Institutional Imperative

intermediate2 min readeconomics · business · sociology · psychology

Buffett calls the organizational pressure to resist change, spend available funds, justify leaders’ wishes, and imitate peers the institutional imperative. He argues that these dynamics can override the judgment of otherwise capable managers.

THE IDEA

Why Managers Can Make Irrational Decisions

My most surprising discovery: the overwhelming importance in business of an unseen force that we might call "the institutional imperative." In business school, I was given no hint of the imperative's existence and I did not intuitively understand it when I entered the business world. I thought then that decent, intelligent, and experienced managers would automatically make rational business decisions. But I learned over time that isn't so. Instead, rationality frequently wilts when the institutional imperative comes into play.

For example: (1) As if governed by Newton's First Law of Motion, an institution will resist any change in its current direction; (2) Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds; (3) Any business craving of the leader, however foolish, will be quickly supported by detailed rate-of-return and strategic studies prepared by his troops; and (4) The behavior of peer companies, whether they are expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated.

Institutional dynamics, not venality or stupidity, set businesses on these courses, which are too often misguided. After making some expensive mistakes because I ignored the power of the imperative, I have tried to organize and manage Berkshire in ways that minimize its influence. Furthermore, Charlie and I have attempted to concentrate our investments in companies that appear alert to the problem. (Warren Buffett, Berkshire Hathaway Inc., Letters to Shareholders, 1989, p.62.)

When to use it

When evaluating a potential acquisition, consider whether the acquiring company is motivated by the need to soak up available funds rather than strategic fit.
When a company resists necessary changes due to internal inertia, recognize the institutional imperative and focus on aligning incentives to overcome it.
When competitors all adopt a new practice, question whether it is genuinely beneficial or just mindless imitation driven by the imperative.

FROM THEORY TO EVERYDAY LIFE

In practice

Resistance to Change

As if governed by Newton's First Law of Motion, an institution will resist any change in its current direction.

Absorbing Available Funds

Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds.

Supporting the Leader's Craving

Any business craving of the leader, however foolish, will be quickly supported by detailed rate-of-return and strategic studies prepared by his troops.

Mindless Imitation

The behavior of peer companies, whether they are expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated.

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A MOMENT TO REFLECT

Put it to work.

Think of an organization you know well. Can you identify a decision that was likely driven by the institutional imperative rather than rational analysis?
What are some practical steps a leader can take to counteract the institutional imperative and promote more rational decision-making?
How might the institutional imperative manifest in a non-profit or government agency? How would it differ from a for-profit business?