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As we sift though the debris of today's crisis, economists and policy makers alike are trying to assess why risk management systems and regulatory constraints didn't kick in before the global economy became engulfed in a tsunami of red ink. But economist Andrew W. Lo, the Harris & Harris Group Professor at MIT's Sloan School of Management, director of the school's Laboratory of Financial Engineering and founder and chief scientific officer of AlphaSimplex Group LLC, an investment adviser in Cambridge, Massachusetts, is less surprised than most seasoned observers. Lo has studied the connections between financial decision making, neuroscience and evolutionary psychology for over a decade. Among his findings are that professional traders, far from being cool-headed and rational, can become transfixed by extreme price movements, their decision-making capabilities temporarily hijacked by emotions such as fear and anxiety. In Lo's view, "behavioral blind spots" (which he defines as evolutionarily hard-wired reactions to perceived risks and rewards) are particularly dangerous during periods of economic extreme: bubbles and crashes. During these times, he says, "market forces cannot be trusted to yield the most sensible outcomes." In an interview with SMR editors, Lo says that balance sheets and income statements are adequate for measuring a company's profits and losses, but provide no information about future risk. He discusses a number of topics relevant to the financial crisis, including the inadequacies of corporate governance, the weakness of standard accounting practices to assess corporate risk and the need for better information and frameworks to inform risk-based decisions. In Lo's view, the financial crisis of 2008-2009 has tested two core ideas: the belief that corporate governance systems are designed to maximize shareholder wealth, and the assumption that markets and businesses will always react rationally to environmental change. If the latter were true, he says, Bear Stearns, Lehman Brothers and other financial institutions would have seen different outcomes.

A new book highlights the role of communities in the diffusion of radical innovations.

Product reconstruction, which covers a continuum of activities from recycling to refurbishing to remanufacturing, allows companies to sell high-performance goods at lower prices than equivalent new products while also realizing higher profits. Product reconstruction may open new markets for companies in meeting the needs of one or more of six kinds of customers: those who need to retain a specific product because it has a technically defined role in their current processes; end-users who want to avoid the need to respecify, reapprove or recertify a product; customers who make low utilization of new equipment; those who wish to continue using a product that has been discontinued by the original manufacturer; people who simply want to extend the service lives of used products, whether discontinued or not; and customers who are interested in environmentally friendly products. Beyond serving a particular market, the company must also possess certain kinds of expertise. To succeed at recycling, for example, it must be intimately familiar with the manufacturing process that initially created the product, be able to make extensive and time-consuming sales efforts (to help compete effectively against the many other companies in this low-barriers-to-entry industry) and be willing to specialize, given that particular materials vary greatly in complexity, time requirements, predictability, capital and labor characteristics and expense.

Two very different ways of thinking about investment and risk are in competition. One emphasizes the financial risk of investing; the other concerns the competitive risk of not investing. In normal times, the bearishness of the former tends to complement the bullishness of the latter. But during extremes in the business cycle, the author argues, the balance between the two can break down. Specifically, companies seem to overemphasize the financial risk of investing at the bottom of the business cycle, at the expense of the competitive risk of not investing. This is dangerous, in the author’s view, because it can create a lasting competitive disadvantage. Using examples from the semiconductor, paper and diamond industries, the author argues that it doesn’t make sense to stamp out either financial or competitive risk, even though financial risk could be eliminated by investing not at all and competitive risk could be eliminated by investing indiscriminately. Instead, managers need to strike a balance between the errors implicit in these two types of risk: the error of pursuing too many unprofitable investment opportunities as opposed to the error of passing up too many potentially profitable ones. The original version of this article was published in the Sloan Management Review in Winter 1993. In this updated version, the author expands his views in light of the 2008 economic downturn.

Are corporate social responsibility programs beneficial to companies when they undertake overseas expansion? To address that question, the authors analyzed both financial and corporate social performance data for more than 800 U.S. public companies. In particular, the researchers set out to examine the relationship between corporate social responsibility and profitable international sales. The researchers found that those companies that had low or high levels of corporate social responsibility had significantly greater success internationally than those with moderate levels of corporate social responsibility. The authors suggest that companies with high levels of social performance may benefit internationally from their good reputation for corporate social responsibility, and companies with low levels may attain cost advantages from overseas expansion. However, companies in between may be "stuck in the middle"--and unable to obtain a competitive advantage internationally from their corporate social responsibility programs. Since retrenching from existing corporate social responsibility efforts can be viewed negatively by existing stakeholders, the authors recommend that companies that are "stuck in the middle" rethink their overseas corporate social responsibility programs--either to de-emphasize competitive advantage or to increase the programs' impact.

The rules of nature can help you succeed in adversity, but they can also steer you wrong.

Business strategy expert and longtime MIT Sloan professor Rebecca Henderson is a sustainability integrationist. Like other founding members of the school's Laboratory for Sustainable Business (S-Lab), she finds sustainability's implications everywhere in daily economic and social life and everywhere interrelated. But among the multi-disciplinary angles from which she attacks sustainability are two questions that are interestingly oblique: What capabilities and behaviors make organizations themselves sustainable? And, why are some organizations so extraordinarily better than others at getting new things done? (Learn more about Henderson, and find selected links to her work on our website sloanreview.mit.edu.) In this installment of The MIT Sustainability Interview series, Henderson spoke with MIT Sloan Management Review editor-in-chief Michael S. Hopkins about the baseline understandings and misunderstandings about sustainability, and the choices it will present to leaders.

Above all else, MIT Sloan professor John Sterman is a world-class "systems guy" he leads the school's System Dynamics Group, is a trained scientist, is co-leader of MIT Sloan's Sustainable Business Lab (S-Lab) and perhaps unsurprisingly brings to any conversation about sustainability a certain impatience with views that refuse either to confront the evident facts or, for that matter, to see the problem whole instead of in parts, to see it as the systemic set of interdependencies that it is. But if indeed this should register as a "but" he is a humanist, too. And "a true optimist." And it is impossible to come away from talking with him without feeling that there is work to do, yes, but that it can be done. And that for businesses, doing that work presents an opportunity, not just a threat.

Jeff Seabright, The Coca-Cola Company’s vice president of environment and water resources, explores how the beverage giant is moving to greater sustainability.