Rewarding Risk Under Free Enterprise

Free enterprise works well when incentives are set to encourage hard work and creativity, but free enterprise can perform poorly when risk taking just for the sake of risk taking is encouraged and rewarded. A 65 year-old with only $100,000 to invest may be taking a big risk, but a multi-millionaire putting $100,000 on the line can hardly be said to be taking the same degree of risk. To say that we should always reward risk means that encouraging casino gambling, cyber-coin gambling, and stock market gambling on highly volatile stocks somehow enhances the efficient allocation of resources. It is all too clear that increasing volatility by excessive risk taking does not contribute to the efficient allocation of resources, but makes the economy more unstable and less likely to operate efficiently or productively.

The maximization of shareholder value mantra has distorted incentives by diverting money away from the real creative entrepreneurs and their workers and, instead, rewarded passive investors who may be taking very little real risk. I came to realize this personally when I recently discovered that I had obtained a seven thousand percent return on some stock that I had purchased a number of years ago. I had even forgotten that I had made the investment. I certainly deserve a descent return on my investment, but seven thousand percent makes no sense. As far as this creative enterprise (Adobe) was concerned, I was a complete deadbeat. Other than provide a little money, I did nothing to help the company. The hard work of creative entrepreneurs and their workers pays off, but not always all that much for them. Their hard work pays off for the shareholder, who gets most of the reward.

But the risk, the risk! Aren’t shareholder bearing the burden of the risk? If you are about to retire and only have $100,000 in your retirement account, then you are certainly taking a serious risk in any uncertain investment. However, eighty-four percent of the stocks are owned the richest ten percent. When you have a lot of money, the question is not whether to invest or not, but where to invest. What else are you going to do with the money? Are you going to take it home and stuff it in your mattress? You can only wear one pair of shoes at a time and only drive one car at a time. Do you really want to buy a lot of cars and have to arrange to change the oil from time to time and get all those state inspections? How many vacation homes do you want to take care of? Sure, you can bid up the price of Picasso paintings and exclusive properties, but at the end of the day investing in the stock market for most stock market investors is not a risky business that could seriously affect their lives. Losing a few million dollars here and there is no serious problem. Just give stock market investors a decent return, but not seven thousand percent. Save most of that money for the creative entrepreneurs and their hard-working employees. If you really believe in rewarding entrepreneurs and their hardworking employees in a free market economy, drop this maximization of shareholder value nonsense and get real about who is taking the real risk.

( Note: Lynn Stout in her book “The Shareholder Value Myth” provides a more complete understanding of this issue. I both bought a copy of her book and also listened to it for free at: https://www.hoopladigital.com/title/11282038 ).