C&B Notes

How “Ownership” Can Impact Valuation

We have previously written about commitment bias, and this piece from Sam McNerney highlights a natural tendency to like something better when you own it.  The application to buying and holding stocks is obvious, and it highlights why — even though it may sound odd — we try to systematically think of all the reasons we should not like the companies we own.

In the late 1970s economist Richard Thaler considered two scenarios.  In the first, a man owns a case of good wine he bought in the late 1950s for $5 a bottle.  When a wine merchant offers to buy his wine for $100 a bottle the man refuses, even though he never paid more than $35 for a bottle of wine in his life.   In the second scenario, a man who mows his own lawn receives an offer from his neighbor’s son to mow his lawn for $8.  The man refuses, even though he wouldn’t mow his neighbor’s same-sized lawn for less than $20.

Why the inconsistencies?  Both scenarios highlight what Thaler termed the “endowment effect,” and it explains our irrational tendency to overvalue something just because we own it.  Or, as Thaler puts it, “goods [that] are included in the individual’s endowment will be more highly valued than those not held in the endowment, ceteris paribus.”

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The takeaway is obvious enough.  We humans are not perfect calculators.  Instead, we overvalue our possessions because they contribute to our identity and the identities of the groups we belong to.  We don’t overvalue goods because we’re loss averse; we overvalue goods because they are part of who we are.