Inside the Mind of the CEO

Wall Street, New York City. Louie Psihoyos / Corbis

If you're looking to the world's large and profitable companies to pull the West out of the downturn by investing and creating jobs, you had better look elsewhere. Their hesitancy to invest is palpable and measured in the tremendous unspent cash reserves building up on corporate balance sheets. But none of the usual explanations—the slack capacity still in the economy, uncertainty over future regulation and taxes, or the "new normal" world of low growth—account for the pervasiveness of noninvesting.

There is a more fundamental and potentially more far-reaching force at work: today's CEOs have been shellshocked by crisis. It is not just the world that's uncertain, it's the managerial class itself that has lost confidence in its ability to make decisions in a world shaped by volatility and shock. Used to making bold, aggressive decisions in the years of fast growth and easy credit, many executives today find that the business instincts that propelled them in their careers are no longer a reliable compass for their actions. Think, as an analogy, of the people who lived through America's Great Depression and remained thrifty and risk-averse for the rest of their lives. We have likely entered a long-lasting shift to more careful and conservative business leadership in the West, one marked by a new ethos of caution that could have profound and possibly negative effects on the economy for many years to come.

Consider the past decade. It opened with the bursting of the dotcom bubble and the destruction of $5 trillion in equity value in the U.S. alone. Then, 9/11 heralded the emergence of a chronic terrorist threat. A rising tide of uncertainty—including geopolitical turmoil, economic volatility, and turbulence in commodity prices and exchange rates—marked the decade even before the financial crisis of 2008. The years since then were the coup de grâce for business confidence.

The new mindset is visible along multiple dimensions. Executives are much more likely to defer decisions or settle for small, incremental improvement in their companies' performance. Many large corporations are marshaling cash because they are anxious over the availability of financing. Others are using their cash to shore up their company pension schemes, again as a protection against future financial risk. This propensity to hold cash and use it to hedge against risks will likely both undermine companies' returns and cause them to hesitate in the face of opportunity.

For the shellshocked CEO, the burden of proof for any investment is higher. We are still seeing companies making acquisitions, for example, but the typical deal today might be Oracle's November 2010 purchase of software maker ATG for $1 billion. It was a small expansion in a familiar market where Oracle's risk stays within well-known bounds.

What other kinds of investments are left that carry limited risk? A logical decision, particularly for a cash-rich Western company, would be to make a major acquisition in a big emerging market. But in China, the regime does not look kindly on foreign majority ownership of a large local company. For India, most Western companies lack the expertise needed to operate there. Russia, for most companies, is an incalculable risk. In the new era of caution, the risks of pursuing a position in unfamiliar markets have grown in parallel with the hostility of governments to acquisitions or investment by foreigners in an ever-lengthening list of "strategic sectors." Favored companies will be those with long-established, viable operations in markets like China, India, and Brazil, as well as those with the type of rich intellectual property that those economies will increasingly seek. Latecomers and dabblers will find the risks too high.

If the "new normal" begets an enduring ethos of caution among the managerial class, it will have profound implications for economic recovery and national policy. If established enterprises remain reluctant investors, governments will have to enact policies specifically designed to spur entrepreneurship and support for smaller enterprises. Countries that embrace entrepreneurship culturally and have large and diverse sources of risk capital will prosper.

Countries where established companies dominate economic activity and top graduates eschew job opportunities at entrepreneurial firms in favor of the prestige and safety of "national champions" will slip further behind. Countries hoping to be the beneficiaries of the next wave of foreign direct investment targeted at countries with low labor costs, like Vietnam, or burgeoning local markets, like Saudi Arabia, may find themselves disappointed, as Western companies are now less willing to take risks. Those who benefited from the investment boom of the past 20 years may enjoy extended prosperity.

Companies will cast off their conservatism only when they accept that the standards they used to assess opportunities and evaluate risk in the past are no longer appropriate. The "new normal" has changed the nature of opportunities, not proscribed them. The greatest opportunity may come to those whose competitors are still stuck in their paralysis. As always, the marketplace will ultimately reward those who stare down their fear and act.

Fuller is the cofounder of Monitor Group.