Tuesday, June 23, 2015

Some Brief Thoughts on the Team Production Theory of the Corporation

I wanted to briefly react to Justin Fox's post on the team production theory of the firm. His contrast between the shareholder and team production view of the firm, and the recognition that the broad acceptance of the shareholder view of the firm is of recent vintage, provides a great short overview of the topic.

These are topics we spend a great deal of time on in my business ethics classes. The focus was on the stakeholder theory of the firm rather than the team production theory, but the idea that the shareholder value theory of the firm is not efficiency maximizing is a common element. There are very good reasons to think that the shareholder value theory of the firm fails to maximize value for any of the interested members of the firm, whether employees, customers, neighbors, or, at least in the very long run, shareholders.

My problem with these conceptualizations is that while the behavior of institutions like boards of directors does show that the interests of other stakeholders have some impact, this impact is generally fairly minor or lasts for only a short period. Doubtlessly, the period when norms involving strong stakeholder interests dominated in the immediate aftermath of WWII and the Great Depression involved great gains for corporations and widely held prosperity. But this period lasted for only a generation, the norms that held this consensus together quickly unraveled as those shaped by these experiences lost their influence. In the long run, formally and explicitly granted rights, such as those governing corporate control, will always win out against informal rights; no matter how effective those informal rights. Since shareholders are granted ultimate control they will always come out ahead in the long run, no matter how inefficient this outcome is.

No large organization can ever function effectively when control is vested in external elites who are not part of the day to day operation of that organization. The problem faced by business in the modern market economy has close parallels to the issues faced by aristocratic societies before democratization. When a group is run for the benefit of a few, no matter what norms seek to impose good behavior on them and how honestly they try to act for the betterment of the group, the reality is that their interests necessarily diverge from those of the other members of the organization. Elites try to make their interests appear invisible, either by claiming their interests are natural or identical to those of the organization they are influencing, but historically it has always been obvious that once their power is limited that their interests diverged sharply from the interests of others.

This is why I find the current property laws governing corporations so troubling. Similar to how aristocratic land ownership lent special privileges and influence to aristocrats under the ancien regime property rights concerning corporate property grant rights and privileges to those that own enough corporate property to exert control. They can circumvent campaign finance laws, speak with the corporations voice to claim broad support, and furthermore can protect themselves and their wealth and station through limited liability laws.

The solution to this isn't terribly difficult. It is simply to grant explicit and formal rights regarding control of the corporations they work for to labor as part of our laws governing corporations. Shareholders, can, and should, retain voting rights and rights regarding residual returns. But unless labor is granted an equal voice I do not see how any stable solution is possible to the problems of governing a corporation. While I admit this is radical the more I learn about business the more inescapable I find this conclusion; the same logic driving democratization of states ultimately holds for firms. I also see no reason to think this would deter investment, aside from an initial downward valuation as control premiums get wiped out, shareholders adjust to lower total returns, and shareholders overreact (yeah, this would be very costly short term, but so is democratization and since this is ultimately an adjustment of claims to wealth and income value is ultimately redistributed not destroyed). In the longer run, however, investors would continue to receive cash flows, incentives to create new businesses would increase since shareholder power would be diluted in more mature businesses, and incentives throughout large organizations would be improved as control comes to align more closely with the interests present in a corporation. But without this change, no matter what the normative appeal or positive benefit a different conception of the corporation has, I do not see how corporations will do anything in the long run but serve shareholder interests since their formal claims to control are given primacy and other claims have little force in law.*

* At least not beyond some minor rights at the margins. But other interests can hardly be said to have much in the way of rights governing control of a corporation in the US; other jurisdictions differ. There are also some situations where specific corporations have granted specific rights, or distributed stock in ways to give other stakeholder groups a capital stake, but these are exceptions to a general rule.

Sunday, June 21, 2015

The Taboo of Discussing Hours and the Alleged Skills Shortage

[Edit: Added links I meant to go with the original post}

In sales, an effective technique is to identify your prospect's pain point and to offer a solution to their problem. The idea is that while there can be multiple benefits your product offers getting someone to switch requires identifying a real problem that they currently have and fixing it.

So when economists question (I'm also reacting to Matthew Yglesias) why aren't we seeing wages go up among high skill workers if there is a skills shortage my thought is that maybe this is indicating that the pain point for high skill employees* isn't their wage level. Instead, my experiences with being in an MBA program and speaking with other people who would be considered high skilled is that generally the concern is with the long hours and level of commitment required. High skill employees are generally relatively satisfied with their income levels, their unfilled needs lie elsewhere.**

This is a major problem for employers since one of the main traits that employers are looking for is a willingness by the employee to be exploited. They tend to phrase this as a willingness to do what it takes, employees as family, a corporate culture where employees work hard and play hard, or "some overtime required," but the bottom line is that the employer expects the employee to be their dependent and to subordinate the employee's goals to the business's goals. Intense pressure to keep labor costs down, even if a business is incredibly profitable already, limits an employer's ability to differentiate itself by offering easy hours.

These limitations are reinforced by a set of beliefs which regards not wanting to take on additional work as laziness, an attitude of entitlement which regards the demands of an employment contract as being unlimited in return for a wage, and a general view that someone that objects to ever increasing demands on their time as an undesirable employee. By defining a good employee as one who does what it takes and making this a minimal qualification for most any high skill jobs employers render themselves unable to attract people talented on other dimensions, employers want employees that will let them run their business a certain way and put business priorities first and what employees really want is an employer that respects them and their priorities outside work; the goals of each group are mutually incompatible.

The result is a deeply dysfunctional labor market. How can the market price labor efficiently when an individual has no way of knowing how much labor they are selling in a given transaction? While high skill employees are confident that they can meet their minimum salary expectations, they find it much harder to get solid information on how much labor they are selling for this salary. Any source of interview advice will emphasize not asking about how long a workweek is or about vacation and leave policy; too many employers regard it as an automatic disqualification. Employers that are well staffed and don't require long hours are afraid to advertise it for fear of attracting the wrong sort of worker.*** Potential employees also know that employers advertising being one of "the best places to work in X" and to give good work life balance are suspect.**** With all other information sources regarding actual hours worked cut off employees are left trying to piece together the bits of information they can find to help them choose where they want to focus their job search. Problematic for trying to recruit based on the one dimensional measure of salary, one of the key beliefs among most job seekers is that a relatively higher salary for a similar position means more hours. Since this is rarely the pain point among high skilled individuals this means the price signal can't work; since a business won't make any firm statements regarding hours, much less a credible commitment to respect an employees time, the price signal just ends up signalling that a job has potentially undesirable characteristics as it does a higher willingness to pay for the same labor input. Among already employed skilled employees why should they take the risk of jumping to a new employer for a higher wage when their wage isn't their main problem? There is simply too much risk for a marginal 10 or 20% pay bump when what they really want is an extra week's vacation and a 40 hour work week so they can be in time for dinner while still making the same wage they currently are.

There are a number of other issues that I think are leading to broken labor markets. One additional point that I do want to briefly mention is that there is a disconnect between when employers talk about skills and much of what I see in the press. I haven't heard anything from businesses that makes me believe that there is a shortage of trained people with the desired skills, the problem arises from businesses wanting proven talent. This is highly problematic, individuals have no way to respond to these incentives and create additional supply since it requires that an individual gain experience from another employer; something that the other employer has an active interest in NOT providing to an employee who will leave in response to the incentives from another employer. There is no way for the market to respond since the source of supply, the competing employer, gains nothing from the transaction between the skilled employee and the new employer.

Tuesday, June 16, 2015

The Influence of Institutional Disparities on Bargaining Power Between Capital and Labor

Mark Thoma has an excellent column regarding rising inequality and the role that the relative bargaining power of workers and employers plays in this. I am in complete agreement as to his points and to his opinion that market power has not received enough attention.

I do want to drill down further regarding the concept of economic power. To understand the disparity in bargaining power we need to be aware of the institutions and norms which give rise to it. Our institutions and norms are simply not those of a world of "the textbook ideal of competitive markets." Instead our institutions have evolved in a direction that serves to greatly reduce the inherent organizational problems of capital without serving a similar role to reduce similar problems faced by labor. Our institutions make it easy for capital to organize itself in the form of corporations and contain elaborate protections to safeguard the rights of owners of capital against others claiming interests and rights in these corporations. Easily available information on the performance of capital investments similarly serve to reduce coordination and collective action problems among individuals who control capital.

Corporate law is the major culprit in this unequal institutionalization. It is obvious enough why early modern legislatures would have seen it necessary to grant very strong rights to capital in order to induce investors to take capital out of land and put it to more productive uses in the under-capitalized world of the time.* It is less obvious why this continues unremarked in market economies that are far from their agrarian past. The problems facing the modern world, and more narrowly modern businesses, are not those of capital scarcity. Sufficient capital exists to easily replicate any given concentration of property, plant, and equipment. What distinguishes businesses is the quality of their internal institutions, the policies, procedures, norms, knowledge, and other intangible qualities that separate the leaders of an industry from those with similar capital accumulations but lesser results.

In the kind of competition that determines success in modern business it seems obvious that the disproportionate rights granted to the capital interest in an organization leads to inefficient incentives. The intangible elements which lead to business success develop at least as much, if not more, out of the labor element of the productive process rather than from the capital investments of owners. Yet, control in the modern American corporation rests with owners and management rather than the lower levels of organizations where institutional norms generally develop and are then propagated within the organization.**

It is not difficult to imagine how laws governing corporations could be changed to more closely conform with the market ideal of equal individuals bargaining from legally equal positions of power freely and without coercion. To a certain extent, the Rhenish model of capitalism already does this, providing some proof on concept. A more complete system would be corporate law which explicitly recognized that employees contribute to an organization in ways not explicitly reimbursed through market income and required that corporations grant employee organizations explicit voting rights and control that grew along with a corporation. As an ideal end point a mature organization would completely extinguish its equity accounts returning capital to investors to be reinvested in new enterprises and leaving control entirely with employees. Current corporate law obviously doesn't allow for this, but it would much more closely resemble the market ideal of the textbooks where capital and labor are equal partners and where the market tends towards a normal rate of return leading investors o continuously seek new and innovative investments in search of higher returns to capital rather than accumulate massive capital stocks in mature blue chip companies.

A second notable institutional disparity is the set of institutions that have evolved explicitly to protect the rights of capital. These are both public institutions, such as the SEC, and private organizations such as the AICPA or the ratings agencies. By providing investors with high quality information, explicit sanctions against violating accepted practices, and making this information readily available these organizations contribute greatly to capital interests overcoming the collective action problems they would otherwise face.

This isn't to say that these organizations aren't enormously beneficial, but why do similar organizations not exist to help labor overcome similar problems? How much better would the labor market function if regular audits were conducted of labor practices and annual reports were made available regarding salary ranges for positions, actual hours worked by position and department, adherence to labor standards, and other characteristics of interest explicitly to labor? What if government organizations existed which regularly policed statements made by companies regarding their efforts to attract the labor the way that the SEC policies registrations of publicly traded corporations?

The disparities in access to information and the relative institutionalization of the interests of both capital and labor are stark and obvious if even a moment's thought is paid to them. Organizations such as labor unions or the NLRB are poor substitutes for the alphabet soup of organizations dedicated to assisting with the efficient allocation of capital. If our society placed a similar priority on the efficient allocation of labor how much more efficiently could our economy allocate resources and how much more closely would it conform to the textbook ideal? Instead, we put up with a situation where capital enjoys disproportionate influence and there is little discussion, or even recognition, that our society has granted capital these rights and that other sets of choices can be made.

Unless something is done at the basic level of institutions I do not see how our economy can be either equitable or efficient. The happy post war period rested on an exceptional set of circumstances, given the unequal distribution of rights in our economic system I do not see how it is possible to reach a stable equilibrium. Instead, the kinds of inefficient disparities we see today, and that we say at the turn of the 19th century, are what I see as the norm. Rights are too unequal for anything else to be the case.

Tuesday, April 28, 2015

Too Much Stuff Means There is a Distribution Problem

Business school has been making me think a great deal about the mismatch between our economic institutions and the actual practice of business. There are many aspects of this which I plan to explore over the summer but one aspect of this is the apparent glut of capital and other goods written about Nick Bunker in this post.

I have to confess, I find the concept of a global oversupply of capital to be incoherent. It can certainly be the case that a nation, or an individual, has more capital then they can possibly use efficiently. But the globe as a whole? How could this be?

The answer, of course, is that its a problem of distribution. If poor people had more capital they would use it more efficiently than rich people that have capital. A poor African like I saw in Zambia could trade their traditional hut with no plumbing for a house with plumbing, let their kid go to school, or possibly invest in a small business. If they had it, they'd put it to good use. Meanwhile, we have a global capital glut because the capital is in the hands of rich folks who are more interested in preserving their capital than putting it at risk. Want to solve the problem? Get it out of the hands of those who don't have a current use for it and into the hands of those that do.

In the context of property rights, I am beginning to see the transition from the feudal era to the capitalist area largely in terms of providing institutions which caused capital to flow from those that sought safety in the form of land to those that were willing to take risks. Our current business friendly regulatory environment has resulted in a social context that is beginning to look more like the feudal era, capital is concentrated in large, mature, stagnant enterprises controlled by people whose goal is to minimize risk rather than maximize growth. If we want to jump start growth we are going to need to rewrite our property laws to get capital back in the hands of risk takers and out of the hands of those that currently have it.

Never thought business school would radicalize me the way it has, but there you go. More on this to come.

Thursday, March 19, 2015

You Could, You Know, Actually Talk to Managers

Sorry for the long hiatus in blogging, I overcommitted between work and my MBA and something had to give.

But a rather good post on rents in the modern economy by Evan Soltas mentioned something that I had to talk about. It's a great post with some great ideas about how to build a research program within economics that would better define and detect rent seeking. However, it also exposed gave full display to some of the frustrations I have with the pedestal given to economic thinking when it is so limited in its methods.

Specifically he mentions "Is it really possible that, as Bloomberg put it, Larry Ellison is "still a bargain" to Oracle at $100 million a year?" and later mentions "To Bivens and Mishel, executives would still do what they do even if they were paid less -- Larry Ellison is not about to sail off in his America's Cup yacht -- which means that executives are, in fact, being paid above their opportunity cost. (The logic here is, if their pay falls below opportunity cost, they would go do that other, next-best project which determines the opportunity cost.)"

The problem is that a fairly big chunk of this compensation problem is commonly and openly talked about in businesses, limiting your methodology as strictly as economists do cuts them off from picking some really low hanging fruit to resolve this problem.

Firms pay top management outrageous salaries because it is a way to reduce total compensation costs. You pay everyone else in the firm far less than they are worth and motivate them by getting them to struggle to gain that golden ticket that will lead them to the top. It reduces total compensation, motivates employees, and shifts consumer surplus from consumers and employees to shareholders and top executives.* Its no mystery, many of my management professors have mentioned this in passing, its widely accepted by both the left leaning members of the profession and the staunch right wing members. This is a natural, and probably inevitable, byproduct of shareholder capitalism.

The social costs of this are, in my opinion, terrible. Many people are unwilling to join the rat race, they want to be compensated fairly now not compete for decades in the hope of a reward that may or may not be rewarded on merit. These people never choose to compete for high power careers, sharply reducing the talent available to business, of course businesses never observe this since these people are not on their radar. Furthermore, there are not enough top positions to go around, this results in up or out promotion systems in many firms, practices such as forced rankings, and in some firms, mandatory retirement to keep the system going; further limiting the matching of available talent to open positions. Other problems are associated with the demands put on lower ranking employees, they have signed up for a major gamble and this drives reckless, and sometimes unethical, behavior, which harms their health, leads to psychological and physical stress associated with poor quality decision making, and drives many talented people to self select out rather than continue in high powered careers. The remnant which eventually gain leadership positions tend to be highly narcissistic (since they don't realize early on how low their odds of making it to the top are), highly motivated by money (since why give up so much of their life to get where they are), and prone to reinforce these norms because they take rightful pride in having made it to the top in such a cutthroat environment after having sacrificed so much.**

This results in an awful business culture that is highly self destructive. The norms formed by it are very powerful, which is the answer to the inevitable question of the libertarian is why doesn't a company defect and recruit the people dropping out of the rate race. Of course, these norms mean that you know before you even start that you are facing 60+ hour weeks, that you are expected to sacrifice your health and well being to the company, and that you need to show early on a willingness to put the needs of the company before your own to get to the top. This means that the best people never step forward, people suited for top management positions tend to be socially and group oriented and value their lives and families above the company, they are never in the running. There is no way to select for them because young people today know what is required of them and the best of them choose careers that will not demand this level of sacrifice, knowing the odds and having a realistic idea of the possibilities and sacrifices involved mean that you have to have a very specific type of personality to even consider aiming for a high powered career these days. So the company seeking to defect from these norms can't find anyone to select for because the people they need know better than to advertise the character traits that the rest of the business world is selecting against.

It's a huge collective action problem, a rather classic one actually, well explained in social sciences outside of economics. It's obvious that companies have developed norms designed to drive income to the top, to use this to motivate employees rather than to induce them monetarily, and that this serves to maximize profits for shareholders more readily than actually focusing on building long term careers for people while recognizing their other needs. It makes everyone but shareholders and winners of the career lottery worse off and since it is social and normative there is no way for markets to correct it. But while this can easily be observed through interviews or even through questionnaires it remains invisible to much of the economics profession.

*Most people in business seem to believe that this also helps to recruit quality people and get the most out of them, though I believe this is a bunch of self justifying bullshit and have yet to discover any methodologically sound evidence of this. Though there is a lot of self confirming nonsense of the form that everyone does this so it must be good, with no effort to reject the hypothesis that this is simply normative behavior disconnected from performance.

**Something I noted from a lot of my management classes is that the managers that outperform the average are people that are not on the fast track to top spots, they tend to be group oriented people unwilling to make the sacrifices required of a high powered career. They tend not to get noticed but in the cases they get tapped they perform well. Current selection methods do a great job at motivating and selecting for front line and mid level management but there are sharp discontinuities between what selects for these individuals best vs. what is necessary at the top. Since proven performance is what boards and managers are looking for by the time they are selecting individuals for the top spots there is no one ideal left because the selection methods used at earlier levels of the process have selected against all the good people. It's crazy, but that's what it is.

Tuesday, October 14, 2014

Quick Thoughts on Norms, Institutions, and Inequality

Something that has been really bothering me since starting my MBA is the extent to which the actual operations of business are run by norms and institutions rather than by economics. Specifically, we seem to have a serious hangover of agrarian norms and institutions that cause serious damage when applied to a market based society. Instead of studying for auditing like I should be I am going to try to use my lunch hour to use this concept to tie together a few disparate blog posts that I believe are tied together by this concept.

Yesterday, Paul Krugman wrote:
Why are debtors receiving so little relief? As I said, it’s about righteousness — the sense that any kind of debt forgiveness would involve rewarding bad behavior. In America, the famous Rick Santelli rant that gave birth to the Tea Party wasn’t about taxes or spending — it was a furious denunciation of proposals to help troubled homeowners. In Europe, austerity policies have been driven less by economic analysis than by Germany’s moral indignation over the notion that irresponsible borrowers might not face the full consequences of their actions.
It isn't clear to me why righteousness is so one sided, on what ethical or moral basis does the debtor bear more blame then the creditor? Going back to biblical times wasn't usury considered sinful and the lender not the debtor the one morally suspect?

Linked to this question we get Mark Thoma's column today regarding the best way to fight rising inequality. In it he writes that "This debate brings up an important question: what is the best way to fight economic inequality? I think most people would agree that the best approach is to provide good jobs to working class households, and to make sure workers receive their fair share of the value of the output they produce." And further down he adds "And if workers have not received the income they deserve – their contribution to the value of the output they produce – as has been the case for the last several decades, then progressive taxation and redistribution returns income to its “rightful” owners. It’s the fair and right thing to do," with some excellent analysis and suggestions in between.

What is tying these concepts together, I think is mentioned in a post by Steve Roth at Angry Bear commenting on Piketty and some remarks by Bill Gates. Steve makes some excellent points on the need to distinguish wealth from capital, however the part I am interested in is his point that:

Important: that stock of real assets is not just the “fixed capital” tallied (because it can be measured) in the national accounts; that’s actually a small part. Knowledge, skills, and abilities (think: education, training, health), business/organizational systems (this is huge), and similar unmeasurables constitute the bulk of real capital — the stuff that allows us to produce in the future. Most of that stock is not specifically claimed, but it is that whole body of real capital that the market it trying to value properly via pricing of claims — basically, holding up its collective thumb and squinting.
To me, this is the crux of the problem regarding widening inequality. How do we as a society assign claims on capital in the form of "knowledge, skills, and abilities, business/organizational systems, and similar unmeasurables"?

In my MBA program we focus a great deal on the stakeholder perspective of the firm. This is all well and good, this is pushing back against the norms portion of those agrarian attitudes that I mentioned or that Krugman is describing as the sense of righteousness about debt. This is probably far too little to have a measurable impact on its own, though shifting norms is a necessary first step for social change.

The deeper problem here is institutional, in our society providers of fixed capital generally have a stronger claim to those "unmeasurables that constitute the bulk of real capital." They receive this claim through a series of institutional features. The first is the relative ease with which providers of fixed capital can combine together in unions of capital, commonly called corporations. This provides them with far greater bargaining power regarding the bulk of capital in our society than other stakeholders with an equal, or greater than, interest and role in the production of the unmeasurables which constitute our capital.

[Lunch hour is over and I am posting this incomplete as I do not know when I will have time to continue this. Hopefully there will be a part two in a semi-reasonable timeframe.]

Saturday, September 20, 2014

How Much of Our Current Political Insanity Can Be Attributed to Early Childhood Brain Damage?

Kevin Drum had a recent blog post on how incarceration rates are down among younger people and up in older populations and the links between this and lead.

This led me to thinking about how a lot of the problems of the last 30 years are commonly attributed to many of the same characteristics that are often associated with criminality such as selfishness and a short term orientation. Since behavior is highly associated with social context, it stands to reason that these traits would be expressed differently in people with higher socioeconomic status then the low status people that are often incarcerated for crimes.

If this association does exist it would help to explain how our society shifted away from the more communal values of the 1950s and 60s when business and government were both moving towards a more inclusive vision that engaged diverse stakeholders* to the time since the 1980s when ideas such as shareholder capitalism began to take hold and dominate public discourse. Today the upper reaches of business and government are dominated by people who are in the age groups that are being associated with higher crime and incarceration rates. If there is an association between lead and criminality in people of low socioeconomic status it would hold to reason that there is a similar influence on people of higher status, perhaps helping to explain some of the extremely short term thinking that has become common on issues like the environment and inequality among people of high status.

*limited of course by holdovers of earlier inegalitarian social relationships and the prejudices of the time, but these were times of progress rather than regress