By Dominique Jacquet

We owe it to John Von Neumann and Oskar Morgenstern to start a spectacular intellectual adventure, Game Theory.

This revolutionary approach to decision-making was initiated at a time when a more or less global economic and monetary order, Bretton Woods, was being formed.

Roughed up by Nixon in the early 70s, this order is in danger of disappearing because of the trade war we are seeing today.

The creators of the theory distinguished cooperative games from non-cooperative games.

In the former, the players can consult each other before the decision is made and establish a cooperative operation for the best of their relationship.

Non-cooperative play focuses on the decision of an individual actor who wishes to maximize his utility function based on what he or she knows or does not know about the predictable reaction of the “adversary”. The best known (and studied) example is the prisoner’s dilemma, which shows that, in the absence of cooperation, betrayal of the partner is the only “rational” (and dominant) strategy. On the other hand, if the two accomplices decided in a cooperative context, they would generate a better outcome.

Without generalizing this result, it seems intuitive that cooperation makes it possible to consider outcomes with higher utility than those suggested by strictly individual choice.

Since its creation, Game Theory has flourished in the non-cooperative world with some remarkable intellectual successes such as Schelling’s demonstration that nuclear deterrence is only effective in cases where the intensity of retaliation is unknown… The deepening of the benefit of cooperation has lagged behind, perhaps because it is more difficult to model or more distant from the individual-centered versus the collective cultural context.

The Agency Theory, which is based on the conflict between managers who only seek their personal interest and shareholders who wish to control them, is strongly inspired by the non-cooperative game.

The accounting treatment of stock-based compensation (SBC) as operating expenses (and not as investment), while this process aligns the interests of key employees and shareholders, clearly shows the desire to validate this conflict between capital markets and companies. However, these two worlds feed off each other, the former being in search of the best project to finance, the latter needing liquidity to finance their industrial ambitions.

The “investor relations” profession, born of the deregulation of the 80s and the need to supplement the information provided by external auditors, rating agencies and financial analysts, has made it possible to strengthen the cooperative link between firms and investors.

Academics, such as Axelrod, had shown that cooperation can be built from a kind of “repetitive non-cooperation” with the concept of give and take and the maximization of individual utility associated with it.

The disappearance of the little cooperation that still existed will result in an increase in the perceived risk and control costs between the different actors. All this contributes to a destruction of value that can be clearly seen in the words of economists: marked concern about future growth.

However, the equity market risk premium that we use in finance to calculate the cost of capital is based on the (future) difference between the “equity” profitability and the interest rate of the risk-free asset. Companies in the market grow faster and create more value for their customers, but they need capital, which justifies their listing. A reduction in the growth outlook, and therefore in the profitability of the equity market, combined with a possible increase in rates caused by uncertainty can result in a reduction in the equity market risk premium: the risk will be less remunerated in the future than it was in the past. One could deduce that the cost of financing the company will be reduced, which would be good news. But, unfortunately, the economic outlook for their investments will decline, leading to a reduction in value creation. But who benefits from this value creation? Among others, all people who invest part of their remuneration on a day-to-day basis in order to build up retirement capital.

The loss of cooperation therefore leads us, in a “mechanistic” way, to a destruction of value at a time when the collective approach is not only useful for economic actors, but necessary to optimize the planet’s resources.

Well done…!