Why are CFOs not always rational?
It’s a provocative statement, however it’s a play on the title of a book I’m reading called The Irrational Ape by David Robert Grimes about why we fall for disinformation conspiracy theory and propaganda, and CFOs are not immune from this.
In this bitesized episode I explain a bit more behind this, share some examples on how we can become more aware of it and a couple steps we can begin to use to overcome the adverse impacts of irrationality.
Andrew: [00:00:00] Hi everyone. And welcome to this week’s Monday memo, and I hope you all have a fantastic weekend and looking forward to the week ahead and one interesting point I’d like to throw out there is maybe this idea of the irrational CFO. I know it’s probably be a bit of a provocative statement, but it’s a play on the title of a book I’ve been reading at the moment called the irrational ape by David Grimes. And it’s about why we fall for disinformation, conspiracy theories, propaganda. And in my mind, how CFOs and finance professionals, we’re not immune from this, if anything, it’s actually more of a paradox for us because CFOs like again, a lot of other finance professionals out there are super smart. And that makes us even potentially more prone to rationality. When you look at studies where the likes of Tetlock and so on. And I think that’s the case because we’ve a lot of information and understanding around us that we can essentially rationalize most things and make them seem rational, even though if they’re not.
[00:01:05]Particularly in our quest to make better business decisions. How many of us have jumped to assumptions that I know, like I did when I started that working longer hours. Somehow translates into more career success. Or perhaps there was a profitable manufacturing company, actually, a very well known one whose company was trending very well.
[00:01:26] Profit wise, their, their operating leverage was increasing. Sales were actually growing faster than expenses, but their working capital had almost burned out because some of their largest customers were slow to pay because of a change in economic conditions. And because 40% of their sales with those customers, they were running out of cash and couldn’t pay the salaries or the impending loan repayments.
[00:01:52] So a profitable business going out of business because. Again, the assumption that things were okay, because the focus was on the profit and that everything will be fine. That’s why, why we sat on this show. Cash is King, but at other frustrating one, we hear a lot of, and some of you I know have encountered this is let’s say.
[00:02:13]There’s a request out there to hire additional team members, whether within finance or sales and so on. And then you get the push back from the CFO saying we can’t do that because we’ll go over our OPEX budget. Even though the hiring in itself. Are the project or the initiative could deliver up to an 800% return on a worst case scenario.
[00:02:36] And then you’re probably really thinking about a rational lead. What’s happened with shareholder maximization or even reallocating resources to the most valuable outcomes. So again, I’m not trying to pick on finance professionals and CFOs, most. A lot of people overestimate the risk of death from terrorism while completely underestimating, more likely killers such as diabetes, heart disease, or simply crossing a busy road without looking left and right.
[00:03:05]And I think the point is, is that our actions won’t always line up with economic theory. Particularly this theory of the rational person. And to do that, we actually have to suspend some of our rational judgment. And, the conditions at work nowadays make this completely understandable.
[00:03:21] I Firstly when we, we work in these fast paced departments, like we do people can be tired, stressed particularly in the middle of the day, our minds may not be as fresh. There’s. Pressure to deliver on deadlines. We’re very deadline driven and finance. We’ve try and help businesses deliver to their budgets.
[00:03:39]And most of all, the environments we’re working in information generally is incomplete. And that just probably compounds the pressure on us trying to get decisions, particularly if we hold accuracy and consistency is key principles, and that all feeds into this second factor in my mind, which is we have a habit.
[00:03:58]Developing mental shortcuts. We call these rule of thumbs or heuristics and these typically favor, speed of decision over quality of decision. And a lot of this you might’ve heard before, but it, but it comes from the work of Daniel Kahneman.
[00:04:15] So the week ahead, if you’re thinking about these mental shortcuts, And why that happened while Kahneman was saying, it’s do a lot with our system. One type thinking, which is about 95% of what our brain focuses on. It’s like this default factory setting, it’s there to save energy and, and protected our ancestors.
[00:04:35]It was designed that they would react in a particular way if they heard rustling in the bushes. Or for instance, more modern days if we don’t spot something that looks right in financial statements, because we recognize that a growth rate’s been incorrectly calculated. And by the way, that’s a very strong point.
[00:04:54] If you’re ever in a meshing on your throat to be the only finance person there that ability to, to check our calculate ratios very quickly, it’s a key value proposition. Of what we do, because over time we’ve probably developed mental shortcuts to be able to do those things quickly. So spot errors quickly, or calculate things like that quickly, but so rustling in the bushes might not be snakes nowadays, particularly in our offices or anything even harmful, but. But it’s more likely if we’re out and about it could be the wind, it could be birds, it could be foxes as the most likely causes. And that leads into our system two brains, which is like the remaining 5% of our thinking, we really should be calculating and likely causes approximate causes or those effects.
[00:05:41]But the challenge is, is that our system two brains are a bit slower. They’re a bit more logical More energy intensive. And I suppose you could say extremely lazy. That’s why we tend to procrastinate over those difficult tasks that require a lot of focus and brain power to get them going and getting them off the ground.
[00:06:01] And I was just thinking, maybe an interesting experiment is to share one of those from a book. Thinking fast and slow and it’s the baseball, baseball bat experiments. So let’s say that a baseball and a baseball bat combined together cost $110 and the bat costs $100 more than the ball.
[00:06:25] So how much does the ball cost? And interestingly enough, if you can follow intuition and these rules of thumbs and mental shortcuts, most people will actually say the answer is 10. But if the baseball really costs $10, would that not then mean that if the baseball bat was $110, cause it’s meant to be a hundred more than you’ve now got $120.
[00:06:47]And interestingly, most people make that mistake, but if you were to slow your mind down a bit and access the system two thinking and. Either create two simultaneous equations or work back deductively from the hundred and 10 you’d actually then find out that the baseball cost $5 and the baseball bat, $105, which is again, the hundred more, but in total is the 110 the experiment was looking for.
[00:07:13]But if, again, you’re in that middle of the day and you’re tired and you’re low on energy, then. Then accessing your system. Two thinking could be a bit difficult. And there was another book I finished by Chris Belchamber and Chris deconstructs, the best practices, the most successful investors in the describes the systems they used to make their successful decisions, how they reduced their failures and also overcame their worst enemy, which was their own minds.
[00:07:43] And particularly in the book, he makes the point that we can all reduce the impacts of thinking with the wrong part of our brains by one, developing a clear set of rules that exist outside of our, our brain system one and allows us then to rely on them because outside the brain and to. Was actually reducing the cognitive expense of our system to thinking by implying software.
[00:08:07] And we do that with like Excel and calculate and song. We’ve been doing it for ages, but maybe we just need to do it with more things and that will help us then avoid accessing our system. One, thinking these mental shortcuts when we could actually be using our system two thinking, and hopefully we’ll have Chris on the show soon.
[00:08:24] I will be speaking with him later today, but. In general, that’s why we bring on guest mentors into the strength and the numbers show to share with you their stories and hard won lessons on how they managed to reduce. Maybe there were Alliance or mental shortcuts or what mental shortcuts they did that worked, or actually it didn’t work.
[00:08:46] And that then helps you straighten the line a bit in terms of go to that sort of wavy line to get to that career experience. You’re looking for helps. Speed up the acquisition of knowledge and turning it into wisdom. And again, that is, that is the importance of having guest mentors who will share their stories.
[00:09:03]So you can become more influential and have more meaningful careers in finance. So look, hope you enjoyed this week’s episodes and the thoughts you went through around this. Mental shortcuts and irrational CFO . And if you did, we really appreciate it when you let your friends and colleagues know and share it with them, you can subscribe on all the major platforms, iTunes, Stitcher, SoundCloud, YouTube, Spotify, and Amazon music.
[00:09:27] And as always, we really appreciate investing your time with us today. So until next time, take care of yourselves and let’s keep on building our strength in the numbers.