On paperclips and shareholder value

Note: A version of this article has been published at the CFA Institute Enterprising Investor Blog.

Imagine an AI that was built to do one task: Manufacture as many paperclips as possible.

In the beginning, the AI uses the existing resources of paper, electricity, and machinery to make as many paperclips as it can. Of course, the AI learns quickly what works and what doesn’t and so it optimises paperclip manufacturing and pretty soon it is far more efficient than any human worker could be.

After a while, the AI starts diverting electricity and paper from other areas in the factory to its machines in order to manufacture more paperclips. A little while later, the AI notices that it can order paper from paper mills and buy new machines to make even more paperclips. The AI becomes so efficient that it makes way too many paperclips, so the owners of the factory try to shut it down. But that would interfere with the AI’s goal to produce as many paperclips as possible, so the AI prevents humans from shutting it down. In fact, the AI recognizes that humans are its competition because they use electricity and paper for other purposes as well. Then, the AI starts to kill humans in order to prevent them from redirecting resources for other uses.

This example of the paperclip maximiser was originally developed by Niklas Boström to show the possible unintended consequences of AI. The AI was never programmed to hurt humans, yet because it was pursuing an unbounded goal, it eventually ended up a killing machine. This tendency is commonly known as instrumental convergence and it is a serious problem to consider in society (even though the above example is obviously extreme).

Think for example about the ultimate goal of corporations. It is commonly accepted that a corporation should maximise profits in order to increase shareholder value. That is all fine and well until a corporation starts hurting society in order to maximise its profits and shareholder value.

While I am an advocate of renewable energy, I am by no means an enemy of the energy industry and fossil fuels. I think that the goal to abolish or ruin the fossil fuel industry is a pipe dream of eco-mentalists. Just think about the many positive uses of crude oil and natural gas. You can take practically every pharmaceutical drug in existence today and trace it back to its origins as a barrel of crude oil. Similarly, it would be impossible to feed the current population of the planet without chemical fertilizers, all of which are made out of crude oil. No, we need the energy industry and we need crude oil and natural gas for decades to come.

Yet, I also think that the stupidest thing we can do with crude oil and natural gas is to dig it up and then set it on fire, which is essentially what we are doing when we use it to produce electricity or run cars.

Yet, energy companies that act as shareholder value maximisers pretty much fall into the trap of the paperclip maximiser. They start digging up oil and gas and try to sell it to make a profit. Obviously, you can make more profits when you sell the oil to people who burn it because they will have to come back and buy new oil from you to burn that as well. 

At some point, humans will figure out that burning fossil fuels causes global warming and all sorts of damages like smog and sea-level rise. So, they try to reign in the production of fossil fuels and promote the use of renewable and clean energy sources. This directly harms an energy company’s goal to maximise shareholder value, and thus, it starts to discredit these people and claims that climate change is a hoax. Meanwhile, the company’s own scientists agree with these forecasts of global warming and the corresponding sea-level rise. Your reaction is to keep these findings out of the public’s eye but start building taller offshore drilling platforms in the Gulf of Mexico and other places to make sure sea-level rise does not damage your platforms. Finally, you also make sure that you place some of your corporate leadership on the board of directors of major banks where they can lobby the banks to provide a steady flow of financing to your projects and ensure that you will be able to generate even higher profits and shareholder value in the future.

If that sounds like fiction, it isn’t. It is pretty much what Lee Raymond did during his tenure as CEO and Chairman of ExxonMobil from 1993 to 2005 and as director of JP Morgan Chase since 2001. In an article by Bill McKibben in Rolling Stone Magazine he is described as the archetypal Bond villain and if you read up on his views on climate change and gay rights, you are tempted to agree. But his actions at ExxonMobil and JP Morgan Chase are not driven by evil. They are simply driven by the goal of shareholder value maximisation.

I tend to look at financial markets and economies as complex dynamic systems, yet traditional finance theory is based on a linear, non-complex view of the world. I find this traditional view so disturbing that I have dedicated an entire chapter in my book to a primer on complex dynamic systems thinking. And if you take that view, you immediately recognise that shareholder value maximisation is a stupid goal. Instead, understanding the world as a complex dynamic system immediately leads you to stakeholder value maximisation as the optimal solution to run a company. It simply isn’t enough to create the highest possible share price because if you do that at the cost of your employees, your suppliers, clients or society as a whole, you will eventually face a backlash in the form of lawsuits or regulation. In the worst case, you will be nationalised or regulated out of business. 

Yet, many companies still try to maximise shareholder value. The result is that they have become used to lawsuits and legal fines as a cost of doing business. (e.g. the financial industry). But a complex dynamic system view of the world also tells us that if lawsuits don’t help, society will create an even bigger backlash against corporations. If you think the current support for leftist politicians like Bernie Sanders or Jeremy Corbyn with their plans to heavily regulate corporations, nationalise some companies and introduce a wealth tax is just a temporary aberration, you have not understood the driving force of these movements. 

I cannot find the source of this quote, but someone once said:

“You have to give people a little bit of socialism to prevent them from asking for a lot.”

Companies and business leaders would be well-advised to heed this.