The Rise and Fall of WeWork
WeWork is a fascinating story in behavioral finance. Founded in 2010, the commercial real estate company provides shared workspaces for start-ups and seeks to build an office space community. Its founder, Adam Neumann, who until recently was the firm’s CEO and board chair, embodied extreme versions of key psychological characteristics that characterize most chief executives.
Neumann was extremely optimistic and confident, neither of which are necessarily a bad things. However, excessive optimism and overconfidence can be dangerous.
Excessive optimism and overconfidence led Neumann to make large, bad financial bets for his company. That said, motive is not typically sufficient for disastrous decision making; also required is a large investment, and until recently, Neumann lacked that. However, early this year, the financial firm Softbank’s head, Masayoshi Son, decided to invest over $4 billion in WeWork. Doing so resulted in Neumann having both the investment and the motive to engage in decisions that could, and ultimately would, significantly destroy value.
The tendency of companies to increase spending when they are flush with cash is known as “cash flow sensitivity.” Some readers might view cash flow sensitivity as being perfectly reasonable; and it might be. The thing is that behavioral research shows that excessive optimistic and overconfident CEOs, when those biases are extreme, are prone to make spending decisions that on average destroy significant shareholder value. In Neumann’s case, the biases were extreme.
To his credit, Neumann built WeWork by identifying unserved needs in the market, and then finding a way to address those needs. Startup founders and entrepreneurs needed work spaces featuring pleasant surroundings, amenities, and communities of people like themselves. WeWork called its customers “members,” thereby emphasizing the social community aspects of the service they were selling.
WeWork did succeed in offering a value to its customers. Unfortunately, the company didn’t offer value to its investors. That is to say: WeWork was unprofitable, and had no clear business plan for becoming profitable.
What makes the WeWork story so fascinating from a behavioral perspective is that until a few months ago, the lack of a positive investment value proposition was news to the company’s major investor Softbank, and to JP Morgan and Goldman Sachs who WeWork selected to take the company public.
WeWork’s attempted IPO went off the rails when investors began to scrutinize the company’s business model, which was part of its S-1 filing with the SEC. Last month, WeWork’s parent company announced that it would lay off more than 15 percent of its workforce. (Meanwhile, Son is also paying Neumann up to $1 billion for his WeWork stock.) Which begs the question: why where investors willing to invest large amounts without asking tough questions?
Part of the answer involves a concept called “value expressiveness,” introduced into finance by my SCU Department of Finance colleague Professor Meir Statman. The concept entails investors choosing to hold securities of companies whose values or activities align with their personal values: holding the stocks of socially responsible companies, while shunning the stocks of companies that fall short.
Neumann believed his company and its philosophy of community could go beyond work spaces, from apartments to education—addressing major social crises such as those related to refugees and orphans.
But investors who overemphasize value expressiveness, and engage in what's called one reason decision making, are susceptible to making investments that are financially unsound.
The other factor behind WeWork’s rise is Neumann’s charisma and ability to read people. Neumann's background was in marketing and entrepreneurship, not basic finance. But neither Neumann nor Softbank’s Masa Son were especially adept at applying basic finance.
Years ago, Softbank’s Masa Son made a big bet on Alibaba, similar in nature to WeWork, basing his investment decision on Alibaba founder Jack Ma’s “look in his eye” rather than on Alibaba’s business model. Just before WeWork’s IPO collapsed, Neumann says Son told him, “The last person I felt this with was Jack Ma.”
Although Alibaba went on to be a huge success, it is worth asking whether Masa Son’s successful bet on Alibaba stemmed from skill or luck? Afterall, there are a lot of passionate people with twinkling eyes pitching ideas that are financially unsound but turn out well, just as there are people who buy winning lottery tickets, despite the odds being against them. Masa Son was eager to repeat that success with Alibaba, based on intuition but not on finance. And Neumann found a way to take advantage.
JP Morgan’s CEO Jamie Dimon was keen to compete with investment bank leader Morgan Stanley, in respect to IPO underwriting. Neumann found a way to offer Dimon an opportunity to meet that need. JP Morgan also invested heavily in WeWork.
That leads us to “motivated reasoning,” a behavioral concept whereby people with an interest in a situation being true overemphasize information that supports the position and downplay or ignore information that runs counter.
There is good reason to suspect the CEOs of both Softbank and JP Morgan exhibited motivated reasoning in respect to WeWork. They did so when they allowed themselves to be persuaded by Adam Neumann’s charisma, and failed to look closely at WeWork’s business model.
Neumann’s uncanny ability to convince investors of his very lofty ambitions for changing the world also reflects a concept called the “better than average effect,” which entails most everyone wanting to be above average.
An extreme version and special case of the better than average effect is wanting your CEO to be a genius, so not just above average but absolute tops. But not every CEO will be an Elon Musk or Steve Jobs, who, for all his genius, was actually fired as CEO of Apple during the first phase in 1985 before re-joining the company in 1997.
As if mesmerized, investors also overlooked the degree to which Neumann used unorthodox measures to transfer wealth from WeWork to himself. Apparently, it did not occur to them that someone who professed to want to be the world’s first trillionaire might do so at investors’ expense.
Unlike Son and Dimon, the financial analysts reviewing WeWork’s S-1, were not subject to motivated reasoning. They focused on WeWork’s financials and did not overlook Neumann’s self-dealing behavior.
WeWork had many happy customers and employees who are now dealing with significant adjustment costs. Time will tell if Softbank is able to salvage the residual value in what remains of WeWork’s assets.
A version of this column was originally published by Forbes on Nov. 24, 2019.