Being a tobacco CEO is not quite as bad as it might seem

Larks28 Jan 2016 3:59 UTC
13 points
19 commentsEA link

Summary: I argue that, contra a recent post, even CEOs of tobacco companies do not do enough direct harm to offset the good they could do by donating their income.

Recently 80,000 Hours wrote a blog post about how CEOs of tobacco companies do so much harm that, even if they donated everything they earned to a highly effective charity, they would still be a net negative impact on the world.

Their argument is pretty simple

  • In aggregate tobacco CEOs are paid $23 for every premature death caused by smoking

  • Top CEOs can affect share prices by 5-40% vs the next best CEO

  • In a commodity business share prices will track sales quite closely

  • Hence top CEOs can affect sales by 5-40% vs the next best CEO

  • Assume 50% of the extra sales will come from gains in market share, and 50% from expanding the market for cigarettes

  • Hence the top CEO is paid $115 - $920 per counterfactual premature death.

  • Premature smoking deaths cost about 10 QALYs as they tend to happen quite late in life.

  • So a top tobacco CEO paid $1,000,000 would cost between 22,000 and 175,000 QALYs

  • It costs AMF $3,000 to counterfactually save a life.

  • The lives saved by AMD occur early in life, so AMF saves about 60 QALYs per life.

  • So if the CEO donated the $1,000,000 they could save 20,000 QALYs

So in the best case scenario, even if the CEO donated 100% of their compensation, they would be approximately neutral. In the worst case, their actions would cost approximately 150,000 QALYs. As such, this lends considerable to support to Rob’s conclusion, that:

“There are very likely jobs such as this, where even considering ‘replaceability’, and even if you donate all your earnings effectively, it would not be enough to offset the direct harm done.”

However, I think that while 80,000 Hours substantially improved on the analysis in the original paper, they omit a number of factors. Unfortunately, almost all of these factors seem to pull in the same direction, causing them to over-estimate the amount of harm done by a tobacco CEO. These include both over-estimating the direct harm done and under-estimating the benefits donating your income would cause.

Over-estimating the harm.

There are many ways in which CEOs can enhance shareholder value that do not involve selling more units. To the extent they do these things instead, we will tend to over-estimate the harm they do as a byproduct of promoting shareholder value.

Sales vs Volume

The article argues that,

“in a commodity industry like cigarettes, share price and sales are likely to track one another fairly closely.”

“Let’s say the top choice for CEO will raise sales 5-40% relative to their next best alternative.2 In that case, these CEOs are actually being paid $60-$460 for each death resulting from the cigarettes they cause to be sold.”

However, Cigarettes are definitely not a commodity industry. For the sake of specificity, lets look at Altria, a large US tobacco company. In 2014 it made an operating profit of $6,900m on revenues of $21,900m—over a 30% operating margin. This is a very high margin, well above that of most companies, and far in excess of that earned by commodity manufacturers.

There are a number of other features of the tobacco market that also suggest it is not a commodity market:

  • Tobacco companies earn a very high return on invested capital, where in a commodity industry this would be competed away by new entrants

  • The retail price is very stable (compare to price of canonical commodities, like oil or corn)

  • There are large price differences between brands

Indeed, cigarettes seem to be about as far as you can get from being a commodity, on a similar level to other consumer staples with a high degree of branding power.

As a result of this, the article omits a key way that CEOs can improve their company: raising revenues by increasing the average selling price (ASP), rather than selling more units.

A key part of the strategy of tobacco companies has been aggressively raising prices to take advantage of the low elasticity of demand. The high level of taxes of tobacco products also helps them, as a large price increase only increases the cost to the end-user by a small percentage—which many of them will blame on the government anyway.

To show how much value can be destroyed when tobacco companies fail to stick to this script, we only have to look at Marlboro Friday, where Philip Morris cut the price on their signature product by 20%. Their share price fell by 26% that day, as the market expected this would dramatically lower profitability. If cigarettes really were a commodity, producers wouldn’t be at liberty to make pricing decisions like that; oil companies can choose how much to produce, but they cannot choose the price they sell at.

Improving production efficiency

Even if tobacco was a commodity industry, there is another simple way CEOs can enhance shareholder value without selling more units: cutting production costs. Indeed, the investors are frequently far more excited about plans to improve margins by making manufacturing more efficient than by expansion plans. This is especially true in a mature industry like tobacco: cost cutting is seen as predictable, low risk and within management’s control; expansion plans require expensive upfront investment and high risk. You might have to lower prices, undermining margins on the existing business, especially if competitors lower prices in response.

Risk

Stock prices vary largely as a function of expectations of future profitability, but not entirely. They’re also a function of the perceived riskiness of future profits. If you can make a company seem less risky to investors you can increase its worth, even if the expected profitability is unchanged.

This is especially evident in the tobacco Industry. Altria currently trades on a 22x trailing Price/​Earnings multiple, well above the average for the market, in spite of the lack of growth in the underlying tobacco market. This is largely because investors perceive the company as very stable and low-risk. This perception is not a coincidence—it is (in part) the result of the decisions of management teams in the industry to reduce volatility.

Are you really the best choice for the job?

There are broadly two different ways of examining the effect of CEO quality on firm performance. One is the approach used in the HBS paper Robert mentioned, where you look at variation in various metrics cross-sectionally and temporally and attempt to correlate that with CEO tenure. The other is to look at market reactions to unexpected CEO terminations—for example this paper. A key distinction between these is that the former looks at how much variation can be explained by CEO choice, while the latter looks at how predictable the impact of different CEOs is. It should be of no surprise that the former type of studies tend to produce larger estimates of CEO impact than the latter: CEO choice might matter a lot, but it’s hard to know ex ante how good the CEO you chose will be.

This introduces another factor we need to control for. Yes, if you really are better than the alternative CEO you might sell more cigarettes, and yes the board clearly thought you were the best choice for CEO—but what if they’re wrong? We need to adjust by the probability that you are indeed the best choice for CEO, conditional on the board thinking you were.

This seems like a pretty hard probability to estimate. My guess is it is quite low—I would expect many potential applicants, and a relatively poor ability to discriminate between them—but in lieu of actual analysis lets just say 50%.

Under-estimating the Benefit

There are probably charities better than AMF, even ex ante

GiveWell recommends AMF so highly not because they think that AMF is the best charity in the world. They don’t even think it’s the best charity in expectation—it’s just the charity they’re most confident has a very high level of effectiveness. If you’re happy taking on a little risk (uncorrelated to the stock market) in return for a better expected outcome, you can probably get at least another factor of two from your donations.

Right to choose

Sometimes people criticise EA for being paternalistic. Who are we, busybody altruists, to decide what is best to others? What makes us think we are so smart? Isn’t this just paternalism?

I think in this case the response in the EA FAQ is excellent:

Some people support GiveDirectly because it gives cash to people in poverty, leaving it entirely up to them how they spend the money. This is seen as empowering people in poverty to a greater extent than choosing services that may ultimately not be desired by the local community.

Others provide basic health services, such as vaccinations or micronutrients, that they regard as so clearly good it is very unlikely the recipients wouldn’t value them (and in any case, could reject if they wanted). They then hope that better health will empower people to improve aspects of their own circumstances in ways we as outsiders cannot.

In cases where the above don’t apply, you have to conduct detailed impact evaluations to see how the recipients actually feel about the service that purports to help them. Of course such surveys won’t always be reliable,

In other cases where people are trying to help non-human animals or future generations, these issues can be even more difficult, and people do their best to predict what they would want if they could speak to us. Obvious cases would include pigs not wanting to be permanently confined to ‘gestation crates’ in which they cannot turn around, or future generations not wanting to inherit a planet on which humans cannot easily live.

This response is amazingly reasonable, and it covers basically everything EAs do. What’s notable is that nowhere do we tell people that their preferences are wrong. We aim to help people promote their goals by giving them money, or trying to work out what they would want, or even helping those who cannot help themselves.

Yet in the tobacco cost-benefit analysis, this is exactly what we do. We count as a cost the negative side-effects of smoking, but give no credence at all to any benefit to smoking. Some people just like smoking! They enjoy it. Perhaps smoking is a mistake—maybe smokers have miscalculated the personal cost-benefit analysis, or maybe they’re too addicted to be able to quit—but there is a consumption good that they get from smoking, and it has to be accounted for in any cost-benefit analysis. Failing to do so stacks the deck against tobacco, and against the tobacco CEO.

Aggregate Impact

Here are the adjustments we have to make to the estimate of the harm caused by a Tobacco CEO’s direct work

    • Price vs Volume—maybe a factor of 2?

    • Sales vs Margin—maybe a factor of 2?

    • Equity Risk—uncertain impact

    • CEO choice uncertainty—maybe a factor of 2? (very uncertain)

    • Better charities than AMF—maybe a factor of 2?

    • Right to Choose—uncertain impact

    Just eye-balling the length of the list, it is clear that this is going to make a big impact!

    Several of these factors seems to require an adjustment by at least a factor of two. Using these highly unscientific numbers, we adjust down the harm caused by at least a factor of 2*2*3 = 8, to between 1,360 and 5,500 QALYs, and increase the good done from donations by a factor of at least 2, for 40,000 QALYs. Net this leaves us with a 34,000-39,000 QALY positive impact from a career as EA tobacco CEO, and without giving any credit for the two of the factors. Of course in practice few would actually donate 100% of their income—but your net impact could still be clearly positive even at much lower donation rates, especially if we consider that you might also be able to differentially promote less harmful types of cigarettes.

    Now, this doesn’t mean that 80,000 Hour’s conclusion—that there are some jobs so bad that even replaceability concerns won’t make Earning to Give in them net beneficial—is false. But Tobacco CEO does seem like it had a strong prima facie case. Who could be more evil? If even selling cigarettes isn’t harmful enough to offset the good done by your earnings, what is?

    Larks28 Jan 2016 3:59 UTC
    13 points
    19 commentsEA link