Information Cascades and Law Firm Strategy
Posted By Rob Millard - 1 Comments -
Much law firm strategy, especially in smaller to medium sized firms where the partners all know each other, is crafted in strategy meetings or at strategy retreats. Typically, such meetings consist of some preparatory information being presented and then, quite quickly, the meeting moves on to consideration of a number of alternatives. It is here where the phenomenon of an “information cascade” can rear its ugly head.
In 2005, behavioral economist Robert Shiller and Karl Case conducted a survey among San Francisco home buyers, measuring their perception regarding likely house price movement in their market. The median expected price increase, over the next decade, was nine percent per year!
Obviously, history has proved them to have been badly wrong. According to Shiller & Case, their baseless optimism was based on two factors: salient price increases in the recent past and the apparent, and contagious, optimism of other people. In effect, an information cascade.
People, it seems, are greatly influenced by a process of social contagion whereby their opinions are heavily skewed by the views that have already been expressed by others. How might this play out in a law firm strategic planning session?
Let us consider that one of the options under consideration is to invest more heavily in a small office that the firm has in another city, perhaps by acquiring a small firm there. Smith is the first to proffer an opinion. He supports the plan. Jackson, who is next, now knows Smith’s judgement. If her independent judgement is otherwise, but she trusts Smith’s judgement no more and no less than her own, she would now be indifferent. She may choose one way or the other, in effect ”flipping a coin.”
Now let’s introduce a third person: Jones. Let’s assume that Jackson’s coin landed on the side of agreeing with Smith and supporting the plan. Jones believes that the plan is a mistake but feels that his reasons for this are inconclusive. He may stick to his guns and oppose the plan, or he may follow Smith and Jackson. Perhaps, he might think, they know something he doesn’t. If he does support the plan simply because Smith and Jackson did, then he is now in an information cascade.
Next come partners Miller, Peters, Carlton and Barnes, and so on.... Assuming that they do have compelling evidence to discredit the plan or some other reason to strongly disagree, they are all likely to follow Smith’s suit. Even …. if Smith was dead wrong and the plan is a terrible one.
Such information cascades are pervasive in the real world. Why do some restaurants thrive while others, equally good or better, stagnate? Why did the folk in Schiller and Case’s study all believe house prices would increase far in excess of inflation? Why did everybody think that collateralized debt obligations (CDOs) and credit default swaps (CDSs) were really, really good (and safe) investments?
The solution is of course to get some empirical evidence of what your partners think about key issues before the herd mentality steps in. This is relatively easy to do if the issues are straightforward. In that case, a simple survey will probably do. In more complex issues or where the risks associated with failure are greater, nothing beats one-on-one discussions with your partners before the meeting. Lawyers have perhaps a greater propensity towards critical-analytical thought than most and they often have personalities that are better suited to stand up against 'herd thinking,' but few would suggest that they are totally immune to it.
Thanks to Mark Thoma at Economist’s View, who blogged about this phenomenon as it affected recent events in investment banking in his post titled Information Cascades and the Financial Crisis. Let’s hope that it does not apply equally to the contents of the Paulson Plan and the Emergency Economic Stabilization Act of 2008.
See also an article by Robert Schiller in the New York Times of 2 March 2008 titled: How a Bubble Stayed Under the Radar. Shiller is professor of economics and finance at Yale and co-founder and chief economist of MacroMarkets LLC.
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