My friend has just switched jobs. She is a lawyer and decided to accept the offer of a former colleague to join him at his new firm. Things like that happen all the time in the law business. In this case, though, she was not the only one to have been lured away – many members of staff received an offer of a job at the new firm and all of them, like her, wanted to accept. Wary of the huge shock that at mass exodus would have on the firm’s boss and on the remaining staff, my friend wondered whether there was any way to mitigate the ‘damage’ so that good relationships wouldn’t be spoiled nor ill-feelings left behind.

“You should all quit at the same time,” was my immediate response. Sure, it would be a massive blow for the boss but, from a psychological point of view, aggregating all the bad news into one dreadful event would be better than enduring a string of staff members showing up at his office with resignation letters over weeks.  It sounds almost counter-intuitive, but when faced with a block resignation the boss would perceive the loss of each individual proportionally less the more of them there are.  However, if they quit separately with a gap of several days in between, he would perceive the departure of each with the same intensity. From a purely hedonic perspective, it is more favourable to aggregate losses and to segregate gains. “Pull off the plaster all in one go,” I counselled.

It turned out the lawyers were not inclined to indulge a well-intentioned behavioural economist; they quit one after the other with an interval of a couple of days between each. The poor boss must have felt that the ground was opening up beneath him.

Read more on the Boerse Frankfurt website

The one wants to have it at any price; the other would touch it with a barge-pole. There is no doubt that the Facebook IPO has polarised opinion. Still, if everything goes to plan, the social network will come to market at a price that values the company at $100bn. That is as much as a PepsiCo, a Total, or a Unilever. Is Facebook really worth that much?

The media reflects the hopes and fears of the investment community. Some bloggers, for instance, believe Facebook is simply too important to miss. The firm and its hoodie founder, Mark Zuckerberg, represent innovation, unconventionality and success for our digital future. Facebook has attracted a massive 900 million users worldwide and has long since vaulted the billion-dollar revenue mark. In each of these accounts, reckon the IPO punters, lies the potential for future business. Admittedly, with such an impressive success story, it is difficult imagine that it could possibly end. However, it is precisely this human tendency to treat the future as simply an extrapolation of the present that could cause investors to err. Facebook’s (literally) Hollywoodian tale is particularly appealing: dramatic, easy to understand and, thanks to the haggling between bankers and investors, very interesting. These attributes mean that Facebook is salient, cognitively available, for would-be investors. These are precisely the conditions under which stocks tend to be favoured and potentially overpriced.[1]

Many investors can still remember another period when internet companies carried the hopes of a generation – the nineties dotcom bubble. Facebook’s revenue numbers might sound impressive, but broken down to the revenue-per-user and the figure comes to just $4.34. In the US, which counts the users with the highest spending, the number of active accounts is actually falling. Most of the new users are from regions where the spend-per-user is markedly lower. What’s more, Facebook still hasn’t managed to break into mobile advertising although the growth in users with mobile devices has been the strongest. ‘Hot air and nothing behind’ bemoan the harshest critics, who fear a Facebook stock crash. IPO buyers are partying like its 1999, they caution. However, an obsessive fear of extreme events like a stock price crash often causes investors to eschew even reasonable risks. In this case, because a sizeable pool of potential, but crash-struck investors is simply absent from the price building, the IPO could actually emerge at a lower price than it deserves. The IPO could actually be underpriced simply because of its association with businesses that collapsed after the dotcom boom a decade ago.

Whether Facebook is really worth its money will be seen in the coming years. The clash of beliefs will certainly not end after the public offering, nor will the internet boom end with Facebook.

A financial transactions tax (FTT) appears to be tiptoeing ever closer; it has escaped its moral, technical and intellectual shackles. Francois Hollande, the new French president seems bent on introducing the measure (his adversary in the electoral race had mouthed the words, but many people had their doubts). What’s more, Hollande has framed its introduction in a new way: no longer is it presented as a punishment for errant bankers, but as means to finance new pro-growth measures. In the UK, the Kay Review of Equity Markets has countered those who criticised the tax on the grounds that it would impede market liquidity and price discovery. The Review board’s interim report was dismissive of the ceaseless pursuit of financial market liquidity as an end in itself, the implication here being that the goals of both seekers and suppliers of capital could be adequately (or even better) served with less liquidity. In any case, with each new trading scandal policymakers become increasingly less inclined to make concessions to the financial community. Finally, leading economists are coming round to the view that a FTT might not be such a bad idea after all. Paul Krugman, for instance, although sceptical about whether it will do much good, does see a chance that it could raise some much-needed tax revenue, and is largely convinced that it will do no harm.

My current preoccupation with the FTT, though, has to do with its impact on investor activism. Already we see an increase in the agitation of the owners of quoted companies, the so-called Shareholder Spring. For some unfortunate CEOs, the annual general meeting has turned into something resembling a public execution. Up until now, it was common for stockholders who were dissatisfied with the management of the companies they owned to simply sell the stock and buy shares in a ‘better’ company. Perhaps due to the realisation that the management of the alternative company reflected the same flaws, there has been a trend towards voting with their hands instead of with their feet – starting with a revolt over excessive boardroom pay. A financial transaction tax, if it comes, will increase the cost of simply switching to an alternative company; agitation at the annual general meeting may actually become the cheapest way to improve investment returns. With time it might even become the norm.  The consequences of the FTT may not be to raise any meaningful tax revenue at all, but rather to effect a change even more profound. Rather than punishing finance, an FTT might accelerate its transformation from a spectator sport into a participative one.

Among the transfers that were supposedly not transfers were the cuts in the rates of interest on loans to the bailed-out countries; ECB bond purchases; a sovereign debt default; and now there is even talk of engineering higher inflation in the EU core states in order to improve the relative competitiveness of the periphery. Assuming monetary policymakers do succeed in quickly securing the desired inflation rates in the respective constituencies (if they do, we would have to ask why they were never able to do it before), it would only create the conditions under which capital transfers might be encouraged, it could  not guarantee that any would actually take place. For instance, if other production locations in the world manage to achieve real improvements in competitively, not just relative ones, the struggling periphery might not see any of the investment capital lost to the core.

The problem with all the transfer methods used so far is that they are limited and slow-acting. In the meantime, the suffering of the citizens in the periphery is heart-breaking.  Human capital, both present and future, is being squandered and nationalism is on the rise. Even if direct cash transfers were permitted now, it is far from certain that these two developments could be reversed. Worse, all of this was entirely predictable. Two years ago, the union’s historians, sociologists, anthropologists, and philosophers could easily have predicted where we would be today. Sadly they were never invited to the overnight meetings in Brussels. So when will we have the first EU philosophers’ meeting, or a historians’ G7, and take note of their recommendations?

In a column in the FT recently[1] Martin Taylor, the former Barclays CEO, expressed great surprise that shareholders had not revolted against excessive banker pay much sooner. Of course, the shareholder discontent is a product of the Zeitgeist – Occupy, the Ninety-Nine Percent, the Shareholder Spring, and all that. One could also argue that it needed a certain time for a critical mass to coalesce around the idea that ordinary people (and ordinary shareholders) could successfully agitate against the excessive and flawed development in boardroom salaries.

Martin Taylor attributed the delayed reaction of the angry stockholder to three other decisive factors. The first is the typical holding period of equity investments, which had become so short that shareholders no longer identified with the firms they owned. One cannot disagree with that. The second argument was that fund managers who are underweight a stock, but still shareholders, have little interest in agitating for pay reform, as they would actually like to see the stock underperform. Finally, he argued, fund managers are anyway not going to revolt against bankers’ pay when their own remuneration is determined by an almost identical pay structure.

The most important explanation for the tardy stockholder has to be a psychological one, though. When it comes to losses, people have a greater need for control than when it comes to gains.  This tendency can even be seen within individual firms. When profits are bubbling, as was formerly the case in investment banking, nobody is motivated to pose any critical or otherwise uncomfortable questions about how the situation came about. In the presence of a glowing trading statement, it would have bordered on blasphemy for someone to ask whether more could have been earned. Those foregone gains might have been precisely the revenues that were missing in leaner times.

In contrast, the criticism becomes particularly audible when losses emerge or earnings targets are missed (perceived nonetheless as a loss by investors). The search for the guilty only begins in earnest when many firms or even the whole economy suffers under losses. These are the conditions wherein people strive to wrest control and when the complaints that rewards were distributed where none were due become the loudest.

Read more at the Boerse Frankfurt website

Japan has been synonymous with technology for decades. More recently though, debt, deflation, and now demographics, have taken their toll on this image. According to the latest figures from the Ministry of the Interior, the Japanese population shrank by more than a quarter-million people last year – the third decline since 2005.  The number of births, at 1.07 million, marked a record low, and this was even not the most striking figure in the data set. The number of children below the age of 14 in relation to the entire population was also an all-time low at just 13.1 percent. By comparison, citizens beyond the age of 65 represented 23.3 of the population, also a record peak. It is hard to find a set of statistics like this anywhere in the world.

The population growth in much of the developed world has been tapering off since years, turning negative in some countries, so this trend is not new. However, the increasing intensity of this process is a challenge for social scientists, especially in Japan where they predict the economy could experience a shortage of experienced, knowledgeable workers in less than 20 years. Some critical commentators suggest that ageing Japanese decision-makers will no longer be able to keep up; the declining quality of decision-making will put the economy at a disadvantage to competing countries whose populations are markedly younger. For some, this is the explanation for the sluggish economic progress already being witnessed. Are ageing decision-makers really holding the economy back? Are decisions made by the greyest grey cells worse?

An earlier post has considered the efficiency of ageing decision-makers in the case of the France’s wealthiest woman, Liliane Bettencourt. However, Japan needn’t end up like the L’Oreal heiress – a court ruled that she was incapable of managing her finances and placed her under guardianship. Academic research[1] has demonstrated that, although decision-making ability does deteriorate with age, the worsening is mostly due to seniors’ slower processing speed and poorer memory. If these factors are compensated for, older people have similar make decision-making quality to their younger counterparts. All that is needed in the boardrooms of Japanese companies, therefore, is more time for the each item on the agenda, and a table large enough to accommodate all the relevant information so the board members do not need to rely on memory.

Before the results of French elections were known much ink was used to speculate how the election of socialist Francois Hollande would lead to the shift in Franco- German axis on the issue of growth and austerity. Essentially Chancellor Merkel and President Sarkozy have invested a lot of political capital and time in the pro-austerity strategy with an aim of solving the crisis.  So despite an increasing number of economic observers having now recognised that austerity in a static growth environment can only be recessionary, it has been difficult for political leaders them to change their stance. In fact despite the austerity backlash on the electoral front and the case of Spain where a stupendously austere budget did not prevent the market from punishing the bond markets, the Chancellor in particular has found herself unable to change her posture.

Seen from a psychological perspective, this behaviour is perfectly understandable. People in a decision-making process typically tend to justify their future decisions based on their cumulative prior investment. This means that, even in the presence of new evidence suggesting that the costs of pursuing a course of action outweigh the benefits, people will tend to act in a way that justifies their previous decision. Often, this will result in good money being thrown after bad because people refuse to accept that the prior investment was in vain.  Politicians are particularly prone to this sunk-cost effect because of their responsibility and because their actions are subject to the public spotlight. These factors mean their psychological commitment to a decision is higher than that of the average person’s.

France’s new president has a distinct advantage when it comes to avoiding the sunk-cost effect trap. This is the first time he holds a government post, so he has not invested heavily into the decision-making as far as the eurozone crisis is concerned, except from the outside.  For him, pressing on with existing policy, or doing an about-turn, represent the same new cost. Also he has little psychological commitment to the crisis previous decisions. Hollande’s election, and the chance to decide without the burden of the sunk cost effect, may well provide new possibilities for the other negotiators too: they can shift away from the austerity template without having to lose face or worrying about making a U-turn on policy.

“It was something ending in ...LING”, I said to my daughter, “and the G was for Germany, not Greece.” What was it? BUMBLING? FAILING? STUMBLING? TRIFLING? No, it wasn’t any of those –there aren’t even 11 letters. What’s more, it seemed that my knowledge of the present state of the eurozone project was interfering with my ability to piece together my memories from 13 years ago. Or was I subconsciously trying to show that the eventual woes of the eurozone were somehow foreseeable in the choice of an acronym hastily stapled together over a decade earlier to allow finance professionals to remember the names of the original members?

Increasingly annoyed by not being able to recall the acronym, I turned to Google. The answer: BAFFLING SIP ^[1]. I could just as easily rearrange that to BAFFLING PSI. Perhaps the choice of acronym was inadvertently prescient after all.

---

[1] Belgium, Austria,Finland, France, Luxemburg, Ireland, Netherlands,German, Spain, Italy, Portugal