I am not an academic, which I believe almost everyone knows. My perspective is simply one of a practicing manager that graduated with a business degree from Babson College way back in 1975. I also picked up a master’s degree in public, not business administration, more than twenty years ago.
My colleagues on the Global Foundation for Management Education Board are all very accomplished business academicians. They know what they are writing about and I was happy to see them volunteer to write their thoughts on the financial crisis and expectations for management education. Naturally, not being an academician, I thought I was exempt from this assignment. Not so, I learned last month while visiting my friend Dave Wilson at GMAC’s offices in Northern Virginia. It was only during our discussion concerning the work of the Global Foundation for Management Education that I learned from our Vice President and Chief Knowledge Officer, Dan LeClair, that I, too, was expected to write down my thoughts on the financial crisis and potential impacts on management education. Okay, my friends, so here they are! Bear with me, it's a long story.
I started my career in June, 1975 as an internal auditor with Exxon Company, USA, in Baltimore, Maryland. Our field unit was responsible for the internal auditing of the Eastern Region of the US, which contained primarily marketing and distribution operations. It didn’t take very long to learn that managers may try to cheat in their operations and financial performance and reporting, and that good internal auditors often catch them. My first fraud was pretty simple. Retail store managers would charge for labor associated with automobile repairs, but when the daily books were done, sly managers would sometimes report significantly less labor revenue than was charged to the customer. Retail managers who practiced this deceit, and there were more back then than the company would likely want the world to know, would say that they were just covering shortages in inventorial parts. But the truth was, they were also keeping some for themselves. When we found an overly gluttonous manager at one of the Baltimore retail stores, corporate security got involved and, well, that gentlemen went to jail. He said he needed the money for a surgical procedure for a family member. There is always a reason.
While this early career introduction to financial manipulation for personal gain might seem trivial, it served a lesson to me that has lasted and has been regularly reinforced for the past thirty-five years. There were many more types of mini-frauds in the oil giant’s field operations, and I daresay, Exxon USA was managed very carefully and with extensive internal controls. Most likely, it was that environment that helped uncover wrong doing before it got out of hand. Yet later on in the 1970’s Esso Italia was caught being a little too financially friendly to Italian government officials with unrecorded company funds. Internal auditors at Esso Europe had pointed out that funds weren’t accounted for, but Esso’s Italian managers assured senior management it was just a simple mistake. The mistake was that Exxon waited too long to clean up the "mistake", and as a result, Exxon Corporation had to file a consent decree with the SEC. Many other corporations had made illegal or questionable payments to foreign governments totalling an estimated US $300 million.
Shortly thereafter the Foreign Corrupt Practices Act of 1977 became law, a law that applied to all US companies and their affiliates no matter where they operated. The FCPA said among other things, "no more bribes to foreign government officers" and that, "access to assets could only be made in accordance with management authorization". Further, companies under the governance of the Securities and Exchange Commission (SEC) must have proper “internal accounting controls” that were monitored by a review process. These requirements applied to all accounts, not just those held in foreign countries.
Corporate accounting Sheriff Arthur Andersen came up with their innovative Transaction Flow Analysis (TFA) process to meet FCPA requirements and hundreds of companies listened to Sheriff Arthur and implemented their system. We will talk more about Arthur Andersen later on. Now it was thought by many a government and elected official, as well as a cadre of managers, that the FCPA would cure the risk of financial malfeasance and that, certainly, detective processes like TFA would catch any evil doers.
Not too many years later, following the mercurial rise in interest rates in the US, we heard there was trouble in the Savings and Loan industry. Many S&L's had so many bad loans that liquidity was decimated. So called regulatory accounting procedures were a major culprit and the S&L industry was knocked to its knees. The Foreign Corrupt Practices Act had not anticipated the S&L risk and TFA application was insufficient to prevent it. What was believed back in the 1980s was that more regulation was needed. The FCPA was just not enough. So, the US government set up the National Commission on Fraudulent Financial Reporting (The Treadway Commission), nicknamed for its leader. Treadway said, in a nutshell, that poorly trained audit committees and ineffective corporate governance were to blame, in part, for the savings and loan debacle and fraudulent financial reporting. Treadway contended that if these malfunctions were fixed, well, all our worries of potential financial shenanigans would be mitigated. So, many more companies adopted internal audit staffs, audit committees were "trained", and a Committee of Sponsoring Organizations made up of accounting gurus, was formed to develop a new framework for internal controls. The advent of stronger corporate governance, including curricula in business schools emerged. Some schools, like Kennesaw in Atlanta, set up centers for corporate governance. Now, it was believed, we would all be financially safe.
Off we went into the 1990s, confident that we had seen our last major financial blow out. It seems that every ten years or so, a new financial crisis arises and sure enough as the 1990s gave way to the new millennium, SEC Chair Arthur Levitt, (Arthur The Great, in my opinion) began talking about earnings management, "big bath" write offs, and other financial statement manipulations that sounded like financial fraud light. Mr. Levitt was a financial soothsayer as it turned out as earnings management and financial reporting loopholes made way for the great fall from corporate Gibraltar emanating from the sleaze at Enron, WorldCom, Tyco and so many others. These emboldened titans learned how to manipulate their growth and stock position by simply cooking the books in a way that allowed firms like old Sheriff Arthur to simply look the other way. After all, the transactions were in accordance with management’s specific authorizations (FCPA) and the audit committee knew what was going on (Treadway). The lawyers said it was fine; yet these global giants fell to their knees and took all of their investors and employees with them. Some took their own lives or fell victim to the aftermath of these corporate meltdowns. Sheriff Arthur passed away. We should have listened to the other Arthur all along.
For the first time, business schools, perhaps by the prominence of Enron bosses Skilling and Fastow’s alma maters, were called out as potential causes of the financial demise. Many schools rushed to increase and enhance their ethics and governance education curricula and AACSB ratcheted up its accreditation standards. Once again, the always-looking-ahead United States lawmakers crafted yet another massive regulation, the Sarbanes-Oxley Act of 2002. This time, for sure, mighty Sox would prevent any further financial failures or fiscal cavities. The once Big Eight accounting firms were now the Final Four, armed to the teeth with regulations and vast armies of newly trained accountants. Section 404 work was the most expansive attack on financial fraud, as well as the most mind-numbing activity to constrain management risk tolerance ever imagined.
No one would dare to make the wrong decision again. Long live the mighty Sox! Comply or die! One need not worry about risk, now that Sox is in the game.
Sarbanes-Oxley was in a full bloom by 2004 which is right about the time the subprime mortgage market was booming. Lots of loans exceeding asset value were awarded to individuals buying over their heads with the urging of loan grantors who all made tidy profits and personal bonuses. Nothing seemed awry because businesses and economies were growing and after all, we had Sarbanes-Oxley to protect all of us. There would be no more Enron-like Tom Foolery. But Sox was a master at compliance, a look-back system, and the hundreds of millions of dollars spent on compliance each year, didn’t do the job when it came to identifying and managing the emerging risks in the financial services industry.
Just about a year ago, the sky fell, triggered by bad loans and the failure of Leman Brothers. Beginning in the US, and then travelling at the speed of light throughout the world, investors lost their appetite for risk and the world plunged into deep recession. In my lifetime, I had never seen the US as close to a depression as we were in late 2008. While we may all speculate on what saved us from financial abyss, I believe that bail outs at least said to the world, "enough is enough. We are going to do something about this." And the world settled down little by little. While I do not want to imply that the world economy is out of the woods in late 2009, I think we have stared down the barrel of financial ruin, and we have survived...at least for now.
The lesson I have learned these past thirty-five years is that every so often, we will face financial threats that will be so invasive they will injure world economic well being. Most of these will be caused by the desire to make more money. While 2008 may have been the biggest financial crisis in my lifetime, much worse could happen if we don’t do two simple things that are so hard to adopt universally. First, we must teach managers to anticipate and manage risks in advance of their occurrences. Managing information swiftly, efficiently and with good intentions is a must. Second, we must eliminate excessive compensation for short term performance. It brings out the worst in human behavior. The implications for management education are continued better ethics and governance education, greatly enhanced risk management curricula, learning goals and assessment techniques, and business curricula and learning goals designed to produce individuals with skills and preferences toward achieving sustained organizational performance and global societal well being. Through international business school alliances and global initiatives to improve the quality of management education, business schools might just be one of the major contributors to enhanced quality of life throughout the world.
Better education, not more regulation, is the key to global prosperity.