The Golden Passport

by Duff McDonald

  Roughly 80 percent of life, Woody Allen has explained, is simply showing up. While the graduates of HBS who permeate Wall Street and positions of corporate authority will insist that they are worth every penny, in reality their compensation isn’t all that connected to their performance. Indeed, in its 2007 survey of executive compensation, the Associated Press found that “CEO pay rose and fell regardless of the direction of a company’s stock price or profits.”16 Some CEOs might deserve to be paid what they have received, but when it comes to the collective, they most certainly did not deserve an increase from average compensation of just 85 times blue-collar workers’ pay in 1990 to something approaching 400 times that amount today. Indeed, they have been paid increasingly large amounts just for showing up.

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  A Decade in Review: 2000–2009

  When Harvard president Larry Summers appointed Jay Light (DBA, ’70) the ninth dean of HBS in 2006, the choice was both traditional and of its time. It was traditional because Jay Light was a product of the HBS system. After receiving his doctorate from the School in 1970, he’d taught at HBS since then, save for a leave of absence to serve as director of investment and financial policies for the Ford Foundation from 1977 to 1979. But Light’s appointment was also of its time—a finance expert whose research had focused on capital markets and institutional asset management, he represented a changing of the guard. The market had triumphed, and the finance guys were firmly in charge.

  From an institutional standpoint, Light continued much of the work that Kim Clark had started. He oversaw the final stage of a $500 million capital campaign launched in 2002 that concluded having raised $600 million at the end of 2005. The School opened a research center in India (in 2006) as well as the Harvard Center Shanghai in 2008. And he finally made good on the School’s periodic-yet-insincere statements of intention to play well with the other schools at Harvard, which by that point included a joint MD-MBA program with the medical school, a joint degree with the Kennedy School, and significant involvement in the Graduate School of Education’s doctoral program in educational leadership.

  But the two most significant events of Light’s administration were once-in-a-century events. The first, the School’s centennial celebration, was literally that. The second, the greatest financial crisis since the Great Depression, eclipsed it. All at once, the man had to celebrate the past, consolidate in the present, and contemplate a dramatically different future. It’s no wonder that he lasted only five years in the job.

  HBS’s 2008 summit celebrating its hundredth anniversary couldn’t have come at a worse time. The global economy was on the brink of collapse, and fingers were being pointed not just at the world’s MBAs, but at HBS in particular. Speaking at the summit, Jay Light sought to do as those in positions of leadership so often do when confronted with their own failures: He tried to spread the blame. It was time, Light suggested, for everyone to admit that they, too, had some apologizing to do. HBS responded to the unfolding financial crisis the same way it has to all of them: First, it claimed bystander status, and then it argued for a central role in determining the way forward.

  “We all failed to understand how much that system had changed in the past fifteen years or so and how fragile it might be because of increased leverage, decreased transparency and decreased liquidity; three of the crucial things in the world of financial markets,” said Light. “We all failed to understand how that fragility could evidence itself in a frozen short-term credit system, something that hadn’t happened since 1907. We also probably overestimated the ability of the political process to deal with the realities of what could happen if real trouble developed. What we have witnessed is stunning and sobering failure of financial safeguards, of financial markets, of financial institutions, and mostly of leadership at many levels.”1

  HBS grad and journalist Philip Delves Broughton was having nothing of it. “Light was wrong to say ‘we all failed’ in the run-up to the crisis,” he says. “We did not all fail. Innocent people, who trusted that the markets were efficient and fair and honest as they bought homes and saved for retirement, did not fail. The stewards of those markets failed. The intellectual feeders of these markets failed. They failed in their very specific role of managing the economic aspects of our society. . . . It should be a profound embarrassment to the Faculty of the Harvard Business School that for the second time in less than a decade it failed to identify an economic catastrophe in which its alumni played a starring role.

  “If the business school’s faculty is so smart, how come they didn’t see all this coming?” he continues. “Why didn’t they warn about it and even try to stop it? Here was a large group of supposedly brilliant business minds, well paid, lavishly resourced, with time and access to every corner of the economic universe—and they missed it.”2

  Light, of course, wasn’t interested in such things. “We will leave the talk of fixing the blame to others, that is not very interesting,” he said during his speech. “But we must be involved in fixing the problem.” But why is it not interesting? Before you can fix the problem, you’ve got to understand it, don’t you? And if your goal is to understand how decisions made by people created a crisis, and how to avoid the dangers of similar decisions in the future, you’re probably going to stumble on a few decisions that weren’t innocent mistakes but those worthy of some sort of blame.

  “You would have to have a heart of stone not to be amused by this piquant accident of timing.” wrote the Financial Times’ Stefan Stern in a column about the centennial. “Here, at the spiritual home of the Masters of the Universe, distinguished graduates could only look on as that same universe threatened to implode. There is no doubt that most HBS graduates leave the institution with a very clear sense of their own worth and capabilities. They are not set up to fail. And yet, equally clearly, HBS alumni were involved at the heart of the investment banking and strategy consulting worlds that now stand accused of destabilizing the world’s financial system to the point of destruction.”3

  Asked later about whether or not HBS deserved blame for the crisis, Light tried another angle—the defense of large numbers. “I think that’s misleading,” he told NPR in 2009. “Look, we have 70,000 alumni.”4 The man’s got a point: When you’ve got that many leaders making a difference in the world, it can get difficult to pinpoint when the difference they are making isn’t necessarily a good one. Scratch that, it’s not difficult at all. And Light’s defense is ridiculous.

  Here’s a short list of leadership positions held by HBS graduates in the lead-up to the crisis, as it unfolded, and its aftermath. What’s remarkable is that it isn’t simply made up of those with their noses in the money trough. It also includes key people in critical positions of oversight, all the way up to the very top, the president of the United States.

  George W. Bush (’75). The president of the United States from 2001 to 2009, the crisis occurred during Bush’s watch.

  Hank Paulson (’70). As George W. Bush’s Treasury secretary from 2006 through 2009, Paulson pretty much single-handedly orchestrated the government bailouts and was the face of the Bush administration’s economic and financial policy at a time when Bush was clearly in way over his head. While it seems the jury will always be out on the wisdom of letting Lehman Brothers fail, Paulson can be credited for bringing the nation’s largest banks to heel in the aftermath.

  Christopher Cox (’77). Chairman of the Securities and Exchange Commission from 2005 through 2009, Cox later claimed that his agency had no power to keep the financial giants that became leveraged to the point of collapse from doing so, but that’s simply not true. At the very least, he could have demanded more disclosure out of the likes of Merrill Lynch and Lehman Brothers. Instead, he oversaw a dwindling SEC staff. He also missed Bernie Madoff’s towering fraud.

  Stan O’Neal (’78). The CEO of Merrill Lynch from 2003 to 2007, O’Neal is the perfect example of the big-bank CEO who threw caution to the wind in pursuit of profit. By mid-2006, just before th
e subprime dam broke, Merrill had $41 billion in subprime CDOs and mortgage bonds on its books.5

  John Thain (’79). Thain followed O’Neal as CEO of Merrill, serving from 2007 to 2009. As the crisis unfolded, he threw huge piles of money at old friends from Goldman Sachs, and was fired after a surprise $15 billion loss shortly after the firm’s sale to Bank of America.

  Jamie Dimon (’82). The CEO of JPMorgan Chase, Dimon was first praised for the rescues of Bear Stearns and Washington Mutual and then raked over the coals for what critics saw as excessive risk taking during the whole London Whale episode.

  The many, many HBS grads at McKinsey & Company. There was a joke in the mid-1990s that since pretty much every bank of importance had hired McKinsey, you had fifty companies focused on the same thing—global strategy—at the exact same time.6 The same was true ten years later, raising an interesting issue of “systemic risk.” While the firm’s fingerprints were nowhere to be found in the detritus of the real estate collapse, they had been advisors to many of the companies who both inflated the bubble and collapsed as a result of it. Whatever their specific advice to specific clients, McKinsey had failed to give them the best advice of all, which was to go in the direction of less, not more. Which makes the value of the advice it did give incidental at best, and destructive at worst.

  Later asked about the lessons of the meltdown, Light replied, “The lessons have been about risk management, about making sure there’s a focus on the possible downsides, how to monitor them, how to manage them, how to be alert to systemic risk. All of those are crucial to the function of a real leader.”7 He’d learned them the hard way: Light and his fellow directors of the Harvard Management Company, which is responsible for investing the university’s endowment, had watched helplessly as the value of that endowment fund fell from $36.9 billion to $26 billion in the year ended June 2009.

  That its graduates had played leadership roles in almost every institution that had made the mistakes of judgment that had brought the global financial system to the brink was no obstacle, either, to the suggestion that they be central to any “leadership” regarding how to avoid making them again. “In the years ahead, our financial systems will look very different from today,” said Light. “The people who will lead and map out those changes are the current Harvard Business School students.”8 But why should that be? Indeed, not too long after the turn of the century, HBS graduates were pretty much running the whole economic show in the United States. But the crisis still happened. Why on earth should they be the ones to whom we look for a way forward? The last time we put them in charge, it blew up in the world’s face.

  One reason those at or from HBS did not comprehend the increasing fragility of the financial system was that they had been enthusiastic supporters of many of the factors that had made it so: efficient markets theory, shareholder capitalism, the perverse incentives of Michael Jensen–inspired compensation packages, “innovation spirals” at the likes of Enron, and HBS-endorsed “risk management” systems at giant financial organizations that were nothing of the sort.

  “A kind of market fundamentalism took hold in business education,” HBS professor Rakesh Khurana told the New York Times in 2009. “The new logic of shareholder primacy absolved management of any responsibility for anything other than financial results.”9 And the tools they used in service of that logic had only cemented it in its place. The capital asset pricing model (CAPM), for example, hadn’t originated at HBS, but it had been studied and refined there, by Michael Jensen, Robert Merton, and others. The effect of CAPM had been similar to that of agency theory in that it reduced a task (in this case, stock selection) to a single number, beta, which was derived from a regression analysis of a stock’s historical movements in relation to the overall market. “While the goal of [the] model was to permit investors to make rational decisions balancing risk and return,” writes Lawrence Mitchell in “Financialism: A (Very) Brief History,” “its unintentional consequence was to separate the investment decision from any need to be interested in, or concerned with, the underlying corporation issuing the stock, leading to a separation of stock ownership from the underlying business and laying the groundwork for an irresponsible and detached investor class.”10

  (Several years after the role of the forces of financialization in the crisis had been clearly enumerated, and the downside of an overreliance on quantification revealed, the sages at HBR showed that they hadn’t been distracted from their seemingly never-ending effort to quantify the unquantifiable. In April 2015, the magazine published “Calculating the Market Value of Leadership,” which advocated for the creation of a “leadership capital index” that would “move beyond casual and piecemeal observations of leaders to a more thorough assessment of leadership”—an index—that “can start to predict the impact leaders have.”11 Good luck with that. Alas, the desire for certainty is a desire that will not die.)

  Anyone expecting HBS to come clean with “We’re sorry, we screwed up” was, as usual, disappointed. Jay Light drew a line on the limits of institutional contrition in “Change Is in the Offing,” a 2009 essay in HBR: “[T]o suggest that business schools and the MBA are the root cause of the global financial crisis is simplistic nonsense that ignores the obvious reality of the many complex and interrelated factors that underlie the problem.”12

  Others weren’t so sure about that. “It is so obvious that something big has failed,” Ángel Cabrera, dean of the Thunderbird School of Global Management in Glendale, Arizona, told the New York Times. “We can look the other way, but come on. The C.E.O.’s of those companies, those are people we used to brag about. We cannot say, ‘Well, it wasn’t our fault’ when there is such a systemic, widespread failure of leadership.”13 Rakesh Khurana, who consistently showed himself to be one of the few at HBS capable of serious self-criticism, echoed that thought. “The problems go even deeper than the curriculum,” he said in 2008. “[Business schools] have actively fostered a mind-set among students” that reduced “business” to the short-term pursuit of profits, which “contributed to this culture of an uncritical view of the market” and thereby helped cause the crisis itself.14

  Light’s colleague Joseph Badaracco made it halfway there, first rolling out the “we’re not as influential as you think” defense but then admitting that mistakes had, in fact, been made. “This was, roughly speaking, a once-in-a-century calamity,” he told the BBC in 2010. “It’s taking place, roughly speaking, on a global scale. It involves institutions of every kind. I don’t think business schools or any other institution are powerful enough or influential enough to take credit for a calamity of this size.” Even so, he added, “[w]e have created a variety of different forums, some running across the entire faculty, where we’ve tried to understand, what could we have done differently? And are we doing the right things now so that future generations of graduates are slightly less likely to fall into the kind of problems that their predecessors did?”

  Not surprisingly, they found gaps in their teaching of the management of risk. “Despite all the brainpower devoted to these, they failed,” said Badaracco. “I think if anything, we taught state-of-the-art approaches to risk, and they were quite deficient. So on that one, we’re going to have to go back and do some serious rethinking. . . . It was widely believed by serious, thoughtful people that a new financial system had been created in which risks were far better distributed. It turned out that distributing risks was the flip side of interconnecting so many important institutions so that when one of them failed, others were damaged or pulled down. And that’s something that simply was not seen.”

  When Badaracco was asked what, if any, damage the crisis had done to the HBS brand, his response was revealing. “I think it has probably suffered a little bit, but not as much as people think,” he said. “We had a lot of graduates right at the center of power—political and financial and economic power. . . . Now, to the extent that these people got decisions wrong, essentially with the entire world economy in peril, w
e’re going to be blamed for that. On the other hand, they all went to the School and so somebody who thinks to themselves I would like to get training and associate with other people who are likely to be at the center of things in the future is going to think hard about coming to this place. . . . You can get a lot of responsibility if you come out of this school. What we’ve been working very hard at is getting students to understand the full magnitude of that responsibility.” Translation: HBS grads at the center of power might have come up short, but they were still at the center of power, weren’t they?

  Others, including David Champion, an HBR editor who earned an MBA from INSEAD, agreed that the blame must be shared. In “An MBA’s Defense of His MBA,” a March 2009 essay in HBR, he blamed . . . parents. And the “workplace.” “On the question of blame, psychologists will tell you that people are far more shaped by their early experiences than by their adult ones,” he wrote. “What we learn from our parents says a lot more about what we become than what we’re going to pick up in a year or two in our mid-twenties. I would also say that, intense as it can be, an MBA does not affect you as much as your workplace.”15

  In the same essay, he dismissed a piece in London’s Times by HBS graduate Philip Delves Broughton that pointed the finger at a number of prominent alumni tainted by the crisis, as “nothing new,” a mere reprisal of the conclusions Broughton had reached in his 2005 exposé about the School, Ahead of the Curve. He was likewise dismissive of McGill’s Henry Mintzberg’s criticism of HBS’s role in the crisis, because those criticisms “also [happened] to bolster an approach to management education that Mintzberg has been advocating for years.” According to Champion, “these commentators may not be the most objective as they have their own axes to grind, or messages to sell.” That their messages had been proved to be true was apparently beside the point.