Tag Archives: Finance

Econ Advice Confirmed

By Robin Hanson · February 24, 2012 11:00 pm · Comments (10)

We … construct management data on over 10,000 organizations across twenty countries, … [and] use a new double-blind survey tool. … We define “best” management practices as those that continuously collect and analyze performance information, that set challenging and interlinked short-and long-run targets, and that reward high performers and retrain/fire low performers. … Our management scoring grid … was developed by McKinsey as a first-contact guide to firms’ management quality. … We also test (and confirm) that these practices are indeed strongly linked to higher productivity, profitability, and growth. (more)

Not a bad quick measure of the quality of management practices. They find:

In manufacturing American, Japanese, and German firms are the best managed. Firms in developing countries, such as Brazil, China and India tend to be poorly managed. American retail firms and hospitals are also well managed by international standards, although American schools are worse managed than those in several other developed countries. We also find substantial variation in management practices across organizations in every country and every sector, mirroring the heterogeneity in the spread of performance in these sectors. One factor linked to this variation is ownership. Government, family, and founder owned firms are usually poorly managed, while multinational, dispersed shareholder and private-equity owned firms are typically well managed. Stronger product market competition … [is] associated with better management practices. Less regulated labor markets are associated with improvements in incentive management practices such as performance based promotion. …

Publicly (i.e., government) owned organizations have worse management practices across all sectors we studied. … Multinationals appear able to adopt good management practices in almost every country in which they operate. … The level of education of both managers and nonmanagers is strongly linked to better management practices.

So, the world would get more productivity and growth if it had fewer government-owned organizations, less labor regulation, stronger product market competition, and more things run by multinational firms. Gee, sounds a lot like standard economists’ advice.

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Info Market Failure

By Robin Hanson · February 12, 2012 9:35 pm · Comments (8)

Unless project gains can be very clearly proven to analysts, or perhaps so small and numerous to allow averaging over them, public firms are basically incapable of taking a loss on earnings this quarter in order to make gains several years later. … CEOs are strongly tempted to instead please analysts by grabbing higher short-term quarterly earnings. …

Private firms are 3.5 times more responsive to changes in investment opportunities than are public firms. … IPO firms are significantly more sensitive to investment opportunities in the five years before they go public than after. (more)

A month ago I said that these results imply that we need wealth inequality, to ensure we make the discretionary investments on which all our future wealth depends.

Today I want to admit that these results also imply that even thick speculative markets, full of lots of people trading lots of money, often have big info failures. While I am a big fan of using speculative markets to aggregate info, I must admit that they quite often fail to aggregate all relevant info, even when a lot of money can be won there.

CEOs at private firms choose investments based on private info on likely rates of return. If the same firm were to be made public, however, the above evidence suggests that CEOs would make less than 25% of those investments. In the other 75+% of cases, the CEO would estimate that market speculators would not credit the stock price for the value of those promising investments, but would instead punish the firm for lower short term earnings. It seems that market speculators cannot distinguish these investments from other less promising ones that CEOs would undertake if speculators were to credit these. CEOs typically know crucial investment details not available to speculators.

Now I can see ways to improve existing stock markets, so that they could aggregate more investment info. We could allow and even encourage “insider” stock trading by firm insiders like the CEO. And we could create decision markets, trading the stock value conditional on specific investment decisions. But while these changes should raise that <25% figure, i.e., the fraction of investments by private firms that would also be made by a public firm, they might not raise it by much.

Speculative markets can work info aggregation wonders, at least compared to common methods like surveys or committee meetings. But if you really want as much info as possible on big investments, we still know of nothing better than rich private investors with a lot on the line.

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You & The Distant Future

By Robin Hanson · February 9, 2012 9:50 am · Comments (5)

I spoke again yesterday to mostly retired folks at GMU’s lifelong learning institute, on “You & the Distant Future” (audio; slides). I talked on near-far theory, long-term bequests, and cryonics.

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Financial Mood

By Robin Hanson · February 4, 2012 1:30 pm · Comments (3)

We care more about the future when happy:

We conduct a random-assignment experiment to investigate whether positive affect impacts time preference, where time preference denotes a preference for present over future utility. Our result indicates that, compared to neutral affect, mild positive affect significantly reduces time preference over money. … Happier respondents are [also] less likely to agree with the “live for today” statement than are less happy respondents. This holds even after controlling for covariates that have been shown to be related to happiness … High cognitive load increases time preference and … individuals with greater cognitive skills, as measured by IQ tests, exhibit lower time preference. (more)

This is predicted by near-far analysis, since happy is far, and the future matters more in far mode. This matters for finance today, as whatever sets discount rates, sets prices:

“All price-dividend variation corresponds to discount-rate variation.” … When it comes to broad price aggregates, such as stocks in general or land in general, price changes basically reflect crazily-changing [discount rate] values. (more)

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Status In Law, Finance

By Robin Hanson · February 3, 2012 8:05 am · Comments (10)

I recently suggested that a big part of what management consulting sells is status, to cow firm opponents into submission, and that this helps explain why consulting firms use so many inexperienced recent grads of elite colleges. JustMe commented:

There are basically three things available to graduates of elite colleges that other students, no matter how hard they work, have little or no access to: elite consulting jobs, investment banking, and corporate law.

Kids from elite colleges aren’t much smarter or harder working than those from the next tier, who are cheaper to hire. But elite grads do have much more polish, shine, etc. – in a word, status. If this helps explain an elite school focus in management consulting, can it also help explain a similar focus in investment banking and corporate law?

Corporate law seems easier. If, as I suggested, our inherited sense of who will tend to win a contest in coalition politics uses certain standard status markers, then the status of one’s corporate lawyers can influence attitudes about who will win a court case. So having a high status lawyer can help get folks within an organization to support standing firm, cow lower status opponents into backing down, and influence the verdict of a judge or jury.

For investment banking, a lot of that is about getting folks with deep pockets to open their wallets to back new ventures. The more it seems that important folks associated with a venture are high status, the more others may be willing to affiliate with that venture as customers, suppliers, investors, compliant regulators, etc. So there should be a big premium on having the key person who represents a venture to potential investors be high status.

I remember Bryan Caplan once suggesting that successful real estate agents tend to be the sort of people who were popular in high school, and that house buyers (especially women) prefer to affiliate with a locally popular person as they enter a new community. Investment banking could be similar, but on higher status scale.

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Too Much Consulting?

By Robin Hanson · January 31, 2012 6:30 pm · Comments (84)

Last night I discussed the popularity of law, finance, and management consulting with Tyler and many somewhat-libertarian-leaning others. I was surprised that most were skeptical that firms get their money’s worth from consulting, more skeptical than for law or finance. I was also surprised that most focused on explaining why kids from elite schools work at such firms, rather than on why firms pay so much for this consulting.

To me, it is easy to understand why consulting firms attract so many elite students, given the wages, prestige, and job experience they offer. And it is also easy to see why firms might pay a ton for consulting, relative to law and finance – changing your basic business strategy can conceivably add enormous value, while minor changes to contract details and financing terms have limited value.

The puzzle is why firms pay huge sums to big name consulting firms, when their advice comes from kids fresh out of college, who spend only a few months studying an industry they previous knew nothing about. How could such quick-made advice from ignorant recent grads be worth millions? Why don’t firms just ask their own internal recent college grads?

Some say that consulting firms use their access to collect data on best practices, data that other firms are eager to pay for. But while this probably contributes, I find it hard to see as the main effect.

My guess is that most intellectuals underestimate just how dysfunctional most firms are. Firms often have big obvious misallocations of resources, where lots of folks in the firm know about the problems and workable solutions. The main issue is that many highest status folks in the firm resist such changes, as they correctly see that their status will be lowered if they embrace such solutions.

The CEO often understands what needs to be done, but does not have the resources to fight this blocking coalition. But if a prestigious outside consulting firm weighs in, that can turn the status tide. Coalitions can often successfully block a CEO initiative, and yet not resist the further support of a prestigious outside consultant.

To serve this function, management consulting firms need to have the strongest prestige money can buy. They also need to be able to quickly walk around a firm, hear the different arguments, and judge where the weight of reason lies. And they need to be relatively immune to accusations of bias – that their advice follows from interests, affiliations, or commitments.

All three of these functions seem to be achieved at a low cost by hiring good-looking kids from our most prestigious schools. These are the cheapest folks you can buy with our most prestigious affiliations, they are smart enough to judge where reason lies, and they have few prior affiliations to taint them with bias. They can not only “borrow your watch to tell you the time,” but can also cow you into submission in accepting that time.

Yes the information contained in consulting advice can be obtained elsewhere at a lower cost. Firms could hire most any smart independent folks, or set up a prediction market. But alas those sources don’t have the raw strength of status to cow opponents into submission, opponents who in practice can block changes no matter what a CEO declares.

So mine is a signaling and status story (surprise surprise). The weight of status often decides outcomes, no matter what the CEOs commands, and so CEOs often need to bring out status ringers, to cow opponents into submission.

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The History of Inequality

By Robin Hanson · January 29, 2012 3:45 pm · Comments (5)

I recently posted on how cities and firms are like distributed as a Zipf power law, with a power of one, where above some threshold each scale holds roughly the same number of people, until the size where the world holds less than one. Turns out, this also holds for nations:

Log Nation Size v Log Rank

The threshold below which there are few nations is roughly three million people. For towns/cities this threshold scale is about three thousand, and for firms it is about three. What were such things distributed like in the past?

I recall that the US today produces few new towns, though centuries ago they formed often. So the threshold scale for towns has risen, probably due to minimum scales needed for efficient town services like electricity, sewers, etc. I’m also pretty sure that early in the farming era lots of folks lived in nations of a million or less. So the threshold scale for nations has also risen.

Before the industrial revolution, there were very few firms of any substantial scale. So during the farming era firms existed but could not have been distributed by Zipf’s law. So if firms had a power law distribution then, it must have had a much steeper power.

If we look all the way back to the forager era, then cities and nations could also not plausibly have had a Zipf distribution — there just were none of any substantial scale. So surely their size distribution also fell off faster than Zipf, as individual income does today.

Looking further back, at biology, the number of individuals per species is distributed nearly log-normally. The number of species per genera:

and the number of individuals with a given family name or ancestor:

have long been distributed via a steeper tail, with number falling as nearly the square of size:

This lower inequality comes because fluctuations in the size of genera and family names are mainly due to uncorrelated fluctuations of their members, rather than to correlated shocks that help or hurt an entire firm, city, or nation together. While this distribution holds less inequality in the short run, still over very long runs it accumulates into vast inequality. For example, most species today descend from a tiny fraction of the species alive hundreds of millions of years ago.

Putting this all together, the number of species per genera and individuals per families has long declined with size as a tail power of two. After the farming revolution, cities and nations could have correlated internal successes and larger feasible sizes, giving a thicker tail of big items. In the industry era, firms could also get very large. Today, nations, cities, and firms are all distributed with a tail power of one, above threshold scales of (three) million, thousand, and one, thresholds that have been rising with time.

My next post will discuss what these historical trends suggest about the future.

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Who Wants Kid $ Insure?

By Robin Hanson · January 25, 2012 11:00 am · Comments (29)

Financial inequality seems to be shaping up as a central issue in the US presidential campaign. (Other sorts of inequality, not so much.) Many note that such inequality has increased in recent decades. But let me repeat my anti-trend-tracking matra: if what matters is the efficiency of our institutions, trends are irrelevant unless they reveal such inefficiencies. So are the institutions that influence our financial inequality inefficient?

Probably the simplest and strongest argument is insurance market failure: being risk-averse, we want to insure against variations in our distant future income, but since this insurance is not available privately, governments must provide it. Why exactly this is not available privately if customers want it isn’t usually clarified. And it could be that the incentive costs of the insurance outweigh its risk-reduction benefits. But this is at least in the ballpark of a plausible institutional argument.

However, it seems to me that as a parent I wouldn’t have wanted to insure against any but the very low tail of possibilities of for my kids future income. I like the idea that one of my kids might someday be very successful or famous. And asking this of my undergrads consistently gets the same answer – very few want such insurance for their own or their kids’ future. Furthermore, parents do not much use the one clear insurance option they have – to teach their kids to share their future income with each other. Most societies used to do this, and our culture evolved away from that. So while teaching kids to share income is both personally and culturally possible, we just don’t do it.

Now you might argue that this is a signaling failure – that we would each in fact like such insurance, but dislike what our willingness to take it would say about us. But you could also tell your kids to keep this income-sharing policy a family secret, only to tell potential spouses. And once such sharing became a long family tradition then continuing it would say much less about personal features. But it seems to me that even if given the option to legally commit all their descendants to such a policy, to prevent all future signaling about it, most folks would still reject such insurance.

Thus it seems to me that most folks think the incentives costs outweigh the risk-reduction gains for such insurance, and do not want it. Thus the insurance market failure rationale for taxing the rich extra just fails.

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Why Hate Firms, Love Cities?

By Robin Hanson · January 16, 2012 9:10 pm · Comments (43)

Families, clubs, professions, industries, firms, cities, and states are all important units of economic organization. That is, we coordinate to some extent via all of these units, to achieve mutual ends. But firms and cities make an especially interesting comparison.

First, firms and cities are similar in many ways. They both vary greatly in size, and can be costly for long-time associates to leave. Both tend to be “selfish” in avoiding and excluding those who do not benefit other associates, and thus tend to favor rich folks. People can relate to both kinds of units as investors, suppliers, leaders, and customers.

Second, people tend to like cities more than firms. For example, many movies are love songs to particular cities, yet few movies have cities as villains. Many movies have firms as villains, but few have firms as heroes. Sporting teams tied to cities play in huge stadiums, while teams tied to firms play in local parks.

While people tend to dislike bigger firms more than small ones, cities tend to be bigger than firms, and the biggest cities tend to be the most celebrated. People tend to resent firms more when it is more costly to leave them, yet it tends to be harder to leave cities than firms. So why are cities loved so much more?

One theory is that we related to cities less directly. If a city doesn’t hire you, you can say particular firms wouldn’t hire you. If a city won’t sell you a dress cheap, it is particular firms that wouldn’t sell it. So cities can more easily escape blame. However, a similar argument would suggest that we love shopping malls more than stores, or TV channels more than TV shows. Yet these seem weak effects, if they exist at all.

Another theory is that we often see firms as illicit dominators. We see the employer-employee relation as a dominance-submission relation, because firms give employees orders. Of course customers often give orders to firms, such as to waiters and cab drivers. But perhaps the joy of sometimes dominating does not outweigh the pain of at other times submitting. (And why are landlords seen as dominators, with renters submissives?)

Now cities do often seem to take a dominance relation to their citizens, such as via police, teachers, and rule-bound officials. But people seem to resent this dominance less. Is this because the major is democratically elected? CEOs are also usually elected, its just via one stock one vote, instead of one person one vote. Do people love cities less where local officials aren’t elected? Do people love non-profit firms as much as cities? Color me again confused.

Added 4p: Andrew Gelman says many firms are actually very popular. Alas he doesn’t have comparable data on cities.

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Future Wealth Inequity

By Robin Hanson · January 13, 2012 11:00 pm · Comments (23)

My last two posts described inequality in firm and city sizes, and in individual wealth. Today, firms and cities are quite unequal, following a Zipf distribution, with a tail power near one (giving a very thick tail.) Individual wealth is a bit more equal, with a bigger power of ~1.4 (and hence a thinner tail).

This distribution of firms and cities seems to result from their being tolerably effective across a wide range of sizes, having long unequal lifetimes, having little net local growth, and holding a roughly fixed total number of people. In contrast, individuals have more equal lifespans, are psychologically inclined to spend more as they get richer, and have spending habits that correlate only weakly across generations. (“Rags to rags in three generations.”)

How might these change in the future? In the em era, I expect firm distributions to stay similar, but expect city and individual wealth distributions to change. I’ve talked before about how I suspect strong gains to em concentration, as they suffer less from travel congestion, leading perhaps to most being in a few dense cities. In this post, let me talk about em wealth.

Since em lifespans should be limited mainly by em wealth, em lifetimes can vary a lot more than human lifetimes, and ems can have more long-term spending consistency. While some ems will spend their wealth on more copies, others will hoard their wealth. Some may even manage to consistently reinvest most of their wealth via something like a Kelly criteria. This seems likely to make future em wealth evolution more akin to today’s firm and city evolution. I thus expect a near Zipf distribution for the high tail of em wealth.

This change in tail power should make em wealth distributions more unequal. Under a tail power of ~1.4, today’s richest person has about $75B, which is about 0.04% of the world’s $200T wealth. Under a power of ~1, the richest person might be about a hundred times richer, holding ~4% of the world’s wealth, or $7.5T.

Since a Zipf distribution has an unbounded expected value, its inequality also depends on the total population size (which follows it). The following table shows this dependence:

The “% of Richest” column says what fraction of the total wealth is held by the one richest person. The “MidW %” column shows the (smallest) fraction of the population that holds half of the total wealth. And the “MidW/ave” column shows how much richer is the mid-wealth person (for whom half of all wealth is held by richer folks) than the average person.

For a Zipf wealth distribution, as the population gets larger wealth gets more concentrated. Even so, the very richest person holds a smaller fraction of the total wealth. The same should apply to firms and cities if they retain a Zipf distribution — the firm and cities that hold most people will get larger, even though the largest firm or city would be a smaller fraction of the total.

In sum, as the population gets larger, I expect firms and cities to get larger.  And for “immortal” ems, I also expect a more unequal distribution of wealth. Even so, as population increases the very largest firms, cities, and rich folks should hold smaller fractions of their respective totals.

Added 11p 14Jan: This post has now been up for a whole day, with zero comments and one vote. Which has to be some sort of record for reader disinterest. This is especially noteworthy, given that I’m especially proud of this post, culminating several days work trying to understand something important about the future. Alas that I  sometimes bore readers, but I’m writing this blog mainly for me, so I’ll continue to write about what most interests me, even if past responses suggest readers won’t be as interested.

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