Business & Credit Opportunities

The good news is that people can move from independence to interdependence. The first step is making a realistic assessment of the management style practiced in the organization today. At work, do you frequently hear, “I don’t care what you think. I’m the boss—so just do it!”? This type of statement, and the thinking and culture behind it, is death to a business and to the possibility of partnerships.

Once you’ve completed all exercises, tally up the totals in the “Yes” and “No” columns. If you answered with a “no” to more than three questions, you may want to think about the independent paradigm of your organization. When leaders value interdependence, they create an environment that encourages involvement. From the boardroom to the shop floor, the more people are involved, the more interaction occurs. With that interaction comes a sense that “we are all in this together,” and information starts to flow freely. The free exchange of information is fundamental to the success of organizations and a cornerstone of creativity. An organization that creates this kind of environment—one that build trust and eliminates fear—moves beyond competition into the zone of creativity and synergy.

An important skill in helping organizations move from independence to interdependence is the ability to achieve consensus. It’s important because consensus drives collaboration between partners. The purpose of using a consensus style of decision making is to create winwin scenarios. Consensus decision making means that all parties feel confident about group decisions and are able to communicate, justify, and defend those decisions to their constituencies.

People achieve a consensus decision through various means; no single way is gospel.When I work with a group, we discuss consensus. Then we build an agreement of what consensus decision making means for this group. This gives the group an opportunity to build a group norm and practice the concept we’ve just discussed. Here are some steps to use when implementing a consensus decision-making style:

• List the mutual goals of the partnership (interest-based needs and wants)
• Identify issues that may prevent the partnership from achieving these goals
• Establish boundaries for working toward the shared goals

According to Stack, Springfield’s success is based on attributes that are the exact opposite of those listed by the telecommunications company employees. While the telecommunications company is still in business, it’s a regulated monopoly. And, not surprisingly, it is clinging to its monopolistic practices by introducing lawsuits to prevent competition from entering its local service market. Clearly its management realizes the company could never compete in an open market, so they’re investing as much as they can into maintaining their independent status quo. In fact, in 2002–03, this company experienced federal investigations into its management and accounting practices. New leadership was brought in to help restore the confidence of customers, employees, and shareholders.

No one at the telecommunications company intended to ignore the ideas of employees. But it’s no mystery what the company really values: control. Adopt a past orientation, maintain the status quo, resist change—and you’ll get a disgruntled workforce, poor productivity, and ultimate loss of control.

Parties will achieve resolution through their joint efforts to discover the best solution. Communication skills are critical. We helped people become better listeners by focusing on a few steps:

Pay close attention to what others are saying. Don’t allow yourself to be distracted by outside influences. Look at your partners when they are talking. Be open to what they’re saying and resist thinking of a retort while they’re talking. After
they’ve spoken, mentally count to ten while you consider how you want to respond. Then respond.

Ask clarifying questions. Try not to compete with your partner. Rather, start by asking clarifying questions: “When you said let’s meet for lunch, I thought you meant at twelve noon. Is that right?” By clarifying, you aren’t forcing your partner to be defensive, but are simply requesting more information.

Paraphrase back to the speaker. Using your own words, repeat what you thought you heard the speaker say. Then ask the speaker if he or she feels you understood the point.

Credit rating agencies try to provide investors with a reliable estimate of credit risk. While S&P’s assessment of credit quality is based on the probability of default, Moody’s uses the product of the probability of default and loss given default, or in other words loss severity, to arrive at a rating. The default probability tracks relative risk over time. When loss severity is estimated, rating agencies consider issue characteristics, the degree of seniority and sector differences. Furthermore, it has to be taken into account that recovery rates vary over time and across jurisdictions. Ultimately, the rating is expected to mirror the future expected loss over time, based on historical experience.

The rating process itself is based on three pillars:

• Evaluation of financial strength with respect to the quantifiable aspects of a particular company’s business;
• Assessment of the management quality and its commitment and ability to maintain a certain credit profile;
• Analysis of the impact of various scenarios on the credit quality of an issuer.

Clearly corporate borrowers have more detailed information about their businesses and credit profiles than do lenders, in particular when they access capital markets to finance their business. Commercial banks usually have a close contact with their clients, thus lending decisions are based on a profound understanding of the borrowers. Because relations between companies and banks tend to be long term, commercial banks are able to monitor the credit quality of a borrower constantly and use covenants to prevent potentially credit-detrimental activities. If necessary, banks can agree to restructure loans in order to recover funds before allowing the company to default.

When companies decide to access the capital markets the relationship between borrower and lender is rather impersonal in the sense that borrowers do not know nor control who lent them the money. Conversely, bond investors often are not able to meet the company management regularly and thus rely primarily on information published by the company itself. Because of this distance between borrowers and lenders, rating agencies’ assessments of the credit quality of an issuer help investors to mitigate the information asymmetry.

Agency ratings are a standard metric of credit quality. Yet the blowup of large corporations like WorldCom, Enron and Parmalat has raised questions about the timeliness of rating changes. Nevertheless, agency ratings are a convenient, widely used indicator for a borrower’s ability to service its liabilities. In their mission statement Moody’s, one of the world’s leading rating agencies, argue that “Credit ratings and research help investors analyze the credit risks associated with fixed-income securities. Ratings also create efficiencies in fixed-income markets and similar obligations, such as insurance and derivatives, by providing reliable, credible, and independent assessments of credit risk. For issuers, Moody’s services increase market liquidity and may reduce transaction costs.” This statement stresses that rating agencies see themselves as the providers of independent assessments of the credit quality of an issuer. Thus their objective is to promote the efficiency of credit markets by reducing the information asymmetry between borrowers and lenders.

As of December 2003, the iBoxx Euro Liquid Corporates Index offered a spread over duration-matched government bonds of 60 bp. Assuming stable spreads, an investor, who measures his performance against government bonds, would have expected to earn an excess return of 60 bp. Yet, this calculation ignores the risk of credit events. If one name blows up and the price of the bond falls to 70 until it is excluded from the index, the portfolio suffers a loss depending on the weight of the issuer. If the index weight of the issuer exceeds 2 percent, the loss on this one name wipes out the complete expected excess return. This example illustrates that insufficiently diversified portfolios are highly vulnerable to idiosyncratic risks. Even for an actively managed portfolio, the concentration on only 40 issuers would require an extremely high success rate of the analyst and portfolio manager in anticipating possible blowups. Clearly, it might be objected that most blowups have significantly smaller weightings and that focusing on “safe” names in actively managed portfolios reduces risk. Yet, especially for real money investors who are benchmarked against government bonds, the risk associated with investing in narrow corporate bond baskets is asymmetric, because they are not able to benefit from an underweight position on overall corporate bonds and particularly on single names.

Compared with credit portfolio products like Tracers and Trains, corporate bond ETFs seem to be the most promising products due to their flexibility of use and ease of shorting. Especially with hedge funds and retail investors they are very popular. Yet, institutional investors face additional investment constraints. Investment guidelines prevent many fixed income portfolio managers from holding corporate bond ETFs because they are considered as equity.

The role of senior managers in developing innovation is often more significant and direct, and it relies on the support and use of information and knowledge. The commercial development of the credit card is an example. In 1958, researchers in the Customer Services Research Department at the Bank of America, with the remit to develop potential new products, created the first credit card. This development was augmented later by seven bankers at Citibank who added the key features of credit cards, including merchant discounts, credit limits, and terms and conditions.

The credit card did not result from a market need; it emerged because people within the banking business used their tacit knowledge. This included their sense of the market and understanding of customers; information and forecasts about economic and social trends; experience with similar product ideas (such as
instalment loans); and knowledge about new technological developments. It heralded the beginning of innovation within the retail financial services industry, and led to such developments as ATM machines and the growth of telephone and internet banking.

The word innovation conjures up the image of a process that is spontaneous and unpredictable, even unmanageable. Innovation literature abounds with stories of serendipitous discoveries and independent-minded champions doggedly pursuing an idea until they hit the jackpot. Often, as the stories don’t fail to stress, the inventors had to persist in secret in their labs without the knowledge or against the will of senior colleagues. The archetypes of such innovators are Art Fry and Spence Silver, the 3M chemists who turned a poorly sticking adhesive into a billion-dollar blockbuster: Post-it notes. In most of these stories, innovation comes from the labs or marketing outposts, not from the top of the organisation. In this situation, the role of management, in the view of Lewis Lehr, a former CEO of 3M, is “to create a spirit of adventure and challenge”.