Ali’s blog

Mostly quant stuff with occasional digressions

A differing point of view

Posted by alifinmath on February 13, 2008

Businessmen on both sides of the pond seem to be more sanguine than economists, as reported by the FT:

In recent months, as a litany of poor data, tales of woe from the financial sector and reports of belt-tightening consumers prompted expert after expert to predict the first US recession in almost a decade, businesses have begged to differ.

Such protestations of optimism by American and European captains of industry raise the issue of whether companies’ desire to capitalise on the last leg of the business cycle will leave them blindsided if a slowdown does arrive. As US economic health deteriorates, the question for chief executives and investors is: can corporate leaders ensure their companies do not lose revenues and customers by retrenching too soon, while at the same time preparing contingency plans for the possibly leaner years ahead?

To many experts, the confident statements coming from American boardrooms ring increasingly hollow. The prospects of a US recession have grown significantly over the past fortnight, as key indicators on employment and business sentiment disappointed economists and Wall Street investors.

Students of past downturns argue that the gap between economists’ pessimism and business confidence is due to a combination of timing and psychology. First, different companies perceive recessions differently, because economic downturns and individual industries’ business cycles are not synchronised. In addition, experience suggests that as the threat of a downturn increases, corporate leaders tend to understate it, in an attempt to maintain morale among staff, customers and investors. When Bain, the management consultancy, looked at the behaviour of 377 of the largest US companies in 1981-2001, it found the same overconfident demeanour displayed by many chief executives today.

“As evidence gathers that a downturn is likely, executives often continue to radiate confidence – and even clairvoyance – about the future. They don’t want to frighten the troops, which will only make matters worse,” say the Bain authors in the Harvard Business Review. “Our research shows that most executives are likely to be overly optimistic in the face of an approaching downturn. Some will contend that their industries are safe, period. Others believe that their own company’s ability to weather a downturn is superior to that of competitors.”

Yet executives’ fighting talk cannot be dismissed as a clever psychological ruse, hubris or even plain old wishful thinking. In today’s globalised economy, a number say their company really can cushion the impact of a domestic downturn, by relying on overseas operations…. It is no coincidence that some of the more optimistic statements have come from industrial companies that have placed bets on fast-growing overseas markets.

Critics charge that the positive talk coming out of America’s boardrooms is in danger of obscuring the worsening reality, thus preventing companies from planning for a downturn. Indeed, evidence from the last recession six years ago suggests that far too many executives insist on seeing the world through rose-tinted glasses.

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