Ronald R Sims. Journal of Business Ethics. Volume 25, Issue 1. May 2000.
Over the past 15 years, “culture” has become a common way of thinking about and describing an organization’s internal world—a way of differentiating one organization’s “personality” from another. Also, an accepted fact by most researchers is that an organization’s culture socializes people (Schein, 1985) and that ethics is an integral part of the organization’s culture (Trevino and Nelson, 1995). Therefore, building and reinforcing an ethical organization means systematically analyzing and managing all aspects of the organization’s culture so that they support ethical behavior. However, often an organization’s culture subtly (and other times not so subtly) conveys to members that certain actions are acceptable, even though they are unethical or illegal. For instance, when executives at General Electric, Westinghouse, and other manufacturers of heavy electrical equipment illegally conspired to set electrical prices in the early 1960s, the defendants invariably testified that they came new to their jobs, found price-fixing to be an established way of life, and simply entered into it as they did into other aspects of their job. One GE manager noted that every one of his bosses had directed him to meet with the competition: “It had become so common and gone on for so many years that I think we lost sight of the fact that it was illegal” (Greenberg and Baron, 1993).
The public admission by John Gutfreund, CEO and chairman of Salomon Brothers, in the summer of 1991 that its government desk had placed illegal bids in 30 of the 230 auctions of government securities in which it had participated since 1986 provides a more recent example of the role an organization’s culture plays in encouraging unethical behavior. Shortly thereafter, both Gutfreund and Thomas Strauss, Salomon’s president, resigned, and the U.S. Treasury Department suspended Salomon from bidding for its clients at future Treasury auctions.
At the time, Salomon was without a doubt the most powerful broker on Wall Street and a topgun trader of government securities. The disclosure threatened not only to shatter the firm’s hard-won franchise and pristine reputation but to eviscerate its culture by striking at the heart of the bank’s character and identity This was surely the worst scandal to hit the company in its 81-year history, and it would take exquisite managerial skill and timing to weather the storm.
Although no one could have predicted the precise form that a crisis would take—or its timing—most industry observers believe that something like this was bound to happen to Salomon Brothers someday Among the preconditions that made a crisis likely were, on the one hand the firm’s aggressively “macho” culture and, on the other, the lax regulatory and increasingly competitive environment that Salomon’s traders faced. Like kindling, these two sets of factors helped to ignite unethical and illegal behavior in the bank (Fombrun, 1996; Siconolfi, 1991).
A New York Times editorial put a moral caveat on the bank’s aggressiveness. It characterized Salomon as a company that celebrated clever evasion of rules and trampled anyone standing in the way of profit and as a company governed by a “culture of greed, contempt for government regulations, and a sneering attitude toward ethics or any other impediment to earning a buck” (New York Times, 1991). Not someone you’d necessarily want to do business with.
We can conclude from the Salomon bond trading scandal that ethics at work is greatly influenced by the organization’s culture. More specifically, the lack of an organizational culture that explicitly promotes and encourages ethical decision making results in unethical conduct. To get back on the ethical road an organization must change. And any organization interested in transforming themselves, must be able to handle change positively—to alter policies, structure, behavior, and beliefs—and do it with a minimum of resistance and disruption. It is far better to deal with the need for change—to modify it, redirect it, or disarm it—than to ignore or fight it. However, for companies like Salomon Brothers a successful ethical turn around doesn’t just happen spontaneously; proper change management is the key to achieving this goal. But, in reality, can an organization like Salomon Brothers turn itself around ethically? If so, what needs to happen for an organization like Salomon Brothers to make a successful ethical turnaround? Finding an answer to these two questions is the focus of this paper.
Changing the Ethical Culture at Salomon Brothers
Changing an organization’s culture is more difficult than developing a new one. Employees in new organizations are quite open to learning and accepting the culture of their new organizational home. However, anthropologists and organizational scientists agree that changing culture is an extremely difficult process (Barrett, 1984). This view is consistent with an idea basic to organizational change and development efforts that changing individual and group behavior is both difficult and time consuming. The human tendency to want to conserve the existing culture is referred to as “cultural persistence” or inertia. Culture has an addictive quality, perhaps because culture members are aware that culture components can not be altered without affecting other, cherished values and institutions (Uttal, 1983). Also an organization’s culture that supports unethical behavior tends to feed on itself. Why would successful (but unethical) managers want to change? They wouldn’t. They would tend to hire people like themselves and perpetuate the culture that exists (Trevino and Nelson, 1995).
Leaders that wish to change their organization’s ethical culture must attend to the complex interplay of formal and informal systems that can support either ethical or unethical behavior. Thus, quick-fix solutions are not likely to succeed. Trevino and Nelson (1995) contend that a broad multi-system approach to changing organizational ethics must be used in diagnosing and changing an organization’s ethical culture. Sims (1992) recognizes that organizational culture has a significant influence on establishing ethical behavior in an organization and enumerates normative recommendations for creating a culture that supports individual ethical behavior. However, Sims does not offer an approach that will systematically aid in the development of a corporate culture that encourages and promotes ethical behavior throughout the organization. Chen et al. (1997) recommend the use of total quality techniques to facilitate the development of a cooperative corporate culture that promotes and encourages ethical behavior throughout the organization. For our purposes, Schein’s (1985) five primary mechanisms available to leaders for embedding and reinforcing aspects of an organization’s culture will be used to systematically analyze efforts by Warren Buffett (and other leaders) to change Salomon Brothers’ culture following their bond scandal fiasco.
Schein’s five primary mechanisms (which will be discussed in more detail in the remainder of the paper) are: attention, reactions to crises, role modeling, allocation of rewards, and criteria for selection and dismissal. The mechanisms emphasize institutional as well as individual processes. In each area, Buffett drastically altered the system and culture that led to the Salomon bond fiasco under former CEO John Gutfreund’s leadership. Buffett placed a commitment to ethical standards as his top priority, and his first actions indicate this commitment. When Warren Buffett had just become acting chief executive officer (CEO) of Salomon, he immediately began to carefully craft a new corporate culture.
Our goal is going to be that stated many decades ago by J. P Morgan, who wished to see his bank transact “first-class business … in a first-class way.” We will judge ourselves in fact not only by the business we do, but also by the business we decline to do. As is the case at all large operations, there will be mistakes at Salomon and even failures, but to the best of our ability we will acknowledge our errors quickly and correct them with equal promptness.
Warren Buffett, October 1991
Schein (1985) describes attention as what the leader focuses his employees to concentrate on (what is criticized, praised or asked about), which communicates his and the organization’s values about them. For example, John Gutfreund’s tenure at Salomon was marked by an absolute attention to a short-term business focus and what was happening that day or that week. Through this short-term perspective (which may simply be a function of being in the trading business), Gutfreund forced his employees to produce profits immediately. As Cooke (1978) has indicated, dedication to short-term revenues above long-term considerations creates a climate where unethical behavior thrives.
Warren Buffett and Deryck Maughan (chief operating officer under Buffett and chairman and CEO following Buffett’s resignation) set out to quickly focus attention on the urgency and severity of Salomon’s situation. With their fate in the hands of government regulators, the firm had to be prepared for an onslaught of bad publicity and, possibly, huge legal fines. Almost immediately, Buffett introduced changes in formerly accepted individual and institutional practices by eliminating many perks of Salomon employees magazine subscriptions were canceled; cars, drivers, and secretaries were discharged; and long-distance phone services and health benefits were cut (Cohen, 1991). Signals were being sent that the Salomon Brothers under Warren Buffett would be very different than it had been under Gutfreund’s leadership. Thus, Buffett’s initial actions demonstrated that it was important and necessary to focus employees on the fact that the culture they were working within was simply not a feasible way to continue to do business.
The new Salomon would be committed to upholding ethical principles and purging those who had a past history of and/or knowledge of unethical or illegal behavior. Buffett displayed his commitment to high ethical and legal standards by immediately issuing a memo to all Salomon senior executives declaring they should report any but the smallest legal infractions to him directly. The full text of this memo is as follows (U.S. Securities and Exchange Commission, 1991):
Unless and until otherwise advised by me in writing, you are each expected to report, instantaneously and directly to me, any legal violation or moral failure on behalf of any employee of Salomon Inc. or any subsidiary or controlled affiliate. You are to make reporting directly to me your first priority. You should, of course, report through normal chain of command when I am unavailable and, in other cases, immediately after reporting to me.
Exempted from the above are only minor legal and moral failures (such as parking tickets or nonmaterial expense account abuses by low-level employees) not involving significant breach of law by our firms or harm to third parties.
My private office telephone number in Omaha is (402) which reaches me both at the office and at home. My general office number in Omaha is (402) 346-1400. The Omaha office can almost always find me.
When in doubt, call me.
Warren E. Buffett
Chairman and Chief Executive Officer
As noted in the memo, Buffett demanded that the executives “report, instantaneously and directly to me, any legal violation or moral failure” of any Salomon employee. This was to be their “first priority,” and he gave a listing of where he could be reached at any time. Buffett closed with, “When in doubt, call me:’ The memo should have left no doubt in the senior Salomon executives’ minds that new procedures and policies were taking shape within the company.
In addition to modifying compliance procedures, the new leadership turned its attention to Salomon’s culture. Although confident that the firm was not “endemically corrupt” as charged by some outsiders, Maughan believed that “certain aspects of the culture needed to be modified.” Maughan continued, “Mozer’s behavior was out of the ordinary, but still we had to reassert the traditional values of the firm. In some way, in some fashion, we had lost our way A certain permissiveness had entered in the air. A bravado was attached to the taking of risk and the making of money. As a result, we were inattentive to shareholders and external constituencies, and not as customer-oriented as we should be” (Paine, 1997).
Maughan pointed to control and compliance as functions needing additional support. “This has nothing to do with the individuals involved, but with the culture and the system,” he said. Accordingly, he took steps to reassert the signif icance and independence of the general counsel and chief financial officer.
Maughan’s view of managing ethics was a mixture of disciplining and leadership. “I lead by example. But when things go wrong, you can’t turn a blind eye. Leadership must enforce values through punishment. If they don’t exercise the power, then the values can’t be upheld. People begin to believe the behavior is okay. I don’t think anyone doubts that current management would act forcefully if someone does something wrong. And I don’t just mean compliance with the law I also mean issues of diversity, the treatment of women, putting customer interests first, not cutting corners. These things are communicated to employees in the speeches we make and in our daily routine. And the vast majority of employees are glad to hear it because they want to work in a quality place.”
Reactions to Crises
A crisis situation, Schein asserts, allows followers to see what is valued by the leader because its emotionality brings these values to the surface. John Gutfreund reacted to crises by using arbitrary dismissal criteria, executing firing decisions ruthlessly, using “sneaky” tactics to secure his own job and covering up and lying about ethical indiscretions. When a legal violation by the firm was brought to his attention, he reacted by attempting to cover-up, not disciplining violators or providing full disclosure to the Salomon regulators. Thus, resulting in the crisis situation Buffett was confronted with when he temporarily took over Salomon.
As noted above, Buffett’s tenure as interim chairman began in a crisis situation. As market developments were sending Salomon into a tailspin, government investigators were swooping in to determine the extent of wrongdoing. The Securities Exchange Commission (SEC), the Treasure Department, the Justice Department, the Federal Reserve Board, the Federal Bureau of Investigation (FBI), and the Manhattan District Attorney were all looking into potential rule violations and by Salomon (Weiss, 1991). Depending on the results of the investigations, Salomon faced a variety of potential sanctions in addition to criminal fines and civil damages: censure, suspension, or debarment from acting as a broker/dealer and as a primary dealer in government securities; administrative probation; modification of its operations; required appointment of board members or managers acceptable to the SEC. Some were putting the chance of criminal indictment as high as 80 percent in the early days of the crisis.
John Gutfreund had purposefully withheld information from the government regulators and Salomon was temporarily barred from its breadand-butter business of dealing in the U.S. Treasury auction. Buffett’s reaction to the crisis was swift. He began to set the tone for a new corporate culture, in preparation for a hearing before the regulators. During that hearing, Buffett’s testimony and his preliminary damage control efforts were rewarded with Salomon being allowed to return to the Treasury securities market.
As Buffett and Maughan faced the press during a break in the August 18 board meeting, no one knew the full extent of the firm’s misconduct. Creditors, customers, employees, Salomon’s insurers, and the markets were all waiting to see what management would say and do. Authorities were moving forward to investigate fully of great concern was whether Salomon would face a criminal indictment. Recalling the demise of E.F Hutton and Drexel, Burnham, many feared that Salomon could not survive a criminal conviction. Buffett explained his role to the assembled group: “My job is to clean up the sins of the past and to capitalize on the enormous attributes that this firm has” (Siconolfi and Cohen, 1991). “Salomon,” he said, “has to earn back its integrity” (Malkin, 1991).
Immediately after the press conference, Buffett convened an executive committee meeting where he made it clear that Maughan was in charge. Buffett sought to draw the curtain on Salomon’s past and to lay the groundwork for a fresh start on Monday. Henceforth, noted one executive, Salomon’s history would have two parts—BC “before crisis,” and AD “after Deryck” (Paine, 1997).
Unlike Drexel Burnham Lambert, Salomon did not hire a public relations firm to generate favorable stories in an attempt to influence the government investigation. Salomon cooperated fully with the authorities. Buffett and Maughan took the approach that the company had done something wrong, had lost the confidence of the government, and that they had an obligation to the government to explain what had happened.
On September 4, Buffett sent letters of apology to the firm’s major customers promising to do business in the future with honesty and candor. On the same day Buffett answered questions before a Congressional committee investigating Salomon and the Treasury securities market. Buffett characterized Mozer’s improprieties as “almost like a self-destruct mechanism … not the act of a rational man at all” (Salwen, 1991). Buffett also said that the former management’s delay in coming forward was one of the most troubling aspects of the situation, raising questions Awhether there was a climate within Salomon that appeared to tolerate or even encourage wrongdoing (Gosslein, 1991). At the hearing, Buffett unveiled changes in Salomon’s compliance system intended to “make Salomon a leader in setting new standards in regulatory behavior in the financial industry.” Buffett also described Salomon’s new board-level compliance committee, to be chaired by Lord Young, a British executive who had preciously served in the Thatcher cabinet.
A final example of how Buffett reacted to the crisis at Salomon occurred in late October 1991 when he spent $600,000 publicizing his thirdquarter letter to the shareholders. On October 31, the two-page ads displaying the letter appeared in The Wall Street Journal, The New York Times, The Washington Post, and The Financial Times. Buffett trumpeted the firm’s new compliance procedures, noting his directive that Salomon’s 9,000 employees “be guided by a test that goes beyond rules: contemplating any business act, an employee should ask himself whether he would be willing to see it immediately described by an informed and critical reporter on the front page of his local paper, there to be read by his spouse, children and friends. At Salomon we simply want no part of any activities that pass legal tests but that we as citizens, would find offensive.”
It is clear that Buffett’s reaction to the crisis at Salomon was to provide full disclosure of the firm’s wrongdoing and not to cover it up as Gutfreund had tried to do. Buffett’s management of crises indicated that ethical wrongdoing would not be tolerated or hidden from the authorities at any costs. Not only did Buffett take action against transgressors, his action showed that Salomon was committed to a new ethical standard. There should be no doubt that Buffett’s reactions to crises was effective in demonstrating to both the firm’s employees and its key stakeholders that nothing less than ethical behavior would be a cornerstone of Salomon’s new culture.
A leader communicates strong messages to his or her employees about their values through his or her own actions, and Schein labels this role modeling. For example, employees who wished to emulate John Gutfreund could not hold to a strong sense of personal ethics. Greed is a quality that can push people to break ethical standards to further their cause and make money. And greed was a seed that Gutfreund planted in Salomon’s culture which contributed to its employees ignoring ethical and legal standards and resulted in the bond trading scandal.
If Salomon had searched for an upstanding and seemingly ethical investor, they could not have found a better role model than Warren Buffett. Perhaps the most important thing that Warren Buffett brought to the Salomon table is his image. For many, Buffett was an inspired and logical choice (especially since his Berkshire Hathaway firm was the major investor in Salomon). However, to this day, newspapers report that he went in to protect Berkshire’s $700 million, but Carol Loomis (1997) suggests that this explanation seems awfully simplistic. Loomis, a friend of Buffett for about 30 years, notes “Sure, he wished for the safety of that investment. But beyond that he was a director of a company in deep trouble and, in a way that few directors do, he felt an obligation to all of its shareholders.” Gutfreund says he asked Buffett to take the job. Buffett thinks he volunteered. Loomis recently indicated that Buffett did not in any case immediately decide to take the job at Salomon, and only decided to take the job “until things got straightened out” after reading a fax of a New York Times story The front-page headlines said: WALL STREET SEES A SERIOUS THREAT TO SALOMON BROS.; HIGH-LEVEL RESIGNATIONS AND CLIENT DEFECTIONS FEARED (Loomis, 1997).
Regardless of how Buffet came to temporarily take over the helm of Salomon, the vaunted “sage of Omaha” has a solid reputation for conservative, long-term investing; he was a custom-made antidote to the get-rich schemes Salomon was being charged with. He was also known as a master at manipulating the media, something he had done skillfully in building his own image as a nice, down-to-earth, grandfatherly sort of guy, and definitely “Mr. Clean.” That personal reputation for integrity proved extremely useful to Salomon.
Although there are numerous examples of contradictions to this image, it is only important that government officials, Salomon’s customers and the investment community in general, perceived him to be a paragon of America’s heartland virtues—almost a mythical figure riding in from Omaha on his white horse to rescue the pitiful New York bankers from their ethical downfalls. Experts have stated that they believe that one of the main reasons Salomon would survive their prosecution is because of Buffett himself (Spiro, 1991). During the Capitol Hill hearings on Salomon’s trading violations, Ohio Representative Dennis Eckart, referring to fictional financial villains, said, “Gordon Gekko and Sherman McCoy are alive and well on Wall Street. Mr. Buffett … get in there and kick some butt” (Suskind, 1991). Thus, there were those who saw Buffett as the “ideal” role model to get Salomon back on track.
One aspect of this Buffett image—being a “penny pincher”—may be the most important one to regulators and others watching the Salomon recovery. Buffett’s Berkshire Hathaway’s employs 22,000 people who are directed by only 11 people at its Omaha headquarters, which resembles a doctor’s office more than the nucleus of a billion-dollar operation. Their offices are located in one corner of only one floor at the end of a hall that has “industrial carpet and plastic weave wall paper” (Suskind, 1991). Berkshire Hathaway’s image is in stark contrast to the one Buffett took over at Salomon.
All of the evidence indicates that Warren Buffett, or at least the public image of Warren Buffett, was an exemplary ethical role model for Salomon employees to follow. It is drastically different from the image and the reality of John Gutfreund. Buffett usually sticks with a company’s current management and invests for long term, not just short term gains (Suskind, 1991). His philosophy is in stark contrast to Gutfreund and his “trader mentality” of going for short term profit, no matter what the cost. In addition, Buffett did not share Gutfreund’s hunger for personal cash flow. He is interested, instead, in maximizing long-term Salomon shareholder wealth.
Maughan’s appointment as chief operating officer (COO) under Buffett (and eventually as the chairman and CEO of Salomon) also reassured Salomon’s internal and external constituents. Dubbed “Mr. Integrity” in the press, Maughan had served ten years in the Treasury Department of the United Kingdom and had worked for four years in the London office of Goldman Sachs. In testimony before the U.S. Congress, Salomon highlighted Maughan’s “strong understanding of the proper relationship between financial institutions and government authorities.” On assuming his new position, Maughan pledged “an absolute insistence on the correct moral as well as legal behavior,” though he added, “I don’t think we want to remove all the elements of our success” (Power and Siconolfi, 1991).
Buffett successfully provided a role model for which Salomon’s employees could emulate and still be successful in the process. Buffett and Maughan wanted Salomon’s employees to move away from modeling their behavior after that of John Gutfreund where they saw an opportunity for power and seized and capitalized upon it for personal gain without giving any thought to the ethical and legal implications of their behavior. As a result of Buffett’s tenure at Salomon there were no more reported incidents of wrongdoing on the firm’s part. No longer were the firm’s employees twisting a situation to their advantage, regardless of the ethical consequences.
Allocation of Rewards
The behavior exhibited by people the leader decides to reward with pay increases or promotions signals to others what is necessary to succeed in an organization—Schein’s allocation of rewards mechanism. Further, research has indicated that the contingencies of reinforcement are critical in explaining the incidence of unethical decisions in the workplace (Worrell, Stead, Stead and Spalding, 1985). Decisions about ethical or unethical behavior stemmed, during laboratory experiments, from subjects’ immediate superiors’ expectations and evaluations. The reward system created by a leader indicates what is prized and expected in the organization.
John Gutfreund rewarded aggressiveness, greed and short-term performance at Salomon. Unlike Wall Street firms of the past, promotion at Salomon was certainly not dependent upon your background (educational, family or otherwise). Promotion and pay was based primarily on performance, but, unfortunately, only on recent performance.
Arguably the most controversial step Buffett took to force cultural change was his concerted attack on the pay structure. Clearly, Buffett favored a closer link between pay and performance. Buffett criticized the prevailing “egalitarian, share of the wealth” method of compensation as more suitable for a private partnership than for a public company dependent on shareholder capital. Thus began Buffett’s “pay for performance” philosophy at Salomon. In addition, Buffett took the unusual step of taking out a two page newspaper advertisement, which declared in part, “Employees producing mediocre returns for owners should expect their pay to reflect this shortfall. In the past that has neither been the expectation at Salomon nor the practice” (Siconolfi, 1991a).
To correct what Buffett termed “irrationalities” in the compensation system overall, compensation was reduced and departmental compensation was linked more closely to department performance in October 1994. It should be noted that Buffett was under increased pressure from Salomon’s key stakeholders to impose a new compensation system designed to limit pay levels that were among Wall Street’s grandest. With Buffett “performance” means return on equity for the stockholders, not each manager’s divisional profits. In 1990, more than 106 employees earned over $1 million in salary and bonuses, but Salomon, Inc. had a return on equity of 10% which was deemed “mediocre” by Buffett. Moreover, although operating profits remained relatively flat from 1989 to 1990, compensation increased by $120 million. To address this “irrationality,” Buffett promptly took back $110 million that had been earmarked for employee bonuses for the third quarter. Although employees certainly were upset with the change, investors were delighted and the stock jumped 8.6% a share on the day of the announcement (Siconolfi, 1991a).
Interestingly, it appeared that Buffett was also taking steps to return to an employee-owned philosophy, which existed at the firm before Gutfreund sold out to Phibro—that is, he intended to force the bankers and traders at Salomon to take more of their pay in Salomon common stock that would not be redeemable for at least five years. This would help to re-instill a long-term focus to Salomon employees and increase their interest in its future. Although individual performance would still be recognized, special arrangements like ones that Gutfreund and certain key managers had made which paid huge bonuses to some traders will be gone. Buffett vowed that top performers would, however, “receive first class compensation” (Siconolfi, 1991a).
Inside Salomon, some saw Buffett’s compensation reforms as a gesture of appeasement toward regulators who believed that Wall Streeters made too much money. They warned that the changes could drive away some of the firm’s best people. Others saw Buffett’s aim as shifting some of the financial impact of the scandal from shareholders to employees.
In his letter to shareholders, Buffett addressed the possibility that some employees would leave the firm because of the announced changes. However, he indicated that the changes were just as likely to induce top performers to stay. He went on, “[Were an abnormal number of people to leave the firm, the results would not necessarily be bad. Other men and women who share our thinking and values would then be given added responsibilities and opportunities. In the end we must have people to match our principles, not the reverse” (Paine, 1997). The emphasis on certain principles and the long-term focus was key to encouraging employees to consider all ramifications of their actions, not just what these actions will mean to their department’s profits this quarter.
Warren Buffett wanted to soften the swashbuckling image of the Salomon of old (Fombrun, 1996). To do that, he prodded the bank to sell off some big blocks of stock and take losses. The $391 million sale of the bank’s shares of ConAgra recorded a $10 million loss, while the sale of SunMicorsystems produced a 17 percent loss. It sent to all traders a signal that Salomon was no longer interested in high-risk wait-outs, that the bank would no longer act as a bully trader, that it would assume a less aggressive stance in the market. If the old Salomon had been like John Wayne, known for its swagger, the new Salomon was to become more like Ozzie Nelson, nice and low key, neither so strong nor so effective.
Buffett’s efforts to rein in the excessive executive pay at Salomon by reallocating rewards (i.e., introducing a new compensation system) proved to be the most frustrating, controversial and disastrous when one considers Schein’s five mechanisms for changing an organization’s culture. In theory, the plan was eminently reasonable. Excessive compensation was one of the main reasons Salomon had been floundering—in 1994 it paid out $1.4 billion to employees, or $277 million more than it collected in net revenues. But the managing directors rebelled against the new plan, fearing they’d pocket a lot less money. Some jumped ship to high-paying European banks, and others to rival Wall Street houses. In all, more than 20 managing directors left Salomon in the year following the firms introduction of the new compensation system.
In June 1995, Buffett and his hand-picked CEO Deryck Maughan scrapped the calamitous plan. While Buffett was working to change the culture at Salomon by reallocating rewards the firm was slipping in its rankings on the investment-banking-deal tables in 1995, partly reflecting the losses of key personnel (Pare and Tully, 1995).
Criteria for Selection and Dismissal
Schein’s last mechanism by which a leader shapes a corporate culture, criteria for selection and dismissal, describes how a leader’s decisions about whom to recruit or dismiss signals his or her values to all of the organization’s employees. Gutfreund’s leadership style selected ambitious, win-at-all cost, aggressive young people and gave them the chance to create new departments, new products, and enjoy success they could not achieve at other firms. Gutfreund’s and his hand picked employees short-term view prevented them from seeing what the long-term costs of this kind of personality and behavior could be on the organization as a whole.
Specific performance guidelines were lacking at Salomon under Gutfreund. The criteria by which Gutfreund dismissed employees was vague and led to ambiguous performance standards. When people are not sure what to do, unethical behavior may flourish as aggressive individuals pursue what they believe to be acceptable behavior. As noted by Drake and Drake (1988) there are both ethical and legal risks associated with Gutfreund’s chosen leadership style:
Reliance solely on subjective measures (e.g., “what my feelings tell me right now”) can lead to vague and inconsistent management policies.
These ambiguities can also lead to crossing ethical and legal boundaries as Salomon’s employees proceeded to do.
To further distance Salomon from the old way of life, Buffett made efforts to ensure that anyone who was even remotely connected with the scandal was no longer employed by the company Carroll (1978) has suggested that disciplining violators of ethical standards is a positive management action to improve ethical behavior of employees. Upon taking control, Buffett severed all relations with Mozer and Murphy, terminated their employment, and declined to pay their legal expenses. Maughan named Eric R. Rosenfeld, previously co-head of U.S. fixed income arbitrage, and a former assistant professor at Harvard Business School, interim head of the government trading desk, an area in which he had no previous experience (House Subcommittee on Telecommunications and Finance, 1991).
Salomon’s former top legal advisor, Donald M. Feuerstein, knew of trading violations in April and had persistently advised senior officials to report them to the proper authorities. He was fired anyway The law firm of Wachtell, Lipton, Rosen and Katz, which had conducted an internal investigation of Salomon in July, also stepped aside. Martin Lipton, a partner at the firm and a close friend of John Gutfreund, had helped to craft the August 9 and August 14 news releases. Robert E. Denham, a long-time associate of Buffett, replaced Feuerstein. Denham set his personal goal as to “make sure Salomon operates according to the highest of ethical principles” (Galen, 1991; Eichenwald, 1991). Creating an ethical advocate’s role is another suggestion made by Carroll (1978) to improve a firm’s ethics, and it appears that Denham will serve such a role at Salomon.
Two weeks later, the Salomon board met and announced that it would not pay compensation and future legal or other expenses of Gutfreund, Strauss, Meriwether, or Feuerstein, except to the extent that the firm was legally obligated to do so under pre-existing agreements.
Not surprisingly, signals of a new emphasis away from stocks and the traders towards bonds, as well as a change in culture, led to many defections in the firm. Such a drastic shift in strategic course necessitated similarly drastic changes in personnel. More conservative, less brash bond employees would be the new rulers at Salomon; the traders’ role in upper management would be limited. In November of 1991, Buffett created a nine-man executive committee, primarily comprised of bond executives, to replace Gutfreund’s office of the chairman and board of directors. The former office of the chairman had seven vice chairmen as members and four of them were already gone by this time (Siconolfi, 1991b). Traders no longer rule at Salomon. The former head of stock trading, for example, Stanley Shopkorn was excluded from the committee and subsequently left the firm. Mr. Shopkorn had a history of “questionable” ethical behavior. His department had caused the firm to be fined $1.3 million on charges that it cheated customers during the crash of October 1987. He kept a handful of black jack cards encased in Lucite to remind visitors of his skill at gambling with Salomon’s money (Smith, 1991). Shopkorn’s exodus signaled to others that the new Salomon will be a more cautious and leaner organization committed to ethical principles.
Firings and resignations have extended past senior employees closely connected to the old regime. Approximately 15% of Salomon’s senior investment analysts, as well as many stock traders and analysts have been fired (Siconolfi, 1991c). Buffett has been criticized for firing so many people so quickly. Alan Bromberg, a securities law professor at Southern Methodist University claimed, “This whole thing may have been an overreaction … sacking and condemning highly talented people for the sake of crisis containment … [Buffett] may have done more damage to Salomon’s morale and its ability to conduct its business than it was worth” (Cohen, 1991).
Bromberg’s comments would be on target in most organizations, but ignores the fact that Salomon’s unique culture seems to have created an atmosphere ripe for the unethical and illegal behavior that occurred. Firing Gutfreund was not enough to change the fabric of the company. Cultural change or an ethical turnaround for a company is a long and complicated process that cannot happen overnight, or by simply firing an unethical CEO. Gutfreund had been at Salomon his entire working career and had made his impact on every part of the organization. He had surrounded himself with people who shared his ethical principles and the same people cannot abide by Buffett’s new rules. Munger argued, “When the final chapter is written, the behavior evinced by Salomon will be followed in other, similar cases. People will be smart enough to realize this is the response we want—superprompt—even if it means cashiering some people who may not deserve it” (Cohen, 1991). By bringing in Denham as an ethical champion and by dismissing those Salomon employees most like Gutfreund, Warren Buffett began to pave the way for a new culture. Although it was too soon to tell if this new culture would maintain its current commitment to ethics, by clearing out the vestiges of the previous one, Buffett was taking the first step.
Warren Buffett’s ideas about whom to recruit or dismiss sent strong signals to Salomon’s employees about the values important to him as a leader. Buffett successfully introduced clearer criteria for selection, dismissal and performance standards in Salomon thus eliminating many of the ambiguities that existed under his predecessor John Gutfreund.
Summary of How Buffett Turned Around Solomon’s Culture
Through Buffett’s efforts, Salomon was able to survive both the negative publicity and the federal penalty in a sense, one could say that the government needed access to Salomon’s massive capital base and was also willing to put its faith in Warren Buffett and the new management philosophy. John Gutfreund’s culture was so deeply ingrained in the fiber of Salomon, Inc., however, that simply removing him and other top managers was not enough. Further steps were taken to kill the culture and return the firm’s ethical credibility.
Warren Buffett was ready to accept this challenge and took many of the necessary steps (through Schein’s [1985 mechanisms by which a leader can influence a corporate culture) to ethically turn around Salomon’s culture:
Attention—Buffett began to focus attention on improving the moral fiber of the firm. Buffett’s efforts were in stark contrast to what occurred under John Gutfreund’s tenure where Gutfreund looked at the most recent bottom line profits and disregarded long-term implications of employees actions.
Reactions to Crises—Buffett swiftly reacted to the crises facing the company by complying with authorities and firing ethical wrongdoers. Gutfreund lied, covered up ethical and legal transgressions, and tried to preserve his own position at any cost.
Role Modeling—Buffett conveyed the image of one of the country’s most ethical investors. Gutfreund set an example of secret deals and for tolerating and hiding unethical behavior.
Allocation of Rewards—Buffett allocated rewards according to employees’ performance and it can be assumed that a lack of commitment to ethical principles would ensure that employees would not be promoted. Gutfreund promoted those who were most like him, lacking any commitment to ethical principles.
Criteria for Selection and Dismissal—Buffett brought in employees who proclaimed their commitment to ethical principles and ushered out all old employees connected to ethical misconduct. Gutfreund had vague policies that confused employees and let them make their own decisions about how to “win” the internal Salomon competition that thrived under his leadership.
Of Schein’s five mechanisms used to analyze Buffett’s efforts to turnaround Salomon’s culture the allocation of rewards under the guise of the new compensation system seemed to have proved to be the most difficult to introduce and sustain by Buffett. While Buffett’s efforts to influence the firm’s culture by reining in the excessive executive compensation was the right thing to do it seemed to have had mixed results as Salomon lost many of its best performers. The criteria for selection and dismissals mechanism brought in a new type of employee to Salomon while eliminating those who possessed the traditional “trader win-at-all costs mentality” which many believe is necessary to be successful in the trading arena. Like Buffett’s use of the new compensation system it can be said that the new criteria for selection and dismissal had mixed results in changing Salomon’s culture. More specifically, many of the individuals who made Salomon what it was in its heyday were either fired or left the firm on their own which resulted in additional losses for the company.
The point should not be missed that while the allocation of rewards and reactions to crises had mixed results which led to a large number of employees being fired or voluntarily leaving the firm Buffett’s efforts were aimed at changing Salomon’s culture. Which in the end he ultimately did. Additionally, Buffett’s use of the other three mechanisms (attention, reactions to crises, role modeling) had clear positive affects on moving Salomon’s culture to one that supported ethical behavior.
While dramatic change is necessary, Salomon like any organization trying to change their culture through an ethical turn around go through a difficult readjustment period. Buffett had to realize that once he had removed all of the employees who were thriving in the old culture, the remaining employees needed to be assured that their positions were safe. Stabilization had to be an important next step for Buffett.
Conclusion: Avoiding Future Ethical Unethical Actions
We’ve never been able to figure out how to reliably prevent the cyclical decline of great civilizations, religions, armies, or corporations. But if we cannot bring ourselves to believe that man and his organizations are perfectible, at least we must believe that we can improve our own areas of responsibility according to some set of ethical standards. To do otherwise is to abdicate to the natural entropy of power (Kelly 1987).
The Salomon example is particularly difficult because so drastic a change was needed to retain the firm’s viability—planned change was not an option. However, the Salomon saga presents a vivid example of how an organization under the right leadership can actively return from the brink and rebuild ethical capital damaged by a scandal. Like Johnson & Johnson before them, Salomon’s adroit efforts under Buffett’s leadership demonstrates that an unethical culture need not be permanent.
While Salomon never achieved its previous ranking and notoriety in the investment banking arena, eventually being bought by the Travelers Group for $9 billion in September 1997, it must be acknowledged that had not Warren Buffett temporarily taken over the helm at Salomon there may not have been a firm to acquire. In the end, an important lesson to be learned from this look at Warren Buffett and Salomon is that no matter who the leader they must work to eliminate any inherent abstractness or the conflicting nature of the organizations ethical standards if they are going to be successful at an ethical turnaround. An understanding of the organization’s culture (and subcultures) is a must first step for the new leader that should quickly be followed by proactive steps to communicate an explicit position on the importance of ethical behavior that will guide the future organization.
Fombrun’s (1996) steps for restoring reputation are particularly helpful to leaders like Warren Buffett who are responsible for ethical turnarounds in organizations. The steps are as follows:
- Step 1: Take immediate and public responsibility for what happened.
- Step 2: Convey concern to all stakeholders.
- Step 3: Show full and open cooperation with authorities.
- Step 4: Remove negligent incumbent managers.
- Step 5: Appoint credible leaders that represent all interests.
- Step 6: Dismiss suppliers and agents tied to the incumbent managers.
- Step 7: Hire independent investigators, accountants, accountants, counsel, PR.
- Step 8: Reorganize operations to ensure greater control.
- Step 9: Establish strict procedures.
- Step 10: Identify and target the practices that stimulated infractions.
- Step 11: Revise internal practices and pay systems.
- Step 12: Monitor compliance.
The goal of today’s and tomorrow’s leaders should be to ensure that they build and maintain a strong ethical organizational culture from the start so that they won’t have to undertake the challenges of turning around an unethical culture. Leaders could do well to follow the advice of Paine (1997) who notes that while there are many approaches to building a corporate value system (culture) based on sound ethical principles, all require the active involvement of company leaders. Paine suggests that four aspects of the leader’s role in developing and maintaining a strong ethical culture deserve special attention:
Developing the ethical framework which serves as an ethical compass to guide planning, decision making, and the assessment of performance. Moreover, it notifies prospective investors, members, and business partners of the organization’s ethical stance. Aligning the organization by paying careful attention to the design of organizational structures and systems like leadership and supervision, hiring and promotion, performance evaluation and rewards, employee development and education, planning and goal setting, budgeting and resources allocation, information and communications, and audit and control.
Leading by example is perhaps the most important factor in building and maintaining a strong ethical culture. While employees typically look first to their immediate supervisors for ethical standards the company’s ethical stance is most powerfully defined through the behavior of invested with great authority. Their behavior sends a message clearer than any in a corporate ethics statement.
Addressing external challenges that propose ethical challenges that are inherent in industries and environments in which organizations operate are important for leaders to be aware of since they may pose major impediments to employee’s behavior. Although it is not always feasible to change problematic conditions, it is important to recognize the pressures they create and to consider carefully the organization’s stance.
Following the guidelines to determine if a firm is at ethical risk suggested by Cooke (1991) can also be an effective first step by an organization interested in countering unethical behavior. Cooke warns of organizational ethics becoming trivialized, because it is such a “hot” topic. By recognizing his warning signs early, an unethical experience, such as that of the Salomon Brothers, may be avoided. Several of the danger signs were exhibited by the culture created by John Gutfreund, including short-term revenue emphasis, arbitrary performance-appraisal standards, an internal environment discouraging ethical behavior and ethical problems being sent to the legal department. Unfortunately, at least one danger sign—primary concern for shareholder’s wealth—appeared in Buffett’s new culture. Once any or all of these signs have been recognized, it is imperative that a firm take corrective measures. Although Warren Buffett took several necessary steps through his leadership, establishment of a code of ethics, discipline of violators, and creation of an ethical advocate’s role, it is also important that leaders committed to ethical turnarounds need to create a long-term strategic and ethical plan. The plan should emphasize a whistleblowing mechanism and, most importantly, a training program in business ethics to ensure that there is little ambiguity when employees face ethical and/or legal dilemmas in the future. In a sense, what is needed at companies like Salomon Brothers is to ensure that ethics becomes paramount in the organization.