# Understanding Risk **URL:** \ **Category:** Great Debates\ **Created:** [March 28, 2011, 8:06pm UTC](https://boards.straightdope.com/t/understanding-risk/576302 "2011-03-28T20:06:25Z")\ **Posts on this page:** 20\ **Page:** 4
**Author:** ![Bryan\_Ekers](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/bryan_ekers/32/183_2.png) [@Bryan\_Ekers](https://boards.straightdope.com/u/Bryan_Ekers)\ **Post date:** [March 29, 2011, 5:09am UTC](https://boards.straightdope.com/t/understanding-risk/576302/61 "2011-03-29T05:09:10Z")
Why do the motives of the capital investors matter, or the amount of their other wealth? It doesn’t matter if the $1 million they invest represents 0.1% of their net worth, or 90%. Their “risk” is that million, plus whatever intangibles attach to reputation and whatnot (at which point motives and other wealth _might_ become relevant). ---
**Author:** ![septimus](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/septimus/32/410_2.png) [@septimus](https://boards.straightdope.com/u/septimus)\ **Post date:** [March 29, 2011, 8:22am UTC](https://boards.straightdope.com/t/understanding-risk/576302/62 "2011-03-29T08:22:47Z")
I’m somewhat confused by this entire thread. Some of the points being made are too obvious for discussion. And some of the points are quite wrong. I’ll begin by mentioning an astute observation (which was pooh-pooh’ed here): > [@carm](#): > > Now imagine another restaurant, except this time the owner has several other business investments. Lets suppose he owns ten restaurants. _Now_, all the owner is risking is 10% of his capital. If the restaurant goes under, who cares? He has another nine… This is a key point, and explains why big businesses can engage in riskier ventures than small businesses. If two investors, one with $10 million in capital, the other with $2 million, contemplate the same $1 million investment, the one less rich will require a better reward/risk ratio to justify the investment. (Google Kelly Criterion.) And a similar effect applies at the very low end. A dishwasher might have to risk a considerable portion of his limited savings to look for a new job, with the costs of busfare, etc. Discussion of executive stock options ignored one important real-world fact: _ **After a fall in stock price, American executives often had their options replaced with new in-the-money options.** _ Finally, I’d ask what the point of the whole thread is. “The rich get richer and the poor get poorer”? Thanks, but we already knew that. ---
**Author:** ![emacknight](https://avatars.discourse-cdn.com/v4/letter/e/3ec8ea/32.png) [@emacknight](https://boards.straightdope.com/u/emacknight)\ **Post date:** [March 29, 2011, 10:17am UTC](https://boards.straightdope.com/t/understanding-risk/576302/63 "2011-03-29T10:17:02Z")
> [@septimus](#): > > This is a key point, and explains why big businesses can engage in riskier ventures than small businesses. If two investors, one with $10 million in capital, the other with $2 million, contemplate the same $1 million investment, the one less rich will require a better reward/risk ratio to justify the investment. (Google Kelly Criterion.) It doesn’t matter at all how much capital the owner has. Take the original OP and compare two owners, opening identical restaurants–one invests everything they have; the other is a Saudi Prince that wanted to own a NY restaurant named Saudi Princes Rule. If both restaurants are a success the dishwasher still invested nothing, and is not entitled to share in the profits. He may be compensated accordingly, but has no claim to the profits. Each owner is entitled to 100% of the profits. And each owner is free to share those profits at his discretion. That is the point of this thread. The dishwasher is entitled to earn a salary based on industry standard and nothing more. If the restaurant fails the dishwasher walks away no worse off than before he was hired. He was unemployed before, he’ll be unemployed after. In the mean time he was paid for the service he provided. ---
**Author:** ![emacknight](https://avatars.discourse-cdn.com/v4/letter/e/3ec8ea/32.png) [@emacknight](https://boards.straightdope.com/u/emacknight)\ **Post date:** [March 29, 2011, 10:25am UTC](https://boards.straightdope.com/t/understanding-risk/576302/64 "2011-03-29T10:25:58Z")
And just to drive this point home: When two people sit down at a black jack table, the dealer doesn’t give a shit how much capital they each have. One guy could be a billionaire the other using the only $20 he has. If both place a $20 bet, both risk $20, and both stand to gain $20. No one cares about their backstory or how long their bus ride was. The homeless/recovering alcoholic/single dad/extra sad dude has no claim to the billionaire’s winnings. Even if he really really really super extra really needed to win. None. He gets rewarded based on what he risks. And loses based on what he risks. Investing in a restaurant, or multinational pharmaceutical is no different. ---
**Author:** ![septimus](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/septimus/32/410_2.png) [@septimus](https://boards.straightdope.com/u/septimus)\ **Post date:** [March 29, 2011, 10:39am UTC](https://boards.straightdope.com/t/understanding-risk/576302/65 "2011-03-29T10:39:38Z")
> [@emacknight](#): > > It doesn’t matter at all how much capital the owner has. … > That is the point of this thread…If the restaurant fails the dishwasher walks away no worse off than before he was hired. He was unemployed before, he’ll be unemployed after. In the mean time he was paid for the service he provided. Didn’t waste a single moment trying to understand any of my post, did you? ---
**Author:** ![emacknight](https://avatars.discourse-cdn.com/v4/letter/e/3ec8ea/32.png) [@emacknight](https://boards.straightdope.com/u/emacknight)\ **Post date:** [March 29, 2011, 11:13am UTC](https://boards.straightdope.com/t/understanding-risk/576302/66 "2011-03-29T11:13:25Z")
> [@septimus](#): > > Didn’t waste a single moment trying to understand any of my post, did you? Let’s just say, I spent twice as long on your post as you did on my OP (which you were confused by). You again go back to comparing the reserves of two investors, and again I told you it’s not relevant. Each invested $1million, each stand to lose $1million. If both choose to put all that in Caterpillar stock, both incur the same risk. I think what you’re confusing is their risk tolerance. I think you’re also confusing the idea of a “risky investment.” I would consider opening a surfshop in Arizona to be a risky venture, much riskier than South Carolina. But if each shop costs $10,000, than I stand to lose $10,000, that is what I risked. The cashier at both shops risks nothing (assuming I’ll be able to pay what I promise). Thus, if one fails, I lose $10,000 and the cashier goes back to being unemployed. If one is hugely popular, I stand to make a windfall, and she gets to keep working. At no point is she entitled to my profits, and at no point is she liable for my debts. If I considered her valuable, perhaps even skilled, I would do everything required to retain her. Perhaps by offering her stock options, a performance bonus, and a cushy severance if she’s dismissed early. See what I did there? What’s actually relevant is how much of the total investment each person makes. If it’s just one guy putting up 100% he’ll get 100% of the profits. If it’s 100 guys sharing a lottery ticket, each gets 1%. No one after the fact cares if that was one sad guy’s last dollar. Every lottery ticket bought carries the same odds, and hence the same level of risk, regardless of the buyer’s circumstance. I believe the expression is, “dice have no memory.” And in this case they have no sympathy either. It also doesn’t matter how poor the dishwasher is, or if he’s a trustfund baby that likes the smell of soap. He invested nothing, and has no claim to the profits. That is the point of this thread. This thread makes me sad. People should know this, but they don’t, and there’s nothing I can do to help. Failing to understand evolution has no impact on a person’s day to day life. But failing to understand risk is itself risky. And as a result, we blame banks instead of people that took massive adjustable rate mortgages. ---
**Author:** ![tomndebb](https://avatars.discourse-cdn.com/v4/letter/t/b9e5f3/32.png) [@tomndebb](https://boards.straightdope.com/u/tomndebb)\ **Post date:** [March 29, 2011, 11:39am UTC](https://boards.straightdope.com/t/understanding-risk/576302/67 "2011-03-29T11:39:03Z")
> [@bump](#): > > Someone’s sure to show up and go on about how the evil white company hates the dishwasher because he’s brown skinned and poor, and how the company should pay him a wage of 10 dollars an hour because he should be loved, or some other softheaded BS like that. > [@Rand\_Rover](#): > > Wow. I award you no points, and may god have mercy on your soul. > > The complete dense idiocy of your post began with your suggestion of a restaurant as a tax shelter, and it just went downhill from there. Your post shows that you have no idea how the world works and simply aren’t interested in learning. Any more threadshitting and you will be Warned for being jerks. [/Moderating] ---
**Author:** ![mazinger\_z](https://avatars.discourse-cdn.com/v4/letter/m/5f9b8f/32.png) [@mazinger\_z](https://boards.straightdope.com/u/mazinger_z)\ **Post date:** [March 29, 2011, 12:38pm UTC](https://boards.straightdope.com/t/understanding-risk/576302/68 "2011-03-29T12:38:17Z")
> [@septimus](#): > > Finally, I’d ask what the point of the whole thread is. “The rich get richer and the poor get poorer”? Thanks, but we already knew that. The point is that anyone who has not invested any capital (knowledge, labor, or money) that is not already compensated (i.e. receive a wage for it), is not entitled to any profit. This should be a no-brainer, but for some reason does not resonate with the target audience. Anyone proposing an economic system where this is the norm, without having to bargain for it, is asking for an economic system set to under-perform if not experience outright failure. If the system doesn’t fail, there is high likelihood that such a system loses innovation because less people are inclined to take risk and be forced to share profits. In addition, there is strong likelihood that we force companies to form as large entities which require amazing amounts of capital, which strains the financial system further. ---
**Author:** ![Nadir](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/nadir/32/7302_2.png) [@Nadir](https://boards.straightdope.com/u/Nadir)\ **Post date:** [March 29, 2011, 2:06pm UTC](https://boards.straightdope.com/t/understanding-risk/576302/69 "2011-03-29T14:06:18Z")
I tried to focus it more into a agreeable definition at the outset, but was immediately attacked for that. Pretty typical around here, par for the course. Enjoy. ---
**Author:** ![septimus](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/septimus/32/410_2.png) [@septimus](https://boards.straightdope.com/u/septimus)\ **Post date:** [March 29, 2011, 2:49pm UTC](https://boards.straightdope.com/t/understanding-risk/576302/70 "2011-03-29T14:49:09Z")
Dear **emacknight** : I wasn’t confused by OP itself, but rather its purpose. For example, you bandy the phrase “_is entitled to_” as though you think contract law and moral imperative are the same thing. Read my lead sentence again: > [@septimus](#): > > Some of the points being made are too obvious for discussion. And some of the points are quite wrong. Most of what you’ve said in the thread is obviously true. Where you get confused is failing to grasp that others understand its obviousness, and want to move beyond the obvious. As for a point of yours which is “quite wrong”, I’ll just note that you devoted a lot of discussion to executive options without ever addressing my point: > [@septimus](#): > > _ **After a fall in stock price, American executives often had their options replaced with new in-the-money options.** _ HTH, but am doubtful. ---
**Author:** ![carm](https://avatars.discourse-cdn.com/v4/letter/c/c2a13f/32.png) [@carm](https://boards.straightdope.com/u/carm)\ **Post date:** [March 29, 2011, 3:23pm UTC](https://boards.straightdope.com/t/understanding-risk/576302/71 "2011-03-29T15:23:54Z")
**emacknight:** risk: n. 1. The possibility of suffering harm or loss; danger. 2. A factor, thing, element, or course involving uncertain danger; a hazard: “the usual risks of the desert: rattlesnakes, the heat, and lack of water” (Frank Clancy). 3. a. The danger or probability of loss to an insurer. b. The amount that an insurance company stands to lose. 4. a. The variability of returns from an investment. b. The chance of nonpayment of a debt. 5. One considered with respect to the possibility of loss: a poor risk. What is _actually_ happening in this thread, is you are trying to force your own, extremely narrow definition of risk onto everyone else. To you, risk = capital invested. That’s fine, but don’t expect everyone else to share that opinion. Especially when the dictionary disagrees with you. To say the staff risk nothing if the company folds is fine. It’s not correct by any normal definition of risk, but by your definition it is both 100% correct and 100% obvious. What is the debate here again? Edit: I don’t really like this definition of risk either, it’s from the free online dictionary; maybe someone with a subscription to the OED can fill us in on the “real” definition ---
**Author:** ![carm](https://avatars.discourse-cdn.com/v4/letter/c/c2a13f/32.png) [@carm](https://boards.straightdope.com/u/carm)\ **Post date:** [March 29, 2011, 3:27pm UTC](https://boards.straightdope.com/t/understanding-risk/576302/72 "2011-03-29T15:27:34Z")
> [@mazinger\_z](#): > > The point is that anyone who has not invested any capital (knowledge, labor, or money) that is not already compensated (i.e. receive a wage for it), is not entitled to any profit. This should be a no-brainer, but for some reason does not resonate with the target audience. Then this should have been the title of the thread. “Risk” applies to a lot more than simply capital invested. ---
**Author:** ![CalMeacham](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/calmeacham/32/35_2.png) [@CalMeacham](https://boards.straightdope.com/u/CalMeacham)\ **Post date:** [March 29, 2011, 3:51pm UTC](https://boards.straightdope.com/t/understanding-risk/576302/73 "2011-03-29T15:51:18Z")
This is the sort of thing that happens when some group takes a common word that has an accepted usage and then uses it in a very specific, usually related, but not identical meaning than the general one. It causes no end of wrangling and ill feeling and pointless arguing. But often the specific use is too ingrained in the particular group’s lexicon. You get some of this with the physical sciences, where terms like _Energy_, _Impulse_, [Velocity\* and others have very specific definitions that aren’t strictly identical with common usage. You get more umbrage when Pragmatists like John Dewey redefined “truth” as only statements that have been proven. This allowed him to talk about “manufacturing truth”, something which severely upset lots of people. Martin Gardner devoted a whole chapter to this in his book **The Whys of a Philosophical Scrivener** and pointed out that most of the argument was due to This particular redefinition and the grief it caused when the common use and this specific use were used by different groups. Same thing here. By most definitions, anybody throwing in their lot with a business has some risk. But in the capitalist scheme, “risk” is defined as **emack** did in the OP. By that definition, and within this philosophy, he is quite correct and the inferences that logically follow are consistent. Only those that take this sort of financial _risk_, defined this was, are taking a chance with the investment, and they are the only ones who profit. There are a whole host of problems and inflammatory statements that can follow from this straightforward situation, if the terms are haphazardly applied. Employeees sure as heck will be at risk if the business founders. You can say that “If you want to take the profits you can put your own money at risk”, but most folks haven’t got the capital, or access to it, to do this. And your employer very probably won’t let you buy into his scheme, unless it is through some stock=sharing arrangement. There are employee-owned businesses, but they’re the minority. ---
**Author:** ![tagos](https://avatars.discourse-cdn.com/v4/letter/t/bbe5ce/32.png) [@tagos](https://boards.straightdope.com/u/tagos)\ **Post date:** [March 29, 2011, 3:59pm UTC](https://boards.straightdope.com/t/understanding-risk/576302/74 "2011-03-29T15:59:22Z")
All the players in the debacles that set off the recession were taking no risk. They were gambling with other people’s money, reaped huge rewards for the most epic Economic Fail in living memory and then had their ‘too big to fail’ trough refilled so they could continue their risk-free snarfling. ---
**Author:** ![XT](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/xt/32/456_2.png) [@XT](https://boards.straightdope.com/u/XT)\ **Post date:** [March 29, 2011, 3:59pm UTC](https://boards.straightdope.com/t/understanding-risk/576302/75 "2011-03-29T15:59:28Z")
Yeah, I agree (ETA: with CalMeacham)…to paraphrase, what we have heeeaah is a failure to communicate. A lot of the people weighing in on this thread are using the term ‘risk’ to mean something completely different than the term is used in the OP. ‘Risk’ has a very narrow and specific meaning in terms of economics, and that’s how the OP is using it. Though I’m not an economics guy, nor do I play one on the SD, it’s clear to me how the term is being used and what it means, but I don’t think that goes for a lot of other folks in this thread. -XT ---
**Author:** ![XT](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/xt/32/456_2.png) [@XT](https://boards.straightdope.com/u/XT)\ **Post date:** [March 29, 2011, 4:03pm UTC](https://boards.straightdope.com/t/understanding-risk/576302/76 "2011-03-29T16:03:48Z")
[QUOTE=tagos] All the players in the debacles that set off the recession were taking no risk. [/QUOTE] That’s simply not true…yet, it has aspects of truth in it. But probably not in the way you think. One of the problems with the system as it was is that the way things were set up, the government took on a lot of the real risk for loans and such wrt housing. Ultimately, there was a line of thinking that said that the loans, regardless of how risky they were, were backup up in the end by the US government…and that allowed people to not have to be as concerned with real risk as they SHOULD have been. I have to run to a meeting, but I’m sure someone will be along to explain this a lot better than I. The OP, for instance, knows a lot about it IIRC. (Sorry to post and run) -XT ---
**Author:** ![Buck\_Godot](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/buck_godot/32/6573_2.png) [@Buck\_Godot](https://boards.straightdope.com/u/Buck_Godot)\ **Post date:** [March 29, 2011, 4:24pm UTC](https://boards.straightdope.com/t/understanding-risk/576302/77 "2011-03-29T16:24:03Z")
So suppose that I believe you that the investor incurs more monetary risk, than an employee who actually does the work that makes the business work. Cutting to the chase, why is it a good thing that only monetary investment risk should be taken into account when determining division of assets? ---
**Author:** ![Whack-a-Mole](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/whack-a-mole/32/141_2.png) [@Whack-a-Mole](https://boards.straightdope.com/u/Whack-a-Mole)\ **Post date:** [March 29, 2011, 4:25pm UTC](https://boards.straightdope.com/t/understanding-risk/576302/78 "2011-03-29T16:25:26Z")
> [@emacknight](#): > > It also doesn’t matter how poor the dishwasher is, or if he’s a trustfund baby that likes the smell of soap. He invested nothing, and has no claim to the profits. That is the point of this thread. So, by your thinking the football players have no right to the massive profits generated (note the league is [currently experiencing a lockout](http://www.bloomberg.com/news/2011-03-28/nfl-players-brady-manning-ask-minneapolis-court-to-block-league-s-lockout.html) of players over their collective bargaining agreement). IIRC (from watching an HBO special years ago so no link) there was a time when football players were earning so little the players would paint houses and such between games to make ends meet. The owners were making fortunes. In your world this is as it should be…the owners put in the investment, the players (employees) have no claim to that money. This happened too with labor before unions were established. The owners of the factories were paying horrible wages (below subsistence), work conditions were terrible and the owners would (not infrequently) have employees shot if they had the temerity to demand something better (even has the company was reaping huge profits). Since the owners, in your world, have all the “risk” this is ok. The employees, in your view, share none of the risk, are not forced to work there so they should have no issue. That about the size of it? ---
**Author:** ![Whack-a-Mole](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/whack-a-mole/32/141_2.png) [@Whack-a-Mole](https://boards.straightdope.com/u/Whack-a-Mole)\ **Post date:** [March 29, 2011, 4:28pm UTC](https://boards.straightdope.com/t/understanding-risk/576302/79 "2011-03-29T16:28:32Z")
> [@Buck\_Godot](#): > > So suppose that I believe you that the investor incurs more monetary risk, than an employee who actually does the work that makes the business work. Cutting to the chase, why is it a good thing that only monetary investment risk should be taken into account when determining division of assets? To add a followup question of mine related to this: If the measure of risk is the investment then once the investment has paid off and returned a reasonable profit then can one say the investor(s) no longer have risk? ---
**Author:** ![Voyager](https://sea3.discourse-cdn.com/straightdope/user_avatar/boards.straightdope.com/voyager/32/133_2.png) [@Voyager](https://boards.straightdope.com/u/Voyager)\ **Post date:** [March 29, 2011, 4:35pm UTC](https://boards.straightdope.com/t/understanding-risk/576302/80 "2011-03-29T16:35:17Z")
> [@emacknight](#): > > Yes, I realize it is bizarre to a lot of people, which is why I started this thread, to help people understand what risk means. > > Driving a car is risky, when you go through an intersection you always have a risk that someone might t-bone you. I could just as easily say you were a moron for not looking center-left-right before proceeding (thank you Young Drivers of Canada). > > And yes, the second driver was a moron who took what would be considered an unnecessary risk. The point of this thread is that when two people set out from their house, each can choose to take a level of risk. One might drive at high speeds while they other stops at green lights to be sure. > > One took more risks and got to his destination sooner (or not at all), the other took longer. > > The issue at hand is what was the upside potential? If they were both trying to get $100million, you might think the second driver a fool. In fact, there is an entire industry that revolves around people driving insanely fast on slick roads in order to win money. Would you still call the guy going 110 on a slippery road a moron? (I’m talking about NASCAR etc) Drivers in NASCAR have all sorts of protection in order to meet the risk, and they are also being compensated for taking the risk. So the cases are hardly the same. People make risky investments all the time. VCs certainly do, but the risks are on the table, the investors are aware of them, and a diversified portfolio addresses the risk. Compare this to the CEO of WaMu, who, fully aware that his company was writing junk mortgages, went full steam ahead, or the many people whose risk models did not include the possibility that the housing market will go down. You seem to be edging towards using risk as a way of reducing personal responsibility. Opening a restaurant anywhere is risky, for certain. Opening a kosher deli in Teheran goes a bit beyond that. [Previous page](https://boards.straightdope.com/t/understanding-risk/576302.md?page=3) [Next page](https://boards.straightdope.com/t/understanding-risk/576302.md?page=5)