The economic analysis underlying corporate decision making: what economists do when confronted with business realities—and how they might improve

Business Economics, July, 2004 by Hugh Schwartz

Are Economists Sometimes Hesitant to Press for Acceptance of Economic Analysis?

Even those economists who said they were well respected in their enterprises sometimes did not present economic arguments to top management when they sensed that the latter would conflict with inclinations of the CEO or other key leaders. The principal reason: doing so was gauged as likely to undermine the credibility of those economists in others areas which they believed were more important or in which their analyses were more influential in decision-making. One remarked, "What is the range of options that the managers of my company will respond to? If I go off on an academic bent, they won't listen." Two respondents insisted, further, that rationality in corporate decision-making has an economic component, a social component, and a personality component. If they do not take that multiple composition of rationality into account, they would not be doing their job.

In a variation of the hesitance theme, one economist said that he dealt with disagreement not by open confrontation but by suggesting the likely implications of alternative courses of action. Other respondents made similar observations, pointing to the importance of the way in which advice was communicated as well as experience. One of them added, "Bottom line importance determines when I'll speak up.... If the bottom line will be impacted, I'll speak up regardless of the individual or the position taken by the individual. They pay me to do that, and while it's uncomfortable sometimes, they keep me around because they know they're getting an honest assessment from me. As soon as you start playing games (which I consider holding back on the economics because of politics), you depreciate your intellectual capital, standing in the company, and value to shareholders."

In any event, judging by the differing comments of respondents in different industries concerning the degree to which the advice of economists is taken into account, I would conclude that the degree of acceptance is influenced by the profitability of the firm and the industry. To extend the argument of Cyert and March (1992) about slack, some highly profitable firms in highly profitable industries do not pay much attention to economists until serious adversity sets in. (Note, though, that when serious adversity sets in, some firms lay off economists to cut overhead.) Finally, while in many firms economists feel free to express disagreements they have with senior management--and indeed those economists are expected to speak up--nearly half the economists interviewed feel that they are too junior and seldom question senior management. There can be no uniform recommendation that is suitable for all enterprises on this point, but NABE and business groups might urge companies to encourage economists to speak up for courses of action that are supported by economic analysis and to criticize those that seem to go against economic rationality.

The responses I am most skeptical about to date are those concerning the way in which adjustments are made after recognition that there has been a mistake. This is particularly the case in the analysis and responses concerning the alleged ability to deal with several situations during the same time period without any loss of the degree of rationality. Experiments in a number of behavioral disciplines indicate that even the introduction of irrelevant data tends to reduce rationality, though three respondents explained how the need to deal with several related situations at the same time could contribute to rational calculation. As for mistakes, respondents have characterized them as frequent, but they may attribute too many of the errors to erroneous information or to being in an oligopolistic market for which the available textbook models were not adequate. While it was claimed that some senior executives were hesitant to acknowledge error, I believe that some of the economists themselves may be in denial that they erred in their reasoning.