Chapter 4 Communication and Stakeholder Management – Capital Project Management, Volume I


Communication and Stakeholder Management


The story of Tesla’s brief life through 2018 made clear that there were some communication and stakeholder issues worth discussing. There they were presented much as they were in the business media, largely for the sake of investor interest. Of course, the list of stakeholders in the Tesla saga is more extensive than that, at least including environmentalists, employees, suppliers, regular car guys, and more. Most had legitimate interests, that is, this was no soap opera to them.

This chapter focuses on the management of project communication and project stakeholder interests. These two areas of interest are, individually, knowledge areas in the Project Management Institute’s paradigm of thought leadership in the area. The next chapter outlines that paradigm. Because these two areas were so acute in the Tesla story, a separate chapter has been given them here, especially toward executive interest in capital project finance.

After Studying this Chapter, the Reader will be Able to

Explain how formal methods and processes can be used by executives to communicate effectively with external stakeholders.

Compare and contrast a private investor environment with a post-initial public offering (post-IPO) one, focusing on the fiduciary responsibilities of executives.

Define corporate governance and provide examples of pitfalls from the research evidence, and contrast group phenomena from individual effects.

Define and briefly explain the practical relevance of these terms: principle–agent relationship, information asymmetry, and moral hazard.

Explain several ways how managerial biases in capital project decision-making processes can affect the cost of capital and project discount or hurdle rates.

Executive Communication in Capital Project Environments

The Tesla experience shows how important it is for managers of corporate capital, including many capital project managers, to consider communications issues seriously (Collyer 2017; Eskerod, Huemann, and Ringhofer 2016; Eskerod, Huemann, and Savage 2016; Muller, Turner, Andersen, Shao, and Kvalnes 2017). Though many technology-oriented people eschew such problems as common sense and not in need of much formal direction, the opposite is sometime the case. To illustrate, it is one thing to observe how Elon Musk’s methods of touching base with his benefactors were not only strained, but also elicited a move to have him ousted from one executive role, and even got him personally indicted by the Securities and Exchange Commission (SEC). That is so glaringly obvious and speaks so strongly to personality, the story might seem anomalous. However, it is another thing to dismiss it too quickly and think that managing the issues cannot be improved. It is simply not the case that common sense is as common as one thinks. Consider:

(Mukherjee May 3, 2018).

… Musk refused to answer questions from analysts on Tesla’s capital requirements, saying “boring questions are not cool” …

Morgan Stanley’s [official] said it was the most unusual he had heard in 20 years in the business, noting that “the analysts on the call represent the providers of capital that Tesla has throughout its history depended upon” …

… a Los Angeles-based private equity firm, called it “the single greatest CEO meltdown in American car history.”

Just when it looked like things had calmed down after a few months had passed, one small slip multiplied the damage several times over:

(Hunnicut August 30, 2018).

… Some corporate governance activists call for the chairman and CEO roles to be split between two people to improve oversight …

Musk has been under pressure over the company’s spending and after tweeting on Aug. 7 that he planned to take the company private, only to abandon the idea by Aug. 24 …

“BlackRock’s approach to investment stewardship is driven by our fiduciary duties to our clients, the asset owners … Our approach to engaging with companies and proxy voting activities is consistent with our commitment to drive long term shareholder value for our clients.”

Most executives are not like Elon Musk, and the aforementioned issues were not project-specific, but the point about the importance of communication remains the same—made especially acute here as it relates not only to project success, but also to corporate governance on the whole. Communications management is a vital element in overall stakeholder management when large amounts of investment capital are at risk. Especially, when large institutions become the major owners of a firm, as opposed to a widely distributed ownership among countless retail investors, each one becomes a credible voice and force in corporate governance.

As time goes on, corporate ownership (equity) is becoming more and more concentrated and institutional; combined with a trend toward greater activism, these points will only become truer over time.

Of course, internal communications are botched all the time, too. An abundance of evidence supports the assertion that categorically speaking, soft factors like poor communications plans, policies, and procedures are the most common causes of project failure (Cleland and Ireland 2002; Kerzner 2006; Meredith and Mantel 2009). But, soft does not necessarily mean informal.

An important principle in Weber’s original theory of bureaucracy (Wren 2007) is that managers are beholden first and foremost to the expectations of their offices, and formal communications should express that. By “formal,” it is usually meant official, usually written, perhaps legally binding, as well as obedient to standing organizational rules.

In its treatment of project communications management, the Project Management Body of Knowledge Guide (PMBOK) emphasizes formal communication issues, in part as a matter of formal documentation. As an obvious example, an overall project plan should contain a separate section that addresses formal communications for purposes of assuring contractual compliance, conflict resolution procedures, and paper trails if nothing else. Beyond documentation for archival reasons, the plan should specify who gets what information, when, and by what medium. Even if project documentation suggested in the PMBOK is never used operationally, it is not done merely for posterity. These days, of course, it is not uncommon for specific projects to have their own websites, at least for local consumption. Electronic media offer an incredible array of options, so the real body of knowledge is always a work in progress. But, the point seems timeless.

“Bureaucracy” can be of great use if understood and managed properly, even in innovative cultures. Joseph Schumpeter, the guru of “creative destruction” and “entrepreneurship,” insisted on this many decades ago, but nobody seems to have noticed.

Contrary to the popular belief, Schumpeter’s championship of entrepreneurship was not unequivocal. He saw, almost 100 years ago now, that even very large and old organizations can learn to be innovative and at least keep pace with the small guys. In the author’s favorite words, innovation processes are now routine, though, by definition, they are and cannot become routinely successful. Project management practices are case in point.

Corporate Governance of Investor Capital

When the word governance is used in the corporate context, it includes the forces that compel managers to maintain their fiduciary responsibilities to the owners of invested equity, bond creditors, and the like. Of course, there are many disparate forms of governance that represent all the various stakeholder groups, not just stockholders. The full list of executive responsibilities goes beyond fiduciary duties alone, but that is the focus for now. Given the present focus, then, it should be understood how going public changes a firm from the standpoint of investor expectations and interests.

An IPO’s Impact on Corporate Orientation

When Tesla went public in 2010, it meant that it became approved by the U.S. SEC to sell shares of stock on exchanges such as the New York Stock Exchange (NYSE), which sits among other stock exchanges all around the world in major centers of finance such as London, Hong Kong, and Tokyo. The process is called issuing an IPO. The offer is one of selling stock to the general public on an exchange. At that point, the corporation is said to be publicly owned or publicly traded.

On pre-IPO financing, private capital is almost synonymous with the term venture capital—except that field also includes the art of making leveraged buyouts (LBOs) of often-desperate firms, sometimes more pejoratively called vulture capital. The two strains of interest should not be confused, but private capital includes both financial arms under the one term.

That clarified, an important related term is angel investor. By bringing in the kinds of personal funds, it would take to keep a young company afloat, and usually motivated by a super-ordinate concern like saving the planet, for example, Musk was very typical of the classic angel investor—except the term usually refers to strong (and usually rich) believers who provide funds, but then stay out of the way. There is no formal definition, but, obviously, Musk was not an angel in this sense, and given his personality and style, it is difficult to imagine him not wanting active participation in return for the risks he took with his own money.

Also, Elon Musk was the major owner or stockholder of Tesla throughout the period being considered. Placing their money where their mouths were, the stated ambitions of Tesla founders did not include cashing out and getting rich quick(ly). Their stated ambitions were long term and lofty and foretold with a degree of certainty the ongoing re-investment of most of their potential personal gain, as well as the capital of external investors.

It is a matter of financial strategy as to what to do about publicly traded equity after an IPO, and in what combination this is done with issuing debt (i.e., selling corporate bonds). The point is that there are many options about what to do if-and-when a firm goes public. Still, in a basic sense, Tesla’s story was rather typical of how an IPO usually breaks a young enterprise from private capital sources of funding.

The next point, though, is that there is indeed a big difference between the expectations of pre-IPO investors and their associated risks, rewards, and entire sets of motives, compared to post-IPO investors. As one should expect, past an IPO, the expectations of investors can change suddenly, and in fact, usually that is why most private capital is withdrawn according to plan. It is typical, for example, for a venture capitalist to hold an expectation of a 20 percent return in only five years (prior to IPO), while the general public normally has much more modest expectations and different time horizons.

Again, IPOs have a reputation for making instant millionaires of most of an upper management echelon, and sometimes, this seems to be the main reason for taking the plunge, that is, for selling out to the highest bidder. It is not uncommon for a technology entrepreneur to have these goals in mind all along. Ironically, the Tesla team was patient about getting rich or at least, apparently more so than about saving the planet. They could have cashed out very young, very rich, and would have been well-justified for doing so.

With that in mind, consider the following article, its source, and its intended audience:

(Poletti July 12, 2016).

… “They haven’t really evolved to what typical public companies look like at this size and complexity,” [the CEO of JPMorgan Chase] said of Tesla. “When you have this kind of ambition, they have to build up credibility with the investor community” …

… Yet the company and its CEO act as if they are made of Teflon, and don’t need to have the types of checks and balances that corporations use to avoid disaster.

“There is a sense that there is a lot on their plate, and this is when you need the right kind of corporate governance structure in place,” Diamond [sic] said.

What is clearly at issue concerns the way that corporations are governed not only by the boards of directors, but also in every broad sense, including social and regulatory pressures of all kinds. As the discussion continues, the interpretations will be economic nature. But, economics is not always about money—its nature concerns a logic, a calculus of a kind, concerning how “value” is exchanged in all forms, generally among willing participants. For example, the politics of swapping favors among influential people is just as economic in nature as swapping stocks and bonds. Interested readers may want to investigate a relatively new field called behavioral economics.

Economic Interpretations of Corporate Governance

A significant amount of economics and finance research has investigated the impact of corporate governance on capital investment decisions, though it is difficult to synthesize too many of the specific findings into one consistent policy for all—one theory, if you will. Much study has been idiosyncratic to the specific research scenarios.

Just for the moment, the issue is the distortion of economically rational capital investment decisions made by the board of directors (BODs) as a group. In other words, the BOD itself is what researchers call a unit of analysis: here, as if it were a single-mined entity like one individual person. One might think of the issue being the group dynamics of this one particular kind of group behavior, except the concern is strictly about financial decisions. A later discussion will address behavioral biases in individuals, that is, the respective executive members.

Research suggests that any information asymmetries that might exist between corporate managers and external investors are no longer enough to justify using financial logic as the basis of selecting members of a corporate portfolio of companies to own and operate. Again, the modern view says a corporate portfolio should represent a wealth-maximizing diversifity of highly related (if not synergistic) competencies and capabilities, which takes expertise and insight, as well as complete information. The issue now is a bit more subtle, more pragmatic, and less abstract. For one thing, the level of analysis shifts from corporations, and their overall levels of performance as the units of analysis of concern, to BODs and their decisions.

Distortions to decisions and decision-making processes used by BODs are caused by the asymmetry of information between managers and shareholders and by manager–shareholder conflicts.

Each of these suggests agency problems, which refers to an extensively studied rubric called the principal–agent theory. This is first and foremost a branch of economics that studies economically irrationalities caused by imperfections in the principal–agent relationship, that is, an owner–employee relationship, or a boss–subordinate relationship, or an original equipment manufacturer–subcontractor relationship, or many other ways of expressing it, including a shareholder–executive relationship. In short, intentionally or unintentionally and hidden agendas aside for the moment, people do not always do what their bosses expect them to do. Everybody has a boss even throughout the structure of corporate governance, and there are economic losses or costs to the imperfections found not only in relatively informal professional relationships, but also in formal contracts and covenants.

Sometimes (and not always correctly), these imperfections are called “moral hazard” as economic categories go, but this is a poor term, in that no intentional moral lapses are necessarily implied.

Related research similarly suggests that there are three main sets of reasons that explain why investment reasons can be made incorrectly by BODs (Adjaoud, Charfi, and Chourou 2011). First and again, there is what economists call asymmetric information that exists between corporate managers and external investors. The information known to each side is not the same as the other side in either quantity or quality, and a common (but very arguable) assumption is that managers have access to more and more complete information that is relevant to the decision at issue.

Information asymmetry increases the costs of capital and can cause managers to reject some otherwise worthwhile project opportunities.

The second reason continues the logic previously noted. Again, asymmetric information creates the likelihood of agency problems. For example, the managerial incentive to enhance professional careers is not always aligned with the best interest of investors, a kind of moral hazard. This can lead to empire building or at least going to lengths to reinforce one’s job security, the manipulation of compensation opportunities, and just plain shirking of erstwhile responsibilities.

The many imaginable possibilities of “agency” can lead to either overinvesting or underinvesting, relative to pure economic rationality.

However, a more forgiving view (strictly of the author’s) might assert that such managerial indiscretions may actually reflect economically rational reactions to the misaligned incentives found in their business relationships. In other words, any economic immorality resides structurally in the hazards themselves and is institutional, not in managers’ reactions per se. On a case-by-case basis, anyway, it serves best to not accuse anyone of anything wrong until incentives are examined. The financial economics researchers being referenced never made any such accusations, but it is worth saying.

Third and aside agency problems, it must be admitted that simple managerial overconfidence may overvalue projects and lead to some of the same bad decisions anyway. A mistake in judgment carries no moral insinuation; one way or the other; it is a matter of competence.

Managers can be fired for making mistakes, but not personally sued unless a crime has been committed. This is the essence of separating ownership from management in capitalist philosophy.

More precisely, when one side has quantitatively and qualitatively different information than the other side, this raises the information risk to investors and compels from them the demand (as in supply and demand) for higher-risk premiums. Consequently, corporate managers underinvest, or in other words, do not approve projects that otherwise might be. Under the conditions noted,

external financiers will require a premium creating higher costs of external finance. If this premium is too high, firms should [be expected to] turn down some positive NPV projects rather than raise equity capital … uninformed external suppliers of funds interpret equity issues as bad news (a signal that equity is overvalued) compared to debt issues and demand a large premium (Adjaoud, Charfi, and Chourou 2011, p. 39)

In other words, the relatively uncertain or incomplete nature of shareholder information compels them to command capital investment price premiums (i.e., a higher cost of their capital) above the correct rate that would be required under conditions of more perfect information available to both sides.

In such instances, project planners’ assigned hurdle rates, the cutoffs for go or no-go project decisions become a bit too high and worthwhile project opportunities are foregone. It creates a conservative bias, as opposed to an optimistic one.

Think of the hurdle rate as the acceptable minimum return on an investment, such as a capital project on the whole, that must be demonstrated in the planning process in order for the project to get approved, funded, and started. Naturally, the hurdle rate itself will vary in accordance with the source and nature of the investment capital. In contrast to using external capital markets like Wall Street, using internal sources (e.g., retained earnings) suggests lower hurdle expectations, which alludes to one reason some companies get accused of sitting on piles of cash. Not only is that view cynical, it is economically irrational. Still, acknowledging that it is not wrong to hold profits in retained earnings (on the liabilities side of a balance sheet, as well as a relatively liquid asset on that side) for a later time when making capital investments is more opportune, it is nevertheless true that imperfections in decision-making regularly occur.

According to what is called the pecking order theory:

… companies prefer using securities that are less sensitive to managers’ private information. This infers that managers prefer to finance their new projects with internally generated funds. When externally generated funds are required, firms issue debt followed by various kinds of hybrid debt such as convertible bonds and finally issue equity (Adjaoud, Charfi, and Chourou 2011, p. 39).

The pecking order in the presence of information asymmetry, then, is from internal sources of funding, and then external forms of hybrid debt, and then equity.

Unfortunately, the complexities, complications, and uniqueness of the Tesla situation during the time it issued the specific convertible bonds that became rated junk due to cash flow problems alone by the end of 2018 make it difficult to interpret as any version of a pecking order problem. For one thing, while there was media criticism about doing that as opposed to issuing more stock from the beginning, there were certainly no retained earnings (or recent profits or cash) in the sequence to peck from in the first place. The logic in that criticism concerns the matter of possible default that was there from the start. Still, the pecking order problem is interesting.

Again as to one manifestation of moral hazard: “Managers have the incentive to build empires and entrench themselves, or conversely to work less, imitate the decisions of other managers, and take unjustifiable risks” (Adjaoud, Charfi and Chourou 2011, p. 40).

Here, it is fair to infer that managers means cadres of less conspicuous and powerful people than Elon Musk was, ostensibly acting alone—middle-level project sponsors and the like who should be involved in the respective decisions. It is edifying to consider differences in leadership styles, which will be left to the reader.

Next, “managers derive private benefits when investing a firm’s free cash flow in unprofitable (i.e., negative NPV) projects rather than paying dividends to shareholders.”

This may sound shocking because it suggests that managers prefer to invest in failures rather than pay the moneys as dividends; but, this is not what is being suggested. Irrespective of conscious intent, this describes a moral hazard that can exist in an institutional structure, in that inferior decisions can be made due to the way a corporation is governed by the BOD. Remember that the unit of analysis in this research is the BOD, as a decision-making entity, subject to group behavior phenomena partly due to its composition and structure.

Continuing, “however, insider ownership has the opposite effect. When private benefits are small, an increase in insider ownership attenuates overinvestment but exacerbates underinvestment” (Adjaoud, Charfi, and Chourou 2011, p. 41).

This does add an additional wrinkle, but it is important not to interpret an increase in insider ownership as a temporal sequence too literally. It contrasts insider ownership to external ownership, it does not necessarily describe the effect of actually adding greater insider-owner representation to a given BOD. Even if it did, it would be a mistake to assume the opposite causation, that is, of the effect of going public—as the general rule, from less-to-more external and independent representation by owners. Also, it does not necessarily contrast private versus public firms.

On a statistical (research) basis alone, in the relative presence of greater insider ownership compared to external ownership, where the rewards to the members are small as opposed to large, BOD decisions tend to be risk-averse, with both the positive and negative consequences that logically follow.

This does make intuitive sense. People are more careful with their own money than with house money in a gaming situation or if you will, other peoples’ money more politically.

That said, it cannot be suggested that decisions of the Tesla BOD were ever risk-averse on the whole at any time; also, the term small rewards does not apply regardless of what small could possibly mean. Whether or not the Tesla BOD could have benefited from greater or lesser internal-owner representation is a matter of speculation, especially because Musk was the major stockholder, CEO, and COB. It is probably better to worry about the multiple-role playing by the major investor than this heuristic research finding—in this particular instance. In other words, worrying about the composition of the Tesla board other than Musk, on the basis of this matter of governance as did the media on occasion, could be futile.

Still and more generally, careerism compels managers to

prefer short-term, lower-valued projects than long-term, higher valued projects … Managers tend to invest in relatively safe projects for reputational concerns. Further, … if bad performance is attributed to a common negative shock … they may prefer to follow the investment decisions of others, leading to suboptimal risk taking (Adjaoud, Charfi, and Chourou 2011, p. 41).

The herding idea is interesting, as one issue that was voiced in the media concerned the independence of the Tesla Members of the Board’s. By analogy, herding within a BOD may be likened to a groupthink phenomenon in organizational behavior. Groupthink goes beyond cronyism; it is a common effect in any group of people, whether or not they are even peers. Personalities aside, groups acting as groups tend to make risk-averse decisions. But, risk-averse does not translate to best, because, in the Tesla case, one cannot really hold personalities aside.

Even in a BOD of peers, sometimes, it is better to have a strong, even authoritarian leader rather than a relatively communal democracy. Musk was strong and authoritarian, though it is arguable as to whether his decisions were best. The Tesla BOD was not risk-averse at all; the simple observation is that Musk had a profound effect on it. Past that, as MOBs tend to know of each other at least by reputation, that career concern seems valid. Then, the diversification of employment risk is no doubt the economist’s way of expressing decision-making behaviors that covers one’s, let us say, avenues of escape. Altogether, so far the picture is one of a board that must have been—or would have been—more risk-averse than Musk.

Given the preceding quote that leaves to be addressed the time horizons of decisions, which brings the issue back to short-term profit versus the establishment of structural profitability not only for the industry, but more acutely for Tesla and its own reputation with investors.

In its young history, it is again interesting that not only did the Tesla founders not get rich quick(ly) and move on to other adventures, they stuck around and got extraordinarily rich in paper assets, that is, stock. They did this not only by making accounting decisions to plow would-be profits back into internal growth, but also by making strategic decisions that eschewed settling for limited opportunities in small markets, and rather, attacking the mass-market challenge.

They, at least, cannot be accused of short-termism, but pressures coming from Wall Street certainly impacted the BOD into taking a more sensitive stance about near-term investment rewards, as would be expected, right at a time of production crises and cash flow emergencies. Note carefully though, that near-term investment rewards is not the same thing as short-term investment risk. While it must be true that some of the Wall Street pressure came from relative latecomers with short-term investment concerns—traders if you will—it was just as certain that much of the pressure was coming from people who had invested years earlier. Then, wisely or not, they had long-term hopes not only for electric vehicles (EVs), but many also had hopes or the fate of the planet. In any case, collectively, they were not only getting impatient about positive returns, but also worried about outright solvency and collapse. To say that the board did “prefer short-term, lower-valued projects [to] long-term, higher valued projects” would miss the point that the costs of capital were simply coming due.

Four Main Sources of Concern

The literature describes four sets of concerns, addressing at once the BODs, ownership structure, managerial compensation, and leverage:


The governance role played by the BOD in reducing investment distortions is limited. First, the CEO may control the information received by the board, which affects the board’s judgment. Second, … career concerns tempt the board to overinvest during economic upturns and to underinvest during economic downturns (Adjaoud, Charfi, and Chourou 2011, p. 47).

These findings, of course, are all unfortunate. The sum of it might be to say that boards do no harm, and that would be a bit optimistic.

As it concerns Tesla, it suggests that the impact of information distortion may have even been exaggerated by Musk’s dual role of CEO and COB, and that leaves aside issues of personality and ownership. As to the career concerns of other MOBs, there were no notable statements in the media that related to economic conditions; but, for that matter, there were no reports of any major project disapprovals at all. Anyway, at this point, it bears noting that independence is sometimes a matter of degree and kind; here, the main issue is stock ownership. On the other hand, many MOBs are well-enough compensated for their services to include that as a career concern in the same vein as equity ownership. Nothing is being accused, though—one would have to have access to minutes of meetings to truly give a good assessment. Media items hardly contain that level of fidelity, which is a good example of information asymmetry with some irony in itself.

Ownership structure:

[E]nhanced monitoring by large shareholders decreases the overinvestment of free cash flows … however, … concentrated share ownership is unrelated to the magnitude of the free cash flow, suggesting that large shareholders are not particularly effective in solving the free cash flow problem (Adjaoud, Charfi, and Chourou 2011, p. 48).

The free cash flow problem, of course, starts with making any of it at all—think of free cash flow as the absolute returns to a project, the margin of main interest.

While Tesla was widely held by many retail investors, at the same time, much of its market cap was held by just a few prominent players who became quite vocal, even calling for Musk’s replacement. Of course, the simplicity of the finding is confounded once more, by Musk being all of CEO, COB, and the major stockholder by far. Not surprisingly, the BOD stuck with Musk:

(Barrabi May 1, 2018).

“Although … one person, could provide an effective leadership for Tesla at the early stage, now in this much more highly competitive and rapidly changing technology industry, it is more and more difficult to oversee Tesla’s business” [a spokesperson for stockholders] wrote …

Tesla’s board of directors … supported Musk “… the Company’s success to date would not have been possible if the Board was led by another director … In light of the significant future opportunities for growth and the careful execution needed in order for the Company to achieve it, the Board believes that the Company is still best served by Mr. Musk continuing to serve as Chairman.”

Then, while it might be inferred from the research that these voices initially had a good effect on making investment decisions, their subsequent impact on cash flow problems that the decisions created was muted. Altogether, that would be a negative effect.

The research also suggests that corporations that are not well-governed tend to make acquisitions as opposed to similar internal investments in capital and R&D that would likely be more profitable (Adjaoud, Charfi, and Chourou 2011, p. 49). This is difficult to assess at Tesla, though, because strategic management research also shows that acquisitions get faster results than internal development. As such, not only do the time value of money calculations affect any comparison, but even more so, strategic timing and concerns such as first-mover advantage. To forgo the latter would be an opportunity cost of the same capital. Recall that Tesla’s acquisition of SolarCity was controversial; but, because Elon Musk was its principal owner too, the instance would be considered anomalous from the theoretical standpoint. It was very meaningful, but it was so meaningful it should stand as its own case study. Otherwise, Tesla made a few acquisitions, but it was hardly a spree.

Managerial compensation:

If the owners know the managers’ employment opportunities, investment alternatives, and risk preferences … a managerial compensation contract may be structured to act in the shareholders’ best interests … On the other hand, the … contract depends on the characteristics of the firm’s investment opportunities as well as … managerial preferences for capital (Adjaoud, Charfi, and Chourou 2011, p. 46).

This issue should not even be addressed here, once again, because of the information asymmetries that one must assume existed between the Tesla BOD, the media, and the author—the latter being particularly in the dark. In any event, it is interesting that the following article appeared only a few months before Musk’s ouster attempt happened in the media:

(No author January 22, 2018).

… Tesla announced Tuesday that it would pay Musk nothing for the next 10 years — no salary, bonus or stock — unless the electric car company nearly doubles in value …

… the new pay plan encourages Musk to focus on increasing sales, profits and the Tesla stock price without holding him accountable to meeting production quotas. It also untethers him from … the only outstanding hurdle from the 2012 agreement … [to] maintain a gross margin of at least 30 percent for four consecutive quarters. The last time Tesla’s gross margin was that high was the first quarter of 2012.

At the face value, that excerpt is fairly plain, but the full article is difficult to decipher. Musk’s contract held him to meeting 10 operational goals, which should relate to financial goals like revenues from sales and gross margin, and in turn market cap and stock options, but production quotas were not among them. It is unclear how all this can happen without the latter. As the production of the 300,000th vehicle was a goal, however, it might be that the board felt that meeting quotas just for the sake of meeting quotas was not really the issue. In other words, it was not really a production scheduling problem in the grandest strategic sense. This certainly would forgive some of the promises quoted often in the media—forgiven by the BOD, that is.

Leverage:Overinvestment can be mitigated by issuing debt because managers will be forced to use free cash flow to pay the debt service instead of investing in wasteful projects … However, excess debt may also lead to underinvestment decisions” (Adjaoud, Charfi, and Chourou 2011, p. 44). The general impression on Wall Street increasingly became the suspicion of unbridled overinvestment, at least where the timing of cash flow was concerned. Several months after the previous article appeared:

(Higgins March 15, 2018).

… Tesla must boost production of the Model 3 or possibly face severe financial consequences … Meeting the goal of 5,000 Model 3s a week by the end of June is critical to generating enough cash to sustain operations without having to raise more capital …

… Tesla is no longer a startup ... Mr. Musk has eschewed operating profit and racked up debt … He had earlier pledged to deliver 500,000 vehicles this year, about five times last year’s total …

“Some big investors are losing patience,” said [an analyst] … “They are less excited about it than they were a year ago.”

In sum, it is impossible to say with confidence what might have been different in the Tesla story, had Elon Musk not been all of largest investor, CEO, and COB. The literature cited here generally assumes a clear and more classic division of labor among executive roles. This is wise from the research standpoint because role ambiguity confounds principal–agent problems. This does not even include roles Musk adopted on an ad hoc basis, such as the de facto COO du jour. Aside some members of the board, who did become vocal and influential, at the face value, it could be said that Musk was something of a one-man governance structure. Then, add to this dry economics the impact of personality, charisma, vision, and the like. In retrospect vis-a-vis the aforementioned articles, consider the prescience of the following, which appeared two years earlier:

(Tobak August 04, 2016).

… Tesla is no longer a startup, which begs the question: Are Musk’s skills suitable to scaling and running a mainstream car company? Musk is a creator. An inventor. An innovator. As long as Tesla was in startup mode – building limited production high-priced vehicles – he managed to perform. But in terms of operations and execution on everything from product pricing and production to cash flow and profits, his track record has been abysmal.

… scaling that Tesla into a mainstream electric car company capable of flawless execution … presents an entirely different set of problems … And to me, it looks like it is simply not in his DNA.

It is probably best to leave genetic predispositions an open question in an economic analysis, so this section will end here.

Managerial Biases in Investment Decisions

The preceding section suggests that there is nothing purely scientific when groups make rational economic decisions; extending that, the focus shifts more to the individual human psychology of executive decision making. The following review is based on research on discounting, in particular, but also has general implications for managing capital projects.

Defaulting to Judgment

Applying judgment is an important and necessary role of managers. Strategic decisions are no exception and on balance using judgment is probably a good thing, especially considering the importance of uniqueness in the pursuit of any true competitive advantage. As well, the myth that true innovation is a matter of pure instinct and defies rationalization and corporatization goes too far, but it does contain a grain of empirical truth. The evidence about Musk makes plain that many people and institutions trusted his judgment to the tune of billions of dollars of invested capital, enough to surpass General Motors, and so on. That much cannot be denied.

Smallish projects can be adjudicated well with good judgment, and sensitivity analysis can be used one project at a time.

This approach may be justified if the project is sufficiently small in monetary terms or if decision are made by vote of a capital budgeting committee, executive committee, or board of directors … The main use of the judgement approach is to supplement and support other more scientific and prudent techniques (Arnold and Nixon 2011, p. 219).

The same research found, though, that people are prone to collect information and substitute judgment instead. The implication is that the information collection phase may have been a waste of time, or close.


More clinically, these are called representativeness and availability biases. “Individuals evaluate the probability of an event depending on similarities of that event with well-known classes, disregarding evidence about the underlying probabilities. Consequently, they usually find patterns in random data” (Biondi and Marzo 2011, p. 423). When evaluating a project, a decision maker may say “I’ve seen this before,” when in reality, the image would correctly be understood to be an illusion. It is perhaps the case that EV naysayers suffered this bias, that is, that Tesla was a car company doomed to fail.

People are also affected by the so-called ‘law of small numbers,’ which is the tendency to believe that even small-sized samples should reflect the properties of the parent population” (Biondi and Marzo 2011, p. 423).

In logic, this very common error is called the inductive fallacy, that is, drawing generalizations from sample sizes too small to be useful in such a way. This is the same error that is assiduously avoided when researchers use large sample sizes. Not so popularly known is that a very large sample size, say, several hundred or thousand, is only needed in order to assure that the sample size is representative of the population on the whole. If representativeness of a smaller sample can be assured, a small sample can be properly be used. This is why sample sizes of 25 or 30 are acceptable if sampling techniques are proper in the first place.

As it concerns projects, representativeness may not sound hard to assure, but remember that the main issue is innovation, which means some degree of uniqueness by definition.

Aside that, it is problematic to assume that experience with anything less than a few dozen projects that share important similarities to a given project proposal is a good enough basis to depend on experience alone. At Tesla, anyway, there was no such database of representative real-world experience for decision makers to refer to. One might be able to count at most a dozen global EV attempts and then, apply them only very carefully, as they were all different business propositions. This error is no less dangerous than sampling on the dependent variable, which is to only consider positives and overlook the non-events. The point concerning this bias is to point to the opposite as it concerns Tesla. While it might sound risky to some, starting over with clean-sheet designs and a different business model worked for Tesla at least in the early going, much to the delight of investors in those early times.

Per the availability bias,

The easier is the recollection of an event, the higher will be the probability assigned to its occurrence ... people make estimates starting from an initial value (anchoring) and then adjusting it in order to find out the final answer over a series of trial and errors … Such a bias can affect estimations of cash flow representations (Biondi and Marzo 2011, p. 423).

Anchoring effects are found in various types of decision scenarios, but here is mention of cash flow specifically. Extending the given hypothetical, the decision maker may base judgments about a project proposal’s estimated cash flow using his or her experience with previous projects, anchoring financial expectations to, say, the average of that.

Just as one of countless possibilities, an odd one is this. An experienced industry executive might think but not say, “Our overly ambitious project sponsors ‘always’ make projections that turn out to be optimistic by about 25 percent. I should fudge this project proposal accordingly.” Again, this is not to suggest whether or not this is a good idea; just that, it may not accord with proposal data that was honestly and carefully developed.

Next, the prospect theory also takes into account the framing effect and anchoring.

[E]very prospect’s value is a function of a reference point, usually the status quo or an aspiration level … an individual frames the value function in terms of gains or losses with respect to his or her own reference point (Biondi and Marzo 2011, p. 424).

Let us not try to get into Elon Musk’s mind on all of this, but it is true that prior to joining Tesla, he had experienced great bounty resulting from his own decisions, which could provide a powerful anchor indeed.

The next part is particularly interesting, in that not only is it a ­behavioral effect apart from economic rationality, it is itself irrational. “[N]ot only do individuals fail to show a unique and positive relationship in the risk-return relationship (subsumed by compound discounting), but they also tend to change the direction of this relationship depending on the way they frame decisions” (Biondi and Marzo 2011, p. 424). This is a bit stunning for any decision maker who is familiar with the basics of finance. Everybody knows that there is a positive relationship between risk and return, but this slice of research shows that the understanding can be reversed due to a framing effect! To reverse the risk-return axiom is to assume that high risks are associated with a lower return (or vice versa).

This would hardly apply to the typical Tesla investor, but it is interesting. Just to speculate, perhaps, an individual may misunderstand probability math, and subjectively inject an additional amount of pessimism based on previous EV failures, irrationally lowering the true expected value of the investment. To be careful though, it would be graceful to posit that the framing effect would have to be profoundly different, as no trained businessperson imagines such a relationship.

On a related note, it is common to assume that prices will always rise, and that there will always be some degree of inflation. We frame the future this way as a matter of course, so some manner of discounting happens instinctively—or at least reflexively after a little bit of professional conditioning. But, in the modern era, and in the kind of decisions mostly assumed in these discussions, these assumptions bear constant re-visiting.

For example, prices do not always go up because, as examples: economies of scale (in right-sized facilities) and scope (including platform designs) should achieve lower unit costs and unit prices; commodity prices are volatile; oil and lithium and all else are rarely in lockstep; advancements in things like robotics and artificial intelligence (AI) will greatly improve efficiencies and thereby real facility capacities beyond crude measures like footprint; industrial and personal productivity generally rises, as well as inflation although they have opposite effects on prices, and so forth. In fact, this is exactly the strategic utility of using learning curves in the first place. These effects are deflationary, just more local to an industry, a market, or situationally to a specific project.

Even when merely adjusting for inflation, this is to net the assumed inflation effect on everything, equally, netting that assumption against the worse assumption—that nothing, at all, will change. The framing effect of mindlessly assuming inflation can backfire on a decision, and partly explains the utility of approaches like risk-neutral pricing in real options (Volume II, this series). Anyway, be assured that there is a positive relationship between risk and return in the vast majority of cases, and this axiom is worth counting on unless contradictory information is very unusual and compelling.

Perceptions About Time

It makes sense that the effects of the impact of the time value of money (and discounted cash flow (DCF) methods) would be biased by one’s experience with time itself. At issue is bias concerning perceptions of discount rates.

First, the “common difference” effect says that the longer the project planning horizon, the lower the discount rate all else held equal.

Second and in what is called the “absolute magnitude” effect, large amounts of invested capital are less discounted than small ones, on a proportional basis.

Third, there is what is called “delay-speedup asymmetry.” Another framing effect, it implies an “asymmetric preference between speeding up a loss and delaying a gain. A greater amount is then required to compensate for delaying an incoming reward … than for anticipating (speeding up) a loss by the same interval” (Biondi and Marzo 2011, pp. 424–425). The asymmetry becomes somewhat alarming when one realizes that the former effect is about two to four times greater than the latter effect. Combining the two, the effect on the discount rate varies not only with the size of the expected payoff, but also whether it is positive or negative. The magnitude of the asymmetry should give a planner pause. Past that, the psychology is complex.

As it concerns Tesla, it seems quite possible that decisions were intertemporally biased because (a) time delays were commonplace and became more-or-less priced into investor expectations of production forecasts (one might even say with a wink and a nod from Wall Street that became the norm); (b) the amounts of capital involved were very substantial; and (c) when push came to shove, actual, experienced delays exceeded anyone’s hopes and aspirations, polarizing stakeholder camps severely. More cautiously, all that will be asserted is that discount rates on things like bonds may have been irrationally determined from the outset and made worse as time went on, as it is a fact that a bad crisis resulted that threatened the company in its entirety. Still, these effects are very complex in combination.

Expectations About Cash Flows

The following biases are not difficult to understand and are probably everyday experiences in human affairs. There are biases called plainly enough, optimism and overconfidence.

“If the description of the company is very favorable, a very high profit will appear representative of that description; if the description is mediocre, a mediocre performance will appear most representative… the human mind appears to work as a pattern-seeking device. This leads decision-makers to give rational meaning to events that can be random (Biondi and Marzo 2011, p. 427).

This is not quite the same thing as presented earlier; it involves external estimations of cash flow, not so much internal estimations.

A related research expression is the false-positive notion, except here, it is assumed to be caused by biased perceptions alone. False positives do not always happen in conditions of true randomness, but also in patterns of data that do not confidently warrant conclusions about apparent positive evidence. Confidence is a matter of deeper statistical analysis of things that appear at face value.

As it concerns Tesla, media presentations changed greatly over a short period, carefully granting the benefit of the doubt for years, to becoming very worried about bond covenants specifically. Mentions about cash flow and, specifically, corporate-level free cash flow came up often, coupled with mentions about only ever declaring a quarterly profit twice, and more specious concerns about in effect, structural profitability. But, it is hard to accuse that bias as being psychologically dysfunctional, not to mention economically irrational. The history of similar experiences would certainly support it.

Sunk Costs Versus Committed Investments

This all-too-common form of economic irrationality is one that a person learns about in any beginning economics curriculum. Here, though, it becomes vital to maintain the distinction between an expense and an investment.

In the author’s experience, sunk costs are generally thought of (implicitly or explicitly) as expenses that have already been incurred, where the idea is that the past is the past and nothing can be done about it anymore. Projects funded in operating budgets have been implicitly characterized that way. Situations vary, but cannot be stylized here; the point is that, when it comes to investments, not all money spent in the past is in the economic meaning, money gone (Biondi and Marzo 2011).

This is not a subtle distinction, but the research largely ignores it. Operationally speaking, including projects funded in the operating budget, money spent is money gone, though the expense should have been “worth it.” This stands in contrast with an investment funded in a capital budget. There, a delay is fully expected from the very beginning, and the time horizon can be many years, sometimes as with science and technology, decades.

However, this is not the place to argue, say, the pros and cons of public subsidization of science, versus venture capital, versus public ownership, and so forth. It will just be asserted that these institutions exist to sort out this very problem. The general idea is still valid and about psychology, not economics. Still, note the ambiguous terms: “[People] are more likely to continue a bad project if they have already made a prior investment … the scale is unrelated to the perception of failure.” It seems that “the past is relevant because it contains information which changes the image of the future; the probabilities which govern future actions are modified by observations on the past” (Biondi and Marzo 2011, p. 429).

Either way, it would be natural for the decision makers at Tesla to be victimized by this bias. Pressure was particularly acute during the time when Tesla experienced so much agony, making the transition from (likely profitable) niche markets, to (dubiously profitable) mass markets. The longstanding commitment was to save the planet, but simple survival came into doubt. The media did suggest an epiphany on all sides of the issue. The real issue, though, is having the foresight and wisdom to draw the distinction between entrepreneurial (Schumpeterian) irrationality and in reality, throwing good money after bad.

Escalating Commitment to a Failing Course of Action

These same words are the actual title of a known psychological phenomenon and strain of research. This effect can be understood as a variation of the sunk cost effect, with the additional assumption that evidence of eventual failure seems rather plain in the present, and available to all. Not only do sunk costs become chased, the intensity of a foolish chase gets worse and worse, and in some cases, downright crazy. Even when evidence of impending failure becomes apparent, escalation of the commitment rises in ways that can be truly irrational.

[C]ontinued investment in a project when expected future results are negative and suggest abandoning it … is now recognized as a major pitfall in the control of an investment project … Individual commitment is usually rewarded … pursuing a failing course of action can then result from the inability of decision makers to free themselves from the social norms (Biondi and Marzo 2011, p. 430).

On social norms, however, it may also be noted that the rationality of career politics (as opposed to classic economic rationality) is a common phenomenon because tenacity is considered a virtue. Even in economics, such transactions are meaningful and studied as principal–agent problems. Finally,

Every business activity constitutes a special relational economic context. Its decision makers receive information through numerous channels that treat and reduce that information by various ways and under special conditions … Because this process is laden with ignorance, hazard, and dynamics, the information is typically blurred or filtered information, meaning that some aspects of the information may be obscured or lost (Biondi and Marzo 2011, p. 436).

Against that admonition, of course, is the commonsense suggestion that the fidelity of planning data, namely, the ultimate outcomes of future uncertainties on final cash flows, is not as important as the overall wisdom needed to make good basic strategic decisions.

The Bottom Line: So to Speak

From the behavioral (and research) point of view, the preceding discussion focused on main effects. There are secondary or side-effects, too. On the whole, the news is good, but not without a few qualifications. Some terms that may be unfamiliar to the reader are explained at length later, mostly in Volume II of this series.

In the [project] developmental stage, most firms agree that cash flows are the appropriate cost-benefit data … including the consideration of opportunity costs … In the selection stage, the use of DCF analysis as the primary selection tool has steadily increased while the use of the payback period in the main analysis has steadily declined. The use of the WACC has also increased … Managers recognize risk differences in projects and adjust the hurdle rate, albeit on an ad hoc basis (Mukherjee and Al Rahahleh 2011, pp. 166–167).

On the other hand, the same body of research says that compared to their respective pros and cons in different real scenarios, the internal rate of return (IRR) is often incorrectly preferred to the net present value (NPV), the use of payback may be used too often and be given too high a priority, and capital rationing is sometimes overdone. More specifically:

[First,] Firms might prefer IRR because of its comparability with returns from returns of other investment opportunities ... [Second,] All firms require project sponsors to compute both NPV and IRR … emphasis on IRR might lead to incorrect decisions… [Third] When a conflict occurs … most firms rank the project by their IRRs but select the bundle that maximizes a firm’s overall NPV (Mukherjee and Al Rahahleh 2011, pp. 166–167).

Of course, imperfections of method matter most if they turn good decisions into bad ones, that is, whether they reject viable project proposals or accept bad ones. Managers who use these methods should understand their advantages and disadvantages with respect to their (a) industries, (b) corporate strategies, and (c) specific project decisions.


This chapter takes mostly the executive view of managing capital projects, here attending to two knowledge areas in the Project Management Institute paradigm—project communication management and project stakeholder management. As the deployment of investor capital is the acute underlying issue, fiduciary responsibilities there immediately turn into a concern for corporate governance, specifically. Fortunately, rigorous economic and finance research has been performed in the issues, which was reviewed and interpreted vis-à-vis the Tesla experience. In this way, the chapter anticipates much more economic rigor concerning capital project budgeting that dominates Volume II in this series.

Discussion Questions

How can bureaucratic processes, methods, and structures be used constructively in the management of innovation?

Considering the pros and cons of going public, what is the right time for an IPO, considering managing fiduciary responsibilities to external stakeholders?

What is corporate governance? How is today’s environment different from the past, and what does research suggest will be trendy in the future?

What is moral hazard, how is it that it occurs, and how do similar agency problems impact capital project decisions?

Discuss how biases in investment decision processes distort the rational cost of capital and in turn, capital project discount or hurdle rates.