The Empire Bias

Firms tend to be managed with an “empire” bias, i.e., toward being too big.  The largest firms are less profitable, they too often reinvest rather than pay dividends, and firm mergers and acquisitions tend to lose money.  Also, as I suggested yesterday, the fact that organizations can be too big at all is probably due to a bias to over-manage top subordinates, to justify and affirm supervisor status.

The fact that we can so easily see this bias shows that investors have limited control over managers.  If it were easier to buy firms out and change their management, presumably we’d see more large firms forced to break up, and more top managers forced to accept autonomous subordinates.  (Which would be a good thing.)  Instead, overly large firms are now disciplined mainly by having to shrink when they run out of money.

Non-business organizations also suffer this empire bias; their managers also overly focus on increasing size and overly-managing subordinates to justify and assert their status.  This empire bias seems worse for states than firms because:

  1. Financial losses quickly threaten firms, but states can be less efficient before war or revolt threatens them.
  2. Preventing war or revolt depends less on supplying value and more on ensuring loyalty, which empire aids.
  3. States accountable to voters or elites tilt toward their biases, and most people under-appreciate org scale disecon.
  4. Non-pivotal voters or elites gain status by advocating more empire, even when empire policies hurt them on net.

A world government should be even more biased to overly-manage overly-large overly-intrusive agencies.  After all, its existence is much less threatened by war or comparison with productive outsiders.  The Soviet Union collapsed because its citizens could eventually see clearly the West’s superior productivity; a world-wide Soviet Union would avoid such embarrassment.

Of course future world governments might add great value dealing with global coordination problems.  Whether a world government will be worth its empire costs depends on how serious and frequent are such problems, and on how much better we learn to structure large organizations to avoid such costs.

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  • Bill

    The reason it is difficult to break up firms and/or buy them out to restructure (other than with the approval of management) is the result of reactions to “greenmail” attacks on corporations in the mid-80’s.

    As a consequence, firms instituted poison pill and other devices to prevent other companies from making hostile bids and extracting payments for withdrawing.

    But, what this did was put management in control–meaning that management can be secure it will not be replaced without compensation, and management can put in all sorts of salary, bonus and other perks.

    We either need shareholder pay for performance and approval mechanisms, or we need to accept the hostile tender offer. What we have today is a decade of management overcompensation and shareholder theft.

    • http://yudkowsky.net/ Eliezer Yudkowsky

      Is there a reason other than “people are crazy, the world is mad, and humans can’t solve their coordination problems” for why shareholders don’t revolt effectively? A majority of shareholders can simply replace the current Board of Directors and start over, just as voters could in principle grab control of Congress at any time. Why doesn’t this happen? If there’s a more interesting reason than “the world is mad” it sounds like a really important topic.

      • http://hanson.gmu.edu Robin Hanson

        The fact that it is expensive for shareholders too coordinate seems sufficient to explain this.

      • Doug S.

        just as voters could in principle grab control of Congress at any time.

        Most voters are pretty happy with their own Congressman – they just hate everyone else’s.

      • Bill

        In the trade, shareholders are known as WDS–weak, dumb and scattered.

        It is too bad that there isn’t an activist mutual fund.

      • http://causalityrelay.wordpress.com/ Vladimir Nesov

        The fact that it is expensive for shareholders too coordinate seems sufficient to explain this.

        But why is it expensive? There seems to be nothing intrinsically expensive in coordinating. We have the Internet, so is it merely a matter of right software?

      • Bill

        Responding to the “why is it expensive to coordinate” question.

        The issue is not as much coordination, as much as it is the standard that a board of directors can invoke to reject a tender offer. Particularly with the advent of greenmail, courts gave more lattitude to boards in rejecting offers, and in some cases you never get there because poison pills and other devices would increase the costs of an offer that was not acceptable to management.

      • anon

        Particularly with the advent of greenmail, courts gave more lattitude to boards in rejecting offers

        Why? Greenmail offers would seem to make shareholders better off–the only problem with them is the selective share buyback. But AIUI, selective buybacks need to be approved with a special resolution by at least 75% of the shareholders (selling shareholders not included).

      • Will Pearson

        There are a few potential reasons at play:

        1) Inertial: Don’t rock the boat if it is somewhat working. What happens if you split up the company too much and lose your economies of scale? if you don’t understand the company is a change you institute likely to be bad?

        2) Idealogical: The share holders might be pro-empire in general, if they benefit from being a member of their own empire. They don’t want to start revolutions in other peoples empires in case it sparks revolutions in their own.

        I know that pension funds are large stock holders and I expect them to be empire-ish, so the idealogical one is the one I’d investigate further.

      • Bill

        Reply to anon,

        Here is some more information regarding how greenmail defenses have strengthened management positions:
        http://www.investopedia.com/articles/stocks/08/corporate-takeover-defense.asp?viewed=1

      • anon

        Good link. It makes sense that shareholders would want some level of defense against takeover bids in order to improve their bargaining position wrt. the acquirer, even if defenses clearly shift power from shareholders to management.

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  • Mikko

    Bigger corporations can buy or destroy small threatening competitors and thus monopolize markets.

    Some companies have either explicit policies or incentive systems (“Nobody got fired from buying IBM”) that make people to buy only from big corporations.

    Additionally, there is often higher status associated with products made by bigger corporations.

  • Jonas

    Additionally, there is often higher status associated with products made by bigger corporations.

    It depends on the market and the product`s image. Individualism and post-materialist values can hinder bigger corporations because the availability of their products is too high for the taste of the “trendy” consumer.

    Sometimes large corporations are also less efficient due to a higher organizational inertia.

  • http://hanson.gmu.edu Robin Hanson

    Bill, yes US law has made buying firms harder.

    Mikko and Jonas, you are pointing to factors that would make firms that are locally efficient be globally too large. I’m talking here about being locally too large.

  • Chuck

    The Soviet Union collapsed because its citizens could eventually see clearly the West’s superior productivity; a world-wide Soviet Union would avoid such embarrassment.

    Perhaps there is research on this topic, but I wonder if, of the many forces at work, a sort of endowment effect (declining GDP) might have been a stronger catalyst than a sort of ‘envy’ effect. For example, I think a lot of impoverished third world nations don’t suffer unrest due to the greater standard of living of their neighbors or enemies. Declining GDP leading to unrest, yes, not relative low or stagnant GDP.

    Another important consideration would be the USSR’s imprisonment-industrial complex and the ‘Gulag’. Soltzenitsen (sp) maintained that much of the improsonment in the Gulag was not simply preserving the state from ‘conter-revolutionaries’ but simply for the acquisition of slave labor (iirc). I wonder how much the insecurity of arbitrary imprisonment (and typically death-by-labor) was also a factor in unrest in the Soviet Union.

    And finally, if I’ve got my soviet history correct, it was a nearly concious decision by Gorbechev and other rulers to not put the unrest in satellites down that permitted unrest in the USSR to flare up.

    As I said, perhaps there is research on the ‘envy-unrest’ theory, but I think these other factors are important as well.

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  • http://www.abs-usa.com Floccina

    Bill wrote:

    It is too bad that there isn’t an activist mutual fund.

    Berkshire Hathaway is close to that.

    Also these are the reason that I prefer companies with one large shareholder large enough to push management to act more in shareholders long term interests.

    On the government side these are good reasons to favor local power over national power.

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