Macro Economy

Lessons from Hindenburg’s ‘skin in the game’ approach

The research firm’s willingness to take a financial bet is what lent credibility to its findings, a point that journalists, scientists and commentators must note

Praveen Chakravarty
February 27, 2023

‘The idea that one stands to lose if wrong is a very important signal of veracity, especially in times of fake and motivated news’‘The idea that one stands to lose if wrong is a very important signal of veracity, especially in times of fake and motivated news’

‘The idea that one stands to lose if wrong is a very important signal of veracity, especially in times of fake and motivated news’ | Photo Credit: Getty Images/iStockphoto

During election season, television is replete with election surveys by various pollsters predicting winners, vote shares and the seat tally of political parties. Suppose there are two television channels, A and B, making forecasts for a particular election but channel B qualifies its prediction with a bet using its own money. It stands to gain big if its predictions come true but loses all if they go wrong. Which pollster are you likely to believe more, A or B? Chances are you may trust channel B more because its incentives are aligned with its predictions. In the words of Lebanese mathematician and philosopher Nassim Taleb, channel B has ‘skin in the game’, an ethical principle of symmetric incentives and accountability.

A moral dilemma

Extending this thought experiment, assume that channel B’s predictions come true and it makes a significant profit from its bet. It is perhaps possible that channel B’s predictions may have influenced some voters to vote in a manner that reinforced its prediction. But an election outcome is dependent on a multitude of various factors. Should the fact that channel B gained financially from its predictions change your view about the merits of its survey? Would you rather have channel A’s survey or regardless of its profits, is channel B’s ‘skin in the game’ survey more preferred? The moral dilemma posed by this thought experiment is at the root of the ongoing Hindenburg Research versus Adani saga.

Hindenburg, a firm that places bets in the stock and bond markets, published a voluminous research report that raised grave allegations about the business ethics of the Adani group of companies and manipulation of share price to inflate the value. Hindenburg also took a large financial bet on the veracity of its report by engaging in a ‘short sale’ of Adani shares that gain when prices fall. Adani shares plummeted and Hindenburg ostensibly made a financial killing.

The Solicitor General of India questioned the motives of Hindenburg in the Supreme Court of India and argued that its report is a fallacious alibi to drive the share price down deliberately and profit from this. Commentators empathetic towards the Modi government (this includes a former Vice Chair of NITI Aayog, a former Chief Economic Adviser, a former Foreign Secretary and many others) have jumped in to cast aspersions on Hindenburg’s motives, notwithstanding the fact that Hindenburg would have lost a lot of money had it been proven wrong. The irony is that Hindenburg’s report has alleged that the Adani Group had deployed a grand scheme using offshore entities and related parties to manipulate its share price and gain from its rise, which is now being castigated as a mischievous report to manipulate the same Adani shares to profit from its fall. This prompts the counterfactual question: had Hindenburg published the exact same research report without making a financial bet, would it be deemed more credible?

There is empirical evidence to show that it may have been Hindenburg’s ‘skin in the game’ approach that helped establish its credibility among market participants. In August 2022, another foreign research firm, CreditSights, published a similar report raising questions on the governance practices and share valuations of the Adani Group. The group responded to those allegations, albeit without any reference to ‘Jalianwalla Bagh’ or a national flag (tapping into nationalism), as it did in its response to the Hindenburg report. The CreditSights report did not elicit much of an uproar and the stock market brushed it off with no impact on the share price of the Adani companies.

In fact, there have been at least eight such news or research reports in the last four years by similar foreign publications (Bloomberg, The Guardian and Morgan Stanley) about the Adani Group’s alleged dubious business practices and share price movements. None of them seemed to have had the impact that the Hindenburg report has had. Arguably, it is because of Hindenburg’s willingness to take a financial bet that lent credibility to its findings than a mere report.

A sign of veracity

The idea that one stands to lose if wrong is a very important signal of veracity, especially in times of fake and motivated news. To claim that the Hindenburg report is a grand devious plot to engineer a fall in the share price and profit is akin to claiming that a pollster engineered an entire election’s outcome to ensure his prediction comes true and he gains financially. The financial market, like the electoral marketplace, is too complex and multivariate to be manipulated so easily. To be clear, I am not claiming markets are efficient and ‘unmanipulable’. If any, they are more wrong than right. But there is a difference between distortions in market structures versus a symmetric incentive structure. It is common practice in financial markets for investors who/that buy shares, to talk them up in the hope of influencing others to buy these shares and drive the price up. This is deemed a legitimate practice and no one frowns upon it. But the exact symmetrical idea of talking down a company and ‘short selling’ its shares seems to elicit an outcry of ‘schadenfreude’, which is illogical.

Illegality versus immorality

In essence, Hindenburg alleged that the Adani Group inflated its stock price illegally to gain. Adani’s backers allege that Hindenburg deflated its stock price immorally to gain. While the charge of immorality is baseless, nevertheless, it is important to make a distinction between the two, as the Supreme Court deliberates this matter soon. Illegality is profoundly different from immorality. One can have a legitimate debate over whether it is ethically reasonable to profit from a fall in the share price as it is to profit from its rise — but that is beyond the scope of the Hindenburg versus Adani matter and ‘short sale’.

Taleb posits that the philosophical idea of ‘skin in the game’ of symmetrical rewards and penalties is very important to cultivate trust and trustworthiness in societies. Contrary to the argument of Adani’s backers, Hindenburg’s ‘short sale’ bet signalled confidence and trust in its research and played a critical role in the exposé of Adani’s alleged financial shenanigans. This was neither illegal nor unethical. If any, such a ‘skin in the game’ approach where journalists, scientists and commentators are held accountable for their words and actions can help reduce the menace of fake news, ‘hit jobs’ and the ‘tyranny of experts’, and instead enhance trust in society and reduce discord.

Praveen Chakravarty is a political economist and Chairman, Data Analytics for the Congress party

‘The idea that one stands to lose if wrong is a very important signal of veracity, especially in times of fake and motivated news’

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