«Volume 23 2009 Page 1-19 The Restructuring of the Saskatchewan Wheat Pool: Overconﬁdence and Agency Murray E. Fulton∗ Kathy A. Larson† ∗ ...»
Conceptual Framework Two conceptual frameworks are used to examine the decisions made by the SWP during the 1990s: cognitive theories of hubris and overconﬁdence, and agency theory. Both theories provide explanations for why the Pool’s investment decisions were unsuccessful. Other factors, of course, were also at work. For instance, a signiﬁcant drop in member commitment has been identiﬁed as an important factor in explaining the poor performance of Project Horizon and the Pool in the late 1990s (Lang & Fulton 2004; see also Lamprinakis 2008). The focus on overconﬁdence and agency in this article is undertaken to explore more fully these two factors and their interrelationship.
Overconﬁdence and Hubris Business executives are generally thought to be overconﬁdent (Brown & Sarma 2007). This over optimism can be linked to selection bias (Gervais, Heaton & Odean 2006), as well as a number of cognitive errors—mistakes in the way that information is processed—that executives routinely make (Lovallo & Kahneman 2003).7 Among these errors or biases is the propensity for people to overstate their ability— i.e., to see themselves as above average in their abilities and skills. Closely related to 8 Journal of Cooperatives this problem are attribution errors, the inclination that people have to attribute positive outcomes to things that they have done, while attributing negative outcomes to outside events. One of the consequences of these cognitive errors is hubris; managers believe they can do anything, even in situations where others have not succeeded.
Over-optimism in business settings also springs from the manner in which business plans are developed. Most business plans start with a proposal. By their very nature, proposals accentuate the positive. However, starting with a proposal that is tilted towards the positive virtually ensures that the ﬁnal plan shares the same tilt.
The reasoning for this is anchoring, the cognitive tendency to put too much emphasis on initial positions and not enough on subsequent information. Furthermore, information acquired to test the assumptions and claims in the proposal will often be chosen to support the initial beliefs that underlie the proposal, a result of the so-called conﬁrmation bias (Lovallo et al. 2007).
Competitor neglect can also be a source of over-optimism. Business plans developed without considering what competitors are planning can easily result in overcapacity, price wars, or product duplication.
The best evidence for overconﬁdence and hubris comes from an examination of business acquisitions (Malmendier & Tate 2005; 2008). This evidence is particularly applicable to the SWP given the large number of investments it undertook in the 1990s. The empirical literature shows that ﬁrms generally overpay for acquisitions, and that the shareholder wealth of the acquiring ﬁrm either falls or remains constant after the takeover.8 There are two underlying reasons cited for this overpayment, overconﬁdence and hubris, and agency problems.9 Hubris means that CEOs have an overwhelming presumption that their high valuation of a takeover target is correct, even when it is not. Hubris and overconﬁdence play a particularly important role when considered in conjunction with the investment funds to which a CEO has access. If CEOs have excess cash available, they will tend to invest it in new ventures or acquisitions.
As outlined above, CEOs will tend to overpay for these acquisitions, and so the investments will often be unsuccessful.
The relationship between CEO hubris and acquisition premium is greater when board vigilance is lacking—i.e., the less oversight by the board, the greater the overpayment. Indeed, it is widely understood that agency problems can also lead to overpayment and poor investments.
Agency theory and oversight An agency relationship occurs when a principal hires or appoints an agent to carry out a task on the principal’s behalf. Because the principal and the agent differ Vol. 23 9 in their objectives and because the agent typically has more information than the principal about the environment in which decisions are being made, opportunity exists for the agent to behave in a manner not in the principal’s interests (Eisenhardt 1989). This means that the principal has to provide appropriate incentives to the agents to get them to behave in the principal’s best interest. In the best-case scenario, the principal’s goals are more or less achieved, albeit at a cost. In the worst-case scenario, only the agent’s goals are met.
A number of agency relationships exist in agricultural co-ops. In a traditional co-op, the farmer-members are the ultimate principals with the elected board members serving as agents. However, a second agency relationship also exists between the board and the co-op’s senior management. This cascade of agency relationships offers substantial room for the agency problem.
Agency theory has been frequently applied to business acquisitions and investments. Jensen (1986) argues that agency problems are likely to be greater in ﬁrms that have excess cash available for investment and acquisition purposes. Managers who have access to internal funds do not have to subject themselves to the monitoring that external capital markets provide. As a consequence, they are better able and more likely to make investments that beneﬁt them personally rather than add shareholder value. Accordingly, Jensen argues, ﬁrms should ensure that excess cash is paid out to shareholders because doing so results in greater oversight.
Staatz (1987) notes that cooperatives can reach a point in size and complexity that makes it impossible for the board to fully monitor managerial behaviour, regardless of the board members’ talents. Quarterly board meetings, which are often the only contact the board has with management, make it difﬁcult, if not impossible, to ascertain if management has exercised proper due diligence on investment proposals. Farmer-elected board members also may not have the knowledge nor business skills that senior managers possess (Ernst and Young Corporate Finance Inc 2002). If board members lack business acumen and simply trust that management provides accurate projections and assumptions, they may end up granting approval to nonviable investments. Thus, if information asymmetry is grouped with board inexperience, an inability to monitor management and an implied trust in management, the agency problem could become quite severe.10 In the case of SWP, the agency relationships that existed after the 1996 share conversion were more complicated than those in traditional co-ops. Because the coop’s shares were owned in part by shareholders that were not farmer members, both the farmer members and the class B shareholders could be classiﬁed as principals.
The board, which was appointed solely by the farmer members, was expected to act as an agent on behalf of both of these groups in its dealings with senior management.
10 Journal of Cooperatives Conceptually, this more complicated agency relationship can be expected to make the agency problem more severe. Because the goals of the farmer members and the investors are likely to differ, and thus some compromise is needed between them, the board and senior management are in a position to claim to both groups that circumstances require that they meet the goals of the other group, all the while undertaking actions that meet only management’s goals. And with two groups of principals in place, the incentive to fully monitor the actions of the board and management is likely to be reduced. The result is that the board and management may have more leeway to pursue their own objectives.
In summary, co-ops that are large and diversiﬁed, are publicly traded, have highly conﬁdent leaders, and have excess internal funds available for investment are likely to be at greatest risk of overinvesting and having investments turn out poorly. SWP possessed all these characteristics, and the result, at least in retrospect, was predictable—the investments made by SWP in the 1990s were largely unsuccessful.
Analysis This section uses evidence collected from published material and 21 personal interviews conducted with former SWP management and board members to illustrate how overconﬁdence and hubris resulted in a number of poor investments, which resulted in the Pool losing customers and incurring an ever-increasing debt. Further analysis of these interviews, conducted from September 2004 to April 2005, as well as additional details on the quotes presented below, can be found in Lang (2006).
Overconﬁdence and Hubris From 1996 to 1999, the Pool invested in approximately 25 acquisitions and long-term debt grew ﬁve-fold. This spending stemmed from a belief of urgency.
The Pool believed that it needed to “move rapidly to beat [the] U.S.” and it needed to “become more of a global player and expand beyond Saskatchewan borders.” There was a conviction that if the Pool did not “stay at a signiﬁcant size... [it would] become one of two things: irrelevant or sucked up.” Interviewees recalled how Pool management and board members arrogantly believed the Pool could become “the ConAgra of the North” and become “one of four or ﬁve top grain companies in the world.” A June 1997 Canadian Business article quoted CEO Don Loewen as saying “if we don’t become a strong, global force, we will just be eaten up by the American [multinationals]. Quite frankly, they’ll eat our lunch” (Casey 1997).
The 1996 share conversion, by enabling access to greater debt, provided the capital for rapid expansion. As one interviewee described it, the Pool felt like it had Vol. 23 11 a “bottomless pit of money.” With the “capital from the public markets, not only could [the Pool] make a lot of decisions quickly, they felt they were expected to. ” A sense of conﬁdence permeated the board and management. The Pool believed it was “well positioned for the changes rapidly transforming the once highly regulated and stable industry” (1997 SWP Annual Report, p. 14). Other grain industry participants expressed conﬁdence in the Pool as well, which, in turn, served to validate management and board members’ beliefs. Scott Schroeder of Dominion Bond Rating Service (DBRS) said the industry changes would “leave few survivors.
Saskatchewan Wheat Pool and Cargill will be the only ones—it’s a pretty safe bet.” (Casey 1997). At the Fourth Agricultural and Food Policy Systems Information Workshop, Barb Isman, Cargill’s Assistant Vice President of Corporate Affairs, stated that to gauge the “future of the western agricultural industry,... policy analysts might use their time and resources most wisely if they simply talked to three companies: SWP, Cargill and... Monsanto.” (Loyns, Knutson, & Meilke 1998, p.
Loewen was seen as the right individual for the job. Investments that he had orchestrated—speciﬁcally Robin’s Donuts and CSP Foods—had turned out well for the Pool, so the board “didn’t think he could do anything wrong.” One board member explained that Loewen was hired because “he was [the] type of individual who moved fast” and the board knew it had to “keep the reins on this individual because he [would] be very aggressive.” Loewen was “absolutely driven by the thought that [the Pool] had to move very quickly.” He had everybody “hooked on this idea of being the biggest and the best.” One board member described the Pool as feeling “invincible and that was driven by Don Loewen’s personality and a number of people around him that just felt [the Pool] couldn’t be stopped.” Loewen’s power and leadership style was reﬂected in the investment decision-making. An interviewee described Loewen’s decisionmaking as “shoot from the hip” based on good gut feelings.
The need to move quickly to diversify and invest affected the analysis and the decision-making process. “Ideas did not get... proper and adequate evaluation, if Loewen wanted to do it everyone would ﬁnd a way to make it happen.” As one board member explained “the argument that was being made was that if [the Pool] did it ﬁrst, no matter what we paid for it, we would prevent our competition from doing it and then we would be successful.” Some interviewees were of the opinion that people “in very senior operational positions [had] no outside experience” and “the board did not have the makeup or people on it... that would occur in a company somewhere else.” One management employee used the words “naïveté and arrogance” to describe the corporate culture. The Pool was considered to be lacking the experience and background in its management and board to say, “No, this doesn’t make sense.” 12 Journal of Cooperatives The quotes and examples presented above provide evidence of signiﬁcant overconﬁdence and hubris by the senior management and board. This overconﬁdence and hubris appears to have stemmed from a number of cognitive errors. Senior management, along with the rest of the organization, clearly saw itself as above average in business acumen. Success was believed to have stemmed from the actions and decisions that management made, rather than due to outside events or good fortune. Anchoring and the conﬁrmation bias were both at work—business proposals and investment analyses were constructed to be optimistic, which in turn appears to have bred further optimism. Finally, competitor neglect seems to have been important. Because the Pool felt it could keep out competitors if it moved quickly, the decisions of these competitors were almost certainly not being considered (see the next section for additional examples).
When the overconﬁdence and hubris were combined with easy access to additional debt capital, the result was a major spending spree. And this spending extravaganza was indirectly encouraged by an apparent unwillingness and/or inability of the board to question and challenge the expenditures being made.
Lack of Oversight The lack of oversight and its connection to an agency problem at the SWP is
best captured by a former employee: