Institutional imperative – the good, bad, and ugly

Institutional imperative

In many articles, I have mentioned the so-called Institutional Imperative proposed by Buffett (also translated as institutional compulsion by many people in Taiwan). This article will talk about this, which can be used to explain common problems in many enterprises. And the root cause of the unreasonable phenomenon.

Other kids have it, I have to have it too

In 1990 Berkshire Hathaway shareholders letter, Buffett defined “institutional imperative:” the tendency of executives to mindlessly imitate the behavior of their peers, no matter how foolish it may be to do so. In 1989 Berkshire Hathaway shareholders letter, Buffett took several examples of institutional imperative as below:

  • As if governed by Newton’s First Law of Motion, an institution will resist any change in its current direction.
  • Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds.
  • Any business craving of the leader, however foolish, will be quickly supported by detailed rate‐of‐return and strategic studies prepared by his troops.
  • The behavior of peer companies, whether they are expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated.

These are common problems of companies. They like to compare with each other and spend a lot of money on inefficient mergers and acquisitions–just as a child would say to his mother: Other children have it, so I have to have it. That’s why I wrote a blog post, “Why most mergers and acquisitions end in failure?

Management negligence, covering up each other

The members of the corporate management team perform their duties in good name, but whether they are the board of directors, supervisors, chief financial officer, chief technology officer, and a bunch of vice presidents with different names; to put it bluntly, for most companies, they are all the guards of the company’s chief executive. They are just high-paying guards hired by the chief executive and the company. In a more serious way of expression, they are all a group of raccoons and a community of interests. The interests of these people are linked together!

Have you ever seen any major fraud cases that were uncovered spontaneously or voluntarily within the company? It was always reported by a departing employee or an internal whistleblower. The reason couldn’t be simpler — because after leaving the company, there is no longer a stakeholder and no internal pressure. This is also why once someone reveals the company’s shortcomings, the company will do everything they can to suppress it and be forced to resign. All companies will also prepare legal provisions with unequal weapons, forcing all employees who have resigned or transferred to sign unequal documents, in order to prepare employees to use legal provisions to force employees to stay silent after they leave.

A best example

Citigroup CEO, Chuck Prince, at the height of the mortgage and leverage tsunami of the mid-2000s, famously said “As long as the music is playing, you’ve got to get up and dance.” Prince was transfixed by the lure of conventional wisdom, by the institutional imperative, and he and his shareholders would soon dance off the cliff as the company’s stock plunged from a 2007 high of $40 to less than $3 in early 2009 (it ever dropped to $1 dollar during these period, closed to delisting standard). During a period of horrendous market and industry performance, Prince managed to underperform both the S&P and his peers.

Bureaucratic or big company disease

Most people like to use the term law of large numbers, but in fact it is not so simple; if we use bureaucratic or large company disease to describe it, it will be more appropriate. This phenomenon is mainly a necessary evil, because as companies and organizations become larger, there will be more classes and slower response, because all big and small things must go through the entire bureaucratic organization to operate ─ ─ whether it is positive or negative. After a long time, it will become the so-called deep-rooted corporate culture; because it is formed over the years, it will be very difficult to make a slight change.

The culprit that stifles creativity

This is the fundamental reason why all listed companies, without exception, must continue to conduct mergers and acquisitions to obtain new ideas. Because of new ideas, good ideas, motives, etc. are filtered out in layers of the bureaucracy. You can also say that this is because of the necessary evils that big companies will definitely cause. Except for this, the bureaucracy, in order to block the future of others, everyone in the company will inevitably resort to misunderstandings and suppress the affiliation under the organization. This is the evil of human nature and cannot be avoided.

What impact will it have?

The impact is great, Buffett once said two paragraphs:

  • If you find a cockroach in the kitchen, there will definitely not be one cockroach: In 1989 Berkshire Hathaway shareholders letter, he wrote “beware of companies displaying weak accounting. If a company still does not expense options, or if its pension assumptions are fanciful, watch out. When managements take the low road in aspects that are visible, it is likely they are following a similar path behind the scenes. There is seldom just one cockroach in the kitchen.”
  • When a well-known industry manager meets a notorious company, it is the manager, not the company, who is usually changed. In 1989 Berkshire Hathaway shareholders letter, he wrote “I’ve said many times that when a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”
Institutional imperative
credit: Flickr

Concluding remarks

Winston Churchill’s famous saying repeatedly quoted by Buffett: “You shape your houses and then your houses shape you.”

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