Reputation Markets

Note: I’ve renamed this newsletter “Ideas & Musings” to better describe the spirit of this newsletter, which I see as emergent, experimental, and evolving.

We’ve talked a lot about markets. We explored how software is eating the world and how there’s no going back. We looked at prediction markets and how they productize the wisdom of the crowds. We discussed how the internet cuts intermediaries out of markets, better aligning value creation & value capture. This week we’ll dive into markets for reputation.

Like any market, reputation markets have their own economies, complete with incentives to earn & spend various forms of capital.

It’s interesting to think about the exchange rate between financial & social capital. If you had to lose all of your either financial capital or your social capital, which would you choose? Most people, the richer they are in dollars, the more they’d be willing to give up financial capital before social capital if forced to choose. Why is that? 

For the rich, money is easier to reacquire with high social capital. But social capital is a different story — it’s much harder to build up. Hence the famous Buffet quote, “It takes 20 years to build a reputation and five minutes to ruin it.”

We can extend this analogy to financial capital on other dimensions. :

Reputations, like stocks, have P/E ratios. Someone’s P/E ratio is effectively measuring the substantive value of X and the multiple above that we’re evaluating X at. CEOs who are good at building hype (e.g. Elon Musk) effectively have high P/E ratios that afford them cheap cost of capital, lower CAC, and better recruiting pipelines. As a result, people with high P/E ratios also earn social capital or knowledge at a rate far above their peers with lower P/E ratios. One’s P/E ratio is effectively measuring "what's the substantive value of X and what is the multiple above that we’re evaluating X at?" A high P/E ratio enables you to get a cheap cost of capital, or, in non financial markets, social capital or knowledge.*

This is good for the capital aggregator to the extent that they can generate strong ROIC on that form of capital, which allows them to get it for cheap. And they usually can, especially if the cheap cost of capital unlocks a constrained resource. But if that resource doesn’t generate high ROIC, then it could be awkward when it’s price converges with reality.

Similarly, reputations, like stocks, have bubbles: Consider a “reputation ponzi scheme”: the idea of building up a reputation based on affiliations with other impressive people with nothing tangible to back it up. 

Other social capital bubbles: If there are just more people willing to vouch for more people, then you end up with too many bad ideas getting funded. And you also end up with people optimizing for getting recommended versus optimizing for building something good. You see both of these in venture capital a lot. 

The problem with these reputation ponzi schemes is that they’re self-reinforcing — each one causes another, resulting in larger social capital bubbles. 

Other market failures exist too: Nepotism is a credit market for reputation rather than cash. Like financial banks, there are social capital "banks" willing to lend social capital to ppl who don't need it and not willing to risk social capital on new & risky people. Except unlike financial markets there is no global Fed that can step in. It all happens locally.

So: reputation markets are inefficient, which means we need to find ways to incentivize social capital investing. What could an AngelList for social capital investing look like? P2P credentialing could be one approach.

*= This paragraph came from Kevin Kwok on my podcast conversation with him. Thanks also to conversations with Byrne Hobart and Zach Davidson which inspired ideas in this piece.