HBS professor proposes a “financial Mayo Clinic” to treat management excesses
HBS professor Bill Sahlman offers a cogent diagnosis of the problems ailing the US financial system in a new paper. Unfortunately, whatever the merits of his proposed remedy - a new player to monitor management excess – it is unlikely to make much headway against the powerful business and government interests opposed to straying too far from the regulatory status quo.
What he envisions is a monitor that would “take an objective, hard-nosed look at major financial firms on a holistic basis. … [The] new monitor would learn from working with many players in an industry. Auditing the best and worst firms would create powerful tools for improving practice.”
What I am calling for is a Mayo Clinic for large financial services firms with the distinction that the new clinic makes house calls.
In his working paper Management and the Financial Crisis (We Have Met the Enemy and He Is Us … Sahlman analyzes a host of management problems from the perspective of culture, incentives, control and measurement, accounting, and human capital. Opposed to quick fixes, Sahlman is in favor of soul-searching on the part of corporate managers, followed by clear steps to revise prevailing notions of risk and reward.
“I believe that the root cause of bad decision‐making resides in the nexus of culture, incentives, control and measurement, accounting and human capital. When those elements are aligned, good things happen and bad things don’t happen. When they are out of alignment, particularly in competitive industries, really bad things happen.”
“Outside agencies – regulators, securities analysts, ratings agencies, auditors, news media, investors, politicians, and regulators – did not prevent the crisis. Nor did boards of directors. While there are many ways to improve how outside agencies function in our system of corporate governance, I doubt any changes will prevent future crises.”
“Such a monitor would look at an organization like CitiGroup from a holistic perspective. They would do a deep dive into incentives, controls and measurement, accounting, human capital and culture. They would identify key risk areas and core underlying assumptions in and across all business units and across all geographic boundaries. They would identify strengths and weaknesses. They would report first to a committee comprising independent directors and then to management and the whole board. The new monitor might even assess appropriate fees for regulators to charge, given the inherent risks at the company, and the implicit or explicit existence of a government guarantee.”
“There are many challenges associated with creating a new kind of monitor. The first and most obvious is how to attract the right caliber people to the team. If the people are materially less capable than those running the company, the process will be ineffective. The second issue is deciding who pays for the service and how much. I believe the fees should be high for systemically risky companies and that those companies should pay. Because great people are needed in such a new firm, individual compensation should be high and probably based in part on a retrospective assessment of the quality of the analysis. The new monitor should not be a government entity, per se. The board of the new firm should comprise outstanding executives and economists.”
“If a new external monitor for corporations would be useful, a similar body for government policy might be as impactful. For example, wouldn’t it be a good idea to try to assess the inherent incentive effects of any new regulation. How will private and public actors behave in response to shifting rules? How will incentives change over time? What control systems are required? Again, these are questions to which the FDIC, the Federal Reserve, the U.S. Congress, and the President should have sought answers.”
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