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What Lehman Brothers, AIG and WaMu All Have in Common

The failure of these companies has created quite unprecedented conditions in the financial markets. There are a lot of buzzwords that we have been hearing as to why these companies have failed: debt, risk, sub-prime, greed and many, many others. But there is one key reason for this entire mess and it presents a valuable lesson for all of us entrepreneurs, managers and investors alike as to what to do and what not to do.

What is the true reason for this crisis? Its very simple: these businesses all had a short-term outlook. Allow me to explain: CEOs are under a tremendous amount of pressure from shareholders to generate stellar returns as quickly as possible. The board of directors, acting on behalf of the shareholders want a return and they want one now. They view returns on a quarterly basis, NOT a yearly basis. If there is a similar company generating even larger returns than this company, this company’s CEO is seen as doing a poor job. He/she will need to amend the company’s portfolio of assets to make sure that this company delivers like (or greater) returns. Otherwise, the CEO is fired.

But there are other incentives for CEOs to have a short-term outlook. CEOs typically don’t last very long at a company anyway. They may last a few years, then, because their company hits a rough patch, they are fired with a very generous severance package. Rumor has it that WaMu’s 3-week-old CEO is already getting a $13 million golden parachute. It pays for CEOs to take risks and get fired, further demonstrating the backwards point of view that a lot of these failing, publicly traded companies have on the importance of short-term gains. They get paid nicely, but it hurts everyone else, especially the shareholders (the owners of the company).

Thus, instead of investing in future, long term growth opportunities, these companies sacrificed this by looking for short-term gains in investing in extremely risky assets and making extremely risky investment decisions. It doesn’t take someone with a graduates degree in finance or economics to know beforehand how risky these practices were and that they would eventually result in a loss. But these companies did this anyway because the leadership has an incentive to have a short-term time horizon for their returns.

The moral of the story? Some risk is necessary, even good. Too much risk is obviously dangerous, but most importantly, your business’ success and growth depends on you having a long-term mindset. Looking for short-term growth will only cause you to forsake investing in long-term success and your company (and your wallet) will suffer because of it. Some immediate-term outlook is important, but it is vital that you strike a balance between short, medium and long-term goals. Use these companies’ failures as a lesson that taking risks for short term profits is, by definition, being near-sighted and can significantly limit your business’ ability to succeed and grow.

There is a second moral of this story for business owners looking to step aside and hire professional managers to take their place: hire those who value an appropriate balance of short, mid and long-term growth, and make sure you incent them to pursue this balance appropriately.

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