Is there Something Wrong with our Wiring?
Posted: September 1, 2015 Written by: W.B. “Bud” Kirchner
“What it lies in our power to do, it lies in our power not to do.” ~ Aristotle.
Should there be a business school class focused on this quote?
A recently released report titled “The Street, The Bull and The Crisis: A Survey of the US & UK Financial Services Industry,” by Ann Tenbrunsel and Jordan Thomas (presented by The University of Notre Dame and Labaton Sucharow LLP), revealed that many in this area “continue to believe that engaging in illegal or unethical activity is part and parcel of succeeding in this highly competitive field.”
What the hell?!?!
We are less than a decade removed from the Global Financial Crisis with the collapse of large financial institutions and the bailout of banks. Yet all those lessons are apparently forgotten because the key findings in Tenbrunsel and Thomas’ report are mindboggling.
- “More than one-third (34%) of those earning $500,000 or more annually have witnessed or have first hand knowledge of wrongdoing in the workplace.”
- “Nearly one in five respondents feel financial services professionals must at least sometimes engage in illegal or unethical activity to be successful.”
- One in 10 said they had felt pressure at their company “to compromise ethical standards or violate the law.”
“Whoever controls work and wages, controls morals.” ~ Susan B. Anthony
On a side note, a New York Times article by Andrew Ross Sorkin says the “asterisk” to this study is that it is presented by Labaton Sucharow, which is “a firm that often represents whistle-blowers in cases against the financial services firms.” As a firm believer of doing your due diligence in every aspect of your life, it is something you should know.
It should also be noted that while this report focused on Wall St. this wiring problem extends beyond Wall St. The temptation and reality is it can and does happen on Main St. But on Main St. it occurs at a different scale and it is generally more straight-forward to fix.
Are there people walking around with this kind of faulty wiring?
The quick answer is yes. There is a 2010 study from scientists at the Massachusetts Institute of Technology that says our moral judgments can be manipulated. In this case – they used magnets! It’s a fascinating look at the brain’s right temporo-parietal junction (TPJ) and how little we still know about the brain.
Anyway, I don’t pretend to have the secret formula to ‘help’ Wall Street, which was obvious when I was asked related questions in a PBS interview. I would add, however, (from the same interview) that I have gone on record declaring I believe small and mid-market enterprise is more about ‘Main Street’ than Wall Street.
However, before leaving Wall Street let me say it is a place complicated by regulatory issues, multiple people to pass the buck to and exacerbated by ‘financial engineering’ (another interview topic). I will reluctantly admit that creating alignment of interest becomes more challenging (but never impossible) as deals become more complicated (read bigger). This is not a rationale for ethically questionable behavior – it is just setting the stage for discussion based on a saner section of the industry.
Shouldn’t matters of ethics, principles and values be straightforward?
“Never let your sense of morals get in the way of doing what’s right.” ~ Isaac Asimov
Let me focus on two Kirchner Group stories that could be of some assistance when you face certain situations as you grow. Each story is centered on the same concept – which I hope illustrates that doing the right thing should not be that complicated.
The concept in our examples can be captured in a simple principle:
If you have an alignment of interest there is less (scope) (rationale) (opportunity) to exploit the situation or the counterparties.
I am, certainly, not suggesting that focusing on alignment of interest is the only solution but what I can say is it is simple and it works. Alignment, of course, comes in many forms but the one that seems to me to be the most successful (surprise) is the alignment around economic interest.
Incidentally, this and all such approaches are further enhanced when conducted in an atmosphere of transparency. This may seem straightforward and obvious but I can promise you there have been times and places (not all of them past) in the world of business when this was not even the exception let alone the rule.
How do we reach alignment?
After almost 10 years in the venture capital business, I can say this was the first time an M&A Firm exceeded my expectations”
~ Venture Capitalist
Performance Based Compensation
It is rare (almost unheard of) for our team to get all of our net fees (profits) for advisory services if we do not help the clients reach their goal. While there are structural situations (e.g. no benchmarks) where that is possible, our culture is built around success-based compensation. In the old days – we called this “skin in the game.” In short, once we cover our costs – the business model is simple: if we help someone then we share success with no scope to do so in a unilateral fashion. In other words our priorities and actions dovetail!
I am quite sure we are not the only group that takes this approach (at least to some degree) but I trust when you see the next example – you will appreciate how much it can become part of a culture.
One of the innovations in our business that we are most proud of is in the area of portfolio rehabilitation – where we are the acknowledged ‘pioneer’ of a model designed specifically to address the nonalignment of interests which had led to abuses similar to those highlighted at the beginning of this blog post.
In 2003, we recognized what we saw as a looming divergence of interests between limited partners (LP) and general partners (GP) as it relates to fund (portfolio of companies) management. Without going into a lot of detail, issues included failure to sell assets in a timely manner (so as to preserve management fees) and charging of fees from companies in fashion that disadvantaged investor’s proceeds.
In order to realign interests our Successor GP Program starts by readjusting the Funds NAV (Net Asset Value) to its realistic value by thoroughly analyzing each company in the portfolio. Extraneous fees are an expense that most LP’s face but in our model we eliminated all extraneous fees and our profit is again tied to our ability to create value for the fund. If we don’t create value then we don’t collect anything beyond our management fees (which simply cover our costs) so our interests are aligned with the LP’s – we both want to create value in the portfolio.
This is not a criticism of all participants but enough were guilty to raise the ire of the SEC (“SEC says taking “close look” at zombie funds“) and attention of The Economist (“Zombies at the gates“).
Not only did we highlight this growing problem (which The Economist estimated to be a $100B problem 10 years later) but we are credited with ‘creating’ a model which is building a growing track record of addressing what is now a prominent example of misalignment of interest. I am happy to say doing the right thing can work:
Our Successor GP model has scaled to 7 distinct transactions, 107 underlying portfolio companies, more than 100 underlying investors and a track record of crystallizing value.
Can we Realign the Misaligned?
I put these examples forward, not because I think they are the be all/end all or to be perceived as a holier than thou context, but rather as examples of efforts that reflect a sense of fair play and are done in a transparent fashion. These options can be a viable alternative to the approach of those with faulty wiring.
Yes, there are a lot of neuroscientific psychological principles I could bring to this discussion but isn’t our basic moral fiber – an honest day work for an honest day pay enough? Or at least shouldn’t it be?
I would not be so presumptuous as to suggest addressing the misalignment of interest as the only issue or guiding principle but it is a simple and effective starting point. Hell it might even work on Wall Street!
“Coming together is a beginning; keeping together is progress; working together is success.” ~ Henry Ford
Going beyond the moral issue (should we ever need to go beyond?) there is a pragmatic rationale. Case in point, we have now been in business for three decades (not sure, but a three decade boutique likely qualifies for the “Guinness World Records”) and even more important, many of our clients and counterparties/partners have been with us for much of that time. I like to think this is because we do the right thing and we practice what we preach!
About the Author: W.B. “Bud” Kirchner is a serial entrepreneur and philanthropist with more than 50 years of business success. He is not a scientist or an academic but he does have a diversified exposure to neuroscience, psychology and related areas. Generally speaking, the ideas he expresses here are business-angled expansions of other people’s ideas, so when possible, he will link to the original reference.