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D E W E Y B A L L A N T I N E L L P Bad to Worse: Why Some Companies Survive Corporate Scandals... and Others Don’t Timothy J. Coleman © 2006 Timothy J.

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Presentation on theme: "D E W E Y B A L L A N T I N E L L P Bad to Worse: Why Some Companies Survive Corporate Scandals... and Others Don’t Timothy J. Coleman © 2006 Timothy J."— Presentation transcript:

1 D E W E Y B A L L A N T I N E L L P Bad to Worse: Why Some Companies Survive Corporate Scandals... and Others Don’t Timothy J. Coleman © 2006 Timothy J. Coleman

2 D E W E Y B A L L A N T I N E L L P

3 Enron n1989: Former pipeline company headed by Ken Lay begins transition into commodity trading company. nAug 2000: Stock price hits record high. nDec 2000: Transformation architect Jeff Skilling named CEO. Resigns after six months. nNov 2001: Partnerships run by CFO Andrew Fastow wrought with conflicts of interest result in large losses. nNov-Dec 2001: Company revises five years of financial statements. Files for bankruptcy. nJun 2002: Auditing firm Arthur Andersen convicted of obstruction of justice. nOct 2002: Fastow arrested. Company’s electricity traders indicted. nFeb-Jul 2004: Lay and Skilling indicted.

4 D E W E Y B A L L A N T I N E L L P WorldCom nApr 1998: Long-distance reseller WorldCom, run by Bernard Ebbers, buys MCI for $47 billion. Stock price soars. nJul 2000: Merger with Sprint abandoned due to regulatory issues. nMar 2002: SEC begins investigating accounting practices and loans to executives. Ebbers resigns. nApr-May 2002: Reported profits drop 78%. Ebbers quits. Debt downgraded to junk. nJun 2002: $3.85 billion in expenses revealed as misreported. CFO Scott Sullivan fired. nJul 2002: Company defaults on debt, files for bankruptcy. nAug 2002: Ebbers, Sullivan and accounting officials Myers, Yates indicted.

5 D E W E Y B A L L A N T I N E L L P Adelphia Communications n1999: Company pays $8.5 billion on acquisitions, doubling the company’s size and ballooning its debt. n2000: CEO, John Rigas, buys a controlling interest in the NHL Buffalo Sabres. nMar 2002: Adelphia discloses its provision of collateral for over $2 billion in loans to the Rigas family. nJun 2002: Stock price plummets. Company files for bankruptcy. nJul 2002: Rigas, two sons, and two other company executives arrested and charged with fraud. nJul 2004: CEO John Rigas and CFO Tim Rigas convicted. Sentenced to 15 and 20 years.

6 D E W E Y B A L L A N T I N E L L P The Country Reacts nMedia and public response nInvestigation by DOJ, SEC, Congress, Others nWhite House Corporate Responsibility Initiative nCorporate Fraud Task Force nSarbanes-Oxley Act nProsecution of executives and others

7 D E W E Y B A L L A N T I N E L L P A Deeper Look nFraud can be explained by failures in corporate ethics, greed, inadequate regulatory system. nBut the corporate debacles of the past few years had deeper, more fundamental causes. nWhat did these companies have in common? Fundamental failures in leadership and management. *2004 three-quarter figures annualized Corporate Fraud

8 D E W E Y B A L L A N T I N E L L P Good to Great nRemains a fixture on best-seller lists more than four years after publication. nJim Collins: former management consultant and Stanford professor. nResearch shows most of the stellar firms were led by low-profile CEOs. nJump in performance usually wasn't triggered by a radical strategy shift.

9 D E W E Y B A L L A N T I N E L L P Research Design: Good to Great nIdentified companies that had not always been great, but made the leap to sustained excellence. nUsed public statistical data to identify such companies and their “transition point.” nPerformed a deep analysis of each, to find out what characteristics they shared that distinguished them from comparison companies that had not made a similar leap.

10 D E W E Y B A L L A N T I N E L L P Research Design: Bad to Worse nConducted interviews with federal prosecutors and other government officials. They emphasized that each company we studied: ØWas headed by an “overpowering” or “larger than life” executive; the Board was disengaged. ØWas driven by explosive short-term growth, with an inadequate foundation for the future. ØViewed business, financial, legal problems as a “bump in the road,” not as systemic failures. nExamined public court documents related to each case: ØIndictments ØEvidence ØTrial Transcripts

11 D E W E Y B A L L A N T I N E L L P Conclusions nGood to Great tLevel 5 Leadership tConfront the Brutal Reality tCulture of Discipline tHedgehog Concept nBad to Worse tImperial CEO tDeny, Delude, Defraud tEmperor’s New Clothes tExpansion Without Discipline

12 D E W E Y B A L L A N T I N E L L P Good to Great Principles nLevel Five Leadership: tHighly capable individuals tContributing team members tCompetent managers tEffective leaders tAmbitious but not for themselves

13 D E W E Y B A L L A N T I N E L L P Good to Great Principles nConfront the Brutal Facts (Yet Never Lose Faith): tThe “Stockdale Paradox” tEncourage “dialogue and debate” over “coercion” tDo not ignore “red flag mechanisms.”

14 D E W E Y B A L L A N T I N E L L P Good to Great Principles nHedgehog Concept: tIdentify “one big thing” that: tYou care deeply about; tYou can be the best in the world at tDrives your economic engine tStick to it. What you are deeply passionate about What you can be the best in the world at What drives your economic engine

15 D E W E Y B A L L A N T I N E L L P Good to Great Principles nCulture of Discipline: tSelf-disciplined people tTake disciplined action consistent with the hedgehog concept. The Good-to-Great Matrix of Creative Discipline Hierarchical Organization Great Organization Bureaucratic Organization Start-Up Organization Low High Ethic of Entrepreneurship Culture of Discipline

16 D E W E Y B A L L A N T I N E L L P Good to Great Principles nFirst Who… Then What: tThe right people matter more than vision, strategy or tactics. nTechnology Accelerators: tBecome pioneers in the application of carefully selected technologies that fit within hedgehog concept tAvoid fads and bandwagons.

17 D E W E Y B A L L A N T I N E L L P Level Five Leadership

18 D E W E Y B A L L A N T I N E L L P Level Five Leadership nThe three companies’ leaders were flamboyant personalities that were highly compensated: tEnron’s Ken Lay tWorldCom’s Bernard Ebbers tAdelphia’s John Rigas nNo correlation between executive compensation and company performance nNegative correlation between charismatic leadership and company performance

19 D E W E Y B A L L A N T I N E L L P Imperial CEOs: Lay and Skilling nJeff Skilling became so sure that he was the smartest guy in the room that anyone who disagreed with him was summarily dismissed as just not bright enough to “get it.” nThe broadband business was in complete meltdown. And there were all sorts of other problems that Jeff Skilling as the company's Chief Operating Officer was wrestling with. And in the middle of all this, Ken Lay walks in Jeff Skilling's office holding up fabric swatches for the new G5 $45 million corporate jet he wanted to buy.

20 D E W E Y B A L L A N T I N E L L P Imperial CEO: Bernard Ebbers nWorldCom’s operations centered around a charismatic leader, the imposing former basketball coach Ebbers. If Ebbers was the oracle, Chief Financial Officer Scott Sullivan was his high priest. nIn 2002, Bernard Ebbers was paid a total of $34.5 million in salary, bonus and stock options--nearly nine times the telecom industry median. He received a grade of ‘D’ for pay vs. compensation. nHis assets included: a multimillion- dollar home in Mississippi and his interests in a lumber company, a marina, a golf course, a hotel and several thousand acres of timberland.

21 D E W E Y B A L L A N T I N E L L P Imperial CEO: John Rigas nAdelphia leadership did not place the fate of the company above personal gain: John and Timothy Rigas caused more than $50 million in cash to be transferred to John Rigas for his personal benefit. nEvery year Adelphia's shareholders effectively spent $6,000 for a jet to deliver a Christmas tree to the New York City home of one of founder John Rigas' daughters. (In 2001, when the first conifer was deemed too stubby, a second one was delivered, also by jet.) nSelf-dealing included the use of Adelphia funds to construct a golf course for $12.8 million, pay off personal margin loans and other Rigas family debts, and purchase luxury condominiums in Colorado, Mexico, and New York City for the Rigas Family.

22 D E W E Y B A L L A N T I N E L L P Level 5 Leader: Gillette’s Mockler nDuring tenure as CEO from 1975 to 1991, Coleman Mockler fought off three hostile takeover attempts. nHe and other executives forewent $2.3 billion in potential gains from stock options and golden parachutes to stake company’s future on huge investments in new technology (Sensor and Mach 3). nPublicly shy. Declined to be photographed for cover of Forbes magazine.

23 D E W E Y B A L L A N T I N E L L P Confront the Brutal Reality

24 D E W E Y B A L L A N T I N E L L P Confront the Brutal Reality nConfront the brutal reality... yet never lose faith: The “Stockdale Paradox” nBad to Worse companies denied their problems tIgnored fundamental business, financial, legal problems nBad to Worse companies deluded themselves and the public about the brutal realities tUsed accounting tricks to create the false appearance of unbroken success nBad to Wose companies defrauded their stakeholders tHid the true facts from shareholders, employees and others until it was too late

25 D E W E Y B A L L A N T I N E L L P Deny, Delude, Defraud: Enron nEveryone in broadband knew the stakes involved in pleasing the market. … though they knew full well that they had met their numbers only by using smoke and mirrors, more than a few regarded the illusion as a genuine accomplishment. nWanda Curry was moved off of the Enron Energy Services analysis after she raised questions about the unit’s accounting practices. nKen Lay, 10/23/01: “I and the board are also sure that Andy Fastow has operated in the most ethical and appropriate manner possible. … Our fundamentals are stronger than they have ever been.” Fastow was fired the next day, and Enron filed for bankruptcy Dec. 2nd.

26 D E W E Y B A L L A N T I N E L L P Deny, Delude, Defraud: WorldCom nCFO Scott Sullivan: “We have to meet the market expectation.” nCEO Bernie Ebbers: “We have to hit our numbers this quarter.” nCEO Bernie Ebbers: “We can’t just issue an earnings warning without talking about what we’re doing about it.”

27 D E W E Y B A L L A N T I N E L L P Deny, Delude, Defraud: Adelphia nHe also specifically said, we can’t afford to have a default. And I took it to mean that it was more important to report numbers that showed us in compliance than it was to show the real numbers. nI said, if in fact we’re telling investors that our rebuild percentages are higher than what they actually are, this would be a good opportunity to scale back. … I don’t recall him adjusting the numbers.

28 D E W E Y B A L L A N T I N E L L P Confronted Reality: CA nIn contrast to Bad to Worse companies, Computer Associates confronted the brutal reality. nAfter scope of its scandal became clear, Board conducted independent investigation of accounting fraud. nOusted its CEO and CFO after misrepresentations came to light. n“Got in front of the problem” by recognizing it as a systemic breakdown, not just a bump in the road.

29 D E W E Y B A L L A N T I N E L L P Culture of Discipline The Good-to-Great Matrix of Creative Discipline Hierarchical Organization Great Organization Bureaucratic Organization Start-Up Organization Low High Ethic of Entrepreneurship Culture of Discipline

30 D E W E Y B A L L A N T I N E L L P Culture of Discipline nAs a result of leadership failures and inability to confront the truth, none of our companies created a “culture of ethics.” nSubordinates did not feel free to question what was occurring. nWhen employees or outsiders did question, dissent was squelched. n…but the Emperor had no clothes.

31 D E W E Y B A L L A N T I N E L L P Emperor’s New Clothes: Enron nWhatever Ken Lay wanted the board to okay, they did. nBoard waived its conflict provisions to allow Fastow to run private partnerships that would do business with Enron. nThose who raised alarms about the company’s practices, such as Vincent Kaminski and Wanda Curry, were marginalized within the company. nEnvironment allowed rogue energy traders to manipulate the California energy crisis in “It’s what we do.”

32 D E W E Y B A L L A N T I N E L L P Emperor’s New Clothes: WorldCom nBankruptcy examiner Richard Thornburgh, a former U.S. attorney general, reported that a “board breakdown” at WorldCom had allowed fraud to flourish. nWorldCom funneled investment banking business to Saloman Smith Barney to influence its top telecom analyst, Jack Grubman, who would issue favorable ratings to Worldcom stock then reap compensation from the investment banking business. nWhen accounting employees complained about the practices at Worldcom, Scott Sullivan assured them that “it wouldn’t happen in the future.”

33 D E W E Y B A L L A N T I N E L L P Emperor’s New Clothes: Adelphia nThe Rigas family was able to elect all but one of Adelphia’s directors given that the family controlled almost all of the company’s “Class B” shares. nJohn, Tim and Michael Rigas, as President, CFO and COO, respectively, exercised day-to-day control over Adelphia with almost no board supervision. nThere was no questioning of unprecedented “co-borrowing” loans, which forced Adelphia to assume joint and several liability for new Rigas family loans that benefited only the Rigases.

34 D E W E Y B A L L A N T I N E L L P Culture of Ethics: Lockheed Martin nImplementation of Lockheed’s ethics program involves everyone, from board members to lower-level employees. There are yearly ethics evaluations. nThere is an almost maniacal focus on ethics; Lockheed sets its standards higher than applicable law. nLockheed sees this focus on ethics as a competitive advantage, instead of a barrier the company must overcome.

35 D E W E Y B A L L A N T I N E L L P Hedgehog Concept What you are deeply passionate about What you can be the best in the world at What drives your economic engine

36 D E W E Y B A L L A N T I N E L L P Expansion Without Discipline: Enron nStarted as a small natural gas company. nTurned into a massive “trading company” that had projects around the world, such as trying to become “the world’s largest provider of premium broadband services.” nProjects included disastrous power plant project in Dabhol, India and failed water venture Azurix.

37 D E W E Y B A L L A N T I N E L L P Expansion Without Discipline: Worldcom nCompany started out as long-distance reseller LDDC. Acquisitions: Advantage Cos., MCI and Sprint (attempted). nStrategy: To acquire companies that were building and had built local networks in cities like New York and Chicago and a lot of the cities across the United States. nNo buildup of momentum to keep flywheel moving. Debt accumulation led to “doom loop” symptoms. Disappointing Results New Direction, Program, Leader, Event, Fad or Acquisition Reaction Without Understanding No Buildup, No Accumulated Momentum

38 D E W E Y B A L L A N T I N E L L P Expansion Without Discipline: Adelphia nCompany expanded at breakneck speed, primarily through acquiring other companies. nCapital pressures created by acquisitions put serious financial pressure on company, contributing to environment in which fraud could occur. nConstantly required to raise additional capital as cost of capital skyrocketed.

39 D E W E Y B A L L A N T I N E L L P Issues for Directors How to Avoid Becoming a Bad to Worse Company

40 D E W E Y B A L L A N T I N E L L P Leadership nDoes management, especially the CEO, demonstrate “level 5 leadership,” or are characteristics of the “Imperial CEO” present? nIs management ambitious first and foremost for the company, or first and foremost for themselves? nDoes management deflect credit and accept blame, or accept credit and deflect blame?

41 D E W E Y B A L L A N T I N E L L P Honesty nHas management, and the board, confronted the reality of the company’s position, while remaining optimistic about the future? nAre dialogue and debate encouraged? nAre “red flags” taken seriously, and viewed as important indicators of the ethical strength of the company?

42 D E W E Y B A L L A N T I N E L L P Hedgehog Concept nHas management arrived at an understanding of: tWhat the company cares deeply about tWhat it can be the best in the world at tWhat drives its economic engine nAre management’s strategy and tactics clearly based on that “hedgehog concept”?

43 D E W E Y B A L L A N T I N E L L P Culture nAre all components of the company (board, executives, employees) involved in the creation of a “culture of ethics?” nHas the company taken steps to measure the company’s culture – and the effectiveness of its ethics and compliance program – periodically? nIs there a top-down commitment to remain faithful to the “Hedgehog Concept” and the principles of honesty and leadership already discussed?

44 D E W E Y B A L L A N T I N E L L P Thank You


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