As someone who studied business and economics in College, I encountered game theory in multiple classes. In particular, the prisoner’s dilemma was something we studied in at least three classes. Being the student that I was, I learned what the theory was and moved on.
Fast forward eleven years, I finally experienced this theory in a very real and unfortunate way. It wasn’t that I committed a crime, but rather a more general case of the phenomenon. From wikipedia:
In game theory, the Nash equilibrium is a solution concept of a non-cooperative game involving two or more players, in which each player is assumed to know the equilibrium strategies of the other players, and no player has anything to gain by changing only his own strategy unilaterally.
I previously worked at a financial services institution where I was growing restless. A colleague of mine, whom I respected very much, was in the same boat. Let’s call him Jim. Jim and I often talked about starting our own company to escape the BS and realize our full potential.
Then there was another one of our colleagues, whom I’ll refer to as TDB. I had referred TDB to my company because a good friend of mine had asked to as a favor. He didn’t have the right experience to be hired at this institution, but through my goodwill, he was hired. TDB never hesitated to cash in on my goodwill and often presented himself as a good friend of mine when the reality is that he is a friend of a friend. At the time, I didn’t mind, I had no reason to.
As Jim and I increasingly talked about our plans, TDB would tag along in these conversations and interject himself in our endeavor. I knew that I didn’t know TDB enough to want to go into business with him. That and as I got to know him more, he exposed himself more and more as a person with questionable character. At the same time, he was seemingly intelligent, and maybe his help wouldn’t be all that bad. TDB did his best to befriend Jim. Jim thought I was good friends with TDB as TDB always presented our relationship that way, so Jim gave TDB the benefit of doubt. The more I saw Jim with TDB, the more I thought Jim saw good qualities in TDB.
Through mutual respect between Jim and me, a positive feedback loop was created. The more I saw Jim and TDB in good repport, the more I trusted TDB. The more Jim saw TDB and I get along, the more he trusted TDB. In the way which animal spirits create disastrous financial bubbles, TDB gained a lot of superficial respect from Jim and me by this positive feedback loop.
Fast forward another year or so, we’re co-founders of a startup. It’s a story I will tell later, but the cliff note version is that TDB single-handedly destroyed the startup twice. The first was salvageable, but the second was not.
Back to theory. Jim and I were essentially playing the prisoner’s dilemma game. We both unilaterally decided that TDB was fit to be our co-founder. If we had collaborated more and conversed frankly about what we thought of TDB, he wouldn’t have been part of the picture. If we had been able to speak without risk of potentially offending each other, we would have ended up at the best possible square of the game, without TDB.
It’s not everyday that I see economic theory applied to the real world. Economic models are often an over-simplification of the real world that it just doesn’t apply. In this case though, the gist of the Nash Equilibrium was demonstrated in a terrible way.
The most important thing I learned from this failed startup experience is to pay a lot of attention to the dynamics of the situation. In finance, valuation of derivatives is all about understanding the stochastic factors underlying the security and figuring out the expected value of the derivative given those stochastic factors. If the dynamics my startup were more fully understood, it would have been easy to see that destruction was the most likely outcome.
Yes, hindsight is 20/20, but that’s what I’m working with. Til next time.
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