principal–agent problem

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pages: 239 words: 69,496

The Wisdom of Finance: Discovering Humanity in the World of Risk and Return by Mihir Desai

activist fund / activist shareholder / activist investor, Albert Einstein, Andrei Shleifer, assortative mating, Benoit Mandelbrot, Brownian motion, capital asset pricing model, carried interest, collective bargaining, corporate governance, corporate raider, discounted cash flows, diversified portfolio, Eugene Fama: efficient market hypothesis, financial innovation, follow your passion, George Akerlof, Gordon Gekko, greed is good, housing crisis, income inequality, information asymmetry, Isaac Newton, Jony Ive, Kenneth Rogoff, Louis Bachelier, moral hazard, Myron Scholes, new economy, out of africa, Paul Samuelson, Pierre-Simon Laplace, principal–agent problem, Ralph Waldo Emerson, random walk, risk/return, Robert Shiller, Robert Shiller, Ronald Coase, Silicon Valley, Steve Jobs, The Market for Lemons, The Nature of the Firm, The Wealth of Nations by Adam Smith, Tim Cook: Apple, transaction costs, zero-sum game

Positive reactions to unexpected CEO deaths, in addition to being vaguely ghoulish, are a manifestation of the basic problem that arises when owners delegate authority to managers—those managers don’t always do what they’re supposed to, and shareholders struggle to control these managers. This is the problem of corporate governance and a manifestation of the principal-agent problem. It’s also the fundamental problem of modern capitalism. You’ve undoubtedly come across a version of this problem in your own life. We all grapple with the principal-agent problem when we interact with contractors, lawyers, doctors, and just about anyone who does something for us. In these settings, we (the principals) appoint someone (an agent) to do something on our behalf (build a house, argue a case, take care of our health). The problem has two dimensions—first, they may be motivated to help us but they undoubtedly have their own agenda (providing for their own families, the desire to leave work early); second, we can’t always know if they’re working on our behalf—we simply can’t watch them all the time and they may know much more than we do (Do I really know the quality of concrete they used in my home?

The next four chapters consider all this messiness. The fourth chapter considers what happens when the relationship between investors and the underlying productive assets they own is mediated by human beings with their own motivations. The resulting emphasis on the relationship between principals (shareholders) and agents (managers) is the problem of corporate governance—and arguably the central problem of modern capitalism. The principal-agent problem, as demonstrated by Mel Brooks’s The Producers and E. M. Forster’s A Room with a View, is also a powerful frame for situations in our life when we are, consciously or unconsciously, behaving on behalf of others. Now that companies have been introduced, we can consider when and how they should combine with each other—an activity known as merging. In the fifth chapter, mergers are paralleled with romantic relationships by exploring how romance and finance have been intertwined from Renaissance Florence to the rise of the Rothschilds to the merger of AOL and Time Warner.

The professional managers and entrepreneurs who run the firms might as well abscond with the money.” In other words, why doesn’t capitalism collapse into an endless series of frauds? Why don’t all entrepreneurs do what Bialystock and Bloom tried to do, and why does anyone invest in anything, given the risks that their money might end up in the hands of opportunistic managers or outright frauds? The answers to these questions illustrate the central problem of modern capitalism—the principal-agent problem—and understanding that problem provides a powerful frame for thinking about our lives. Once upon a time, capitalism was simple. Think back a few hundred years. Merchants, farmers, and storekeepers owned their businesses and managed their businesses on an everyday basis. Yes, there were departures from that—including slavery and the role of sovereigns in commerce—but I already indicated that this was a fairy tale.


pages: 574 words: 164,509

Superintelligence: Paths, Dangers, Strategies by Nick Bostrom

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agricultural Revolution, AI winter, Albert Einstein, algorithmic trading, anthropic principle, anti-communist, artificial general intelligence, autonomous vehicles, barriers to entry, Bayesian statistics, bioinformatics, brain emulation, cloud computing, combinatorial explosion, computer vision, cosmological constant, dark matter, DARPA: Urban Challenge, data acquisition, delayed gratification, demographic transition, Donald Knuth, Douglas Hofstadter, Drosophila, Elon Musk, en.wikipedia.org, endogenous growth, epigenetics, fear of failure, Flash crash, Flynn Effect, friendly AI, Gödel, Escher, Bach, income inequality, industrial robot, informal economy, information retrieval, interchangeable parts, iterative process, job automation, John Markoff, John von Neumann, knowledge worker, Menlo Park, meta analysis, meta-analysis, mutually assured destruction, Nash equilibrium, Netflix Prize, new economy, Norbert Wiener, NP-complete, nuclear winter, optical character recognition, pattern recognition, performance metric, phenotype, prediction markets, price stability, principal–agent problem, race to the bottom, random walk, Ray Kurzweil, recommendation engine, reversible computing, social graph, speech recognition, Stanislav Petrov, statistical model, stem cell, Stephen Hawking, strong AI, superintelligent machines, supervolcano, technological singularity, technoutopianism, The Coming Technological Singularity, The Nature of the Firm, Thomas Kuhn: the structure of scientific revolutions, transaction costs, Turing machine, Vernor Vinge, Watson beat the top human players on Jeopardy!, World Values Survey, zero-sum game

This is the problem that a project faces when it seeks to ensure that the superintelligence it is building will not harm the project’s interests. This part, too, can be thought of as a principal–agent problem—the second principal–agent problem. In this case, the agent is not a human agent operating on behalf of a human principal. Instead, the agent is the superintelligent system. Whereas the first principal–agent problem occurs mainly in the development phase, the second agency problem threatens to cause trouble mainly in the superintelligence’s operational phase. Exhibit 1 Two agency problems The first principal–agent problem • Human v. Human (Sponsor → Developer) • Occurs mainly in developmental phase • Standard management techniques apply The second principal–agent problem (“the control problem”) • Human v. Superintelligence (Project → System) • Occurs mainly in operational (and bootstrap) phase • New techniques needed This second agency problem poses an unprecedented challenge.

This first part—what we shall call the first principal–agent problem—arises whenever some human entity (“the principal”) appoints another (“the agent”) to act in the former’s interest. This type of agency problem has been extensively studied by economists.1 It becomes relevant to our present concern if the people creating an AI are distinct from the people commissioning its creation. The project’s owner or sponsor (which could be anything ranging from a single individual to humanity as a whole) might then worry that the scientists and programmers implementing the project will not act in the sponsor’s best interest.2 Although this type of agency problem could pose significant challenges to a project sponsor, it is not a problem unique to intelligence amplification or AI projects. Principal–agent problems of this sort are ubiquitous in human economic and political interactions, and there are many ways of dealing with them.

But we have seen enough to conclude that scenarios in which some machine intelligence gets a decisive strategic advantage are to be viewed with grave concern. CHAPTER 9 The control problem If we are threatened with existential catastrophe as the default outcome of an intelligence explosion, our thinking must immediately turn to the search for countermeasures. Is there some way to avoid the default outcome? Is it possible to engineer a controlled detonation? In this chapter we begin to analyze the control problem, the unique principal–agent problem that arises with the creation of an artificial superintelligent agent. We distinguish two broad classes of potential methods for addressing this problem—capability control and motivation selection—and we examine several specific techniques within each class. We also allude to the esoteric possibility of “anthropic capture.” Two agency problems If we suspect that the default outcome of an intelligence explosion is existential catastrophe, our thinking must immediately turn to whether, and if so how, this default outcome can be avoided.


pages: 222 words: 60,207

Circus Maximus: The Economic Gamble Behind Hosting the Olympics and the World Cup by Andrew Zimbalist

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airline deregulation, carbon footprint, East Village, en.wikipedia.org, full employment, Gini coefficient, income inequality, New Urbanism, principal–agent problem, race to the bottom, selection bias, urban planning, young professional

The Bidding Process Erodes Possible Gains The fact that the existing power structure imposes itself on the bidding process has another unfavorable implication. Consider the following stylized model of the bidding process. In each of the three cases, there is a monopoly seller of hosting rights (either FIFA or the IOC). Case One —Perfect information and no principal-agent problem —Outcome: Expected net gains are bid away In this case, it is assumed that the IOC or FIFA each has complete information about the bidders and each of the bidders has complete information about its own bid and those of its competitors. It is further assumed that there is no principal-agent problem. This means that the body representing the city or country (the local organizing committee) fairly represents the interests of the entire resident population. The local organizing committee is the agent of the entire resident population (the principal).

The winning bid in such a case usually goes to the most exuberant bidder, who not only outbids all the other bidders but also generally bids higher than the possible gain, an outcome known in game theory as the winner's curse. The result is a net financial loss and a net overall loss, even though the organizing committee (agent) in this case is still assumed to fairly represent the interests of the local population (the principal). Case Three —Imperfect information and a principal-agent problem —Outcome: outlandish overbid This case moves yet closer to reality by acknowledging a principal-agent problem. That is, the local organizing committee, the agent, is controlled by the private interests that stand to gain the most from hosting, and these interests are not coincident with those of the host country's or city's population (the principal). The condition of imperfect information again facilitates extravagant bids from each of the prospective hosts.

Note that if the overall return to hosting approaches zero, and if there are feel-good benefits from hosting, this implies that there will be a negative financial result. That is, the host will have to pay to achieve the feel-good effects, bringing the overall net return to zero.3 This case is the most favorable for the bidding cities or countries. It is also the least realistic of the three cases. Case Two —Imperfect information and no principal-agent problem —Outcome: winner's curse and net loss The sole difference between this case and the prior one is that the assumption of perfect information is dropped, making case 2 a better approximation of reality. In this case, each bidder does not know what its potential benefits and costs might turn out to be when it participates in the bidding competition. The winning bid in such a case usually goes to the most exuberant bidder, who not only outbids all the other bidders but also generally bids higher than the possible gain, an outcome known in game theory as the winner's curse.


pages: 334 words: 98,950

Bad Samaritans: The Myth of Free Trade and the Secret History of Capitalism by Ha-Joon Chang

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affirmative action, Albert Einstein, Big bang: deregulation of the City of London, bilateral investment treaty, borderless world, Bretton Woods, British Empire, Brownian motion, call centre, capital controls, central bank independence, colonial rule, Corn Laws, corporate governance, David Ricardo: comparative advantage, Deng Xiaoping, Doha Development Round, en.wikipedia.org, falling living standards, Fellow of the Royal Society, financial deregulation, fixed income, Francis Fukuyama: the end of history, income inequality, income per capita, industrial robot, Isaac Newton, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, labour mobility, land reform, liberal world order, liberation theology, low skilled workers, market bubble, market fundamentalism, Martin Wolf, means of production, mega-rich, moral hazard, offshore financial centre, oil shock, price stability, principal–agent problem, Ronald Reagan, South Sea Bubble, structural adjustment programs, The Wealth of Nations by Adam Smith, trade liberalization, transfer pricing, urban sprawl, World Values Survey

This is because there is a fundamental gap in information between the principals and their agents. For example, when the hired manager says that she has done her best and that the poor performance is due to factors beyond her control, the principal will find it very difficult to prove that she is lying. The difficulty of the principal controlling the agent’s behaviour is known as the ‘principal-agent problem’ and the resulting costs (that is, the reduction in profits due to poor management) the ‘agency cost’. The principal-agent problem is at the centre of the neo-liberal argument against SOEs. But this is not the only cause of inefficiency of state ownership of enterprises. Individual citizens, even if they theoretically own the public enterprises, do not have any incentives to take care of their properties (the enterprises in question) by adequately monitoring the hired managers.

But all three arguments against state ownership of enterprises actually apply to large private-sector firms as well. The principal-agent problem and the free-rider problem affect many large private-sector firms. Some large companies are still managed by their (majority) owners (e.g., BMW, Peugeot), but most of them are managed by hired managers because they have dispersed share ownership. If a private enterprise is run by hired managers and there are numerous shareholders owning only small fractions of the company, it will suffer from the same problems as state-owned enterprises. The hired managers (like their SOE counterparts) will also have no incentive to put in more than sub-optimal levels of effort (the principal-agent problem), while individual shareholders will not have enough incentive to monitor the hired managers (the free-rider problem).

Despite having secured, through skillful lobbying, a series of tariff hikes that were not formally permitted under the terms of the original contract, Maynilad walked away from the contract when the regulator refused to grant yet another tariff hike in 2002.19 State-owned enterprises are often more practical solutions than a system of subsidies and regulations for private-sector providers, especially in developing countries that lack tax and regulatory capabilities. Not only can they do (and, in many cases, have done) well, under certain circumstances they may be superior to private-sector firms. The pitfalls of privatization As I have pointed out, all the alleged key causes of SOE inefficiency – the principal-agent problem, the free-rider problem and the soft budget constraint – are, while real, not unique to state-owned enterprises. Large private-sector firms with dispersed ownership also suffer from the principal-agent problem and the free-rider problem. So, in these two areas, forms of ownership do matter, but the critical divide is not between state and private ownership – it is between concentrated and dispersed ownerships. In the case of the soft budget constraint, arguably the distinction between state and private ownership is sharper, but even here it is not absolute.


pages: 347 words: 99,317

Bad Samaritans: The Guilty Secrets of Rich Nations and the Threat to Global Prosperity by Ha-Joon Chang

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affirmative action, Albert Einstein, banking crisis, Big bang: deregulation of the City of London, bilateral investment treaty, borderless world, Bretton Woods, British Empire, Brownian motion, call centre, capital controls, central bank independence, colonial rule, Corn Laws, corporate governance, David Ricardo: comparative advantage, Deng Xiaoping, Doha Development Round, en.wikipedia.org, falling living standards, Fellow of the Royal Society, financial deregulation, fixed income, Francis Fukuyama: the end of history, income inequality, income per capita, industrial robot, Isaac Newton, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, labour mobility, land reform, liberal world order, liberation theology, low skilled workers, market bubble, market fundamentalism, Martin Wolf, means of production, mega-rich, moral hazard, offshore financial centre, oil shock, price stability, principal–agent problem, Ronald Reagan, South Sea Bubble, structural adjustment programs, The Wealth of Nations by Adam Smith, trade liberalization, transfer pricing, urban sprawl, World Values Survey

This is because there is a fundamental gap in information between the principals and their agents. For example, when the hired manager says that she has done her best and that the poor performance is due to factors beyond her control, the principal will find it very difficult to prove that she is lying. The difficulty of the principal controlling the agent’s behaviour is known as the ‘principal-agent problem’ and the resulting costs (that is, the reduction in profits due to poor management) the ‘agency cost’. The principal-agent problem is at the centre of the neo-liberal argument against SOEs. But this is not the only cause of inefficiency of state ownership of enterprises. Individual citizens, even if they theoretically own the public enterprises, do not have any incentives to take care of their properties (the enterprises in question) by adequately monitoring the hired managers.

But all three arguments against state ownership of enterprises actually apply to large private-sector firms as well. The principal-agent problem and the free-rider problem affect many large private-sector firms. Some large companies are still managed by their (majority) owners (e.g., BMW, Peugeot), but most of them are managed by hired managers because they have dispersed share ownership. If a private enterprise is run by hired managers and there are numerous shareholders owning only small fractions of the company, it will suffer from the same problems as state-owned enterprises. The hired managers (like their SOE counterparts) will also have no incentive to put in more than sub-optimal levels of effort (the principal-agent problem), while individual shareholders will not have enough incentive to monitor the hired managers (the free-rider problem).

Despite having secured, through skillful lobbying, a series of tariff hikes that were not formally permitted under the terms of the original contract, Maynilad walked away from the contract when the regulator refused to grant yet another tariff hike in 2002.19 State-owned enterprises are often more practical solutions than a system of subsidies and regulations for private-sector providers, especially in developing countries that lack tax and regulatory capabilities. Not only can they do (and, in many cases, have done) well, under certain circumstances they may be superior to private-sector firms. The pitfalls of privatization As I have pointed out, all the alleged key causes of SOE inefficiency – the principal-agent problem, the free-rider problem and the soft budget constraint – are, while real, not unique to state-owned enterprises. Large private-sector firms with dispersed ownership also suffer from the principal-agent problem and the free-rider problem. So, in these two areas, forms of ownership do matter, but the critical divide is not between state and private ownership – it is between concentrated and dispersed ownerships. In the case of the soft budget constraint, arguably the distinction between state and private ownership is sharper, but even here it is not absolute.


pages: 503 words: 131,064

Liars and Outliers: How Security Holds Society Together by Bruce Schneier

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airport security, barriers to entry, Berlin Wall, Bernie Madoff, Bernie Sanders, Brian Krebs, Broken windows theory, carried interest, Cass Sunstein, Chelsea Manning, commoditize, corporate governance, crack epidemic, credit crunch, crowdsourcing, cuban missile crisis, Daniel Kahneman / Amos Tversky, David Graeber, desegregation, don't be evil, Double Irish / Dutch Sandwich, Douglas Hofstadter, experimental economics, Fall of the Berlin Wall, financial deregulation, George Akerlof, hydraulic fracturing, impulse control, income inequality, invention of agriculture, invention of gunpowder, iterative process, Jean Tirole, John Nash: game theory, joint-stock company, Julian Assange, mass incarceration, meta analysis, meta-analysis, microcredit, moral hazard, mutually assured destruction, Nate Silver, Network effects, Nick Leeson, offshore financial centre, patent troll, phenotype, pre–internet, principal–agent problem, prisoner's dilemma, profit maximization, profit motive, race to the bottom, Ralph Waldo Emerson, RAND corporation, rent-seeking, RFID, Richard Thaler, risk tolerance, Ronald Coase, security theater, shareholder value, slashdot, statistical model, Steven Pinker, Stuxnet, technological singularity, The Market for Lemons, The Nature of the Firm, The Spirit Level, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, too big to fail, traffic fines, transaction costs, ultimatum game, UNCLOS, union organizing, Vernor Vinge, WikiLeaks, World Values Survey, Y2K, zero-sum game

Reputational: In some organizations, people who are perceived to work harder are treated better by their peers. In most organizations, they're treated better by their superiors. Institutional: Organizations have all sorts of rules about employee behavior. Employees are supervised. Firing, promotions, and raises are all tied to performance—at least in theory. Security: Time cards, auditing, employee monitoring, formal performance reviews, and so on. In economics, this is known as the principal–agent problem: the principal (in this case the organization) hires an agent (the employee) to pursue the principal's interests, but because the competing interests of the principal and the agent are different, it can be difficult to get the agent to cooperate. Defection isn't all-or-nothing, either. Defections can be as diverse as coming in late, not working very hard, venting, whining, passive-aggressive behavior with coworkers, stealing paper clips from the office supply closet, or large-scale embezzlement.

And a smart company can often protect itself by spinning off the risky asset in a subsidiary company, or selling it off completely. Mining companies do this all the time. The result of all this is that, by leaving the security to the owner, we don't get enough of it. In general, the person responsible for a risk trade-off will make the trade-off that is most beneficial to him. So when society designates an agent to make a risk trade-off on its behest, society has to solve the principal–agent problem and ensure that the agent makes the same trade-off that society would. We'll see how this can fail with government institutions in the next chapter; in this case, it's failing with corporations. Think back to the sandwich sellers in the local market. Merchant Alice is one of those sandwich sellers, and a dishonest, unscrupulous one at that. She has no moral—or reputational—issues with potentially poisoning her buyers.

For example, while the king might decide that the country will go to war and all able-bodied men are to be drafted into the army, he won't decide what sorts of security measures will be put in place to limit defectors. Society delegates the implementation of societal pressures to some subgroup of society. Generally these are institutions, which I'll broadly define as an organization delegated with implementing societal pressure. We've already discussed delegation and the principal–agent problem. We're now going to look at how that plays out with institutions. In 2010, full-body scanners were rushed into airports following the underwear bomber's failed attempt to blow himself up along with an airplane. There are a lot of reasons why the devices shouldn't be used, most notably because they can't directly detect the particular explosive the underwear bomber used, and probably wouldn't have detected his underwear bomb.


pages: 443 words: 51,804

Handbook of Modeling High-Frequency Data in Finance by Frederi G. Viens, Maria C. Mariani, Ionut Florescu

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algorithmic trading, asset allocation, automated trading system, backtesting, Black-Scholes formula, Brownian motion, business process, continuous integration, corporate governance, discrete time, distributed generation, fixed income, Flash crash, housing crisis, implied volatility, incomplete markets, linear programming, mandelbrot fractal, market friction, market microstructure, martingale, Menlo Park, p-value, pattern recognition, performance metric, principal–agent problem, random walk, risk tolerance, risk/return, short selling, statistical model, stochastic process, stochastic volatility, transaction costs, value at risk, volatility smile, Wiener process

Source: Adapted from Kaplan and Nagel (2004) and Creamer and Freund (2010b). 3.4 Earnings Prediction and Algorithmic Trading 3.4.1 EARNINGS PREDICTION Many of the recent bankruptcy scandals in publicly held US companies , such as Enron and WorldCom, are inextricably linked to a conflict of interest between shareholders (principals) and managers (agents). This conflict of interest is called the principal– agent problem in finance literature. The principal–agent problem stems from the tension between the interests of the investors in increasing the value of the company and the personal interests of the managers. The principal–agent conflict has also led to the so-called ‘‘earnings game.’’ CEOs’ compensation depends on their stock options. So, top managers concentrate on the management of earnings and surprises. The Wall Street companies want to keep selling stocks.

., 2000), while companies that have more outsiders as directors grant more compensation packages, such as equity-based compensation, to directors aligned with shareholders’ interests (Ryan and Wiggins, 2004). Jensen and Murphy (2004) indicate that the fundamental motivation to grant executive options, which is to align corporate and managerial goals, is not fulfilled by the current executive compensation policy. On the other hand, current research shows that some of the policies are at least partially effective. Another major area where the principal–agent problem is evident is the insider ownership. According to Jensen and Meckling (1976), the separation of 54 CHAPTER 3 Using Boosting for Financial Analysis and Trading ownership and control is often seen as an opportunity for managers to accumulate wealth at the expense of shareholders (Berle and Means, 1932; Shleifer and Vishny, 1997). Ang et al. (2000), using a sample of small US companies, show how agency costs increase with a decrease in managerial ownership as proposed by Jensen and Meckling (1976).

See also Constant rebalanced portfolio technical analysis 436 Portfolios (continued ) (CRP-TA) trading algorithm; Multiagent portfolio management system; Subprime MBS portfolios MBS, 77 tranches of, 77 vintage of, 77 Portfolios value, expected change in, 385 Portfolio utility, 286 Position strategy, 33 Positive process, 310 Powell’s method, 6, 14, 19 Power-type utility functions, 305 Preaveraging technique, 267 Prediction nodes, 50, 51 Prediction rule, 48, 49 Prespecified terminal time, 295 Price behavior, analyzing after rare events, 28 Price change distributions, 31 Price distribution distortion, 91 Price evolution in time, 30 Price movement(s) corresponding to small volume, 30 detecting and evaluating, 44 persistence of, 27–46 Price movement methodology, results of, 35–41 Price process, 121 Price recovery probability of, 44 after rare events, 45 Price volatility, UHFT and, 241 Price–volume relationship, 27–28 outlying observations of, 28 Principal–agent conflict, 53 Principal–agent problem, 60 Probability of favorable price movement, 35–36 Poisson, 240 Probability density, 13–14 Probability density function (pdf), 119, 120, 163, 171, 335. See also Forecast pdfs; pdf forecasting; Sample pdfs Probability distributions, 165 Probability mass function (pmf), 171 Probability surfaces, 35, 37 Proportionality constant, 402 Pure optimal stopping problems, 311 Put options, demand for, 106 Index Put options chains, constructed VIX using, 105–106 p-values, 138–139, 204–205 pVIX-b, 102–103, 105.


pages: 504 words: 126,835

The Innovation Illusion: How So Little Is Created by So Many Working So Hard by Fredrik Erixon, Bjorn Weigel

Airbnb, Albert Einstein, asset allocation, autonomous vehicles, barriers to entry, Basel III, Bernie Madoff, bitcoin, Black Swan, blockchain, BRICs, Burning Man, Capital in the Twenty-First Century by Thomas Piketty, Cass Sunstein, Clayton Christensen, Colonization of Mars, commoditize, corporate governance, corporate social responsibility, creative destruction, crony capitalism, dark matter, David Graeber, David Ricardo: comparative advantage, discounted cash flows, distributed ledger, Donald Trump, Elon Musk, Erik Brynjolfsson, fear of failure, first square of the chessboard / second half of the chessboard, Francis Fukuyama: the end of history, George Gilder, global supply chain, global value chain, Google Glasses, Google X / Alphabet X, Gordon Gekko, high net worth, hiring and firing, Hyman Minsky, income inequality, income per capita, index fund, industrial robot, Internet of things, Jeff Bezos, job automation, job satisfaction, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, joint-stock company, Joseph Schumpeter, Just-in-time delivery, Kevin Kelly, knowledge economy, labour market flexibility, laissez-faire capitalism, lump of labour, Lyft, manufacturing employment, Mark Zuckerberg, market design, Martin Wolf, mass affluent, means of production, Mont Pelerin Society, Network effects, new economy, offshore financial centre, pensions crisis, Peter Thiel, Potemkin village, price mechanism, principal–agent problem, Productivity paradox, QWERTY keyboard, RAND corporation, Ray Kurzweil, rent-seeking, risk tolerance, risk/return, Robert Gordon, Ronald Coase, Ronald Reagan, savings glut, Second Machine Age, secular stagnation, Silicon Valley, Silicon Valley startup, Skype, sovereign wealth fund, Steve Ballmer, Steve Jobs, Steve Wozniak, technological singularity, telemarketer, The Chicago School, The Future of Employment, The Nature of the Firm, The Wealth of Nations by Adam Smith, too big to fail, total factor productivity, transaction costs, transportation-network company, tulip mania, Tyler Cowen: Great Stagnation, University of East Anglia, unpaid internship, Vanguard fund, Yogi Berra

As well as carrots, investors sometimes use sticks, insisting that key individuals in the companies they are investing in should have “skin in the game.” In younger firms, that usually means that entrepreneurs are required to coinvest alongside an outside investor; this sometimes even goes as far as demanding that entrepreneurs mortgage family homes for the purpose of locking owners and management together – the capitalist version of a Mexican standoff. Much as tools for ownership control have improved, they have not solved the principal–agent problems. In fact, the grayer that capitalism has grown, the more acutely necessary it has become for owners to ensure that their capital is not going to get squandered. Shareholder and ownership agreements have tied management to a bureaucratic notion of the company. Moreover, owners have increasingly been incentivized to change the allocation of corporate funding – from equity to debt – and to handle the agency problem by restricting management access to the cash flow.

Chance character (i), (ii) Belgium profit margins (i) taxi services and regulation (i) Bell, Alexander Graham (i), (ii) Bell Labs (AT&T) (i) Bellamy, Edward (i) Bellman, Richard (i) benchmarking (i), (ii) benefits, and incomes (i) Benz, Karl (i) Bergman, Ingmar (i) Berkshire Hathaway (i) Berle, Adolf (i) Berra, Yogi (i) Bezos, Jeff (i) Bhide, Amar (i) big firms big firm market dominance (i) and investment allocation for innovation (i) and private standards (i) relative importance of in European countries (i) reputation of (i) see also firm boundaries; firms; multinational (global) companies “big swinging dicks” (i) big-data business models (i) biofuels and EU regulation (i) see also energy sector biotechnological sector, and EU regulation (i) Bismarck, Otto von (i) bitcoin (i) BlackBerry (i) blackboard economics (i) Blackrock (i) blockchain (mutual distributed ledger) technology (i) Blue Ribbon Commission (US) (i) The Blues Brothers (movie) (i) boom and bust cycles (i), (ii), (iii) boomer (or baby boomer) generation (i), (ii), (iii), (iv) Boston Consulting Group index of complicatedness (i) on performance imperatives (i) on working time of managing teams (i) branding (i), (ii) Brazil and BRIC concept (i), (ii) taxi services and regulation (i) BRIC as a Bloody Ridiculous Investment Concept (i) countries (Brazil, India, Russia, and China) (i), (ii) Bridgewater (i) Brin, Sergey (i) Britain see United Kingdom (UK) British managerialism (i) Brockovich, Erin (i) Brookings (i) Brown, Gordon (i) Brynjolfsson, Erik, The Second Machine Age (Brynjolfsson and McAfee) (i), (ii) budget process, and compliance officers (i) Buffett, Warren (i), (ii) bureaucracy and capitalism (i), (ii) and competition (i) and compliance officers (i) and globalization (i), (ii), (iii), (iv) and IBM (i) and index of complicatedness (Boston Consulting Group) (i) and Indian economy (i) and managerialism (i), (ii), (iii) and organizational diversification (i) and principal–agent debate (i) and socialism (i) see also bureaucracy brake; bureaucrats; corporate managerialism; managerialism bureaucracy brake, and regulation (Germany) (i) bureaucrats vs. entrepreneurs (i), (ii) see also bureaucracy; bureaucracy brake Burning Man festival (Nevada) (i) Burns, Scott, The Clash of Generations (Kotlikoff and Burns) (i) business-building skills, vs. financial skills (i) business cycles, and productivity (i) business development, and strategy (i), (ii) business information technology (IT) services (i) business investment and cash hoarding (i) and corporate net lending (i), (ii) declining trend (i) explanations for decline (i) and financial regulation (i), (ii) and gray capitalism (i) investment allocation for innovation and big firms (i) low investment growth vs. fast corporate borrowing growth (i) measuring issues (i) and mergers and acquisitions (i) and policy uncertainty (i), (ii) and shareholders (i), (ii), (iii) UK business investment (i), (ii) US business investment (i), (ii) see also asset managers; investment; R&D business management (i), (ii) see also corporate managerialism business productivity growth (i) Business Week, on Peter Drucker (i) CAC 40 index (France) (i) cadmium (i), (ii) Canada diffusion of innovations (i) GDP figures (i) North American Free Trade Agreement (i) cancer research, and innovation (i), (ii) capital accumulation, and capitalism (i) capital expenditure (capex) (i), (ii), (iii), (iv)n39 capital markets (external) (i), (ii), (iii), (iv), (v) capitalism and agency (i) and asset bubbles (i) and bureaucracy (i), (ii) and capital accumulation (i) “complex by design” capitalism (i) criticism of Western capitalism (i) crony capitalism (i) death of capitalism utopia and socialism (i) decline of Western capitalism (i) and digital age (i) and dissent (i), (ii), (iii) and eccentricity (i), (ii), (iii), (iv), (v) and economic dynamism (i), (ii), (iii) and Enlightenment (i), (ii) and entrepreneurship (i), (ii) financial capitalism (i), (ii), (iii), (iv) free-market capitalism (i) and individual freedom (i), (ii), (iii) and innovation (i), (ii), (iii), (iv), (v) joint-stock capitalism (i), (ii) and labor vs. work (i) vs. the market (i), (ii) Marxist monopolistic theory of (i) “middle-aged” capitalism (i), (ii), (iii) “money manager capitalism” (Hyman Minsky) (i) and organization (i) and planning machines (i) rentier capitalism (i), (ii), (iii), (iv), (v), (vi) and Swedish hybrid economy (i) and technology (i) see also capitalist ownership; corporate managerialism; entrepreneurs; entrepreneurship; the future (and how to prevent it); globalization; gray capitalism; regulation; rich people capitalist ownership and corporate globalism (i) and diversification (i) and gray capitalism: case of Harley-Davidson Motor Company (HD) (i); decline/obituary of capitalist ownership (i); dispersed ownership (i); gray ownership (i), (ii), (iii), (iv), (v), (vi); severing gray capital–corporate ownership link (i) ownership structure reforms (i) and pensions (i) and principal–agent problem (i) and uncertainty (i) car industry car sales and regulation (i) driverless vehicles (i), (ii), (iii), (iv) German car production and value chains (i) lean production (i) US environment-related regulations (i) Carew, Diana G. (i) cargo services and deregulation (i) see also air cargo services cash hoarding (corporate savings) (i), (ii), (iii), (iv), (v) catalytic converter technology (i) Central Europe, German-Central European supply chain (i), (ii) chemicals, and EU regulation (i), (ii) Chicago school of economics (i) Chili, and Cybersyn project (i) China and BRIC concept (i), (ii) exports from European Union (i) GDP (2014) (i), (ii) and globalization (i), (ii), (iii) R&D spending (i) sovereign wealth fund (i) Christensen, Clayton (i), (ii) Churchill, Winston (i) Clark, Gregory (i), (ii)n41 classical market liberalism (i) Clinton, Bill (i) Club des Chiffrephiles (i) Coase, Ronald (i), (ii), (iii), (iv), (v) Coca-Cola (i) Code of Federal Regulations (US) (i) cognition, mechanistic vs. organic (i) collaboration “noise” (i) Comin, Diego (i) command economies (i), (ii) command-and-control (i), (ii) community-generated content, and socialism (i) companies see big firms; firm boundaries; firms; multinational (global) companies competition and bureaucracy (i) and containerization (of global trade) (i) vs. contesting markets (i) and financial regulation (i) and firm boundaries (i), (ii) and geography of production (i) and globalization (i) life-or-death competition (i), (ii), (iii), (iv) and market concentration (i) and mergers and acquisitions (i) move of from countries to firms (i), (ii) and multinationals (i) oligopolistic (or monopolistic) competition (i) and planning machines (i) see also market contestability competitive forces concept (i) complexity “complex by design” capitalism (i) market complexity (i) see also regulatory complexity/uncertainty compliance officers (i) complicatedness index (Boston Consulting Group) (i) compound growth (i) Compustat, corporate cash holdings (i) computer technology/computerization and corporate managerialism (i) and knowledge obsolescence (i) and labor (i) and leisure (i) and market socialism (i) and production (i) and quantum dots/cadmium (i) see also digitalization; ICT (information and communications technology); information technology (IT); software technology Conference Board (economics consultancy) (i), (ii) consolidation (i), (ii) see also mergers and acquisitions Consumer Protection Act (US) (i) containerization (of global trade) (i) contestability see market contestability contracts (i) copying, and strategy (i), (ii) corporate borrowing and low investment growth (i) see also corporate net lending corporate control, and specialization (i) corporate failure see failure corporate globalism (i), (ii), (iii) corporate managerialism and bureaucracy (i), (ii), (iii), (iv), (v) and capitalism, decline of (i), (ii), (iii) corporate destruction and innovation: IBM (i); Microsoft (i), (ii); Nokia (i), (ii), (iii), (iv), (v) formula of failure (i) and globalist worldview (i) and globalization (i), (ii), (iii), (iv) managerial ideology on the rise (i), (ii) planning: planning machines (i), (ii), (iii); risk and uncertainty (i); strategy (i) regulation (i), (ii) regulation and compliance officers (i) Swedish managerialist culture (i), (ii) value vs. numbers (i) see also bureaucracy corporate medical research, and financial regulation (i) corporate net lending (i), (ii) see also corporate borrowing corporate politics (i), (ii), (iii), (iv) see also political world corporate savings (cash hoarding) (i), (ii), (iii), (iv), (v) corporate size and entrepreneurship (i) and globalization (i) and regulation (i) corporate social responsibility (CSR) (i) corporate socialism (i), (ii) corporate socialization (i) corporate valuations (i) costs production costs (i), (ii), (iii) sunk costs (i), (ii), (iii), (iv) transaction costs (i), (ii), (iii), (iv), (v), (vi) transmission costs (i), (ii), (iii) Cowen, Tyler (i) creative destruction fear of and political institutions (i) and globalization (i) and innovation (i), (ii), (iii), (iv), (v) and New Machine Age (i) and Nokia (i) and present-day capitalism (i) see also withering credit rating agencies (i), (ii), (iii) Credit Suisse, on stock markets (i) crony capitalism (i) cronyism (i), (ii), (iii), (iv) culture of experimentation (i), (ii) see also entrepreneurs; entrepreneurship culture of individualism (i) see also dissent; eccentricity; freedom customer loyalty (i) Cybersyn project (i) cyclical effects, and productivity (i) da Vinci, Leonardo see Leonardo da Vinci Darwinianism (i), (ii) Das, Gurcharan (i) data see recorded data (national accounts) data economy, and productivity (i) DAX 30 index (Germany) (i) de Blasio, Bill (i) debt and dividends/share buybacks vs. investment (i), (ii) and economic decline (i) vs. equity funding (i), (ii), (iii), (iv), (v), (vi) and retirement savings (i), (ii) decision-making probabilistic decision-making (i), (ii) and strategy (i) decoupling (productivity/incomes) thesis (i), (ii) deregulation case of air cargo services (FedEx) (i) and diffusion of innovations (i), (ii) OECD product market regulation (PMR) indicators (i), (ii) and reallocation of business (i) and regulatory accumulation (i) wave in 1980s–1990s (i), (ii) see also regulation; regulatory complexity/uncertainty Descartes, René (i) design (i) development vs. research (i), (ii) see also incremental development; R&D diffusion and deregulation (i), (ii) and globalization (i), (ii) and occupational licenses (i) and productivity (i) and R&D (i) “diffusion machine” (i), (ii), (iii) digital age and capitalism (i) and politics (i) digitalization and innovation (i) and leisure (i) and managerialism (i) and productivity growth (i) and regulation (i) and second unbundling of production (i) see also computer technology/computerization; ICT (information and communications technology); information technology (IT); “servicification” (or “servitization”) direct-to-consumer sales (i) dirigisme (France) (i) discriminate dynamism theory (i) dispersed ownership (i) dissent (i), (ii), (iii), (iv) see also culture of individualism; eccentricity diversification and investment (i), (ii) organizational (i), (ii) dividends (i), (ii), (iii), (iv), (v) DJs, and jobs and technology debate (i) dock labor, and containerization (of global trade) (i) Dodd-–Frank Act (US) (i), (ii), (iii), (iv) Dolly the Sheep (i) Dr.

Johnston) (i) globalist worldview (i), (ii) globalization attitudes to globalization survey (IMD Business School) (i) and bureaucracy (i), (ii), (iii), (iv) and business investment (i) and capitalism, decline of (i), (ii) and competition (i) and creative destruction (i) and diffusion (i), (ii) and entrepreneurship (i), (ii) and financial institutions (i) horizontal (i), (ii), (iii), (iv), (v) and innovation (i), (ii), (iii), (iv) and managerialism (i), (ii), (iii), (iv) and mergers and acquisitions (i) and planning (i) and productivity (i), (ii), (iii) and regulation (i) and specialization (i), (ii), (iii), (iv), (v), (vi), (vii) and Swedish economy (i) vertical (i), (ii), (iii), (iv), (v), (vi), (vii) see also corporate globalism; globalization (overview); multinational (global) companies globalization (overview) 1st face/phase (1945–1980s) (i), (ii), (iii) 2nd face/phase (1980s–) (i), (ii), (iii), (iv), (v), (vi), (vii) changing nature of (i) characteristics of multinationals (i), (ii) globalist worldview (i), (ii) “globalize or die” (i) impact on France (i) impact on Germany (i), (ii), (iii), (iv) impact on US and UK (i), (ii), (iii) markets and firm boundaries (i) scale to scope (i) specialization and sunk costs (i), (ii) unbundling of production: first unbundling (i); second unbundling (i), (ii), (iii), (iv) see also corporate globalism; globalization; multinational (global) companies GM (genetically modified) potato, and EU regulation (i) GMOs (genetically modified organisms), and EU regulation (i), (ii), (iii) “Goldilocks and the Three Bears” (story) (i), (ii) Goldilocks principle (i), (ii) Goldman Sachs (i), (ii) Golec, Joseph (i)n28 Google dual share structures (i) and European regulation (i) and globalization (i) Google Glass (i), (ii) and Motorola (i) Project Loon (i), (ii) Gordon, Robert (i), (ii) Gore-Coty, Pierre-Dimitri (i) Gou, Terry (i) governments see political world; politics Graetz, George (i) Grasso, Richard (i) gray capitalism capitalist ownership: case of Harley-Davidson Motor Company (HD) (i); decline/obituary of capitalist ownership (i); dispersed ownership (i); gray ownership (i), (ii), (iii), (iv), (v), (vi); severing gray capital–corporate ownership link (i) “complex by design” and principal–agent problem (i) crowding out of innovations (i) financial capitalism: financialization of real economy (i); intermediaries and asset managers (i), (ii), (iii), (iv), (v), (vi) pensions and retirement savings (i), (ii), (iii), (iv), (v), (vi), (vii) rentier capitalism (i), (ii), (iii), (iv) resource allocation according to rentier formula (i) rich people vs. capitalists (i), (ii) sovereign wealth funds (i), (ii) Graylin, Will Wang (i) Great Recession and aspirations (i) and asset management industry (i) and cash hoarding (corporate savings) (i) and continuing economic decline (i) and firm entry-and-exit rates (i) and global trade (i) and globalist worldview (i) and high-growth firms (i) and investment funds (i) and New Machine Age hype (i) and policy uncertainty (i) and rich people vs. capitalists (i) and stockholding periods (i) and unemployment (i) and US productivity (i) see also financial crisis (2007) Greece, left-wing populism (i) green building codes (US) (i) green/renewable energy and regulation in Europe (i), (ii) and sunk costs (i) Greenspan, Alan (i), (ii), (iii) Greenspan Puts (i) Grey (alias of Ursley Kempe) (i), (ii) gross domestic product see GDP (gross domestic product) Group of Seven (G7) countries, labor productivity (i), (ii) growth see economic growth; GDP (gross domestic product) guilds (i), (ii) see also occupational licenses Gulf states, and sovereign wealth funds (i) Gulfo, Joseph (i) Gyllenhammar, Pehr G.


pages: 302 words: 83,116

SuperFreakonomics by Steven D. Levitt, Stephen J. Dubner

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agricultural Revolution, airport security, Andrei Shleifer, Atul Gawande, barriers to entry, Bernie Madoff, call centre, clean water, cognitive bias, collateralized debt obligation, creative destruction, credit crunch, Daniel Kahneman / Amos Tversky, deliberate practice, Did the Death of Australian Inheritance Taxes Affect Deaths, disintermediation, endowment effect, experimental economics, food miles, indoor plumbing, Intergovernmental Panel on Climate Change (IPCC), John Nash: game theory, Joseph Schumpeter, Joshua Gans and Andrew Leigh, loss aversion, Louis Pasteur, market design, microcredit, Milgram experiment, oil shale / tar sands, patent troll, presumed consent, price discrimination, principal–agent problem, profit motive, randomized controlled trial, Richard Feynman, Richard Feynman, Richard Thaler, selection bias, South China Sea, Stephen Hawking, The Wealth of Nations by Adam Smith, too big to fail, trickle-down economics, ultimatum game, urban planning, William Langewiesche, women in the workforce, young professional

But you don’t necessarily need a pimp to stay out of jail. The average prostitute in Chicago will turn 450 tricks before she is arrested, and only 1 in 10 arrests leads to a prison sentence. It’s not that the police don’t know where the prostitutes are. Nor have the police brass or mayor made a conscious decision to let prostitution thrive. Rather, this is a graphic example of what economists call the principal-agent problem. That’s what happens when two parties in a given undertaking seem to have the same incentives but in fact may not. In this case, you could think of the police chief as the principal. He would like to curtail street prostitution. The cop on the street, meanwhile, is the agent. He may also want to curtail prostitution, at least in theory, but he doesn’t have a very strong incentive to actually make arrests.

., 27–28 Pasteur, Louis, 204 perfect substitutes, 37 pilots, World War II, 147 “pimpact,” 37, 40 pimps, 37–38, 40–41, 56 police and increase in crime, 104 and pimps, 40–41 and prostitution, 32, 41, 55 and stolen cars, 174, 175 and terrorism, 66 See also Genovese, Kitty Policy Implications of Greenhouse Warming (NAS report), 190 polio, 143–45, 147, 157 politics, and prostitution, 25 popular culture, and crime, 100 population, and cheap and simple fixes, 141–42 positive externalities, 175, 176 practice, deliberate, 61 predictions, economic, 16–17 pregnancy, of prostitutes, 34 premarital sex, 31 President’s Council of Economic Advisors, 115 price for prostitutes, 24–25, 29–30, 33–37, 42, 53–54, 55 raising, 42 See also wages price insensitive, 54 principal-agent problem, 41 prisoners and guard-prisoner experiment, 123 release of, 100–102 Prisoner’s Dilemma (game), 108 professions. See careers/professions; specific profession prostitutes/prostitution and Allie, 49–55 arrest of, 32, 41 as career, 54–55 in Chicago, 23–25, 26–38, 41–42, 50–55, 70–71 clientele of, xvi, 33, 35 competition for, 30–31 and condoms, 36, 53 data about, 27 demand for, 43, 54, 55 and deviant acts, 34 downside for, 29–30 and drugs, 29, 36 and escorts, 49–55 exit strategy for, 55 as geographically concentrated, 32–33 incentives for, 19–20, 25, 41 and Internet, 40, 51 legalization of, 55 male, 36 monkey, 215, 216 need for champion for, 31–32 part-time, 42 as perfect substitutes, 37 and police, 32, 41, 55 pregnancy of, 34 price for, 24–25, 29–30, 33–37, 42, 53–54, 55 and principal-agent problem, 41 protection for, 31 and race, 32–33, 35–36 Santa-like, 43 and sellers versus users, 25–26 street, 36, 41–43, 52, 54, 71 as trophy wives, 52–53 and type of tricks, 33–35 Venkatesh study of, 26–37, 38, 40–42, 70–71 and violence, 38 women as dominant in, 23–26, 40 See also pimps puerperal fever, 133–38 race, and prostitution, 32–33, 35–36 Ramadan, 57–58, 59 rational behavior, 122–23, 213–14 real estate Allie’s license for, 55–56 residential, 38–40 Reid, Richard, 65 rejection, and altruism, 108, 109 “relative-age effect,” 60 religion, 82–83 repugnant idea, 199–200 reputation, and baseball card experiment, 116 retirement home visits, experiment concerning, 105–6 revolutionaries, 63–64 “Rimpact,” 39, 40 Ripken, Jr., Cal, 92 Robespierre, Maximilien, 63 Roosevelt, Franklin Delano, 144, 157 Rosenthal, A.

See careers/professions; specific profession prostitutes/prostitution and Allie, 49–55 arrest of, 32, 41 as career, 54–55 in Chicago, 23–25, 26–38, 41–42, 50–55, 70–71 clientele of, xvi, 33, 35 competition for, 30–31 and condoms, 36, 53 data about, 27 demand for, 43, 54, 55 and deviant acts, 34 downside for, 29–30 and drugs, 29, 36 and escorts, 49–55 exit strategy for, 55 as geographically concentrated, 32–33 incentives for, 19–20, 25, 41 and Internet, 40, 51 legalization of, 55 male, 36 monkey, 215, 216 need for champion for, 31–32 part-time, 42 as perfect substitutes, 37 and police, 32, 41, 55 pregnancy of, 34 price for, 24–25, 29–30, 33–37, 42, 53–54, 55 and principal-agent problem, 41 protection for, 31 and race, 32–33, 35–36 Santa-like, 43 and sellers versus users, 25–26 street, 36, 41–43, 52, 54, 71 as trophy wives, 52–53 and type of tricks, 33–35 Venkatesh study of, 26–37, 38, 40–42, 70–71 and violence, 38 women as dominant in, 23–26, 40 See also pimps puerperal fever, 133–38 race, and prostitution, 32–33, 35–36 Ramadan, 57–58, 59 rational behavior, 122–23, 213–14 real estate Allie’s license for, 55–56 residential, 38–40 Reid, Richard, 65 rejection, and altruism, 108, 109 “relative-age effect,” 60 religion, 82–83 repugnant idea, 199–200 reputation, and baseball card experiment, 116 retirement home visits, experiment concerning, 105–6 revolutionaries, 63–64 “Rimpact,” 39, 40 Ripken, Jr., Cal, 92 Robespierre, Maximilien, 63 Roosevelt, Franklin Delano, 144, 157 Rosenthal, A.

State-Building: Governance and World Order in the 21st Century by Francis Fukuyama

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Asian financial crisis, Berlin Wall, Bretton Woods, centre right, corporate governance, demand response, Doha Development Round, European colonialism, failed state, Fall of the Berlin Wall, Francis Fukuyama: the end of history, George Akerlof, Hernando de Soto, information asymmetry, liberal world order, Live Aid, Nick Leeson, Pareto efficiency, Potemkin village, price stability, principal–agent problem, rent-seeking, road to serfdom, Ronald Coase, structural adjustment programs, technology bubble, The Market for Lemons, The Nature of the Firm, transaction costs, Washington Consensus, Westphalian system

Another approach—more workable in the private sector than for public agencies—is to reunite owners and managers by giving the agents stock options or other forms of equity ownership.3 Economic theories about organizations, like economic theories more generally, begin from a premise of methodological individualism. That is, organizations are fundamentally understood as collections of individuals who learn to cooperate socially for reasons of individual self-interest. This perspective thus tends to emphasize conflicts of interests between members of the group (that is after all what principal-agent problems are all about) and to underplay concepts like group identity, socialization, leadership, and so forth. It is certainly worthwhile to try to understand problems of corporate governance or public corruption in principal-agent terms and to use this framework to design institutions that try to bring divergent incentives back into alignment. However, there are at least three basic reasons why there can be no optimal specification of formal institutions and thus no optimal form of organization, particularly for public sector agencies.

Such organization cannot be taken for granted and is usually not something that can be brought about through public policy. Finally, many public sector organizations have independent bases of political power. Even if parents are organized into PTAs and are armed with plentiful information on the performance of their local schools, they may not have the political power to sanction poorly performing teachers or administrators or to reward good ones. Many organizations do not “solve” the principal-agent problem through a formal system of monitoring and accountability at all. Rather, they rely on a mixture of formal mechanisms and informal norms, which usually is a more effective way of improving the quality of low-specificity outputs. Institutional economists have been trying to deal with the problem of “hidden action” for a long time (Miller 1992). In labor markets there are many activities where the individual output of a worker cannot be measured accurately.


pages: 204 words: 67,922

Elsewhere, U.S.A: How We Got From the Company Man, Family Dinners, and the Affluent Society to the Home Office, BlackBerry Moms,and Economic Anxiety by Dalton Conley

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3D printing, assortative mating, call centre, clean water, commoditize, dematerialisation, demographic transition, Edward Glaeser, extreme commuting, feminist movement, financial independence, Firefox, Frank Levy and Richard Murnane: The New Division of Labor, Home mortgage interest deduction, income inequality, informal economy, Jane Jacobs, John Maynard Keynes: Economic Possibilities for our Grandchildren, knowledge economy, knowledge worker, labor-force participation, late capitalism, low skilled workers, manufacturing employment, mass immigration, McMansion, mortgage tax deduction, new economy, off grid, oil shock, PageRank, Ponzi scheme, positional goods, post-industrial society, Post-materialism, post-materialism, principal–agent problem, recommendation engine, Richard Florida, rolodex, Ronald Reagan, Silicon Valley, Skype, statistical model, The Death and Life of Great American Cities, The Great Moderation, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, transaction costs, women in the workforce, Yom Kippur War

If the promise of a dollar in the jar is what compels someone to be friendly, then does that not cheapen smiles in general? Conversely, how can service workers and customers be on equal footing if the cashier’s livelihood depends on the largesse of the person ordering the mochachino? The presence of in-your-face money not only hurts the relationship between the customer and the service worker, it also damages the relationship between the worker and the firm. Tipping creates what economists term a principal-agent problem. In other words, it creates different incentives for the worker and the owner of an establishment. A waiter whose income largely derives from tips is more likely to give an extra scoop of ice cream to a customer. Research shows that these kinds of acts do increase tips on average, but they, of course, cut into the profit margin of the ice cream parlor. More important, tipping is not good for the workers themselves, either.

Make an argument about the loss in productivity associated with rude neighbors and the increasing crime that results from distracted urban citizens. And if you want to resist the forced implementation of television screens in the backseat of taxicabs (as if advertisements outside the window are not enough), then don’t complain about their aesthetics or the invasion of once private space by commerce. Instead, whip up some talking points addressing the “principal-agent problem,” in that the revenue stream does not go back to the cabdriver or the passenger but rather to a third party, who doesn’t have to pay for their installation or suffer through their monotonous content. In short, if you can’t beat the logic of the market, then join it—but on your own terms. And keep in mind that every economy is built upon a paradox (or multiple paradoxes). In time, inevitably, these paradoxes become the death knell for a given system of production and distribution—though not usually unfolding in the way early naysayers had predicted it would.6 For example, industrialization and its twin brother modern capitalism brought with them a series of contradictions.


pages: 280 words: 79,029

Smart Money: How High-Stakes Financial Innovation Is Reshaping Our WorldÑFor the Better by Andrew Palmer

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Affordable Care Act / Obamacare, algorithmic trading, Andrei Shleifer, asset-backed security, availability heuristic, bank run, banking crisis, Black-Scholes formula, bonus culture, break the buck, Bretton Woods, call centre, Carmen Reinhart, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Graeber, diversification, diversified portfolio, Edmond Halley, Edward Glaeser, endogenous growth, Eugene Fama: efficient market hypothesis, eurozone crisis, family office, financial deregulation, financial innovation, fixed income, Flash crash, Google Glasses, Gordon Gekko, high net worth, housing crisis, Hyman Minsky, implied volatility, income inequality, index fund, information asymmetry, Innovator's Dilemma, interest rate swap, Kenneth Rogoff, Kickstarter, late fees, London Interbank Offered Rate, Long Term Capital Management, loss aversion, margin call, Mark Zuckerberg, McMansion, money market fund, mortgage debt, mortgage tax deduction, Myron Scholes, negative equity, Network effects, Northern Rock, obamacare, payday loans, peer-to-peer lending, Peter Thiel, principal–agent problem, profit maximization, quantitative trading / quantitative finance, railway mania, randomized controlled trial, Richard Feynman, Richard Feynman, Richard Thaler, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, short selling, Silicon Valley, Silicon Valley startup, Skype, South Sea Bubble, sovereign wealth fund, statistical model, transaction costs, Tunguska event, unbanked and underbanked, underbanked, Vanguard fund, web application

Maritime trade in medieval Italy was fostered by a form of partnership called the commenda, in which one partner invested labor and the other put in money; the profits from the journey were split between the two parties, with a common division being 75 percent to the moneyman and 25 percent to the traveler. As well as being a financial contract, the commenda also defined the obligations that the traveler had to carry out when he was voyaging. This was an early attempt to solve the “principal-agent” problem that bedevils corporate governance today, in which shareholders have to rely on managers to exercise good judgment in running the companies they own.6 Equity and debt enable people with money to spare to allocate it to people who need capital. They are also ways of sharing risk, another of finance’s most fundamental jobs. Lenders can spread their money around a lot of different borrowers, as can equity investors, reducing their concentration of risk.

., 32 Keys, Benjamin, 48 Kharroubi, Enisse, 79 Kickstarter, 172 King, Stephen, 99 Klein, David, 182 Krugman, Paul, xv Lahoud, Sal, 166 Lang, Luke, 153, 161–162 Laplanche, Renaud, 179, 184, 188, 190, 193–194, 196–197 Latency, 53 Law of large numbers, 17 Layering, 57 Left-digit bias, 46 Lehman Brothers, x, 44, 65 Lending direct, 84 marketplace, 184 payday, 200 relationship-based, 11, 151, 206–208 secured, xiv, 76 unsecured, 206 See also Loans; Peer-to-peer lending Lending Club, 172, 179–180, 182–184, 187, 189, 194–195, 197 Leonardo of Pisa (Fibonacci), 19 Lerner, Josh, 59 Lethal pandemic, risk-modeling for demographic profile, 230 exceedance-probability curve, 231–232, 232 figure 3 historical data, 228–229 infectiousness and virulence, 229–230 location of outbreak, 230–231 Leverage, 51, 70–71, 80, 186, 188 Leverage ratio, 76–77 Lewis, Michael, 57 Liber Abaci or Book of Calculation (Fibonacci), 19 LIBOR (London Interbank Offered Rate), 41 Liebman, Jeffrey, 98 Life expectancy government reaction to, 128–129 projections of, 124–127, 126 figure 2 ratio of young to older people, 127–128 Life-insurance policies, 142 Life-settlements industry, 142–143 Life table, 20 Limited liability, 212 Liquidity, 12–14, 39, 185–186 List, John, 109 The Little Book of Behavioral Investing (Montier), 156 Lo, Andrew, 113–115, 117–123 Loans low-documentation, 48–49 secured, 76 small business, 181, 216 student, 164, 166–167, 169–171, 182 syndicated, 41 Victory Loans, 28 See also Lending; Peer-to-Peer lending Logistic regression, 201 London, early fire insurance in, 16–17 London, Great Fire of, 16 London Interbank Offered Rate (LIBOR), 41 Long-Term Capital Management, 123 Longevity, betting on, 143–144 Loss aversion, 136 Lotteries, 212, 213 Low-documentation loans, 48–49 Lumni, 165, 168, 175 Lustgarten, Anders, 111 Lynn, Jeff, 160–161 Mack, John, 180 Mahwah, New Jersey, 52, 53 Marginal borrowers assessment of, 216–217 behavioral finance and, 208–214 industrialization of credit, 206 microfinance and, 203 savings schemes, 209–214 small businesses, 215–219 unsecured lending to, 206 Wonga, 203, 205, 208 Marginal borrowers (continued) ZestFinance, 199, 202, 205–206 Maritime piracy, solutions to, 151–152 Maritime trade, role of in history of finance, 3, 7–8, 14, 17, 23 Market makers, 15–16, 55 MarketInvoice, 195, 207, 217–218 Marketplace lending, 184 Markowitz, Harry, 118 Massachusetts, use of inflation-protected bonds in, 26 Massachusetts, use of social-impact bonds in, 98 Matching engine, 52 Maturity transformation, 12–13, 187–188, 193 McKinsey & Company, ix, 42 Mercator Advisory Group, 203 Merrill, Charles, 28 Merrill, Douglas, 199, 201 Merrill Lynch, 28 Merton, Robert, 31, 113–114, 123–124, 129–132, 142, 145 Mian, Atif, 204 Michigan, University of, financial survey by, 134–135 Microfinance, 203 Micropayment model, 217 Microwave technology, 53 The Million Adventure, 213–214 Minsky, Hyman, 42 Minsky moment, 42 Mississippi scheme, 36 Mitchell, Justin, 166–167 Momentum Ignition, 57 Monaco, modeling risk of earthquake in, 227 Money, history of, 4–5 Money illusion, 73–74 Money laundering, 192 Money-market funds, 43, 44 Monkeys, Yale University study of loss aversion with, 136 Montier, James, 156–157 Moody, John, 24 Moody’s, 24, 235 Moore’s law, 114 Morgan Stanley, 188 Mortgage-backed securities, 49, 233 Mortgage credit by ZIP code, study of, 204 Mortgage debt, role of in 2007–2008 crisis, 69–70 Mortgage products, unsound, 36–37 Mortgage securitization, 47 Multisystemic therapy, 96 Munnell, Alicia, 129 Naked credit-default swaps, 143 Nature Biotechnology, on drug-development megafunds, 118 “Neglected Risks, Financial Innovation and Financial Fragility” (Gennaioli, Shleifer, and Vishny), 42 Network effects, 181 New York, skyscraper craze in, 74–75 New York City, prisoner-rehabilitation program in, 108 New York Stock Exchange (NYSE), 31, 52, 53, 61, 64 New York Times, Merrill Lynch ad in, 28 Noncorrelated assets, 122 Nonprofits, growth of in United States, 105–106 Northern Rock, x NYMEX, 60 NYSE Euronext, 52 NYSE (New York Stock Exchange), 31, 52, 53, 61, 64 OECD (Organization for Economic Co-operation and Development), 128, 147 Oldfield, Sean, 67–68, 80–84 OnDeck, 216–218 One Service, 94–95, 105, 112 Operating expense ratio, 188–189 Options, 15, 124 Order-to-trade ratios, 63 Oregon, interest in income-share agreements, 172, 176 Organization for Economic Co-operation and Development (OECD), 128, 147 Overtrading, 24 Packard, Norman, 60 Pandit, Vikram, 184 Park, Sun Young, 233 Partnership mortgage, 81 Pasion, 11 Pave, 166–168, 173, 175, 182 Payday lending Consumer Financial Protection Bureau, survey on, 200 information on applicants, acquisition of, 202 underwriting of, 201 PayPal, 219 Peak child, 127 Peak risk, 228 Peer-to-peer lending advantages of, 187–189 auction system, 195 big investors in, 183 borrowers, assessment of, 197 in Britain, 181 commercial mortgages, 181 CommonBond, 182, 184, 197 consumer credit, 181 diversification, 196 explained, 180 Funding Circle, 181–182, 189, 197 investors in, 195 Lending Club, 179–180, 182–184, 187, 189, 194–195, 197 network effects, 181 ordinary savers and, 184 Prosper, 181, 187, 195 RateSetter, 181, 187, 196 Relendex, 181 risk management, 195–197 securitization, 183–184, 196 Peer-to-peer lending (continued) small business loans, 181 SoFi, 184 student loans, 182 Zopa, 181, 187, 188, 195 Pensions, cost of, 125–126 Perry, Rick, 142–143 Peterborough, England, social-impact bond pilot in, 90–92, 94–95, 104–105, 112 Petri, Tom, 172 Pharmaceuticals, decline of investment in, 114–115 Piracy Reporting Centre, International Maritime Bureau, 151 Polese, Kim, 210 Poor, Henry Varnum, 24 “Portfolio Selection” (Markowitz), 118 Prediction Company, 60–61 Preferred shares, 25 Prepaid cards, 203 Present value of cash flows, 19 Prime borrowers, 197 Prince, Chuck, 50–51, 62 Principal-agent problem, 8 Prisoner rehabilitation programs, 90–91, 94–95, 98, 108, 112 Private-equity firms, 69, 85, 91, 105, 107 Projection bias, 72–73 Property banking crises and, xiv, 69 banking mistakes involving, 75–80 behavioral biases and, 72–75 dangerous characteristics of, 70–72 fresh thinking, need for, xvii, 80 investors’ systematic errors in, 74–75 perception of as safe investment, 76, 80 Prosper, 181, 187, 195 Provisioning funds, 187 Put options, 9, 82 Quants, 19, 63, 113 QuickBooks, 218 Quote stuffing, 57 Raffray, André-François, 144 Railways, affect of on finance, 23–25 Randomized control trials (RCTs), 101 Raphoen, Christoffel, 15–16 Raphoen, Jan, 15–16 RateSetter, 181, 187, 196 RCTs (randomized control trials), 101 Ready for Zero, 210–211 Rectangularization, 125, 126 figure 2 Regulation NMS, 61 Reinhart, Carmen, 35 Reinsurance, 224 Relendex, 181 Rentes viagères, 20 Repurchase “repo” transactions, 15, 185 Research-backed obligations, 119 Reserve Primary Fund, 44 Retirement, funding for anchoring effect, 137–138 annuities, 139 auto-enrollment in pension schemes, 135 auto-escalation, 135–136 conventional funding, 127–128 decumulation, 138–139 government reaction to increased longevity, 128–129 home equity, 139–140 life expectancy, projections of, 124–127, 126 figure 2 life insurance policies, cash-surrender value of, 142 personal retirement savings, 128–129, 132–133 replacement rate, 125 reverse mortgage, 140–142 savings cues, experiment with, 137 SmartNest, 129–131 Reverse mortgages, 140–142 Risk-adjusted returns, 118 Risk appetite, 116 Risk assessment, 24, 45, 77–78, 208 Risk aversion, 116, 215 Risk-based capital, 77 Risk-based pricing model, 176 Risk management, 55, 117–118, 123, 195–197 Risk Management Solutions, 222 Risk sharing, 8, 82 Risk-transfer instrument, 226 Risk weights, 77–78 Rogoff, Kenneth, 35 “The Role of Government in Education” (Friedman), 165 Roman Empire business corporation in, 7 financial crisis in, 36 forerunners of banks in, 11 maritime insurance in, 8 Rotating Savings and Credit Associations (ROSCAs), 209–210 Roulette wheel, use of in experiment on anchoring, 138 Royal Bank of Scotland, 186 Rubio, Marco, 172 Russia, mortgage market in, 67 S-curve, in diffusion of innovations, 45 Salmon, Felix, 155 Samurai bonds, 27 Satsuma Rebellion (1877), 27 Sauter, George, 58 Save to Win, 214 Savings-and-loan crisis in US (1990s), 30 Savings cues, experiment with, 137 Scared Straight social program, 101 Scholes, Myron, 31, 123–124 Science, Technology, and Industry Scoreboard of OECD, 147 Securities and Exchange Commission (SEC), 54, 56, 57, 58, 64 Securities markets, 14 Securitization, xi, 20, 37–38, 117–122, 183–184, 196, 236 Seedrs, 160–161 Sellaband, 159 Shared equity, 80–84 Shared-equity mortgage, 84 Shepard, Chris, xii–xiii Shiller, Robert, xv–xvi, 242 Shleifer, Andrei, 42, 44 Short termism, 58 SIBs.


pages: 318 words: 77,223

The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse by Mohamed A. El-Erian

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activist fund / activist shareholder / activist investor, Airbnb, balance sheet recession, bank run, barriers to entry, break the buck, Bretton Woods, British Empire, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, carried interest, collapse of Lehman Brothers, corporate governance, currency peg, Erik Brynjolfsson, eurozone crisis, financial innovation, Financial Instability Hypothesis, financial intermediation, financial repression, fixed income, Flash crash, forward guidance, friendly fire, full employment, future of work, Hyman Minsky, If something cannot go on forever, it will stop - Herbert Stein's Law, income inequality, inflation targeting, Jeff Bezos, Kenneth Rogoff, Khan Academy, liquidity trap, Martin Wolf, megacity, Mexican peso crisis / tequila crisis, moral hazard, mortgage debt, Norman Mailer, oil shale / tar sands, price stability, principal–agent problem, quantitative easing, risk tolerance, risk-adjusted returns, risk/return, Second Machine Age, secular stagnation, sharing economy, sovereign wealth fund, The Great Moderation, The Wisdom of Crowds, too big to fail, University of East Anglia, yield curve, zero-sum game

We’re still dancing.”1 And when the music did indeed end, Chuck Prince lost his job and Citi almost went bankrupt. — In effect, good old-fashioned human blind spots, inadequate mindsets, cognitive narrowness, hubris, and institutional rigidities were in play. Their potentially disastrous impact was amplified by excessive risk taking associated with misaligned financial incentives, classic principal-agent problems, and excessive short-termism. And the results were cumulative deteriorations on the ground that had already far outpaced the ability of the whole system to adequately understand the problem and play catch-up. As such, it wasn’t long before the consequences became scarily obvious to all. By the summer of 2008, it was no longer a question of crisis prevention; the world was thrown into full crisis management mode—and on a scale and scope that few had ever thought possible in our modern global economy.

Forced not just by regulatory actions but also by market pressures, banks have built considerable capital cushions to offset the impact of possible future mistakes and adverse exogenous shocks; these cushions will be further enhanced in the years ahead as additional capital requirements (“surcharges”) kick in for what are now known as the “GSIBs,” or the “global systemically important banks”1—including those banks that are still viewed as too big to manage and/or too big to fail. At the same time, considerable efforts have been devoted to cleaning up balance sheets, be it through the disposal of shady assets or better pricing and risk assessments. There have even been efforts to better align internal incentives and try to reduce classic principal/agent problems that result in excessive short-termism and irresponsible risk taking. And all this has been supplemented by a revised legislative framework, including Dodd-Frank in the United States, the details of which are still under implementation (and some have already been diluted by bank lobbying). The net outcome is—undoubtedly—greater banking system soundness. To the extent that there are efficiency losses, and there are, they are viewed as an acceptable cost for pulling banks away from a culture of excessive risk taking and pushing them toward greater safety, both for them individually and for the system as a whole.


pages: 386 words: 122,595

Naked Economics: Undressing the Dismal Science (Fully Revised and Updated) by Charles Wheelan

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affirmative action, Albert Einstein, Andrei Shleifer, barriers to entry, Berlin Wall, Bernie Madoff, Bretton Woods, capital controls, Cass Sunstein, central bank independence, clean water, collapse of Lehman Brothers, congestion charging, creative destruction, Credit Default Swap, crony capitalism, currency manipulation / currency intervention, Daniel Kahneman / Amos Tversky, David Brooks, demographic transition, diversified portfolio, Doha Development Round, Exxon Valdez, financial innovation, fixed income, floating exchange rates, George Akerlof, Gini coefficient, Gordon Gekko, greed is good, happiness index / gross national happiness, Hernando de Soto, income inequality, index fund, interest rate swap, invisible hand, job automation, John Markoff, Joseph Schumpeter, Kenneth Rogoff, libertarian paternalism, low skilled workers, lump of labour, Malacca Straits, market bubble, microcredit, money market fund, money: store of value / unit of account / medium of exchange, Network effects, new economy, open economy, presumed consent, price discrimination, price stability, principal–agent problem, profit maximization, profit motive, purchasing power parity, race to the bottom, RAND corporation, random walk, rent control, Richard Thaler, rising living standards, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, school vouchers, Silicon Valley, Silicon Valley startup, South China Sea, Steve Jobs, The Market for Lemons, the rule of 72, The Wealth of Nations by Adam Smith, Thomas L Friedman, Thomas Malthus, transaction costs, transcontinental railway, trickle-down economics, urban sprawl, Washington Consensus, Yogi Berra, young professional, zero-sum game

And the only way employees can steal without getting caught is by performing transactions without recording them on the cash register—selling you a burger and fries without issuing a receipt and then pocketing the cash. This is what economists call a principal-agent problem. The principal (Burger King) employs an agent (the cashier) who has an incentive to do a lot of things that are not necessarily in the best interest of the firm. Burger King can either spend a lot of time and money monitoring its employees for theft, or it can provide an incentive for you to do it for them. That little sign by the cash register is an ingenious management tool. Principal-agent problems are as much a problem at the top of corporate America as they are at the bottom, in large part because the agents who run America’s large corporations (CEOs and other top executives) are not necessarily the principals who own those companies (the shareholders).

On the other hand, the employees doing fancy things (like designing new financial products) will always have more information about what they are really up to than their superiors will; and their superiors will have more information than the shareholders. The challenge is to reward good outcomes without creating incentives for employees to game the system in ways that damage the company in the long run. One need not be a corporate titan to deal with principal-agent problems. There are plenty of situations in which we must hire someone whose incentives are similar but not identical to our own—and the distinction between “similar” and “identical” can make all the difference. Take real estate agents, a particular breed of scoundrel who purport to have your best interest at stake but may not, regardless of whether you are buying or selling a property. Let’s look at the buy side first.

Investment: A History by Norton Reamer, Jesse Downing

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activist fund / activist shareholder / activist investor, Albert Einstein, algorithmic trading, asset allocation, backtesting, banking crisis, Berlin Wall, Bernie Madoff, break the buck, Brownian motion, buttonwood tree, California gold rush, capital asset pricing model, Carmen Reinhart, carried interest, colonial rule, credit crunch, Credit Default Swap, Daniel Kahneman / Amos Tversky, debt deflation, discounted cash flows, diversified portfolio, equity premium, estate planning, Eugene Fama: efficient market hypothesis, Fall of the Berlin Wall, family office, Fellow of the Royal Society, financial innovation, fixed income, Gordon Gekko, Henri Poincaré, high net worth, index fund, information asymmetry, interest rate swap, invention of the telegraph, James Hargreaves, James Watt: steam engine, joint-stock company, Kenneth Rogoff, labor-force participation, land tenure, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, margin call, means of production, Menlo Park, merger arbitrage, money market fund, moral hazard, mortgage debt, Myron Scholes, negative equity, Network effects, new economy, Nick Leeson, Own Your Own Home, Paul Samuelson, pension reform, Ponzi scheme, price mechanism, principal–agent problem, profit maximization, quantitative easing, RAND corporation, random walk, Renaissance Technologies, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sand Hill Road, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spinning jenny, statistical arbitrage, survivorship bias, technology bubble, The Wealth of Nations by Adam Smith, time value of money, too big to fail, transaction costs, underbanked, Vanguard fund, working poor, yield curve

Despite the fact that the firm had a policy that no individual dispatched to an overseas location trade for his personal benefit, there were many captains and shipmen who simply failed to heed the command.126 Another East India employee, William Keeling, actually demanded that he be given an exception to trade for his own account or he would resign. While those at headquarters were angered by this request, they ultimately agreed on one condition: that he ensure that nobody else in his crew was doing the same and to punish other offenders. It was a farcical but apparently successful way of dealing with the issue, and Keeling did enforce the company policy on his inferiors with great effect.127 Indeed, the principal-agent problems and the issues arising involving fiduciary duty are nothing new today, but they extend in time and space to centuries past and to nations afar, as evidenced by the English involvement in Japan. While many foreign companies did well there despite the issues with agency problems, Japan’s days of financial openness were numbered. One of the longer-term causes of Japan’s seclusion was the rise to power of Tokugawa Hidetada.

The English, Dutch, and Portuguese did not take at all well to the isolation sought by Japan. The British Crown exploited India with respect to natural resources and other goods. Cross-border politics was already quite important to the way investment was, or was not, conducted. Many premodern enterprises were also plagued by the very same problems faced in investment today, including fundamental principal-agent problems. The East India Company could not manage to prevent its employees from transacting for their own accounts when stationed abroad in Japan, and the solution (a rather comical one) was at times to allow a leader abroad to trade for his own account as long as he prevented his subordinates from doing likewise. The fourth point of concentration, to be continued in chapter 2, is that the transition to the democratization of investment was a radical historical transformation.

See price-to-earnings Pecora Commission, 190 Pension Benefit Guaranty Corporation, 112 pensions: corporate-run, 110–14; funds, 282, 303, 327; growth of, 117; insurance and, 106, 112; plans, 258, 292; Presbyterian Church and, 101–2; reinsurance, 111–12; in Rome, 58–59, 60; Social Security and private, 109–10; sophistication of, 112–13; taxes and, 109–10, 112; Union Army, 105 “Pensions: The Broken Promise” (NBC Reports), 111 People’s Charter, 77 performance: fees,17, 273, 31011, 312–15; of investment professionals, 247–55; new clients, firm size and, 297–98 permanent income hypothesis, 121–22 Peruzzi bank, 43 Philadelphia Saving Fund Society, 103–4, 134 Philemon, 24 Phormion, 25–26 Picard, Irving, 148 Pike, Sumner, 192 pink sheets, 180 piracy, 41 Pittsburgh Survey, 125 Plato, 24 430 Investment: A History Plotkin, Eugene, 187–90 Poincaré, Henri, 230 political democratization, 63 Polybius, 51 Ponzi, Charles (Carlo), 152, 156–58 Ponzi schemes, 149, 151–52, 194 Ponzi v. Fessenden, 158 population growth, in Europe, 71 Portugal, 47 power elite, 7–8, 318 Presbyterian Church, 101–2 Prescott, Edward, 252 price-to-earnings (P/E) ratios, 204 PricewaterhouseCoopers, 174 “Pricing of Options and Corporate Liabilities, The” (Black and Scholes), 235 Primary Reserve Fund, 143 principal-agent problems, 47, 61 printing press, 71 private equity, 258, 274–77 private wealth management, 137–39 probabilistic insurance, 252 Procter & Gamble, 189 procurators, 19–20 Prohibition, 164 pro magistro (manager in provinces), 51 promissory notes (tegata), 46 property, separate “claim” on, 46 proprietary trading, 221–22 prospect theory, 251–52 Protestant Reformation, 36 Provident Institution for Savings, 134 public asset management, 16 public auction (sub hasta), 50 public debt: issuance of, 96; Italian city-states securitization of, 82–84; from War of Spanish Succession, 67 public markets, 82–97; Amsterdam and, 84–85, 97; consolidation of, 94–95; emergence of, 63, 98; London and, 86–87, 97; Second Industrial Revolution and, 89; technology and, 89–90; United States and, 88–89, 97 public-private partnerships, 321, 323–24 put options, 151 qirad, 55 Quad/Graphics, 188 Quakers, 74 Quanfu governmental agency, 28 quantitative easing, 217 quantitative fund (quant strategy), 264, 267–68 Quantum Fund, 263 Qur’an, 37 Railroad Retirement System, 109 Rajaratnam, Raj, 186–87 Rampart Investment Management, 151 randomness, 230 real economy, finance and, 208, 222–24 real estate: analysis of, 207; investments, 136; Japan and, 217; loans, in Greece, 27; values, 214–15 real estate investment trusts (REITs), 280–81 real ownership, 4, 333 Reebok, 189 regional exchanges, 94–95 regulations: improved, 147; prohibiting too much stock ownership, 123; Regulation Q, 114, 143; response to Crash of 1929, 210–12; response to Great Depression, 210–12; response to Index 431 Great Recession, 219–22; SEC and, 166, 180, 194–95, 259 Reinhart, Carmen, 225 REITs.


pages: 518 words: 147,036

The Fissured Workplace by David Weil

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accounting loophole / creative accounting, affirmative action, Affordable Care Act / Obamacare, banking crisis, barriers to entry, business process, call centre, Carmen Reinhart, Cass Sunstein, Clayton Christensen, clean water, collective bargaining, commoditize, corporate governance, corporate raider, Corrections Corporation of America, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, declining real wages, employer provided health coverage, Frank Levy and Richard Murnane: The New Division of Labor, George Akerlof, global supply chain, global value chain, hiring and firing, income inequality, information asymmetry, intermodal, inventory management, Jane Jacobs, Kenneth Rogoff, law of one price, loss aversion, low skilled workers, minimum wage unemployment, moral hazard, Network effects, new economy, occupational segregation, Paul Samuelson, performance metric, pre–internet, price discrimination, principal–agent problem, Rana Plaza, Richard Florida, Richard Thaler, Ronald Coase, shareholder value, Silicon Valley, statistical model, Steve Jobs, supply-chain management, The Death and Life of Great American Cities, The Nature of the Firm, transaction costs, ultimatum game, union organizing, women in the workforce, Y2K, yield management

Demanding Capital In chronicling the rise of the modern corporation, Adolph Berle and Gardiner Means in the early 1930s worried about the social consequences of the divorce of ownership and control. John Kenneth Galbraith thirty years later expected this schism to lead to managerial dominance of the economic landscape, as corporate leaders and their minions sought stability and persistence of their positions, leading to business and cultural malaise. Mainstream economists, at the same time, worried that the principal/agent problem inherent in the separation would lead businesses to become fat and lazy, unresponsive to the need to create value for their shareholders and not willing to make the changes necessary for the United States to compete with emerging countries, particularly Japan. These concerns look almost quaint now. Economists began to raise very different concerns a few years later, when they began emphasizing the disciplining effects of capital markets and the role of management in maximizing a business’s value to shareholders, who are the residual claimants to what was produced by the firm.1 The efficient market model of financial markets holds that the value of shares reflects the market’s take on a company’s underlying value and future prospects.

What the Glue Must Do For fissuring to be successful, the lead company must design and deploy mechanisms that assure that the businesses in orbit around it operate in a way compatible with its core strategies.54 Importantly, the chosen organizational mechanisms must ensure that the secondary players do not undermine the basis of the lead company’s core competency (for example, brand image, product quality, coordination economies).55 Easier said than done. The principal/agent problem—that is, the difficulty faced by one party (the principal) of using another party (the agent) to undertake work on its behalf—arises because information is costly. First, it is costly for the principal to gather information about the agents in selecting across them: some agents may have qualities that might undermine the objectives of the principal. If the characteristics of the agent are particularly hard (costly) to see, the agents who approach the principal first might be the ones who in fact the principal wants to avoid.

Of course, the problem of incomplete contracts remains even given explicit standards: there will never be sufficient pages in a manual or enough lawyers to craft them to cover every exigency that might arise to assure that the core values of a company are protected while shifting work to others. But the contract systems that have emerged, and the organizational forms that have grown around them, clearly try to do so to the extent possible and significantly curtail the principal/agent problems that may arise. Examining the three elements of standards reveals how serious companies are about keeping the core elements of fissuring from undermining one another. Explicit Standards: What We Expect The glue for fissured employment rests on explicit and detailed standards crafted by lead businesses and followed by all subsidiary organizations. The competitive importance of standards, as well as their detailed content, has been overlooked in much of the literature dealing with incomplete contracting.58 One reason is that standards reflect core competencies and reveal strategic—and proprietary—aspects of the lead business.


pages: 346 words: 101,763

Confessions of a Microfinance Heretic by Hugh Sinclair

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accounting loophole / creative accounting, Bernie Madoff, colonial exploitation, en.wikipedia.org, end world poverty, financial innovation, financial intermediation, Gini coefficient, high net worth, illegal immigration, inventory management, microcredit, Northern Rock, peer-to-peer lending, pirate software, Ponzi scheme, principal–agent problem, profit motive

It even quoted one respondent in a particularly disturbing section: “In some cases, I could see that they [clients] reduced their food to save money to repay their debts, or in others, they forced their children to drop out from school to find jobs to earn more income to support the repaying of debts.”20 This is a major criticism from insiders, and yet the sector largely brushed it aside. How could the funds provided by well-meaning investors have led to accusations of child labor and increases in poverty? In economics, this problem is referred to as the principal-agent problem. The principals (pensioners, philanthropists, NGOs, individuals, for-profit investors) hire the agent—a specialized fund—to invest their funds on their behalf. The impoverished end-borrower wants to pay the least possible for a loan, and the ultimate investor in a microfinance debt fund usually makes a negligible return (covering inflation and perhaps 1 or 2 percent more, but that’s it).

., 175 Inter-American Development Bank, 12 visit to Grameen Trust Chiapas, 22–25 International Association of Microfinance Investors (IAMFI), 200 International Finance Corporation, 18 J Jackson, Jessica, 177 JP Morgan Chase, 175 K Keen, 175 Khosla, Vinoid, 204 Kiva, 11, 70, 102, 135 business model, 170–74 criticized in New York Times, 167, 168–69 default rates, 175 interest rates charged clients, 171–72, 174, 177–78 investment in LAPO, 139, 148, 153, 169, 175, 177–78 investment in Nicaragua, 199 partners, 173 profitability, 173–74 public relations, 175–76 response to criticism of LAPO, 177–80 withdrawal from LAPO, 179, 184 Klachteninstituut Financiële Dienstverlening (KIFID), 144 Kristof, Nicholas, 13 L Lift Above Poverty Organization (LAPO), 83 accounting problems, 91–92 business model, 101–2, 114–15 client desertion rates, 110, 138, 185 creditor taskforce, 161 deception of rating agencies, 152–53 forced savings, 101–2, 139, 144, 157 interest rate calculations, 91–93, 157 interest rates charged, 99, 100–2, 138, 142–43, 157, 180, 183, 185, 210 IT system, 90–92, 97, 99–100, 103, 107 microfinance fund investments in, 109, 113, 115–19, 121, 139, 167, 182, 216 profitability, 115, 158, 182–83, 185, 187, 190, 192 rating agency evaluations of, 137–38, 153, 156–58, 185, 219 transformation into a bank, 144–45, 158, 182 loans, microfinance consumption, 5–6, 78 default on, 20, 62, 157, 171, 175, 205 group guarantees of, 7, 19–20, 36 interest rates, 2, 5–6, 10, 60, 92–93, 99, 100–2, 157, 171–72, 174–75, 177–78, 180–81, 182, 183, 194, 220–21 purposes of, 5–6, 18–19, 77–78, 150–52, 171 LuxFLAG, 220 M M-Cril, 136, 203 M2 software, 84–86, 140 MacDougal, David, 199 MacFarquhar, Neil “Banks Making Big Profits from Tiny Loans,” 167 Mahmood, Asad, 154–55 Manuel, José, 26, 40–48, 84–86, 88, 99–100, 103, 105 Maputo, Mozambique, 32–33, 39 crime in, 56–57 Mecene Investments, 166 men, as microfinance clients 145, 234 Mexico, microfinance in, 19–26, 208, 210 microDINERO, 211 microfinance economics, 239–49 microfinance funds, 67, 227–28 Banana Skins surveys of sector, 80–81 business model, 72–79, 170–74 cooperation among, 78–79, 115–16 cost structure, 77–78, 238 due diligence on investments, 76, 98, 111–14, 118, 121–22, 137, 139, 158, 161, 169, 187, 192, 199–200 investors in, 12, 70, 175, 176, 177, 179, 189–91, 192, 196 lack of transparency, 166, 176, 179, 181, 191–92, 219–21 overinvestment in Nicaragua, 193, 194, 196, 198–200 principal-agent problem, 81–82 profitability, 102, 173–74, 190, 192, 194, 199, 216–17 public relations, 72–73, 76–77, 170, 175–76, 199, 202, 210 regulation of, 82, 116, 176, 188, 189, 192, 196, 197, 221, 231 microfinance rating agencies, 136–40, 156–58, 185, 237 methodologies, 137 warnings of financial problems, 139–40, 203 MicroFinance Transparency, 181, 184, 220–21 microfinance, microfinance institutions (MFIs), 3 as nonprofits, 19, 114–15, 182 business model of, 18, 20–21, 34–35 Christian, 65–66 clients, 5, 10, 11, 18, 19–20, 36–37, 77–78, 110, 138–40, 145, 150–52, 193–98, 205–7, 212 comparison to favelas, 215–16 competition among, 73–74, 104, 197 defense of, 2, 4–5 effective models, 222–24 financing of, 18, 36–38, 65–66, 73–76, 100, 111–14, 138–39, 191 gender-based lending by, 142, 145–46 harassment of clients, 20, 195, 203–8 history of, 8–10 impact on poverty, 3–4, 13, 78, 92, 100, 142–43, 179, 201, 212–12, 217, 247–49 interest rates charged by, 2, 5–6, 10, 60, 92–93, 99, 100–2, 138, 157, 171–72, 175, 177–78, 180–81, 182, 183, 249 IT systems in, 26, 39–40, 83, 84, 99–100, 105, 237 lack of transparency, 166, 170, 191–92 loan and other products, 20–22, 225–26 principles for fixing the sector, 225–38 profitability of, 18, 115, 172–73, 190, 191, 212–13 public relations, 4–5, 10, 12, 65–67, 73, 128–29, 142, 143–44, 147, 148, 153, 160, 171–72, 175–76, 182–83, 195, 218–21 regulation of, 37, 64, 65, 82, 189, 196, 197–98, 207, 221, 231 summary of critique of, 5–7 transformation into banks, 34, 100, 114–15, 144–45, 182, 192 use of client savings, 33–36 Microfinanza Rating, 136 MicroPlace, 116 deception on website, 160 raising money for LAPO, 167 MicroRate, 136, 165, 184 2006 rating of LAPO, 138–39 confirmation of LAPO rating, 158, 159 withdrawal of LAPO rating, 152–54, 203 Microsoft Corp., 175 MIX Market reports, 197–98 Africa Works, 65 Fondo de Credito Comunitario, 61 India, 203 SKS, 204 Mkandawire, Bentry, 99 Mol, Eelco, 70, 71 Molijn, Bruno, 108–10, 133, 144–45 moneylenders, 18, 203 Mongolia, microfinance sector in, 149–56, 152, 179 Morgan Stanley, 200 Mozambique, 41–52, 56–57, 84 poverty in, 32–33 Mujeres de Zinacantan, Las, 26 MyC4, 70, 135 N Nestor, Camilla, 181 Netherlands, 160 employment law, 127 government investments in microfinance, 84, 111, 148 New York Times, 13, 108, 167 critical articles on microfinance, 11, 167–69, 178, 180, 183, 184, 200 Nicaragua, 8 collapse of microfinance sector, 80, 140, 193–97 microfinance bubble, 193–98, 201 microfinance impact on poverty, 201 no paga movement, 195–97 regulation of microfinance, 197–98 Nigeria, 83, 87, 89, 94–96, 179 corruption in, 84, 86–87, 94, 103 microfinance in, 99–103, 138–39, 142–43, 211 working conditions in, 87–89 Norway, investigation of Grameen Bank, 209–10, 259n32, 259n36 Not One The Same (NOTS), 70, 160 O Omidyar, 175 Otero, Maria, 75, 158 Overseas Development Institute, 208 Oxfam Novib, 67, 70, 71, 84, 105 conflict with Triple Jump, 112–13 investment in LAPO, 110, 111–13, 116, 133, 138, 190 learns about LAPO problems, 108–10, 144, 145 P PayPal, 116 Park, David, 33, 61, 62, 64 peer-to-peer organizations (P2Ps), 79 business model, 170–77 lack of transparency, 166 PlaNet Finance group, 136 Planet Rating, 136, 154, 184 LAPO rating, 156–59, 165, 169, 178, 181 second LAPO rating, 182 Pouit, Jean, 99 Pouliot, Robert, 166 poverty reduction, 2, 3–4, 6, 7, 78, 92 ProCredit, 70 Q Quantum Hedge Fund, 204 R Raiffeisen, Wilhelm, 9 responsAbility, 169, 182, 189, 199, 216 risk, management of, 34, 36 Roodman, David, 184, 211, 216 S Schwab Foundation, 180 Securities Exchange Commission, 37, 65, 116, 148, 159 Sequoia Capital, 204 Shah, Premal, 177, 178 Shorebank International, 9 Sinclair, Hugh, 38 arrival in Mozambique, 30–32 background, 4, 7–8, 11–12, 15–17 confronts BlueOrchard, 186–89 confronts Triple Jump with evidence of fraud, 118–23 Conserva and, 26–26 deals with crime in Mozambique, 56–57 deals with crime in Nigeria, 94–96 death threat against, 155 Deutsche Bank and, 10, 143, 154–55, 208 discusses LAPO with AMT, 219 discusses LAPO with Calvert, 146–47, 159 discusses LAPO with Kiva, 177–80 discusses client protection wtih SMART Campaign, 219 files complaints with regulators, 144 Grameen Trust Chiapas and, 18–25 informs Oxfam Novib about LAPO, 108–10 introduction to microfinance, 4, 16–17 LAPO IT project, 90–92, 99–103 lawsuit against Triple Jump, 125–27, 129–33 learns P2P business, 135 lessons from Mozambique, 65–66 move to the Netherlands, 68, 69 organizes LAPO project, 83–86 project in Argentina, 104–5 project in Ecuador, 104 project in Peru, 104 reviews LAPO for Triple Jump, 112–18 Sam Grottis and, 58–59 speaks at ASN Bank annual meeting, 142–43 travel in Nigeria, 86–89 warns World Relief about problems at FCC, 61–64 work at Fondo de Credito Comunitario, 33–34, 38–60, 63–64 work in Mongolia, 149–56 work in Nicaragua, 194–95 Skoll World Forum, 75 SKS collapse in share price, 204–5 floats IPO, 203–4 interest rates charged, 204 profitability, 204 SMART Campaign and, 206 SMART Campaign, 182, 192 client protection principles and, 205, 206, 218–19 Society for the Elimination of Rural Poverty, 206 Soros, George, 204 South Sudan, 174, 179 Standard Chartered Bank investment in LAPO, 146, 169, 182 StreetCred, 16–17 T Times of India, 205, 207 Triodos Bank, 113 Triodos-DOEN fund, 70 Triple Jump, 67, 69, 200 defends lawsuit against Hugh Sinclair, 125–28, 130–31 Dutch court ruling against, 131–33 fires Hugh Sinclair, 122–24 funding of LAPO, 98 investment in LAPO, 139, 147 investment in Nicaragua, 199 knowledge of LAPO problems, 104 management experience, 70–72 misrepresentation of LAPO to investors, 112–13, 145, 147, 159 mission statement, 72 profitability, 174 reaction to criticisms of LAPO, 143–44 Triple Jump Advisory Services, 70, 72 U U.S.


pages: 385 words: 111,807

A Pelican Introduction Economics: A User's Guide by Ha-Joon Chang

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Affordable Care Act / Obamacare, Albert Einstein, Asian financial crisis, asset-backed security, bank run, banking crisis, banks create money, Berlin Wall, bilateral investment treaty, borderless world, Bretton Woods, British Empire, call centre, capital controls, central bank independence, collateralized debt obligation, colonial rule, Corn Laws, corporate governance, corporate raider, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, deindustrialization, discovery of the americas, Eugene Fama: efficient market hypothesis, eurozone crisis, experimental economics, Fall of the Berlin Wall, falling living standards, financial deregulation, financial innovation, Francis Fukuyama: the end of history, Frederick Winslow Taylor, full employment, George Akerlof, Gini coefficient, global value chain, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, Gunnar Myrdal, Haber-Bosch Process, happiness index / gross national happiness, high net worth, income inequality, income per capita, information asymmetry, intangible asset, interchangeable parts, interest rate swap, inventory management, invisible hand, Isaac Newton, James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, knowledge economy, laissez-faire capitalism, land reform, liberation theology, manufacturing employment, Mark Zuckerberg, market clearing, market fundamentalism, Martin Wolf, means of production, Mexican peso crisis / tequila crisis, Northern Rock, obamacare, offshore financial centre, oil shock, open borders, Pareto efficiency, Paul Samuelson, post-industrial society, precariat, principal–agent problem, profit maximization, profit motive, purchasing power parity, quantitative easing, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, savings glut, Scramble for Africa, shareholder value, Silicon Valley, Simon Kuznets, sovereign wealth fund, spinning jenny, structural adjustment programs, The Great Moderation, The Market for Lemons, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, trade liberalization, transaction costs, transfer pricing, trickle-down economics, Vilfredo Pareto, Washington Consensus, working-age population, World Values Survey

The next two biggest shareholders owned around 6 per cent each. Even acting in unison, these three together do not have one-quarter of the votes. The separation of ownership and control Dispersed ownership means that professional managers have effective control over most of the world’s largest companies, despite not owning any significant stake in them – a situation known as the separation of ownership and control. This creates a principal-agent problem, in which the agents (professional managers) may pursue business practices that promote their own interests rather than those of their principals (shareholders). That is, professional managers may maximize sales rather than profit or may inflate the corporate bureaucracy, as their prestige is positively related to the size of the company they manage (usually measured by sales) and the size of their entourage.

That is, professional managers may maximize sales rather than profit or may inflate the corporate bureaucracy, as their prestige is positively related to the size of the company they manage (usually measured by sales) and the size of their entourage. This was the kind of practice Gordon Gekko (you’ve met him in Chapter 3) was attacking in Wall Street, when he pointed out the company that he was trying to take over had no less than thirty-three vice presidents, doing God knows what. Many pro-market economists, especially Michael Jensen and Eugene Fama, the 2013 Nobel Economics Prize winner, have suggested that this principal-agent problem can be reduced, if not eliminated, by aligning the interests of the managers more closely to those of the shareholders. They suggested two main approaches. One is making corporate takeover easier (so more Gordon Gekkos, please), so that managers who do not satisfy the shareholders can be easily replaced. The second is paying large parts of managerial salaries in the form of their own companies’ stocks (stock option), so that they are made to look at things more from the shareholder’s point of view.


pages: 355 words: 92,571

Capitalism: Money, Morals and Markets by John Plender

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activist fund / activist shareholder / activist investor, Andrei Shleifer, asset-backed security, bank run, Berlin Wall, Big bang: deregulation of the City of London, Black Swan, bonus culture, Bretton Woods, business climate, Capital in the Twenty-First Century by Thomas Piketty, central bank independence, collapse of Lehman Brothers, collective bargaining, computer age, Corn Laws, corporate governance, creative destruction, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, discovery of the americas, diversification, Eugene Fama: efficient market hypothesis, eurozone crisis, failed state, Fall of the Berlin Wall, fiat currency, financial innovation, financial intermediation, Fractional reserve banking, full employment, God and Mammon, Gordon Gekko, greed is good, Hyman Minsky, income inequality, inflation targeting, information asymmetry, invention of the wheel, invisible hand, Isaac Newton, James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, joint-stock company, Joseph Schumpeter, labour market flexibility, liberal capitalism, light touch regulation, London Interbank Offered Rate, London Whale, Long Term Capital Management, manufacturing employment, Mark Zuckerberg, market bubble, market fundamentalism, mass immigration, means of production, Menlo Park, money market fund, moral hazard, moveable type in China, Myron Scholes, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, paradox of thrift, Paul Samuelson, Plutocrats, plutocrats, price stability, principal–agent problem, profit motive, quantitative easing, railway mania, regulatory arbitrage, Richard Thaler, rising living standards, risk-adjusted returns, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, shareholder value, short selling, Silicon Valley, South Sea Bubble, spice trade, Steve Jobs, technology bubble, The Chicago School, The Great Moderation, the map is not the territory, The Wealth of Nations by Adam Smith, Thorstein Veblen, time value of money, too big to fail, tulip mania, Upton Sinclair, Veblen good, We are the 99%, Wolfgang Streeck, zero-sum game

The formation of the South Sea Company in the new century, together with the stellar performance of its stock, accelerated an already powerful slew of incorporations, with 195 joint stock companies being formed in the year to August 1720. These were popularly known as ‘bubbles’. A central feature of incorporation was that it increased the scope for fraud, because the people running the bubble companies had access to other people’s money. In the modern jargon, there was a principal–agent problem. The agents, or managers, were not properly accountable to the principals, or stockholders, because corporate governance was rudimentary. Trading in the shares was frenetic and often fraudulent, as Daniel Defoe, author of Robinson Crusoe, explained in a tract entitled The Anatomy of Change-Alley, in which he said: There is not a man but will own ’tis a complete system of knavery; that ’tis a trade founded in fraud, born of deceit, and nourished by trick, cheat, wheedle, forgeries, falsehoods, and all sorts of delusions; coining false news, this way good, that way bad; whispering imaginary terrors, frights, hopes, expectations and then preying upon the weakness of those whose imaginations they have wrought upon, whom they have either elevated or depressed.32 When the South Sea Company collapsed, fraud was revealed on the part of directors, who had corrupted members of the cabinet, using shares in the company as bribes.

One reason is that share prices are not set by private investors – the ‘representative household’, in the economic jargon – but by fund managers to whom savers and pension fund trustees have delegated authority for managing their money. These fund managers, the agents, may have a very different agenda to that of savers and trustees, the principals. They also have more and better information about companies and markets. So there is, as the economists put it, both a principal–agent problem and an information asymmetry problem. These lead to conflicts of interest. The technology bubble in the second half of the 1990s provides a good example of how the conflict works. Dot.com stocks rose initially on the basis of a conviction that technology had fundamentally changed the way the economy worked, so that expectations of future profits spiralled while conventional methods of company valuation were abandoned.


pages: 376 words: 109,092

Paper Promises by Philip Coggan

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accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, balance sheet recession, bank run, banking crisis, barriers to entry, Berlin Wall, Bernie Madoff, Black Swan, Bretton Woods, British Empire, call centre, capital controls, Carmen Reinhart, carried interest, Celtic Tiger, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, debt deflation, delayed gratification, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, falling living standards, fear of failure, financial innovation, financial repression, fixed income, floating exchange rates, full employment, German hyperinflation, global reserve currency, hiring and firing, Hyman Minsky, income inequality, inflation targeting, Isaac Newton, John Meriwether, joint-stock company, Kenneth Rogoff, labour market flexibility, light touch regulation, Long Term Capital Management, manufacturing employment, market bubble, market clearing, Martin Wolf, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Myron Scholes, negative equity, Nick Leeson, Northern Rock, oil shale / tar sands, paradox of thrift, peak oil, pension reform, Plutocrats, plutocrats, Ponzi scheme, price stability, principal–agent problem, purchasing power parity, quantitative easing, QWERTY keyboard, railway mania, regulatory arbitrage, reserve currency, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, The Chicago School, The Great Moderation, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Wealth of Nations by Adam Smith, time value of money, too big to fail, trade route, tulip mania, value at risk, Washington Consensus, women in the workforce, zero-sum game

These rents may emerge from a lack of competition, since the government guarantee may create a barrier to entry for new firms. Or it may result from a lack of transparency. Financial products are often complex with the result that the effective price is obscure; clients may be paying over the odds without realizing it. The prices charged by the industry represent a transfer of wealth from the rest of the economy. This is a ‘principal-agent’ problem in that the interests of the client and those of the people who handle their money are not aligned. Paul Woolley, a former fund manager, has set up a centre to study what he calls ‘capital market dysfunctionality’ at the London School for Economics. He describes his former industry in harsh terms. ‘Why on earth should finance be the biggest and most highly-paid industry when it’s just a utility, like sewage or gas?

leverage leveraged buyout Lewis, Michael Liberal Democrat party (UK) Liberal Party (UK) life expectancy life-cycle theory Little Dorrit lire Live 8 concert Lloyd George, David Lombard Odier Lombard Street Research London School of Economics Long Term Capital Management longevity Louis XIV, King of France Louis XV, King of France Louvre accord Lucas, Robert Lucullus, Roman general Luxembourg Macaulay, Thomas McCarthy, Cormac Macdonald, James MacDonald, Ramsay McKinsey McNamara, Robert Madoff, Bernie Malthusian trap Mandelson, Peter Marais, Matthieu Marco Polo Mares, Arnaud Marks & Spencer Marshall, George Marshall Aid Marshalsea Prison Mauro, Paolo May, Sir George means/media of exchange Medicaid Medicare Mellon, Andrew mercantilism Merchant of Venice, The Meriwether, John Merkel, Angela Merton, Robert Mexico Mill, John Stuart Milne-Bailey, Walter Minsky, Hyman Mises, Ludwig von Mississippi Project Mitterrand, Francois Mobutu, Joseph Mongols monetarism monetary policy monetary targets money markets money supply Moody’s Moore’s Law moral hazard Morgan Stanley Morgenthau, Henry Morrison, Herbert mortgages mortgage-backed bonds Multilateral Debt Relief Initiative Napier, Russell Napoleon, emperor of France Napoleonic Wars Nasser, president of Egypt National Association of Home Builders National Association of Realtors National Association of Security Dealers Netherlands New Century New Hampshire New Jersey Newton, Sir Isaac New York Times New Zealand Nixon, Richard Norman, Montagu North Carolina Northern Ireland Northern Rock North Korea North Rhine Westphalia, Germany Norway Obama, Barack odious debt Odysseus OECD d’Orléans, duc Ottoman Empire output gap Overstone, Lord overvalued currency owner-equivalent rent Papandreou, George paper money paradox of thrift Paris club Passfield, Lord (Sidney Webb) Paulson, Hank pawnbroking pension age pension funds pensions Pepin the Short Perot, Ross Perry, Rick Persians Peter Pan Philip II, King of Spain Philip IV, King of France PIGS countries PIMCO Plaza accord Poland Ponzi, Charles Ponzi scheme population growth populism portfolio insurance Portugal pound Prasad, Eswar precious metals Price-earnings ratio primary surplus Prince, Chuck principal-agent problem printing money private equity property market protectionism Protestant work ethic public choice theory public-sector workers purchasing power parity pyramid schemes Quaintance, Lee quantitative easing (QE) Quincy, Josiah railway mania Rajan, Raghuram Rand, Ayn Reagan, Ronald real bills theory real interest rates Record, Neil Reformation, the Reichsbank Reichsmark Reid, Jim Reinhart, Carmen renminbi Rentenmark rentiers reparations Republican Party reserve currency retail price index retirement revaluation Revolutionary War Ridley, Matt Roberts, Russell Rogoff, Kenneth Romanovs Roosevelt, Franklin D.


pages: 306 words: 85,836

When to Rob a Bank: ...And 131 More Warped Suggestions and Well-Intended Rants by Steven D. Levitt, Stephen J. Dubner

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Affordable Care Act / Obamacare, Airbus A320, airport security, augmented reality, barriers to entry, Bernie Madoff, Black Swan, Broken windows theory, Captain Sullenberger Hudson, creative destruction, Daniel Kahneman / Amos Tversky, deliberate practice, feminist movement, food miles, George Akerlof, information asymmetry, invisible hand, loss aversion, mental accounting, Netflix Prize, obamacare, oil shale / tar sands, Pareto efficiency, peak oil, pre–internet, price anchoring, price discrimination, principal–agent problem, profit maximization, Richard Thaler, security theater, Ted Kaczynski, the built environment, The Chicago School, the High Line, Thorstein Veblen, transaction costs, US Airways Flight 1549

Going for a first down on fourth and short yardage in your own territory is likely to increase the chance your team wins (albeit slightly). But Belichick had to know that if it failed, he would be subjected to endless criticism. If his team had gotten the first down and the Patriots won, he would have gotten far less credit than he got blame for failing. This introduces what economists call a “principal-agent problem.” Even though going for it increases his team’s chance of winning, a coach who cares about his reputation will want to do the wrong thing. He will punt just because he doesn’t want to be the goat. (I’ve seen the same thing in my research on penalty kicks in soccer; kicking it right down the middle is the best strategy, but it is so embarrassing when it fails that players don’t do it often enough.)

., 138–40 Pataki, George, 119 Paulos, John Allen, 286 Paulson, Henry, 236 Peltzman, Sam, 166 penny, 61–65 penny floor, 65 Pepsico, 59–60 perfect substitutes, 60 petroleum extraction, 109–16 Pettitte, Andy, 149–50 Pham, David “the Dragon,” 193 pilots, 83–86 pirates, 314–19 Pittsburgh Steelers, 212–19 Plack, Les, 47 Planned Parenthood, 65–67 Pledge-a-Picket, 66 poker: cheating, 154–58 how not to cheat, 153–55 Internet, 127–30, 157 one card away from final table, 192–95 record that can never be broken, 192 shootout tournament, 193 World Series of Poker, 187–88, 192–95 Polamalu, Troy, 216 Poland Spring bottled water, 3–4 Pollan, Michael, 169 postage, exemption from, 141–43 practice, ten thousand hours, 199, 201–2 praise, 351 Pre-Implantation Genetic Diagnosis (PGD), 280–82 prices: anchoring, 309 of autographed baseballs, 80–81 bounty on bin Laden, 57–59 of cars, 54–57 of chicken wings, 75–77 and corporate sponsorships, 81 discrimination in, 173 of food, 116 of gas, 86–90 for hate mail, 49–51 housing, 67–69 of kiwifruits, 77–80 peak oil, 109–16 of a penny, 61–65 of prescription drugs, 52–54 rising, 110, 111 of shrimp, 344 of songs, 69–71 and substitutes, 113 supply and demand, 78–80, 110, 112, 115, 128, 341–44 of voices in animated films, 306 priming, 228–29 principal-agent problem, 209 Prius Effect, 185 procrastination, 121 profits, going green for, 172–74 pro-life movement, 65 prostitution: Berlin brothel, 173 escort service, 261–67 legalization of, 255–56, 265–67 race: in the marketplace, 315–22 TV viewing habits, 322–24 rain forest, saving, 174–75 randomization, 322 rational addictions, 92–94 Reeve, Christopher, 102 Reilly, Barry, 225–26 Rickman, Neil, 225–26 RICO (federal racketeering statutes), 232 Rios, Brandon, 72 risk-aversion, 125–27 risk-taking, 121 Rochambeau (Rock, Paper, Scissors), 188–89 Rodriguez, Alex, 149 Roethlisberger, Ben, 103 Roe v.

Social Capital and Civil Society by Francis Fukuyama

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Berlin Wall, blue-collar work, Fall of the Berlin Wall, feminist movement, Francis Fukuyama: the end of history, George Akerlof, German hyperinflation, Jane Jacobs, Joseph Schumpeter, Kevin Kelly, labor-force participation, low skilled workers, p-value, Pareto efficiency, postindustrial economy, principal–agent problem, RAND corporation, Silicon Valley, The Death and Life of Great American Cities, transaction costs, World Values Survey

Arrow, “Classificatory Notes on the Production and Transmission of Technical Knowledge,” American Economic Review 59 (1969) : 29-33. 12 Thispoint is made in Masahiko Aoki, “Toward an Economic Model of the Japanese Firm,” Journal of Economic Literature 28 (March 1990) : 1–27. 444 Tanner Lectures on Human Values which various agents within an organization seek to maximize their power relative to other agents. Everyone who has worked in a hierarchical organization knows that there is a constant struggle going on between superiors and subordinates to control information ; the withholding of information is frequently a subordinate’s most important source of leverage over a superior. In addition to principal-agent problems, organizations suff er from other diseconomies of scale related to information-processing. Many transaction costs are internal to organizations and are created by the difficulties in passing information up and down a large hierarchy. W e have all worked in hierarchical organizations in which Department X doesn’t know what Department Y on the next floor is doing. Ideally, information ought to be processed as close to its source within the organization as possible.


pages: 124 words: 30,520

Rebooting Democracy: A Citizen's Guide to Reinventing Politics by Manuel Arriaga

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banking crisis, business climate, David Graeber, financial innovation, first-past-the-post, Gunnar Myrdal, Occupy movement, principal–agent problem, Slavoj Žižek

Elections are the oversight mechanism: according to one of the central myths of our democracies, that is the time when citizens “pass judgment” on the performance of the incumbent leaders/party and collectively decide whether they are worthy of reelection. Now, to evaluate how reasonable our collective faith in this mechanism really is, briefly entertain the following analogy. We will take our cue from introductory courses in microeconomics, in which the principal-agent problem is commonly presented by adopting the perspective of a shop owner (the principal) who decides to hire a manager (the agent) to supervise the daily operation of his business. The question we should ask ourselves is: in the absence of strong social norms and/or an emotional tie between the two, how reasonable is it to expect that the manager will perform his job satisfactorily if the shop owner were to drop by the store every four years to check on how well business is going?


pages: 1,088 words: 228,743

Expected Returns: An Investor's Guide to Harvesting Market Rewards by Antti Ilmanen

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Andrei Shleifer, asset allocation, asset-backed security, availability heuristic, backtesting, balance sheet recession, bank run, banking crisis, barriers to entry, Bernie Madoff, Black Swan, Bretton Woods, buy low sell high, capital asset pricing model, capital controls, Carmen Reinhart, central bank independence, collateralized debt obligation, commoditize, commodity trading advisor, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, deglobalization, delta neutral, demand response, discounted cash flows, disintermediation, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, framing effect, frictionless, frictionless market, George Akerlof, global reserve currency, Google Earth, high net worth, hindsight bias, Hyman Minsky, implied volatility, income inequality, incomplete markets, index fund, inflation targeting, information asymmetry, interest rate swap, invisible hand, Kenneth Rogoff, laissez-faire capitalism, law of one price, Long Term Capital Management, loss aversion, margin call, market bubble, market clearing, market friction, market fundamentalism, market microstructure, mental accounting, merger arbitrage, mittelstand, moral hazard, Myron Scholes, negative equity, New Journalism, oil shock, p-value, passive investing, Paul Samuelson, performance metric, Ponzi scheme, prediction markets, price anchoring, price stability, principal–agent problem, private sector deleveraging, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, reserve currency, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Robert Shiller, Robert Shiller, savings glut, selection bias, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stochastic volatility, survivorship bias, systematic trading, The Great Moderation, The Myth of the Rational Market, too big to fail, transaction costs, tulip mania, value at risk, volatility arbitrage, volatility smile, working-age population, Y2K, yield curve, zero-coupon bond, zero-sum game

Disagreement is especially important for explaining the high level of trading volume, but it also can help explain correlation or volatility risk premia as well as some cross-sectional patterns in equity returns. For example, high levels of disagreement and short-selling constraints together predict relatively low equity returns because overvalued stocks cannot be shorted and tend to be held by the most optimistic investors. Asymmetric information refers to situations in which one party is better informed than the other, leading to so-called principal–agent problems (including moral hazard, adverse selection, conflict of interest). Vayanos–Woolley (2010) show that delegated asset management can cause momentum patterns. As investors (principals) try to learn about a manager’s (agent’s) skill from his past performance and effectively chase returns, the resulting fund flows push prices away from fair values, inducing short-term momentum and long-term reversal patterns. 5.3 DETOUR: A BRIEF SURVEY OF THE EFFICIENT MARKETS HYPOTHESIS Before turning to behavioral finance, it is appropriate to briefly survey the efficient markets hypothesis (EMH).

There are also transaction costs and model uncertainty to consider. Trading costs on leveraged strategies can be significant. Barring remarkable hubris, no arbitrageur can be completely confident that his model or view is correct. One important implication for long-horizon institutional investors is that when they delegate asset management, external managers may not inherit the ultimate investor’s long horizon. Principal–agent problems shorten horizons from both sides, a phenomenon that can make the long-horizon investor lose his natural edge. Market turmoil in 1998 and 2007–2008 taught us additional features that should discourage arbitrage activities—VaR-based risk management and crowded trade risk:• Risk management systems that make sense for any one investor can increase systemic risk. A vicious circle can arise when rising risks (in VaR models or in other reactive risk measures) trigger mandatory or voluntary position reductions (but the problem is much worse if mandatory); widespread liquidations can destabilize the markets and require further reductions.

Investors may be more aware of historical average yield spreads than of historical excess returns; the excess return analysis above is somewhat complex and its unappealing evidence is rarely publicized in Wall Street research. More commonly, we hear how much wider average yield spreads have been than average default losses. The appeal of credit to institutional investors is not universal. Swensen (2009), just to give one example, is highly critical of non-government debt and argues that the principal–agent problems in corporate bonds are underappreciated. Because firm managers’ interests are better aligned with shareholders than with lenders, discretionary management actions are more likely to benefit the former at the expense of the latter. Finally, institutional demand may contribute to overpricing: banks are the largest asset managers and must hold credit risk disproportionately, while insurers often opt for high-yielding assets as long-term investments, adding to the oversubscription of corporate bonds. 10.3 FOCUS ON FRONT-END TRADING—A POCKET OF ATTRACTIVE REWARD TO RISK There is one exception to the disappointing performance of credit.


pages: 695 words: 194,693

Money Changes Everything: How Finance Made Civilization Possible by William N. Goetzmann

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Albert Einstein, Andrei Shleifer, asset allocation, asset-backed security, banking crisis, Benoit Mandelbrot, Black Swan, Black-Scholes formula, Bretton Woods, Brownian motion, capital asset pricing model, Cass Sunstein, collective bargaining, colonial exploitation, compound rate of return, conceptual framework, corporate governance, Credit Default Swap, David Ricardo: comparative advantage, debt deflation, delayed gratification, Detroit bankruptcy, disintermediation, diversified portfolio, double entry bookkeeping, Edmond Halley, en.wikipedia.org, equity premium, financial independence, financial innovation, financial intermediation, fixed income, frictionless, frictionless market, full employment, high net worth, income inequality, index fund, invention of the steam engine, invention of writing, invisible hand, James Watt: steam engine, joint-stock company, joint-stock limited liability company, laissez-faire capitalism, Louis Bachelier, mandelbrot fractal, market bubble, means of production, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, new economy, passive investing, Paul Lévy, Ponzi scheme, price stability, principal–agent problem, profit maximization, profit motive, quantitative trading / quantitative finance, random walk, Richard Thaler, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, sovereign wealth fund, spice trade, stochastic process, the scientific method, The Wealth of Nations by Adam Smith, Thomas Malthus, time value of money, too big to fail, trade liberalization, trade route, transatlantic slave trade, transatlantic slave trade, tulip mania, wage slave

With the unification of the empire after the Warring States period, this problem increased in significance as the new emperor brought together a set of culturally related but politically disparate entities with questionable loyalties. In a sense, much of the philosophical discourse in China before and after the reunification relates in some way to the problem of bureaucracy—a system in which one person works under the direction of another in an organization. Embedded in large-scale organizational structure is a fundamental issue that is called by modern economists the “principal-agent problem”: a principal (boss) must delegate a task to an agent (employee). The problem is that by delegating a task, the principal cannot be sure that it will be done exactly as he or she wishes. The agent might not work hard or might be dishonest. Agency can be thought of as a problem of motivation, but it is also a problem of information. If the principal could always check up on the agent, and reward or punish according to effort and honesty, then the bureaucracy would function perfectly.

In some sense, they were complex commodity futures that functioned as a medium of exchange. FIGURE 16. A paper certificate from the Song dynasty that functioned as a means of payment for military supplies. TRAVELING MONEY Stephen Ross is a finance professor at the Massachusetts Institute of Technology and is one of the creators of modern financial theory. Among many other things, he developed the basic theoretical framework of the principal-agent problem. He is also a good friend of mine who shares an interest in China. One day I was visiting his office and I idly glanced at a document framed on his wall. I realized, to my surprise, that I could read some of the Chinese characters. I could make out the characters for “money” and a couple of characters that seemed to read “Great Song” (i.e., the name of the Song dynasty). Another character in the title read “cash.”

See Sulpicii banking family portfolio optimization, 504–8 Portuguese discovery and trade, 315, 316 Pouget, Sébastien, 298–99 power: debt of nation-states and, 401–3, 421; of government, undermined by investment class, 57; reorganized by finance, 8; of Roman wealthy class, 105 predatory loans, in ancient Near East, 64 present value, 243–44; Fisher on investment decisions and, 471–72, 484 prestiti, 229–32, 236–37, 254 price of time: Drehem tablet and, 40; rate of return as, 6–7; Venetian government debt and, 237 prices controlled by Chinese government: Guanzi on, 161; Wang Anshi and, 190; Zhouli and, 174 prices of commodities. See commodity prices principal-agent problem, 167, 169. See also agency problem private enterprise: becoming instrument of European governments, 305; Fibonacci’s Liber Abaci and, 248 private enterprise vs. state ownership in China: Han dynasty and, 174; Song dynasty and, 189–91; up to 1949, 200, 426 privatization: of Athenian silver mines, 88–89; vs. nationalization, 302–3; of Roman Empire functions, 103 probability, 258; in China, 270–72; Condorcet’s social vision and, 273, 274, 275; derivative pricing and, 284; diversification of investments and, 404; Hoyle on card games and, 367; Law’s understanding of, 349; Malthus’s pessimistic predictions and, 274–75; modern finance and, 276; mortality and, 262.


pages: 687 words: 189,243

A Culture of Growth: The Origins of the Modern Economy by Joel Mokyr

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Andrei Shleifer, barriers to entry, Berlin Wall, clockwork universe, cognitive dissonance, Copley Medal, creative destruction, David Ricardo: comparative advantage, delayed gratification, deliberate practice, Deng Xiaoping, Edmond Halley, epigenetics, Fellow of the Royal Society, financial independence, framing effect, germ theory of disease, Haber-Bosch Process, hindsight bias, income inequality, invention of movable type, invention of the printing press, invisible hand, Isaac Newton, Jacquard loom, Jacquard loom, Jacques de Vaucanson, James Watt: steam engine, John Harrison: Longitude, Joseph Schumpeter, knowledge economy, labor-force participation, land tenure, law of one price, Menlo Park, moveable type in China, new economy, phenotype, price stability, principal–agent problem, rent-seeking, Republic of Letters, Ronald Reagan, South Sea Bubble, statistical model, survivorship bias, the market place, The Structural Transformation of the Public Sphere, The Wealth of Nations by Adam Smith, transaction costs, ultimatum game, World Values Survey, Wunderkammern

One reason is that the “imperfect empathy” postulated by Bisin and Verdier may not be a full characterization of the behavior of the parents; it is more persuasive to write an altruistic utility function in which the parents cared exclusively about the happiness of their children as they saw it, which may mean that the culture they acquire for their children diverges significantly from their own culture if they regret their own past cultural choices (Christopoulou, Jaber, and Lillard, 2013). Alternatively, even if the parents choose an outsider to socialize their offspring in their own image, there may be a serious principal-agent problem, because the parents can only monitor their children’s socialization process imperfectly. It might be thought that in the modern age vertical transmission has become relatively unimportant. In her popular The Nurture Assumption, Harris (2009) amasses a great deal of evidence to show that the cultural impact of parents on their children in today’s society is limited. In her view, the evidence suggests that social behavior is largely the result of the interactions of children with their peers (that is, other children) and that parents have only limited effect on their children past the toddler years.

As we have seen, culture can affect Smithian growth through the creation of an ideological environment (or, as some would prefer to call it, social capital) that is conducive to commerce and better-functioning markets. A Lockean belief in property rights, for example, or a belief that most people are trustworthy leads to the reduction of transactions costs and thus stimulates commerce. Related to trust is loyalty, which mitigates principal-agent problems. A belief in the virtuousness of loyalty to an employer or an organization saves monitoring costs and thus enhances both efficiency and trade. Public-mindedness (or asabiya in Ibn Khaldun’s famous formulation), is a third cultural element related to cooperation: the willingness to avoid free-riding and contribute to a collective good despite the incentive that each individual has to shirk.

The Business of Alchemy: Science and Culture in the Holy Roman Empire. Princeton, NJ: Princeton University Press. Smith, Pamela H., and Schmidt, Benjamin. 2007. “Knowledge and Its Making in Early Europe.” In Pamela H. Smith and Benjamin Schmidt, eds., Making Knowledge in Early Modern Europe. Chicago: University of Chicago Press, pp. 1–16. Sng, Tuan Hwee. 2014. “Size and Dynastic Decline: The Principal-Agent Problem in Late Imperial China 1700-1850.” Explorations in Economic History, Vol. 54, pp. 107–27. Snobelen, Stephen D. 1999. “Isaac Newton, Heretic: the Strategies of a Nicodemite.” British Journal for the History of Science Vol. 32, pp. 381–419. ———. 2012. “The Myth of the Clockwork Universe: Newton, Newtonianism, and the Enlightenment.” In Chris L. Firestone and Nathan Jacobs, eds. The Persistence of the Sacred in Modern Thought.


pages: 500 words: 145,005

Misbehaving: The Making of Behavioral Economics by Richard H. Thaler

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3Com Palm IPO, Albert Einstein, Alvin Roth, Amazon Mechanical Turk, Andrei Shleifer, Apple's 1984 Super Bowl advert, Atul Gawande, Berlin Wall, Bernie Madoff, Black-Scholes formula, capital asset pricing model, Cass Sunstein, Checklist Manifesto, choice architecture, clean water, cognitive dissonance, conceptual framework, constrained optimization, Daniel Kahneman / Amos Tversky, delayed gratification, diversification, diversified portfolio, Edward Glaeser, endowment effect, equity premium, Eugene Fama: efficient market hypothesis, experimental economics, Fall of the Berlin Wall, George Akerlof, hindsight bias, Home mortgage interest deduction, impulse control, index fund, information asymmetry, invisible hand, Jean Tirole, John Nash: game theory, John von Neumann, Kenneth Arrow, late fees, law of one price, libertarian paternalism, Long Term Capital Management, loss aversion, market clearing, Mason jar, mental accounting, meta analysis, meta-analysis, money market fund, More Guns, Less Crime, mortgage debt, Myron Scholes, Nash equilibrium, Nate Silver, New Journalism, nudge unit, Paul Samuelson, payday loans, Ponzi scheme, presumed consent, pre–internet, principal–agent problem, prisoner's dilemma, profit maximization, random walk, randomized controlled trial, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Coase, Silicon Valley, South Sea Bubble, statistical model, Steve Jobs, technology bubble, The Chicago School, The Myth of the Rational Market, The Signal and the Noise by Nate Silver, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, transaction costs, ultimatum game, Vilfredo Pareto, Walter Mischel, zero-sum game

It just looked risky compared to the particular manager’s budget. In this example, narrow framing prevented innovation and experimentation, two essential ingredients in the long-term success of any organization. Both this example of the risk-averse manager and the story of the CEO who would have liked to take on twenty-three risky projects, but would only get three, illustrate an important point about principal–agent problems. In the economics literature, such failures are usually described in a way that implicitly puts the “blame” on the agent for taking decisions that fail to maximize the firm, and acting in their own self-interest instead. They are said to make poor decisions because they are maximizing their own welfare rather than that of the organization. Although this depiction is often apt, in many cases the real culprit is the boss, not the worker.

Others, such as the owner or one of the coaches, would often fall in love with some player and insist on trading up to get their guy. Furthermore, on the few occasions where the team did trade down in the first round, getting a later first-round pick plus an additional second-round pick, the extra pick would not last long. The extra pick had the feel of “house money” and was usually traded away quickly to grab another “sure thing.” The failure of teams to draft optimally is a good example of a situation where a principal agent problem would be more accurately labeled a dumb principal problem. When an economist says of a team trading up, “That is just an agency problem,” they mean that the general manager or the coach is worried about his job and needs to win now or get fired. Of course, it is perfectly rational for coaches and general managers to be worried about losing their jobs—they do often get fired. But I think blaming their bad decision-making on traditional agency problems is a mischaracterization.


Governing the Commons: The Evolution of Institutions for Collective Action by Elinor Ostrom

agricultural Revolution, clean water, Gödel, Escher, Bach, land tenure, Pareto efficiency, principal–agent problem, prisoner's dilemma, profit maximization, RAND corporation, The Death and Life of Great American Cities, The Nature of the Firm, transaction costs

., 167, 170-1 Philip II of Spain, 81, 227n21 Philippine Water Code, 85 Philippine zanjeras, 59-61, 82-9, 102, 194-5, 228n27,n29,n31, 228-9n32,241n26 Phyne, J., 205, 218n6, 241n27 Picardi, A. C., 3 Picht, c., 55,64 Pinkerton, E., 23, 218n6, 220n21 Plott, C. R., 30 Pocock, D., 218n6 policy analysis, 23-6, 191-2 policy prescriptions as metaphors, 21-3, 184-5 policy space, 142 1>001, J., 5 Popper, K. R., 38 Port Lameron Harbour, Nova Scotia, 179-80 Scotian inshore fisheries 229n33 108-9, 119, l>rice, M., 225n7 277 Index principal-agent problem, 17 prisoner's dilemma, 3-5, 6-7, 11, 16,39, 42-3,46-8, 182-3, 217nl see also games privatization, 12-14, 136 see also property rights, private; voluntary association privileged group, 111 profit maximization, 207 property rights, 20, 66-7 communal, 13, 60-4, 66, 224n3, 224-5n5, 229n37; see also common pool resource private, 12-13, 18,22,60-1,63--4,157, 175-6; see also privatization provision, 32-3, 47, 49-50, 55-6, 223n26 demand-side problem of, 49 supply-side problem of, 49 see also design principles, congruent rules entrepreneurship, 127-33 133-6 quasi-voluntary compliance, 94-5, 97-9, 125-6, 229n39 see also compliance rate Rabibhadena, A., 241n26 Radnitzky, G., 221n6 Rahman, A., 241n26 H., 217n1 action, 33-8, 193 rationality principle, 38 see also rational action Raymond Basin, California, 111-14, 116, 122, 124, 128, 134, 179-80,189-90,202,209,212-13, 231n8,232n18,235n32 exchange pool in, 114 report of the referee in, 111-12 watermaster in, 114, 125, 234n26 see also California groundwater basins Reder, M. w., 243n15 Renshaw, w., 232n18 rent dissipation, 48-9, 145, 150, 155, 157, 179, 238n6 Replenishment District Boundary Committee, 131 resource common pool, see common pool resource flow, 30,47 nonstationary (fugitive), 13 open-access, 32,175-6 renewable, 30-1 stock, 30, 47 see also common pool resource resource system, 13, 30-3, 43 resource units, 30-3, 43 Rhodes, R.


pages: 220 words: 73,451

Democratizing innovation by Eric von Hippel

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additive manufacturing, correlation coefficient, Debian, hacker house, informal economy, information asymmetry, inventory management, iterative process, James Watt: steam engine, knowledge economy, meta analysis, meta-analysis, Network effects, placebo effect, principal–agent problem, Richard Stallman, software patent, transaction costs, Vickrey auction

Open source software users are not consumers in the conventional sense. . . . Users integrate into the production process itself in a profound way.” Weber’s central thesis is that the open source process is a new way of organizing production: One solution is the familiar economy that depends upon a blend of exclusive property rights, divisions of labor, reduction of transaction costs, and the management of principal-agent problems. The success of open source demonstrates the importance 170 Chapter 12 of a fundamentally different solution, built on top of an unconventional understanding of property rights configured around distribution. . . . And it relies on a set of organizational structures to coordinate behavior around the problem of managing distributed innovation, which is different from the division of labor.


pages: 206 words: 70,924

The Rise of the Quants: Marschak, Sharpe, Black, Scholes and Merton by Colin Read

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Albert Einstein, Bayesian statistics, Black-Scholes formula, Bretton Woods, Brownian motion, capital asset pricing model, collateralized debt obligation, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, discovery of penicillin, discrete time, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, floating exchange rates, full employment, Henri Poincaré, implied volatility, index fund, Isaac Newton, John Meriwether, John von Neumann, Joseph Schumpeter, Kenneth Arrow, Long Term Capital Management, Louis Bachelier, margin call, market clearing, martingale, means of production, moral hazard, Myron Scholes, naked short selling, Paul Samuelson, price stability, principal–agent problem, quantitative trading / quantitative finance, RAND corporation, random walk, risk tolerance, risk/return, Ronald Reagan, shareholder value, Sharpe ratio, short selling, stochastic process, The Chicago School, the scientific method, too big to fail, transaction costs, tulip mania, Works Progress Administration, yield curve

In his paper on the subject, “Competitive Equilibrium under Uncertainty,” he also determined the significance of what we now know as a rational expectations equilibrium.1 Radner went on to establish equilibrium under uncertainty in 1968, and thereby proved an assertion that Kenneth Arrow had made but had not proved more than a decade earlier that a competitive market could still be efficient even if the range of futures instruments does not span all possible states.2 Indeed, Marschak and Radner would go on to collaborate in the extension of their models of information and uncertainty to the theory of teams and of decision-making within organizations. This work between Marschak and Radner itself spawned a new literature on organizational theory and on the principal-agent problem that is crucial to our understanding of financial markets. When their work culminated in the seminal book Economic Theory of Teams, published by Yale University Press in 1972, Marschak was in his seventy-fourth year.3 His career had spanned six decades and he had saved some of his most significant work for last. Over a most diverse, productive, active, and inspirational career, Marschak was elected to preside over two learned societies and had been appointed a fellow in 1963 to the Royal Statistical Society and a distinguished fellow in 1967 to the American Economics Association.


pages: 304 words: 80,965

What They Do With Your Money: How the Financial System Fails Us, and How to Fix It by Stephen Davis, Jon Lukomnik, David Pitt-Watson

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activist fund / activist shareholder / activist investor, Admiral Zheng, banking crisis, Basel III, Bernie Madoff, Black Swan, centralized clearinghouse, clean water, computerized trading, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, crowdsourcing, David Brooks, Dissolution of the Soviet Union, diversification, diversified portfolio, en.wikipedia.org, financial innovation, financial intermediation, fixed income, Flash crash, income inequality, index fund, information asymmetry, invisible hand, Kenneth Arrow, light touch regulation, London Whale, Long Term Capital Management, moral hazard, Myron Scholes, Northern Rock, passive investing, performance metric, Ponzi scheme, principal–agent problem, rent-seeking, Ronald Coase, shareholder value, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, Steve Jobs, the market place, The Wealth of Nations by Adam Smith, transaction costs, Upton Sinclair, value at risk, WikiLeaks

Civil society organizations and other platforms designed to represent citizen investors and to champion market accountability are often outgunned. Another reason solutions have been lacking is that our economic models have become too narrow. Under certain assumptions, any transaction between a willing buyer and a willing seller will benefit both. But in the real world, those assumptions don’t always apply. As we shall see in chapter 6, “externalities,” principal-agent problems, and behavioral biases all combine to create a more complex world than exists in most economics journals. We do not mean to suggest that atomized regulation should be abandoned. But by combining it with a systemic approach, we could allow traditional command-and-control regulation to address major abuses and stop bad practices, while designing the institutions of market-based self-policing for continuous self-correction.


pages: 265 words: 69,310

What's Yours Is Mine: Against the Sharing Economy by Tom Slee

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4chan, Airbnb, Amazon Mechanical Turk, asset-backed security, barriers to entry, Berlin Wall, big-box store, bitcoin, blockchain, citizen journalism, collaborative consumption, congestion charging, Credit Default Swap, crowdsourcing, data acquisition, David Brooks, don't be evil, gig economy, Hacker Ethic, income inequality, informal economy, invisible hand, Jacob Appelbaum, Jane Jacobs, Jeff Bezos, Khan Academy, Kibera, Kickstarter, license plate recognition, Lyft, Marc Andreessen, Mark Zuckerberg, move fast and break things, move fast and break things, natural language processing, Netflix Prize, Network effects, new economy, Occupy movement, openstreetmap, Paul Graham, peer-to-peer, peer-to-peer lending, Peter Thiel, pre–internet, principal–agent problem, profit motive, race to the bottom, Ray Kurzweil, recommendation engine, rent control, ride hailing / ride sharing, sharing economy, Silicon Valley, Snapchat, software is eating the world, South of Market, San Francisco, TaskRabbit, The Nature of the Firm, Thomas L Friedman, transportation-network company, Uber and Lyft, Uber for X, ultimatum game, urban planning, WikiLeaks, winner-take-all economy, Y Combinator, Zipcar

LAPO was for several years a major partner of “peer-to-peer” lender Kiva, until Kiva cut ties in 2010.33 The episode highlighted a fact that was worrying some observers: “peer-to-peer” lending is not actually peer-to-peer; instead, Kiva works with intermediary partners that in turn make loans that were not, as many thought, interest-free.34 As microfinance grew in scale it has spawned a web of interacting operations. Microfinance funds invest in microfinance institutions that are rated by microfinance rating agencies, and that make loans through other partners. Principal-agent problems become pervasive and, without a regulatory framework, there were incentives everywhere that not only enabled corruption but, Sinclair argues, pushed participants to keep a lid on stories of corruption—to try to fix them quietly rather than to risk the reputation of the broader industry. Taking a charity and turning it into a bank is, as Sinclair says, a great way to build assets and then capitalize on them.


pages: 237 words: 72,716

The Inequality Puzzle: European and US Leaders Discuss Rising Income Inequality by Roland Berger, David Grusky, Tobias Raffel, Geoffrey Samuels, Chris Wimer

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Branko Milanovic, Celtic Tiger, collective bargaining, corporate governance, corporate social responsibility, double entry bookkeeping, equal pay for equal work, fear of failure, financial innovation, full employment, Gini coefficient, hiring and firing, illegal immigration, income inequality, invisible hand, labour market flexibility, labour mobility, Long Term Capital Management, microcredit, offshore financial centre, principal–agent problem, profit maximization, rent-seeking, shareholder value, Silicon Valley, Silicon Valley startup, time value of money, very high income

The Board and the remuneration committee set executive compensation, and it is the much more complicated issue of corporate governance that deserves more public attention. The ultimate principals, of course, are the shareholders, but the complexities are such that it is much easier to broadcast segments about CEO paychecks than discuss corporate governance issues. Five Principles for Moving Forward 207 The principal-agent problem, where the agent acts as the principal rather than advancing the interests of the owner, is neither unique to CEOs and business, nor is it a contemporary issue. Ancient Roman legislators in various periods, avowedly voting in the interests of the people, craftily, and sometimes quite openly, promoted their own interests. With regard to CEO compensation, a conversation needs to evolve between shareholders, notably pension funds and other large institutions, and the boards of directors.


pages: 261 words: 103,244

Economists and the Powerful by Norbert Haring, Norbert H. Ring, Niall Douglas

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accounting loophole / creative accounting, Affordable Care Act / Obamacare, Albert Einstein, asset allocation, bank run, barriers to entry, Basel III, Bernie Madoff, British Empire, central bank independence, collective bargaining, commodity trading advisor, corporate governance, creative destruction, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, diversified portfolio, financial deregulation, George Akerlof, illegal immigration, income inequality, inflation targeting, information asymmetry, Jean Tirole, job satisfaction, Joseph Schumpeter, Kenneth Arrow, knowledge worker, labour market flexibility, law of one price, light touch regulation, Long Term Capital Management, low skilled workers, mandatory minimum, market bubble, market clearing, market fundamentalism, means of production, minimum wage unemployment, moral hazard, new economy, obamacare, old-boy network, open economy, Pareto efficiency, Paul Samuelson, pension reform, Ponzi scheme, price stability, principal–agent problem, profit maximization, purchasing power parity, Renaissance Technologies, rolodex, Sergey Aleynikov, shareholder value, short selling, Steve Jobs, The Chicago School, the payments system, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, ultimatum game, union organizing, Vilfredo Pareto, working-age population, World Values Survey

—Michael Jensen and Kevin Murphy, 2004 In the US, a corporation is led by the CEO, who is supervised by a board of directors. Often, the CEO also presides over the board. Board members or directors can be current or past managers of the corporation or they can come from outside. Among the external directors, there are some who qualify as independent directors, meaning that they have no close personal ties to the CEO. The principal–agent problem of shareholders with regard to CEOs would be less severe if boards would fulfill their task of controlling the CEO. Instead, boards tend to be controlled by the very CEO they are supposed to supervise. The consequences extend far beyond executives setting their own pay level using other people’s money. If there is no independent oversight, executives are free to pursue their own goals to the detriment of the company.


pages: 339 words: 109,331

The Clash of the Cultures by John C. Bogle

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asset allocation, collateralized debt obligation, commoditize, corporate governance, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, estate planning, Eugene Fama: efficient market hypothesis, financial innovation, financial intermediation, fixed income, Flash crash, Hyman Minsky, income inequality, index fund, interest rate swap, invention of the wheel, market bubble, market clearing, money market fund, mortgage debt, new economy, Occupy movement, passive investing, Paul Samuelson, Ponzi scheme, principal–agent problem, profit motive, random walk, rent-seeking, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, statistical arbitrage, survivorship bias, The Wealth of Nations by Adam Smith, transaction costs, Vanguard fund, William of Occam, zero-sum game

As ownership was gradually diffused into far smaller shareholdings, however, effective shareholder power declined, even as the latent power of those voting rights remained intact. Agency Costs and Managerial Behavior In 1976, another pair of wise academics—Harvard Business School’s Michael C. Jensen and University of Rochester’s William H. Meckling—added another brilliant insight on corporate behavior. “America has a principal/agent problem,” as The Economist explained their seminal paper. “Agents (i.e., managers) were feathering their own nests rather than the interests of their principals (shareholders).” In “Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure,” Jensen and Meckling set forth “a theory of (1) property rights, (2) agency, and (3) finance (as they relate to) the ownership structure of the firm.”


pages: 523 words: 111,615

The Economics of Enough: How to Run the Economy as if the Future Matters by Diane Coyle

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accounting loophole / creative accounting, affirmative action, bank run, banking crisis, Berlin Wall, bonus culture, Branko Milanovic, BRICs, call centre, Cass Sunstein, central bank independence, collapse of Lehman Brothers, conceptual framework, corporate governance, correlation does not imply causation, Credit Default Swap, deindustrialization, demographic transition, Diane Coyle, disintermediation, Edward Glaeser, endogenous growth, Eugene Fama: efficient market hypothesis, experimental economics, Fall of the Berlin Wall, Financial Instability Hypothesis, Francis Fukuyama: the end of history, George Akerlof, Gini coefficient, global supply chain, Gordon Gekko, greed is good, happiness index / gross national happiness, Hyman Minsky, If something cannot go on forever, it will stop - Herbert Stein's Law, illegal immigration, income inequality, income per capita, industrial cluster, information asymmetry, intangible asset, Intergovernmental Panel on Climate Change (IPCC), invisible hand, Jane Jacobs, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, knowledge economy, labour market flexibility, light touch regulation, low skilled workers, market bubble, market design, market fundamentalism, megacity, Network effects, new economy, night-watchman state, Northern Rock, oil shock, Pareto efficiency, principal–agent problem, profit motive, purchasing power parity, railway mania, rising living standards, Ronald Reagan, selective serotonin reuptake inhibitor (SSRI), Silicon Valley, South Sea Bubble, Steven Pinker, The Design of Experiments, The Fortune at the Bottom of the Pyramid, The Market for Lemons, The Myth of the Rational Market, The Spirit Level, transaction costs, transfer pricing, tulip mania, ultimatum game, University of East Anglia, web application, web of trust, winner-take-all economy, World Values Survey, zero-sum game

Neither form of organization can deliver good results in contexts where there is asymmetric information, meaning that one person knows something that others cannot monitor in any way—for example, how much effort they’re putting in to their work, or how hard a task requiring certain skills actually is to carry out (think about calling a plumber to fix a leak—you have to trust his diagnosis; likewise with doctors or teachers). That asymmetry will often be linked to a principal-agent problem: public sector workers (agents) are carrying out tasks for citizens and taxpayers (principals), in the way that corporate managers are working for shareholders. The advantage in those relationships is on the side of the agents. Whether a certain task is in the public or private sector will not change the information structure. “Public goods” (in the economist’s sense) retain their characteristics making them hard to price and manage no matter who is providing them.


pages: 471 words: 124,585

The Ascent of Money: A Financial History of the World by Niall Ferguson

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Admiral Zheng, Andrei Shleifer, Asian financial crisis, asset allocation, asset-backed security, Atahualpa, bank run, banking crisis, banks create money, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, BRICs, British Empire, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, collateralized debt obligation, colonial exploitation, commoditize, Corn Laws, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, deglobalization, diversification, diversified portfolio, double entry bookkeeping, Edmond Halley, Edward Glaeser, Edward Lloyd's coffeehouse, financial innovation, financial intermediation, fixed income, floating exchange rates, Fractional reserve banking, Francisco Pizarro, full employment, German hyperinflation, Hernando de Soto, high net worth, hindsight bias, Home mortgage interest deduction, Hyman Minsky, income inequality, information asymmetry, interest rate swap, Intergovernmental Panel on Climate Change (IPCC), Isaac Newton, iterative process, John Meriwether, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, knowledge economy, labour mobility, Landlord’s Game, liberal capitalism, London Interbank Offered Rate, Long Term Capital Management, market bubble, market fundamentalism, means of production, Mikhail Gorbachev, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, mortgage tax deduction, Myron Scholes, Naomi Klein, negative equity, Nick Leeson, Northern Rock, Parag Khanna, pension reform, price anchoring, price stability, principal–agent problem, probability theory / Blaise Pascal / Pierre de Fermat, profit motive, quantitative hedge fund, RAND corporation, random walk, rent control, rent-seeking, reserve currency, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, seigniorage, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spice trade, structural adjustment programs, technology bubble, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Bayes, Thomas Malthus, Thorstein Veblen, too big to fail, transaction costs, value at risk, Washington Consensus, Yom Kippur War

In turn, Indian textiles could be traded for pepper and spices from the Pacific islands, which could be used to purchase precious metals from the Middle East.31 Later, the Company provided financial services to other Europeans in Asia, not least Robert Clive, who transferred a large part of the fortune he had made from conquering Bengal back to London via Batavia and Amsterdam.32 As the world’s first big corporation, the VOC was able to combine economies of scale with reduced transaction costs and what economists call network externalities, the benefit of pooling information between multiple employees and agents.33 As was true of the English East India Company, the VOC’s biggest challenge was the principal-agent problem: the tendency of its men on the spot to trade on their own account, bungle transactions or simply defraud the company. This, however, was partially countered by an unusual compensation system, which linked remuneration to investments and sales, putting a priority on turnover rather than net profits.34 Business boomed. In the 1620s, fifty VOC ships had returned from Asia laden with goods; by the 1690s the number was 156.35 Between 1700 and 1750 the tonnage of Dutch shipping sailing back around the Cape doubled.


pages: 545 words: 137,789

How Markets Fail: The Logic of Economic Calamities by John Cassidy

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Albert Einstein, Andrei Shleifer, anti-communist, asset allocation, asset-backed security, availability heuristic, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Black-Scholes formula, Bretton Woods, British Empire, capital asset pricing model, centralized clearinghouse, collateralized debt obligation, Columbine, conceptual framework, Corn Laws, corporate raider, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Daniel Kahneman / Amos Tversky, debt deflation, diversification, Elliott wave, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, George Akerlof, global supply chain, Gunnar Myrdal, Haight Ashbury, hiring and firing, Hyman Minsky, income per capita, incomplete markets, index fund, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invisible hand, John Nash: game theory, John von Neumann, Joseph Schumpeter, Kenneth Arrow, laissez-faire capitalism, Landlord’s Game, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, market clearing, mental accounting, Mikhail Gorbachev, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Myron Scholes, Naomi Klein, negative equity, Network effects, Nick Leeson, Northern Rock, paradox of thrift, Pareto efficiency, Paul Samuelson, Ponzi scheme, price discrimination, price stability, principal–agent problem, profit maximization, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, RAND corporation, random walk, Renaissance Technologies, rent control, Richard Thaler, risk tolerance, risk-adjusted returns, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, technology bubble, The Chicago School, The Great Moderation, The Market for Lemons, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, unorthodox policies, value at risk, Vanguard fund, Vilfredo Pareto, wealth creators, zero-sum game

During the 1960s and ’70s, many commentators and investors expressed concern that CEOs were more interested in building up personal fiefdoms, complete with lavish headquarters, plush corporate resorts, and private jets, than in acting in the interests of shareholders. In an extremely influential paper published in 1976, Michael Jensen, now of Harvard, and the late William Meckling depicted the relationship of CEOs and stockholders as a “principal-agent” problem, a dilemma that arises, to some extent, whenever one party (the principal) employs another (the agent) to do a job. As anybody who has hired a contractor knows, it can be difficult to monitor an agent’s behavior: the contractor may say he is working diligently, but is he telling the truth? Often, that information is hidden. Two common but partial solutions to this problem are to pay the agent after the completion of the job, or to offer him a success fee.


pages: 422 words: 131,666

Life Inc.: How the World Became a Corporation and How to Take It Back by Douglas Rushkoff

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affirmative action, Amazon Mechanical Turk, banks create money, big-box store, Bretton Woods, car-free, colonial exploitation, Community Supported Agriculture, complexity theory, computer age, corporate governance, credit crunch, currency manipulation / currency intervention, David Ricardo: comparative advantage, death of newspapers, don't be evil, Donald Trump, double entry bookkeeping, easy for humans, difficult for computers, financial innovation, Firefox, full employment, global village, Google Earth, greed is good, Howard Rheingold, income per capita, invention of the printing press, invisible hand, Jane Jacobs, John Nash: game theory, joint-stock company, Kevin Kelly, laissez-faire capitalism, loss aversion, market bubble, market design, Marshall McLuhan, Milgram experiment, moral hazard, mutually assured destruction, Naomi Klein, negative equity, new economy, New Urbanism, Norbert Wiener, peak oil, peer-to-peer, place-making, placebo effect, Ponzi scheme, price mechanism, price stability, principal–agent problem, private military company, profit maximization, profit motive, race to the bottom, RAND corporation, rent-seeking, RFID, road to serfdom, Ronald Reagan, short selling, Silicon Valley, Simon Kuznets, social software, Steve Jobs, Telecommunications Act of 1996, telemarketer, The Wealth of Nations by Adam Smith, Thomas L Friedman, too big to fail, trade route, trickle-down economics, union organizing, urban decay, urban planning, urban renewal, Vannevar Bush, Victor Gruen, white flight, working poor, Works Progress Administration, Y2K, young professional, zero-sum game

Cipolla, Before the Industrial Revolution: European Society and Economy, 1000-1700, 3rd ed. (New York: W. W. Norton & Company, 1994). 8 A Child Is Born For a comparison of perspectives on the agendas behind the birth of the corporation, refer to the following scholarly books and articles that formed the basis for my own inquiry: George Cawston and A. H. Keane, The Early Chartered Companies: 1296-1858 (New York: Burt Franklin, 1968). Ann M. Carlos, “Principal-Agent Problems in Early Trading Companies: A Tale of Two Firms,” The American Economic Review 82.2 (1992): 140-45. Ann M. Carlos and Stephen Nicholas, “Giants of an Earlier Capitalism: The Chartered Trading Companies as Modern Multinationals,” The Business History Review 62.3 (1988): 398-419. Ann M. Carlos and Stephen Nicholas, “Agency Problems in Early Chartered Companies: The Case of the Hudson’s Bay Company,” The Journal of Economic History 50.4 (1990): 853-75.


pages: 515 words: 132,295

Makers and Takers: The Rise of Finance and the Fall of American Business by Rana Foroohar

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3D printing, accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, additive manufacturing, Airbnb, algorithmic trading, Alvin Roth, Asian financial crisis, asset allocation, bank run, Basel III, bonus culture, Bretton Woods, British Empire, call centre, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, carried interest, centralized clearinghouse, clean water, collateralized debt obligation, commoditize, computerized trading, corporate governance, corporate raider, corporate social responsibility, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, crowdsourcing, David Graeber, deskilling, Detroit bankruptcy, diversification, Double Irish / Dutch Sandwich, Emanuel Derman, Eugene Fama: efficient market hypothesis, financial deregulation, financial intermediation, Frederick Winslow Taylor, George Akerlof, gig economy, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, High speed trading, Home mortgage interest deduction, housing crisis, Howard Rheingold, Hyman Minsky, income inequality, index fund, information asymmetry, interest rate derivative, interest rate swap, Internet of things, invisible hand, John Markoff, joint-stock company, joint-stock limited liability company, Kenneth Rogoff, knowledge economy, labor-force participation, labour mobility, London Whale, Long Term Capital Management, manufacturing employment, market design, Martin Wolf, money market fund, moral hazard, mortgage debt, mortgage tax deduction, new economy, non-tariff barriers, offshore financial centre, oil shock, passive investing, Paul Samuelson, pensions crisis, Ponzi scheme, principal–agent problem, quantitative easing, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, Rana Plaza, RAND corporation, random walk, rent control, Robert Shiller, Robert Shiller, Ronald Reagan, Satyajit Das, Second Machine Age, shareholder value, sharing economy, Silicon Valley, Silicon Valley startup, Snapchat, sovereign wealth fund, Steve Jobs, technology bubble, The Chicago School, the new new thing, The Spirit Level, The Wealth of Nations by Adam Smith, Tim Cook: Apple, Tobin tax, too big to fail, trickle-down economics, Tyler Cowen: Great Stagnation, Vanguard fund, zero-sum game

“While there are a number of good board members, you’ve got some board members making four hundred thousand dollars a year that are actually counterproductive. They’re not going to go against their buddy [the CEO] who put them there.”39 That’s often true, but the real reason that corporate governance in this country isn’t stronger is that all the incentive structures for board members and CEOs alike are working against long-term decision making. It’s an issue called the “principal-agent problem” in academic circles. The collusion isn’t so much between the CEO and his golf buddies as it is between corporate executives and financiers. CEOs today have every reason to bolster short-term share price value, as the Street wants them to, because it will also result in higher compensation for them, since most executives receive the bulk of their compensation in stock options. Wall Street analysts, whose ratings help dictate the value of firms in the marketplace, typically look at only the yearly cash flow projections of a firm.


India's Long Road by Vijay Joshi

Affordable Care Act / Obamacare, barriers to entry, Basel III, basic income, blue-collar work, Bretton Woods, business climate, capital controls, central bank independence, clean water, collapse of Lehman Brothers, collective bargaining, colonial rule, congestion charging, corporate governance, creative destruction, crony capitalism, decarbonisation, deindustrialization, demographic dividend, demographic transition, Doha Development Round, eurozone crisis, facts on the ground, failed state, financial intermediation, financial repression, first-past-the-post, floating exchange rates, full employment, germ theory of disease, Gini coefficient, global supply chain, global value chain, hiring and firing, income inequality, Indoor air pollution, Induced demand, inflation targeting, invisible hand, land reform, Mahatma Gandhi, manufacturing employment, Martin Wolf, means of production, microcredit, moral hazard, obamacare, Pareto efficiency, price mechanism, price stability, principal–agent problem, profit maximization, profit motive, purchasing power parity, quantitative easing, race to the bottom, randomized controlled trial, rent-seeking, reserve currency, rising living standards, school choice, school vouchers, secular stagnation, Silicon Valley, smart cities, South China Sea, special drawing rights, The Future of Employment, The Market for Lemons, too big to fail, total factor productivity, trade liberalization, transaction costs, universal basic income, urban sprawl, working-age population

Their implied claim that planners have the information to work out the economy’s ideal trajectory, and the power to make it happen, was breathtakingly pretentious. Not surprisingly, they led to huge and costly errors. It has become clear that in the real world the investment interdependency argument can, for the most part, only justify ‘indicative planning’. (The argument for indicative planning is probably strongest in coordinating investments, public and private, in infrastructure networks.) The government also suffers from a ‘principal-​agent problem’. Its functionaries (legislators, bureaucrats) may pursue their own agendas rather than act in the public interest. They may shirk their duties or feather their own nests. They may make deals that benefit special-​interest groups at the expense of the general good. State intervention can also cause losses due to ‘rent-​seeking’. This typically happens when governments intervene by requiring firms to obtain licenses, permits, and monopoly rights for the use of scarce resources.


pages: 472 words: 117,093

Machine, Platform, Crowd: Harnessing Our Digital Future by Andrew McAfee, Erik Brynjolfsson

3D printing, additive manufacturing, AI winter, Airbnb, airline deregulation, airport security, Albert Einstein, Amazon Mechanical Turk, Amazon Web Services, artificial general intelligence, augmented reality, autonomous vehicles, backtesting, barriers to entry, bitcoin, blockchain, book scanning, British Empire, business process, carbon footprint, Cass Sunstein, centralized clearinghouse, Chris Urmson, cloud computing, cognitive bias, commoditize, complexity theory, computer age, creative destruction, crony capitalism, crowdsourcing, cryptocurrency, Daniel Kahneman / Amos Tversky, Dean Kamen, discovery of DNA, disintermediation, distributed ledger, double helix, Elon Musk, en.wikipedia.org, Erik Brynjolfsson, ethereum blockchain, everywhere but in the productivity statistics, family office, fiat currency, financial innovation, George Akerlof, global supply chain, Hernando de Soto, hive mind, information asymmetry, Internet of things, inventory management, iterative process, Jean Tirole, Jeff Bezos, jimmy wales, John Markoff, joint-stock company, Joseph Schumpeter, Kickstarter, law of one price, Lyft, Machine translation of "The spirit is willing, but the flesh is weak." to Russian and back, Marc Andreessen, Mark Zuckerberg, meta analysis, meta-analysis, moral hazard, multi-sided market, Myron Scholes, natural language processing, Network effects, new economy, Norbert Wiener, Oculus Rift, PageRank, pattern recognition, peer-to-peer lending, performance metric, Plutocrats, plutocrats, precision agriculture, prediction markets, pre–internet, price stability, principal–agent problem, Ray Kurzweil, Renaissance Technologies, Richard Stallman, ride hailing / ride sharing, risk tolerance, Ronald Coase, Satoshi Nakamoto, Second Machine Age, self-driving car, sharing economy, Silicon Valley, Skype, slashdot, smart contracts, Snapchat, speech recognition, statistical model, Steve Ballmer, Steve Jobs, Steven Pinker, supply-chain management, TaskRabbit, Ted Nelson, The Market for Lemons, The Nature of the Firm, Thomas L Friedman, too big to fail, transaction costs, transportation-network company, traveling salesman, two-sided market, Uber and Lyft, Uber for X, Watson beat the top human players on Jeopardy!, winner-take-all economy, yield management, zero day

. §§ Oliver Hart and John Moore, “Property Rights and the Nature of the Firm,” Journal of Political Economy 98, no. 6 (1990): 1119–58. ¶¶ For example, Oliver Hart and Bengt Holmstrom, The Theory of Contracts, MIT Department of Economics Working Paper 418 (March 1986), https://dspace.mit.edu/bitstream/handle/1721.1/64265/theoryofcontract00hart.pdf%3Bjsessionid%3DD2F89D14123801EBB5A616B328AB8CFC?sequence%3D1. Holmström’s earlier, pathbreaking work on the “principal-agent problem” (Bengt Holmström, “Moral Hazard and Observability,” Bell Journal of Economics 10, no. 1 [1979]: 74–91, http://www.jstor.org/stable/3003320), provided a foundation for a large subsequent economic literature on the economics of incentive contracts, including incomplete contracts theory. As Holmström and Paul Milgrom noted, the firm itself, including all its rules and norms, can be usefully thought of as an incentive system.


pages: 651 words: 180,162

Antifragile: Things That Gain From Disorder by Nassim Nicholas Taleb

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Air France Flight 447, Andrei Shleifer, banking crisis, Benoit Mandelbrot, Berlin Wall, Black Swan, Chuck Templeton: OpenTable, commoditize, creative destruction, credit crunch, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, discrete time, double entry bookkeeping, Emanuel Derman, epigenetics, financial independence, Flash crash, Gary Taubes, George Santayana, Gini coefficient, Henri Poincaré, high net worth, hygiene hypothesis, Ignaz Semmelweis: hand washing, informal economy, invention of the wheel, invisible hand, Isaac Newton, James Hargreaves, Jane Jacobs, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, Kenneth Arrow, knowledge economy, Lao Tzu, Long Term Capital Management, loss aversion, Louis Pasteur, mandelbrot fractal, Marc Andreessen, meta analysis, meta-analysis, microbiome, money market fund, moral hazard, mouse model, Myron Scholes, Norbert Wiener, pattern recognition, Paul Samuelson, placebo effect, Ponzi scheme, principal–agent problem, purchasing power parity, quantitative trading / quantitative finance, Ralph Nader, random walk, Ray Kurzweil, rent control, Republic of Letters, Ronald Reagan, Rory Sutherland, selection bias, Silicon Valley, six sigma, spinning jenny, statistical model, Steve Jobs, Steven Pinker, Stewart Brand, stochastic process, stochastic volatility, The Great Moderation, the new new thing, The Wealth of Nations by Adam Smith, Thomas Bayes, Thomas Malthus, too big to fail, transaction costs, urban planning, Vilfredo Pareto, Yogi Berra, Zipf's Law

It is easy to assess iatrogenics when the surgeon amputates the wrong leg or operates on the wrong kidney, or when the patient dies of a drug reaction. But when you medicate a child for an imagined or invented psychiatric disease, say, ADHD or depression, instead of letting him out of the cage, the long-term harm is largely unaccounted for. Iatrogenics is compounded by the “agency problem” or “principal-agent problem,” which emerges when one party (the agent) has personal interests that are divorced from those of the one using his services (the principal). An agency problem, for instance, is present with the stockbroker and medical doctor, whose ultimate interest is their own checking account, not your financial and medical health, respectively, and who give you advice that is geared to benefit themselves.


pages: 740 words: 217,139

The Origins of Political Order: From Prehuman Times to the French Revolution by Francis Fukuyama

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Admiral Zheng, agricultural Revolution, Andrei Shleifer, Asian financial crisis, Ayatollah Khomeini, barriers to entry, Berlin Wall, blood diamonds, California gold rush, cognitive dissonance, colonial rule, conceptual framework, correlation does not imply causation, currency manipulation / currency intervention, demographic transition, Deng Xiaoping, double entry bookkeeping, endogenous growth, equal pay for equal work, European colonialism, failed state, Fall of the Berlin Wall, Francis Fukuyama: the end of history, Francisco Pizarro, Hernando de Soto, hiring and firing, invention of agriculture, invention of the printing press, Khyber Pass, labour market flexibility, land reform, land tenure, means of production, offshore financial centre, out of africa, Peace of Westphalia, principal–agent problem, RAND corporation, rent-seeking, Right to Buy, Scramble for Africa, selective serotonin reuptake inhibitor (SSRI), spice trade, Stephen Hawking, Steven Pinker, the scientific method, The Wealth of Nations by Adam Smith, Thomas L Friedman, Thomas Malthus, trade route, transaction costs, Washington Consensus, zero-sum game

It is for this reason that organizational specialists like Herbert Simon have argued that authority in any large bureaucracy does not flow only from the top to the bottom, but oftentimes in a reverse direction as well.14 Chinese emperors experienced this problem much as modern presidents and prime ministers do, in the form of unresponsive and sometimes outright rebellious bureaucracy. Ministers objected to policies proposed by their boss, or quietly failed to implement them. Of course, Chinese rulers had certain tools that modern executives don’t: they could administer vicious floggings on the bare buttocks of even their most senior ministers, or casually imprison or execute them.15 But this kind of coercive solution to the principal-agent problem didn’t solve the underlying issue of information. Bureaucrats often didn’t carry out the wishes of their leader because they had better knowledge of the real conditions of the empire—and could hide their activity from him. A large country like China had to be governed by delegation to local authorities, but then these local authorities would commit abuses, become corrupt, or even conspire against the central government.