The world of banking and finance has earned more than a little opprobrium in recent years. Some of the black marks: The pumped-up subprime loan and layered derivatives mortgage crisis, which led to the Great Recession; the false, “robo” signed affidavits that led to people losing their homes through illegal foreclosures; the LIBOR and foreign exchange trading scandals; the hundreds of billions in fines paid for wrong-doing, while executives rarely, if ever, went to prison despite the typically large sums involved.
Financial services are one of the most robust sources of employment in the U.S., with high average wages, and it attracts talented young people from beyond the narrow set of Ivy League schools.
The typical hand-wringing about young people going into finance also obscures the reality of how rewarding those jobs can be. Many people find finance intellectually rich and a source of lifelong learning. They often start a finance career not for the money but because they know that many other bright people go into the profession, and they want to be surrounded by them. Or, in later years, many migrate toward finance — even doctors and lawyers — as they discover that thinking hard about the value created by a business is fascinating.
And it is truly fascinating. Why is Amazon worth close to half a trillion dollars (twice the value of Walmart) when it has barely generated any profits? Should a subscriber of Snap.com be valued the same as a Facebook user? What is the impact of scalable 3D printing or artificial intelligence on the future of manufacturing? How will the crisis of problematic loans in Italian banks be resolved? These are rich questions that do not yield to simple analysis. The questions in finance can be as intriguing and as challenging as the diagnostic problems facing doctors, the logical puzzles facing lawyers, the unresolved questions facing scientists, and the strategic challenges facing executives.
Finally, the global financial crisis has taught us about the havoc that finance can wreak — and how central the industry is to our lives. Our educational trajectories, our family circumstances, and our quality of life are dictated in part by financial logics. Am I saving enough? Too much? Is that investment in my education worth it? Why do my spouse and I always fight about money? How do I get out from under this mountain of debt?
As much as we begrudge finance’s power in society, the reality is inescapable: Finance plays an enormous role in all our lives, and many of us find it deeply interesting and challenging.
People are really upset about finance, and some of them have good reason to be. Obviously, finance is not doing everything it should be doing, but there are also a lot of misconceptions. We desperately need finance to be humanized. That’s part of the problem today: People perceive it as a complex topic that is not accessible. In fact, it’s pretty intuitive.
We are struck by the parallels between the big ideas of finance and big questions in life. That parallelism really strikes a chord, and the reason is because people want meaning and wisdom, but they don’t want it dispensed from upon high. They want it from their lives, and they want it from their work. So if you can talk about meaning by talking about leverage or value creation or options, you can communicate it in a way that’s more resonant than talking about it in some abstract way.
The real dilemma posed by careers in finance is why and how some of the people who go into it — including some of our best and brightest — end up behaving poorly. Even those of us who enjoy thinking about finance can see that the practice of it is broken.
The usual reactions to misbehavior in finance are outrage or regulation. Regulation is part of the answer, but it is not a panacea: Blunt regulatory instruments carry unintended consequences that can create as much havoc as what they are designed to solve. Moreover, many regulators and legislators are captured by the industry, so we can’t hope for much from them. Outrage about finance can also backfire. In fact, the low reputation of the profession only means that people in finance are held to an ever-lower standard.
Bad behavior in finance results, in part, from the unique way in which participants, particularly investors, understand their own performance. Finance is different from other fields in two ways: Financial markets provide near immediate and easily quantified feedback, and the consequences of decisions can be inflated by leverage. Humans in all fields typically make sense of the world’s feedback by attributing positive outcomes to themselves and bad outcomes to situational factors, but finance creates these attribution errors on a more massive scale and at a higher frequency than any other field. As a result, it should come as no surprise that finance features more than its fair share of unsavory characters with an inflated sense of self-importance and invulnerability. And the sharp rise in markets-based compensation — including high-powered incentives for money managers and equity compensation for CEOs — has further fueled the depth and breadth of these errors.
The irony of this situation is that the discipline of finance warns against precisely this pattern. Finance teaches us that it is nearly impossible to isolate the effects of luck and skill in financial markets. It teaches us humility, too: Risk is omnipresent, difficult to measure, and hard to price, so as a result, true skill is hard to isolate. Only over long horizons, if at all, might we come to understand what skill is — and who the truly skillful are.
This is part of a broader pattern: The practice of finance has become divorced from its underlying ideas. For the profession to recover its reputation, its practice needs to be anchored again in the underlying ideas — and the central ideas in finance are actually quite noble. Insurance, leverage, risk management, value creation, asymmetric information, and options are all concerned with exactly the same philosophical question that many of us are concerned with in our lives: what is most valuable to us and how to create and measure it.
As a result, the core ideas of finance have humanity and nobility embedded in them. Take insurance. For most of us, insurance is about as mundane and uninteresting as it gets. But the founder of the philosophical tradition of pragmatism, Charles Sanders Peirce, became preoccupied with insurance companies. He ran around giving lectures saying “We are all insurance companies.” He understood that the problem facing humans and insurance companies is fundamentally the same: We live in a world filled with randomness and chaos and must decide about the risks we undertake. And his solution for insurance companies and human beings was the same — go out and gather data, experience the world, sample what it has to offer, and understand the patterns in the chaos so that you can navigate the seeming randomness of life. Insurance is not only fascinating but profound, if you think about it this way.
Bankruptcy is fantastic, because it’s such a dramatic thing. It’s the story of Robert Morris, who is the wealthiest man in the Colonies, who is first asked to be the treasury secretary before Alexander Hamilton, because he had done so much to finance the Revolution.
Obviously, nobody knows his name anymore, and the reason why is, he turned down that job. He went on to become, again, the wealthiest man in the new country. He owned half of New Jersey, half of New York — and then he went bankrupt. And his bankruptcy was the triggering event for us to stop thinking about bankruptcy as a moral failing. The Bankruptcy Act of 1800 changed a lot of things about bankruptcy because of Robert Morris. We started to view failure not as something that you should look down on and demonize, but as something where you should actually protect the people who fail, and you should understand it as a consequence of risk-taking, not moral failure.
We have a real problem in the retail sector. What’s interesting about what’s happening is, once these companies teeter on the edge, then it becomes a question of how do you know when to declare bankruptcy.
Some people, like the American Airlines CEO, say, “I’ll never declare bankruptcy. It’s wrong, and you have to live by your commitments.” That’s nice to say, but it’s not realistic. The next CEO comes in at American Airlines and basically restructures the airline, he guts the pensions, he does some things that are terrible and some things that are wonderful, but in the longer run, he actually gets the company through. And the company emerges in a much stronger way.
The person who’s usually valorized — the guy who says, “I stand by my commitments, no matter what” — is not really the hero. It’s the guy who’s willing to go through the muck of a bankruptcy to salvage the assets who is actually the hero of that story.
If people have a better understanding of finance in general, then maybe they will be more hands-on with a lot of elements that end up being very important to them, especially later in life.
With people generally, finance is really intimidating. As a consequence, people do passive things — they don’t really want to engage because they’re intimidated by the ideas, and that is really unfortunate and really costly to us individually and to us as a society — because finance is just so important. It’s so important to your life when you think about retirement. It’s so important to your life when you think about student loans. If you block it all out, that’s a terrible way to live. So for people outside of finance, it’s a way of saying, “Come on in. It’s easier than you think, and you can learn a bunch of stuff just with stories.”
Finance has got a bad rap, and you need to be able to explain finance, and we need to make finance more aspirational. And in fact, the underlying ideas are worth aspiring to.
Part of what happens in finance is that people — as you know, it’s a very un-diverse sector. There’s underrepresentation of women and of minorities. Part of the way people rationalize that is they think, “Well, gosh, finance is so meritocratic.” The market is a hard master, and I go demonstrate my worth every day because I’m investing, and I’m trying, and the market is telling me I’m doing well or I’m not doing well, and so if people aren’t represented, it’s just a function of that meritocratic nature.
That’s really problematic. In fact, the underlying ideas of finance would suggest exactly the opposite, which is there is a ton of luck in the world. Finance is, in a way, about how you can never separate out luck from skill. You should be really humble about any accomplishments in finance because the whole idea behind, for example, efficient markets is that it’s really, really hard to beat the market. Yet people in finance routinely say they do. This is one of the puzzles about finance: People like to think of it as this skill-based, meritocratic thing, and that justifies all kinds of exclusions. In fact, there’s no industry where it’s easier to dress up failure as success. Every fund is in the top quartile.
As a whole, the finance industry is fairly ethical. It’s a good industry, and it does something incredible, which is it transfers capital from people who have it to people who need it, which is the biggest thing to do in capitalism.
So it’s a great industry, and it has great ideas. It’s just that we’ve lost track of those ideas. The real thing is, let’s get back to these underlying ideas as a way to move the industry forward.
In the recent past, we’ve seen things going on with Deutsche Bank and Wells Fargo. When you think about it, the number of issues that pop up in the finance industry — especially in the last couple of years – have been small, but when something happens, it is a massive problem. It’s hard for a lot of people to really want to delve into the finance industry when you see these huge issues popping up.
There are these problematic things that happen, which signal that there is a real underlying problem. And then they get blown out of proportion, which creates a societal taint on finance. That taint — and that view of “finance is kind of evil”– is doubly bad, because then there’s nothing to aspire to. People in finance are a little bit ashamed of going into it, or they try to think of their professional life as separate from their personal life because finance is “dirty.”
That’s really problematic. You should bring your personal and professional life together. You work in a field that’s actually fantastic. It’s got these great ideas — live up to that. Let’s make finance aspirational, as opposed to defining it downward, as an evil field.
Will the next insider trading scandal be avoided by the simple prescription that practitioners should hold true to the ideas of finance? Perhaps not. But over the longer run, it is only by anchoring the profession’s practice in noble ideas that we can expect people in the industry to behave in an aspirational way.
Demystification is critical, as finance is being demonized by many people who don’t fully understand the underlying ideas. That demonization is quite counterproductive, as finance is too important to society to be caricatured in simplistic ways. And, the easiest way into these ideas is through stories. At the same time, the best hope for fixing finance is to reconnect practitioners to the humanity of the underlying ideas of finance.
One of the problems today is that the questions and solutions of finance are not always viewed through a moral prism. Humanities force us to ask questions about how to behave in problematic situations. Anchoring the ideas of finance in stories drawn from the humanities holds the promise of making the ideas more accessible and resonant and hopefully avoids the blinders that some people in finance have.
Humor has this incredible way of disarming people and making the lessons more memorable. The ideas of finance need to work past people’s cynicism about finance and need to survive more than a few hours in a classroom. Humor can help with that.
Finance has become more specialized, more abstract, and more quantitative, we’ve lost touch with the concerns of most people. Humanities have lost touch with many people by deriding commerce and finance. The gulf between the two is a loss to all. People in finance have lost the richness of the humanities, and humanists are spending too much time talking to themselves and not to broader audiences. There’s just an enormous opportunity in bringing those back in touch with each other.
Markets are being moved by the prospect of tax reform. That’s been a huge piece of why people have been getting excited in markets. That’s pretty misplaced because the kinds of things that are being talked about are not going to happen.
What will actually end of happening, either this year or next, is a pretty narrow corporate tax reform, where the corporate tax rate comes down to something more like 25% or 22%, and most importantly, we get out of this worldwide regime. Both of those things are going to help financial players and markets a lot, and that’s great, because it’s going to help the economy more importantly a lot. It’s going to free up a lot of capital that can come back to this country. It’s going to make the U.S. a better place to invest. Those are the really important things.
But the market has gotten ahead of itself, because there’s talk about this border adjustment tax, which would have a lot more significant effects. When people readjust their expectations to something more modest — which is going to be better, frankly — it’s going to take them a little while to digest that.
Some of the banks have grown bigger. The biggest have grown bigger. There’s been very little to no entry of newcomers, and there have been no real bust-ups. That’s true across the sector. Only now do we see some compression in alternative assets and in hedge fund fees. So it’s been really slow moving, which says something about the political power of finance and maybe just the unwillingness to tackle it.
What happens in the longer run is, these large banks have a business model problem, and they’ve got to figure out how to make money, and they’ve got to figure out what their business model is. Unless they do that, it’s going to be tough to sustain them.
Finance should re-orient to core functions, which are value-creating, like managing people’s risks, like simple credit, simple brokering, and get away from the things that are more extractive, like chunks of the money-management industry, which are a little more questionable. That’s what should happen — moving back to simpler, core finance, like what banks in a way used to be in some sense, and get away from these much more complex institutions that are both hard to regulate and hard to manage.
Many great humanists were steeped in finance. The composer Charles Ives began and ran the largest insurance agency in the United States; T. S. Eliot remained a banker at Lloyd’s even as Ezra Pound mocked him for doing so; Wallace Stevens never left The Hartford even though Harvard offered him a tenured professorship; Jeff Koons began as a cotton futures trader and still uses finance in his art; Richard Wright drew on his work in selling insurance in his literature, and so on. However, this collision between the humanities and finance seems to happen less and less.
As their role expands to include ever more nonfinancial demands, CFOs know they must build new skills to lead. Faced with advances in technology and growing responsibilities, many CFOs are bracing themselves for more change ahead—and understand that they must adapt to be effective. There are new demands on CFO time, such as digitizing critical business activities and managing cybersecurity, in addition to traditional finance duties. While these newer responsibilities present opportunities for finance leaders to differentiate themselves—and their companies—from competitors, companies are not yet prepared to manage these challenges.
Most CFOs know it’s no longer enough to play their traditional role. Instead, for CFOs to deliver value as their duties evolve, the results suggest that they must build skills in other areas of the business, play a more active leadership role, and rethink their usual approaches to overcoming external pressures and finding new investment opportunities.
Today’s CFOs are responsible for much more than finance. On average, five functions other than finance now report to the CFO. More than half of CFOs say their companies’ risk, regulatory compliance, and M&A transactions and execution report directly to them, and 38 percent of CFOs are responsible for IT. Some CFOs even manage cybersecurity and digitization, suggesting just how diversified the list of demands on the CFO is.
For the most part, CFOs understand that their roles continue to change and expect to adjust their course. About four in ten CFOs say they spent the majority of their time in the past year on roles besides traditional and specialty finance. Among these other roles, CFOs most often focused on strategic leadership, organizational transformation, and performance management.
What’s more, CFOs themselves and respondents in other roles believe that CFOs can create value in several ways, and not necessarily by fulfilling traditional duties. Eighteen percent of CFOs say that, in the past year, they have created the most value for their companies through their traditional finance work. But others are most likely to cite strategic leadership (22 percent) as the area where they’ve created the most value. Looking ahead, CFOs would prefer to spend less time on traditional finance activities in the next year—and more on strategic leadership (two-thirds of all respondents say CFOs should spend more time here), organizational transformation, performance management, and big data and technology trends.
Still, the nonfinancial responsibilities—including those related to technology—are putting many CFOs on alert. Less than one in three believe their companies have the capabilities they need to be competitive in their digitization of business activities. Fewer than half feel their companies are well prepared or very well prepared to be competitive on their cybersecurity capabilities.
Top executives acknowledge the value that finance chiefs bring to their companies, and CFOs themselves agree. In matters of finance, both groups largely agree that CFOs are very involved members of their teams. They also agree that CFOs should spend more time as strategic leaders in the years ahead.
But as the CFO’s role evolves, so are the expectations that other company leaders have for them. Not surprisingly, then, the data show that CFOs perceive some of their contributions differently than do others in the C-suite. Majorities of CFOs and other C-suite executives agree that their CFOs are significantly or the most involved in bringing deep financial expertise to discussions, focusing group discussions on the creation of financial value, and serving as the executive team’s public face to financial stakeholders. But for activities beyond finance, the results suggest there’s a gap between the leadership that CFOs currently demonstrate and what other business leaders expect of them. For instance, 72 percent of CFOs say they are significantly involved or the most involved executives in allocating employees and financial resources. Yet only 29 percent of other C-level executives say the same about their CFO peers.
CFOs also rate the performance of their finance functions differently than their fellow executives. While 87 percent of CFOs rate their finance functions as effective, only 56 percent of other C-level executives say the same. These groups also report differing views on the challenges that finance functions face. Whereas CFOs are likelier than their peers to cite a lack of resources and skills as barriers to effective finance-function performance, others in the C-suite most often identify a lack of innovation mind-sets.
On the whole, CFOs recognize the need to move beyond traditional or textbook practices. But few say their companies use innovative methods to make decisions. Roughly two in three CFOs say their companies do not yet have the capabilities for agile decision making, scenario planning, and decentralized decision making they’ll need to be competitive in the coming years.
Likewise, many say their companies use basic financial controls in their decision making—but few report the use of more advanced practices. When asked about their capital-allocation processes, most CFOs agree that their companies set capital-expenditure budgets at the project level, use comparable metrics across business units, and track the results of specific projects. These practices support the foundation of a strong capital-allocation process. Fewer CFOs, though, report using tactics that would foster further learning or innovation. Just 30 percent of CFOs say their companies formally review investments made three to five years ago, and one-quarter say they’re using new methods to identify funding opportunities.
Assert proactive and strategic leadership. CFOs perceive some of their contributions to the C-suite differently than other leaders do. One such divergence is the CFO’s involvement in strategic decisions, suggesting that finance leaders have more room than they may think to leverage their expertise and influence—especially since many other C-level executives believe CFOs should spend more time on strategic leadership in coming years. Finance leaders could start by more explicitly articulating the scope of their role, which may help finance leaders increase the engagement and effectiveness of the executive team.
Adopt an investor’s mind-set—and more innovative practices. Many CFOs are aware of their financial stakeholders’ interests, but less than half agree that their companies keep cash scarce—which investors often see as an indication that a company will be disciplined in its investments. The finding highlights the importance of demonstrating capital discipline by translating an investor mind-set into a day-to-day management style. That could also mean adopting innovative finance processes: for example, moving away from a typical, annual capital-budgeting process toward a more agile one, with flexible budgets, quick decision making, and a performance-management system to match. Maintaining a more investor-based mind-set could also help preclude the kinds of misunderstandings that draw the attention of activist investors, which less than one-third of CFOs say their companies are well prepared to manage.
Embrace technological advances. If new technologies and trends are adding to the evolution of the CFO’s role, they also have the potential to make it easier for finance leaders to understand current business complexities. There is a wide range of tools that can help CFOs benefit from big data and the digitization of finance processes; for example, software that automatically completes repeatable, standardized, or logical tasks, such as processing transactions or integrating data to derive business insights. CFOs should increasingly use such tools to lead complex enterprise-resource planning efforts, among other challenges that they are being tasked with managing.