Adventure of Strategy

In 2004, in the aftermath of the Enron / Worldcom / Arthur Andersen etc debacle, a book that I read by Alex Berenson and Mark Cuban titled The Number: How the Drive for Quarterly Earnings Corrupted Wall Street and Corporate America turned out to be a real page-turner. It outlined all the 20th Century financial crises, ending with the [then] most recent one. The authors concluded that executive compensation was to blame. Specifically stock options (in particular) and other aspects that encouraged executives to sacrifice long term vision on the alter of short term results. The book concluded on a sombre note, with a warning that things were unlikely to change and that short term greed would, in time, induce another crisis.

Sadly, as we all now know, they were right. This morning, there were several blog posts in my aggregator commenting on Princeton economist Alan Blinder's article in the Wall Street Journal titled Crazy Compensation and the Crisis. Here are two of them:

Greg Mankiw's Blog - Blame the Board

Mark Thoma - "Crazy Compensation and the Crisis"

Across the pond in the UK, Alice Cook's blog 'UK Bubble' presents a post titled All Debt and No Equity, showing how reluctant UK firms are to raise capital by issuing new equity. As any first year MBA student knows, equity capital is far more expensive in the long term than debt, because the latter is simply repaid without having to fund capital gains resulting from the company's growth. Debt funding, if you can find it right now, also currently costs next to nothing. Cook suggests that the real reason for the aversion to issuing new equity is the effect that the dilution will have on share prices and ..... yes .... bonuses are usually linked to share price performance, so managers have a strong incentive to keep the share price high in the short term even at the risk of long-term corporate sustainability. So, given the degree to which the credit supply has constricted, companies may be giving up growth opportunities that could be funded with equity funding instead, because executives fear for the impact on their pockets personally.

If we can't fix this, then we would be justified in wondering just how long it will be before another crisis driven by compensation systems that over-reward short-term performance drives the western world to the brink of collapse again!!!

There are models that seek to balance compensation sensibly with strategy. The balanced scorecard is perhaps the best known and I have worked with several law firms now to align their compensation systems for both partners and employees with its principles. It is as well to remember that Arthur Andersen had a balanced scorecard system too .... the "four rocks on which our firm is based" it was apparently called, although cynics reportedly called it the "three pebbles and a boulder" because of the degree to which revenues were prioritized over the others. In other words, their scorecard wasn't balanced.

As firms scramble to redesign their compensation systems and make them more performance-driven, it is critical to think carefully about the unanticipated consequences that the changes may drive. There is a great clamor at present to ditch lockstep systems and focus relentlessly on performance. I worry that "performance" in many cases is being defined in the same way as in the "Wall Street Syndrome" described above ..... short term and focused [almost?] exclusively on "the number."  Designing effective compensation systems that balance short term performance with sustained, long-term profitability and corporate resilience and agility may in fact be one of the most important strategic priorities facing law firms right now.

I'd love to hear your comments on this ....

its really sad that high corporates are trying to make quick money through fake means and not going for innovation.the sathyam tragedy in india is a similar one in the recent times