Business concepts and applications

Business

In order to determine the degree to which business schools have failed the nation in the way that they train their students, we must examine the antecedents of the recent economic meltdown, the ways in which business schools train their students, and the links between these two. It is hypothesized that business schools are not the main contributor to the problem, but rather a failure of government.

The current economic meltdown was precipitated by a number of different factors. An extensive study by the Wharton School of Business (2008) analyzed these factors. The first major contribution to the crisis was courtesy of the Federal Reserve, which held interest rates below equilibrium levels in the months and years following the dot-com bust and the September 11th terrorist attacks in order to stimulate the economy. With stocks in the doldrums, the excess money in the system as a result of the Fed's actions was pumped into real estate, creating a housing bubble. With too much money to invest, bankers allowed their lending standards to falter, resulting in a dramatic increase in subprime mortgages, or mortgages of lower quality. Bankers were thus fed by greed, since such mortgages could attain higher returns for their higher risk (Palmer, 2008).

The next step in the problem was that the banks, in an attempt to offload some of this excess risk, bundled their mortgages into what were known as collateralized debt obligations. These instruments were, in essence, not nearly as safe as they were made out to be. When the Fed raised interest rates in the middle part of this decade, the housing bubble burst. Banks were soon inundated with foreclosures as lenders could not cover their payments, nor could they sell their homes.

Wall Street is attributed blame for the crisis for two reasons -- the excessive risk-taking on the part of lending institutions, and the use of complex derivative instruments to spread the risk throughout the economy and around the world. For their part, the bankers were simply doing their job -- they took on risk in order to increase shareholder value and then tried to spread that risk around to others, who were more than willing to pay for it.

Business schools today are based on capitalist theory and the concepts of risk and return. These concepts derive from study of market behavior, and accurately reflect human nature. While humans are sometimes altruistic or otherwise irrational investors, for the most part their actions are based on greed. They will do what is best for themselves. Business schools are based on this fundamental concept.

So for example, employees at banks are willing to take on higher risk levels because those risk levels improve bottom line performance. Managers, who should be representing the interests of shareholders, allow the increased risk because it produces better short-term returns. The time and risk orientation of the shareholders, in this case, was misinterpreted. Leadership at the highest levels on Wall Street -- not in all firms but in most -- failed to uphold the concept of long-term maximization of shareholder value, instead focusing on short-term returns and ignoring the risk associated with these returns.

What is taught in business school does not support this. The orientation towards profit is natural, and a part of the manager's job. However, the orientation towards excessive risk-taking is not taught in business school, but rather learned in the workplace. The government exhibited lax oversight of the banking industry. Indeed, the FDIC chairperson Sheila Bair had called for increased regulation of the mortgage industry and those calls fell on deaf ears in both Washington and on Wall Street (Lizza, 2009). Those within and without the industry were more interested in the short-term profits generated by the industry than protecting the public.

The short-term time orientation of managers that causes them to ignore risk in favor of returns is a strictly Wall Street phenomenon. That is the land of quarterly earnings reports, and substantial punishment of a firm's stock if it fails to live up to expectations. The market movers on Wall Street have a short-term time orientation and that drives the bankers to have one as well. That the government encourages such behavior by bailing out banks so that they do not need to face the negative consequences of risk only exacerbates the problem.