This week I interviewed Professor Sydney Finkelstein who teaches at Dartmouth College in New Hampshire. Finkelstein is best known for his superb book Why Smart Executives Fail which identifies blind spots and patterns of behavior that unleash the storms of corporate pathology - flawed executive thinking and delusional attitudes that stop the company from reality-testing; breakdowns in communication systems that stop important information from getting through; chief executives convinced of their personal pre-eminence and systems that prevent the organization from correcting its course.

During our conversation, we talked about why companies fail and whether better corporate governance can actually save them.

SOX FIRST: What are the main reasons companies screw up?

FINKELSTEIN:As you know you can write a book on this topic. There are several. First I would say there is an assessment of their strategy that is off the mark, in particular a company that doesn't focus on the right strategies and where their strategic thinking starts to break down. The second is around culture and I call that the delusions of a great company. In particular that relates to organizations that have been quite successful and that have become quite enamored with that success and slowly but surely they start to push out alternative points of view. The third explanation is more along the lines of communication and information systems in organizations, in particular how key pieces of data are missed and signals of changes going on in the environment are not picked up. And the fourth one, of course, is the individual behaviors of leaders. They relate to arrogance but also a lack of learning, a lack of open mindedness, not being open in particular to the changes going on around them.

SOX FIRST: One of the things that comes through in your book is that nothing breeds failure like success.

FINKELSTEIN: Yes, that is a major warning sign in of itself.

SOX FIRST: But when you look at companies that have been around the longest, and I'm thinking of an outfit like GE, they have an ethos of constantly evolving and changing. Is that what companies need to do to avoid going under?

FINKELSTEIN:GE is a stellar example, although the truth is their stock price has been quite stagnant for several years now. The Jeff Immelt era in terms of bottom line shareholder return has not been very impressive but on any other dimension, he has been reconfiguring an entire organization. The ability to be flexible and adaptable when the world is changing around you is of course critical. It's not that complicated an idea, it seems quite obvious except that companies don't do that because they get locked into things they did before and it's very difficult to break out because one of the things you have to do is acknowledge that you did something wrong or whatever worked for you in the past is maybe not the right path anymore.

SOX FIRST:So do you have to constantly change the business model to avoid failure?

FINKELSTEIN: It depends on the company. It's possible that a very successful business model might continue to be a winning one. It depends on the nature of the industry. GE of course is a changing organization. Maybe it's because they have so many different businesses, that might account for it. I would say that most organizations cannot stay with exactly the same model indefinitely but some may last longer. I'm thinking right now of Google. It's still new so it's hard to say what will happen five years down the track but I would say Google is a very good example of a company that cannot stay the course because it is a very dynamic industry. An interesting comparison is with AOL in the same industry. AOL came up with an idea to make it easy to get on to the Internet and they charged a monthly subscription. So how did they change that model as the industry developed? Well, all they did is go from giving you one free hour to 10 free hours to 500 free hours and sending you discs in the mail. That's just doing the same thing as the world is changing. Google has actually been adapting.

SOX FIRST:The other good example of difficulties changing would would be Microsoft.

FINKELSTEIN: Yes, well they missed on two major things. One they recovered from and that was the Internet. The second thing they missed out on was search and it looks like they have fallen so far behind given the lead Google has.

SOX FIRST: One of the interesting points in your book is that the failures keep happening over and over again. And yet, we have had an explosion in business education. Is this a failure of the business schools?

FINKELSTEIN: I would be the last to tell you yes. I think the reason why we see history repeat itself is because organizations consist of people and people behave the way people behave which means sometimes we we don't like to be criticized, we don't like negative feedback and sometimes we stick our heads in the sand. We don't always want to change, we take pride in the work we do. These are human traits and those aren't going away, those are deeply embedded in what it is to be human and they go far beyond just 50 to 200 years of business. They are part of our make up. But it's because it's about people that at the end of the day we continue to do the same troublesome things. One of the interesting findings from my research is that the same patterns seem to occur in different countries. Snowbrand, the dairy company in Japan, blew up in the same way that WorldCom did, Samsung lost billions of dollars in the automobile industry. Parmalat is another perfect example. Even across cultures, as powerful as national cultures are, you still see the same patterns. So why is that? My answer to that is it's still about people and the nature of people is much more powerful than country differences. Does that mean you can't adapt and change and learn? Of course, there are tremendous opportunities to do that but you have to be constantly vigilant and you also need to put in place systems and opportunities to make those adjustments.

SOX FIRST:What about the role of directors?

FINKELSTEIN: I think directors have a real problem because they don't have full data. They don't have all the information that's going on. The part to me that's frustrating is that they have an opportunity. There are ways to expand the amount of information. It's really about identifying the potential vulnerabilities in organizations to failure and I have been doing this work by studying directors and by studying executive teams. There are a variety of mechanisms you can put in place. In fact, I have created some diagnostics and tools, so there is an opportunity for directors to learn more. They don't always do it but I'm thinking that because of the changes in the economy and the changes in corporate governance, I think more and more directors will become more open to the idea to dig into this in more detail and capture the data.

SOX FIRST:Of course now in the US there is a great focus on these systems through Section 404 of Sarbanes-Oxley.

FINKELSTEIN:Yes, that's created a lot of business for a lot accountants. It's kind of like a horror story. The evil empire in Arthur Andersen finally gets vanquished and it's the end of the story and you think you can walk away and it comes come back up and it costs companies even more money because they have to do all this compliance work.

SOX FIRST: There still seem to be these debate about the independence of directors and the separation of the role of chairman from CEO.

FINKELSTEIN: It is not helpful. There is a lot of research on those questions. The typical things that the so-called corporate governance experts look at have no impact on the bottom line, in study after study. Such as the separation of CEO and chair. The research is quite clear. It doesn't make a difference. There are more important things than that and the more more important things are the way a team in the board of directors works together, interacts and the extent to which board members are open-minded.

SOX FIRST:What about the independence of directors?

FINKELSTEIN: It makes no difference. Even though intuitively we all wish it but the data is quite clear on that. I see those as simplistic answers to corporate governance, and the nature of business is such that we often look at those simplistic solutions. The tougher solutions really relate to doing the assessment and really understanding what's going on with the boards of directors in terms of their knowledge about what's going on in the organization and the extent to which they can work effectively as a group. Those are things to which in my own research have made a difference and the diagnostic work that I do tries to assess that.

SOX FIRST:But what about cases where directors are totally conflicted?

FINKELSTEIN:I'm not advocating that as a good thing to do. I'm simply saying that the data in the large studies does not support that as a key differentiator. I'd say if there is a conflicted director, you either remove the director or remove the conflict but that doesn't lead to superior financial results. That might avoid embarrassment, that might avoid a problem but the data is quite clear. It's low hanging fruit and relatively easy to fix. It's good to have independence and it's good to have a separation of chair and CEO but don't expect those things to make a difference in terms of financial performance. Take some of the major failures like Enron and WorldCom. Look at their corporate governance and it was spot on in terms of what you want. So you're looking at the wrong things.

SOX FIRST:So based on what you're saying, you can have the most water-tight laws and rules for corporate governance in the world but that's not going to stop fraud or company meltdown. Is that right?

FINKELSTEIN: I don't know if I actually said that but I don't disagree.