Credit Rating Agencies

Roger Lowenstein has a great new article in this week's NYT magazine about the role that the credit rating agencies played in the mortgage meltdown. He speaks at length about the conflict of interest that the credit rating agencies face, since they collect fees from the very clients that they are evaluating. Of course, these conflicts have always existed, but Lowenstein explains why the conflicts are most pronounced and worrisome when it comes to mortgage-backed securities, as opposed to corporate bonds:

The evidence on whether rating agencies bend to the bankers’ will is mixed. The agencies do not deny that a conflict exists, but they assert that they are keen to the dangers and minimize them. For instance, they do not reward analysts on the basis of whether they approve deals. No smoking gun, no conspiratorial e-mail message, has surfaced to suggest that they are lying. But in structured finance, the agencies face pressures that did not exist when John Moody was rating railroads. On the traditional side of the business, Moody’s has thousands of clients (virtually every corporation and municipality that sells bonds). No one of them has much clout. But in structured finance, a handful of banks return again and again, paying much bigger fees. A deal the size of XYZ can bring Moody’s $200,000 and more for complicated deals. And the banks pay only if Moody’s delivers the desired rating. Tom McGuire, the Jesuit theologian who ran Moody’s through the mid-’90s, says this arrangement is unhealthy. If Moody’s and a client bank don’t see eye to eye, the bank can either tweak the numbers or try its luck with a competitor like S.&P., a process known as “ratings shopping.”

Oil Bubble?

I'm not an expert on the crude oil market, but naturally, we are all very interested observers. I was struck by this recent article in the Wall Street Journal, in which a number of people express the argument that we are in the midst of a massive bubble in the oil market. It will be interesting to watch this play out over the coming months and years.

Inside-Outsiders

One of my mentors, Joe Bower, has published new research on the very important topic of CEO succession. In his new work, Bower argues that firms should aspire to elevate "inside-outsiders" to the CEO post. Here is Bower's explanation:

The answer to problems with CEO succession is what I call inside-outsiders. These are men and women who have performed well and risen high, but have maintained their objectivity. They are aware ofhow much change is needed to sustain success or turn around a failure, but they also know the organization, its culture, and its people. They can do more than bring in consultants or make across-the-board cuts. Beyond getting short-term profits, they can build for future growth. These unusual people are often found at the periphery of the organization, managing new businesses or new markets.

The idea is that companies should try to find someone who combines the experience and knowledge of a typical insider with the fresh perspective and divergent thinking typical of an outside hire. I think it's good advice, and it's particularly interesting to note that these people often may have spent a great deal of time at the periphery of the organization, forging into new markets, launching new products, or coming up with entirely new business models. Those experiences at the periphery expose executives to new ways of thinking and give them a fresh perspective on deeply held assumptions and mental models to which many insiders perhaps become overly wedded over the years.

Capitalizing on a Recession?

Can companies actually grow stronger during a recession? What can they do to capitalize on the problems that their rivals encounter during tough economic times? Suppose you have a sturdy balance sheet, low debt, and plentiful amounts of cash. How can you employ these strengths to take on rivals who have been weakened considerably?

First, invest heavily in research and development now so that new products and services are ready for launch as the economy begins to grow again. Your competitors may be inclined to cut R&D, particularly if they face high interest payments, substantial drops in revenue, and the like. If so, your acceleration of investment now will yield a strong product advantage in the coming years.

Second, spend some time learning about the customers of your weakest competitors. You might be inclined to go after their largest and most attractive clients. However, be aware that your rivals are probably working desperately to save those customers. They might not, however, have the time and resources to focus on smaller clients. Focus your attention on these potential new customers, particularly those with attractive growth prospects and strong balance sheets.

Third, identify your most critical suppliers and distributors, and determine if any face the possibility of severe impairment to their business due to the economic downturn. Assess the risk to your business if they should falter badly or even fail completely. Then, examine ways in which you might help those supplies and distributors weather the downturn. Even the smallest gesture can sometimes build an enduring loyalty that will pay off for years to come.

Finally, think carefully about your talent needs. As weak companies lay off employees, many good people will find themselves searching for work. Other skilled workers may still have a job, but they may be disenchanted with their struggling firms. Capitalize on this opportunity to identify and attract talented employees, while slack exists in the labor market.

I'm reminded of the importance of considering these questions when I read Steven Jobs' recent quotes about Apple's strategy in the days and months ahead. Jobs promises to expand the firm's research and development efforts this year, even if economic growth does turn negative. Here is what he told Fortune magazine a few weeks ago, reflecting on the last recession as well as the current economic climate: "In fact we were going to up our R&D budget so that we would be ahead of our competitors when the downturn was over. And that's exactly what we did. And it worked. And that's exactly what we'll do this time." Of course, Apple sits in an enviable position. They have an impressive balance sheet, mountains of cash, and no debt. If your firm also finds itself in such a position of strength, remember that it too can use the recession to become even stronger relative to the competition.

Deciding how to Decide

Noted political scientist and former Assistant Secretary of Defense Joseph Nye applies my framework on decision-making in the opening to a commentary in yesterday's Financial Times. It's an interesting read, regardless of where you stand on the political spectrum.

Guest Post: Leadership Training Through Virtual Worlds

The rise of virtual worlds like Second Life and World of Warcraft has led to innovative new ways to train corporate leaders. In a virtual world, people are represented by avatars and can practice their skills in a variety of settings with other professionals. This is a cost-effective way to train a large amount of people in various situations. In short, this is business training of the future.

While many video game aficionados were always told that their hobbies were pointless, even the youngest players are gaining leadership training without realizing it. John Seely Brown and Douglas Thomas of Wired magazine write:

When role-playing gamers team up to undertake a quest, they often need to attempt particularly difficult challenges repeatedly until they find a blend of skills, talents, and actions that allows them to succeed. This process brings about a profound shift in how they perceive and react to the world around them.

They become more flexible in their thinking and more sensitive to social cues. The fact that they don't think of gameplay as training is crucial. Once the experience is explicitly educational, it becomes about developing compartmentalized skills and loses its power to permeate the player's behavior patterns and worldview.

It isn't just the "accidental" training that companies are interested in, however. The aforementioned Second Life serves as a training ground and collaboration tool for many different industries. The Coalition Connection, for example, is a University of Maryland project that provides virtual training for a group of emergency responders.

Is this new age in leadership training free of problems? Certainly not, as there are cultural and technical obstacles people must overcome. Not everyone is Web-savvy and trained in PC gaming, after all. However, more companies are relating virtual world training to their bottom line. It is extremely cost effective to undergo this sort of widespread training, especially when remote workers must be brought together.

Elastic Collision is one of many consulting firms that helps businesses to develop their own virtual world presence. As the company states, corporate training sessions can "leverage the educational potential of virtual worlds." Will every company adopt this new technology? Perhaps not, but the most innovative companies already have.


Susan Jacobs is a freelance writer as well as a regular contributor for CollegeDegree.com, a site helping students select an online college degree. Susan invites your questions, comments and freelancing job inquiries at her email address susan.jacobs45@gmail.com.