Economy & Credit Chest

When I was working as an internal consultant on the organizational effectiveness team with the telephone company, the company’s leaders didn’t like the information we reported. In fact, the president contracted with an outside consulting group to come in and assess our internal consulting group. This outside firm found conducting the assessment a frustrating experience—so frustrating that they cited the company as one of the most difficult clients they’d ever encountered.

They went so far as to report that their efforts were “sabotaged” and the reliability of their assessment was compromised due to lack of cooperation. Ultimately they advised against basing any future decisions on their internal assessment. They felt it was a waste of their time and the company’s money. Leadership’s mistake was pitting one group against another instead of having the two teams work together. Had the president encouraged the latter strategy, the internal consultants could have advised the outside consultants about the company culture and the political landscape. At the same time, the outside consultants could have contributed a fresh and objective perspective.

To compare both asset classes and tranches one needs to construct a corporatebond fund invested in 100 equally weighted BBB corporate bonds (assuming that the bond fund pays a Libor _ 100 bp and runs a maturity of 5 years). The risk/return tradeoff between a corporate bond fund and a BBB–CDO note looks as shown previously.

The BBB note sustains a higher cumulative default rate before suffering any losses, as the equity absorbs the initial losses. But the corporate bond fund may outperform in severe default scenarios. This is largely because of the leverage in the CDO note. At one stage the mezzanine notes become the equity of the structure. The huge difference in IRR is explained by the extra risk between the cash bonds and the BBB-tranche as a total.

One way of appraising competing options is to look at the desired outcome and then see which option will achieve it. This simple approach is often complicated by the need to prioritise goals, reduce costs or minimise risk, and in selecting the best option usually involves trade-offs and compromise. Another approach is to establish criteria for the final decision – for example, it needs to work quickly, not be expensive, take a reasonable amount of time to organise and so forth – and then score each option against these components on a scale of 1–10. The highest-scoring option wins. With both approaches, you need to fully understand what each option requires, how it works and what it achieves.

Effective decision-making depends on a collection of leadership skills that can be learnt and are often closely linked. These include the following:

• An ability to foster innovation and creativity and to exploit synergies between people, sometimes disparate and distant teams.
• The intelligence and courage to recognise and learn from mistakes.
• The perception and sensitivity to analyse competing options, and the ability to help others to find their solutions.
• Skills of delegation and empowerment so that decision-making can be devolved to others in the organisation with sufficient time or insight.
• The capacity to motivate people so that they are inspired to prevent or solve problems themselves, as well as proactively implementing decisions.
• An ability to focus others on the twin issues of serving customers and managing change.
• Skilled communication.
• The courage and ability to make critical decisions.