Thursday, February 01, 2007

machiavellian nature of the real decision maker

My last two blog entries have described the theory of economics being an abstract method of measuring both society and the environment. Investment time horizons should be extended to reflect the long term nature of an investment's impact and that when this is done, economic evaluations can be used as the sole tool for decision making.

Unfortunately, this is a normative theory; it describes how I think things should be done. As a consultant, it is my role to spend too much of my time contemplating how to make things more effective. This is the way we compete with other consulting organisations. While the rest of the world gets on with the doing, we contemplate how the doing can be more effective.

The other thing we do is contemplate how we can incorporate this normative theory into the real world. In essence we contemplate how we make it a positive theory.

To do this, we have to develop positive theories of our own for current practice. Positive theories are theories that describe the way things are actually done rather than those that describe how they should be done. This blog entry aims to describe how investment decisions are currently executed. It is based on observations over 14 years across dozens of industries in 10 countries.

The common thread between my normative argument and the positive theory is the importance of time horizons. In our positive theory, people are motivated by improving their own lot. Altruism does not exist. In this light, a decision maker makes decisions that suit his or her motivation to improve their own position. Sometimes, this will be an improvement to their financial position. In this instance people will make the decision that will increase the chance of financial reward. In other instances it will be power, a lasting legacy etc.

The time horizon of the decision maker looking to increase their own financial wealth will be extremely short. Even a non-fraudulent decision maker with these motivations will focus on projects that "payback" quickly instead of long lead time projects that "payback" 10 times the amount in present day terms.

If the decision maker wants to leave a legacy behind, then they will focus on longer term decisions. Their tenure in the organisation will be longer and their succession planning will be detailed and targeted. It is important for the information providers to understand the motivations of the individual making the decision. These motivations will drive the tools being employed by that organisation to assist them to make a decision.

Here's some observations to assist in determining what drives your decision makers:
Financially motivated
  • Payback used as assessment method
  • Subjective overlay applied to financial analysis (e.g. 2+2 = whatever you want it to be)
  • Focus is on short term (e.g. quarterly) results
  • Reward structure is financially based.
  • Analysis is retrofitted to a decision
Legacy motivated
  • Cost/benefit analysis is used over the life of the investment
  • Focus is on long term vision of the organisation
  • Vision has meaning to everyone in the organisation
  • Rewards are a mix of financial and non-financial
  • Financial analysis has forecast error only not bias error
  • An analysis is never retrofitted to a decision
Of course, even positive theories are falsely formulated. I'd be very surprised if this theory wasn't shot down in a ball of flames. Please feel free to do so. Let the evolution begin.

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