“Markets can remain irrational longer than you can remain solvent.” -Keynes
Those of us managing companies have taken way too seriously what we learnt at college about the economic theory of rational man. In practice, this principle links compensation systems with performance levels in a very deterministic way. Given we work for money, a more attractive salary linked to the right indicators will produce the professional behavior we hope for. As Rubini pointed out several years ago in the Davos Forum, recessions clearly show this theory does not work. Neither at the individual level nor at the collective one does the rational quest for interest in of itself explain economic and professional behaviors.
Reality is somewhat more complex. In fact the merit of those who take on responsibilities in the public sector and the private one includes capturing nuances that go beyond the simplifications that the majority uses for decision making.
Robert J. Shiller, recent winner of the Nobel Prize in Economics talks of the impact of emotional factors on market volatility. His book, “Irrational Exuberance” explains that the evolution of variables like real estate prices do not have any basis in the true foundations of the economy. It has been said time again and again that the two emotions that guide economic behavior are greed and fear. During expansive cycles, the impression is that there are great opportunities to profit from in such times. The urge to accumulate as much wealth as possible acts as a factor that overheats economic activity. In contrast, fear sets in during recession cycles. Financial decisions become conditioned by strong withdrawal, further accentuating the effects of contraction. This bipolarity goes hand in hand and drives the manic highs and lows of our history. The human being, as a financial animal, decides with a calculator in one hand and psychiatric meds in the other. We often swing between the dictates of reason and the impulse of our moods. And we must recognize that the emotional part more often than not wins.
This is about enhancing, in ourselves and in our organizations, the dominant moods of the current times.
One way to handle these crises (both booms and slumps) is what we call countercyclical emotions management. This is about enhancing, in ourselves and in our organizations, the dominant moods of the current times. Without using such terminology, Warren Buffet described this it in a practical way when he declared, “Be fearful when others are greedy, and be greedy when others are fearful.”
We prefer to substitute the term greedy by ambitious, and fear by prudence. This way managing countercyclical emotions entails an active promotion of expansive sentiments in times of recession and prudent moderation of our impulses in times of growth.