Spero Consulting

Anal­o­gously: The Gangs That Can’t Shoot Straight

Last week in The Under­state­ment of the Year! we wrote, “The prob­lem, dear reader, is that few senior man­agers (and almost no board members) understand the val­u­a­tion and risk mod­els used for securitizations…”

Today, there is an arti­cle in The Wall Street Jour­nal, Citi Direc­tors Mull Replac­ing Chair­man, that pro­vides addi­tional evi­dence to sup­port our claim.

To be frank, unless it is we, we don’t really care who Citi selects as a chair­man, and we doubt that you do, also.

We’re more inter­ested in the way that the article’s writ­ers describe board mem­ber Richard Par­sons as “one of the few Cit­i­group direc­tors with expe­ri­ence in finan­cial services.”

One of the largest finan­cial ser­vice firms in the world, and only a few direc­tors with (any type of) finan­cial ser­vice expe­ri­ence. How could they lose? we ask sar­cas­ti­cally. There is a mul­ti­tude of types of expe­ri­ence with finan­cial ser­vices firms; so, we’d argue that while such expe­ri­ence is nec­es­sary, it is by no means suf­fi­cient to under­stand and eval­u­ate com­pli­cated prod­ucts, hedges, strate­gies, and risks.

To be faced with such inex­pe­ri­ence, it must be the case that either senior man­agers are par­tic­u­larly poor judges of tal­ent or those inex­pe­ri­enced direc­tors were nom­i­nated specif­i­cally because they lacked expe­ri­ence or despite their lack of experience. 

The for­mer rea­son for pur­posely select­ing the inex­pe­ri­enced is clearly cyn­i­cal and involves senior man­age­ment attempt­ing to nom­i­nate mem­bers who are much more likely to be weak and unable to pro­vide the req­ui­site level of oversight.

The lat­ter rea­son may or may not be cyn­i­cal. For exam­ple, an unknowl­edge­able direc­tor may have been cho­sen because he or she is par­tic­u­larly savvy and a fast learner (not cyn­i­cal) or because he or she has a mem­ber­ship at Augusta or Oak­mont or some other exclu­sive golf club where senior man­agers might like to play (very cynical).

Now, we’re will­ing to stip­u­late that in many mar­ket and eco­nomic set­tings, it may not seem to mat­ter. In fact, it is pos­si­ble in the over­whelm­ing major­ity of the cases that it doesn’t seem to mat­ter, but that doesn’t mean that such nom­i­na­tions are indeed consequence-​free.

For such cases, we like the anal­ogy of a cop who is a par­tic­u­larly bad shot. That fact is almost never directly rel­e­vant as law enforce­ment offi­cers rarely draw their weapons and fire. So, it may seem that it doesn’t matter.

Unfor­tu­nately, the self-​aware offi­cer real­izes that he or she is a poor shot and acknowl­edges his or her inabil­ity to respond effec­tively to extreme sit­u­a­tions. This knowl­edge likely col­ors or influ­ences his or her behav­ior in all set­tings, includ­ing inci­dents where only a very small prob­a­bil­ity of esca­la­tion exists. 

Such behav­ior is usu­ally cor­rectly inter­preted by the other rel­e­vant par­ties as weak­ness. How­ever, in some cases the officer’s may over-​react or behave in an extremely risk-​averse man­ner due to his or her per­sonal inse­cu­rity. Regard­less, in both cases, the officer’s and society’s well-​being has been compromised.

It is much the same with gov­er­nance and risk man­age­ment within firms. Those direc­tors lack­ing ade­quate fire­power are unlikely to deter anti-​social behav­ior; thus, weak boards are more likely to induce exces­sive risk-​taking and increased odds of a dis­as­ter (although that real­iza­tion may not occur). Is that increased prob­a­bil­ity of dis­as­ter worth 18 holes at a world-​famous course? Don’t answer that!