"Misunderstanding of the Nature of Company Performance: The Halo Effect and Other Business Delusions"

Phil Rosenzweig

California Management Review

Summer 2007, pp. 6-20

The "halo effect" refers to "the basic human tendency to make specific inferences on the basis of a general impression." An example would be a performance evaluation where a person who performed well on one important dimension would also be rated inaccurately higher on other dimensions.

The author of this article claims that "As long as people are asked to assess companies when they already have an opinion about their performance, their evaluations are likely to be biased—and their resulting findings of questionable value." The popular studies intended to uncover the "secrets" of exceptional companies (Tom Peters and Robert Waterman's "In Search of Excellence"; Jim Collins and Jerry Porras' "Built to Last"; and Jim Collins' "Good to Great") are all perceived to have fallen under the halo effect by relying too much on subjective descriptions (media reports, retrospective descriptions, etc.) of companies that were performing very well at the time of the study. In fact, a large portion of these companies were unable to maintain their high performance after the books were published, and their success may not have been clearly attributable to the "principles" or descriptions provided in the books. Rosenzweig says these studies "have helped promote a fundamental misunderstanding of the nature of company performance. They have diverted our attention from a more accurate understanding of what it takes for companies to achieve success."

Rosenzweig identifies three misconceptions about company performance:

• That there exists a formula, or a blue-print, which can be followed to achieve high performance—"In fact, formulas can never predictably lead to business success with the accuracy of physics for a simple but profound reason: in business, performance is inherently relative, not absolute...companies compete for customers, and...performance of one company is inherently affected by the performance of others."
• If we mistakenly believe that firm performance is absolute, not relative, we may wrongly conclude that it is driven entirely by internal factors, such as the quality of its people, the values they hold, their persistence, and the like.
• Since strategic choices are made under conditions of uncertainty about competitors, customers, and technology, they always involve risk. Even good decisions may turn out badly because of this element of risk.

The author concludes that "The task facing executives is to gather appropriate information, evaluate it thoughtfully, and make choices that provide the best chances for the company to succeed, all the while recognizing the fundamental nature of uncertainty in the business world."

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