"California Scheming" and "How Fastow Helped Enron Fail.

"California Scheming" and "How Fastow Helped Enron Fail.


The Enron scandal illustrates the extent to which the decision-making process can fail. TIME magazine has done an extensive look at the demise of this company and the collateral damage inflicted on stockholders, suppliers, customers, and employees. Navigate to http://www.time.com/time/2002/enron/. There you will find two interesting articles entitled "California Scheming" and "How Fastow Helped Enron Fail. Relate this article to the failure to "Escalation of Commitment and Ethics in Decision Making that you read about in your text. If at first you don't succeed, try, try, again. Then quit. No use being a damn fool about it. ?W. C. Fields In the previous chapters, we examined single decisions and the ways in which judgmental and motivational biases and the framing of information can influence our responses to them. However, many critical managerial decisions concern a series of choices rather than an isolated decision. We are prone to a particular type of bias when approaching decisions serially?namely, a tendency to escalate commitment to our initial decision. This chapter opens with an explanation of the individual tendency to escalate commitment. In the second section, we show how a competitive environment increases the tendency to escalate commitment. The third section provides a taxonomy of explanations for the psychological tendency to escalate and offers recommendations for eliminating nonrational escalation behavior. Consider the following examples of situations that invite escalation: "c You personally decided to hire a new manager to work for you. Although you had expected excellent achievement, early reports suggest that she is not performing as you had hoped. Should you fire her? You have invested a fair amount of time and money in her training, and you wonder if she's just in the process of learning the ropes. You decide to invest in her success a bit longer and provide additional resources to help her achieve. Two months later, her performance is still subpar. Although you have even more reason to "cut your losses, you also have a greater investment in this employee. When should you give up on your "investment? "c You accept a position with a prestigious consulting firm, believing that the job offers an excellent career opportunity in an organization that has room for you to grow. Two years later, you have not progressed as rapidly as you had expected. Anxious to demonstrate your worth to the company, you decide to invest large amounts of unpaid overtime to get ahead. Still you fail to get the recognition you think you deserve. By now, you have been with the organization for several years and would lose numerous benefits, including stock options, if you decide to leave. You are in your late thirties and feel you have invested some of your best years with this company. Do you quit? "c You work for a private equity firm and make a decision to invest $2 million in a start-up venture. You personally argued for this investment against some skeptics in your firm. One year later, the CEO from the start-up appears in your office and says: "I have bad news, and I have good news. The bad news is that the company is running out of cash. Without additional funds, we will definitely go under, and you will lose the $2 million. The good news is that I am quite confident that if you invest another $1 million, we can work out the bugs in our invention and still be a great success. Do you invest the additional $1 million? Although each of these decisions represents a very different situation, they share a number of common elements. In each case, you have to make a decision as a result of a previous decision. You hired the employee. You took the job. You made the investment. In each case, you have invested a great deal of time, effort, and resources in your selected course of action, and now things are not working out as you had hoped. We frequently face similar decisions of varying importance. Should you sink more money into that old wreck of a car? How long should you stay on hold with an airline before hanging up? When the price of a stock that you own goes down, how far should you let it go before selling it? Inertia frequently leads us to continue on our previously selected course of action, or we may feel we have "too much invested to quit. How do you know when to quit? At what point does continuing on the same course of action become irrational? And why, when such behavior becomes irrational, is it so common? These are the central questions of this chapter. Although we are taught from an early age to "try, try again, the fact is that misdirected persistence can lead us to waste a great deal of time, energy, and money. However, directed persistence can lead to commensurate payoffs. The key to making intelligent decisions in dynamic contexts such as those presented above is being able to discriminate between situations in which persistence will pay off and those in which it will not. A variety of authors from different fields have presented ideas relevant to the three hypothetical situations described above, using a number of different terms (such as escalation, entrapment, and persistence) to describe commitment to a previously selected course of action. In this chapter, we define nonrational escalation as the degree to which an individual escalates commitment to a previously selected course of action to a point beyond that which a rational model of decision making would prescribe. Accountants and economists provide insight into how to handle these scenarios. Experts from these areas tell us that in such situations we need to recognize that the time and expenses that we have already invested are "sunk costs. That is, these costs are historical, irrecoverable, and should not be considered in any future course of action. Our reference point for action should be our current state, and we should consider all alternative courses of action by evaluating only the future costs and benefits associated with each alternative. For example, if you are considering whether to quit a doctoral program, it is irrelevant whether it took you six months or four years to get to the point you are at now; the key decision involves the future costs and benefits of exiting versus the future costs and benefits of continuing. Accounting professors teach their students to recognize sunk costs in accounting contexts, yet the decisions of managers trained in accounting suggest that the textbook advice to ignore sunk costs seldom translates to wise solutions to real-world problems. Why is it so hard for managers to truly absorb the sunk-cost concept? In part, because typical training of the concept lacks a clear description of the reasons that we intuitively tend to include sunk costs in our calculations. To eliminate escalatory behavior from our repertoire, we need to identify the existing nonrational behavior within ourselves, "unfreeze that behavioral pattern, and prepare for change. Decision makers who commit themselves to a particular course of action tend to make subsequent decisions that continue that commitment beyond the level suggested by rationality. As a consequence, they often allocate resources in a way that justifies previous commitments, whether or not those initial commitments now appear valid. The following section examines the components of this behavior in more detail.