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Andreessen on The Psychology of Human Misjudgment
Great insights from two legendary entrepreneurs - that's what Marc Andreessen is offering up in a series of posts on Charlie Munger's The Psychology of Human Misjudgment. Munger is Warren Buffet's long-time partner and vice-Chairman at Berkshire Hathaway. Andreessen writes:
Mr. Munger's magnum opus speech, included in the book, is The Psychology of Human Misjudgment -- an exposition of 25 key forms of human behavior that lead to misjudgment and error, derived from Mr. Munger's 60 years of business experience. Think of it as a practitioner's summary of human psychology and behavioral economics as observed in the real world.
Here's a taste of Munger:
...almost everyone thinks he fully recognizes how important incentives and disincentives are in changing cognition and behavior. But this is not often so. For instance, I think I've been in the top five percent of my age cohort almost all my adult life in understanding the power of incentives, and yet I've always underestimated that power. Never a year passes but I get some surprise that pushes a little further my appreciation of incentive superpower.
...We [should] heed the general lesson implicit in the injunction of Ben Franklin in Poor Richard's Almanack: "If you would persuade, appeal to interest and not to reason." This maxim is a wise guide to a great and simple precaution in life: Never, ever, think about something else when you should be thinking about the power of incentives...
Andreessen is going through the speech and offering comment from his own experiences. Here's Andreessen with an important example:
...the result of shifting from stock options to restricted stock should be obvious: current employees will be incented to preserve value instead of creating value. And new hires will by definition be people who are conservative and change-averse, as the people who want to swing for the fences and get rewarded for creating something new will go somewhere else, where they will receive stock options -- in typically greater volume than anyone will ever grant restricted stock -- and have greater upside.
Read the whole thing, it's the first post in a series I'm very much looking forward to reading.
Posted by Alex Tabarrok on March 28, 2008 at 07:35 AM in Economics | Permalink
Comments
Munger's piece provides a lot to chew on. Your post reminds me that it might be worth reading Poor Richard's Almanack.
Posted by: Rich Berger at Mar 28, 2008 8:40:00 AM
Munger's ugly and wrongheaded use of the pronouns "she" and "her" where "he" and "his" are correct makes his essay unreadable to those of us who speak English instead of PC-speak.
Posted by: Robert Speirs at Mar 28, 2008 11:31:05 AM
Munger's ugly and wrongheaded use of the pronouns "she" and "her" where "he" and "his" are correct makes his essay unreadable to those of us who speak English instead of PC-speak.
Posted by: Robert Speirs at Mar 28, 2008 11:31:24 AM
Andreesen's take on stock v. options makes sense for perfectly rational workers who always keep in mind their compensation and stake in the enterprise.
Regarding the incentive for existing employees, is there any evidence to support that employee performance is affected by the nature of the compensation package? (Is this really a question for Byran Caplan, regarding irrationality?) I could easily see there being a correlation, with my hypothesis being that employers who tailor their compensation packages with incentive in mind will have other policies that promote productivity. But what about the copycats, does mimicking a wise employer's compensation plan cause better productivity?
The point about incentives for new hires appears more self-evident in that rational thought is very likely to impact a point decision with high stakes for the decider. I have more doubts about how much rational thought impacts ongoing behavior, regardless of the stakes for the decider.
Posted by: Rimfax at Mar 28, 2008 11:50:08 AM
following your link get us this:
Andreessen quotes:
Mr. Gates wanted Mr. Buffett's input on whether to drop options in favor of restricted stock at Microsoft. [Gates] recalls asking: "How will employees respond to getting a lottery ticket that gives them a definite amount instead of one that could amount to nothing or a ridiculous sum?"
Mr. Buffett's reply, according to Mr. Gates, was: "My wife would rather have a ticket for one fur coat, than a ticket that gave her two or nothing."
then Andreessen writes:
_snip_
And new hires will by definition be people who are conservative and change-averse, as the people who want to swing for the fences and get rewarded for creating something new will go somewhere else, where they will receive stock options -- in typically greater volume than anyone will ever grant restricted stock -- and have greater upside.
And sure enough, in the wake of shifting towards restricted stock and away from stock options, Microsoft's stock has been flat as a pancake. The incentive works.
++++++++++++++
So Munger's partner, the head of the best longterm success in business, gave the advice.
But that is not my point.
My point:
Microsoft was already topped out.
Like a lot of entrepreneurial tech companies when the CEO leaves, or gets tired the company goes flat. Sometimes they leave because they see flatness coming and want to go out on a high note but there you have it.
Microsoft, Dell, Yahoo etc. - flat
(sure Gates was/is still there but once he stepped up to Chairman the fire was pretty much gone)
Apple - still cooking
Google - still cooking
Net: I'll keep my copy of Munger's original speech without appending Andreessen's wisdom.
Posted by: JRip at Mar 28, 2008 1:58:06 PM
The Speirs comment reminded me of something that once amused me, although I can adjust to "she" and "her" with very little mental jarring.
I was working once on a product that would be used by low-paid clerical people, and the manual consistently used "she" and "her". I remember wondering "Are they trying to balance out the perceived use of 'he' and 'his' here in an attempt at political correctness, or are they implying that only women would condescend to take a job like THAT?"
Posted by: jens fiederer at Mar 28, 2008 2:55:30 PM
here is Munger's article:
http://www.jeremybroomfield.com/munger2.pdf
Posted by: Lemmy Caution at Mar 28, 2008 3:28:54 PM
Do stock options really count as incentives? I suppose they do for a few of the company executives. But other employees' efforts will have only a very small impact on the company stock price, so they will be only very slightly more motivated. Stock options could work by creating a psychological link between the success of the employee and the success of the company, but that is not an Incentive.
Posted by: jsalvati at Mar 28, 2008 3:44:49 PM
Let's give some corporate CEO's some incentive to get this action and legislation passed.
Get as many people to make these phone calls.
Call congressional contributor and war contractor General Electric
Corporation at 800 386 1215 or 203 373 2211 and tell the person who
answers, that you want the GE CEO Jeffrey Immelt to get Bush to end
the war in Iraq and then Bush resign with Cheney and until that
happens you will not buy any GE products and that you will tell your
friends about this. Then call a local appliance store that sells GE
appliances and tell the person you will not buy any GE products
from their store until they can convince the GE CEO to convince
George W Bush to end the war and then resign with Cheney.
Call congressional contributor Rite Aid Pharmacies at 800 325 3737 and
tell the person that you want the Rite Aid CEO to get the congress
and the President to enact HR 676 single payer universal health care
and repeal Medicare Part D and place the drug benefit in Medicare Part
B covering 80% of the cost of drugs with no extra premiums, no extra
deductibles, no means tests, no coverage gaps, and remove the
means test for Medicare Part B and until that happens, you won't buy
ANYTHING from Rite Aid.
Call congressional contributor Wendy's restaurants at 614 764 3553
and tell the person in that you want their CEO to get the congress
and the President to enact a $10/HR MIN. WAGE into law and until this
happens you will not go to a Wendy's Restaurant.
Call your local Exxon/Mobil gas station and tell the manager that you
will not get your car repaired there, nor will you buy gasoline there
until their parent company sets their price so that they can sell you
gasoline for $1.75 a gallon. Then only do business with other gas
stations. We will no longer stand for $3 a gallon gasoline.
Kentucky Residents:
Call General Electric Appliances Corporation in Louisville at
502 452 4311 and other appliance stores that sell GE products
and demand that they get Senator Mitch McConnell to get an
end to the Iraq war and for Bush and Cheney to resign and until
that happens you will not buy any GE refrigerators, stoves,
televisions, dishwashers, ovens, lightbulbs, etc. Get as many
Kentucky residents to make these phone calls.
After you make these calls you can also call Mitch McConnell's office
and tell his office that you have called GE in Lousiville and won't
buy their products until Mitch McConnell gets an end to the war and
gets Bush and Cheney to resign.
General Electric Appliances
9500 Williamsburg Office Plaza
Louisville, KY 40222
USA
tel: 800 626 2000
tel: 502 452 4311
502 452 4313
Posted by: The Liberal Democratic Party of the United States at Mar 28, 2008 6:38:46 PM
Robert Speirs,
It is not Munger who used she and her gratutiously and at every possible turn, it was Anderseen who did insisted on doing that.
Posted by: scott clark at Mar 28, 2008 7:05:26 PM
is there any evidence to support that employee performance is affected by the nature of the compensation package?
the head of HR where I worked tried to twist an HR chestnut of "people don't leave due to pay" into putting lipstick on the no / very low raises this year. I don't believe that at all -- if people were paid 2x what they currently are they wouldn't quit. So pay definately has something to do with it as people will put up with a lot more if they are paid quite a bit of money.
Plus people in the tech industry are abusing Drucker's observation that professional skills / reputation / education mean more to them than in other professions to argue that they don't need to pay that much. Bah!
Posted by: BlogReader at Mar 28, 2008 9:15:46 PM
In the mid-1990s I attended a business meeting in Calif. to discuss information delivery to the legal market (print, online, CD, etc.). I had no clue who the people were at the meeting (I was there as I was a legal editor who had an interest in, and experience working with, print and online info delivery, proprietary vs. open systems, etc.).
After about 5 minutes, the balance of the 1-hour meeting devolved into me asking non-stop questions of the oldest person in the room about all kinds of issues pertinent to print and digital delivery and sales.
After the meeting I told my boss, "Man, that guy really gets it - clearly the brightest bulb in the room." My boss asked me if I knew who he was: "No, who is he?" "That's Charlie Munger, Warren Buffet's partner."
I'll bet in most rooms he is still the sharpest guy there.
Posted by: chug at Mar 29, 2008 7:35:33 AM
I copy and pasted both Munger's famous speeches, this one, and The Art of Stockpicking, and used a Text-to-speech software to convert them to MP3 and have been listening to them non-stop for the last 3 months.
If they gave Nobel prizes for capitalism, Munger and Buffett should be the first two living recipients. Who is more deserving would be a toss up. Munger's two contributions, the latticework of mental models and the psychology of misjudment would probably top Buffett's Shareholder letters but for the popularity of the latter.
Posted by: Andrew at Mar 29, 2008 9:29:39 AM
"Munger's ugly and wrongheaded use of the pronouns "she" and "her" where "he" and "his" are correct makes his essay unreadable to those of us who speak English instead of PC-speak."
Hahaha! That's why he won't ever get a Nobel prize! If you are involved in business or investiong, it's probably the most important think you would read in a decade (and that's only because you probably wouldn't read his other essay or Buffett's letters) and grammar snobbery holds you up? I think Charlie would call that something like negative association bias.
Copy to Word, use Find/Replace and swap He for She whatever your sexual preference, then have a ball!
Posted by: Andrew at Mar 29, 2008 9:41:11 AM
It's also a little ironic to accuse Charlie of being PC.
It's funny when people get criticized from both sides of the spectrum.
Posted by: Andrew at Mar 29, 2008 9:42:42 AM
"people don't leave due to pay"
Somewhere I read that people stay because of pay, but leave due to unhappiness. Flip sides of a coin.
Considering I took a 70% pay cut to return to graduate school I'd concur. By the way, I'd have to say that graduate school is similar to a quote I heard about having kids. It doesn't give your life meaning, but it does give it imperative.
I agree with Charlie's assessment that incentives can be resisted, but over time continued resistance becomes harder and harder. Like our attempts to resist gravitational sag as we get older.
Posted by: Andrew at Mar 29, 2008 10:00:35 AM
There is no obstacle to options in a private company. Even in a public company they can be issued out of the money at nominal cost. There use in mature companies is more likely to incentivize fraud than value creation. Incentives are important, but it is important to know what you are incentivizing.
Posted by: Lord at Mar 29, 2008 12:49:05 PM
My point:
Microsoft was already topped out.
Like a lot of entrepreneurial tech companies when the CEO leaves, or gets tired the company goes flat. Sometimes they leave because they see flatness coming and want to go out on a high note but there you have it.
Microsoft, Dell, Yahoo etc. - flat
(sure Gates was/is still there but once he stepped up to Chairman the fire was pretty much gone)
Apple - still cooking
Google - still cooking
Uh, until 2003, Apple wasn't even in the kitchen. In 19 years, it went up barely over 200%, or a third of the Dow. Granted, MSFT has flattened out, but it went up 1300% in its first 5 years and over its first 14 years to its peak it went up almost 58000%(!). Google for all its hype has still gone up only about 300% since its IPO. If those two stocks are still cooking for the next decade, we can compare them to MSFT.
Posted by: Mo at Mar 30, 2008 1:33:39 AM
Andreesen is a one-hit wonder, not a "legendary entrepreneur".
Posted by: Sameer Parekh at Mar 30, 2008 12:02:42 PM
Just an off-the-cuff, SWAG, but it seems like Apple is transitioning from a PC company to a design company that specializes in PCs.
This is good for the business, but considering Steve Jobs runs a cult of personality, I'm not willing to bet that Apple can continue to excel once he's gone. Look how well Apple did during the period when he left the first time.
Jobs was one of the ones where were "creative" in their incentivizing (e.g. backdating). So, I kind of see him like the NCAA coach who, as one sports announcer said, walks the "blackish" side of the gray line.
And, he almost died of pancreatic cancer. You don't get luckier than surviving pancreatic cancer.
Again, I don't know enough about it. But it's not intriguing enough for me to want to...yet.
Posted by: Andrew at Mar 31, 2008 6:31:08 AM
