Imperfect business management

Alex Tabarrok writes,

management matters and it matters in systematic and fairly easy to replicate ways. If mis-measurement explained productivity differences, Lemonis would not be able to successfully turn firms around. But he can and does. How?

Mainstream economics starts with the assumption that firms are behaving optimally. This is absurd. Firms are operated by human beings, and human beings are flawed. People always make mistakes, and there are always opportunities to improve.

I am guessing that when badly-run incumbents lack regulatory protection, it has become somewhat easier to drive them out of business. Transportation costs have come down. So have communication costs. This increases the geographic reach of strong competitors. So the worst retailers and the worst companies that need software management skills have a really hard time sticking around.

The requirement to earn a profit is probably the most important check on bad management. Non-profits can be poorly run as long as donors are tolerant. Sectors in which the government is heavily involved can be inefficient, because the government can always be counted on to boost demand and restrict entry. So my guess is that it’s easier to survive as a badly-run “green energy” firm or a badly run college than as a badly-run software company or a badly-run grocery chain. Note that I mean “badly run” in relative terms, because, again, humans are flawed, so that every company is “badly run” in absolute terms. Yes, I know that some of the “green energy” firms that received government subsidies went under, but it seems reasonable to say that they lasted longer than they would have with the same strategy and execution but no government help.

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7 Responses to Imperfect business management

  1. Michael L says:

    “The requirement to earn a profit is probably the most important check on bad management”

    It is not a high bar to cross. In my few decades of experience combined with the experience of my peers, I can confidently say a high majority of companies are poorly managed.

  2. Tom DeMeo says:

    In my experience, the biggest problem out there is that once an organization gets used to a particular revenue flow and profit margin, it almost always cannot back up gracefully when things change. It either finds a way to maintain and expand that flow, or it fails.

  3. edgar says:

    Looking at a specific case can sometimes clarify these questions, or deepen one’s cynicism. Iberdrola, the multinational electric utility, for example, might be useful. They have investments in upstate New York and England, Ohio, North Carolina, and elsewhere.

    A March 2015 report by Good Jobs First on US government subsidies to corporations states that “The largest recipient of grants and allocated tax credits is the Spanish energy company Iberdrola, which acquired them by investing heavily in U.S. power generation facilities, including wind farms that have made use of a renewable energy at provision of the 2009 Recovery Act providing cash payments in lieu of tax credits. Iberdrola‚Äôs subsidy total is $2.2 billion.”

    Despite this largesse, Iberdrola seriously lags on return to equity compared to the sector and other benchmarks:

    Now. let’s bounce back to 2012, and look at their corporate governance. At that time Iberdrola officials were assuring the world that Iberdrola was committed to “good governance” ( ) assuring us that they were at the vanguard of diversity and was subsidizing shareholder activism.

    So to summarize, vast government subsidies to a company whose “good governance” is focused on everything but its actual performancewinds up producing a market laggard that holds a good chunk of the US electricity market.


  4. Matthew Young says:

    Don’t ask me, I am horrible at it

  5. Jay says:

    There is also the possibility, which I think rather likely, that many firms are pretty well managed, but are optimizing for something other than returns to shareholders. For example, many firms’ management prefers the flexibility of having little debt (which is another way to say they’re not risk-tolerant). This actually makes quite a bit of sense, as the failure of the company would have a huge impact on the management team’s lives. Shareholders would prefer the company to take more risks because they take more of the gains from risks that pay off and can manage their risks through diversification. It’s a principal-agent problem, and the usual solution (stock options) is only moderately effective.

  6. T Boyle says:

    “Mainstream economics starts with the assumption that firms are behaving optimally.”

    Really? I didn’t think it did anything of the sort.

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