The Winner’s Curse: Why Smart People Lose Their Way | Alex Imas – EP 716

26:09And every time we actually win a bid on an oil well, we end up having less oil in there than we thought we did. And we keep losing money. What's going on? And they published these papers in trade journals, calling it the winner's curse by basically saying, look, something is wrong. Every single time we end up winning, we end up actually losing. What's going on? And folks like Richard Thaler, Max Bazerman, and other people delved into it and started to understand the psychology behind the phenomenon. Yeah, man, it's so interesting. I spent the early part of my career working as a practice leader at Arthur Anderson.

26:43I was in the Houston market and I still remember sitting in this room at ExxonMobil with hundreds of executives across the industry, hearing an economist come and talk to us saying that we had reached the peak of big oil. And from this point in history going forward, there was going to be a demise every single year. Boy, was he wrong with the evolution of how we do fracking and other things. What science finds a way. Yes, exactly. But it reminds me of markets and how modern markets change, which is something that you guys covered in the book. And you did it through social contagion and the persistence of overconfidence in modern markets by examining Reddit and Robinhood.

27:33And I was hoping you could give the audience a little bit bigger take of what I'm talking about here. With Robinhood and the proliferation of these online communities, essentially, so this has a bit more to do with the stock market. and these like meme stock phenomenon. There's obviously many more implications, but the meme stock phenomenon is a great example. We've had bubbles in the past. And in the past, then going back to the 1600s, we've had bubbles. And it's this idea that people over, there's this herd mentality where people think like, yeah, maybe this is overvalued, but everybody else is bidding on it.

28:14If I don't bid on it, I'm gonna miss out on all this money to be made. So I'm gonna bid on it too. And the price goes through the roof. And then one day somebody wakes up and says, hey, this is a bubble, I'm getting out. And this starts that whole downstream cycle where everybody ends up losing money except for that one person who got out in time. And this idea behind bubbles is now, again, supercharged when you have these digital spaces like the combination between Reddit, for example, and Robinhood. What does that combination look like in practice? The GameStop situation is a very nice example because it allows people to coordinate their decisions in a fundamentally different way.

28:53They can say in the wall, there's a subreddit called WallStreetBets. What WallStreetBets allows people to do is to say, look, we're going to all hold on to this. And actually, they have their own language to talk about the fact that everybody is going to be holding on to these sorts of stocks. So they buy the stocks. And without Reddit, you don't really know who else is going to sell because nobody's coordinating. Everybody's sitting independently in their house. With Reddit, you have the ability for people to coordinate to say like diamond hands. What that means is that everybody's committing on holding.

29:27And what that means is that bubble can go on for a much longer time than what we've seen before. Because what we've seen before is these things like are bubbling up and they've explode, bubbling up and explode. With GameStop, you look at the price now and it's actually, it hasn't crashed. It went down certainly from the peak, but it's still up there because people are coordinating to hold their shares saying, look, we're going to keep this going. And the ability for people to coordinate on buying these things very easily through Robinhood and the combination of being able to publicly coordinate and communicate on these forums has led to a very different financial market for retail traders than say what we had even 10 years ago.

30:10Yeah, that was just shocking when that happened a few years ago to see how a community platform like that drove such a huge market change. It was fascinating and scary at the same time. I'm not sure your thoughts about it, but I still remember that and just being in complete awe about what happened. There's two different models of financial markets out there. There's a model of kind of efficient markets where the price of a stock is the discounted future cash flow of that company. That's the standard rational model. The people are saying like, look, this is the price that this stock is worth because that's how much it's going to be paying out through dividends and all sorts of other things to me.

30:55And that's how much I'm willing to pay for it. This is the fully rational model. The other one is by John Maynard Keynes, who was this giant economist in the 20s and 30s. And he called the stock market a beauty contest. What's the, what does he mean by that? Back in the day, you had these newspaper contests where there was a whole page of different faces. Let's say usually was women's faces. And the winner of the contest was the one who picked the face that everybody else picked. So not the one he preferred, the one that everybody else picked. So this gets into this idea of theory of mind, where my decisions are based on what I think everybody else is thinking.

31:40And that's a fundamentally different model of the stock market, where now I don't care how much cash flow GameStop has. I don't care how much cash flow AMC has. I am buying GameStop because I think other people are going to buy GameStop, and that's it. And that, and therefore, because of that, the odd, these online forums have this huge power of coordinating this behavior because now I can say, look, I know that GameStop is going to pop because a lot of people are saying GameStop is going to pop. And now you have AMC and Kohl's and all of these other different completely random companies popping just because of this phenomenon.

32:18Yeah, man, it is so interesting. Yeah. Well, I wanted to ask you about some of the classics, and I thought we could start with loss aversion. We've long believed loss is hurt about twice as much as equivalent gains please us. Does this still hold true in the hyper-stimulated digital environment, or are attention and emotion, do you find changing that ratio? That's a great question. We don't have a lot of data on this, first of all. So you're thinking, like, what is the loss of version on crypto or something like that? Right, exactly. Or like just a completely digital asset. I don't think anybody I know has collected data on this, but this is quite an interesting question.

33:00What are the implications of behavioral economics when you have physical goods, such as a house, a mug, other sorts of products? What are the implications of behavioral economics in that space for a world where a lot of stuff is just going to be digital, completely isn't going to have a physical presence in the world. If I was to hypothesize and based on some of my own data where I've run endowment effect experiments with digital art, and essentially I found that things are largely unchanged. If I tell you that you are the owner of an art piece versus I ask you, how much are you willing to pay for that art piece.

33:45Your valuations change just from me telling you you own it, the minimum that you'd now be willing to accept a part with it increases by two and a half times relative to five seconds ago before I told you that. And this is like the, for your audience, this is the NFTs, non-fungible tokens, which are now used to allow digital creators to have some ownership over their art. So the endowment effect doesn't seem to really weaken when you go into the digital space, at least in that sense. Okay. Well, another one I wanted to go into was the fairness anchoring effect. And so I guess the way I want to frame this is fairness and norms.

34:27So there are a lot of modern pricing debates that people get into about rejecting deals that we see online and feeling that they're unfair, even when they cost us money. etc. What does this say about the role of fairness in sustaining social trust? In my view, fairness and norms are key for sustaining cooperation. In many experiments is the fact that if you have a game, so it helps to go through an example of this sort of game. So the public goods game is a really nice way of studying these things. What it means is that let's say me and you and maybe two or three other people are playing this game.

35:10And the game is fairly simple. Me and you have an amount that we're given. So like that's an endowment that let's say it's two bucks. Each of us has two bucks. And then we decide how much of the two bucks to contribute to the quote unquote public good. Whatever we contribute gets added up, multiplied by some amount, and then divided evenly between all of us. What that means is that even those who didn't contribute anything would still get a piece of the public good. What does that mean for economic? What does economic theory say about this? Well, if I get something without contributing anything, guess what I'm going to do?

35:47I'm going to contribute nothing. And then guess what happens? Nobody contributes anything. So the economic theory is a very strict prediction of what happens in public goods games. What actually happens in reality? Well, people contribute something. They contribute 20, 30, 40 % of their endowment, especially in the first period. They contribute something, gets divided, everybody gets something. But as the game continues, especially in the very final round, those contributions go to zero. In the final round, people think, well, everybody else is contributing something. You know what? What if I just don't contribute anything and I'll still get paid?

36:23Guess what? Everybody else is thinking the same thing, and then nobody contributes and nobody gets anything other than their endowment. So basically, the overall pie shrinks as the game progresses. So the real innovation happened in 1999-2000 with Ernst Faire and Simon Gochter. Ran a game of the public goods game, but they introduced one little extra thing, which has to do with fairness and norms. What they did is that after every single round of the public goods game, everybody has the opportunity to spend a little bit of their own money to take away a larger amount from somebody else. what does this actually mean in practice?

37:03It allows people to punish those who don't contribute. If people feel like, whoa, this was unfair, I contributed something, but you didn't, I can now punish you, hurt you at a cost to myself. Again, economic theory, very simple prediction. Why the H-E-L-L would I spend money to punish somebody else? I wouldn't. So the economic theory predicts no contributions, no punishment. What ended up happening in this game, people felt like non-contributors were acting unfairly, and they were more than willing to punish them. And what did that do to the game? It meant that people who were thinking, maybe I won't contribute, now they got worried about getting punished, so they contributed.

37:48So contributions went up almost all the way. And not only did they go up in the beginning, they stayed high through the entire game, even in the last round, because even in the last round, if I don't contribute, I'm still going to get punished. So I'm going to contribute. So adding this element of fairness, of punishing norms, allowed cooperation to flourish in this setting. Without the ability to punish people who violate norms, cooperation just completely went to crap and was, by the final round, there was none of it left. Well, and now I wanted to talk about one of the things that Richard Thaler is most famous for, which is his work on nudges, which he did with Cass Sunstein, who has been on this program.

38:36And what I wanted to revisit this in its ethical dimension, and you've been discussing a little bit about this in the past couple of answers, but we started this episode talking about choice and the research that you've done around how to make better choices. But there's this tension between helping people to make better choices versus manipulating their autonomy. And so you've explored this dual use quality of throughout the book. And what did you find that's most meaningful about the research? So the whole nudge program was started by a paper called libertarian paternalism. And the idea there was to say, look, standard economics defines a choice set in a particular way.

39:29And behavioral economics says that choices can change without affecting people's ability to make decisions. So what does that mean? So let's go to the 401k example. So So the 401k example, the classic opt-in, opt-out study. So before Bridget, Madrian, and Shea had this landmark study in the late 1990s, essentially what did that look like? People chose to opt-in into a retirement plan, and most people didn't. What they did instead is to say, hey, instead of people choosing to opt-in, let's make the default that they are in the plan, and if they want to, they can opt-out. So all it is that instead of checking the top thing, the bottom thing is checked.

40:12For standard economists, it doesn't matter, right? It's the choice that is exactly the same. I'm deciding whether I opt in or opt out. Turned out this raised opt in rates to the roof. Many more people ended up being enrolled. Right. So this is the behavioral economics part. This is a classic nudge. You don't change the actual choice environment. People are free to make the same decisions as before, but they're making different decisions because you're introducing this seemingly irrelevant factor, which is what Richard calls it, into the mix, what people are defaulted in. The ethicality behind it depends on who you ask, frankly.

40:50When you're getting into ethics, this is a normative field. So different people have different opinions. Now you're in the world, you're not in the data world, you're in the opinion world. Right. And there's a group of people who view nudges as perfectly ethical. Other people disagree with that statement. They think that your behavioral economics should be part of the coercion. People can have disagreements about this. I think with something as important as retirement savings, you have to start thinking about the costs and benefits to people when they're reaching retirement. Then they're thinking, wow, I forgot to opt in into my 401k plan.

41:27I really wish I did. If only somebody had nudged me to contribute to my 401k, I would have ended up with more money for my retirement. In other cases, in the case of organ donations or something like that, Richard and Cass have work in this space saying, look, we should give people full autonomy and nudges don't really belong in that space. So it really depends on the context and it depends on the argument. Yeah. I also wanted, since we're on this topic, to explore Amazon and Amazon Prime sales, because I understand Amazon uses nudges as well as anyone does. How should a listener think about this when it comes to the psychological triggers that happen when Amazon is doing a Prime Day?

42:15Yeah. So I think we talked about this in the beginning of the conversation. Companies have been doing these behavioral science, behavioral economic experiments since they started. So Amazon is literally doing thousands of VB tests on how a prime day advertisement, how it should look, where it should look, to who it should. And then you have different versions and those different versions are given to different people depending on their buying habits. The optimization of behavioral science in order to get people to purchase is just, it's done to a very, very huge extent by these companies. Now, I haven't looked at specific things that particularly Amazon has done, but certainly there's research in behavioral science showing that something like making shipping free, for example, or doing expedited shipping for a lower amount on a specific day really gets people to purchase because they're thinking, wow, their loss aversion is getting activated there that they feel like they're going to be losing less money.

43:16This is something that they really want. They want this thing faster. This is the whole self-control, myopia thing being taken advantage of. Now I get to have this thing, which maybe I don't need at all, but hey, I get it faster. I'm going to buy it. That's to say that they're doing a lot of different things all at the same time. And they're making these cocktails of behavioral science in order to get people to purchase. Firms have been doing this since the beginning of capitalism. It's just now it's on a completely different scale. We've talked about the digital world a few times now. I want to think about digital biases, specifically digital biases from a standpoint of authoring, and I think of Substack.

43:56And I think in general, I'm finding that people are under-reporting their use of AI tools because of something you explore in the book, which is the social desirability bias. But to me, if someone asks you if you're using AI to help with your writing and someone answers no, it's almost unbelievable to me. Because if you're using a Google search or literally any technology that's out there, all of it is underpinned by different AI frameworks. So arbitrarily, you are using it in almost any research that you're doing. But what do you think it reveals about how humans perceive technology's role in their competence or their creativity?

44:42I think so. I have a paper about this on AI and social desirability bias. So we run a study at the large university asking students about their AI use. And when you ask them, how much do you use AI ever? Right? The answer is like 63%. And you might think, wow, that's low. Most students, I think, are using AI. And it turns out if you ask a slightly different question, and this is using techniques from psychology in order to overcome social desirability bias, you ask not whether you use AI, you ask whether your friends use AI. Now, social desirability bias isn't really affected because it's not me.

45:23You're asking about my friends and that number is 95%. So that gap between 95 % and 60 something percent, that is the gap that people are misreporting their AII use. essentially. And we've collected other data to confirm that the gap, that it's underreporting versus overreporting in one condition versus the other. So this is something that's going to be a challenge for companies, for policymakers, especially for educators. So this is a space that I'm very interested in from both a personal perspective, I'm a teacher, but also from a policy perspective in terms of like, how do we think about university or higher ed in the age of AI?

46:07Obviously, we can't say never use AI, become a luddite. But also we want people to use AI in a way that helps them to learn something. So they retain some information, but they also learn how to use these tools in an effective way that's going to help them when they exit the university. And that kind of cause benefit is something that that conversation is happening right now, but it needs to happen faster. Yeah. I can't remember if I was talking to Bobby Parmar or Judd Kessler, but one of them was telling me in their class that I've understood that the papers that they're getting back are progressively getting better and better because it's obvious students are using AI to help them write them.

46:48But what I wish I remembered which one told me this, but what they were doing in their class was taking it to another level. So they were making them come in front of the class to show the application of what they researched to make sure that they were retaining what they were writing about. And they were telling me that it really showed a huge difference between who was actually retaining and using the information versus who was just using the AI tools. Because I find myself, when I'm using them a lot, I'm not retaining as much about the work that I'm doing as compared to when I'm doing a whole bunch of research and then having to write it on my own.

47:31There's great research about this. Shiri Malamud, who's Judd's colleague at Wharton, shows that if you do research through AI versus just Googling it, so you have access to Google, which also uses AI, but in a different way, versus LLMs to help you research a topic, you just simply retain more information, even though you're reading the same information. When you search for it yourself and parse through it, the way that our brain works is to retain the information between the pauses. So like when you're reading a book versus you get the spark notes from a book, right? Why did we discourage spark notes like in 30 years ago, 20 years ago when I was in school?

48:08The information is the same, but the process of reading the book, the text and pausing, flipping back and forth, all of that is part of learning, but it's discounted because it doesn't seem like that's not where the information is. And that process is really, we need to be very explicit about what actual learning looks like in order for the broader population to understand that AI is an incredible technology. But reading Winner's Curse by saying, what is in the Winner's Curse, give me a two-paragraph summary, versus actually reading the book, you're going to retain something very different. Yeah, absolutely.

48:49Well, Alex, if listeners could take two or three practical tools from this conversation to improve their own decision making, where would you tell them to start? Don't succumb to the sunk cost fallacy. So the sunk cost fallacy is this idea that I've already done something. I've already gone down this path. I might as well keep going, even though it's looking like a bad decision. Don't succumb to that sunk cost fallacy. always take a moment, think, is the next step? If I hadn't gone into this decision to begin with, if I hadn't paid money to invest in the stock, if I hadn't taken that one class in that topic, would I still do that next thing?

49:29If the answer is no, stop, do something else. Just this is one of the most important things that behavioral science has taught us. I think the first thing that I said, don't worry about things that have very low probabilities of happening. Don't argue about those things. I think that's a very good lesson too. I use it all the time in my own life. And the other thing that I've done research on and that's in the book is take time to deliberate. Fast decisions are not necessarily good decisions. So system two thinking. System two thinking. And people know this, but it doesn't work into their everyday lives.

50:09So a lot of states have cooling off periods before they can get a divorce. There's a reason for that. There's cooling off reasons before you can purchase a firearm in many states. There's a reason for that. The reason is that we know that decisions are better if we think harder, we cool off, the emotions wear off, and we can consider all of the options. And it's actually very easy to incorporate that lesson into your everyday life in terms of stopping and thinking while you're making important or semi-important decisions. Alex, I always love to ask this question. What does it mean to you to live a passion-struck life?

50:47I think I'm extremely lucky to be doing what I'm doing because I've stumbled into a field where I feel passion-struck and just passionate every single day, literally every single day, because there's just so much out there to explore and to learn about. And for me, living a passion struck life is to keep my mind open, to read, to say yes all the time instead of saying no. If I don't think I have time to do something and it sounds new and potentially exciting, just make the time and do it. That's really... And taking risks has led me to be quite interested and excited and passionate in my everyday life in terms of what I do every single day for work, as well as for fun.

51:41And lastly, Alex, where's the best place listeners can learn more about you? I'm active on X or Twitter, however you want to call it. So I have Alex Cmos on that platform. And my website is AlexCmos.com. And if you guys want to check out the book, it's got a very active website, winnerscurse.org. It's got a lot of these materials. It's got slides to take these sorts of concepts and break it down. It's got replication materials for the experiments if you want to run them, learn how to run them by yourself. So that's another place. Well, Alex, it was such an honor to have you. Thank you for joining us on PassionStrike.

52:19Thank you so much, John. Thank you. That brings a close to today's conversation with Alex Emis, which stayed with me the most is how quietly the winner's curse operates, not just in markets or negotiations, but in lives shaped by escalation comparison in environments that reward winning without revealing cost. Alex showed us that good decision-making isn't about intelligence or restraint. It's about clearly seeing inside the systems we're operating in. Meaning isn't about accumulating wins. It's about choosing what can be sustained without distortion. And that brings us to what's next in the Meaning Makers series.

52:51In my upcoming episode next week, I'm joined by Shanna Pearson, where we'll explore how meaning is cultivated not through optimization or acceleration, but through presence, embodiment, and the discipline of slowing down. If Alex helped us see the hidden cost of winning, Shanna will help us explore what it looks like to live from alignment rather than escalation. It bothers me when people refer to ADHD as a superpower. It really does because there's nothing about ADHD that makes life easier. and it's difficult to manage adhe on so many levels like in your relationships career personal health name it and so when people are like oh this is superpower you should be able to do like all of these things so much you've got this and you don't and you know that life is really hard and you know that you're struggling and you know you're working a hundred times harder than every single human and longer than anyone there's no superpower and so then you just feel like there's something else is wrong with you because you can't even use your superpower.

53:51You don't even know where it is. Like where's the superpower part of this? Before you move on with your date, I'd invite you to pause and ask where in my life might momentum be substituting for discernment? If you want support applying these ideas, you can join me inside my sub stack at the ignitedlife.net, where each episode in the series is paired with reflection tools designed to help you integrate insight into how you actually live. As we continue the meaning makers, remember, significance isn't built by winning at all costs. It's built by choosing what truly holds. I'm John Miles. You've been PassionStruck.

54:23Until next time.