Good Investors Make Money. Great Investors Create Value. | Mihir Desai

People have a bad impression of finance, and that's mostly worrying because its often justified, says Harvard Business School professor Mihir Desai. The sector is in dire need of rehabilitation, and there are several ways it can be done. The first is to realize that turning money into more money is a shortsighted investment. To play the long game, the system needs to focus on and reward value creation, which drives innovation and the economy. The second is to demystify finance (which is what Desai's new book The Wisdom of Finance is all about). Desai explains that finance got into its current state because it's more complicated than it needs to be, which makes it harder to control, given the general lack of understanding among the public. To remedy that, Desai taps into the brain's own strengths: humans process stories much better than they process logic, so narratives from history, literature and philosophy can be used to teach and demystify finance. As an example, the The Parable of the Talents from the Bible teaches value creation as well as a finance textbook can. The philosophy of Charles Sanders Peirce can teach risk management and insurance. Mel Brooks can teach fiduciary responsibility. Finance has become demonized, but it's not a system that we can live without. It's becoming more pressing than ever to make reforms that increase value in society, rather than wealth. Mihir Desai's most recent book is The Wisdom of Finance: Discovering Humanity in the World of Risk and Return.
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Transcript: So I’ve been concerned because finance has become demonized in the last several years and decade or two. And in part it’s for good reason, which is the practice of finance in many ways is broken. We see a lot of activity that is value extracting as opposed to value creating, and that is really disturbing. And, you know, that’s not just the financial crisis, but we see it in various parts of finance: in asset management to some degree, in banking, and so it is really worrisome that A: people have such a terrible impression of finance, and B: that we sometimes live up to it. But the truth is that we can’t live without finance and we need to rehabilitate finance. And the reason we can’t is because it is so central to the modern economy.
So I think even people who are really upset about finance have to acknowledge that it’s really central, and we have to make it better. It is the fundamental mechanism by which companies grow, we save, we allow ourselves to potentially borrow to go to college, we save for our retirement. And innovation in general has to be funded. So finance is really central. What we have to try to figure out is how and why it's become so extractive as opposed to creating value.
How do you know whether you’re creating value, and what is the recipe for creating value? So that sounds very finance-y. In fact I use The Parable of the Talents, which is a very odd parable from the bible, a very harsh parable in the bible, which effectively captures the logic of value creation straight out of a finance textbook.
By that I mean it tells the story of these three servants, two of whom actually use what they’re given well and one of whom buries his talents. People don’t often know that the word talent is actually historically money. It is now—the modern notion is what we now think of as an ability.
But the neat thing about that story is it maps to the basic recipe for value creation and finance which is, just to be a little technical, you know, you beat your cost to capital. You surpass people’s expectations. You do it for a very long period of time and you continue to grow. So that’s how companies create value. That little recipe for value creation, I show is exactly what is in The Parable of the Talents. And, in fact, John Wesley Mitchell, who is the founder of Methodism, in his essay on The Parable of the Talents, basically says almost the exact recipe for value creation that kind of comes out of a textbook which is, you know, beat your cost to capital, which is a way of saying: give back more than you take as long as you can to as many people as you can, and so on and so forth. So it’s actually kind of neat in the sense that The Parable of the Talents, that recipe for value creation, actually maps to the recipe for a reasonably good life. So that’s one example, but there’s like the book is littered with kind of basically examples like that.