WHAT WAS Sir Fred Goodwin thinking when he committed Royal Bank of Scotland to the fateful pounds 48bn takeover of ABN Amro? And the bankers who piled into sub-prime CDOs and 100%-plus mortgages? As the City’s turkeys come thudding home to roost, one by one, like howitzer shells, an urgent question is how and why previously successful people made such awful decisions – and whether such catastrophes can be avoided in future.

Actually, Goodwin may not have thought about it very much at all. If, as seems likely, he was confident he was on familiar ground, he may have leapt straight to his preferred course with only a cursory consideration of alternatives. And if he did, he wouldn’t be alone.

In textbooks and conventional wisdom, improving decision-making is a matter of better analysis: clearer objectives and more astute discrimination between a range of options. Yet as a timely new book (Think Again , by Sydney Finkelstein, Jo Whitehead and Andrew Campbell) makes clear, rational analysis of this kind plays a surprisingly small part in most decisions, and the emotions a surprisingly large one.

Paradoxically, the problem is not that people are bad at making decisions. It’s that, for most purposes, we are so good at it that we don’t even know how it’s done. Research described in the book shows that the extraordinary human ability to act on the basis of incomplete information in complex conditions can be subverted by the very short-cuts that are at the heart of the processing miracle: pattern recognition and what the authors call ‘emotional tagging’.

Pattern recognition is self-explanatory. Emotional tags attached to the patterns of experience recognised are equally crucial. Emotions actually lead the decision-making process, providing focus and impetus to action – ‘feed, fight, flee or any other of the f-words’ – without which the process would just be data-processing. The trouble is that both the short-cuts can be tricked, and since they are unconscious we have no way of recognising that it has happened.

For instance, although the banks’ fall from grace happened after the book was finished, the authors speculate that Goodwin may have been misled by both his heart and his head. His previous experience, notes Whitehead, told him he could create value by buying sprawling rivals and aggressively taking out costs. This approach had worked well in the past, winning him a knighthood to boot.

Past success (which is a neglected hazard, the authors note) may well have reinforced his determination to push ahead, even as the economic storm clouds were gathering. But conditions differed in critical respects from those he was familiar with. In a credit crunch, the balance sheet – both RBS’s own and that of the target – was more important than cost-cutting potential. With the same information, rival Barclays backed off. Not only did RBS go ahead – it amplified the risk by offering cash.

Powerful prejudgments (for example, a strong belief that growth comes from high leverage and sweating capital) and emotional attachments (self-interest, ambition) all pushed in the same direction, apparently making Goodwin blind to the risks inherent in the worsening climate. With variations, similar stories could be told about Dick Fuld at Lehman Brothers, who also misinterpreted his experiences and missed opportunities to change course, and many other actors in the financial drama.

Which raises a second question: why didn’t they shift their views until too late? Reversing the usual emphasis, Think Again argues that, given the unconscious nature of decision-making, it’s all but impossible for individuals to eliminate mistakes through self-correction. Better, in their view, to develop awareness of ‘red-flag conditions’ that signal danger and establish external safeguards that can challenge distorted thinking.

Interestingly, it is errors that seem to be the key teachers here. Having spectacularly miscalculated over the Bay of Pigs, President Kennedy recognised the danger of getting the decision wrong in the Cuban missile crisis and counteracted it with a variety of measures – including setting up a ‘decision group’ to provide challenge and debate, chaired by his brother. Contrast this with Tony Blair’s inability to spot giant red flags over Iraq that were visible to most of the UK population. The invasion was apparently never even voted on in cabinet.

Safeguards at individual and corporate level have their limits. Some of us would argue that the credit crunch is the product of the biggest mistake of all – a lethal compounding of misleading experience, ideological prejudgment and turbocharged self-interest – in the shape of the financial sector’s unshakeable belief in market efficiency. What are the safeguards against such meta-mistakes? Keeping the red flags flying suddenly takes on an unexpected new significance.

The Observer, 25 January 2009

THERE’S A case for saying that the credit crunch is all down to Charles Darwin.

Keynes wrote: ‘The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed, the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually slaves of some defunct economist.’

Now, technically Darwin is a defunct biologist rather than political philosopher or economist. But his interest in economics was keen, and equally keenly reciprocated. One perceptive interpreter of On the Origin of Species , 150 years old this year, saw it as ‘the application of economics to biology’. As the crowning expression of Victorian individualism, continental writers argue, the theory of natural selection, with its underlying theme of competition and struggle, could only have originated in the laissez-faire England of the period.

Bastardised and coarsened, the concept of ‘the survival of the fittest’ (a phrase only later adopted by Darwin from Herbert Spencer) has powerfully shaped modern business. The robber barons of the early 20th century quickly latched on to the self-serving idea that ‘might is right’ – cut-throat economic competition was the normal state of affairs and the rise to the top of the strongest was part of natural law and the inevitable outcome of history.

This mentality persists, especially in the US, and indeed the idea of the inevitability, and desirability, of individual struggle in weeding out the strong from the weak is what distinguishes Anglo-American from Rhine capitalism. It perfectly informs the ethos of the financial sector over the last two decades, as well as the rise of the Russian oligarchs and the development of the virulent Chinese strain of capitalist competition.

Darwinism endows such phenomena with a veneer of scientific rationale. Republican senators’ reluctance to intervene to prolong the lives of US banks, the chilling belief of City traders in their own superiority, as uncovered in interviews by The Guardian‘s Polly Toynbee and David Walker, the self-justifying arguments in favour of stratospheric pay rises for chief executives and cutbacks for the less fortunate – all have uncomfortable echoes of the crude social Darwinism that influenced not only the robber barons but also the far greater 20th-century monsters, Hitler and Stalin.

Natural selection may be, as some argue, the most important idea in human history – the nearest thing to a ‘theory of everything’ to exist. Richard Dawkins, among others, has proposed a ‘universal Darwinism’ – a process of variation, selection and retention that applies to business, social and cultural phenomena as well as biology. In recent years, evolutionary versions of economics, psychology and ecology have all burgeoned.

But while such ideas are genuinely attractive and interesting, as the evolution of evolution ironically demonstrates, for practical purposes natural selection is a devious and treacherous taskmaster. If companies have no inevitable life cycle – some last for months, others for centuries – and don’t reproduce, how does the process work? Darwin himself, as cautious in his research as he was bold in his thesis, would no doubt be aghast at some of the wilder application of his ideas. His version of evolution is blind mutation is random, and outcomes determined by functional improvement.

Companies, on the other hand, are intentional entities, able to strategise towards long-term purpose – taking one step back to take two steps forward in the future, for example. What’s more, no one studying management could possibly argue that ‘progress’ was historically inevitable: indeed, the reverse argument can be made, that bad management is driving out good. As Ricardo Semler, the iconoclastic head of the free-form Brazilian company Semco, observes, most corporate forms are colossally inefficient as well as environmentally disastrous – an evolutionary nightmare. In this situation, there’s no time left for painstaking improvement on an evolutionary scale: only disruptive innovation will do.

Meanwhile, the simplistic ‘might is right’ case has been blown apart by the force of events. However it originated, the credit crunch is the meteorite that is causing the mass extinction of what now can be seen as financial dinosaurs. Suddenly the once mighty are so no longer – in the new credit-starved world investment banks are extinct, by the end of the year most hedge funds will have gone out of business, and even Russian oligarchs are finding food hard to come by.

As Darwin cautioned: ‘It is not the strongest of the species that survive, nor the most intelligent, but the ones most responsive to change.’ Or in the words of Orgel’s second law (after Leslie Orgel, an eminent biochemist of the 1960s – history doesn’t record his first law), ‘Evolution is cleverer than you are.’

The Observer. 18 January 2009

IN RETROSPECT, one of the most remarkable things about the events of 2008 is that there weren’t any. In 1968 the streets of Paris and London rang with protests over the Vietnam war and class solidarity in 1984 the miners went on strike for more than a year. By contrast, over the past year, banks, jobs and money in colossal quantities have disappeared with barely a murmur of dissent, let alone the explosions of outrage that you might expect.

This apparent fatalism is no doubt partly numbness in the face of figures that are truly incomprehensible. Where the liabilities of high-street banks are multiples of GDP, and a single hedge fund is responsible for write-offs that equal the UK’s defence budget, it’s hard to feel anything other than helpless.

More insidiously, it is also a measure of how completely the message of ‘One Market under God’ (to quote the title of an entertaining and telling polemic by Thomas Frank) has been internalised.

Yet outrage and contempt are sometimes in order, not least to ensure that we don’t get fooled again. Even now, some would argue that the crunch is the result of a bold experiment in financial innovation gone wrong – a mistake, certainly, but justifiable in the sense that, if it had come off, the resulting era of ultra-cheap money would have led to the prospect of capitalist prosperity without end.

Another view would be that the reasons why it nearly came off also meant that it couldn’t – the reliance on personal incentives untrammelled by any wider sense of responsibility left the system permanently teetering on the knife-edge where risk shades into outright fraud. As such, the disasters of 2008 are not an aberration but the culmination of a rewriting of the management project that now leaves many companies with a vacuum at their centre.

What’s been lost over the last three decades is only now becoming clear. Some of the warning signs were already visible in the succession of increasingly frequent panics and scandals of the last decade and a half – Enron, the dotcom boom, LTCM. Less obviously, the last 30 years have seen a steady erosion of balance between stakeholders. While layoffs of staff – ‘the most important asset’ – were once a last resort for employers, they are now the first option. Outsourcing is so prevalent that it needs no justification. And the company’s welfare role is now so attenuated that it barely exists. First to go was the notion of career more recently, the tearing-up of company pension obligations is another unilateral recasting of the conditions of work – a historic step backwards – that has aroused barely a ripple of objection.

The justification for this behaviour is, of course, the pressure of the market. But this is to disguise a betrayal. As a class, ever since the separation of ownership and management in the 19th century, managers have always occupied a neutral position at the heart of the enterprise – neither labour nor capital, but charged with combining the two for the benefit of both the company and society itself.

Everything changed in the 1980s, however, with the advent of Reagan, Thatcher and Chicago School economists who preached the alignment of management with shareholders in the name of ‘efficiency’. In effect, ‘efficiency’ came to mean short-term earnings to the detriment of long-term organisation-building; what was touted as ‘wealth creation’ was actually ‘wealth capture’, from suppliers, clients and employees as well as competitors, on the grandest scale since the robber barons. Its purest expression was private equity.

Managers never looked back. As late as the 1980s, a multiple of 20 times the earnings of the average worker was perfectly adequate CEO pay. But under the compliant gaze of shareholders and remuneration committees, performance-pay contracts boosted the ratio to 275 times by 2007.

As we now know, ‘performance pay’ was a misnomer, an incentive for financial engineering that has destroyed value on a heroic scale. But it’s not just shareholder value that has suffered. By severing any common interest between top managers and the rest of the workforce, fake performance pay has fatally undermined the internal compact that makes organisations thrive in the long term.

Perhaps the most poignant emblem of this dereliction is the British pub. The pub is the archetypal small business – the simplest, most rooted organisation there is. Pubs have thrived for centuries. But they are now closing at a rate of around 30 a week. Part of this is due to changing social habits. But it is also the case, not to put too fine a point on it, that pubs have been rogered frontwards, backwards and sideways by financial whizzkids who piled them with complex debt and left them desperately underinvested – at the same time extracting exorbitant fees for the privilege. The death of the local is a fitting monument to a bankrupt management model. It’s time to get angry.

The Observer, 11 January 2009

This article appeared in Management Today. See the rest of it at http://bit.ly/bb51zB