RISKY BUSINESS

Are companies confronting more mega-scale crises than
ever before? UPDATE Editor Lari Fanlund posed the question
to School of Business faculty members Dan Anderson, Roger
Formisano and James Seward, and got their take on what
companies should be doing to prepare for when the next
big thing goes wrong.

You’ve got the collapse of Enron and WorldCom, the
devastation of Hurricane Katrina and now the threat
of an avian flu pandemic. What gives?

Dan Anderson: As far as the natural disaster you
mentioned, about 99.9 percent of the scientists in the
world feel the recent spate of hurricanes is related to
global warming. All the global warming models point to
more hurricanes and stronger and more frequent storms.
So, in terms of the long-range crisis that we’ll be dealing with
over the 21st century, I see it as climate change.

Roger Formisano: As far as the next big threat, it’s going to be an 8.1
earthquake hitting California.

Anderson: I have to agree. It could be tomorrow or it could be in 30 years, but it’s going to come, and it will put the impact from Katrina and other natural disasters in the shade. Another problem over the long term is going to be water shortages. There was a report by the United Nations that by 2025 half the people in the world will have water shortages. Close to home, there are all kinds of debates on whether water can be taken out of the Great Lakes basin. Another huge concern is a shortage of oil. If consumption continues at its current rate, we’re going to hit a wall and the shock is going to really rattle financial markets.

On the business side, what do you see as the biggest looming dangers?

James Seward: Two things: soaring health care benefits and unfunded pensions and the ability
of companies to use the bankruptcy process to stick other people with their costs. The only way legacy airlines have been able to get their cost structures down has been by going through bankruptcy. I think we are going to see more of this.

Another ticking time bomb possibly is what all these private equity and hedge funds are doing with businesses they are buying. Often they aren’t operating managers, and they are paying very high prices for these businesses. Any time prices get high, you get nervous. Will they know what to do with these businesses?

Formisano: And then there’s real estate. You hook a real estate bubble with a natural disaster and all of a sudden you have people who thought they had some value built up finding it’s gone.

What’s to blame for “rogue” practices that have brought down huge corporations in recent years?

Seward: I’m reminded of the question, “When do you want to rob a bank?” The answer is, “When the money is in the safe.” When it comes to internal crises caused by misbehavior, it tends to be at firms that have lots of money available, and which need highly specialized skills to run them. That can set the stage for the kind of things that happened at Enron. There’s a great book by Kurt Eichenwald, “Conspiracy of Fools: A True Story,” that looks at Enron. It seems clear that [Enron CFO] Andy Fastow did a lot of very complicated financial things that most people couldn’t understand. It basically came down to him saying: “Trust me.” Many companies today have the opportunity to get into these situations. Fortunately, most companies have people who don’t take advantage.

Formisano: When it comes to the Enrons and WorldComs, those kinds of crises are fairly cyclical. With the implementation of Sarbanes-Oxley, we can hope that for the time being we’ll being seeing fewer self-inflicted wounds.

We have to remember that at the turn of the century we had a whole lot of people called “robber barons.” There’s a reason greed is in the “seven deadly sins” category! There always has been a willingness to push the limits. That creates innovation and new business models and there are many good things about it, but it’s up to leaders to keep things under control. Some firms do it well and, obviously, some do not.

Anderson: One of the most startling facts to me over the last 25-30 years has been the relationship between paid compensation for CEOs vs. the average worker’s. In the United States about 20-25 years ago, the CEO’s pay was around 40 times that of the average worker. Towers-Perrin, the consulting firm, did a study in 2000 and found the ratio had risen to 530—a CEO made 530 times what an average worker made. It’s probably up to 600 times today. Roger and I did a study of insolvent insurance companies and found what often happens is leaders get so addicted to the money that they lose their judgment in managing the firm. So, the fact that we’re dealing with so much money in CEO salaries nowadays may play a role in seeing so many missteps.

Seward: I agree with both of you. There are two things going on. One is externally driven: things like weather, terrorism and macroeconomic events pose one sets of risks that almost all companies face directly or indirectly. Companies must set up strategies to manage risk in order to respond to outside events that affect the company. But as Roger mentioned, there are other things going on inside the company. All the things that happened with WorldCom, Enron and Tyco were purposefully done by people inside the companies. Sarbanes-Oxley came about as a result of misbehavior. These kind of things are cyclical because we react to them; we pass legislation or we throw people in jail. It’s hard to imagine a Sarbanes-Oxley written to prevent hurricanes—who are you going to fine?
Boards of directors are in the bull’s eye. They have to set up policies to police internal behaviors and have policies in place so when things happen outside the firm, they can react to them as well. I think the world is more crisis driven, there’s no doubt about it.

Are there characteristics of firms that tend not to cope well with a crisis?

Formisano: I think there is a little bit of a pattern in that companies that have gotten themselves in trouble, often had a founder who created a tremendous organization, but who has gained too much power. We’re talking about leaders like Bernie Ebbers at WorldCom who closet themselves and stop listening to advice.

Seward: And as we’ve seen on the political front, often the real crisis is caused by attempts to cover up. In the case of Enron, WorldCom and Tyco, there was a set of very poor basic business decisions that were made worse by a factor of 10, 20 or 30 by all the things done to try to cover up. The larger and more complex the company, there are more places where you can pull those kind of shenanigans and hide things.

It seems there are “waves” in industry. The airline industry is in crisis now; the automobile industry is clearly next in the queue. We seem to go through these patterns where entire industries are affected.

What can companies do once they are hit with a crisis?

Anderson: The most important thing is to act fast. Of course, you need to already have a disaster plan in place before a crisis hits. (See page 17.) That said, I think you ought to have the CEO, or at least a very high level spokesperson, address the issue. Somebody in the organization should be identified as being in charge of the overall crisis management response. Another thing I think more American CEOs should consider is apologizing when their company has done something wrong, the way Japanese CEOs do. It’s a basic thing most of us do in our one-on-one relationships—when we make mistakes, we apologize.

The Tylenol tampering case, when Johnson & Johnson pulled all the bottles off shelves, is often cited as an example of crisis management done right.

Anderson: They did what I was just suggesting. They acted right away. It was top management. They didn’t say, “Well, let’s see, let’s just pull the medicine from the south part of Chicago.” Or, “If you used half the pills, we’ll give you half a refund.” All pills were immediately pulled off the shelves and full discounts were given.

Seward: Right. You need to embrace tough decisions in not-so-great circumstances. As to why everyone doesn’t resolve problems the way Johnson & Johnson did with Tylenol, I wonder if it’s because we’ve become a very litigious society.

Formisano: I would agree. A fear of legal repercussions does affect how companies feel they can resolve a crisis.

And what resources are available to help companies prepare for or prevent a crisis?

Anderson: There are many sources of good information: textbooks, insurance companies, management consultants. One of the best sources that is often overlooked is trade associations.

Formisano: In our Center for Leadership and Applied Business in Executive Education, we offer a three-day program on crisis management and public relations that is intended to get people thinking about what they need to do to prepare.

Anderson: Our students are taught in risk and insurance courses things you can do to prevent a disaster, such as making quality products that don’t hurt people. Or, if you are a pharmaceutical company and your early studies show there is a problem with a product, face up to it, rather than trying to hide the bad news.
In class, we talk about trying to cut down on conflicts of interest. The problems Merrill Lynch had with their brokers was a conflict of interest between retail brokerage and investment banking. The conflict at Arthur Andersen was between consulting and auditing.
My favorite overall risk management advice in the area of ethics is, “If you don’t want to read about what you are doing in the morning newspaper, quit doing it.” Just do that test. Ask yourself, “What would happen if this popped up on the front page of The Wall Street Journal? Would it be awful?” We are moving toward a much more open, transparent emphasis-on-disclosure world.
Formisano: Not to make excuses, but it isn’t just in businesses that this kind of misbehavior occurs—nonprofits, government and others have their own scandals. There is all kinds of research that shows that pressure—often financial pressure —leads people to cross the line. The answer, to go back to what Dan said, is, “Do you have a moral compass? At the end of the day, are you doing what’s right?”

RELATED READING

“Corporate Survival:
The Critical Importance
of Sustainability Risk
Management”

By Dan Anderson
iUniverse, Inc./2005
427 pages

This book, by a UW-Madison School of Business professor, and a participant in our UPDATE faculty roundtable on crisis management, deals with crisis situations, including deterioration of natural ecosystems, global warming/climate change, asbestos and Superfund liabilities. It also explores litigation and boycotts brought against corporations and their directors and officers for environmental and social justice abuses.
He analyzes the increased pressures brought on U.S. based multi-national corporations from global competition and regulations, particularly in the European Union and Japan. ”I wanted to provide examples of successful corporate responses to crises,” said Anderson.
In the book, he gives strategies for developing sustainability risk management systems and explores their considerable advantages, which he believes include decreasing risk costs, increasing competitive advantage, improved community image, enhanced reputation, and increased profitability and stock performance.

“The Resilient Enterprise”
By Yossi Sheffi
The MIT Press/2005
338 pages

“The Resilient Enterprise” looks at dozens of case studies of business crises—famous and not-so-famous—by a professor of engineering systems at MIT. It also examines ways companies prepare for trouble. For example, Wall Street firms, taking a lesson from 9-11, have increased redundancy in their recordkeeping by creating multiple data centers. Fed Ex, we are told, keeps two empty planes in the air at all times to fill in whenever and wherever one of its planes is grounded.
The Wall Street Journal’s George Anders sums up the book’s message this way:

“Crisis control can be a competitive advantage for companies that get it right. Wise planning at headquarters is part of the answer, but only part: Companies need a whole culture of flexibility. It is impossible to know where trouble will hit next, but it is possible to create an atmosphere in which people at all levels respond to disruptions quickly and confidently.“