SDA Professor of Strategic and Entrepreneurial Management
Are you happy with how things are going in society, politics and business?
The 2013 Edelman Trust Barometer is at a historical low and indicates that times demand that leaders should behave differently. Take the financial services industry as an example: The global economic decline and the liquidity crisis are often dated to various events, including when BNP Paribas terminated withdrawals from three hedge funds (2007), the U.S. subprime mortgage crisis and the bursting of the U.S. housing bubble, the plummeting of the values of securities tied to U.S. real estate pricing, and the overall damage of financial institutions globally
The reasons for the crisis were manifold: excessive financial leverage (including the use of off-the-balance-sheet financial vehicles), ill-considered acquisitions, diversification based on dubious synergies, flawed risk management and governance systems, as well as problems of vertical and horizontal coordination along the wider banking value network. The economic side effects cascaded globally, impacting the European sovereign debt crisis, which created high levels of household debt, trade imbalances, and record-high unemployment, thus imposing severe austerity measures. In the financial industry, many banks have lost more than 90% of their share price, scores of banks were foreclosed, and of those that survived, many have yet to fully recover.
The 2007-8 global financial crisis illustrates not just the technical difficulties of modelling risk, but it also raises the question of whether such risks may be inherently un-modelable. It appears that commerce and management policies that were guided by short-term profitability objectives have led to the development of ever more complex, opaque and difficult to evaluate financial systems and banking instruments. The problem of risk measurement turned into a problem of risk mismanagement. The speed with which trading in ‘toxic assets’ brought the interbank lending market to a standstill revealed the inadequacy of ex post volatility as a proxy for ex ante volatility, and also a basic truth: as conditions change, the future is often different from the past.
The financial crisis as well as the sovereign debt crisis have shown that firms need to create more robust business models. However, it seems that the task of developing resilience—a firm’s ability to adapt, endure, quickly bounce back, and then thrive despite a catastrophic event—appears on most managers’ strategic issue list only after a shock has occurred. It is like restarting with the back exercises your doctor has prescribed you after you had another acute lumbago problem. For how long will you do the exercises this time? Most likely until you forget the pain and your physiotherapist is not controlling you anymore.
Many managers seem to have forgotten the pain the financial services crisis caused to banks, investors, clients and the economic and social system at large. Of the 20 largest US bankruptcies in the past 2 decades, 10 occurred in the last 2 years. As a consequence, regulators are forcing banks to reduce their financial leverage, limit bonuses and link them to long-term results. This is a good start. But without the willingness of bank executives to manage their businesses in a more responsible way, they will always find ways to return to old schemes – and there is evidence supports that this is already happening.
We need a public debate about responsible leadership – and not just in banking – that includes issues of maintaining personal and professional integrity, building public trust, and ensuring that ethical standards are respected. Responsible leaders create resilient firms. They have started to go back to old business practices and as a consequence some of them have also reached again higher profitability levels. Similar to big global social issues we need some brave managers and their stakeholders to renounce to higher levels of short-term profitability for the sake of increased resilience and persistent superior performance.