Business Acumen and the Connection to Behavioral Finance
Perth Leadership Institute formally defines business acumen as "the behavioral propensity to create capital". This definition is based on psychometric research based on behavioral finance by Dr. E. Ted Prince. Our informal definition is "the ability to create positive financial outcomes". It is also defined colloquially as “a nose for profit."
Ram Charan defines business acumen as “linking an insightful assessment of the external business landscape with the keen awareness of how money can be made — and then executing the strategy to deliver the desired results.” (Strategy and Business, February 28, 2006)
The leadership development community has been relatively late in linking business acumen to behavioral finance. It has become clear that business acumen is about behaviors rather than about knowledge or qualifications. The emergence of behavioral economics and finance shows us that business acumen is a result of unconscious cognitive biases that collectively enable a person to have a sustainable ability to create wealth.
Behavioral Finance and Prediction of Company Valuation
We now understand that if you can identify financial behaviors in a quantitative way that links these behaviors with outcomes, you now have a revolutionary new way of approaching investment performance. In fact you can use management behaviors as a way of predicting future valuation. this overcomes the deep problem that financial metrics are lagging indicators of performance. Behaviors are leading indicators of performance.
This means that financial behaviors can be used as a new approach to areas such as credit ratings, stock ratings, asset allocation and portfolio management. However to be able to this this you need scientifically-derived metrics on financial behaviors. This is what perth Leadership Institute has been doing for the past 12 years.
Business Acumen Defined
E. Ted Prince and Ram Charan are quoted by Wikipedia on Business Acumen.
A study published in Human Resource Management International Digest conducted by E. Ted Prince entitled, Business acumen: a critical concern of modern leadership development: Global trends accelerate the move away from traditional approaches, reveals why traditional leadership development approaches, which rely on personality and competency assessments as the scientific core of their approach, are failing. The paper demonstrates the importance of business acumen in leadership-development approaches and contends that business acumen will have an increasing impact on leadership development and HR agendas. Research into this relationship resulted in the creation of the Perth Leadership Outcome Model, which links financial outcomes to individual leadership traits.
Defining Business Acumen in Quantitative Terms
Perth Leadership Institute has developed assessments which assess and measure the business acumen of individuals and teams. These assessments are based on the Perth Leadership Outcome Model, developed by Dr. E. Ted Prince. The underlying model is based on a behavioral finance paradigm. We have operationalized this definition by defining business acumen as being the difference between the innovativeness of an individual and the resources used in achieving that particular level of innovation.
We can adopt this approach because innovativeness is reflected in the gross margin impact of that person and their resource use is reflected in their expense impact. The difference between gross margin and expenses is operating profit. This reflects the level of business acumen of this individual. Therefore we can define business acumen in both behavioral and quantitative terms, as reflected in the income statement of an individual or a company.
Our Research into Business Acumen
Our research supports and extends other research in the areas of behavioral economics and behavioral finance. These emerging disciplines have shown that there are underlying cognitive biases that affect business decisions and often lead to poor and unintended financial results.
These decisions need not be financial decisions. The underlying idea behind our research is that all decisions have financial consequences, even if they are not explicitly about financial matters. If we wish to understand the financial performance that results from our leadership, we must understand and measure these cognitive biases in order to be able to predict financial outcomes and performance and in order to be able to improve them.
Everyone has cognitive biases. Most of these biases tend to adversely impact financial outcomes. Our cognitive biases are different in their strength and impact. We each have financial traits and these cognitive biases mean that these financial traits result in different financial performance depending on who is managing and leading.
Because each individual has unique personal financial traits, there are innate calculi that manifest in our financial decisions; financial signatures that are innate and which cannot be changed. The expression of these financial traits is an individual's financial mission, which, through the growth of an individual's business acumen and through self-awareness from training, can be altered. Though unconscious, these behaviors can be targeted and controlled in order to improve financial outcomes including profitability and valuation through the development of business acumen.
Business Acumen Assessment Instruments
Perth's behavioral assessments can predict the financial outcomes from a person's or a team's behaviors based on their measurements of the cognitive biases that impact financial outcomes. With these results, business acumen development programs can intervene and improve the financial decision making capabilities of an individual or team based on improved self-awareness of the behaviors that lead to positive financial outcomes.
Improved business acumen sharpens a person's or a team's ability to link one's own behavior to the external business playing field with a new awareness as to the behavioral linkages involved. Perth's business acumen programs, business acumen seminars, and business acumen assessments are designed to provide awareness and development of business acumen at the individual, team, and and company level.
Business Acumen and Financial Literacy
It is important to note that business acumen is not the same thing as financial literacy. The latter is formal knowledge that can be learned. However learning may not affect decision-making favorably. Often higher financial literacy may lead to poorer decision-making due to the increased strength of the cognitive bias of over-confidence.
In short, the key issue in achieving positive financial outcomes is not financial knowledge per se but an awarness of the links between behavior and financial outcomes and the mental agility needed to change one's behavior, even when this is not comfortable foe the decision-maker.
For more of Perth Leadership's insights on business acumen, you may be interested in our White Paper, The Role of Business Acumen in Leadership Development.