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Crime and Punishment

In high school, I tried to get a summer job across the river in Manhattan.  A bull market raged in the summer of 1987 and Duran Duran was on the soundtrack.  I’ll never forget the morning of my interview, walking down McDonald Avenue toward the F train wearing a fresh-pressed suit and spiffy-shined shoes.  It was still early yet and Mrs. Pulaski was sweeping off her stoop, as she did each summer morning, with an ancient straw broom that looked like she’d brought it over from the Old Country.  Seeing me coming, she offered me a banana and some advice: “little Chris, always remember: the gangsters and thugs may live in Brooklyn, but the real crooks work in the City.”

Of course, Brooklyn’s convicted get all-expense paid stays in places with foreboding names like Attica, Dannemora, Rikers, and The Tombs.  The City’s crooks, on the other hand, get to wear that fashion accessory of the once-rich and now infamous: the ankle bracelet. 

And boy, do they get to wear those bracelets in some fancy places.  Look at this (do I need to say, “alleged?”) scoundrel, Madoff.  Where’s he serving his house arrest?  The Upper East Side?  Maybe Montauk?  But hey, those December winds howl on Eastern Long Island.  I mean, that place may be fancy in-season, but in the winter it’s positively hard time.  Just dreadful, Lovey!

Anyhow, I got to thinking about a lecture I’d heard in college about the transformation of punishment in America .  Since the earliest colonists focused on community above all else, crimes and deviations from norms were seen affronts to society and punishment took the form of publicly-assigned shame.  Think pillories, stocks, scarlet letters.

During the industrial revolution, society became more mobile, more dynamic  Family supplanted the community and the primary unit of organization.  Punishment became more guilt-oriented, more inwardly-focused; guilt, after all, is a matter of conscience while shame is a matter of reputation.  Guilt seeks forgiveness while shame seeks concealment from view.  As we became more guilt-focused as a society, shame lost it sting.  We’ve literally and figuratively become shameless (Exhibit A: Hilton, Paris.)

So what does this have to do with PE?  I’ve often said that managers who are intrinsically motivated to build portfolio companies are the ones I want to hire; ones for whom the pride of building something greater trumps it all.  If they fail, it'll hopefully be because of poor execution or bad luck, not because of mislaigned interest.  Of course, it’s very tough to test for that mindset, but that’s the essence of the voodoo I try to do.

As for Madoff, let’s find some suitable public punishment once he’s found “guilty” in a court of law.  In the markets, as in a democracy, there must be trust.  And Madoff’s (ahem, alleged) fraud makes him the poster child for this era’s breakdown in trust.  Since punishments should fit crimes, maybe he should also become the poster child for a return to shaming?  Let’s set up some pillories in Times Square and have the people come with buckets of slop, entrails and dung to hurl his way.  Sure, I’ll line up to huck a tomato or two, but I’m guessing I’d be near the end of a very long line. 

And I think the whole thing could be cathartic, a sloppy capstone to an era whose closing headlines were all provided by grifters and slicksters.  And who knows?  If people started again worrying about being shamed, worrying about the effect of their actions on the community, maybe the next scalawag might think twice before messing with our trust.

Heading to Abilene?

So I’m a huge fan of a good story.  And I also love thinking about how decisions get made in organizations.  Put the two together and I’m hooked; you had me at hello – or in the case of the Abilene Paradox, you had me at “hey, y’all.”

For those of you who don’t know the Abilene Paradox, it’s a management parable about a family in a dusty Texas town that ends up traveling fifty miles to Abilene for dinner because nobody spoke out against taking a trip that none of them had wanted to take, not even the person who had halfheartedly suggested they go to Abilene!

It’s an interesting story because businessfolk are constantly making group decisions.  And in a rush to make choices, these founders, GPs, LPs,CEOs, or whatever often seek to avoid the discord that can lengthen or even derail the decision-making process.  But in seeking to tamp down possible conflict, these choice-makers typically fall victim to the ever-lurking, insidious evil of groupthink. 

And over the course of a year, a team can make hundreds of decisions.  Since strategy is an integrated set of informed choices that lead to timely action, decisions build on themselves and all of a sudden the failure to speak up in even the smallest of debates can have repercussions that resonate over time.

In a tough economy the cost of poor choices is higher, since capital is scarcer and sand slips inexorably through the hourglass.  Precisely at the time when people should be emboldened to speak up, the opposite seems true.  The pendulum swings from greed to fear and people are motivated by trepidation, insecurity, timidness.  Upward feedback can take on a rosier glow than usual.  There’s an old Japanese proverb that seems to encapsulate people’s fear during tough times: “the nail that sticks up is the one that gets hammered down.” 

You can also get the blowhards in downturns: the “often wrong, but never in doubt” crowd.  On the one hand, I love those cats.  They get stuff done and they're proud of it!  On the other hand, maybe Yeats was describing them when he said, “the best lack all conviction / while the worst are full of passionate intensity.”

But hey, it’s all self-preservation; people are hard-wired by millenia of evolution and decades of experience to act in certain ways in times of stress.  I can dig that.  Robust debate and intellectual honesty are actually pretty complicated and counter-intuitive.  Sometimes, it’s just easier to go along and get along.

So here’s my Christmas wish: forget the Wii Fit; all I want from Santa this year is for my GPs and portfolio company management teams to crank up the frankness a bit for 2009.  You guys are a pretty honest bunch to start with, no doubt, but maybe we all can make a New Year’s resolution of going out on a limb a bit more, while also cutting everyone else a little extra slack.  The quality of your debates and decision process may well prove to be the difference between an unwanted dinner date in Abilene and an invitation to ring a bell at 11 Wall Street.

Bad Drivers

I’ll never forget the day I told old man Moran that I wanted to go to college at Berkeley.  It was nineteen eighty-nine (a number, another summer) and I said it just to see if I could get a rise out of the oldster by naming a school as far away from Brooklyn as I could think of.  His craggy face crumpled up as if he’d suffered sudden-onset gastric distress and Moran (who’d left Brooklyn exactly once in his life to attend Basic Training before going island-hopping across the Pacific) spat: “Berkeley?  Berkeley?  That friggin’ place makes Woodstock look like friggin’ Parris Island.”

It’s a real shame that he passed a few years ago (rest well, sir,) because I would’ve loved to see the look on his face when I told him that I’d been invited to help teach a class at Berkeley’s Haas School (thanks, Terry!)  I would’ve made sure to tell the old man that people were nude moonbathing or some such nonsense.  He would’ve eaten it up.

Anyhow, the whole thing was a blast and the kids were pretty sharp.  The lesson for the day was (insert moment of reverence here): The Yale Case.  For those who haven’t actually seen the HBS case in question, it’s basically a 20-page precursor to David Swensen’s seminal opus, Pioneering Portfolio Management; it lays out how Yale was able to generate returns that became the envy of the investment world.

Of course, people read the case (or the book) and their response was: we gotta get us some of that illiquid private stuff!  You could say that the case study laid the intellectual groundwork for the PE boom.  But hey, I’m not complaining; after all, it laid the groundwork for me having a job . . . 

So there I was talking about how so many people had taken away the wrong message from the book.  The message wasn’t necessarily “do private equity” (or do anything else specific in the book for that matter),” but rather, the message was: “if you’re going to do any of this stuff, you’ve got to do it well!”  I mean, look at page 20 of the 2007 Endowment report.  Those cats added $11 billion over the trailing 10 years relative to their composite benchmark.  Now that’s execution!  And execution is critical because the meager (sometimes nonexistent) compensation you typically get for straying from plain vanilla US equity falls far short of compensating you for the risk, illiquidity, and brain drain of playing in those funky asset classes.

But then I started thinking about it and realized that for most people there’s no functional difference between, “do this,” and, “do this well.”  Why?  Because over 80% of drivers think they’re better than average on the road; most people have a positive bias to their self-image.  Come on, if Swensen can put up Top Quartile numbers, why can’t I?  After all, I’m good enough, I’m smart enough, and doggone it, people like me!

Of course, that’s private equity’s analogue to the preponderance of drivers thinking they’re better than the average bear: the comically-large cohort of managers who claim to be top quartile.  In fact, I’ve been wondering lately if someone should start a top quartile verification service that would provide seals of approval for pitchbooks (or maybe special gold stars to sprinkle liberally in track record sections of PPMs).  Not that it matters: the opportunity costs are so high (particularly today) that being top quartile likely won’t even begin to cover those high opportunity costs.

So the more I noodled on it, the more I thought that maybe Pioneering Portfolio Management should come with a disclaimer: don’t try this at home.  Of course, trying this at home was exactly what the next book was about.