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Finance Prof's New Book Challenges Stagnation, Division Mindset

Sep. 14, 2020 11:17 AM ET
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I recently interviewed Alex Edmans about his game-changing new book, Grow the Pie: How Great Companies Deliver Both Purpose and Profit. I call it "game-changing" not as a cliché for important or interesting, but with a more literal and specific meaning. It has the potential to change the game of corporate finance and investing because it challenges the rules extant in the current game.

The current game is a zero-sum one: What goes to me was taken from you, what goes to you was taken from me, what goes to shareholders was taken from workers, what goes to worker was taken from shareholders. The current game assumes a disharmony of interests among the groups currently called 'stakeholders'. The players in the game advocate for their particular side to get a maximal share of the pot and to leave the other player with a lessened share.

But those don't have to be the rules. Those rules are not grounded in the nature of reality itself; they are grounded in ideologies of class conflict which have shown themselves to be at variance from reality.

Marx thought that profit was stolen from workers, therefore the growth of capitalism would lead to an economic crisis for workers. But now, more than a century and a half since Marx’s writings, worker well-being improvements are vastly better than they were when those theories were formulated.

Not long before that, the Rev. Thomas Malthus popularized the view that population growth tended to outstrip food production and that, therefore, each of us who eat, eat at the expense of those who will inevitably starve. In fairness, it's not clear that Malthus actually believed and intended to promote that theory, but history received it, nevertheless.

Economists have largely done away with these errors, though they are experiencing a resurgence right now in both the populist right and the populist left.

Professor Edmans shows that this zero-sum game, which he calls the 'pie-splitting mindset,' to some degree persists in finance. As a financial practitioner who works a lot in the world of ESG (Environmental, Social, Governance) investing and corporate activism, I am forced to agree. Social activists both outside and increasingly inside the industry fixate on pie-slice-proportions instead of pie slice size. Activists and the press flood us with CEO pay comparisons: CEO-to-line worker; CEO-to-peer; CEO-to-other officers. Inadvertently, anticipating Edmans' pie metaphor, a few of these are actually called 'CEO pay slice'.

The political world is also stuck in this thinking. Politicians complain about stock buy-backs as though the cash used to buy those stocks is shoveled into a furnace and burned, rather than being transferred to pension plans and individual stockholders to be reinvested in some better opportunity, often to private equity start-ups.

On the other hand, conservative and libertarian thinkers too often see generous pay packages, for example, as coming at the expense of shareholders. Other forms of relational capital building -- for example, generous terms with suppliers, pollution minimization, philanthropic efforts in the communities in which the company operates, and flexible workplace rules -- are seen as money taken from shareholders, robbed from the one and only social obligation a company is alleged to have: to maximize profits.

This principle is alleged to have come from the great Milton Friedman. Edmans, however, rebuts this mythical understanding of Friedman, showing that he had a far broader view, acknowledging ways in which generosity and creation of social capital could be in the long run better for shareholders.

The narrow view of shareholder interests, let's call it Faux Friedman, has become a bogeyman for the left and a talisman for the right, which means that this misunderstanding is something which they share and on which they both depend.

If you've listened to my interview with Peter Thiel, you know that I'm on board with the growth mindset (which Peter describes as the leap from Zero to One, a discontinuous jump in innovation and output) and of the virtuous cycles: innovation, profit growth, wage growth, social capital, repeat.

Edmans builds the rigorous empirical case for the growth mindset. He seems to read voluminously from academic financial journals and he himself is one of the editors of a prestigious, peer-reviewed financial journal, Review of Finance, and has written extensively for other journals. But having started his career with Morgan Stanley in investment banking (London) and fixed income sales and trading (New York), he is able to bridge back and forth between the world of academic analysis and practitioner relevance.

We spent about an hour together across a web connection, and the Atlantic Ocean, discussing his book and whatever else came up.

A lightly edited recording of that discussion can be found here.

I plan to review my notes from the book regularly and to follow Professor Edmans' web page and social media feed regularly. Although I don't always agree, he is font of information that I know that I cannot afford to ignore.

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