Archive for May, 2005

Professors vs Students

Wednesday, May 25th, 2005

An irony of business school finance departments is the conflict of interest between
professors and students. Nearly all business school students attend for the
purpose of becoming wealthy. As a result, their interest in finance, apart
from getting jobs in finance departments, is to
find and exploit market inefficiencies.

Professors, by contrast, are rewarded for explaining how the
overall competitive structure works, and publishing their findings widely.
Thus, every time they discover a market inefficiency, they broadcast it, and
the inefficiency disappears. For example, the January Effect was attenuated
greatly by widespread awareness.

Professors are also rewarded socially for teaching that markets are too
efficient to permit individuals to make consistently supernormal returns through
portfolio selection. This despite the fact that certain types of
portfolios, which would be considered off the efficient frontier by Modern
Portfolio Theory, have long been shown to
consistently outperform the market as a whole. An example of this is to
hold a portfolio of only the cheapest two quintiles of listed stocks, as
measured by PE or price to book value.

As a result, few professors are teaching students what they really want to
know: how to think about the process of identifying and exploiting market

“Professors vs students” essentially recapitulates the difference between economic policy and business policy. The goal of business policy is to seek competitive
inefficiency with no upper limit, as a way of maximizing return on equity.

By contrast, the goal of economic policy is generally to maximize growth of GDP per capita by maximizing competitive efficiency, including by preventing permanent large-scale competitive advantages in business. All non-extremists appreciate the value of compromise between these two positions, and all economic policy debate is simply about where to draw the line between the two.

The “business policy vs economic policy” conflict is sensible and understandable. Less so is the professor vs student conflict, because the student is actually paying the professor for advice he can’t use. At Harvard and Stanford, for example, the student pays on the order of $100 per lecture hour, fully loaded.

This is not to say business school isn’t useful or valuable. But it’s
important for the student to understand what he’s buying.