Book Review: Ending the Management Illusion: How to Drive Business Results Using the Principles of Behavioral Finance

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Book Review: Ending the Management Illusion: How to Drive Business Results Using the Principles of Behavioral Finance By Hersh Shefrin, McGraw Hill: 2008, vii + 317 pages

Someone whose business responsibilities or research areas do not overlap with behavioral finance will find Shefrin's latest book an interesting and efficient way to learn about how behavioral principles can be extended from the realm of investment decisions to the arena of corporate financial management. Most chapters, which can easily be digested in separate sessions, are concise and interesting. The text is written at the middle-management level and will also be useful for academics that teach or consult for executives.

The first chapter of the text is one of the strongest. It uses excellent real-world illustrations to explain the psychological arguments and traits that induce educated, powerful individuals to make biased decisions and introduces Shefrin's recommendations for improving the way corporations are managed. Improving access to financial information and financial literacy for all of a firm's employees are cornerstones of Shefrin's recommendations for ways to eliminate behavioral biases, and he provides several examples of how firms have successfully attained these laudable goals. The second chapter discusses the financial metrics the author would include in each employee's training, but the level of discussion is a bit advanced, even for finance professionals if they do not use valuation principles on a regular basis.

The middle chapters of the text are its weakest components. Chapter 3, "Narrow Financial Focus on Projects and Financing: Traditional Approach", contains a litany of stories of financial mis-steps made by managers at a variety of familiar firms that do not really serve to advance the educational recommendations the author is making. It also lavishes praise on firms that use managerial techniques of which the author approves in a way that sounds self-serving and diverts attention from the author's main points. The discussion of the difference between Free Cash Flow to the Firm and Free Cash Flow to Investors remains difficult to parse after several readings. Chapter 4's reliance on accounting measures of return and investment is puzzling given earlier discussions of the importance of distinguishing between accounting profit and actual cash flow. Chapter 5, "Involving the Workforce in Financial Planning", is quite dense. Corporate managers could probably convinced of the importance of using simulated games and other experiential techniques to teach employees about the crucial value drivers of the business they are in without a long pretend "conversation" at an environmental firm. …