Klarman vs. Friedman

I thought I blogged on it but I had not. On November 11, I had read a good piece by Luigi Zingales in FT on maximising shareholder welfare and not shareholder value. That did appear somewhat incomplete to me. What he was trying to say was that maximising shareholder welfare over the long-run means attaching less importance to shareholder value in the short-run.

I forwarded it to the students at the IFMR B-School with the following message:

As you have access to FT and WSJ, you should read more such articles. 

In the class, you can also discuss whether what Boeing did – withholding information – is correct, even if it maximised profit and shareholder value in the short-run.

Sometimes, one does not have to change one’s goals. It can be still profit maximisation and shareholder value but having a long-enough horizon will make all the difference.

I was happy to find that Seth Klarman echoed my thoughts in his address at the Harvard Business School at the inauguration of the Klarman Hall on October 1. HBS Alumni Association carried that speech two months later in December:

Consider corporate time horizons. It’s a choice to attempt to maximize corporate results over the very short run and a different and sometimes harder decision to take a longer-term view. I’m convinced that one of society’s most vexing problems is the relentlessly short-term orientation that manifests itself in investing, in business decision-making, and in our politics. Educational and philanthropic endowments, for example, with institutional time horizons that necessarily span centuries, invest their funds with monthly performance comparisons.

This is the same as what I had told my students in my brief email to them. In fact, the running theme of Seth Klarman’s speech was about short-term vs. long-term horizons. It is short and well worth a read.

In fact, in his speech, Seth Klarman questions Milton Friedman’s credo that the social responsibility of a business was to maximise profits. Recently, I read somewhere that Milton Friedman had caveated it. But, I do not think that the caveat was adequate. This was his caveat:

I have called it a “fundamentally subversive doctrine” in a free society, and have said that in such a society, “there is one and only one social responsibil ity of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception fraud.” [Link]

This is too narrow. It does not include ethics. Not to be deceptive is not the same as doing the right thing. This is almost legalese. To engage in open and free competition is not as forceful as arguing that businesses should not actively smother or kill competition by buying them out and then killing the business. Milton Friedman also did not anticipate how humans would interpret him to their convenience.

He did not have a long-enough horizon himself to think of how humans, with short-term horizons, would interpret him!

A (t)horny issue and other links

The Swiss sure have their problems!! The rest of us will only be too happy to trade ours for theirs. Referendum on cows’ horns is coming up in Switzerland! [Link]

Augustin Carstens called the bitcoin ‘a bubble, Ponzi scheme and an environmental disaster’ way back in February. Well said [Link]. The value of bitcoin has collapsed and I suspect that the benefits of ‘Blockchain’ are vastly overstated.

Paul Tudor Jones sounds the alarm on corporate credit in the United States:

If you go across the landscape you have levels of leverage that probably aren’t sustainable and could be systemically threatening if we don’t have . . . appropriate responses [Link]

IMF had chipped in with its own (eloquent, doubtless) warning on leveraged loans, little realising its own culpability on the matter. It warned central banks against raising rates ‘prematurely’ from 0.0%. The truth was that in 2015-16 the world was in dire straits. Hence, their warnings, perhaps, on premature tightening. But, then, it means that the programme of zero short-term interest rates and QE (which held down long-term rates) were a failure. Why persist with them? So, they created the mess that they are warning against now!

Did they earn their stripes?

Nov. 14 2018 — Stripe Inc.’s $245 million capital raise was the clear highlight of U.S. financial technology fundraising in the month of September, weighing in at more than four times the next-highest raise. Stripe’s massive round even stood out in comparison to other sectors, ranking in the top 15 of all U.S. private placements during the month.


The latest raise values Stripe, a payments company founded in 2009, at $20.25 billion on a post-money basis. The most recent valuation is a massive increase from November 2016, when a $150 million infusion valued the company at $9.15 billion. But on a percentage basis, an even bigger jump in valuation came from May 2012, when the company was valued at about $100 million, to January 2014, when its valuation skyrocketed to $1.75 billion. [Link]

The return of robber-barons?

I receive the NBER digest every month and the papers that the Digest features are almost always very interesting. In the October 2018 Digest, I came across this paper:

Are EU Markets More Competitive than Those in the U.S.? 

Since 2000, gross profit rates in the United States have risen and industry concentration has soared, but these trends are not found in the European Union.
Until the late 1990s, most U.S. markets were viewed as highly competitive relative to their international counterparts. Many European countries implemented U.S.-style free market regulatory models during this time period. 

In How EU Markets Became More Competitive Than U.S. Markets: A Study of Institutional Drift (NBER Working Paper No. 24700), Germán Gutiérrez and Thomas Philippon argue that over the last two decades, U.S. markets have gradually become less competitive, and that, because this trend was not echoed in Europe, European markets today are actually more competitive than those in the United States. In many cases, the EU markets exhibit lower levels of industry concentration and excess profitability, as well as fewer regulatory barriers to entry.

The researchers find that starting around 2000, gross profit rates in the United States began to increase while the labor share declined. These developments are much more muted in the EU. A similar trend is observed in measures of industry concentration.

The researchers explore whether industry composition drove the divergence in concentration. They consider whether the emergence of high-tech industries drove the broad increase in concentration observed in the United States. They discount that explanation, noting that “the rise in U.S. concentration since 2000 is pervasive across most sectors, just as the stability/decline in EU concentration is.” Industries that experienced significant increases in concentration in the United States, such as telecom and airlines, did not experience parallel changes in the EU.

In the airline industry, the researchers find, the “rise in U.S. concentration and profits closely aligns with a controversial merger wave that includes Delta-Northwest (2008), United-Continental (2010), Southwest-AirTran (2011) and American-US Airways (2014).”

They suggest that the divergence in market competitiveness between the U.S. and Europe is related to the powers granted to EU regulatory institutions at their inception. They note that both the European Central Bank and the Directorate-General for Competition were given more political independence than parallel institutions in the United States and thus have been able to pursue more aggressive antitrust enforcement in recent years. In the U.S. between 1996 and 2008, they write, the Federal Trade Commission “…essentially stopped enforcing mergers when the number of remaining competitors is 5 or more.” 

In all areas of antitrust the researchers find decreasing enforcement in the United States and increasing enforcement in the EU. The Directorate-General for Competition is more likely to pursue “abuse of dominance” cases than is the U.S. authority, and financial penalties in cartel cases tripled as a share of EU GDP between 2000 and 2016.

The decline in U.S. market competitiveness has had meaningful consequences for U.S. consumers, the researchers point out. Broadband internet prices in the U.S., for example, are significantly higher than in the EU, where the telecom industry is less concentrated. 

They buttress their case for the comparative lack of political independence of U.S. regulatory bodies by noting the higher levels of both lobbying and campaign contributions in the U.S. than in the EU. Political campaign contributions are 50 times higher in the U.S. than in the EU.

Source:The NBER Digest, October 2018

It is often assumed that a capitalist economy is a competitive economy. But, it need not be. Is Capitalism synonymous with competition? In theory, it is. In practice, it is not. The guy with the most market capitalisation wins? Is that capitalism?

Sarah O’ Connor’s piece in FT on how big companies are pushing governments around confirms why market concentration rises. Governments are doing the bidding of companies and not that of real markets. Pro-business is not pro-market. Pro-business is anti-competition and ani-consumer. Even anti-society.

‘The Economist’ now suggests or describes how labour unions are regrouping using technology to re-establish themselves or how technology is allowing workers to regroup themselves. Technological developments might have led to the erosion in their power base. Funny that ‘The Economist’ does not include globalisation and the offshoring of jobs as one of the things that led to the erosion of the powers of labour unions. In any case, it is good for capitalism too that labour unions are coming back.

May be, this is what is needed for the rising tide of market concentration in America to be reversed.

Invisible band vs. Invisible hand

Jonathan Haidt’ column from 2015 on the organisational structure in Sears is useful. But, it is not clear if the blame on the bankruptcy of Sears can be laid solely on that. At some level, there is some merit in having a clean organisational structure with each business in Sears operating as an independent company.  But, he points out that this ruled out cooperation between businesses and that Sears businesses even privileged Samsung brand rather than Sears’ own brand of consumer durables in shelf spaces. Perhaps, the KRAs of the CEOs of each of the businesses could have also included a component for cooperation and synergies between the businesses. An interesting case-study for students of organisational structure and behaviour, etc.

It cannot be said that much of this wisdom is hindsight, because Sears is in trouble now. The article was written three years ago. It can be even called prescient, actually.

He concludes that invisible bands matter as much as inevitable hands. Nice. Read the post here.

Validating Jonathan Haidt is Nick Hanauer whose speech delivered on September 30th at MIT, where Nick Hanauer won the 2018 Harvard and MIT Humanist of the Year award calls for killing ‘Homo Economicus’ to bring about the destruction of ‘neo-liberalism’ that celebrates selfishness or self-centredness.

His profile says that he is a Seattle-based serial entrepreneur, venture capitalist, author, and activist with a knack for identifying and building transformative business models.

These are powerful sentences:

The neoliberal claim that the sole purpose of the corporation is to enrich shareholders is the most egregious grift in contemporary life. Corporations are granted limited liability in exchange for improving the common good. Thus, the true purpose of the corporation is to build great products for customers, provide good jobs for employees, provide a fair return to shareholders and to make their communities stronger—in coequal measure. [Link]

I am all for the pendulum swinging in the direction of greater consideration to other stakeholders, esp. in the developed societies. But, I am far more ambivalent on their benefits for developing societies where these might be interpreted (or, misinterpreted) deliberately as calling for greater government intervention, regulation and the return of State-directed socialism. Let us see.

Soulless capitalism is now global

In the last three years, CEOs’ combined compensation has expanded at a compound annual growth rate (CAGR) of 18.3 per cent, against 13.3 per cent growth in corporate earnings, 4.8 per cent CAGR in net sales and 10.1 per cent annual rise in the total salary and wages bill. [Link]

There are at least seven top executives among listed companies who earn more than a thousand times the compensation of their median employees….The gap at the very top of this ranking was actually higher in this larger sample, with the top executive earning over 25685 times the pay of the median employee.

The top companies in terms of this difference for 2017-18 include information technology, auto and engineering companies.

There are also no women in the top ten list of remuneration multiples for either year. [Link]

The above two are from Indian corporate sector!

Nearly 50% of the US Foreign Direct Investment Income for the United States come from five tax havens. In other words, profits-shifting by US corporations overseas is rampant. [Link]

Gabriel Zucman, Professor at University of California, Berkeley, author of the paper above, has this to say:

If globalization means ever-lower taxes for the rich and for multinational companies, and ever-higher taxes for those who presently don’t benefit from globalization—for retirees, for small businesses—then it’s a scam. It doesn’t work. [Link]

Check out this discussion of a paper by Thomas Piketty published in April 2018. The link to the paper is here.

Piketty says that both the Left and the Right mainstream parties have been captured by elites – intellectual or moneyed or both. He takes three countries – US, UK and France. So, the only option left for the people is to go with the populists because there is no consideration for their concerns in the mainstream parties of the Left and the Right. It is not about the Left vs. Right but Globalists vs. Nativists. Makes sense.

Instead, both the left- and right-wing parties have come to represent two distinct elites whose interests diverge from the rest of the electorate: the intellectual elite (“Brahmin Left”) and the business elite (“Merchant Right”). Piketty calls this a “multiple-elite party system”: the highly educated elite votes one way, and the high-income, high-wealth elite votes another.

There is a very good summary of the critique of the Piketty paper and other related papers by Thomas Edsall here. But, I personally believe that Piketty is on the ball here, notwithstanding the neglected role of race in Piketty’s analysis, as his critics charge.

I don’t think it is a white vs. black thing in America or white vs. non-white (black or brown). It is about ‘globalists’ and ‘nativists’ as Piketty put it. Globalists are comfortable with racial and religious minorities and immigrants as they see these minorities as similar to them although they are not in economic terms. Far from it. It assuages their guilt at being self-centred globalists, unrooted locally and unconcerned about local issues where they reside.

Thomas Edsall’s NYT article had a link to this very interesting sounding paper, ‘Why Hasn’t Democracy Slowed Rising Inequality?’. The paper is co-authored by four  academics and can be found here. Have not read it yet.

On a related note, the interview with Dani Rodrik, also by promarket.org, a month before the discussion of the paper by Piketty took place is also interesting. In this interview, Dani Rodrik distinguishes between economic populism (‘good’ populism) and political populism (‘bad’ populism).

He defines economic populism, in the context of the United States as follows:

Today in the US, economic populism would take the form of bringing the financial sector down to size, reducing the influence of Wall Street in political institutions, and having much greater regulation of the financial sector. It would mean taking aim at concentrations of power in high-tech and digital industries. It would mean taking aim at our current pattern of trade agreements, which often privilege particular corporate interests and investors. [Link]

Gulzar Natarajan deal with some of the elements of ‘economic populism’, as outlined by Dani Rodrik above, in our forthcoming book, ‘The Rise of Finance – Causes, Consequences and Cures’.

As for market concentration, high-tech and digital power, lest we forget, here is the story of Barry Lynn of (formerly) the New America think-tank who was fired (in 2017) because they had dared mention Google by name:

In the run up to that event, the leadership at New America became very concerned about the fact that some of our work was focused on Google, and they asked us to maybe add different people to the panels, to frame panel discussions in different ways, to give them a heads up, to let other organizations have a say in what we’re doing. That had never happened before and it was very clear that it had to do with Google. Because we’ve done events in which we’ve really hammered Wal-Mart or Anheuser-Busch or Amazon, and there were no problems. But that event, it was the fact that we were mentioning Google by name that got people really upset. [Link]

UNCTAD’s annual report for 2017 presents the evidence for and the consequences of market concentration:

Concentration has increased markedly in terms of revenues, assets (both physical and non-physical), and market capitalization: in 2015, the combined market cap of the world’s top 100 firms was 7,000 times that of the bottom 2,000 firms, whereas in 1995 the same multiple was 31. At the same time, the share of surplus profits grew significantly for all firms in the database, from 4 percent of total profits in 1995–2000 to 23 percent in 2009–2015. For the top 100 firms, the share of surplus profits grew from 16 percent of total profits in 1995–2000 to 40 percent in 2009–2015.

The trend toward concentration, the authors note, has not extended to employment. Between 1995 and 2015, as the market cap of the world’s top 100 firms quadrupled, their share of the job market didn’t even double… [Link]

There is a counter-argument that much of the surplus that accrues to market concentration is not rent but due to technology leadership and productivity. But, it is strange that such critics do not acknowledge that both arguments need not be mutually exclusive.

A former Google Scientist tells Senate to act over Google’s unethical and unaccountable China censorship plan. Bravo!

Finally, this review of Walter Scheidel’s book, ‘The Great Leveler’ is worth a read. I had not heard of the book until my good friend Ajit Ranade mentioned it to me. Walter Schidel, I understand, thinks that violent levelers have been more often the answer to inequality – Four Horsemen’ – warfare; revolution; state collapse; and pandemics – have been the primary mode through which income levelling has occurred throughout history.

Despite overwhelming evidence, this LSE blog expresses the hope that peaceful levelers will achieve the job as they have done sporadically and feebly in a couple of minor instances.

But, let me end this blog post on that hopeful note.