In February 2009, the Queen asked a professor at London School of Economics about financial crises, which has now become the question of 2009, at the cost of a few trillion dollars and millions of job losses, “If these things were so large, how come everyone missed them?”

Why was the elephant in the room not visible to anyone? Here, though, we change the question somewhat and ask: even if the companies could have seen the elephant in their boardroom, what would they have done differently?

Consider the corporate response to the recession hitting the auto industry in the UK. The decisions taken include extending the 2008 Christmas shut down (Aston Martin, GM); layoffs (Aston Martin, Bentley, Jaguar Land Rover, Mini, Nissan, Toyota); temporary closure of plants (Honda, GM, Jaguar, Mini, Nissan, Toyota), reduced number of working days in a week (almost all companies); and salary cuts (Honda). These are tough business decisions.

Would the managements of these companies have taken these decisions two years ago if they knew the recession was going to be this bad?

If you asked a management expert the answer would be ‘yes’ the companies would have taken these decisions to stay afloat by becoming leaner and fitter. Tough times require tough decisions, will be the logic forwarded.

But do businesses really behave like that? Do they behave ‘rationally’ when downside risks, perceived or real, are recognised? The answer is ‘it depends’.

Depends - but on what?

First the management will consider how tough decisions will be responded to in the market?

Consider a situation where a board of directors of a company comes to a view that, as a result of certain developments beyond their control, there will be significant negative impact on sales two years down the line. Suppose the appropriate response by management is thought to be reducing costs by making some employees redundant. Will they do it?

They would weigh the impact of announcing such decisions on the share price of the company. If company is planning to raise funds in short term after such announcement they would worry about impact on credit ratings, and so on. They would weigh the possible trade union criticism and publicity liability it may generate.

Consider a chief executive retiring in next six months and due to realise benefits of stock options, will there be incentive to make decisions which may be good for the company in two years time but will push the share prices down now?

Therefore, although the board might successfully identify the risk, they may end up postponing the tough decision.

Second, there is research evidence that firms that have been successful for considerable length of time do not respond well to emerging threats. They suffer from ‘strategic persistence’ syndrome. Successful airline and trucking companies in the US continued with old methods even after radical changes to their environment, including the deregulation of airlines (1978) and trucking (1980). They experienced poor performance over the five years following deregulation.

So past success breeds the view that old tricks will continue to deliver better performance. Sadly, evidence is to the contrary. This ‘strategic persistence’ could thus stop the managements from doing the right thing even if they knew two years ago about the severity of current recession.

Third, some managers may just like the status quo and believe in the maxim if it ain’t broke don’t fixit.

Fourth, one may ask would the central banks have reduced interest rates and eased money supply two years ago, if they had seen the recession coming?

My answer is NO. The monetary policy as practised is reactionary in nature. It is used to reduce the supply of money when inflation is increasing (after an event which has already occurred) and to increase the supply of money to boost demand (in the recession, as now - again, after the event has occurred). This macroeconomics axiom of being reactionary rather than proactive would therefore have prevented the central bankers from acting during the ‘normal times’ of two years ago, even if they saw the recession coming.

Knowing the future results in one response - experiencing the present may result in another.

Find out more

The Paradox of Success: An Archival and a Laboratory Study of Strategic Persistence Following Radical Environmental Change by Pino G Audia, Edwin A Locke and Ken G Smith from The Academy of Management Journal, Vol 43 (5) October 2000 features the research on strategic persistence.

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About the author

Devendra Kodwani is Lecturer in Finance at the OU Business School. His research interests include the economic regulation of utilities and he has written several papers on privatisation and regulation.

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