Risk and return in the eye of the beholder

The corporate finance practice team at McKinsey & Co has joined the long line of people looking at the large cash hoard being assembled by corporations and asking “why?”. In an article in the McKinsey Quarterly, they suggest a surprising answer:

One factor that might go unnoticed, however, is the surprisingly strong role of decision biases in the investment decision-making process—a role that revealed itself in a recent McKinsey Global Survey. Most executives, the survey found, believe that their companies are too stingy, especially for investments expensed immediately through the income statement and not capitalized over the longer term. Indeed, about two-thirds of the respondents said that their companies underinvest in product development, and more than half that they underinvest in sales and marketing and in financing start-ups for new products or new markets. Bypassed opportunities aren’t just a missed opportunity for individual companies: the investment dearth hurts whole economies and job creation efforts as well.

The article provides a useful examination of biases in decision making. Many managers would concur that a million dollars lost on a bad investment in the recent past would tighten the finances of a company much more than a million dollars won would relax the constraint. This may be especially so in a period when creditors are deleveraging and equity holders are quite wary about bad news.

The McKinsey piece reminds us that a project is not just the Power Point slides and the numbers in a spreadsheet, but what these are in the eye of the beholder.  But how does that relate to the global picture of corporate cash hoards? It’s one thing to be humble about the quality of decision making and the biases that affect it. It’s an entirely other thing to connect those biases to the very large aggregate economic fluctuations in the global economy, including the cash that companies seem to think it is prudent to husband very carefully right now. When did prudence became a bias?

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