Mike Kueber's Blog

May 30, 2014

Diversity at Google

Filed under: Business,Culture,Law/justice — Mike Kueber @ 2:21 pm
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The big story in the technology world this week is that Google released its diversity numbers.  (Facebook to follow.)  The release was in response to pressure from the cottage liberals, like Jesse Jackson, who are concerned that the technology world is an exclusive club for white males.

What did the numbers show?  Well, Google’s tech employees are mostly men, and they are mostly white if you consider Asians to be white and Hispanics to be not-white:

  • American workforce – 47% women, 16% Hispanic, 12% black, and 12% Asian
  • Google techies – 17% women, 2% Hispanic, 1% black, and 34% Asian

So, what is causing this situation that is so distressful to cottage liberals?  Well, according to an article in USA Today:

  1. “At its heart, there are two reasons for the mismatch, experts say. The first is pipeline. White and Asian men are much more likely to have access and take advantage of technical schooling that leads to jobs at tech firms than historically disadvantaged minorities.”
  2. “Finally, high tech isn’t a very welcoming place if you don’t fit in.”

Aside from racial and sexual balancing, why should diversity be an objective for Google?  As explained in the USA Today article:

  • “By putting its numbers out there, Google is taking the steps necessary to bring change. Doing so isn’t about window dressing. It actually makes it a better and more profitable company, says Ed Lazowska, a professor of computer science and engineering at the University of Washington-Seattle. ‘Engineering (particularly of software) is a hugely creative endeavor. Greater diversity — more points of view — yields a better result.’”

I don’t know about you, but I think Google as presently staffed has been highly creative in software engineering, and if I were a stockholder, I wouldn’t want the company to start focusing on social engineering.

A remarkably similar article in the NY Times provided additional support for the proposition that the demographics of the Google workforce are a result of the demographics of the pipeline that provides those workers:

  • Tech companies have often blamed the lack of diverse workforces on the pipeline — they can only hire the people who apply for jobs, and those tend to be white and Asian men, they say. That is partly true. For instance, only 18.5 percent of high school students who took the Advanced Placement exam in computer science last year were girls. In eight states, no Hispanic students took the test and in 12 states, no black students took it. The problems start as early as childhood, when girls are discouraged by parents and teachers from pursuing technical pursuits.

Of course, the liberal agenda of the NY Times will not be blocked by mere statistics:

  • “Yet some of the blame also falls on tech companies. There can be a sexist culture that turns away women, as evidenced by the high attrition rate among technical women as compared to men. And women who try to start tech companies face exclusion by a venture capital network dominated by a chummy fraternity of men. This is all despite the fact that the data — which in Silicon Valley usually reigns supreme — shows that diversity on groups benefits research, development, innovation and profit.”

To sum up two liberal newspapers – (1) the tech pipeline is not turning out sufficient numbers of women, Hispanics, and blacks; (2) tech companies discriminate against women, Hispanics, and blacks, and (3) although tech companies are perhaps America’s premiere industry, it would function much better if it were forced to hire a workforce that “looks like America.”

Call me skeptical.

May 28, 2014

Sunday Book Review #137 – Young Money by Kevin Roose

Filed under: Book reviews — Mike Kueber @ 3:53 am
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I enjoyed Young Money so much that I couldn’t put it down, literally.  I can’t remember ever reading a book in one day, especially one with 285 pages, but this Memorial Day (albeit a dreary, rainy day in SA) I devoured all of Young Money.

Kevin Roose in Young Money writes about eight college grads who, despite the 2007-2009 earthquake in the financial-services industry, decide to start their careers on Wall Street, primarily as investment bankers.

The subject of investment bankers has always been a mystery to me, ever since reading about Tom Wolfe’s Masters of the Universe in Bonfire of the Vanities.  Among the mysteries to me was what do these masters do and how does someone get to be one.  After reading this book, I finally have a basic understanding of these matters.

Investment banking contrasts with commercial/retail banking.  While commercial banks deal with individuals and small businesses, investment banks deal with big corporations.  An investment bank will provide whatever financial services a big corporation needs, such as loaning it capital, hedging against price changes in essential supplies, taking it public or private, or helping it buy or sell assets, divisions, or other companies.

To become a junior Master of the Universe for an investment bank, it helps immensely to attend an Ivy League school.  According to Roose, the major investment banks on Wall Street recruit primarily at so-called Target Schools – the Ivies, plus Stanford, Duke, NYU, and U of Chicago.  Each year, thousands of these kids following their junior year in college are brought to Wall Street as summer interns and, assuming they perform adequately, they are offered two-year employment contracts following their graduation.

The business model for young hires at investment banks is remarkably similar to that at major law firms.  The young hires are paid lavishly, with young lawyers being paid as much as $150k a year and young bankers being paid $70k, plus an annual bonus ranging from $20k to $75k.  But they all work like slaves, and following their apprenticeship, only a small fraction of them are retained by their company for careers.  Two major differences, however, are (1) the best young lawyers stay with the major law firm, whereas the best young investment bankers are hired away by private equity/hedge funds, and (2) young lawyers actually bill clients for their prodigious hours of work, whereas young investment bankers merely provide unbilled documentation (Excel spreadsheets and book-length Pitch materials) to the senior investment bankers in selling various financial products to large corporations.

Although many of the kids have backgrounds in business, this is not required.  All of the new employees start with a 10-12 training course that prepares even liberal-arts grads to performing the job.

The book’s eight profiled subjects are as follows:

  1. Arjun Khan was an Indian-American from Fordham who was hired by Citigroup into its Mergers & Acquisitions division. After his two-year gig, he joined a private-equity company in Brazil as an Associate.
  2. Chelsea Ball was from Georgetown and was hired by Bank of America Merrill Lynch into its public-finance division. After her two-year gig, she took a huge pay-cut to work for a small financial-services company and then recently launched her own start-up.
  3. Derrick Havens was from the U of Wisconsin and was hired by Wells Fargo’s Chicago office as an analyst before getting a job on Wall Street with a private-equity company, where he remains employed.
  4. Jeremy Miller-Reed was from Columbia and was hired by Goldman Sachs into its commodity division. He hated his job and left after his two-year gig to work for a Silicon Valley start-up.
  5. Samson White was from Princeton and was hired by Goldman Sachs into its mortgage division. He hated his job and left after his two-year gig to attempt a start-up technology company with a friend.
  6. Soo-Jin Park was from Wellesley and was hired by Deutsche Bank into its risk-management division, which is considered a middle-office position (like legal) because it doesn’t generate income. Deutsche didn’t provide a track for her to move to a front-office position, so she eventually left Deutsche and found a front-office position at a commercial bank (not an investment bank).
  7. J. P. Murray was a black from Temple who was hired by Credit Suisse as an analyst in its health-care investment-banking division. He was laid-off due to cut-backs prior to his two-year contract expiring.
  8. Ricardo Hernandez was an Hispanic from San Antonio who went to Cornell to become a doctor, but was lured by J. P. Morgan into its Mergers & Acquisitions division. He was eventually funneled into the company’s Latin American division, where he thrived. He is currently an Associate, which means he makes more, works less, and has a career path.

One of the major themes propounded by Roose is that investment banking is guilty of draining some of America’s best brains from doing something beneficial.  I first heard this pitch many decades ago by Harvard president Derek Bok with respect to the legal profession, and Roose makes essentially the same point by classifying work as either creative or distributive:

  • Creative work involves bringing something new into the world that adds to the total available to everyone.
  • Distributive work only carries the possibility of beating out competitors and winning a bigger share of a fixed-size market.

Capitalism, unfortunately, provides outsize rewards to some distributive work (e.g., investment bankers, lawyers), and the best way to combat this financial incentive is to reduce the prestige associated with the work.  While some smart people are called to certain jobs with high prestige despite low pay (e.g., teachers), Roose would like for more smart people to be called away from investment banking with high pay because of low prestige.

Maybe that works, maybe it doesn’t.  The percentage of the Ivy grads going into investment banking since the crash of 2007-2009 has dropped, but we will have to wait to see whether this change is permanent.

May 25, 2014

Sunday Book Review #136 – Essentialism by Greg McKeown

Filed under: Book reviews — Mike Kueber @ 10:31 pm

Essentialism is subtitled “The Disciplined Pursuit of Less.”  In the book, author Greg McKeown attempts to show readers that their lives can be more successful and enjoyable if they learn to make thoughtful decisions about their agendas instead of allowing others to control how they expend their energy.

I can attest to the tendency of most people to concede to requests or demands from other people instead of setting out their own course.  As McKeown points out, humans are hard-wired to say “yes” to requests, to please other people.  We get a lot of satisfaction from developing a reputation as a helpful, go-to person. But if we are pre-occupied with serving a multitude of people, we will be distracted from working on what is fundamentally important to us.  Instead, we need to establish our objectives and then direct our energy toward those objectives, personally and professionally.

To become an essentialist, a person needs to separate the important, essential stuff in life from the trivial, nonessential stuff and then to prioritize the nonessential stuff.  “If you don’t prioritize your life, someone else will.”  McKeown makes fun of corporations whose mission statements often attempt to give equal priority to all stakeholders – i.e., customers, stockholders, employees, vendors.  When you try to prioritize everything, you actually prioritize nothing.  “Trade-offs are real, in both our personal and our professional lives, and until we accept that reality we’ll be doomed to be … stuck in a ‘straddled strategy’ that forces us to make sacrifices at the margin by default that we might not have made by design.”  You can’t do it all.

Ayn Rand would have found McKeown’s disdain for never-ending altruism to be refreshing.

 

 

 

Saturday Night at the Movies #116 – Reign Over Me, American Hustle, She’s Out of My League, and August: Osage County

Filed under: Movie reviews — Mike Kueber @ 12:55 pm

Reign Over Me (2007) is a drama that depicts a NCY dentist (Adam Sandler) who is afflicted with PTSD after his wife and kids were killed on one of the 9/11 planes.  Financial settlements have enabled him to avoid becoming a street person, but he has become almost nonfunctional despite efforts by friends and family.  Then he encounters an ex-college roommate (Don Cheadle) who is willing to interject Sandler’s distressing situation into Cheadle’s almost idyllic life.  Both guys are worth rooting for.  The Rotten Tomato critics give it 64%, and the audience is much more favorable at 82%.  I’ll split the baby and give it three stars because there is no gripping romance for either guy.

American Hustle (2013) is a comedy-drama involving an elaborate con (based on true-story Abscam), reminiscent of The Sting.  Christian Bale and Amy Adams are no Paul Newman and Robert Redford, but they are enjoyable, as is FBI agent Brad Cooper, who has forcibly enlisted Bale and Adams to snare bigger game.  In the end, you have a hard time deciding which of the terribly flawed Bale or Cooper you want to see walk away with the girl (Adams).  The other girl is Jennifer Lawrence and you don’t wish that ditz on anyone.  The movie was critically acclaimed, with a 93% score from the Rotten Tomato critics, but only 75% from the audience.  It received 10 Oscar nominations, including Best Picture and all four acting slots, but no wins.  I thought the characters were interesting and nuanced, especially Jeremy Renner, as a corrupt politician who actually was, deep-down, a public servant.  I give the movie three and a half stars out of four.

A friend at yoga practice referred me to the romantic comedy She’s Out of My League (2010) after I mentioned to her a couple of movies that I’d seen recently in which gorgeous women fall for plain guys – Notting Hill and There’s Something About Mary.  Well, my movies included beauty & the beast storylines, but her movie actually examined the concept, with dialogue suggesting that one person could not expect to be with another person who was more than two points higher of the dating scale of ten – e.g., a five could go out with a seven, but not an eight.  This rule was called the Tao of Love.  Jay Baruchel stars as a charming, albeit five-rated, TSA agent, while Alice Eve is a warm, personable, hard-ten event planner.  T.J. Miller is hilarious as a Steve Stifler-like sidekick to Baruchel and Krysten Ritter is biting as Eve’s wingperson.  The Rotten Tomato critics are mixed at 58% and the audience mostly agrees at 57%.  Like Notting Hill and There’s Something About Mary, She’s Out of My League causes a romantic like me to feel, at least for two hours, that a five can end up with a ten, so I give the movie three stars out of four.

A few weeks ago, I wrote about Lovely & Amazing, and said the following – “Lovely & Amazing (2001) is a comedy-drama about a neurotic, insecure woman and her three daughters.”  This week, I saw August: Osage County (2013), another movie about a crazy mother of three daughters who seem destined to carry on the family tradition.  Although August wasn’t as critically acclaimed as Lovely & Amazing, its star-studded ensemble cast is truly amazing, led by Meryl Streep and Julia Roberts, both of whom received Oscar nominations.  The Rotten Tomato critics liked it only at 64%, and the audience was barely better at 68%, and the Wikipedia review is laced with terms such as dystopian, dysfunctional family, and black comedy-drama.  But I enjoyed it and its entire ensemble immensely, especially Roberts and Chris Cooper.  Coincidentally, the ensemble include Margo Martindale, who played Buffalo Heiffer in Lonesome Dove 25 years ago, the same TV miniseries that was a springboard to Chris Cooper’s career.  I give the movie three and a half stars out of four.

May 24, 2014

Mark Cuban wades into the Donald Sterling fiasco (again), and Stephen A. Smith bails him out

Filed under: Culture,Sports — Mike Kueber @ 5:08 am
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While the media first attempted to lynch Donald Sterling for the bigoted comments that he made privately to his girlfriend, the Dallas Maverick’s owner Mark Cuban tried to slow down the lynching by warning against a slippery slope:

  • But at the same time, that’s a decision I make. I think you’ve got to be very, very careful when you start making blanket statements about what people say and think, as opposed to what they do. It’s a very, very slippery slope. Again, there’s no excuse for his positions. There’s no excuse for what he said. There’s no excuse for anybody to support racism. There’s no place for it in our league, but there’s a very, very, very slippery slope.”

But Cuban quickly backed off from that position and seemed to be in favor of a forcible sale of the Mavericks until earlier this week, when Cuban created a firestorm by admitting that he, too, was prejudiced and bigoted in certain situations:

  • I know I’m prejudiced, and I know I’m bigoted in a lot of different ways. If I see a black kid in a hoodie on my side of the street, I’ll move to the other side of the street. If I see a white guy with a shaved head and tattoos, I’ll move back to the other side of the street. None of us have pure thoughts; we all live in glass houses.”

The lynch mob attacked Cuban for stigmatizing black kids in a hoodie and suggested that Cuban was laying the groundwork for cutting Donald Sterling some slack.  But Cuban received some support from an unexpected source – Stephen A. Smith (a black journalist) from ESPN’s First Take. 

Smith pointed out that Cuban, by giving both black and white examples, was not excusing racism, but rather was pointed out that “presentation matters.”  According to Smith, people are going to treat you differently based on the way that you present yourself.  Hoodies, tattoos, or pants halfway down your ass don’t give anyone a right to shoot you, but if you present yourself that way, don’t expect to be treated respectfully.  (Some wag pointed out that Patriot coach Bill Belichick wears a hoodie and expects to be treated respectfully.  I suspect that he would not generally be treated respectfully if he is not recognized as the Patriot coach.)

Cuban later apologized to the Trayvon Martin family for using the hoodie example, but other than regretting his example, he stood by his statement.  On the next edition of First Take, white guy Skip Bayless opined that the apology was necessary and appropriate, while Smith doubled down to say that the clarification was nice, but the additional context was unnecessary.

I agree with Stephen A.’s point that presentation matters.  Further, I have previously discussed how people will naturally profile.  Racial profiling, however, is a special concern, and although it is scientifically almost impossible to stop, it is something that America needs to work to minimize.

With respect to the Donald Sterling matter, it seems that Cuban’s comments militate in favor of reconsidering the draconian sanctions proposed by NBA commish Adam Silver and there is nothing wrong with that.  Reconsideration is always a good tack to take when dealing with a lynch mob.

P.S., Smith also made a distinction that I have previously made between racism and bigotry – i.e., racists feel superior while bigots strongly dislike.  Based on this definition, Smith said that blacks and whites are both bigoted, but only whites are racists.  I’m not sure that I agree that blacks can’t be racists, too, but in any event, those definitions seem to put Donald Sterling’s comments more into the bigoted category than the racist category.

May 22, 2014

The demise of the white majority in America

Filed under: Culture,Issues,Politics — Mike Kueber @ 7:54 pm
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For many years, the media has been reporting on the demise of white people as the majority in America.  For example, as reported in the NY Times in 2008:

  • The census calculates that by 2042, Americans who identify themselves as Hispanic, black, Asian, American Indian, Native Hawaiian and Pacific Islander will together outnumber non-Hispanic whites. Four years ago, officials had projected the shift would come in 2050.”

This new coalition of minorities is often referred to as “majority minority.”  And the liberal media loves to trumpet that “demography is destiny.”  For example, the Daily Beast contains a column titled “Is Demography Destiny?” and then asks in its header, “Has the changing composition of the American electorate handed Democrats a permanent majority?”

But two articles in the New York Times this week evoke Mark Twain’s retort, “Reports of my death have been greatly exaggerated.”  The first article reported on the revival of the GOP’s previously ridiculed strategy of getting out the white vote instead of broadening its base to include more minorities.  This strategy was characterized as similar to the GOP’s Southern Strategy, which Nixon used in the late 60’s to secure the presidency.  (Due to my sorry searching skills, I can’t find the Times article to confirm my recollections.)

The second article reported on the increasing number of Hispanics who are self-identifying as members of the white race.  Apparently, between 2000 and 2010, 1.2 million Hispanics switched from identifying themselves to the U.S. Census as whites instead of “some other race.”  (Thirteen million of 35 million Hispanics self-identify as “some other race.)  According the article:

  • The data provide new evidence consistent with the theory that Hispanics may assimilate as white Americans, like the Italians or Irish, who were not universally considered to be white…. The data also call into question whether America is destined to become a so-called minority-majority nation, where whites represent a minority of the nation’s population. Those projections assume that Hispanics aren’t white, but if Hispanics ultimately identify as white Americans, then whites will remain the majority for the foreseeable future.”
  • “White identification is not necessarily a sign that Hispanics consider themselves white. Many or even most might identify their race as ‘Hispanic’ if it were an explicit option. But white identification may still be an indicator of assimilation. White identifiers are likelier to be second- and third-generation Hispanics than foreign-born and noncitizen Hispanics. They also have higher levels of education and income…. The results are a strong sign that fears of a unique ‘Hispanic challenge,’ where Hispanics immigrants might remain as a permanent Spanish-speaking underclass, are overblown. In that regard, the census numbers are not new: There is mounting evidence that Hispanics are succeeding in American society at a pace similar to that of prior waves of European immigrants.”

Assimilation is music to my ears.

 

 

 

 

May 19, 2014

Castro crawfishing

Filed under: People — Mike Kueber @ 4:55 pm

For the past few days, the local and national media has been reporting that San Antonio’s mayor, Julian Castro, will be taking a new job in Washington.  Although Castro had coveted the job of heading the Department of Education, he has apparently decided to accept the job of Secretary of Housing and Urban Development, the same job that his controversial predecessor, Henry Cisneros, had during the Clinton administration.

As expected, the media attention has been fawning, with a focus on how this new job will prepare him to run as Hillary Clinton’s running mate.  No one has thought to charge Castro with violating an express promise to his San Antonio constituents that he would serve as the San Antonio mayor for all of the eight years allowed under the city’s term-limit rule.  It seems that the voters have become so cynical about political promises that no one considers it noteworthy for another politician to blatantly crawfish on his broadly disseminated commitment.

Even if one doesn’t expect politicians to keep their promises, one might think there would be some curiosity in the media for understanding what prompted Castro to change his mind.  I suggest that Castro, like Sarah Palin, has tired of the “dream job” and wants to “get while the getting’s good.”  By leaving now, he can claim his legacy of “Pre-K 4 SA” and can distance himself from the impending demise of the foundering street-car project.  And he can avoid the embarrassment of another election that shows how unpopular he has become.

In the business world, this kind of behavior is common-place – i.e., moving on and up before your bad decisions catch up with you.  Because of the fawning media, this move is a no-brainer.

Saturday Night at the Movies #115 – There’s Something About Mary, Rust & Bone, Sound City, and Reign Over Me

Filed under: Uncategorized — Mike Kueber @ 3:31 am

Last week, when I blogged about Notting Hill, I mentioned that it reminded me of There’s Something About Mary (1998) because they both had the homecoming queen falling for the ordinary guy, and us guys love that scenario.  Well, the Mary flick was on HBO, too, so I decided to give it another viewing, and loved it all over again.  Although I didn’t recall how farcical the cast of characters were, they were enjoyably funny.  More importantly, Cameron Diaz is more attractive than Julia Roberts, with both of them at their best, and the stalkerish Ben Stiller is more likeable as an American than Hugh Grant as a milquetoast Brit.  The Rotten Tomato critics loved the movie at 83%, but only 60% of the audience did.  That must be a misprint because the movie was a blockbuster (highest grossing comedy of the year) that catapulted Diaz and Stiller into stardom.  There is no way 40% of the audience didn’t enjoy the movie.  I give it four stars out of four.

Sound City (2013) is a documentary about an LA music studio that started in 1971 and survived until 2011.  It produced records from Tom Petty, Fleetwood Mac, Neil Young, Rick Springfield, and Nirvana.  The movie is primarily the work of Dave Grohl, Nirvana’s drummer, who purchased the studio’s iconic mixing console, moved it into a new studio, and has recorded new music from stars of the past who recorded in the original studio.  The Rotten Tomato critics love this documentary at 100% and the audience is almost as favorable at 89%.  Although I enjoy music, I have no appreciation for the distinctions that create great music.  As pitcher Jim Palmer said about his Hall of Fame coach Earl Weaver’s pitching knowledge, “The only thing Earl knew about major league pitching was that he couldn’t hit it.  I just don’t get it, but I give the movie three and a half stars out of four.

Rust & Bone (2012) is a French flick about two losers who use each other.  The guy is a no-account kickboxer who moonlights as security/bouncer, and the girl is a former killer-whale trainer who becomes even more depressed when she loses her legs in an accident at work. She, Marion Cotillard is the movie’s claim to fame, as she won as Oscar in 2008 in La Vie en rose, about singer Edith Piaf.  The Rotten Tomato critics score it at 82% and the audience is almost as favorable at 79%.  I didn’t enjoy the characters, so obviously the movie was a downer – one star out of four.

 

May 18, 2014

Modern management

Filed under: Business — Mike Kueber @ 12:21 pm

One of my longest-held business-management beliefs, in addition to the Peter Principle (i.e., employees rise until they reach their level of incompetence) is that managers are evaluated more on their ability to be managerially correct than on their actual effectiveness.  By managerially correct, I mean things like social graces, an upper-middle-class feeling of entitlement, or what Dilbert referred to as “managerial hair.”  By contrast, professional coaches may be able to skate by for a while by smooth talking and good manners (e.g., Cowboy Coach Jason Garrett), but eventually they have to produce on the scoreboard.

Although part of a coach’s job requires technical competence (e.g., Xs and Os), the major requirement is the ability to motivate others to perform.  That is why the best practices of successful coaches should be emulated by business managers, but my experience is that they are not.

For example, just this week I was visiting with a friend who works as a salesperson.  He and a large group of co-workers are introducing a new product and are under tremendous pressure because the initial results have been disastrous.  Their manager responded to this pressure by sending them a rah-rah cheerleader email filled with hackneyed platitudes.  And this is not an anomaly; I’ve seen it throughout my working life.

As I reflected on the email, I wondered if this was something Coach Pop of the Spurs would say to motivate his troops.  I can’t imagine he would.  In fact, if it were suggested, I suspect Pop would say that his players are intelligent adults who know what they have to do and that rah-rah pep-rally stuff would be insulting and counter-productive.  Instead, he would speak to them as professionals who know what they need to do and then let them individually motivate themselves.

So, sports motivation has joined the 21st century; I wonder why business motivation remains fixated on mid-20th century techniques.

Incidentally, a little over a year ago, I reviewed a book on business motivation called Drive by Daniel Pink.  In Drive, Pink argues that too many companies continue to use a motivational technique that came out of the Industrial Age – the carrot-and-stick approach.    He suggests that a better technique for the 21st century would have three components:

  1. Autonomy – an off-shoot of autonomy is a results-only work environment (ROWE).
  2. Mastery – an important part of mastery is what Pink calls “flow.” This occurs when a person is challenged with something not too easy, yet not too hard. Sounds like an athlete in a “zone.”
  3. Purpose – attaching your efforts to a cause larger than yourself.

According to my friend, his company clearly remains ensconced in the 20th century.  That’s not good for the company’s long-term prospects, but I hope Darwin finds lower-hanging fruit for a few years.

 

May 17, 2014

Sunk costs

Filed under: Business — Mike Kueber @ 1:00 pm
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Earlier this week, one of my sons told me that the renters in his rental house said they loved the house so much that, instead of extending the lease another twelve months, they would like to buy the property.   My son rejected that possibility out-of-hand, not only because the rental activity has been profitable, but also because he is interested in expanding his inventory of rental properties.

During our conversation, my son mentioned that one of his considerations against selling the house was that he had recently gone through the expensive process of refinancing the house to secure a more favorable interest rate.  That consideration initially made sense, but upon further reflection, I concluded that it did not, and I sent him the following email to point this out:

  • During our conversation about your rental house, we lapsed into flawed thinking that I didn’t realize until I was on a bike ride later in the day. Although the flawed thinking doesn’t necessarily change your decision to rent your SA house instead of selling it, it is something that we should keep in mind.
  • The flaw – We both agreed that there is a general guideline that refinancing is not a smart decision unless you can lower your interest rate by a couple of percentage points and that you don’t sell the house for about five years. Based on that guideline, we concluded that it made sense to keep renting your house for at least another four years to offset the cost of the refinancing. Upon further reflection, I believe that thinking is wrong. Actually, the costs of refinancing are so-called sunk costs, and, although they made economic sense based on your expectations at the time you spent them, they should not play any role in future decisions on selling vs. renting. An analogy would be me making decisions on the fate of Jimmy’s pickup based on the money that I have spent recently fixing it up. I shouldn’t decide to keep it just because I want to get my money’s worth for tuning up the engine or fixing the suspension or repairing the A/C. Similarly, deciding whether to sell a stock shouldn’t depend on whether I would be selling at a profit or a loss; instead, I should sell the stock whenever I think it is overpriced and is going to drop.
  • So, deciding to rent your SA house probably makes economic sense to you for a variety of reasons, but one of them shouldn’t be the money you have already spent on refinancing the house 12 months ago. You are renting the house because it provides you a monthly cash flow and along with an increasing equity interest. The only reasons to sell would be to eliminate the business risk, which we believe is not great, or if the offered price was too generous to turn down.”

My son didn’t necessarily agree:

  • “Good point but I think you are still looking at it a little off. You compared the house to Jimmy’s truck but that is not quite a good comparison since Jimmy’s truck is a complete liability in that it only will decrease in value and does not generate any income. My house is an asset that generates income in part due to the money that I invested to refinance it. A better comparison would be to compare it to a rental car. The rental company would not want to sell its rental cars until at least the cash it had generated and its sale price were greater than the money that the company paid to purchase and maintain the car. You could keep Jimmy’s truck forever and it would never make back the money you spent to tune it up.”

I didn’t agree and responded as follows:

  • “Maybe Jimmy’s truck isn’t a good analogy, but the point is that it is sometimes a mistake to make decisions to stay with a course of action just because it will prevent a previous decision from looking bad. For that reason, perhaps the stock analogy is the best one.”

Upon further reflection, I think my position could be better defended with the following undeniable fundamentals:

  1. Every asset that you own has a price, especially investment assets.
  2. Your selling price for an asset, especially an investment asset, depends on considerations such as its current market value, its likely future market value, its value to you, your need for cash, your alternative investment opportunities, and a property’s cash flow. But the amount that you paid for an asset should have, logically, almost no effect on your selling price for that asset.

I realize that these fundamentals essentially beg the question, but thinking in terms of establishing an asset’s price makes it easier for the evaluator to see the irrelevance of an asset’s prior costs or expenses – i.e. sunk costs.  Wikipedia provides a better explanation of sunk costs:

  • In traditional microeconomic theory, only prospective (future) costs are relevant to an investment decision. Traditional economics proposes that economic actors should not let sunk costs influence their decisions. Doing so would not be rationally assessing a decision exclusively on its own merits.
  • Evidence from behavioral economics suggests this theory fails to predict real-world behavior. Sunk costs do, in fact, influence actors’ decisions because humans are prone to loss aversion and framing effects. In light of such cognitive quirks, it is unsurprising that people frequently fail to behave in ways that economists deem “rational”.

About.com says essentially the same thing:

  • Sunk costs are unrecoverable past expenditures. These should not normally be taken into account when determining whether to continue a project or abandon it, because they cannot be recovered either way. It is a common instinct to count them, however.

Thus, the cost of securing a favorable mortgage is already sunk and should have no effect in a deciding how much money would be enough to entice my son to sell his rental house instead of continuing to rent it.  But loss aversion explains why it does.

 

 

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