Plenary Session on Restoring Public Trust

Thanks to SNHU and Chris and Mary Papoutsy for hosting a plenary session to ask these important questions on ethics and morality.

These are times of great uncertainty worldwide. They are times characterized by speed. Speed of information flow, speed of decision making, speed of implementation. The faster we can access information the faster we want decisions means ever more rapid growth and sometimes maturation of organizations.

Certainly, to me one of the least attractive things about discussions of ethics and morality is the sometimes “righteous indignation” attitudes of the media and of the dangerously uninformed.

We take a kind of glee, don’t we, when the mighty fall.

I am allergic to that kind of knuckle-head thinking because I empathize with just how hard it is to build and run an enterprise day by day with the responsibility of many people’s lives and livelihoods. I guess that I am wired to see the other side of the question, to believe in innocent until proven guilty, to think through the dilemmas of the dark side.

And so far, Out and out RULES haven’t seemed to help, have they?

So perhaps by giving some examples and asking some tough questions, we have a learning moment.

Paul Brontas has just given you some superb food for thought, and I would like to build on several of his points, particularly in thinking about the fiduciary role.

THE ROLE OF INVESTMENT BANKING

Why is it germane to discussions of Ethics and Morality

It’s all about CAPITAL

Peter Drucker definition of capital: “the resources withheld from current consumption and allocated instead to future expectations”

The Content of Investment Banking work:

The investment banker’s role is to connect the sources of capital with the consumers of capital – sometimes this is done in the form of raising capital to put into a new venture, we call this venture capital, sometimes raising capital from the public, a public offering, sometimes from a bank we call this a debt recapitalization, sometimes from investors for ownership succession, often selling or recapitalizing the equity of the business.

INVESTMENT BANKING HAS BUILT IN ETHICAL DILEMMAS

Investment Banker as Intermediary or Principal

Broker or Dealer

Investor or Banker

(so that is a built in conflict-which role are you being asked to play)

So it’s all about capital (from which all good things come…)

Raising it,

Accumulating it

Deploying it, and ultimately

Giving it away… (What do we say about the phenomenon of people who have accumulated the most capital in the world, in history and just gave it away?)

So that is the nature of the work itself:

1. to work with capital users to evaluate their requirements for capital and how they could create surplus capital from it (which we call profit)

2. to work with capital providers – different kinds of capital has different personalities

3. to negotiate, structure , price capital transactions between the providers and consumers of capital…often multiple times.

4. Built in potential conflicts, because for every provider there is a user, for every seller, there is a buyer, so you have built in different points of view, often held very passionately.

Compensation of IB firms is demanded by clients to be outcome oriented, with interests that are aligned to theirs = success fees = large, risky, big profit or loss = behavioral

So there are built in ethical dilemmas in what we do, how we do it, and how we get compensated for it.

What is the style in which the work is done

Each IB project or engagement is a very important thing to that client

TIME AND EFFORT VS. VALUE CREATING ECONOMY

Let’s discuss for a minute the TIME AND EFFORT ECONOMY VERSUS THE ENTREPRENEURIAL ECONOMY

T & E Economy

Employees,

Little control

Strive for guaranteed income

Job security

Value Creating Economy

Entrepreneur

Results Oriented

No job security

No Guaranteed income – wants slice of value created

Employees try to maximize income

Investors try to maximize capital

THE PHYSICS OF THE PUBLIC MARKET and PRIVATE MARKET

Different for the public market, versus the private market

In the public market, these are impersonal, ROI driven transactions…

The public market is a speculative, diversified, liquid market, dominated by large impersonal institutions who are speculative traders. The market is highly regulated for both issuers and investors.

Very difficult to be a participant in the public market to rise above self interest when you are in the swimming pool with sharks all trading on speculative information.

Investment Banking decisions in the public market is driven by price, politics, process.

The PRIVATE MARKET is characterized by concentrated ownership, non diversified, it is completely illiquid, somewhat less regulated.

The owner-manager is often trying to create something of sustainable, lasting value, and is often rising above mere self interest to do it. As a consequence, the successful players in this market often take on the personality of principal owners. Think Patagonia for example, and you’ll know what I mean.

In the private market, Capital transactions are often life transforming transactions

Investment Banking decisions in the private market is based upon TRUST TRUST TRUST.

Each project has great opportunity for learning… you go to school everyday.

In an environment where we all expect things to be done faster and faster

KIND OF FIRM matters – financial supermarket versus boutique --playing field has been absolutely leveled by technology. What are the kinds of people, leaders that you would find in each?

TWO BIGGEST EARTHQUAKES IN capital markets LAST 25 YEARS

1. IN PUBLIC MARKETS

Completion of the movement of the market towards large impersonal institutional investors. These are insurance companies (investing the float), private and public pension plans (TIAA-CREF), endowment managers, and aggregators (like Fidelity). Profound impact on market – move towards larger capitalization firms away from <$1 billion market cap public companies. Who owns these firms? YOU DO. According to Pension Research Council, institutional investors own 68% of the stock of public companies in the US up from 9% in 1950. Karl Marx might find it very ironic that in the worlds largest capitalist society, the workers now own the means of production.

2. In PRIVATE MARKETS

a. The formation, rise, and now complete dominance of the private equity firm and an investor in private companies. What is a private equity firm?

i. Class of investment

ii. LP fund with a limited life

I have been very energized by Professor Beerel in her very articulate writing on the difference in concepts between ethics and morality. She defines immoral as someone who takes actions counter to the current community expectations within a particular time and context.

My experience resonates with that. These are complicated decisions.

I submit to you that the LANDSCAPE that you or your enterprise operates in (T&E/VALUE CREATING, public or private) has a profound impact on morality of decision making.

Why is this important to ethics and morality? Let’s look at the questions raised by just one real life case – clients/friends of mine - have changed the names.

WHITE MOUNTAIN FURNITURE CASE

Aesthetically beautiful designed, appearing to be hand-made line of residential wooden furniture –really almost collectible, multi generational

Kate and Jane

34 years ago in 1972

Room-mates at a local University

Couldn’t find jobs, but enjoyed design and woodworking

Woke up won day with 500 ee’s and $50 million sales, grown at 15% a year highly profitable

40-40-10 ownership no management ownership

Success sharing plan

Open book company

56 years old!

BIG responsibility

How do we assure the longevity of this business beyond just us as individuals?

Other than a nice house and a big wooden boat, all investment in the world is in company

BIG trends

Competitors are BIG companies

Furniture making gone offshore

Biggest furniture seller in world is…W

Consumer wants everyday low prices

Furniture traditionally has high coefficient of labor, so it chases low labor cost

Jane and Kate convene their small Board of Directors:

1. How do we assure the future of the company and achieved some liquidity on our hard earned equity in this company?

2.What are our responsibilities to our stakeholders… to ourselves?

We are all temporary owners. What is the SIGNIFICANCE OF THAT?

Any action we take fills our constituencies with self concerned behavior, what’s going to happen to me? Employee, vendors, customers, management, United Way, local colleges.

But what is best for the longevity of the organization? Staying static is not an option. GM and Ford are proof of that, or if you need more drama, wait until they file for bankruptcy, which I would guess each ultimately will.

Summary

Restoring Public Trust implies that the public ask tough questions, of others…BUT ALSO OF OURSELVES

Who benefits from public or private company decision making?

Who owns these companies?

If you don’t want Jane and Kate to move mfg offshore, does that mean you are willing to return that lamp you bought from W for 19.99 and buy one of theirs for $235?

What Jane and Kate did - not the end of the story, but the end of this chapter—so far.

If you want public company management decisions to be more long term, does that mean you will instruct your TIAA CREF manager to hold onto that stock even after two quarters of operating losses because management is making important long term decisions?

Let’s be very deliberate. Here we are in a higher education setting. Let’s be scholarly before making a judgment on ethics or morality.

Connect the dots. Who benefits? Are you willing to change your behavior accordingly?

Too few CEOs and owner managers have a vision beyond mere self gain.

Some organizations (for profit and not for profit) act oblivious to the responsibility attached to the successes and power that they has acquired. If they do that, together we will reject the free market paradigm and than will be a day of sorrow and woe.

What are the issues in front of us right now that we ought to be thinking about--- what is right and what is wrong in the way that we build capital and in the way that we use up the environment, and in the way that we treat people?

If we can have an ethical community, where is the leadership that is thinking through these issues, not just pointing fingers?

Historically speaking, our market driven society is VERY VERY young.

And I think that it justifies a highly optimistic view of our future by the fact that we are asking questions about ethic and morality that ultimately assures the survival of our socio political system.

Peter Worrell, Managing Director, The Bigelow Company, LLC.
November 8, 2006

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