Celebrating humanity's flourishing through the spread of capitalism and the rule of law
15 Jun 2015 Leave a comment
in applied welfare economics, economics of media and culture, income redistribution, movies, politics - USA, poverty and inequality, Public Choice, TV shows Tags: comedy, Left-wing hypocrisy, Leftover Left, Occupy Wall Street, top 1%, Twitter left
The 25 richest comedians (or why not to go into standup comedy) from @randal_olson randalolson.com/2015/03/04/top… http://t.co/cp3lSnuPOf—
Tyler Vigen (@TylerVigen) March 17, 2015
12 Jun 2015 Leave a comment
in liberalism, politics - Australia, politics - New Zealand, politics - USA Tags: expressive voting, Green Left, Leftover Left, political correctness, rational irrationality, Twitter left
@KayHymowitz i find it passing strange that counter-culturals left like Winner now are the most reactionary.. http://t.co/hj2MEc4Buu—
Old Whig (@aClassicLiberal) April 06, 2015
07 Jun 2015 Leave a comment
in economics of education, liberalism Tags: free speech, Left-wing hypocrisy, political correctness, speech codes, Twitter left
03 Jun 2015 Leave a comment
in economic history, entrepreneurship, financial economics, human capital, industrial organisation, labour economics, labour supply, occupational choice, survivor principle Tags: CEO pay, entrepreneurial alertness, Occupy Wall Street, separation of ownership and control, superstar wages, superstars, top 0.1%, top 1%, Twitter left
The members of the top 1% whose income increased the most between 1979 and 2005 were real estate professionals followed by financial professionals – see figure 1.
Figure 1: increase in share of national income (including capital gains) received by top 1% for each primary taxpayer occupation in top 1% between 1979 and 2005
Source: Jon Bakija, Adam Cole and Bradley T. Heim “Jobs and Income Growth of Top Earners and the Causes of Changing Income Inequality: Evidence from U.S. Tax Return Data”.
Figure 2 shows that the fastest-growing shares among the top 1% as in figure 1 are not necessarily the largest occupational group are those income earners. Moreover, their fortunes seem largely unrelated to each other.
Figure 2: Percentage of national income (including capital gains) received by top 1%, and each primary taxpayer occupation in top 1%
Source: Jon Bakija, Adam Cole and Bradley T. Heim “Jobs and Income Growth of Top Earners and the Causes of Changing Income Inequality: Evidence from U.S. Tax Return Data”.
The next members of the top 1% in terms of income growth were rather respectable group:professionals and scientists and arts, media and sports. The latter,arts, media and sports get a complete pass on their membership of the top 1% despite their great success in increasing their incomes since 1979 at the expense apparently on the bottom 99% if the Twitter Left is to be believed.
Figure 3: increase in share of national income (including capital gains) received by top 0.1% for each primary taxpayer occupation in top 0.1%between 1979 and 2005
Source: Jon Bakija, Adam Cole and Bradley T. Heim “Jobs and Income Growth of Top Earners and the Causes of Changing Income Inequality: Evidence from U.S. Tax Return Data”.
Arts, media and sports superstars are one of the fastest-growing members of the top 0.1% – see figure 3. Again, the arts, media and sports superstars get a complete pass on their membership of the top 0.1% from the Twitter Left. Most of the other occupations in the top 0.1% don’t strike me as anything other than working rich – see figure 3 and figure 4.
As with the top 1%, the top 0.1% of income earners are a mixed bag of occupations – see figure 4. Their fortunes are unrelated to each other terms of the forces driving there are increased incomes.
Figure 4: Percentage of national income (including capital gains) received by top 0.1%, and each primary taxpayer occupation in top 0.1%
Source: Jon Bakija, Adam Cole and Bradley T. Heim “Jobs and Income Growth of Top Earners and the Causes of Changing Income Inequality: Evidence from U.S. Tax Return Data”.
30 May 2015 Leave a comment
in applied price theory, applied welfare economics, comparative institutional analysis, development economics, economic history, entrepreneurship, growth disasters, growth miracles, income redistribution, politics - Australia, politics - New Zealand, politics - USA, Public Choice, public economics, rentseeking Tags: entrepreneurial alertness, Leftover Left, taxes and the labour supply, The inequality and growth, Thomas Piketty, top 1%, Twitter left
Tim Taylor, the editor of the Journal of Economic Perspectives, has written a superb blog post on why we should be sceptical about a strong relationship between inequality and economic growth. Taylor was writing in response to the OECD’s recent report "In It Together: Why Less Inequality Benefits All,".
Taylor’s basic point is economists have enough trouble working out what causes economic growth so trawling within that subset of causes to quantify the effects of rising or falling inequality inequality seems to be torturing the data to confess. The empirical literature is simply inconclusive as Taylor says:
A variety of studies have undertaken to prove a connection from inequality to slower growth, but a full reading of the available evidence is that the evidence on this connection is inconclusive.
Most discussions of the link between inequality and growth are notoriously poor of theories connecting two. There are three credible theories in all listed in the OECD’s report:
The report first points out (pp. 60-61 that as a matter of theory, one can think up arguments why greater inequality might be associated with less growth, or might be associated with more growth. For example, inequality could result less growth if:
1) People become upset about rising inequality and react by demanding regulations and redistributions that slow down the ability of an economy to produce growth;
2) A high degree of persistent inequality will limit the ability and incentives of those in the lower part of the income distribution to obtain more education and job experience; or
3) It may be that development and widespread adoption of new technologies requires demand from a broad middle class, and greater inequality could limit the extent of the middle class.
About the best theoretical link between inequality and economic growth is what Taylor calls the "frustrated people killing the goose that lays the golden eggs." Excessive inequality within a society results in predatory government reactions at the behest of left-wing or right-wing populists.
Taylor refers to killing the goose that laid the golden egg as dysfunctional societal and government responses to inequality. He is right but that is not how responses to inequality based on higher taxes and more regulation are sold. Thomas Piketty is quite open about he wants a top tax rate of 83% and a global wealth tax to put an end to high incomes:
When a government taxes a certain level of income or inheritance at a rate of 70 or 80 percent, the primary goal is obviously not to raise additional revenue (because these very high brackets never yield much).
It is rather to put an end to such incomes and large estates, which lawmakers have for one reason or another come to regard as socially unacceptable and economically unproductive…
The left-wing parties don’t say let’s put up taxes and redistribute so that is not something worse and more destructive down the road. Their argument is redistribution will increase growth or at least not harm it. That assumes the Left is addressing this issue of not killing the goose that lays the golden egg at all.
Once you discuss the relationship between inequality and growth in any sensible way you must remember your John Rawls. Incentives encourage people to work, save and invest and channels them into the occupations where they make the most of their talents. Taylor explains:
In the other side, inequality could in theory be associated with faster economic growth if: 1) Higher inequality provides greater incentives for people to get educated, work harder, and take risks, which could lead to innovations that boost growth; 2) Those with high incomes tend to save more, and so an unequal distribution of income will tend to have more high savers, which in turn spurs capital accumulation in the economy.
Taylor also points out that the OECD’s report is seriously incomplete by any standards because it fails to mention that inequality initially increases in any poor country undergoing economic development:
The report doesn’t mention a third hypothesis that seems relevant in a number of developing economies, which is that fast growth may first emerge in certain regions or industries, leading to greater inequality for a time, before the gains from that growth diffuse more widely across the economy.
At a point in its report, the OECD owns up to the inconclusive connection between economic growth and rising inequality as Taylor notes:
The large empirical literature attempting to summarize the direction in which inequality affects growth is summarised in the literature review in Cingano (2014, Annex II).
That survey highlights that there is no consensus on the sign and strength of the relationship; furthermore, few works seek to identify which of the possible theoretical effects is at work. This is partly tradeable to the multiple empirical challenges facing this literature.
The OECD’s report responds to this inclusiveness by setting out an inventory of tools with which you can torture the data to confess to what you want as Taylor notes:
There’s an old saying that "absence of evidence is not evidence of absence," in other words, the fact that the existing evidence doesn’t firmly show a connection from greater inequality to slower growth is not proof that such a connection doesn’t exist.
But anyone who has looked at economic studies on the determinants of economic growth knows that the problem of finding out what influences growth is very difficult, and the solutions aren’t always obvious.
The chosen theory of the OECD about the connection between inequality and economic growth is inequality leads to less investment in human capital at the bottom part of the income distribution.
[Inequality] tends to drag down GDP growth, due to the rising distance of the lower 40% from the rest of society. Lower income people have been prevented from realising their human capital potential, which is bad for the economy as a whole
I found this choice of explanation curious. So did Taylor as the problem already seems to have been solved:
There are a few common patterns in economic growth. All high-income countries have near-universal K-12 public education to build up human capital, along with encouragement of higher education. All high-income countries have economies where most jobs are interrelated with private and public capital investment, thus leading to higher productivity and wages.
All high-income economies are relatively open to foreign trade. In addition, high-growth economies are societies that are willing to allow and even encourage a reasonable amount of disruption to existing patterns of jobs, consumption, and ownership. After all, economic growth means change.
In New Zealand, interest free student loans are available to invest in higher education as well as living allowances for those with parents on a low income. There are countries in Europe with low levels of investment in higher education but that’s because of high income taxes not because of inequality.
The OECD’s report is fundamentally flawed which is disappointing because most research from the OECD is to a good standard.
via CONVERSABLE ECONOMIST: Does Inequality Reduce Economic Growth: A Skeptical View.
28 May 2015 Leave a comment
in financial economics, industrial organisation, managerial economics, organisational economics, survivor principle, theory of the firm Tags: CEO pay, Leftover Left, leveraged buyouts, market for corporate control, mergers and takeovers, superstar wages, superstars, Twitter left
The Washington Centre for Equitable Growth in a review of Thomas Piketty accidentally contradicted their own arguments about the emergence of the top 0.1%. They quote Piketty:
on page 302 of his book that the rise in labour income “primarily reflects the advent of ‘supermanagers,’ that is, top executives of large firms who have managed to obtain extremely high, historically unprecedented compensation packages for their labour.”
according to the Washington Centre for Equitable Growth:
these supermanagers were being vastly overly compensated given their questionable contributions to productivity.
The Washington Centre for Equitable Growth then goes on the argue that in 1979, most of the top managers worked for large, publicly traded firms but by 2005 more were working in closely held firms.
Who are today’s supermanagers and why are they so wealthy? equitablegrowth.org/research/today… http://t.co/Ts2OkOUk5g—
Equitable Growth (@equitablegrowth) December 03, 2014
I wish to explore this point about the biggest gains in both percentage terms and magnitude were among privately held business professionals and they are vastly overcompensated relative to their productivity. The key to the argument as explained in a link to a Robert Solow article by the Washington Centre for Equitable Growth is:
Piketty is of course aware that executive pay at the very top is usually determined in a cosy way by boards of directors and compensation committees made up of people very like the executives they are paying.
Piketty is equally direct about the ability of top managers to set their own pay:
It is only reasonable to assume that people in a position to set their own salaries have a natural incentive to treat themselves generously or at the least to be rather optimistic in gauging their marginal productivity.
Emmanuel Saez is less coy:
…while standard economic models assume that pay reflects productivity, there are strong reasons to be sceptical, especially at the top of the income ladder where the actual economic contribution of managers working in complex organizations is particularly difficult to measure. In this scenario, top earners might be able partly to set their own pay by bargaining harder or influencing executive compensation committees.
When arguing that the optimal top income tax rate is 83%, Piketty, Saez, and Stantcheva push for that high top tax rate in part because top executives are more likely to bargain for higher pay when tax rates are lower and receive funds that might go elsewhere within the firm.
Emmanuel Saez and Gabriel Zucman explore the new wealth divide in the U.S. equitablegrowth.org/research/explo… http://t.co/WKJKAigAPN—
Equitable Growth (@equitablegrowth) October 24, 2014
The only comment I could find on the increasing number of privately held companies that pay top executives so well is frustration by the Washington Centre for Equitable Growth that it complicates statistical collection. No other analysis is undertaken.
Xavier Gabaix and Augustin Landier found back in 2008 that what a major company’s CEO earns is directly proportional to the size of the firm that they are responsible for running. Executive compensation closely track the evolution of average firm value. During 2007 – 2009, firm value decreased by 17%, and CEO pay by 28%. During 2009-2011, firm value increased by 19% and CEO pay by 22%. Xavier Gabaix and Augustin Landier also found that compensation for executives has risen with the market capitalization. From 1980 to 2003, the average value of the top 500 companies rose by a factor of six. Two commonly used indexes of chief executive compensation show close to a proportional six-fold matching increase.
What intrigued me about this casual reference to the great number of super managers employed by privately held firms is the argument that they have a cosy relationship with their board of directors immediately collapses. That argument about executive pay is usually in the context of the separation of ownership from control. In large publicly held companies the executives are subject to less scrutiny by shareholders as few of them have a large enough individual stake in the company to gain from the extra effort of monitoring their pay packages.
When the pay packages of top executives is questioned, it is always pointed out that there is an easy way to test for whether top executives cheat shareholders by overpaying themselves.
This simple test is comparing the pay of large private companies and public companies with a large or a few share holders with public companies with diffuse share holdings. Private equity typically also pay its top executives very well, even though the capacity to dupe public shareholders are not a factor.
Privately owned companies and public companies with a few large shareholders can easily keep track of the pay packages of the executives and the board of directors hired to monitor them. Private equity ownership have high pay-for-performance but also significant CEO co-investment.
The standard argument for excessive compensation for CEOs is free rider problems prevent shareholders from doing sufficient monitoring of executive compensation practices, and that the problems have been getting worse over time. For example, in a classic paper, Bebchuk and Fried (2004) argued that executive compensation is set by CEOs themselves rather than boards of directors on behalf of shareholders,
This argument does not apply to private companies with a few shareholders but they still offer large pay packages to their top executives. Companies, be they public or private that pay any employee more than they contribute risks takeover and loss of market share and failure through higher costs.
The burst of takeovers and leverage buyouts in the 1980s were partly driven by opportunities to profit from reducing corporate slack and downsizing flabby corporate headquarters of large publicly listed companies. Cleaning out the overpaid executives and overstaffing in the headquarters of large corporations was an express purpose of these takeovers and leveraged buyouts.
The response of the Left over Left of the day was support regulation to stop these mergers and takeovers rather than applauding them as giving lazy, overpaid top executives a kick up the backside and from the boot out the door. This regulation to make hostile takeovers more difficult undermined the market the corporate control rather than strengthened it as Michael Jensen explains:
This political activity is another example of special interests using the democratic political system to change the rules of the game to benefit themselves at the expense of society as a whole.
In this case, the special interests are top-level corporate managers and other groups who stand to lose from competition in the market for corporate control. The result will be a significant weakening of the corporation as an organizational form and a reduction in efficiency.
Central to the hypothesis of the Twitter Left of CEOs overpaying themselves is there is free cash within the business they pocket in pay rises, fringe benefits and lavished corporate headquarters rather than pay out in dividends or invest in profitable investments.
CEOs with high pay packages are now much more likely than 20 or 30 years ago to be employed in private companies where the shareholders have far greater opportunities to ensure they get value for money.
All modern theories of the focus in part or in full on reducing opportunistic behaviour, cheating and fraud in employment and commercial relationships. The market for corporate control, and mergers and takeovers realise large benefits from displacing underperforming manager teams. Premiums in hostile takeover offers historically exceed 30% on average. Acquiring-firm shareholders on average earn about 4% in hostile takeovers and roughly zero in mergers.
Another reason for high CEO pay in both public and private companies is CEOs tend to be more risk adverse than their shareholders. The shareholders in any one company has a diversified portfolio and protected by limited liability if the company fails because of a risky venture. Moreover, shareholders receive nothing in dividends if the company breaks even so they would prefer that managers pursue business ventures likely to do more than break even.
The agent principal conflict ears as long as the company breaks even, the CEO gets paid. Out of career concerns, a CEO does not want to be at the head of a company that fails because his re-employment prospects are quite grim. High-risk/high-reward ventures are less attractive to top executives because if they fail, their human capital that is specific to the failed company is worthless elsewhere.
To encourage CEOs to take risks, paying them were share options makes them more interested in risky ventures because their pay goes up in line with the risks they take which they would otherwise not take but for option being paid in options. Privately owned companies are well aware of this risk aversion among their chief executives which is why they pay them so well and often in share options and bonuses for taking risks.
The Washington Centre for Equitable Growth simply did not address the reasons for privately owned companies paying the top executives so well.
The incomes of executives, managers, financial professionals, and technology professionals who are in the top 0.1% is very sensitive to stock market fluctuations. This volatility in the pay of CEOs is inconsistent with the notion that their pay is linked to their ability to form cosy relationships with the boards of directors rather than with their performance.
These top 0.1% CEOs are working super rich whose fortunes rise and fall with the businesses they direct. Top CEOs are paid so much more because they direct the fortunes of large enterprises. In such cases, a small amount of extra talent is worth because the benefits of that small amount of extra talent are spread over such a large firm.
15 May 2015 1 Comment
in economic history, entrepreneurship, financial economics, human capital, industrial organisation, labour economics, occupational choice, property rights, survivor principle, theory of the firm Tags: entrepreneurial alertness, Eugene Fama, Leftover Left, separation of ownership and control, super-rich, superstar wages, superstars, top 1%, Twitter left, working rich
The rise of the rentiers is nothing new. What is new is the degree of financial globalization and liberalization that has supercharged the fortunes of the super-wealthy even beyond robber baron levels. But it’s no mystery how to reverse this. It’s a matter of setting better rules for markets and taxing earners at the top a bit more.
In the course of a deranged rant against the entrepreneurs in society, the Atlantic collected an excellent set of information suggesting that the working rich have replaced rentiers as the super-rich. Rentiers are the idle rich. A rentier is a person or entity receiving income derived from patents, copyrights, interest, etc.
In The Evolution of Top Incomes: A Historical and International Perspective (NBER Working Paper No. 11955), Thomas Piketty and Emmanuel Saez concluded that:
While top income shares have remained fairly stable in Continental European countries or Japan over the past three decades, they have increased enormously in the United States and other English speaking countries.
This rise in top income shares is not due to the revival of top capital incomes, but rather to the very large increases in top wages (especially top executive compensation). As a consequence, top executives (the “working rich”) have replaced top capital owners at the top of the income hierarchy over the course of the twentieth century…
The Twitter Left claim that the surge in top compensation in the United States is attributable to an increased ability of top executives to set their own pay and to extract rents at the expense of shareholders. Obviously, from the chart below the pay the top 0.1% goes up and down with the share market. Top wages do not seem to have any independent power to dupe shareholders into overpaying them in bad times.
Xavier Gabaix and Augustin Landier found back in 2008 that what a major company’s CEO earns is directly proportional to the size of the firm that they are responsible for running. Executive compensation closely track the evolution of average firm value. During 2007 – 2009, firm value decreased by 17%, and CEO pay by 28%. During 2009-2011, firm value increased by 19% and CEO pay by 22%.
Xavier Gabaix and Augustin Landier also found that compensation for executives has risen with the market capitalization. From 1980 to 2003, the average value of the top 500 companies rose by a factor of six. Two commonly used indexes of chief executive compensation show close to a proportional six-fold matching increase.
Better executive decisions create more economic value. If the number of big companies is greater than the number of good chief executives, competitive bidding will push up executive pay to reflect the value of the talent that is available.
What happens to share prices when there is a surprise CEO resignation? Up or down? Apple went up and down in billions on news of Steve Jobs’ health.
When Hewlett Packard’s CEO Mark Hurd resigned unexpectedly, the value of HP stock dropped by about $10 billion! This makes his $30 million in annual compensation a bargain for shareholders. The fall in share price represents the difference between what the market expected from Hurd as Hewlett Packard’s CEO and what the market expects from his successor. Was Hurd under-paid?
There is an easy way to test for whether top executives cheat public shareholders. Compare the pay of large private companies, and public companies with a large or a few share holders, with public companies with diffuse share holdings. Private equity typically also pay its top executives very well, even though the capacity to dupe public shareholders are not a factor.
The burst of takeovers and leverage buyouts in the 1980s were very much driven by opportunities to profit from reducing corporate slack and downsizing flabby corporate headquarters of large publicly listed companies.
The response of the Left over Left of the day was support regulation to stop these mergers and takeovers rather than applauding them as giving lazy capitalists their comeuppance. This regulation undermined the market the corporate control rather than strengthened it as Michael Jensen explains:
This political activity is another example of special interests using the democratic political system to change the rules of the game to benefit themselves at the expense of society as a whole.
In this case, the special interests are top-level corporate managers and other groups who stand to lose from competition in the market for corporate control. The result will be a significant weakening of the corporation as an organizational form and a reduction in efficiency.
Central to the hypothesis of the Twitter Left of CEOs overpaying themselves is there is free cash within the business they pocket in pay rises, fringe benefits and lavished corporate headquarters rather than pay out in dividends or invest in profitable investments.
The interests and incentives of managers and shareholders frequently conflict over the optimal size of the firm and the payment of free cash to shareholders. What to pay the top executives is a minor manifestation of this common entrepreneurial difference of opinion the future of the business.
These conflicts in entrepreneurial judgements are severe in firms with large free cash flows–more cash than profitable investment opportunities. Jensen defines free cash flow as follows:
Free cash flow is cash flow in excess of that required to fund all of a firm’s projects that have positive net present values when discounted at the relevant cost of capital. Such free cash flow must be paid out to shareholders if the firm is to be efficient and to maximize value for shareholders.
Payment of cash to shareholders reduces the resources under managers’ control, thereby reducing managers’ power and potentially subjecting them to the monitoring by the capital markets that occurs when a firm must obtain new capital. Financing projects internally avoids this monitoring and the possibility that funds will be unavailable or available only at high explicit prices.
Michael Jensen developed a theory of mergers and takeovers based on free cash flows that explains:
Michael Jensen noted that free cash flows allowed firms’ managers to finance projects earning low returns which, therefore, might not be funded by the equity or bond markets. Examining the US oil industry, which had earned substantial free cash flows in the 1970s and the early 1980s, he wrote that:
[the] 1984 cash flows of the ten largest oil companies were $48.5 billion, 28 percent of the total cash flows of the top 200 firms in Dun’s Business Month survey.
Consistent with the agency costs of free cash flow, management did not pay out the excess resources to shareholders. Instead, the industry continued to spend heavily on [exploration and development] activity even though average returns were below the cost of capital.
Jensen also noted a negative correlation between exploration announcements and the market valuation of these firms—the opposite effect to research announcements in other industries. Not surprisingly, after a successful corporate takeover, there is major changes to realise the untapped benefits they saw in the company that the incumbent management were not seizing capturing:
Corporate control transactions and the restructurings that often accompany them can be wrenching events in the lives of those linked to the involved organizations: the managers, employees, suppliers, customers and residents of surrounding communities.
Restructurings usually involve major organizational change (such as shifts in corporate strategy) to meet new competition or market conditions, increased use of debt, and a flurry of recontracting with managers, employees, suppliers and customers.
All modern theories of the focus in part or in full on reducing opportunistic behaviour, cheating and fraud in employment and commercial relationships. The market the corporate control, and mergers and takeovers realise large benefits from displacing underperforming manager teams. Premiums in hostile takeover offers historically exceed 30 percent on average. Acquiring-firm shareholders on average earn about 4 percent in hostile takeovers and roughly zero in mergers.
In terms of corporate control, Eugene Fama divides firms into two types: the managerial firm, and the entrepreneurial firm.
The entrepreneurial firms are owned and managed by the same people (Fama and Jensen 1983b). Mediocre personnel policies and sub-standard staff retention practices within entrepreneurial firms are disciplined by these errors in judgement by owner-managers feeding straight back into the returns on the capital that these owner-managers themselves invested. Owner-managers can learn quickly and can act faster in response the discovery of errors in judgement. The drawback of entrepreneurial firms is not every investor wants to be hands-on even if they had the skills and nor do they want to risk being undiversified.
The owners of a managerial firm advance, withdraw, and redeploy capital, carry the residual investment risks of ownership and have the ultimate decision making rights over the fate of the firm (Klein 1999; Foss and Lien 2010; Fama 1980; Fama and Jensen 1983a, 1983b; Jensen and Meckling 1976).
Owners of a managerial firm, by definition, will delegate control to expert managerial employees appointed by boards of directors elected by the shareholders (Fama and Jensen 1983a, 1983b). The owners of a managerial firm will incur costs in observing with considerable imprecision the actual efforts, due diligence, true motives and entrepreneurial shrewdness of the managers and directors they hired (Jensen and Meckling 1976; Fama and Jensen 1983b).
Owners need to uncover whether a substandard performance is due to mismanagement, high costs, paying the employees too much or paying too little, excessive staff turnover, inferior products, or random factors beyond the control of their managers (Jensen and Meckling 1976; Fama and Jensen 1983b, 1985).
Many of the shareholders in managerial firms have too small a stake to gain from monitoring managerial effort, employee performance, capital budgets, the control of costs and the stinginess or generosity of wage and employment policies (Manne 1965; Fama 1980; Fama and Jensen 1983a, 1983b; Williamson 1985; Jensen and Meckling 1976). This lack of interest by small and diversified investors does not undo the status of the firm as a competitive investment nor introduce slack in the monitoring of payments to top executives.
Large firms are run by managers hired by diversified owners because this outcome is the most profitable form of organisation to raise capital and then find the managerial talent to put this pool of capital to its most profitable uses (Fama and Jensen 1983a, 1983b, 1985; Demsetz and Lehn 1985; Alchian and Woodward 1987, 1988).
More active investors will hesitate to invest in large managerial firms whose governance structures tolerate excessive corporate waste and do not address managerial slack and and overpaid executives. Financial entrepreneurs will win risk-free profits from being alert and being first to buy or sell shares in the better or worse governed firms that come to their notice.
The risks to dividends and capital because of manifestations of corporate waste, reduced employee effort, and managerial slack and aggrandisement in large managerial firms are risks that are well known to investors (Jensen and Meckling 1976; Fama and Jenson 1983b). Corporate waste and managerial slack also increase the chances of a decline in sales and even business failure because of product market competition (Fama 1980; Fama and Jensen 1983b).
Investors will expect an offsetting risk premium before they buy shares in more ill-governed managerial firms. This is because without this top-up on dividends, they can invest in plenty of other options that foretell a higher risk-adjusted rate of return. The discovery of monitoring or incentive systems that induce managers to act in the best interest of shareholders are entrepreneurial opportunities for pure profit (Fama and Jensen 1983b, 1985; Alchian and Woodward 1987, 1988; Demsetz 1983, 1986; Demsetz and Lehn 1985; Demsetz and Villalonga 2001).
Investors will not entrust their funds to who are virtual strangers unless they expect to profit from a specialisation and a division of labour between asset management and managerial talent and in capital supply and residual risk bearing (Fama 1980; Fama and Jensen 1983a, 1983b; Demsetz and Lehn 1985). There are other investment formats that offer more predictable, more certain rate of returns.
Competition from other firms will force the evolution of devices within the firms that survive for the efficient monitoring the performance of the entire team of employees and of individual members of those teams as well as managers (Fama 1980, Fama and Jensen 1983a, 1983b; Demsetz and Lehn 1985). These management controls must proxy as cost-effectively as they can having an owner-manager on the spot to balance the risks and rewards of innovating.
The reward for forming a well-disciplined managerial firm despite the drawbacks of diffuse ownership is the ability to raise large amounts in equity capital from investors seeking diversification and limited liability (Demsetz 1967; Jensen and Meckling 1976; Fama 1980; Fama and Jensen 1983b; Demsetz and Lehn 1985). Portfolio investors may know little about each other and only so much about the firm because diversification and limited liability makes this knowledge less important (Demsetz 1967; Jensen and Meckling 1976; Alchian and Woodward 1987, 1988).
It is unwise to suppose that portfolio investors will keep relinquishing control over part of their capital to virtual strangers who do not manage the resources entrusted to them in the best interests of the shareholders (Demsetz 1967; Williamson 1985; Fama 1980, 1983b; Alchian and Woodward 1987, 1988).
Managerial firms who are not alert enough to develop cost effective solutions to incentive conflicts and misalignments will not grow to displace rival forms of corporate organisation and methods of raising equity capital and loans, allocating legal liability, diversifying risk, organising production, replacing less able management teams, and monitoring and rewarding employees (Fama and Jensen 1983a, 1983b; Fama 1980; Alchian 1950).
Entrepreneurs will win profits from creating corporate governance structures that can credibly assure current and future investors that their interests are protected and their shares are likely to prosper (Fama 1980; Fama and Jensen 1983a, 1983b, 1985; Demsetz 1986; Demsetz and Lehn 1985). Corporate governance is the set of control devices that are developed in response to conflicts of interest in a firm (Fama and Jensen 1983b).
At bottom, the private sector is highly successful designing forms of organisation that allow large sums of money, billions of dollars to be raised in the capital market and entrusted to management teams.
via The Rise and Rise of the Super-Rich – The Atlantic and How the Richest 400 People in America Got So Rich – The Atlantic.
13 May 2015 Leave a comment
in economic history, politics - Australia, politics - New Zealand, politics - USA, Public Choice Tags: British Labour Party, Labour Party, Leftover Left, Twitter left, UK politics, withering away the of proletariat
12 May 2015 Leave a comment
in development economics, environmental economics, environmentalism, global warming, growth disasters, growth miracles, health economics Tags: climate alarmism, doomsday prophets, The Great Enrichment, The Great Escape, The Great Fact, Twitter left
Leaving the Left Exposed. James Hansen: dld.bz/dBnyq http://t.co/ZQsKSJxlr1—
The Left, Exposed (@leftexposed) April 23, 2015
10 May 2015 Leave a comment
Brilliant paragraph by @NickCohen4 on how the Left hate the English. theguardian.com/commentisfree/… http://t.co/NIoQJUhUA0—
Guy Walters (@guywalters) May 10, 2015
09 May 2015 Leave a comment
in economic history, economics of regulation, entrepreneurship, industrial organisation, international economic law, international economics, law and economics, politics - Australia, politics - New Zealand, politics - USA, property rights Tags: Australian productivity commission, free trade agreements, investor state disputes settlement, Leftover Left, preferential trade agreements, Senator Elizabeth Warren, Twitter left
In the Washington Post a few months ago, Senator Elizabeth Warren made a balanced case against investor state dispute settlement, not only in the Trans-Pacific Partnership. But in any trade agreement.
Apart from a few rushes of blood in rhetoric to appeal to her base, she made reasoned arguments, good use of history, and put up constructive alternatives to what she was criticising. Furthermore, she put forward arguments that appealed to every point in the political spectrum. The Left over Left critics of investor state disputes settlement clauses in trade agreements in New Zealand never do that.
She echoed arguments I have made the at investor state disputes settlement clauses have no place in trade agreements between liberal democracies.
Liberal democracies have independent courts and honest politics where everyone gets a fair go. That means sometimes you’re on the losing side of politics, but you as free to persuade the majority that they are mistaken. That is democracy in action: sometimes you win, sometimes you lose and there is an election in a few years where you can get another go.
New Zealand has a Closer Economic Relations Agreement with Australia. One provision is a requirement that in most cases New Zealanders are treated the same as Australians under Australian law.
To explain this, some years ago, a New Zealand television production company successfully sued the Australian television regulator to have New Zealand made television shows recognised as Australian content under the 50% Australian content regulations for free-to-air television in Australia.
Note the New Zealand business sued in the Federal Court of Australia and won. They had their day in court.
Senator Warren makes the point that if a business in the USA is unhappy with a regulation, they can challenge by normal democratic and legal means, which investor state disputes settlement undermines:
If a foreign company that makes the toxic chemical opposes the law, it would normally have to challenge it in a U.S. court. But with ISDS, the company could skip the U.S. courts and go before an international panel of arbitrators. If the company won, the ruling couldn’t be challenged in U.S. courts, and the arbitration panel could require American taxpayers to cough up millions — and even billions — of dollars in damages.
Senator Warren also provides a good history of the emergence of investor state disputes settlement and the relevance of that history to contemporary developments:
But after World War II, some investors worried about plunking down their money in developing countries, where the legal systems were not as dependable. They were concerned that a corporation might build a plant one day only to watch a dictator confiscate it the next. To encourage foreign investment in countries with weak legal systems, the United States and other nations began to include ISDS in trade agreements.
Investor state disputes settlement were indeed created to protect businesses that did not have robust democracies and legal systems. Would be international investors in one of these countries were promised international redress if there was a coup, a takeover of their investments or some other unforeseen negative impact because sovereign risk.
She then asked why are these provisions in trade agreements with liberal democracies where they have no relevance:
Those justifications don’t make sense anymore, if they ever did. Countries in the TPP are hardly emerging economies with weak legal systems. Australia and Japan have well-developed, well-respected legal systems, and multinational corporations navigate those systems every day, but ISDS would pre-empt their courts too.
Senator Warren also makes a good point that investor state disputes settlement undermines competition between legal jurisdictions and the rewards for having a sound legal system:
…to the extent there are countries that are riskier politically, market competition can solve the problem. Countries that respect property rights and the rule of law — such as the United States — should be more competitive, and if a company wants to invest in a country with a weak legal system, then it should buy political-risk insurance.
Political risk is is an entrepreneurial opportunity for the insurance market. The World Bank’s Multilateral Investment Guarantee Agency provides insurance to those investing in developing countries against expropriation (including indirect expropriation), as well as acts of war and terrorism. Export Finance schemes of many governments offer political risk Insurance. Anyone who travels in the less safe countries of the world routinely buys travel insurance.
The World Bank puts out an annual index on ease of doing business in every country of the world so foreign investors can’t say they won’t warned of the risks they were taking for the profits they sought.
Investor state disputes that were indeed referred to international arbitration used to be rare. Now they are more common as Senator Warren explains:
From 1959 to 2002, there were fewer than 100 ISDS claims worldwide. But in 2012 alone, there were 58 cases.
Recent cases include a French company that sued Egypt because Egypt raised its minimum wage, a Swedish company that sued Germany because Germany decided to phase out nuclear power after Japan’s Fukushima disaster, and a Dutch company that sued the Czech Republic because the Czechs didn’t bail out a bank that the company partially owned. U.S. corporations have also gotten in on the action: Philip Morris is trying to use ISDS to stop Uruguay from implementing new tobacco regulations intended to cut smoking rates.
In a response to Senator Warren’s op-ed, Gary Clyde Hufbauer said:
…only 13 ISDS cases have been brought to judgment against the United States. The United States has not lost a single case.
Why? Because the United States does not expropriate private property without compensation, and the United States does not enact arbitrary or discriminatory laws against foreign firms. Contrary to what the Senator implies, American taxpayers have not had to cough up millions and even billions of dollars in damages. They have not had to cough up anything.
The best part of Senator Warren’s op-ed is when she appeals to all points of the political spectrum based on arguments that do indeed appealed to them:
Conservatives who believe in U.S. sovereignty should be outraged that ISDS would shift power from American courts, whose authority is derived from our Constitution, to unaccountable international tribunals. Libertarians should be offended that ISDS effectively would offer a free taxpayer subsidy to countries with weak legal systems. And progressives should oppose ISDS because it would allow big multinationals to weaken labour and environmental rules.
Senator Warren did make a good case against investor state disputes settlement, particularly between liberal democracies. Foreign investors should take their chances in domestic politics and the courts like the rest of us. They’ve invested in a liberal democracy with independent courts, honest politicians and a commitment to a market economy.
Investor state disputes settlement clauses in trade agreements allow foreign investors to sue the host country for laws, policies, or court decisions they find objectionable. This gives foreign investors more rights than local investors; more influence than local citizens. That is contrary to equality before the law, which is the essence of liberalism.
The point that the Twitter Left rarely makes against investor state disputes settlement, and Senator Warren goes a way towards making is the shield offered by investor state disputes settlement clauses against predatory, corrupt governments in underdeveloped countries, many of which were socialist kleptocracies, has become a sword against regulations that arise in any liberal democracy that were sought and obtained through normal democratic means.
The Australian Productivity Commission held a public inquiry into regional and bilateral trade agreements in 2010. The commission specifically addressed investor state disputes settlement in its subsequent report:
1. There does not appear to be an underlying economic problem that necessitates the inclusion of ISDS provisions within agreements. Available evidence does not suggest that ISDS provisions have a significant impact on investment flows.
2. Experience in other countries demonstrates that there are considerable policy and financial risks arising from ISDS provisions.
The Productivity Commission concluded that investor state dispute settlement provisions are just not worth bargaining coin:
Nor, in the Commission’s assessment, is it advisable in trade negotiations for Australia to expend bargaining coin to seek such rights over foreign governments, as a means of managing investment risks inherent in investing in foreign countries. Other options are available to investors.
The Australian Productivity Commission was quite right to question the advantages of setting up a preferential legal system for anyone:
…a bilateral arrangement with Australia to provide a ‘preferential legal system’ for Australian investors is unlikely to generate the same benefits for that country than if its legal system was developed on a domestic non-preferential basis.
To the extent that secure legal systems facilitate investment in a similar way that customs and port procedures facilitate goods trade, there may be a role for developed nations to assist through legal capacity building to develop stable and transparent legal and judicial frameworks.
When the Left over Left usually argues against investor state disputes settlement provisions they get so carried away with the conspiratorial rhetoric that they overlook a much better argument.
Investor state disputes settlement provisions are bad deal from liberal democracies. Liberal democracies with the rule of law, a market economy and private property rights offer ample protections to any foreign investor.
In trade agreements with less democratic countries, the need for reciprocal promises may not be worth the price when there are other options for investment protection, such as political risk insurance.
The question must be asked as to who lobbies for these agreements considering how much is opposition they provoke, and how useful they are as a mobilisation tool for the Twitter Left in their relentless campaign against lower prices and higher living standards.
08 May 2015 Leave a comment
in economics of media and culture, technological progress Tags: Anti-Science left, Greens, Leftover Left, organic farming, sustainability, Twitter left
06 May 2015 1 Comment
in environmental economics, global warming, health economics Tags: Anti-Science left, anti-vaccination movement, climate alarmism, conjecture and refutation, GMOs, precautionary principle, Twitter left, University of the Internet
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