Will Mitchell’s Comments on Receiving the BPS Irwin Award

10 August 2009 at 7:30 am RussCoff 4 comments

| Russ Coff |

A big congratulations to Will for winning this prestigious award. It is really something to hear a person’s students describe how their mentor has altered their lives. Many misty eyes in the room…

Embedded in Will’s comments after receiving the award was an observation that in many business settings, such as in developing countries, effective business decisions cannot be made using the risk-based tools (like NPV) that are so often taught in business schools. He argued that, in the face of Knightian uncertainty, these tools fail miserably.

So what would be a set of tools to address uncertainty? The closest that I teach would be scenario analysis and real options. Here, one still needs to estimate parameters like the volatility of the investment or probabilities of outcomes (for decision trees or binomial trees). Of course, the assumption that these parameters could be known still suggests reflect risk rather than uncertainty. However, I emphasize sensitivity analysis (such as simulations, etc.) on these parameters to address the fact that they cannot be known.

First, is this the best set of tools available for Knightian uncertainty?

Second, is Will right that these are left out of most strategy courses? Perhaps we need to re-think the curriculum a bit…

Entry filed under: Conferences, Education, Former Guest Bloggers, Strategic Management, Teaching.

John Hughes Heterogeneity and Health Care

4 Comments Add your own

1. Peter Klein | 10 August 2009 at 8:14 am

I thought it was a great ceremony as well. I immediately felt guilty for failing to mentor my own students the way Will apparently mentors his. (Actually one of the former students said Will rejects the “mentoring” model in favor of an “apprenticeship” model, but you get my point.)

The only thing that puzzled me in Will’s remarks was his statement that embracing Knightian uncertainty is equivalent to saying “I don’t know.” Maybe I’m reading too much into this wording, but that’s not the way I’d put it. Knight is explicit that entrepreneurs _do_ know something about the uncertain future, they simply cannot parameterize this knowledge in terms of probability theory. In place of expected values, computed in the standard way, they exercise judgment or _verstehen_. They don’t flip a coin! In Mises’s words, the entrepreneur relies on his “specific anticipative understanding of the conditions of the uncertain future,” an understanding that “defies any rules and systematization.” See here for more on this point.
2. Steve Phelan | 10 August 2009 at 1:09 pm

What about Sarasvathy’s work on effectuation?
http://www.effectuation.org
3. Will Mitchell | 11 August 2009 at 3:28 pm

Thanks for the kind words. It was a very moving evening for me.

And, yes, I do think apprenticeship (apprentice=”works for an expert to learn a trade”) is a more useful model than mentorship (mentor=”a wise and trusted guide and advisor”; I am not particularly wise and it would be truly unwise to follow me into some of the places I go).

Re Russ’s point about uncertainty: Hyoung-Goo Kang, Rich Burton, and I have a recent working paper on comparing tools for different combinations of risk, uncertainty, and controversy (available at http://faculty.fuqua.duke.edu/~willm/bio/cv/index.htm)

The core point here is that if one uses “traditional” financial tools suited to risky situations in cases when probability distributions are meaningless (e.g., what was the ex-ante probability that mortgage holders on pools of sub-prime mortages would default?), then one risks making really bad decisions — and if enough people make similar bad decisions, then the problems become social rather than individual.

chears!

will
4. Will Mitchell | 11 August 2009 at 3:39 pm

Here is the URL for the working paper without the trailing parenthesis

http://faculty.fuqua.duke.edu/~willm/bio/cv/index.htm

Click through on the “Working Papers” link and look for: “How Firms’ Capital Budgeting Methods Differ as Knightian Uncertainty and Controversy Vary: Bower and Brealey & Myers Are Both Right, Sometimes” (with Hyoung Goo Kang and Rich Burton), July 2009.