For some reason, the saga unfolding around Sir Fred Goodwin’s pension revelations last week made a connection in my brain with distant memories of economics lectures.  The lecture in question was on the “behavioural theory of the firm”, taken from a book of the same name by Richard Cyert and James March.  Before this book was written in the sixties, the main theory of the firm in economics circles was that of “transaction costs”, which says that the reason businesses exist is that individuals find themselves trading at a sufficient volume for it to stop making sense to work independently; trading as a single entity saves everyone time and money, so that’s what everyone does.  This is the sort of theory that economists love – transaction costs can be measured and modelled, because you can put numbers against them.  The behavioural theory, on the other hand, says that actually firms exist and behave for a set of very non-rational reasons that can be hard to quantify.  To understand why firms act in certain ways, you have to understand the underlying behavioural drivers of the people involved.  Cyert and March suggested, for example, that while the owners of a business would typically be more interested in longer term profit, the managers would be more interested in shorter term growth.

This is where Sir Fred comes in, as his behaviour since he took over at RBS in 2001 would make him a fitting poster boy for the behavioural theory, and his decision to hang onto his enhanced pension pot has put his character into the public spotlight in a way that most executives will never experience.  Former colleagues have given us insights into the personality and behaviour of a man who drove one of the most rapid and aggressive expansions of a financial institution ever seen.  To put it politely, it doesn’t sound like Sir Fred was suffering from any ego-related problems during that period.

Now it’s been a long time since I studied the “behavioural theory” at business school, and I must confess that I’ve never looked in detail at the original source material, but the question that struck me last week is this:  Isn’t it a bit odd that we even have something called a “behavioural theory” to describe this kind of thing?  Doesn’t it all seem incredibly like common sense?  Ego-driven personalities in charge of organisations are surely going to find ways to justify aggressive business expansion just as much as similar personalities in previous centuries justified military expansion.  Everyone who works in an organisation knows this, and it’s visible at every level, not just the top.  Fiefdoms tend to emerge around egos, not rational process boundaries, and most people can see from how rapidly certain individuals’ fiefdoms grow exactly who is going to make it to the top.

Appending the word “theory”, though, brings the whole thing back into the comfortable territory of scientific language, which is where economists like it to be.

And that’s why I think the behavioural theory is a useful parable for organisational life as a whole.  Because we live in a culture where legitimacy is bound up in what is scientific and rational, we find it really hard to deal with things that we know are real but don’t reduce easily to numbers.  Everyone might know from experience who the best and worst performers in a firm are, but decisions still have to defer to the outcomes of the performance management regime, because we have no way of dealing with things that aren’t measured.  Everyone might know that a plan is never going to work, but when confronted by a dictatorial boss, they can’t rely on their intuition because it isn’t backed up by “hard” analysis.  Everyone might know that the real reason a board member stepped down had nothing to do with their personal life, and that the financials are going to suffer as a result, but how do you quantify executive politics?

The current financial crisis actually isn’t too difficult to model and understand rationally, as is nicely demonstrated by Jonathan Jarvis’ visualisation (see below).  What the visual telling of the crisis highlights is that rational theory and modelling can’t stop humans doing stupid things.

There’s a deeper problem though, which is this:  We lack an organisational language for discussing things that don’t reduce to numbers.  Information that is quantifiable becomes “hard”, a metaphor that equates tangibility with reality – you can see and touch hard things, whereas feelings and intuition are “soft”, not to be trusted.  The message is this:  If you can’t put a number on it, then it ain’t real, and should be left outside the meeting room door thankyou very much.

And so we insist on trying to squeeze everything into models with absurd rational names like “behavioural theory”.  I like to think that this is just a hangover of industrialisation, and that with time (and probably a few more crises) a new paradigm will emerge.  Let’s hope it’s sooner rather than later.

One closing thought:  If there’s a danger in thinking that the only fact is a “hard” fact, there’s an equal danger in the opposite direction.  The problem is not that we are using rational, quantitative “facts” when we should be using experiential, intuitive “facts”.  The problem is that we find it necessary to split the two apart in the first place.

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