'If the facts don’t fit the theory, throw out the facts.' - Albert Einstein.
Classical economics view humans as “rational actors” who, by nature, make decisions based on reason and structured thinking and behave in ways that maximise advantage and utility and minimise risks and costs. However, one only has to read the report recently released by the UK Financial Services Authority Board on RBS’ ill-fated acquisition of ABN Amro in 2007 to realise that this could not be further away from the reality.
This view ignores the powerful impact of cognitive biases - the tendency to make decisions and take actions based on limited acquisition and processing of information or on self-interest, over confidence, or attachment to past experience. Cognitive biases result in perceptual distortion, illogical interpretation, inaccurate judgments or irrationality and lead business people to making the wrong decisions.
The recurrence of poor outcomes such as mergers routinely failing to deliver expected synergies; strategic plans not being implemented successfully or large investment projects delivered over budget and late are further evidence of repeated patterns of this irrationality, inconsistency and incompetence in decision-making, particularly when we are faced with the uncertainty related to making plans for the future and defining a strategy.
The UK FSA's investigation of RBS’ downfall clearly highlights the fingerprints of cognitive biases and their negative impact on the decision to acquire the ABN Amro bank that subsequently led RBS to post a £24b loss in 2008, the largest in British corporate history.
The investigation revealed that the deal had been driven by one dominant CEO who had earned a good reputation following the successful integration of NatWest by RBS in 2000 but who was under pressure from shareholders for better performance. With a dominant personality, the CEO’s decisions routinely faced no countervailing voices, neither in the RBS hierarchy nor from its Board; and the ABN deal was no exception.
It also highlighted the absence of any genuine strategy behind the deal. The report stated "the wrong price, the wrong way to pay at the wrong time and the wrong deal". No proper market analysis had taken place, no appreciation of the true value of ABN Amro (well below expected as it turned out), no assessment of implications of putting two large wholesale banking businesses together, no analysis of the risks and their impacts (neither business risks nor integration risks), no clear plan of how RBS would develop these businesses, no realistic takeover integration plan (as attested by the blasé attitude of senior RBS managers to the complexity of integrating a bank like ABN Amro).
The fingerprints of cognitive biases can be seen present across the whole decision-making process that led to this ill-fated acquisition: misleading pre-judgements and prior experiences (RBS’ successful takeover of NatWest); inappropriate extrapolation, power of story telling and delusion of absolute performance (the holy grail of building rapidly an investment bank à la Goldman Sachs); emotional tagging (as the NatWest experience had been so good); over confidence and illusion of understanding (how different could this integration be from NatWest’s); selective exposure and retention (even if some advisors and hedge funds expressed concerns, none of them were heard), emotional attachments (feral reaction to knowing that another competitor was also bidding); inappropriate attachments and self interests (from both a CEO who wanted to increase its returns and was only considering the acquisition to achieve this and the seniors in Investment Banking who had an interest in managing a larger empire); confirming with the group (as RBS’ strategy was merely copying that of its competitors); sunflower management (as attested by the lack of dissenting views), etc.
Not every organisation has the benefit of an analytical and facts based investigation from the UK FSA to review what went wrong with their strategic decisions. In most cases, failure is associated with bad luck rather than bad decision-making driven by cognitive biases. Many business leaders would benefit from spending time and effort to build a disciplined and consistent process for making strategic decisions to increase their chances of catching cognitive biases before they hijack their decision-making.
More findings on the ABN Amro take-over from UK FSA here
by Christelle Espinasse - inSTRATEGIA
