Selker Leadership

Greg Selker: Marc, I’m interested in your thoughts on what you think is the ideal role a Board of Directors can take in bringing about a higher level of accountability across their company’s executive ranks?

Marc Morgenstern: Let’s go back to my first proposition which is understanding “the mission”. If we’re talking about a Board holding an executive team to a higher level of accountability, my first question is – “what did the Board ask the executive team to do?” Some Boards don’t actually ask their executive leadership to do anything. The executives’ goals are translated as this year’s budget. That’s not a lot of direction.

Now I will also tell you that I have lots of maxims that I have developed through the years, and one of “Morgenstern’s Maxims” is, “an expectation unarticulated is a disappointment guaranteed”. The core of that is that you obviously have articulation and expectation.

So what’s the desired corporate outcome? Is it change or is it innovation? Is it de-leveraging the capital structure? Is it getting more liquidity or driving higher profits? Is it increasing market share? Is it a 3 year or a 5 year goal?

Pretend for a moment that you had ten simultaneous Boards for each public company. Even if each Board was very responsible, you might still have ten legitimately different views of what the goal of the company should be; and therefore, different views on the goals the executives should be held accountable for producing.

So when you say, “holding a team to a higher level of accountability”, I’m not quite sure what that means. Does it mean that if they don’t reach the desired goal, they should be fired or have their pay reduced?

The consequences of that would be that executive teams would be fighting with Boards all day long to make sure that the budget and goals were lower so they didn’t fail on their assigned tasks.

Greg Selker: Well, Marc first of all, I would say that a base level of accountability would be that a Board seriously engages their executive team in having this kind of discussion. Fundamentally starting with, “what are we committed to as a company?” And secondly, I would say that established goals are not only defined in financial and budgetary terms, but that they encompass values and behavioral areas as well.

Marc Morgenstern: And I agree with that. I guess part of my point is that it’s a two-way street. Boards can’t hold executives to a higher level of accountability until executives can hold Boards to a higher level of accountability.

Greg Selker: I agree with you 100%. And I think that we could probably forward a pretty solid argument that says that today, a Board for a complex global company that meets on a quarterly basis does not actually have enough insight into the business to even hold their executive team accountable.

Marc Morgenstern: Yes. In fact the problem is that much of corporate behavior is still driven by models that were created in the 1890’s, worked in the 1950’s and maybe even the 1970’s, but may not work today. This is very true of the concept of quarterly Board meetings. In the 1950’s or 60’s, the world moved at a pace where certainly much less happened in any 3 month period than in any 3 month period now.

Greg Selker: The rate of change has accelerated not only because of our global nature, but also with the speed of decisions and actions that are being taken given our communications networks.

Marc Morgenstern: Yes. It makes sense to ask ourselves, ‘what was the quarterly meeting a proxy for?’ To me it was a proxy for, ‘we meet often enough that we’re not likely to be tremendously surprised by information that we do not know.’

And you almost have to assume that if a quarterly meeting worked in 1960, quarterly meetings do not work in today’s world. And then the question becomes, “What is the right model today? Is it six times a year; twelve times a year?”

Again, the answer, depending on the nature of the company, could be different. Maybe it makes sense to go to a 2-day board meeting quarterly, and a one to three hour update every month. I think there are lots of perfectly viable alternatives. But they all depend on greater frequency of Board and management interaction, and achieving greater Board involvement. It’s funny, because the Boards of many public companies still meet four times a year. This is always a surprise to me, because most of the privately-held emerging growth companies I’m involved with meet monthly.

Greg Selker: Right, and there is greater contact between the CEO, the executive team and Board Directors.

Marc Morgenstern: This also means that Directors are then more a part of pro-active planning than commenting on something that has already happened.

Greg Selker: Right.

Marc Morgenstern: So in my opinion, a critical area to talk about is how the role of the Board of Directors needs to change, but it needs to change both from a business perspective and a legal perspective.

If we look at the statutory words about Boards of Directors going back to the late 1800’s and early 1900’s, a Board is spoken about as a body that manages the company and oversees the executive team.

Well this was a time when businesses were all located in one city. Remember, there were no multi-state businesses until Henry Flagler figured out, on behalf of John D. Rockefeller, how to do interlocking trusts. This was in the 1860’s and 1870’s and represented the first time you had businesses that crossed state lines. Though for many years post this, 50-80 years, most businesses in one way or the other were local or regional. They simply weren’t national. And they were smaller.

Let’s translate this into today’s world. If you’re a really conscientious Director of a company doing $10 million dollars a year, I would bet you know an awful lot about the business, down to very small decisions being made, and you can impact these decisions and the company.

Now let’s take the opposite end of the spectrum, and by the way, my observation is not driven by recent events. I’ve been saying this for several decades. How can anybody suggest that a Director of a company like Citibank could conceivably know what was going on in the myriad businesses, even if they spent every day, all day, talking to the CEO? How could you ever know what was going on in a business doing a billion dollars a day?

And so with scale, this means there is an inability for a Director to perform the duties charged. You’re simply too far removed. In a company like Citibank, there are so many layers between a Director and the operational reality, that they’re reading paper of a paper of a paper of a paper of a paper. Their data is tremendously filtered. Not because someone is trying to do something malevolent. It’s filtered because you’re ten thousand miles away from the operation geographically and organizationally.

And so as that separation between a Director and an asset gets farther and farther away, what do we all really think those nice people could do? They’re sort of left with the only thing they can do, which is to try to do a lot of talking with senior management, and maybe the management layer below that. And after that, what else could they do?

Maybe a company like Citibank should have ten Boards of Directors as an example. You know, why is there a concept of only one Board? Why is it only at the top? Maybe we need to find a different definition? Maybe there should be three Directors for any division that’s greater than a billion dollars? I can think of lots of alternatives.

But what I believe is that no matter how many people are on the Board, no matter how often they meet and how well meaning they are, there is no way that a Director of Citibank could ever really claim to have the same knowledge and involvement of the company than a Director for a $10, $50 or $100 million business. And yet it’s the same statutory word, it’s the same legal charge, and it’s the same mission. And I simply don’t think that works.

Greg Selker: Well, this makes sense to me. How do we go from this philosophical discussion of trying to alter the corporate reality of Boards, to putting it into action? What are some of the suggested steps that you believe could be taken to bringing about change, besides broadening this conversation to include more people?

Marc Morgenstern: I guess that first you’d have to get a fairly broad consensus that the overall concept of a Board of Directors is outdated. It is a buggy whip manufacturer in the automobile age. And then, we need to engage in a serious discussion knowing that this is not a one day discussion and it’s not a simple answer.

Greg Selker: No, not at all. And as you said, there could be multiple, valid structures each depending upon the company and the context.

Marc Morgenstern: So the classic American approach for this would be to default to the fact that it is State law, and not Federal law, that overall governs Boards of Directors. It is the State law of the corporation that says what the Director’s charges are.

And in general, different States have taken different approaches to the same problems. Over a period of time, you have enough data to say, – “You know what? The State of Maryland had what seemed like a great idea when in 1990 they passed this law. But now that we’ve had a chance to look at it in the real world for ten years plus, we see a lot of flaws with it.”

Then Montana passed a law approaching this problem differently, and at the time we thought it was a bad idea. But you know what? Fifteen years later we’ve seen how it works, and it’s really a good idea.

This state by state approach often leads to consensus that the three good things in the Maryland law and the two good things in the Montana law should be combined and evolve to a common standard.

But what’s unsatisfying to people about this approach is that it’s messy, and it takes time. And you have to allow things to play themselves out so that you can see what things work, what things don’t work, and what things work okay but could be better. And that’s a 5 to 20 year process.

At the end of the day, there will be a tremendously improved society, but along the way you may have had a lot of very bad individual experiences. And so we come back to the whole concept of risk and reward, but at a societal and governmental level. And to me, the benefits of that sort of experimentation justify the risk.

I think over an extended period of time to end up with the best answer to this dilemma by permitting state variation creates a very acceptable risk-reward ratio. Other people could comfortably disagree and I would understand that.

But still, almost everything in life comes down to risk-reward or cost-benefit. I’m prepared to live with short-term uncertainty and short-term failures, if in the longer run we produce a much better legal and business foundation for the next hundred years of our society. Some people would not be okay with that.

Greg Selker: Marc, you’re on a number of Boards. Have you brought some of these concepts of restructuring, rethinking the core definition of what the Board of Directors is, to the companies in which you’re a Board Director?

Marc Morgenstern: The short answer would be yes. But not necessarily because it was driven by me, but because I tend to be on Boards and involved with Boards of people who are at least like-minded enough that what I’m saying is not emotionally or intellectually dissonant to them.

And so what I would tell you is that I think that really smart CEO’s are changing Board behavior because in theory, while it’s the Board that calls the Board of Directors meeting, in the real world it’s the CEO.

So number one, good CEO’s attract and recruit good Boards. And good CEO’s, for either offensive or defensive purposes, want more relationship between the Board and management. And I say relationship rather than meetings, because meetings are just a proxy for information exchange and relationships.

So I’m not involved with any public companies that literally only have four meetings a year. Whether they have four or six formal meetings varies. They almost all have extended phone conferences in-between meetings. They almost all provide monthly information packets that are very intelligent and well designed by management and the Board through an iterative process where management says, “I think this information or format is what’s helpful”. And the Board looks at it and says, “yeah that’s great, but we’d like this report prepared differently”, or “we’d like two more reports or whatever it is the Board thinks they need to see to get good information.

Board meetings are much longer today than in the past. There are many more off-site meetings to make sure that management isn’t distracted. There are many more meetings that take place at an operating headquarters or operating division. Because that’s one of the ways that a Board can get a much better feeling of the person managing a large division; we’ve only ever heard their name a hundred times – let’s go meet the person. And let’s go meet the person who’s their number two or number three person.

And by the way, let’s make sure that the division knows that the Board of Directors was there – that there really is a Board of Directors and they really are paying attention, and Directors are real people. And so you de-mystify some of the concepts of a Board of Directors. As opposed to what usually happens, which is, the Board of Directors is usually only “real” to about a handful of people: CEO’s, General Counsel, CFO’s, COO’s, and the Treasurer. All the people who typically directly and routinely interact with the Board.

The Board of Directors needs to be real to many more people. The Board can go to the people, which is a very good solution. Or, what many companies are doing is that at every Board meeting, they bring in the next three officers in a division, or the head of Sales and Marketing. People who do not ordinarily appear in Board rooms. And this person prepares and gives a presentation and is available for Q and A.

This sort of interaction creates the potential for open-ended questions and immediate management responsiveness, almost like a built-in stress test. Can this person stand up to that kind of inquiry? If they succeed, that’s great. If they don’t, do they go away determined to improve now that they have a better sense of how a Board of Directors thinks? Hopefully, they will.

Greg Selker: One of the best corporate practices that I’ve run across when it comes to Board and executive interaction, was a $3 billion company that had an annual retreat to which the executive team, plus the next layer down of the folks who were identified as high potential succession candidates, were invited.

There were group presentations made to the Board, and different Directors were paired up with executives on a rotating basis throughout the weekend, and from one year to the next. This meant there was real interaction that occurred over a 2 or 3 day period between a Director and an executive or junior executive, not just the typical two to three hour presentation..

Marc Morgenstern: I think whatever venue and whatever the format, more interaction is better than less interaction.

Greg Selker: I would agree.

Marc Morgenstern: There is real benefit to informal one-on-ones. Some people are not particularly comfortable presenting to a group that’s very formal – it’s not what they do all day long. But sitting talking to a human being one-on-one, is normal and comfortable, and they’re much more likely to - not that they would be dishonest in the Board environment - but they would be more open and honest in a different way in a one-on-one environment.

Greg Selker: Yes, that is a different kind of interaction that’s invites a deeper level of conversation and communication.

Marc Morgenstern: And the development of individual trust and intimacy. This also sets the stage for a Director to call two months later and say, “You know, I’m hung up on something we discussed, can we talk about it?”

Greg Selker: Yes, absolutely. It becomes an opportunity for mentorship for a Board Director who has more experience and knowledge to be able to impart that to a younger executive, while at the same time enabling the Director to provide some insight into who that person is to the CEO and the senior team.

Marc Morgenstern: Another benefit is that you’ve really both talked and listened to somebody one-on-one. If you’re getting reports from them later on, you’ll always read the reports differently because you’ll have a better understanding that when Jane uses the word “must”, she may mean it would be helpful. If John uses the word “must”, he may mean this is absolutely a condition precedent. So understanding people and therefore, understanding their vocabulary, simply lets Directors listen and gather data more efficiently and effectively.

Greg Selker: So you are saying that part of the redesign of a Board of Directors is taking its mandate seriously of directing a company and become more involved, however that is structured or constituted.

Marc Morgenstern: Well, not necessarily. Because more could also be meddling. A Director can’t be a micro-manager. And you probably couldn’t have five Directors each calling the same person, and then each reporting back to the Board, – “Gee, I had a discussion and the person said “X”, and another Director says no they said “Y”. Because the Directors probably asked different questions, thinking they’re asking the same question. You have to manage against disconnects.

Greg Selker: Absolutely, right. I didn’t mean that the Board should begin to be engaged in the management of the operations of the company.

Marc Morgenstern: Yes. You know, there’s a fine line between a Board having greater involvement, on the one hand, and end-running the CEO on the other. And you know there’s a reason why, in effect, people always come to a single cusp point at which a CEO is talking to a Board. Some of that’s very good, because there’s a monolithic management voice saying something.

Some of that’s very bad, because there’s a lack of permeability between the Board and the rest of the company. So I don’t think there’s a simple balance, or even by the way, a balance that is true of the same company across time.

It’s always changing. Probably the single greatest problem facing people generally today is the rate of change. What was a good answer yesterday…

Greg Selker: …isn’t a good answer today or tomorrow.

Marc Morgenstern: And if you extended that to laws, it’s the same thing. This is truly the most fundamental disconnect as we talk about Boards, regulation and accountability. The length of time it takes to put laws in place and the bureaucracies, regulatory environment and people to manage them. No matter what change you make, by the time it’s spun through a system, the stimulus that caused the change, in today’s world, by definition has changed. And so the final managerial or legislative response, if not inadequate, was responding to a different stimulus.

This is the same issue with a Board of Directors. Anything that we’re saying right now is probably directionally accurate. But a year from now there could be a technology that would totally alter the way in which the problem is looked at, and what the best response is. This is one of the things we really haven’t touched on with respect to where we began our conversation, the under-utilization of technology by the SEC, Boards of Directors and many other groups.

Why don’t most Boards of Directors have (in effect) a LinkedIn equivalent with the top 50 executives in a company, or the top 10? Why isn’t there an open-ended online forum? Why aren’t documents being exchanged more frequently and annotated in that fashion rather than by hard copy? If you have companies that are increasingly not in one place, however the phrase “not in one place” is defined, you really have “distributed teams”. Then you have to find a way to work more collaboratively.

There are so many evolving forms of collaborative software, annotation software, and community and communication software. There are devices like Skype. Most people do so much better if they’re looking at someone’s face while talking to them. We communicate words, and we communicate with words, gestures and body language and many other things. I don’t want to call the CEO – I want to see the CEO. And yet I will just tell you that many company’s IT infrastructures, including most major law firms, don’t accommodate Skype. Most companies are more concerned about the security of their IT system, the risk side of the equation, than the reward side, which is better communication. So people’s personal technology access may be greater at home than in the workplace. That’s a problem.

For many companies the risk-reward ratio is focused on security. That’s largely driven by MIS and IT people. The discussion isn’t driven by senior management and the Board focusing on the reward side of the question with the degree of priority it deserves. If somebody gives you the answer, “We can’t do Skype”, not too many Directors say, “Well then we’ve got a problem with our network infrastructure and we better change it so you can do Skype.” They just accept it. This is disturbing and a very common pattern and something that I think needs to be talked more about.

Greg Selker: Marc, we’ve talked about board accountability in terms of the board’s responsibility to give guidance to and develop a successful relationship with executive management; let’s talk about board and corporate accountability in a different context. I’m interested in your thoughts on what you think constitute best practices around measuring, reporting and compensating performance, and in particular, if whether or not the pressures around quarterly reporting unduly influence both executive and board behavior.

Marc Morgenstern: Now we could say that quarterly measurements are good or bad. I tend to think they’re bad. But as long as it is what it is, then you’re going to have executive and Board behavior that are tremendously influenced by this. Even though people always decry the measurement of short term profits, the fact is, that’s what is rewarded in the market place.

So if the driver of behavior is reward for short term profits, why would anyone expect a different result from rational people dealing in a known universe? And I think the answer is, you really can’t.

If the Board says, we don’t care what the market place thinks – we want you to do A, B and C, and the executive does exactly what the Board wants, and the Board really believes this course of action is in the best long term interest of the company over five years, the Board truly sets compensation based on its desired outcome. But in those five years, the market says, “We’re not interested in these things. We don’t have the patience for that, and we’ll take your stock from $100 to $8.” What happens then? Employee stock options are worth nothing and you can’t attract or retain the best and the brightest. People say, “They’re a fallen angel – they used to be good, but now they’re bad.” There’s tremendous negative reinforcement – and by the way, danger.

Because if the stock price is $8, and a long term strategic buyer says, “Boy that company is worth $100, I’ll go in and offer $16 and I’ll tell the Board you have to take it because it’s in the best interest of the shareholders because it’s a 100% premium over current trading price” What Board of Directors is going to turn down a 100% premium? That’s pretty tough. Make it a 200% premium on $8, I’ll pay you $24. It’s still worth $100.

So if it’s worth more to the private market place than the public market place, guess what – it will end up in the private market place. So a lot of the behaviors we see are the self-defense of public companies who perform in the arena in which they’re placed and act in accordance with the way in which they’re judged.

Greg Selker: So it seems we may need to radically change both the communication mechanisms and those in which results are reported and evaluated and considered by shareholders and by the public market place.

Marc Morgenstern: Yes, but you can’t do this from inside – you can only do this from outside.

Greg Selker: Well this basically brings us back to the SEC, but certainly other kinds of agencies or regulatory commissions or committees that could look at and address these issues at a more systemic level.

Marc Morgenstern: And, I could put an outrageous proposal on the table. As soon as I say it, you’ll recoil - Instead of quarterly results from a public company, why don’t we just give annual results?

Greg Selker: I don’t recoil at all. Personally, I think that is a good idea. Because I believe wholeheartedly in the principles in which you’re describing and have believed them myself for years. Short-term reporting tends to skew executive behavior to the short-term.

Marc Morgenstern: Yes, but here’s why the world would recoil. They would say, “Well, transparency is the current God”. And if you only report once a year, I don’t have any transparency. So I equate transparency with an immediacy of data. And as soon as people value immediacy of data over information, then you’ve lost the whole battle.

And so the world says more reporting (and more reporting in granularity) is a good thing because that’s what they think transparency is. And particularly again – going back to a world that changes so quickly. If a company went a year without reporting, it could be a completely different company. But if you’re a truly long term investor, a private investor, you couldn’t care less about the quarter. It’s an absolutely arbitrary, meaningless measurement. It’s no more logical than once every four months – or once every two months. It’s just what’s existed for a very extended period of time.

Let me say just one more thing. The shorter the measurement period, the more the data and less the information.

Greg Selker: Got it. So if a company has systems in place that allow accessibility and transparency of data, the difference between quarterly reporting would be a management report that consolidates that information, and says, here’s what it means.

Marc Morgenstern: You know right now we have sort of a hybrid which says that it’s okay to give people information quarterly, which if you’re a public company, you do with the 10-Q. But there are a fair number of things that if they happen, we can’t wait for a quarter to learn about them.

So for instance, you have the 8-K’s which are used to report major events. If you’ve made an acquisition, a director resigned over disagreement on major policy, major changes in compensation, changes in the share ownership of Executive Officers and Directors, all these things go under the 8-K or Form 4 filings.

So there’s a mechanism now for things in between quarters. There’s a tremendous amount of work involved in a 10-Q. Outside of the filing there is the whole internal management discussion and analysis, and the external public reporting of the results with the accompanying analysis and discussion. And if you think about it, part of the obligation of public companies is to discuss trends. If I’ve got a year to report something, I’ve got a year’s data to observe – I could probably tell you what a trend is or isn’t. However, the shorter the period of time I’m looking at, if I look at only three months of data, it’s much harder to discern what is and is not a trend. Is a “change” the effect of seasonality, is it an aberration? Is it a result of a currency fluctuation? I don’t know. And to pretend that I could magically report once a month, what does one month’s data really mean?

You know last year at this time, the company had 22 shipping days in January while this year, January only, we had 19 shipping days. I mean variables like that produce incredible differences. If you’re a retailer looking at comparable quarters, did Easter fall in the second quarter or the first quarter? Was Christmas a six week selling season or a four week selling season?

And so it’s very hard to actually give an analysis or provide information that is more than just data. I can give you the data – the sales last year were $10, and this year they were $9 – that’s a $1 difference; that’s data. But what does it mean? I don’t know. It could simply mean a shorter selling season. It could mean I had the same level of inventory and orders to be shipped, but three trucks broke down and so the shipment was delayed. Or the last shipping day of the month last year was a Friday, and this year is a Monday.

So the shorter the time period – no matter how conscientious you are, the harder it is to really give an analysis that is a genuine analysis.

Greg Selker: So in the spirit of trying to deliver accessibility and transparency, how would a company go about doing this to provide not only the immediacy of information, but also some sense as to a consolidated, kind of high level view of what this information means?

Marc Morgenstern: Well, let me address some of this at a philosophical level. As an example, every company that I’ve ever been involved with as a director or lawyer that has gone through the IPO process, upon their public offering, I have encouraged them to make a blanket policy statement that they do not endorse analyst earnings, nor do they make their own projected earnings. Just a flat out statement.

This frequently causes a lot of aggravation with the underwriters of that process. They say, ‘Your stock price won’t be rewarded and people won’t follow you.” But if you don’t put yourself under the pressure of the system of projected/reported quarterly earnings, then you don’t have to engage with your own projection. And every quarter if something is wrong, you don’t have to say – “Oh gee, we projected 12 cents – now we think it’s going to be 9 cents”. And so you simply can avoid an enormous amount of aggravation by doing it this way and ultimately, it creates a safer environment.

Again, reasonable people can disagree. Some people will say, “They’re not getting 20 analysts to follow me.” Well maybe, maybe not. But generally, if you’re a profitable, good company, analysts will follow you. But you will have reversed the game on them by refusing to play the way they want to play. They will still make their own estimates. There’s nothing you can do about that. But it will be theirs, not your estimates. So you won’t have an obligation to amend, modify and update your own disclosures. And you will make the task of being a public company much easier.

By the way, if 500 public companies all said collectively “We’re not going to provide projected earnings”, you would almost immediately change the whole global investment evaluation process. But that’s what it would take – it would probably take 10 or 20 of the top 50 companies. If AT&T,IBM or several other large companies just said, “We’re not going to project earnings. We’re comfortable enough that you’re going to follow us anyway.” In my view, you’d create an enormously better environment because you would take the betting aspect out of it, and truly make it much more like long-term investing.

Greg Selker: So it would have a ripple effect to much smaller companies?

Marc Morgenstern: Yes, if $50 to $100 million dollar companies did the same thing on their own, it’s largely irrelevant.

Greg Selker: Right.

Marc Morgenstern: This is a place where scale matters – mass matters – and branding matters.

So as is true of many things – it used to be that if it’s good for General Motors, it’s good for the country. I’m not so sure GM is the right metaphor anymore, but you get my point.

Greg Selker: Right. Well this kind of brings us to really talking about enlightened leadership, because I believe that’s what it would take in order to bring some of these changes about. What do you see needs to happen in order to bring about this level of enlightened leadership?

Marc Morgenstern: Well I think it’s a combination of enlightened leadership at an individual and a company level. But I think there are also lots of organizations like business roundtables, for example, where those leaders gather together, and that’s one of the places where you can reach an agreement across 20 companies of what you think a recommended course of action is. So if an umbrella organization of enlightened leaders says to its enlightened leaders – “this is what we recommend”, then you can really get change.

Greg Selker: Yes.

Marc Morgenstern: And by the way, Why don’t you see activist shareholders, if they’re so concerned about short term profits, why don’t you see them demanding longer term goals and less reporting and fewer projections? And you know why. Most activist shareholders want more projections and more data allowing them to make shorter term decisions, rather than more information.

But there is no reason why genuinely enlightened shareholders shouldn’t be involved in pushing for these kind of changes, as well as enlightened leaders and Boards. In fact, if the pressure for change exists from each of these perspectives, that will increase the likelihood of change actually happening.

Greg Selker: Well Marc, this has been a fascinating conversation and I know that we could talk for several more hours on additional topics. Thank you so much for your insights.

Marc Morgenstern: You’re welcome Greg. This was fun and a good dialogue.

Marc Morgenstern is the Founder and Managing Partner of Blue Mesa Partners. He serves as a Senior Advisor and/or Board member for growth companies in industries as diverse as telecom, enterprise software, social broadcasting, specialized steel service centers, printing and imaging, and solutions for protection and renewal of residential and municipal infrastructure.

Over his 25 year plus career as a nationally prominent corporate and securities lawyer, he has been a director of numerous public and private companies, and a principal advisor at hundreds of public and private companies board meetings advising about corporate governance, mergers and acquisitions, executive compensation, public and private equity financing, financial statement restatements, Sarbanes-Oxley compliance, and hostile takeover defenses.
 
Prior to devoting his full-time efforts to entrepreneurial activities, Mr. Morgenstern was the leader of the West Coast Corporate and Securities Group for a national law firm, and previously had been the long-time Managing Partner and CEO of a midwest regional law firm focused on entrepreneurs and emerging growth companies (public and private).

His observations have appeared in national media, including CNBC’s Squawk Box (private equity), The Deal (private equity and hedge funds), CFO magazine (Sarbanes-Oxley), Wall Street Journal (cost of being public), Los Angeles Times (Blackstone IPO), Tech Republic (strategic planning), New York Times (how a good board helps grow companies), Compliance Week (stock option expensing), Entrepreneur Magazine (problem investor syndrome), San Francisco Chronicle (Sarbanes-Oxley and IPO’s), and the San Jose Mercury News (sale of restricted securities).

We are thrilled to present this Leadership Interview with Marc Morgenstern.

Greg Selker: Marc, thank you for participating in our on-going series of leadership interviews.

Marc Morgenstern: My pleasure.

Greg Selker: I’m looking forward to talking with you in this context. We’ve known each other for a number of years, but our interactions have generally been about specific projects, rather than a more broad philosophical conversation on these particular issues.

Marc Morgenstern: Indeed.

Greg Selker: Marc, you have developed an expertise and have written extensively about the SEC, and specifically how the regulatory environment affects both the IPO process and privatization of companies.

In your recent article published on The Huffington Post, you wrote about the U.S. capital markets regaining their once world-renowned reputation for safety, transparency and liquidity. To me the necessary ingredients to bring this about are the SEC creating rules that are designed to balance long-term results, as opposed to short-term profits, their enforcement of these rules, and the degree to which an executive team is held accountable by a Board of Directors for behaving in accordance to these rules.

Do you agree with my categorization of these three major areas?

Marc Morgenstern: Well I think the short answer is that I sort of agree in part, and don’t agree in part. I think you’ve described very closed ended categories, and I think the real answers lie in a more open-ended way of thinking about our current condition.

As a starting point, it makes sense to try to understand where we are in the context of looking at the dynamics that drive behavior as a very broad concept. In other words, what do people believe that their mission is and how does their behavior match up?

If you talk about the SEC, the first thing that everyone needs to understand is that the SEC has a dual mandate. On the one hand, their very clear mandate going back to 1933 is that they’re supposed to protect investors.

Now starting with Reagan in 1980 or 1981, the rules changed and an additional mandate to the SEC was added, (and by the way I think it is quite a sensible one) and that is that the SEC is also responsible for capital formation.

These are absolutely counter-cyclical charges from the government. They’re supposed to protect toward safety, which generally means driving farther away from capital formation. Or enable capital formation, which generally means driving further away from safety. I don’t know really what Congress intended, but I’m going to assume that these dual mandates reflect a fundamental characteristic of the capital market place, which is striking the balance between risk and reward.

So the goal of the agency is to achieve this balance. Now I don’t think that the balance is there, and there are many reasons for this.

Greg Selker: Well, regardless of the reasons for this imbalance, how would you describe it?

Marc Morgenstern: Let’s talk about it philosophically first, and this get’s back to my response to your categorization of the possible solutions to regain our transparency, safety and liquidity. What is the SEC’s long standing mandate and how do they regulate things? The answer is that there’s a very sharp distinction between how the Federal government historically is regulated, and how state governments are regulated.

The Federal Government operates in a disclosure driven securities model which assumes that the marketplace is grown-up and sophisticated. The role of the SEC and the Federal Government is to make sure that investors have the facts that they need in order to make informed, rational investment decisions. That’s a disclosure system.

The States have always had a sharply different, very paternalistic view to protect investors from things that the regulators don’t think they should invest in. It’s substantive regulation. As an example, in the tax shelter days of the 1980’s, many states had leverage ratios governing investments. You couldn’t invest in an oil and gas deal if the leverage ratio was more than 3 to 1 or 5 to 1.

The SEC’s view was different saying, “You can do whatever you want to as long as investors are aware of the leverage ratio. We’re not here to tell you whether or not to make the investment. We’re just here to make sure that you know what you’re investing in.”

So part of what has happened over the last couple of years, particularly around Sarbanes-Oxley, is that I think the Federal mandate has gotten quite confused. And to me the tipping point was Sarbanes-Oxley when the legislation said that a public company cannot make a loan to one of their Executive Officers or Directors. That moved the Federal Government into regulating the substance of what a company can or cannot do. Previously, these kind of substantive regulations were always governed under State (corporate) law.

Greg Selker: As opposed to Federal law and the SEC, which was really more focused on transparency and full disclosure?

Marc Morgenstern: Yes, and my comment at the time was - well, if the SEC can regulate that aspect of compensation, because that’s what loans tend to be, why can’t they say that you can’t have more than six weeks or three weeks vacation or a limit on your bonus?

Greg Selker: Little did you know that you were being prescient.

Marc Morgenstern: Well actually I did know, because it was just a little thing, but sometimes little things lead into very big things. And although I didn’t know exactly what it would lead to, it changed Federal philosophy from disclosure to substantive regulation.

And unfortunately, much more troubling to me was the fact that this outcome is so frequently true of well-intended, but ultimately self-defeating rules. New rules were implemented because people were outraged. You may remember the scandals from the 80’s where people had taken loans from their companies and didn’t repay them?

Greg Selker: Yes, absolutely.

Marc Morgenstern: And the fact of the matter was that those loans were fraudulent and illegal, all conduct which was subject to State law. You know, Boards of Directors did not authorize $100 million dollar loans. That was a violation of all corporate law.

Those loans were concealed from the Board of Directors. There were 50 statutes on the books that would have recovered the money, but instead of acknowledging that the laws were perfectly okay and enforcement was needed, populist outrage moved to eliminate the variable. That, by the way, is the consistent pattern of human behavior and regulation over time. And it is happening again today for very predictable reasons. People are angry about things and the legislative response is to say, “Let’s look at the variables and make them go away.” And that never works.

Greg Selker: This is why you said you both agree and disagree with my categorization of the solution to our crises?

Marc Morgenstern: Yes. If we automatically default to more rules and regulations, which is where many people want to go, the first question is, how many laws will the SEC inherit? Congress passes a law and the SEC is then charged with enforcing it.

And the second question is, what does enforcement mean when you’re the SEC? And that answer takes us right back to compliance. Public companies have to file their annual reports and their quarterly reports, and the SEC is charged with going through them and saying, “it’s ok or it’s not ok”. And every three years – and notice it’s only every three years - they must review the 10-K for every public company. Well, think how much happens in a three-year period.

Greg Selker: Right, an enormous amount.

Marc Morgenstern: Anybody who really believes for a second that this represents active enforcement is foolish. Of course, it isn’t. But the SEC has only so many resources, and the three-year review was again, a very consistent regulatory response. Which is to say, ‘We’ll make a rule and assume that it fits all categories across all public companies.’

What possible sense does that make? Because with finite resources, doesn’t it make more sense to allocate resources on a risk adjusted basis so that SEC personnel spend the time where it counts the most? So the SEC’s charge shouldn’t be to review 10-K’s every three years. The charge should have been: the SEC will evaluate where risk is, and review most often the disclosure documents that it thinks represent the highest level of risk - and review least often the documents that they think represent the lowest level of risk. Recognizing that it’s not perfect – that perfect is not one of the alternatives.

Many years ago in response to a question about Sarbanes-Oxley and the regulatory environment in general, Irwin Federman, the founding partner of US Venture Partners said, that in his experience, “one-size-fits-all only works with muu-muus and athletic socks.” I thought that was a really telling observation.

So you have to give the SEC a much more flexible approach to managing risk. And if you think about it, this approach is completely consistent with how the largest accounting firms conduct their audits.

A Big 4 audit report typically would say, “We know our audit isn’t perfect. We concentrated our efforts on identifying and auditing the riskiest components of this business. And we are telling you, the Board of Directors and the people reading the financial statements, what we think are the greatest levels of risk, and then what we believe is the best approach to disclose and mitigate this risk.”

And to me this kind of audit says, mathematically, we can’t do everything.

A Big 4 audit report says, “What we can do is tell you what we did and how we did it. You can agree with our methodology or not. You can question our assumptions. But you can’t question our transparency.”

Transparency doesn’t mean perfect – and transparency doesn’t mean you go down to the smallest variable on someone’s balance sheet. And that’s where I think people consistently have a very serious misperception. Because the goal cannot be perfection. The goal can only be progress.

Greg Selker: So in the spirit of progress – and also given what you described as the reality both of human nature and the tendency to default to ruling out a variable as the path of least resistance, what do you think would be a new way of looking at the SEC that would help bring back transparency, safety and liquidity, but also increase accountability?

Marc Morgenstern: Well, I think maybe the easiest way to start (oddly enough) is with SEC operations rather than with the SEC’s mission. Because if you give somebody a mission that they cannot accomplish with their personnel or their tools, then it’s doomed to fail.

So to me the right question is – what’s the best thing you can do to improve the SEC? And it has nothing to do with rules. It has to do with the people who are there, and the tools they have to do their job.

This is fairly straight-forward. When you have relatively inexperienced people, and many of the staff at the SEC are lawyers who have 2-6 years experience, they’re going to be, intentionally or unintentionally, unarmed and inadequately prepared to deal with the people they’re investigating who have been in business for 30 or 50 years and who have much greater capital and technology resources. That is an unfair fight to begin with.

So the first thing to do is to make the SEC a place that highly compensates its employees, and will therefore attract highly skilled and experienced individuals. And for some reason, paying people what they’re worth is an unpopular view in Congress. But the simple truth is you need to pay more to get the best people. And this may be more than a Congressman or Senator makes – I can’t help that. The marketplace sets compensation, not me.

Greg Selker: Agreed. And what would you say about the revolving door between the SEC and financial institutions?

Marc Morgenstern: I don’t have a problem with it and I’ll tell you why. When I first started practicing law, the best and the brightest worked at the SEC. They were an astounding agency in the 60’s, 70’s and 80’s. And by the way, today, the employees of the SEC get paid less than people at Treasury for reasons that are obscure to me. In my opinion this is the main source of the problem, not the fact that people leave the SEC for jobs in the private sector.

A very common pattern in the past was people would do their public service at the SEC for 5,10 or 12 years, and then they would take a well-paid job in the private sector. I simply don’t have a problem with that. This populated the private sector with people who understood the regulatory environment, while having the best people spend significant, effective time at the SEC.

Greg Selker: So you’re suggesting that if we raise the pay scale to competitive levels, the SEC will again attract the best and the brightest? And while there may be a revolving door, the tenure of SEC employees will be longer. The SEC won’t just become a jumping off point to a more lucrative position within the private sector.

Marc Morgenstern: That would be absolutely correct. This would shift the pattern of 2 or 3 years at the SEC as a resume builder, to people who are there for 10 or 15 years, while bringing tremendous value to the institution, including adding to the institutional memory.

Greg Selker: Absolutely. Over the past 15 or 20 years, being employed at the SEC has defaulted more towards building your resume and establishing connections for a more lucrative job – rather than trying to build longevity within the institution and to make a difference.

Marc Morgenstern: Right, because when people are in their first couple of years out of law school, the economic disparity between them is not that great. But as people get older, they have families, and larger responsibilities. They need more money. They have to put their kids through college just like everybody else does. So today the system rewards leaving early. This is a real problem.

Greg Selker: So rather than try and legislate against the revolving door, let’s raise the pay scale and let the competitive marketplace do its thing.

Marc Morgenstern: Yes, I think this is an approach that will work better than what we have now. Now an unintended consequence of a more seasoned SEC employee base may be that there will be a far greater likelihood that SEC staff will potentially be investigating companies, and people, with whom they’ve had prior contact and relationship. In other words, we may have greater regularity of conflicts of interest. Here are my thoughts on how to deal with this, and, I know my suggestion is one about which reasonable people can have philosophical disagreement. People will look at the same set of circumstances, and see either a “conflict” or a “convergence”. The question should be is that conflict or convergence good or bad?

If you are dealing with people that you’ve dealt with before, and for many transactions there can be many related parties, some people simply instinctively recoil and say – “Oh, if these are related parties it’s a conflict and that is bad”.

Other people look at it and say – “Oh, if they’re related parties, I’m going to get much better service because if there’s a problem, there’s a much higher likelihood that it will get solved precisely because they are related parties. This is good.” 

So it’s the same set of circumstances with two different interpretations. And I’m definitely not suggesting that either one is right or wrong. But I grew up really believing in the concept of disclosure. In other words, what you do with conflicts is to disclose them, make sure that the impacted people really understand them, and then let those people make an informed decision. And that, by the way, is the basis for most corporate law.

If you look at the responsibilities of a Board of Directors and the exercise of the Business Judgment Rule, you know that this rule is built on twin towers; Duty of Loyalty, and Duty of Care. Duty of Loyalty basically says the only reason a Director is taking a particular action is because he or she believes it’s in the best interest of the corporation.

Now does that mean that a Director with a conflict cannot vote in the case of a conflict? No, it does not. It means that there are three ways that people typically approach the problem. The first step is obviously if a Director has a conflict, this must be disclosed Now it’s been disclosed, so what are the company’s options? They could say, “Gee, we’re still uncomfortable with this; we don’t want the Director to vote or be in the room, please leave while we discuss this matter.”

But there are people who say, “No, we know that there’s a conflict, and we’re happy to have you be part of the discussion, but you shouldn’t vote on it.” And the third option is everybody just says, “We know the conflict and therefore, we understand your bias. Please be in the room and vote because we all understand what your motivation may be, and with this understanding, we can make an informed decision as a board.”

To my way of thinking, the ability to make an informed decision among adults is a major driving principle. I don’t want to tell people which one of those three routes to take. I’m okay with having them decide whatever they want that will work for their particular environment. And I think dependent upon the environment and circumstances, any one of these options will be the best choice, but not necessarily a universal choice.

When we refer to “interviewing” as a critical skill, we often focus on the “interviewer” and not the person being interviewed. Sure, there are those cursory sites for the new graduates just entering the job market that focus on the highly genericized rules pertaining to interview prep and answering the behavioral questions. But what about the rules for the executive level interview?

What does a seasoned executive interviewing at the VP to “C” level need to do to maximize that 45 to 60 minutes spent in front of the executive recruiter or CEO so that that person walks away with a deep sense of who you are, especially from a values perspective; and how your actions and results not only impacted the bottom line but truly represented your principles and beliefs?

The sad truth is if you are in the job market and have been out there interviewing, you quickly discover that most companies do a pretty poor job of it. This is especially true at the executive level. So the burden is on the interviewee to develop their interviewing skills and go beyond “Interviewing 101”. This requires looking both inward, as well as, outward when doing the prerequisite interview research.

The following tips and exercises address not only how to elevate your ability to assess potential employers and their culture; but how do you define who you are from a values perspective and how do you communicate that in an interview?

Click here for our Tips On How To Maximize Your Interview , and increase the probability of getting the job you want in the process, and if you find this helpful, we’d love to hear from you! We’re about to launch a webinar taking this content to the next level in terms of its impact and applicability in today’s market. If you’re interested in participating in our How to Maximize Your Interview webinar, please let us know.

As we begin to see the first signs of recovery in our economy, and the first signs of recovering from the H1N1 virus, our elected and appointed officials from President Obama to Fed Chair Ben Bernanke are saying that the economic slowdown is starting to “slow down”. With that, we can expect an increase in demand for goods and services, and companies once again will begin to hire new employees…albeit slowly.

With the shift away from layoffs, another “virus” rears its pathogenic head: most people do not really understand what it takes to make a successful hire. A virus replicates itself within the cells of a living host, much like the bad habits perpetuated within organizations. Poor hires are continually made because people are mostly weak when it comes to interviewing, assessing and hiring individuals, teams and leaders.

So how should you gauge whether a hiring decision was successful? It is definitely NOT whether the hired employee remains for one year - the typical and laughable guarantee offered by the executive search industry. Pretty much anyone can last a year in a company, and many do. In fact, at larger companies, it is often the case that a bad hire gets transferred and becomes someone else’s problem. Or, in the case of a senior level hire who really doesn’t work out, the company defaults to lowering the bar and accepting mediocrity, often taking several years to get out of the ditch, if it does at all.

I propose two very clear measurements of a successful hire, and a boost to your hiring immune system: Q2H2 – 2 Questions to ask yourself before Hiring another employee.

First, do you enjoy working with the person? Are you excited about the prospect of tackling projects and tasks with him or her? When you think about working with this person, do you have a high level of confidence that you will be able to achieve your goals? All of us know what it is like to have this experience, or its’ opposite.

The second clear measurement is more objective. Have this person’s responsibilities stayed the same, grown or diminished over time? The answer to this question truly brings it home. Think about it. If you’re a successful leader, you’re developing your direct reports, and as their capabilities grow, their responsibilities will as well, and you end up delegating more. Your purview becomes more strategic, and your daily activities become less tactical. If you’re a successful employee, your capacities expand and you take on additional responsibilities. The nature of the universe and of life is to change, either for better or worse, and your decisions impact this. It’s pretty clear cut.

The answers to these two questions takes the mystery out of whether or not someone is a successful hire and leaves no room for fudging a response. When you honestly look at your personal track record of hiring people, and ask yourself these two questions, I’m pretty sure you will most likely see that your track record at making a successful hire is 50/50 at best. In other words, it’s a coin toss.

Yes, I still assert that the model of executive search is broken, something I have been saying consistently for the past 7 years, (see The Model Has Been Broken.) But the quality of executive search firms are only one of the mitigating factors keeping most company’s talent and culture steeped in mediocrity. Regardless of whether or not an executive search firm is used, the model of interviewing and assessing candidates is broken. I don’t care if you’re a small business owner, a manager in a mid-sized company, or a CEO of a multi-billion global corporation; hiring decisions depend on your ability to interview and assess people, and mostly, people do a poor job of this.

So as we get closer to moving into a period of economic and flu recovery, it makes sense to examine how you interview, assess and hire people, and begin to change your approach. It is more important than ever to allocate resources where they will make the biggest difference, and it’s about time to stop spreading the “bad hire” virus that seems to infect all sizes and kinds of businesses and begin to seriously talk about what it takes to interview and assess people in a way that informs the decision process and guides a successful hire. And remember to wash your hands.

Steve Hardardt is Senior Vice President- Human Resources and Business Administration and joined tw telecom in 2007. Prior to joining tw telecom, Steve was employed by Johns Manville Corporation as Vice President- Human Resources & Communications for their Building Products Division. Previously, Steve held HR leadership roles with several industry leading companies including Honeywell, Monsanto, Hasbro, Frito-Lay and Dow Jones & Company. Steve earned his BS degree from Cornell University’s School of Industrial and Labor Relations.

In the complete Leadership Interview, Steve shares his thoughts on developing a values-based culture, what it takes to be a strategic-minded HR business partner, and principles of executive compensation. For the complete Leadership Interview click here: steve-hardardt-leadership-interview

On strategic HR leadership…

Greg Selker: As you look at the different qualities that a HR officer really needs to have in order to be viewed and perceived as a good, tactical practitioner who has sound command of programs and processes, what do you see are some of the differences that can elevate that same HR officer to someone who is perceived by the business as a strategic value added business partner?

Steve Hardardt: You know for me it starts with being business minded. You just have to invest the time to understand what makes the business profitable. You know, how does the business work – what are those key levers that will improve the company’s ability to win in the marketplace? Tied closely to that is the importance of making time to think strategically – and at the risk of sounding cliché – there really are two components to that. One is to be a full partner and participant in the strategic business planning process. The second is to engage that same leadership team in the process to develop a people strategy that will enable achievement of the business strategy.

Greg Selker: So help business leaders see that focusing on people enables the delivery of their strategic business plan?

Steve Hardardt: Precisely. Beyond that, there are some common traits that I think a great or effective HR leader, as well as an effective leader of most other functions, needs to have. One is you have to get results. Once you build a plan that’s agreed upon, it’s essential that you have the ability to achieve your desired results through others. Next you have to understand what capabilities you need to have on your HR team. You have to actively develop your organization keeping these capabilities in mind.

You’ve got to work with each team member to enhance their capabilities to match these needs. And while this may seem obvious, you have to assume the role of a trusted advisor to many people in the organization – whether it’s the CEO or the executive team or first line managers or individual contributors. If you take the time to learn the organization and get to know the people, you’ll develop the trust and the confidence of others that allows you to offer some hopefully sage advice and to bear influence. This is essential for somebody to become a true business partner as an HR leader in any organization.

Greg Selker: For HR executives coming up through the ranks – perhaps more junior HR leaders at this point, what advice would you give to have them think more strategically along the lines that you have lain out? For its one thing to say it – but it’s a significant jump to move from tactical practitioner to strategic thoughtful, value added partner

Steve Hardardt: So there are a number of things that I would offer to folks as advice that helped me during my career and the first one is – whenever you have the opportunity to partner with or support an effective business leader, jump at the chance. Play whatever role you can to support them. If they have good business acumen and they understand and value people, you will learn a tremendous amount. By providing great service to that business leader you can create a mutually beneficial relationship. So get as close to your business partners as you can. It will broaden your perspective. The second thing is to experience as many roles or opportunities as you can.

It doesn’t matter if it’s on a project basis or through a variety of organizational roles. You have to put yourself in a position where you can really understand the breadth of all of the people related processes that are under the HR umbrella, talent management, total rewards, and organizational effectiveness. I have found that the broader your set of experiences, the better strategic business partner you are to your organization.

 

Steve’s 3 Principles of Executive Compensation…

Greg Selker: Well I think the last area to talk about is looking at executive compensation – and particularly with the passage in Congress of the stimulus plan and the restrictions placed on executive compensation for firms who have taken TARP funds. What are your thoughts on those proposed changes to curb executive compensation on Wall Street, and assuming those changes are implemented – how do you think they might impact executive compensation more broadly across the marketplace and specifically within your sector?

Steve Hardardt: Companies who have received TARP funds in the Congressional stimulus packages should be held accountable to Congress who gave them those funds. For publicly traded companies, like tw telecom, there is accountability to a board of directors. Regarding executive compensation, I think you need to implement a strategy that’s based on at least three philosophical pillars.

The first pillar is that you have to have a competitive compensation plan in order for a company to be able to attract and retain the executive talent needed to run their business, both today and in the future. The second pillar is that compensation, in whatever form it comes, really needs to be performance based. This has the dual components of rewarding individuals based on their contributions to an organization, and for compensating people based on the organization’s performance in absolute terms as well as relative to its peers.

The third pillar is that executive comp clearly needs to be aligned with shareholder interest, provided that you have a plan designed so that executives have the opportunity to share in the success of the business as do shareholders. I think these three philosophical pillars help construct fair compensation plans that help everybody achieve their needs.

Greg Selker: When we look at the performance based element of compensation in the changes mandated in the stimulus plan, it would push all bonus compensation into restricted stock and limit an executive’s ability to partake in the gains of that stock until 100% of the borrowed funds are paid back.

Steve Hardardt: It’s difficult to forecast what effect this provision would have on company performance as well as individual retention. But the point I would make, that we embrace, is the importance of having an independent board and an independent comp committee as part of that board who have the ability to establish and design the compensation plan. This has to happen with a competent compensation consulting partner. And that same comp committee and board need to be able to act independently in making decisions that are in the best interest of the shareholders and the company.

Greg Selker: Very true. I would only add an adjective there that it needs to be a strong, independent board and compensation committee.

Steve Hardardt: Agreed – absolutely agreed.

For the complete Leadership Interview with Steve Hardardt, click here: steve-hardardt-leadership-interview

We are all aware of the uproar caused by the $175 million in bonus payments made to AIG executives. It has been the straw that has broken the public’s back unleashing frustration and anger. Journalists and pundits have detailed the absolute travesty of the individuals receiving them who are no longer with the company and who were also at the heart of foisting credit default swaps into the marketplace. And with the almost-unanimous wrath of Congress bearing down on the bonus recipients, with the 90% taxation clawback measure passed by the House of Representatives, executive compensation has once again moved into the spotlight and illuminated two very different perspectives.

Driven by obscene greed, regardless of the long-term impact on their companies or the economy, executive comp has been vilified as one of the more blatant symptoms that something is terribly wrong. This perspective has led to the comp limits recently written into law as part of the Stimulus bill, the tax clawbacks passed by the House, and without a doubt will result in additional compensation changes demanded by the Senate. However, there is another dialogue to acknowledge: the potential deleterious effect these policies could have on the ability of any company receiving TARP funds, to retain and hire the real leadership necessary to help us out of this mess. Somehow these two perspectives that are at odds with each other need to be rectified!

On March 24th, Secretary of the Treasury Tim Geithner said, “This issue of excessive compensation extends beyond AIG, and requires reform of the system of incentives and compensation throughout the financial sector.” Well, I’m all for reforming compensation on Wall Street, and wherever else it makes sense, but as we move down this path we need to look at this from a holistic perspective to make certain we get it right.

These comp plans were not created in a vacuum, folks. They have the stamp of approval of boards of directors, and were constructed under the watchful eyes of the top compensation consulting firms in the country. With all of this high-powered intellect and experience, what went wrong? The problem is that most plans do not meaningfully account for “how” the results are achieved. So there is no connection to people’s behavior.

While compensation is one of the strongest drivers of behavior, most companies fail to take advantage of this truth and acknowledge the profound relationship between compensation, behavior, culture and values. This means that if you have a clear set of values that are defined behaviorally, and compensation is tied equally to the results and “how” the results are achieved, people will most certainly be compelled to behave in a manner that creates the desired culture while reaching the stated goals.

Here is AIG’s value set as an example:

People Develop diverse talent. Reward excellence.
Customer Focus Anticipate their priorities. Exceed their expectations.
Performance Be accountable. Manage risks. Deliver AIG’s strength
Integrity Work honestly. Enhance AIG’s reputation.
Respect Value all colleagues. Collaborate with one another.
Entrepreneurship Seize opportunities. Innovate for and with customers

Source: AIG’s Code of Conduct

Looking at this in the context of the recent bonus payout is laughable at best. Most certainly these values have not been clearly defined behaviorally within AIG, and to whatever degree they were, they were not significantly tied to compensation. If values-representative behavior had been significantly tied to compensation, the most egregious of the bonus payments would not have even been on the table, nor would they have occurred.

Bottom line, until Wall Street and other companies begin to define values-representative behavior which is tied to the achievement of results, and significant compensation is at stake, we will be doomed to repeat the same mistakes.

Wake up people, the secret is in tying values representative behavior to compensation!

When I started Selker Leadership in 2002, it was to reinvent executive search as a client-centric service that delivered unprecedented value. Seven years later, I am proud to report that our PVA methodology has altered the way people are selected, interviewed and hired. The “V” in PVA stands for Values. It was our premise then, and is still our fundamental core principle, that when you define values-representative behavior for a specific job, and test for this in an interview, you will end up attracting, hiring and developing leaders, and building a values-based culture (See: The Steps to Building a Values-Based Culture of Leadership Part 1, Sept 2002; The Steps to Building a Values-Based Culture of Leadership Part 2, October 2002; Values-Based Hiring as the Leverage to Building High-Performance Organizations, May 2003; and Use your Corporate Sunscreen, April 2008)

Well, what goes around comes around. While “values” haven’t been isolated in the media commentary or blogosphere, when you look at the companies on Wall Street at the heart of our economic collapse, anyone can see that these companies have been chock full of executives seemingly void of values and behaving badly. Now I don’t mean to blame the executives personally, since the truth is, they were behaving within the cultural thresholds of their companies, making decisions consistent with their policies, and getting paid according to their compensation plans. It just so happens that the culture, decisions, policies and compensation plans were not at all representative of the values emblazoned on the company’s walls, websites and corporate Codes of Conduct. It is the “Enron Syndrome” all over again: develop a set of “good sounding” altruistic corporate values, use them to recruit and rally the troops, while the executive leadership does whatever they want in direct contradiction, with a damaging ripple effect.

Just pick any of the leading institutions who participated in the securitization of mortgages and other high-risk instruments and have been the recipients of Federal TARP payouts. I guarantee you will see that these companies all state they are committed to some very familiar corporate values, just like AIG:

• People Develop diverse talent. Reward excellence.
• Customer Focus Anticipate their priorities. Exceed their expectations.
• Performance Be accountable. Manage risks. Deliver AIG’s strength.
• Integrity Work honestly. Enhance AIG’s reputation.
• Respect Value all colleagues. Collaborate with one another.
• Entrepreneurship Seize opportunities. Innovate for and with customers.
Source: AIG’s Code of Conduct

The problem is that these values all exist in a vacuum as an idealized set of concepts that have no relationship to, or bearing on the work that people do on a daily basis. Until all of us, executives, managers, board directors, shareholders, workers and citizens all demand a change, as a country we will continue to experience the “Enron-Syndrome”

Recently, a high level executive candidate of mine was interviewing for a pivotal role that reported directly to my client, a CEO. The candidate was a “game changer”, with a history of pointing out how the “status quo” wasn’t cutting it, and implementing improvements. As we moved into checking his references, it was no surprise that I heard about some past difficulties the candidate had with certain individuals. It was clear that over the course of his career he had to take some unpopular stances in order to drive change.

After 20 years in the executive search industry, it never ceases to amaze me how one bad reference can bring a candidate’s viability to a screeching halt. Now look, I understand there are issues that surface in the reference checking process like financial impropriety, integrity, and other potentially sordid details. These should, and will justifiably stop someone’s candidacy cold. However, even this type of information must be vetted through a number of sources in order to conclude that there truly is an issue, and get to a satisfactory level of understanding of the “truth”.

But when information surfaces that is not so clear cut, what do you do? Certainly, it is essential to know if there is a behavioral thread that points to long-standing weaknesses with a candidate. However, it is often the case that negative feedback points to something else entirely.

Betty Davis famously said, “If everyone likes you, you’re pretty dull.” I take a different perspective and say, “if everybody likes you, you are probably mediocre.” Just ask Michael Dell, John Chambers or Jack Welch if over the course of their careers they always won the popular vote. Bottom line, if you’re committed to delivering the extraordinary, you are not going to be everybody’s best friend, especially in this trying economy.

This doesn’t mean that references aren’t important; in fact, quite the contrary. It means you need to look at the reference checking process as your opportunity to create a very complete and holistic picture of a candidate over the course of his or her career.

To this end, I’ve developed Three Cardinal Rules of Reference Checking that have always served me well.

1. If you dig long and deep enough, you can find dirt on God (also the Pope, Mother Teresa, and even Oprah!)

No one is infallible. If someone has a long career, the chances are they’ve stepped on some toes and made mistakes along the way. Look at your own life and career. If you’re like most people, you’ve learned from your mistakes. While you want to understand the mistakes candidates have made, what’s really important is to determine if and what they learned from them. And remember, you can even find dirt on God, so if the candidate appears to be spotless, that fact alone is a red flag!

2. Understand the context in which the information is given.

In order to get to a complete picture about a person, you have to understand the following relationships:

Candidate – reference
Candidate – company
Reference – company

And…

What was going in the company at that particular time

The lesson here is that oftentimes a successful reference check tells you as much or more about the reference and the company than the candidate.

Several years back I had a finalist candidate for a senior position. We were in the middle of the reference checks, and the candidate was ready to sign on the dotted line as a direct report to the CEO. We typically identify and speak for 45-60 minutes with 12 people in our standard reference checking process. We had received consistently balanced feedback, and as we were winding the process down, the CEO talked briefly with a non-supplied reference that had searing things to say about our candidate. Based on this one reference, the CEO withdrew the offer.

However, we had discovered through our process that this non-supplied reference, a career employee at his company, had a history of accusing any of his direct reports who left for employment elsewhere, as being personally disloyal to him, and also to their company. We discovered ample corroborating evidence from multiple sources that this individual would go out of his way to say disparaging remarks about a departing employee, continuing this pattern of spreading malicious gossip long after the employee had left.

Unfortunately, my CEO client didn’t pay attention to understanding the context of the reference!

3. The relevance of the reference is in direct proportion to its age.

The older the information, the less relevance it has. In other words, give more credence to newer information.

A few years ago, I was checking references on a candidate for a senior sales position, and ended up being routed to an unsupplied reference that worked with the candidate early in his career. Typical to a reference with older information, he couldn’t really comment on the important elements in the role for which the candidate was being considered. I then asked if there was anything else he wanted to comment on that he thought was relevant, and much to my shock and surprise he stated that the candidate had exhibited “racist” tendencies and had discriminated against African-American employees! What?!

When someone delivers a bombshell like that, you have to find out more information, so I pressed the individual to explain the specifics of what happened, and also tracked down several other people who were at the company at the time, keeping in mind that the alleged incident occurred 20 years ago.

I discovered that the candidate had indeed not promoted an African American employee. This individual was subsequently dismissed due to poor performance, filed a discrimination lawsuit against my candidate and his company, which ended up being thrown out of court. End of story, a disgruntled employee without a cause. I ended up telling my candidate that something had surfaced around a discrimination lawsuit from his past, but that I had gotten to the bottom of it and determined it was meaningless.

He laughed about it and told me, “You know what’s crazy? When that incident happened I was newly married. You haven’t known this ‘til now, but my wife is African American and as you do know, we’ve had and raised three wonderful children. I never understood this incident when it happened. Thanks for finding out the truth on your own.”

Racist tendencies indeed!

With more people than ever out of work and the candidate pool becoming so deep and wide, it is easy for employers to fall into a false sense of security and just hire people based on their resumes or a recommendation from a good friend. Conducting thorough reference checks has never been more important. However, keep the Three Cardinal Rules of Reference Checking in mind and use them to guide your process. Reference checks should not make or break the hire BUT inform it. Remember, even Bernie Madoff had great references.

In a mid-January 2009 article in Business Week, L. Kevin Kelly, the CEO of Heidrick & Struggles said, “the business model for the executive search industry is broken.” In Heidrick’s most recent earnings call, he elaborated by stating that leadership advisory services represent “the evolution of the search business going forward.”

In their most recent earnings call, Gary Burnison, Korn Ferry’s CEO, outlined one of their key strategic imperatives to “create a more consultative solutions based workforce to drive integrated revenue growth.”

Welcome to my world, Kevin and Gary, and “better late than never”. But please don’t hold it against me if I listen to your pronouncements of a new model of search with a healthy dose of skepticism.

I founded Selker Leadership in 2002 because I knew then that the executive search model was broken, and it needed to be fundamentally altered to deliver actual value. This realization led to the development of our patent-pending PVA™ (Performance Values Assessment™) methodology. (see: Believe What We Say, Not What We Do; How Should I Know? I’m Just the Search Consultant!; What have you done for me lately and why it doesn’t matter, and Values Based Hiring as the Leverage to Building a High-Performance Organization).

I wanted to address the travesty that executives universally report that regardless of whether they’ve used retained or contingency search, internal recruiting, networking or Monster.com, their personal track record at hiring is 50/50. Translation: 50% of the money spent on executive search has resulted in a hiring mistake. (P.S. you will want to multiply your wasted money by a factor of 7X to include the intangible costs.) It really is crazy when you think about it. In your businesses, 50% failure would be unacceptable, so why would you accept it when you are dealing with the most important asset – the talent.

Some firms may augment executive search with leadership services, and change their overall mix of business. This will certainly allow them to maintain their earnings and price/share, and please their partners and shareholders, but it won’t alter the fact that their retained executive search processes are still a crap shoot. Bottom line, until executive search firms begin to seriously address the core processes and methodology of their business, hiring a great executive and leader will continue to be a coin toss.

What’s the solution? Well, first, stop spending your hard earned money on a process that fails at least 50% of the time. The economy is finally forcing many of you to come to this conclusion.

Then, find a search partner who delivers more than empty promises, but the onus is on you. You’ll have to pay greater attention in the selling process, become a discerning buyer who looks for firms that add qualitative value through their processes, and sees the proof by analyzing sample search deliverables and through your own reference checks.

Or, you can just call us. We’ve got a seven year jump on the rest of the crowd.

The recent fervor over the competing proposals from the White House and Congress to cap executive pay for firms who have received TARP assistance has everyone from Carly Forina to Donald Trump weighing in on whether or not this is a good idea. And while it appears the exact details of how compensation will be capped still need to be worked out in negotiations between the administration, Congress and the firms who have received money, on the surface I can say that there is a direct correlation between how executive compensation is structured, and a firm’s (and industry’s) ability to attract and retain their talent base.

As a career executive search professional with over 20 years of experience, I know that there are three main reasons why people ultimately accept or decline a job:

1. The Opportunity Quotient, meaning, the inherent challenge, the ability to have fun, impact a situation, have greater responsibility and work with great people are all compelling reasons to move forward.
2. The Compensation Package, both short-term and long-term allows greater wealth creation and accumulation.
3. There are Personal Reasons that come into play and force one’s decision either to accept or decline an offer. These could be life changing and unforeseen circumstances such as a family illness or a divorce that either does not allow relocation to a new geography, or forces geographic relocation.

Here’s the rules:

 1. The Opportunity Quotient needs to always be a factor. Even if the Compensation Package is astronomical, if the Opportunity Quotient is not there to some degree, a new executive won’t be long in the job.

And no matter how good the Opportunity Quotient is, if the Compensation Package is less than the executive’s current comp, they won’t be coming to your company. This will always be the case except if:

•  The executive has already acquired significant wealth, and the Opportunity Quotient is significant. Then the executive may accept an offer of employment even without a better Compensation Package. (I placed a CEO at an exciting technology company who took a $750,000 a year pay cut and put $1 million of his own money into the company to acquire an additional 10% equity stake. In this case, the executive saw that the long-term wealth creation opportunity outweighed the short-term compensation loss.)

2. People very rarely accept an offer of employment at a lower base salary than they currently have. This will always be the case except if:

• On a comparative basis the long-term wealth creation potential in the new opportunity is far greater than the difference in their new to current base salary.

3. In nearly all cases with most people, Personal Reasons trump everything and either force someone to not accept an offer regardless of how good the Opportunity Quotient or Compensation Package is; or accept an offer even if there isn’t a great Opportunity Quotient or Compensation Package.

Given this, what can we surmise about the compensation caps under consideration for those companies accessing TARP funds?

If $500,000 base salaries for executives are significantly below the median point in the industry, unless the long-term wealth creation opportunities are significantly better, it will be extremely difficult to attract and retain top talent.

Given the mandate that no restricted stock granted can be sold until all loans are paid back to the U.S. Government, unless the potential long-term wealth creation opportunity is better than what can be achieved at a company who has not taken TARP funds, it will be extremely difficult to attract and retain top talent.

Given these factors, on the surface I would conclude that the best bet to attract and retain top executives into these troubled firms is to attract new executives who:

• Look at turning around a high-profile player under intense scrutiny in the financial services sector as a “once in a lifetime” opportunity to transform a company an industry, and help right the U.S.A.’s and the world’s overall financial health and viability; and,
•  Have already achieved a sustained level of wealth creation in their lives; or,
• The executive is a “next step” candidate, e.g. the operations, revenue and/or role are all slightly larger than the executive’s current or past operations, revenue and role; and because of this, the Opportunity Quotient is highly attractive.

Come to think of it, given how badly our current crop of past and recently successful financial executives (measured by how much they’ve been paid) have so totally screwed things up, with their short-term thinking around profits and wealth creation which lined their own pockets, and led to the incredibly bad decisions and actions around risk mitigation that have resulted in the myriad toxic assets on their books, maybe going downstream to the “next step” candidates to lead our beleaguered financial firms isn’t such a bad idea after all!