By Michalis Zaouras on September 30, 2009

Difficult times need risky people, or is it the other way around?

One year ago, if I remember well, Bank of Cyprus acquired a Russian bank pledging most of its assets. Other examples would be Bank of America acquiring Merrill Lynch, JP Morgan Chase acquiring Bear Sterns and Washington Mutual and Lloyds TSB acquiring HBOS. While the last of these cases needed government intervention to survive the turmoil. In all cases huge amounts of money have been used, in a time that money liquidity is the most important for a business to survive.

So why would anyone risk the sovereignty of its organization by taking aggressive decisions in a risky and highly volatile environment. A short answer would be that the government has guaranteed, as in the case of Lloyds TSB, the bad debts inherited by the acquisition. The problem, even if you have been given some guarantees, is that if you are not solid enough to overcome a negative shock then you shouldn’t have taken the risk from the first place. At the end of the day, Lloyds TSB needed bail out from government, resulting in deterioration both of managers’ prestige and company’s competitiveness.

Another explanation would be that managers are not maximizing profits but maximize personal interest, for example they might care more for prestige and fame. This could also be a result of the no alignment of stockholders interest with managers, a well known problem called moral hazard. So the manager might choose to acquire another firm because the biggest the company you manage the more prestigious for the manager. But this leads to a new question, since government officials know about the problem of motives alignment then why offering the guarantees in the first place?

Concluding, giving away money and promises would not solve the problem. When we set a policy we, the economists, should also take in consideration alignment of interests, as well as the efficiency. Difficult times need not risky people and hasty decisions, need well constructed programs and efficient allocation of resources. The structure of decision making and firms’ competition philosophy should also be reexamined because what we have learned from the crises is that risky people will create difficult times.

1 comment:

  1. That's why i feel the new projections of USB on Greek and Cypriot banking shares are ridiculous - they are still being made with a risky aggressive spirit in mind, when the way forward now is a slow and gradual. So you get NY firms putting all the Greek banks under "buy" while the IMF places them at the bottom on Europe in terms of security and performance. See the tag for the artcile in today's "Oikonomia".