Moral Hazard is Corporate Kryptonite

In *Thinking Fast and Slow*, Kahneman relates a story told to him by Richard Thaler. It goes like this:

Once there was a gathering of executives from a large company. Each were asked about taking risky projects with a positive risk-adjusted expected value. The middle managers, who would be taking those risks, took a pass: put my job on the line? No thanks.

The CEO, on the other hand, wanted them to go for it. Kahneman’s explanation, which I like, is that the CEO benefits from diversification while the middle managers do not. A losing bet could cost them their job, but if they all make the bet, the CEO will take credit for the (very likely) subsequent growth.

There are some assumptions built into this assessment, though. Here is another story, from Arnold Kling:

Although I took no formal survey, I got the impression that most of them [middle managers] would agree with the following statements:

  • Corporations should give middle managers more freedom to take risk.
  • Corporations should be more willing to make mistakes and accept failure.
  • Corporations should offer more rewards and incentives for innovation.

…Suppose we re-phrase [these points] in terms of economic risk and reward. We might express them as:

  • Corporations should enable middle managers to make larger bets with corporate resources than is the case currently.
  • The downside risk of these bets should be borne more by the corporation and less by the middle manager than is the case currently.
  • More of the upside of these bets should accrue to middle managers than is the case currently.

…Middle managers understandably do not want the same degree of personal downside risk as entrepreneurs. However, in the absence of personal downside risk, the middle manager’s incentives would be skewed toward taking unjustifiable risks. Bureaucratic controls and limits on upside incentives may be an appropriate adaptation for correcting this potential bias.

As happens all the time when evaluating risks, we think statistical when we should be thinking behavioral. The risk changes depending on who is facing it and with what incentives (ie how hard they will work).

The point, I suppose, is that risk, which is rather an abstract sort of thing, in most businesses it is really a measure of the degree to which someone will be up to the task and can be controlled by highly skilled and motivated players. Real motivation, though, only comes when your ass is on the line. This is unacceptable for most people. Excellence, this line of thought goes, is driven by incentives (risk), and so is rare.

Bureaucracy is the blunt instrument that protects an organization from its most potent threat: risk without accountability. Moral hazard.

The result, as Arnold says here, is mediocrity. The base case for all organizations.

Vampires, Tooth Fairies, Santa Claus, IT Projects

I don’t believe in IT projects. Well, mostly not, but I’ll get to that later. First, here’s Ars Technica on a failure of the Romney Campaign: its app, Orca:

The goal was to put a mobile application in the hands of 37,000 volunteers in swing states, who would station themselves at the polls and track the arrival of known Romney supporters. The information would be monitored by more than 800 volunteers back at Romney’s Boston Garden campaign headquarters via a Web-based management console, and it would be used to push out more calls throughout the day to pro-Romney voters who hadn’t yet shown up at the polls.

Here’s the failure part:

When the Romney campaign finally brought up Orca, the “killer whale” was not ready to perform. Some field volunteers couldn’t even report to their posts, because the campaign hadn’t told them they first needed to pick up poll watcher credentials from one of Romney’s local “victory centers.” Others couldn’t connect to the Orca site because they entered the URL for the site without the https:// prefix; instead of being redirected to the secure site, they were confronted with a blank page, Ekdahl said.

And for many of those who managed to get to their polling places and who called up the website on their phones, there was another, insurmountable hurdle—their passwords didn’t work and attempts to reset passwords through the site also failed. As for the voice-powered backup system, it failed too as many poll watchers received the wrong personal identification numbers needed to access the system. Joel Pollak of Briebart reported that hundreds of volunteers in Colorado and North Carolina couldn’t use either the Web-based or the voice-based Orca systems;  it wasn’t until 6:00 PM on Election Day that the team running Orca admitted they had issued the wrong PIN codes and passwords to everyone in those states, and they reset them. Even then, some volunteers still couldn’t login.

Someone fire the IT department for effing this up. Right? Yet, consider this:

IT projects are easy scapegoats for organizational failures.

Exactly.

IT projects, academia aside, are chasing a business objective. All business projects involve technology, it’s just that normally the technology is very familiar (paper, pencils, telephones).

Unfamiliar technology, on the other hand, can create problems…

Hey, learning on the fly is hard. New technology doesn’t evolve gradually to fit your business. It ‘tips’ into the mainstream after furious validation and iteration in some other sector of the economy then gets chucked at new industries by startups.

Usually it doesn’t stick; that’s why startups are risky. But when startups don’t stick, the business still gets done (it just goes to someone else). It’s the tech that dies, useless.

Startup failures are failures to compete, not failures of technology, per se. The thing that irritates me about “IT projects” is the implicit dissociation of the technology from the business.

Most managers don’t understand the pitfalls of implementing new technology because most new technology doesn’t matter. In the real world we observe that incumbent firms are conservative, reacting “too late” to ideas already validated by the marketplace.

But we also know that business advantage is precious and risking your business on a new idea is insane.

Also remember something Peter Drucker taught: innovation is what matters and that is definitely not the same thing as what we think of as being technology. It’s about process. This can mean smartphone apps, sure, but can also mean weekly internal meetings. Linus Torvalds says: “Bad programmers worry about the code. Good programmers worry about data structures and their relationships.” The tool doesn’t matter, the process matters.

So let’s walk though what the Romney campaign’s process idea:

  1. You need a list of for-sure GOP voters. Easy, already do that.
  2. You need a bunch of people on-site to note which for-sures have voted. Easy, got volunteers everywhere.
  3. Now cross off those that voted and contact those that did not. Wow, interesting idea, we should have been doing that all along.

Ok, give cell phones and pencils to the volunteers and they can make the calls. Right?

Nope, we need to build something that has never been done before. And give it to… seniors? With no instructions? This is a project run by someone who does not know what they’re doing. Because, I’d suggest, it was not run by the person in charge.

To me, the leader of an organization has two qualities: first, he/she is the person that best understands the value that the organization creates. Said another way: the leader has the power to set the priorities of the organization because he/she understands what they should be.

There’s a tradeoff in undertaking a big new project: distraction exchanged for a new competitive edge. A sure cost for an uncertain benefit. The leader, who is best positioned to understand the upside of this trade, makes the call.

But here’s another quality of the leader: he/she is probably the most competent executive as well. And think about the root of the word ‘executive’: execute. An important project must be run by an outstanding operator who can never lose sight of the organization’s priorities in the million of little decisions that go into execution.

Big failures land on the CEO’s desk. If they’re big enough to matter, he was in charge. If he wasn’t, he’s an idiot.

Summer Students and RIM

In my everlasting journey through Founders at Work, I came across this quote about RIM:

One of the things I realized was that to get strong co-op students, you had to start early because, by the second year, you’ve lost them already to some other company. So we started hiring first- and second-year students, knowing that they were not really going to be full-time employees for 3 to 4 years after that. It was a 3- to 4-year investment we started making with students early on because I knew their value. We treated them like full-time employees. We’re the largest co-op employer in Canada.

Building teams this way is an very long term strategy. What does the company’s recent troubles mean for these students?

Incidentally this is exactly our strategy for hiring green shoots. Few years till you graduate? Awesome. We aren’t always in the market for full time employees so we don’t want to set these kids’ expectations. More importantly, we need to hire strong when we do dip into the market.

Job interviews are incredibly ineffective; you don’t know what someone’s made of until you’ve put them through their paces. And if you caught someone early that you like they might still be available (or perhaps easily poachable) when you come calling.

Unfortunately this year we literally ran out of space in our office so had to suspend the program. It will begin again.

“Intelligence” = Negativity

One quick aside.  Last year, the more bearish you were on Under Armour, the better a team scored.  But guess what?  Under Armor rose 15% in the last 7+ months — the team that finished last had the result that was the best, and the winner did the worst.  I know many of my readers don’t like Jim Cramer, but one thing that he said shines through here: “The bear case always sounds more intelligent.”  The same is true in the biases of judges for academic competitions.

That’s David Merkel. I remember a professor at university who said that an MBA gives you a thousand reasons to say “no” to something but no ways of saying “yes”. We systematically overestimate the intelligence of two kinds of people: the articulate and the negative.

But trashing an idea is the easy way out. Being a smart booster is the most difficult job on earth. And the most lucrative.

Two Lessons From Iron Mike

Mike Tyson is my favorite boxer. Obviously this has something to do with his in-ring feats, sure, but everything that’s interesting about him comes from his mind. He has one of the most interesting and powerful minds on earth. Seriously.

All the more so because he agrees with one of my more ridiculous beliefs: there’s no such thing as the good ol’ days. Everything’s better today:

“They would be tough for anybody to fight. I know people hate to believe this but they’re tough for anybody. Sometimes we don’t want to believe it. We’re stuck on apple pie in our era. We like Chuck Berry; we like Elvis Presley. People get better as men from the cavemen to now. We are supposed to get better. From the 80s to now we’ve got better. We’ve got more technology, more people are made, we get more money, the world is bigger, and we become better. So these guys would be difficult to beat for anybody who came before them.”

And, next, knowledge and wisdom can sometimes be a burden:

Tyson is a changed man. Gone is the bristling machismo, and sparks of aggression. “I wasn’t ready to know all this back then [as champion of the world]. I am now. If I’d learnt all that then I probably would never had been a good fighter. I’d have been too docile and meek then. At that particular time it was suitable for me and now that’s not too suitable for me.”

I like that lesson. Sometimes a deep understanding hinders success. I would argue that’s because knowledge is often illusory. In other words, mostly we’re all full of shit. Stop talking. Do stuff.

From Delusion Comes Grandeur

When I was in University we played this team building game where we were given a block building puzzle of some sort to solve. We were timed.

After putting everything together the best time in the room was announced, let’s say it was 2 minutes. Wow, good time, we all thought. Then the instructor told everyone that a rival school’s best team did it in 10 seconds. Huh?!

Immediately our expectations of excellence were reset. Let’s figure this out and try again. After the next round, our times were read out: 4 seconds, 6 seconds, 8 seconds, 8 seconds, etc.

Was the story about the other school true? Meh, maybe. Didn’t matter. All we needed was a different definition of success.

Now read this story from the video game world:

The race to build the next great RTS was on, and consequently Blizzard was about to be publicly embarrassed by its choice to show so early in the development lifecycle. Just a short walk away from the Blizzard booth was that of another game which appeared to be better than StarCraft in every respect: Dominion: Storm over Gift 3, from Ion Storm.

It’s 1996 and you want to buy an RTS game. Would you pay money for this?

Dominion Storm game screenshot

Dominion Storm

Or this?

StarCraft "Orcs in space" screenshot prior to the project reboot

While we didn’t have the opportunity to play Dominion Storm because it was a hands-off affair, it didn’t seem necessary. The Ion Storm staff members who demonstrated the game had a remarkable event that showed great-looking game units, including a signature unit that moved like the AT-AT walkers first seen in “The Empire Strikes Back” during the Battle of Hoth. With other impressive units of all sizes and forms, electric fences that could be chained together to create impenetrable barriers, and isometric-perspective artwork that showed the game units from a more compelling angle than did our nearly top-down perspective, Ion Storm’s game was kicking our ass in every regard.

It was a glum crew that made the drive back to Orange County to lick our wounds and plan for the future. The fundamental problem was that StarCraft wasn’t envisioned as a triple-A game; it was intended to fill a hole in Blizzard’s development schedule so that the company would ship a game in 1996 and thereby continue to generate revenues.

…At some point I talked with Mark and Patrick about how Dominion Storm knocked us on our heels, and they let us in on Ion Storm’s dirty little secret: the entire demo was a pre-rendered movie, and the people who showed the “demo” were just pretending to play the game! It would be an understatement to say that we were gobsmacked; we had been duped into a rebooting StarCraft, which ultimately led it to be considered “the defining game of its genre. It is the standard by which all real-time strategy games are judged” (GameSpot).

Teach Children Grit and Set Their Ideas Free

Here is Econtalk:

Paul Tough, author of How Children Succeed, talks with EconTalk host Russ Roberts about why children succeed and fail in school and beyond school. He argues that conscientiousness–a mixture of self-control and determination–can be a more important measure of academic and professional success than cognitive ability. He also discusses innovative techniques that schools, individuals, and non-profits are using to inspire young people in distressed neighborhoods. The conversation closes with the implications for public policy in fighting poverty.

And here is a new thinker in my intellectual universe: Bret Victor. I’m somewhat amazed by this guy. He’s one of those people that can make profound things not sound pompous or douchey. Here is a talk by him and here is an interesting piece on learning programming.

His core principle: “creators need an immediate connection to what they’re creating”. Watch the video for some illustrations on what this means to him and ways he’s using this idea to guide his professional life.

A deeper meta-principle, which Bret also touches on, is that you (yes, you) should have a core philosophy/principle that guides your actions. It’s a refreshing way of looking at life.

But, to circle back on the podcast on grit, a guiding principle is great but you still will never achieve anything without a driving force. Inspiration and perspiration.

Life Coach Spurs QE3?

One of the most remarkable teaching moments in organizational behaviour is perhaps coming to a close. For years now Bernanke has been in the odd position of implicitly denouncing his life’s work.

Bernanke spent his academic years studying the great depression. His conclusion? That occasionally recessions are bizarre demand-side beasts that monetary policy can mitigate. There may well only be a few of these episodes in history: the depression, Japan in the 90s and… today.

It’s some kind of cosmic miracle that a man with his background is in charge of the fed. He’s the Chosen One, in the right place with the right skills at the right time. If only someone with his understanding were in charge of the fed in the 30s! Or running the BOJ!

Well maybe not. What we’ve seen instead is a man forced by organizational politics to abandon what he (probably) sees as the truth. Publicly Bernanke’s job is to be the voice of consensus, no matter what his private beliefs are. He has the odd distinction of being someone whose private beliefs are extremely well known. How… inconvenient.

Enter a mystery man:

Mr. Robinson, the managing partner of Vantage Leadership Consulting, a Chicago strategic talent-management firm, has been a frequent visitor to the Fed chairman’s office this summer.

Though Mr. Bernanke’s schedule is generally crammed full of gatherings with staff, other policy makers and prominent figures in academe and finance, the Fed chief met four times with Mr. Robinson between May 9 and July 20, according to Mr. Bernanke’s monthly calendars of appointments, obtained through public-records requests. He also met twice with the Fed chairman in 2011.

A 58-year-old licensed psychologist, Mr. Robinson specializes in helping companies foster leadership, both in working with firms to select leaders and through executive coaching, according to the Vantage website….

While his work varies with each organization, Mr. Robinson said three decades in the business have underscored a few basic principles.

“We spend a lot of time trying to help people understand organizations don’t function like individuals,” he said. Workplace politics and an employee’s reputation, for example, can play a part in company dynamics.

And Mr. Robinson emphasized the importance of getting the right people in charge.

“Leaders cast long shadows,” he said. “You cannot overestimate the impact of a leader.”

And perhaps such leadership has been taught?

What Is A Good Company? A Bad One?

In good organizations, people can focus on their work and have confidence that if they get their work done, good things will happen for both the company and them personally. It is a true pleasure to work in an organization such as this. Every person can wake up knowing that the work they do will be efficient, effective and make a difference both for the organization and themselves. These things make their jobs both motivating and fulfilling.

In a poor organization, on the other hand, people spend much of their time fighting organizational boundaries, infighting and broken processes. They are not even clear on what their jobs are, so there is no way to know if they are getting the job done or not. In the miracle case that they work ridiculous hours and get the job done, they have no idea what it means for the company or their careers…

That’s Ben Horowitz. There is also a discussion about a company called Go, which you’ve never heard of but are about to learn something from:

When I first met my friend Bill Campbell, he was chairman of Intuit, on the board of Apple and a mentor to many of the top CEOs in the industry, including Steve Jobs and Jeff Bezos. However, those things did not impress me nearly as much as his time running a company called GO Corporation. GO essentially attempted to build an iPhone in 1992. The company raised more money than almost any other venture capital back startup in history and lost nearly all of it before selling itself for nearly nothing to AT&T in 1994.

Now that probably doesn’t sound impressive. In fact, it probably sounds like a horrible failure. But I’d met tens of GO employees in my career, including great people like Mike Homer, Danny Shader, Frank Chen and Stratton Sclavous, and the amazing thing was that every GO employee that I’d ever met counted GO as one of the greatest work experiences of their lives. The best work experience ever despite the fact that their careers stood still, they made no money and they were front-page failures. GO was a good place to work.

My favorite test for whether a company is excellent company or not is whether the people who were a part of it go on to do extraordinary things. Think of the Paypal mafia.  It’s not clear to me that GO passes this test.

In the (re)insurance business, there are two Paypal mafias that come to mind: AIG’s actuarial department in the 80s and F&G Re. The top ranks of my business have over the last 20 years been massively over-represented by people with one of these two lines on their resume.

There is also an interesting discussion on HN about a rather controversial passage in the piece. Here’s the setup:

At Opsware I used to teach a management expectations course because I deeply believed in training. In it, I made it clear that I expected every manager to meet with her people on a regular basis. I even gave instructions on how to conduct a 1:1 meeting so there could be no excuses.

Then one day while I happily went about my job, it came to my attention that one of my managers hadn’t had a 1:1 with any of his employees in over six months.

Ben threatened to fire this manager and the manager’s boss if they didn’t fix this in 24 hours. A commenter thought that was harsh and perhaps a bit arbitrary. Another one responded with this:

It’s even worse than that, the people that work for you will make their number one priority not getting fired.

I’ve worked at a company like that before. Management worked hard on whatever problem the CEO noticed last, while doing their best to hide any other problems from him.
As a manager you do much better at aligning everyone’s interests so that your staff does what they want to do, which just happens to work towards the outcome you want. It’s more about gentle course corrections ahead of time than grabbing the wheel from them.

This is evocative to me of the hardest management problem in insurance. In insurance, like in all businesses, there is pressure for companies to grow. In insurance, also like in other businesses, growing by cutting your prices to the point where you lose money is one self-defeating option.

Unlike in other businesses, though, the break-even price for insurance is basically unknowable when you charge it. So you charge something that is probably close and work out differences across time.

This means insurance managers can be a schizophrenic bunch. One day they’re focused on growth, the next day they’re worried that they’re cutting their prices too much to grow profitably. The worst managers expose their employees to the full horror of this uncertainty. The best find a balance and help their subordinates find their own balance.

I’m not sure this criticism is justified in the story, but the lesson still stands: understand your management priorities and be consistent in applying them.

And one of those priorities is that your turf should be a good place to work.

Together Everyone Achieves More

I love the leadership freak for frequent little little pump-ups. Today’s was good:

Leaders who can’t ask people to do hard things can’t get hard things done. Meaningful contributions require deep commitment and effort. Weak leaders assume others can’t or won’t step up. They rule out before they ask.

Ruling out:

  1. That’s too hard for them. Making it easy prevents people from stepping up. Give people the opportunity to do hard things. I’m not suggesting you intentionally make things hard for others.
  2. They already contribute so much. Translation, they can’t make meaningful contribution in new areas.
  3. They wouldn’t be interested.
  4. They’re too valuable where they are. If anyone says that to you, update your resume’.

I work in a human capital business. In human capital businesses we can’t scale by adding servers and clever code. We scale by adding clever people. And the companies that scale best don’t poach experts, they train them.

To me the key to successfully training people is to put them in the driver’s seat and tell them to lean heavily on the team. The change in leadership might not even mean a change in the functional roles.

Let’s say there’s an accountant, a lawyer and a janitor working on a project. The lawyer reviews the legal documents and normally also reports up to the VP. Today we put the janitor in charge of reporting up. The lawyer still does the docs, the accountant does the figures and the janitor scrubs the toilets. But after cleanup he receives the others’ work, reviews it and takes the heat if the VP doesn’t like the work.

Maybe the janitor didn’t know much about the work before, but I bet you he’ll learn faster than he ever thought he could. If everyone buys into this process, you can create an extraordinary culture.

The idea is that we’re trying to cultivate an alignment of identity with the task, which (to me) is the fundamental quality of leadership. It can’t be taught, it must be experienced.