The Witch's Dilemma
The witch gave the man two options. One, he could have a woman that, to him, would appear stunning. But the world would see her as ghastly. Or two, he could have a woman that, to him, appeared hideous. But to the world she would look beautiful.
So goes the dilemma from some fairy tale I recall from childhood, the source of which eludes my most diligent Wikipedia searches. (If anyone remembers the title, please pass it along.)
Imagine yourself in a revealing moment of brutal honesty. Which option would you choose if the witch forced this decision on you? Switch the genders around if needs be, but be truthful.
I suspect most people would claim option one, confident in their ability to filter out the judgment of people around them. But I think they would be overestimating their capacity to be misunderstood. Disapproval and criticism from our family, friends, and colleagues has a withering affect on our psyches. Even if we put on confident airs, we shiver at the thought of others ridiculing our choices behind our backs. We want to be understood. We want our people to confirm our choices with their support. We want inclusion in the most desperate way.
And so I believe, despite our protests, the vast majority of us would select option two.
Yet there are those with the steely resolve to pull off option one. They are outliers. They have a tremendous capacity to be misunderstood.
Corporate CEO's, the Capacity To Be Misunderstood, and Decision Making
I'd like to hire a social psychologist to visit the CEO's of all publicly traded companies, administers the Witch's Dilemma test in conjunction with a heavy dose of truth serum. I would ask her to use the responses to rate the individual executives' capacity to be misunderstood. (Perhaps there are alternative questions we could devise that get to the heart of the matter. These CEO's are emotionally intelligent folks. They didn't get where they are without developing the ability to read into people's intentions...the questions behind their questions.) And I would compare that rating to the CEO's track record of making bold (albeit sensible) long-term investments in the well-being of their businesses versus managing earnings to keep various constituencies content.
My suspicion is that those CEO's that could be lumped in with option one (ugly wife) would correlate more closely with making better long-term decisions on behalf of their businesses. The other group would have a more difficult time departing from the expectations of their shareholders, employees, customers, family members, etc. Understandably so. It's tough to do.
Getting to my point, when I see a business that combines some set of competitive advantages with the potential to grow and compound earnings, I want the leaders of that business to invest in that growth. This should go without saying, but very often it's a difficult thing to do. Not so much because the operational expansion is daunting (though there is that part, too), but because the company must often take a winding path to secure that growth. It's confusing. It changes things. It's easy to misunderstand.
Let's think a little about how a company grows. First, it must identify an opportunity to a.) expand its current offerings; b.) add new offerings; and/or c.) move offerings into new markets. In most cases, each option requires teams to make a judgment call. On the most fundamental level it is, can we execute that growth in a profitable way? In other words, will the added costs of increasing headcount, ramping up production, expanding infrastructure, investing in R&D, buying equipment, or marketing more aggressively...are these costs likely to succeed AND produce revenue in excess of costs and invested capital?
While executives can learn to mitigate risk (just as we do with investing), there is no crystal ball providing play-by-play of how the future will look. They must use their judgment. And investors hope they bring a certain amount of analytical rigor, management skill, experience-based intuition, and wisdom to the ways they spend the company money. In an ideal scenario, they possess a deep understanding of the strengths of their business - its advantages over the competition, barriers to entry, and moats - and know how to invest behind these strengths. (The better the strength, the easier the planning process!)
But there are no guarantees. Expansion is and always will be an exercise in predicting the future. It is about, after all, believing that additional supply you produce will be consumed by increased demand. A management team will try and fail. They MUST try and fail (at least occasionally) to test the limits of the business potential.
The most bold attempts to grow and compound earnings on behalf of investors - those investments with the greatest possibility for outsized rewards - do not happen in short time frames. They require big investments over long horizons with the real possibility of depressed earnings over the ramp-up period.
This enervates holders of the company's stock - investors, employees, the CEO, his/her family. While all of them will say they want the earning to grow, each group tends to be averse to the risk and time required to make that happen. If you were to provide them with a slight bump in their dividend payout versus putting the same amount of cash into investments that have a high likelihood of paying out a nice return in, say, five years (but impair earnings growth in the meantime), far too many will forego a better payday for the feel-good immediate gratification.
Worst yet, if the investments are made in growth, they depress earnings for multiple periods, and the market has trouble understanding how and/or when the investments will pay off, the stock price will feel that misunderstanding.
And this is where the CEO's decision making becomes hard. He must choose between investing in the long-term prospects of the business, a move that will impact earnings next quarter and bring the ire of Wall Street. Or he can punt. Making timid investment choices; managing the earnings by looking first at whether the next statement will satisfy analyst expectations for the company's performance. And then deciding how much more to allocate to investment in the company's future.
If he invests for the future and is misunderstood, the move will generate a share price drop. And a lot of people are affected by the stock dropping. People that are important to the CEO. People he must see everyday. People who influence his life; that invested in no small part because they believed in him.
Back To the Witch's Dilemma
So here the CEO is playing out the Witch's Dilemma. If he goes with option one - investing in the future of the business that impacts short-term results...the woman that looks pretty to him, but ugly to the world - the share price will be hammered. He will be misunderstood. People who have invested with him will be disappointed. They will feel less wealthy as a consequence of his decisions.
And all CEO's know that if they get labeled with the dreaded letter "U" (Underperformance), many of the constituents they disappointed, along with a new slate of activist investors, will turn up the heat. They will make noise and start demanding change. The pressure will be enormous.
The CEO asks himself...will I even be around long enough to see these bold investments come to fruition? Or will my board bend to the discontented swarm and show me the door?
Being misunderstood is very hard on a person.
Allow me this aside about the concept of learned helplessness...
The psychic punishment of being misunderstood conjures memories of "learned helplessness" a concept belonging to psychology and the term being coined by Dr. Martin Seligman in the late-1960s.
Seligman ran a research lab at Cornell University and spent much of his time experimenting with lab rats. In one particular and somewhat cruel study, he placed a lab rat in a specially constructed box, repeatedly rang a bell, and followed the sound with a mild electric shock. The rat quickly learned to anticipate the shock when he heard the bell. As you can imagine, the rat would become frantic at the sound, running around his box in a futile attempt to avoid the discomfort.
It took very few rounds of this "bell-plus-shock" routine before the rat's behavior changed. The bell still evoked agitation, but once he resigned himself that he had no control to stop the shock, the rat basically gave up and took it.
This observation led Dr. Seligman to his theory of learned helplessness, a phenomenon as easily applied to humans as rats. When faced with stressors most humans - including powerful CEO's - that perceive they lack the control to resolve or avoid it end up sucking it up and going with the flow.
And so most CEO's elect to avoid the discomfort of being misunderstood (if not fired) and choose the Witch's option two. Even though they know the investments will pay off for long-term shareholders, that they will enhance the firm's competitive advantages, that they will compound its earnings...the vast majority of CEO's swallow hard and go with the woman that looks beautiful to the world but that they recognize as unattractive and unsavory.
Anyone For Investing In a Car Periscope?
I'll conclude with a light-hearted parallel...
Season eight of HBO's Curb Your Enthusiasm highlights this dilemma in an episode called Car Periscope. By way of quick summary, Larry David and his agent Jeff are weighing an investment with an inventor of a device you snake above your sunroof in traffic jams to see the source of the slowdown and review your options for getting out quickly.
It's a terrible concept, clearly, and the two are ready to decline the investment opportunity. But they meet the inventor's wife and are struck by the disconnect. She is somewhat homely while the inventor is a decent looking guy. Larry is unabashedly shallow. He always wants the younger more attractive woman. It's foreign to him that a man would ever choose anything less; that someone would subject himself to the ridicule of the guys. This inventor is an outlier. He sees something in his wife that others don't, and he possesses the capacity to be misunderstood. Surely this belies some deep-seeded virtue in this inventor. In Larry's logic, if he has the qualities that permit him to be comfortable and confident with the less attractive girl, perhaps he possesses the tenacity required of an inventor and businessman.
Hijinks ensue. The investment falls through, but Larry believes he has found a new model for gauging the character of men. He meets with his investment manager and, upon seeing a photo of his gorgeous wife, fires him. He selects another adviser on the sole basis of his plain-looking spouse.