Managers and loss aversion

This review will discuss the strengths and weaknesses of the article ”Traders, managers and loss aversion in investment banking: a field study” by Paul Willman, Mark Fenton-O’Creevy, Nigel Nicholson and Emma Soane. It is claimed in the article that managers tend to concentrate much more on evading losses in the business instead of aiming to make profits. The way managers and traders interact with each other in their working environment is also highlighted. The authors claim that traders are becoming more and more autonomous and an effective managers’ control seems difficult to occur.

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This statement is further elaborated by conducting a research regarding four major investment banks with offices in London. The participants in the survey, 118 traders, 10 senior managers and trader-managers, express their opinions about taking risks, freedom and bonuses. Indeed, it is important to distinguish risk aversion and risk seeking. Glen Arnold claims that ”a risk averter prefers a more certain return to an alternative with an equal but more risky expected outcome”. While a risk seeker prefers a more uncertain alternative and actively seeks risks that might possibly reduce a loss.

An example of people who love taking risks could be those that like gambling and casinos. They are clear about the possibility of loosing but still the thrill of financial risk is too high to resist. It is ironically though that ”rich people can afford to take risks, but they don’t need to. While the poor need to take risks, but they simply can’t afford to. ‘ One could agree with the the article that losses could have as high influence over people as well as making profits. Many psychological studies argue that mitigating losses is inevitable part of human nature.

An example to prove this statement is that if one has i?? 500, he or she would prefer to save the money instead of investing it somewhere aiming to double it. The risk of losing these i?? 500 is too high and consumers tend to prefer safety first. The authors of the article expand on this idea using the Fig. 1 where the prospect theory utility graph has arcuated shape in the positive area. This brings us to the conclusion that people are more willing to cut losses rather than making gains simply because mistakes can be very costly.

As one manager who took part in the research project stated: ”My veto works only one way – to reduce risk. ” In addition, traders achieve a great level of autonomy and managers become interventionist in the realm of losses. The authors’ preferences are unequivocal: high bonus payments depreciate gains in investment banking and ”the concealment of losses by traders” leads to a widespread business burden. One can agree with the article in respect of the point that direct supervision of traders is time-consuming, requires resources and efforts (Mintzberg, 1983).

As highlighted in the paper many managers are former traders, which creates concerns. Some of them want to continue trading and do not feel fully engaged in their work, do not take it seriously. As one of them claimed with reticence ”management is becoming more and more a full time job”. This illustrates that most managers are not happy with their position and the smaller payment they receive, additionally creates conflicts and even lack of motivation. As explained in the article managers are unable to monitor traders all the time, so the relationship between them is mainly based on trust and on mitigating losses.

However, if managers are not familiar with the potential problems their organization is facing, that creates serious concerns. If loss-adverse traders are able to remain unseen then the future of the organization is put on line. A consequence of a similar situation is Barings’s collapse, where profits have been inflated. In this matter, it is logical to conclude that control over traders is very little and sometimes insignificant. So one might suggest that traders should be monitored not only when they are making losses and ”get out of line” but also when they are making profits.

This might help to actively control losses and diminish them. As described by Glen Arnold it is essential to have ”a review of what went right, what went wrong, and why, may enable better decision making in the future. ” One might claim that if there is not a constant monitoring of traders’ actions, then managers are concerned mainly about the short run, while they should also pay attention to future perspectives and aim to improve the business. Another cause for concern highlighted in the article is connected to the high bonus payments and more importantly the way in which they are paid.

First, contingent pay was mentioned to be a very high proportion of total pay which is believed to be a potential cause for diminishing gains in the business. Furthermore, the time of the year might influence the decision of whether to take risks or not. For instance, one could agree with the article that in the last months before a profit for the year, people need to become risk averse and keep things tight. However, one of the traders that participated in the research project claimed that he or she would prefer taking risks in the last couple of months, which creates a contradiction.

However, as we can see the authors recognized that this is highly personal and depend on human nature, which is one of the strengths of the article. One might also agree that the structure of the article is good and proficient and the language that the authors use is competent and efficient. Moreover, one could agree that the article puts some serious issues and questions about management of traders, and in places contributes to business knowledge. However, in order to informatively analyse the paper and be able to make conclusions about it, it is necessary to focus on its limitations.

There are several weaknesses that could be outlined. First of all, it might be considered out of date because of the lack of recent data and research. Furthermore, the research is done in 2002 which is before the Financial Crisis and that makes it quite obsolete and may be even irregular. Nowadays, business environment is changing pretty fast and keeping information up to date is essential. Although the data was collected after a bull market run, the authors give advance notice on this matter and pay attention that it might influence their research and results.

Second, the article cannot help in making conclusions about different markets and trading simply because it is focused only on four investment banks. So, the research seems limited and cannot be used to describe other markets. Moreover, one might believe that the interviews taken are not fully objective and they are simply opinions of some managers and traders. Additionally, the authors selected only those representative examples which prove their theory but do not mention those that are more controversial. This brings us to think about how clear and accurate is the research method used.

Indeed, much of what is written in the article draws attention on relevant theory. Still, there is no fixed model that best describes the nature of traders and the focus on relevant theory seems to over complicate the issue. An outcome of the article is connected to understanding the behavioural finance, in other words the fact that managers tend to feel losses much more accurately than they feel gains. The influence of psychology on people, in this case managers and traders, is huge and many investors feel redundant about taking risks.

However, giving the context of the article a consumer might be quite disappointed of the fact that his or her investment might not be maximized due to the lack of motivation of traders and managers. However, the aim of the authors to highlight the management of traders in financial markets and their role is powerfully argued. Still, taking into account some limitations, I would claim that a further development and investigation are needed in this area in order to make a general and advanced conclusion on a matter.