The Question

Building Better Wall Street Leaders?

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Sunday, September 20, 2009

A major cause of the financial crisis was a failure of leadership in a financial sector that had become focused on its own short-term profits rather than the long-term health of the economy. What does Wall Street have to change to produce better leaders, a different culture and a more long-term focus?

Thomas L. Monahan III is the chairman and chief executive of the Corporate Executive Board, a leading provider of best-practices research, data and tools to more than 120,000 executives and organizations.

The first responsibility of financial sector leaders is not to improve the long-term health of the economy, it is to create value for the owners of their companies. In doing so, they will make a series of decisions that are good for the economy as a whole.

The most obvious way to fail to create value is to go out of business, wiping out your shareholders' capital, as happened to several large financial institutions. Others came perilously close to this fate; in some cases, accepting highly dilutive capital infusions to survive.

So what lessons should industry leaders take from these events as they develop future leaders?

First, it's clear that major financial institutions had not been exhaustive enough in understanding how their portfolios and businesses would fare in a variety of scenarios. Scenario planning -- relentlessly asking "what would happen if?" -- is a particularly essential discipline in financial industry. Too often, leaders assume that the future looks like the past and build their business around assumptions that don't hold up. Leaders in the financial industry clearly didn't model just how vulnerable their businesses were to very plausible scenarios, and thus failed to curtail or counter certain risks.

Second, they can do a better job measuring and understanding the velocity of risk. Financial leaders certainly don't have a monopoly on flawed assumptions, but conditions can change quickly in their industry. The ability to understand the rate at which key risks can develop and swamp the firm is as important as the ability to identify and size these risks. Understanding risk velocity helps ensure that your response systems kick into gear quickly. Several firms might have been saved if boards and management teams had moved more quickly as the first signs of trouble arose.

The phenomenon of increased risk velocity affects leaders across industries as information flows more quickly. Think about the sudden shifts in movie-going behavior demonstrated this summer as people "tweeted" positive and negative reviews immediately and shaped next-day box office receipts. Word of mouth always affected the ultimate popularity of movies but typically took weeks, not hours, to play out.

Raju Narisetti, a managing editor at The Washington Post, is a former founding editor of Mint, a business newspaper in India.

The financial sector in most parts of the world is focused on short-term profit for the simple reason that consistent short-term profitability is important to long-term success in any business. So short-termism isn't necessarily the explanation for the financial problems in past years, and it is wishful thinking on our part to expect that a long-term focus would yield better leaders. To expect Wall Street, on its own, to provide the new leadership that can fundamentally change the way capital markets behave is unrealistic.

The recovery game plans to come out of this crisis are largely spearheaded by institutions and countries that led the world into the crisis -- namely the United States and Britain -- and their solutions don't necessarily reflect the views and suggestions of countries, including some in Europe, let alone Asia, where these problems were less intense or better contained.

Returning financial institutions to medium-term financial stability through sensible lending and borrowing practices, and without bailout crutches, will help countries like the United States and Britain regain some semblance of international financial leadership. And successful recovery will require better coordination among global institutions and regulators. But there is a larger vacuum that won't be filled anytime soon.


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