Windfalls Can Be a Curse...


Windfalls, successes from unpredictable R&D, can be troublesome. Individuals often do not deal well with sudden large influxes of cash. Here’s why that’s important.

Windfalls+ can be a curse depending on the personality of the recipient. Management in firms receiving large windfalls (e.g., a legal settlement) would just as soon squander the windfall as put it to good use. Instead of distributing the windfall in the form of extraordinary dividends to shareholders, the “correct” answer, they spend the windfall on suboptimal internal investments in order to better secure their own jobs.1 Similarly, gamblers, recipients of tax refunds, and other recipients of windfalls often spend the money on conspicuous consumption, rather than paying off debt or saving for the future.

Many individuals do a mental accounting of their income and expenses, and windfalls by definition fall outside that accounting. Sudden wealth invokes strong emotions, values, and personal psychology. How you cope with an unexpected fortune depends on your character. It’s not uncommon for a person who strikes it rich to feel guilt or fear. What seems clear, though, is individuals don’t treat this new-found wealth using the same mental constructs as for their daily mental accounting: it’s extracurricular money often used in extracurricular ways (which can include donations to charity, as a sort of thank you to the gods for the unexpected gain).

Many investment advisers recommend setting aside windfalls (e.g., lottery winnings) for a period of months before making any decision on how the money is to be used. It gives time for the emotions of the windfall to settle down, and often permits a more rational, considered decision.

Smaller windfalls can more readily be included into mental calculations of firm management and individuals. Smaller windfalls keep firms from rushing out and making rash acquisitions or other forms of corporate conspicuous consumption. Smaller windfalls more easily fit into the current mental accounting of individuals and managers.

Windfall psychology is complex, and is largely uncharted territory in the behavioral sciences. It’s integral to the branding for Franchise Capital Management+. Our contention is we can turn what is perceived as a liability (the unpredictability of R&D) into a desirable asset (steady growth punctuated by moderate windfalls). To successfully accomplish this sleight-of-hand requires much more in-depth analysis into the uncharted realm of investor psychology for windfalls. This research may have to wait for a few years of accumulated data to build up in a functioning Franchise Capital Management firm+. But the first firm to refine this formula can set up a significant patent hurdle for any me-too+ imitators.

Editor's Picks for April, 2011

  • 1. The money must be spent or distributed, or executives risk being acquired by corporate raiders who will view the cash as a means to finance the acquisition (here).