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Interesting article from Steve DeAngelis on Enterprise Resilience Management Blog:
”Prevention Better than Mitigation”
Steve looks at Rent-Way, a company that ultimately had to sell its business to competitor Rent-A-Center after a transparent attempt by its CEO, William E. Morgenstern, to correct the corporate fraud being conducted by executives in the company. Despite inviting the SEC to investigate, firing the culpable executives, and working openly to mitigate secondary and tertiary effects of the illegal activity, the CEO failed in the face of other systemic conditions and horizontal activity: interest rates charged by banks increased as a result of the fraud, shares plummeted within hours of its announcement, and ultimately on the consumer end, high gas prices cut revenues:
In addition to contacting the SEC, Morgenstern and his board fired the culpable executives. They hoped that their openness and quick action would contain the crisis. In Duhigg’s words: “Rent-Way’s own journey, which came to a head last month, offers a chilling lesson: Even the most virtuous decisions have unforeseen, often damaging, consequences, and full disclosure may create as many problems as it solves.”
Adding to the static means failure to anticipate, navigate, and mitigate systemic pressures preemptively. Adding to the static means: operating openly to solve an existing systemic problem, whether in the smaller system — corporation — or the larger system — market, society. One might say that the smaller system was already wracked by systemic forces before Morgenstern acted; but one might also say that the larger system’s systemic forces had already had a hand in shaping the smaller system’s operation. Reactionary measures may work to change the smaller system, but they will prove less effective for changing the larger system: they only reinforce that systemic reality.
The real problem is this: transparency is either an angel or a bogeyman, i.e. a false ideology. Although Mr. Morgenstern, backed by open acknowledgment by the SEC for his efforts, believed that he was being ‘open’ about Rent-Way’s problems, other horizontal forces (investors, financial lenders) saw that this was a corporation wracked by fraud; in addition, another horizontal force (the consumers) saw only high-priced rental products and the higher gas prices that limited the availability of those products. The first group may have seen Rent-Way’s ‘openness’ — following as it did a closed, fraudulent activity — but they also saw other things with it that blurred the image, other avenues for investment. Consumers, on the other hand, may have had absolutely no awareness of Morgenstern’s open activity; or if some did, they also saw various effects on their pocketbooks in addition to that vision of ‘openness.’
In a complex, highly competitive world, any open activity is sure to produce more static, as other forces acknowledge the activity and work against it whether conscientiously or with knee-jerk reactions: competitors, sensationalists, consumers, those who would capitalize on that activity or by reacting to it without concern for the welfare of the original actor. Transparency is not transparency if it operates in only one domain or a handful, because data flows from every direction and modifies the emergence of memes for the receiver. In Once - Upon - A - Time - World, monopolies on data creation, within domains, enabled a semblance of transparency to have the effect that transparency is intended to have; but no more. In Once - Upon - A - Time - World, a fear of monopolies on data creation inspired the hope that a diffusion for data creation would bring on the Golden Age in human civilization; but in the Now, we are seeing that growing levels of static are crippling our ability to respond to systemic problems.
See also: John Robb, In Other Words.
Posted by Curtis Gale Weeks on Dec 14, 2006 01:00 PM
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8 Comments
Transparency allowed consumer and credit market participants to shun a company that had been poorly managed. The system worked perfectly. Transparency is not supposed to be good for people who want to commit fraud and get away with it, so admitting your companies history of fraud is hardly a way out.
Let’s say Mr. Morgenstern had not disclosed the problems. In a culture of transparency, people would eventually sniff out that something is being hidden and the system would work. In a culture that doesn’t value transparency, his fraud riddled company would get the same credit rating as one that is well run, and the system would fail.
I like this idea of “static” in the system. Static is part of the landscape of 5GW. Knowing how to work with it rather than against it, understanding how to use it for advantage, seems important.
RyanLuke: I’m working on a new post that will take a closer look at the term static. I think you will like it! (Hopefully, it’ll be up tomorrow.)
Abu Nopal: I think you have missed one central point of the post: that transparency may prove unwieldy in a ‘static’ world suffering from systemic problems — for solving those problems. Especially in a system which highly values competitiveness, personal ambition, personal success, conflict. Naturally, what we call problems might vary from person to person. Consider the ‘world’ of corporate investors, financial institutions, and Rent-Way; next consider how many CEO’s may not take Morgenstern’s approach to solving a systemic corporate problem, using what happened to Rent-Way as their model; then ponder how much more likely fraud will go unreported when it is discovered internally. (Of course, another CEO might not hide the fraud he discovers, but act covertly or clandestinely to solve it before it can be discovered! — as I’m sure already happens within our relatively resilient American economy.)
The post was not about transparency vs utterly-closed; i.e., not about a false absolute dichotomy. But the post I’m working on for tomorrow will go into this a bit better.
This situation reminds me of a saying by Mark Twain that went something like this:
It is better to keep your mouth shut and have people think you are a fool than to open your mouth and erase all doubt.
I thought I understood your post, unless by static you mean stasis, in which case I didn’t.
Static is a cost but not an overwhelming one. It’s also a reality check. Investors and consumers can sift through background noise, usually better than analysts can. People know how to discount most of what they see as well as read between the lines, so more static is really more information. It only doesn’t seem so to newbies, for whom the noise is too much.
Morgenstern is not supposed to have any good options. If you’re a consultant working for him and your job is to find him a way out, then I’m sorry for you. Normative pressures are supposed to put him up against the wall, faced with only noble or ignoble death. The question here can’t be about acoustics, how much static, because that’s roughly a constant (a point I can defend, but with enough difficulty that for now it will just have to stand as a marker of the line between our views). The question has to be about whether and when to apply those normative pressures.
Here is another point where I may have misunderstood you. You do seem to be arguing that normative pressures (for openness) cause debilitating static, in your words “failure to anticipate” etc. You say it’s not about a false absolute dichotomy, fine, but that’s setting up bushido as a straw man for my point of view. Not quite fair.
> (Of course, another CEO might not hide the fraud he
> discovers, but act covertly or clandestinely to solve it
> before it can be discovered! — as I’m sure already happens
> within our relatively resilient American economy.)
Exactly. That’s where the red line is. Morgenstern had to fall on his sword because he blew it. He learned about the problems way too late. More than the fact of fraud itself, this is what creditors were looking at.
One also shouldn’t discount the level of spin in the ERM article. Morgenstern’s decision is mis-characterized as a poor one when it was actually the best one he could make. It led to his company becoming an acquisition target instead of to him doing a perp walk, very good results under the circumstances. The article also fails to consider the activities of short sellers, competitors and others, all of whom act on weakness and who may have known of the problems before Morgenstern did.
His public statements are, of course, for the public.
> “This wasn’t a broken company. And when I found illegal
> activity, I exposed it. But that shouldn’t have ended a
> great company. I don’t know what else we should have done.”
… which amounts to “I’m shocked, shocked” at what happened. I’m certain he knew exactly what kind of fight he was in for. He assessed his situation well, acted well and maintained his own viability as a business man. I suspect that the company was very broken. One doesn’t have a group of executives committing fraud in a company that doesn’t have much deeper problems.
The error of many analysts, and certain comment posters who depend on rudeness to make their point, is in believing that god neglected to put subtlety in the world before they themselves came along to invent it.
I hope you aren’t referring to me here because I wouldn’t ever want to give that sort of impression. I was directing that Mark Twain quote at Morganstern’s situation.
I was always taught that you don’t air your dirty laundry in public. To me, and I would think to most of his investors Morganstern would have been better served to clean his own house than to throw himself onto the mercy of the SEC. Yes, he probably did the -right- thing, but I don’t think he did the -best- thing. DeAngelis’ point was that if he had built more resilience (possibly more internal transparency) into the company he never would have had to make the decision.
I like the concept of static here. Morganstern’s problem was that when he did go to the SEC it is only the big words like Fraud and Scandal that come through the background noise. Not very liekly to make investors happy. Cleaning his own house he can legally and financially ruin those responsible and still be part of the static. If anything comes out through the static then it is accompanied by Corporate Housecleaning and Enforcement of Ethics!
sorry. Yes I did think you were directing that comment at me. My mistake. At least what I said remains valid for analysts.
> if he had built more resilience (possibly more
> internal transparency) into the company he never
> would have had to make the decision.
To that extent, a good point.
Other than that I can’t think of a response to you that isn’t covered in my previous post. Our differences are clearly laid out.
But I think the key point is not to underestimate the depth of the crisis in the company. The article only gives surface details. There was blood in the water long before 2001. I’m fairly certain that by the time he allegedly found out about the problems, he was already bound to the alter and ready to be sacrificed, but he walked away. I’m impressed and I think the article completely misses the real story.
Let me offer a different example of static for comparison.
Try to look up a road test of any new car on the internet. This is a market in which the unsophisticated retail customer matters much more than the institutional buyer, so the static has a correspondingly larger effect on the market outcome.
But this doesn’t come from an effort at transparency. This is, first, an intentional proliferation of spam and second, an effort to buy off and manipulate as many ‘expert’ voices as possible, something the noise level makes even easier than it was pre-internet.
As a result, consumer reports, with its decidedly house wifey slant, and the manufacturer’s own marketing are the only clear signals left.
But as evidence that this whole thing is bad for the auto makers instead of good for them, the housewifey and institutional markets are the only ones in which they understand the customer well and are able to deliver the right product. Other niches are filled with caricatures instead of smart products.