Links/Issues for Tomorrow's Class session

"No one can earn a million dollars honestly."
       -- William Jennings Bryan

Historical Fortune 500
Kevin Hallock paper on Interlocking Directorates
David Larcker presentation on Executive Compensation

What is happening in the product market to enable a firm's stock to experience high growth rates?

When this happens was the stock undervalued earlier?

What about CEO risk aversion?
Disruptive Innovation

Asset Equations and Moral Hazard

We didn't fully cover the last slide in the PowerPoint from today.  So I will start with that on Thursday.  It is a puzzle.  Let me see if I can explain the issue here.

The asset equation that I briefly showed is from this document, on page 3.  The important point to note is how we typically interpret such an equation.  The asset value, "A," is measured in current time, that is the value of the asset today.  The return "a₁" happens 1 period into the future.  Similarly, the return "a_t" happens t periods into the future.  In other words, the asset value is the sum of the appropriately discounted future returns.

On the other hand, in assessing the reputation of an individual, we typically look at past performance.   Typically, the rule of thumb is to trust somebody who has had strong past performance and to distrust somebody else who has had weak past performance.

The puzzle is how in one case can the reputational asset be forward looking only while in the the other case where we assess the assess we are backward looking only.  Can that make sense?  If so, how?

Card Playing

Though the title of the post may seem frivolous, this is meant as a serious message.  I'm guessing that several of you have played poker, and not just penny ante. I wonder if any of you have played bridge.  It is the ideal card game for talking about the issues in chapter 5.

In all card games each player is dealt some cards that they see and the other players do not.  This is an example of private information. After the deal has concluded but the play hasn't yet started, each player knows what is in their own hand, but not what is in the hands of the other players.  In some card games those cards are then revealed sequentially during the play.  The play of the cards can communicate not just what has happened, but what cards remain as private information.  In poker, it is the betting that offers the possibility of communicating.

Bridge is interesting here because it is a team game and the effectiveness of the team depends in part on how well messages that are sent are understood by the partner.  There is also usually a logic to the sequencing of the play of the cards.  Effective teams find the right sequence.

If you have trouble coming up with examples for the prompt this week, it's okay to use card playing as one such example.

More on Darwin this time on economies of networks

I'm ignorant on issues of human physiology, so I don't really know if this is true or not, but the story is that we each have an appendix that is a vestigial organ.  This means that at some time in our evolutionary history the appendix was functional, but the need that it satisfied disappeared while the organ did not.  Vestigial organs are a feature of the evolutionary approach.  It's not possible to explain them from an efficiency perspective.  (And do note that with the appendix it is possible for it to become seriously inflamed, at which time the person has an appendectomy.  So, even if it doesn't do good, it is possible for the appendix to do harm.)

This idea ha an economic analog which is called "lock in" and is a rather important concept.  Lock in belies a sense of dynamic efficiency.  The most well known example is the QWERTY keyboard.  I wrote a post about that a while back that has links to other very good references on the subject.  By the way, subsequent to writing that post I learned that Colorado College is a place that does have students take one course at a time and focus on that.  I don't know other residential colleges that do this, but it is fairly common with executive education and online learning.

Reconciling The Rationality/Efficiency View With Making Bonehead plays

Econ students are taught about Adam Smith and his notion "the invisible hand" that guides the privately good behavior to produce socially efficient outcomes.  Biology students are taught about a different sort of competition - Darwin's Survival of the Fittest.  Individual "behavior" is genetically determined.  But genes can mutate.  Some mutations produce advantage and those that do tend to propagate.

In the last several years, some economists have been trying to apply Darwin's approach to economic competition.  There are a few reasons for doing do and one is given by the title of this post.  Behavior can be based on traditional belief, which is very much like behavior being determined by genes.  But sometimes we try new things, which is like having a mutation.  When the new thing seems better than the old thing we call it an innovation. One doesn't need full rationality to explain innovations. All it takes is a search for doing better than at present and then learning by experience from the experiment in trying.  Often that learning suggests the next experiment to try.  This view may be somewhat more realistic - humans learn but aren't fully rational.  I find that an appealing approach.

There is a different reason for economists to emulate Darwin.  Robert Frank, an economist in the Business School at Cornell, has been writing about this idea.  This is a very interesting read and won't take you long to get to the gist.  Competition is about individual advantage.  Individual advantage that propagates often also creates advantage for the species. Once in a while, however, traits that create individual advantage can actually be harmful to the species.  In the linked piece, Frank says the latter can happen when the advantage is relative only. The metaphor is that the overall pie is smaller but the individual gets so much bigger a slice that the individual is better off.  So there can be individually good but socially destructive innovation.  This is meant as an argument for some regulation and against laissez-faire.

Follow Up On Today's Class

It occurred to me after class that I may not have motivated the practice of writing weekly reflections particularly well.  It's something I've tried in other courses.  I had particular success with it in an honors seminar, so it seemed like a good thing to do.  Also, I tend to write reflections quite a bit.  Here is one on that seminar class written after the course concluded.  It might give a much better idea of what I'm trying for.

Beware of the typos!  That piece has a fair number of them.