Capital Markets

The Long View

What can finance chiefs learn from history to help navigate the current downturn?
Janet Kersnar and Jason KaraianFebruary 2, 2009

Corporate executives often criticise business-school academics for being remote, relying on outdated research and case studies that bear little relation to current conditions. But as the recession challenges what most managers thought they knew about business cycles — few will have experienced a downturn as severe as this one during their working lives — many are scrambling for guidance. Now the professors’ knowledge of history may provide the key to unlock some of the most vexing issues facing executives today. With this in mind, CFO Europe spoke with leading academics to find out more about past downturns so as to manage more effectively in the months ahead.

“As always,” says Philippe Haspeslagh, dean of the Vlerick Leuven Gent Management School in Belgium, “serious downturns stem from fear and a loss of trust that comes after exuberance.” In this regard, the current recession is not unique, he notes. As in the past, companies’ strategic, financial and operational priorities need to be reassessed, advice on which academics hold forth in the following pages. And for those who still criticise professors for being out of touch, Haspeslagh notes that a dean is not unlike “a CEO of a medium-sized company.” Like a chief exec, he is investigating the impact of the downturn on the business school, learning lessons of his own along the way. As he knows from both experience and study, “credible” external communications and “focusing, energising and reassuring” internal messages are critical in times such as these. “People are scared,” he says.

Bolster the Balance Sheet

Manuel Ammann,

University of St Gallen

Manuel Ammann sees a silver lining in the current crisis, at least for those in his line of work. What’s happening today “isn’t totally inconsistent with what we’ve always taught,” says the professor of finance at the University of St Gallen in Switzerland. The crash is providing “excellent” new case studies that he can use at the lectern for years to come.

One of the “old topics” that Ammann reckons finance chiefs need to think hard about in the coming quarters is capital structure. Determining optimal leverage is a subject the professor never tires of discussing with CFOs. But it’s not as straightforward as many would like. “There’s no such thing as an optimal balance-sheet structure that cuts across entire business cycles,” he says. The challenge is to remain vigilant and adjust balance sheets in concert with business cycles. “If there’s an important lesson of past crises and the current one for CFOs, that’s probably it,” he adds.

It’s a lesson the banks are taking in, which in turn makes it difficult for those that rely on the credit markets to get their own balance sheets in shape. While he acknowledges the frustration that finance chiefs must feel as few of the bailout funds make their way into corporate loans, Ammann, who is also director of the Swiss Institute of Banking and Finance, is more conciliatory. “I wouldn’t deny that there was some irresponsible behaviour [but] the reason the banks need the bailouts is not to lend more, but to fix their balance sheets,” he says. “Whether it’s good for the economy is another matter.”

Remember Japan

Jean-Pierre Lehmann, IMD

Based on his experience of living and working in Japan in the late 1980s and early 1990s, Jean-Pierre Lehmann sees similarities between the country’s “lost decade” after the bursting of its asset-price bubble and the current downturn rocking western economies. Foremost among these similarities, notes the professor of international political economy at Swiss business school IMD, is the “level of hubris.”

In the late 1980s, the country’s financial institutions — convinced that the model developed by corporate Japan marked a paradigm shift — forecast that the economy would soon grow to become the largest in the world. “They were the Muhammad Ali of the global economy, and were not about to accept being knocked out,” as Lehmann describes it. As a result, the crash was met with a period of prolonged denial, delaying a recovery.

There was a similar sense of invincibility among the financial community leading up to the present downturn. But thankfully economies in the West have been faster to acknowledge the severity of their situations, with governments and companies acting aggressively to address the crisis.

That said, executives can still learn much from Japan. Companies such as Toyota “remained at the top, through good times and bad,” Lehmann says. A key element of their success has had to do with incentives. “Whenever something goes wrong, the top takes a 30% or 40% reduction in salaries,” the professor says. Given that these executives are generally paid far less than their western counterparts, the cuts are “more than symbolic,” he adds, but help junior staff accept reductions, while also fostering a sense of loyalty during morale-sapping times.

Today, with excessive executive compensation in the public spotlight yet again, it’s a practice to bear in mind. “If the boss makes 300 times more than the guy on the shop floor, it’s just wrong,” Lehmann says. “The biggest hope that I have is that this crisis knocks some sense into us.”

Grin and Bear It

Valter Lazzari, SDA Bocconi

Valter Lazzari takes a fatalistic view of the recession. For corporate managers, “there is not much I can tell them,” he says.

In terms of its worldwide scope, this downturn is similar to the global recession of 1974, but its severity makes it a problem for public policy rather than private actors. The “output gap” — that is, the shortfall between current activity and potential production — is so large that, practically speaking, the pressure on companies’ top lines is overwhelming, the professor believes. Companies, of course, should try to cover the shortfall with restructuring and cost-cutting, “but this can only achieve so much,” Lazzari says. “It cannot solve the entire problem.” The gap will only be addressed, the professor reckons, by “a huge boost in public spending.”

In the meantime, the professor advises managers to muster their powers of positive thinking. “The situation is so bad that we need a big government,” he says. “Let’s hope that a big government is also a good government. This is a big risk.”

Judge Value

James Dow, London Business School

It’s all about shareholder value. That’s what students in James Dow’s corporate finance course at the London Business School hear time and time again. “You won’t find people who say they don’t believe in it, but it’s quite a radical idea,” he says. “It means that you don’t believe in anything else. It doesn’t mean shareholder value mixed in with other things; it means shareholder value is your objective.”

But as he tells his students, “people don’t object to the concept, they object to applying it,” even when times are good. For example, the reluctance of companies to conserve surplus cash flow is a “clear breach of the shareholder value maxim,” he says. Companies that cave in to stakeholder pressure to invest their cash often skew capital allocation decisions. As he sees it, divisions of a company that are high value but offer low returns because of low risk are sometimes neglected in favour of high-risk, high-return divisions that may offer lower shareholder value. “All companies are guilty of this,” he points out. “That has very dramatic effects.”

All told, management is “never radical enough,” Dow asserts. “You never hear, ‘The best thing I can do as a manager is to strip down the business ruthlessly, wind it up and return as much capital as possible to you, the shareholder,’” he says. “The only way it happens is in a recession, when sick companies get killed off.”

Make Heads Count

Eric Weber, IESE

What does the current recession have in common with past crises? “A massive collapse of confidence at every level,” replies Eric Weber, associate dean and professor of accounting and control at Spanish business school IESE.

Restoring confidence should be a priority, Weber teaches. “If there’s one thing we can learn from past crises — even if they weren’t as bad as this one — it’s that talent is the key to survival,” he claims. Though the professor acknowledges that cutting labour costs is sometimes unavoidable, he advises firms to “clean out the ‘tail’ of the organisation instead of just reducing everything by a certain percentage.”

For employees, “more than ever, they have to understand that they work at a solid company with a future that depends on them,” he says. If internal confidence is not bolstered, a company’s best people will move, resulting in “a regression to the mediocre mean.” The market for skilled people is always active, he adds. “There are a lot of firms out there circling like sharks, looking for companies that let their talent go.”

A hiring freeze shouldn’t mean that companies also curtail training, succession planning or even recruiting activities, Weber says. “There are lots of companies that are having a hard time but still keep the ball rolling on the development of talent,” he notes. “They don’t want to be caught on the wrong side of the war for talent when the crisis is over.”

Plan for Battle

Marc Buelens, Vlerick Leuven Gent Management School

Students are much more receptive these days, according to Marc Buelens, a professor of management and organisation at the Vlerick Leuven Gent Management School in Belgium. “When everyone becomes rich without trying, they don’t need business professors,” he says. “Now they think they can learn something from what happened ten or 20 years ago.”

In this regard, the current recession follows the “classic” model, Buelens notes. “It’s much deeper than previous ones, but it’s a classic downturn.” In thinking about the past, the professor has developed a nine-point plan of practical advice for managing in a recession. (See “Recession Survival Guide” at the end of this article.) He rattles off the list from memory to rapt audiences.

Jason Karaian is deputy editor
and Janet Kersnar is editor-in-chief at CFO Europe.

Recession Survival Guide

  • Keep it simple.

    Focus on a few, simple guiding principles.

  • Speed it up.

    Be more responsive to clients. This is why simplicity is important: complex business models are slow to adapt.

  • Stay loyal to fundamentals.

    This is not the time to change your strategy.

  • There is no substitute for courage.

    Intelligence, vision or mathematical models will take managers only so far.

  • Cut from high to low, when it comes to labour.
  • Keep communicating, both internally and externally. Address rumours immediately.
  • Make no idle or empty promises.
  • Split the company into small, self-contained units.

    If one unit has to go, the system still survives. Economies of scale can come later.

  • Put the best people onto the biggest opportunities, not the worst problems.