Back in the early 2000’s, we looked at tax-exempt options for our corporate debt. If we wanted short-term rates, we could issue our bonds in “variable rate demand mode” (or VRDN’s) or in “auction rate mode” (ARS).
At the time there was a slight difference in rates; the auction-rate securities were a little bit more than the VRDN’s. “Why is that?” I asked my friendly banking institution. “Well, there is the risk of a failed auction with the ARS’s, but that has not happened in the past decade”. For more on evaluating decisions based on outcomes, refer to the earlier blog Moccasins.
Now, it is a main tenet in Finance 101 (no matter where you went to school) that we do not get return without taking risk. So investors were taking the risk, in exchange for a higher return, of an auction failing and being stuck with the securities. But hey, that hasn’t really ever happened in recent memory, so how much of a risk can it be?
Fueling this thinking, in a lot of the mid-decade Treasury literature, the industry talked about measuring performance with one of the primary metrics of efficiency and effectiveness touted as how much we were earning on our idle cash balances. Many “portals” sprung up where we could take our pick of hundred of money market funds, generally sorted by yield. So most treasury managers, responding to the incentives and “what gets measured gets done”, would duly pick the highest yielding money-market funds or securities in order to look better on their metrics…and feel good about it.
Hmmm…remember Finance 101? No return without greater risk.
Come 2008-2009, these investors re-learned the lesson the hard way…the money-market funds with the better returns, or the direct investments they made, involved auction rate securities that have been failing ever since, and they still haven’t seen their money.
I know that people hold different opinions about the financial crisis in 2008 – greedy banks, loose regulation, etc. – but I have to say that people thinking they were getting something for nothing was a contributor. What’s that saying – “if it seems too good to be true, it probably is”? Where was that thought as they went through the portal screens with the highest yielding money-market funds?
Part of the reason it was nowhere to be found was the metrics they were subjected to. Nobody wants to be below benchmark!
Every metric, because it incents certain behavior, encourages us to disregard other behaviors. In the case of the financial crisis, it rewarded return while it ignored the risk involved to get it. Bad decision? Maybe, maybe not (see the blog about Moccasins). But don’t be surprised something bad happened, because the risk was plain to see all along in the rates that people were getting. We don’t always get the empty chamber in Russian roulette.
In other cases, by incenting individual performance we encourage others to ignore team performance. In the systems where ratings are forced to a curve or there are targets for each category, we are going to encourage some Machivellian behavior. What better way to ensure I get that “Exceeds Expectations” than to make sure everyone else fails and ends up in “Needs Improvement”?
Can this be managed? Maybe…but maybe not. One of my bosses bosses talked about how our company did not have to worry about undercurrents of dissatisfaction or disagreement because of our strong “open door” policy. I ask you – how many open doors have you passed by where you thought “if I go in and tell them x it will hurt my career or their perception of me”…and kept on walking?
Personal opinion: anyone relying on an “open door” policy to ascertain what is really going on and reassure themselves that all is well with the world is fooling themselves unless backed up by at least 25% of their time being spent re-enforcing it.
So, beware of establishing metrics – we will get what we measure, and we won’t get what we don’t, even if we don’t know it. Don’t let the carrots you bestow let your employees take you down a rabbit hole where you do not want to be.
I would love to hear your thoughts about this view of metrics or your stories on this topic if you have them.
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