Managing a company in the 21st century is a risky business, demands for even better performance are increasing on a day-to-day basis and management has never been under more stress to add value to investors.

The majority of investors by value are of course the institutional investors who are only interested in the balance of their portfolio and the growth prospects within the next reporting period.  There is by nature no intrinsic loyalty towards stocks from these investors and they tend to react by managing through the "herd instinct" of the overall market.  It is indeed sad that corporate decisions are based on the expectation of market reaction rather than the validity of the creation of wealth by the idea or project within the business.  This behaviour is perfectly understandable as the portfolio managers are merely reacting to the need to add wealth to their shareholders; indeed it is a very vicious circle.

Risk managers need to be aware of likely reactions from corporations who are striving to make themselves a viable investment vehicle for the institutional investor.  The institutional investor is in its pure form essential for the corporate as they provide essential liquidity to the investment market.  However it is the way corporations react that makes the market an inhibitor to individual corporate growth, if not the whole market.

One way for a company to react is to see where it is not conforming to the industry averages listed as ratios.  These efficiency ratios drive some high level corporate decision making in the interest of short-term value creation.  For example a company may be seen to be more expensive than like industries in the area of staffing.  It reacts by creating a large number of redundancies, thus next time it is measured it performs better than the industry average and thus is rewarded by the market with an increase in its share price.  This illusion lasts for a short time then more is demanded, the spiral continues until there is no more to give.  This action of short-term value creation via redundancy is ultimately rewarded by the market moving away from the company in the long term and its survival is then problematic in its current form.

Decisions need to be based on more than just conformity to an average, indeed very few meet the norm, this means nothing as long as value is created in line with the corporate culture and vision.  For example the company as described above that has met short-term expectations by creating an illusionary cash flow via redundancy destroys itself in the long term because it makes itself unavailable to its customers because there are insufficient staff to meet the needs of the market.  Thus closing branch offices and centralising functions merely serve to shrink the client base.  New hungry emerging business then take market share, they grow through their lifecycle and become long-term victims.

The above demonstrates the downside of downsizing to meet the short-term expectations of an intrusive investment market without weighing up the long-term ramifications.  Again risk managers need to be aware of the decision-making environment they work within and be prepared to safe guard the long-term wealth of the entity.

Downsizing for productivity and positioning for future growth is necessary in today's business world but downsizing to conform to ratio analysis is corporate greed and stupidity in its purest sense.