Warren Buffett: Why Rationality Wilts In The Face Of The Institutional Imperative

In his 1989 Berkshire Hathaway Shareholder Letter, Warren Buffett explained why the rationality of the most decent, intelligent, and experienced managers wilts in the face of the institutional imperative. Here’s an excerpt from the letter:

My most surprising discovery: the overwhelming importance in business of an unseen force that we might call “the institutional imperative.”

In business school, I was given no hint of the imperative’s existence and I did not intuitively understand it when I entered the business world.

I thought then that decent, intelligent, and experienced managers would automatically make rational business decisions. But I learned over time that isn’t so. Instead, rationality frequently wilts when the institutional imperative comes into play.

For example: (1) As if governed by Newton’s First Law of Motion, an institution will resist any change in its current direction; (2) Just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds;

(3) Any business craving of the leader, however foolish, will be quickly supported by detailed rate-of-return and strategic studies prepared by his troops; and (4) The behavior of peer companies, whether they are expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated.

Institutional dynamics, not venality or stupidity, set businesses on these courses, which are too often misguided. After making some expensive mistakes because I ignored the power of the imperative, I have tried to organize and manage Berkshire in ways that minimize its influence.

Furthermore, Charlie and I have attempted to concentrate our investments in companies that appear alert to the problem.

You can read the entire letter here:

Berkshire Hathaway 1989 Shareholder Letter