This past week, WeWork’s parent the We Company announced that it would lay off more than 15% of its workforce. The layoffs mark the close of an amazing story that captured the imaginations of people around the world, and which in the end turned out too good to be true.
Readers interested in an entertaining description of WeWork’s history might want to view last week’s television program Nexus, produced in London, where I was a guest. In this post, I build on some of the main points I made during the Nexus program. In what follows, I assume that readers are familiar with the basic facts of WeWork’s chronology, and focus on some of the deeper psychological issues underlying the eventual fiasco.
WeWork is a fascinating behavioral finance story. Its founder, Adam Neumann, who until recently was the firm’s CEO and board chair, embodied extreme versions of key psychological characteristics that characterize most chief executives. In this regard, most CEOs are excessively optimistic and overconfident, which is not necessarily a bad thing. However, extreme excessive optimism and overconfidence can be dangerous.
Extreme excessive optimism and overconfidence provided Adam Neumann with the motive to make large, bad financial bets, at least for his company. That said, motive is not typically sufficient for disastrous decision making; also required is means; and until recently, Neumann lacked those means. However, in early 2019 financial firm Softbank’s head, Masayoshi Son, decided to invest over $4 billion in WeWork. Doing so resulted in Neumann having both the means and the motive to engage in decisions that could, and ultimately would, significantly destroy value.
The tendency of companies to increase spending when they are flush with cash is known as “cash flow sensitivity.” Some readers might view cash flow sensitivity as being perfectly reasonable; and it might be. The thing is that behavioral research shows that excessive optimistic and overconfident CEOs, when those biases are extreme, are prone to make spending decisions that on average destroy significant shareholder value. In Neumann’s case, the biases were extreme.
To his credit, Neumann built WeWork by identifying unserved needs in the market, and then finding a way to address those needs. The needs Neumann identified were those of startup founders and entrepreneurs who required work spaces featuring pleasant surroundings, amenities, and communities of people like themselves. WeWork called its customers “members,” thereby emphasizing the social community aspects of the service they were selling.
WeWork did succeed in offering a positive value proposition to its customers. That was perfectly fine. Unfortunately, the company’s problem was that it did not simultaneously offer its investors a positive value proposition. That is to say: WeWork was unprofitable, and had no clear business plan for becoming profitable.
What makes the WeWork story so fascinating from a behavioral perspective is that until a few months ago, the lack of a positive investment value proposition was news to the company’s major investor Softbank, and to JP Morgan and Goldman Sachs who WeWork selected to take the company public.
WeWork’s attempted IPO went off the rails when investors began to scrutinize the company’s business model, which was part of its S-1 filing with the SEC. That model made clear that WeWork was unprofitable and had no plan for becoming profitable. The interesting question is why investors would be willing to invest large amounts without asking enough questions to uncover this most inconvenient truth. Part of the answer to the question is charisma.
Neumann is charismatic, and he knows how to read people. Years ago, Softbank’s Masa Son made a big bet on Alibaba, similar in nature to WeWork, basing his investment decision on Alibaba’s founder’s strong eyes rather than on Alibaba’s business model. Masa Son was eager to repeat that success, and Neumann found a way to offer Masa Son something to meet that need.
JP Morgan’s CEO Jamie Dimon was eager to compete with investment bank leader Morgan Stanley, in respect to IPO underwriting. Neumann found a way to offer Dimon an opportunity to meet that need. JP Morgan also invested heavily in WeWork.
“Motivated reasoning” is a behavioral concept whereby people with an interest in a situation being true overemphasize information that supports the position and downplay or ignore information that runs counter to the situation being true.
There is good reason to suspect that the CEOs of both Softbank and JP Morgan exhibited motivated reasoning in respect to WeWork. They did so when they allowed themselves to be persuaded by Adam Neumann’s charisma, and failed to look closely at WeWork’s business model when they committed investment dollars. For that matter, they also overlooked the degree to which Neumann used unorthodox measures to transfer wealth from WeWork to himself. Apparently, it did not occur to them that someone who professed to want to be the world’s first trillionaire might do so at investors’ expense.
Unlike Son and Dimon, the financial analysts reviewing WeWork’s S-1, were not subject to motivated reasoning. They focused on WeWork’s financials and did not overlook Neumann’s self-dealing behavior.
WeWork had many happy customers and employees who are now dealing with significant adjustment costs. Time will tell if Softbank is able to salvage the residual value in what remains of WeWork’s assets.