Thought of the Week - Do managers know when to hire?

But at least, one would expect managers to hire people at the right time, namely when there is plenty of opportunities to grow the business and there will be an actual need for additional employees. But new research indicates that many managers may not even be able to do that consistently.

The necessary ingredient for a manager to go on a hiring spree is optimism about the future. If the CEO of a company is not optimistic about the future growth of the business, it is unlikely that the number of employees of a company will grow substantially. But here comes the rub: If managers are over-optimistic about the future, they may hire too many people that they then have to let go again a little later.

The more optimistic managers are, the more they tend to hire. But the new study also found that the influence of manager optimism on hiring decisions tends to get larger when investor sentiment about the company or the company’s profitability is low.

The driving force seems to be that when a company is doing well, it is already hiring more than its peers, and manager optimism doesn’t really create an additional hiring push. However, if a company is struggling (maybe because the economy is not doing so well or because the firm itself is struggling against its peers) an overly optimistic manager can make all the difference between hiring additional people and not hiring them. The problem is that optimistic managers in such struggling companies start to hire too many people and then end up with a cost base that is rising faster than revenues and too many people trying to find work.

The result is declining margins in an already struggling business and declining labour productivity as more and more employees engage in additional bureaucracy to justify their existence in the company. Have you ever wondered why so many malfunctioning companies have endless meetings that never lead to anything? Because there are lots of people in this meeting who actually aren’t needed to run the business but have to somehow busy themselves and show that they add value when in fact, they don’t.

The irony of it all is that once the manager loses his or her optimism again, external consultants are then called in to reduce costs and make the company leaner. This then leads to wonderful cookie-cutter prescriptions to reduce the number of employees across all units by a certain percentage without any understanding of which units and which people in the organisation actually add value. In my experience (and you can tell I have been burnt by these exercises before), it is often the politically well-connected people that manage to save their behinds at the expense of people who actually do the work who get fired.

The people who suffer are of course the employees who lose their jobs, but also shareholders who face a company that is run into the ground by over-optimistic managers who hire the wrong people at the wrong time.

The research also shows that there is only one way to rein in these over-optimistic managers. And no, it’s not the shareholders. It is good governance. Companies with better corporate governance are less prone to make these mistakes, while companies with a board that is too cosy with the CEO and senior management are likely to let things slide and indirectly create a mess.

Thought of the Week features investment-related and economics-related musings that don’t necessarily have anything to do with current markets. They are designed to take a step back and think about the world a little bit differently. Feel free to share these thoughts with your colleagues whenever you find them interesting. If you have colleagues who would like to receive this publication please ask them to send an email to joachim.klement@liberum.com. This publication is free for everyone.