Incentives matter You can imagine two slightly different sorts of "rationality" in economic matters. One kind of rationality is the stereotypical Econ-101 kind, cold calculating maximization of personal benefits, particularly financial benefits. On this model, a rational person more or less always chooses the thing that makes her more money rather than less money, no matter how it affects anyone else or how unusual it is or how bad it looks. The other kind of rationality is more like reasonableness, acting the way a normal person would act in the circumstances, optimizing a wider set of fuzzier and more social benefits. On this model, a multibillionaire who works 16-hour days to make more money might seem a little … irrational? Hasn't she already optimized her wealth? Aren't there other things to optimize? "One dollar for eternal happiness?" muses C. Montgomery Burns. "I'd be happier with the dollar." One thing to say here is that the people who are Econ-101-rational tend to be the ones who make the most money. Every time you read about a workaholic billionaire and think "boy, not me, if I had a billion dollars I'd be on the beach," the answer is always "well that's why you don't have a billion dollars." If you have the characteristics that enable you to make a billion dollars, you don't usually turn them off once you get there. Another thing to say here is that modern theories of public-company capitalism tend to encourage and reify Econ-101 rationality. If you run a family business, you want it to make a lot of money, but you also want to spend time with your family and take nice vacations and be friendly with your employees and feel like a pillar of the community and all that nice, normal, human stuff. If you are the chief executive officer of a public company you also want those things, probably, but modern financial theory and practice are largely built around beating that desire out of you. "CEOs' incentives should be aligned with the interests of shareholders," is a thing that people think, and the shareholders don't come on vacation with you. They're not spending time with your family or befriending the employees or being lauded as pillars of the community. They're just in it for the money, so you should be too. So "how do we stop CEOs from taking too many vacations" is genuinely an important topic in the modern corporate finance literature; the answer, as usual, is stock options. "How do we get CEOs to take more risk," too, that sort of thing. The point is to get CEOs to abandon their normal human instincts and make them think like shareholders instead. And shareholders, as shareholders—as a diverse anonymous group of people with no strong shared connection to the company other than money—aren't like normal humans. Their rationality is of the pure profit-maximizing kind. This is a well-known critique of modern companies—that they act like psychopaths, like monstrous sci-fi robots. Some people think it's a problem, and they want to fix it, either by making CEOs care about people other than shareholders ("stakeholder capitalism") or by making shareholders care about things other than money ("socially responsible investing"). These suggestions have their own problems; the shareholder-value-maximization theory has some real advantages in functionality and coherence. My point here is not that it's bad; it seems quite plausible to me that the best form of rationality for a corporation could be this sort of profit-maximizing instrumental rationality. My point is that it intersects strangely with normal human behavior. It just … it just sort of makes you awkward at parties, you know? This Bloomberg story about the Amazon.com Inc. HQ2 saga is low-key one of the most insane things I've ever read: When Elon Musk secured $1.3 billion from Nevada in 2014 to open a gigantic battery plant, Jeff Bezos noticed. In meetings, the Amazon.com Inc. chief expressed envy for how Musk had pitted five Western states against one another in a bidding war for thousands of manufacturing jobs; he wondered why Amazon was okay with accepting comparatively trifling incentives. It was a theme Bezos returned to often, according to four people privy to his thinking. Then in 2017, an Amazon executive sent around a congratulatory email lauding his team for landing $40 million in government incentives to build a $1.5 billion air hub near Cincinnati. The paltry sum irked Bezos, the people say, and made him even more determined to try something new. And so, when Amazon launched a bakeoff for a second headquarters in September 2017, the company made plain that it was looking for government handouts in exchange for a pledge to invest $5 billion and hire 50,000 people. The splashy reality-television-style contest generated breathless media coverage, attracted fawning bids from 238 cities across North America and ended with Amazon deciding to split the so-called HQ2 between New York and Virginia. Then progressive politicians attacked the $3 billion in incentives offered by New York, and Bezos pulled out. Envy? Why? What? I mean, I don't know, I guess I get it. I stew for days when I find out that people I dislike have more Twitter followers than me. Maybe when you're at the rocket-billionaire level you go around thinking "why does the other rocket billionaire get more tax incentives than I do?" It does seem relevant that Amazon is a trillion-dollar company, that Bezos is the world's richest person, that he has a complicated and active personal life. The non-maximization of tax benefits is not obviously a problem; you could not identify a way in which his life is worse because of it. You might think at some point he'd be like "fine Elon can have the tax incentives, I have things to do, I will just have to content myself with my vast wealth and total control of all commerce." But, no, he'd be happier with the dollar. It does make you awkward at parties though: A team that included real estate chief John Schoettler drew up a request for proposals, highlighting such must-haves as an airport with direct flights to Seattle and good universities. The word "incentive" was used 21 times. Some team members cringed, worried that Amazon would come across as tone-deaf given Bezos's wealth, not to mention triggering a national debate over income inequality. They knew officials would offer tax breaks regardless. Demanding them left Amazon exposed to accusations of corporate greed. But the naysayers were quickly hushed and sent to work on other projects. The remaining members of the team believed any fallout would be short-lived and overshadowed by the sheer size of Amazon's investment. "Hello good sir we are Amazon and we're here for your money": Yes, fine, that's what you mean, but couldn't you say it in a nicer way? Bridgewater There is a conspiracy theory floating around out there that Bridgewater Associates LP's returns are, somehow, not real. This is not, to be clear, true; there is no evidence for it, and the arguments for it are laughably bad. But I can see why it's appealing. Bridgewater is weird, secretive, and enormously successful. It's the world's largest hedge fund firm, it has a long history of good returns, and its employees all run around rating one anothers' believability on iPad apps. Wouldn't it be funny if it was all a Ponzi? But another possible conspiracy theory—an even better one, one that goes even more to the heart of Bridgewater's mystique, one that is even more counterintuitive and contrarian and surprising and funny—would be, what if Ray Dalio's firm is not a pure meritocracy of searing self-examination and critical exchanges of ideas? What if it is not free of ego and office politics and personality clashes? What if Dalio is just like "all of you go get me coffee and whoever's coffee is the tastiest gets to manage the portfolio"? I am not convinced that's true either, exactly, though I do think that it's easier to convince yourself that your personal preferences represent "meritocracy" than it is to convince yourself that bad returns are good. It is easier to build a strange new form of office politics than it is to get rid of office politics, easier to have idiosyncratic personal attachments than none. Anyway here's a Wall Street Journal article about Bridgewater, Dalio, his plans to hand control over to successors, and his clashes with executives and successors, including departing co-chief executive officer Eileen Murray. It features this amazing sentence: Ms. Murray suggested Mr. Dalio revamp the investment team, focusing more on merit rather than whom Mr. Dalio personally liked, according to the person in whom she confided. Imagine going up to Ray Dalio, the author of "Principles," the celebrity guru of "idea meritocracy" and "radical transparency," and saying "hey Ray have you ever considered promoting people based on merit rather than personal fondness"! I am not sure I can think of a worse thing to say to him; I want desperately to watch Bridgewater's video of that confrontation. ("The company in a statement said 'that never happened,'" Murray also denies it, and Dalio says that the Journal article "is filled with intentional factual errors.") This is also pretty sweet: Several years ago, Mr. Dalio arranged a conversation with Russian President Vladimir Putin to discuss economic policy, said some of these employees. Employees expressed concerns about engaging with the autocratic leader, and Mr. Dalio told one that "if you're so smart, why aren't you rich?" according to people who heard the comment. The purest form of ideas meritocracy! I mean, to be fair, if you structure your hedge fund around the theory that a meritocracy of ideas is the best way to make a lot of money, and then you make a lot of money, you might quite reasonably draw from that experience the not-logically-entailed-but-still-plausible conclusions that: - you succeeded in building a meritocracy of ideas, and
- whoever has the most money has the best ideas.
Really money is the ultimate believability score. The article also supports another mostly joking theory that I have long held about Bridgewater, which is that its computers do the investing and the main challenge for the firm is keeping Dalio from interfering with the computers. Apparently the system works: Mr. Dalio has at times also ignored his investment team's research, frustrating employees. This happened in 2018 when the U.S. dollar was dropping in value, and Bridgewater had bet the dollar would rise. The drop worried Mr. Dalio. He wanted Bridgewater to bet that the dollar would continue to fall, and clashed with his investment team, according to people familiar with the matter. In the end Bridgewater's computer systems overruled Mr. Dalio, the people said, and the dollar's rout turned into a rally. The WSJ Dollar Index finished the year up 4.3%. I should say that most of the juicy claims in the Journal article are followed by on-the-record denials from Bridgewater and the people involved, and that Dalio wrote an angry response about "The Wall Street Journal's Fake and Distorted News" that includes this passage: They are investigative journalists that The Wall Street Journal hires to dig up dirt on successful people and companies and to write negative articles about them. The Wall Street Journal and other publications don't have investigative journalists write complementary articles on people because those articles don't sell, which is why our country has no heroes …. Liquidity We talked last month about a pleasing theory, proposed by Cliff Asness of AQR Capital Management, that liquidity is bad. The theory is that there is a lot of noise in investing, a lot of overreaction to news and panicked selling when stock prices drop. If you eliminate the noise, and the ability to sell, you might eliminate the overreactions and get better returns. Asness: Liquid, accurately priced investments let you know precisely how volatile they are and they smack you in the face with it. What if many investors actually realize that this accurate and timely information will make them worse investors as they'll use that liquidity to panic and redeem at the worst times? What if illiquid, very infrequently and inaccurately priced investments made them better investors as essentially it allows them to ignore such investments given low measured volatility and very modest paper drawdowns? "Ignore" in this case equals "stick with through harrowing times when you might sell if you had to face up to the full losses." What if investors are simply smart enough to know that they can take on a lot more risk (true long-term risk) if it's simply not shoved in their face every day (or multi-year period!)? Asness used this theory to make an argument about the expected returns of private equity as an asset class. I used it to explain why a lot of private tech unicorns have gone public at disappointing valuations. We talked about it as a fun, counterintuitive theory of how the world might work. But in another form it is actually a very old theory underlying some common market rules. Lots of markets have rules that say that if stocks go down too far, you can't sell them anymore. China's, for instance, today: China's stock market opened to the most savage wave of selling in years, with thousands of shares falling by the daily limit after just minutes of trading. Though investors turned on computers hours early to tee up their sell orders, many of them couldn't exit the market fast enough. All but 162 of the almost 4,000 stocks in Shanghai and Shenzhen recorded losses, with about 90% dropping the maximum allowed by the country's exchanges. … The huge number of stocks trading limit down means it could take days for investors to execute their orders, prolonging the sell-off. "I was anxious before the market opened, and had made plans on what to sell and by how much last Friday," said Bruce Yu, a fund manager with Franklin Templeton SinoAm Securities Investment Management Inc. in Taipei. "Some of my trades weren't made today -- we'll see if we can sell them tomorrow." Well, the liquidity is bad, but of course if this is a temporary overreaction to bad news then the bad liquidity is actually good. If you can't sell everything you want to sell, and you shouldn't be selling, then you're just being protected from yourself: "My biggest concern was that investors would rush to redeem their holdings in private and mutual funds," said Jiang Liangqing, a money manager at Ruisen Capital Management in Beijing whose team is working from home across China. "A key task for us is to reassure our fund holders and ask them to stay calm." Of course if the news—mainly coronavirus news—is that bad, if it will lower long-term stock prices by more than the limit-down amount, then bad liquidity is just bad: Stock prices are adjusting to reality too slowly, trades are happening at the wrong price, buyers can't step in because the price is still too high, sellers can't get out prudently, etc. The question of "is liquidity good" is more or less: Will you lose more money by panicked selling in overreaction to short-term news, or by being unable to sell in sensible reaction to long-term news? Lunch Stuff Uh: Citigroup has suspended one of its most senior bond traders in London after the US investment bank accused him of stealing food from the office canteen. Paras Shah abruptly left his post last month as Citi's head of high-yield bond trading for Europe, the Middle East and Africa. The bank suspended Mr Shah after alleging he had stolen food from the canteen at its European headquarters in Canary Wharf, London, according to four people familiar with the matter. Citi declined to comment. Mr Shah declined to comment over email, referring inquiries to Citi. … Mr Shah is likely to have received a seven-figure pay package, according to rival traders and junk bond investors, and was suspended weeks before Citi was due to pay bonuses to senior staff. I have no idea what happened here and it's obviously super strange, but I will say that, if your high-yield bond trader steals food from the canteen, you have to stop him! Sure the cost of the food is an infinitesimal fraction of the money he's making for you, but it's the symbolism of the thing. "Dishonest," "risk-loving" and "rule-breaking" are now bad characteristics for bond traders at banks to have. If, later, a customer has a complaint about how they were treated by the trading desk, it will look bad for you if the head of that trading desk also stole food from the canteen. "If he stole a sandwich despite making millions of pounds a year, he might sneakily take an extra quarter-point on bond trades with customers," etc., it is obvious stuff. You can see how this would create some cultural problems, in that "dishonest," "risk-loving" and "rule-breaking" were once kind of good characteristics for bond traders at banks. Not all that long ago, if you interviewed for a bond trading job at a bank and didn't swipe some cookies from the canteen on the way out, they might have worried about your aggressiveness. Sneakily taking an extra quarter on bond trades with customers is not entirely bad, you know; you get the extra quarter! How can you be trusted to mislead clients about how much you paid for a bond if you wait on line to pay for your food like a chump? In a previous era—one when regulators had a higher tolerance for dishonesty and banks had a higher tolerance for risk—the optimal characteristics of a bond trader were different, and there will be an adjustment period as the previously optimal traders get managed out. For stealing food from the canteen. I don't know. Obviously another theory is "we want to employ the bond traders who steal food and don't get caught," etc.; management of a global bank is complicated. Things happen At BlackRock, Public Firings, Overseas Probe Send Message About Office Misbehavior. (Earlier.) WeWork has a new CEO. Credit Suisse freezes investment bank bonus pool. Church of England Devises an Index for Climate-Conscious Investing. How Japan Inc became a target for activist investors. Coronavirus Forces World's Largest Work-From-Home Experiment. China's Once-Hot Peer-to-Peer Lending Business Is Withering. Payment-Services Giant Worldline to Buy Ingenico in $8.6 Billion Deal. Leon Black's Apollo Sues Former Employees. Luckin Coffee Stock Takes a Dive as Short Sellers Respond to Fraud Claim. SEC Brings Charges Against Fraud Targeting Amish and Mennonite Investors. Harvard Alum Gets the School Its First Super Bowl Touchdown. "When you come from the red-light district, you don't get invited to fancy balls or the Oscars. But when you're a prince you do." One Guy Gets Entire Park to Sing Bon Jovi. Google Maps hack art project. If you'd like to get Money Stuff in handy email form, right in your inbox, please subscribe at this link. Or you can subscribe to Money Stuff and other great Bloomberg newsletters here. Thanks! | 
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