Silver Lining to Financial Crisis?

Excellent leaders persevere in the face of adversity such as the current financial crisis.  We need to help our people through difficult times, with personal resiliency and authentic optimism about the future.  We have to be candid about the dire situation of the financial markets and the significant pain and suffering that awaits employees in countries affected by the downturn. In the US, the likely long-term recession or horrific possibility of a sequel to the great depression is a possibility we must acknowledge.

But today, November 27 2008, is the day people in the US celebrate those things we appreciate.  On Thanksgiving, can we also have a vision of the big picture beyond the painful side of the crisis?  Can we credibly claim an upside?  The Scientific Leader thinks so.  I’ll outline some of the potential good that may come to business as a result of this difficult time, and welcome your own ideas:

• Demise of Snake Oil

Could it be that a massive financial belt tightening across industries and boarders will cause leaders to consider the evidence before they buy?  I suspect that managers and employees will be more prudent than ever before, when cash is extremely limited.  As Bob Sutton notes that 90% of Consultant’s advice is crap; those of us in the 10% minority who use evidence may see an uptick in our business.

• Respect for Uncertainty

Too few leaders historically cared about risk and uncertainty as major aspects to business management.  But the recent high-profile collapses may have changed this forever.  Lazy managers and leaders of the past would rely more on intuition and judgment instead of the more complicated and tedious methods that use probability.  But as Richard Feynman once noted, “Mother Nature Can’t Be Fooled”.  The scientific method requires uncertainty to approximate the truth.  Leaders who seek to manage risks and returns would do well to study the leadership methods to measure and value risk and uncertainty.  These include Monte Carlo and Real Options methods as part of a portfolio in managing Enterprise Risk. 

• Substance trumps slick

Will companies managing through this downturn tolerate glitz without substance?  Will the trash and trinkets given away at large-company meetings lessen?  I don’t know for sure, but I suspect there will be less tolerance for this in the near term at least.  The free t-shirt for the “flavor of the month” initiative may be as endangered as the constant initiative churn that burns capital without creating value.  Demonstrable value may come into vogue again.  The Scientific Leader’s “Cue See” model attempts to be a practical way of discerning and improving the value creation process.

• Global Cultural Savvy

With the US Dollar likely to follow the way of Zimbabwe, firms heavily dependent on the dollar will have to hedge their risk.  Even small to medium sized firms may be wise to consider holding retirement and other assets in foreign equities, currencies, bonds, and hard assets like gold.  To do this, Americans will have to learn more about other countries rules.  In many cases, people will find that places such as Singapore and Hong Kong have even more freedom than the so called “land of the free”.  Americans may have more sensitivity to different ways of working and doing things, rather than a mindless, “US is Best” mantra of the past.  Businesses like Peter Schiff’s Euro Pacific Capital are staged to take their business and help them diversify.

What upsides do you see from such a crisis for business?

Management, Enterprise Risk Management, Evidence-based Management, Peter Schiff, Monte Carlo, Real Options

American and European Human Capital Options

A derivative is a financial instrument that gets it’s value from something else.  One special type is an “option” that gives the owner a right, but not the obligation, to buy or sell an asset.  Human resource, or personnel, employment is a special case of Real Options applied to people. In our case, though, we own ourselves and our labor, but for the right price we’re willing to lease it out to employers and clients for a period of time. 

In the case of employment, hiring an employee amounts to buying (call option) the right to utilize labor for 8 hours a day.  In some cases, the terms of an employment contract are extremely limited, such as contracts for professional athletes and union members.  These amount to a European option, such as the case where the owner of a baseball team has the right to release an athlete, on but not before a certain date.  The more flexible type of employment arrangement is the American option variety.  With an American option, the owner can exercise their right (e.g. liquidate the asset, or fire the employee) without respect to a specific date.  In option terms, letting a person go, or not hiring a consultant for another project is called a “put option”.

But with human assets, there are numerous other options employers can choose to take – including redeploying people to work on new projects, in new departments and in different jobs.  The more flexible a person in having skills and motivation to work in areas that are profitable to the firm, the more valuable the person. 

When mixed with psychometrics such as The Scientific Leader’s Computer-Adaptive Measurement(TM) approach, human capital can be valued the same way as other uncertain financial assets – using Managerial Real Options.  Have you valued your human capital the same way as professional financiers?  Do you know where your human capital is best deployed in the portfolio of job tasks and projects in your firm?  How flexible and adaptable is your workforce – to be able to redeploy them to new work as customers, markets, and economic crises unfold?  Have you considered the option of investing in growing the skills of your employees to increase their value and reduce your risk, through training and development?

Real Option, Management, Business, Human Capital, Skills, Valuation, Risk, Enterprise Risk Management, Psychometrics, Computer Adaptive Testing, CAT, Computer Adaptive Measurement, Rasch, Training, Learning, Selection, European, American

$7.7 Trillion Increases Probability of Inflation: Skills Required for Enterprise Risk Management

In a move suggesting the U.S. Government is role modeling Zimbabwe, Bloomberg reports Fed Chairman Bernanke and Treasury Secretary Paulson are prepared to provide more than $7.76 trillion US Dollars – amounting to half the value of everything produced in the nation last year – to try to rescue the US financial system.  This includes the recent guaranteeing of $306B of Citigroup debt this week and $3.18 trillion already tapped by financial institutions.  The commitment eclipses the earlier $700 billion “Troubled Asset Relief Program”.  This inflation of the money supply – printing dollars out of thin air, and in large volumes – will likely devalue the currency and suggests future runaway inflation.

Human Capital & Risk Management
What skills are required by businesses and individuals to mitigate these risks?  While no one can know the future with certainty, The Scientific Leader speculates that for organizations, as part of Financial Risk Management, the management of money in different currencies becomes a crucial skill.  Financial Risk Management is a subset of the larger Enterprise Risk Management.  For larger firms, Financial Risk Management happens in the Treasury department.    As firms liquidate their dollars and switch to other currencies, and hard assets like gold, they will be more reliant on financial professionals with treasury expertise.  Similarly, the treasury department will likely be every more focused on hedging currency risk with financial futures and derivatives.  All of this sort of work could increase the demand for financiers with treasury expertise, and in the short run increase their salaries significantly if the demand outstrips the supply.  Firms that do not yet select financial professions with objective measures of prudence and conscientousness may also increase their use of pre-hire selection processes, such as our computer-adaptive Work Personality Inventory(TM).

What will be the consequence of this sort of runaway inflation on employees?  The lowest paid employees are likely to suffer the most.  An inflated dollar will purchase fewer goods and services, and the least skilled employees will likely suffer the most.  Employers that are still in business can attract and retain these sorts of employees by providing different sorts of benefits that help them survive the crisis, such as firm-subsidized food and housing. 

How severe do you expect the current recession to get?  What human capital risk mitigation practices are you employing now personally to weather a potential sequel to the great depression?  Confession – I’m moving my assets to Peter Schiff’s Euro Pacific Capital.  What are you doing?

Gold-Collar Workers: Living Assets, Volunteer Workers

Guido von Rossom sounds like the name of an avant-garde artist, but he’s actually the “Benevolent Dictator for Life” of the Python programming language community and uber-Geek at Google.  As author of the popular Python language, he’s an extremely scarce human asset who chooses to rent his labor to Google.  Because he’s a programmer’s programmer, and famous for authoring a major language, he could easily work for himself, or another employer in a heartbeat.  The Scientific Leader’s recent blog coverage has been disproportionately focused on executives, so it’s high time I detail about the high-valued talent who make excellent innovations in technology and science. In many cases, these folks are worth more than their bosses, and take home bigger paychecks because of it.

Guido isn’t the only “gold collar” employee around.  As highly skilled, innovative, extremely intelligent and highly valuable employees, they’re they’re distinct from their less skilled white-collar counterparts.  They’re wealthy, and very techno-literate, according to USA today.  Gold collar knowledge workers represent a quintessential example of a scarce, difficult to replicate asset in the “Resourced Based View of the firm” (RBV), a model for business strategy.  The RBV argues that firms can earn sustainable profits that exceed the competition if and only if they have significantly better resources that are tough to copy by competitors.  Barney provides four tests of whether firm resources can gain sustained competitive advantage:

1. Valuable – is the outcome or output that they produce (directly or indirectly) something customers pay for?
2. Rare – are the resources scarce, and ideally dwindling in availability?
3. Imperfectly copied – is it hard for competitors to imitate the performance?
4. Non-substitutable – are there other assets that can do the same job?

The Resource-based View has its’ proponents and opponents, and Jay Barney has done some of the most extensive research worth reading.

But recent work presented in last year’s Academy of Management Conference, January 2007 suggests that these brilliant gold-collar workers are able to use their own ingenuity, mixed with existing hardware and software to create large amounts of value and fundamentally represent the secret to business strategy.  This view – that assets mixed together create value – is very consistent with my own paper in next year’s Society for Industrial/Organizational Psychology (SIOP) conference, introducing and testing empirically the “Cue See(TM)” model. I developed the model to help define and manage just this sort of intangible asset value, of white and gold collar workers, mixed with other assets. Cue See is also useful for detecting and mitigating risk in operations.

Are you systematically hiring and retaining these extremely scarce sources of competitive advantage? Who are the pivotal talent pools that, without them, would evicerate your ability to create value?  Are you systematically mitigating these risks?

Gold Collar, Human Capital, Risk, Enterprise Risk, Programming, Information Technology, IT, Computer Science, SIOP, Psychology, Retention, Engagement, Cue See, RBV, Resource-Based View, Strategy

Improved Leadership Due Diligence White Paper

Key Lay of Enron

I’m very grateful to all the helpful words of encouragement about my free whitepaper, “The Three Stooges of Operational Risk: Advances in Leadership Due Diligence and Rasch Measurement“.  I made numerous additions to the white paper including:

a) Detailed treatment of the evidence-based definition of leadership

b) Virtual Reality-based Assessment

c) Six Sigma / Industrial Engineering-inspired improvements to detecting faking

and much more.  I would greatly appreciate more feedback.  Is the business case compelling to you?  How much do traditional methods hurt your ability to assess and mitigate executive risks?

Technorati Tags: Risk, Enterprise Risk Management, Leadership, Management, Business, Assessment, Rasch Measurement, IRT, Psychometrics, Computer Adaptive Testing, Virtual Reality

Psychometrics to Assess Priest Risks: Human Capital Valuation at the Vatican

Did you ever think that the Pope would rely on psychological science to improve his priests’ performance?  Is there any doubt that the recently uncovered longstanding horrible clerical abuse scandals are materially damaging to the Catholic Church?

The Catholic Herald reported yesterday that the Vatican recently blessed the psychometric assessment of seminary candidates for priesthood, some of which have already been used by various groups for a number of years.  Unlike most pre-hire selection procedures, the Vatican’s approach intends to screen out psychopathology, sexual orientation and predict the probability of leading a celibate life.  Each group within the Catholic church, known as a diocese will be allowed to use different forms of psychological assessment within broad guidelines from the Vatican.

Clearly, this is an attempt to avoid the sorts of child abuse uncovered in the last few years.  While the Catholic Herald doesn’t report on what types of assessments, or psychometric methods are to be used, it does reference a need for skilled practitioners to be involved to avoid misuse.  It made me wonder whether they’ve developed specific instruments for uniquely Catholic inqueries (e.g. knowledge and skill about their own doctrine) and whether they reuse known instruments of psychopathology. 

Like other forms of Risk Management and Real Options, the Vatican is proposing the use of a form of Human Capital risk assessment to mitigate downstream risks to reputation and potentially, tithes (monthly church donations, often at the rate of 10% of income).  The option to continue a seminarians studies, and make him a priest is their right, but not obligation to exercize.  Detecting risks early, and either intervening or preventing a prospective candidate to enter the priesthood altogether is also a special-case example of classical personnel selection in Industrial-Organizational Psychology.  Anyone else like to see the item bank for the Computer-Adaptive Test of Homogenous Orthogonal Liturgical Informative Content (CATHOLIC) 😉 ?

Technorati Tags: Catholic, Priest, Risk, Abuse, Psychology, Selection, Tithe, Enterprise Risk Management, ERM

Free Whitepaper: Three Stooges of Operational Risk

 

The Real Three Stooges

Who are the Three Stooges of the recent Financial Meltdowns?  How do you detect and mitigate leadership risk?  The Scientific Leader is pleased to present a free whitepaper that gives an overview of modern methods of Enterprise Risk Management, combined with Industrial/Organizational Psychology to detect and mitigate Leadership, Culture and Employee Risks. Are you using science to manage your talent pools?

Insurance & Private Security Options Thwart Pirates

Need pointers on avoiding pirate risks from the experts?  Now, the Standard Club offers a free report on avoiding pirate risks, including hiring private security firms when government security is insufficient.  The UK-based Standard Club insurance firm specializes in insuring shipowners against liabilities, insuring 73 million gross tons globally.

As I’ve noted previously on this blog, Pirate activity off the coast of Somalia has skyrocketed in 2008, gaining the attention of both the government and private sectors.  According to Forbes, insurance premiums for ships passing through Somalia’s Straits of Aden have gone up 10x from $900 to $9,000, because Pirates are demanding millions (e.g. $35M for a Ukrainian ship headed to Kenya with tanks and other military equipment).  The private military firm, Blackwater Worldwide has reportedly sailed a ship with helicopters to escort customers through the Straits of Aden, as part of an expert security force form of insurance.  The price firms are willing to pay for Blackwater or Standard’s insurance is a special case of Real Options – insurance paid to avoid violence, damage or ransoms.  This market is worth between $13 billion and $15 billion annually, according to Forbes.

Standard Club’s recommendations include:

• High alert for any ship within 300 miles of the Somali coast
• Speak with ships that have recently sailed through the area
• Prepare a response plan to include communications, media and crew management
• Post extra lookouts
• Ensure bridge team is fully staffed
• Maintain constant radar vigilance
• Long Range Acoustic Devices – emiting painful sound – have shown to be a useful deterrent
• Thermal Imaging Devices can give advanced warning

The right, but not obligation, to deploy these technologies, and the training of the crew to use them effectively, amounts to a Real Option, used by Finance to value uncertain and risky investments, and mitigate major downsides.  In this case, technology, private security, business processes, and maritime insurance can be used to mitigate pirate risks.  My colleague Dr. Johnathan Mun of Real Options Valuation has excellent software that I like to use to evaluate how much it would be worth to invest in one or more Real Options.  Check out his website if you’d like to learn more – he’s a great teacher.

Technorati Tags: Risk, Business, Management, Pirate, Real Option, Finance, Insurance, Somalia, Pirate, Technology

Standard & Poor’s Taking Closer Look at Enterprise Risk Management

Standard & Poor’s, the famous business rating firm, has announced that they will begin applying their assessment of Enterprise Risk Management to their traditional ratings of companies, even for non-financial institutions.  They report that they won’t establish any type of rating system until they get some experience assessing risk management, which is unlikely to occur before 2009.

S&P Views ERM as:

• An approach to assure the firm is attending to all risks;
• A set of expectations among management, shareholders, and the board about which risks the firm will and will not take;
• A set of methods for avoiding situations that might result in losses that would be outside the firm’s tolerance;
• A method to shift focus from “cost/benefit” to “risk/reward”;
• A way to help fulfill a fundamental responsibility of a company’s board and senior management;
• A toolkit for trimming excess risks and a system for intelligently selecting which risks need trimming; and
• A language for communicating the firm’s efforts to maintain a manageable risk profile.

S&P’s actions are likely to stimulate many companies to take ERM seriously, according to Laura Taylor, a consulting director at Aon.  But S&P and Aon aren’t the only Risk Management experts that are taking note of the increased interests of all forms of Enterprise Risk Management, including leadership, culture and human resources sources.  Other consultancies authoring additional ERM resources include Ernst & Young and Accretive Solutions.

I was especially pleased to see specific consideration of human resource and “cultural” risks, even though the actual listing was a bit dry.  In my view, culture reflects that attitudes, beliefs and values about how people behave in the workplace, and ultimately resides inside employees and leaders.  While traditional Risk Management firms do a good job with probabilistic models of uncertainty and downsides, they do a very poor job of applyin modern Psychometrics, Rasch Measurement, to quantify the likelihood and severity of leadership and cultural risks.  Is your ERM approach informed by the science of human behavior at work – Industrial/Organizational Psychology?

Technorati Tags: Enterprise Risk Management, ERM, Business, Risk, Psychometrics, Psychology, Industrial/Organizational Psychology, Rasch Measurement, IRT

Free Enterprise Risk Management Resources

Are you looking to learn more about Enterprise Risk Management, with all the recent high-profile financial meltdowns?  If so, there are some good, free resources you should consider:

• The Committee for the Sponsoring Organizations of the Treadway Commission (COSO) has a nice free overview of their integrated framework in multiple languages, and a useful PowerPoint presentation suggesting good methods to apply their framework.

• The Casualty Actuarial Society (CAS), also has a nice free overview of Enterprise Risk Management that is slightly different than COSO’s.

• The Association of Chartered Certified Accountants (ACCA), have a recent policy paper, “Climbing Out of the Credit Crunch“, available for download that gives 122,000 accounting professional’s view of the primary and secondary root causes for the recent financial disasters.

• Wikipedia has a good overview of Enterprise Risk Management.

Technorati Tags: Enterprise Risk Management, Business, Management, Actuarial, COSO, CAS