Note on Rationality

Abstract

“Rationality” is a term that comes up often during investment conversations, and yet it has not been definitively defined. For example, economists and investors each use and define the term rationality differently. The objective of this note is to profile three general definitions of the term “rationality,” and then to demonstrate how one of these definitions is practically applicable to investment management. This is demonstrated first via historical profiles of two executive managers who publicly declared their intention to create shareholder value. Such declarations are often made but not all executive managers follow-through, and for those that do follow-through there is wide variation in value creation effectiveness, especially over time. Therefore, insight into when such declarations have a higher probability of being realized could help to practically inform investment analyses. Given the profile nature of this note, it is not our intention to thoroughly survey or examine the intricacies of either the concept of rationality or executive management in general. Rather, our intention is to introduce the concept of rationality from an investment perspective and then to practically profile its usefulness. Toward this end, the paper closes with suggestions on how to supplement traditional forms of investment analysis with rationality-based/inspired input.

Keywords: Rationality, Managerial Behavior, Investment Analysis

JEL Classification: G02, H32, L2