Mental biases are not our only bias. Another kind of bias arises when one person is acting on behalf of another. This is called an agency problem—a situation in which the owner of a project has to rely on someone else for information, and this someone else has divergent interests. An example may be shareholders who rely on corporate management to undertake projects on their behalves, or a division manager who has to rely on department managers for information about how profitable their proposed projects really are. A cynical synopsis of agency biases would be “all people act and lie in their own self-interest.” Now, although everyone does have incentives to lie—or at least color the truth—corporations are especially rife with such agency distortions. Of course, few people sit down and contemplate how to best and intentionally lie. Instead, they convince themselves that what is in their best interest is indeed the best route to take. Thus, mental biases often reinforce incentive problems: “wishful thinking” is a disease from which we all suffer.
You can take the fact that we have already had to mention agency issues repeatedly in this blog as an indication of how important and pervasive these are. But, again, lack of space forces us to highlight just a few issues with some examples:
1. Competition for Capital Managers often compete for scarce resources. For example, division managers may want to obtain capital for their projects. A less optimistic but more accurate estimate of the project cash flows may induce headquarters to allocate capital to another division instead. Thus, division managers often end up in a race to make their potential projects appear in the most favorable and profitable light.
2. Employment Concerns Managers and employees do not want to lose their jobs. For example, scientists tend to highlight the potential and downplay the drawbacks of their areas of research. After all, not doing so may cut the project and thereby cost them their jobs.
3. Perks Managers do not like to give up perks. For example, division managers may like to have their own secretaries or even request private airplanes. Thus, they are likely to overstate the usefulness of the project “administrative assistance” or “private plane transportation.”
4. Power Managers typically love to build their own little “empires.” For example, they may want to grow and control their department because bigger departments convey more prestige and because they are a stepping stone to further promotion, either internally or externally. For the same reason, managers often prefer not to maximize profits, but sales.
5. Hidden Slack Managers like the ability to be able to cover up problems that may arise in the future. For example, division managers may want to hide the profitability of their divisions, fearing that headquarters may siphon off “their” profits into other divisions. They may prefer to hide the generated value, feeling that the cash they produced in good times “belongs” to them—and that they are entitled to use it in bad times.
6. Reluctance to Take Risk Managers may hesitate to take on risk. For example, they may not want to take a profitable NPV project, because they can only get fired if it fails—and may not be rewarded enough if it succeeds. A popular saying used to be “no one was ever fired for buying IBM,” although these days Microsoft has taken over IBM’s role.
7. Direct Theft Managers and employees have even been known to steal outright from the company. For example, a night club manager may not ring sales into the cash register. Or a sales agent may “forget” to charge her relatives. In some marginal cases, this can be a fine line. For example, is taking a paper clip from the company or answering a personal e-mail from the company account really theft? In other cases, theft is blatantly obvious. In September 2002, Dennis Kozlowski, former CEO, was charged with looting $600 million from Tyco shareholders. His primary defense was that he did so in broad daylight—with approval from the corporate board that he had helped put in place.