Like a physician with her stethoscope at the outset of a check-up, astute shareholders and directors should use the level and trend of a utility’s market-to-book ratio (MtB) as one of the first...
Black Swans and Turkeys
The industry isn’t as robust as we might think.
Nassim Nicholas Taleb has become something of a celebrity in the past couple of years. Taleb’s 2007 book, The Black Swan: The impact of the highly improbable , warned decision makers about the folly of relying on econometric analysis to manage risks, because unprecedented “black swan” events eventually show up and turn that analysis on its head. The subprime mortgage bust seemed to prove Taleb’s theory, catapulting him to rock-star status in the world of financial economics.
Taleb’s Black Swan Theory is illustrated in a parable—ironically about a different bird: the Thanksgiving turkey. From the turkey’s point of view, life is predictable and stable, with daily feedings, care and protection by the farmer. But then Thanksgiving rolls around, with a big surprise the turkey couldn’t have foreseen from its lifetime of experience.
Taleb isn’t saying people should try to be like smart turkeys and predict their own Thanksgiving doomsdays. Instead he’s suggesting that we should altogether avoid the turkey’s problem—that we shouldn’t rely on strategies that leave us vulnerable to unprecedented events.
Taleb writes on his website, www.fooledbyrandomness.com: “While most human thought (particularly since the enlightenment) has focused us on how to turn knowledge into decisions, I focus on how to turn lack of information, lack of understanding and lack of ‘knowledge’ into decisions—how not to be a ‘turkey.’”
Toward this end, Taleb identifies several steps for protecting the economy against black-swan events (see “Ten principles for a Black Swan-proof world,” Financial Times, April 7, 2009) . While Taleb’s 10 steps are mostly aimed at big-picture policy issues, many of them also can be applied to a given industry or organization.
The good news for the U.S. investor-owned utility industry is that our business is inherently structured to avoid some of the pitfalls Taleb identifies. The bad news is we’re not impervious to black-swan events. Our collective necks are vulnerable to the farmer’s axe.
The parable of the turkey contains two key lessons. The first is that, like the turkey, we don’t know what we don’t know; our critical mistake is to assume our individual lifetimes of daily experience accurately represent our futures.
The specific lesson for the utility industry is that we shouldn’t rely on probabilistic, econometric analysis in our planning and risk management, because such analysis can’t compute the black swans—the radical changes that can and do happen in economics, technologies, resources, and social structures.
Everybody knows our world is in a state of flux; this fact is made starkly evident by today’s uncertain policy environment (see “ Legal Battleground ”). But few understand just how disruptive a black swan can be. Imagine, for instance, what would happen if a global currency war collapsed the greenback, dried up international debt sources and bankrupted the U.S. Treasury. Or what if the greenhouse effect suddenly reached a tipping point, and the global climate went haywire beyond Al Gore’s worst nightmares? Or on the flip