all the wrong way with lbj

  • Date:01 Sep 2005
  • Type:CompanyDirectorMagazine

All the wrong way with LBJ

It is called the LBJ effect, a course of action named after the American president who put more resources into the Vietnam war even though it was clear the war could not be won. As Larry Stybel and Maryanne Peabody* explain, the LBJ effect also explains some corporate behaviour

In 2004, President George Bush was asked by a reporter to reflect what mistakes had he made since 9/11. President Bush seemed puzzled by the question and searched for the right words. He said he was sure that he had made some mistakes, but nothing came to mind.
News analysts suggested that 2004 was a presidential election Year. President Bush was not going to give any Democratic opponent an opening that could be used against him. We suspect that this analysis is both valid and incomplete.
Our experience with powerful CEOs is that President Bush’s puzzlement was probably genuine. Intellectually he must know that mistakes had been made. But he could not name those mistakes.
Consider the tragedy of (US department store) Montgomery Ward’s slide into oblivion. The seeds of Montgomery Ward’s destruction were planted 50 years ago by Sewell Avery, former chairman/CEO of Montgomery Ward & Company. Between 1941 and 1957, he refused to open a single new store. He rationalised that the US would go into severe economic depression following World War II. “Why build $14-a-foot buildings,” he said, “when we can soon do it for $3 a foot?”
Montgomery Ward’s Chicago rival Sears Roebuck did not share Avery’s pessimism. Sears began its expansion into the suburbs, doubling its revenues while Ward’s stood still. Sears never looked back. Montgomery Ward never caught up.
The problem is not that the CEO of Montgomery Ward made a mistake. All CEOs make mistakes. The problem is not even that Avery refused to acknowledge that he made a mistake. The problem is that Avery became MORE committed to his mistake when it became clear that events were proving him wrong.
Twenty years of social psychology laboratory studies and common sense confirm the existence of the LBJ Effect, named after the American President who put more resources into the Vietnam War once it became clear that the war could not be won.
The LBJ Effect is a tendency for decision makers to escalate commitment to a failing course of action.
• Under the leadership of An Wang, Wang Labs placed its future on selling proprietary software and peripheral equipment. When it was clear that the market was moving to open systems, Dr Wang increased spending for R&D and advertising on its closed systems architecture.
Boards want to hire champions. Champions are bred to be decisive and self-confident. Hiring champions is a double edge sword. Champions will have difficulty admitting that they are failing.
• People with poor self-concepts are immune from the LBJ Effect: evidence of failure confirms their negative evaluation.
Along similar lines, Professors Ulrike Malmendier of Stanford University and Geoffrey Tate of the University of Pennsylvania looked at the personal portfolio decisions of CEOs in Forbes 500 companies. They identified “overconfident” CEOs as those who under-diversify their personal portfolios at the expense of maximisation of their stock option holdings.
These “overconfident” CEOs tend to engage in more acquisitions than average. They were prone to using corporate cash and untapped debt capacity to acquire companies.
Since the late 1990s the average merger destroyed shareholder value for the acquiring firm while providing a good opportunity for shareholders of acquired companies. This negative outcome is particularly true for the type of acquisitions preferred by overconfident CEOs: acquisitions that diversify the company out of its core competence.
Of course, history has little impact on the overconfident CEO. They are predicated to believe that their acquisition is special. Their acquisition will prove the exception to the rule.
Warren Buffet said it best in the 1981 Berkshire Hathaway annual report:
“Many managements apparently were overexposed to the story in which the imprisoned handsome price is released from a toad’s body by a kiss from a beautiful princess. They are certain that their managerial kiss will do wonders for the profitability of the target company.
“We’ve observed many kisses but few miracles.
“Nevertheless, many managerial princesses remain serenely confident about the future potency of their kisses.”
Why do you need competent boards dominated by strong outsiders?
From a behavioral science perspective, the argument goes like this:
1. Good CEOs are champions. Champions believe in themselves. If they did not have believe in themselves, boards would not want them leading the charge for increasing shareholder value.
2. In the absence of a strong countervailing force, some CEO champions will rigidly hold on to a once successful business model that ought to be thrown away. In the absence of a strong countervailing force, some CEO champions will foolishly rush into M&A activities that defy both logic and statistical probability. In the absence of a strong countervailing force, they will pour more resources into a failed course of action.
3. This strong countervailing force is called the board of directors.
At a cultural level, the LBJ Effect can be fought by the board insisting on a culture where it is acceptable to fail, to learn from mistakes, and to try again. It is a culture where “mid course correction” is not necessarily a sin and “stick-to-itness” is not necessarily a virtue.
Perhaps the most famous example of a corporate culture that supports this notion is Johnson & Johnson (Wesfarmers is a good Australian example). On the desks of most executives within the J&J organisation is a framed one-page document called, “Our Credo.”
The J&J Credo is a series of principles that govern management decisions:
When there was a concern that a batch of Tylenol had been poisoned, a division manager unilaterally ordered all bottles of Tylenol off the US market. That action was taken without consulting corporate headquarters. It was justified to management on the basis of the credo. Senior management at J&J backed the local manager and the employees were enormously proud of it.
This use of a corporate values statement is not unique at J&J. We have consulted at other companies with credos. And some of these companies had problems as severe as the Tylenol crisis. But in no other company would a middle level manager make a major decision based on an esoteric company principle. With respect to failure, the J&J Credo states:
“Employees must feel free to make suggestions and complaints ... We must experiment with new ideas. Research must be carried on, innovative programs developed, and mistakes paid for.”
In other words, failure is not “bad”. It is part of the necessary price for being innovative.
Boards seeking to influence CEOs to make mid-course corrections have a semantic problem. Leaders must be convinced that mid-course corrections will not be labeled as “indecisive” or “waffling.” Such negative words are inconsistent with a positive sense of self. On the other hand, adaptability in the face of changing circumstances is consistent with a positive self-concept.
Some CEOs deride Sarbanes Oxley as an example of legislative overkill. They say that it will move the board/CEO relationship into an adversarial stance. Such a stance will only harm shareholders and waste resources. Our perspective is that the LBJ Effect reflects the fact that powerful people are only too human. And they are all too human in predictable ways.
A valid checks and balances system keeps the LBJ Effect from getting out of hand.

* Maryanne Peabody and Laurence J. Stybel are co-founders of Board Options ( Its mission is to increase board effectiveness through the application of practical behavioral science