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Source link: http://archive.mises.org/9637/management-theory-is-not-to-blame/

Management Theory Is Not to Blame

March 19, 2009 by

Is management theory to blame for the current crisis in the world economy? Some commentators think that business schools’ focus on shareholder wealth maximization, performance-based pay, and the virtue of self-interest have led banks, corporations, and governments astray. We think, however, that management theory has much to offer policymakers, practitioners, and analysts seeking to understand the current crisis. FULL ARTICLE

{ 17 comments }

Florian Kren March 19, 2009 at 9:28 am

The picture contains an awesome amount of fundamental economic knowledge, great choice.

Austroglide March 19, 2009 at 10:11 am

“Some commentators think that business schools’ focus on shareholder wealth maximization, performance-based pay, and the virtue of self-interest have led banks, corporations, and governments astray.”

This would have been a more fulfilling topic.

David Ch March 19, 2009 at 10:23 am

Im very pleased you posted this article. It described in general terms the specific heart of th ecredit crunch. When the banks effectively stopped lending to each other last year, it wasnt because they didn’t want to lend. It was that they were paralysed by a lack of information. None of them had a clue as to whose balance sheets were carrying ‘bad’ assets, and in what proportion to the other assets they might have been carrying, so the safest course of action was to lend to none of them. And credit spreads widened spectacularly. And so the prices of the entire range of heterogeneous assets started falling across the board in a spiral of self-fulfilling prophecy.

Of course, all that was needed to get it all moving again was to flush out the information, and permit all those overvalued assets to be repriced honestly in th emarket. Correctly priced, a bad asset is no longer a bad asset, even a portfolio of subprime loans!

And to achieve that, all that had to be done was to stand back and watch. Andf even if a bank failed, its assets and business units are sold off and in the process repriced, and continue in someone else’s hands. But what with liquidity support, and rescue packages and stimulus spending and bailouts and such, all the Fed and governments have done is to simply block information from flowing, and gum up the works.

It has long been the case that the Feds setting of money market pricing by decree has distorted the information flow between the monetary and so-called ‘real sector, but now they have been successfully blocking information flow WITHIN the money markets!

greg March 19, 2009 at 3:19 pm

The problem is simply the failure of most people in business to understand basic accounting principles! It is not rocket science, it is just add, subtract, mulitpy and divide.

If the people in charge would have seen the over leverage and misallocation of funds, they would have never went that far. This is why the small regional banks that have a CEO with a good understanding of accounting are doing so well.

There is a saying in business, what gets measured gets done! And they will throw everything at it to make sure the measured results are at the highest level, no matter what the cost.

So I guess I have to disagree to your points, our current problems is more about a breakdown in the corporate structure and its inability to self audit the entire business.

tom brakke March 19, 2009 at 3:27 pm

“Every manager knows that directing specialized resources to the wrong projects is a bad bet, even if it leads to a slight boost in short-term earnings.” I think the knowledge was optioned out of them.

Miklos Hollender March 19, 2009 at 4:34 pm

Peter,

I think it’s obvious that the incentive structures of AIG etc. were wrong because they incentivized short-term profit-making from highly dubious loans and not the long-term wise management of the company. The took high risks, took the bonus on the short-term profits, and happily retired with millions of boni when the repercussions of wrong decisions arrived. If I owned any shares of these companies I’d be mad and rightly so.

Managers, shareholders and customers were all caught in a shortsighted madness of the perfect get-rich-fast bonanza madness.

This can be argued that it was ultimately caused by the usual ABCT central bank-induced cycle. Likely it was.

But it does NOT mean their incentive structures were good. They were still bad.

Peter March 19, 2009 at 5:40 pm

If the people in charge would have seen the over leverage and misallocation of funds

You use of “would have” isn’t English; “had” is the word you’re looking for.

Pablo March 19, 2009 at 9:19 pm

Great point on the incentive structure Greg. Besides, the only reason these companies are being ¨salvaged¨ is by tax payer money. How would these crooks get a job after this great ¨blunder¨. Without diminishing the ABCT effect over decision making (information distortion), rent seekers save the day just pay up and you´ll see daylight, e.g. GM, Chrysler, AIG, etc. Diminish the power of the State!

frank March 20, 2009 at 2:19 am

Exactly. It’s not the money, it’s what the money is spent on.
But also, it’s not the managment, it’s what is being managed.
Lack of innovation and leadership is the only problem that will ever exist.
So quit watching the other guys, waiting for something to happen.
Quit worrying about what happened, who caused it, and how it should be.
Quit dreaming about the perfect system.
It doesn’t matter.
Create something valuable.
Create wealth.

Reasonsjester March 20, 2009 at 6:46 am

I thoroughly appreciated this re-emphasis of heterogeneity as a corrective to the slipshod macro-economic analysis I receive de rigueur in my graduate political science department. There is a tendency to regression to Keynesian generalities when discussing contemporary economic issues that often distorts or obscures a much more specific and useful explanation. The result of the dominance of macroeconomics in guiding the thinking of political analysts that it often leads to intellectual sloppiness and is generally obstructive of pursuing fertile leads for linking particular policies and specific economic outcomes. Thank you for your clear and memorable corrective.

pbergn March 20, 2009 at 2:02 pm

Good article…

DS March 21, 2009 at 7:53 am

Having recently gone through an MBA program at a “Top 50″ business school, the only time shareholder wealth maximization was mentioned was in passing, or as a basic premise that was too simplistic to use in practice. We spent whole classes trying to talk around it, and most of the professors who had never worked in the real world discounted it as a viable way to run a company. I was astounded at how few times it was said out loud that companies should have goal of making a profit. It was almost like it was a big secret that nobody wanted to say out loud.

The real problem with incentive based pay is that it is often structured to stress the wrong outcomes, not that it is a flawed idea in itself. Giving stock options or profit sharing to an assembly line worker doesn’t actually change the way the that worker will do his job because his effect on that is too diffuse. If the he does a good job and the guy next to him does a crappy job won’t have much affect on whether the profit sharing check comes through. If his incentive pay was based on how well he does his own job then it should directly affect how he performs.

I actually think there is something flawed in the idea of a public company to begin with – owning shares in a public company does not really make you an owner of that company in any real sense. Unless you own a huge chunk of stock, the only time you can experience real ownership is if the company is liquidated – in which case you probably get nothing after the bond holders are paid. There is an illusion of ownership but owning stock actually entitles you to no claim on the company’s earnings unless they choose to give you a dividend – which it is under no legal obligation to do. The only way to make money owning stocks is to find a bigger sucker someday to buy it after it has already gained in value, usually because everybody else thinks it will gain in value (how’s that for circular logic?).

But to be clear, this crisis was caused by the Fed and the government, and all central banks and governments around the world sending AIG and Bank of America and Caterpillar and General Motors and…… false signals through their manipulations of the monetary and financial system. The companies responded to what they could measure – the immediate business conditions of their customers and suppliers – and acted accordingly. In the bubble that was created, all of the signals being generated told investment banks to leverage up to 40 to 1 and at the time, based on what they could “sense” from the world around them, that seemed logical at the time. They should have seen that this was absurd, and the people loaning them the money to leverage that high REALLY should have seen that it was absurd. But the moral hazard created by the government made these things look rational, and in a way they were. The end result will be that these companies will survive (and maybe even come out with an enhanced competitive position versus their competitors – like Goldman Sachs) as will their bankers who loaned them the money. So who really made an error, the companies or the government?

A business can only operate within the limited view of the world it has through the minute by minute signals it is sent through the price system. The government manipulations that sent false signals, which are very difficult to distinguish from real signals, is to blame.

olmedo March 21, 2009 at 10:08 am

business beside their mediocre education have become apologists for a lot of the abuses of the last decades.

specially for their increasing favoritism of debt over equity, in the sense that it makes companies perform better.

the other thing is their teaching that that crap pot science called “risk quantification” . which basically says that risk is something that can be quantify therefore, “priced” and managed.

sounds familiar??.

olmedo

olmedo March 21, 2009 at 10:10 am

business schools, besides their mediocre education, have become apologists for a lot of the abuses of the last decades.

specially for their increasing favoritism of debt over equity, in the sense that debt makes companies perform better.

the other thing is their teaching that that crap pot science called “risk quantification” . which basically says that risk is something that can be quantify therefore, “priced” and managed.

sounds familiar??.

olmedo

Marc Monet March 22, 2009 at 4:13 pm

“Some commentators think that business schools’ focus on shareholder wealth maximization, performance-based pay, and the virtue of self-interest have led banks, corporations, and governments astray.”

Only because you “think” that management theory has much to offer does not make the above statement wrong.

Moreover, you make a huge assumption in your conclusion, when you assert that markets always work (“…the path to economic recovery is to allow markets to channel specialized resources to their highest-valued uses…”).

Rob Berriman March 23, 2009 at 9:58 pm

Marc Monet,

Just because you don’t like a particular outcome of the market doesn’t mean it doesn’t work.

Get the government the hell out of the way.

“Leave us alone!!!”

Marc Monet March 24, 2009 at 5:45 am

Dear Berriman,

Why do you believe that the market allocation mechanism always works; whether or not such an outcome is desirable is, of course, another normative question, which could also be discussed? I suggest you read some of George Akerlof’s work before you propagate dogma you cannot back up by facts.

In addition, I do not see how your last sentence qualifies as a civil comment in the spirit of the Mises blog; if you do not appreciate other opinions to advance discourse please spare us with your hatred and small-mindedness.

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