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Should you have seen the Enron disaster coming?
How about WorldCom or Tyco? The alluring idea that investors in those companies might have been able to foresee trouble, if only they'd known what to watch out for, is what prompted us to invite Prof. Sydney Finkelstein to appear on our Oct. 3 program. He's the author of Why Smart Executives Fail, a massive study of companies and managers that have gone terribly wrong. The book includes his advice on spotting blowups before they happen.
After reading his book and interviewing him on the program, and thinking back on 25 years of covering business for FORTUNE, I'm persuaded that some disasters will always remain unsuspected by virtually everyone until they actually happen in a great big way. But I'm also persuaded that many of the worst corporate catastrophes can indeed be foreseen, and that the biggest impediment to foreseeing them is not an absence of evidence, but rather a failure by investors, employees, customers, and suppliers to accept what they know, to listen to the message of their inner voice. In a great many cases, people in close contact with a future disaster know, deep down, that something's wrong. The hard part is bringing that knowledge into the open and confronting what it means.
We know this because of all the stories that have come out in the wake of the collapses and indictments at Enron, Adelphia, WorldCom (now MCI), HealthSouth, and Tyco. And I know it through experience.
Very early in my career I wrote a glowing article about a company, now forgotten, called Baldwin United. Believe me, you don't care about the details of what this outfit proposed to do, but in general it was going to revolutionize a couple of corners of the annuity and municipal bond businesses. In truth I was too inexperienced to evaluate its financial strategy, but I could tell that its claims were grandiose, and that it seemed to possess very little capability to realize them. Beyond that, something just didn't feel right. I couldn't say exactly what, and that was the problem. There were all kinds of rational arguments for why the company would succeed, but my inner voice said this outfit was trouble. I listened to the rational arguments. Within a year or so of my sunny report, the company had melted down.
That wasn't the only example. In my career so far I have the dubious distinction of having interviewed three high-flying business people who later killed themselves, two apparently for business-related reasons. In neither case was I the least bit surprised. I have also interviewed at least two senior business people who went to prison (a total that may increase dramatically, depending on the outcome of pending cases). Again, few events could have surprised me less. Of those four people, I had written a glowing article about only one. That's progress, right? By then I had an MBA and had learned a lot about business and finance, but more important, I was learning to listen to the inner voice.
That's really the essence of Prof. Finkelstein's five warning signs that a company is headed for trouble. I believe they're all right on the money and worth noting, with my own examples. If you have any significant contact with a company, you'll spot at least some of these factors if they're present.
Excessive complexity. This is what Enron was all about. It was turning the markets for electricity, gas, shipping capacity, broadband capacity, and who-knows-what-else upside down and inside out with its very own Master of the Universe finance wonks. Understand it? You can't. But we can. Trust us. Long Term Capital Management, another famous meltdown, was the same.
Racing at high speed. Most of the failed dot-com companies had business plans premised on growing faster, or winning more regulatory approvals, or developing more new software, or achieving greater market penetration, than any company ever had. A primary indication of trouble.
Excessive hype. How can we tell it's excessive, you ask? When a company claims its going to change the world or at least revolutionize an industry, watch out. That was Enron. Also Oxford Health Plans. Also just about every dot-com bubble stock.
Distracted CEO. I go to a lot of conferences. It's part of my job. But when I see certain CEOs turning up time and again, I know trouble is ahead. It's the same when CEOs are clearly devoting significant time to multiple charities or seeking nonstop publicity. Some of the most successful CEOs in America, such as Reuben Mark of Colgate Palmolive and Joe Luter of Smithfield Foods, are people you rarely hear about.
A question of character. Can you trust this executive, this organization? If you've got any personal experience to go on, just sit quietly, close your eyes, and ask that question. Then listen for the answer. If it's "No" you needn't ask anything else.
The hard part about using Prof. Finkelstein's warning signs is admitting to yourself that you've seen them. People's capacity for self-delusion is always greater than we imagine, as we saw in the late '90s. Yes, public transformations of companies -- better governance, greater transparency -- are important. But private transformations of our abilities to accept what were seeing in companies are at least as vital.
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