Wednesday, May 16, 2012

Corporate Disasters and the Information Disincentive

Imagine a hypothetical corporate executive in charge of something that goes terribly wrong. I don’t mean JPMorgan CEO Jamie Dimon, who squeaked past a sort of confidence vote days after disclosing a trading loss of $2 billion or more, but a hypothetical executive in a vaguely similar situation. What are an executive’s incentives when everything goes wrong?

An executive wants to do the same thing as anyone else on a salary: to keep his job. This is especially true of top CEOs, who may earn as much in a day as some workers make in a year. If their strategy has turned into a disaster and they know they will be fired, their key objective is to delay the inevitable in order to keep drawing a salary for a few more days.

Imagine that you were being paid $10,000 a day and had just made a mistake that put the future of your company in doubt, but no one understood what had happened yet. You might even draft a letter of resignation, but how could you ever send it, knowing that you could collect another $10,000 by putting off that action until tomorrow?

This also means that executives in a crisis situation have a stronger incentive to contain problems than to solve them. For the CEO, it is especially important to keep the facts of the situation hidden from the board of directors. For other executives, it may be just as important to keep the CEO from finding out all the details of what is going on. For ordinary employees in possession of information that might indicate bankruptcy for the corporation, there is a similar incentive to keep that information under wraps just long enough to dust off the resume and get a new job.

The same salary that creates the incentive to work also creates a disincentive to disclose disasters. As a result, when financial disaster strikes a corporation, especially if it was preceded by an executive or any employee making any kind of decision, it is almost impossible to determine what actually happened. No one wants to get caught fabricating information, of course, but when something has gone terribly wrong, there is a strong incentive to shade, obfuscate, and delay, and in the already confusing environment of the corporation, that is usually all it takes.