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Finance, family, and friends

Finance, family, and friends

by Alejo Jose G. Sison | May 07, 2018

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Family, friends, and finance don’t mix well. However, HBS professor Mihir Desai has taken up the challenge and thrown all three into a heady, yet delightful cocktail in his book The Wisdom of Finance. His trick? The deft use of allegories relating financial activities to familiar life-events.

Thus, not only do we get a grip of often abstruse business operations, but we also gain helpful insights into our everyday relationships.

Let’s start with marriage.

How best to allocate time, energy, and other resources in choosing partners? The key lies in ensuring the right options. Options grant the right, but not the obligation to use assets. (Think, for instance, of home appliance guarantees. Under specified conditions, we have the option to return, exchange, or get our money back, if dissatisfied with the purchase.)

In the marriage market, women —who get pregnant— are said to bear great risks. They then have to create an options portfolio with much care, accepting only suitors who possess the values they desire in a partner. But they should be even more cautious in deciding whom to marry, for “marriage is the death of optionality”.

From a different angle, marriage is like entering into a merger, when firms eliminate all boundaries between them. When do mergers make sense, instead of, say, a spot market transaction, or a strategic alliance? When should we call Uber, or rent a car, or buy one straight out? Is it enough to Tinder, or ought we to live together, gaining stability, or perhaps tie the knot, to reap more benefits? The economic reasoning behind these cases is strikingly similar.

And when a marriage doesn’t work, the alternative, divorce, functions much like bankruptcy. It seeks an orderly distribution of assets with a view to a “second chance” of re-marriage. But it certainly leaves a lot of collateral damage in the form of innocent children in its wake.    

Nonetheless, a stable and loving family is undoubtedly the best form of insurance. Those lucky to have one are better able to cope with the random evils of economic misfortune, natural disasters, illness, and death. Despite their unpredictability, in the aggregate, they follow the bell-shaped curve of normal distribution, making it somewhat possible to manage their harmful effects.

However, first, we have to pool risks, facing dangers and losses in solidarity; the more people together, the better. (Remember that family membership, besides, is adventitious.) Our protection then lies in treating insurance as a common good. And strong family ties diminish incentives for individual members to engage in reckless behaviors that may jeopardize safety or wellbeing. Family members take care of each other.

Parenting challenges can be framed as agency relationships. Parents are like investors and children, workers, between whom we find information asymmetries and conflicts of interests. Why should parents, as principals, care not only about themselves, but also the welfare of children as agents? Conversely, why should children, as principals, trust their parents as agents, when these exercise managerial options? Understandably, parents with young children behave as agents, deciding on what they consider is best for them. Think of “helicopter parents” and “tiger moms”.

But sooner than later, parents will have to fade out, allowing offspring to take control over their own lives. Children cannot forever be agents of their parents’ desires and growing-up means being able to make decisions by oneself. Decisions concerning children’s education benefits from a strategy of diversification: spreading risks over different, unrelated assets.

It would be foolish to specialize too much, too soon, enrolling five year-old kids in a tennis academy where they play the sport three hours a day, for example. (I’m exaggerating here.) Who knows if the knowledge and skills most valuable in the market today will be replaced by AI and robotics tomorrow, or obtained through genetic engineering? A broad and well-balanced education is still best.

Besides providing education, parents also have to worry about building up the family estate, and here financial leverage comes in handy. The need for leverage changes depending on the family’s stage in the life-cycle, following the shape of an inverted U.

Families need some leverage when starting out; although too much debt can compromise growth. Once mature, families may again require leverage, but they have to be careful because it then can hasten decline.

The best time for leveraging is at the peak of earning power (roughly between 45 and 55 for college-educated males). But why leverage when you’re at the top? For the same reasons firms benefit from leveraged buy-outs (LBOs). Heads of families may sometimes get lazy or complacent, favoring meager, although secure earnings over growth. Of course taking on debt entails risks. Yet that may be a small price for faster growth and greater welfare, notwithstanding the duty to work harder and better.

By leveraging, we’re committing ourselves to do our best. The reason for leveraging can also be found in the gospel parable of the talents. Everyone is given talents of immense value, although distributed unequally. Nevertheless, we’re supposed to develop them fully, for we will be held to account if we fail. We’re stewards, taking care of capital for and on behalf of others. Thus, we should always strive to grow our business, trying to exceed the cost of capital and surpass expected returns.

Inevitably, parents will move on and the family estate will be distributed among heirs. Then, the parable of the vine-dressers should be brought to mind. Despite differences in the duration and hardship at work, all journeymen were paid the same. Upon hearing their complaints, the vineyard owner retorted, “Had they all not been paid the agreed wages? Why protest at this gesture of kindness and generosity?” Remembering this story could help heirs focus on gratitude instead of grievances.

Friendships can also be cast in financial terms as capital asset pricing. Finance teaches that assets should not be priced in isolation, but relative to the portfolio. Thus we distinguish among high-beta, low-beta, and negative-beta assets. High-beta assets, which fluctuate in sync with the portfolio, have low values. Low-beta assets, which don’t fluctuate in tune with the portfolio, have high values. Yet negative-beta assets, which run opposite to the direction of the portfolio, are the best. These investments can save us when disaster strikes.

Time and energy dedicated to acquaintances should follow this logic. High-beta individuals are our LinkedIn connections or Facebook contacts; they’re tail-wind in fair weather sailing. Low-beta friends are of greater value, for they can help in times of difficulty. Even more valuable, however, are our negative-beta family members and friends. They stand by us unconditionally.

At the beginning of the book, Desai shares his disappointment when the majority of HBS students interested in finance opt for a career in investment banking, rather than insurance or corporate finance, which are more humdrum. They wish to be at the cutting-edge of financial engineering and be handsomely rewarded. Of course this is understandable.

But, perhaps, it only goes to show that something has gone amiss, beyond all these clever metaphors. It’s the idea that no matter how necessary finance, business, and the economy are for flourishing, they are not the supreme, unqualified good many take them to be. Rather, finance is at its finest in support of family, friends, and the community, when it enables the practice of activities choice-worthy in themselves.

Alejo José G. Sison teaches at the School of Economics and Business at the University of Navarre and investigates issues at the juncture of ethics, economics and politics from the perspective of the virtues and the common good. He is an editor of the recently published "Business Ethics: A Virtue Ethics and Common Good Approach” (Routledge 2018). He blogs at Work, Virtues, and Flourishing from which this article has been republished with permission.  

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