Wednesday, August 4, 2010

A Response to Peter Kleins Lecture: Corporations and the Free Market

A Response to Peter Kleins Lecture: Corporations and the Free Market
by Alex Merced

Listen to Peter Kleins Lecture here

 You've might have read in previous posts on Liberty is Now that I am one of the Libertarians who criticize corporations role in the free market. Although Let me make a few quick bullet points as far as where I do agree with Kleins lecture:

- I do agree that Limited Liability is not in itself illegitimate, through mutual contractual agreements one can delegate liability without special legal entities. Although, I think of liability as something you own, so through a contract your can transfer title to that liability, but unlike a C Corp it can't be completely separated from ALL owners, at least one owner will have to take title to the liability which is why a Limited Partnership I think is more akin to what is possible in a free market than a C Corporation.

- I agree several mechanisms prevent CEO's and other firm managers from being lazy, and making sure they are competitive, but this is not really from where I attack C Corporations.


The Premise of my Critic:

That due to the separation of management and liability unique to C-Corps that publicly traded companies are inherently unsustainable cause everyone in the checks and balance chain has short time horizons for example:

- The CEO and other Officers don't necessarily have ownership (though a lot of them do), although the overriding incentive is to keep their job, which means to please to shareholders proxy, the Board of Directors.

- The Board of Directors once again may or may not have ownership, but the overriding incentive is to keep their directorship and to do this they need to please the shareholders.

- Due the ease of getting in and out of an investment in a public company, investors tend to have short time horizons and will want short term gains, they don't care about the long term since they'll soon enough sell it and move to the next investment. So if Directors and Officers make decisions for the long term sustainability of the company that adversely affect the short term dividend and growth outlook be sure the shareholders will act to change the board.

Counter Point: Wait, won't a lot of this money be managed by professional money managers who should know better?

- Money Managers for Mutual Funds and Pension Funds also don't necessarily have ownership and are judged by their performance on the short term. So to keep their jobs, their time horizon is kept quite short, which is characterized by the number of pension funds that ran surpluses during bubbles but didn't change the allocation to more prudent variations to lock in those gains in order for the manager to keep their job. Now, most pension funds are under funded for the benefits they need to pay out.



Why is the Limited Partnership Better for Corporate Governance?

The General Partner - The people at the top of the totem pole making the highest decisions regarding the business has unlimited liability, so with that being the case, they have a stake in the long term sustainability in the company.

The Limited Partner - Has legitimate limited liability, yet can't liquidate their shares at a whim, they will need to find a buyer and get the approval of the general partner. Since the shares are less liquid, the limited partner wants the company to have a stable sustainable value so the value persists till he can find a buyer for their shares, meaning the investor now has a stake in the long term of the company.





Other Factors to Consider for Corporate Governance:

- To Moral Hazard of Public Unemployment Insurance on employer and employee incentives, versus the sustainable incentives of privately purchased unemployment insurance

Employee: If the employee has to pay higher premiums for more unsustainable jobs, then he might take a lower wage sustainable job cause he'll bring home more wages after the premiums, which will incentivize talent to go to sustainable firms not high paying unsustainable firms. Also if you work in a field where jobs are scarce, private plans can allow you to purchase more coverage beyond the 6 month standard at no cost to the tax payer. Employees can also lower their premiums by becoming more skilled and educated, since these would lower the risk of job loss.

Employer: If the employee won't work for the employer cause premiums are too high, this is an incentive for employer to develop a sustainable job atmosphere and company to lower those premiums.

- The effect of Corporate Tax Laws  many of the incentives for bizarre corporate expenditures is that they are tax write offs, and it's better that the company spend it on golden curtains and high priced furniture and than let the government take the same money from them in taxes.With simple tax reforms, corporation would have an incentive to be more frugal and let that money trickle to the bottom line for larger dividends to investors.

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Founder of this blog is Alex Merced - Contact him at alexmerced@alexmerced.com







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