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Maxed-Out Incomes (2)

by afew Wed Jun 3rd, 2009 at 07:15:34 AM EST

The directors of such [joint-stock] companies, however, being the managers rather of other people's money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master's honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.

-- Adam Smith, The Wealth Of Nations (1776)

It's on the basis of Adam Smith's distrust of managers that Adolf Berle and Gardiner Means, in The Modern Corporation and Private Property (1932) provided their critique of the development of the modern corporation run by managers rather than proprietors with, according to them, deleterious effects.

The Modern Corporation and Private Property - Wikipedia, the free encyclopedia

Private enterprise ... has assumed an owner of the instruments of production with complete property rights over those instruments... Whereas the organization of feudal economic life rested upon an elaborate system of binding customs, the organization under the system of private enterprise has rested upon the self interest of the property owner - a self interest held in check only by competition and the conditions of supply and demand... Such self interest has long been regarded as the best guarantee of economic efficiency. It has been assumed that, if the individual is protected in the right both to use his own property as he sees fit and to receive the full fruits of its use, his desire for personal gain, for profits, can be relied upon as an effective incentive to his efficient use of any industrial property he may possess.

Shareholder capitalism, argued Berle and Means from this classical perspective, destroys efficiency because shareholders delegate responsibility to managers, who do not share the motives of the property owner, posing a problem both of diligence in the protection of the interests of "those who have ventured their wealth" and of distribution of the returns. In other words, managers, after taking power in the concentrated remains of nineteenth-century family firms, deviate the Invisible Hand from its normal utilitarian workings.


The story is outlined in an article by Philippe Delvalée on the Alternatives Economiques website. Delvalée explains that this classical view of the dangers of the "managerial revolution" became the conventional wisdom until the 1960s and early 1970s. At that point they were challenged by new ideas that purported to reconcile management with the magical efficiency of property ownership. These new ideas, especially pioneered by Jensen and Meckling in Theory of the Firm : Managerial Behavior, Agency Costs and Ownership Structure (1976) (pdf), concerned agency theory. They posited that it was possible to align the interests of the agent (manager) on those of the principal (shareholder), in spite of the following obstacles:

  • asymmetric information: the managers know what is going on in the enterprise and will naturally use their knowledge to further their own interests;
  • contracts will never cover all potential events and issues and are therefore insufficient;
  • the issue of lawsuits concerning managers' non-acquittal of their responsibilities is most uncertain;
  • the threat of selling shares is weakened by the fact that it reduces the share price for the shareholders themselves.

The way to deal with the "principal-agent problem", said the agency theorists, was to use the carrot rather than the stick:

  • pay managers high basic salaries to be sure to attract the brightest and the best;
  • offer bonuses for performance in the interest of shareholders;
  • tie managers strictly to shareholder interests by making shareholders of them via stock-options.

And this is the new CW that replaces the classical view as Thatcher and Reagan come into power. Delvalée explains:

Salaires des patrons : comment en est-on arrivé là ?Bosses' Salaries: How Did We Get Here?
...dès lors que des incitations adéquates sont mises en place, les managers ont eux aussi intérêt à maximiser les profits des détenteurs de titres. Ce qui, plus largement, est censé permettre d'allouer les capitaux de façon optimale aux utilisations les plus efficaces. La boucle est bouclée : on retrouve la main invisible chère à Adam Smith......once adequate incentives are implemented, managers share the profit-maximising interests of stockholders. Which, more broadly, is supposed to permit optimal capital allocation to the most efficient uses. We have come full circle: we're back with the invisible hand dear to Adam Smith...
Dans un tel contexte, que les dirigeants s'enrichissent beaucoup n'est donc pas un problème puisque cela profite à tout le monde. Aux actionnaires bien sûr, mais aussi à l'économie dans son ensemble, car la hausse du cours des actions de telle ou telle entreprise n'est que le signe de la bonne utilisation des capitaux mis à sa disposition. C'est pourquoi les diatribes mettant en cause le caractère exagéré des rémunérations perçues sont repoussées d'un revers de la main par les théoriciens de l'agence. Pour eux, il n'est d'ailleurs même pas besoin non plus de chercher à justifier ces rémunérations par d'hypothétiques écarts de productivité entre les dirigeants et les salariés « normaux ».In such a context, it's not a problem when top managers get very rich because it benefits everybody. The shareholders of course, but also the overall economy, because the rise in the share price of this or that company is only the sign of the correct use of the capital made available to it. This is why rants against exaggeratedly high remuneration are brushed aside by agency theorists. According to them, there isn't even any need to bother justifying this remuneration by hypothetical productivity gaps between top managers and "normal" employees.

So the miracle CEO who manages - one way or another - to keep quarterly profits up and rising, determining a high share price, can claim absolutely as much as s/he likes, because magical economic theory says that s/he is maximising utility. That this system favorises risk-taking, flexibility with regard to accountancy rules, and (to put it mildly) pro-cyclical activity, could not possibly be relevant. Neither could the fact that there is no check on the use of asymmetric information to further managerial interests which are protected by golden parachutes, while shareholders can and do find themselves in free fall. This huge gift to upper management has been one of the causes of the "long bull market" bubble and the current crisis, and of the increasing concentration of income in the hands of a small group.

So, yes, taxing very high income at a very high level could usefully make its return (see Maxed-Out Incomes (1)), but agency theory has to bite the dust, and new forms of corporate governance, new corporate forms, have to see the light of day.

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European Tribune - Maxed-Out Incomes (2)
The directors of such [joint-stock] companies, however, being the managers rather of other people's money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own.

Exactly. Good old Adam Smith......much maligned IMHO.

The evolution of 'private copartnery' enterprise models is actually addressing the Principal/Agency problem you refer to, by enabling new forms of risk/revenue sharing engagement between stakeholders.

I did a bit of research the other day in relation to the incidence of the UK Limited Liability Partnership I bang on about.

As of last Thursday 29th May, there had been 46,036 of these beasties incorporated since 6th April 2001, and getting on for half of these were in the last two years.

This is despite almost complete silence from BERR (formerly DTI) on the subject of LLPs - which I call the Corporate That Dare Not Speak Its Name.

Similarly, professional firms have routinely become LLPs (they blackmailed the DTI into introducing the form in the first place) but most would never dream of advising their clients to use LLPs, since there is far more money in complex and conflicted enterprise models.

No one - apart from the tax-man, and he doesn't find out for a couple of years - has the faintest idea what most of these LLPs are doing, since there are no reporting requirements other than minimal accounts after maybe 21 months or so.

Similarly in the US the simple but effective LLC is also in pretty pervasive use, and Vermont appears to be ahead of the game by actually making them Virtual.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Mon Jun 1st, 2009 at 01:14:31 PM EST
... Partnerships to Corporations has shown, Adam Smith got very much of that right. The joint-stock Commercial Corporation Form is at best a necessary evil, and as such alternative forms that do not share its faults ought to be promoted.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Mon Jun 1st, 2009 at 01:44:21 PM EST
[ Parent ]
I did hold out the "new corporate forms" as a hook, knowing who would seize it! ;)
by afew (afew(a in a circle)eurotrib_dot_com) on Mon Jun 1st, 2009 at 02:52:59 PM EST
[ Parent ]
I was on the hook long before then!

"The future is already here -- it's just not very evenly distributed" William Gibson
by ChrisCook (cojockathotmaildotcom) on Mon Jun 1st, 2009 at 03:06:03 PM EST
[ Parent ]
Agency theory legitimized and camouflaged the usurpation of governance of publicly held corporations from share holders by corporate executives.  Share holders merely vote on a slate of candidates proposed by the board, whose members have been hand picked by the executives.  Financial corporations, through the massively disproportionate bonuses and stock options awarded these executives, has effectively captured the US Congress and Executive Branches through the mechanism of campaign finances and has used the resulting control to remove regulatory restrictions on its own behavior, which now is almost exclusively oriented towards the short term personal profits of the controlling executives in the various enterprises.

Over the last thirty years financial corporations have used their power to manipulate the equity markets to their own benefit, notable exceptions occurring when miscalculations were made, to inflate gigantic real estate bubbles for their short term profit, oblivious to longer term consequences, to force non-financial corporations into sub-optimal stock market strategies, such as stock buy back, to protect themselves from financial predation, and to opportunistically break up US manufacturing companies, ship the capital equipment to China and elsewhere, fire the workers, dump any pension obligations on the public, sell the real estate and other tangible assets for more than the stock market value of the former enterprise, import goods that are cheaper in every sense as a replacement for former domestically manufactured goods and done so without consideration for national account balance concerns and under market conditions best described as a competitive feeding frenzy.

This would be bad enough were it part of a well thought out program of extracting the maximum wealth from that economy for the benefit of the very few. But the only parts that apparently were thought out were those that involved making the short term profits. The long term consequences of these actions on the health and stability of the society and economy within which they were occurring were ignored. They were considered to be "externalities."  Throughout this process the role of government has been ridiculed, stigmatized,  minimized and, ultimately, suborned into one of supporting the ongoing looting via  governmental regulatory agency actions, congressional actions and executive actions.  But instead of a program of governance we have had an un-managed, un-mitigated rolling catastrophy, in large part because no one organization had enough power to actually be accountable.  The government, in effect, has become the zombie of a cabal of pirates who are fighting for control, with the leadership and direction frequently changing.  Worse still, there is no clear prospect for the general public to even grasp, let alone acknowledge, the situation.

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Mon Jun 1st, 2009 at 09:05:31 PM EST
The best succinct description of the causes and manner of our current condition I've read in a while.

I can swear there ain't no heaven but I pray there ain't no hell. _ Blood Sweat & Tears
by Gringo (stargazing camel at aoldotcom) on Mon Jun 1st, 2009 at 11:07:56 PM EST
[ Parent ]
Thanks.  It has been baking a while.  I suppose I could add links, but I wanted to get something down while the thought train remained intact.  Afew's diary inspired me.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Mon Jun 1st, 2009 at 11:11:52 PM EST
[ Parent ]
ARGeezer:
Worse still, there is no clear prospect for the general public to even grasp, let alone acknowledge, the situation.

bingo

the 'great unwashed' has become the 'great brain-washed'

there's a lot of 'work' to undo...

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Tue Jun 2nd, 2009 at 04:30:06 AM EST
[ Parent ]
Yes, I've kind of given up on sending pearls of wisdom, like ARGeezer's paragraph and countless other longer versions, to folks in hopes of awakening them to the mess on our doorsteps. IT just seems to go nowhere.

I can swear there ain't no heaven but I pray there ain't no hell. _ Blood Sweat & Tears
by Gringo (stargazing camel at aoldotcom) on Tue Jun 2nd, 2009 at 09:29:28 PM EST
[ Parent ]
of every project, my friend.

paul spencer
by paul spencer (spencerinthegorge AT yahoo DOT com) on Wed Jun 3rd, 2009 at 08:43:43 PM EST
[ Parent ]
And if you doubt its effectiveness, witness Chris Cook's efforts on behalf of the new forms of economic organization that he has tirelessly championed here and elsewhere over just the last year or so.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Thu Jun 4th, 2009 at 01:51:08 PM EST
[ Parent ]
On top of divorcing ownership and management, the corporation further removes the "owner's" interest because, as you, Chris, and I have discussed elsewhere, the owner hasn't contributed to the corporation itself but has merely bought stock on the speculation market and is betting the management will let him flip it for a profit, real health of the corporation be damned.
by rifek on Tue Jun 2nd, 2009 at 07:50:09 PM EST
[ Parent ]
... so I have it for future reference.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Tue Jun 2nd, 2009 at 09:47:03 PM EST
[ Parent ]
I'm flattered.  Use it in good health. :-/

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Tue Jun 2nd, 2009 at 10:08:56 PM EST
[ Parent ]
In economic circles, so much emphasis is put on the corporation in theory, and very little on what the corporation actually produces. It doesn't matter if they're making soap or pistons.

The fact that something such as planned obsolescence might contribute to so-called "agency theory" simply reinforces he point that this has all become a metaphysical exercise.

God help us if a corporation ever patents "cold fusion."

by Upstate NY on Tue Jun 2nd, 2009 at 02:28:39 PM EST
Corporations produce profits for shareholders.

It doesn't matter what the corporation produces, as long as profits continue to rise.

It's amazing that we have an entire financial culture based on this kindergarten appreciation of economic 'logic.'

But it's not just an economic problem - it's also a mental health problem. Cult followers are proud of statements like 'There's no room for sentiment in business' and 'Our main aim is increasing shareholder value' as if these are attitudes to be proud of, rather than evidence of mild psychosis.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Wed Jun 3rd, 2009 at 08:27:57 AM EST
[ Parent ]
Cult followers are proud of statements like 'There's no room for sentiment in business' and 'Our main aim is increasing shareholder value' as if these are attitudes to be proud of, rather than evidence of mild psychosis.

"These...attitudes" have, in fact, turned into a mild culturally normative psychosis whose effects on the body politic are anything but mild.  The question is whether those not so suffering can intervene with sufficient success as to prevent this psychotic body politic from getting itself killed or committing suicide.  The prognosis is grave.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Wed Jun 3rd, 2009 at 09:44:38 AM EST
[ Parent ]
ThatBritGuy:
Corporations produce profits for shareholders.

It doesn't matter what the corporation produces, as long as profits continue to rise.

Indeed. But using partnership frameworks(or even trust  frameworks, after a fashion), it is as possible to do without inefficient and bloated (to coin a phrase) rentier shareholders as it is to do without bank, as opposed to stakeholder, credit.

Within a partnership there is no profit and no loss.

"The future is already here -- it's just not very evenly distributed" William Gibson

by ChrisCook (cojockathotmaildotcom) on Wed Jun 3rd, 2009 at 12:52:17 PM EST
[ Parent ]


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