In the July Monthly, Noel Pearson zeroes in on one of the key structural issues underlying the recent crisis; why did so many corporations (especially financial ones) act in a manner so disastrously contrary to their own self-interest?
His short answer? “The cause of Greenspan’s bewilderment [this follows an extended quote from Greenspan’s mea culpa testimony last October] is so obvious that he, the most brilliant of rationalists, cannot see it: he had assigned self-interest to corporations, but self-interest can only be held by people.”
Absolutely right, I think, even though the increasingly euphoric mood in the years leading up to the bust had managed to snare plenty of (presumably self-interested) principals as well. The deeper structural distinction is still vital:
The question, therefore, is who gets to determine the interest of the institution. In the modern corporation, it is the management. But the self-interest of managers, who have no significant ownership of the corporation, is disconnected from the interests of the other parties with a stake in the corporation’s fortune and fate.
He cites Professor Lucien Bebchuk of Harvard Law School who distinguishes between “controlled companies” and “widely held companies”.
In controlled companies, the problem of governance centres on opportunism by the controlling shareholder. In widely held companies, it centres on opportunism by managers, who exercise de facto control. Bebchuk argues that reforms to improve corporate governance and protect investors must take into account the fundamental differences between controlled and widely held companies – that “one size fits both” reforms will not work.
Once again, complex as this issue undoubtedly is, this seems about right.
Before closing, one more quote which nicely juxtaposes the behaviour of JP Morgan (both man and company) during the Panic of 1907 with that of financial institutions more recently.
It was for good reason that collapse was averted following the Panic of 1907 by the actions of the financier JP Morgan, in the absence of any governmental mechanism to rescue the financial system. It was Morgan’s self-interest in his own organisation and the wealth that was tied up in it that drove him to provide a guarantee to the banks – in the form of a $100 million gold loan – in order to avert a general collapse. [ . . . . ] In those days, owner-oligarchs concerned themselves with the long-term survival of their organisations, whereas today the manager-oligarchs’ self-interest is short-term. And so we have a long list of venerable institutions that have fallen over (or should have fallen over, had they not been heavily transfused with the blood of taxpayers) like so many ten-pins.
One thing seems certain; quite apart from the need to (hopefully?) deal with the broader systemic and structural issues, never again should the incentive structures for managers and employees of financial institutions be allowed to so grievously diverge from the long-term interests of their hosts.
Easier said than done, of course.