Not rocket science, Toshiba.

My go-to joke about rocket science is that my husband's best friend is, in fact, a rocket scientist at NASA--so every time I need to know if something's rocket science, I can just ask Randy.  ("No, that's not rocket science, Nancy.")

It's not rocket science to figure out that alleged pressure from Toshiba's top brass may have led to serious accounting problems (see here and here).  The formula is [top brass has particular incentives to get big rewards] + [incentives are linked to the company's financial performance] + [the better the performance, the bigger the incentives] = [increased tendency to lean on lower-level managers to fudge results].

Do the lower-level managers have options?  Sure, but none of those options will end with happy results.  Balk at upper-level pressure?  Get fired.  Yield to upper-level pressure?  Run the risk of being part of a conspiracy.  Blow the whistle (I have no idea what the whistleblower laws are in Japan)?  Maybe come out unscathed (technically) but run the risk of becoming a pariah.  Cynthia Cooper's autobiography is still my favorite book about whistleblowing.

So what's the solution?  Boards need to think hard--and strategically--about what incentives they're giving to their C-level officers.  Bad incentives = bad consequences, every single time.

Perverse incentives strike again.

Cross-posted at my main blog here.

We're not very good at learning from our mistakes, are we?

My husband, my friend Bala, and I have edited two books on Enron.  We edited the first one as a way of figuring out what had happened at Enron so that people could avoid making those mistakes again.  We did the second book after realizing that no one seemed to have learned from Enron, and we wanted to figure out why smart people don't learn from their mistakes.  (I'm talking with the publisher soon about a third edition, meant for both law schools and business schools.)

Two different articles this week made me realize that the willingness to learn from mistakes is a rare quality.  The first one, in the Wall Street Journal, involved a CEO who allegedly wanted his subordinates to lie about the company's financials (shades of, among other things, WorldCom).  The second one (here) has to do with Fannie and Freddie being willing to finance mortgages that have very low downpayments.  A three percent downpayment leaves the buyer with very little skin in the game.

So why don't we learn from others' experiences?  There's a whole slew of possible explanations, but the one that appeals most to me is the idea that humans will find a number of ways to fool themselves--maybe not consciously, but subconsciously.  After all, "we're" not manipulating financials; we're "adjusting" them to comport with the predictions that "must" be correct.  "We're" not encouraging people to lower their emotional and financial connections to their homes; we're "enabling people who wouldn't otherwise be able to afford a home to get one."  It's a frustrating business, this refusal to extrapolate from past financial disasters.  But it's a stubborn problem.

The answer to the question of whether we learn from our past missteps: "No."

Over at Credit Slips, there's an Adam Levitin post on the new QM/QRM mortgage rules (here).  Couldn't have said it better myself, and his post is worth reading.

Two reasons to watch the Dewey & LeBoeuf indictments.

Here's one.  The other one is the use of RICO to include lawyers in conspiracies (here).  It will be interesting to see if the two intersect.