Professor Alex Edmans makes the case for a pie-growing mindset. Acknowledging the challenges and trade-offs in pie-splitting, Edmans argues that pie-growing creates the most welfare for the most people.  Core ideas Edmans argues for (along with pie-growing) are: the importance of “omission errors”, the multiplication principles, the importance of materiality judgements and comparative advantage. If I were to pick out two other principles that weave throughout the densely argued book, they would be the ideas of personal agency and a reliance on fact-based evidence over ideology.  (See link for Webinar where Alex and I discuss his book)

Interspersed with lively stories and backed by evidence, it makes for better reading than a dry academic text. However, it is still packed with references to studies and data that makes the book dense reading and above the one-shot idea business books that line airport bookshops.

Omission errors are harder to track, but might be more serious for creating value. Value creation, for Edmans, is not about firm value but about society value. Expressed on an individual level as a fear of failure, it may cause enterprises to avoid innovation development and the likely high failure rate that entails. Edmans further argues that omission errors may be caused by too strong a desire to avoid “commision errors”. An error of commission may be in overpaying a business leader but the larger omission error may be in that business funding an innovation project that the company is uniquely able to research and benefit society as a whole.

The pie-growing mentality with a focus on society then has firm profit as an oblique by-product of society value creation (cf. John Kay, Obliquity). Profit is a side effect of pursuing social value creation. This contrasts with some forms of the “Stakeholder” model or the “Enlightened Shareholder Value” model (ESV). Under ESV, a firm creates long-term value by positive relations with stakeholders (cf. Business Roundtable Statement, 2019) such as customers, suppliers, regulators and employees etc. ESV is an extension of Milton Friedman’s arguments on profit maximisation (cf. Freedom and Capitalism) but argues long-term firm profits are only maximised by good treatment of stakeholders. Under ESV, social value is a by-product of firms seeking to maximise profits.

ESV advocates argue long-term profit is concrete, measurable, focused and objective.

Edmans argues that growing social value may be less concrete but that it’s intrinsic rather than instrumental. Social value creation considers externalities better even at the cost of focus.

Edmans argues intrinsic motivations leads to more long-term profits. This is important where value increasingly arises from intangible value (cf. Haskel and Westlake, Capitalism without Capital). Accounting for externalities better is a way of tackling pollution and climate challenges that simple profit maximization is poor at handling.

I suspect both ESV advocates (eg Michael Jensen) and market libertarians (eg Cliff Asness) will still have concerns over the measurement difficulties of social value and the trade-offs involved. However, many economists agree that GDP is not an entire measure of a nation’s wealth, not accounting for environmental capital (cf. Tyler Cowen’s Stubborn Attachments) and social capital. Better environmental capital accounting would be helpful. Market libertarians argue that there are few examples of market failure (although response to pandemics might be one area, topical as of 2020, climate might be another). They may argue that Pieconomics still leaves unresolved where there are market failures over externalities. State capacity libertarians may argue that such externalities, for instance pandemics or climate, might be better handled by state or non-profit maximising entities (eg ARPA) focused on an aspect of social value (agreed by that society) rather than private firms - although the ideas are not mutually exclusive.

Edmans’ arguments are a counterpoint to the “Degrowth” economists or the Donut (cf Kate Raworth, Donut Economics). Under a degrowth framework, humans need to live within certain planetary boundaries. While both may agree circular growth is sustainable, pie-growth would account for externalities and for intangible growth. (Personally, I find Edmans arguments better backed up than Mazzucato’s book Value of Everything. I find Edmans’ arguments then sitting alongside Colin Mayer’s book, Prosperity.)

Edmans moves on from the theory to articulate three principles to use when judging value creation.  These are:

Multiplication: An activity should have social benefits that exceed its private costs

Comparative Advantage: Social benefit should outweigh social costs

Materiality: Activity should benefit material stakeholders (a firm is not all things, to all people)

Edmans then provides evidence on the positive use of share buybacks and incentive schemes within his framework. His conclusions on share buybacks and incentives run counter to the narratives of some commentators who posit (often without evidence) that share buybacks do not enhance value. The arguments are that buybacks are made at the cost of value enhancing projects into, e.g., innovation. Edmans finds the situation much more nuanced. There is a limit to value enhancing projects. Similarly, Edmans has less concern (although not zero concern) on magnitude of pay for management but more concern about whether pay structure is aligned to long-term value creation - or pie growing. The amount management receives in pay is outweighed by the pie grown by all stakeholders in this model.

The last shorter chapters of the book cast the lens of pie-growing onto nations and individuals. Here the idea of personal agency comes through. Individuals have “voice” as well as “exit” as choices (cf. Hirschman’s Exit, Voice, Loyalty) can act upon business via choice and action. This area is less developed but touches on purpose and growth mindset. (Interested readers could see Dweck’s Mindset or Microsoft CEO, Satya Nadella’s Hit Refresh)

 

Suitable for a thoughtful lay reader as well as covering material useful to business leaders and investors in the field. This book is recommended on some of the latest thinking and evidence on how companies deliver both social value, purpose and profit.

Sources and notes:

Written in personal capacity, I did review an advanced draft of the book for free. Edmans sits on an advisory committee, which I chair. I paid for a Kindle copy and have been gifted a hard copy.

Alex Edmans site.

See Ray Dalio on analysis on pie-splitting and pie-growing. Dalio is concerned about the inequalities associated with pie-growing although Edman’s framework does partly address this.

John Kay’s book, Obliquity looks at why (traditional) share holder value is a by product.

Milton Friedman argues free markets and individual choices maximises welfare by seeking profit maximisation (within the rules of the game). See Capitalism and Freedom.

Albert Hirschman looks at the philosophy of choice and agency amongst other ideas in Voice, Exit and Loyalty.

Haskel and Westlake, Capitalism without Capital examines the rise of the intangible economy.

Kate Raworth argues for re-imagining economic growth and the boundaries humans should live within. Her book is Doughnut Economics.

Colin Mayer examines the responsibility of business and the history of the corporation, and where capitalism might go next in, Prosperity. 

Tyler Cowen articulates State Capacity Libertarianism and lays out some of his philosophy in Stubborn Attachments, including why we undervalue the environment and future generations and inadequacy of GDP.