I suspect that a lot of my readers also visit the Whopper Investments blog, so you might have noticed that I gave this post an identical title as his last one: Incentives matter. Whopper summarizes my thinking about the subject in the following sentence: “I believe that people are always going to do what’s in their best interest”.
This is of course very important when you scrutinize what insiders are doing at a company, but it is equally true when you read an article online. What are the incentives of the author? I recently wrote a post for Seeking Alpha about Deswell Industries. For regular readers of my blog not a new name since I own it since the beginning of 2012. At the time I spend little time about looking at the underlying business, my main concern was whether or not the company was potentially a fraud since it’s doing business in China.
So my incentives for writing this post, and publishing it on SA:
- Reviewing and updating my investment thesis
- Gain some exposure on SA, maybe attract some new readers to my blog
- Last but not least: make a few bucks
SA pays authors a minimum of $150 dollar for a good article on a under-followed micro/small cap while there is minimum payment of $500 dollar for an article that is selected as an “Alpha Rich” idea. So what is your incentive as a writer: to write a piece that convinces the SA editors that the stock offers an asymmetrical risk/reward ratio! It’s no longer about publishing the most balanced research. Of course you should mention some negatives because you sound smarter if you do, but it’s easy to downplay a specific issue. I wish it wouldn’t be true, but after writing the article I realized how you are tempted to do it. Even without the money the incentive would be there: it’s also an ego thing.
In the case of Deswell Industries I don’t think it would have been too hard to write an article that sounded a lot better. You have the downside part of the story covered with the large amount of cash on the balance sheet, and it’s easy to write for example a nice story on how the business has decent long-term prospects (not impossible) or how the leasehold land of the company could potentially be a very valuable asset (for the record: I don’t think this is very likely, but you see on SA a reader that is trying to make this case). It doesn’t even matter if you fool the SA editors or not, the end result is the same.
So what does this mean for me?
My number one motivation of starting this blog is to improve my investment process and skills. I often think about my write-ups as a sort of public visible checklist (without the checks). By writing an ‘exclusive’ article for SA I’m giving myself a competing incentive, and that is a dangerous thing because it’s already easy enough to be biased towards your own idea’s. So you don’t have to expect a lot of other SA articles from me in the future, although I might occasionally review an existing position (or maybe write about something I don’t own).
A slightly related topic is my decision to keep the blog free from advertisements. That would also introduce a competing incentive: away from the quality of posts and towards the quantity of posts. I don’t think advertising revenue would be material anyway, so no reason to do something that subtracts from the main goal of the blog.
What should it mean for you?
Nothing! You should be doing your own thinking and research anyway. But when you read something it still pays to think about the incentives of the writer, because it can tell you where you could start looking to find the weak points in the thesis. Unfortunately this means on SA that authors have an incentive to make the story sound as positive and convincing as possible. I understand why they are doing this, because it’s at the same time also an incentive for people to write true “Alpha Rich” articles, and I think they are succeeding with that part of the equation. I do see more interesting articles appearing than in the past.