Monday, August 8, 2011

Appropriate Compensation #9: Upon Mature Reflection

I worked with a guy once who had a wonderful way of reversing his expressed opinion on a matter, which was particularly useful when he found that it conflicted with the boss’s opinion.

When it was clear that he’d dug himself into a hole, he’d invariably preface his remarks with: “Upon more MATURE reflection….”

We’ve identified a number of significant issues that we believe add risk to TRE transactions when compared to the typical factoring transaction. The financial statement issue; the personal guarantee issue; the lien priority issue; for example, are all significant and all clearly differentiate the TRE transaction.

Before moving to the question of what kind of pricing response might be appropriate I want to bring up another element that is perhaps the most difficult to analyze and probably impossible to quantify. It is, nevertheless, quite real.

It is the fact that a real-time, competitive auction environment creates a unique potential for self-defeating behavior: behavior that is influenced by the trading environment in a way that does not affect the typical factoring transaction.

There is a great deal of literature about the impact of bidder motivation and psychology on behavior in various auction environments.

The TRE auction environment is one in which, unlike some others, the Buyer does not have the practical option to exit the trade to correct a buying or bidding error. There is no opportunity to say: “Upon more MATURE reflection…..get me out of this thing!” And then to sell what might have been purchased in error, or in haste, or under pressure to put money to work or even just in a momentary fit of pique at having lost a number of auctions that day.

All of these things, and more, can be the cause of a Buyer looking up from an Awarded Auction Report and saying “I can’t believe I really did that.” The only thing to be done at that point is own up to the lapse and hope the thing actually gets paid.

That is not to say that the decisions of the typical factoring company are not subject to the motivations of competitive pressure and internal goal setting. Of course they are.

But they are not subject to the pressures of a real-time auction environment, which requires that decisions be made very quickly, usually without prior warning, frequently in the face of new information that has not been previously analyzed, often in an environment of excess market liquidity, and often in competition with others with differing motivations for participation.

One of the dynamics proven true in competitive auctions is the increase in the perceived “need” to win as the number of “lost” auctions increases. That is, a buyer’s propensity to act against his own bidding rules will tend to increase with the number of unsuccessful bids made. That’s a dangerous but very real temptation when being the successful bidder is defined in terms of “winning” the auction.

In fact, the successful bidder is the one who only bids according to his pre-established bidding rules.

And it might be that a consistently successful bidder is NOT particularly successful at keeping funds deployed in some market environments. But that’s a different question.

I can tell you that, based on my own experience, there is a dynamic in the competitive, real-time auction environment that has clear error-making potential. Some Buyers will be more susceptible to it and some less. So the actual level of incremental risk is as much Buyer-driven as process-driven.

Whatever the actual MEASURE of incremental risk, the fact of incremental risk in real-time, competitive auctions is well documented in academic literature and clearly felt in practice.

I confess that I have found myself (and I will bet that many other Buyers have as well), after placing a bid or winning an auction, wishing that “upon more mature reflection” there was an un-do function on the TRE platform!

It is no coincidence that the competitive nature of the TRE buying environment is stressed in TRE's marketing to SELLERS rather than to Buyers!

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