Posts Tagged ‘principle agent dilemma’

CEO Pay

Thursday, July 14th, 2016

Dear Friends,

It seems to me, a painter who charged for paint but used white wash, a drywaller who put up cardboard instead of sheetrock and a paver who used clay slurry instead of asphalt, would not deserve a huge bonus, but that is exactly what our CEOs do… and get. The difference in treatment for the new class and the rest of us is as stark as it is baffling. You would think people would start a rumpus over it. Instead, we take it, doing our best at our job and settle for shoddy workmanship from the new class. Meanwhile they demand us to deliver excellent quality at high rates of productivity for ever lower wages. Our economy, wages and standard of living corrodes every day for it. Today the new class is fighting an undeclared war against the hoi polloi. So much so that now we live in the age of the principle agent dilemma.

Our businesses have become so politicized they no longer function as profit making enterprises but lackeys of the progressives. Examples like Target are glaring. Target has decided to poke it’s customers in the eye with such absurdities as allowing men into the woman’s bathroom. On the face of it that decision alienates customers, corrodes the value of the shareholders and puts employees jobs at risk. The decision to follow a political regime changes Target from a retailer that provides value to customers, jobs for employees and returns on investment for shareholders, is a form of corporate suicide. The CEO however will not suffer for his decision, there will be no negative consequences for him, but the fallout for everyone else will be disastrous. From children being abused in the bathroom to shareholders loosing their hard earned money, the rest of us will be on the loosing side of that gambit. If Target goes belly up from that policy, the CEO will still get his bonus, and another cushy job, where he can impose his absurd political beliefs on the rest of us, even as he has used cardboard in place of drywall.

Stock buybacks is another example of how the new class embezzles money from shareholders. Stock buybacks, the main reason the stock market has risen to record highs, provide no real return to shareholders but instead corrodes the actual value of their stock. The new class borrow money against the real value of the company, diminishing that value, then buy it’s own stock artificially increasing the stock price while eroding it’s actual value, because that money is not used to buy the means of production so the company can be more profitable in the future, nor is it used to expand territory, or integrate with it’s suppliers or retailers to provide a basis for future profit growth. All a stock buyback does is make a short term stock price rise, in the absence of future profit potential, so the upper management, the new class, can get huge bonuses for that price increase. In other words, they use clay slurry instead of asphalt, the moment it rains the reality of what they have done will become apparent.

The new class is in favor of any and every regulation that comes down the pike. Regulations make the job of a CEO much easier. While that statement may seem counter intuitive it is truth incarnate. Regulations are easy for a large firm to follow, with their armies of new class lawyers and deep pockets to meet them, regulations are death for small businesses that compete with large corporations. To paraphrase Milton Friedman… If a CEO faces competition from a small business that makes a better product at a lower price point, that CEO can lower prices and increase quality, which both lowers his bonuses and makes her work harder, or they can go to their trapped regulators and get the small business shut down. Obviously, as history shows, they will go to government to stifle competition. In doing so they crush innovation, the lifeblood of a market economy and drive down wages by lowering demand for labor. It is almost like they are using white wash instead of paint.

We pay top dollar to our principles for inferior work. Every day the new class is living the principle agent dilemma everywhere we look. They politicize their firms, they destroy value and stifle innovation, all to the very real detriment of everyone else. The new class is the agent and the rest of us are the principles. We own companies when we have IRAs and we are the citizens of government, we are the principles, the new class, CEOs, lawyers, journalists, bureaucrats, teachers, politicians, professors, etc… are our agents. They are supposed to work for us. The trouble is, the agent will abuse his position for personal gain all day long, if they can get away with it. Many people do raise a commotion, but in the end only empower the new class to further abuse their positions, because the new class channels that anger to increasing their power as our agents. Regulation is increased, journalism veers decidedly leftist, political correctness becomes ever more ingrained and our liberty is washed away by it. The problem starts and ends in our colleges and universities where our children are indoctrinated into the new class mindset. It is past time to wrest our education system from Marxists and progressives and instead teach common sense, work ethic and basic logic.

Sincerely,

John Pepin

Stupid Capitalism

Tuesday, June 16th, 2015

Dear Friends,

It seems to me, when a company makes it difficult to purchase their services or products, it is clear those that run the company are either stupid or want it to go bankrupt. AT&T is one example. I challenge you to call the 800 number they advertise and purchase new service. After an hour or so in the voice response maze, with no way to talk to a human being, out of frustration you and most people, will give up and buy the services of a competitor. Companies that make it nearly impossible to purchase their products and services are not only abusing the customer and their employees but the shareholders as well. This is another example of the principle agent dilemma. Sadly, AT&T is not the only company that does this.

People work hard for their money, those that forgo instant gratification to put some away and invest in companies like AT&T, reasonably seek a return on their hard earned money. Those who run the companies however, look to maximize instant profits, (which maximize the bonuses of upper management, (the new class)), at the cost to the shareholders, (the bourgeois). In this case the virtuous behavior of the shareholders is rewarded with the villainy of their agents. AT&T is no longer the company it once was, perhaps a bit of history would help to enlighten the reader of how pernicious the incentives are for the new class.

In 1984 Judge Greene broke up the Phone company, (AT&T and Western Electric) into the “Baby Bells” as well as AT&T. The Baby bells took over the plant, Central offices, pole lines etc… while AT&T got the most profitable lines of business, Telephone sets, Business telephone systems, bell labs, long distance and the burgeoning computer end of the business. AT&T was also offered the Internet, which the new class that manage the business flatly refused. Management decided that while all the lines of business were profitable, long distance was the most profitable and required the least employees, so they began laying off their employees and shutting down every other line of business to focus on the highly profitable long distance. Back then it cost as much as fifty cents a minute to make a long distance call!

They got out of computers just at the start of the computer revolution, forgoing the tremendous profits they could have had, they flushed the telephone set business down the toilet leaving that line of business to foreign competitors, they mismanaged Bell Labs and walked away from the potentially highly profitable business of telephone systems. They laid off all their employees in those lines of business and gave themselves huge bonuses for it. At every turn they heartlessly eliminated jobs to cut the cost of doing business as they eliminated lines of business. The result? Once AT&T faced competition from Sprint, MCI and a host of others, the competition ruthlessly drove down the profitability of long distance to rock bottom driving AT&T out of business. The employees lost their jobs and the shareholders were ruined. Upper management however got golden parachutes and landed on their feet. The name AT&T was bought by a baby bell, Southern Bell, or SBC.

At one time Verizon offered a product called ISDN. It predated modern asynchronous DSL. It was only marginally profitable however, so upper management decided they didn’t want to sell it, preferring to sell the more profitable T1 service, so they made it hard to get and put in intentional problems making the service difficult to install. Today, it would seem, the same mindset prevails at the upper echelons of AT&T. They are not alone in the short sighted, company ruining, group think, Fairpoint is leading the charge to flush out marginally profitable lines of business. Residential phone service is considered a looser by those managers who seek huge profits without any employees. Maybe that is why they they make it so difficult to purchase their services and refuse to offer services people are knocking down the door to buy.

We all know the effect of the Internet, in fact, you are reading this article on the Internet. For the internet to work however there must be a high speed access to as many households as possible. The demand for high speed access is stupendous and is growing. Some claim over the air is the answer, but anyone who knows the limitations of radio, know that will only be a stop gap measure. Fiber to the premises is the product that will eventually win out. Verizon offers fiber to the premises in a few places and the product is amazing. AT&T refuses to place the fiber necessary to implement the product however, and is abandoning that product, (and the profits) to it’s competitors, as is Fairpoint and a host of other baby bells.

Here is where flushing marginally profitable lines of business is absurd, wire line telephone services are an in to the customer who seeks high speed internet service. Such services as wire line could be considered a loss leader… something a firm sells at a loss, to get customers to buy more profitable products. A lumber store might sell two by fours at a loss to pull in home builders who will later buy the more profitable windows and doors. Plain old telephone service, (POTS), could be that loss leader, pulling in customers who will later purchase fiber to the premises. Those who run companies like AT&T, Fairpoint and other baby bells don’t see it that way. Instead of building for the future, and playing to win, they are playing to lose. Albeit, to lose as slowly as possible, but when you play to loose the loss is guaranteed. But don’t worry, those that ruin the firm will land on their feet, as they always do, those that will take it on the chin are the employees, customers and especially the shareholders… as we always do.

Sincerely,

John Pepin

Billion Dollar Business Idea

Thursday, May 28th, 2015

Dear Friends,

It seems to me, a smart business idea that could net someone millions, and perhaps billions, is a website that reads and posts a simple to read synopsis of every shareholder’s report, briefly describing any changes the board wants to make, the likely consequences to the company and profits short and long term of those changes, an easy to read and understand report on any election to the board of trustees regarding their background, philosophy of corporate governance and work history, those synopsis and reports would be written for every firm with over one hundred million in gross revenue, and for a nominal fee that synopsis could be read by any shareholder of those companies. Companies that are ethical would offer to pay for the service for their shareholders. To get that done, such a company needs to become well known, create simple to read, correct and understandable reports and synopsis, as well as the intellectual capital to make it work. The potential earnings of such a company are staggering.

If there was such a company it could be a paradigm shift in the principle agent relationship. Today the agents have all the power. They send shareholders a several hundred page document that we are supposed to read and understand, that is in arcane language, redundant and actually says nothing of any import pertaining to the question they want us to vote on. That paradigm has created a lop sided power relationship between the principles and agents. That lop sided power in the relationship has allowed many companies to be run against the shareholder’s interests and have enabled senior management to get an out sized portion of the profits. I mean really, what employee is worth tens of millions of dollars, while running a company into the ground?

Empowering the principles to over see the agents can only lead to protecting the principle’s interest and limit the power of the agents to abuse their position. The power differential in the principle agent relationship has been used for over a century to enrich the senior management at cost to the shareholders and customers. Examples abound where shareholder profits and wealth have been undermined by management. One famous case was when J D Rockefeller bought an iron company, converted it into a publicly traded company, sold the shares for double what he paid, and remained as the CEO, reaping even more profit at the expense of the shareholder chumps.

Such a rebalancing of the principle agent relationship would create better run companies that would have a better relationship with their customers. Everyone is self interested, which is to say we all seek to maximize our returns on our investments. Economists call human beings rational maximizers. Clearly, since we are all self interested, if given actionable knowledge, we would seek to increase the longevity of our assets, seek long term profits instead of short term gain, provide excellent quality service and products to our customers while ensuring the company’s business model is consistent with the times. In short, instead of our agents working under pernicious incentives, we could return the entrepreneurial ethos to businesses.

If the principle’s interests are protected and the companies themselves are better run, the macro economy will improve, by potentially starting a new wave of Schumptarian economic expansion. Schumpeter coined the term, “Creative Destruction,” to explain the macro business cycle. In it, he posited… a new idea that improves efficiency in management, production or product, starts the business cycle. In the creative part of the cycle, as the new idea is implemented, the macro economy grows at a rapid pace. Once the idea is mostly implemented and the gains have been mined out, the old firms that have become outdated go belly up, ushering in the destruction portion of the business cycle, (recession). The recession destroys inefficient firms, freeing up capital, space and equipment for the next entrepreneur to begin the cycle again.

When a new firm is started, the more disruption it creates the more profit there is to be had, especially in the financial services sphere, where the sector is awash with other people’s money. As in any innovative idea that is disruptive, starting a business that reads and produces synopsis of every firm’s shareholder reports, board of trustee elections and board of trustee requests, would be a sea change in the way shareholders get information about the firms they own, by leveling the information landscape. In and of itself such a firm would start the creative cycle. Such a firm would need a great deal of startup capital to hire the necessary lawyers, MBAs and knowledge base to make such reports, and do it inside the regulatory framework that has been set up by the agents to protect their interests, or to change the regulatory environment if needed. The initial cost would be high, but the profit over the long term, the benefit to shareholders and the economy at large, would be tremendous.

Sincerely,

John Pepin

The Pernicious Effect of the Principle Agent Dilemma.

Thursday, May 21st, 2015

Dear Friends,

It seems to me, the way business is done today flies in the face of true capitalism, undermines our standard of living and creates a false idea of what capitalism is. The modern paradigm where firms are owned by stockholders and run by the new class, has created a set of incentives that inevitably lead a business to maximize profits, by making chumps of the shareholders, lowering the wages of employees, poking the customers in the eye at every chance, enriching the new class out of proportion to their worth… while at the same time, providing as little actual value as possible for those profits. The new class has embraced the socialist system for corporate governance. This has led people to negatively associate capitalism with all those bad things, which is a total perversion of real capitalism, such low esteem for capitalism that is produced by the modern corruption of the capitalist ideal can only lead to a lower standard of living, now and in the future.

Economists call this predicament the Principle Agent Dilemma. The shareholders are the principles and the new class CEOs, and management are the agents. In the modern system of corporate governance, the agents have no real oversight by their employers, the shareholders, and so they serve themselves at the cost to shareholders, customers and labor. That is the crux of the dilemma. The principles are not served by the agents but in fact the value of the shareholder’s investment is eroded by the self serving new class that run businesses today.

Examples of the new class poking their own customers in the eye are legion. Walmart has ordered their employees not to say Merry Christmas during the Christmas season, to placate people who hate their business anyway, despite the fact the overwhelming majority of their customers are Christians. United airlines incompetency is legendary and is magnified by the rudeness of their service desk. As I discovered first hand on a recent trip. These are just two examples of the many that we find in our own lives.

A cursory look at the way profits are distributed in a modern corporation is telling of the incentives of those who run them. The shareholders get a pittance for their investment of hard earned dollars, while the CEO gets rich running the company into the ground. This is one of the reasons investors eschew dividends for growth. They understand that the CEO and top management will take the lion’s share of the profits as wages, stock options and bonuses, while paying out nothing to those who own the company… the shareholders, which makes the only way to get a return on investment, to invest for the short term, since the company will be run into the ground eventually by the new class, making dividend investing a loosing proposition, since that is a long term investment strategy.

Maximizing profits today while minimizing value is the name of the game. Companies run by the new class seek to provide as little value to the customers as possible, even as they poke the customers in the eye, while raiding the wages of the employees. Employees are not seen as assets but as liabilities and are treated as such. This creates incentives for employees to job jump, ignore customer needs, and have no emotional investment in the company they work for. Today it is common knowledge, that a kid entering the job market will work for perhaps a dozen firms in his or her lifetime, because there are no long term jobs out there where the company provides a pension to those employees who have been with he company for decades. The new class run companies wage war against their employees, stockholders and customers, to maximize the CEO’s profits over the short term.

If you look at the old way businesses were run, and today where companies are run by their founders, entrepreneurs, and even a few shareholder companies where the CEO has an investment in the company, the paradigm is far different. Almost all companies in business today were started by entrepreneurs, once the entrepreneur became too old, infirm, was pushed out or needed to cash out, the business was moved to the modern corporate system, which as often as not, bankrupted the business. Not because of a flawed business model, changing economic circumstances or recession, but due to the malfeasance of the agents. Apple is one such example.

Entrepreneurs provide maximum value to the customers, adore the business and cherish their employees, while a CEO doesn’t have any investment at all, not even an emotional one. That was the business model of the eighteen hundreds and still is today in a few companies. IBM was called the worst run company in the world, when Watson ran it, he valued his customers, and laborers and they all knew it. When the new class took it over they ran it into the ground, almost bankrupting it at a time when the digital revolution was at full swing, the employees that had been cherished by Watson and had terrific esprit de corps under him, are now miserable and hate their jobs, because it is made clear they are not valued, but are mere temps, to be replaced the moment a cheaper employee can be found. Their wages are under assault even as the new class management are enriched at cost to the shareholders. Now that IBM has abandoned their core business for cloud computing the end of that esteemed fixture of our economy is at hand.

These things explain why people increasingly are turning away from capitalism to socialism. As your wages are lowered and your job security is eroded, the value of your savings is stolen and the opportunities for your children evaporate, it is human nature to become angry at what you see as capitalism. But it is not capitalism that is the villain, it is the new class’ predilection for egoism and socialism, that is the real culprit. The new class in government pass regulations enabling more corporate malfeasance, by protecting giant companies from competition from entrepreneurs, who are then enriched by the new class agents who run those rising monopolies, creating a feedback loop of corruption, lower standard of living for most people and a hatred of the capitalist system. All of which explains that the principle agent dilemma is far more pernicious than most people realize.

Sincerely,

John Pepin

The Insanity of the New Class…

Thursday, February 5th, 2015

Dear Friends,

It seems to me, Obama is channeling Marx in his latest diatribe against technological growth. Along with the US President, the elite in the media chant the absurdity… that productivity innovations are bad. On Bloomberg radio yesterday, they were interviewing some CEO and the questions constantly turned to how the advance in technology is damaging the middle class, and that the reason wages are stagnant and dropping is because of the advances in productivity. The theme is that labor saving wipes out labor. To someone who is ignorant about economics that might sound logical, but it is in fact spurious logic… an argument made to sound logical but is in fact illogical and used to fool the listener. It is critically important to understand the truth behind this lie. Technological driven productivity gains are critical to an increasing standard of living. Moreover, the reason wages are stagnant and jobs are scarce in the US and around the world is that regulatory constraints on our economies have reached critical mass, and are melting down our economies.

Marx basic theme in his Manifesto was that the mechanical loom was going to drive everyone out of work. He said, “As the forest of arms looking for work grows ever thicker, while the arms themselves grow ever thinner…” Meaning the mechanical loom made the production of cloth so much less labor intensive, and most people worked in the textile industry at the time, mass starvation was just around the corner. That is essentially the exact argument Obama made about ATMs. Of course Marx was proven wrong in his assessment just as Obama is in his. The mechanical loom allowed the price of a wool coat to drop, (the evil deflation), so that the average worker could afford one! Imagine, the mechanical loom allowed a mere plebeian to wear a warm coat! Horrors! He didn’t have to stuff his shirt with straw to keep warm he could wear a warm coat!

The Bloomberg interviewer argued against the Schumpeter model, by saying that those workers in the buggy whip industry got jobs in Ford’s factories making much better wages with less taxing labor, but today, there are no new jobs for the laid off workers to go to. An ignorant argument at best and spurious at worst. The reason that wages are stagnant is that government policies, policies designed to protect the politically favored, are destroying the creation of small businesses. For the first time in US history the creation of small businesses is NEGATIVE!!! Let that sink in a moment, there are more small businesses going bankrupt… than are being created! Creative destruction needs, as a fundamental input, new businesses and new business models. Regulation, taxation and the lack of standards, have so undermined that fundamental aspect of a growing economy that small business creation is now negative.

There was a story in the media the other day about some kids walking from house to house in New Jersey shoveling driveways for spending money. I did that when I was a kid. It is a great way for children and young people to learn that labor creates wealth. In a market system that is an important lesson. In America today however, the police were called, and the kids counter revolutionary snow shoveling business was shut down by the state. There was another story recently about some kids setting up a lemonade stand, they were also shut down by the government, running afoul of some regulation. In a society where even children cannot shovel a driveway or set up a lemonade stand, without facing daunting regulation and a police investigation, how can any business get started?

Without new businesses, creative destruction is destroyed. Giant firms are not entrepreneurial, that is a basic law of economics. Large corporations are run by the new class, for the new class, and against the interests of employees, customers and shareholders. The very definition of the principle agent dilemma. Anything that threatens the status quo is to be feared. Those at the top of large corporations always pay lip service to entrepreneurial ideas, but when faced with the choice of striking out on a new path or staying on the old one, unless there is a large bonus in it for them, the old one is always preferred. That is why new ideas are implemented by entrepreneurial small businesses. If those new ideas are profitable those new small businesses grow to large ones and wealth is created, if not, the risk taker gets a haircut. That is why Capital expenditure is so low while mergers and acquisitions are so high.

The new class progressives have effectively wrested the economy from the Bourgeois, (shareholders and entrepreneurs). Large corporations are able to line the pockets of politicians to protect their businesses from competition. When they do face competition their response is telling of their utter incompetence. Blockbuster is a perfect example of this in action. When faced with competitors who provided a better product at a lower price point, Blockbuster would have preferred to regulate their competition out of business, but couldn’t because of public scrutiny, so they did the next best thing, they raised their prices and lowered the quality of their product… to maintain their profit margin. The new class executives got their bonuses. Of course in doing so, they ignored the basic mantra of any and all businesses, provide value to the customers else they will shop elsewhere. So, Blockbuster went bankrupt, wiping out the investments of the shareholders, screwing their employees and abandoning their customers. The only ones who made out were the new class executives who got their bonuses and new executive jobs.

It isn’t creative destruction that is broken, nor is it the market system, it is the nonsense of the new class, in academia, politics and business, that has broken our economy. Regulation, taxation and cronyism have combined to eliminate small business start ups. So much so that the creation of small businesses has turned negative. Creative destruction requires small businesses to implement the new ideas that every economy, everywhere need, to grow the standard of living of the people. The new class run the businesses they have wrested from the owners, for themselves, at cost to every other element of our population. When faced with competition, lowering price and raising quality are not even a consideration, raising prices and lowering quality are the norm now, to maintain the bonuses of the new class. Deflation, the normal course of price evolution in a market economy is attacked as evil, so government can continue it’s profligate spending, to hide the outcomes of their policies and their cronyism. The “journalists” at Bloomberg are inculcated in the new class way of thinking, as are the “journalists” of every other major news outlet, and so we get one unanimous voice, all agreeing creative destruction is dead and socialism is the way forward… forward into slavery. Just as Joesph Schumpeter predicted.

Sincerely,

John Pepin

The Next Killer App…

Thursday, June 6th, 2013

Dear Friends,

It seems to me, there is a huge opportunity for economic innovation. This opportunity is not only game changing, in the way it could lower the overall cost to run a company, but the efficiency that would be gained in reacting to new opportunities, agility that could enable much larger companies to have such nimbleness, would increase the longevity and profitability of any company. This game changing, fountain of youth for corporations, could stabilize and drive stock markets to paying a larger percentage of profits out as dividends, instead of bonuses. This innovation stands at the very edge, within our reach, but at the very limit of our grasp… it is, innovation in corporate governance. It would generate as much growth as the internal combustion engine or the transistor.

There is not a one who is reading this, who has not heard of a family business or solely owned company that was sold to Wall Street, and shortly after went into bankruptcy. Stories abound of this business or that firm who made the best wing wang there ever was. The owners were called stupid and the management style of the founders was universally criticized. Then, the owner retired or died, and the company went public. The buyers immediately take out a huge loan in the business name and give them selves a fat bonus. Some then move directly on, leaving the business and stockholders, with the debt for their bonus. A few years later, struggling to cover the loan debt for the bonuses, the company fails, the stockholders loose their hard earned money and the workers loose their jobs.

A few of the companies that come to mind, IBM, Apple, Digital, and Orrick, along with thousands of others. They were run by families and entrepreneurs. The founders were ridiculed by the apparatchiks of finance and business, all of the firms were profitable and grew extrinsically, by getting new customers and intrinsically, by meeting those customer’s needs more efficiently. When each of those companies was sold to Wall Street they were run into the ground. In the case of Apple, when the founder came back, he took the company from bankruptcy to the most valuable company in the World, IBM only just survived total collapse, Digital is history.

Since this paradigm plays out over and over in the corporate cycle it would seem a logical place for innovation. The underlying problem is… the principle agent dilemma. The principles, the stockholders, own the company, the agents, the managers of the company, are supposed to work in the agent/owner’s, the stockholder’s, interests. They often don’t. The individual stockholder is limited in his or her knowledge of the company, how it is run, the direction the senior management is taking etc… and thus his or her power to protect their own interests. Due, legitimately, for protection of the company’s assets, this necessarially sets up a further problem… asynchronous knowledge.

Even if the individual stockholder has such knowledge and seeks to make change he or she sees fit, it is exceedingly difficult because each of their voices is very small, due to the widely distributed ownership. Unless a sufficiently large group of them get together, their voices are irrelevant. Moreover, the system as it now exists is set up so that a small group of people can give themselves fat bonuses, at someone else’s expense. The incentives in this system, are for those that are profiting by it to keep it in place, at all costs.

The next clear opportunity in today’s system, ripe for innovation, is how to run the company, after it is sold into the public market. Assuming the company has not been looted because of some other new innovation in corporate governance, or even if it has… the people who take over at the top always come in with big ideas. Well, I am a big believer in big ideas, but they are only big ideas if you yourself are willing to put your own hide at risk, like the founders did. When gambling with someone else’s money one’s risk tolerance goes up considerably. At the same time as big ideas are implemented, rigid structures are put in place, to shore up the sloppy ones that existed before. The one two punch is devastating to the corporate ecosystem, and in the case of where the firm was looted beforehand and has a high debt load, the third punch is a sure knockout blow.

This problem translates into lost jobs, lost opportunities, and the lost earned wages that make up most of people’s retirement funds. Everyone in corporate governance knows the problems, but no one seems to be fond of catching the wrath of the power brokers, who get fat from the system. Remember, under a truly capitalist system, anyone who is making overly high profits quickly meets equally high competition for those profits. In cases where this does not happen, it is usually government regulation that stands in the way. Regulation that was supposed to fix some other problem, that was caused by other regulation that was supposed to fix some other problem, and on and on… Adding a regulatory element to the question. Perhaps what is needed, is not more regulation but… a company constitution for new firms? What do you think it should say?

Sincerely,

John Pepin

Regulation and the Principle Agent Dilemma

Thursday, August 25th, 2011

Dear Friends,

It seems to me that Chief Executive Officers, COEs, of large corporations have many of the privileges as owners of large companies, but have none of the responsibilities. As we see empirically with teenagers, people who are given freedom, without responsibility, often run amok. Perhaps this is a large part of why the corporate structure of today’s firms show such a divergence from the will of the principles, (the stock holders). This is often described as the “Principle/Agent dilemma.” This question and the questions it brings up have great import to the economic well being of humanity.

Of course there are some responsibilities for a CEO but they pale in comparison to that of an owner. An owner is actually personally responsible for his or her company. But the CEO has many layers of responsible people under him or her. They sometimes get responsibility when a corporation is caught,. Enron and MCI are the only two I can think of readily, where the CEO was held responsible. But, wait, the CEO of MCI was the owner, and the CEO of Enron was also an owner… Goldman or JP Morgan?

The modern CEO, more often than not, is paid far higher than most owners… historically. So we can safely say some CEOs are paid more, as a percent of profit, then some owners. With higher pay and less personal responsibility, the modern CEO, (agent) has less incentive to meet the needs of the stockholders (principle). As the group of CEOs that fall within the some that make more as a percentage of profits than an owner then we can safely say, that the interests that those corporations are governed for, will increasingly be for the agents and not the principles. In fact the very actuality of a CEO getting paid more than an owner of a similar company in size, scope, profits and industry, prove that that company, at least, is governed in the interests of the agents not the principles.

Government could address this problem and many others by adopting a new paradigm for regulation. Take for example the modern incarnation of regulation, “A minimum 5/8 inch nylon braded rope must be used to lash. The lashing must be 6 turns per linear foot, with 2 inch spacing…” Regulated to the minutest detail. Now I have no problem with government researching best practices but regulating to the nth detail is absurd. One problem with it is It stifles innovation for better practices.

Maybe a better way would be to regulate outcomes. Instead of regulating how a thing is done regulate the results of it’s manufacture. Take the rigging industry. There is a common set of safety standards and well researched levels of injuries. We can say that there is a background level of injuries in any industry. This level of background of injuries would form the basis of outcome based regulation. Lets say for arguments sake, that there are 10 major injuries per 10,000 hours worked in Abc industry with 1 death. If we base regulation on an injury rate of 1/10,000 and regulate Abc industry accordingly, then if the rate of injuries exceeds that rate then the industry is drastically penalized.

But don’t fine the shareholders, fine the CEO and board of directors, threaten the top corporate brass with jail. If the injury rate goes up beyond a certain set point then the CEO would be held personally responsible for the increase in injuries. This is the only way to back off on some safety regulation. Otherwise, people being people, safety would immediately slack off and the rate of industrial accidents would skyrocket. But if outcome based regulation were enacted, first, (it exists in a lesser form today), and advertised it, the background rate of industrial accidents could be lowered while the productivity of our industries would be raised.

With the positive externality of better corporate governance. The potential of lower accident rates, or any other rate that regulation seeks to mitigate, allowing a greater percent of the workforce to remain productive throughout their lifetimes, and a better handle on the corporate principle agent dilemma make this an idea who’s time has come. Let us not forget that as the productivity of a society grows so does it’s innate wealth. No matter where you are on the societal ladder if the whole ladder goes up you rise too.

International Banking Regulation

Wednesday, January 27th, 2010

Dear Friends,

It seems to me that to call for world regulation of banks, as Obama and Gordon Brown have, opens Pandora’s Box. Once the UN or other such governing agency gets it’s claws into the banking industry… the bribes, graft and kick backs will flow like a mighty river. A cataract capable of filling the wheels of civilization with debris.

Everyone knows that people are not good police of themselves. Else why spend the money on a judiciary or even traffic police. They would be completely redundant. But we do need police and we do need a judiciary. Mankind, as Carneades said, Imposed a set of laws and moors on itself out of necessity. Because people, being like animals, each seeking his or her own good, make true justice impossible. For a man to be truly just he must do damage to his own self interest…

So when taken to it’s logical conclusion if people in general are poor police of themselves…And the Elite are people. Then doesn’t it follow that the Elite, (Politicians who hold office and regulators), are poor police of themselves as well? But they have no real monitor. The fact that they effectively are not policed at all escapes most people.

Occasionally a politician is caught at some felony. There is a firestorm of media and then… the politician usually keeps his or her job. In fact, often they are given a raise and bonus. Tim Giethner, Charlie Rangel and taxes come to mind, this tax season. There are no negative consequences for politicians in the US who are caught doing something the average citizen would go to jail for. What are the incentives here?

Take it to a higher level… The UN. Totally un policed. No actual or proposed oversight. The Oil for food fiasco would have sent business men to jail for years and years. Not one corrupt UN executive or bureaucrat even lost their job.

Today bank coordination is done by the G 20 nations. But what do you think will happen if the utterly corrupt UN bureaucrats get the ability to regulate every bank in the world? Knowing that even if they are caught red handed in some criminal enterprise they won’t even loose their job? I’m thinking… Papa Smurf is wise enough to know the answer.

How would your company treat you if you were siphoning funds from a humanitarian effort of your companies into your own pockets. And in doing so you enabled a rival company to get information about your company. Most businesses would frown on this type of behavior. The UN has no problem. I wonder how many Oil For Foods are going on right now? And how many have gone on that we will never know about? This is an example of an agent not acting on behalf of the principle.

The answer to the principle agent dilemma, as it pertains to government, is the NUMA . The NUMA would set a group of Elite against the other group of Elite. As Madison said in the Federalist Papers, faction must be pitted against faction. He likened liberty to faction as air to fire. But he didn’t advocate removing liberty (air) to eradicate faction (fire). He advocated that to keep faction weak, keep them small and set them against each other. Like starting backfires. The NUMA is a vehicle to go there. To set the Elite in the NUMA against the Elite that make our law, regulate our industries, and police our behavior, would force all the Elite to follow the laws… as they are written.

Forcing the Elite to follow the laws as we are forced to do would be a great incentive for them to read some of what they are enacting. Perhaps if they read some of what they vote on they might not pass such foolish laws. Laws that they have no fear of being held to. Ignorance is no excuse under the law, (unless you write law, regulate law or adjudicate law).

Today, the more corrupt you prove yourself to be the more banks you get to regulate… a win win.