Gamestop and Engine No 1
I have been thinking about parallels between two surprising David versus Golaith episodes in the US capital market during 2021 which appear on the surface to be totally different and unrelated.
The first was the GameStop saga in which retail investors coordinated on Reddit (r/wallstreetbets) to drive up the stock price of a struggling company by several thousand percent. I blogged about this event at that time here and here. In short, many retail investors hated the big hedge funds who were short selling GameStop and hammering its stock price, and these retail investors came together on Reddit to engineer a short squeeze that inflicted heavy losses on these hedge funds.
The second was the successful proxy fight waged by the activist hedge fund Engine No 1 against ExxonMobil. This fund succeeded in getting three of their nominees elected to ExxonMobil's board though it owned only 0.02% of ExxonMobil's stock. Engine No 1 achieved its victory by gaining the support of major proxy advisory firms and many of the large institutional investors while individual shareholders tended to favor the company’s nominees. ("How Exxon Lost a Board Battle With a Small Hedge Fund", New York Times, May 28, 2021).
The first similarity that I see is that both demonstrate the importance of memes in the world of finance. GameStop itself is described as a meme-stock in a pejorative sense. But there is nothing pejorative about meme as originally defined in Richard Dawkins' The Selfish Gene. Memes in this sense are similar to narratives (as in Shiller's Narrative Economics), and they have a very significant effect on financial markets at least till the meme fades away. Climate change is as much a meme in this sense as GameStop.
The second similarity is that both these episodes raise tricky issues about assessing the rationality of the key protagonists. In the case of GameStop, the first impression of most observers is that of irrational investors driving prices far away from fundamentals. But my blog post at that time argued that rationality in economics requires only rational pursuit of one's goals, and does not demand that the goals be rational as perceived by somebody else. From this perspective, the Redditors pursued their goals quite rationally, efficiently and successfully. These actions might have been injurious to their wealth, but economic rationality does not require wealth maximization. Warren Buffet can give away most of his wealth through his philanthropy and still be a highly rational investor.
In the case of Engine No 1 also, there is a troubling question of rationality. The amount that this fund spent on the proxy fight was a very large fraction of the entire value of its investment in ExxonMobil. (Initially, it was thought that the amount spent by Engine No 1 on the proxy fight equalled 85% of the cost of its 0.02% stake in ExxonMobil, but subsequent estimates suggest that it might have been only 40%). The appreciation of ExxonMobil attributable to the proxy fight would almost certainly be far lower than even the lower estimate because the bulk of the stock price movement would be due to changes in the oil price cycle. Moreover, the proxy fight was quite close and even just before the voting, Engine No 1 could have expected only about 50% chance of success. When they began the proxy fight, the probability of success would have been far lower. It is hard to imagine a rational calculation in which initiating the proxy fight would have been a positive expected value bet for Engine No 1.
But there is a deeper level at which the proxy fight was quite rational. The proxy fight was a wonderful boost to the reputation and visibility of Engine No 1. It seems obvious to me that the same amount of money spent on advertising would have been far less effective in establishing it as a serious player in the hedge fund business. Engine No 1 appears to have pivoted away from climate activism and from activism in general, but it does run an active investment business which continues to benefit from the aura gained during that proxy fight.
The third similarity that I see is highly speculative and is probably something that finance professors like me should leave to psychologists and sociologists to think about. I wonder whether the Covid-19 pandemic led to a temporary change in people's goals and aspirations. Was there a temporary increase in the willingness of people to sacrifice short term self interest (narrowly defined) in favour of larger goals? As the pandemic faded away, and the battle between humanity and the virus gave way to wars between humans and humans, did this burst of altruism also decay giving way to the renewed ascendancy of narrow pecuniary rationality? If there is any truth in this wild speculation of mine, the rise and fall of meme stock investing and the rise and fall in ESG investing would both seem to me to fit in well with this explanation.
Posted at 1:05 pm IST on Wed, 11 Dec 2024 permanent link
Categories: behavioural finance
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