Uncertainty Wednesday: Learning from Notre Dame

It was upsetting to see Notre Dame burn on Monday, as the building is a beloved landmark to the many millions who have visited Paris and enjoyed a stroll near its majestic presence. In addition it is also a major symbol for many French and an ongoing place of religious worship. It now appears that reconstruction is not only possible but will also be well funded (prompting some interesting debates about fairness).

In today’s Uncertainty Wednesday, I want to focus on an important lesson from the disaster. The apparent cause for the fire was an ongoing renovation project. Notre Dame was in pretty good shape for a building of such an advanced age. That means interventions have limited upside (marginal improvement) but, as we have seen, dramatic downside. Whenever the payoff structure of any activity has this asymmetry of limited upside, unlimited downside it is advisable considering not engaging in it at all, or proceeding with extreme caution.

As it turns out, this structure is pervasive and yet we don’t pay nearly enough attention to it. For a second example, one need look no further than the recent crashes of two Boeing aircraft (see post from a few weeks ago). Any modification to a working aircraft has limited upside and massive downside. In the case of the Boeing 737 MAX 8, the improvement was supposed to provide better fuel efficiency. That’s a worthy goal for sure, but a marginal improvement. Given the downside potential it means either not to do it at all or to be incredibly cautious.

And here is a quick example from the startup world. Adding debt to the financing mix can improve your cost of capital. But it also increases the risk of going out of business entirely. So again we encounter the structure of marginal improvement combined with existential downside risk.

Teaser: next Uncertainty Wednesday we will look at how the nearly same intervention can have a very different payoff structure when the circumstances are different.