Motivation matters: the game-playing at GameStop

29th Jan 21

This post is being published in the middle of a “short squeeze” currently shaking up financial markets on the other side of the Atlantic. The story of GameStop, the hedge funds than bet on its collapse, and the day-traders who stumbled into the counter-position and created ten-figure losses for Wall Street (yes, ten figures) says something very interesting at the start of 2021 about what motivates us as managers, financial experts and investors.

If you haven’t followed the story so far…

GameStop is a retail chain that sells computer games. Oops. Most of them are now streamed or sold online, and the pandemic closed a lot of retail for a lot of the past year. Hedge fund Melvin Capital decided to short the stock, betting that a bad 2020 and its own shorting activity would drive the shares from about $4 into the ground. (Ideally, GameStop would go bust and Melvin would never have to buy back the shares it shorted.)

So far, so cynical – targetting the weak and hastening their collapse. But, argue the “shorts”, it’s all a natural part of a capitalist system that finished off doomed companies to make room for strong ones. The trouble is, back in 2019 a user of the Reddit investment chat room WallStreetBets (whose username is profane, which is highly consistent with the very base chatroom culture, so we’ll call him u/dfv) reckoned the company was, in fact, undervalued.

He saw potential for a turnaround, leveraging the company’s customer base for e-commerce activity. (His YouTube channel is an incredible watch right now. Videos from last summer describe exactly what's happened...) And when Ryan Cohen – who’d had an e-commerce success story with Chewy Inc – took a 10% holding in the company in August (he joined the board in January), the /wsb community started to get on board more widely, in part because u/dfv's YOLO ("you only live once") position was starting to look shrewd. GameStop was becoming a “meme stock”, where the chatroom’s performatively reckless investors jump in with call options (betting the stock will rise) and share purchases to show their support.

Melvin Capital thought this was dumb. The pro investors were so sure this retailer would fold, the total amount of shares they sold short was around 140% of the total shares in existence. In November, a /wsb user posted a video about Melvin's extremely short position. By January the squeeze looked on, and when Melvin's proxies on TV became vocal about the weakness of GameStop and the silliness of the retail buyers of the stock (possibly to encourage negative sentiment around it to make their play work), this simply enraged the “degenerates” (their word) at /wsb, who responded by buying more stock and more calls.

The problem during late January has been that the short sellers can’t close out their positions – and every day they don’t they are bleeding cash. Some reports say the total hit to institutions was more than $70bn by the 28th January (although this seems very toppy...). They need to buy a lot of GameStop shares to close their positions – but no-one is selling. A company worth, optimistically, maybe $30-a-share has been trading north of $450, with extremely wild price fluctuations.

It ain't what you do (it's the way that you do it)

It’s become a cause celebre, not just within the existing /wsb community, but now on Main Street and Capitol Hill, too. Result? The short sellers are having to pay massively inflated prices for any shares they can prize out of the “diamond hands” of retail investors.

The /wsb community alleges that the hedge funds are so panicked, they've been using “short ladders” (selling instruments they do own to each other at depressed prices to panic GameStop holders into selling theirs, fearing the market is falling) to get out of a hole. That could be ethically (and perhaps even legally) dubious if it turns out to be true. The users at /wsb also allege the mainstream media has bought into disinformation about Melvin closing its positions in order to convince people to panic sell.

And when popular trading app RobinHood prevented new buying in Gamestop ( for the perfectly credible reason that, as a broker, they were unable to back fresh transactions with their clearing house without a massive influx of cash), the community hardened further: “the pros are trying to screw us,” they said, “just because they messed up and we noticed.” Needless to say RobinHood has been resolute in denying it was bowing to pressure from exposed short sellers. (At pixel time, they seem to have re-opened for purchases of GameStop shares after an influx of capital.)

Short squeezes are rare, but they’ve happened before. The most famous was probably the VW "infinity squeeze", which saw shares in the carmaker spike massively in 2008, costing hedge funds $30bn. How GameStop plays out is anyone’s guess. Retail investors late to the party could get badly burned. Wall Street and the regulators could close ranks to prevent systemic problems (it’s a real risk). Politically it’s actually united Democrats and Republicans in anger that the system is trying to take away the ball as soon as the underdogs are the ones exploiting its flaws.

(We want to know what Gamestop CFO Jim Bell thinks about all this. He used to be a Naval Flight Officer leading squadron and flight operations in the US Navy from 1989 to 1998, so it's quite possible he saw action in the Gulf - he's presumably quite used to adrenaline. The price will crash eventually – that’s the whole point of a short squeeze – but the “normal” price it settles at is going to be well north of the $4 it was trading at, offering real possibilities for raising fresh finance to fund a turnaround. Amusingly, the only recent release on the company's IR page is about its top-100 place on the LGBTQ workplace equality index.)

Lessons for financial execs (however it ends up unwinding)

First, abstract accounting and investment structures can turn out to matter a huge amount in the real world. None of you are likely to face a short squeeze. But working with a PE firm that’s got its incentive structures wrong, for example, can be a nightmare. A really startling proportion of management equity packages (even in good times) never end up paying out. That’s demotivating and hurts the ability of the company to deliver. Finding backers with a really good sense of the rewards for solid performance, not accounting tweaks, is a good tip. You don't want the GameStop kind of nonsense derailing your own focus.

Second, play a long game. The best PE houses (and management teams) show enlightened self-interest. If you squeeze a business until the pips squeak and engineer short-term cashflows at the expense of long-term viability, you might do OK in your next reported numbers. But smart buyers will spot what you’ve done and walk away. The best investors create viable long-term strategies and leave clear opportunities on the table for the next buyer. They get better multiples – and a rep for being trustworthy. GameStop management was under pressure, but eventually saw that the long game - and the talent to help execute it - was Ryan Cohen's turnaround plan. That's not the only reason the shorts are hurting, but it shows there's real value in thinking strategically.

Third, motivation matters. Melvin Capital screwed up its short position and was reckless in pursuit of finishing off a business it thought was doomed. Call us fuzzy-headed do-gooders, but that’s a lousy motivation for any decision. That’s not to say as a finance executive you can’t be realistic. One of the best CFOs we know launched a PE fund specifically to buy dying companies but manage their decline responsibly (and profitably).

It’s the 21st century. Purpose and motive matter to people. Assume everything you do will be seen. Assume your motivations will always be questioned. Ask yourself: what might employees, customers, regulators and shareholders say about what we’re doing and why? None of you reading this need much encouragement to play a straight bat and be positive in your management approach. What Gamestop tells us, in part, is that negative motivations can end up becoming a lightning rod for simmering discontent. What started out as a cynical, if realistic, investment strategy has ended up being a catalyst for a much bigger conversation about wealth, power and Wall Street excess.

We’ve seen it before. When Sir Philip Green cynically offloaded BHS, no-one was fooled. Result? The outcry resulted in him having to pump £363m into the retailer’s pension fund. Ultimately, the difference between Melvin Capital and /wsb isn’t that one side is manipulating the system and the other isn’t – they’re both battling with abstract concepts, they both want to get rich without actually making anything. No, the real difference is that one believes in the death of a business and the other wants to give it a chance. Motivation matters.

Addendum (30th Jan)... We made it to the weekend with GameStop shares traing at $313 in after hours trading. This past fortnight has turned /wallstreetbets from a community of bad taste gamblers looking to get rich or die trying, into frontline soldiers in the fight against Big Money. (Generalisation of any community is so gauche. It's still a very diverse bunch, from semi-pro hedge-fund types to - lately - social justice warriors sticking it to the man.) There is still a massive amount of short interest stuck in GameStop, which the share and call holders think can still propel the shares to four-figure levels. But the systemic problems that have caused this and other "meme stocks" to become restricted for traders are fascinating for finance execs, even if you're not in a quoted business. This thread from Twitter is a great primer on settlement plumbing and how it can go horribly wrong, for example. But the whole farrago is going to contain lots of lessons in multiple dimensions. It's a once-in-a-decade fritz rather than a seismic shift. But plenty of people will be working on how to make sure it doesn't happen again.