The assignment is as the following:
Part a): Behavioral Economics Definition and Motivation: Define behavioral economics, behavioral biases, and counter-balancing strategies using Ross and/or Dan Lovallo & Oliver Sibony terminology. Discuss the pros and cons that motivate corporations to be concerned about Behavioral Economics. Discuss positive and negative impacts on corporations of behavioral bias both on the part of CEO’s as well as employees and unions by highlighting some examples. Similarly highlight pros and cons of corporations implementing counter-balancing strategies.?
Part b): Strategic, Economic, & Positioning Outcomes: Using 10-K or other validated financial, market share, or competitive positioning data, students will relate the outcome of behavioral bias and/or counter-balancing strategies to earnings per share in subsequent years using NPV and/or other economic indicators including changes in Financial Health, Cost of Capital, Capital Structure, and/or corporate Beta. As I read this section, I will reflect on the questions, are strategic impacts (e.g. bankruptcy/successful product launch/IPO; first-to-market successful product launch, market share gain/losses), economic outcomes (e.g. realized shareholder value gains/losses, financial ratio changes from five categories of financial health to include stock price, eps, dividends, etcetera), and competitive position (e.g. maintenance, improvement or loss in industry position) improved or deteriorated over the period being considered? Are the conclusions supported by the quantified evidence for the first corporation case? For the second corporation case?
Behavioral economics is defined as the principle that is used to boost participation on matters to do with the retirement saving plans. Behavioral limits have rationality that is useful to managers, when they want to understand the behavior of investors as well as when they want to exploit the stock price of organization. When the management on the other side is making decision that concerns the organization, they ought to keep away bias that may be taking place between them. The returns on invest will be high if biasness in the organizations behavior will be avoided at all costs. When business is avoided, the decisions will be made by the organization after analyzing the mistakes made. The right measure taken to ensure it is rectified as soon as possible to avoid negative effects to the organization. However, the source of bias behavior has been to be investigated and the management has the mandate to ensure that, behavioral bias no longer occurs again among them. Biasness can affect the expertise of the management whereby, they are not in a good position of producing their best in their decision making process.
According to Sibony &Lovallo, the effective decision making biases are:
Usually, the human resources, the leverage, and the financial capital all joined to the supply chain of major enterprises in order to improve and develop the environmental and social accountabilities. For instance, civil and governments society always put pressure on major enterprises; enterprises are forced to function in complicated networks of supply chain relatives. However, it has to be in worldwide level, and tolerate with complex internal firm’s structures that are not responsive to decision- making procedures at all time.
The behavioral economics is currently in the mainstream. It has moved beyond the neoclassical economic theory assumptions of a perfect rational market. The behavior economics is type of psychological, cognitive, emotional and social process that is linked with economic decision making procedure of the company. Behavioural economics explains why irrational decisions are taken and why the decision does not follow the economic models. Behavioral model has been typically integrated from neuroscience, micro economic and psychology theory. These behavior models include wide range of methods, fields and concepts. The study of behavioral economics involves how decisions are made in the market and how the public choice is influenced. There are three types of behavioral finances:
Heuristics: Approximate rule of thumb decisions are taken by the customers instead of strict logical decisions.
Framing: The mental emotional filters that are made by stereotypes and anecdotes of the customer depend upon understanding events.
Market inefficiencies: The market inefficiencies involve non rational decision making and miss-pricing (Dequech, 2011).
The behavioral biases are those errors or mistakes that occur by irrational mental process. Irrationality is common human behavioral habit that cannot be changed or avoided. The limited rationality can be defined as sequence of many emotional, cognitive biases. These also include unchecked heuristics, habits and reflexes. The psychology of customer minds shows that it sometimes driven away by the groups and society influences. It takes a contamination form and unable the customer to make rational analyses. Some examples of behavioral biases related to market anomalies are cognitive biases, emotional biases, and autopilot or reflexive biases.
Cognitive biases further include: Individual biases that involve representativeness, anchoring, availability, unfounded beliefs, heuristic, memory flaws and logical fallacies and Collective biases that involves systematic dependence on social learning (Veselá and Klimová, 2014).
Emotional biases further include: Individual biases that involve affect heuristic, loss aversion, hope and fear and over confidence and Collective biases involve herding and mimicry.
Autopilot and reflexive biases that is beyond emotion and cognition include: Individual biases that involves addictions, habits, bad reflexes, compulsions and inertia and Collective biases involves taboos, rules and rites.
Market anomalies involve mispricing, momentum, price clusters.
The behavioral financing is recently emerging and it gives alternative approaches to classical finance definition of rational economy. The behavioral finance is concentrated towards cognitive and psychology science literatures to verify customer decision making that diverts from rational choices. Researchers have earlier focused on behavioral issues on investor biases, framing and heuristics effects.
Counter balancing is defined as exposing individuals to various treatments of orders to make sure that such order effects and carry over effects gives equal experimental conditions (Medema, 2013).
Rational thought is the best tactic that is employed in business to identify bias behavior, which is harmful to the organization at large (Kleas & Wilkinson, 2012). The activities employees of a particular company indulge in are a way of bringing risks to their lives and health behavior comes out as a result. They are advised of ways of exercising their bodies to keep them fit for their jobs and have a reliable health at all time. When people are aware of the risk ahead they can easily take the right actions that will enable them to eat healthy meals and prevent diseases from attacking their bodies. Employees like the opportunity of enjoying all the meals that they need to eat but the problem is that too many options can overwhelm them leading to financial wastage on unnecessary things, which are of no benefit. When one wants to eat too much, he will end up spending too much on food whereas; the body requires up to a certain percentage of food intakes the rest is a waste. Employees are encouraged to have a good health through various encouragements but this does not necessarily mean that they will be healthy.
Mark Hurd and Alan Mulally are the CEO’s that will be debating their cases on how they have analogized the levels of behavioral biases and counter-balancing strategies.
Presently, Mr. Hurd is Co-President, board member, and director of Oracle Corporation. From 2005 to 2010 Mark was the CEO of “HP.”2 Prior that Carly Fiorina was the CEO of “HP”; she was exiled because of her deficit while on duty. HP had several of financial dilemmas such as gaining profit of server and PCs market, which was an outcome of the essential decision for HP to buy Compaq, one of the computer manufacturers, in 2010. On the other hand, during the five years Hurd toke over Fiorina’s position; a lot of development and have been made in HP. Purchasing “EDS” Electric Data Corp for $13 Billion, which made HP top IBM, was an important decisions (Takahashi 2010). Moreover, cutting of staff’s salaries by 5%, and reducing workforce by 10%, then cutting 20% of his salary all of these are serious and affective changes (Essays, UK. 2013). Action oriented bias was implemented very well and effectively during the five years Mr. Hurd spend in HP. Therefore HP’s performance was improved and back to compete progressively in the market in such short time. However, when speaking of the interest bias, we find out that HP’s board has fired Mr. Hurd due to inappropriate use of HP’s resources and lying about his personal relationship with a coworker. This decision taken by the board cost HP major losses billions of dollars in stock value, shareholders, and several lawsuits. After a deep investigations and going back and forth on why exactly the board fired Hurd the secret letter have leashed the truth and firing him was a valid decision.
Hurd had done a lot of shaking up for HP, and there were mostly affective outcomes financially and hold a strong position among competitors in the market. A noticeable increase of HP’s revenue occurs in 2005 going from 86,696 million to 126,033 million, as an example. In addition, in 2010 the net earnings per share became to $3.78 per share, which in the past before Hurd was in the picture the net earnings per share was $1. As shown in tables below:
Yes, Mark clearly has been beneficial to HP and stability bias was countered by shaking every thing up as mentioned previously. HP compensation committee gave him a bonus and his salary increased as a reward. Jackson (2009) states that “although H-P’s performance has hit the wall in the past two years, Hurd’s pay has dramatically increased. For 2008, Hurd’s total compensation reached $43 million, which made him the fourth highest paid CEO in America for 2008. Hurd’s total compensation increased 73% from his $25 million in 2007, even though H-P’s stock price declined 29% in 2008.” However, the result of getting Hurd out of HP after his relationship with fisher appeared in 2011, the earnings from operations have decreased by two billion dollars as well as 40 decreases in esp. from the previous year. Therefore, in order to keep the stock price up, increasing dividends per share was the best way as shown in the below table.
The Ford Motor Company’s CEO, Alan Mulally is the second case. William Ford “grandson of Henry Ford” was the CEO for ford but due to bankruptcy dilemma back then the Ford family decided on brining in new heritage to Ford. Since 2006 Mr. Mulally has changed a loft in ford and one of his primary rulings is to bring back the “Taurus nameplate.” He stated, “I couldn’t understand why the company previously has scrapped the Taurus, which had been one of the company’s best sellers.” Moreover, a major action Mulally have done was to make Ford to borrow $23.6 billion and having all of Ford’s assets to be mortgage. The main reason behind this is to protect the company from any crisis in the market or unforeseen occurrences. Everybody was surprised from his action, but now no one in the Ford family cannon give him credit for that, especially after automotive industry crisis happened in 2008-2009. Other competitors such as General Motor and Chrysler have asked the United State Congress and ask for government loans, but Ford was financially stabled at the time. In addition, he encouraged and helped Ford to sell Jaguar and Land Rover for $2.3 billion to Tata-Motors and received $23 billion in debt with no regrets and better to focus on Ford products and brand. The losses for ford was decreased to 14.6 billion in 2008, due to Mulally behavioral biases and after turning things around in 2011 Ford had a profit of $7.8 billion, which was magnificent. William Ford the previous CEO said, “Alan was the right choice to be CEO and it gets more right everyday.” It was obvious that Ford was shaken up very well from top to bottom encountered to be stability biased. It took 24 months to make the whole market talk about Alan, “Ford’s executives finally stopped making decisions based on what was best for their own careers and started trying to figure out what was best for the company as a whole. That was something that had never happened before in Dearborn and it was the key to Ford’s phenomenal resurgence,” an automotive reporter Mr. Hoffman stated. He did not stop there; he had a technique for management and focused on cheaper, faster, lighter, and smaller products. The Eco Boost engine is the prefect example it is 1-liter, 3-cylinder, “he brought aircraft-building discipline to the auto industry, nobody in the auto industry has an engine that can compete with the 3-cylinder Eco Boost” Mr. Reinert a retired Toyota Engineer said. In addition, he lowered the labor cost from $76/hr to $55/hr after negotiation and agreement with United Auto Workers. He lived in Dearborn, Michigan three miles away from his office at the Ford’s global headquarter.
The essential financial progress for Ford in the last 4 years while Mulally was the CEO till July 1st, 2014 are shown in the tables listed below. Initially, Ford had $-12,613 million net income in 2006; the following year it decreased to $-2,723 million. When the crisis occurred in 2008 Ford asked the government for the loan not because they needed the money but because other competitive companies might top Ford after the government loan. “Ford didn’t really need the funds, but asked to be included so it wouldn’t suffer by competing with subsidized companies” Amadeo as US economic expert mentioned. A new loan was started in 2010, but less than the first loan in 2006 by 40% because the dept. was decreased. As a result, the net income for Ford in 2011 reached pleasing digits even among competitors. The Financial Times Arcelor Mittal called Mulally Person of the Year, as well as the CEO of the year by The Financial Times and Chief Executive Magazine both awards in 2011.
In the first table, starting in after the industry crisis 2010 we can see the stable increase in revenue, earning per share, and net income and the best digits are from the year 2011; $ 20,213 million in net income and 4.94 earning per share, and the best revenue was $146,917 million in 2013. From the second table we can notice the lowest total operation expenses was $11,545 million and not much higher for the following years. As of today, Ford share price is almost $16 per share, which is very promising. Mulally’s approaches have led Ford for a new era since he started with Ford, “He has brought Ford back to greatness and he has also developed the next generation of management” Ford Chairman Bill Ford said.
Using the economic indicators, the outcome of behavioral bias has affected the financial health negatively; since, the financial sector has not been working accordingly. The returns on the financial sector has very been poor following that, the best brains were not the one managing finances. Huge sum of money has been stolen leading tote fall of the sector in the case of many organizations. When the financial leaders are bias, they will value their own welfare and forget the welfare of the other people who also need financial aid. The market share has been affected by the bias behavior because, the economy has fallen down due to mismanagement by inexperienced individuals who were not informed on how to handle stock exchange to better market share (Solomon & Bamossy, 2013). Whenever there is bias, competition is too high and other companies end up taking better positions compared to the one that has bias in its management. With behavioral bias an organization will automatically fail in front of its competitors in the market who will employ the expertise technology thus, achieve the best outcome. When communication is effected in any organization and biasness kept aside the organization will prevail through all the challenges that may come on its way.
References:
Bryce, R. (2014). The secret to Alan Mulally’s success at Ford. Retrieved from
Dequech, D. (2011). Conflict and Cooperation: Institutional and Behavioral Economics. Review of Political Economy, 23(1), pp.152-153.
Donlon, J. (2011, June 27). CEO of the Year Alan Mulally: The Road Ahead. Retrieved March 29, 2015, from https://chiefexecutive.net/ceo-of-the-year-alan-mulally-the-road-ahead
Gabriel, J. (2014). Case Studies in Sustainability Management the oikos collection (Vol. 3). Sheffield: Greenleaf Publishing.
https://fortune.com/2012/04/12/how-ford-bounced-back/
https://h30261.www3.hp.com/~/media/Files/H/HP-IR/documents/reports/2011/hewlett-packard-annual-report-final-pdf.pdf
https://highered.mcgraw-hill.com/sites/dl/free/0078112699/862163/Chapter01.pdf
https://library.corporate-ir.net/library/71/710/71087/items/188196/05-10k.pdf
https://mitsloan.mit.edu/newsroom/2006â€Âmulcahy.php
https://www.businessinsider.com/mark-hurd-jodie-fisher-hp-2011 12#ixzz35mCDm8GD%E2%80%9D
https://www.detroitnews.com/article/20140521/OPINION01/305210010
https://www.usnews.com/news/bestâ€Âleaders/articles/2008/11/19/americasâ€Âbestâ€Âleadersâ€Âannemulcahyâ€Âxeroxâ€Âceo
Kleas, M. & Wilkinson, N. (2012). An Introduction to Behavioral Economics. Palgrave Macmillan; 2nd edition edition
Managers and Managing
Medema, S. (2013). The Tyranny of Utility: Behavioral Social Science and the Rise of Paternalism. History of Political Economy, 45(4), pp.755-757.
Naughton, K. (2014). Ford Names Fields Its Next CEO as Heir to Mulally’s Turnaround. Bloomberg.com. https://www.bloomberg.com/news/2014-05-01/ford-names-fields-ceo-effective-july-1-saying-mulally-to-retire.html
Solomon, M. & Bamossy, G. (2013).Consumer Behavior: A European Perspective. Consumer Behaviour: A European Perspective
The Case of Behavioral Strategy, Dan Lovallo and Olivier Sibony
Veselá, D. and Klimová, K. (2014). Knowledge-based Economy vs. Creative Economy. Procedia – Social and Behavioral Sciences, 141, pp.413-417.
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