The Counterfactual Theory of Value

The Labor Theory of Value argues that the value of a product or a service is determined by the amount of labor required to produce it. If so, something that takes 100 hours to produce is worth 10x more than something that takes 10 hours.

One issue with the Labor Theory is it often causes people to work much harder than they need to, out of a belief that hard work is inherently good. But here, I’d like to answer a conundrum: In startups, why do the founders receive such a disproportionate percentage of equity? The CEO might own 40% of the company, while no employee owns more than 2%. It’s not that the CEO worked harder. And yes, many entrepreneurs argue that they’re being compensated for taking a risk.

But Johnathan Bi recently asked me: “What if they’re compensated by a Counterfactual Theory of Value?”

That is, what if pay is determined by asking: “How much would this company be worth without this individual?” The lower the valuation, the higher their pay should be — no matter how hard they work.

Baseball managers use the Counterfactual Theory of Value all the time, using a statistic called “Wins Above Replacement.” It predicts how many more wins a player gives their team, compared to whoever would replace them.

Elon Musk provides another example. Today, Tesla is worth more than $1 trillion. Without his will and personality, Tesla probably wouldn’t exist. It certainly wouldn’t have such a cheap cost of capital and so many passionate brand advocates. If Elon resigned tomorrow, the company’s value would likely fall by hundreds of billions of dollars. Taken together, Musk is worth almost $300 billion because the counterfactual would be so different without him.

So when determining somebody’s economic value, ask yourself: “What’s the counterfactual?”

Cover Photo by Clark Young on Unsplash