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PROFIT, SOCIAL RESPONSIBILITY & CORPORATE PERFORMANCE:

The Case for Regulatory Reform with the Finance Industry as the Case
By Dave Livingston, Managing Principal, Llinlithgow Associates (www.llinlithgow.com )

Dave is a management consultant primarily focused on improving enterprise performance by


coupling strategy with execution thru the design and implementation of workable, integrated
management systems. He blogs on this and related issues in Economics, Markets & Investments
and specific industries and companies at www.llinlithwo.com/bizzx, his BizzXceleration blog.

The focus of the Finance Industry on short-term financial reform and bonuses led us all to the brink of disaster in
2008 and has caused a wave of anger in the citizenry, most business folk and even much of the industry itself. At
least those portions that were badly damaged by the mis-behaviors the caused them to almost be driven out of
business themselves. While that anger is obviously justified much of the discussion has centered on emotional
judgments. Here we would like to consider the case for reform from two more hard-headed, analytical if you like,
perspectives. One is from the point of view of Society and the Industry as members of that society. The other from
a “business case” perspective. Either alone justifies significant regulatory reform. Taken together we consider the
case to be overwhelming.

No business or other organization exists solely for the sake of existence. It exists to create a value for society,
whether that’s measured in profit terms or not. A hospital’s contribution, for example, is the effective and
affordable treatment of patients while a university contributes educated students. The contribution of any
business, properly understood instead of pejoratively labeled, is profits. Profits are NOT a bad thing per se. In fact
without profits no business could or would exist. Profits are not just the reward for management of resources.
There are also the funds which provide insurance to keep a business running in bad times, the source of funding
for developing new products and services and they pay for labor and investment. A reasonable return is
necessary for the health of business and the health of society.

Overall then a business, as a business, has three strategic goals. First, it must deliver value. In this case profits.
But those profits should be based on contribution and not financial engineering. Second, in its own long-term
interest, it needs to be a productive workplace where the worker is made effective. People are social animals and
the more comfortable they are in their environment then the more they will contribute to the health and
performance of the organization. Third, an organization or business must be socially responsible.

Specifically it must do three things as a component of society. First, it must create no harm as the result of its
operations. When it does it’s obligated to correct that as soon as feasible. Second, where the industry collectively
creates a harm, it is the responsibility of the business to band together to address those harms, when otherwise
individual firms would not be able to do so affordably. And third, when society is itself suffering from larger ills, for
example pollution, healthcare or education challenges, it is in business own interests to contribute to solving those
problems.

At the end of the day it is in any business’s own self-interest to create the environment and ecology that best
balances its own opportunities with the overall health of society. It is in fact a fundamental responsibility of
management to act in a socially responsible manner. A failure to do so can be considered a failure of fiduciary
responsibility in the broadest sense. In the case where a business fails to act responsibly, and in fact harms and
seeks to continue to harm society, there is no choice but for Society to act to eliminate or reduce that harm when
the business will not. This is likely to be a second best alternative to willing, constructive and cooperative action
on the part of the business, which will know its own operations better than outsiders. It is, unfortunately, better
than the alternatives.

In this collection of essays we work thru the interactions between society and businesses using the Finance
Industry as the case study, mostly because of the current situation, but also because it is a litmus test for the role
and importance of regulation. The issues of business performance are considered in separate essays. But let us
summarize them here for reference.
Profit, Performance and Social Reponsibility

The role of the Finance Industry is to provide the effective and efficient allocation of capital. Effective meaning
directed toward the uses that provide the best overall return for society. Efficient meaning delivering that service
at the lowest cost. Sadly the Industry failed rather miserably at that and in fact did so badly it damaged itself,
almost beyond repair. The business case for the Industry as a whole fails on five counts.

1. The malfeasant mis-behaviors almost collapsed the world economy; one could even say without too much
hyperbole that it threatened Western Civilization. We’ve avoided Great Depression 2.0 just barely and cannot
afford the risk of it recurring.

2) The collective and cumulatively losses of the last couple of years wiped out most of the last decade'
s profits,
even though they were all funny money in the first place. In other words the Industry almost destroyed itself. It'
s in
their own best interests since obviously they can't be allowed to play without adult referees.

• NB: the bonuses that the Industry started paying itself grew exponentially starting in the ' 80s, accelerated
in the '
90s and turned into a bubble in the '
00s. And put compensation completely out of line. There is no
evidence that those bonuses contributed positively to the health of society. In fact all the evidence is the
other way.

3) Post de-regulation in the '


80s we began almost three decades of wild indulgence in debt and over-consumption
that loaded up the Industry, the consumer and business with leverage that we couldn't sustain.

4) That debt caused savings to drop to nothing and severely retarded investment and economic growth.

5) The lack of economic growth led to a relatively stagnant economy with poor job creation and flat to declining
wages and benefits. And that, in turn, has led to an increasingly stratified society where the top 1% of earners,
strangely enough somewhat concentrated in the Finance Industry, to garner all of the gains of the last three
decades.

When a society, historically, spends more effort on rent-seeking and power elites focus their careers on rule
manipulation then it eventually succumbs to sclerosis and dies. Just ask the farmers and peasants who harvested
all the wood on Easter Island and destroyed the ecology just to keep making giant statues for the Chiefs.

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Table of Contents

Predator Prey Symbiosis: Crisis, Leadership and Values 4

Burn the Witches: Private Outrage, Public Policy and Butterfly Effects 7

Helmet Laws vs. Adult Supervision: Re-Regulation & Finance Industry Futures 11

Firestorms, Finance, Futures: From Sociopathic Dysfunction to Value Creation 14

Leaders, Leadership & Culture: Crisis, Values and Performance 18

Beginning a Great Debate: People Singing, Politicians Making Sausage 22

About Llinlithgow Associates 25

Essays on Performance and Readings Collections 26

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March 08, 2009

Predator Prey Symbiosis: Crisis, Leadership and Values


http://llinlithgow.com/bizzX/2009/03/crisis_leadership_leaders_and.html

This post is something of a bookend for the last one (Good


Boats, Good Captains: Applying the Investment Mantra for
Profit) which dealt with screening and analyzing companies
that are likely to do well. If it wasn'
t perfectly clear a critical
factor is the honesty, integrity and leadership of management,
particularly the executive team as a whole. Here we' re going
to dive a tad deeply into the consequences and causes of bad
management. In the readings we use the terrible example of
the sturm und drang over Wall Street bonuses as our jumping
off point for a deeper exploration of executive leadership.

Make no mistake about it - it' s a critical factor, Wall St. as a


whole with some major exceptions violated both fundamental
principles and their own long-term self-interest and broke the
rules of social responsibility. A strong, even harsh conclusion
? Perhaps but we think if you' ll follow us thru on the
arguments the logic is worth considering. And matters as
much to you as a tribesman voting on who will be the tribal
warchief and take responsibility for his life. The cartoon, drawn from this week'
s Economist on the implosion of
Bear captures the situation without further discussion IOHO.

Predators vs Prey: a Balanced Ecology

We entitle this post Predator vs Prey because the thinking in


population biology and ecology that describes the interactions
between predators and prey nice represents the inter-actions
between aggressive pursuit of profit and a focus on careful,
cautious focus on value. Think of the blind pursuit of profit, in
the short-term, as being the rough equivalent of a predator
species so blinded by kill-lust that it reduces the prey species
below a sustainable minimum. These charts are drawn from
the Wikpedia discussion of the Volterra-Lotke equations on P-
P interactions; one of the first and sustained excursions into
mathematical biology and still in use today to some extent.

The top chart shows how the cycles in population of the two
species interact over time. When the prey population gets too
large because there predator species is too small there is a
population explosion followed by a surge in predators. In other
words when the picking' s get too easy the predators get more
aggressive. The problem of course, say in the second
component, is that if the population of prey falls below minimal
levels the population won' t renew itself and the entire system
collapses. Hmm...making more sense now.

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Looking for the Balance

In any human socionomic ecology most


folks would like to have a decent job (fair
day' s work for a fair wage) but the system
as a whole requires people who are willing
to be both aggressive and step up and take
responsibility for companies and other
organizations and institutions. For a healthy
institution or a healthy total system the two
populations need to be in some sort of
balance or excess complacency will
collapse it while excess aggression will
destroy it. The key driving questions are the
tradeoffs between Interests and Focus (or
timeframe). Most folks can get away with
most of their efforts directed in the short-
term and their own narrow self-interests. I
like to think of us as Hobbits.

Then there are those who focus on the Big


Picture, that is on broad interests but don' t inject a strong sense of reality into their thinking. Contrawise there are
those who' s focus is strictly on their own short-term self-interest and aggressive and responsible behavior segues
into excess predation. What' s required is a large enough portion of the population who aggressively pursue a
broader set of interests. This is the group one would choose executives from - those prepared to act in the
institution'
s broad interests, balance them against their own immediate gains and be prepared to sacrifice for
longevity, stability and prosperity.

Leadership is NOT an Accident

Lest you think we' re talking out


of our hat on this we point you
to the feel-good story of the
year - the landing of Flight 1549
in the Hudson. We' ve all come
to know, at this point, how
much of a miracle that was. But
if you click on the graphic you' ll
be treated to a 2 minute
simulation that plays out in real-
time to give you an idea of just
how little time these guys had
to make the right decisions in
no time at all.

That capability was not created


by accident but was the result
of years of training, experience,
thinking things thru and
preparing for that one moment
when it was all on the line. In
crisis we all react as we're
trained, whatever the source of

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the training.

This simulation can be found on YouTube at: http://www.youtube.com/watch?v=_G2TLqxWM04&fmt=18 .


Another simulation with a view of the bird strike and the landing plus live cockpit conversation in REAL TIME is:
http://polizeros.com/2009/03/01/amazing-simulation-of-flight-1549/

Ecological Stewardship

Several years ago Peter Drucker


published what we think is the
greatest management book of all
time (Management: Tasks,
Responsibilities, Practices ). Despite
it'
s being published in 1973 it' s
diagnosis of what' s required of
management and executive
leadership is a prescient diagnosis of
the failures we're all victims of over
these last several years. Drucker
puts forward a simple list of critical
task for Managment.

By-the-way, the reason for this


graphic depiction of a dashboard of
key economic indicators is to make
clear how bad things were, and of
course, still are. In a nutshell we fell
off a cliff as the result of leadership
failures and self-serving gain
seeking. And in the process put the health of our entire society at risk.

 
 
 
 

That is lay it out logically and efficiently and make sure it' s effective. How would you rate the Finance
Industry given the disaster' s we' ll be suffering thru for years to come ? Given that the last decade'
s worth
of profits have been destroyed and the viability of many nameplate firms is gone we' d say an
ungentlemanly D- would be generous.

  
   


My friend Bob Sutton wrote a great book(The No Asshole Rule: Building a Civilized Workplace and
Surviving One That Isn't ) last year which has resonated with a lot of folks. Given that what Drucker is
talking about is the socio-psychological aspects of the workplace environment Bob wouldn' t have been
able to write that book if many deserved a gentleman' s C. Yet the list of firms who create worker-friendly
environments also tends to be the list of firms who perform well. Given how notorious the Finance
Industry is for terrible workplace environments where it's dog eat dog and devil take the hindmost an F-
seems appropriate.

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And by this Drucker doesn' t mean something namby-pamby like "Save the Whales". Instead he means
that Management are also members of the larger society and have a responsibility to see that it prospers,
not just the firm. Instead he focuses on those things that an enterprise or other institution can do. If you
work in a Hospital or University is the institution taking care of the legitimate interests of all it'
s
constituents and stakeholders? If you work for a private enterprise that enterprise still exists within a
social matrix - is it acting responsibly? Better by far to be proactive in solving problems before society as
a whole decides to solve them for you because your benefit is grossly exceeded by your damage.

One example he uses is Theodore Vail and the definition of ATT' s purposes. Vail made absolutely sure that
instead of becoming a regulated business that the company was respectful of the general public interest. On this,
there being no grade lower than F-, we've probably reached the point where the Finance Industry is expelled from
school for bad behavior. And their reward is going to be a new regulatory regime imposed on them over their
protests. A sound awareness of the socionomic ecology would have had the Industry stepping forward early and
forcefully to develop workable and responsible regulatory behavior and institutions. Instead we'
ve gone thru the
Tech Bust, Enron and WCOM and the near-death of Western Civilization in the last two years.

Drucker published this magnum opus in 1973. Sadly almost none of its concepts and prescriptions have seen the
light of day. As Ye Sow, So Shall Ye Reap!

And just in case you think we' re making to strong a case or exaggerating it we offer up this refresh of the High-
frequency economic data we' ve used so many times before. Without going into detail we' ll just say that a terrible
economic situation appears to have crossed over yet another tipping point into really serious problems.
The bottomline point here, to come full-circle, is that responsible, statesmanlike stewardship of the Company or
Institution will determine who indeed are the "Good Captains and Good Ships" you want to go storm sailing on !

March 22, 2009

Burn the Witches: Private Outrage, Public Policy and Butterfly Effects
http://llinlithgow.com/bizzX/2009/03/burn_the_witches_private_outra.html

First off if it'


s not clear we hope you took at least
two fundamental points away from the prior post:

1) we've got a long....g way to go in this business


cycle, it'
s just started and eyeball inspection tells
you it'
s gonna get deeper and uglier.

And 2) the last two week' s rally is a bear market


sucker's rally not founded on realities but triggered
by the Pandit Put and whimpering out with the Big
Ben (not)Bang.

Which roughly translated means it' s time to go


inverse. The third major sub-theme is that we are
utterly dependent on public policy, both in the US
and around the world, for triage, damage repair,
stimulus and recovery and long-term restoration of
growth. Which hides a fourth - public policy is co-
dependent between political leadership and the

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"will of the people". Before trying to walk rationally, and we hope, rigorously thru the various policy aspects and
consequences we need to do some emotional (lizard-brain) level-setting. Accordingly we appeal to those great
diagnosticians of the public psyche, Monty Python, who in one simple five-minute vignette capture and
encapsulate everything from crowd psychology to false positive leadership to letting apparent logic mislead you.
We really do think you ought to watch the whole clip to ground the rest of this post!

There are three things at play here:

1) downturn in the economy vs. fiscal stimulus policy,

2) broken credit markets vs. monetary policy and credit "fixes" and

3) political will, games and leadership.

Of the three the most important at this juncture is the third. We say juncture because the Administration and the
Fed are taking almost all the right steps IOHO (btw all the smart punditocracy who' re so smart should dig into the
details and come up with alternatives if they' re so much more brilliant than the guys on the hot seats; as TR puts
it, "there'
s nothing like stepping into the ring'
s blood and dust yourself" or something to that effect!). All that said
we say juncture because the AIG bonus screwup is serving as a lightening rod for the fears, uncertainties and
massive distrust of our private sector leadership. Who in fact failed us miserably.

We spent a whole post (Predator Prey Symbiosis: Crisis, Leadership and Values) discussing why their behaviors
were immoral, reprehensible, severely damaging the public well-being and violated the essential foundations of
the social contract. All well and good. And the sensible pundits, e.g. Joe Nocera, et.al. of the NYT, who' re trying to
inject a few notes of rationality into the "burn the witches" anger are doing their best. But nobody is getting the
whole picture right, again IOHO.

The problem is that, as an essentially social species, we rely on trust between members of the same tribe to
function and for twenty years or more that trust has been increasingly abused. The net result is a poisoning of the
ecology on which we all rely. So here' s the bottomline, so-to-speak; the anger is entirely justified even if counter-
productive. Until it'
s bled off or re-directed our risks of doing something self-damagingly stupid are going to
increase. In other words the single most important economic and financial datum to watch is whether this
firestorm blows out or turns into a populist conflagration and takes us with it. The latter we give a low probability
but an increasing risk. Unfortunately the former is also low - about all we can hope for is that the lid is kept on the
pressure cooker long enough to bleed off the over-pressure and give the substantive programs some time to
work.

Economic Policy

In the readings you' ll find another collection


that looks at various policies designed to get
the economy going again and repair and re-
start the credit markets, both in the US and
around the world. At the end you' ll find a bunch
of excerpts that speak to the mini-essay we
just wrote on the political challenges. As we
said in our last post (History Review to Look
Ahead: Markets, Economy & Business Trifecta)
getting the economy going again is the
fundamental strategic priority; and doing it in
such a way that it becomes first self-sustaining
and then gets back on a growth is the
intelligent way to go about it. In the last set of
readings we pointed you especially to two
Econtrary essays by Paul Kasriel discussing

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fiscal policy during the Great Depression and the role of smart vs. stupid public spending. Public spending that
subsidizes increased consumption is a "bad" idea. Public spending that invests in re-vitalizing the capital base
(infrastructure, new inventions and innovations, education, healthcare, etc.) could put us back on the vanished
Golden Path.

To re-prove that fundamental argument we' ve created a composite chart from one of Paul' s essays that shows
how the economy was doing during the GD; the main point here is that a recovery was underway until the
triumphal return of economic orthodoxies (at least of the time) caused budget tightening and the return of Phase
II. Coupled with the really abysmal monetary policies of the time...well we' d really not want to try and dig our way
out of this by starting WWIV, the strategy we defaulted to last time we were in a mess this serious ! Here' s one
more sad and dangerous set of facts for you on the international front. The rest of the world is actually in worse
trouble now than the US. And is by and large facing more discombobulated policy responses, Europe in
particular. In fact the only two countries where the leadership is stepping up to the plate are China and the US.
Europe looks set to dis-coordinate itself into a disaster and Japan is in worse shape. So either we make this work
or kaboom !

Monetary Situation

Speaking of credit markets, monetary


policy and central bank fixes take a look at
this composite chart, which shows the
behavior of key interest rates from Jan08
to now and YtD. The rates charted include
the TED spread, the 3Mo Treasure (IRX)
and the 10Yr Treasury (TNX). TED is the
different between Libor and IRX. Notice
how rough it was last year leading to the
catastrophic levels reached in the Sep/Oct
timeframes and how "repaired" it got as
disaster was averted. While the wheels got
kept on the wagon it' s still wobbly and in
fact started wobbling worse earlier this
year but again appears to be improving.

We' re a long way away from having


restored credit markets; in fact we're still in
the Triage and emergency field medical
care stage. Hopefully the upcoming
Treasury plans will be the equivalent of
getting to the MASH, in combination with the Fed' s huge quantitative easing program and special facilities like
TALF designed to credit flowing to consumers and small businesses again. Then we can start working on re-
engineering the architecture of the entire set of regulatory frameworks (one of the most interesting essays
excepted below is on by Sec. Paulson calling for just that. Stop and think about that...ex-GS CEO, ex Rep.
Sec....lightening rod and he says it needs major re-constructive surgery...wow!).

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The Peasants are Revolting

Let' s close by re-iterating our starting point


with some personal anecdotes. Talking to my
friends and neighbors for months now they' re
still in denial and shock but moving rapidly
toward anger. In fact two close friends, both
experienced executives of long standing, who
pay some attention but not a lot to financial
and economic affairs both went out of their
way to share their feelings with me recently.
Or more accurately chose me to vent their
outrage out.

If two business executives of decades of


experience and fairly conservative in their
outlook are that PO' d think how the populace
in general feels. Like we said the Monty
Python clip is not really humorous in these
circumstances. And all to many of the pundits
are wanting to weigh the witch against the
duck and burn here if she fails the test (to
really get both the joke and the indictment
you have to watch the clip). But you should be watching the political news just as much as the economic
news...it'
s NOW as important for the market and economic outlook.

UPDATEs: One of the truly startling things (cf. the excerpt on the revival of Ayn Rand' s popularity) is the
combination of near criminal malfeasance, utter social and political tone-deafness and willingness to sacrifice the
public trust (with the attendant violation of implicit fiduciary responsibilities and breaking the Social Contract) that
Financial executives specifically and many executives in general are still committed to (committed...now there' sa
word !). The world is changing, the peasants are about to burn down the castle and they appear to be still
planning the next dinner party. Check out this post from
• Bob Sutton: Oblivious Rich Assholes
• Seth Godin:The myth of big salaries (it's all marketing)
• Tim Walker: “It’s going to take some patience.”

Breaker, Breaker. We got us a convoy!

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March 30, 2009

Helmet Laws vs Adult Supervision: Re-Regulation & Finance Industry


Futures
http://llinlithgow.com/bizzX/2009/03/helmet_laws_vs_adult_supervisi.html

Well last week should have been another


stunner, beginning as it did with the
biggest extension of the biggest bailout
since the GD and ending with the largest
regulatory re-thinking since the
cumulative total of GD and intervening
decades legislation and regulation.
REALLY stop and think about that for a
moment - almost EIGHT DECADES of
incremental change has been
compressed into sixty days. Or being
slightly more fair 120 going back to Sept
and the TARP kickoff.

Five weeks ago everybody wanted to


hang Geithner for malfeasance and lack
of detail, now he' s a genius and a hero.
Be careful what you ask for too ! Pundits
and interests on the left, right, up and
down are all choking, albeit more quietly,
on these details. Yet nothing should be a
surprise since there' s a clear pathway
from Bush Administration decisions and
recommendations, including Paulson' s
tentative plan from last spring (btw on of the key readings is a FT oped by Henry supporting a regulatory overhaul
that looks like this one on a worldwide basis).

Of this set of initiatives what's most important - the economics, the financial technicalities, the politics or the
popular reaction? Actually all of them !! What' s still missing is a context to help organize, categorize and organize
our thinking about these myriad complexities so we' re going to take our best shot at explaining what' s going on.
And make no mistake - these are enormous changes, mostly for the better IOHO, long over-due and the Finance
Industry and it' s role will never be the same again. The last three decades of business models, strategies and
profit/performance relationships are gone forever! We ended the last post with the accompanying cartoon to
capture the popular reactions to date and so we start there. Now lets dig into the strategic context.

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Helmet Laws and the Public Good

My personal reaction to seatbelt laws was they were


unnecessary interferences in private decisions; as we
used to say in the rock climbing game when the
tourists went round the back side of difficult climbs,
started down ravines and went splat in the parking lot
that's how you sort out the riffraff and wannabees
from the folks who belonged there. Ditto for
motorcycle helmet laws and cellphone laws. All of
which have become widely adopted.

Now for anyone who' s almost been run over by some


weekend shopper chattering away (in our case one
nice lady looked us directly in the eye and then
almost ran us over and didn' t even notice !) these
laws begin to make more sense. Take at look at this YouTube clip and ask yourself what level of responsibility
was displayed by the rider. Then ask whether or not the law made sense. Without a helmet this guy would have
been history. Here' s the policy implication - if the only person to be hurt had been the rider then sobeit. And if
irresponsible riders had to post insurance for the bucket and mop brigades required for cleanup as well the public
costs would have been balanced out.

The realities are lots of folks continued, continue and will continue to act irresponsibly and the costs are not
restricted just to them but impact the general public. There' s the general principle - when the costs to society
greatly exceed the cost to private individuals regulation is our only recourse.

Keep On Breathing: the Financial Circulatory/Respiratory System

What does that say about the Financial System


If you go back to the Congressional testimony in
the summer of ' 07 on executive compensation
one can only characterize the responses of the
boards, chairmen and compensation
committees as being beyond tone deaf. And as
publicly irresponsible as a drunken motorcyclist
driving thru streets full of school children.

We have at least $180B invested in AIG to date


trying not to save the company but save the
world economy; literally. (If you check out
several of the last posts that show the credit and
equity markets and economic data that should
now be beyond challenge we hope !!!).

The credit breakdowns and crisis is often


compared to a terrible plumbing problem with
rusted and clogged pipes, frozen values, and
bad water. A fair analogy if you consider that it'
s
not just a house but the whole neighborhood
and town. A better analogy we think, that
represents the complexity and inter-connections
is how your circulatory system takes oxygen and
energy and gets it into your system until it

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reaches the cellular level where a complex and inter-connected set of metabolic and bio-chemical reactions keeps
you going. Credit has been called the lifeblood of the economy and, in some senses, that' s almost literally true.
It'
s pervasive, systemic and systematic involving inter-actions at the most minute and granular levels on up to
grand flows of macro-systems. To tell that story we' ve composited a graphic that traces thru the flows of the
circulatory system as a model and metaphor.

Supreme Truth and Systemic Poisonings

Back in 1995 the Aum Shinrikyou cult put Sarin gas into the
Tokyo subway systems to purify things and bring on the new
world, since they were an elect and spiritual elite who had
deeper insights into the mysteries of the Universe. Now
there are many good people in the Finance Industry but the
leadership, perverse incentives and lack of controls
combined with the "deeper grasp of the mysteries" of
financial engineering led the Finance Industry as a whole to
effectively mimic the cult'
s actions. Only instead of 5,000
people who were affected locally we had six billion who are
affected globally.

For nearly three decades the Industry has argued that it was
capable of self-responsible adult supervision, that is it
wouldn' t drive recklessly, didn't need to wear helmets and
was performing both a privately profitable and public good service. That turns outs out to be entirely false to fact.
And, judging by the shell-shocked lack of leadership in response to these disasters the industry isn' t stepping up
to the plate to help re-formulate the proper "helmet laws" so society is going to do it for them. Which is truly
unfortunate on many levels and in several ways. First off we truly do need a finance industry to help mobilize and
allocate capital; much of human progress is built on the gradual evolution of capital markets, at least indirectly.
And there' s still going to be huge profit potentials for well-constructed, designed and operated financial institutions
as a result. The question really becomes which ones.

Can You Hear the People Singing?

As Peter Drucker pointed out almost forty years


ago businesses are social institutions and cannot
survive or prosper if the societies of which they are
a part are not also healthy and prosperous.
Enlightened self-interest would, for a responsible
adult, motivate businesses to encourage the
welfare of the broader society. Or at least not
damage it.

Drucker identifies three major goals or


responsibilities of the effectively managed
business:

1) deliver an effective service that creates value -


in the case of businesses this means making a
profit that is sustainable in the long-run, i.e. balances short- and long-run decisions. Then,

2) operates efficiently and effectively by making work productive and the worker achieving. In other words by
making sure that work is logically designed but also recognizing that people are social animals and to be effective
one has to account for the non-economic dimensions of the business as a social institution. Finally,

Page 13 of 30
Profit, Performance and Social Reponsibility

3) act in a socially responsible manner to ensure that society is doing well (or as we put in an earlier post make
sure that the prey populations are sustainable and self-renewing).

Social responsibility requires two things - first when the activities of your business impact the broader society
move to reduce the harm. For example when you create a pollutant act to clean it up before society forces you to
do it. Second, identify broader social problems that are connected to your business and act proactively to
eliminate them before they become so bad that society has to. The classic example is the Auto companies and
Healthcare, which they' ve known is a competitive problem for six decades yet failed to pursue the social remedies
of regulatory and insurance overhauls required.

Farther and Farther Behind the Curve

In particular Drucker points out that denial and fighting


rear-guard actions to prevent regulation when it' s in the
interests of society and your company is a management
failure, grossly counter-productive and irrational in the long-
run. Paraphrased, either change the regulations or change
the regulations!

Let me translate that: if business operations


create a problem that individual businesses cannot solve because of the profit impacts and
therefore require general regulation it is the fundamental responsibility of management to
proactively engage in working with other institutions to craft the legislation and regulation. To
fail to do so is irresponsible, malfeasant and a gross failure of managerial leadership.

The Finance Industry would never be the same again after testing their engineering skills to destruction. But after
the social damage they' ve done society cannot allow them to self-supervise. Something they should have been
addressing for the last thirty years; there have been plenty of warning signals. Instead they chose to pursue the
path of lobbying for greater and greater freedom which led to greater and greater risk-taking. Pursuing the
analogy it's as if the Aum cult kept making more sarin.

The question is what happens now ? We' ll take that up in another post but here' s a hint: get out in front and help
shape things or get run over by the Juggernaut. Two more: you won' t like the alternatives AND if it gets out of
control nobody will win.

April 07, 2009

Firestorms, Finance, Futures:


From Sociopathic Dysfunction
to Value Creation
http://llinlithgow.com/bizzX/2009/04/firesto
rms_finance_futures_fro.html

We' ve been plowing thru various aspects of


the Finance Industry and it's outlook as well
as the broader socio-political context since
the end of January. Starting with a broad
overview and then tunneling down into
specific sectors outlook. The AIG firestorm
led to or was associated with a look at the
broader context. No business or other institution can exist other than on the sufferance of society, and if it does

Page 14 of 30
Profit, Performance and Social Reponsibility

not contribute value to that society it will be changed - one way or another. That makes it a fundamental
management responsibility of any business to be
aware of broader socio-political trends and problems
and to act proactively to intercept or correct them. If
nothing else by anticipating problems and acting to
support broader policy responses to problems
beyond the industry' s immediate ability to cope with.
Judging from the remarks of the new Citi CEO the
Finance Industry gives new meaning to the phrase
tone-deaf. Now that some of the details are leaking
out we' ve found out that in the President' s recent
meeting with key CEOs he basically said, "we' re the
last thing between you and the pitchforks". We' re
tempted to put up the "Can You Hear the People
Sing" graphic and URL again but hopefully the point
is still relatively fresh in your minds, as it appears
not to be in the minds of the industry.

The real question is now what ? Mike Mayo (cf. the


readings) as well as Meredith Whitney came out
yesterday and said in effect to short the Financials.
Advice we heartily agree with because there is no function or aspect of the industry that doesn' t appear to be
broken. From internal execution capabilities to strategy to broader socionomic positionings. The really sad thing is
that it doesn't have to be this way. During the 1980s we were all the beneficiaries of major value-creating
innovations from money market funds to reasonable de-regulation to discount brokers to mutual funds. In the ' 90s
that innovation evolved into internal financial engineering rather than value-creation and in this decade it clearly
metastasized into value-destroying, on both the business, industry and social levels, "innovation". To survive,
recover, return to profitability and restore it'
s place as a valued part of the system the Industry needs to realize
these firestorms will rage and change everything.

Drucker Principles and Finance Futures

As we' ve worked our way thru an analysis and assessment of the broader impacts and consequences of the
finance industry we' ve ended up depending quite a bit on Peter Drucker' s insights on the major performance
criteria for business value creation. The graphic at right is a summary of one interpretation combined with our
earlier framework of the major sectors of the industry. But let' s start by quoting Drucker (p. 369, "Management:
Tasks, Responsibilities, Practices"):

"Essentially being a member of a leadership group is what traditionally has been meant by the
term "professional". ...as a member of leadership group a manager stands under the demands of
professional ethics - the demands of an ethic of responsibility. [A professional] is public in the
sense that the welfare of his client sets limits to his deeds and words. And Primum no nocere,
"not knowingly to do harm," is the basic rule of professional ethics. There are important areas
where managers still do not realize they have to impose on themselves the responsibilities of the
professional ethic. The manager who fails to think through and work for the appropriate solution
to an impact of his business because it makes him "unpopular in the club" knowingly does harm.
That this is stupid has been said. That this always in the end hurts the business or industry more
than a little temporary "unpleasantness" would have hurt has been said too. But it is also gross
violation of professional ethics".

We trust Prof. Drucker' s points are crystalline ? Just to compress and paraphrase them the actions of the industry
are harmful, counter-productive and are going to lead to a massive social backlash that' s entirely justified by the
facts of the situation and the necessities of society. Remember if you do not create value society has NO reason
to tolerate you. If in fact you destroy value and massively harm society it cannot even afford to tolerate you. In the
graphic we' ve tried to depict the relative performance on the Drucker Principles of each of the major lines of

Page 15 of 30
Profit, Performance and Social Reponsibility

business with the caveat that there is no multiple-red color to properly represent the behavior of the securities
related business and the damage caused.

The Theory of the Case

When a logician or lawyer is looking for the core,


fundamental argument that drives the entire rest
of a complex chain of argument they talk about
the "Theory of the Case". We' ve come to think
that's a nice, powerful, description of how to
think about a business. That is to ask "what is
the theory of the case?".

In other words what' s really going on here, what


are you going to do about it and why are you
convinced and convincing that value-creating
performance will result. So far all we'
ve heard
from the Industry has been denial, rear-guard
defensive actions and what can only be
described as "forlorn hope" attacks. Nowhere
have we seen anybody stepping up to present
the theory of the case for the immediate crisis let alone for the necessary future timeframes. Instead they'
re
leaving leadership to Washington, speaking for society. And Washington is indeed stepping in to fill the vacuum.
But the policy-makers and politicians know they aren' t experts and would more than likely welcome constructive
engagement that looked to the greater good of society as well as the industry. Not just continuing defenses of
egregarious compensation packages.

Observations, Suggestions and


Opportunities

We aren' t so bold ourselves as to make detailed


suggestions just yet but we would like to make some
observations and suggest some trial balloons.
Across the entire spectrum of banking and financial
services, including banking per se, consumer
finance, SMB finance, financial companies,
investment services and advisory services we think
the basic business model and strategies of the
future will have to deal with several key factors:

1. The industry will be significantly de-leveraged.

2. A focus on customer service, putting the customer's interests ahead of the firm's, will create
value and ultimately a differentiating competitive advantage.

3. Fairness and value for compensation need to be fundamental principles of operation.

4. Innovation in new value-creating services and capabilities needs to be the driving strategic
mantra of the new industry.

5. Survival, recovery and effective innovation need to be based on effective and principled
management systems.

Page 16 of 30
Profit, Performance and Social Reponsibility

Which leads to some strawmen suggestions for financial innovations just to get the ball rolling:

1. Hedge-like funds for small investors to be able to cope with a low-return, topsy-turvey world.

2. Non-opportunistic (i.e. non-exploitative and with non-exorbitant interest rate) consumer finance and
credit cards.

3. Securitized business finance based on deep understandings of fundamentals AND loanee re-payment
capabilities. For example trade finance could be greatly expanded and help out the growth of the global
economy.

4. Micro-finance in the inner city.

5. Ratings mechanism reforms coupled with performance insurance and/or bonding.

6. Localization of financial services where branch offices and staff truly return to being local in their
knowledge and connections. This could be coupled with a "franchising" approach to combine the
economies of scale of large institutions along with superb local knowledge.

7. Merchant banking for small companies in the best, "ye olde English" sense of informed investment in
serious business opportunities. For example in green energy, bio-tech, etc.

8. Operations-based investing based on business fundamentals for the Private Equity sector.

9. Macro-monitoring and advisory services to help with budgeting, capital planning, expense control and
general business planning.

Now if you’re wondering why we threw out this list of possible new business opportunities it’s not because we’re
experts in Finance. But neither are the suggestions entirely without thought. Each would be a major new business
that would create value for its customers and profits for its owners and founders.

In other words it’s not necessary to make profits by paying people bonuses to load on surcharges on
overdrafts, pump up interest rates on credit cards or persuade people who can’t afford it to buy
mortgages they can never repay.

The industry could do well by doing good and earn its money the old fashioned way – by earning it.

SEE CHANGES: Glimmers of Hope, Honesty and


Re-Thinking

The industry is faced with some very stark choices: Cooperate


(go along with unavoidable policy changes just to survive),
Collaborate (become pro-actively involved in shaping that policy)
or Cave (be plowed under and constrained for decades by the
popular anger at the violations of the public trust). The financial
firms you want to be investigating and investing in are the ones
that satisfy the Drucker principles AND have clear responses on
the "Theory of the Case" on all timeframes for all lines of
business.

So far we haven' t seen any. Let' s hope that that'


s just our lack of
information access and not the reality. Otherwise a vital and
important industry will do itself and us irreparable harm!

Page 17 of 30
Profit, Performance and Social Reponsibility

Nothing like good timing. As we were putting up this post it turns out Lloyd Blankfein was giving a truly stunning
speech in Washington that finally acknowledges the public responsibilities of the Finance Industry, in detail.
(http://www.c-span.org/Watch/watch.aspx?MediaId=HP-A-17196 )

In particular he supports almost point by point the major elements of the Geithner Plan as well as the call for
greated worldwide regulatory over-sight coming from the G-20 meeting. His speech got widespread, rapid and,
dare on say, shocked coverage from a wide range of the commentariats. You can find some of this in the
readings as well as a a valuable assessment from Steve Perlstein of the WaPo highlighting the need for
fundamental cultural change. Our collective bottomline is that we consider all the points we' ve been making in this
post and it's predecessors to have been supported by perhaps the leading executive in the Industry !
There is, btw, an enormous collection of readings after the break that we highly recommend you at least skim.
Judging from the readership stats that hasn' t been the case but there's quite a collection surveying the evidence
behind the points we' re making !

UPDATE2: Just ran across a fabulous oped from the WSJ on Wall St. cultural breakdowns that both fits nicely
with our overall theme and serves as the perfect counter-point to Blankfein'
s Mea Culpa.

The point being this - external and internal structural changes are vital but …

UNLESS THE STREET CHANGES IT'S CULTURE....IT'S CULTURE WILL BE CHANGED.

Leaders, Leadership & Culture: Crisis, Values and Performance (Updates)


http://llinlithgow.com/bizzX/2009/04/leaders_leadership_culture_cri.html

For a lot of reasons this is a post we'd very much prefer to not
write but feel we have to because of the crisis, the deep-
seated structural changes that it will be required and the
major re-thinkings of corporate culture that are mandatory for
survivorship. The difference between winners and losers in
this maelstrom will not just be logical examinations or
disciplined execution but will require executives to adopt new
behaviors. The question is will they?

There was a rather bitterly amusing New York magazine story


(excerpted below) on the backlash in the Finance Industry
recently that details the inability of members of that
community to come to grips with those adaptations. The
problem seems to be that the last 20-30 years of aberrational
profits are being taken as the norm and the culture expects to
be paid as they have been. Instead of how they will be! What was particularly striking is that the blog post that
drew our attention used the accompanying picture from our favorite cigar and single malt bar, though you have to
look at the background...not the eye-candy. We wonder however whether the foreground are professionals in
what service industry?

Page 18 of 30
Profit, Performance and Social Reponsibility

Re-Considering JR, Values and


Performance

Back in the day we used to not watch Dallas as the


soap opera never appealed to us and the dissing of
business really turned us off. Our experience then,
and to a large extent now, is that most people and
most executives in business are competent, bright,
and want to do well and also do good. The complete
antithesis of JR. Unfortunately we then got Enron,
WCOM, etc. etc.

And now we have the complete dysfunctional


breakdown of a major industry....which is also the
only industry among them all which is systemically
critical to the health of the economy and of society
for that matter. The question for us (which in this case means me, you and the rest of America) is does this man
speak for the preponderance of business executives or not?

On that answer rests the future of economic health and social development. The stakes couldn' t be more serious.
Our answer was absolutely not. In 2000 it became there are too many exceptions but the rule was still in favor of
the Roman virtues. Now ? Well, unfortunately time will tell. And based on how the Finance Industry's culture is
reacting the signs aren't that encouraging. On the other hand there are clear examples of leaders who have
stepped up the plate, faced the challenges and positioned their companies for the future. From HPQ to WMT to
P&G to MickeyD' s.

The bottomline here is that the principles of fundamental business performance


require good ethics and a sense of social responsibility.

Why You Care: Profits and Economic


Futures

To understand both how important this is and how


aberrational the last decade has been take a look at
this composite graphic (concatenating several points
we' ve made before). The top sub-chart shows Profits
and Wages as shares of GDP (Profits on the left).
Except for the Tech Bubble wages were in a long-
term secular decline but Profits "bubbled" up
enormously because businesses weren' t hiring or
investing in this weak recovery. That'
s going to get
worse.

The second and third sub-chart shows the shares of


profits (% of GDP again) going to "normal" business,
Finance and International business. Normal
operations didn' t get out of line and took a big hit
beginning in '06 (Fortune tells us today that profits are
the worst in the history of the F500 listing) while int'
l,
as you' d expect shows an uptick.

Page 19 of 30
Profit, Performance and Social Reponsibility

But Finance...ah Finance ! It went from 1% to 2% to 3% of GDP in three decades. Now tell me what value-add for
the economy and society as a whole was created here? In general Finance is a critical industry but has it been so
innovative and value-creating that it'
s profits should have gone up 100% every decade? And in particular in this
last one? The evidence would seem to indicate not. Structurally, if for no other reasons, we'
d see a future for the
Industry were profits return to the more justifiable 1% figure.

That'
ll be a shock to a lot of folks won'
t it?

Earnings Performance and Outlooks

The big debate in this bear rally has been on the


earnings outlook, which is how long-term trends in the
economy are reflected in the quarterly headlines. This
graphic pretty well captures a part of the problem. As
Fortune points out earnings so far are as dismal as
they've ever been and looking to get worse.

Even worse the outlook is for a sustained period of


continued under-performance and lowered valuations
(something we' ve been harping on a lot and for a long
time. Aside from recent postings continuing to dissect
this little problem we provide excerpts from two
postings from almost a year ago in the readings that illustrate how long these challenges have been clearly
visible).

Business Performance

Business performance comes from delivering on five


key elements both separately and as a whole. No
one can be taken in isolation. The responsibility for
making all the moving parts synch up lies with
executive leadership at the top and management as
a whole. For businesses to do well in this crisis
management must step up to these responsibilities
on several dimensions and balance them out. Our
favorite guru of gurus puts it much better of course.
That would be our boy Mr. Drucker:

"A manager' s job should be based on a task that


has to be done - one that makes a visible and, if
possible, measurable contribution to the success of
enterprise. A manager' s job exists because the task
facing the enterprise demands it' s existence - and
for not other reason."

"A manager has two specific tasks.

The first is creation of a true whole that is larger than the sum of the its parts, a productive entity that
turns out more than the sum of the resources put into it. The manager must simultaneously ask two double-
barreled questions: What better business performance is needed and what does this require of what activities ?
And: what better performance are activities capable of and what improvement in the business results will they
make possible ?"

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Profit, Performance and Social Reponsibility

"The second major specific task of the manager is to harmonize in every decision and action the
requirements of the immediate and long-range future. He cannot sacrifice either without endangering the
enterprise".

The Social Consequences

As the recent Tax Tea Parties show there is an


enormous amount of public anger at the
failures of management leadership to serve
either the interests of their companies, of their
stakeholders, including employees, business
partners and investors, and of society as a
whole.

A few years ago Jared Diamond published an


interesting follow-up book to his earlier "Guns,
Germs and Steel" that asked what enabled
societies to survive, adapt and prosper or
fail...he titled it "Collapse". In this recent PBS
interview he boils it down...the biggest cause
of failure is the failure of leadership to act
for more than their own narrow self-interest.
http://www.youtube.com/watch?v=bnZgbyiG8wc

In some circles they call that a failure of fiduciary responsibility.

As Wuzu said to Fojian in "Zen Lessons: the Art of Leadership":

"As a leader it is essential to be generous with the community while being frugal with
oneself. As for the rest, the petty matters, do not be concerned with them.

When you give people tasks, probe them deeply to see if they are sincere. When you
choose your words, take the most serious. Leaders are naturally honored when their
words are taken seriously; the community is naturally impressed when people are chosen
for their sincerity.
When you are honorable, the community obeys even if you are not stern; when the
community is impressed, things get done even if no orders are given. The wise and the
stupid each naturally convey their minds, small and great each exert their effort.

This is more than ten thousand times better than those who hold on by authoritarian
power and those who cannot help following them, oppressed by compulsion"

That was written over 1200 years ago, yet it still seems more than relevant today. By these measures who would
you judge is leading well and how not ? On those answers rest your decisions.

UPDATES: Why It Matters

We just added a whole slew of other readings excerpts using the Finance Industry, sadly, as our whipping boy.
What triggered this recent massive rally in the markets was the belief that the Markets and the Finance Industry
were beginning to self-repair and see some daylight. Only it turns out that a) they were engaged in deeply
deceptive reporting (we' d use other words but why bother) and b) that really is a giant freight train loaded with
explosives, not daylight. All of the banks are experiencing huge increases in defaults and losses in their main
lines of business. And doing their best to continue misleading the investing public. On every test of leadership,
public faith and confidence and good business practice we have to judge the last six weeks an abysmal failure.
Both Wuzu and Drucker would be sadly and terribly disappointed...not least because this is both stupid and

Page 21 of 30
Profit, Performance and Social Reponsibility

unnecessary self-inflicted damage. But check out the readings for yourselves. Start with Jim Jubak'
s vidclip and
move on to the slew of stories dissecting the disaster.

November 19, 2009

Beginning a Great Debate: People Singing, Politicians Making Sausage


http://llinlithgow.com/PtW/2009/11/the_beginnings_of_a_great_deba.html

Let's go back and pick our theme of Financial re-


regulation. On the surface that may appear to be a real
swerve from our discussions of, stress and self-
management. Or even the first bookend on "change is
hard". It's actually not. Now this is critically important in
and of and for its own sake. But it' s also a case in point. It
actually points to the problems when self-delusions and
hubris create gigantic problems. It also a perfect example
of the problems with sausage-making in the policy and
political factories. It should be fairly clear at this point that
reform is necessary and justified.

But as reform has wound its twisty path thru the factory
the Industry has been fighting it tooth and nail. Normally
all that, like all the other momentous changes we' re
collectively tackling has been more visible than usual so
we get an inside view of the slaughtering and processing
that would normally be well hidden. The question, tying both threads together, is what kind of sausage do you
want? In other words this about change on the personal and social level.

      !
 " #      

An interesting question is it not? Overall it turns out


we all drank the koolaid, some much more than
others and therefore more directly responsible. But a
central cause was a widely shared belief that
markets would govern themselves. An argument
that ignores the vital role of law, a court system and
police to enforce it. As well as rules and regulations
that make markets possible. There is no market that
has ever existed that didn' t have some mechanism
for defining the nature and quality of goods, how
they can be exchanged or what the price-setting
mechanisms are. And ways of adjudicating and
resolving disputes.

Whether it'
s buying groceries, getting a new car or house, something arcane like a wheat (or pig) futures contract.
Or punishing the guilty and malfeasant - just ask Bernie Madoff or think back to Enron and Ken Lay or Worldcom
and Bernie Ebbers. Not only did we all drink the koolaid and surf a wave of funny money to buy all those things
we believed.

Nonetheless when there are rules there are those who will focus on manipulating them to their own advantage
rather than playing the game. And from time-to-time there are key players who try and make sure the game stays
honest, fair and just. When the players spend more time on manipulation than trying to win economists call that a
rent-seeking society - in other words rule manipulations trying to create rents just like the old German River

Page 22 of 30
Profit, Performance and Social Reponsibility

Barons put up their castles at bends in the river to force merchants and bargemen to pay tolls, or rent. In the late
'90s when the players were really starting to play rules one person, Brooksley Born, took a shot at reforming the
game and was shut down by the koolaid drinkers. With the widespread applause of the Industry and society
ringing in their ears. PBS did a marvelous special on her and The Warning
(http://video.pbs.org/video/1302794657/ )which you click on the picture to watch. The web page is here.

$  %  & #         

Now everybody' s sworn off Koolaid - well almost everybody. A


few weeks back there was an Industry conference in NYC
(SIFMA) where Charlie Rose interviewed Jaime Dimon. Mr.
Dimon is one of the good guys inside the Industry in all this and
he has a lot of wise and insightful things to say. BtW - Rose
has changed the structure of his web site so the clicking on the
clip takes you to it rather than the specific interview. You have
to scroll the archives - in this case the online only specials. But
it'
s really well worth your trouble, at least IOHO.
(www.charlierose.com)

Perhaps the most interesting thing is Dimon acknowledges the


problems and failures, recognizes the need for a massive regulatory overhaul, has some well thought out
suggestions and comments and so forth. But at the end of the day there are some things he still finds too hard to
swallow about some of the proposals on the table. And this is the best of the best - literally. If he's pushing back
how're the lobbyists in the backroom doing? Especially now that they are really doing God' s Work, at least
according to Lloyd Blankfein of Goldman Sachs. You know them - the secret government who' s profited the most
from public money and support and is in the process of paying the biggest bonuses in a decade? A decade of
widespread over-consumption of the Koolaid where bonuses were outrageous? And now they' re paying bigger
ones?

#    '     (  )  (


 (    * 
*  

At the same conference Rose also interviewed Tim Geithner who


talked about all the things that need to be done as we re-think
what's a safe industry and how we get there. There' s probably no
better sketch of what needs to be done and, from a strictly policy
perspective, how we might get there. Larry Summers and the
President have made similar speeches. We even commented
before on the President' s. The question of how the sausage is
going to get made is a, shall we say, tad problematic. In the
readings you' ll find a collection of excerpts and links to some key
readings that survey the situation, review the history and talk about
the politics involved. Worth skimming at least.

Now at the heart of the Industry's pushback is the argument that


what they do is essential to the efficient and effective functioning of
our economy, and therefore the health, well-being and prosperity of our society. In the longrun they're right -
thruout history sound capital markets are essential (cf. Ferguson' s "Ascent of Money" on PBS). The glitch is in
that word sound.

Page 23 of 30
Profit, Performance and Social Reponsibility

+       " ,  




In previous posts plus some other investigations the business


case, as it were, practices as usual and limited reform fail on five
counts:

1) Financial Industry malfeasance almost destroyed the


economy, brought on Great Depression 2.0 and might have
collapsed Western Civilization.

2) The collective and cumulatively losses of the last couple of


years wiped out most of the last decades' s profits, even though
they were all funny money in the first place. In other words the
Industry almost destroyed itself. It'
s in their own best interests since obviously they can'
t be allowed to play
without adult referees.

• NB: the bonuses that the Industry started paying itself grew exponentially starting in the ' 80s, accelerated
in the '
90s and turned into a bubble in the '
00s. And put compensation completely out of line. There is no
evidence that those bonuses contributed positively to the health of society. In fact all the evidence is the
other way.

3) Post de-regulation in the '


80s we began almost three decades of wild indulgence in debt and over-consumption
that loaded up the Industry, the consumer and business with leverage that we couldn't sustain.

4) That debt caused savings to drop to nothing and severely retarded investment and economic growth.

5) The lack of economic growth led to a relatively stagnant economy with poor job creation and flat to declining
wages and benefits. And that, in turn, has led to an increasingly stratified society where the top 1% of earners,
strangely enough somewhat concentrated in the Finance Industry, to garner all of the gains of the last three
decades.

When a society, historically, spends more effort on rent-seeking and power elites focus their careers on rule
manipulation then it eventually succumbs to sclerosis and dies. Just ask the farmers and peasants who harvested
all the wood on Easter Island and destroyed the ecology just to keep making giant statues for the Chiefs.
We are not just debating Financial Reform but the kind of society we want, whether we can find it within ourselves
to change and, indeed and not to get too dramatic, the future of Capitalism. Can we find the governance
mechanisms that make it work and renew the most productive system mankind has ever come up with? Or we will
choose to continue the descent into Collapse (cf. Jared Diamond)? A great debate indeed.

Page 24 of 30
Profit, Performance and Social Reponsibility

About Llinlithgow Associates

Llinlithgow Assoc. is a management


consultancy focused on evaluating Customer Problem
businesses to reduce risk, leverage under- • Value Proposition
developed opportunities in operations and • Business Model
increase overall enterprise performance to • Strategy
improve investment return.

Our approach is based on BizzXceleration, a


proprietary framework with 25 years of Management System
development, to review and analyze Marketing, Sales &
•Budgeting system Service
Business Models and Strategy, key •Management Controls • Customer value focus
operating functions and supporting •Operating Plans • Process Discipline
infrastructure and management systems. •Resource Development • Business-driven
From there we develop comprehensive,
integrated operating plans that tie all the
components of the business into a high-
Core Operating
performance enterprise. Functions
• Functional Efficiency
Several years ago Michael Lewis published • Inter-function
an interesting book on how the Oakland A’s Integration
took a systematic look at how the game •Value Alignment

really works, and what investments in


players, strategies and tactics were most likely to result in the most wins for the lowest cost. Our approaches are
similar in taking a systematic look at the whole business, each of the major components and the best way to tie
everything together into a high-performance system.

We start by looking at the basic core value proposition and it’s translation into the Business Model and Strategy.
Typically we next examine Marketing and Sales operations, where it is possible to reduce operating costs by
30%, shorten the sales cycle by 30% and increase the closure rate by 30%. This is primarily the result of
establishing good processes and discipline.

BizzXceleration is comprehensive but integrated across the total reach and range of business activities and
issues. And emphasizes a pragmatic, workable approach that results in a stepwise path to performance
improvement. We believe that our approach mitigates business risks, improves operational performance and can
lay the groundwork for 10-30% EBITDA improvements in post-deal execution.

If you would be interested in further discussions, more detailed descriptions or the review and testing of specific
opportunities we would enjoy hearing from you. We can be reached at contact@llinlithgow.com .

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READINGS COLLECTIONS

Essay Collections on Finance Performance

The Broken Finance Industry: Credit, Crisis, Collapse and Broken Business Models
The credit crisis of 2007-2008 that metastasized into a collapse and nearly caused Great Depression 2.0 was
largely created by broken business models based on bad practices, malfeasance, excess leverage and synthetic,
structured investment products. We' ve all learned the hard way that the Finance Industry is more than just
another industry but impacts us all. By looking back, perhaps in anger and certainly in dismay and puzzlement,
we can understand more about how this all came to pass. And, as a result, more about what to expect because
all of these problems remain with us. If you' d like to get a better understanding of how broke the Industry is and
what the consequences are this is a place to start.

The Broken Finance Industry II: Crisis, Adaptation, Innovation and Value?
The Finance Industry brought itself and us to the brink of disaster thru bad practices and poor management. But
effective capital markets are vital to the health of the economy. Now we need to consider what' s broke, how to fix
and how govern the Industry for its own benefit and the health of society.

Facing the Firestorm: Finance Industry, Popular Anger and Re-regulation


The Finance Industry appears to have returned to profitability on the back of public funds and government support
programs. Its refusal to acknowledge that debt is leading to a tidal wave of initiatives for regulatory and legislative
reform which will be made worse by a refusal to constructively cooperate. Society needs a productive Finance
Industry and will get it either voluntarily or otherwise. The Industry'
s refusal to see these pressures will make
things more difficult than necessary, but are unavoidable without leadership and a sense of social responsibility.

The Firestorm is Coming: Financial Sector Reform, Puschbak, Sausage-making and the Public Interest
The recent news about large bonuses briefly moved the Finance Industry and the subject of reform to the front
pages, where it' s now fallen off as attention drifts elsewhere. But giant bills are moving thru both Houses of
Congress that will forever change the Industry. Here we take a look at the politics, whether or not the Industry as
it is actually is an effective allocator of capital and whether or not the "Bonus Culture" is an essential part of that.
Our findings are that the business case against reform doesn' t hold, in the interests of society, the economy and
the Industry itself. We even work thru the argument that reform is necessary since adult referees to ensure a fair
and level playing field is vital to the Industry itself.

Appalling Leadership Failures

What Red Ink? Wall Street Paid Hefty Bonuses Despite crippling losses, multibillion-dollar bailouts and the
passing of some of the most prominent names in the business, employees at financial companies in New York,
the now-diminished world capital of capital, collected an estimated $18.4 billion in bonuses for the year. That was
the sixth-largest haul on record, according to a report released Wednesday by the New York State comptroller.
While the payouts paled next to the riches of recent years, Wall Street workers still took home about as much as
they did in 2004, when the Dow Jones industrial average was flying above 10,000, on its way to a record high.
Some bankers took home millions last year even as their employers lost billions. The comptroller’s estimate, a
closely watched guidepost of the annual December-January bonus season, is based largely on personal income
tax collections. It excludes stock option awards that could push the figures even higher. The state comptroller,
Thomas P. DiNapoli, said it was unclear if banks had used taxpayer money for the bonuses, a possibility that
strikes corporate governance experts, and indeed many ordinary Americans, as outrageous. He urged the Obama
administration to examine the issue closely. Bonus Payout Graphic

Obama Calls Wall Street Bonuses ‘Shameful’ President Obama branded Wall Street bankers “shameful” on
Thursday for giving themselves nearly $20 billion in bonuses as the economy was deteriorating and the

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Profit, Performance and Social Reponsibility

government was spending billions to bail out some of the nation’s most prominent financial institutions. “There will
be time for them to make profits, and there will be time for them to get bonuses,” Mr. Obama said during an
appearance in the Oval Office with Treasury Secretary Timothy F. Geithner. “Now’s not that time. And that’s a
message that I intend to send directly to them, I expect Secretary Geithner to send to them.” It was a pointed — if
calculated — flash of anger from the president, who frequently railed against excesses in executive
compensation on the campaign trail. He struck his populist tone as he confronted the possibility of having to ask
Congress for additional large sums of money, beyond the $700 billion already authorized, to prop up the financial
system, even as he pushes Congress to move quickly on a separate economic stimulus package that could cost
taxpayers as much as $900 billion. This week alone, American companies reported as many as 65,000 job cuts,
and public anger is rising over reports of profligate spending by banks and investment firms that are receiving
help from the $700 billion bailout fund. About half of that money is still available, but the new administration has
yet to announce how it will use it, and many analysts think it will take far more to stabilize the banking system.
Should Mr. Obama have to go to Congress to seek more money for the bailout fund to avert the failure of more
banks, he would most likely encounter opposition within both parties and demands for tighter restrictions on pay
for executives of institutions that receive government assistance. Mr. Geithner has already signaled a willingness
to impose stricter compensation limits as part of a revamped approach to dealing with the banking crisis, but with
his strong words on Thursday, Mr. Obama seemed intent on reassuring Congress and the public that he would
step up the pressure on bankers before granting them additional assistance. Mr. Obama was reacting to a report
by the New York State comptroller that found financial executives had received an estimated $18.4 billion in
bonuses for 2008, less than for the previous several years but the same level of bonuses as they received in
2004, when times were flush. “That is the height of irresponsibility,” Mr. Obama said. “It is shameful. And
part of what we’re going to need is for the folks on Wall Street who are asking for help to show some
restraint and show some discipline and show some sense of responsibility.”

• Getting Theirs Cuts Both Ways on Wall Street


• It’s Theirs and They’re Not Apologizing

Talking Business: It’s Not the Bonus Money. It’s the Principle. When you get right down to it, the purchase of
a new plane or an office renovation is pretty meaningless for companies as large as Citigroup or Bank of America.
It’s not unheard of for executives to spend $1 million or more on remodeling when they get the corner office. It’s
pocket change. And companies can usually make a halfway decent business case to justify a new airplane. (It
goes longer distances than older planes, can take more executives to meetings, allows the top brass to be more
efficient and productive, etc., etc.) The question of whether bailout money was used to pay for these perks — as
alleged by The New York Post, which broke the Citi airplane story — is, at best, ambiguous. Indeed, breaking the
airplane contract and sending the jet back to the manufacturer will probably cost the bank more than keeping the
plane. None of that matters. You could make the same argument about the auto executives who flew on
corporate jets when they came to Washington to ask Congress for help: surely, it was a better use of their time to
fly rather than drive from Detroit, as they did the second time around, after being spanked for taking the jets. That
didn’t matter either. What matters is the symbolism. At a time when the country is in such trouble — and
executives are asking for bailouts — anything that smacks of plutocracy is going to arouse justifiable populist
anger. “This has been building for 20 years,” said Richard C. Ferlauto, director of corporate governance for the

American Federation of State, County and Municipal Employees. “Regular working people haven’t gotten
ahead in the economy. They understand that tremendous wealth has been created, and they say, ‘Where’s
mine?’ ” He continued: “These guys seem to be living in another universe. So the symbolism of the umbrella
stand and the private jet is powerful.” The umbrella stand, of course, was a reference to the $15,000 umbrella
stand that the former Tyco chief executive Dennis Kozlowski bought with company funds — and that is part of the
reason he is now behind bars. But there is something else as well. Most people still don’t fully understand what,
exactly, Wall Street did that caused so much trouble for the country and the financial system. I spoke this week to
David M. Smick, author of a scathing book about Wall Street, “The World Is Curved: Hidden Dangers to the
Global Economy.” In indignant tones, he talked to me about the sophisticated off-balance-sheet vehicles the
banks used to hide risk and game the system, and the “mortgage-backed securities they were shoving out the
door.” He concluded, “I find their behavior just appalling.”

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Why the Merrill Bonuses Are a Watershed MomentIn the midst of the Vietnam War, an Air Force major told war
correspondent Peter Arnett that it was necessary to destroy the town of Ben Tre in order to save it. The twisted
logic came to encapsulate the insanity of the entire decade-long fiasco. We' ve now reached a Ben Tre moment in
the financial crisis, thanks to Wall Street'
s fat-cat bonuses, especially those at Merrill Lynch. New York attorney
general Andrew Cuomo is investigating why Merrill issued $3.6 billion in bonuses to executives last year - even
though the firm lost nearly $28 billion and had to be taken over by Bank of America, with taxpayer assistance. And
now the Wall Street Journal has identified some of the top recipients, including 11 executives who received more
than $10 million each, in the same year that Merrill barely escaped a total flameout. But to the rest of us, it'
s
absurd that anybody should earn a multimillion paycheck when their firm is flat-lining. "RBS and ABN Amro are
both bankrupt, yet the banker who put that deal together walks off with $30 million," former Federal Reserve
Chairman Paul Volcker said at a recent conference in New York. "There' s something the matter with that system."
It'
s obviously worse still when a firm paying billions in bonuses turns around and leans on middle-class taxpayers
for assistance.

The Theory of the Case

Finally, outrage over huge bonuses Just a mere $18.4 billion in Wall Street bonuses, and suddenly the entire
country is like Kansas in the 1890s, raising hell instead of corn, screaming for revenge on money power that has
done us so wrong while rewarding itself so generously. The outburst of populist rage is particularly alarming when
we consider how easily such sentiments were managed just a short while ago. Americans have known about
mounting inequality and king-sized Wall Street bonuses for years. But we also had an entire genre of journalism
dedicated to brushing the problem off. Now the populist shoe is on the other foot, though, and it' s the liberals'turn
to hail the wisdom of the crowd. Maybe, in its fury at the millions doled out to bankers who drove their institutions
into the ground, the public understands something about moral hazard that the Treasury Department doesn' t.
Maybe, in its rage for fairness, the public is on to something that the banking industry' s remaining defenders need
to acknowledge. It is merely this: Wall Street' s compensation system isn' t just aesthetically displeasing to liberal
snobs. It is the very heart of the problem. According to Bill Black, a professor of economics and law at the
University of Missouri-Kansas City and an authority on dysfunctional financial systems, "It is the compensation
system that has proved to be the weak point in everything critical that went wrong, that has produced a global
catastrophe." At each stage of the disaster, Black said -- loan officers, real-estate appraisers, accountants, bond
ratings agencies -- it was pay-for-performance systems that "sent them wrong." The need for new compensation
rules is most urgent at failed banks. This is not merely because it would make for good PR but because lavish
executive bonuses sometimes create an incentive to hide losses, to take crazy risks and even, according to
Black, to "loot the place through seemingly normal corporate mechanisms." This is why, he continued, it is
"essential to redesign and limit executive compensation when regulating failed or failing banks." Our leaders may
not know it yet, but this showdown between rival populisms is, in fact, a battle over political legitimacy. Is Wall
Street the rightful master of our economic fate? Or should we choose a broader form of sovereignty? Let the
conservatives'hosannas turn to sneers. The market god has failed.

Animal Instincts: Main Street Seeks Revenge on Wall Street ... The outrage expressed by many so-called Main
Street folks over the proposed Wall Street bailout is based on more than a sense of injustice. It' s about revenge, a
basic animal instinct shared by humans, chimpanzees and even blue-footed boobies. And Washington politicians
would be wise to listen up and stick some get-back-at-' em clauses into the bailout bill if they hope to get the
support of the average American, says one behavioral economist who studies these things. In phone calls made
by constituents to politicians, as well as e-mails to news organizations and other media, the public has expressed
a preference for a package that helps consumers and homeowners without assisting fat cats on Wall Street. In
fact, a Pew Research Center survey conducted Sept. 27 through Sept. 29 found that nearly 70 percent of
Americans say they feel angry about the government' s plan, and half admit they are scared. President Bush and
other leaders who support the bailout warn, however, that if financial institutions are not propped up quickly and
significantly with public money, the average American will pay the price. Bring it on, many people seem to be
saying. Dan Ariely would agree. "People are willing to lose money to get those people [on Wall Street] to suffer"
because the corporate financial leaders have violated a social contract, says Ariely, a behavioral economist at
Duke University. "We need to include revenge in the bill."

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Exemplars: Mulally at Ford and the USMC

Alan Mulally: The Outsider at Ford But the man who chose Mulally, Chairman William Clay Ford Jr., says his
CEO' s progress in shaking up a calcified culture has thus far kept Ford independent and away from the U.S.
Treasury' s loan window. Under Mulally, decision-making is more transparent, once-fractious divisions are working
together, and cars of better quality are moving faster from design studio to showroom. John Casesa, whose
Casesa Shapiro consulting firm advises the industry, is impressed, too. "The speed with which Mulally has
transformed Ford into a more nimble and healthy operation has been one of the more impressive jobs I' ve seen,"
he says. "It probably would have been game over for Ford already but for the changes he has brought." No one
understood the travails of running the automaker better than Henry Ford' s great-grandson. The company was
bureaucratic and hostile to new ideas. And below the C-suite, it hadn' t yet sunk in that Ford was fighting for its life.
The chairman also knew his company had a history of "organ rejection," or spurning outsiders. He had watched
executives from outside arrive at Ford only to be isolated and even hazed. He resolved to give Mulally all the help
and advice he needed. Mulally' s biggest challenge, Ford said, would be breaking down silos, specifically the
operating regions around the world -- Europe, Asia, South America, and Australia -- that were more interested in
defending their turf than working together. It was a culture, Ford explained, where one's career had come to
mean more than the company.

• Mulally: Ford's Most Important New Model


• How Mulally Will Tackle Ford's Troubles, An Interview with Bill Ford and Alan Mulally
• Ford's Shrinking Losses Play Up Mulally's Progress
• Alan Mulally: Ford's Fixer, Commentary: Mulally Led Ford Seems Like A Good Risk For
Taxpayers

A Tragedy of Errors, and an Accounting The jet crashed nose down in the University City neighborhood of San
Diego, hitting two homes and damaging three. Four people, all members of a Korean immigrant family, were
killed—36-year-old Youngmi Lee; her daughters, Grace, 15 months, and Rachel, 2 months, and her 60-year-old
mother, Seokim Kim. Lee' s husband, a grocer named Dong Yun Yoon, was at work. The day after he' d lost his
family, he humbled and awed San Diego by publicly forgiving the pilot—"I know he did everything he could"—and
speaking of his faith—"I know God is taking care of my family." His grace and generosity were staggering, but
there was growing local anger at the military. Why was the disabled plane over land? The Marines launched an
investigation—of themselves. This Wednesday the results were announced. They could not have been tougher,
or more damning. The crash, said Maj. Gen. Randolph Alles, the assistant wing commander for the Third Marine
Aircraft Wing, was "clearly avoidable," the result of "a chain of wrong decisions." Mechanics had known since July
of a glitch in the jet's fuel-transfer system; the Hornet should have been removed from service and fixed, and was
not. The young pilot failed to read the safety checklist. He relied on guidance from Marines at Miramar who did
not have complete knowledge or understanding of his situation. He should have been ordered to land at North
Island. He took an unusual approach to Miramar, taking a long left loop instead of a shorter turn to the right, which
ate up time and fuel. Twelve Marines were disciplined; four senior officers, including the squadron commander,
were removed from duty. Their military careers are, essentially, over. The pilot is grounded while a board reviews
his future. This wasn' t damage control, it was taking honest responsibility. And as such, in any modern American
institution, it was stunning. The day after the report I heard from a young Naval aviator in predeployment training
north of San Diego. He flies a Super Hornet, sister ship to the plane that went down. He said the Marine
investigation "kept me up last night" because of how it contrasted with "the buck-passing we see" in the
government and on Wall Street. He and his squadron were in range of San Diego television stations when they
carried the report' s conclusions live. He'd never seen "our entire wardroom crowded around a television" before.
They watched "with bated breath." At the end they were impressed with the public nature of the criticism, and its
candor: "There are still elements within the government that take personal responsibility seriously." He
found himself wondering if the Marines had been "too hard on themselves." "But they are, after all,
Marines."

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Is 'Octomom' America's Future? A moment last Monday, just after noon, in Manhattan. It'
s slightly overcast, not
cold, a good day for walking. I' m in the 90s on Fifth heading south, enjoying the broad avenue, the trees, the wide
cobblestone walkway that rings Central Park. Suddenly I realize: Something' s odd here. Something' s strange. It'
s
quiet. I can hear each car go by. The traffic' s not an indistinct roar. The sidewalks aren' t full, as they normally are.
It'
s like a holiday, but it'
s not, it'
s the middle of a business day in February. I thought back to two weeks before
when a friend and I zoomed down Park Avenue at evening rush hour in what should have been bumper-to-
bumper traffic. This is New York five months into hard times. One senses it, for the first time: a shift in energy.
Something new has taken hold, a new air of peace, perhaps, or tentativeness. The old hustle and bustle, the wild
and daily assertion of dynamism, is calmed. A major reason people are blue about the future is not the stores, not
the Treasury secretary, not everyone digging in. It is those things, but it' s more than that, and deeper. It' s Sully
and Suleman, the pilot and "Octomom," the two great stories that are twinned with the era. Sully, the airline
captain who saved 155 lives by landing that plane just right—level wings, nose up, tail down, plant that baby, get
everyone out, get them counted, and then, at night, wonder what you could have done better. You know the
reaction of the people of our country to Chesley B. Sullenberger III: They shake their heads, and tears come to
their eyes. He is cool, modest, competent, tough in the good way. He' s the only one who doesn' t applaud Sully.
He was just doing his job. This is why people are so moved: We' re still making Sullys. We' re still making those
mythic Americans, those steely-eyed rocket men. Like Alan Shepard in the Mercury rocket: "Come on and light
this candle." But Sully, 58, Air Force Academy ' 73, was shaped and formed by the old America, and educated in
an ethos in which a certain style of manhood—of personhood—was held high. What we fear we' re making more
of these days is Nadya Suleman. The dizzy, selfish, self-dramatizing 33-year-old mother who had six small
children and then a week ago eight more because, well, she always wanted a big family. "Suley" doubletalks with
the best of them, she doubletalks with profound ease. She is like Blago without the charm. She had needs and
took proactive steps to meet them, and those who don' t approve are limited, which must be sad for them. She
leaves anchorwomen slack-jawed: How do you rough up a woman who' s still lactating? She seems aware of their
predicament. CBS Sixty Minutes Interview

On Public Virtue Those who study the rise and fall of civilizations learn that no shortcoming has been as surely
fatal to republics as a dearth of public virtue, the unwillingness of those who govern to place the value of their
society above personal interest. Yet today we read outcries from conscientious congressmen disenchanted with
the proceedings of their legislative body and totally disgusted with the logjamming effect of their peers'selfish and
artful distancing of themselves from critical spending cutbacks, much-needed belt-tightening legislation without
which the long-term existence of our Republic itself is endangered. Probably no character trait was so universally
identified by our Founding Fathers as essential to the long-run success of the American experiment as selfless
public virtue. In those days of decision, almost all of them were quick with pleas for its encouragement and
institutionalism. For instance, John Adams, in a letter to his friend Mercy Warren, author and sister of
revolutionary leader James Otis, wrote: "Public virtue cannot exist in a Nation without private, and public Virtue is
the only Foundation of Republics. There must be a positive Passion for the public good, the public Interest,
Honour, Power and Glory, established in the Minds of the People, or there can be no Republican Government,
nor any real liberty." The connection between liberty and public obligation probably occurred naturally to those
who founded the United States. Many of them were exceptionally well read in political history and theory. The
founders'debates were salted with easy references to Locke, Hume, Machiavelli, and Montesquieu, as well as the
ancients: Aristotle, Seneca, Marcus Aurelius, and that second-century Greek who was the great historian of the
early Roman republic, Polybius. That Roman Republic and its ethos, particularly during its first three hundred
years, were a national model for our founders'dreams.

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