Catastrophic Optimism and Avoiding Corporate Collapse

Alice Schroeder, Corporate Director and Advisor at Hawthorn Hill LLC, is the respected author of The Snowball: Warren Buffet and the Business of Life, a #1 New York Times and #1 Wall St Journal bestseller published in 2008.

As a keynote speaker at the recent Australian Institute of Company Directors’ National Conference in Singapore she cautioned directors to be wary of the four key risks she believes significantly contributed to the corporate collapses in the US and Australia in recent times.

Catastrophic Optimism

The tendency to be overly optimistic of the organisation’s chances of success can be seen in the high failure rate of strategy that has been researched across companies for many decades. Catastrophic optimism is the extreme end of this overly bullish attitude to the company’s strategy and good directors have the discipline not to get caught up in the excitement of the ‘blue sky’ of the possible. They ask probing questions to test the robustness of the thinking and the reasonableness of the assumptions underpinning the strategy.

Wilful Ignorance

Ignoring information trends, failing to ask the right questions and focusing on the wrong issues are all signs of wilful ignorance. This risk sits squarely with the Board and the test for a board is to constantly ask whether they have demonstrated care and diligence appropriate to the times in making decisions and monitoring the performance of the company.  “The hardest thing to explain is the glaringly evident which everybody has decided not to see.” Ayn Rand.

Complexity

The more complex an organisation becomes, the more difficult it is to see the torpedo ready to strike at the company’s weaknesses. Commonly used risk analysis metrics (such as Value At Risk) are not particularly good at measuring cumulative probabilities and give false security regarding the exposure to particular risks. Good directors must see through the complexity to help identify the real exposures to the business.

Hubris

Definition: excessive pride or self confidence, arrogance, (in Greek tragedy) an excess of ambition and pride ultimately causing the transgressor’s ruin.

Most often seen in flashy boardrooms, corporate jets, and executives that resist having to justify their decisions to anyone else, hubris has been the precursor to many a company’s downfall. Good directors will ensure that the interests of the shareholders are not mortgaged by executives or a board who begin to believe their own PR regarding their abilities and therefore their entitlements.

In the interests of learning from the mistakes of others and not feeling the need to make them personally, Schroeder’s observations are a timely caution to all directors for what to look for and be wary of in the behaviour of boards and executives.

 

Posted in - Strategy