How could shares in a megaproject return value to shareholders?

post by ryan_b · 2019-01-18T18:36:34.916Z · LW · GW · 12 comments

Contents

12 comments

In my previous post [LW · GW] on buying shares in a megaproject [LW · GW], several people asked the most reasonable of questions: how would the shares return value?

A simple description of shareholder value:

Assets - Liabilities = Equity

Basic project outcome:

Budget - Costs = Surplus

So the concept is fundamentally to treat the budget as the assets column, put the costs in the liability column, and treat every dollar you are under the budget as an increase in shareholder equity. At the conclusion of the project, the shares will be bought back for that surplus in cash.

This means the price the share sells for is a direct bet on how well the project will do against the budget.

This is analogous to how investors buy in to start-ups; the investment becomes the assets and in exchange they get a share of the equity. But in the case of megaprojects, the initial investor is getting the project outcome as compensation; the equity should instead go to management as their compensation. Now this gives management the incentive to be as efficient as possible, while also giving them the flexibility to raise more capital in exchange for equity.

For comparison with some of the ways this is currently done, consider the fixed-price contract and the cost-plus contract. The former gives the contractor an incentive to be efficient by forcing them to hold all the risk; the latter shifts the risk back to the contractee. Fixed-price is common for things that are predictable, like services; cost-plus is common for things that are risky or require R&D to complete, like defense procurement. Megaprojects are usually of the latter sort.

Tangential but worth also addressing: why a financial asset instead of a prediction market?

12 comments

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comment by Gurkenglas · 2019-01-18T23:21:40.459Z · LW(p) · GW(p)

Seems misaligned. Shareholders would prefer a project that they predict will deterministically use exactly its budget to first bet all on black in a casino, then either be immediately bankrupt or able to complete and then pay out its original budget.

That is of course true for anyone who buys a call option right now as well.

Replies from: rossry
↑ comment by rossry · 2019-01-20T04:57:22.658Z · LW(p) · GW(p)

Proves too much; this is similarly true of shareholders in any company with a debt+equity capitalization.

It's true that shareholders' incentives are not perfectly aligned with creditors'. In private corporations, this is handled with governance practices; for public megaprojects it seems like even less of an issue.

Replies from: Gurkenglas
↑ comment by Gurkenglas · 2019-01-20T20:28:52.698Z · LW(p) · GW(p)

Investors would prefer to invest in moonshot megaprojects over, like, infrastructure megaprojects. Does this also prove too much?

If after 10% of the time and the budget, the startup can tell that success is very unlikely, should they be incentivized to abort? Because the current setup would seem to have them chug along until the budget is gone.

Replies from: rossry
↑ comment by rossry · 2019-01-21T10:54:23.484Z · LW(p) · GW(p)

Investors would prefer to invest in moonshot megaprojects over, like, infrastructure megaprojects.

I don't think this is true; as in corporate equity markets, the preference should be responsive to price, and equity shares should trade over naive book value, but at a price where the marginal investor is indifferent to buying more.

In fact, insofar as the Miller-Modigliani assumptions hold, any capitalization of the project in terms of equity and debt should trade at the same total price (and so, raise the same funding), just with a different mix of the total coming from the debt and the equity.

should they be incentivized to abort?

Clearly that would be ideal, but this scheme doesn't make this issue worse than the status quo (and provides the advantage that at least there's some market-based metric to tell you that the project is going off the rails).

comment by uncomputable · 2019-01-18T19:05:04.068Z · LW(p) · GW(p)

So some organization will still cough up the initial budget, and then some set of potential shareholders will decide that this project will be the first megaproject to run under budget. They'll then give the project more money, in exchange for getting that money back, plus whatever the project doesn't use out of their original budget?

I don't feel like incentives are aligned very well, here.

The organization sponsoring the project is going from the current situation where they can at least lie and pretend that the possibility exists that they'll come in underbudget, to one where they're guaranteed to burn >=100% of the budget if only because they've got to give away the leftovers at the end. In exchange they get maybe a few percent more budget. Do shareholders even get to elect the board of directors?

Middle managers on the project could now easily benefit financially by shorting the equities and sabotaging the project.

Replies from: ryan_b
↑ comment by ryan_b · 2019-01-18T19:39:55.101Z · LW(p) · GW(p)
The organization sponsoring the project is going from the current situation where they can at least lie and pretend that the possibility exists that they'll come in underbudget, to one where they're guaranteed to burn >=100% of the budget if only because they've got to give away the leftovers at the end.

This is a feature, not a bug. We prefer the world where the project never gets funded in the first place to the world where it gets funded based on lies and then runs 150% of the budget and provides only 50% of the benefit.

Middle managers on the project could now easily benefit financially by shorting the equities and sabotaging the project.

Management can do this now in regular companies, and it isn't a problem: it mostly doesn't occur to them; it damages reputations to appear incompetent; it is also a crime.

Replies from: Dagon, mr-hire
↑ comment by Dagon · 2019-01-21T03:19:25.327Z · LW(p) · GW(p)

We prefer the world where the project never gets funded in the first place to the world where it gets funded based on lies and then runs 150% of the budget and provides only 50% of the benefit.

Wait, is that true? There are some projects so valuable that I'd want them even at twice the budget and a quarter the incorrectly-estimated value. There are LOTS of projects that I don't want even if under budget and full estimated value (on the wrong dimensions).

Replies from: ryan_b
↑ comment by ryan_b · 2019-01-21T16:54:12.405Z · LW(p) · GW(p)

If the project is worthwhile at the real costs and real benefits, then we should be able to get it approved on that basis; if we can’t that indicates another problem. The challenge here is incentivizing a good faith effort to find that information out at all.

Replies from: Dagon
↑ comment by Dagon · 2019-01-22T02:59:14.409Z · LW(p) · GW(p)

Cost estimates are simple lies or errors, and it's easy (ish) to compare against real costs incurred. Benefits are multidimensional and hard to measure, so are impossible to compare promises to results.

Will a new stadium improve the area's prestige and economic outlook? How would I even resolve the bet?

Replies from: ryan_b
↑ comment by ryan_b · 2019-01-22T19:47:48.696Z · LW(p) · GW(p)

I'm a little unclear: if you cannot measure the outcome, how do you know you want the project?

Will a new stadium improve the area's prestige and economic outlook? How would I even resolve the bet?

Things like land values, the revenues of the businesses around the stadium, and number of permanent jobs working for the stadium and new businesses which rely on stadium traffic are all reasonable kinds of measures. Even if they are difficult to project with accuracy, the same reference class method can be used for the overall impact.

I flatly disagree that it is impossible to compare promises to results; either the things that were promised came to pass, or they did not. This is no different to any other measurement problem. The number of jobs the project will generate has been a popular kind of promise, and both headcount and compensation are routine things economists measure.

If the objection is that deliberately vague promises are impossible to compare, I would agree and that is entirely the fault of the project backers; there's no way to stop investors in a company from cutting a personal check based on a hand-shake either. However, I note that it is pretty rare for large investments to be made without specific predictions, and I suspect that if projects were put on the same footing as companies people would mostly carry the same assumptions for investing in them.

The ability to compare between different project proposals efficiently seems like an important desiderata to me, and I think it would also have a bearing on the results problem.

↑ comment by Matt Goldenberg (mr-hire) · 2019-01-20T22:52:16.510Z · LW(p) · GW(p)

The typical middle manager can't tank enough projects to effect a stock price. This is not true in the case of an individual project.

Replies from: ryan_b
↑ comment by ryan_b · 2019-01-23T18:31:48.105Z · LW(p) · GW(p)

The sabotage issues that Tesla may be facing suggest you are right; that is a risk that will have to be assessed.