80’s. And by the way, today, the employees of the SEC get paid less than people at Treasury for reasons that are obscure to me. In my opinion this is the main source of the problem, not the fact that people leave the SEC for jobs in the private sector.
A very common pattern in the past was people would do their public service at the SEC for 5,10 or 12 years, and then they would take a well-paid job in the private sector. I simply don’t have a problem with that. This populated the private sector with people who understood the regulatory environment, while having the best people spend significant, effective time at the SEC.
Greg Selker: So you’re suggesting that if we raise the pay scale to competitive levels, the SEC will again attract the best and the brightest? And while there may be a revolving door, the tenure of SEC employees will be longer. The SEC won’t just become a jumping off point to a more lucrative position within the private sector.
Marc Morgenstern: That would be absolutely correct. This would shift the pattern of 2 or 3 years at the SEC as a resume builder, to people who are there for 10 or 15 years, while bringing tremendous value to the institution, including adding to the institutional memory.
Greg Selker: Absolutely. Over the past 15 or 20 years, being employed at the SEC has defaulted more towards building your resume and establishing connections for a more lucrative job – rather than trying to build longevity within the institution and to make a difference.
Marc Morgenstern: Right, because when people are in their first couple of years out of law school, the economic disparity between them is not that great. But as people get older, they have families, and larger responsibilities. They need more money. They have to put their kids through college just like everybody else does. So today the system rewards leaving early. This is a real problem.
Greg Selker: So rather than try and legislate against the revolving door, let’s raise the pay scale and let the competitive marketplace do its thing.
Marc Morgenstern: Yes, I think this is an approach that will work better than what we have now. Now an unintended consequence of a more seasoned SEC employee base may be that there will be a far greater likelihood that SEC staff will potentially be investigating companies, and people, with whom they’ve had prior contact and relationship. In other words, we may have greater regularity of conflicts of interest. Here are my thoughts on how to deal with this, and, I know my suggestion is one about which reasonable people can have philosophical disagreement. People will look at the same set of circumstances, and see either a “conflict” or a “convergence”. The question should be is that conflict or convergence good or bad?
If you are dealing with people that you’ve dealt with before, and for many transactions there can be many related parties, some people simply instinctively recoil and say – “Oh, if these are related parties it’s a conflict and that is bad”.
Other people look at it and say – “Oh, if they’re related parties, I’m going to get much better service because if there’s a problem, there’s a much higher likelihood that it will get solved precisely because they are related parties. This is good.”
So it’s the same set of circumstances with two different interpretations. And I’m definitely not suggesting that either one is right or wrong. But I grew up really believing in the concept of disclosure. In other words, what you do with conflicts is to disclose them, make sure that the impacted people really understand them, and then let those people make an informed decision. And that, by the way, is the basis for most corporate law.
If you look at the responsibilities of a Board of Directors and the exercise of the Business Judgment Rule, you know that this rule is built on twin towers; Duty of Loyalty, and Duty of Care. Duty of Loyalty basically says the only reason a Director is taking a particular action is because he or she believes it’s in the best interest of the corporation.
Now does that mean that a Director with a conflict cannot vote in the case of a conflict? No, it does not. It means that there are three ways that people typically approach the problem. The first step is obviously if a Director has a conflict, this must be disclosed Now it’s been disclosed, so what are the company’s options? They could say, “Gee, we’re still uncomfortable with this; we don’t want the Director to vote or be in the room, please leave while we discuss this matter.”
But there are people who say, “No, we know that there’s a conflict, and we’re happy to have you be part of the discussion, but you shouldn’t vote on it.” And the third option is everybody just says, “We know the conflict and therefore, we understand your bias. Please be in the room and vote because we all understand what your motivation may be, and with this understanding, we can make an informed decision as a board.”
To my way of thinking, the ability to make an informed decision among adults is a major driving principle. I don’t want to tell people which one of those three routes to take. I’m okay with having them decide whatever they want that will work for their particular environment. And I think dependent upon the environment and circumstances, any one of these options will be the best choice, but not necessarily a universal choice.
As we begin to see the first signs of recovery in our economy, and the first signs of recovering from the H1N1 virus, our elected and appointed officials from President Obama to Fed Chair Ben Bernanke are saying that the economic slowdown is starting to “slow down”. With that, we can expect an increase in demand for goods and services, and companies once again will begin to hire new employees…albeit slowly.
With the shift away from layoffs, another “virus” rears its pathogenic head: most people do not really understand what it takes to make a successful hire. A virus replicates itself within the cells of a living host, much like the bad habits perpetuated within organizations. Poor hires are continually made because people are mostly weak when it comes to interviewing, assessing and hiring individuals, teams and leaders.
So how should you gauge whether a hiring decision was successful? It is definitely NOT whether the hired employee remains for one year - the typical and laughable guarantee offered by the executive search industry. Pretty much anyone can last a year in a company, and many do. In fact, at larger companies, it is often the case that a bad hire gets transferred and becomes someone else’s problem. Or, in the case of a senior level hire who really doesn’t work out, the company defaults to lowering the bar and accepting mediocrity, often taking several years to get out of the ditch, if it does at all.
I propose two very clear measurements of a successful hire, and a boost to your hiring immune system: Q2H2 – 2 Questions to ask yourself before Hiring another employee.
First, do you enjoy working with the person? Are you excited about the prospect of tackling projects and tasks with him or her? When you think about working with this person, do you have a high level of confidence that you will be able to achieve your goals? All of us know what it is like to have this experience, or its’ opposite.
The second clear measurement is more objective. Have this person’s responsibilities stayed the same, grown or diminished over time? The answer to this question truly brings it home. Think about it. If you’re a successful leader, you’re developing your direct reports, and as their capabilities grow, their responsibilities will as well, and you end up delegating more. Your purview becomes more strategic, and your daily activities become less tactical. If you’re a successful employee, your capacities expand and you take on additional responsibilities. The nature of the universe and of life is to change, either for better or worse, and your decisions impact this. It’s pretty clear cut.
The answers to these two questions takes the mystery out of whether or not someone is a successful hire and leaves no room for fudging a response. When you honestly look at your personal track record of hiring people, and ask yourself these two questions, I’m pretty sure you will most likely see that your track record at making a successful hire is 50/50 at best. In other words, it’s a coin toss.
Yes, I still assert that the model of executive search is broken, something I have been saying consistently for the past 7 years, (see The Model Has Been Broken.) But the quality of executive search firms are only one of the mitigating factors keeping most company’s talent and culture steeped in mediocrity. Regardless of whether or not an executive search firm is used, the model of interviewing and assessing candidates is broken. I don’t care if you’re a small business owner, a manager in a mid-sized company, or a CEO of a multi-billion global corporation; hiring decisions depend on your ability to interview and assess people, and mostly, people do a poor job of this.
So as we get closer to moving into a period of economic and flu recovery, it makes sense to examine how you interview, assess and hire people, and begin to change your approach. It is more important than ever to allocate resources where they will make the biggest difference, and it’s about time to stop spreading the “bad hire” virus that seems to infect all sizes and kinds of businesses and begin to seriously talk about what it takes to interview and assess people in a way that informs the decision process and guides a successful hire. And remember to wash your hands.
We are all aware of the uproar caused by the $175 million in bonus payments made to AIG executives. It has been the straw that has broken the public’s back unleashing frustration and anger. Journalists and pundits have detailed the absolute travesty of the individuals receiving them who are no longer with the company and who were also at the heart of foisting credit default swaps into the marketplace. And with the almost-unanimous wrath of Congress bearing down on the bonus recipients, with the 90% taxation clawback measure passed by the House of Representatives, executive compensation has once again moved into the spotlight and illuminated two very different perspectives.
Driven by obscene greed, regardless of the long-term impact on their companies or the economy, executive comp has been vilified as one of the more blatant symptoms that something is terribly wrong. This perspective has led to the comp limits recently written into law as part of the Stimulus bill, the tax clawbacks passed by the House, and without a doubt will result in additional compensation changes demanded by the Senate. However, there is another dialogue to acknowledge: the potential deleterious effect these policies could have on the ability of any company receiving TARP funds, to retain and hire the real leadership necessary to help us out of this mess. Somehow these two perspectives that are at odds with each other need to be rectified!
On March 24th, Secretary of the Treasury Tim Geithner said, “This issue of excessive compensation extends beyond AIG, and requires reform of the system of incentives and compensation throughout the financial sector.” Well, I’m all for reforming compensation on Wall Street, and wherever else it makes sense, but as we move down this path we need to look at this from a holistic perspective to make certain we get it right.
These comp plans were not created in a vacuum, folks. They have the stamp of approval of boards of directors, and were constructed under the watchful eyes of the top compensation consulting firms in the country. With all of this high-powered intellect and experience, what went wrong? The problem is that most plans do not meaningfully account for “how” the results are achieved. So there is no connection to people’s behavior.
While compensation is one of the strongest drivers of behavior, most companies fail to take advantage of this truth and acknowledge the profound relationship between compensation, behavior, culture and values. This means that if you have a clear set of values that are defined behaviorally, and compensation is tied equally to the results and “how” the results are achieved, people will most certainly be compelled to behave in a manner that creates the desired culture while reaching the stated goals.
Here is AIG’s value set as an example:
People Develop diverse talent. Reward excellence. Customer Focus Anticipate their priorities. Exceed their expectations. Performance Be accountable. Manage risks. Deliver AIG’s strength Integrity Work honestly. Enhance AIG’s reputation. Respect Value all colleagues. Collaborate with one another. Entrepreneurship Seize opportunities. Innovate for and with customers
Source: AIG’s Code of Conduct
Looking at this in the context of the recent bonus payout is laughable at best. Most certainly these values have not been clearly defined behaviorally within AIG, and to whatever degree they were, they were not significantly tied to compensation. If values-representative behavior had been significantly tied to compensation, the most egregious of the bonus payments would not have even been on the table, nor would they have occurred.
Bottom line, until Wall Street and other companies begin to define values-representative behavior which is tied to the achievement of results, and significant compensation is at stake, we will be doomed to repeat the same mistakes.
Wake up people, the secret is in tying values representative behavior to compensation!
Well, what goes around comes around. While “values” haven’t been isolated in the media commentary or blogosphere, when you look at the companies on Wall Street at the heart of our economic collapse, anyone can see that these companies have been chock full of executives seemingly void of values and behaving badly. Now I don’t mean to blame the executives personally, since the truth is, they were behaving within the cultural thresholds of their companies, making decisions consistent with their policies, and getting paid according to their compensation plans. It just so happens that the culture, decisions, policies and compensation plans were not at all representative of the values emblazoned on the company’s walls, websites and corporate Codes of Conduct. It is the “Enron Syndrome” all over again: develop a set of “good sounding” altruistic corporate values, use them to recruit and rally the troops, while the executive leadership does whatever they want in direct contradiction, with a damaging ripple effect.
Just pick any of the leading institutions who participated in the securitization of mortgages and other high-risk instruments and have been the recipients of Federal TARP payouts. I guarantee you will see that these companies all state they are committed to some very familiar corporate values, just like AIG:
• People Develop diverse talent. Reward excellence.
• Customer Focus Anticipate their priorities. Exceed their expectations.
• Performance Be accountable. Manage risks. Deliver AIG’s strength.
• Integrity Work honestly. Enhance AIG’s reputation.
• Respect Value all colleagues. Collaborate with one another.
• Entrepreneurship Seize opportunities. Innovate for and with customers. Source: AIG’s Code of Conduct
The problem is that these values all exist in a vacuum as an idealized set of concepts that have no relationship to, or bearing on the work that people do on a daily basis. Until all of us, executives, managers, board directors, shareholders, workers and citizens all demand a change, as a country we will continue to experience the “Enron-Syndrome”
Ken Goldman is an accomplished executive with extensive financial, operational and business management experience and a solid track record of success. He served as senior vice president, finance and administration, and CFO of Siebel Systems from August 2000 until the close of Oracle Corporation’s acquisition in January 2006. Prior to that, he held CFO positions at Excite@Home, Sybase, Inc., Cypress Semiconductor and VLSI Technology. Ken’s experience additionally includes board director, audit committee chairman, and financial advisory roles at several leading public and private technology companies. Ken earned his bachelor’s degree in electrical engineering from Cornell University in 1971 and his master’s degree in business administration from Harvard Business School in 1974. He is a member and the former president of The Financial Executive Institute, Santa Clara chapter, and was formerly a member of the Financial Accounting Standards Board Advisory Council (FASAC) from 2000 to 2004.
Greg Selker: So first of all, Ken, thank you for taking the time to talk with me. I’ve come to know you off and on over the past few years, and so I’m just thrilled to have this opportunity to engage with you in this way.
Ken Goldman: Same here.
Greg Selker: I think the first area to talk about is the economy. Let me start out by saying that you’ve got a well deserved reputation for being one of the financial executives in the [Silicon]valley that runs the tightest ship. You’ve got great functional command over all of the areas of the financial organization – it’s your reputation and it’s well-deserved. So, from your perspective of someone who’s spent his lifetime building his career within financial organizations of large companies and for having a high degree of accountability, what’s your reaction in looking at some of the most aggrieves excesses that have occurred over the past six months in the collapse of the financial sector?
Ken Goldman: Actually it’s very simple. There were two things that most amazed me. The first is the lack of really understanding and being concerned with the balance sheet. While I’m not an accountant, one of the things I was trained to do is to manage the balance sheet very well. So I’m amazed at how poorly these folks with a very sophisticated financial understanding did in terms of managing the balance sheet and balancing risk. The second thing is, if you look at some of these toxic assets held by many institutions, they never could and still can’t really measure their value and hence the impact on their balance sheets. The simple axiom is that if you can’t measure it – you can’t manage it. Since the value of these assets has turned out to be nebulous, they have not been able to manage the risk - and then take action accordingly.
As I watched this whole drama unfold it was clear that people played too aggressively toward the end. Clearly folks like Lehman Brothers and Bears Stearns had the opportunity to raise money. It’s like playing Russian roulette – you can hold out and hope to get a better deal, but at some point you have to know when to fold them up, take the money and live another day. It’s sort of amazing that the people who should have been very smart financiers – didn’t act like it. They didn’t add a little bit of conservatism to their plan and just take some money. Even if it would have been very “expensive money.” If they had done that, they would still be in business today.
Greg Selker: Right.
Ken Goldman: One of the things I’ve always told my staff is - focus on the balance sheet, and focus on cash. I remember at Siebel when we had $2B in cash on the balance sheet and we got all this flack about our lack of a stock buyback! More recently you’ve seen many other companies buyback their stock by going into debt, leaving them with no liquidity. And where are all the activist hedge funds that drove those companies to do that, and realized that was the wrong strategy? So, I think there was a lot of fast money – aggressive money, that played out as if the world only goes up and to the right. Well it’s good to plan that it could go the other way as well. This is fundamental training on what could go wrong, being prepared for that, and taking appropriate actions.
Greg Selker: Right.
Ken Goldman: You know, it’s no different than your personal balance sheet. I was just talking with some friends earlier today about the many folks that put all their money with Madoff. How can you put 100% of your assets with one guy!? The point is to diversify so if one investment goes south – it may make you very unhappy, but at least it’s only one of your assets – it’s not 100% or 90%. I’m amazed at how many folks basically put all their eggs in one basket. The last point I’ll make about this, which I’ve been saying and will continue to for years, is I really wish we would require good accounting financial literacy education – starting in high school and in college.
A friend of mine who used to be Juniper’s CFO, Marcel Gani, teaches an advanced accounting class at Santa Clara, after they have taken accounting 101. He’ll give a 10 question quiz, and these are simple questions, to the class ahead of time to gauge the level of their understanding of accounting, and they’ll consistently get seven or eight questions wrong.
Greg Selker: And this is an advanced accounting course?
Ken Goldman: Yes. It just validates that at basic educational levels we’re not spending enough time, and people are not taking seriously enough a goal to really understand accounting. I think that people need to take responsibility for their net worth. They need to understand how to manage their money. This all starts with having some rudimentary accounting and financial literacy skills.
Greg Selker: Certainly when you look at Wall Street and Madoff–and I think there’s a direct correlation between the inability to measure assets with the propagation of collateralized debt obligations, the lack of regulation surrounding them, and the irrefutable evidence that something was wrong with Madoff’s results. What’s in common with both is an acceptance of something that on the surface doesn’t jive with reality.
Ken Goldman: Definitely. In the instance with Madoff, here are people making money every month regardless of whether the market is down or up – they still make money. But at some point you have to think that this doesn’t make sense.
Particularly people who did any study at all of what he was doing. They would have known it was impossible to consistently get those results. Whoever was auditing his accounts was a one man game and somebody that no one had ever heard of. So where were the hedge funds and fund of funds that were investing folks’ money with Madoff? The most rudimentary due diligence would have led to ask the question, “who is auditing these accounts?” My own sense is that the general regulatory bodies in the US spend too much time worrying about “after the fact” enforcement - as opposed to “before the fact” anticipating the investigation to prevent it.
Greg Selker: Have you read some of the articles that Michael Lewis has written? An article in the New York Times in early January chronicled Harry Markopolis, an investment officer in a fund somewhat competitive to Madoff who tried for years to get the SEC to investigate what he surmised was outright fraud?
Ken Goldman: I’ve read a number of Michael Lewis articles but I didn’t see that one – if you want to send me that – that would be great, because he is extremely lucid
Greg Selker: I’d love to. One of the main points he made in the article “The End of the Financial World as We Know It” was that the revolving door needs to close between the SEC and Wall Street. There needs to be a greater time lag that occurs from individuals leaving firms and then joining the SEC.
Ken Goldman: That’s true, but I don’t know if that’s the core issue. I think the issue frankly, is on emphasis. I think the emphasis has to be on compliance – ferreting out issues ahead of time – doing more checks ahead of time – and stopping things early. In other words, where was the SEC in terms of reviewing the accounts of Wall Street – giving them actions to do and preventing what would occur – as opposed to after the fact fault finding and going after enforcement? You can now punish Madoff all you want– that doesn’t help anybody who lost their money in the $50B wipeout. They should have found him in the first place and stopped the fraud before it got going.
Greg Selker: Ken, it sounds like you’re in favor of more rigorous regulation?
Ken Goldman: I think regulation is good, if it’s done right. It doesn’t have to stifle creativity or the drive to make money. Good regulation just means that information is reviewed, and you make sure people are adhering to certain rules. I don’t think there’s anything wrong with that.
Greg Selker: I agree.
Ken Goldman: The other analogy that I used in a discussion the other day was about internal audit. Look, you can either beef up internal audit capabilities in a company, or you can spend more time on making certain you have the right controls in place and that these are being adhered to. I want to spend more of my time and my people’s time on controls. Making certain we have the people and the systems to get it done right first.
Frankly, I think we’re in a centralized world and need to centralize finance as opposed to de-centralizing it. I want to get it done right and not assume that internal audit will find something wrong after the fact. Because I think it’s always much harder to find what the source of the problem really is after the fact. If you find it after the fact – by definition it’s after the fact. The real question is would you rather have quality up front, or do you want to fix it after it’s broken? If you do it right the first time – then you don’t have to worry about all these specialists. The Japanese have done this well for many years – build quality up front. It isn’t any different in building financial controls. If you build the right controls up front, instead of going around after the fact and then checking it to see if it’s right, you have the controls in place to make sure you’re doing it right.
Greg Selker: Measure your choices.
Ken Goldman: Yes. I’d rather have 80% of the regulatory bodies worried about making sure companies are doing it right first, and maybe 20% enforcement. As opposed to 80% enforcement – and 20% making sure they’re doing it right. Again, I don’t know if those numbers are right – I’m just giving you directionally where I’d like to see the emphasis.
Greg Selker: What are your initial thoughts on the proposed salary cap on executive compensation in the financial sector, and what do you think Silicon Valley could teach Wall Street about executive compensation?
Ken Goldman: Well first of all let me say that the proposed compensation caps strike me as a little vindictive, but I can understand the feeling that something has to change. Wall Street has brought this upon themselves. They’ve acted short sighted and short-term oriented in their thinking, and even worse, they’ve been driven by an entitlement mentality as opposed to a performance driven mentality. I mean, how many businesses could survive if the rules of compensation were no matter how we perform as a company, we’re going to be paid our bonus regardless. This is not how we’ve paid our executives at companies I’ve been involved with.
Typically around technology companies, there’s a bonus pool that’s created that is dependent upon corporate performance. Once the pool’s created, participation is determined by individual achievement of personal goals along with other criteria. If the corporate performance isn’t there, then there’s no money to fund the pool, and there’s no cash bonus payouts. This has worked pretty well for us over the years. On Wall Street, for some of the firms, particularly for some of the largest ones, this has not been the case. It’s been a situation where people were paid bonuses regardless of corporate results. It’s the epitome of a culture of entitlement. Now I know that these practices have not necessarily existed at all firms, or that they have existed at all times over the years, but they seem to be more prevalent recently.
Maybe the answer is to move bonus payments more towards stock payments as opposed to cash, stock payments occurring in both options and restricted shares. In some firms, I know that the granting of stock has been an important component of their bonus structure. But even with these firms, given the horrific results reported, maybe the right thing to do would be to pay bonus awards in their entirety with stock. This also would have the effect of pushing long-term thinking and investment in the company as opposed to short-term thinking, short-term payout, and entitlement. I won’t pretend to have all the answers here, but I know that this entitlement mentality and culture with its focus on short-term rewards has to be replaced by a performance mentality and culture, and a reward system that incentivizes employees for longer-term results.
Greg Selker: I know we’ve talked in the past about the overall IPO market and how that affects your plans as a company in terms of your growth and expansion. With the current climate and the return of the IPO market being volatile, and most likely pushed out even further, how does this effect how you look at growing and developing your own employee base?
Ken Goldman: Well I think the good news is we are private. The expectations with Fortinet before I got here were to go public in ’06 – ’07; but we weren’t ready as a company to do that. In ’08 we probably were close to being ready. I honestly never felt the market in 2005 was conducive to taking a company public. Last year was a year in which we had more companies withdraw their filings than file to go public. My perspective is you that you only file for an IPO when you’re absolutely prepared to go out – come hell or high water. I never felt there was a time in ’08 where it looked like a good market for a public offering. 2008 was just way too volatile.
In terms of ’09, the conventional wisdom says it’s going to be a horrible year – but I never believe conventional wisdom. I think Q1 will be a horrible quarter – a really horrible quarter actually. But that could become a low point and therefore, from a very low base, things hopefully have got to improve. So I think there’s a chance the market could improve later this year as opposed to everybody’s perspective that it’s going to be horrible. The thing that I worry about is when things do start to improve, with all the money being put into the system inflation could come back. With inflation, interest rates would likely go up, and now you have the seeds of another downturn.
All of this has to be managed. But my own sense is that even though conventional wisdom says everybody has basically written off ’09 and maybe even ’10 – I mean everybody – it’s like when you watch sports, everyone says, “Team X is going to win.” Well maybe team X ends up winning, but maybe they lose. We’re in the space where I don’t think any of us know. But the point is, I’m not willing to give up on the year like a lot of other people have just because it’s obviously started off pretty ugly.
Greg Selker: Well I’m glad to hear that.
Ken Goldman: So there’s a little ray of hope. So maybe you’ll come back and quote me at the end of the year and find out I was wrong - and so be it.
Greg Selker: We feel the same way actually. From our perspective, even though there’s a lot of conflict going on, I think there are pockets of growth. Even in retrenchment people are looking more carefully at who they have on board, what they need to do to get the most out of their people, and what they need to do to bring people into their company who deliver even greater expectations.
Ken Goldman: Somebody had a good comment at a meeting I was at this morning. They said, “the worst thing you can do is waste a recession.” I think this is a very good way of saying it.
Greg Selker: Absolutely.
Ken Goldman:Don’t waste a recession. Use the time well to do things that need to be done, and force yourself to do things you might not have done otherwise.
Greg Selker: Exactly.
Ken Goldman: So if it’s upgrading your people – hiring in some very good people that are now available – rolling out some new products – and just doing certain things. Don’t just “give up.” Use the recession wisely, knowing that at some point things will come back and you’ll be more prepared for it. Don’t just hunker down and do nothing. “Don’t waste the recession.”
Greg Selker: So with that in mind what are the ways in which you see your company not wasting the recession?
Ken Goldman: Well in our case, in technology, I’ve always learned that it’s all about the products. Always remember that – technology is all about the products. So we’re going to continue to invest heavily in R&D. We’re going to continue to focus on bringing out our new products on a timely basis. Then we’re going to look at how we can price attractively, and how we can aggressively hire good sales people from other companies. I think it is a great time to hire sales people. So we’ll continue to do what we have been doing, which is to invest in people.
We will also set some high standards in terms of our quotas for this coming year. We’re setting a high bar for achievement and we’re aggressive. On the conservative side, we’re budgeting to keep our expenses under control. We’re going to make sure we’re running an efficient shop and not spending money in a nonsensical way. On the other hand, we intend to invest in areas that we think will pay dividends when we do have an upturn. We think we can grow through the tough times and gain market share.
Greg Selker: Right, beautiful.
Ken Goldman: So that’s what we are doing. Based on my prior experiences in the semiconductor industry, there will be an upturn, you just don’t know when. But you do know that it’s easier to gain market share in a downturn than in an upturn. Because in an upturn, the rising ocean lifts all ships. In a downturn, there’s always some that don’t have the cash resources, or the wherewithal to make significant gains. And our goal is to gain market share. So we’re going to drive what is necessary to produce that result. We have a strong balance sheet with a strong cash flow. We have a clean balance sheet. We’re well poised. It’s all about the “core” details of the balance sheet, when you come back to it. People get hung up on the P&L – and they forget about the balance sheet. The balance sheet is really very important. I can tell you that I know every account on our balance sheet. I review this in detail at least quarterly. I review all of our assets, prepaids, other assets and all the little stuff.
I love Finance. I love planning. But the accounting and your cash position are very important. This is where it all starts. And some things haven’t changed. I’m still a big fan of really getting into the details. If I get into the details and my people get into the details, that means we’re watching what’s important. To me, cash flow is very simple. How much did my cash go up? I don’t need a big cash flow statement. I do look at it, but the cash flow statements you see in these financial statements don’t often help you. The key is: what’s my actual balance sheet cash? How much did it increase? Then look at the key drivers of that. That is what I do.
Greg Selker: Ken, how many boards are you on now?
Ken Goldman: I’m on six boards now. Three public and three private.
Greg Selker: And of the public companies – are you on the audit committee for all three?
Ken Goldman: Yes. All the private ones too.
Greg Selker: Well that’s a significant time commitment.
Ken Goldman: Yes it is. It’s the reason why I get so many calls to join boards. You think they want me for my looks? The good news is I’m able to do some of the meetings from my office– so I’ll call in for the private companies. You know, I was reading something about Warren Buffet where he said that being an operating guy helps him invest, and being an investor helps him run an operating company. My involvement with boards follows the same principle. Being CFO with Fortinet helps my work on boards – and being on boards helps my CFO role. There was a period of time when for a few months after I left Seibel as their CFO I was just on boards, and frankly you start losing your edge.
Greg Selker: I see what you’re saying.
Ken Goldman: I think a company can have one or two professional board members, but I think a well balanced board needs to be composed of people that are still in the game and still actively working. Because, you’re just a lot sharper when you still have to make decisions and kick some butt yourself. So I think I’m actually a better board director, and a better financial executive for doing both than just one or the other. When I was only sitting on boards, I didn’t think I was accomplishing as much. Too many meetings. But now as the CFO of Fortinet, and sitting on several boards – I actually have been accomplishing more as a board director and as an operating executive.
Greg Selker: Very good. Well Ken, this has been great – so thank you for your time and insights.
In a mid-January 2009 article in Business Week, L. Kevin Kelly, the CEO of Heidrick & Struggles said, “the business model for the executive search industry is broken.” In Heidrick’s most recent earnings call, he elaborated by stating that leadership advisory services represent “the evolution of the search business going forward.”
In their most recent earnings call, Gary Burnison, Korn Ferry’s CEO, outlined one of their key strategic imperatives to “create a more consultative solutions based workforce to drive integrated revenue growth.”
Welcome to my world, Kevin and Gary, and “better late than never”. But please don’t hold it against me if I listen to your pronouncements of a new model of search with a healthy dose of skepticism.
I wanted to address the travesty that executives universally report that regardless of whether they’ve used retained or contingency search, internal recruiting, networking or Monster.com, their personal track record at hiring is 50/50. Translation: 50% of the money spent on executive search has resulted in a hiring mistake. (P.S. you will want to multiply your wasted money by a factor of 7X to include the intangible costs.) It really is crazy when you think about it. In your businesses, 50% failure would be unacceptable, so why would you accept it when you are dealing with the most important asset – the talent.
Some firms may augment executive search with leadership services, and change their overall mix of business. This will certainly allow them to maintain their earnings and price/share, and please their partners and shareholders, but it won’t alter the fact that their retained executive search processes are still a crap shoot. Bottom line, until executive search firms begin to seriously address the core processes and methodology of their business, hiring a great executive and leader will continue to be a coin toss.
What’s the solution? Well, first, stop spending your hard earned money on a process that fails at least 50% of the time. The economy is finally forcing many of you to come to this conclusion.
Then, find a search partner who delivers more than empty promises, but the onus is on you. You’ll have to pay greater attention in the selling process, become a discerning buyer who looks for firms that add qualitative value through their processes, and sees the proof by analyzing sample search deliverables and through your own reference checks.
Or, you can just call us. We’ve got a seven year jump on the rest of the crowd.
Recently, a high level executive candidate of mine was interviewing for a pivotal role that reported directly to my client, a CEO. The candidate was a “game changer”, with a history of pointing out how the “status quo” wasn’t cutting it, and implementing improvements. As we moved into checking his references, it was no surprise that I heard about some past difficulties the candidate had with certain individuals. It was clear that over the course of his career he had to take some unpopular stances in order to drive change.
After 20 years in the executive search industry, it never ceases to amaze me how one bad reference can bring a candidate’s viability to a screeching halt. Now look, I understand there are issues that surface in the reference checking process like financial impropriety, integrity, and other potentially sordid details. These should, and will justifiably stop someone’s candidacy cold. However, even this type of information must be vetted through a number of sources in order to conclude that there truly is an issue, and get to a satisfactory level of understanding of the “truth”.
But when information surfaces that is not so clear cut, what do you do? Certainly, it is essential to know if there is a behavioral thread that points to long-standing weaknesses with a candidate. However, it is often the case that negative feedback points to something else entirely.
Betty Davis famously said, “If everyone likes you, you’re pretty dull.” I take a different perspective and say, “if everybody likes you, you are probably mediocre.” Just ask Michael Dell, John Chambers or Jack Welch if over the course of their careers they always won the popular vote. Bottom line, if you’re committed to delivering the extraordinary, you are not going to be everybody’s best friend, especially in this trying economy.
This doesn’t mean that references aren’t important; in fact, quite the contrary. It means you need to look at the reference checking process as your opportunity to create a very complete and holistic picture of a candidate over the course of his or her career.
To this end, I’ve developed Three Cardinal Rules of Reference Checking that have always served me well.
1. If you dig long and deep enough, you can find dirt on God (also the Pope, Mother Teresa, and even Oprah!)
No one is infallible. If someone has a long career, the chances are they’ve stepped on some toes and made mistakes along the way. Look at your own life and career. If you’re like most people, you’ve learned from your mistakes. While you want to understand the mistakes candidates have made, what’s really important is to determine if and what they learned from them. And remember, you can even find dirt on God, so if the candidate appears to be spotless, that fact alone is a red flag!
2. Understand the context in which the information is given.
In order to get to a complete picture about a person, you have to understand the following relationships:
Candidate – reference
Candidate – company
Reference – company
And…
What was going in the company at that particular time
The lesson here is that oftentimes a successful reference check tells you as much or more about the reference and the company than the candidate.
Several years back I had a finalist candidate for a senior position. We were in the middle of the reference checks, and the candidate was ready to sign on the dotted line as a direct report to the CEO. We typically identify and speak for 45-60 minutes with 12 people in our standard reference checking process. We had received consistently balanced feedback, and as we were winding the process down, the CEO talked briefly with a non-supplied reference that had searing things to say about our candidate. Based on this one reference, the CEO withdrew the offer.
However, we had discovered through our process that this non-supplied reference, a career employee at his company, had a history of accusing any of his direct reports who left for employment elsewhere, as being personally disloyal to him, and also to their company. We discovered ample corroborating evidence from multiple sources that this individual would go out of his way to say disparaging remarks about a departing employee, continuing this pattern of spreading malicious gossip long after the employee had left.
Unfortunately, my CEO client didn’t pay attention to understanding the context of the reference!
3. The relevance of the reference is in direct proportion to its age.
The older the information, the less relevance it has. In other words, give more credence to newer information.
A few years ago, I was checking references on a candidate for a senior sales position, and ended up being routed to an unsupplied reference that worked with the candidate early in his career. Typical to a reference with older information, he couldn’t really comment on the important elements in the role for which the candidate was being considered. I then asked if there was anything else he wanted to comment on that he thought was relevant, and much to my shock and surprise he stated that the candidate had exhibited “racist” tendencies and had discriminated against African-American employees! What?!
When someone delivers a bombshell like that, you have to find out more information, so I pressed the individual to explain the specifics of what happened, and also tracked down several other people who were at the company at the time, keeping in mind that the alleged incident occurred 20 years ago.
I discovered that the candidate had indeed not promoted an African American employee. This individual was subsequently dismissed due to poor performance, filed a discrimination lawsuit against my candidate and his company, which ended up being thrown out of court. End of story, a disgruntled employee without a cause. I ended up telling my candidate that something had surfaced around a discrimination lawsuit from his past, but that I had gotten to the bottom of it and determined it was meaningless.
He laughed about it and told me, “You know what’s crazy? When that incident happened I was newly married. You haven’t known this ‘til now, but my wife is African American and as you do know, we’ve had and raised three wonderful children. I never understood this incident when it happened. Thanks for finding out the truth on your own.”
Racist tendencies indeed!
With more people than ever out of work and the candidate pool becoming so deep and wide, it is easy for employers to fall into a false sense of security and just hire people based on their resumes or a recommendation from a good friend. Conducting thorough reference checks has never been more important. However, keep the Three Cardinal Rules of Reference Checking in mind and use them to guide your process. Reference checks should not make or break the hire BUT inform it. Remember, even Bernie Madoff had great references.
