Sunday, December 30, 2007

Mao the management guru

The Economist year-end issue is a delight with its collection of articles on several topics other than economics. This year's issue has articles on, among other things, life in the Dharavi slum, the Koran and the Bible and the state of the Mormons. The piece that caught my eye is the one on Mao Zedong as management guru.

The Economist contends that Mao is the sort of guru that mediocre or non-performing CEOs might want to emulate- after all, not every CEO can aspire to be an Alfred Sloan. Most management books talk about how to emulate the peaks attained by the likes of Sloan. But the run- of- the-mill CEO needs something more practical to survive and prosper. Mao fits the bill.

The four key lessons that "under-performing, overcompensated" CEOs might learn from Mao are:

1. A powerful, mendacious slogan: Mao's slogan was "Serve the people". He hardly lived up to it, says the Economist, but that's not the point- he was able to justify everything he did in relation to an attention-grabbing slogan.

2. Ruthless media manipulation: Promote yourself ruthlessly- it may termed "personality cult" but it " is hard to distinguish from the modern business practice of building brand value."

3. Sacrifice of friends and colleagues: Don't let people stay close to you for too long- they may want your job. Also, do not hesitate to blame failures on others and get rid of them. Mao practised this dictum faithfully- and this is what sensible superiors at investment banks do after a bad quarterly result.

4. Activity substituting for achievement: Think big and keep coming up with plans and initiatives- they may flounder in the long run but you will be gone by them.

How true is the above description of Mao? It is true but it not the whole truth. Mao may have been a bad leader once he came to power but he was capable of sacrifice, heroism and genuine achievement on the way to the top- the Long March was not a delusion and he did succeed in toppling a discredited regime. His early achievements were also not inconsiderable- land reforms, for instance.

It is the record of substantial achievement with an element of personal sacrifice, however collosal the failures, that must explain why Mao has a standing in China today that Stalin lacks in Russia. Stalin too faithfully acted on the four lessons but he is a reviled figure in Russia today. He was not bereft of achievement- his successful defence of the Soviet Union against Hitler, for instance. But he lacked a comparable record of sacrifice- he is seen merely as a grabber and wielder of power.

That said, the Economist's lessons certainly hold true for non-performing CEOs in the corporate world. An individual may have earned the CEO's job or may have hacked his way to the top. But, once there, he can get away with non-performance and worse if he faithfully sticks to the four lessons. Sloganeering, projection in the media and creating an illusion of results are undoubtedly useful in making one's stay at the top productive- for oneself.

Friday, December 28, 2007

Ethics or self-interest?

Tarun Das of CII has a piece in today's TOI in response to Swaminathan Aiyar's column earlier in the month. Aiyar had faulted the Tatas for their pusillanimity in not favouring hostile takeovers - the context was Rata Tata's comments about not wanting to force a deal on Orient Express Hotels, the international hotel group in which the Tatas have a minority stake. The management of Orient Express had stirred up a controversy with what are believed to be racist comments about the desirability of having an Indian group as owner for an international hotel brand.

Das takes Aiyar to task for not appreciating that Indian business groups are driven by values , not just commercial goals.

On the business and commercial side, Tatas follow the practice of negotiated mutually acceptable acquisitions and mergers. They have said it repeatedly that hostile takeovers are not their policy for growth and expansion. This is a value system of the group, which earns it respect, not hostility. Therefore, Aiyar’s opinion that these values and traditions be dropped is unfortunate. This is not what Indian industry should be known for. In fact, his advice leads one to think of trying to evolve an informal code to be followed by Indian corporations with regard to mergers and acquisitions, the cornerstone of which should be: No hostile takeovers.

........Business is not only about accumulating wealth and glory. It is not about growth for the sake of size. It is about being a good corporate citizen. This is the model to follow for corporate India. Orient Express may come and go, but the Tatas will go on forever. So, too, will responsible Indian companies.
Das protests too much, methinks. Hostile takeovers are a means of getting rid of inefficient management and creating value for shareholders. Management will want to hang on to companies for their own reaons which may not be in the interests of shareholders. Hostile takeovers and the market for corporate control are an excellent cleansing mechanism.

Now, there may commercial reasons why the Tatas or any business group may not want to go down the hostile takeover route in a given reason- they may think, for instance, that they will generate too much ill- will in a given community or they may not have the cooperation of senior managers. But to tout opposition to hostile takeovers as a 'value' is a bit thick.

I don't think a company or a business group is at all being a 'bad corporate citizen' by using hostile takeovers- it is making an important contribution to the efficient utilisation of society's assets. Students of corporate finance would take this as a given.

Das's outburst and his suggestion that the Indian corporate sector should adopt a code against hostile takeovers makes me wonder: is it about values or about protecting Indian business groups? After all, if the Tatas use hostile takeovers today, they and other business groups cannot oppose such takeovers aimed at them tomorrow.

Room for optimism about the world economy

I know I'm sticking my neck out on this but I do believe that the world economy will ride out the present storm, bruised but not knocked out. I believe central bank intervention combined with fiscal policy will help limit the damge of the sub-prime crisis.

The critical problem today is banks' unwillingness to lend to each other because no bank is sure how badly damaged the other guy is. They will know pretty soon- once the first and second quarter results are in and the losses are accounted for. After that, things should be more normal in the banking sector and for the world economy. Remember, there is no generalised threat to world economies (of the sort posed by, say, a huge oil shock). There is a downturn in the US caused by factors specific to the US economy. That is part of the reason the impact on the world economy, I believe, will be limited.

See my relatively bullish views in the ET, Cheer up, the outlook is not so bad.

Wednesday, December 26, 2007

The Chinese are a-coming!

Am back from a longish trip, hence this gap in my blog writing.

Bear Stearns, Citigroup, UBS, Morgan Stanley.... the list of American firms offering equity stakes to Chinese and Asian firms is growing. Another troubled firm, Merrill Lynch, is getting an infusion from Temasek, the Singapore investment firm.

What does this mean? First, large overseas investors clearly think that the world's investment banks, although in trouble at the moment, are a good investment bet. The sub-prime crisis will end sooner or later- in my view, sooner rather than later- and banks with a fundamentally sound franchise will bounce back.

Secondly, the absence of hostility towards acquisitions by Chinese or Asian firms in blue-blooded western financial firms is striking. That's clearly because large funds are required- and the Chinese seem to have the filthy stuff. Considering how closed China's own financial market is to foreign firms, it is interesting that Chinese funds are now in a position to breeze into western firms. Remember, they acquired an over 10% stake in Barclays during the year and also a stake in Blackstone, the private equity firm.

We are clearly seeing sovereign wealth funds flex their muscles. They are sitting on assets of around $3 trillion and this is expected to rise to $10 trillion soon. Should India too follow suit? There are a couple of issues that economist Gary Becker has highlighted. One, these funds lack transparency and hence monitoring of performance becomes difficult. Secondly, being goverment-owned, they may not deliver the sort of performance one associates with private sector funds.

Becker thinks the funds should simply return some of the excess they have to their citizens as a national dividend or the government should cut taxes. Individuals will then be left with more surpluses which they will manage more efficiently than sovereign funds will manage theirs.

I am not sure about the second proposition, that government ownership is necessarily inimial to efficient fund management- UTI Mutual Fund has done pretty well in recent years. Lack of transparency is the real issue. In India, we do have excess forex reserves but nowhere near what China has. These excess reserves are better spent on developing infrastructure. China has first-rate infrastructure, so it can think of other uses for its reserves. For us, infrastructure spending should be the priority, not passive fund management.

Wednesday, December 19, 2007

Dangers of rupee appreciation

In today's ET, Swaminathan Aiyar pooh-poohs the claim that rupee appreciation is causing job losses in millions. He says he toured Gujarat and found little evidence of big job losses in its export oriented sectors. He is right.

But the big problem posed by rupee appreciation to date is not an export slowdown and the resultant job losses. The problem is that it entrenches the belief among market players that the rupee has become a one way bet. Combine that with higher interest rates in India compared to other countries and you have a recipe for Big Trouble- there will huge capital inflows in expectation of windfall gains and this will cause the sort of rapid appreciation in rupee that could spell serious trouble for the real economy. Then, you will have a serious export slowdown, the possibility of overheated assets and, finally, a sharp reversal in capital flows that could cause the economy to collapse.

Central bank blitzkrieg

Central banks showed what sort of fire power they are capable of on Tuesday when the European Central Bank injected a massive Euro 350 bn into the markets. This follows coordinated injection earlier by various western central banks and the US Fed in a bid to ease liquidity fears. Banks have been shy of lending to each other because they don't quite know how creditworthy the counterparty is and they are also hoarding cash to deal with the deepening impact of the sub-prime crisis. This has caused the inter-bank rate to rise sharply over central bank's bechmark rates.

Will it all work? Well, the intervention is certainly better than sitting idle. It reduces the possibility of bank collapse arising from liquidity problems in the short-run. Long-run, conditions will return to normal only when there is clarity about where a given bank stands in terms of losses. Over the next two quarters, once accounts are finalised and released, a measure of clarity should return.

The criticism against these moves and also against any cuts in interest rates is that these increase moral hazard- they benefit traders who are eyeing their year-end bonuses. There is merit in this criticism but this is not a problem we can focus on for now- it should be dealt with at the firm-level by restraining bonuses for people who took foolish risks. The costs to the wider economy from doing nothing are huge. But central banks should certainly tighten regulation once conditions in the world economy stabilise.

Friday, December 14, 2007

Remembering Ravi Mathai

December 11 is Institute Day on the campus. The community foregathers at Louis Kahn Plaza. Awards are handed out to those who have completed 20 years of service, to children of staff and faculty who have done well in studies or in other activities. There is an entertainment programme with contributions from campus kids as well as students. There is a certain vibrancy in the air. In its 46th year, IIMA retains a spring in its stride. My thoughts drifted towards the man who made much of our success possible, IIMA's legendary founder-director, Ravi Mathai. I devoted my last ET column to him.

There's a puzzle I haven't been able to crack. How on earth did Vikram Sarabhai zoom in on Mathai as the first director? He was a BA from Oxford who had then joined the corporate world. Only two years prior to joining IIMA, he had switched to IIM Calcutta. He was all of 38. And he was called to preside over the collection of dons Sarabhai had already assembled. (IIMA was founded in1961, Mathai was appointed director in 1965). Says something about Sarabhai's talent spotting abilities.

When Mathai came in, he had a bit of a student revolt on his hands. The PGP had been started in 1964 and discontent was brewing amongst the students. Every evening, he would sit with the students in the open ground for hours, listen to them patiently and reason with them. The revolt died down. This is one of many nuggets about the man in a two volume collection of tributes to Mathai that is available in our library.

Amongst MBA students, there is insufficient appreciation of the 'soft' aspects of management. It is much easier to relate to the number crunching part. If you want proof that the 'soft' aspects matter, that culture and process have a lot to do with an institution's success, IIMA is proof. Mathai thought through these aspects carefully and he came up with something that can be called truly world-class. How to run an organisation of knowledge workers is an art- management guru Peter Drucker wrote a great deal on this subject. Academic institutions represent an extreme in the class of knowledge workers, so if you can make things happen there, you have achieved something. That is what Mathai achieved.

My column mentions some of the elements. I did not have a chance to mention how Mathai went about grooming talent. That was a time when it was not easy to bring in too many doctorates in management. Mathai's solution was to find people with a basic aptitude for academics and then send them over to Harvard Business School for a doctorate. They signed a bond, came back and served and, of course, had the option of leaving thereafter. C K Prahalad (a PGP product who joined IIMA as faculty thereafter) was one of the beneficiaries. Mathai reckoned that some people would leave. But even if a few stayed backed, that would be a big gain. And a few did stay back.

As I mention in my column, one of the astonishing things Mathai did was to step down a little after completing seven years on the job. He had everything going for him. Age was on his side. His record had been spectacular. He had terrific equations with all the major stakeholders. Kasturbhai Lalbhai, then chairman, and Sarabhai pleaded with him to continue as director. He could have been director until retirement. Yet the man chose to walk away from the job. Because he had thought through the governance implications very carefully.

Mathai had been careful to distance the Institute from government. This he did by making government one of many stakeholders with local businessmen and the state government being other stakeholders. IIMA is nominally accountable to the IIMA Society and it has an MoU with the government. That's how autonomy was ensured. He also made sure that the Board of governors did not dictate matters nor, for that matter, the director himself. He devolved power to the faculty by making the Faculty Council the principal instrument for decision-making. All key matters (even today) have to be brought to the Faculty Council for deliberation.

Which is all fine as long as there is a Ravi Mathai in the saddle. But not every director can be expected to be an angelic Ravi Mathai. In the present scheme of things, it is possible for a director to concentrate powers in himself with little accountability to anybody in particular since both the Ministry and the Board have been distanced from the decision-making process. Mathai found an answer to this problem: a single term for the director, after which the director reverts to a faculty role. This substantially addresses the problem of checks and balances on the office of director. All this is clear as crystal today. But for Mathai to have thought of it over three decades ago at the height of his success!

In relinquishing his job, Mathai lived up to the highest traditions of self-abnegation so greatly revered in this country. In many other ways, he set almost impossible standards of conduct. He instituted a rule (since waived) that the director should not be involved in consulting. He declined to seek reimbursement of his travel and medical bills. He never projected himself, it was always the Institute that got projected. I have heard that he was rather reclusive, locking himself in his house at the end of the day and mentally reviewing the events of the day.

The great thing about people like Mathai is that not only do they create the foundations for durable success, they also set standards for those who follow. It is impossible for anybody sitting in the director's chair to escape comparison with Mathai.

Monday, December 10, 2007

Bengalooru Bangalore-d

These are not the rosiest of times for IT companies. Their profits are being squeezed by a rising rupee, they face high rates of employee attrition, they have come in for sharp criticism from the Health minister for the working conditions to which BPO employees are subjected and their stocks have lost some of their sizzle.

Now, they are coming for in flak from the city with which they have come to be associated and which they claim to have placed on the international map, Bengalooru. Outlook magazine has an interesting story by Sugata Srinivasulu on how IT companies and their employees are being viewed with disfavour by many in Bangalore.

The world's most celebrated IT city is now considering that privilege to be a curse. Infosys and Wipro are no longer considered gateways to heaven, but more as roads to hell. When Infosys's Narayana Murthy was charged with showing 'disrespect' to the national anthem, there was a glaring absence of sympathy for the IT czar in the public domain, whereas earlier there would have been a tidal wave of support. Likewise for Wipro, when it was charged by a government panel of encroaching upon Bellandur lake to build its guest house. Another time, when the state government proposed to set up an education training and management institute with the Azim Premji Foundation, there was a letter campaign against it. There is now a perceptible change in the way the public in Bangalore looks at Murthy and Premji, the two most revered symbols of its IT industry—that they're no different from other businessmen who merely make profits for their company and their shareholders.

Well, well. What precisely are the grievances that people in Bangalore have against IT folk? The litany of complaints includes: rising property prices thanks to the IT employees' purchasing power, grabbing of prime land by IT companies, the bar and disco culture and IT employees being preferred in the bridal market.

There is a clear divide between other middle-class professionals, including the many in the public sector, and the IT employees. Those on the former side resent the rise to prominence of the latter.

The feature set me thinking. There are other professions that pay even more- the financial services sector, for instance. How come we do not see a similar resentment towards investment bankers and private equity people in Mumbai? I guess that's because partly the city is not yet identified with these professionals, they are not that numerous and, besides, in Mumbai, there are other sectors that absorb people and pay well.

IT dominates Bengalooru in a way in which other sectors do not dominate any metropolis and, also, the disparity between a dominant sector and other sectors in any city is not as great. If the proposed International Finance City materialises in Mumbai, we can expect an even greater backlash than what we are seeing in Bengalooru today.

A second reason could be that IT does not have the same linkages with the domestic economy. Finance professionals create prosperity in companies they take public, the stock market benefits thousands of shareholders. IT is seen to benefit only the people in the sector and nobody else. True, as Subroto Bagchi points out, IT creates benefits (such as declining telecom costs) but these effects are indirect and not as visible, hence the resentment.

Thirdly, to some extent, the prosperity of IT and its employees is seen as coming at the expense of the economy. IT companies have benefited from huge allotments of land at concessional prices, they benefited from an undervalued rupee for over a decade and they benefited from tax concessions as well. The charities made by some IT personalities are seen as poor compensation for the benefits earned.

So, what do we do? Throw IT out? Not at all. Can greater philanthropy help? To some extent, maybe- for instance, a classy university run at affordable prices on IT endownments might help assuage popular sentiment.

But the biggest corrective, I reckon, will come from the very economic environment that created IT's prosperity- no more concessional land, a decline in profitability from a rising rupee and its attendant costs (including layoffs in the IT sector) and a greater focus on the domestic economy on the part of IT firms in the face of a rising rupee.

Thursday, December 06, 2007

Goldman's success

I had a post yesterday on Goldman's success. I said it wasn't just luck or skill but the uniqueness of its business model that explained its success.

In today's FT, John Gapper argues that the firm benefits from the edge it gets by engaging in activities that involve conflicts of interest:

Big investment banks run advisory, securities and investment businesses but keep them walled off from each other to avoid conflicts of interest and trading on inside information. Goldman has been more aggressive than any other bank in putting the three together – it often advises a company on a transaction, finances it and invests its own money.

That regularly puts Goldman in delicate spots. It swaps from advising on a sale to bidding for the property, or its private equity arm co-invests with another fund in a company its bankers have found for sale. It often faces accusations of conflicts of interest over its overlapping roles but it brushes them off by saying that its job is to “manage conflicts”.

It has got away with this because it is too powerful to ignore. Private equity firms grumble that Goldman advises them on deals and competes with them but they accept it because it has such a big network of corporate clients that they cannot cut it off. One day, however, this balancing act will blow up in its face.

Goldman’s skill, luck and edge have combined this year to produce its great escape. The three will not always align so well.

This is an argument that others have made, notably Philip Augar in his book, The Greed Merchants. Point is: such conflicts of interest are not unique to Goldman. Perhaps the conflicts are more acute in the case of Goldman because of its higher involvement in activities that entail its own capital.

Maybe Goldman benefits more from the access to information it has as a giant investment bank. But how come the others are not seeing such benefits? Because they are not as much into proprietary activities or have not developed as much expertise in these.

Wednesday, December 05, 2007

Does better governance explain Goldman's success?

Goldman Sachs is one firm that has defied the meltdown in the financial sector. It has sub-prime exposures but it hedged these by shorting mortgates, so it has come out of the present turmoil smelling of roses. What explains Goldman's success at a time of widespread risk management failure?

John Plender, writing in FT, contends this is because of superior governance:

Much of it is down to culture. Until recently, Goldman was a partnership, which is one of the best risk-control mechanisms invented. The culture of partnership, which entails a high degree of mutual surveillance in the common interest, still survives in spite of Goldman’s status as a listed company.

......Most importantly, Goldman ascribes as much status, prestige and pay to people engaged in control functions as to those running businesses. It constantly rotates human capital back and forth between risk control and business operations.

...The structure of boards is also relevant. In the US governance model, the chairman and CEO roles tend not to be split, while the boards are dominated by non-executives who too often lack expertise in risk. Over the recent credit cycle, these non-executive directors permitted a huge escalation of risk across the banking system. They also sanctioned pay deals for CEOs, complete with rewards for failure, that encouraged risk escalation.

....In contrast, Mr Blankfein (CEO of Goldman) is accompanied on the board by two other executive directors, together with Stephen Friedman, a former senior partner of the firm. So there is a core group on the board steeped in the disciplines of risk. And Goldman’s managing directors include Gerald Corrigan, a former head of the Federal Reserve Bank of New York, who is regarded as the pre-eminent expert on financial plumbing.

I am not entirely persuaded. The risk management systems and structures that Plender associates with Goldman are to be found at other Wall Street firms as well- and yet they have done badly. I should know: I have worked for a Wall Street firm myself.

Assigning as much importance to control functions as to managing businesses, for instance, is not unique to Goldman although rotation between the two may be. I also doubt that a superior quality of board has to do with better risk management: it's next to impossible for a board to assess and monitor risk at a large investment banking firm.

What, then, is the explanation for Goldman standing out- apart from the luck factor? My guess is that Goldman's business model may have something to do with it. It is more heavily into deriving income by using its own capital than many others and it has the advantage of long experience in these - proprietary trading, hedge funds, private equity, etc. At a time when the global economy has been booming, private equity especially has a huge upside. Merrill's drive into these businesses is relatively recent and this may explain why it has stumbled badly.

Having a unique business model may help at the margin more than better governance. Macquarie Bank is a fabulous success. That is because its business model was unique- I doubt that better governance is the factor.

Monday, December 03, 2007

Wall Street bonuses- skewed against shareholders?

Goldman Sachs will be handing out huge bonuses even in what is a miserable year for Wall Street. No question, Goldman has done well. It has hedged subprime risks, has reported healthy profit for the third quarter and is expected to do well in the last quarter as well. Enough reason for its CEO to walk away with something in excess of the $54 mn he earned last year.

But people at the top at Goldman know that huge payouts in times such as these are bound to attract hostility. They have sought to preempt it by announcing the creation of a charity, Goldman Gives., to which senior executives will contribute a part of their compensation. Each contributing partner will have his or her own account in the charity and will have say in determining beneficiaries.

In this, Goldman people are doing what the Narayana Murthys and Aziz Premjis have done long back as also Bill Gates and Warren Buffet (although both Gates and Buffet seemed to need some prodding). It helps if you are seen to give back to worthy causes; it also helps if you are seen to have a not very flamboyant lifestyle.

The problem arises with bonuses at firms that have not done well. How do you justify bonuses at firms that have seen an erosion in shareholder value? I address this in my latest ET column, Sorry, you can't touch my bonus.

There are two reasons why Wall Street might think this is justified. The first is that variable pay is a big piece of compensation on Wall Street - and this has to do with individual, not firm performance. If you don't have variable pay, then base pay will have to go up - and Wall Street firms would like to avoid that. The second reason is that performance is easilly measurable unlike in non-financial firms.

Fair enough. However, in financial firms, including banks, there is an issue of rewards not taking into account losses to the firm down the road. Firms pay when the individual performs but don't expect him to pay back when he inflicts losses on the firm. This does seem to be a problem given the scale of bonuses.

True, stock options that vest over a longish period go some way towards addressing the problem. But several problems remain. What if options vest in the third year and the individual
causes a loss in the fourth? What about payments that are made in cash? And what about rival firms taking care of options that are yet to vest when they poach a high performer?

Banks and investment banks are highly leveraged and banks enjoy a security net at the expense of the taxpayer. High leverage can result in high returns to equity and high bonuses when the going is good. It can result in bankruptcies when the going is bad. Incentives in financial firms seem to be skewed in favour of the individual and against the shareholder. The problem needs to be addressed.