SoCap08 - Financial Return Maximization is Absurd

Last week, I was SoCapO8, a conference that was oversubscribed nearly 3-fold, where most people have signed up in the past few weeks, post-financial catastrophe.

There is a lot going on in the social investment space, but I want to address, specifically, one item, since my for-pay job at the groupery is a bit hectic due to a major upgrade (...and if you run volunteer organizations, you should check it out! It's a powerful product and a great team!).

Back on-topic: on Tuesday evening was The Economist Debate Series:

Motion: This house believes you can maximize social returns by maximizing financial returns. Two voices for, two voices against.

    * Moderator: Matthew Bishop, The Economist
    * Shari Berenbach, Calvert Foundation
    * Elizabeth Funk, Unitus
    * Steve Zuckerman, Self Help
    * Alvaro Rodriguez-Arregui, Ignia Partners LLC

I realize this is where the argument is, but I'm going to address the underlying question:

Is the idea that we are able to consciously maximize financial returns a fantasy?

I believe so.

(1) Maximizing financial returns begs the question: over what time frame?  In order to value something at this moment, I have to make assumptions about the net present value of future cash flows. This requires me to make assumptions about the future.

• If we say "1000 years" (taking it to the extreme) it becomes obvious that we can't possibly know enough about the intervening time to say with any certainty at all whether what we're doing is maximizing financial return or not. The idea is that the further out you go, the less the impact is on the present, but...

• If we say "a long time but something we think we might know about" (let's say 10-100 years) then our instinct is to turn this into a Sharpe ratio (risk-adjusted return), and start thinking about what risks we need to protect against in order to "maximize financial return."  But we can only guess what those risks might be, and how likely they would be, and start making assumptions about which risks we should mitigate (despite the cost) vs. which risks we can allow to happen because they're either so rare and costly to mitigate that it would wipe out our return if we did so, or conversely because we feel they are so inconsequential.

And now we can get bogged down in what people might refer to as "policy arguments" about those risks. But the point is that it's not knowable in the 10-100 year range what will maximize return, because we don't know how risks might play out, and we can't even decide which risks to mitigate.

So we can't maximize risks without knowing the environment we're in, and we can't know the environment before it exists.  Your idea of maximizing return depends on your picture of the risk environment; mine depends on my picture.

But let's continue, because people do *act* with the idea that they're maximizing revenue, as a way of life. What is going on there? They believe, we believe, we're maximizing each transaction.

So, let's examine that. We're in the immediate time frame, and we have to still keep in mind what we expect future cash flows to be like for the length of time our decision is in effect (think "will this car suit me for the next 5 years?").  The further out we go, the more our projections might be just flat-out wrong.  Most decisions we make, we believe will impact us for a few years. But then, we start imagining retirement or our grandchildren's livelihoods and realize we have to somehow plan for that too - plan for something we can't begin to control. And then often we're struck, again, with the absurdity of knowing the risk environment in the future well enough to make any decisions today.

Maximizing financial return sets us up to walk into traps!

Well, really it sets us up to keep our head down and watch our feet. But we're not walking down a road! We're walking through a field.  While making sure each step we take is on solid ground is certainly important, the question remains: where will that lead us?

We don't know! We don't know because the picture we have in our mind of what's at the other side of the field is a fantasy. We can't see it; we're focused on our feet and the next few steps we're going to take. We don't have any real idea where we're headed.

So the question we are taught to think about and answer, "Can maximizing financial returns lead to maximized social returns?" is backwards! I propose a new question:

(How) can maximizing social returns lead to maximized financial returns, over a time frame of one full lifetime (80 years)?

Does this frame change the way you think about growth?

Comments

[mdangear]

Thank you Jessica for this excellent demonstration of how absurd the concept of maximizing profit is.
I would add one more dimension which the fact that maximizing returns for a given venture does not mean the same thing for all the stakeholders. Typically you have the entrepreneur, investors and employees, and each group has their own view on what maximizing return means. And even within the investor group there are several layers of investors, who came in at different times and different stages of the company (early, late, private, public, etc...).
So now maximizing return means doing it while keeping a balance to make sure all stakeholders are happy, otherwise the business cannot survive. Clearly it cannot be a one-dimensional discussion.