“It’s present in every profession and in every human being. And it causes perfectly terrible behavior… Human nature, with its version of what I call ‘incentive-caused bias,’ causes this terrible abuse. And many of the people who are doing it you would be glad to have marry into your family compared to what you’re otherwise going to get.” –Charlie Munger
This article is part of a multi-part series on human misjudgment by Phil Ordway, managing principal of Anabatic Investment Partners.
Munger recalled gall-bladder removal surgeries at a community hospital wherein the doctor at fault thought the gall bladder was the source of all medical evil; he was not doing it out of malice or greed.
Other examples included sales pitches by CRE brokers (never in 70 years even one within hailing distance of the truth); cost-plus-percentage-of-cost contracts – a felony for the government to write one, but law firms still have this system; and “people who create things like cash registers, which make misbehavior hard, are some of the effective saints of our civilization…the cash register was a great moral instrument when it was created.”
Update
This tendency was wrapped into the discussion on “Reward and Punishment Superresponse Tendency,” but agency costs probably deserve special attention as a unique sub-segment of this phenomenon.
A stark example came recently when one member of a small team running the family office of a very wealthy, high-profile businessman described his job to me as doing just enough to make sure the head man “barely remembers we’re here.”
The role of the board of directors is worth considering, especially regarding Munger’s rule and the zone of insolvency
Jason Zweig has also noted that while it may be impossible to quantify, both Munger and Buffett believe that Berkshire’s structure minimizing agency costs has played a large role in Berkshire’s success.
About The Author: Philip Ordway
Philip Ordway is Principal and Portfolio Manager of Anabatic Fund, L.P. Previously, Philip was a partner at Chicago Fundamental Investment Partners (CFIP). At CFIP, which he joined in 2007, Philip was responsible for investments across the capital structure in various industries. Prior to joining Chicago Fundamental Investment Partners, Philip was an analyst in structured corporate finance with Citigroup Global Markets, Inc. from 2002 to 2005, where he was part of a team responsible for identifying financing solutions for companies initially in the global power and utilities group and ultimately in the global autos and industrials group. Philip earned his M.B.A. from the Kellogg School of Management at Northwestern University in 2007 and his B.S. in Education & Social Policy and Economics from Northwestern University in 2002.
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