Why do companies fail? Economist Hyman Minsky posits that stability itself breeds instability. When an organization is successful, it becomes increasingly difﬁcult to take new risk. While a company striving to become successful is required constantly to anticipate changing circumstances, these habits are difﬁcult to maintain in the successful market leader. Vision tends inevitably to narrow.
Assumptions are not facts. One once highﬂying technology company was supposed to be able to see into the future, by matching supply and demand trends precisely, in real time, thus proving the ability to generate tightly focused forecasts. The technology worked very well, it seems, but the forecasts did not. The company analysts had not included the ability to adjust the forecasts to reﬂect changes in one key variable: the rate of growth. Company executives believed they had a superior grasp of reality and acted on the information they had, to the company’s disadvantage.
Data is not information. In another company, cash ﬂow was falling and its lenders were insisting on asset sales and deleveraging, along with the appointment of outside advisors. The company, in the waste management sector, had 52 proﬁt centers, and no method of easily aggregating the data into useful information. To make matters even harder to understand, the company thought about its business activity by product line: residential and commercial hauling, and landﬁlls. This method ignored the functional connection between the hauling activity and the company owned landﬁlls. The use of landﬁlls not owned by the company required tipping fees, which signiﬁcantly reduced proﬁtability. Once the advisors rearranged the data by geographic market segment and reduced the number of proﬁt centers, the resulting information made it easy for management to see which assets were not proﬁtable, and sell them forthwith. Instead of forcing a liquidation, their banks were suddenly competing to offer the company new ﬁnancing on much better terms.
Accounting does not equal reality. The subprime meltdown, analyzed ad nauseam elsewhere, provides another example of participants blinded by bad information. One company’s loans were sold into a securitization each quarter, prompting recognition as income of the discounted value of the difference between the expected interest income from the loans, adjusted for expected losses and prepayments, and the interest rate the securitized vehicle would pay to investors. Using the accounting procedure required, the assets resulting from each securitization were capitalized as assets on the balance sheet.
It is easy to see how the company lost sight of the fact that the asset on its books represented only assumptions as to likely future receipts. Its “earnings” showed attractive growth, not because the company was earning more, but because it was valuing the expected future cash ﬂows on ever more aggressive assumptions, to support the stock price. Even its lenders had been caught up in the momentum, lending the company large amounts on an unsecured basis. When the opportunity to securitize dried up and the company had to sell its loans directly to buyers, it could not support itself. Had the company not been blinded by what it believed to be the value of its main asset, the capitalized value of expected future cash ﬂows, its board would have been able to take advantage of an offer to buy the company. Instead they faced liquidation.
Challenge the Status Quo. It is difﬁcult to challenge the status quo and get appropriate attention paid to considering whether the information available matches the nature of the decisions to be made, and more so to persevere in testing data quality and resulting conclusions. Organizations that do not support such questions, however, and perpetuate the making of decisions based on ﬂawed information are often destined to disappear.
Remember that ﬁsh cannot see water, and build the habit of always taking the time to ensure that the information provided, and the assumptions it is based upon, reﬂect the nature of the decisions to be made.
Deborah Midanek Bailey
Deborah is a corporate director and long time restructuring professional.
Deborah has been directly involved in much of the extraordinary innovation that has taken place on Wall Street over the last few decades, and in handling the consequences of its excess. With solid knowledge of capital markets from all points of view and a long record of success in building and rebuilding companies from the bottom up, Deborah focuses relentlessly on defining transitions as positive processes. Not interested in merely preserving companies, organizations and jobs, instead she works to drive them to levels previously unimagined. She has led turnaround teams for diverse companies including Parmalat USA, Mississippi Chemical, and FINOVA. Earlier, she served as CEO of United Companies Financial Corporation and Standard Brands Paint.