Companies & Industries

10 Management Lessons from Lehman's Demise


The way the failed bank was run violated numerous tenets of Peter Drucker's "scholarship of common sense," writes Rick Wartzman

Former Lehman Brothers Vice-President Lawrence McDonald has titled his insider account of the firm's demise A Colossal Failure of Common Sense. Peter Drucker, meanwhile, was once said by the London Business School's Sumantra Ghoshal to "practice the scholarship of common sense."

With this sharp contrast in mind a year after Lehman went bust here are 10 management lessons derived from Drucker's insights:

1. Executives who are preoccupied with their company's daily stock price or consumed with quarterly earnings targets don't make very good stewards of the enterprise.

"The most critical management job is to balance short-term and long-term," Drucker declared in a 1999 interview, adding that a "one-sided emphasis" on the former is "deleterious and dangerous."

Ultimately, said Drucker, deciding "whether a business should be run for short-term results or with a focus on the long term is…a question of values. Financial analysts believe that businesses can be run for both simultaneously. Successful businesspeople know better."

2. Tying individual compensation to short-term gains only exacerbates the problem.

It rewards the executive "for doing the wrong thing," Drucker said. "Instead of asking, 'Are we making the right decision?' the temptation is to ask, 'How did we close today?' It is encouragement to loot the corporation."

The Aspen Institute recently urged companies to "define firm-specific metrics of long-term value," and then use these measures "both to communicate with investors" and to "better align executive compensation" with what truly matters. The Federal Reserve is also considering forcing financial institutions to adopt policies that tie pay to long-term performance. Drucker would have lauded this initiative.

3. People don't like it when those who've exhibited the worst cases of managerial myopia get filthy rich in the process.

Inevitably, said Drucker, there is "an outbreak of bitterness and contempt for the super-corporate chieftains who pay themselves millions." Former Lehman Chief Executive Richard Fuld, who enjoyed $40 million in pay and benefits in 2007, recently complained that he has "been pummeled. They're looking for someone to dump on right now, and that's me," Fuld said.

Drucker, it's plain, wouldn't feel sorry for him. "Few top executives," he once remarked, "can even imagine the hatred…and fury that has been created" because of their unjustified pay. "I don't know what form it will take, but the envy developing from their enormous wealth will cause trouble."

4. High profits don't necessarily mean that you're producing anything of genuine value.

Lehman, in fact, reported record earnings in 2005, 2006, and 2007. That may have impressed the investment community. But that's not what counts in the end. "Securities analysts believe that companies make money," said Drucker. "Companies make shoes."

5. Moving money around isn't the same thing as producing actual goods and services.

To be sure, financial instruments have a vital role to play in spreading risk and ensuring the smooth functioning of the global economy. But when Wall Street is generating 40% of U.S. corporate profits, something has gotten way out of whack.

Drucker called this worldwide flow of capital and credit the "symbol economy," as distinct from "the real economy." "Americans," he said, "cannot live in a symbol economy where businessmen play only with numbers."

6. When you buy and sell lots of assets at prices that are considerably higher than the underlying value of what's being traded, the run-up can't possibly last.

"The average duration of a soap bubble is known—it's about 26 seconds," said Drucker. "Then the surface tension becomes too great and it begins to burst. For speculative crazes, it's about 18 months."

7. Even professional bankers, who ostensibly are experts in "risk management," aren't immune from the soap-bubble syndrome.

Of course, this doesn't mean that they don't try to outsmart the system. The tendency is for firms to resort to "'trading for their own accounts,' that is, to outright speculation," Drucker noted. "This, however, as centuries of financial history teach (beginning with the Medici in 15th century Europe) has only one—but an absolutely certainmoutcome: catastrophic losses."

8. It's especially hard to avoid those losses when you don't want to hear any bad news.

Lehman and most other investment banks refused to even contemplate the "potential danger" of becoming overly leveraged, McDonald recounts in his book. "Wall Street was listening for calm seas, record profits, best-ever growth, joy, wealth, prosperity, and b-o-o-o-o-n-u-u-s. Anything less was essentially out of the culture." When Lehman's fixed-income chief warned Fuld about the unsustainable bets that the firm was making, McDonald adds, Fuld "decided to bully him, to belittle him publicly."

Other former Lehman bankers paint a similar picture, saying that Fuld and his top lieutenant weren't interested in dissenting views. But "dissent…is essential for effective decision-making," Drucker said. Without it, those at the top simply can't take on what Drucker described as "the most important task" they're responsible for: "to anticipate crisis."

9. As long as human beings are in charge of our major institutions, this won't be the last crisis we see.

"Scandals are a normal feature of the landscape," said Drucker, who wouldn't be shocked that companies are once again taking on substantial risk and selling the kinds of exotic financial products that triggered the Great Recession. "They very typically begin with something that goes wrong, and you…brush it under the rug. And you end up by trying to brush elephants under the rug. And then it doesn't work any more, and it collapses."

10. "Stupid people make stupid mistakes. Brilliant people make brilliant mistakes."


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