The Bernie Ebbers and Kenneth Lay Phenomena
By Dr. Ichak Adizes
What is going on?
Many executives are now either on trial or under indictment for unethical conduct. CEOs are getting increasingly worried about their legal liabilities.
Millions of dollars are being spent on lawyers and accountants – not to mention the time invested by top executives – to bring corporations into compliance with the new Sarbanes-Oxley Act of 2002.
What is going on? Have CEOs suddenly lost their ethical compass, or have government regulatory agencies simply become more eager and zealous?
I suggest that there are several reasons for the host of cases brought to trial, and that there are some effective steps we can take to bring about changes in behavior.
Although many cases are clearly ethical in nature, involving executives who actually stole from the company, I submit that in a significant number of these cases, those who were brought to justice were not fully conscious of their breach of ethics. This does not mean that they are not liable. It means that their behavior had been allowed to exist, virtually condoned, by the organizational culture that is typical to companies at a particular stage of its lifecycle.
Just like human beings, organizations go through a lifecycle, with typical stages and typical transitional problems at each stage. I call these stages Courtship, Infancy, Go-Go, Adolescence, Prime, Aging, “Witch Hunt,” Bureaucracy and the final stage, Death.
The arrogance of success: The Go-Go years
In Go-Go companies, the stage where the company is not a start-up anymore and is growing rapidly, faster than its administrative infrastructure can catch up with, the Founder usually believes that since he or she built the company, therefore, de facto if not de jure, he is entitled to control it. This is his “baby.” This perception does not necessarily change even as the company becomes public and a Board is elected. You might compare it to the fight many mothers-in-law have with their daughters-in-law. The son, although now married, is subconsciously still considered his mother’s “baby.” She does not necessarily accept the daughter-in-law as her son’s partner. She does not transform her behavior to adapt to the transition.
My experience is that the leaders of a Go-Go company, especially if they founded it, perceive public ownership as a debt obligation: They believe their job is to earn a fair return for investors, and if the stock appreciates significantly they believe they have satisfied that obligation. They do not perceive public stockholders as real owners and partners, nor do they regard the Board that represents those owners as really entitled to manage the company. It is still the Founder’s “baby” and what they do with their “baby” they believe is no one’s business as long as the stock has appreciated.
At this stage of the lifecycle, the Board is composed of fraternity brothers or golf club chums and/or family members – all of whom have made a fortune from the company going public. They do not feel prone to challenge the benefactor. I have seen many Boards who had no real operational control over the usually charismatic CEO/Founder of a company that went public. They were there mostly to clap hands and shout bravo to the Founder/leader for the company’s unbelievable rate of success. And if the Founder spends lavishly on himself, they turn a blind eye because they are making a fortune themselves on their stock options and the stockholders are not doing badly either – so who has a reason to complain?
To further aggravate the problems of transition, when their companies go public, Founders behave even more imperially than the way they behaved before the company went public. Going public means success. In capital letters. Financially and in terms of community status. The more successful the company is, the more imperial the Founders tend to be and the sloppier their style of management becomes. (Please note that the companies that are now in trouble were extremely successful before they got into trouble.)
With the incredible success and applause from everywhere, the Founders believe they walk on water and have difficulty admitting that their feet, their knees, or eventually their necks are getting wet. After going public many of them are so full of themselves that their heads are in the clouds and they refuse to come back to earth and face facts. The unexpected enormous success makes them feel omnipotent; thus they believe they can weather any problems. They have done it before. Have they not built this incredibly successful company in spite of all the obstacles and in spite of many warnings in the past?
I had an experience with the Founder of a very successful company who was so successful that he lost touch with reality. He literally believed he could do no wrong. Whoever dared to disagree with him got fired or was ostracized.
Such Founders take full personal credit for the company’s success. It is as if it was their genius alone that was responsible for that success – and therefore the geniuses deserve to do as they like. These Founders do not think twice about buying a plane paid for by the company that they then use for their personal needs, or furnishing an unnecessarily lavish office that costs a fortune, stocked with lots of expensive art that might end up in their homes. Furthermore, they believe that they are entitled to these fringe benefits for the incredible success of the company they led, for their intelligence and entrepreneurial leadership. And it all feeds their ego – which is in ample supply or they would not have started the company in the first place.
Again, I am neither justifying nor supporting this behavior or belief system. I am just describing what I have noticed over 30 years of working with Founders and CEOs of Go-Go companies. I am hoping that explaining what I perceive to be their state of mind can help us find the right solution to this behavior. After all, the behavior is not new. It began before the company went public: The company paid many of the personal expenses of the Founder and no one challenged it then. When the company goes public, the Founder does not abruptly change his behavior. He continues doing what he had been doing for years when the company was private. The company does not change its behavior and culture either just because it’s gone public. It allows the behavior and even condones it.
I suggest that the lavish way the Founder treats himself at the expense of the public company is the result of a behavior that failed to make the necessary cultural transition from the time it was a private company.
Necessary: Mandatory training course for Boards and CEOs
Such a course would outline the managerial, cultural and stylistic as well as legal and ethical changes that become necessary when a company goes public. Beyond just financial listing on the stock market and the requirement for financial disclosure, there must be a cultural transformation that the company has to go through. All officers of the organization must be made aware of the managerial and behavioral pitfalls the company will face as it goes public. As Board members, they should be certified as fully understanding the managerial and cultural transformation that needs to happen.
Going public is not just a task for lawyers. The transition to becoming a public company is not just a legal issue. It is also a behavioral issue, a managerial and ethical transformation that needs to be explained and trained for.
To avoid fraternization of the Board, I would even recommend that with the approval to do the listing, the SEC should appoint from the public at large a Board member who is trained and certified for the task.
The dangers of an inadequate organizational structure
A second reason for the legal mess some executives are in is that the organization should have, but did not, structurally and thus in an institutionalized way, provide them with the right choices to make the right judgments.
Imagine that in court only the prosecutor is allowed to present his or her case. Or only the defender can speak. The judge or jury will be at a tremendous disadvantage and justice will not be served. It is called single advocacy. And that is what is happening in business organizations.
When the CFO controls the treasurer, the financial planning and the controller of the company, the CEO has only one source of financial information: the CFO. The CEO gets only one interpretation of what is going on.
Auditing the company books is not sufficient as a quality control mechanism because by the time an audit finds something, it might be too late. The horse has galloped out of the barn. Audits provide a post mortem while the CEO needs to decide upfront and in real time.
Accounting is not as simple as 2 + 2 = 4. True, it involves numbers, but accounting is the art and science of determining cost and value, and how to account for them can vary significantly. Anyone with even cursory knowledge of accounting knows that profit can vary depending on how inventory and depreciation are valued, not to mention more complicated items like cash equivalents, future contracts, etc.
Without multiple and, preferably, conflicting interpretations of information, the CEO has no opportunity to make his own judgment as to what is right or wrong. Even if he wants to know what is going on, how many CEOs have the depth of training to really understand what is legal and what is not? It is not black and white at all, if it ever was, and it is getting increasingly gray.
Take Kenneth Lay: The whistle-blower told him that something inappropriate was going on in accounting. But could he make the call as to whether it was kosher or not? The world has become so complex and the laws so elaborate that it takes a professional to interpret what is right or wrong – and they often do not agree. Lay asked the auditors – the professionals. They told him that what had been done was OK. He asked the lawyers. They too advised him that it was legal. Did he have enough expertise and confidence to overrule his expensive lawyers and auditors and disagree with his highly paid CFO? Could he have had? Should he have had?
What should be done?
My recommendation is to always structure the company for DOUBLE ADVOCACY!
Never, ever, should a CEO be in a situation where he has only one source of information on strategic issues and thus is subject to a single-sourced recommendation. This is the same principle typically applied to lawyers or surgeons: When in doubt, always get a second opinion. And since the need for strategic decisions is continual in companies that are subject to an accelerated rate of change, the organization should be structured to provide continual double advocacy.
This principle applies to the President of the United States, as well. For example, he has to rely on reports the CIA gives him. If they are the only channel through which he receives intelligent information or so-called intelligence – in other words, if he has no dissenting intelligence to consider, then his space to maneuver and to use his own intelligence (judgment) is severely limited.
Realistically, in a single advocacy the King is nude, to use a children’s tale as an analogy. The CIA may have spent ten manpower years studying an issue, analyzing it with the expertise derived from one hundred combined years of education. They present a position paper. How much time and knowledge does the President have to evaluate their analysis? Can he dedicate an equivalent number of years? Obviously not. He can act like he is in command, but whoever made the recommendation is the power behind the throne.
What he needs is an equally qualified organization, highly professional and knowledgeable, that takes the same case as an assignment and comes up with a separate, preferably dissenting, analysis. Now the President can listen to both positions and the supporting evidence or assumptions that led to each. He is given a choice of recommendations, and thus has a better chance of making a better judgment.
True, the double advocacy system and structure is less efficient because there is double effort spent on the case – but it is an effective system. The cost of a mistake made in a single advocacy far outweighs the cost of having double advocacy.
In democratic societies, public policy decisions are made in a double advocacy system. We have liberal and conservative views, whose proponents debate each other openly with freedom of expression and freedom of dissent.
Democratic systems are not efficient. They are effective. Dictatorship with single advocacy, on the other hand, is efficient, but we all know the disasters they bring to their societies.
Today, companies are structured with single advocacy. In my consulting practice, I recommend double advocacy: the controller and the finance person should report separately to the CEO. The finance person will make recommendations designed to satisfy the investor community; these recommendations usually represent the liberal view. The accountants usually represent the conservative view and stick to a strict interpretation of the regulations. There will and should be professional conflict between the two, but now the CEO has a chance to really understand what is going on. He has been warned by each side about the repercussions of the other’s plan of action and is in a position to decide what to do and do it proactively, rather than wait until an audit tells him that what was done was the wrong thing to do – or go to jail and then know for sure (and even then it is a maybe) that what was done was wrong.
One more point. The Sarbanes-Oxley Act, as a solution to the problem of lack of accountability, is scaring the daylights out of Boards of Directors. Out of fear, they are getting into micro-management. But Board members are only part-timers, and they often do not know the business in detail. So authority is moving further upstream, away from where the action is, and that can cause even more bureaucratization of organizations than size and the need to control the increasing complexity of operations usually mandates.
As change accelerates, we understand less and less what is going on. In a situation of uncertainty, institutionalized instead of happenstance double advocacy is necessary to interpret data, so that the decision-maker will not be dependent in his judgment on a single interpretation of that data. The more change and uncertainty there is, the more important the rule of double advocacy becomes.
Furthermore, the more change, the more training we need, including of our Boards and CEOs.
NOTES: See Ichak Adizes: Managing Corporate Lifecycles (Santa Barbara, CA: Adizes Institute Publications, 1999)