Archive for the ‘Economy and Business’ Category

Overall, CEOs don’t earn their big paychecks

April 14, 2014

o-CEO-PAY-570

The following is by Mark Symonds for Forbes

It isn’t every day that academic research comes along to tell you something you really wanted to hear and that you suspected was the truth all along.  In this case it’s about the long running debate around top executive pay.

A recent paper by J. Scott Armstrong of the Wharton School and Philippe Jacquart of France’s EMLYON, seem to have finally established that paying top dollar simply doesn’t get a better job done.  And, in fact, it might actually get a worse one done.

According to Armstrong and Jacquard, while there is plenty of evidence that financial incentives can be effective in motivating people to do mundane and boring tasks, individuals do the more interesting and challenging stuff…well, because it’s interesting and challenging.

Perversely, they say, very large financial incentives may actually hinder top performance. The paper argues there is strong evidence that individuals can become fixated on incentives and either become limited in their thinking, unable to digest and adopt new ideas or alternately become convinced that they will achieve the goal automatically so do not need to try as hard as they might otherwise.  Whatever the outcome, every other stakeholder from the more modestly earning employee to the corporate stockholder loses out.

And finally the research also suggests that we might not really be getting the brightest and best talent at the top because the tools and processes used to identify candidates are either limited or downright faulty

There is simply too much emphasis on past performance, personal recommendation, unstructured interviewing, an unwillingness to ask really difficult and searching questions and that more dangerous selection criterion of all – gut instinct. Worryingly, it seems that the headhunters and in-house recruiters charged with hiring occupants of the corner office may be relying too much on perception and too little on good, hard facts.

The paper points out that CEOs who win prestigious industry awards constantly out-earn those that don’t.  Yet the stocks of the companies the award winners head up consistently under-perform in comparison to those of their less publicity hungry peers.  Perhaps because the latter spend their time running their businesses well instead.  [snip]

Unlike many academics, who might shy away from coming up with a solution, EM Lyon’s Jacquart is one willing to give the obvious if uncomfortable answer – namely that current incentive models need to be abandoned and overall executive pay should be reduced.

And he’s also ready with a counter to those who will doubtless argue that this will make it impossible to recruit the right people and bring major banks and corporations crashing to the ground.

“Yes, of course this may make it more difficult to recruit very senior individuals from outside an organization, at least in the short term. However it would force businesses to focus more on the development of the talent it already has, the talent that is more likely to be more loyal to and understanding of its aims, goals and methodologies.”
[snip]

via Big Company CEOs Just Aren’t Worth What We Pay Them.

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Chipotle profits by investing in employees

April 12, 2014

The Chipotle Mexican-style restaurant chain enjoys good profits and good growth, while paying its employees generously and promoting from within.

220px-Chipotle_Brandon_Its current policy began about nine years ago when founder Steve Ells and then-COO Monty Moran visited the restaurants, and notice that the one that were best-run were all managed by employees who had started as restaurant crew members and worked their way up.

They decided to make that into a system, and reward restaurant managers, not for achieving set targets of holding wages and other costs down, but for mentoring employees and training them to be managers.

Click to enlarge.

Click to enlarge.

Why do so many managers ignore the examples of Chipotle, Costco and other companies and instead grind their employees down instead of building them up?  

I am reminding of a saying Bertrand Russell once made about human nature, When people are mistaken as to what is in their interest, the course they believe to be wise is more harmful to others than the course that really is wise.

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Free enterprise vs. capitalism

April 12, 2014
Adam Smith

Adam Smith

I define “free enterprise” as the “system of natural liberty” advocated by Adam Smith, in which people are free to pursue their own goals in their own way, “subject only to the law of justice.”

I define “capitalism” in the same way as Karl Marx, who coined the word — a system in which political and economic power is in the hands of owners of financial assets

By these definitions, free enterprise is not necessary to capitalism, nor vice versa.  What’s necessary for capitalism is institutions that allow great concentrations of wealth, such as limited liability corporations, lending at compound interest and the power of banks to create money.  Government-protected monopolies help, too.

In the same way, capitalism is not necessary to free enterprise.  The Phoenician traders in the ancient world, who traveled from the eastern Mediterranean to Britain to buy tin, were not capitalists in the way that J.P. Morgan or John D. Rockefeller were capitalists, but they certainly had the entrepreneurial spirit.

Karl Marx

Karl Marx

Adam Smith, the great economist and philosopher, did not particularly admire capitalists.  He saw economic competition as a means to hold their power in check.

As for myself, I am not an opponent of either free enterprise nor capitalism, although I am a critic of both, especially the latter.  I think the working of the free market is a more effective way to coordinate economic activity than central planning, provided that it is, as Smith said, “subject to the law of justice” — unlike Milton Friedman and others, who thought a free market could be a substitute for the law of justice.

Likewise, I see a benefit to being able to create concentrations of wealth and use them to create new sources of wealth for the benefit of society.   American capitalists made it possible to create a steel industry,a computer industry and all the other industries.  Maybe this could have been done in some other way, but this is the way it happened. 

The problem is how to prevent mere possession of wealth from enabling its owners to monopolize the fruits of the economic system, which is what is happening now and which Marx thought was the inevitable result of capitalist ownership.

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Piketty’s formula: its scope and limits

April 4, 2014

Source: Emmanuel Saez and Garbriel Zucman

http://gabriel-zucman.eu/files/SaezZucman2014Slides.pdf

http://www.slate.com/blogs/moneybox/2014/04/02/wealth_inequality_is_it_worse_than_we_thought.html

The brilliant French economist Thomas Piketty has an economic formula which shows why, most of the time, the wealthy elite captures a larger and larger share of a nation’s income, and also why, some of the time, the rest of the nation catches up.

pikettybookcover00While my previous post about Piketty and his great book is long, I don’t really explain his formula and how it works.

His formula, which he calls the fundamental law of capitalism, is as follows:

The capital income ratio (a) equals the rate of return on capital (r) times the national wealth (beta*),

That is, if the national wealth – every form of property that can produce an income for its owner, which is what Piketty calls capital – is six times, or 600 percent, of the nation’s annual output, and the average rate of return on capital is 2 percent, then owners of capital will receive 12 percent of the nation’s income in that year.

If a nation’s annual income is static and the owners of capital reinvest some of their income, then capital will be a larger multiple of the national income the following year, and the owners of capital will receive a larger share of national income.  If a nation’s annual income is growing, but the return on investment is a higher percentage than the growth rate, the owners of capital will get a larger share of national income the following year.

Once this is explained, it seems obviously true – at least to me.   And it seems to be a problem – at to me.   The graph above, prepared by Emmanuel Saez of the University of California (Piketty’s long-term collaborator) and Gabriel Zucman of the London School of Economics, shows how unequally wealth is distributed in the USA.  More than 1/5th of U.S. wealth is owned by 1/1000th of the population.  It is easy to see how the normal working of Piketty’s formula could cause them to suck up more and more of the nation’s income.

Thomas Piketty

Thomas Piketty

What do you do about it?   Piketty proposed graduated taxes on income, inheritance and wealth itself, sufficient to bring return on investment down to the rate of economic growth. 

I don’t see anything wrong in principle with a wealth tax.   I pay a property tax on my house.  Why shouldn’t a billionaire pay taxes on his investment portfolio?    But this is going to take a long time to bring about, even if everybody agrees.  For one thing, it will require the elimination of all the tax havens where the super-rich hide their money, which will require international agreement.  For another, increasing the government’s revenue does not necessarily benefit the public – if taxes are used to finance aggressive war, for example.

There are other possible solutions, because there are other factors in the equation.  If strong economic growth can be restarted, if the economic growth rate exceeds the return on investment rate, that would solve the problem.   Strong labor unions and minimum wage laws would increase the income share of working people and the middle class.   There are many possible approaches.

In theory, the solution could be wider ownership of capital by the public, such as by ESOPs (employee stock ownership plans) or by pension funds.  Back in the 1970s, the management analyst Peter Drucker noticed that pension funds were acquiring a bigger and bigger share on the U.S. stock market.  Eventually, he predicted, this would accomplish the Marxist dream of worker ownership of the means of production!

This didn’t happen because the corporations that controlled the pension funds didn’t allow it to happen.  But if workers controlled their pension funds, it would be a different story.  This would not be a practical reality any time soon, or perhaps ever.  The point is that tax policy is not the only means to deal with hyper-concentration of wealth.

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Why the rich will probably get richer

April 2, 2014

CAPITAL IN THE TWENTY-FIRST CENTURY by Thomas Piketty (2013) translated by Arthur Goldhammer (2014)

Thomas Piketty of the University of Paris is the world’s foremost authority on income distribution and the super-rich. All the charts you see how income is being redistributed upward to the top 1 percent of income owners are based on work by him and his collaborators. In this new book, based on 20 years’ work, he concluded that it is not an aberration that ever-greater shares of income go to a tiny elite. Piketty said this is the natural working of a market system.

According to Piketty, the higher you go on the income scale, the larger the amount of income comes from investments rather than work. When the economic grows at a higher percentage rate than the average rate of return on investment, income becomes more widely distributed. When the average rate of return on investment is greater than the rate of economic growth, the owners of economic assets gain at the expense of everybody else.

His research is based on 200 years of data on income and wealth distribution in France, the UK, the USA and other countries, which now can be analyzed and processed with computer technology. His book would be a good supplement to David Graeber’s Debt: the First 5,000 Years, whichi is sketchy on precisely the past two centuries.

Piketty concluded that the average rate of economic growth since 1800 is about 1 percent a year for the countries he studied, and the average rate of return on investment is about 4 to 5 percent a year. Unless something happens to change one or the other figures, a wealthy elite will grow richer and richer at the expense of everyone else, until there is nothing left to invest in.

pikettybookcover00Piketty defines “capital” as anything you can own that will generate income. In the late 18th and early 19th centuries, capital (by his definition) consisted mainly of agricultural land and government bonds. Now it consists mainly of housing, industrial machinery and stocks and bonds of private corporations. Few economists would define “capital” in so broad a way, but if all you’re interested in is income distribution, it doesn’t matter what form “capital” takes.

If you read English and French novels set in the early 19th century, the characters consist mainly of members of what Piketty calls the “dominant” class, which are the 1 percent of the population who receive 30 to 60 times the average income, and the “well-to-do”, who consist of the next 9 percent. Characters in Balzac and Jane Austen seek wealth through inheritance, marriage and patronage of wealthier and more powerful people. Nobody in those novels thinks that wealth is acquired through hard work and superior talents. Piketty said there is nothing to prevent a reversion to this kind of world, although the difference between wealth and poverty wouldn’t be quite so extreme.

The reason the history of the 20th century was different, he wrote, is the great destruction of capital during the two world wars and the Great Depression. This cleared the deck for the great surge in prosperity of 1945-1975, which benefitted all segments of the population. Since then, according to Piketty, the growth in income has been sucked up by the dominant and well-to-do classes.

Now I don’t think that someone born in 1900 would have thought the prosperity of 1945-1975 justified the catastrophes of 1915-1945. This points to an important limitation of Piketty’s book. It is full of fascinating information, drawn from a wide variety of sources, ranging from centuries of income and property tax records to social history, economic theory, literature and financial

Thomas Piketty

Thomas Piketty

journalism. But when it comes right down to it, he deals with only one subject, the income share of the super-rich. He doesn’t have theories on how to eliminate poverty, promote economic growth, set priorities for public investment or any other important objective. This is not a criticism. It is just a description of what the book is and isn’t about.

His one subject – which is important – is the economic elite and how, short of violent revolution, to prevent from sucking up an undue share of society’s wealth and income. But as the experience of 1915-1945 shows, destroying the power of capital does not, in and of itself, make things better for everyone.

Piketty focuses on data from France and the UK because the United States is, in good and bad ways, exceptional compared to the rest of the world. During the past 200 years, the boundaries of France remained roughly the same and population grew from 30 million to 60 million. During the same period, the United States expanded from a narrow strip along the Atlantic to the Pacific coast, and its population grew from 5 million to 300 million.

Income distribution in the United States historically has been more equal than in Europe, he noted, at least for white men in the Northern states. The chief form of capital in the early United States was agricultural land, and this was very cheap compared to Europe. Early settlers and immigrants brought little wealth with them. What they created was the fruit of their labor. A great deal of the capital for building U.S. factories and railroads came from European investors. The great American hereditary fortunes did not emerge until the dawn of the 20th century.

The South was different from the North because the economic elite possessed enormous capital in the form of enslaved human beings. Piketty estimated that in the 1770-1810 period, the economic value of slaves in the South exceeded the value of all land, housing and other forms of wealth, and also exceeded the total wealth of the North. The result was a high concentration of wealth, and a large gap between rich and poor white people, which persists to this day.

Differences in earned income, while great in all countries, have seldom been as important as differences in income from wealth. The exception is the surge in corporate compensation in the United States and other English-speaking countries in the last generation. Piketty showed, by means of international comparisons, that the current size of executive compensation cannot be justified on the basis of merit or results. It is the result of executives being able to influence their own pay, and the lack of standards as to how much is enough.

The disturbing fact about investment income is that the more you have of it, the higher your rate of return. Piketty compared the returns on endowment funds of American universities, which are a public record, by size categories. The larger the fund category, the higher the percentage return, with Harvard by far outpacing all the rest.

This is because the larger the fund, the more the owner can afford to get expert investment advice, and the better able the owner is to invest small amounts in high risk, high return investments. Also, unlike an individual who has saved for retirement, the super-wealthy person or institution does not have to take out a significant percentage to live on.

The implication is that once you reach a certain level of wealth, your wealth becomes self-sustaining. A Bill Gates or a Steve Jobs can simply coast. He not longer needs the entrepreneurial drive that brought him success in the first place. Piketty’s analysis of the Forbes 400 list indicates that inherited wealth is at least as important as entrepreneurial wealth, and he thinks Forbes vastly underestimates income from passive investments because of lack of access to tax havens.

Piketty’s solution is a tax on capital – which, remember, is by his definition any form of income-producing property – sufficient to bring the average return on investments down to the expected rate of economic growth. He pointed out that some forms of wealth, such as real estate and buildings, already are taxed. In principle, taxing stock portfolios is no different.

Since the average rate of return is greater for greater wealth, his proposed tax would be graduated, with a zero or 0.1 percent rate for fortunes below 1 million euros and perhaps rising as high as 2 percent above 5 million. These don’t seem high, but they are high compared to expected rates of return. He also favors continuation of the graduated income tax and inheritance taxes. His purpose is not to prevent people from getting rich. It is to prevent the rich as a group from getting richer at a faster rate than the economy is growing.

The revenue from the wealth tax should be spent in reducing government debt, which Piketty sees as a transfer of income from taxpayers to wealthy holders of government bonds. It is better to tax the rich than borrow from them, he said.

Piketty’s proposals require much better information about wealth and income than we have now. The first step would be for the international community to require reporting of financial information from places such as Switzerland and the Cayman Islands that act as tax havens.

The 577-page book and the 76 pages of notes are crammed with information of interest even to those who don’t accept his basic argument. It is not written in technical language, which is part of the reason it is so long; Piketty, like the late Isaac Asimov, explains everything from the groun up.  If you don’t have time to read the whole book, his core argument can be found in the Introduction or Conclusion.  Or click on some of the links below.

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Gold as a hedge against inflation

March 28, 2014
GoldPriceSince_1791_2013

Double click to enlarge.

Source: http://visualizingeconomics.com/

Hat tip to http://www.ritholtz.com/blog/

Who in Ukraine will benefit from an IMF bailout?

March 23, 2014

Economists Michael Hudson and Jeffrey Sommers, in this informative interview with the Real News Network, said that most people in Ukraine will suffer, because the condition for an IMF loan will be lower living standards for a country already poor by European standards, higher taxes and fewer public services and a bankruptcy sale of the Ukraine’s rich farmland and other assets at bargain prices.

IMF loans never go to the people of the country receiving the loan.  They go to pay off the country’s creditors.  An IMF loan to a country is like a debt consolidation loan to a private individual.  In the case of Ukraine, the country’s creditors fall into two groups — the Russian Federation and its Gazprom natural gas company, to which Ukraine has billions of dollars owing and which no longer will sell Ukraine gas at a below-market price; and banks in western Europe and the United States, which have made billions of dollars in loans to the previous government.   Whichever group to which the IMF loans flow (I’m not betting on the Russian Federation), they won’t go to help ordinary Ukrainians.

Ukraine will then be in debt to the IMF, which will demand repayment by squeezing the money out of the Ukrainian people and by selling off Ukrainian national assets at bargain prices.  Rich Ukrainians may acquire some of these assets.  They will be the only Ukrainians who will benefit.

Hudson and Sommers pointed out that U.S. energy companies are planning for a disruption in Russian natural gas exports to western Europe, and building LNG (liquified natural gas) terms in U.S. ports so as to be able to sell gas in Europe.

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Why franchisees should organize

March 19, 2014

I’ve written about low wages and poor working conditions at fast-food restaurant chains, but the fact is that a humane business owner who is a franchisee may not be in a position to treat employees humanely.

Franchisers of fast-food restaurants impose strict controls on franchisees, including the prices that they charge.

So if McDonald’s (to take a hypothetical example) says the price of a double cheeseburger is a dollar, and it costs more than a dollar to make the double cheeseburger, the “owner” of the individual McDonald’s restaurant loses money.

I put “owner” in scare quotes because a franchisee does not have the self-determination of a true owner.  Under a truly independent business owner, the franchisee is not free to raise or lower prices in response to supply and demand.

The effect of unionization of fast-food workers or a higher minimum wage will be to squeeze franchisees while the effects on franchisers at the top of the economic food chain will be minor and indirect.

The answer, as Martin Longman wrote in the Washington Monthly, is for franchisees to unionize to protect their own interests.   As Longman pointed out, franchisees typically pay thousands of dollars just for the right to the franchise, basic business decisions such as prices are made for them, and they often have to buy basic supplies from suppliers designated by the franchiser.  They are in much the same situation as sharecroppers in the Old South in an earlier era, and have just as little ownership rights.

Everybody who is in a position to be squeezed by giant corporations — employee, franchisees, suppliers — has a right to organize collectively to equalize the bargaining power.   It is not in the interest of franchisees and suppliers to be shock absorbers between these giant corporations and the workers who make their profits possible.

If franchisees organize, their organization would of course not be called a “union” [1].  It would be called an “association” or “federation” or something like that.  But the purpose would be the same.

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How insiders rob banks and cause crises

March 18, 2014

William K. Blank is professor of economics and law at the University of Missouri at Kansas City, a former bank regulator and author of The Best Way to Rob a Bank Is to Own One (which I haven’t read).

In this TED talk, he explains how crooked bankers enrich themselves through what he calls “control fraud”.  The method is as follows:

  • Make a lot of loans to people you know can’t pay you bank.
  • Conceal the bogus nature of the loans through fraudulent appraisals.
  • Collect high interest rates (for a while)
  • Report record profits (for a while)
  • Collect an enormous salary and enormous bonuses (for a while)
  • Escape scot-free with your riches when the crash comes.

There are two other elements that he doesn’t mention in this particular talk.

  • Convert the loans into financial securities and sell them to suckers
  • Go to Congress and the Federal Reserve Board to be bailed out when the crash comes.

Black said all this has been facilitated for the past 20 years by the Clinton, Bush II and Obama administrations, and by the Federal Reserve Board during that period.  Everything is in place for another crash as big as what came before.

It seems obvious to me that we Americans need to (1) break up the “too big to fail” banks (those whose assets exceed a certain set percentage of Gross Domestic Product, (2) refuse to insure deposits that are used for risky investment and (3) prosecute financial fraud, as was done in the Bush I administration following the savings and loan crash.

LINKS

America Has Become a “Cheater-Take-All” Nation by Willliam K. Black for AlterNet.

The Big Lie That Haunts the Post-Crash Economy by Dean Stockman for The New Republic.   The “big lie” is that “everyone” is to blame for the crash of the housing bubble, when in fact the bubble was mainly due to crooked financiers.

New Lawsuit Alleges That Wells Fargo Has a Manual for Mass Fabrication of Foreclosure Documents by Yves Smith.

Why Prosecutors Whiffed on Subprime Crime by Barry Ritholtz for Bloomberg View.

Hat tip for the video to Yves Smith.

The shock doctrine in Ukraine

March 6, 2014

Naomi Klein, in her book, The Shock Doctrine, told how the global banking system took advantage of crises, and sometimes created crises, in order to force national leaders to accept policies against their will.   This seems to be what is going on in Ukraine.

Ukraine has beem in gave financial difficulties.  Last fall the International Monetary Fund offered Prime Minister Viktor Yanukovich a bailout, under conditions that reportedly included a doubling of prices for gas and electricity to industry and homes, the lifting of a ban on private sale of Ukraine’s rich agricultural lands, a sale of state assets, a devaluation of the currency and cuts in funding for schools and pensions to balance the budget.  In return, Ukraine would have got a $4 billion loan, a small fraction of what was needed.

Then the Russian Federation offered a $15 billion loan and a 30 percent cut in gas export prices.  Naturally Prime Minister Yanukovich accepted.  Then all hell broke loose.

Arseny Yatsenyuk

Arseny Yatsenyuk

A mysterious sniper killed peaceful demonstrators in Maidan square in Kiev and, as has happened with mysterious sniper attacks in Venezuela, Thailand and other countries, the killings sparked a violent uprising.

U.S. Assistant Secretary of State Victoria Nuland said in a leaked telephone conversation with the Ukraine ambassador that “we” want the former banker, Arseny Yatsenyuk, installed at Yanukovich’s replacement, rather than some more popular politician.  And that’s what happened.

Yatsenyuk said he will do whatever it takes to get IMF financing, even though this probably will make him the most unpopular prime minister in Ukraine history.  He in fact has little choice.  The Russian offer has understandably been withdrawn, and Ukraine is in a much more desperate plight than it was six months ago.

Elections are scheduled for May, but that’s plenty of time for Ukraine to be locked into binding commitments to the IMF.

Ukraine is a country rich in natural resources but poor in money — an inviting target for financial speculators.   Based on what has happened in other countries in like situations, I look for Ukraine’s resources and assets to be sold off at bargain prices.

I don’t see what business a U.S. Assistant Secretary of State has trying to name the head of a foreign government, or how this in any way benefits the American people.  It seems to be an example of the workings of Wall Street as a component of Michael Lofgren’s deep state.

LINKS

The shock doctrine

Washington’s Man Yatsenyuk Setting Ukraine Up for Ruin by Kenneth Rapoza for Forbes.

The Rape of Ukraine: Phase Two Begins by F. William Engdahl for World News Daily Information Clearing House.

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