Introduction
The concept of management has been studied and explored for centuries. Many business experts have endeavored to unravel the truth behind management of organizations and its overall impact in the business performance. Based on this analogy, it follows that managers play a crucial role in directing certain activities within an organization.
They can either cause an organization to prosper or fall down to its knees, depending on several management principles, which might be adopted (Jones & George, 2007). This case study explores how various organizations get affected by different management patterns, with reference to Lehman Brothers. To attain this objective, several segments will be covered including the company’s profile, history, business growth, growth, crisis circumstances, bankruptcy and its current situation.
Lehman Brothers
Lehman Brothers is one of the companies in the world, which will forever be remembered for its major role in the commercial and financial history of the United States. For more than one hundred and fifty years, the company remained active in the American market, expanding its services to several countries around the world (Ryback, 2012). A close analysis of Lehman Brothers offers insights into how the American market has been transformed through industrial and technological advancement.
Company profile
Lehman Brothers was once a common name on the New York Stock Exchange before it collapsed in 2008. The company specialized in financial services across the world. It is worth noting that Lehman Brothers was ranked as the fourth largest investment organization in the country. The company was widely involved in an array of financial activities, including but not limited to investment banking, private banking, trading and private equity.
At the peak of the global financial crisis in 2008, the company was among several others, which could not survive the crisis. In September 2008, the firm applied for Chapter 11 bankruptcy protection, after a huge number of its clients withdrew from the company. Besides this, Lehman further registered massive losses on the stock market, with most of its assets being devalued by several American agencies dealing in credit rating (Ryback, 2012).
Aside from its outstanding performance in America’s financial market, the organization equally registered the largest bankruptcy in the country’s history. As a result, the company is considered to have contributed towards the global economic crisis, which rocked the world in 2000s.
Following the filling that was done of September 15 2008, Barclays agreed to purchase the company, even though the decision was to receive a regulatory approval to allow change of ownership and management of the organization. The agreement was endorsed by James Peck of the U.S. Bankruptcy Court, a few days after it had been filed.
Importantly, Barclays was to acquire the company’s head office building in New York and several North-American investment divisions. Seven days after this agreement, Nomura Holdings went on record by expressing its intensions to purchase the company’s assets in Australia, Japan and Hong Kong (Ryback, 2012). Additionally, Nomura was to acquire the company’s investments in parts of the Middle East and Europe. The deal was sealed on October 13 2008.
Company History
The history of Lehman Brothers dates back in mid 19th century when, Henry Lehman immigrated to America from German at the age of twenty three years in 1844. While in Alabama, Henry ran a dry goods store, named, ‘H. Lehman’ before it changed to ‘H. Lehman and Bro’ in 1847, when he was joined by his brother, Emmanuel Lehman. Lehman Brothers was finally established in the year 1850, when Mayer Lehman, the youngest brother teamed up in Alabama (Barsch, 2012).
Due to the availability of cotton in 1850s, the three brothers considered it as a form of payment for merchandise. As a result, they started dealing in cotton business, before it expanded to become a leading segment of their operations. Unfortunately, Henry Lehman succumbed to yellow fever in 1855, leaving the business in the hands of his two brothers, who focused on trade and brokerage.
As the cotton business continued to expand, most activities shifted to New York City, where Lehman Brothers launched its first branch office. For effective management, Emmanuel moved to New York City (Barsch, 2012).
The Civil War of 1862 saw Lehman Brothers, team-up with John Durr, a merger that resulted into the birth of Lehman, Durr Co. It is believed that the new company played a major role in the reconstruction of Alabama. Their joint efforts further bred the New York Cotton Exchange in the year 1870. Additionally, the firm explored other fields like the railroad bonds and financial advisory business.
By 1883, Lehman Brothers gained membership for the New York Stock Exchange, where they had their initial public offering in 1899. In 1906, the firm experienced a shift from its partnered with Goldman Sachs, to form the General Cigar Co. under the leadership of Philip Lehman.
The following years saw Lehman Brothers underwrite several issues, in collaboration with Goldman Sachs. In 1925, Lehman Brothers experienced a change in management after Robert Lehman rose to the helm of the company’s management from his father, Philip Lehman. It is during Philip’s time that the company embarked on venture capital as the market continued to grow, moving to the One William Street location (Barsch, 2012).
Lehman Brothers underwrote the initial public offering of Dulmont, which facilitated the financing of America’s Radio Corporation in 1930s. Besides this, they were involved in the funding of other companies like Kerr-McKee and Halliburton. It is believed that 1924 marked a turning point in the running of the company as John Hancock became the first non-family member to partner with the company.
Others who followed suit included Paul Mazur and Gutman Munroe in 1927. Robert Lehman, the last family member to lead the firm died in 1969, leaving a huge management gap, coined with the looming financial crisis (Barsch, 2012). This saw Pete Peterson coming on board to save the situation, based on his management experience at Bell & Howell Corporation.
Under the leadership of Pete, the company experienced several mergers and acquisitions, i.e. it acquired Abraham & Co. before merging with Kuhn, Loeb & Co., which was considered to be financially struggling. The resultant company, Lehman Brothers, Kuhn Loeb Inc. rose to become the fourth leading investment bank. Credit was given to Peterson for leading the company from dwindling performance to reputable profit margins in five consecutive years (HITC, 2008).
Despite the company’s outstanding performance, there was mounting pressure from traders and bankers. This forced Peterson to appoint Lewis Glucksman as the company’s co-CEO in 1983. This was the beginning of management issues as the CEOs conflicted in terms of their management styles.
Consequently, power pressure and poor performance of the company led to the ousting of Peterson, one of the firm’s best CEO. Unfortunately, upset bankers left the company, following management wrangles, which haunted the firm. Although Lehman Brothers had a strong competitive internal environment, it could not overcome the test of time. It was this pressure that compelled Glucksman to sell it to Shearson at $360 million in 1984.
In 1988, the company’s merger with E.F. Hutton & Co. bred Shearson Lehman Hutton Inc. (HITC, 2008). Due to diversification of several firms, most of them were spun off as the organization retained its original name as Lehman Brothers.
The firm’s head offices at World Trade Center were destroyed by the 2001 terror attack, causing it to shift to Manhattan in 2002. The Company got intertwined into the American mortgage lending crisis, which ushered it to the world of bankruptcy in 2008. After it filed a bankruptcy petition, its assets were sold out to several firms like Barclays and Nomura among others.
Business crisis circumstances
According to financial analysts, the housing boom experienced in early 2003 was to haunt Lehman Brothers because of the financial decisions, which were adopted. As a result of the boom, Lehman Brothers ratified a decision that supported the purchase of five mortgage lenders, which included BNC Mortgage and Aurora Loan Services. Unlike other mortgage providers, Aurora allowed borrowing of cash without complete documentation from customers.
The initial stages of the acquisition were quite encouraging as its revenues in the real estate business grew exponentially between 2004 and 2006. It is during this time that Lehman Brothers registered higher profits in real estate than asset management or any other form of banking investment.
By 2006, Lehman Brothers had gathered approximately $146 billion, which translated into an increment of ten percent from the previous year. This trend was to continue up to 2007, when the company registered a historic net income of $4.2 billion, which was realized from total revenue of $19.3 billion (HITC, 2008).
Company miscalculation
By the year 2008, the company’s stock hit a new value of $86.1, which had not been witnessed throughout its history. This meant that Lehman Brothers enjoyed a market capitalization of nearly $60 billion. Nevertheless, there were tangible cracks in the housing market, leading to a rise in defaults, especially on subprime mortgages. After the first quarter of 2007, there were concerns over the high rate of mortgage defaults that was likely to affect the performance of Lehman Brothers (HITC, 2008).
Nonetheless, the concern was followed by the firm’s record profit announcement. Lehman Brothers management, including the company’s financial officer, saw no need of getting alarmed by home delinquencies; they believed that the looming financial crisis was not going to affect their performance. Additionally, the CFO noted that the crisis within the subprime mortgages was not going to affect the country’s economy.
Lehman Brothers Downfall
The credit crisis that started in August 2007 had significant impact on Lehman’s stability as its stocks registered a shocking drop on the stock market. As a result, the company was forced to react by retrenching 2,500 people, who worked in mortgage related sections. In addition, the firm closed down its BNC unit, due to the losses that were already visible, together with Aurora offices in three American states.
Even as the U.S. government erected measures to tame the situation, Lehman Brothers continued to dominate the housing market (HITC, 2008). The firm gathered $85 billion in 2007, which was four times its shareholders’ equity and the leading in the market. This was realized when it underwrote several mortgage securities. While many people expected the company to act swiftly in containing the mortgage crisis towards the end of 2007, no serious action was implemented.
Towards bankruptcy
Unlike other mortgage companies in the country, Lehman Brothers was surrounded by certain factors, which made it more vulnerable to the effects of the looming crisis in America. Its ratio of assets to shareholders’ equity reached thirty one percent in 2007, with enormous mortgage securities.
Bear Stearns’ situation nearly collapsed in March 2008. This caused an alarm that resulted into a drop of up to 48% in Lehman’s status; many thought that Lehman was to follow suit as the second mortgage underwriter to fall (Fitzpatrick & Thomson, 2011). Investors’ confidence in the company slightly increased in April 2008, through an issue of preferred stock, which favored Lehman’s shares. Nevertheless, the trend did not last as managers got concerned with the firm’s mortgage portfolio.
Lehman Brothers recorded a loss of $2.8 billion on June 9 2008. This was the first loss, which the company had registered, from the time it was spun off. Despite this loss, the company’s management announced that a total of $6 billion had been collected from the organization’s investors. Furthermore, its liquidity pool had risen to a total of $45 billion as its gross assets dropped with a margin of $147 billion (Fitzpatrick & Thomson, 2011).
Reaction to the crisis
Lehman’s response to the crisis was considered to be negligible and too late. This included several overtures, which were made to its prospective partners during summer. While these efforts were on, its stock fell by 77% in September 2008, amid poor performance of several markets around the world. It was during this time that investors put the company’s management to task over its intentions to remain independent (Fitzpatrick & Thomson, 2011).
Moreover, the management became hopeless when Korea Development Bank put on hold its pursued interest to purchase a stake of Lehman Brothers. This development was quite devastating; the company registered a 45% fall in its stalks and a further 66% of credit-default swaps.
As a result, several hedge fund clients cut links with the company, together with short-term creditors. Its fiscal performance, which was announced on September 10 2008, emphasized the fact that its financial base was quite fragile due to the unfolding events within the global financial market.
This had led to a $3.9 billion loss and $5.6 billion write-down. In addition, the company’s management saw the need of restructuring its business in order to counteract the effects of the crisis, which were threatening the survival of the firm. This was followed by a decision to evaluate the company’s credit ratings and a suggestion to sell its stake to a strategic investor to avoid a fall in its rating. Unfortunately, these efforts saw the company drop to a 42% in its stock, in twenty four hours (Williams, 2010).
A series of the company’s unsuccessful plans left it with $1 billion by the end of the week. One of the rescue options was an agreement with Barclays PLC and Bank of America to oversee the takeover, but it did not go through. Having exhausted all it considered to be rescue strategies, Lehman Brothers declared bankruptcy, mid September, after registering a dismal performance and a drop of 93 % in its stocks (Williams, 2010).
The collapse of Lehman Brothers was not an ordinary occurrence in the U.S. financial market and around the world. This was based on its market stake and influence in America and other countries. There were many unanswered questions about the collapse, with a section of observers questioning the government’s responsibility to support Lehman, as it had intervened in Bear Stearns in March 2008. The company lost up to $46 billion (Williams, 2010).
Management Failure
From the analysis of the case study above, it is evident that the collapse of Lehman Brothers was intertwined with a range of issues. While most financial firms suffered as a result of the looming global financial crisis, the role of the management in Lehman’s case was questionable. Simple management principles were violated, leading to a plunge of the firm’s stock and ultimate collapse in September 2008. This segment gives a critical analysis of the company’s management approach and how it promoted its demise (Delaney, 2011).
The issue of excess leverage significantly affected Lehman Brothers. Under normal circumstances, financial leverage involves investing of a loan in order to realize as high rate of return as possible. What is obtained as the difference between the loan rate and the interest rate is referred to as the spread. It is quite common for banks to engage in borrowing of money from other financial institutions and settle their debts under a fixed interest rate.
For the case of Lehman Brothers, it is evident to note that the firm was overleveraged. The company’s management agreed to borrow money from other sources to invest in numerous projects, with the main one being in mortgage securities. Nevertheless, it was realized that most of the collateral assets had a lower value than expected (Delaney, 2011).
As a result, mortgage-backed securities became valueless while the firm’s spread experienced a shift from positive to negative. The company experienced good performance, being ranked among leading American firms for many years. The company further started with a balance sheet, which showed that it owned resources, which were more than what it owed. This was quite encouraging as it indicated its stability and opportunities for making profits.
However, this trend did not last forever as Lehman owed more than what it owned; an indication of business collapse. Many expected swift measures from the management, which instead took the matter lightly, noting that the global financial crisis was not going to affect the firm (Delaney, 2011).
This assumption turned out to haunt the management before handing it over to the world of bankruptcy. The failure to tame the situation was a demonstration of management failure, since managers are charged with giving direction and setting pace in the business world (Jones & George, 2007).
Additionally, the company failed to respond on debt-to-equity ratios. Under normal operations, these ratios denote the value of a company’s debt, measured against a corresponding dollar of equity. This ratio is regulated by the Federal Insurance Corporation, which favors a value of 10:1.
It is important to note that FDIC does not regulate investment banks, causing them to maintain high ratios. For instance, Lehman Brothers registered a ratio of 60:1, implying a low cushion value. Due to lack of intervention, such high ratios for the company implied that bankruptcy was inevitable in the case (Barsch, 2012).
The compensation plan, which was crafted by Lehman’s management, further spelt doom for the success of the company. In most cases, bonuses and compensation schemes arose when the organization’s performance was at its peak. However, investors and employees were not asked to give any money back to the firm (Barsch, 2012).
In other words, the scheme was keen to reward high levels of risk taking, which generated high returns, but failed to take similar measures as a result of losses and low returns. The management did not critically look into the implications of the scheme before implementing it.
Besides general management failure, the contribution of individual CEOs also led to the collapse of the firm. A good example is Richard J. Fuld, who worked for the company for years, rising to become the firm’s chairman. He was well known as a risk taker and had high expectations of loyalty from his staff.
He was brutal and constantly intimidated other employees of the company. Because of his personality, Fuld rejected being advised by his senior executives. He believed in himself and ignored other people, serving Lehman solely from his office. This management style severely haunted the company as it bred miscalculation of the impact of the financial crisis for mitigation measures to be erected (Barsch, 2012).
The company’s Board of Directors did not have enough experience in overseeing an investment company, which had diverse goals in the financial market. To make matters worse, the board had only one member from outside who had formal knowledge and background of the financial sector. As a result, it was impossible for the company to consider a halt of portfolio expansion in the real estate industry and unpromising securities.
The functioning of the risk committee also showed how incompetent the board was. Between 2002 and 2007, the committee did not see the need for frequent meeting as it met twice a year (Ryback, 2012). This was quite daring as the global financial crisis was just around the corner. Contrary to the expectations of many, the board endorsed a remuneration package of about $500 million to Richard J. Fuld. Fuld did not see any problem with the move despite the fact that Lehman Brothers was grasping for its last moments.
A few days before the company announced a loss of approximately $4 billion, Mr. Fuld commended the entire board for its support. He lacked the interests of the firm at heart to have accepted such a hefty package when the firm was headed for a downfall.
To add insult on the company’s incompetent management, Richard J. Fuld did not see the need of selling the firm at a discount in 2007, following Hank Paulson’s recommendations. He believed that the firm was fit to be sold off at a premium.
As if this was not enough, the management unanimously agreed to distribute shares to its employees in early 2008, hopping to realize better prices, which would generate higher payouts (Ryback, 2012). This was the least that the management could offer, based on the global economic status and performance of the firm.
Management Solutions
Although the collapse of Lehman Brothers was partly attributed to the global financial crisis, the management was also responsible for failing to respond swiftly. This means that the management had a role of implementing certain measures capable of stabilizing the situation and save the firm from liquidation (Jones & George, 2004).
As mentioned above, the leverage level of Lehman was too high. Consequently, the firm got addicted to debts, putting the bank at the edge of collapsing. The most appropriate remedy for this situation was the implementation of borrowing control measures to tame the debt-to-equity ratio (Jones & George, 2007).
Lehman Brothers’ management had the most significant role in taming the situation. It needed a market oversight team to actively address the changing financial dynamics in the market. Although the risk committee was to advise the firm’s management, this was not easy due to its inefficiency and inactiveness; it met twice annually between 2000 and 2007.
Harmonized management was equally necessary to sail through the stormy financial market. This was not the case as senior executives like Fuld made independent decisions and remained defiant to his senior managers. Additionally, it was necessary for the firm to hire competent managers and strategic analysts to study market trends and make informed decisions (Jones & George, 2004).
This would have saved the company from cases of doling of the company’s shares and unwarranted payment of hefty packages to its managers, when it needed money to save it.
Conclusion
From the above case analysis of Lehman Brothers, it is evident that the management of an organization plays a major role in determining its performance. Based on decisions made, a firm can either thrive or crumble. For Lehman, the bankruptcy misfortune can largely be attributed to ineffective management, which was later coupled with the late 2000s financial crisis that rocked world markets.
References
Barsch, P. (2012). Marketing Lessons Learned from the Collapse of Lehman Brothers. Scribd. Web.
Delaney, T. (2011). Lehman Brothers. Financial Training Partners. Web.
Fitzpatrick, T., & Thomson, J. (2011). How Well Does Bankruptcy Work When Large Financial Firms Fail? Some Lessons from Lehman Brothers. Economic Commentary, (23), 1-6.
HITC. (2008). Lehman Brothers – A Brief History. Here is the City. Web.
Jones, G., & George, J. (2004). Essentials of Contemporary Management. New York City: McGraw-Hill/Irwin.
Jones, G., & George, J. (2007). Contemporary Management. New York City: McGraw-Hill/Irwin.
Ryback, W. (2012). Lehman brothers: Too Big to Fail? Toronto Leadership Centre for Financial Sector Supervision. Web.
Williams, M. (2010). Uncontrolled Risk: The Lessons of Lehman Brothers and How Systemic Risk Can Still Bring Down the World Financial System. New York City: McGraw-Hill Professional.