Longreads + Open Thread

Vapes, Markets, Growth, Nolan, Marx, Minsky, Company-States, Hurdle Rates



Open Thread

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Søren Fryland Møller had some thoughts on Thursday’s post on hurdle rates. Some highlights:

Shareholders (unless very concentrated ownership) only cares about the systematic risk not the idiosyncratic etc etc.
For management, idiosyncratic risk matters a lot, and getting a single long term investment wrong matters a lot more to them than the average shareholders.
Yes, idiosyncratic risk should be in the cash flow forecast and only systemic risk in the CoC and hurdle rate, etc. - but it's rational for managers to operate with hurdle rates that are much higher than the shareholders' estimate of the company's CoC given this difference in risk exposure. It's "cleaner" and easier to use a high hurdle than a complicated probability weighted cash flow forecast.

This is true, but also seems like an incentive misalignment. Essentially, managers are managing their risk in order to maximize company-level risk-adjusted returns, but shareholders in the aggregate probably want them to maximize portfolio returns. Which raises some interesting possibilities: does this explain some of private equity’s historical excess returns? They might incentivize managers to take risk in a way that benefits the portfolio instead of one company.

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