December 05, 2007
Behavioral Corporate Finance (and a New Article in HBR)
Posted by Troy Paredes

The December 2007 edition of the Harvard Business Review has an article entitled "Deals Without Delusions" (by Dan Lovallo, Patrick Viguerie, Robert Uhlaner, and John Horn).  This article caught my eye because of my interest in behavioral corporate finance (the psychology of managerial decision making).  Focusing on M&A decisions, the article offers an interesting assessment of various psychological biases that can impact managers. 

A particularly tough question in this area is what to do about managerial psychological bias, if anything?  One prospect is to do more by way of formalizing dissent on boards, such as through the appointment of a formal devil's advocate (although I would never mandate such a thing).  Lots of studies, for example, suggest that dissent can counter various biases.  Without question, there are lots of challenges with this idea.  As many have pointed out, too much dissent can foster distrust.  Managers may start playing things too close to the vest.  Managers may become timid.  The devil's advocate may start competing against the CEO for power.  And the like.  That said, it strikes me that there is room for the board to participate more in managerial decision making in a constructive way.  Perhaps board members do not have the time or expertise to override managers' business recommendations (hence, the ascendancy of the monitoring board).  However, board members might be able to press managers (in a way they often do not) so that managers themselves make better, more informed, more rational (i.e., less biased) decisions.  That's what the devil's advocate function envisions.

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