Doing the Right Thing Introduction and Lessons in

Doing the Right Thing: Introduction and Lessons in Ethics and Leadership from Enron and Worldcom MGT 5531, Class 1 January, 2011

Agenda w Course introduction – Topics, readings – Activities w Team Class Assignments w Ethics Revisited: Enron & Worldcom – What have we learned already? – Is there any more to learn? • About how the world works? • About how we think? • About ourselves?

Course Highlights w Topics – Thinking like a senior executive – Aligning: • structure, strategy and environment • people, purpose and culture – Doing the right thing w Books – Bolman & Deal, Reframing Organizations – Collins, J. Beyond Entrepreneurship: Turning Your Business into an Enduring Great Company. – Gallos, Business Leadership w Activities – Class leadership – Case memos – Final paper

Case Opportunities February 5 Columbia Team: T 3 Philips/Matsushita Team: Cypress Semiconductor Team: Countdown Big/small: Starbucks Team: Resilience Meg Whitman @ e. Bay Team: Team One Paul Levy @ BDMC Team: GE’s Talent Machine: the Making of a CEO Team: Carl Zappos. com 2009 Team: Chhart February 19 March 5 March 19

Paul Levy at Beth Israel Deaconness w Multimedia and print cases. Basically, this tells a story about organizational change as viewed from the perspective of the change agent – in this case Paul Levy, the new CEO of a large Boston teaching hospital that provided quality care but was going broke. The multimedia case includes substantial interview material with Levy, and assorted auxiliary material.

Philips vs. Matsushita w Written case and brief video. The written case is a big picture story of two firms – Philips in the Netherlands, and Matsushita in Japan – who evolved to become global competitors. The case provides a multi-decade historical sweep of how each firm evolved its leadership, strategy, and structure. The video clip shows one of the Philips CEOs talking to an executive class at Harvard.

Zappos. com 2009 w The case chronicles Zappos rise from dot com startup to the net’s dominant player in shoe retailing, with a particular emphasis on how the company manages people and culture. The case ends as Zappos faces the possibility of being acquired by Amazon.

Team Meetings w Syllabus: questions, suggestions w Class leadership: decide on your preferences

Roles for Columbia Case & Day 8 MMT Meeting w w Ron Dittemore – Space Shuttle Program Manager Linda Ham – Mission Manager Don Mc. Cormack – Mission Evaluation Room Manager Rodney Rocha – Debris Assessment Team Co-Chair, NASA Engineer w Pamela Madera – Debris Assessment Team Co-Chair, United Space Alliance Engineer w Calvin Schomburg – Thermal Protection System expert, NASA Engineer

What are the characteristics of an effective manager?

What are the characteristics of an ethical manager?

Enron and Worldcom w What went wrong at Enron and Worldcom? w Could it happen to you?

O’Toole: Realist or Rushmorean? Realist/Contingency: Rushmorean w Leader’s job is to do what’s necessary to achieve leader’s ends and move organization forward w What’s necessary “all depends” w Values-based w Respect followers: expressed through “listening to them, faithfully representing them, pursuing their noblest aspirations, keep promises made to them, and never doing harm to them or their cause” – In a crisis, tough, even tyrannical leadership may be necessary

Realist or Rushmorean? w Which are you? – – Realist? Rushmorean? Some of each A pretending to be B? w Which do you want to be? w Which do you think you need to be?

Just do the right thing? “If everyone will follow their own best instincts – do their own jobs ethically and legally – businesses and business people will be known for what the vast majority truly are: honest, productive, constructive, competent, and deserving of the country’s trust. ----Dick Thornburgh, Former U. S. Attorney General

A Manager Who Agrees: Andrew Fastow, former Chief Financial Officer, Enron

A Manager Who Agrees

“We’re going to make money without having to do anything but the right thing. ” --Andy Fastow, Chief Financial Officer, Enron [Fastow was indicted in October, 2002, on 98 counts of conspiracy, fraud, money laundering, insider trading and other charges. In a plea bargain this month, he pleaded guilty to two counts of wire and securities fraud, in return for two five-year prison terms. ]

What was the right thing? w CEO Jeff Skilling describes Enron’s values

Enron’s Values

Enron’s Values w Communication w Respect w Integrity w Excellence

Espoused vs. Real Values w Skilling was described by subordinates as a “Darth Vader” who created an environment of fear and cut-throat competition while turning a deaf ear to anyone who offered input he didn’t want to hear. “After Enron’s collapse in late 2001, one of the interviewers, Professor Robert F. Bruner of the University of Virginia, said that Skilling was ‘very smooth, very smooth. ’ But, he added, it later became clear that Skilling was not doing what he said he was doing” (Dewan, 2002, p. C 7).

How Did Enron Get Off Track?

Enron 1985 w Born in merger of Houston Natural Gas and Internorth (Omaha) – changed name to Enron w Ken Lay – born in Tyrone, Missouri, son of a Baptist preacher, with a Ph. D. in economics, became Enron’s first CEO w Largest gas pipeline business in U. S. w Low-cost producer with economies of scale w Slow growth and cyclical profitability dependent on price of gas

As Ken Lay in 1985… w What do you see ahead of you? w What options would you consider for where to take the company? w Would you – Play it safe? – Reach for the stars?

Enron 1985 - 2000 1985 2000 Revenue $10. 2 billion $100 billion Net income $125 million $979 million Market cap $2 billion $96. 0 billion

Changing Vision w Gene Humphrey w Ken Lay w Jeff Skilling

Changing Vision (Gene Humphreys, Ken Lay, Jeff Skilling)

Two Directions In the late 80 s and early 90 s, Enron was evolving in two distinct directions at once: w Merchant (Skilling): buying, selling, making markets – Exploit deregulation and overbuilt existing domestic infrastructure – “Asset light” w International (Rebecca Mark): big capital investments in energy assets (primarily abroad) – Power plant in India – Water in Latin America

Merchant Model w Jeff Skilling

Merchant Model (Jeffrey Skilling)

Weather

Fruits of Enron’s Labors w In September, 2001, a month before the collapse, Enron came in at the 30 th position on Fortune’s list of the 50 fastest growing companies – it was by far the largest company on the list w For six consecutive years through 2000, Enron was voted the most innovative of Fortune’s “most admired companies” – and it was duly hailed by analysts, reporters, and business school professors

Aggressive? PBS Interviewer: A general comment that I've heard about Enron, and to a certain extent about you, [is] that you're very, very smart, very aggressive. You'll lay out your argument, "The rules in California are terrible, " but then once you see what the rules are, you guys push those rules to the edge in an effort to make a buck. Skilling: That's probably fair, yes. Once you set the rules to a marketplace, we adhere to the rules. If that's what you're saying, that's what we do.

Improving Earnings: Enron and California Electricity w “Death Star” and “Load Shift” – create appearance of overload on the power grid, and then get paid to relieve the congestion w Buy capped power ($250 megawatt) in California, sell it outside California (at up to $1200 megawatt w “Ricochet” – buy capped power in CA, sell it to 3 rd party, then buy it back and resell it in CA at a much higher market price

Energy Trading

Improving Earnings: Enron’s Creativity at Work w “Mark to market”Accounting

Improving Earnings: Enron’s Creativity at Work w Selling the dogs – Sell underperforming assets to an “independent” partnership controlled by Fastow – Partnership borrows the money from banks (or other financial institution) – Enron books a profit on the sale and guarantees the loans – Or: sell to a financial institution (e. g. , power barges off Nigeria sold to Merrill Lynch) with a promise to buy back at a premium in 6 months

Improving Earnings: Enron’s Creativity at Work (II) w “Pre-pay” – Enron is paid up-front for promise of future delivery of gas or oil to an “independent entity” controlled by a lender, such as Chase’s “Mahonia” – Mahonia promises to deliver gas to Chase – Chase promises to deliver gas to Enron – No one has to deliver any gas, but Enron gets money now which it books as operating income, and the lender gets its money back later – along with a profit on its energy “sale”

Improving Earnings: Worldcom’s Creativity at Work w Accrual releases w Capitalize line costs

Kotter: What Leaders Really Do w Managers cope with complexity through: – Planning and budgeting – Organizing and staffing – Controlling and problem-solving w Leaders cope with change through: – Setting a direction – Aligning people – Motivating

Enablers: A, B, C, D, E w Enron & Worlcom got a lot of help – from all the best people

A is for Accountants w Arthur Andersen, until the 1990 s, a highly successful and respected gold standard in the accounting business “stamped its approval on the dirty books of Sunbeam, Waste Management, Enron, Global Crossing, Qwest, and World. Com. The scandals that enveloped those corporations alone have cost investors more than $300 billion and have put tens of thousands of people out of work. ” (Business Week, August 12, 2002)

Accountants (II) w 1980: Andersen and other “Big 5” firms derived most of their income from auditing, where professional standards and ethics were central w “Slowly, auditing went from being the soul of the firm to a loss leader used to attract and retain the consulting contracts. Just as the vast riches represented by stock options helped corrupt ethics at some corporations, consulting helped push Andersen and its rivals off course. ” (Business Week, August 12, 2002)

B is for Banks and Brokers w “One of the most sordid aspects of the Enron scandal is the complicity of so many highly regarded Wall Street firms—a complicity that is stunningly documented in internal presentations and e-mails…. They show banks helping Enron mask debt as cash flow from operations and create phony profits at the end of a quarter. They also show almost all of them put money into Fastow's partnerships because of—not in spite of—their potential for abuse. Most of all, the documents show that the banks weren't merely enablers; they were truly Enron's partners in crime. ” (Mc. Lean & Elkind, The Smartest Guys in the Room: The Amazing Rise and Scandalous Fall of Enron)

Banks and Brokers (II) w J. P. Morgan, Citigroup, and Merrill Lynch originally cast themselves as Enron’s victims, but later admitted abetting fraud, paid a total of $366 million in fines, and promised internal reforms

Banks and Brokers (III) w The 1933 Glass-Steagall act mandated separation of banks, brokers, and insurers w The walls of separation gradually crumbled, particularly in the 1980 s as the Federal Reserve carved out growing loopholes w After repeated attempts, Glass-Steagall was finally repealed in 1999

C is for Consultants w Mc. Kinsey & Co. , “the high priest of high-level consulting” worked so closely with Enron that managing partner Rajat Gupta sent his chief lawyer down to Houston after Enron’s collapse to see if the consulting company might be in legal trouble. The lawyer reported that Mc. Kinsey was safe, and Gupta insisted bravely, ” We stand by all the work we did. Beyond that, we can only empathize with the trouble they are going through. It’s a sad thing to see. ” (Business Week, July 8, 2002)

Consultants (II) w When Rajat Gupta became Mc. Kinsey’s managing partner in 1994, “some colleagues argued for keeping Mc. Kinsey small, to safeguard its culture and quality. Gupta was of another mind: He aggressively expanded abroad, opening up far-flung branches throughout Asia and Eastern Europe. In all, he expanded Mc. Kinsey's network to 84 worldwide locations from 58, boosted the consulting staff to 7, 700 from 2, 900, and lifted revenues to $3. 4 billion from $1. 2 billion in 1993. ” (Business Week, July, 2002)

D is for Directors w “[Worldcom’s] board played far too small a role in the life, direction and culture of the company. The Audit Committee did not engage to the extent necessary to understand address the financial issues presented by this large and extremely complex business…. The compensation committee dispensed extraordinarily generous awards without adequate attention to the incentives they created, and presided over enormous loans to Ebbers that we believe were antithetical to shareholder interests and unjustifiable on any basis. [Worldcom Special Investigative Committee. ]

D is for Directors II w Enron’s Board of Directors allowed the company “to engage in high risk accounting, inappropriate conflict of interest transactions, extensive, undisclosed off-the-books activity, and excessive executive compensation” and “was compromised by financial ties between the company and certain Board members. ” (Report of U. S. Senate investigating committee, July, 2002) w “In 2000, over several meetings, the board's compensation committee approved $750 million in cash bonuses to Enron executives [$253 million to top five] in a year when the Houston-based company reported net income of $975 million. ” (Business Week, July 29, 2002)

Directors III w "Whatever else their failings, Enron's non-executive directors were as well qualified as almost any group of outsiders could have been to judge the regulatory and business risks which arose from the company's business. That they failed to do so is testimony to the complexity of the monitoring task. " “(Deakin and Konzelmann, “Learning from Enron. ” Centre for Business Research, Cambridge University, 2003. ) w Yes, they’d been warned about high-risk accounting practices, and they’d voted to waive the ethics policy so Andy Fastow could manage the off-books partnerships, but wasn’t that what made Enron successful: innovation, risk-taking, “new-economy? ”

E is for Everyone Else w In September, 2001, a month before the collapse, Enron came in at the 30 th position on Fortune’s list of the 50 fastest growing companies – it was by far the largest company on the list w For six consecutive years through 2000, Enron was voted the most innovative of Fortune’s “most admired companies” – and it was duly hailed by analysts, reporters, and business school professors

Incentives w Keeping the stock price high and rising was vital to both Enron and Worldcom – but as they grew, that became harder and harder w “Enron is laser-focused on earnings per share and we expect to continue strong earnings performance. ” (Enron Annual Report, 2000) w Enron’s target was 15% growth year-over-year in E. P. S

Incentives (II): Trained and Expected to Lie? w CEOs and CFOs, at Enron, Worldcom and everywhere else, live in a world of turbulence and uncertainty, but they’re rewarded for providing steady growth (in Enron’s case, 15% a year, in Worldcom’s the 42% expense ratio) w “ One bad quarterly earnings report these days and a company’s stock gets hammered. This quarterly vision practically forces senior managers to look for short-cuts that will inflate short-term results at the expense of longterm sustainability. ” (David Batstone) w Enron and Worldcom’s dilemma: they couldn’t afford to miss targets, but dug themselves into ever deeper financial holes in massaging the numbers

To leave, or not to leave [home] – that is the dilemma

Staying Home w Staying home is safe and we’re protected by the anchors of familiar people, surroundings, and expectations w But. . it’s also stultifying – it blocks learning, development, learning who we can become and what we can do

Going to the Frontier w The frontier challenges us, forces us to learn, and breeds innovation w But…we leave behind many of the social and ethical anchors that provide direction w The rules are often fuzzy, and there may be no sheriff in town w So…we’re thrown back on our individual or group moral compass (inculcated by family and culture) to guide us – if that fails, we’re in trouble

What are the qualities of good leadership?

What are the qualities of good leadership? – Two answers Jim Collins, Beyond Entrepreneurship Bolman and Gallos, Reframing Academic Leadership Authenticity Focus Decisiveness Passion Focus Courage Personal touch Wisdom Hard/soft people skills Integrity Communication Ever forward

Leadership… w Is about change and possibility w So it requires willingness to innovate, create, take the risks of going to the frontier w But, how do we know if we’re ready? Do we have the intellectual, personal and ethical capacities that tilt the odds in our favor?

Edgar Schein w “Leadership is intertwined with culture formation, evolution, transformation, and destruction. Culture is created in the first instance by the actions of leaders; culture is also embedded and strengthened by leaders. When culture becomes dysfunctional, leadership is needed to help the group unlearn some of its cultural assumptions and learn new assumptions. The leader of the future must be a perpetual learner. ”

David Batstone w “The person who lives his or her life in pursuit of success – be that measured by wealth, fame, or social status – will be sorely disenchanted with the pot of gold at the end of the rainbow. Success alone cannot satisfy our deepest longings for significance. ”

Andre Delbecq A good company: w Motivated by strong sense of calling w Driven by deep sense of mission w Embraces subsidiarity w Sensitive to human dignity w Committed to stewardship of resources w Is attentive to the common good, justice, needs of the poor