Tuesday, 24 February 2009

Misunderstanding management decisions

Robert Peston posts an odd blog today, which implies that he thinks all business decisions are either absolutely right or wrong, and not contingent on the situation or on business judgment.

He cites £1.5-2bn of costs which Fred Goodwin did not take out of RBS - despite his reputation as a cost-cutter - and which Stephen Hester has now identified.

Well, surely in today's business environment some costs are no longer appropriate which were nevertheless justified in 2007. The private plane which he cites may be the perfect example. When there is competition among investment banks to win new M&A instructions or IPOs, being able to pick up executive in a private plane for meetings in your office could be a good marketing investment. When there is no competition - or indeed no mergers - or when the executives become much more price-conscious, it may no longer be cost-effective.

As we've discussed before, it's dangerous to assume that apparently-extravagant expenditure is really wasteful. Companies have bought their private jets for a reason, and they organise sales conferences in Las Vegas for a reason too.

Undoubtedly there is an agency problem here: it's easy for executives to decide that an expensive sales conference is a good use of money when it isn't their money. And it may be too simplistic to just consider this as just part of the compensation package for managers - it may be much more cost-effective to instead give them a bit more money.

As a matter of public policy (since RBS is majority state-owned), if we are looking to stimulate the economy as a whole we don't necessarily want companies to cut back on their spending. We ought to be encouraging spending which maximises the velocity of money, as well as achieving economic efficiency.

I don't know the right answer - but all these factors merely show that this is a complex decision and that the answer is far from obvious.

The real reason for making certain decisions is symbolism. It's important for taxpayers who feel worried about the recession to see that high-profile people, especially those paid by the public, are making decisions that do not look extravagant - regardless of the management rationale behind them.

Fortunately the bandwidth of public discourse is limited, meaning that there is only room for so many high-profile people in one economy. Thus RBS can sacrifice its plane and make us all feel prudent, without every company and every person in the country having to cut back on their spending too. And a good thing too!

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