When should we fire the CEO?

Posted on December 26, 2010

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Professor Wiggly: ” Here’s an interesting article that I have permission from it’s authors to share with you. It was writen befiore Hawking’s published his ideas about model dependent realism but refects that theme, as well as Simon’s mantra no decisions without emotiolly anchored assumptions (biases). It helps explain why CEO’s and economists  get it wrong, and why we had the recent economic meldown.

When Should We Fire The CEO? [1]

Summary

We use to believe, and many apparently still  believe, that CEOs can profitably map and manage the future – in slower, simpler times a reasonable assumption. But it’s less and less valid in a global economy involving interdependent networks, serial uncertainty and high systemic risk.

And yet for the past decade the global economy boomed. If that economy is as uncertain as we suggest how can we account for its success?

We offer the following proposal – heresy? Since CEOs are less and less able to successfully map and manage the ‘real’ future they unwittingly focus their energy on mapping and managing our beliefs about that future. Successful CEOs – those with contagious confidence – construct trusted artificial islands of certainty.

It’s obvious on Wall Street where they peddle promissory notes – bets on bets on bets.

But we also see it on Main Street where CEOs peddle reconstructions of the past and constructions of the future in the form of creative quarterly and annual reports. They fabricate highly interdependent networks of stability involving directors, bankers, auditors, rating agencies, consultants, government agencies, unions, etc. These networks become so integrated that the CEOs who constructed them can’t restructure them without the input of massive amounts of external energy provided by bailouts and bankruptcies.

In brief we need CEOs with contagious confidence more that they need us. Therefore in spite of new rules and regulation, it will continue to be CEOs who decide when to walk and how much to take with them.

When Should We Fire the CEO?

The economic meltdown has been blamed on many things but near the front of the parade are the greed and incompetence of the leaders of once revered financial institutions, be they private like AIG and Lehmann Brothers or government backed like Fanny Mae and Freddy Mac. Sucked into their back draft come such titans of industry as General Motors and Chrysler. Included in the finger pointing are government institutions for a lack of controls on financial institutions and even promoting mortgages to what turned out to be individuals lacking the financial wherewithal to sustain making payments. Even the once revered Alan Greenspan, former head of the Fed is getting his share of the mud thrown around for keeping interests rates too low for too long.

Documenting and critiquing the large body of evidence assigning blame lies beyond the scope of this paper. That is a task for many years to come. The Crash of 1929, eighty years ago continues to be a topic for study and debate. Instead we focus on one major facet of the problem, we focus on CEOs. The leaders of these institutions so much under attack. Our question for examination is what kind of knowledge enables us to make confident judgment about executive responsibility and compensation and the very current issue of when to fire the CEO?

A great deal of public anger and press is now focused on the role of the CEO, on their apparent failure to provide sound management and particularly on their lavish and for many, unwarranted bonuses. This has certainly been the case for such high profile examples as General Motors, Lehmann Brothers and AIG. For some reason the early signs of impending doom were not seen by the CEO, nor the Board as sufficiently ominous to fire the CEO or send him a negative financial message. But we are operating with the advantage of distance of time and location. Had we been in the Board’s chairs we may, at the time, have read the downturns as temporary aberrations. Besides, we sometimes belong to the same clubs and selflessly help each other out, such as donating precious personal time to sit on each other’s Board.

Some Do Get Fired

Before continuing further we do recognize that firings do happen. Proctor and Gamble provides an example. In 2000 they replaced their CEO because they were in trouble. P&G had missed third quarter earnings and the stock price took a header from $86 to $60. Fingers of blame pointed at mistakes in all directions.

The new boss, A. G. Lafley, believes that the chief culprit was an overly ambitious restructuring program that attempted to ‘change too much too fast’ and fouled up the smooth operation of the business. So the possible lesson is CEOs may get turfed when attempting and failing to change the strategic direction of the corporate beast.

However, Lafley has written in the May, 2009 issue of the Harvard Business Review, “But our biggest problem in the summer of 2000 was not the loss of $85 billion in market capitalization. It was a crisis of confidence.”

Can we conclude from the P&G example that although CEOs make mistakes – particularly when trying to restructure the system – that the mistakes that get them fired are those that create a crisis of confidence? Does Lafley’s insight help us understand and perhaps avoid the kind of mess currently savaging both Wall Street and Main Street?

A Successful Failure?

Let’s now look under the hood of one global corporation very much at the centre of the current meltdown __ General Motors. An example where the CEO was fired _ eventually.

At first glance it looks like CEO Rick Wagoner was a successful failure – GM lost market share while profits and stock values fell. Not only did he keep his job, first as head of the US auto division and then as CEO, but also continued to receive lavish rewards. How come he wasn’t fired? He really tried to turn the beast around. Is he one of those CEOs who can ‘fail’ but succeed in keeping the job as long as they don’t create crises of confidence?

It’s not that Rick Wagoner was an incompetent or dishonest CEO. No, those who knew him considered him a conscientious and respected executive. But in the end he was ‘ asked’ to resign as CEO of General Motors, not by his board of directors – supposedly  the shareholder ‘watchdogs’ – but by the President of the United States.

Such an astonishing event demands that we critically reconsider the role of the CEO. Can our current financial mess really be blamed on a batch of confused CEOs? Or does the blame rest elsewhere, on directors, shareholders, employees, customers, and on government agencies all clinging to false expectations of what our CEOs can deliver?

Rick Wagoner became CEO of GM in 2000 but was head of US auto operations for six years before that. He inherited a beast that consistently yielded market share to Toyota and Honda, and in the past four years losses topped 80 billion dollars.

He was dealt bad cards? Yes, Wagoner inherited some bad cards. Nevertheless he played and won some big hands. Two years into his tenure as chief executive GM reported a 30% rise in operating earnings, and did so in a stagnant market. Also, the gains – $3.9 billion operating profit – wasn’t an accounting diddle but resulted from a 5% increase in sales against tough competition.

In spite of these gains, credit analysts pointed to the under funded $76 billion pension fund and downgraded GM’s debt, resulting in an 8% drop in stock value. Wagoner couldn’t win – the sins of his predecessors plagued GM.

And notice, not only did Wagoner generate a profit but early in his tenure GM finally recaptured the lead from Ford in the lucrative truck business. Demonstrating power and control he successfully fought off assaults from a major shareholder and also deserves three cheers for arranging to unload the burdensome health care package into union hands. Furthermore he continued the expansion of auto sales outside the United States, while at home introduced significant cost controls while improving product lines. For instance stingy Consumer Reports started listing an increasing number of GM cars as best buys.

Yes, he was slow off the mark in developing hybrids. And yes he made a bad bet on hydrogen technology. Meanwhile Toyota introduced the Prius selling over 2 million units. Belatedly GM is finally coming out with the electric Volt.

In brief Wagoner made valiant attempts to turn the beast around, ultimately failed, and seeking a bailout flew to Washington in his corporate jet, was ‘fired’ but may still drive away with 20 million dollars.

Is that fair?

Not if we accept the position that one of the CEO’s main tasks is to increase shareholder value.

But notice, unlike the CEO who P&G fired, Wagoner apparently created no major crisis of confidence among his own board of directors and although unable to successfully restructure the firm in order to capitalize on changing opportunities he was able to make some significant incremental changes. It was only when he created a crisis of confidence with President Obama that he had to exit for the final time.

The current recession provides ample evidence, flowing from both Wall Street and Main Street, that many of our most trusted CEOs were ‘successful failures’ in managing their companies, in postponing crisis of confidence, and astonishingly successful in managing both their compensation and golden handshakes.

How come?

It looks like we’ve been blind if not downright dumb.

It’s time to take off our blinders, smarten up and replace our treasured but obsolete assumptions; assumptions that served us well in simpler, slower times before we drifted into the rapids of the global economy, before our CEOs tried to manage serial uncertainty.

In such unpredictable political-economic environments what can we reasonably expect from our CEOs?

What can we realistically expect from our CEOs?

We offer the following six propositions – heresies? – for your consideration.

1) Most of the time CEOs, like the rest of us, cannot successfully map and manage the future – certainly ‘the big three’ auto firms have failed to do so, joined recently by big banks, financial services and insurance firms.

2) Because there’s never enough rationality and reliable information to accurately read the future CEOs, like the rest of us, creatively reconstruct positive pasts and construct optimistic futures – for example quarterly and annual reports.

3) However, unlike the rest of us successful CEOs typically possess enough contagious confidence to attract continuing support from directors, bankers, employees, suppliers, dealers, customers and government agencies – support for that CEO’s particular reconstructions and constructions – an indeterminate mix of reasoning and rationalizing. Furthermore, if they’re lucky they catch a rising market. In a nutshell we’re presuming that since CEOs can’t map and manage the serial uncertainty of the global economy that, instead, they unwittingly and sincerely map and manage our beliefs about uncertain futures.

4) Unlike the rest of us, successful CEOs also possess the ability to manage the awesome complexity inherent in large corporations (e.g., priority setting and damage control skills – Wagoner excelled at these).

5) The very qualities that define a well managed corporation – integrated systems of expectations, priorities, people, technology, operating procedure, money and material – also make it difficult to change its direction even if conscientious CEOs like Wagoner try.

6) The protected and preferential position of CEOs in the business hierarchy provides them with the degrees of freedom to be a ‘successful failure’ (e.g., it can take years – even decades – to decide to buy out or fire them).

Of the six propositions #3 (contagious confidence) and # 5 (changing direction) are probably the most controversial so we’ll consider them in turn.

Contagious Confidence: Constructing artificial islands of certainty on Main Street

We can probably agree that Wall Street includes confidence games – both sincere and devious – designed to map and manipulate people’s beliefs about the future. Our financial wizards constructed and peddled artificial islands of certainty – ‘insured’ promissory notes – with risk precisely calculated to decimal points by scientists – some of them Nobel Prize winners. Who, it turns out know more about mathematics than human behavior. But that’s Wall Street.

Can we really make a case that Main Street also manages serial uncertainty by constructing networks of artificial islands of certainty? Yes, quarterly and annual reports consist of ‘creative’ positive reconstructions of the past and promising constructions of the future. But in what other ways do CEOs construct stability and reduce uncertainty?

Do CEOs not construct – select – and nourish supportive or tame boards of directors, colleagues, auditors, consultants, and compensation committees who support or defer to the CEO’s conscientious if imaginary constructions of the unknown and unknowable future. This deferential network serves as self-perpetuating, quasi-stable systems acting to dampen disruptions, whether arising from within or outside the system.

But those CEOs blessed with contagious confidence also construct artificial networks of stability using multi-year contracts with bankers, employees, suppliers, dealers and customers. Some of which help ensure corporate survival through the rough seas of uncertainty, whereas others, such as contracted, debt, deals, products, bonuses, health and pension benefits dangerously constrain system maneuverability.

Finally, notice that some corporations build and maintain artificial networks of stability with federal government agencies. For example Wall Street sends it’s best and brightest to serve stints in powerful federal agencies, like Treasury, to ensure that ‘corporate friendly’ policies prevail.

Summarizing, in proposition #3 above, we propose that CEOs cannot successfully map and manage the serial uncertainty of the evolving and dynamic political-economic environment. Instead ‘successful’ CEOs, relying on contagious confidence to construct artificial and resilient networks of stability.

We next consider Proposition #5 which states that the very qualities that define a well constructed and managed corporation – integrated systems of expectations, priorities, people, technology, money and material – also make it difficult to change direction even when skilled and conscientious CEOs like Wagoner attempt to do so.

Must we really rely so heavily on bailouts and bankruptcies to turn the beasts around?

Deconstructing and Reconstructing Artificial Networks of Stability

Like bad habits and addictions corporations resist change, even when survival is at stake. In cases like GM, AIG and the big banks the network of stable linkages is so extensive, the systemic risk so high, that we can’t allow them to fail. So somehow we must beg, borrow or steal the necessary resources, the energy, to prop them up with bailouts, or deconstruct them through bankruptcy. But must it take disasters to generate the energy necessary to turn the corporate beasts around?

Is the ‘beast’ analogy too extreme? A popular alternative compares organizational restructuring to changing the course of an ocean liner  – it takes time to overcome the inertia. But viewing the CEO as captain of a ship who simply turns the rudder is not only too simplistic it’s also too optimistic.

To account for this pervasive resistance to change we might better view GM’s dysfunctional organizational behavior as a systemic addiction. They can’t kick the habit. At best corporations make well-intentioned incremental changes. But, like other addicts before actually changing course they usually have to hit bottom. Frequently it takes bankruptcy to generate the external energy required to achieve radical restructuring, and to wash away the sins of the fathers – corporate myths, habits, unsustainable benefits.

A model is useful to the degree that it’s simpler than but similar to the ‘reality’ that’s being modeled. While the ocean liner model was too simple and optimistic, the addiction analogy is too simplistic and pessimistic.

At the very least we need a model that helps explain why with so much high-priced corporate brainpower running the show we must rely on exorbitant bailouts and devastating bankruptcies to restructure dysfunctional corporations and their dependent networks?

We turn to the fountainhead of powerful models for understanding both the stability and plasticity of complex systems – we turn to physics.

Physics to the rescue? We find a promising model that helps account not only for the stability and resistance to change of complex systems, but also helps explain under what conditions significant changes can occur. It’s not a billiard ball model borrowed from the relatively orderly world of classical physics, but rather from the dynamic domain of quantum mechanics.

With apologies we borrow the isomeric model which describes how different combinations of the same atoms can lead to very different molecules – molecules with different physical and chemical characteristics, different ‘energy’ levels. Also, the larger the molecule the more alternative configurations are possible – the more atoms, the more combinations and permutations – therefore, the more complex the system. We can add to the complexity by adding additional atoms and linked networks of molecules.

So we’re drawing an analogy between isomeric systems and corporations. Obviously the same group of people can be combined in different ways to yield various kinds of organizations demonstrating different energy levels and survival rates. The fascinating, and for our purposes, the most relevant characteristic about isomeric systems concerns the amount of energy required to move atoms from one location to another. It is like a solar system with the atoms behaving like planets cycling comfortably and securely around their particular gravitational orbit. To change location requires not only escape energy to overcome the gravitational pull of it’s current orbit, but also enough to overshoot the new orbit before the atom gradually settles back down into that higher rotation. Unless it has overshoot energy the atom gravitates comfortably back into its original location.

The main point to bring back from this little thought experiment concerns the astonishing amount of energy required to change complex systems. First, notice the energy required to move one person – one atom – into a different position in the organizational configuration – to escape the gravitation pull of their old job and the network of adjacent expectations, plus enough overshoot energy so they enjoy sufficient support and time to gradually settle into the new position.

Notice too the extra energy that must often be expended by others throughout the system who are affected by that one move. Now multiply that by the energy required to move many people and procedures to new configurations within the same organization. Now multiply that by the additional energy required to move more people and procedures to new configurations in linked or networked organizations – banks, suppliers, dealers, customers, government agencies.

If, as we are suggesting, CEOs lack the ability to map and manage the future, and/or lack access to the surplus energy required to deconstruct and reconstruct dysfunctional corporations, then pray tell how so many not only survive, but also thrive and retire very, very rich?

Catching and creating rising tides. One obvious explanation is that some are lucky enough to catch a rising tide and like Toyota and Honda, without burdensome baggage, ride it oh so successfully. Others create a rising tide like Microsoft and Google – is Microsoft showing signs of a bit of corporate arthritis? But market tides rise and fall. We need an explanation that accounts for the prevailing ‘success’ of so many CEOs even when they lose market share, when their stock value and profits fall.

We’ve come full circle. If they can’t map and manage the actual future, and they can’t catch or create a rising tide, then ‘successful’ CEOs of global corporations reconstruct positive pasts and promising future. If they can’t manage the future they manage our beliefs about that uncertain future.  In fact the artificial networks of certainty they create are so stable and resilient that the CEOs who built and/or ‘manage’ them can’t restructure them – can’t turn the beast around.

So When Should We Fire the CEO?

Not simple.

1)    It’s difficult to determine when a rising tide is temporarily dipping or actually falling. By the time we find out that it’s really tanked most CEOs have flown off into the golden sunset.

2)    Again, by the time we decide the CEOs construction was impotent, or a Frankenstein monster, firing him or her is a no brainer.

3)    Yes, common sense says that prudent CEOs should establish ‘adequate’ reserves – should save for a rainy day. But that’s one of those ‘after-the-fact’ wisdoms. How can you put good money to rot in a sock when there are so many golden opportunities, competitive necessities, crises and dividend hungry shareholders? Anyway, everybody knows that if you want to be successful you’ve got to take risks. That’s what’s made America great – its entrepreneurial spirit! A view strongly taken by that august institution The Economist, in the May 30th – June 5th 2009 edition referring to it as that “gung-ho spirit of enterprise”.

4)    Furthermore, the CEOs aren’t the only ones who fail to save for a rainy day. Look in the mirror. Come to think of it where do you find a safe sock these days – bonds, real estate?

After-the-fact solutions: Following the recent meltdown there are of course a flood of after-the-fact rational analyses – which is the only time rational analysis seems to work. Anyway such postmortems yield a variety of ‘solutions’ including additional government controls on corporate behavior and executive compensation. But be careful, we don’t want to kill the goose that presumably lays the golden eggs – stimulates economic growth, provides employment, pays taxes, and most important helps millions of uncertain people – like you and me – decide what to do next – including directors, employees, bankers, suppliers, dealers, customers and those in government agencies.

Sharholder activism. There are renewed signs of shareholder activism, for instance demanding a direct say on executive compensation. How will shareholders fare when pitted against the CEO’s contagious confidence backed up by their cheer leaders – their selected board of directors, their carefully constructed network of dependent and deferential supporters?

If conscientious CEOs have trouble generating the massive energy necessary to reconstruct their own organization, how can we expect a loose collection of shareholders to do it? Even major shareholders have trouble making an impact. Even when they do get a foot in the door it typically results in minor incremental changes – rearranging a couple of atoms. Even if they succeed in unloading the CEO, they must replace him or her with another who can’t read the future so must create it while managing the awesome complexity of the corporate network of expectations.

Of course shareholders have the power to sell and walk. But where? On which other artificial islands should they build their hopes? Berkshire-Hathaway?  Microsoft? Apple? Google, Yahoo, the small town bank? Or, what about that little garage down the street? There are a couple of college dropouts claiming to have a breakthrough on cold fusion – cheap, safe energy – enough to construct and reconstruct any and all systems we ever need.  And all it requires is just the right combination of Perrier Water and lightening. They’re working on the details.

Notice too that large organizations, whether public or private, whether Wall Street or Main Street, increasingly rely on spin – money can always be found for lobbyists, public relations experts and lawyers – all growth industries, all ‘experts’ in shaping our beliefs about the uncertain future?

We seem to be having trouble answering the question: when should we fire the CEO?

Finally, we propose that in the face of serial uncertainty we desperately need people possessing contagious confidence. Therefore, we reluctantly conclude that in most cases, short of blatant and clumsy fraud, or economic collapse, it will continue to be the CEOs who decide when to depart, and how much to take with them. As Mr. Lafley said, it took a crisis of confidence for P&G to pull the trigger.

And what do we do with the obsolete network of artificial islands of uncertainty they often leave behind?

We can hire a new CEO, a new, expensive purveyor of contagious confidence. Or we can try to keep the sinking islands afloat with bailouts. Or we can blast them apart with bankruptcy – our economic atom smasher.

Right now bailouts and bankruptcy seem to be the flavors of the day.

But we’ve faced tough times before. And leaders glowing with contagious confidence emerge – Roosevelt, Churchill, Gandhi, Reagan, Mandela and Obama – around whom massive amounts of hope, energy and ingenuity gravitate. And low and behold we build new and resilient bridges of certainty into the fuzzy future.

Selected Bibliography

A. G. Lafley took over P&G in 2000 blaming failed attempts at restructuring resulting in “a crises of confidence.” (Harvard Business Review, May 2009.)  He too was replaced as CEO during the recent global crises of confidence.

In spite of years of attempting to radically restructure itself GM finally encountered their crises of confidence. Jerry Flint (Forbes.com 3/30/09) acknowledges that given GM’s history of failure CEO Wagoner had to go, but wonders if his replacement will be any better – hopefully ‘not a another boring finance-guy.’  Flint believes they need a spirited car-guy. But notice it’s not that executives don’t recognize that restructuring is difficult. Way back in 1988 a GM executive named Elmer Johnson said “We have vastly underestimated how deeply ingrained are the organizational and cultural rigidities that hamper our ability to execute.”(See David Brooks, New York Times, June 1, 2009).

Nevertheless, we propose that executives continue to overestimate their rational capacity to deconstruct those ingrained rigidities. Conventional wisdom presumes that leaders successfully map and manage the future by relying on the rational analyses of facts. Over 30 years ago Herb Simon won a Nobel Prize for challenging this popular rational model by introducing the concept of ‘bounded rationality’, by proposing that we must cut complex problems down to mind size by relying an simplifying and emotionally anchored assumptions, rules of thumb, biases (for a popular presentation see Simon (1983, Reason in Human Affairs, Stanford University Press.) But the ‘rational man’ model lives on despite continuous challenges, for instance see: Agnew & Brown (1982, From skyhooks to walking sticks: On the road to non-rational decision making, Organizational Dynamics, 1982 Autumn; 11(2): 40-58; Kahneman (2003, A perspective on judgment and choice: Mapping bounded rationality. American Psychologist, 58, 697-720). Finkelstein, Whitehead & Campbell (2009, How inappropriate attachments drive good leaders to make bad decisions, Organizational Dynamics 38 (2), pg. 83-92) .For those interested in restructuring and in the isomeric model of stability and change see Erwin Schrödinger (1992, What is life. Cambridge University Press, Chapter 4 and Figure 12.)  This is a delightful read written by a Nobel Prize winning physicist exploring the mysteries of biology – one can read it in a few hours; one will not forget it in a lifetime’ (Scientific American). Also see: Derry, J. F. (2004, Review of What Is Life? by Erwin Schrödinger. Human Nature Review. 4: 124-125) and for more in-depth discussions of the isomeric model, energy transfer and human behavior see Understanding Understanding: Essays on Cybernetics and Cognition by Heinz von Foerster, published by Springer-Verlag 2003 (e.g., pages 160-163).


[1] Copyright 2009

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