I have a recent Op Ed in the International Business Times discussing Business Schools and the Financial Crisis. In the article (see Knowing What and How, Without Wondering Why) I address what I see as some curricular challenges that Business Schools will face in the wake of the crisis.

While I believe that the criticisms of Business Schools are largely overdone, I argued that we need to encourage students to think more deeply about the concepts, tools, and formulae we present in class, rather than simply seek to apply them. Moreover, I have advocated for a curricular approach that favors analytical skills over simple technical skills. I wrote:

Business schools have been criticized for espousing and promulgating models of individual behavior based on economic self-interest. They have been blamed for failing to impart ethics; emphasizing shareholder profit maximization above all else; encouraging short-term profitability at the expense of long-term organizational health; and for helping design and create the exotic financial instruments that helped get us into this mess.

I agree that the economic system is structured in a way that sometimes provides management an incentive to enrich themselves at the expense of shareholders, or shareholders at the expense of other stakeholders. However, I believe that the criticism of business schools as encouraging individuals to act in a self-interested, even opportunistic, manner is largely overblown. Our teaching in that respect is less normative than descriptive. We seek to describe human behavior (which tends toward self-interest) rather than encourage our students to act in such a fashion. As evidence, look no further than the financial crises that preceded the current one. Many of those occurred before the advent of business schools, yet share some of the same self-interested human behaviors at their core.

This does not mean that business schools are beyond reproach. It is true that the development of some financial derivative products have been based on models that have come out of business schools. Moreover, although we have long understood the consequences of self-interested behavior, we have not been very effective in creating tools to keep such behavior in check.

However, our greatest challenge as an enterprise comes not from the development of complex models, but in the manner in we teach students to use them. That is, we are quite good at teaching students what to do and how to do it. However, we do not prepare them well enough to ask tough questions about why we are doing it in the first place, and why it matters in the grand scheme of things.

We produce skilled and proficient technicians who know how to calculate the net present value of a revenue stream. We teach students how to accurately value assets and price risk given existing formulae. We explain how firms can streamline operations in an effort to create optimal organizational structures.

Yet for all those positive contributions, we do a poor job when it comes to questioning the validity of the assumptions underlying the pricing models that we teach, describing the boundary conditions of such models, and integrating across disciplinary boundaries to create a greater understanding (and appreciation) for how individual parts interrelate to affect the whole.

To read the Op Ed in its entirety, please visit Knowing What and How, Without Wondering Why.

Although I wrote the piece with Business Schools in mind, I do not think that it is purely a Business School phenomenon. I think the issue generalizes fairly well to a broad class of managerial failures that ocurred during the crisis. That is, managers perfected execution, but failed when it came to analysis. It reminds me of the now infamous Chuck Prince (then CEO of Citigroup) quote, “As long as the music is playing, you’ve got to get up and dance. We’re still dancing.”

Too bad most kept dancing, without wondering whether dancing was the right thing to be doing.

In previous posts (see Chrysler Still Needs a Miracle or Chrysler/Fiat Update) I suggested that the Fiat/Chrysler deal looked increasingly like a longshot. Fiat was asking for deep concessions from both the auto union and Chrysler’s creditors, and it seemed unlikely that Fiat was going to receive those concessions.

But over the past few days, the Obama Administration, the auto union, and Chrysler’s creditors seemed to have come to some sort of understanding (see Treasury Close to Deal with Chrysler Creditors, Chrysler Reaches Agreement with UAW, and UAW Gets 55%).

Hallelujah??

Maybe, but not so fast. Several issues remain:

1. Creditors must agree to the debt cancellation.

According to the NY Times:

Chrysler has about $6.9 billion in secured debt owned by big banks like Citigroup and JPMorgan Chase and a group of hedge funds. Under the proposal, all of the debt would be canceled in exchange for $2 billion in cash…

The Treasury drew up the latest proposal in consultation with Chrysler’s biggest secured creditors, which hold about 70 percent of the company’s secured debt. It requires approval by almost all of the secured lenders. That could be difficult as some lenders, including several hedge funds, may hold their ground and reject it.

2. The issue of pay for union workers must still be resolved. Although Chrysler, the federal government, and the union have come to terms with respect to pension and benefits, my understanding is that they have not yet reached a meaningful agreement to reduce wages. Just how important are wage reductions to Fiat? That remains to be seen. According to the Michigan Messenger:

The new agreement does not cut wages, but it does apparently reduce Chrysler’s commitment to pay into the UAW-run retiree health care fund.

3. According to the latest accord, the auto union will get a 55% equity share in Chrysler. The US government will get a 10% share. Fiat would get a 20% share. Where does the other 15% go? Is this 15% set aside for Fiat depending upon whether it meets performance goals? Will this 15%, or a portion of it, get doled out to Chrysler’s creditors? This was not entirely clear to me.

4. Ultimately, Fiat needs to agree to be party to the alliance. Until that happens, there is no deal. Time will tell if these concessions are enough to convince Fiat that the deal is worthwhile.

Nevertheless, given the concessions that all parties have made to help Chrysler avert bankruptcy, a Fiat alliance seems far more likely today than it did as little as one week ago. Chrysler is no longer looking for a miracle. Perhaps now just a random act of kindness.

But assuming a Fiat/Chrysler deal goes through, the question then becomes: Is this the best outcome for Fiat, Chrysler, and the auto industry? It is not entirely clear. The global auto industry continues to be plagued by massive overcapacity. Keeping a weak competitor around will certainly not resolve systemic overcapacity.

For Fiat, it might be a bit premature to re-enter the U.S. market (the most competitive auto market in the world) and sign on for a complicated global expansion/integration (see Fiasco for Fiat?). Let’s also not forget that Fiat is a firm that, as little as two years ago, was on the verge of bankruptcy itself.

Finally, for Chrysler, it is not clear that its products (even with technology infusions from Fiat) can improve quickly enough for it to once again become a profitable enterprise. For this reason, and as I’ve mentioned before, Chrysler likely needs more than Fiat and an additional $6 Billion infusion from the federal government to survive.

So even if the deal goes through this week, it is entirely possible that Chrysler might end up right back in the same place – on the verge of bankruptcy.

And we wait…

The big story today is the Obama administration’s decisions regarding GM and Chrysler aid (see US Lays Down Terms for Bailout). I won’t spend time re-hashing the specifics; instead, I will provide commentary on the plan as it has been advanced, assuming you already know the specifics.

Overall, I think this plan represents a sensible approach. It recognizes that there is substantial heterogeneity across GM and Chrysler. Their importance to the broader economy differs. GM is obviously the more systemically important firm of the two. Moreover, the two are not on equal footing with respect to future prospects. GM’s product portfolio moving forward is far superior. For these reasons, I have been an advocate of treating GM and Chrysler differently (see Pre-Packaged Bankruptcy, Preventing Moral Hazard, and Aid for Chrysler? Just say No! for details).

Kudos to the auto task force for recognizing this and responding accordingly. As a result, the Obama administration has committed to seeing GM through this crisis. Chrysler, by contrast, is on its own.

The Obama administration will provide additional aid for GM, and has committed to an out-of-court restructuring, provided GM receives substantial concessions from its creditors and its union. In the absence of a meaningful agreement with the UAW and bondholders, at the very least, the US government has pre-committed to act as GM’s DIP financier in bankruptcy, and guarantee its existence through the restructuring process (see Could GM Survive Bankruptcy?). The threat of bankruptcy for GM (hopefully a credible one) should be enough to elicit cooperation from the bondholders and the UAW.

With respect to Chrysler, this is the beginning of the end. The administration has told Chrysler that it has 30 days to strike a deal with Fiat or else it will not receive any additional public funds. This creates a dilemma for Chrysler. It needs Fiat to survive, but Fiat needs the US government to commit a significant amount of capital before it agrees to any deal. After all, Fiat does not intend to inject capital into Chrysler (see Fiasco for Fiat and Chrysler and Fiat Revisited). What is clear is that Chrysler would require significantly more to survive than the $6 Billion that the government has promised in the event that they strike a deal with Fiat (see GM, Chrysler Need More Aid than Requested). Fiat knows that. Moreover, the likelihood that the US government will continue to throw money at Chrysler (in excess of the $6 Billion promised), even if they strike a deal with Fiat, is remote. Fiat knows that too.

So the writing is on the wall. Chrysler is likely finished.

What is unclear to me from the plan as it has thus far been outlined, is whether the US government acts as the DIP financier when Chrysler goes bankrupt, or whether it allows Chrysler to be liquidated. Obama seems to be hinting (as I listen in real time) that the government will act as DIP financier to Chrysler, …but I am skeptical.

Irrespective of whether the US government acts as Chrysler’s DIP financier, Chrysler will serve as a lesson to GM, its creditors, and its bondholders union. Allowing Chrysler to go bankrupt should be enough to wake up GM’s creditors and bondholders union to the reality that US taxpayers will not support them indefinitely.

As a first shot over the bow, the Obama administration began by ousting Rick Wagoner.

UPDATE @ 11:30am

One last point, some have been asking why not just impose bankruptcy now (at the very least for Chrysler) if that will be the endgame anyway. I think the answer to this question lies in the shock that would have reverberated throughout the market. A sudden bankruptcy would have caused panic among stakeholders of all sorts. At this point, bankruptcy for Chrysler is all but assured. Bankruptcy for GM is a real possibility (perhaps 50/50). So the point of today’s action (stopping just short of imposing bankruptcy) is to forewarn market participants. Given this information, it would be prudent for those who have a stake in this outcome to get their affairs in order.

I’ve had a series of interesting conversations with thoughtful, articulate, and intelligent academics who span disciplinary boundaries (finance, economics, sociology, and psychology) about what the future of the field of financial economics should/will/might look like. In light of the financial crisis, this has been a popular topic of conversation.

There have been two recurring themes:

1. Are the fundamental assumptions about human behavior associated with the dominant paradigm in financial economics appropriate?
2. Is shareholder wealth maximization the appropriate objective function?

With respect to the former, I have been engaged in conversations with folks who echo some of Willem Buiter’s concerns. In a brilliant blog post (see State of the Art Uselessness) Buiter contends:

The most influential…theorists all worked in what economists call a ‘complete markets paradigm’. In a world where there are markets for contingent claims trading that span all possible states of nature (all possible contingencies and outcomes), and in which intertemporal budget constraints are always satisfied by assumption, default, bankruptcy and insolvency are impossible. As a result, illiquidity – both funding illiquidity and market illiquidity – are also impossible…

[The] complete markets…theories not only did not allow questions about insolvency and illiquidity to be answered.  They did not allow such questions to be asked.

It is clear that, when searching for an appropriate simplification to address the intractable mess of modern market economies, the starting point of ‘no markets’…is a much better one than that of ‘complete markets’.

My Comment: One of the things that drew me to the field of strategy in the first place (versus finance or economics) is that we start with a baseline assumption that markets are incomplete, and markets break down. But back to Buiter:

In…approaches to monetary theory…the strongest version of the efficient markets hypothesis (EMH) was maintained.  This is the hypothesis that asset prices aggregate and fully reflect all relevant fundamental information, and thus provide the proper signals for resource allocation.

My Comment: I would go one step further and suggest that associated with the EMH-dominated financial economics view is an assumption that there is a true, objective, underlying fundamental price for an asset. We might deviate from that price in the short run; but in the long run, the fundamental price will prevail. Buiter alludes to that as well, although he does not come right out and say it:

The efficient markets hypothesis assumes that there is a friendly auctioneer at the end of time – a God-like father figure – who makes sure that nothing untoward happens with long-term price expectations or (in a complete markets model) with the present discounted value of terminal asset stocks or financial wealth.

What this shows, not for the first time, is that models of the economy that incorporate the EMH…are not models of decentralised market economies, but models of a centrally planned economy.

My Comment: Interesting, so in treating human behavior as governed by the tenets of homo economicus, our agentic models actually obviate agency.

In one of the conversations that I had with a prominent game theorist and a well-regarded entrepreneurship scholar, some of these issues came up. For example, we discussed the importance of incorporating the varying belief-structures of the participants in a market into the value equation. The participants themselves may have such varying beliefs about the market that, in effect, they might actually be playing different games governed by different rules. In such a circumstance it might be better to analytically treat assets as not having an intrinsic (fundamental) value, but rather, to treat the “value” of the assets as contingent upon participants’ subjective beliefs – i.e., the value of the asset is only worth what the next guy is willing to pay for it.

With respect to the second issue (shareholder wealth maximization), I have had more than a few conversations with prominent economists and sociologists about the social implications of a dogmatic adherence to models of shareholder wealth maximization. Unfortunately, if incentives are structured such that they exclusively reward shareholders (and in some cases, managers) at the expense of other constituents (stakeholders), this could lead to suboptimal social outcomes.

As an alternative, a group of scholars in strategy have offered a Stakeholder view of the firm. Stakeholder Theory, most closely associated with Edward Freeman (see wikipedia for a brief overview), suggests that firms ought to incorporate the interests of various stakeholders into their decision calculus, and not simply what’s best for shareholders. They argue that this would result in a firm that generates value not just for shareholders, but also for stakeholders (suppliers, customers, employees, communities, etc.). It shifts the maximization problem from one of individual utility maximization (in the interest of shareholders) toward one of joint utility maximization (balancing the disparate concerns of various interested parties).

Shareholder maximization vs. Stakeholder maximization has been a topic of considerable debate in the strategy literature over the past 15-20 years. And given the social costs of this financial crisis, I would not be surprised to see the Stakeholder view gain more traction in the years to come.

All told, I think the field of financial economics would be well served to be more inclusive when it comes to behavioral approaches to human behavior (whether from economics or psychology) and behavioral views of the firm (whether informed by psychology, sociology, or economics). Thankfully, not only are both processes well underway, but in some quarters, they have been for some time.

As I mentioned several weeks ago (see Visit to the FT), I recently spent some time with Adam Jones, author of the FT Management Blog, and Business Education Editor at the Financial Times. Adam conducted a brief interview in which we discussed Business Schools, and job prospects for Business School graduates. The interview appeared in the on-line version of the Financial Times 2009 Business School Rankings.

Below is a brief overview of my comments.

On applications:

• applications to full-time MBA programs near all-time highs
• applications to Ph.D. programs near all-time highs
• applications to corporate-sponsored, and executive, programs way down

On job prospects:

• the current job market (for 2009 graduates) is extremely challenging
• the job market for 2010 graduates will likely be worse
• the job market for 2011 graduates is uncertain but likely difficult, as the post-recession recovery will be slow

On majors, course selection, and job opportunities for finance students:

• finance students are becoming more flexible (looking in consulting, general management, accounting, and other fields)
• finance students are looking in non-traditional markets (Dubai, Abu Dhabi, continental Europe, and Asia)
• increasing interest among students in general management courses, and in general management as a major

As promised, a link to the web page with full video is below. Unfortunately, the Financial Times would not allow me to embed the video on my site.

I am currently in London, spending the month as a visiting scholar at the London Business School. Since I have been hanging around town, Adam Jones, author of the FT Management Blog, and Business Education Editor at the Financial Times, invited me in to do an interview about the economic downturn, and how it has been impacting applications to Business Schools, and the job prospects of Business School graduates. The interview is scheduled to be aired on January 26th, concurrent with the release of the 2009 FT Business School Rankings (I will post a link to the rankings and the video when they become available).

Adam and I had a nice discussion. We went over some of the points I raised in my post Crisis for MBA Grads Seeking Jobs, …and more.

Adam began by asking about Business School applications. We discussed the following:

• applications to full-time MBA programs are at an all-time high
• applications to Ph.D. programs are at an all-time high

Both of those effects are to be expected, as business school applications generally run counter-cyclically with the economy. However, I noted that for Business Schools that rely on corporate-sponsored programs (executive MBA, non-degree granting executive programs, and custom executive programs) for a good chunk of their revenue, this downturn will be especially difficult. The outlook for executive programs is particularly grim, as corporations rein in discretionary spending, and demand for such programs experience a sharp decline.

Adam then asked about the job prospects for Business School graduates. I answered:

• the job market has been challenging (to say the least) for graduates of the class of 2009
• as bad as it has been for the class of 2009, unfortunately things are shaping up to be worse (dare I say awful) for graduates from the class of 2010. While economic recovery seems likely sometime in late 2009/early 2010, layoffs continue for some time after recessions officially end. This is because those industries that start coming out of recession do not hire quickly enough to offset losses in the industries that continue to feel the effects of the recession. In addition, even when growth begins again, firms are reluctant to hire at first so as not to expand if there is a reversion to recession (i.e., a double-dip recession). Instead, they prefer to do more with less (asking existing workers to put in more hours, work overtime, etc.).
• the job prospects for 2011 graduates are uncertain, as I expect the post-recession recovery to be a slow one. To me, the immediate growth engine for the U.S. economy moving forward is unclear. I see some potential in alternative energy, nano-technology, and biotech (specifically, genome mapping and its associated applications). However, whether those industries will truly grow fast enough to bring robust growth back to the economy is uncertain. Moreover, although it is likely that the global economy will return to growth in 2011, there is a decent probability (at least in the U.S.) that the recovery will be a jobless one.

We also discussed several other topics. For example,

• Adam asked how finance students were faring given that there had been so many layoffs in the financial sector. To that I responded that my experiences have been that finance students, in particular, were becoming more flexible with respect to the kinds of positions they have been willing to consider. Many are now open to consulting, general management, accounting, and other fields. In addition, I shared some anecdotes about students of mine who had been looking for jobs in non-traditional markets – exploring opportunities in places like Dubai, Abu Dhabi, continental Europe, and Asia. At this point, many are willing to go just about anywhere for gainful employment.
• Adam also asked about the types of electives that students were considering in this environment. I mentioned that I had been noticing an increasing interest general management courses, and in general management as a major.

More to come…

It should come as no surprise that university tuition has been rising at a rate faster than inflation, and faster than income growth. In fact, Tamar Lewin at the New York Times recently published a fascinating article about tuition trends (see Higher Education May Soon Be Unaffordable). She writes:

The rising cost of college — even before the recession — threatens to put higher education out of reach for most Americans, according to the biennial report from the National Center for Public Policy and Higher Education.

Over all, the report found, published college tuition and fees increased 439 percent from 1982 to 2007 while median family income rose 147 percent. Student borrowing has more than doubled in the last decade…

“If we go on this way for another 25 years, we won’t have an affordable system of higher education,” said Patrick M. Callan, president of the center, a nonpartisan organization that promotes access to higher education.

Although I agree with the premise, I am not sure I agree with the inference.

Yes, tuition has been rising at an unsustainable pace. Yes, a university education may be priced higher than the fundamentals will currently bear. Yes, it is a problem that American families have funded tertiary education by relying increasingly on debt (but c’mon, haven’t American families funded much of their recent consumption with debt??).

I agree that the cost of higher education might price some out of the market entirely. However, I do not think the effect will be as large as the author believes. Rather, the cost of higher education, coupled with what I view as a fundamental shift in consumer behavior as a result of the recession, will more likely usher in a shift in consumption versus an end to consumption.

Gone are the days of taking on exorbitant amounts of debt to send children to private institutions with tuition (not including living expenses) of $40,000 per year, or more. Instead, families will increasingly opt  for public universities with tuition in the $10,000-$15,000 range.

For example, families in Texas might start asking tough questions like, “Is the difference in the price between Harvard and the University of Texas really worth the $120,000 difference?” I am not willing to argue that real differences between being educated at a private university and a public university do not exist; however, I am not sure whether those “benefits” (to the extent that they do, in fact, exist) justify the additional premium in all cases. And those considerations are likely to impact the decisions of consumers.

Let’s face it, frugality is here (see Mish on Frugality or BusinessWeek’s The New Age of Frugality). I view this largely as a welcome development. After years of spending well beyond our means, Americans have discovered discipline.

The question for universities (private and public alike) is whether this frugality represents a temporal or structural shift in consumption patterns. In my opinion, the shift toward thrift is likely to persist for some time. If frugality represents a fundamental structural shift in consumer mentality and behavior (as I believe it does), individual universities (private universities especially) would be well served to carefully consider what that might mean for their institution in the coming years, and prepare accordingly.

One thing’s for certain: Frugality is likely to hold tuition increases in check for the foreseeable future.

This summer I wrote about what I saw as a particularly grim job market for the business school graduates of 2009 (see Job Market Update and Job Prospects for B-school Grads). Back then I wrote:

The students who will really, truly feel this recession are the graduates of 2009 (and maybe even the graduates of 2010). I expect the job market moving forward to be abysmal, and for the hiring season of 2008-2009 to largely be a bust.

There is now growing evidence that this is the case (see Crisis Hits the Business Schools). Alison Damast of BusinessWeek writes:

Second-year students…without job offers appear to be in the most precarious position. According to a survey by the umbrella group MBA Career Services Council, about 70% of the 77 schools surveyed said they saw a downturn in full-time recruiting opportunities in financial services in October. Meanwhile, about half of the schools said overall full-time job postings and on-campus recruiting this fall was either flat or down 5% during the same period, with some indicating it has fallen as much as 10%.

In the coming year, the job market for MBAs may begin to bear a striking similarity to the period following the dot-com bust when some banks and consulting firms rescinded or renegotiated job offers they had extended to second-year students. That hasn’t happened this time around—yet.

As bad as that may sound, I think that those are rosy numbers. The worst is yet to come, and this job market will turn out to be far worse than that of the dot-com bust. This economic recession is far deeper and more broad-based than that of 2001-2002. In fact, I have been hearing anecdotally from sources (both internal and external to my university) that while recruiters have continued to visit and interview, there are increasingly fewer and fewer offers.

So I still anticipate an extremely difficult year for MBA grads looking for jobs. And unfortunately, I have had to revise my estimates for the next academic year. It is starting to look like it will be worse for the class of 2010.

I sincerely hope I am wrong.

I was recently informed that my blog has been named one of the “Top 50 Business Professor Blogs” by MBAExplorer.

At first I was flattered. It was a nice gesture, and it certainly feels great to be recognized as one of the top bloggers in the field.

But after thinking it over, I can’t help but wonder – Are there really 50 business professors who have blogs??

So while I thank the MBAExplorer for recognizing this blog, I must conclude that my blog most likely qualifies for the list by default

But seriously, they have compiled a nice list of blogs by business school academics. I encourage you to take a gander at what some of my colleagues have been writing.

I came across the following article in CFO magazine last night (see Ports in a Storm). The article details how applications have been picking up at business schools over the past year, and how such a stylized fact hints at an economic slowdown.

Anyone wanting further proof that the world economy is in trouble need look no further than the nearest business school. Many schools are hailing a bumper year for their full-time Master of Business Administration (MBA) programmes, which are popular with executives looking to hone their moneymaking skills while sitting out a downturn.

…Preliminary figures from the Graduate Management Admission Council (GMAC), an international organisation of business schools, show that 77% of full-time programmes have reported higher demand for places this year.

Applications to full-time MBA programs generally run counter-cyclically with the economy. In good times, fewer folks want to go back to school because there is ample opportunity to make good money, and leaving money on the table can be difficult. In fact, I remember during the dotcom boom that MBA students were dropping out of school in droves to open e-businesses that promised to make them rich. We all know how that turned out.

In bad times, people go back to school not only because their earning potential is lower, but also because many find themselves out of work, and with few alternatives. Going back to school allows students to wait out the economy.

But it would be wrong to look at a boom in applications and assume that it translates into a boon to the bottom-line. Although full-time applications tend to go up during economic downturns, other B-school offerings suffer – e.g., part-time MBA, executive MBA, and executive education programs.

During recessions, businesses reign in discretionary spending. One easy way for businesses to decrease costs is to eliminate spending on educational benefits for employees. Businesses often sponsor candidates for part-time and executive MBA degrees. And corporations are prime clients for custom executive programming. These lines of business (part-time, executive MBA, and exec ed) are generally more profitable for business schools than full-time MBA programs.

I anticipate corporate funding for these programs will dry up.

And although applications were up for most business schools this past year, it is likely that they will continue to increase in the coming years. As the article explains:

Worryingly for those betting on a swift economic recovery, business schools reckon that next year could yield an even bigger crop of applicants.

This does not bode well for our economy.