For the first decade of the twenty-first century, Tony Hayward was an executive in the prime of a spectacular career. Having steadily moved up the ranks of British Petroleum from his 1982 position as an oil rig geologist, Hayward joined BP’s senior management team in the early part of the new millennium. During this time BP performed extremely well financially and was highly regarded as a progressive, eco-friendly corporation—at least for an oil company. Hayward was commonly viewed as the most likely successor to BP’s very visible CEO, Lord John Browne.
While BP was still under Browne’s leadership, a variety of disasters confronted the company. In the wake of a 2005 blast at the firm’s Texas City refinery, which killed fifteen people and injured more than 170 others, Hayward criticized his company’s management during a town hall meeting in Houston: “We have a leadership style that is too directive and doesn’t listen sufficiently well. The top of the organization doesn’t listen sufficiently to what the bottom is saying.”1 Soon after, BP was confronted with a scandal regarding Lord Browne’s sex life and the fact that, in Clintonesque form, he lied about it under oath.
Speeding up its planned process for selecting a new chief executive, BP announced on January 12, 2007, that Hayward would be Browne’s replacement. Hayward immediately became one of the most visible executives in the world. He faced a variety of difficult challenges, all closely followed by the media. At a 2009 lecture at Stanford University, Hayward outlined his philosophy about running BP, saying the company’s “primary purpose . . . is to create value for our shareholders. In order to do that, you have to take care of the world.”2
Hayward was arguably at the top of his game, leading a challenging company in a very difficult industry. Then, suddenly, he was faced with his biggest career challenge by far: an explosion on BP’s Deepwater Horizon oil platform in the Gulf of Mexico on April 20, 2010. Eleven people were killed immediately, and oil began leaking from the platform at an alarming rate. It soon became clear that the spill could become the largest ecological disaster in the history of the world. An enormous number of jobs in and along the Gulf Coast vanished overnight, lives were shattered, and entire communities were devastated. After initially making the error of downplaying the spill, Hayward compounded it by making a number of highly unfortunate comments:
• “What the hell did we [BP] do to deserve this?”3
• “The Gulf of Mexico is a very big ocean. The amount of volume of oil and dispersant we are putting into it is tiny in relation to the total water volume.”4
• “I think the environmental impact of this disaster is likely to be very, very modest.”5
But Hayward’s biggest verbal mistake by far occurred on May 30, when he told a reporter:
• “There’s no one who wants this thing over more than I do. I’d like my life back.”6
If you missed this gaffe at the time, can you predict how the world responded to it? That’s right, the media and the general public quickly and widely condemned Hayward for his selfish, callous comment.
Had Hayward thought one step ahead before speaking, he likely would never have made the gaffe. In fact that was his view as well, as he said a few days later: “I made a hurtful and thoughtless comment on Sunday when I said that I wanted my life back. When I read that recently, I was appalled. I apologize, especially to the families of the 11 men who lost their lives in this tragic accident. Those words don’t represent how I feel about this tragedy, and certainly don’t represent the hearts of the people of BP—many of whom live and work in the Gulf—who are doing everything they can to make things right.”7
Let’s step back in time. In 2005–6 I worked as a consultant for BP and spent time with Hayward. He is bright, cautious, and reserved in style. I would vouch for his general thoughtfulness. But with one sudden failure to think one step ahead, his life was permanently changed. His apology for the comment came too late. On June 8 President Obama said that Hayward “wouldn’t be working for me after any of those statements.”8 With pressure coming from many directions, on June 18 the chairman of BP’s board said that Hayward would not be involved in the company’s efforts in the Gulf. In July BP announced Hayward’s dismissal.
At the time of the spill, Hayward was under enormous pressure. He was in the middle of multiple crises and in all likelihood was short on sleep. But all he had to do was to think one step ahead before speaking to consider how the media, the loved ones of those killed, the newly unemployed, and the rest of us, as interested observers, would respond to hearing the well-paid head of an oil company say that he wanted the crisis to end so that he could get his life back. Precisely because he was the CEO of a company in crisis, it was all the more incumbent upon him to think one, or better yet, several steps ahead.
In fact most of us fail to think even one step ahead before speaking and acting, a type of focusing failure that prevents us from seeing beyond the present moment. Groups and entire organizations have trouble thinking a step ahead as well. In early 2012, for example, the foundation Susan G. Komen for the Cure, one of the leading nonprofits involved in the prevention and treatment of breast cancer, made a significant policy decision that highlights the need for both organizations and individuals to think one step ahead.9
You have probably known people who have participated in the Komen Foundation’s Race for the Cure and may well have sponsored someone who walked long distances to raise money for breast cancer research and treatment. The foundation is one of the most successful disease-advocacy organizations in the world, and its pink ribbons have made the fight against breast cancer quite visible. Up until 2012 the Komen Foundation had few, if any, enemies.
Part of the foundation’s operations focuses on breast cancer screening and education programs, which are administered through many different health care organizations. One of the providers of these services is Planned Parenthood, a nonprofit provider of low-cost health services to women. As you probably know, Planned Parenthood has attracted a great deal of controversy because, in addition to the many health services its facilities provide, some also provide abortion services. For many women, particularly those lacking health insurance and access to affordable medical care, Planned Parenthood is their main source of health care. Each year Planned Parenthood’s affiliates provide more than 750,000 women with breast examinations and, when needed, provide mammograms and ultrasounds to those who cannot afford further diagnostic services.
On January 31, 2012, the story broke that, under alleged political pressure, the Komen Foundation was quietly cutting off the approximately $700,000 that it provided to Planned Parenthood annually for breast cancer screening and education programs. A spokesperson for the foundation claimed that the main factor behind the decision was a new rule the organization had adopted that prohibits grants to organizations that are being investigated by local, state, or federal authorities. Under this rule Planned Parenthood arguably was disqualified from funding, as it was the subject of what was broadly seen as a politically motivated inquiry by Republican Representative Cliff Stearns of Florida. Stearns claims that his goal is to ensure that Planned Parenthood is not illegally using federal resources for abortions. Pro-choice advocates argue that Planned Parenthood has already proven that it does not use federal funds to perform abortions, and they view Stearns’s activities as simply a means of harassing an effective, pro-choice organization. Nancy Brinker, the CEO of the Komen Foundation, denied any political motives behind her organization’s decision to stop funding Planned Parenthood. However, John Raffaelli, a member of the Komen board, informed the New York Times that the decision was rooted in a desire among senior executives to disassociate Komen from Planned Parenthood for political reasons.10 The decision by Komen was speculated to have originated with Karen Handel, who was appointed senior vice president for public policy in April 2011. During her unsuccessful 2010 campaign to be governor of Georgia, Handel, an abortion opponent, had pledged to eliminate funding for Planned Parenthood.
Based on only the information I’ve presented so far, do you think you could have predicted what would happen next? Critical stakeholders of the Komen Foundation were outraged, the organization suffered a significant blow to its reputation, and the cause the foundation supports suffered as well. Within a couple of days, massive numbers of donors to the Komen Foundation protested the decision and threatened to cut off their money. The seven California affiliates of the Komen Foundation released a statement saying that they opposed the national organization’s decision. Twenty-six U.S. senators criticized the decision and urged the foundation to reconsider. Planned Parenthood donations skyrocketed in a show of support. Criticizing the decision as a threat to women’s health, Mayor Michael Bloomberg of New York City personally pledged $250,000 to Planned Parenthood to help replace the lost funding.
Politics aside, from the perspective of this book, all of this public outrage could have been anticipated by the leaders of the Komen Foundation. While some of them may have strong antiabortion beliefs, they should have recognized that there was a significant overlap between stakeholders of the Komen Foundation and stakeholders of Planned Parenthood—yet they failed to do so. In a YouTube video that has since been pulled from the web, Komen CEO Brinker issued a plea aimed at appeasing the mounting criticism and restoring her organization’s reputation, but it was a failure.
Three days after its initial announcement, the Komen Foundation reversed itself and said it would continue to support Planned Parenthood. Four days later Handel submitted her resignation. The foundation apologized for casting doubt on its commitment to saving women’s lives. But in a world where organized protest campaigns spread like wildfire overnight, the apology may have come too late. The New York Times argued that the Komen Foundation had betrayed its mission and suffered a “grievous, perhaps mortal, wound.”11
In the span of just a few days, between the disclosure of Komen’s decision to withdraw funding to Planned Parenthood and its declaration to restore it, women’s health suffered a setback, and the Komen Foundation injured itself in ways that no outside critic or organization could have done. Why? Because key leaders in the organization failed to notice what was easy to predict by thinking one step ahead and anticipating the likely fallout from their decision.
In both the BP and Komen episodes, the critical failure to think ahead involved the consideration of how the broader public would respond to the media’s reporting of the story. But all of us, even those who are not covered so closely by the media, would be well served to think about how others will respond to the actions we are considering before we undertake them.
In 1966–67, while working as an assistant professor in the Economics Department at the University of California at Berkeley, George Akerlof wrote a thirteen-page paper entitled “The Market for Lemons.”12 Three academic journals rejected the article, but a fourth journal accepted it and published it in 1970. In 2001 Akerlof won the Nobel Prize for this classic paper. Akerlof explains that “The Market for Lemons” dealt with a very simple insight: “If he wants to sell that horse, do I really want to buy it?”13 Essentially Akerlof argued that a potential buyer of a commodity should consider the motives of the seller and make inferences based on the seller’s willingness to transact. As I suggested in chapter 8, a buyer is well advised to put herself in the shoes of the seller. This is particularly important when the seller has more information than the buyer does.
Akerlof presented this classic paper as an abstract economic model, but, as its title suggests, he illustrated it using the market for used cars. Simplifying his argument, there are good used cars and bad used cars (“lemons”) on the market. Differences in quality are determined by factors such as the seller’s driving style, level of maintenance, and accident history—factors that the prospective buyer cannot observe or easily determine.
Consider the task of a buyer who is examining a used car without knowing whether it is a good car or a lemon. What is her best estimate of its quality? Perhaps she estimates that the car is of average quality. Thus she will be willing to pay the price of an average-quality car. Assuming many used-car buyers make similar estimates, let’s consider what happens to the owners of carefully maintained, never-abused, high-quality used cars: they can’t get their car’s fair market value. Taking this argument a step further, we can expect that many owners of good cars will not put their cars on the market; instead they will keep their cars, give them to family members, and so on.
Consequently the elimination of good cars from the publicly available market reduces the average quality of available cars. As buyers become aware of this, they revise downward their expectations for cars that reach the market. In turn, owners of moderately good cars no longer can get a fair price, and they pull their cars off the market as well. This downward trend continues until only lemons reach the market. Akerlof’s model assumes a relatively uninformed buyer and ignores the role of warranties, inspections, and so on. Yet his insights clarify why your new car drops greatly in value the moment you drive it off the lot: Who would want a car that a new-car buyer is willing to sell just minutes, days, or even weeks after the purchase? Who, offered such a car, wouldn’t wonder, “Why are they selling?”
Akerlof’s brilliant paper assumed that used-car buyers are ill-informed about cars but think rationally about what they are willing to pay based on the presence of asymmetric information—that is, the fact that the seller knows more than they do about the car’s quality. While buyers are indeed suspicious in some contexts, most of us actually tend to be fairly naïve in many other contexts. The failure of most of us to think one step ahead prompted the U.S. government, five years after Akerlof’s paper was published, to enact a federal “lemon law” (the Magnuson-Moss Warranty Act) designed to protect used car buyers in all states.
Based on Akerlof’s abstract version of the used-car problem, Bill Samuelson and I wrote a decision problem that highlights the challenges facing the ill-informed buyer.14 If you haven’t seen it before, work through the problem and consider what offer you are willing to make.
Acquiring a Company
In the following exercise you will represent Company A (the acquirer), which is currently considering acquiring Company T (the target) by means of a tender offer. You plan to tender in cash for 100 percent of Company T’s shares, but you are unsure how high a price to offer. The main complication is this: the value of Company T depends directly on the outcome of a major oil exploration project it is currently undertaking. Indeed, the very viability of Company T depends on the exploration outcome. If the project fails, the company under current management will be worth nothing—$0 per share. But if the project succeeds, the value of the company under current management could be as high as $100 per share. All share values between $0 and $100 are considered equally likely. By all estimates, the company will be worth considerably more in the hands of Company A than under current management. In fact, whatever the ultimate value under current management, the company will be worth 50 percent more under the management of Company A than under Company T. If the project fails, the company is worth $0 per share under either management. If the exploration project generates a $50 per share value under current management, the value under Company A is $75 per share. Similarly, a $100 per share value under Company T implies a $150 per share value under Company A, and so on.
The board of directors of Company A has asked you to determine the price they should offer for Company T’s shares. This offer must be made now, before the outcome of the drilling project is known. From all indications, Company T would be happy to be acquired by Company A, provided it is at a profitable price. Moreover, Company T wishes to avoid, at all cost, the potential of a takeover bid by any other firm. You expect Company T to delay a decision on your bid until the results of the project are in, then accept or reject your offer before the news of the drilling results reaches the press.
Thus, you (Company A) will not know the results of the exploration project when submitting your price offer, but Company T will know the results when deciding whether or not to accept your offer. In addition, Company T is expected to accept any offer by Company A that is greater than the (per share) value of the company under current management.
As the representative of Company A, you are deliberating over price offers in the range of $0 per share (this is tantamount to making no offer at all) to $150 per share. What price offer per share would you tender for Company T’s stock?
My Tender Price is: $____ per share.
The key features of this problem, paralleling the challenges facing buyers in Akerlof’s abstract representation of the lemons problem, include the following facts:
• The buyer doesn’t know the value of the firm; he knows only that the value under current management is between $0 and $100 per share, with all values equally likely.
• Whatever the firm is worth to the seller, it is worth 1.5 times as much to the buyer.
• The buyer must make his offer armed with only this distributional information, but the seller will know the exact true value of the firm when accepting or rejecting the offer.
Since the firm is worth 50 percent more to the buyer than to the seller, it appears to make sense for a transaction to take place. However, although the facts presented are pretty straightforward, the rational analysis of this problem is not intuitive, even for very bright people, because they fail to think one step ahead.
I have given this problem to many accomplished people at many levels of corporate seniority, including CEOs, accounting firm partners, and investment bankers, and the most popular range of answers is always between $50 and $75 per share. The common yet naïve cognitive process that leads to these answers is that, “on average, the firm will be worth $50 per share to the target and $75 per share to the acquirer; consequently, a transaction in this range will, on average, be profitable to both parties.”
This logic would be rational if the other side (the target) also had only distributional information about its value. However, the problem specifies that the target would know its true value before accepting or rejecting your offer.
Let that fact sink in: the seller knows the company’s true value; you do not. Now follow a rational thought process over the decision as to whether or not to make an offer of $60 per share:
If I offer $60 per share, the offer will be accepted 60 percent of the time—whenever the firm is worth between $0 and $60 per share to the target. Since all values are equally likely, between $0 and $60 per share, the firm will, on average, be worth $30 per share to the target when the target accepts a $60 per share offer, and will be worth $45 per share to the acquirer. To the acquirer, then, a $60 offer results in a loss of $15 per share (the $45 value minus the $60 per share offer). Consequently, a $60 per share offer is unwise.15
Note that the same kind of reasoning applies to any offer. On average, the acquiring firm obtains a company worth 25 percent less than the price it pays whenever its offer is accepted. If the acquirer offers $X per share (substitute your offer for $X as we analyze the problem) and the target accepts, the current value of the company is anywhere between $0 and $X per share. As the problem is formulated, any value in that range is equally likely, and the expected value of the offer is therefore equal to $X divided by 2. Since the company is worth 50 percent more to the acquirer, the acquirer’s expected value is 1.5($X/2) = 0.75($X), only 75 percent of its offer price. Therefore, for any value of $X, the best the acquirer can do is not to make an offer ($0 per share).
Yes, it is possible to earn money by making an offer on the firm, but the odds are long. You are twice as likely to lose money as you are to make money. The paradox of the “Acquiring a Company” problem is that even though in all circumstances the firm is worth more to the acquirer than to the target, any offer above $0 per share leads to a negative expected return to the acquirer. The source of this paradox lies in the high likelihood that the target will accept the acquirer’s offer when the firm is least valuable to the acquirer—that is, when it is a “lemon.”
The answer to this problem is so counterintuitive that even when researchers pay people according to how well they think it through, the same pattern of mistakes emerges. Readers of this book who learn the habit of thinking one step ahead will have the analytical ability to follow the logic to the optimal offer of $0 per share. Yet without assistance most people make a positive offer. They systematically exclude readily available information—that the seller is privileged to information that they are not—from their decision processes. Like people who buy expensive jewelry without an independent appraisal, or out-of-town home buyers who trust their bank to appraise the value of the home, or acquirers in the merger market, a majority of bidders fail to account for the asymmetric relationship that could negatively affect them. They fail to realize that their outcome is conditional on acceptance by the other party and that acceptance is most likely to occur when it is least desirable to the negotiator making the offer.
In 1985, a couple of years after publishing the “Acquiring a Company” problem, I joined the faculty at the Kellogg School of Management at Northwestern University. One of my new colleagues at Kellogg was Roger Myerson, one of the world’s great game theorists, who has since won the Nobel Prize in Economics. During this era game theorists analyzed the behavior of rational actors in competitive contexts and provided important insights into how to think about the decisions of other parties. Consistent with their models, many game theorists then largely believed that humans acted rationally. In their work they stressed the importance of thinking ahead about the decisions of others when calculating what to do next.
The “Acquiring a Company” problem provided pretty convincing evidence, however, that at least in some contexts people actually do not do a good job of thinking even one step ahead or behaving all that rationally. This was a decade or so before it became common knowledge that all of us are prone to act predictably irrationally, so I was unsure how traditional game theorists would respond. Yet Roger seemed to like our results. When I asked him why he wasn’t bothered by the implied refutation of a core aspect of game theory’s predictions, he explained that he had never been deeply committed to game theory as a description of human behavior but remained firmly committed to the prescriptive value of game theory. Why? Because game theory underscores the importance of thinking one (or more) steps ahead.
Roger thought that MBA students and executives typically received too little exposure to game theory in the curriculum and that the “Acquiring a Company” results should serve as an advertisement for that fact. I think he was right. Because our intuition leads us astray, we need to be guided to think about the decisions of others and, more broadly, to think at least one step ahead. Game theory encourages, indeed demands that we do precisely that.
The “Acquiring a Company” problem pits intuition against more systematic analysis. And once again we see important limitations of intuitive, System 1 thinking. We automatically rely on simplifying tools, but we have the potential to use rational System 2 processes to more fully anticipate the decisions of others and identify the best response.
Imagine that you have just arrived in England’s Manchester Airport with three traveling companions. The plan is to take a taxi to the local train station and the train into London. In this story, you already have tickets for the train ride to London, which is 200 miles south of Manchester. As you approach the taxi stand, a group of drivers are sitting around chatting. The drivers appear to know each other quite well. You inform the driver of the lead taxi that you need a short ride to the train station. One of his colleagues informs you that the trains are on strike, and the lead taxi driver offers to take all four of you to London for £300 (about $600 at the time of the episode). Do you accept? Do you negotiate for a lower price? Or do you take some other action?
I believe that I am generally pretty good at implementing many of the ideas that I write about, such as decision making and negotiation. But this book originated with an exploration of one of my weaknesses: my failure to notice. I am actively working to be better at noticing, with some anecdotal successes. One of my rare successes occurred in Manchester.
Standing on the sidewalk outside the Manchester Airport, I certainly felt like I was caught in a tough situation. We could accept the offer gratefully, or we could haggle for a lower price, but either action entailed the risk of later finding out that the claim of a strike was fraudulent. Or I could run into the airport to ask at the information booth if there was in fact a railroad strike. But if the claim about the strike was true, I was going to feel awkward returning to the taxi stand.
With little time to deliberate, I said to my spouse, Marla, “Don’t let him load the luggage yet.” I ran into the airport, up to the information booth, and quickly asked whether there was a train strike. Dashing back to the taxi stand, Marla, and our two friends, I pulled them aside with the news that there was no strike: the driver’s claim was a scam.
With hindsight I made the right decision. But how did I notice that the data appeared to be suspicious? I think that some of the ideas in this chapter helped. I realized that the information that I needed was only 100 feet away, in the airport. I thought about the incentive of the taxi drivers: to get an expensive fare to London. And I didn’t focus solely on the issue of how we would get to London.
This story makes me look good, but I should point out that as I ran back into the airport, I was concerned about my suspicion of the taxi driver’s claim. What if I was wrong? Might cynicism have crept in to my analysis of the situation? If the driver was being honest, indeed trying to be helpful, my suspicion could have been embarrassing. Given the friendships among the drivers and their shared ethnic background, they could have concluded my suspicions were those of a bigot; I could have risked losing a drive into London when it was our last recourse for getting there. Fortunately, however, I got this one right.
In life there are times when we do think one step ahead, and we do so with a cynical attitude—but the danger is that we can be too cynical. Negotiators frequently need to choose between trusting the other party or being cynical of her motives. Too much trust, and you’re a sucker. Too much mistrust, and you could miss an opportunity or fail to develop an important professional relationship. I am probably too cynical in life. While I got the taxi problem right, I am sure that I have missed out on many valuable opportunities as a result of my cynicism.
Experimental research suggests that I am not alone. Consider the “hidden card game” between a seller and a buyer, which I adapted from the work of Ariel Rubinstein with my colleagues Eyal Ert and Stephanie Creary:
A deck of 100 cards includes all values between $1 and $100, in dollar increments. The seller starts by randomly drawing two cards from the deck. After being told the value of the lower of the two cards, the buyer must decide whether to buy the two cards from the seller at a fixed cost of $100. The cards’ value to the buyer is the sum of the two cards. The seller is rewarded a fixed amount ($10) if the buyer buys the cards. Thus the seller’s interest is to sell the cards regardless of their value. The buyer, on the other hand, wants to buy the cards only when they are valuable (when the sum of cards exceeds $100).16
If you are going to play multiple rounds of this game and your goal is to maximize your average payoff (a concept known as “expected value maximization”), you should buy the cards whenever the value of the lower card exceeds $33. Can you see why? At $34, all values for the other card fall between $35 and $100 and are equally likely. This makes the sum of the two cards anywhere between $69 and $134, for an expected value of $101.50, again, all values being equally likely.
Our research examined how buyers react when they see that the lower card is $40, making all values for the combination of the two cards between $81 and $140 equally likely, which implies an expected value of $110.50. To start with, imagine that the seller is an automated computer that is negotiating with the potential buyer with no opportunity for communication. As the buyer, all you know is that the lower of the two cards is worth $40. Given the arithmetic just presented, if you are risk-neutral, you will make the purchase.
Now reconsider the problem when the seller is another human being and the two parties have the opportunity to interact via email. As the buyer, do you like having the opportunity to talk to a live seller before deciding whether to buy, or do you prefer getting no additional information from a computer? Most people prefer to interact with the human seller. You might want to reconsider the value of this interpersonal information, however.
In our study, when we switch from a computerized seller to a live seller, the acceptance rate of the buyer dropped significantly. Among buyers in the computer-seller condition, 78 percent made the expected-value maximizing decision to purchase the two cards. Fewer than half (45 percent) made the decision to buy from the human seller. The communication between sellers and buyers made the potential buyers cynical about sellers’ claims, such that they assumed the worst about the value of the hidden card. In their email discussion, buyers’ messages included comments such as “I think you’re lying,” and “Yeah, right, why should I believe you?” Overall, buyers’ cynicism worked against them. The buyers would have been better off acting as if they were dealing with a computer, doing the arithmetic, and accepting the uncertain outcome of always accepting the cards when the lower card was equal to $40.
Ironically sellers believed that communicating with buyers would help them close the deal. They were wrong: cynicism turned out to be the main result of their communication with buyers.
So should you be trusting or cynical? Many would answer on one side or the other. But my view is that either answer would be wrong. My answer is “It depends,” specifically on what can be learned by thinking one step ahead. Thinking one step ahead allows you to identify when to be trusting and when to be cynical. It is wise to think carefully about the decisions and motives of the other party so that you can understand what a problem looks like from his or her perspective. Thinking ahead may help you identify when reasons to trust exist and when you have justification to be cynical. While it doesn’t make sense to be cynical simply because you are dealing with a person rather than a machine, we should not necessarily trust all individuals in all contexts. In some situations it is fairly costless to collect additional information to test our intuition, but we often fail to do so. Your goal should be to understand the strategic behavior of others without destroying opportunities for trust building.