Resisting the institutional imperative PDF Print E-mail
Written by Travis Morien   
t is the long term investor, he who most promotes the public interest, who will in practice come in for the most criticism, wherever investment funds are managed by committees or boards or banks. For it is in the essence of his behaviour that he should be eccentric, unconventional and rash in the eyes of average opinion. If he is successful, that will only confirm the general belief in his rashness; and if in the short run he is unsuccessful, which is very likely, he will not receive much mercy. Worldly wisdom teaches that it is better for reputations to fail conventionally than succeed unconventionally. - John Maynard Keynes

Failing conventionally is the route to go; as a group, lemmings may have a rotten image, but no individual lemming has ever received bad press. - Warren Buffett

One of the big shocks that Buffett got when he left business school was just how irrational many managers really are. In school he was taught that the experienced managers of leading companies were honest and intelligent, and automatically made rational business decisions. When Buffett actually got out into the real world, he found that rather than rationality and wisdom, there is a much stronger force that operates in business.

This force, which drives managers with the most excellent credentials to invest capital in bizarre ways and adopt silly approaches purely because it seems to be what everyone else is doing is what Buffett calls the "institutional imperative".

The institutional imperative manifests itself in four ways:

 

  • The organisation resists any change whatsoever in its current direction, and will seize upon any evidence that they are doing the right thing while fastidiously ignoring evidence to the contrary.
  • Just as work expands to fill time, and waistlines expand to fill belts, projects and acquisitions will materialise to soak up all available capital.
  • Any business plan of the CEO, however stupid it may be, will receive immediate support from a legion of lackeys who will produce copious data and detailed rate of return and strategic studies to support the boss's thesis.
  • The behaviour of peer companies, irrespective of differences in circumstances, whether they are acquiring, expanding, setting dividend policy, downsizing, putting the troops through customer service training or setting executive compensation will be immediately and thoughtlessly copied.
The most typical examples of this sort of self-destructive me-too behaviour include commodity businesses having price wars to preserve market share even if it means selling at below the cost of doing business, share buyback schemes just because everyone else is doing them, moving in blocs to structure remuneration for top management, the rise and fall in takeover activity on a seasonal basis and the adoption of sales strategies as an industry standard, without anyone really stopping to consider if it is even worth while and most particularly in the adoption of strategies that may boost short term earnings but harm long term growth, such as certain measures that may require high initial expenses but lead to massive long term cost savings.

Buffett finds it is not the owners who are at the greatest risk of being blinded by the institutional imperative, but the managers themselves in their inability to accept fundamental change.

Buffett notes that even when managers do accept that change is needed or the company could face shutting down, carrying out the plan is so difficult that many managers choose instead to try to buy their way out of the doldrums by buying a new company rather rather than execute potentially far cheaper measures to change the direction of the existing company.

Why do managers act like this? Buffett notes three reasons: most managers cannot control their lust for hyper-activity, preferring instead to go out and buy something, they are constantly comparing themselves to companies inside and outside of their own industry, making changes to reflect the "new ways of thinking", which are in fact only the old ways with new fads inserted and most managers tend to have an exaggerated sense of their own abilities.

Other reasons include poor capital management skills. Most CEOs rise to that rank from within other areas of the company like information technology, engineering or marketing. When they do reach the top they lack the necessary skills to make decisions on the allocation of capital. What occurs then is that CEOs turn to their staff, consultants and investment bankers and the institutional imperative enters the process.

The biggest reason for the institutional imperative though is just mindless imitation of other companies. Every company is different and can not be run to a standard formula, however with managers spending as much time watching their rivals and adopting what they see as normal for other companies as actually running their own business, many companies can all go down the same tube by making the same mistakes.

 
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