The art of high-quality decision-making – with David Holland

Every conversation we have on The Value Perspective podcast ends with us asking our guest for two things – a book recommendation and an example of a bad outcome that can be attributed to a poor decision-making process. As the co-founder of a corporate strategy firm, company valuation and cashflow expert David Holland is spoilt for choice on the latter and so, instead, he condenses his answer into a single theme.

“If I had to wrap it all up as an idea, I would say financial engineering,” he tells us. “There are countless decisions I think are poor-quality because they are predicated on too much debt and on overvaluing debt. It is insane to be levering up to the extent that many companies do because of course, by doing so, you are increasing your probability of default.

“And if you get into that situation, you have angry clients, suppliers asking for money, employees talking to other companies – and you are going to spend your whole day dealing with bankers. So I distrust financial engineering and I distrust managers who are too reliant on it. I want to hear about operational improvements, how they are running a better business and how they are making positive net present value investments.

Value destruction

“What I do not want to hear about is financial engineering, which destroys more value than it creates. Yes, if you are lucky, you might end up fabulously rich but, more often, it can be highly costly. I do not think most companies really and truly understand the risks of debt and I do not think they properly model it. If they did, they would not use as much of it.”

Of course, taking on debt is just one of a huge range of possible decisions facing businesses – and those who run them – every day. In time, they will eventually end up knowing which they got right and which they got wrong. Given none of us has the power to tell the future, however, what matters more than the outcome of any individual decision is the quality of the process used to reach it.

In Distinguishing between skill and luck in investment, here on The Value Perspective, we highlighted our podcast with Michael Mauboussin, where the market strategist and author discussed using a two-by-two matrix – originally promoted by the behavioural scientists J Edward Russo and Paul Shoemaker – as a way of analysing process (good or bad) versus outcome (good or bad).

Three components

For his part, as we covered in Helping probabilities pass the clarity test, Holland picks out three components of “a high-quality decision”, adding: “The first part is what do you want to gain from the situation? Next you need to understand what your alternatives are? And then, thirdly, what information do you need? That will be the probabilities, the key drivers and the range of those drivers.”

After we spoke, Holland kindly sent through the following table of questions, which he has created to help businesses assess the quality or otherwise of their strategic decision-making process. It starts with how they judge the quality of a decision – you should know enough from this piece not to get the one-point answer – and finishes with how they assess the prospects for other potential roads along which they could travel.

As Holland notes in Four quadrants, strategy is the first element of decision-making businesses must address. “What can you do about clarifying your objectives?” he asks. “What are the opportunities and alternatives? These are what you need to run through a decision model, using a high-quality decision process – and that is because it is so much better to get the decisions right upfront than to try to fix bad decisions later on.”