The Wall Street crisis calls for the new financial-services firms to be run much like conglomerates and for executives with much greater depth and breadth of management skills
Since the repeal in late 1999 of the 75-year-old Glass-Steagall Act, which separated investment and commercial banks, Wall Street has been moving back to the future. The events of the last several weeks have brought about further transformation. The old Wall Street—large independent investment banks with 35:1 leverage and big, deposit-based commercial banks—is gone.
The new financial companies that have emerged in the wake of the financial crisis are likely to have not only a different business model but a different leadership and governance model as well. These new entities are, in fact, complex financial holding companies with multiple businesses, lower leverage, less risk, and subject to more regulation. They are engaged in the full spectrum of banking activities, including deposit gathering, commercial lending, trading, mergers and acquisitions, financial structuring, and handling initial public offerings.
Indeed, the complexity is so great that it will take extraordinarily skilled and intelligent individuals to run them single-handedly, and unusually talented and knowledgeable boards to govern them well. Management models and boards of directors will need to change to achieve deeper and better insights into the strategies, growth opportunities, and risk profiles of these companies.
Shortage of Leaders
At Spencer Stuart, we see the probability of a syndicated leadership model emerging in financial-services firms. This model would be similar to that of conglomerates comprised of business units headed by chief executives with profit-and-loss responsibility. Such a model for financial-services companies would require executives with much greater depth and breadth of management skill. (It is possible that some companies will spin off strategic business units to reach a more manageable size. These could be wholly owned but autonomous businesses or they could be public companies partially owned by the bank holding company.)
Regardless of which path these new behemoths choose, they are likely to realize that there is a shortage of leaders with the broad skills needed to manage effectively. However, leaders will emerge over time, as new models of bank management are successfully implemented. Talent will come from both within banking and perhaps from related and diversified financial-services companies with similar characteristics, such as insurance, consumer and commercial finance, and asset management. It may also come from outside the financial-services industry altogether as the industry seeks operating skills in restructuring, risk mitigation, and regulatory oversight.
CEOs, working closely with their boards, will devise the new management model and the structure of their senior leadership teams. Given the strains under which financial firms are operating, CEOs will need new ways to attract and motivate CEO-ready managers to tackle near-term challenges. They will also need to develop executive talent by providing high-potential leaders with opportunities to manage across businesses and functions.
End of Silos
But that is only the beginning. Given the new regulations that are sure to come as the result of the financial disaster, CEOs of financial conglomerates will need to work with regulatory authorities more closely and be more knowledgeable in the ways of Washington. This will also be a requirement for business unit leaders. CEOs will need to ensure that business unit leaders understand the total organization and how senior leaders of the different businesses can work together cooperatively to capitalize on the overall company model. The era of discrete business units working in their own silos is over.
CEOs will coordinate the collective skills of unit leaders to expand the enterprise, while balancing the culture of the company to manage interunit envy and conflict. Understanding how the risk profiles of each unit blend into the overall risk profile of the company will also be essential. CEOs and business unit leaders will require systems and tools to provide improved measurement of unit and enterprise risk. This will be a formidable yet necessary task, as the current market meltdown had made clear.
CEOs will need to manage liquidity of their enterprises while maintaining a global watch on financial markets, risk assumptions, and trends that can sour investments. They will need to understand the nuances of commercial, consumer, and investment banking in order to manage capital allocation among units. The CEO's task is such that some companies may decide to divide the roles of CEO and chairman of the board. (The chairman could be a nonindustry person, if there is a split, in order to help broaden the skill sets of the board.)
Business unit leaders will need several skills in addition to operating abilities. They will need to understand in detail the risk profiles of their products and business units. They will have to restructure and reduce costs to better align with lower margins and revenue streams. They will need to develop new ways to pay star players for performance without upsetting the culture of the institution and its long-term growth. They will need to grow and manage their units on a worldwide basis in a more integrated global marketplace.
More Relevant Directors
The new bank holding companies will need different boards, too. Directors need backgrounds and skills that are more relevant. In addition, directors need to be more engaged and to grasp in greater detail the firms they govern. Finding such directors will not be easy, and it is unlikely any one board member will possess all of the required skills. These will include financial expertise; risk-management experience; a background operating in a regulated industry; global experience; HR and compensation expertise; P&L experience out of financial services, especially as it relates to reengineering/reducing cost bases; and, in some cases, a consumer financial background.
The days of large boards comprised of community leaders and those representing major customer groups are gone. We expect bank holding companies will reduce the overall size of their boards to achieve better governance. (Banks have the largest boards in the S&P 500 today. Some are more than twice the size of the average board of 11 directors.)
While finding directors might be a challenge, boards will have some options. Some might expand their geographic reach beyond North America. Others might select retired investment bankers and chief financial officers who understand mergers and acquisitions, financial structuring, and derivative products. And some can look for retired lawyers with regulatory, securities, and compliance experience who are without conflicts.
As part of their efforts to increase oversight of these complex holding companies, boards might establish their own risk committees to evaluate the firm's risk profile apart from management. This might be similar to an insurance company's reserve calculations, where boards (with outside advisers) and management separately compute reserves, then negotiate a final number. They might enhance third-party evaluation by extending their consulting resources to include risk assessment, operations, and technology and derivatives. We also expect boards will establish a better balance of compensation for senior executives between short- and long-term incentives to motivate executives while avoiding excess compensation and discouraging stars from leaving for private firms.
The new financial-services company will develop over time. Five years from today, the framework for managing and governing these complex combines should be in place. Until then, we expect companies to experiment and search for models that work best for them. Because there are huge differences between a Goldman Sachs (GS) and a Wells Fargo (WFC), we don't expect the management model will be identical or work in the same way from firm to firm. However, we do expect some similarities. Financial-services companies will: better understand and control risk; work harder to attract strong general managers who are CEO-ready, able to manage all facets of the business, and focused on synergy; and organize around strategic business units to pursue profitable growth opportunities. Only with new models will the industry be positioned to resume strong growth.