Factors Influencing CEOs of Publicly Traded Companies:: Deviating From Pre-Established Long-Term Strategies in Response to Short-Term Expectations

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CHAPTER 1:

INTRODUCTION TO THE STUDY

Introduction and Executive Summary

The problem addressed in this qualitative study was the practice that CEOs of U.S.-based publicly traded companies abandoned the execution of pre-established long-term strategies (PELTS) for short-term objectives. The purpose of this study was to determine why CEOs abandoned these long-term strategies. This was important of because despite stricter regulations, there have been an increased number of massive failures of U.S-based, publicly traded companies (PTC) since 1980s. This was also accompanied with accelerated CEO turnover, public concerns about CEOs’ performance, and decision choices.

One key indicator of this surge in the progressive massive failures was the number of bankruptcy filings in a 25 years period from 1981 to 2006. According to Carroll and Mui (2008) from 1981 to 2006, 423 U.S. companies with assets of more than $500 million filed for bankruptcy. Their combined assets, at the time of their bankruptcy filings, totaled more than $1.5 trillion on combined annual revenue were almost $830 billion (p. 2). More than half of these companies were publicly traded. Carroll and Mui (2008) continue, Over those twenty-five years, 258 publicly traded companies combined for more than $380 billion in write-offs (p. 2). These numbers do not include the most recent economic crisis of 2008.

Another indicator of these failures and their effect, in the same period of time, was reflected in statistical evidence of publicly traded companies’ higher risk-ratings. Standard & Poors (S&P), for example, provides such ratings on approximately 4,000 publicly traded companies on an annual basis. According to Slywotzky (2007),

In the mid-1980s, over 30 percent of S&P stocks were rated A (high quality, low risk), by the mid-2000, that figure had fallen to 14 percent. During the same period, C rated stocks (low quality, high risk) had risen from 12 percent of the total to 30 percent. (Slywotzky, 2007, p. 4)

The level of risk of publicly traded companies continuously rose with no specific and effective strategies to correct that trend. For example, Slywotzky (2007) wrote that these massive failures of publicly traded companies resulted in large market-value collapses.

He added that

From 1993 to 1998, 10 percent of Fortune 1000 companies lost 25 percent of their market value in one month. From 1998 to 2003, 10 percent dropped 55 percent in one month. And during the last twelve years, 170 of the Fortune 500 lost 50 percent or more of their value over a twelve-month period. (Slywotzky, 2007, p. 5)

This made it more and more difficult for publicly traded companies, experiencing significant devaluation, to raise capital, and executing long-term strategies and according to Slywotzky (2007) recovery from devaluations took longer (p. 5).

Some of these failures could be blamed on new economic principles, the fast and ever-changing nature of the global market, competition, product obsolescence, costs of operations, lack of capital, bad corporate strategies, economic collapse of the market or poor execution of good strategies, and from illegal corporate business practices.

However, the researcher noted from the literature review, that the press, media, and other private and public agencies attributed most of these massive corporate failures to CEOs’ greed and Wall Street. But, the explanation that greed was the main driving factor in these failures was not sufficient to solve or reverse the increased number of massive failures and poor risk ratings of U.S.-based publicly traded companies. But, with regard to putting too much focus on greed as the primary culprit of the collapse, Stiglitz (2010) wrote that

We have to be wary of too facile explanations: too many begin with the excessive greed of the bankers. That may be true, but it doesn’t provide much basis for reform. Bankers acted greedily because they had incentives and opportunities to do so, and that is what has to be changed. Besides, the basis for capitalism is the pursuit of profits: should we blame the bankers for doing (perhaps a little bit better) what everyone in the market economy is supposed to be doing? (Stiglitz, 2010, p. 6)

Melloan (2009) goes even further to remove Wall Street as the culprit to blame for the recent crisis of 2008 and even for the depression of 1930s. He wrote that the 2008 slump was not caused by Wall Street greed (p. 17). He also wrote that Wall Street didn’t bust up the U.S. economy in 1930. The Dow Jones average had recovered most of its two- hundred-points Crash dive of October and November 1929 by April 1930 (p. 14).

But, there was also evidence to suggest that CEOs progressively deviated from their corporations’ pre-established long-term strategies (PELTS) in responding to short-term pressures, possibly in order to satisfy Wall Street’s perceived short-term expectations, to seek favorable analysts’ reports, and to adapt to the changing demographics of investors’ mix. The recognition that business leaders of publicly traded companies manage their corporations to demonstrate short-term earnings on a regular basis was noted by the private as well as governmental institutions. For example, Krehmeyer, Osragh and Schacht (2006) cited the former U.S. Securities and Exchange Commission (SEC) Chairman William H. Donaldson as follows:

In 2003, former U.S. Securities and Exchange Commission (SEC) Chairman William H. Donaldson called upon business leaders at a corporate governance forum "[to] manage the business for long-term results and to get away from the attitude that you’re managing the business out of a straight jacket that has been put upon you to create earnings per share on a regular basis (Krehmeyer, Osragh & Schacht, 2006, p. 3)

This statement by the former chairman of the SEC comes after the bursting of the high- tech bubble of 2000 and confirmed the public awareness of the problem that was addressed in this study.

The events surrounding the high-tech bubble and the massive failures of WorldCom and Enron had a significant effect on the U.S. economy. In these cases, direct intervention by the U.S. government was necessary, creating more regulations to protect not only shareholders but the U.S. economy at large. On June 29, 2002, President G. W. Bush said that he wanted tough standards after WorldCom and Enron scandals and he pressed congress to pass a 10-point plan proposed in March of 2002 to improve corporate responsibility (CNNMOney.com, Bush: Criminal CEOs need Jail, June 29, 2002, p. 3).

The Sarbanes Oxley Act, a bill that was signed by congress and President G.W. Bush in 2002, consisted of regulations to enable better audits of company’s finances. It was created to remedy weaknesses in accounting and corporate governance exposed by massive fraud at Enron Corp. and other firms (Fletcher & Plette, 2008, p. 1).

Along these lines, in response to the president’s message about tough standards, former New York Attorney General Eliot Spitzer, Wall Street’s key prosecutor, forced many reforms and major changes in the investment banking industry years before the collapse of that industry market in 2008. He discovered then that Wall Street’s analysts, mutual funds managers and brokerage firm’s use unethical and greedy practices that putting ordinary investors at a major disadvantage (Wiener, 2005, p. 449).

Weiner (2005) stated that

On April 28, 2003, Spitzer, along with the SEC chairman William Donaldson and other state securities regulators, announced a $1.4 billion agreement where ten of Wall Street’s largest investment banks accepted fines and reforms to settle allegations that they put out biased stock research during the stock-market bubble of the late 1990s...Among the key points in the settlement, Wall Street was required to put together an independent research fund that would provide unbiased analysis of the financial markets, to set up an investor-education program, to tally the performance of analysts each quarter, and to end the practice of using hot IPOs to curry favor with executives and board members of prospective investment-banking clients. (Weiner, 2005, p. 449)

Despite, the increased number of new rules and regulations, the increased scrutiny on CEOs and the intense attention to business practices to protect against the surge of failures in publicly traded companies, the events of the 2008 crisis proved that deeper understanding and better strategies had to be developed to address this surge.

As result of the more recent financial crisis of 2008, taxpayers’ liabilities were expected to exceed $14 trillion within a year (Ritholtz, 2009). Ritholtz (2009) said that

As of this writing, the response to the credit crunch, housing collapse, and recession by various and sundry of government agencies had rung up over $14 trillion in taxpayers’ liabilities, including bailouts of Fannie Mae and Freddie Mac, General Motors and Chrysler, American International Group (AIG), Bank of America, and Citigroup. It has forced capital injections into other major banks, and government-engineered mergers involving once-vaunted firms Bear Stearns, Goldman Sachs, Morgan Stanley, Merrill Lynch, and Washington Mutual. (Ritholtz, 2009, p. 6)

These massive numbers significantly affected the U.S. economy, the investment community, shareholders, labor force and loss of jobs, and the global market. Much of the financial crisis of 2008 was attributed to unregulated OTC derivatives. The use of OTC derivatives, a highly misunderstood term, but much written about during the financial crisis of 2008, posed many challenges on the public market. According to Spence (1999)

OTC or ‘over-the-counter’ derivatives are bilateral transactions that are privately negotiated and settled off-exchange. Derivatives are by definition ‘derive from something else’. They can be derived from (‘written on’) any underlying instrument or asset, provided that a valuation of that underlying instrument can be agreed by the two parties to the contract. (Spence, 1999, p. 54)

There were warnings about the potential outcome of unregulated practices in the public market of OTC derivatives. In 1999, Brooksley Born, then the chairman of the Commodity Futures Trading Commission (CFTC) warned about the risks to the public of such practices and fought to make changes.

In the 1990s the head of the Commodity Futures Trading Commission, Brooksley Born, had called for such regulations-a concern that took on urgency after the New York Federal Reserve Bank engineered the 1998 bailout of Long-Term Capital Management, a hedge fund whose trillion-dollar-plus failure threatened to bring to bring down the entire global financial market. (Stiglitz, 2009, p. 148)

Brooksley Born's efforts failed. Actually, the Commodity Modernization Act of 2000 was designed to guarantee that derivatives remained unregulated (Stiglitz, 2009, p.148). The conclusion from these reviews is that eventually there was recognition that the approach to unregulated derivatives’ practices that were highly based on short-term incentives to financial institution worked against long-term stability of these institutions. According to Stiglitz (2009) Greenspan finally admitted that there was a flaw to his approach to regulation, he said it was because the banks had done such as bad job looking after their own interests. He could not believe that they would undertake risks that that would put their very existence in jeopardy, and he evidently did not understand the importance of incentives-which encouraged excessive risk-taking. (p. 149).

In late 2009, after several major banks were bailed out with taxpayer’s money. President Barack Obama criticized ‘the short-term’ strategies employed by CEOs of some of these large banks. On December 14, 2009, in a meeting with Wall Street bankers at the White House, the President urged major U.S. bank leaders to help taxpayers who had bolstered their banks with federal bailouts. The President stated the following:

Short-term gains are of little value to our banks if they lead to long-term chaos in the economy...I made very clear that I have no intention of letting their lobbyists thwart reforms necessary to protect the American people. (Liberto, 2009)

This strengthened the publics’ overall impression that the leaders and CEOs of these large publicly traded institutions leaned toward decisions that were based on short-term gains and thus abandoned pre-established long-term strategies. The failures that preceded the collapse of 2008 had a dramatic effect on the U.S. economy as well. For example, the high-tech bubble of 2000, according to Stiglitz (2010), resulted in tech stock prices drop by 78% between March of 2000 and October of 2002. It had an overall effect on the economy and the recession of 2001, since much of the investments were in tech stock (p. 4).

The market value of some of the largest U.S.-based publicly traded companies dropped significantly in this same period. According to Hartman (2004) companies that were affected were HP, IBM, Cisco Systems, AOL Time Warner, The Gap, and Charles Schwab (Hartman, 2004, p. 5). He added that actually

257 public companies, with a total of $258 billion in assets, declared bankruptcy in 2001, eclipsing the 2000 record of 176 companies with $95 billion in assets. By May 2002, 67 more companies had gone bust, among them Fortune 500 enterprises, for which failure had always seemed out of the question. (Hartman, 2004, p. 5)

At the time of the high-tech bubble, this represented a devastating blow to the U.S economy where failures of Fortune 500 companies were thought to be impossible.

Leaders of governmental and educational institutions and executives of large publicly traded companies emphasized again the importance of long-term strategies. For example Carly Fiorina (2006), the former CEO of Hewlett Packard, stated the following:

The role of a CEO is to think about years, not quarters. Quarterly results are a measure of past decisions and actions, and a CEO must always face forward. Sustainable performance and operational excellence must be achieved and choices must be made for the long-term health of the business. I do not believe a CEO should manage quarterly earnings or manage the stock price. A CEO’s job is to manage the company and to do so with discipline by making the right choices, building the required capability, setting appropriate goals and creating a culture of excellence, accountability and integrity. (Fiorina, 2006, p. 224)

This quote contains a consistent message about the benefits of long-term strategies and CEOs are warned to stay away from decisions, solely to manage short-term objectives. Fiorina also believed that part of a CEO’s job is to create a culture of excellence, accountability and integrity. In the case of WorldCom and Enron, CEOs failed to do so and caused massive failures as a result of misconduct and false financial reporting, driven by short-term temptations.

The researcher believed that there was a need to better understand how factors, inherent in the environment of publicly traded companies, influenced CEOs’ decisions to deviate or abandon pre-established long-term strategies (PELTS). Accordingly, the researcher wanted to speak directly to CEOs of selected U.S.-based publicly traded companies to get their perspectives on these factors. Therefore, the researcher employed a sampling method to obtain in-depth face-to-face interviews with CEOs of selected U.S. publicly traded companies.

The environment of Publicly Traded Companies

The researcher provided a short overview of the publicly traded companies’ environment to better understand the factors CEOs face in leading these corporations in challenging economic times. Although it is recognized that managing publicly traded companies requires adjustments, a certain level of expertise, skills, and leadership qualities that were different from those needed to lead privately held companies, the direct relationship between factors influencing CEOs on the strategic decision-making processes, short-term as well as long-term, are not well understood. The environment of publicly traded companies is inherently challenging to CEOs who have to manage several conflicting interest groups.

The pressure on CEOs for short-term performance and managing conflicting interests groups had a resulting effect on CEOs tenure in the last two decades. The rate of failures of CEOs as leaders of publicly traded companies is higher today than it was decades ago and there is evidence to support that CEOs’ turnover is accelerating. Nadler (2007) cited a CEO succession study by Booz Allen Hamilton which found that

15.3% of CEOs worldwide and 16.2% in North America left office in 2005. This represents, according to the study, an increase of 70% globally, and 54% in North America as compared to 1995. The study also reports that a third of the departures occurred before the scheduled succession date, and was due to performance problems. (Nadler, 2007, p. 1)

This only add to the challenging dilemma that CEOs face in setting up priorities and choosing to stay course with long-term strategies or deviating to respond to short-term pressures. In the literature, Wall Street is at times described as having two cultures. For example Levitt (2002) the former chairman of the Security and Exchange Commission (SEC)