In his book, The Halo Effect: … and the Eight Other Business Delusions That Deceive Managers, author Phil Rosenzweig discusses the following 8 delusions about success:
1. Halo Effect: Tendency to look at a company’s overall performance and make attributions about its culture, leadership, values, and more.
2. Correlation and Causality: Two things may be correlated, but we may not know which one causes which.
3. Single Explanations: Many studies show that a particular factor leads to improved performance. But since many of these factors are highly correlated, the effect of each one is usually less than suggested.
4. Connecting the Winning Dots: If we pick a number of successful companies and search for what they have in common, we’ll never isolate the reasons for their success, because we have no way of comparing them with less successful companies.
5. Rigorous Research: If the data aren’t of good quality, the data size and research methodology don’t matter.
6. Lasting Success: Almost all high-performing companies regress over time. The promise of a blueprint for lasting success is attractive but unrealistic.
7. Absolute Performance: Company performance is relative, not absolute. A company can improve and fall further behind its rivals at the same time.
8. The Wrong End of the Stick: It may be true that successful companies often pursued highly focused strategies, but highly focused strategies do not necessarily lead to success.
9. Organizational Physics: Company performance doesn’t obey immutable laws of nature and can’t be predicted with the accuracy of science – despite our desire for certainty and order.A good risk manager will notice that all 8 of these delusions have a flip side that applies to risk analysis and risk management.
a. Bad results <> Bad Culture – there are may possible reasons for poor results. Culture is one possible reason for bad results, but by far not the only one.
b. Causation and Correlation – actually this one need not be flipped. Correlation is the most misunderstood statistic. Risk managers would do well to study and understand what valuable and reliable uses that there are for correlation calculations. They are very likely to find few.
c. Single explanations – are sometimes completely wrong (see c. above), they can be the most important of several causes, they can be the correct and only reason for a loss, or a correct but secondary reason. Scapegoating is a process of identifying a single explanation and quickly moving on. Often without much effort to determine which of the four possibilities above applies to the scapegoat. Scapegoats are sometimes chosen that make the loss event appear to be non-repeatable, therefore requiring no further remedial action.
d. Barn door solutions – looking backwards and finding the activities that seemed to lead to the worst losses at the companies that failed can provide valuable insights or it can lead to barn door solutions that fix past problems but have no impact on future situations.
e. Data Quality – same exact issue applies to loss analysis. GIGO
f. Regression to the mean – may be how you describe what happens to great performing companies, but for most firms, entropy is the force that they need to be worried about. A firm does not need to sport excellent performance to experience deteriorating results.
g. Concentration risk – should be what a risk manager sees when strategy is too highly concentrated.
h. Uncertainty prevails – precision does not automatically come from expensive and complicated models.