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Wells Fargo And The Lobster In The Pot

11/22/2016

This month brought more bad news to Wells Fargo, as the bank acknowledged that it increased its reserves for litigation expenses by 70 percent to deal with lawsuits from former workers, customers and investors while also dealing with ongoing investigations from the Department of Justice and other governmental regulatory agencies. On top of that, three senators wrote to new CEO Tim Sloan accusing the bank of effectively blacklisting terminated employees who had tried to raise concerns over the banks ethical practices. And in yet another instance of questionable ethical behavior, the bank agreed to
pay $50 million to settle a class action suit against alleged over-charging for mortgage appraisal services.

But a disturbing and unspoken backdrop to this story is that Wells Fargo’s fall from grace is not an isolated aberration, but only the latest in a series of corporate scandals that have betrayed consumer trust and destroyed shareholder value in many large enterprises, including Enron, HealthSouth, Tyco, Arthur Andersen, Siemens, Barclays, General Motors and Volkswagen. Why is unethical corporate behavior so prevalent and what should be done to prevent future falls from grace? The short answers are that CEOs often suffer cultural myopia and outside directors frequently fail to provide adequate oversight.

The insidious nature of corporate cultural breakdowns is that they usually emerge as gradual backsliding from a company’s noble founding vision, rather than as a sudden, reckless ethical breach. In Wells Fargo’s case, as the bank ratcheted up pressure on its employees to meet ever more challenging sales quotas, the incidence of fraudulent activity crept up over time. But much like a lobster in a pot brought to a slow boil, senior executives remained unalarmed, dealing with known transgressions as isolated incidents, while continuing to boast of the bank’s customer-friendly values and superior financial performance.

Volkswagen’s bogus emissions scandal provides another case in point. Prior to his resignation, CEO Martin Winterkorn set extremely ambitious growth targets in an obsessive drive to overtake Toyota and GM as the world’s top-selling automaker, and was well known for his mercurial aversion to hearing bad news from subordinates. It is not hard to see how such CEO mindsets promote a toxic corporate culture of ends justifying the means, dictating organizational decisions on who gets praised, rewarded, promoted or fired. The trouble with incentives is that they work, and Wells Fargo’s and VWs employees reacted accordingly.

Executives and employees deeply immersed in the day-to-day activities of a decaying corporate culture are often unable to see emerging danger signals that are glaringly obvious to an outsider granted access to observe a company’s operations. As a career management consultant, I observed numerous instances where employees accepted dysfunctional or unethical behaviors as “just the way things are done” in their organization. For example, GM’s lobster-in-the-pot undoing was in part caused by “the GM nod,” where managers in a meeting would nod in agreement at the need for corrective actions, but leave the room and do nothing, other than blaming coworkers for management problems. This pervasive cultural norm tragically led to over 100 deaths from a faulty ignition switch design that was known within the corporation for years. Yet recognition of the crucial need to eliminate the GM nod only surfaced after a comprehensive outside review headed by a former U.S. attorney.

It is exactly because an external perspective is essential in detecting and responding to ethical lapses in a corporate culture that outside directors have the need and responsibility to provide such oversight. For example, Wells Fargo’s Corporate Responsibility board subcommittee has the explicit charter of monitoring the company’s reputation generally, including with customers. Its members are all outside directors with distinguished careers and who currently also serve on other corporate and nonprofit boards. This experience should give board members the broad perspective and objectivity to ensure compliance with the firm’s vision and values -- not despite, but because of CEO myopia. Why did they fail?

In my experience advising corporate boards, while outside directors want to do the right thing, they too often remain overly reliant on information fed to them by corporate executives. Since transcripts of board meetings are not public, and Congress chose not to question board members in its recent hearings, we really don’t know precisely what steps Wells Fargo’s board did or didn’t take. But it is not too hard to imagine that the ethics committee was given and accepted assurances from management that the bank was taking appropriate steps to control growing incidents of fraudulent practices.

In retrospect, it would be useful to know whether Wells Fargo’s board had access to complete and timely information on the breadth and duration of the company’s fraudulent behaviors, whether they responded with sufficient rigor, and if not, why not? Under any circumstances, the severe and possibly irreparable damage done to Wells Fargo’s corporate image and market value should prompt all outside directors to reexamine the processes they use in exercising their oversight function. Unless and until all boards ensure compliance with reasonable standards of ethical corporate behaviors by vigilantly and independently seeking information from a variety of sources, we are bound to witness more corporate falls from grace.

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Jumping to the Wrong Conclusions on the AT&T/Time Warner Merger

11/15/2016

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Within hours of the announcement of the proposed AT&T/Time Warner merger last month, Donald Trump weighed in strongly opposing the deal for concentrating too much power in the hands of too few. It’s understandable that Trump would not want the parent of CNN to amass any more market power. But in a rare instance of policy agreement, Hillary Clinton’s surrogates also signaled immediate antitrust concerns with potential adverse consumer impacts, mindful of widespread populist sentiments in the electorate.

On the other side, several business pundits were more bullish, lauding AT&T for responding to the need to do something to strengthen its position in the brutally competitive wireless service provider business, while others suggested now was a good time to secure debt financing to pay for an acquisition, before the Fed raises interest rates. As for Time Warner, its CEO Jeff Bewkes was generally given good marks for securing a higher price for his shareholders than 21 Century Fox was willing to pay two years ago.

But none of these hasty pronouncements get at the crux of what would ultimately make this an attractive deal for these two corporate giants. Simply put, the key question is whether the proposed merger will help AT&T and Time Warner to bring better content more efficiently to more customers, faster and at lower prices than either company could provide on their own. The answer is far from clear.

AT&T’s CEO Randall Stephenson attempted to preempt the chorus of antitrust concerns by noting that the proposed merger is a case of pure vertical integration, marrying a content provider and a telecom distribution services company that have virtually no direct business overlap. In this regard, the Time Warner deal is fundamentally different from AT&T’s offer five years ago to acquire T-Mobile USA, which was blocked by the Justice Department on fears that the proposed horizontal merger would reduce competition and harm consumers.

In retrospect the regulators proved to be right in seeking to protect consumer interests. After being forced to withdraw their acquisition offer, AT&T had to pay a $4 billion breakup fee that T-Mobile used to significantly upgrade its wireless infrastructure. Under the leadership of a new CEO, John Legere, T-Mobile emerged as a fiercely capable competitor, pioneering numerous marketing initiatives giving consumers more flexible mobile services at lower prices. T-Mobile has been growing at AT&T’s expense, adding about 5.5 million new subscribers – nearly three times more than AT&T – over the past eighteen months.

While AT&T has been struggling in the competitive, saturated wireless services market, Time Warner also faces the prospect of growing competition for quality content and consumer engagement from traditional and new players, most dauntingly including Facebook, Google, Amazon and Netflix. So both players have legitimate reasons to seek new ways to strengthen their capabilities and relevance amidst industry transformation.

AT&T’s CEO notes that “the world of distribution and content is converging and we need to move fast … to curate, [and] to format content differently for [emerging] mobile environments.” Can the proposed vertical integration merger fulfill Randall Stephenson’s vision?

Some of the most extraordinarily successful companies in other industries have built their business by exploiting a highly vertically integrated business strategy. Exemplars include Apple, Ikea and Zara, each of whom has been able to deliver superior and unique products to market faster and cheaper, as a result of the extensive assets and capabilities built organically across their value chains over time.

But the strategic context underlying the AT&T/Time Warner deal is vastly different. AT&T has traditionally competed vertically by trying to attract as many customers as possible for non-exclusive products and services sold through its branded distribution channels. Time Warner on the other hand is a horizontal player, attempting to attract as many distributors as possible to deliver its proprietary content to market at the highest possible prices. Putting these two companies together creates significant challenges, which provides a very tenuous path to victory.

Stephenson’s vision is that the AT&T/Time Warner union will be able to create unique products and services faster and more efficiently, positioning the merged companies to become competitively advantaged. But it will have to do so without unduly eroding the profits Time Warner currently earns by selling proprietary content through competing telecom distribution channels, and without incurring the regulatory wrath of the Justice Department, who has already signaled concerns with growing industry concentration. Threading the needle to satisfy all three of these requirements for a successful deal will not be easy.

Wall Street likes businesses with predictable, stable business outlooks. But in assessing the prospects for the proposed merger of AT&T and Time Warner, the reality may be a bit of damned if you do or don’t.

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Wells Fargo And The Lobster In The Pot

Jumping to the Wrong Conclusions on the AT&T/Time Warner Merger

Len Sherman

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