The World's Dumbest Idea: Maximizing Shareholder Value (2014) [pdf] | Hacker News Reader

The World's Dumbest Idea: Maximizing Shareholder Value (2014) [pdf]

gmo.com

72 pointskick35 comments

The challenge is that people need to think of shareholder value more broadly.

If I'm running a company, maximizing shareholder value might include:

- paying my employees top dollar so that my turnover is lower and I don't waste money on recruiting

- donating money to local school to incentivize students to join my industry, so that I have a pool of potential employees in the future

- providing really nice (and expensive) customer service as that will make me more competitive and I'll end up with higher market share

Maximizing shareholder value doesn't necessarily mean cutting costs to the bone, treating employees like crap or polluting my local river.

Yeah, the problem seems to be more about short-term thinking. So then, why are shareholders becoming so short-sighted?

My theory is the increased abstraction between shareholders and actual businesses is to blame. Having patience for long-term thinking by a company means understanding the business, seeing why they're doing what they're doing, looking at the long-game for how things will work out in the end. More and more it seems like shareholders just want to play the market; buy low and sell high with little interest in getting their hands dirty with the business itself.

Honestly what you just said should be so self evident to anyone who understands concepts of net present value and basic economics, that anyone who views shareholder value as something else should just be ignored.

Nah. I agree with Paul Romer and think the world's dumbest idea was devaluing the need for empirical evidence in economics by ignoring identifiability[1]. Without that, the whole of economics becomes unhinged from reality and devolves into ideology. One can't even properly ask or answer the question "Is maximizing shareholder value good for the economy?" if the methods of such an inquiry ignore empirical evidence.

[1]https://paulromer.net/the-trouble-with-macro/WP-Trouble.pdf

This is a popular secular trend that's very important to watch out for. You never know when's the next big rewiring of property relations, and it's foolish to think it will not happen again. Suffice to say that "socialism" is no longer the dreaded name for failed economic policies of the past, it's a popular word with the young people. I'm not advocating for or against it, it's just a fact that there's some chance that it will happen.

Declining labor share as a % of GDP is very real and very threatening (it does piss many people off, whether or not they know about this metric).

"Distribution of Average Income Growth During Expansions" is quite scary too.

>"socialism" is no longer the dreaded name for failed economic policies of the past

The only reason it ever was "the dreaded name for failed economic policies" is because of political lies conflating Communist Autocracy (USSR, China) with Social Democracy (basically all of Western Civilization) during the Cold War. Socialism has been, is, and will continue to be incredibly popular in America where the word is quite possible hated more than anywhere else.

From The New Deal in the 30s (not many people would want to get rid of Social Security or interstate highways for example) to Wall Street and auto industry bailouts to today's oil and farm subsidies, socialism is incredibly popular among both the right and the left wing of US politics.

Without the spectre of Soviet Russia and mutually assured destruction hanging over America's head, the boogeyman of "socialism = Stalin" is a lot harder to maintain.

When the author literally lists dozens of ideas that me and other people have spent their entire lives working on and dismissed them out of hand, I can’t even bring myself to read anymore.

I don’t know anything about the firm GMO, but this guy is a troll and no one who actually cared about or respected finance would start a white paper with that sentence.

What are some examples? Genuine question since I really don’t have a dog in this fight and am curious about learning more.

It would take days to talk about the stuff that guy doesn’t believe, but let’s talk about risk premia.

Put simply, risk premia is the idea that a greater risk should yield a greater return. That is, no rational investor would bear more risk without being compensated for it. Here’s an example. You can play one of two games an infinite number of times in an instantaneous amount of time: one game you flip a coin and win a dollar on heads, tails you pay 99 cents. The other game you flip a coin and either win 1,000,000 dollars or pay 990,000 dollars. Which game would you play? Any rational person would play the former game, it has the same expected value with less risk or less volatility.

I haven’t read this guy’s thoughts on why it’s stupid, but it’s a fundamental underpinning of finance and you would be hard pressed to find any real non-trolling financial professional arguing against it. It’s so intuitive that almost all everyday people would agree.

Further reading would be about the capital market line (CML), the security market line (SML), and the efficient market hypothesis (EMH).

Another idea he thinks is stupid is VaR (value at risk). While there are different ways of calculating it, all it simply means is: what is the probability that my portfolio loses x% of value tomorrow. There’s many ways of calculating it, the simplest being just calculate the historical correlations of all the assets in your portfolio and figure out the portfolio variance. Using linear algebra the variance is:

Var(portfolio) = x^T P x

where x is a column vector of security weights and P a square covariance matrix of all assets. Assuming a normal distribution (a bad assumption btw), we can easily calculate the, day, 5% chance of losing x amount of dollars tomorrow.

Anyways, all I’m saying is that the stuff he’s shitting on (CAPM, EMH, Beta, etc) is so fundamental to the very fabric of finance itself, that he should get a Nobel prize if he actually had any good rebuttals. What he’s saying is like someone proposing an alternative to Newtonian physics in the 18th century. Which would be fine, but if he truly believed in what he was saying he would either have completely remade finance or he would be working in a different industry. Seeing that this firm GMO is working in the asset management space, I find it almost impossible that the employees of said firm aren’t using or don’t believe in the above mentioned concepts. In fact as a finance professional, I bet they believe in and use the aforementioned concepts every day and this guy is just stirring up shit in order for their firm to get more assets.

>Here’s an example. You can play one of two games an infinite number of times in an instantaneous amount of time: one game you flip a coin and win a dollar on heads, tails you pay 99 cents. The other game you flip a coin and either win 1,000,000 dollars or pay 990,000 dollars.

Both have the same risk percentage wise.

The risk of extinction is greater for the second game. Which game would you play?

Both have a 100% risk of extinction when played infinite times instantly. Doesn't matter which you choose.

Betting infinite dollars does tend to lead to extinction.

There's a 0% chance if you have infinite leverage.

Part of what you are saying seems to focus on the idea that "these ideas are fundamental and everyone is doing this", which is true but a slight misdirection from other important issues.

The reason they are fundamental and popular is because they are very compelling ideas with very plausible assumptions, and they tend to chronically outperform other strategies. It is like someone saying "Assuming average performance going forward is the stupidest idea since beanie babies" - ok, they can say that. Sometimes it is true. But it is a default position of such overwhelming practicality that there needs to be a really good reason to move away from it.

The issue isn't going to be the ideas, misinterpretations and misconceptions about applications are the problem and that happens no matter how good or bad the underlying idea is.

Is he wrong? It's not necessary to care about or respect something to critique it. Is he wrong?

Not sure why it's so en vogue to communicate this way any more. What's the point? If you're trying to rile up your tribe members I suppose it helps there, but it doesn't actually change anything. Folks that don't agree with you are going to go shields up and bounce everything you say.

If you can't see that in the main, using Shareholder Value as the main driver of corporate behavior is a bad thing, well, sorry.

In a society where society provides infrastructure, defense, etc, corporations should have a trio of responsibilities.

1) Shareholder (including primarily stock compensated executives) returns

2) Employee (non primarily stock compensated) pay, benefits, and well-being.

3) Society.

American capitalism has embraced #1 to the exclusion of all else, enabled by lax labor laws, corporate tax loopholes, and lower capitol gains taxing. ¯\_(ツ)_/¯

I didn’t mention anything after his first sentence. I’m not going to get into shareholder value, but I will get into his flippant disregard of the most important discoveries of finance.

With respect, the fact or idea that some group of people has spent their life on something does not necessarily make it into the correct choices.

You misunderstood the GP. He isn’t saying it’s correct, only that it doesn’t deserve to be dismissed out of hand. I.e., it deserves a more robust treatment before dismissal is warranted.

It does make them experts in the field, and qualified to call out bullshit.

Which means experts in the field were qualified to call bullshit on, say, Galileo or Copernicus? Sometimes entire fields are themselves based on bullshit, until a better theory comes along.

I don't think it's this extreme in this case, and the parent provided some good elaborating context elsewhere, but do remember to stay humble and open.

Yeah, that opening sentence was extremely valuable, because it let me decide to stop reading so quickly.

Why do you feel you need to defend finance?

The fiance mindset has won and taken over the world. Being this defensive about one opening sentence makes you sound like sore winner.

I don't know anything I'm sure compared to you, but I do know that we are trashing the environment and we aren't even bothering to feed clothe and give basic health care to everyone yet and we probably never will.

I suspect maybe it's because we think in terms of finance.

In medieval times they used to have people debate endlessly on obscure points of theology and catechism. Just because they had a lot of erudite people poring over that esoterica doesn't meant it was useful.

> I suspect maybe it's because we think in terms of finance.

You're only stating a bias here. It tells us something about you, nothing about the world.

If you're not going to pursue shareholder value (and you're upfront about that) then you aren't going to get many investors.

Profit comes to mind.

>To move from the micro to the macro, we can contrast the returns achieved by shareholders in the era of managerialism (defined here as 1940-90, although the results are robust to the exact sample chosen) with those achieved in the era of SVM (1990-2014).

>Given this data, the natural follow-on question is, of course, what went wrong?

I don't really understand. Can you really do a comparison like this? Aren't the events that transpired during these two periods very different from one another? My layman's expectation is that WW2 and its aftermath would have a significant positive effect on the first period considered. I would also guess that globalization in the second period would have an impact due to manufacturing moving away from the US.

Am I just mistaken and you can just straight up compare these two periods with one another?

Maximise societal value, maximise shareholder value consistent with the first goal. Tax and regulatory oversight are parts of trying to maximise the first goal. It depends on honesty and utilitarian views. If you are selfish in motivation, self interest does not maximise societal outcome.

Here's the (non-pdf) executive summary:

https://www.gmo.com/americas/research-library/the-worlds-dum...

I wrote about this years ago [1] and all the feedback I received was: Hey that's great and all, but the business world will never care about anything other than percentage return. Go start a charity if you don't share that priority.

[1]https://medium.com/@andrewkemendo/startups-need-to-start-val...

The companies with the highest Corporate Social Responsibility budgets also pay the least taxes. Go figure.

Capitalism is supposed to result in the highest good for the greatest number. In practice it's often more like "the cheapest, lowest quality we can get away with providing before you take your business elsewhere."

Maximizing shareholder value would be a fine goal for a corporate entity that had received no special deals from government. Like limited liability. Like corporate personhood. Like infrastructure and other subsidies. Like tax preference. Like exemption from paying for broadly dispersed externalities via regulatory capture. Like government help to quash freedom of association - oops, I mean collective bargaining.

Oh, but wait, that's not the kind of deal that's on offer, is it? IS IT? No, once you've formed a corporation you've made a contract with the government. I mean "contract" in the philosophical sense, not the legal one which has been quite deliberately defined to suit the very entities we're discussing. The contract is that you will receive these favors, in return for some social good or at least for not undermining the social good that already exists. Go read your history, on the early corporations chartered to build canals and such. Corporations should be held to that deal, or the contract should be considered broken and all the favors withdrawn. Why? Because honoring contracts is the most fundamental pillars of a real functioning market - the very market that laissez-fairists who push the "maximizing shareholder value" fallacy claim to revere. To say it's OK to break contracts is to say you don't believe in markets. If you don't have real markets and you don't have socialism all that's left is oligarchy.

Oops. That's the part we're not supposed to figure out, isn't it? I see the downvote brigade has already shown up.

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