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Economics & Finance

How to avert a financial crisis: why anticipation and management go a long way

Companies are overreacting to the economic downturn but, had they been better prepared in the first place, they wouldn’t find themselves in such a fix. This is according to Ludo Van der Heyden, INSEAD Professor of Technology and Operations Management.

“I think knee-jerk reactions very often are the result of the fact that you have been in some way not watching things and that you’ve not been anticipating things. If you anticipate things, you don’t need to (react like this).”

Pointing to research in the area of social sciences, Van der Heyden adds that a sequence of small steps is easier to manage than one big step. A good example in government, he says, is the European Union project, which consisted of many small steps leading to one big stride at the end. He adds that even their so-called crises become relatively minor with time, and with the successful handling of every ‘crisis’ event, the confidence grows that further crises will be managed.

The lack of foresight that led to the current crisis, Van der Heyden says, boils down to poor management first, left unchecked by poor corporate governance, and finally magnified by poor regulatory governance. “Some people knew what was happening but the herd instinct was too great. The money was too tempting which caused people to lose their common sense.”

He adds: “I think we are basically in what I call a hole of a failure of governing management. If you look at the US, (it) just had the biggest corporate governance reform that was meant to end crises such as the one we are living. The Sarbanes-Oxley reforms came as a reaction to Enron. We now know that a big opportunity was missed to put governance in a more central place – governance as a way of motivating managers and also disciplining them.”

“And I think the US governance model has failed us,” he argues. “It has been too financial and too ideological, with the surprise outcome that shareholders actually incentivised managers to be more short term than they would otherwise have been. That has been a major element in the crisis.”

While many companies are hurting, Van der Heyden believes that family businesses in particular have been relatively shielded from the financial crisis (which is not to say that all family firms have weathered the crisis). He says, on average, they have not overreacted and, indeed, many have managed to stay the course while absorbing the losses.

“Family businesses are more anticipative anyway than publicly-listed firms. They have a longer-term horizon, react less in a ‘bang bang’ way, and are more focused …  It has been shown that family businesses waste less money on unrelated acquisitions, because families are prudent and do not invest in businesses they do not understand.”

Too many business values disappeared due to the lure of money and wealth, Van der Heyden says, but he believes there is a way to restore the balance: it starts with recognising the importance of fairness in business. “That business has to be fair and has to be managed fairly is the central notion of that proposition. The reason is because fairness is a necessary condition for sustainable performance.”

“There have been so many violations in this financial crisis of a lack of fairness, in goals and objectives, also in the processes and we've seen the results … I think the crisis, in that sense hopefully, will be a revolution and restore the notion of responsibility of management towards society – that you can't enrich yourself at the expense of society.  So you have to produce value, and wasteful management should be punished. Certainly social responsibility will survive the crisis …”

Still, there are other lessons that can be learnt from the crisis, one of which is putting in place a corporate holding structure. “The GEs will come out of this crisis in a much better way because they do not have all their eggs in the same basket. So the notion of the portfolio – the famous holding structure which is so decried for being inefficient – is, in my view, one way to mitigate the risk in a business sense.”

Another lesson learnt will be the importance of corporate governance. “I think transparency will be increased … we should never forget that a whole banking sector was built offline from the balance sheet. This, I think, will no longer be (the case). And what was the principal reason? Because the whole idea was to keep it secret from scrutiny and separate from the regulators.”

Even so, Van der Heyden believes we should come out of the crisis in better shape than before. “Maybe I'm a positive-minded person but I see good parts of this crisis. There was too much nonsense in business and perhaps there was – maybe I should eliminate the ‘perhaps’ – there was some nonsense in our teaching as well, (in advocating) that managers ought to live and die for the shareholder. Well, we are dying alright …”

“We, as teachers, should look inwards and say what is our analysis, what's our diagnosis and what could we have done differently? What do we need to do differently in the future to reduce the probability of this happening? Are we learning the right lessons? Because it's a bloody mess that we could do without and, primarily, because the people who suffer the most are not the people responsible for it.”

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