There’s your problem. Homo economicus sees exactly the same level of risk in this bet no matter what his circumstances are. In the real world, however, the perceived risk (and actions taken around that risk) will differ greatly depending on circumstances. I guy down to his last C-note is going to evaluate the risks of that $20 bet a lot differently than I would. As tagos notes, many of the regulatory deficiencies that led up to the crash came from this misunderstanding. We heard that we could trust the financial industry, since they would not take undue risks (and I said undue, not any). In fact they had strong pressures on them to take undue risks.
In all but the simplest cases we don’t do a good job in computing probabilities. We do fine with dice (assuming some basic level of mathematical ability) but we don’t do well with other things, which explains why so many restaurants get opened.
We can see another example in Japan. A 9.0 earthquake had never happened, so TEPCO assigned it a zero probability. They were slightly wrong.
So, CEOs hired into a company, with no capital at risk, should get nothing besides straight compensation? Works for me.
In fact sharing profits in the way you seem to find an anathema is the norm for Silicon Valley companies, and it seems to have worked out pretty well around here. At its most basic, why would anyone with skill and no money want to join a start-up if there were not the chance of striking it rich from upside profitability? Early employees of start-ups get stock, and the VCs seem to be quite happy with this. So, your understanding of the real world is a bit off.
Capital can diversify in a way that a dishwasher cannot.
I’m not saying that every business should be run as a collective and even if it was i don’t think the dishwasher’s share of profits would be commensurate with the profits of the firm but the risk taken by shareholders of a large corporation is not teh wsame as the risks taken by a small business opwner who is basically all-in on the success of their small business.
You have a simplistic view of CEO compensation. CEO compensation is not determined by value added, its determined by the executive compensation committee and teh way it works in the USA, the CEO’s compensation is determined largely by other CEOs at other companies. There is a reason why US CEOs get paid so much more than their counterparts from other industrialized nations. Its not because they are outperforming those CEOs, its because they have set up a system to get paid more.
Have you heard of resetting options? Those options don’t always become worthless, their strike price is lowered.
Stock options started as a substitute for fixed salaray that was supposed to align the interests of the manager with the shareholder.
It took very little time for stock options to go from a substitute for fixed salary into an addition to fixed salary (after all the alignment with shareholder interests were stil there regardless of whether the option replaced salary or were merely thrown on top of salary).
From there it didn’t take very long to make those option virtually perpetual and reset them any time the stock price dropped. (after all, who caress what happened in the past due to cyclical drops in stock price, what matters is that the incentives are aligned going forward).
So today you have options that keep getting rolled over. Cyclical drops in stock price result in stock options being extended and reset at lower strike prices and cyclical increases in stock price results in incredible profits for mediocre performance.
I wouldn’t have an onjection to stock options that are keyed off of relative performance to an industry group but as complicated as these stock options can get, apparently that is a level of complexity that noone seems to want to adopt.
Thats not always true in practice.
They’re doing fine compared to all the other schlubs that used to work at the same company that got destroyed.
A CEo as investor is an investor when they have their investor hat on.
I think the point is that people that ran the largest insurance company into the ground seem to be getting bonuses simply for sticking around.
The tax implication was that direct salary over $1,000,000 was not deductible so what happens is that the salary is paid in theform of deferred compensation. As much as I think that how we pay our executive s and bankers is a problem because of the incentives they create, I think capping deductible salary at $1MM is kind of stupid. It was one of those symbolic gestures that hurt more than it helped.
I think this thread really lies at the heart of the debate:
Capital does nothing but take risk, that is the sum total of their contribution to the enterprise. It is a necessary function and once locked in, it is not always easy to back out. The question is why capital deserves so much of the gross profit from the enterprise.
Lenders stand in front of capital and they take interest. capital takes more risk so they take more reward. In this sense, it is easy to compare apples to aples in the case of equity versus debt. This is not as easy a comparison to make in the labor v capital context.
You ever hear of countervailing power? There is a reason why Unions were formed, Negotiating severance is not something most people can do before they accept a job. Most lawyers working at the top law firms don’t get to negotiate very much about their compensation when they get hired. Most bankers working at the top investment banks don’t get to negotiate their compensation before they get hired.
The only lawyers or bankers that I know that get to negotiate their compensation bring their own book of business. They are negoatiting not for their labor but for the the enterprise value that they add.
While I did not say that specifically, I’m having trouble seeing how it is inferred. Regardless, the point is you should re-read my post and notice the term that I used: “bargained for” before you accuse me of being a bit off. What I have problem is that all labor should not expect it as an automatic starting point, from mail room clerks to CEOs.
Have you read your profit sharing agreement? They vary widely by industry and even in the same industry. One of my colleagues works for a division that hasn’t seen a profit in almost 10 quarters, yet, he still manages a bonus and some sort of profit sharing because the overall parent company is profitable.
Nonetheless the point remains, anything above market wages should be bargained for. I did not make the assumption that the OP’s start-up restaurant was paying anything less than market rates, that is something you completely assumed by my response.
On my side business, I have put together start-ups that had adequate capital and offered no stock incentives or additional bonuses, but they paid market rates (sometimes better, imo). That’s why people join start ups. But, to expect both, market rate wages and complete upside from profitability is the anathema.
I’m going to try to re-situate the OP in a way that doesn’t change the central premise but maybe avoids some of the criticisms and hijacks.
Here’s the big philosophical premise on which my re-situation is based: freedom is better than coercion. It’s better to set up a society that maximizes the freedom of its members and minimizes the coercion applied to them.
So, in the OP situation, the owner freely agreed to hire the chef, waitress, and dishwasher, and each of them freely agreed to work there in exchange for the agreed-upon compensation. By putting up the money, the owner agreed to lose that money if the business doesn’t work out. So, all parties have exercised free choice and there’s no coercion involved.
In comes one of our resident “capitalism is bad” people who bemoan the fact that more of the upside of the business isn’t shared with the workers. Well, the only way to accomplish your goal is to use coercion (ie, have someone, typically the government) force the owner to share the profits.
But there’s no wrong here that needs coercion to stop it. All parties freely entered into an agreement. O one is being taken advantage of. If the workers wanted a share of the profits, then they could bargain for it. The owner would no doubt want to reduce their base pay in exchange. By demanding that profits be shared, you are essentially forcing the employees to accept reduced base pay.
That is not always the case. Employees can demand equity for their labor. Hedge fund managers do it,CEOs do it, but simply put, the dishwashers of the world cannot do it unless they are unionized. Capital is different than labor, you need both to have an viable enterprise but capital tends to be concentrated in few hands while labor is far more evenly dispersed. As long as there is a positive risk adjusted net present value to an investment, capital will flow to those investments with the highest risk adjusted net present value (and as we can see from recent events, capital will even fly to investments with negative NPV (short term treasuries had a negative yield for a while there) when it must). The question is why we attribute so much of the product of the combined efforts of labor and capital to the owners of capital?
But your argument for how profits should be divided (at least in part) was based on the notion that the restaurant owner faced destitution if the restaurant failed.
You said:
Which could be read to mean she loses everything she had invested in teh restaurant but might still have a lot of money on teh side but then you finish the post by saying this:
Its interesting that you fail to recognize that even if she lost everything, she loses none of her ability to be a dishwasher (who, according to you can save and become a restaurant owner).
So you ahve also to some extent injected the backstory of the owner into the analysis, the heroic restaurant owner who has put it all on the line to make a go of it while the dishwasher can come and go as they please to any dishwashing job (which they can use as a catapult to becoming a restaurant owners if he is thrifty and saves up).
I suspect CEOs (or their agents) have to bargain for the amount of options and bonuses in their contract, but not their presence. They are pretty standard. By that token I didn’t have to bargain for options either. At a certain level this kind of profit sharing is standard for all or most large companies.
I’ve been under bonus plans for over 20 years. There is a wide diversity. Your friend may be getting a bonus because the division exceeded goals. Sometimes the bonus is allocated to personal, division, and corporate results. But the point stands - they are extremely common, and do not have to be bargained for.
Whatever you think should happen, the fact is that this stuff does happen without bargaining. I don’t know what business you are in, but around here no one would be an early employee of a start-up without stock. Why take on the risk without an upside? Your industry might be different. I suspect a much larger percentage of restaurants would be considered startups as compared to electronics companies, and this might push the threshold for profit participation up.
I don’t know how much my friends who joined start-ups got in compensation - none of them gave the impression of rolling in dough. Except during the Bubble these companies want to keep a lid on expenses, and offering options and stock is an excellent way of doing this. On the other hand, you need to attract people from established companies who are doing well, not the losers. It is the same as the reason that most companies no longer pay volunteers to leave during a layoff. You lose the best people, the ones who can easily find a job and also get money to leave.
Totally agree. Dan Ariely notes that the runup in CEO salaries began after the Feds forced companies to publish them. The CEOs were supposed to be ashamed of being greedy - what happened is that their salary became a point of competition with others.
I usually associate risk with volatility rather than level of investment. I do not consider a million dollar purchase of inflation adjusted treasuries as being nearly as risky as buying $1000 worth of lottery tickets. Just putting up the cash is not enough to warrant returns. In many busiensses, lenders provide most of the capital and they earn an interest rate, they also risk their principal if the business fails but they have less volatility and get a commensurately lower expected return.
I thought the point of this thread was that business owners (as the providers of capital) deserved all the profit while labor deserved whatever businessowners could get away with paying them.
Perhaps because what youa re stating is opinion (at least in aprt) about where profit should go.
We blame banks because it is the banks that took the risks that ruined our economy. People don’t walk into a bank and demand a mortgage, they apply for one.
Please give a pointer to whoever claimed that there should be a law requiring profit participation or options. I haven’t noticed anyone proposing this.
What I have noticed is an OP with a simplistic definition of risk who seems to think that only those who invest money deserve any upside returns. In reality those critical to the enterprise typically get upside returns even if they don’t invest any money. Further, in some places this is standard and doesn’t have to be negotiated. The dishwasher isn’t critical, and is unlikely to be included in any kind of bonus plan. The chef is, and a good chef is going to demand it or expect it as a matter of course. Any owner too enamored of the contribution of his capital and who thinks it is evil for others to ask for profit participation is likely to only be able to hire losers.
Is that capitalistic enough for you?
The problem was the development of the private label securitization market. Until that happened, we didn’t have all these alt A and subprime mortgages. Fannie and Freddie didn’t issue CDOs and credit default swaps. They were largely a wholesaler and insurer of conforming mortgages. That was their business. If we never had private label securitization and the non-bank mortgage lenders like coutnrywide, we would never have had a meltdown.
The answer is that that’s the wrong question. Your question is from a top-down perspective, asking why “we” (whoever that is really) “allow” (whatever that means really) profits to go to owners of capital. But that’s neither here nor there. The product of the system that every participant freely chose to create is that the owner makes money if the business is successful and loses money if it’s not. All participants freely chose this.
You (a non-participant) aren’t happy with the arrangement, so you come up with grand theories and use words such as “social justice” and “equality” to try to force the people who freely chose to create the system to make a different system that is more to your liking.
Why do you think it’s OK to tromp all over the agreements made by participants in the system? What if I called you up one day and said “no no no, you shouldn’t be a tax lawyer in a big city, you really should be a farmer. That would better promote justice and equality and other goodness for all mankind. You are doing it wrong.” You’d probably tell me to kindly fucko off.
But, of course, you see a dishwasher as something less than human. They of course shouldn’t be allowed to make their own choices, whereas you should be. This is the greatest element of hypocrisy in thinking like yours–you think your beliefs would elevate the dishwasher but they actually denigrate him.
You are being way too kind to the banks. They actively solicited business from people who did not need additional mortgages, actively solicited refis, and often flipped people who could qualify for fixed rate safe mortgages into risky adjustable ones, and had compensation and bonus packages in place to encourage this.