I was a bit confused by the answer given in the CFAI and I hope someone would clarify.
Question 3, Reading 12, asks to identify and discuss two constraints on Morissons’ ability (my emphasis) to achieve their primary objectives using an ouright sale of MBI shares. I put this down for an answer:
Liquidity constraint: the family depends on divident income from MBI. The sale of the MBI will require them to find a substitute for the lost income stream in order to cover their daily expenses. 2. Tax contraint: an outright sale will trigger a large tax liability, considering that Morissons have 90% of their assets invested in MBI that has a tax cost basis of 0. The answer given by CFAI states these two: 1. Tax (which is more or less what I already wrote) 2. Mr. Morrison attachment to the company. I don’t really get what atatchment has to do with ability to decrease their risk and achieve diversification in a tax efficient manner. Can someone please explain this?
you are attached to the company. so even if the company stock goes down - you are unwilling to let go your position.
emotional biases - endowment (you are the company so the stock is you), loss aversion, status quo, regret aversion (If I sell the stock now, and it say rises soon after - I would lose the killing I might have made), (over) confidence the company will do well, hence this loss position is a temporary one…
all of these prevent the sale of the company stock.
Even if the stock were doing well - the realization that you are having most of your portfolio in one stock, hence you are undiversified - should have made you look elsewhere instead - get out of the concentrated stock position and buy into a more diversified portfolio.
The upshot is that you have to look at these answers as CFA Institute looks at them. You may not like it, but, frankly, who cares? If they say he’s attached to the company, he’s bloody well attached to the company. Read the answer and learn from it: that’s how CFA Institute looks at it.