One of the realities of Principle One: Stay in Business is more than likely someone will put you out of business. As discussed in the article in this series by that name, it could be you or someone else. Unfortunately, one of the entities that can put you out of business involves the courts through legal action, generally filed by the government. Enron, Madoff Investments, Nortel Networks, and Worldcom are some of the headline grabbing companies that have been closed as a result of their willful mismanagement and resulting legal action. Billions of dollars were lost due to these and similar failures in the last several years. Although tragic to the employees, stockholders, and customers, these companies represent a small fraction of the 5,500 publicly traded companies in the United States.
It is highly doubtful that any of the CEOs of these companies planned their demise or even saw it coming at the time that the actual first failure occurred. Instead, the path to failure was probably first started as a “just this once” wink of an eye and ignoring some established processes or regulations. The root cause typically is an attempt to “make the numbers.” The “numbers” can be revenue, expenses, net profit, earnings, or some other financial metric. Much more recently, some individuals at some level in Volkswagen decided to create software that gave the illusion that they could meet emission standards for some of their diesel powered automobiles. This was certainly no accident with incredible consequences.
The fixation with “making the numbers” usually involves the desire to meet investor expectations or to maximize their personal compensation. Although large failures are associated with public companies and Wall Street expectations, private companies with commitments to investors or bank loan covenants can also fall into the “just this one time” trap. Unfortunately, one time typically leads to a repeat performance due to the company’s inability to make up the difference and cover their losses. It is symptomatic of the gambler’s fallacy that essentially states that if the player keeps playing, they can make up their losses. Unfortunately, just like the gambler, it seldom works out for the company. The first occurrence becomes the first step down the slippery slope. It is very hard to climb back up the slide!
With today’s pressure on CEOs to never miss a short-term expectation that is often set by outsiders, it is easy to see how they fall into the trap. On the one hand, they know it is the wrong thing to do, but on the other hand, if they miss the expectation they fear that they may not be around long enough to execute their plan which they are confident will work. Private company CEOs or entrepreneurs feel the same pressure and do not want to provoke the ire of their investors. Unlike many Wall Street institutions that are more interested in promoting stock volatility than actual company long-term viability, private company investors are generally far more patient and understand short-term misses.
Unfortunately, to temper near misses, many companies make knee-jerk reactions as counteractions which can actually cause further damage down the road. Commonly during earning seasons, companies that have missed their revenue targets will announce cost cutting programs aimed at improving their bottom line performance. This action is a convenient but simplistic solution that does not address the root cause of the problem. The logic is simple; if cost cutting is determined to be effective when revenue and earnings were announced, why wasn’t the action taken earlier or did it just “happen” to occur at the same time; hmmmm.
The obvious answer is to avoid starting down the slippery slope in the first place. Take the shot and explain your position and what you plan to do to correct the situation. In virtually every case, you will live to fight another day. As we all have seen time and time again, the cover-up is worse than the crime.