Arnold Kling  

Face-Saving and the Business Cycle

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From a new paper by Steven R. Grenadier, Andrey Malenko, and Ilya A. Strabulaev.

When decision makers face the unappealing task of revealing unsuccessful outcomes that impact their reputations, delay may be their first instinct.1 Delay becomes even more enticing if they can wait for industry-wide downturns in order to hide individual failings and instead "blend in with the crowd," by liquidating their projects strategically when many other projects have to be terminated.

This sort of just-so story, if you can buy it, would help the PSST model. One of the problems with PSST is explaining why there is a sudden imbalance between expanding and contracting sectors. I tend to suspect that there are reasons to cancel projects at the same time that other firms are canceling projects. Moreover, since so many Garett Jones workers are engaged in projects, this would cause a rise in unemployment.

The idea of the paper is that firms accumulate bad projects during a boom. They hold onto them in order to--as I would put it--save face. When someone signals the end of a boom (for example, by coming to Congress with hurried legislation to bail out banks), it becomes ok to kill off the bad projects.

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CATEGORIES: Macroeconomics

COMMENTS (7 to date)
david writes:

I remember when once upon a time it was the socialists saying things like this and then the neoclassicals would respond about bills on the sidewalk.

mdb writes:

Layoffs, from experience, happen in a downturn both due to business slowing down and it is a great way to eliminate poor performers without fear of a lawsuit. There could probably be thousands of reasons for everyone dump at once - I could see contracts as barrier to trimming during the boom and on and on.

Costard writes:

Liquidating often means selling, and it's questionable whether anyone can save face by unloading assets at the worst possible moment. In any event it is valuations that drive a boom, not earnings, and at such times "success" takes on strange meanings. Imprudent decisions are applauded; blind risk is rewarded. But so what? Money is being made, the future is uncertain, and when there is food on the table -- you eat.

Glen Smith writes:

Reminds me of the story about the condemned prisoner who offers to teach the king's horse to sing. The king may die or the horse may learn to sing but at least the prisoner got a few more years to plan his escape.

Foobarista writes:

One other element is there's often senior management turnover at the start of a "bust". New CEOs and other new senior management will typically have a mandate to cut costs and restructure.

Josh writes:

add to that the accumulation bad workers. middle managers want to maximize the number of workers they are managing, and no one likes to fire. in a bust they are forced to pick and choose.

bryan willman writes:

this would fit well with limits of management bandwidth.

when things are going well all attention will be focused on "get more"

when conditions go bad people will be forced to "get small"

also, laying people off in a downturn reduces the hazard that your smart but mismanaged people will go help a competitor

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