Hello and welcome you are listening to Patrick Boyle on
Finance, a podcast exploring ideas from quantitative finance,
examining events occurring in markets right now and financial
history to see what lessons can be taken away, including
interviews with some of the most interesting people in the world
of finance. To learn more about the podcast,
visit on finance.org. Sam Altman, the CEO of Open AI,
told the Wall Street Journal last year that AI means that a
lot of people are going to lose their jobs.
So he was probably not awfully surprised to lose his job as the
CEO of Open AI last week. There was probably no one better
prepared for such an outcome. I imagine that he kept his
personal items in a little box next to his desk at work so that
nothing would be accidentally left behind in the office when
he eventually got the call from HR, and that he immediately fled
to his bunker in New Zealand, probably expecting all of the
other Silicon Valley CEOs to be waiting there to greet him.
It turns out that all of the drama ad Open AI was a storm in
a teapot. Yesterday morning, we learned
that in a dramatic reversal, Altman will be reinstated under
the supervision of a new board that contains only one member
from the prior board and Open AI's largest investor.
Microsoft is expected to have a larger voice in Open AI's
governance going forward. A lot of the goings on at Open
AI relate to its strange corporate structure, which
relate to how it was initially funded.
There are lessons that can be drawn from the chaos at Open AI
that apply to the recent trends we've seen towards stakeholder
capitalism. Open AI was founded in 2015 by a
group of high profile entrepreneurs and researchers.
Among them were Sam Altman, Reed Hoffman, Elon Musk, Peter Thiel,
Amazon Web Services, and a few others.
Its stated mission was to advance artificial intelligence
in a way that would benefit society as a whole,
unconstrained by a need to generate a financial return.
They announced that they would freely collaborate with other
institutions and researchers by making their patents and
research open to the public. The founders pledged over $1
billion to the venture, but actually only contributed around
$130 million, the majority of which came from Elon Musk.
Open AI was able to hire some of the top researchers in the space
early on, despite paying a lot less than Facebook and Google,
partially because researchers said that they were excited by
the opportunity of working with some of the top people in the
field and. Because they believed in the
mission of the company. After three years, Elon Musk
left his board seat claiming a conflict of interest with Teslas
AI R&D endeavors relating to autonomous driving.
Insiders say that Musk pitched that he should be running the
company. And when Altman and Open AI's
other founders rejected this proposal, Musk walked away,
reneging on a massive plant donation, which left a nonprofit
with no ability to pay the astronomical fees associated
with training AI models on supercomputers.
Unable to balance its research goals with its budget
constraints, Open AI made the announcement of creating Open, a
ILPA, separate legal entity that operates as a capped profit
corporation in 2019, the profits being capped at 100 times any
investment. The company explained this
decision saying we need to invest billions of dollars in
the coming years into large scale cloud compute, attracting
and retaining talented people, and building AI supercomputers.
This transition from nonprofit to for profit required Open AI
to balance its desire to make money with its stated commitment
to ethical AI development. They said that the cap on
profits was there to prevent investors from being enticed to
try and grab limitless wealth by deploying software that could be
very harmful. I'll let you decide whether that
was a real concern they had or a good way of marketing and
investment in the firm. This unconventional structure
meant that Open AI had a board of directors, which in theory
controls the entire corporate structure, which includes the
charity and the capped profit company, but which, unlike other
boards, is not accountable to shareholders.
The directors are in fact not allowed to own any stock to
prevent a conflict of interest because they are specifically
not supposed to be aligned with shareholders.
The nonprofit's principal beneficiary is humanity, not
open AI investors, according to their website.
Which may mean that they are accountable to everyone,
including you. Or it may mean that they're
accountable to no one, the company's operating agreement to
investors says in writing. It would be wise to view any
investment in Open AI in the spirit of a donation, with the
understanding that it may be difficult to know what role
money will play in a post AGI world.
Documents like this that were written by an actual lawyer
highlight the problems that we're starting to see from the
combined popularity of science fiction in Silicon Valley and
widespread micro dosing of hallucinogens.
OK, so while the Open AI investor documents write about
the unknowable role that money will play in a post AGI world,
we haven't gotten there yet. And in the real world, where the
role of money is reasonably well defined, Open AI is an
unprofitable company and is expected to need to raise a lot
more money over time from investors like Microsoft to keep
up with the high costs of building more.
Sophisticated chat bots. Despite this lack of
profitability, the company is valued by investors at $86
billion, and Bloomberg reported last weekend that some investors
were considering writing down the entire value of their Open
AI Holdings 20. $86 billion of value evaporated in a weekend,
and the reason given by the board was that Altman had not
been consistently candid with them.
With billions of dollars in jeopardy, some investors started
exploring legal action. But the problem with that is
that it's not clear how to sue a board whose legal duty was to
the safety of humanity, not to investors.
Microsoft may have been willing to sign the wacky documents like
they did and pretend that the board, which answers only to
humanity, were in charge. But because Open AI requires
investors to write large checks to fund the ongoing losses at
the company, Microsoft were easily able to exert control,
which is what they did. They pushed for Altman to be
reinstated while also offering him a role at Microsoft.
Altman quickly confirmed that he and Greg Brockman, another Co
founder who left on Friday, would join Microsoft.
Open a is key partner. Former colleagues would have an
open door to follow and join a new AI unit, according to
Microsoft chief Satya Nadella. As much of A win as this might
have appeared for Microsoft, people were saying that they had
managed to buy the hottest AI firm for zero.
This might not have been the optimal outcome for them, as
they would likely have had to deal with antitrust regulators
and lawsuits from other Open AI investors.
Now the board doesn't answer to the staff at Open AI either.
Other than that, the staff make up some of humanity.
But the staff do all of the work while the board attend
occasional meetings where they worry about the future of
humanity. Not a lot would be going on at
Open AI without employees. The majority of Open AI 700 or
so employees signed an open letter to the board demanding
that the board resign and that they rehire Altman.
The letter stated that the board had told the employee leadership
team. That allowing the company to be
destroyed would be consistent with the mission.
The employees said that unless their demands were met, they
would resign from Open AI and join the new subsidiary of
Microsoft being headed up by Altman and Brockman.
As a side note to all of this, you have to wonder what the
employee contracts at Open AI look like that the entire staff
could leave to work for a major investor in the company.
Leaving Open AI as an empty shell, typically, executives
like Altman would have contracts that prevent them from hiring
key staff once they're no longer at the firm, and staff would
have signed Ndas, preventing them from taking any technology
with them. The press are reporting that
this mass revolt by open AI staff was the primary reason for
the boards about face. So while the board on paper only
reports to humanity, investors and employees won out.
The Open AI story is a bit of a crazy one, where Microsoft and a
number of other sophisticated investors agreed to put billions
of dollars in and employees got stock grants all at an $86
billion valuation without the contractual or fiduciary rights
that investors might normally expect.
Open AI is not the only company with this type of structure
either. Anthropic, A rival company
started by a group of former Open AI employees, has set
itself up as a public benefit corporation, a legal structure
that is meant to insulate it from market pressures.
The Open AI case highlights a trend that we've seen in recent
years in favour of unusual corporate governance.
I wrote about this issue in my corporate finance textbook as
while there's been a general move towards better and better
corporate governance over time, bad corporate governance has
been a growing issue, particularly in Silicon Valley,
where companies like Google, Facebook, and Snap structured
their IPOs such that founders were left with unchallenged
power to do almost anything that they want.
At these firms, founders were given special shares with
special voting powers, meaning that they don't have to listen
to investors whatsoever. Investors looked at these
companies and felt that the founder CEO had such a great
track record that there was little consequence to having
poor corporate governance. Berkshire Hathaway, Warren
Buffett's company has a similar unusual structure where the A
shares get more votes than the B shares do.
The different voting rights were allegedly put in place so the
company and its leadership would not be beholden to investors
seeking short term profit. This structure at Berkshire
Hathaway has kept Warren Buffett in firm control, even as he has
given away more and more of his shares to charity.
The A shares can be converted to B shares, but B shares can't be
converted to A shares. Starting in 2006, Warren Buffett
began giving away large amounts of Berkshire Hathaway stock to
charities. But prior to donating them, he
converts his A shares to B shares.
Since Class B shares have diminished voting rights, this
has the effect of preserving his voting control, even as his
percentage ownership of Berkshire declined over the
years. While investors might feel that
there's little consequence to having poor corporate
governance, this could be short sighted since you're buying
shares of companies in perpetuity.
Leaders who might be doing a great job today but are not
accountable to shareholders can take value destructive paths in
the future without answering to anyone.
Meta's Reality Labs division, which houses its efforts to
build the Metaverse, has lost around $46.5 billion since 2019.
Would Mark Zuckerberg have been able to waste this much money if
he was accountable to investors? Under a normal corporate
governance structure, there's a good chance that he would have
been pushed out by shareholders a few years ago.
As the losses were mounting, there have been numerous studies
on the relationship between corporate governance and
investment performance. Gompers ET al.
Found that companies with stronger shareholder rights have
higher profits and trade at higher multiples than companies
would weak governance. A few years ago, the Business
Roundtable and Nonprofit Lobbyist Association, whose
members are CEOs of major U.S. companies, put out a press
release saying that corporations should be run to protect all
corporate stakeholders, defined to include customers, society
and employees, rather than following the conventional
objective of maximizing shareholder wealth.
This is what's become known as stakeholder capitalism.
Critics of shareholder wealth maximization celebrated this
announcement as an acceptance of their long term belief that
focusing on shareholder wealth had brought about income
inequality, the outsourcing of manufacturing jobs, and other
societal costs and externalities.
Traditionalists viewed this announcement as foolish and
caving into the woke mob. Cynics argued that it meant
nothing was just PR, and that everything would continue on as
normal. Now, to most people, these
arguments might appear to not matter whatsoever, but they do
matter because the various stakeholders in a company have
very different interests. Actions that benefit one
stakeholder group can be reasonably expected to make
other stakeholder groups worse off.
These conflicts of interest mean that a board that is supposed to
represent everyone often represents no one other than
themselves and their own specific objectives.
As what the motor And wrote a great blog piece on this topic a
few years ago. He looked at the different
models of corporatism. Cutthroat corporatism, where the
end game is stockholder wealth maximization at almost any cost.
Crony corporatism, where companies focus less on
efficient operations than on connections to government, with
the objective being tilting the scales of competition in the
companies favor. Managerial corporatism Where the
interests of executives Dr. the direction of a company and.
Investors and other stakeholders are ignored and finally
constrained corporatism where companies preserve the primacy
of shareholders while constraining how they interact
with other stakeholder groups. Constrained corporatism is what
we mostly see where companies are restricted in their actions
by the legal and regulatory constraints, self-imposed
constraints and market driven constraints.
The motor and describes stakeholder capitalism as
confused corporatism, which on the surface might look like
constrained capitalism, but due to the multiple objectives with
no clear ranking of importance, leaves you with a structure
which is destined to fail. The events at Open AI over the
last week really highlight this issue.
Open A is new board will consist of three people, at least
initially, Adam D'Angelo, the chief executive of Quora and the
only holdover from the old board, Brett Taylor, a former
executive at Facebook and Salesforce, and Larry Summers,
the former Treasury Secretary. The board is expected to grow
from there. Open AIS largest investor
Microsoft is also expected to have a larger voice in open AIS
governance going forward, and this may include a board seat.
If we want companies to behave better in their interactions
with society. Putting boards in place that are
not accountable to anyone other than a vague concept of the
greater good is probably not the best approach.
The Volkswagen emissions scandal from 2015 highlights that bad
corporate behaviour can harm shareholder value.
Volkswagen was hit with huge fines, recall costs and a
damaged brand. Because of their illegal
behaviour, a board focused on shareholder value is able to
make decisions that are good for society as a whole, especially
when constrained by the legal system and a reasonable code of
ethics. It may be far from perfect, but
it does appear to be better than the alternatives.
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