Behavioural Economics and the Facebook IPO

Facebook, the social network, has raised $16bn in an initial public offering that values the company at $104bn, meaning it is now among the 25 most valuable public groups in the United States. This recent article by John Wasik (Reuters Money) discusses whether or not it is a good idea to get a piece of the action. Daniel Kahneman declined to comment specifically on Facebook, but raised the importance of a number of behavioural biases: overconfidence, optimism-bias and anchoring; to name a few. Liam has blogged before on behavioural finance, and I flagged the work of James Montier in a comment on that post. Avanidhar Subrahmanyam's review of the behavioural finance literature is available here, free-to-access.

Benartzi TED talk on Save More Tomorrow

The 2004 JPE paper "Save more tomorrow" by Thaler and Benartzi is one of the most famous papers in behavioural economics and behavioural finance. Drawing on the principle of myopic loss aversion, they designed a pension scheme whereby people enrolled but contributions did not start until first pay increase. This increased substantially the savings rate and the paper has been replicated in many contexts and is a very famous application of behavioural economics research.

Benartzi gives a fascinating TED talk on this paper but also more generally on behavioural finance and the role of behavioural economics in facilitating more rational saving and investment patterns.

Short-Termism, Patience and Finance

As a popular open-source encyclopedia states, time preference pertains to how large a premium a consumer places on enjoyment nearer in time over more remote enjoyment. Some readers may be more used to thinking of this as "patience"; which the same open-source encyclopedia tells us is "the state of endurance under difficult circumstances, which can mean persevering in the face of delay or provocation without acting on annoyance/anger in a negative way; or exhibiting forbearance when under strain, especially when faced with longer-term difficulties." So there is an obvious overlap between these concepts: illustrated well by the Stanford Marshmallow Experiment.

I have elaborated on the above because I recently read a paper on time preference in the domain of finance, with the following title: "Patience and Finance". This was essentially a speech delivered last year by Andrew Haldane, the Executive Director for Financial Stability at the Bank of England. I became aware of the paper after doing a key-word search for "patience" -- and then discovering a link to Haldane's speech on the Corporate Law and Governance blog. That blog-post also describes a lecture delivered by Haldane in May of this year, as follows:

"In the lecture - titled "The short long" and available here (pdf) - Mr Haldane notes the (relative) paucity of studies on short-termism in capital markets. He argues, on the basis of his empirical research, that short-termism is statistically and economically significant in capital markets and appears to be increasing. In response to this finding of market failure, Mr Haldane identifies possible public policy responses including those concerning transparency, governance, contract design and taxation."

I googled "short-termism" to find more material on the problem; and found this Telegraph artcle from last year: "Vince Cable was right on the evil of short-termism". The Telegraph article states that: "humans are seemingly hard-wired for short-termism and, worse, they make poorer decisions the more short-term they become. Ask someone if they prefer £10 in a year or £11 in a year and a day and they will, rightly, opt for the £11. But ask them if they would prefer £10 today or £11 tomorrow and they will invariably put out their hand for the money straight away." This is of course, the classic hyperbolic discounting example.

The Telegraph article also tackles the question of why the financial services industry has become fixated on short-term performance: "Companies which used to announce figures twice a year now feel the need to do so quarterly. Fund managers are judged on ever-shorter timescales and unsurprisingly start to play it safe, hugging benchmarks and avoiding the long-term judgements that may be right but won't necessarily come good before the next review. As Keynes observed way back in 1936: 'Investment based on genuine long-term expectation is so difficult today as to be scarcely practicable'."

Of course, the recent speech (and lecture) by Andrew Haldane indicates that the quote from Keynes rings true very much today. Even though there has been talk about long-term incentive plans and "long-term bonuses" for the financial sector, it remains unclear to me if anything substantial is being done to reduce the extent of short-termism in finance. However, there is laboratory evidence on the benefits of improving incentive structures, produced 20 years ago at this stage: "Behavioral Consequences of Corporate Incentives and Long-Term Bonuses: An Experimental Study". There is even a recent book with chapters on 'Investment Management Short-Termism' and 'Long-Term Performance Incentives for Investment Managers': "Saving Capitalism From Short-Termism: How to Build Long-Term Value and Take Back Our Financial Future".

To finish, I will ask if any reader has ever heard of the term IBGYBG? Apparently it is "a text-messaging acronym, like LOL or OMG. It was shorthand for a phrase often used in the investment banking business during the run-up to the 2008 Great Financial Crisis". It meant: "I’ll be gone; you’ll be gone". Now that is all about the short-term.

Trust in Financial Institutions

Kevin talked about a potential graph of the year. The graph below is a contender for me. This comes from recent Gallup research on trust in financial institutions across Europe, summarised here in an article by Julie Ray. Perhaps not surprising but an amazing change in the Irish economic landscape in the last two years.

NBER Paper: Determinants of Joining Employee Share Plans

To Join or Not to Join? Factors Influencing Employee Share Plan Membership in a Multinational Corporation

Alex Bryson, Richard B. Freeman NBER Working Paper No. 16292 Issued in August 2010 Many firms encourage employees to own company stock through share plans that subsidize the price at favorable rates, but even so many employees do not buy shares. Using a new survey of employees in a multinational with a share ownership plan, we find considerable variation in joining among observationally equivalent workers and explore the reasons for the variation. Participation in the plan is higher the greater the potential pay-off from joining the share plan, which indicates that rational economic calculations affect the decision to join. But there is also evidence that psychological factors affect the decision to join. Some non-members say they intend to join in the future, which means they forgo the benefits of immediate membership. The proportion of workers who purchase shares varies across workplaces beyond what we predict from worker characteristics. This suggests that co-worker behavior influences decisions. Indeed, workers say that they pay most attention to other workers and little attention to company HR management in their decision on joining.

Behavioral Finance & Economics Research

The 2009 Behavioral Finance & Economics Research Symposium will be held on September 23-25, 2009 at Hotel Monaco-Chicago. The program is available here.

This link is the homepage for the Academy of Behavioral Finance and Economics.

Behavioural Finance at the University of Crete

Since 2006, the Department of Economics at the University of Crete has been running its Advanced Summer School in Economics and Econometrics (sponsored by the European Commission, the Hellenic Ministry of Education and Religious Affairs and the University of Crete). This year, August 2-9, 2009, the specialised topic is "Behavioural Finance". Professor Hersh Shefrin (Santa Clara University, Leavey School of Business) will be the Distinguished Guest Professor. More details are available here.

Robert Shiller Lecture from Nudge Blog

A really superb lecture on behavioural finance from Robert Shiller - those doing my courses will recognise hopefully all of the topics - looking at him lecture is rekindling my ancient ambivalence with respect to powerpoint - chalk and talk can be a disaster when there are lots of very complex notation but in this case I dont think this lecture would have been as engaging if he had got each point noted as a bullet.

http://nudges.wordpress.com/2009/02/10/robert-shillers-lecture-on-behavioral-finance/


Yale have a channel now on youtube - Shiller's full course is available on this. You would be mad not to spend a few hours with this plugged in to your ears if you are interested in financial markets. Amazingly few downloads

http://www.youtube.com/user/yalecourses