ProfessorBainbridge.com

"Why Is Creating Value Good, Profits Bad?"

Paul Hiseh discusses the titular question:

"Profit" is a dirty word. Profit-seeking businessmen are stock villains in Hollywood movies. "Occupy Wall Street" protestors demand, "People not profits" (whatever that means). Companies reporting healthy profits are automatically assumed to be exploiting customers and can only atone for this by "giving back" to their communities. "Making a profit" has an unsavory, morally suspect taint.

Yet simultaneously, Americans have a far more positive view of the concept of "creating value." The mainstream press lauds visionary businessmen who "create value," such as the late Steve Jobs of Apple. The business literature routinely emphasizes the importance of "creating value." So many organizations wish to be seen as "creating value" that it has become a business cliche, like "best practices" and "thinking outside the box."

But in a free society, "creating value" and "making a profit" are just two sides of the same coin.

He goes on to explain why in detail. Recommended reading.

Krugman's wrong about private equity too

When Newt Gingrich and Paul Krugman are singing out of the same hymnbook, your best bet is to assume they're both wrong. I've explained why Gingrich is wrong to criticize private equity. Larry Ribstein recently explained why Paul Krugman is equally out to lunch on the issue. 

It's a close question whether Krugman or Gingrich is being more intellectually dishonest, but I give the nod to Krugman.

Memo to Harry Reid: Millionaires got rich creating jobs

Typical Harry Reid nonsense:

National Public Radio went looking for one of these fictitious millionaire job creators. ... Many of our job creators are like unicorns, they're impossible to find and don't exist. That’s because only a tiny fraction of people making more than a million dollars, probably less than one percent, are actually small business owners and only a tiny fraction of that tiny fraction is a traditional job creator.

What the senator overlooks, among other things, is that countless jobs are created in the process of their owners becoming millionaires:

Using data from the Census Bureau Business Dynamics Statistics and Longitudinal Business Database, we explore the many issues regarding the role of firm size and growth that have been at the core of this ongoing debate (such as the role of regression to the mean). We find that the relationship between firm size and employment growth is sensitive to these issues. However, our main finding is that once we control for firm age there is no systematic relationship between firm size and growth. Our findings highlight the important role of business startups and young businesses in U.S. job creation. Business startups contribute substantially to both gross and net job creation. In addition, we find an “up or out” dynamic of young firms. These findings imply that it is critical to control for and understand the role of firm age in explaining U.S. job creation.

Becoming millionaires thus is the reward established entrepreneurs earn for the job creation they provided when their firm was a start up.

In any event, show me one private sector job Harry Reid ever created.

Fairness is in the eye of the beholder

Lexington recycles a Bagehot post as commentary on Obama's newfound populism. A recommended read.

Should the Eurozone force private creditors to take a haircut?

Predictably, Felix Salmon gets it wrong. Equally predictably, Megan McArdle gets it right.

Will the EU Adopt the Tobin Tax?

Only over the City of London's dead body, I expect. In any case, Thomas Humphreys has an interesting analysis of the proposed EU financial transactions tax.

"What Milton Friedman might say to the Occupy movement"

Greg Mankiw has some video clips of what Friedman might say to the Occupy Wall Street crowd.

Not in my name: An open letter to the Council of University of California Faculty Associations re Occupy Wall Street

The Council of University of California Faculty Associations purports to be "a coordinating and service agency for the several individual Faculty Associations -- associations of UC Senate faculty -- on the separate campuses of the University of California," which claims to "represents them to all state- or university-wide agencies on issues of common concern." It purports to gather and disseminate "information on issues before the legislative and executive branches of California's government, other relevant state units dealing with higher education, the University administration, and the Board of Regents."

The Council's mission statement posits that it will "concentrate our attention on employer-employee issues like faculty salaries, medical, fringe, and retirement benefits, and other conditions of work like teaching load and outside employment policies."

Yet, despite that limited remit, the Council has decided to speak out in support of the Occupy Wall Street movement:

The social movement known as Occupy Wall Street (OWS) is growing and raising issues of direct relevance to the faculty, students and staff of the University of California, including contracting opportunities and increasing debt loads for our students created by a system of privatized education and a refusal to provide high quality affordable public higher education. The Council of UC Faculty Associations, on behalf of all UC faculty, is making a petition supporting OWS available for UC faculty to sign. 

Hold it right there. The Council does not speak for this member of the UCLA faculty and I deeply resent its claim to do so. In the first place, the issues raised by OWS--even assuming one can identify them with precision--are way outside the scope of the Council's mission of monitoring "employer-employee issues like faculty salaries, medical, fringe, and retirement benefits, and other conditions of work like teaching load and outside employment policies." There is no conceivable way, for example, that anything coming out of OWC could favorably affect faculty salaries. To the contrary, the OWS demands for cheaper higher education would inevitably result in lower salaries and worse benefits.

Turning to the specifics of the petition the Council has put forward, purportedly in my name and those of all other UC faculty, you claim that:

Only by identifying the complex interconnections between repressive economic, social and political regimes can social and economic justice prevail in this country and around the globe. 

I haven't heard such nonsensical socialist cant since the Iron Curtain fell. As such, it's just the sort meaningless mumbo jumbo one would expect from a bunch of liberal arts faculty. (English? Sociology? Certainly not any discipline requiring a nodding acquaintance with economics.)

You further assert that:

The demonstrators are demanding substantive change that redresses the many inequitable features of our society, which have been exacerbated by the financial crisis of 2009 and the subsequent recession.  Among these are: the lack of accountability on the part of the bankers and Wall Street firms that drove the economy to disaster; rising economic inequality in the United States; the intimate relationship between the corporate power and government at all levels, which has made genuine change impossible; the need for dramatic action to provide employment for the jobless and protect programs such as Social Security, Medicare, and Medicaid, in part by requiring the wealthy to pay their fair share of taxes; and the disastrous effects of the costly wars that the United States has been conducting.

1. It's been well documented that the financial crisis of 2007-2008 was mainly, albeit not exclusively, the fault of excessive and deeply flawed government regulation. Read Peter Wallison's Dissent from the Majority Report of the Financial Crisis Inquiry Commission and open your minds to reality.
2. The real problem with effecting change is not the relationship between corporations and the government, but rather the pervasive web of left-liberal special interest groups that seek constantly to grow the size of government, protect unsustainable entitlement programs, and strangle economic growth. Of particular relevance, given the Faculty Association's quasi-union functions, it's been well documented that public sector labor unions have become a chief obstacle to meaningful reform. As I have noted previously, "A core problem with public sector unionism is that it creates a uniquely powerful interest group. In theory, bureaucrats are supposed to work for and be accountable to the elected representatives of the people. But suppose those bureaucrats organize into large, well-funded, powerful unions that can tip election results. With very few and very unique exceptions, no workplace in which the employees elect the supervisors functions well for long. ... In effect, public sector unionism thus means that representatives of the union will often be on both sides of the collective bargaining table. On the one side, the de jure union leaders. On the other side, the bought and paid for politicians. No wonder public sector union wages and benefits are breaking the back of state budgets." Not surprisingly, public sector unions have emerged as staunch supporters of OWS.
3. Define "fair share" and then we can talk. As a member of the 53%, I figure my current share's is more confiscatory than fair.

The Hill recently reported that:

[Newt] Gingrich also said that an education system that was teaching “really dumb ideas” was another cause of the current demonstrations. “We have had a strain of hostility to free enterprise – and frankly, a strain of hostility to classic America – starting in our academic institutions and spreading across this country,” said Gingrich, who is also seeking the Republican nomination.

Congratulations on so aptly proving his point.

Back during the Bush years, it was popular for various Hollywood liberals to oppose the President's policies using the phrase "not in my name." It works for me here. You do not speak in my name.

In short, the aging 60s radicals and the young wannabes in your midst need to get over their 60s nostalgia and get back to the work of educating people to do something more useful with their lives than holding protest marches.

Is regulation a drag on the economy? Shockingly, CNN Money found a Democrat who said no

CNN Money reports:

Gary Burtless, a labor economist at the Brookings Institution, said there is little evidence to suggest that government regulations are killing jobs.

"There is a lack of confidence that demand would exist for the extra products businesses would produce by increasing hiring," Burtless said.

So if not regulations -- what is the biggest problem? One prime suspect is a lack of demand for the goods and services that businesses produce.

"I think it's pretty plain that there hasn't been a robust rebound in consumer consumption," Burtless said.

And Burtless said complaining about regulations is not something new for the business community -- which can of course lower costs and increase profits if regulations are repealed.

"There are certain businessmen who say regulation is an issue, but they also said the same thing when the economy was robustly growing," Burtless said. ...

Burtless doesn't find the "uncertainty" argument convincing.

"Those laws haven't gone into effect yet. How are those things limiting jobs?" he asked. "I think you've got to actually make the case that lots of regulations have sprung up since January 2009 to make this complaint carry very much water."

What CNN Money doesn't tell you is that according to OpenSecrets.org, Burtless has made around $6,000 in political donations since 2007, exclusively to Democrats, and mostly to Barack Obama.

So there's no guarantee this is a nonpartisan think tanker. Instead, there's a risk he's got a partisan agenda. Of course, so do I, but my readers already know that and can discount it appropriately. CNN Money failed to advise their readers of Burtless' politics when it let his analysis drive the story. Was that fair and balanced? 

Is the Eurozone facing a Lehman moment?

Free exchange and David Skeel comment

Can you have Main Street without Wall Street?

Free Exchange makes an interesting point:

AS WALL STREET protestors express their frustrations with the finance industry they, and many others, are mourning the loss of a great entrepreneur, Steve Jobs. Perhaps the more self-aware protestors are questioning how capitalism can deliver nice things like an iPad and not so nice things like a CDO-squared. Jonathan Chait is mulling this question and reckons you can pick and choose--you can villainize the financial industry and canonize Silicon Valley visionaries--without being inconsistent.

There is a reason the movement is called “Occupy Wall Street,” not “Occupy Main Street” or “Occupy Silicon Valley.” It is no doubt because most of the participants, or sympathizers, understand that Wall Street is not the same thing as free enterprise — that it is one element that, unlike Apple, poses a unique threat to the functioning of the free marketplace.

I agree you can make some distinctions. But Mr Chait fails to appreciate that while finance is different, it cannot be separated from other industries. The fact is that entrepreneurship, in Silicon Valley in the last thirty years or just about any industry at any point in history, requires capital. You may create a prototype that could change the world, but it's not going to go anywhere if you can't finance it. What would Silicon Valley have been without venture capital and private equity?

Go read the whole thing.

I just love corporations

With the economic illiterates occupying Wall Street, it's time to revisit the defense of corporations that I offered in my essay Reflections on Twenty Years in Law Teaching:

I tell my students about Nicholas Murray Butler, president of Columbia University and winner of the Nobel Peace Prize, who wrote that: “The limited liability corporation is the greatest single discovery of modern times. Even steam and electricity are less important than the limited liability company.”

I tell them about journalists John Micklethwait and Adrian Wooldridge, whose magnificent history, The Company, contends that the corporation is “the basis of the prosperity of the West and the best hope for the future of the rest of the world.”[1]

There is no doubt that the corporation is now the key economic institution in Western nations. In the United States, for example, the corporation is the predominant form of business organization by every measure except sheer number of firms. According to recent census data, although corporations account for only about one fifth of all business organizations, they bring in almost 90% of all business receipts.

The corporation also has proven to be a powerful engine for focusing the efforts of individuals to maintain economic liberty. Because tyranny is far more likely to come from the public sector than the private, those who for selfish reasons strive to maintain both a democratic capitalist society and, of particular relevance to the present argument, a substantial sphere of economic liberty therein serve the public interest.  Put another way, private property and freedom of contract were “indispensable if private business corporations were to come into existence.”[2] In turn, by providing centers of power separate from government, corporations give “liberty economic substance over and against the state.”[3]

Yet, two centuries ago, leading business and economic thinkers – including the great Adam Smith – derided the joint stock company. Few businesses were organized as chartered companies. Each company’s charter required a special legislative act. In many places, legislatures granted charters only to quasi-public entities, such as railroads and canals. In most, legislatures rarely resisted the temptation to revise or even repeal existing charters arbitrarily. Even in the United States, where the Supreme Court’s famous Dartmouth College decision gave corporations substantial constitutional protections at a relatively early date, such legislative meddling remained commonplace.

And so I ask my students: What explains the relatively rapid development in the mid-19th century of a recognizably modern corporation and, in turn, that entity’s emergence as the dominant form of economic organization?

The answer has to do with new technologies – especially the railroad – requiring vast amounts of capital, the advantages such large firms derived from economies of scale, the emergence of limited liability that made it practicable to raise large sums from numerous passive investors, and the rise of professional management.

For the most part, these advantages remain true today. The corporation remains the engine of economic growth, both at the level of giants like Microsoft and garage-based start-ups.

The rise of the corporate form thus has “improved the living standards of millions of ordinary people, putting the luxuries of the rich within the reach of the man in the street.”[4] The rising prosperity made possible by the tremendous new wealth created by industrial corporations was a major factor in destroying arbitrary class distinctions, enhancing personal and social mobility. Many of the wealthiest businessman of the latter half of the 19th Century and the 20th Century began their careers as laborers rather than as scions of coupon-clipping plutocrats.

The Absurdity of the Anti-Corporation Movement

I forced my Corporate Governance class to sit through excerpts of the execrable documentary The Corporation yesterday so that they could see for themselves the absurdity of the anti-corporation movement. Doing so was quite timely, because we're hearing the same sort of silliness from the Occupy Wall Street crowd, as Doug Mataconis observes:

On Friday, this group of a few hundred people that purports to be the vanguard of some populist movement issued the ambitiously titled “Declaration of the Occupation of New York City” purporting to set forth the reasons they’re protesting:

As one people, united, we acknowledge the reality: that the future of the human race requires the cooperation of its members; that our system must protect our rights, and upon corruption of that system, it is up to the individuals to protect their own rights, and those of their neighbors; that a democratic government derives its just power from the people, but corporations do not seek consent to extract wealth from the people and the Earth; and that no true democracy is attainable when the process is determined by economic power. We come to you at a time when corporations, which place profit over people, self-interest over justice, and oppression over equality, run our governments. We have peaceably assembled here, as is our right, to let these facts be known.

This “corporations run the government” meme has been around since the 1970s, and it’s no more true now than it was then. As Rick Moran points out, if corporations really ran the government would we have an EPA, OSHA, SEC, the EEOC, the FHA, the Department of Labor, or any of the other number of state and federal agencies regulate corporate behavior? If corporations truly “ran” the government, then why would any of these organizations exist?

Corporations do influence the government, of course. But then so do labor unions, the legal profession, the medical profession, special interest groups based on one form of racial or ethnic grievance or another, and lobbying interests ranging from Iowa corn to Texas oil. The problem isn’t corporations, the problem is that we have a government that has its fingers in nearly every aspect of the economy. That means that policy makers have the ability to pick economic winners and losers every day, and it’s only natural that those policies would be of concern to the people that they’re going to impact most directly, the businesses affected by them. That’s lobbying and petitioning the government for redress of grievances, not “running the government.” This kind of reflexive anti-business mentality seems to be quite common in some sectors of society, but it has little basis in reality and seems firmly entrenched in resentment and envy rather than an honest examination of the country’s political system.

Occupy Wall Street

Frank Pasquale is predictably impressed with the Occupy Wall Street movement.

The atmosphere was both positive and serious-minded. A band played music or drums that could be heard throughout the plaza. A group manned laptops on stone blocks. Dozens of beds and cots, covered in plastic, spread diagonally from southeast to northwest.

In contrast, I tend to side with a friend of mine who observed on Facebook that:

I don't understand why anyone is taking Occupy Wall Street seriously. An OWS spokesman "says OWS doesn’t need policies because they will create social change by 'building a model society' in Zuccotti Park, where people share food and sleeping pads according to their needs and arrive at decisions through discussion and consensus."

I guess the idea is that the American people will give up capitalism once they see how wonderful it is to camp out in a park and dress up like zombies.

One of the truly great things about capitalism is that it made camping out an optional hobby rather than a life necessity.

Update Doug Matatconis takes a look at what he calls The Incoherent Agenda Of Occupy Wall Street and comments that:

For the most part, the message, of “Occupy Wall Street” seems to be little different from the same leftist critiques of free market capitalism that we’ve been seeing for decades, and just as intellectually incoherent as those ideas were back then. Politically, it’s an odd movement simply because it’s rather obvious that these are people inclined to vote for Democrats. Likely, they were people swept up in the Obamamania of 2007 and 2008. To some degree, then, one wonders if they aren’t motivated as much by disappointment in a President who clearly never really shared the “progressive” goals that they hold dear, with a little bit of soak-the-rich resentful populism mixed in for good measure.

The declining attractiveness of being public

I'm going to be on a panel on "Rethinking Shareholder Value and the Purpose of the Firm" here at UCLA on Thursday:

​Join UCLA School of Law, The Aspen Institute and top thinkers in business and law to explore what priorities are legally demanded of corporations, rethink what is meant by "creating shareholder value," and ask "What really is the purpose of the firm?"

Panelists include Professor Stephen Bainbridge, UCLA School of Law; Professor Henry Hansmann, Yale Law; and Roger Martin, Dean, Rotman School of Business, University of Toronto. The panel will be moderated by Professor Lynn Stout, UCLA School of Law.

The organizer sent around several questions to stimulate our thinking, including the following:

The number of publicly-listed US firms has declined from nearly 9,000 in 1997 to only about 5,000 today.  What’s more, many of the firms  that do go public (LinkedIn, Google, Zynga) have dual-class shares.  Do these two data points suggest that the public corporation is a less attractive way to do business?  If so, why?

Here's what I came up with in reply:

I addressed the first prong of this question at some length in my paper, Corporate Governance and U.S. Capital Market Competitiveness (October 22, 2010), which is available at SSRN: http://ssrn.com/abstract=1696303.

During the first half of the last decade, evidence accumulated that the U.S. capital markets were becoming less competitive relative to their major competitors. The evidence reviewed herein confirms that it was not corporate governance as such that was the problem, but rather corporate governance regulation. In particular, attention focused on such issues as the massive growth in corporate and securities litigation risk and the increasing complexity and cost of the U.S. regulatory scheme.

Tentative efforts towards deregulation largely fell by the wayside in the wake of the financial crisis of 2007-2008. Instead, massive new regulations came into being, especially in the Dodd Frank Act. The competitive position of U.S. capital markets, however, continues to decline.

My essay argues that litigation and regulatory reform remain essential if U.S. capital markets are to retain their leadership position. Unfortunately, the article concludes that federal corporate governance regulation follows a ratchet effect, in which the regulatory scheme becomes more complex with each financial crisis. If so, significant reform may be difficult to achieve.

There are three major reasons why federal intervention in corporate governance tends to be ill conceived. First, federal bubble laws tend to be enacted in a climate of political pressure that does not facilitate careful analysis of costs and benefits.  Second, federal bubble laws tend to be driven by populist anti-corporate emotions.  Finally, the content of federal bubble laws is often derived from prepackaged proposals advocated by policy entrepreneurs skeptical of corporations and markets.

In her critique of SOX, Roberta Romano proposed that these problems could be addressed in several ways: "The straightforward policy implication of this chasm between Congress’s action and the learning bearing on it is that the mandates should be rescinded. The easiest mechanism for operationalizing such a policy change would be to make the SOX mandates optional, i.e., statutory default rules that firms could choose whether to adopt. An alternative and more far-reaching approach, which has the advantage of a greater likelihood of producing the default rules preferred by a majority of investors and issuers, would be to remove corporate governance provisions completely from federal law and remit those matters to the states. Finally, a more general implication concerns emergency legislation. It would be prudent for Congress, when legislating in crisis situations, to include statutory safeguards that would facilitate the correction of mismatched proposals by requiring, as in a sunset provision, revisiting the issue when more considered deliberation would be possible."

In adopting Dodd-Frank, Congress ignored that advice. As a result, Dodd-Frank suffers from the same three flaws as its predecessors.

The federal role in corporate governance thus appears to be a case of what Robert Higgs identified as the ratchet effect. Higgs demonstrated that wars and other major crises typically trigger a dramatic growth in the size of government, accompanied by higher taxes, greater regulation, and loss of civil liberties. Once the crisis ends, government may shrink somewhat in size and power, but rarely back to pre-crisis levels. Just as a ratchet wrench works only in one direction, the size and scope of government tends to move in only one direction—upwards—because the interest groups that favored the changes now have an incentive to preserve the new status quo, as do the bureaucrats who gained new powers and prestige. Hence, each crisis has the effect of ratcheting up the long-term size and scope of government.

We now observe the same pattern in corporate governance. As we have seen, the federal government rarely intrudes in this sphere except when there is a crisis. At that point, policy entrepreneurs favoring federalization of corporate governance spring into action, hijacking the legislative response to the crisis to advance their agenda. Although there may be some subsequent retreat, such as Dodd-Frank’s § 404 relief for small reporting companies, the overall trend has been for each major financial crisis of the last century to result in an expansion of the federal role. The unfortunate conclusion thus seems to be that there is no cure insight for the corporate governance aspects of the American Illness.