By William K. Black
July 10, 2018 Bloomington, MN
Economists generally focus on increasing productivity as the driver of development. Among the most troubling economic developments in the West in the last decade is the weak gains in productivity, particularly in a time of rapid technological advances. Neoclassical economics pictures firms as engaged in a fierce, endless battle for survival where failure is certain for firms that are even slightly less efficient that their rivals. This struggle is supposed to produce relentless, rapid advances in productivity. Something has gone very wrong with the neoclassical narrative of competition, productivity, and growth.
Weak productivity and efficiency is supposed to remedy itself. The neoclassical (and Austrian) economics claim is that it creates a profit opportunity for entrepreneurs to enter who either will run a more productive firm or serve as consultant to explain to existing firms’ CEOs the secret of improving efficiency. This series of articles focuses on one of these supposed examples of Austrian “spontaneous order” – executive coaching.
The term ‘executive coaching’ is supposed to serve as a description and as a metaphor. As a metaphor, it removes the shame element of needing a coach to improve one’s performance as a manager. The best athletes in the world all have coaches.
Executive coaches are still ‘hot,’ but they were one of the ‘big’ new ideas in management around the turn of century and millennium. This prompted two articles in the Harvard Business Review about executive coaching. Those articles, unintentionally, revealed a great deal about the twin competence and integrity crises in elite business leaders that had just become obvious in the Enron-era frauds. One of the most revealing facts was how blind the most prestigious ‘executive coaches’ were to those twin crises.
As I have explained in prior posts, the creation of ‘modern executive compensation’ has proven catastrophic, principally because of its perverse effects on CEO behavior. Modern executive compensation created both a criminogenic environment encouraging CEOs to use their seemingly legitimate firms as ‘weapons’ to defraud and predate on customers and the government, but also created powerful, perverse incentives to run the firm in a manner harmful to its long term viability. Indeed, Michael Jensen, the intellectual ‘father’ of modern executive compensation and other researchers, warn that three-quarters of CFOs admit that they would manipulate income and expense recognition to boost current reported profits even if they knew it would harm long-term profitability. Modern executive and professional compensation also provides the CEO with a means to ‘loot’ the firm with near impunity and to ‘signal’ to other officers, employees, and external ‘controls’ (auditors, appraisers, attorneys, and credit rating agencies) that the CEO will reward them if they act to aid the fraud and predation. The CEO can send this ‘signal via compensation’ in an implicit manner that removes the need to discuss or promise the quid pro quo that can send you to prison. The CEO can also generate a “Gresham’s” dynamic by punishing honest professionals and controls. In a Gresham’s dynamic bad ethics drives good ethics from the markets and professions because the unethical gain a market advantage.
A deeply unethical CEO however, will never hire a prospective ‘executive coach’ who signals that he understands the perverse incentives and CEO fraud and predation schemes. The firms that CEOs use for fraud and predation most need executive coaching, but they will not get effective executive coaching. Executive coaches are blind to this fact. (The most competent are willfully blind.) Their vainglorious claims emphasize their brave candor in dealing with their clients. However, they never give examples of taking on a CEO’s corrupt culture that creates widespread fraud, predation, or sexual harassment.
The real world fact that I set out above about more than three-quarters of CFOs admitting that they would manipulate accounting in a manner that they knew would harm the firm’s (and shareholders) long-term value in order to ‘smooth’ earnings. No CEO or CFO puts that in writing. They say the opposite in writing and public speaking about the firm’s policies. Jensen, correctly, insists that we call this “lying.” How did such an extraordinary percentage of CFOs come to lie and harm the firm – contrary to the written, explicit (Potemkin) creed set by the CEO? The answer is that almost everyone knows that the typical CEO’s formal policy is not the real policy that the typical CEO wants.
What is the executive coach for the CFO supposed to coach the typical CFO to do? Violate the CEO’s actual policies by following the Potemkin policies that the CEO had the General Counsel craft to help deceive investors? I have never heard of an executive coach doing so. I have never read an account by an executive coach purporting that they gave such ethical advice – much less advised the CFO that she should blow the whistle on the CEO to the board of directors and the SEC. I have never read any executive coach encouraging whistleblowing. That too happens for a reason – over three-quarters of CEOs would not hire them if they ever encouraged an executive to blow the whistle on possible accounting fraud (implicitly) encouraged by the CEO. This means that the firms that most desperately need executive coaching of integrity will not hire coaches with a record of the highest integrity.
The next installment in this series of articles about executive coaches will present in more detail another example of our family rule that “it is impossible to compete with unintentional self-parody.” The context is the claim, which so many executive coaches’ websites chant like a mantra even today, about the extraordinary success of coaching.
A particularly weak Psychology Today article (November 1, 2002) on executive coaching made this mantra famous among executive coaches.
Both coaches and the companies that snap them up are fueled by the bottom line. Employees at Nortel Networks estimate that coaching earned the company a 529 percent “return on investment and significant intangible benefits to the business,” according to calculations prepared by Merrill C. Anderson, a professor of clinical education at Drake University.
Wow! A 529 percent “return on investment” (ROI) plus “significant intangible benefits.” Coaching must have turned Nortel into an unstoppable juggernaut. The astonishing precision of being able to calculate a “529” percent return on something as amorphous as executive coaching is miraculous. It is such a vast return that all Western nations needed to avoid their productivity crash was to sign up every C-suite officer for executive coaching.
This should cause us to ask why Western firms have not become super-profitable and super-efficient since late 2002 when Psychology Today alerted them to Professor Anderson’s astonishing “calculations” (which he made public on November 2, 2001). Actually, he did not make public only the results, not the calculations, but oh those results! The supposed ROI was just as ‘precise’ but far larger than the Psychology Today article reported a year later.
Including the financial benefits from employee retention boosted the overall ROI to 788%.
If you know Canadian business, you already know where the self-parody comes in. Anderson had some spectacularly bad timing. His supposed astonishing return on investment occurred during the dot-com bubble – and Nortel was one of the world’s largest tech firms. Almost exactly a week after he published his (non) ‘calculations,’ Enron announced it had overstated its profits by over $600 million (that too would prove a lie, the true loss was far larger) – beginning the disclosure of the Enron-era frauds.
Anderson’s timing (and choice of subject) with regard to Nortel was also unfortunate, particularly his claim about “employee retention.” The SEC, in announcing Nortel’s agreement to settle the SEC’s complaint of widespread securities fraud by Nortel, stated:
According to the Commission’s complaint, from late 2000 through January 2001, Nortel made changes to its revenue recognition policies that were not in conformity with U.S. Generally Accepted Accounting Principles (GAAP). The changes were made to fraudulently accelerate revenue into 2000 to meet its publicly announced revenue targets for the fourth quarter of 2000 and for that year. The complaint alleges that Nortel also selectively reversed certain revenue entries during the 2000 year-end closing process when its acceleration efforts pulled in more revenue than necessary to meet its targets. These actions, the complaint alleges, inflated Nortel’s fourth quarter and fiscal year 2000 revenues by approximately $1.4 billion.
Nortel’s supposed extraordinary ROI from executive coaching was the product of a massive bubble and what the SEC investigators found to be widespread accounting fraud.
“Employee retention” was an oxymoron at Nortel. Here are some excerpts from Nortel’s timeline before and shortly after Anderson’s homage to Nortel’s supposed gains in employee retention.
Jan. 18, 2001
Nortel posts fourth quarter results on par with Wall Street expectations. Nortel earned $825 million on revenue of $8.82 billion, compared to earnings for $697 million on revenue of $6.57 billion in the fourth quarter of 1999. Full year revenue hit $30.38 billion, up 42 percent from $21.29 billion in 1999. Nortel enjoys success, its employee count hits 93,500.
Despite projecting 30 percent growth in 2001, Nortel cuts its earnings and sales forecast in half, citing the weak U.S. economy. That warning is a catalyst for a 33-percent drop in Nortel’s stock and triggers a number of class action lawsuits.
Oct. 2, 2001
Nortel Networks announces CFO Frank Dunn will replace John Roth as president and CEO. Nortel also announces adjusted earnings projections, adding that it would further restructure and reduce head count by another 20,000 in the quarter.
Oct. 18, 2001
Nortel posts a $3.5 billion loss in the third quarter.
Jan 18, 2002
Nortel suffers another steep fourth quarter slide in sales, reporting fourth-quarter revenue from continuing operations of $3.46 billion, down 58 percent from $8.2 billion in the same period a year before. The company posted a loss of $1.83 billion, compared with a loss of $1.41 billion in the same quarter a year prior. The company says it expects to return to profitability in the fourth quarter of 2002.
Feb 11, 2002
Nortel Chief Financial Officer, Terry Hungle, resigns after buying and selling company stock within his retirement plan in violation of company policy.
May 29, 2002
Nortel announces plans to cut 3,500 jobs and says it may sell its optical-components business as it revamps its operations to save money.
June 4, 2002
Nortel shares drop to new lows on concerns a new financing will further dilute its stock.
Sept. 3, 2003
Nortel’s employee numbers hit 35,500, a massive dip from the nearly 95,000 just two and a half years prior.
In the next installment, I explain that Nortel’s management was a cesspool of incompetence and lacked integrity. As the reader has probably guessed by now, Nortel’s senior managers and the perverse incentives that dominate so much of the Western world destroyed Nortel – Canada’s technological gem that had existed for over a century. They destroyed about (U.S.) $250 billion in (claimed) peak shareholder value and about 90,000 jobs – and the CEO that began the destruction was named Canada’s CEO of the Year in the year he helped doom the company and its employees’ jobs.
Anderson’s ‘calculations’ about Nortel’s supposed miraculous ROI improvement were obviously farcical to anyone sentient in 2001 when he made them, but “executive coach” web sites continue to quote his “529 percent” claim today. (They are too lazy to have looked up his paper on the web or they would be claiming “788 percent.”) The purpose of their websites is to convince firms to shell out tens of thousands of dollars to them because of their combination of business and psychological acumen – and they are so clueless that they are citing Nortel as their greatest success story for executive coaching. They are obviously still in business, so senior officers at business firms are so clueless that they are paying tens of thousands of dollars in fees to coaches who demonstrate on their own web sites that they are clueless.
Ponder what one has to believe about the staggering, endemic incompetence of Western corporate officers if paying tens of thousands of dollars to these clueless coaches actually had an ROI of nearly 8:1. If the executive coaches and the senior officers of the firms that hire them were right about the spectacular returns achievable by hiring even clowns as coaches, hiring competent coaches of integrity would transform Western firms and magically restore productivity and growth. To believe that, however, these senior corporate officers and executive coaches would have to know that existing managers are commonly pathetic and that neoclassical economic theory was nonsense.
It is amazing how capitalism as practiced these days is destroying the very corporations that are supposed to be the backbones of the system.
If the CEOs won’t destroy their publicly traded companies, the vulture capitalists will take them private to plunder them even more rapidly.
Having been born and raised in the mid-1900’s I have become accustomed to the term “turn of the century” relating to the beginning of the 20th century (1901 etc). So it came as a shock that your use of this term referred to the more recent of these events. Can I suggest that it may be more reasonable to refer to this event as “turn of the millenium” and thus prevent any confusion to your more mature audience. But otherwise, what a great article, thank you!
Love this article. So sick of hearing the airy fairy tales about the economy when in the real world things are going in the tank and in fact even getting more decriminalized… the idea that we have given up our rights to information and trial by jury are the signs of a dying economy….
What a wonderful piece. Thanks for that from this Bytowner (Ottawan).
“…This should cause us to ask why Western firms have not become super-profitable and super-efficient since late 2002 …”
Not surprising that the perverse incentives driven C suit denizens are missing the profit boat. Looting their corporations means skimping on investment. Minsky: investment (becomes) is profits. To be profitable, they need to invest, not loot.
I do hope that these big corporations are allowing the cost of making their products to be fairly shared among those who actually produce them. Otherwise, with less and less balance between labor and management, there will soon be no demand for highly priced goods of diminishing production until a point is reached where business management is all about getting a few mechanical tools to produce nothing that is affordable or worthwhile owning.
My favorites are Jack Welch(LinkedIn) and Jeffrey Immelt both CEO’s of GE who beggared the company to feather their own nests.