Using Business Leadership (2nd edition) An Instructor’s Guide for Effective Teaching

The company's unrelenting stress on growth and its absence of controls helped push execs into unethical behavior

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The company's unrelenting stress on growth and its absence of controls helped push execs into unethical behavior

At Enron, they called her "the Weather Babe." Lynda R. Clemmons, a French and history major from Southern Methodist University, was supposed to be emblematic of the rebels in Enron's freewheeling culture. In 1997, as a 27-year-old gas-and-power trader, she launched an esoteric enterprise in weather derivatives. Within two years, her startup had written $1 billion in weather hedges to protect companies against short-term spikes in the price of power during heat waves and cold snaps.

Clemmons' story made the rounds, from a favorable Harvard Business School case study to The New York Times' business section, where she was pictured in black leather on a Harley-Davidson. She was, after all, a product of what Enron's culture was supposed to be all about: smart, sassy, creative, and risk-taking. And Enron made the most of her business, trumpeting weather derivatives as yet another high-potential deregulated market.

Like other Enron initiatives, this one never lived up to the hype. "It was such a flaky business," says John Olson, an analyst at Sanders Harris Morris in Houston. "They got more mileage out of the public relations than they actually made in earnings." Not exactly the way Enron's "cultural revolution" was supposed to play out. But as everyone knows, with Enron, nothing was quite as it appeared.

CORE VALUES.  For most of the 1990s, CEOs at Old Economy companies struggled to turn slow-moving organizations into nimbler, more flexible outfits. Failure cost chieftains their jobs at General Motors (GM ), Eastman Kodak (EK ), Westinghouse, and a host of other behemoths. Truth is, real transformations are the exception rather than the rule. Changing the core values, the attitudes, the fundamental relationships of a vast organization is overwhelmingly difficult. General Electric's (GE ) Jack Welch and IBM's (IBM ) Louis V. Gerstner Jr. have been lionized for having led two of the very few successful makeovers.

That's why an army of academics and consultants descended on Enron in the late 1990s and held it up as a paragon of management virtue. Enron seemed to have transformed itself from a stodgy regulated utility to a fast-moving enterprise where performance was paramount. The Harvard case study put it simply enough: "Enron's transformation: From gas pipelines to New Economy powerhouse."

If only that were true. Many of the same academics are now scurrying to distill the cultural and leadership lessons from the debacle. Their conclusion so far: Enron didn't fail just because of improper accounting or alleged corruption at the top. It also failed because of its entrepreneurial culture -- the very reason Enron attracted so much attention and acclaim.

The unrelenting emphasis on earnings growth and individual initiative, coupled with a shocking absence of the usual corporate checks and balances, tipped the culture from one that rewarded aggressive strategy to one that increasingly relied on unethical corner-cutting. In the end, too much leeway was given to young, inexperienced managers without the necessary controls to minimize failures. This was a company that simply placed a lot of bad bets on businesses that weren't so promising to begin with.

SKILLING'S MODEL.  Before 1990, Enron was a sleepy, regulated natural-gas company dominated by engineers and hard assets. That year, Enron Chairman Kenneth L. Lay hired McKinsey & Co. partner Jeffrey K. Skilling, who had been advising Lay as a consultant. Skilling's mandate was to build Enron Finance into an asset-light laboratory for financially linked products and services. Skilling expanded the unit into a model of what all of Enron would become. Its success led to his promotion to president in 1997 and to CEO in early 2001.

Skilling's recipe for changing the company was right out of the New Economy playbook. Layers of management were wiped out. Hundreds of outsiders were recruited and encouraged to bring new thinking to a tradition-bound business. The company abolished seniority-based salaries in favor of more highly leveraged compensation that offered huge cash bonuses and stock option grants to top performers. Young people, many just out of undergraduate or MBA programs, were handed extraordinary authority, able to make $5 million decisions without higher approval.

In the new culture, success or failure came remarkably fast. "One potential flaw in the model was that Enron managers tended to move relatively quickly, not within businesses but between businesses," says Jay Conger, a management professor at London Business School who studied Enron. "If you move young people fast in senior-level positions without industry experience and then allow them to make large trading decisions, that is a risky strategy."

"KIDS RUNNING LOOSE."  It was not unusual for execs to change jobs two or three times in as many years. Indeed, turnover from promotions alone was almost 20%. Clemmons, for example, went from analyst, to associate, to manager, then director, and finally to vice-president running her own business, all in seven years.

"In larger companies like IBM and GE, even though there is a movement toward youth, there are still enough older people around to mentor them," says James O'Toole, professor at the Center for Effective Organizations at the University of Southern California. "At Enron, you had a bunch of kids running loose without adult supervision."

In theory, of course, the kids were closely supervised. Skilling often described the new culture as "loose and tight," one of the eight attributes of the successful companies profiled by McKinsey consultants Thomas J. Peters and Robert H. Waterman Jr. in their best-selling book, In Search of Excellence. The idea is to combine tight controls with maximum individual authority to allow entrepreneurship to flourish without the culture edging into chaos.

At Enron, however, the pressure to make the numbers often overwhelmed the pretext of "tight" controls. "The environment was ripe for abuse," says a former manager in Enron's energy services unit. "Nobody at corporate was asking the right questions. It was completely hands-off management. A situation like that requires tight controls. Instead, it was a runaway train."

COMPROMISED RELATIONSHIPS.  The train was supposed to be kept on the tracks partly by an internal risk-management group with a staff of 180 employees to screen proposals and review deals. Many of the unit's employees were MBAs with little perspective and every reason to sign off on deals: Their own performance reviews were partially done by the people whose deals they were approving. The process made honest evaluations virtually impossible. "If your boss was [fudging], and you have never worked anywhere else, you just assume that everybody fudges earnings," says one young Enron control person. "Once you get there and you realized how it was, do you stand up and lose your job? It was scary. It was easy to get into 'Well, everybody else is doing it, so maybe it isn't so bad.'"

It didn't help that Enron's Risk Assessment & Control group was answerable not to the board of directors but to Skilling, who was encouraging all the risk-taking. Another essential "check and balance" in the culture -- Enron's in-house legal staff -- was also compromised because of its reporting relationships. Instead of being centralized at headquarters, it was spread throughout the business units, where it could more easily be co-opted by hard-driving executives. "The business people didn't want to slow down for much," says one former in-house lawyer.

Central to forging a new Enron culture was an unusual performance review system that Skilling adapted from his days at McKinsey. Under this peer-review process, a select group of 20 people were named to a performance-review committee (PRC) to rank more than 400 vice-presidents, then all the directors, and finally all of Enron's managers. The stakes were high because all the rewards were linked to ranking decisions by the PRC, which had to unanimously agree on each person. Managers judged "superior" -- the top 5% -- got bonuses 66% higher than those who got an "excellent" rating, the next 30%. They also got much larger stock option grants.

Although Skilling told Harvard researchers that the system "stopped most of the game playing since it was impossible to kiss 20 asses," other Enron managers say it had the opposite effect. In practice, the system bred a culture in which people were afraid to get crossways with someone who could screw up their reviews. How did managers ensure they passed muster? "You don't object to anything," says one former Enron executive. "The whole culture at the vice-president level and above just became a yes-man culture."

EMPHASIS ON "I."  Several former and current Enron execs say Andrew S. Fastow, the ex-chief financial officer who is at the center of Enron's partnership controversy, had a reputation for exploiting the review system to get back at people who expressed disagreement or criticism. "Andy was such a cutthroat bastard that he would use it against you in the PRC," says one manager. He could filibuster and hold up the group for days, the exec adds, because every decision had to be unanimous. A spokesman for Fastow declined comment.

Although managers were supposed to be graded on teamwork, Enron was actually far more reflective of a survival-of-the-fittest mind-set. The culture was heavily built around star players, such as Clemmons, with little value attached to team-building. The upshot: The organization rewarded highly competitive people who were less likely to share power, authority, or information.

Indeed, some believe the extreme focus on individual ambition undermined any teamwork or institutional commitment. At other companies, by contrast, an emphasis on individual achievement is balanced by a strong focus on process and metrics or a set of guiding values. "In the Enron culture, there was no significant counterbalance," says Jon R. Katzenbach, a consultant and former McKinsey colleague of Skilling who has studied the company. "The lesson is you cannot rely solely on individual achievement to drive your performance over time. Companies with only that one path overemphasize it and run into trouble, switching over to vanity and greed."

A CHEATING CULTURE.  That emphasis on the individual instead of the enterprise may have pushed many to cross the line into unethical behavior. The flaw only grew more pronounced as Enron struggled to meet the wildly optimistic expectations for growth it had set for itself. "You've got someone at the top saying the stock price is the most important thing, which is driven by earnings," says one insider. "Whoever could provide earnings quickly would be promoted."

The employee adds that anyone who questioned suspect deals quickly learned to accept assurances of outside lawyers and accountants. She says there was little scrutiny of whether the earnings were real or how they were booked. The more people pushed the envelope with aggressive accounting, she says, the harder they would have to push the next year. "It's like being a heroin junkie," she says. "How do you go cold turkey?"

The problem is, you can't. "For almost every model or system, there are certain limits," says USC's O'Toole. "It's harder to keep the growth growing and to keep coming up with new ideas. That kind of culture has a subtle encouragement to cut corners and to cheat. You can see everyone else moving forward, and you have to keep up."

Clemmons, who left Enron in March of 2000, isn't so sure. "It's quite clear that there were some accounting issues and bad decisions that had nothing to do with the trading side of the business," she says. "To distill it all down to the culture is utter bulls---." As academics do their revisionist thing, they're not likely to agree.

By John A. Byrne, with Mike France, in New York and with Wendy Zellner in Dallas

“At Enron, the environment was ripe for abuse: The Company’s unrelenting stress on growth and its absence of controls helped push execs into unethical behavior.” Reprinted from February 15, 2002 issue of Business Week by special permission. Copyright © 2002 by The McGraw-Hill Companies, Inc.

The New Yorker: July 22, 2002



Are smart people overrated?
Five years ago, several executives at McKinsey & Company, America's largest and most prestigious management-consulting firm, launched what they called the War for Talent. Thousands of questionnaires were sent to managers across the country. Eighteen companies were singled out for special attention, and the consultants spent up to three days at each firm, interviewing everyone from the C.E.O. down to the human-resources staff. McKinsey wanted to document how the top-performing companies in America differed from other firms in the way they handle matters like hiring and promotion. But, as the consultants sifted through the piles of reports and questionnaires and interview transcripts, they grew convinced that the difference between winners and losers was more profound than they had realized. "We looked at one another and suddenly the light bulb blinked on," the three consultants who headed the project—Ed Michaels, Helen Handfield-Jones, and Beth Axelrod—write in their new book, also called "The War for Talent." The very best companies, they concluded, had leaders who were obsessed with the talent issue. They recruited ceaselessly, finding and hiring as many top performers as possible. They singled out and segregated their stars, rewarding them disproportionately, and pushing them into ever more senior positions. "Bet on the natural athletes, the ones with the strongest intrinsic skills," the authors approvingly quote one senior General Electric executive as saying. "Don't be afraid to promote stars without specifically relevant experience, seemingly over their heads." Success in the modern economy, according to Michaels, Handfield-Jones, and Axelrod, requires "the talent mind-set": the "deep-seated belief that having better talent at all levels is how you outperform your competitors."

This "talent mind-set" is the new orthodoxy of American management. It is the intellectual justification for why such a high premium is placed on degrees from first-tier business schools, and why the compensation packages for top executives have become so lavish. In the modern corporation, the system is considered only as strong as its stars, and, in the past few years, this message has been preached by consultants and management gurus all over the world. None, however, have spread the word quite so ardently as McKinsey, and, of all its clients, one firm took the talent mind-set closest to heart. It was a company where McKinsey conducted twenty separate projects, where McKinsey's billings topped ten million dollars a year, where a McKinsey director regularly attended board meetings, and where the C.E.O. himself was a former McKinsey partner. The company, of course, was Enron.

The Enron scandal is now almost a year old. The reputations of Jeffrey Skilling and Kenneth Lay, the company's two top executives, have been destroyed. Arthur Andersen, Enron's auditor, has been driven out of business, and now investigators have turned their attention to Enron's investment bankers. The one Enron partner that has escaped largely unscathed is McKinsey, which is odd, given that it essentially created the blueprint for the Enron culture. Enron was the ultimate "talent" company. When Skilling started the corporate division known as Enron Capital and Trade, in 1990, he "decided to bring in a steady stream of the very best college and M.B.A. graduates he could find to stock the company with talent," Michaels, Handfield-Jones, and Axelrod tell us. During the nineties, Enron was bringing in two hundred and fifty newly minted M.B.A.s a year. "We had these things called Super Saturdays," one former Enron manager recalls. "I'd interview some of these guys who were fresh out of Harvard, and these kids could blow me out of the water. They knew things I'd never heard of." Once at Enron, the top performers were rewarded inordinately, and promoted without regard for seniority or experience. Enron was a star system. "The only thing that differentiates Enron from our competitors is our people, our talent," Lay, Enron's former chairman and C.E.O., told the McKinsey consultants when they came to the company's headquarters, in Houston. Or, as another senior Enron executive put it to Richard Foster, a McKinsey partner who celebrated Enron in his 2001 book, "Creative Destruction," "We hire very smart people and we pay them more than they think they are worth."

The management of Enron, in other words, did exactly what the consultants at McKinsey said that companies ought to do in order to succeed in the modern economy. It hired and rewarded the very best and the very brightest—and it is now in bankruptcy. The reasons for its collapse are complex, needless to say. But what if Enron failed not in spite of its talent mind-set but because of it? What if smart people are overrated?

At the heart of the McKinsey vision is a process that the War for Talent advocates refer to as "differentiation and affirmation." Employers, they argue, need to sit down once or twice a year and hold a "candid, probing, no-holds-barred debate about each individual," sorting employees into A, B, and C groups. The A's must be challenged and disproportionately rewarded. The B's need to be encouraged and affirmed. The C's need to shape up or be shipped out. Enron followed this advice almost to the letter, setting up internal Performance Review Committees. The members got together twice a year, and graded each person in their section on ten separate criteria, using a scale of one to five. The process was called "rank and yank." Those graded at the top of their unit received bonuses two-thirds higher than those in the next thirty per cent; those who ranked at the bottom received no bonuses and no extra stock options—and in some cases were pushed out.

How should that ranking be done? Unfortunately, the McKinsey consultants spend very little time discussing the matter. One possibility is simply to hire and reward the smartest people. But the link between, say, I.Q. and job performance is distinctly underwhelming. On a scale where 0.1 or below means virtually no correlation and 0.7 or above implies a strong correlation (your height, for example, has a 0.7 correlation with your parents' height), the correlation between I.Q. and occupational success is between 0.2 and 0.3. "What I.Q. doesn't pick up is effectiveness at common-sense sorts of things, especially working with people," Richard Wagner, a psychologist at Florida State University, says. "In terms of how we evaluate schooling, everything is about working by yourself. If you work with someone else, it's called cheating. Once you get out in the real world, everything you do involves working with other people."

Wagner and Robert Sternberg, a psychologist at Yale University, have developed tests of this practical component, which they call "tacit knowledge." Tacit knowledge involves things like knowing how to manage yourself and others, and how to navigate complicated social situations. Here is a question from one of their tests:

You have just been promoted to head of an important department in your organization. The previous head has been transferred to an equivalent position in a less important department. Your understanding of the reason for the move is that the performance of the department as a whole has been mediocre. There have not been any glaring deficiencies, just a perception of the department as so-so rather than very good. Your charge is to shape up the department. Results are expected quickly. Rate the quality of the following strategies for succeeding at your new position.
a) Always delegate to the most junior person who can be trusted with the task.
b) Give your superiors frequent progress reports.
c) Announce a major reorganization of the department that includes getting rid of whomever you believe to be "dead wood."
d) Concentrate more on your people than on the tasks to be done.
e) Make people feel completely responsible for their work.

Wagner finds that how well people do on a test like this predicts how well they will do in the workplace: good managers pick (b) and (e); bad managers tend to pick (c). Yet there's no clear connection between such tacit knowledge and other forms of knowledge and experience. The process of assessing ability in the workplace is a lot messier than it appears.

An employer really wants to assess not potential but performance. Yet that's just as tricky. In "The War for Talent," the authors talk about how the Royal Air Force used the A, B, and C ranking system for its pilots during the Battle of Britain. But ranking fighter pilots—for whom there are a limited and relatively objective set of performance criteria (enemy kills, for example, and the ability to get their formations safely home)—is a lot easier than assessing how the manager of a new unit is doing at, say, marketing or business development. And whom do you ask to rate the manager's performance? Studies show that there is very little correlation between how someone's peers rate him and how his boss rates him. The only rigorous way to assess performance, according to human-resources specialists, is to use criteria that are as specific as possible. Managers are supposed to take detailed notes on their employees throughout the year, in order to remove subjective personal reactions from the process of assessment. You can grade someone's performance only if you know their performance. And, in the freewheeling culture of Enron, this was all but impossible. People deemed "talented" were constantly being pushed into new jobs and given new challenges. Annual turnover from promotions was close to twenty per cent. Lynda Clemmons, the so-called "weather babe" who started Enron's weather derivatives business, jumped, in seven quick years, from trader to associate to manager to director and, finally, to head of her own business unit. How do you evaluate someone's performance in a system where no one is in a job long enough to allow such evaluation?

The answer is that you end up doing performance evaluations that aren't based on performance. Among the many glowing books about Enron written before its fall was the best-seller "Leading the Revolution," by the management consultant Gary Hamel, which tells the story of Lou Pai, who launched Enron's power-trading business. Pai's group began with a disaster: it lost tens of millions of dollars trying to sell electricity to residential consumers in newly deregulated markets. The problem, Hamel explains, is that the markets weren't truly deregulated: "The states that were opening their markets to competition were still setting rules designed to give their traditional utilities big advantages." It doesn't seem to have occurred to anyone that Pai ought to have looked into those rules more carefully before risking millions of dollars. He was promptly given the chance to build the commercial electricity-outsourcing business, where he ran up several more years of heavy losses before cashing out of Enron last year with two hundred and seventy million dollars. Because Pai had "talent," he was given new opportunities, and when he failed at those new opportunities he was given still more opportunities . . . because he had "talent." "At Enron, failure—even of the type that ends up on the front page of the Wall Street Journal—doesn't necessarily sink a career," Hamel writes, as if that were a good thing. Presumably, companies that want to encourage risk-taking must be willing to tolerate mistakes. Yet if talent is defined as something separate from an employee's actual performance, what use is it, exactly?

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