The Lie of Open Markets
Democratizing markets with uninformed investors makes markets less accessible, less efficient, and everyone loses.
I am deeply opposed to sports betting. I also believe in freedom and autonomy. So if I really want to sports bet, I should be able to. I should be able to get in my car, drive to Las Vegas, get a hotel room, go to the casino, and place bets. But I should not be permitted to sit on my couch and tap a few buttons and lose money, because it is bad.
How bad? I would argue sports betting has zero marginal benefit to society. It leads to higher household debt, lower savings, increased bankruptcies, credit score declines, spikes in gambling problems (which lead to anxiety, depression, and suicide risk), and an uptick in domestic violence (as well as family conflict and relationship breakdowns), not to mention it erodes the integrity of sports, as we just saw.
Retail investing is not dissimilar to this. Being able to bet money in the public markets is probably also bad. You are, in the simplest of terms, placing a bet. Like sports betting, the folks on the other side of that trade are infinitely better informed than you, because it is quite literally their job to be. So there should probably be some more restrictions on retail investing. Unlike sports betting however, retail investors and their counterparty aren’t making a pure bet; they’re not the only entities in the market. There’s also the stock of the companies they buy and sell.1
Several months ago, a friend of mine was offered a generous RSU package at a company that is—in no uncertain terms—deeply overvalued by retail investors. Their price is so high that it was difficult to see further sustainable upside. As we talked it over, I couldn’t exactly quantify how the market as a voting machine (in the short term) seemed to have a protracted impact on the company itself.
Dan Sundheim of D1 Capital offered an answer on Cheeky Pint this week. As he put it (edited for clarity):
“I think the public markets are kind of problematic at this point. Let’s just take Stripe, for example, and I won’t speak for John, but basically Stripe grows earnings [and] cash flow at some amount. Value compounds and they do tender offers and the tender offers are relatively in line with the value creation and therefore the people who are working at the company, and they’re creating that value, get paid for that value because the stock price goes up in line with value creation. Now what we see in public markets is you take your company public and depending on what the retail crowd is doing that day, the stock may trade at some insane value and most people are high-fiving, “This is amazing! Our stock is trading two X where it should be. This is great, we’re all rich.” The problem with that is that you’ve now pulled forward a ton of value and so all the people working at the company now are being overpaid because they didn’t actually create this value. The stock gets this value and then the people who you’re hiring, and those people are probably more likely to just cash out because they’ve just made too much money.”
[John Collison interjects]
“You’re robbing future employees to pay your current employees.”
“Exactly. And then future employees now you have to give them stock options or RSUs at a stock price you don’t really believe in. And so the stock is so volatile that you’re actually not being paid as an employee based on value creation. You’re being paid arbitrarily based upon multiples which have nothing to do with the true intrinsic value of the company. I think obviously it’s bad to be undervalued as a company because then you’re issuing stock to employees at too low of a value and then they don’t appreciate it usually. But it’s pretty bad to be overvalued, too. Because employees, if the stock doesn’t go up, they will definitely come back to you and ask for more options. If the stock goes up way more than it should, they’re not going to come back to you and be like, “Oh, you know what? Hey, I made too much money.” And so you end up having this asymmetric—I think it’s really not a healthy dynamic to be a public company.”
This challenge is unique to public markets because—as Dan points out—retail investors are divorced from fundamentals (i.e. they are betting). Sure, the company in question could dilute them (and often does), but that comes with a host of problems. Tender offers for their part are “relatively in line with the value creation” because these sophisticated investors are better informed. The whims of retail investors leads to a cascading effect s.t. markets are less efficient despite being democratized, and finance becomes less accessible in the long term.
I would argue that this conundrum can be fixed by implementing increased restrictions on retail investing. In other words, not unlike sports betting, an everyday American shouldn’t be able to trade stocks from their couch, because it is bad for society.
To that end, maybe, there could be a threshold of assets to trade in public markets. Something like a few hundred thousand earned per year or a million of assets in the bank. Maybe, too, you could have a series of tests people could take if they really wanted to invest. We could even call them a “Series” and have different numbers to denote the topic.
I am, of course, arguing that you should have an accreditation threshold for public markets in addition to private markets. The goal is simple: reinforce the integrity of public markets such that companies aren’t getting hurt by retail investors hurting themselves.
After the recent betting scandal, you could actually probably make a similar case in sports; the bets begin to influence the players and teams themselves, not just the bettors and their counterparty(s) (the platforms).