Unions and Market Forces and the Distribution of Economic Rewards

[lesslucid]

Uh, thought I'd create a thread here for this since it didn't seem especially appropriate in the Garriot in Space thread.

Perhaps I can kick it off by giving my inaccurate summaries of other people's views and then they can kick off by telling me what I've gotten wrong?

On the "Market Forces, Yay!" side we have people saying that if some people (particularly, some computer game developers and programmers) make vastly more than others, its because they have provided vastly more value, or taken bigger risks, or in some other way acted in ways that created more wealth and therefore the fact that they are more wealthy than others is the proper reward for their efforts. In fact, without the possibility of becoming so wealthy being available to them, they would have lacked the incentives to make the kind of decisions that they did and thus might never have done what they did and this would have left everyone worse off.

On the "Market Forces, Not Quite So Yay!" side, we have people saying that unionization or some other form of regulation or redistribution of wealth would help to flatten out the distribution, the scale of the inequality of which is beyond what is necessary for providing an incentive to do good work and is just a bit ridiculous, really.

On the "Market Forces, Yea, They Also Produce Unions!" side, there is an argument that the free market creates incentives not merely to do work and make stuff and invent stuff and sell stuff, but also creates incentives to do stuff like forming cartels and price agreements and lo, even unto unions. I think there's something Stiglitz says about second-best solutions that might be relevant?

Anyway, that's what I gleaned from that part of that thread, from off the top of my head. :)

[AaronSofaer]

On the "Market Forces, Yea, They Also Produce Unions!" side, there is an argument that the free market creates incentives not merely to do work and make stuff and invent stuff and sell stuff, but also creates incentives to do stuff like forming cartels and price agreements and lo, even unto unions. I think there's something Stiglitz says about second-best solutions that might be relevant?


I'm on this side of the argument. My only caveat is that, basically, I hate unions, cartels, price agreements, and for good measure, most employers and corporations, too.

I feel that many entities in today's economic market act in an irrational manner in the long term and that this is highly unfortunate. This includes both unions and corporations.

[Fugitive]

I'm not sure what unionization even has to do with success stories like Garriott's. The wealth they reaped would have been because of their own investments into the company, and a union can't just say "Okay, we're going to force you to give us x% of that."

The best they could do would be to lean on the company and try to convince them to open up additional private shares for the employees to buy, but that's often done without unionization and still needs the employees to take their own financial risks. There's no automatic spreading of the successful profits.

[AaronSofaer]

Also, labor and input of labor aren't the only things important as far as compensation from a company goes. More important is value added to the company, and from the person's perspective, even more important than that is the risk.

Compensation has to be commensurate with the risk, the value, and the labor invested, in that order. An entrepreneur assumes most, if not all, of the risk involved; the value of the company without him would be exactly zero; and he generally would put in an inordinate amount of labor and energy.

As such, his compensation should be much larger than anyone else in the company, assuming he is the only person assuming the risk of starting up the company with his personal funds.

[Jason McCullough]

An entrepreneur assumes most, if not all, of the risk involved.....

.....except he can't lose more money than he personally invests; when the company goes under, it's the creditors that wear a barrel, not the founder. I don't think limited liability is a bad idea, mind you, it's just pretty far afield from the mental model people have of how risk works here.


Compensation has to be commensurate with the risk, the value, and the labor invested, in that order.

You should tell the market they have to work like that, it'd clear things up.

[Phil_Stein]

.....except he can't lose more money than he personally invests; when the company goes under, it's the creditors that wear a barrel, not the founder.

Jason, while what you say is literally true, I'm not sure that it affects the discussion much.

I'd encourage you to read up on the Modigliani-Miller theorem (http://en.wikipedia.org/wiki/Modigliani-Miller_theorem).

In a nutshell, it says that under certain idealized circumstances, the difference between equity and bond holders is merely how risks and rewards are split up.

Or, in the real world, while there are risks to parties other than the founder(s) and other equity holders, in general, the other parties are aware of those risks, those risks are less than for the equity holders, and those other parties are compensated to the degree that they bear such risks.

Example: In another thread (http://www.quartertothree.com/game-talk/showthread.php?t=45457), id4698 asks the forum for advice on raising $1.5 million in investment capital. Let's say that some investors think his idea is sound and want to back him. Assuming the investors are not foolish, they will demand compensation (a share of the rewards if the idea succeeds) proportionate to the risk. Perhaps id4698 will invest $150K himself, and the other $1.35 million will come as a note (debt). If so, that note will very likely have provisions that allow the outside investors to capture much of the upside if the idea becomes a smash success.

Yes, there are also other parties at risk outside of equity and bond holders, including customers and (non-equity) employees. But more often than not (IMO), these parties will be in some kind of position to assess risks and act accordingly. If you are hired by a new startup company with no revenues yet, and your joining that firm involves risk to you (perhaps quitting a more stable job), then you will probably investigate the company reasonably well, and demand something to make up for your increased risk (higher pay, a more fun work environment, stock options, etc).

There may be parties that assume risks that don't consent to such risks. A new factory that pollutes the environment but that isn't capitalized well enough to pay for the cleanup. But there are (imperfect) ways to address these kinds of issues. The way to deal with such problems, IMO, is to improve these ways (regulations, inspections, and so on).

[Jason McCullough]

In a nutshell, it says that under certain idealized circumstances, the difference between equity and bond holders is merely how risks and rewards are split up.

It's a good result, but I'm not sure what the practical relevance to this discussion is of a theory that doesn't include bankruptcy, asymmetric information, is wildly inconsistent with the real-world result of everyone self-financing as much as possible, and assumes an efficient market to boot.

Anyway, I'm just disagreeing with "the entrepreneur assumes most if not all of the risks" as a justification for entrepreneurs making all the money because the premise is false.

[Phil_Stein]

Let's put it this way, Jason:

Risks and rewards are generally apportioned as the parties agree.

Again, using the id4698 example. He wants $1.5 million for a software/entertainment venture. It's not entirely clear what that venture is, but let's say he wants to make a game.

Consider 3 scenarios:

1) id4698 is a 17 year old kid who's been daydreaming about making a better WoW for a while, and he's bought himself a "How to make 3D Games" book. A rational unrelated investor would be highly unlikely to fund him, so it's moot.

2) id4698 is a game industry veteran with a proven track record. He has a team of other solid vets lined up, and a sound plan. An investor might fund him, but game development is risky, so assuming the investor is wise, he/she will demand a large portion of the upside.

3) id4698 is Sid Meier in disguise. Sid probably doesn't need the moeny, but perhaps wants to mitigate his risk. Sid will ask for, and receive, very generous terms from any investors he works with. Sid will likely receive the lion's share of the profits from the venture.

If I understand you correctly Jason, you're assuming that those who put up the capital are naive. If you think real world investors who fund startups are that naive, then perhaps you should create such a startup yourself, under the "heads I win, tails you lose" philosophy. I suspect you'll find the real world is not quite like that.

[Unicorn McGriddle]

Yeah, unions will fix everything. In America. Maybe next time.

[AaronSofaer]

.....except he can't lose more money than he personally invests; when the company goes under, it's the creditors that wear a barrel, not the founder. I don't think limited liability is a bad idea, mind you, it's just pretty far afield from the mental model people have of how risk works here.


If the creditors are going to wear a barrel if the company goes down, they're probably going to be living in a castle made of solid gold if it goes well.

[Rollory]

I'm not sure what unionization even has to do with success stories like Garriott's. The wealth they reaped would have been because of their own investments into the company, and a union can't just say "Okay, we're going to force you to give us x% of that."

Except that's exactly what Disconnected was hinting at as being a preferable outcome.

[Jason McCullough]

If I understand you correctly Jason, you're assuming that those who put up the capital are naive. If you think real world investors who fund startups are that naive, then perhaps you should create such a startup yourself, under the "heads I win, tails you lose" philosophy. I suspect you'll find the real world is not quite like that.

I don't think I'm explaining myself clearly, then. I'm not talking about "overall reward level"; by risk I mean "the error bounds on the expected rate of return, including the worst case of bankruptcy." You can have any level of expected reward combined with any level of risk.

"Fundamentals risk", to make up a term, is made up a bunch of things: competence, quality of idea, timing, market conditions, luck etc. There's basically a fixed pile of risk to distribute in any venture, no matter how safe; a low-risk investment still has risk that is distributed to the participants. That's certainly not entirely borne by the entrepreneur; it's borne by the investors and creditors based on relative amounts of money put in, legal structure, equity arrangements, you name it.

Now compare risk to reward. In general, entrepreneurs can lose the time and foregone wages they invested; they're rarely a significant source of capital (right?). By contrast, investors lose money, usually far more money (right?) than is represented by entrepreneur wages and time.

Obviously this isn't a bad deal for creditors and investors, or they wouldn't do it - they do pretty well overall. The reason they do pretty well is that the risk is commensurate with reward.

Now independently of that there's asymmetric information problems between the individual investors on everyone one of those risk factors - can the bank or investor trust the founder when he says he's competent? Can the founder trust them not to sell him out? I don't see how that changes the above, however; if anything, again the people with all the money are in a less-informed position than the founder. As a result, they charge a risk premium, which is why interest rates go down the more established it is that you're not going to fuck up.

The more risk you absorb, the more you're going to want of the overall return; perfectly fine and normal. Entrepreneurs do not, however, absorb most or all of the risk, so I think Aaron's statement is wrong.

You can then introduce labor into this as another set of stakeholders absorbing some level of risk and reward, but considering the levels of founder investment seen in most startups (right?) I don't think just even comparing labor and the founder gets you the founder having most or all of the risk involved.

Not that I disagree with the founder getting paid more than anyone else; he's usually the owner of the key bit necessary for production - his ideas and plans - so he tends to get paid what that's worth.

[Phil_Stein]

Jason, I'm not totally sure what your problem with the status quo is. I agree with most of what you say in your expanded comments, with perhaps my main quibble being with how much the entrepreneur puts in.

If entrepreneurship was far more rewarding for talented individuals than, say, climbing the corporate ladder, then the market would adjust as corporate types would flee for entrepreneurial positions. Arguably, this happened for a few years during the boom centered around 1998 or so, but I'd argue that the perceived rewards of entrepreneurship during that time were a bit of an illusion, and that most folks who quit good safe jobs for tech startups probably came out behind.

But in any case, the decision to become an entrepreneur, assuming one is already in a relatively good and safe job, is not a trivial one. Entrepreneurs generally invest either cash or foregone wages, work a LOT of hours, and the number who truly hit the jackpot is smaller than you might think if you just read glossy business magazines.

[wildpokerman]

The market system works because it produces well publisized outsized rewards for some which keeps most of us working hard for a below average reward in hopes of that big score.

[Mordrak]

The market system works because it produces well publisized outsized rewards for some which keeps most of us working hard for a below average reward in hopes of that big score.

You mean the lottery?

[Jason McCullough]

Jason, I'm not totally sure what your problem with the status quo is. I agree with most of what you say in your expanded comments, with perhaps my main quibble being with how much the entrepreneur puts in.

Did I say I had one? :)

I think the US should either have a lot more social welfare insurance-type programs, a lot more redistribution of income, or a lot more unions; I'm not picky about the route to get the outcome.

[AaronSofaer]

Jason, my comment was more about entrepreneurs who -do- take up that risk themselves. Ones who don't put in the initial investment out of their own personal finances generally won't be reaping the largest of the rewards.

[Jason McCullough]

Who would these people be? Entirely self-funded startups?

[antlers]

I'm coming in late so I might be off-topic, but I don't think the risk-reward is out of balance between investors and entrepreneurs, it's out of balance between the entrepreneurs and the employees of the startup who don't have a significant equity stake. They don't suffer less than the entrepreneur if the enterprise fails, and they gain hardly anything if the enterprise succeeds.

The way the economy is structured, most people can't attract capital personally and so they have no choice but to work for people who can. This is where the inefficiency of the market resides. What's really being rewarded by the arrangement, then, is being the one who can attract investors and raise capital. You don't have to be able to be able to add value in any other way. And ability to attract capital is basically a network effect, which means it ends up being distributed kind of randomly.

[AaronSofaer]

They don't suffer less than the entrepreneur if the enterprise fails, and they gain hardly anything if the enterprise succeeds.


That assumes the entrepreneur has put zero of his own finances into the company.



Who would these people be? Entirely self-funded startups?

Not necessarily "entirely". Every dollar you put in of your own finances, you might just not get back if it tanks. That's risk right there.

[noun]

LLCs are a plague. It's not a coincidence that corporate ethics went into the shitter around the same time LLCs became widely popular. LLCs encourage more risk and less rational decisions because the consequences for the executives aren't as severe when they fail.

[Jason McCullough]

Not necessarily "entirely". Every dollar you put in of your own finances, you might just not get back if it tanks. That's risk right there.

Well, do you have any information on the general distribution level of founder investment vs. anyone else? I'm going by anecdote here myself.

[Damien Falgoust]

LLCs are a plague. It's not a coincidence that corporate ethics went into the shitter around the same time LLCs became widely popular. LLCs encourage more risk and less rational decisions because the consequences for the executives aren't as severe when they fail.
Oh bullshit. You clearly know next to nothing about choice of business form.

Perhaps you'd like to explain exactly how in the LLC form there are lesser consequences for risk-taking executives than, say, the corporate form?

In fact, why don't you set out the salient differences between the LLC form and the corporate form for the class?

[Anaxagoras]

Oh bullshit. You clearly know next to nothing about choice of business form.

Perhaps you'd like to explain exactly how in the LLC form there are lesser consequences for risk-taking executives than, say, the corporate form?

In fact, why don't you set out the salient differences between the LLC form and the corporate form for the class?
Or you could, you know, answer your own questions (in the affirmative or negative) and actually contribute something.

[AaronSofaer]

Well, do you have any information on the general distribution level of founder investment vs. anyone else? I'm going by anecdote here myself.


Anecdotes here, too. My google-fu fails me.

[Damien Falgoust]

Or you could, you know, answer your own questions (in the affirmative or negative) and actually contribute something.No, I'll save the actual answers until after noun demonstrates his ignorance. He's the one making outlandish claims, I want to see his basis for making them. I'll happily put on a clinic on choice of business form after the kookery is exposed.

[noun]

Perhaps you'd like to explain exactly how in the LLC form there are lesser consequences for risk-taking executives than, say, the corporate form?

In fact, why don't you set out the salient differences between the LLC form and the corporate form for the class?

I thought about rising to the bait quoting all the relevant differences between the two (c corporations having shareholders, LLCs filing as sole partnerships, etc. etc) but given that you're an actual lawyer, I'm sure there's some awesome tidbit you're just waiting to post.

So go ahead, prove me wrong. It's clear you're DYING to.

[Damien Falgoust]

Not until you explain how there are lesser consequences for risk-taking executives in an LLC versus a corporation.

I really, really want to hear this.

(I actually vaguely recall posting a summary of the differences between the various business forms a long, long time ago, but damned if I can find it now.)
(Not it, but here's a start (http://www.quartertothree.com/game-talk/showpost.php?p=664466&postcount=75) for the direction this conversation will inevitably take. Also see Phil Stein's contributions in the same thread.)
(Holy cow, noun dropped out of that other thread when Phil called him out for making a similar error on damn near the same topic.)

[noun]

The way I understood it, LLCs can file taxes as a sole proprietorship and aren't required to be overly strict with their bookkeeping the same way a c-corporation with stockholders must. So the opportunity to fudge numbers can be greater, albeit on a smaller scale.

As far as liabilty goes, am I wrong that standard C corporations are more liable for asset seizure than LLCs? You're the Texas lawyer with 10 years of Usenet posts on legal issues, correct me if I'm wrong. If you do it with a minimum of douchebaggery, I might even listen.

[Damien Falgoust]

LLCs may elect to be taxed on a pass-through basis, like a sole proprietorship or a standard partnership, while retaining the same limited liability for investors that a corporation provides. In short, this means that there is no tax at the entity level, unlike a corporation, which is taxed when the corporation earns income and again at the shareholder level when dividends are declared. A LLC only files an informational return, and the entity's earnings are taxed on each member's tax returns.

So yes, that's correct.

What isn't correct, and what you did not explain, is how this different tax treatment suddenly translates into less risk aversion on the part of executive management.

The executives in an LLC have pretty much the same exposure as an executive in a corporation. And both forms provide limited liability to the firm's investors -- if the enterprise goes belly-up, the shareholders/membership holders' personal assets cannot be pursued, and their risk is limited to the amount of dollars they elected to invest.

There is no difference in risk of asset seizure between a corporation and a LLC. I have no idea where you got that idea.

There is no difference in the adequacy of the bookkeeping required among the two entities. Again, I have no idea where you got that idea. Both have to meet taxing authority standards, and, if publicly traded, will require independent auditors to sign off on their financial statement presentation.

Incidentally, if you say "corporation," you're implicitly talking about a C-corp. No one really uses S-corps anymore, as an LLC or LLP provides the same pass-through treatment without the size limitations imposed by the tax code.

[Damien Falgoust]

(Holy cow, noun dropped out of that other thread when Phil called him out for making a similar error on damn near the same topic.)
Heh. You're consistent, noun, I'll give you that much.

[Desslock]

By contrast, investors lose money, usually far more money (right?) than is represented by entrepreneur wages and time..

That's actually impossible. You don't understand what a valuation is.


Now independently of that there's asymmetric information problems between the individual investors on everyone one of those risk factors - can the bank or investor trust the founder when he says he's competent?

They don't - they charge an appropriate cost to the borrowing commensurate with the underwriting risk.

The only entry barriers to being a successful entrepreneur are intelligence, work ethic and risk tolerance, at least in an open society like the U.S. That doesn't mean you'll necessarily be successful if you have those attributes (that's the cost to having a high risk tolerance) since luck and happenstance can have a huge effect.

[Desslock]

I think the US should either have a lot more social welfare insurance-type programs, a lot more redistribution of income, or a lot more unions; I'm not picky about the route to get the outcome.

What outcome is that, third world status and a much lower standard of living for everyone?

See "Soviet Union, Fall of" at your local publicly funded library.

[SmokeyNecrosis]

More bread and circuses for the masses, while no bid contracts and tax repeal for the elite. I thought everyone was too occupied by Angelina Jolie's new baby pictures and Lindsey Lohan's partying to notice.

[Tortilla]

What outcome is that, third world status and a much lower standard of living for everyone?

See "Soviet Union, Fall of" at your local publicly funded library.

If you think a more equitable distribution of wealth == communism you really need to brush up on your politics and economics.

[Jason McCullough]

That's actually impossible. You don't understand what a valuation is.

Uh, so investors, in general, don't lose money when businesses go under?


They don't - they charge an appropriate cost to the borrowing commensurate with the underwriting risk.

I assume you're referring to how banks make money aggregated across all business loans, even including the ones that go under. Using that logic insurance companies don't lose money when a house burns down, I guess. There's also still creditors and investors with large exposure to specific businesses which it doesn't really apply to, also.


The only entry barriers to being a successful entrepreneur are intelligence, work ethic and risk tolerance, at least in an open society like the U.S. That doesn't mean you'll necessarily be successful if you have those attributes (that's the cost to having a high risk tolerance) since luck and happenstance can have a huge effect.

So banks or investors will loan you money regardless of your net worth, income, past history at starting businesses, or credit history? There's also the illegal but still there categories of racial and sexual discrimination.


See "Soviet Union, Fall of" at your local publicly funded library.

It's a miracle Europe and Japan haven't collapsed, what with their largely government-run health care systems and strong unions.

[Desslock]

Uh, so investors, in general, don't lose money when businesses go under?.

The difficulty in responding to your comments is that it's difficult to tell which kookery you embrace, and which kookery you're falsely ascribing to others. The above sentence, for instance, has nothing to do with my response, so it may either highlight your inability to understand it or it's just representative of the latest nutball theory you're positing.

Amazing that it's so difficult to tell which - you're a human magic 8 ball.


So banks or investors will loan you money regardless of your net worth, income, past history at starting businesses, or credit history?

Whining about not being attractive to investors when you are inexperienced, are unable to put skin in the game, have no history of accomplishment and a proven inability to responsibly service your debt obligations is inane. That's equivalent to complaining that you can't start at shortstop for the Yankees despite never playing baseball before, not owning a glove, and having a history of bashing softballs through your neighbours' windows. You don't get to start as a proven commodity - you have to earn it.

Sure people have different initial capablities to raise capital, but as usual you completely disregard (or are ignorant of) the fact that capital is far more accessible in current American society than it ever has been in any other society/community/nation in the history of this Earth (or Mother Gaia, if that's your preference). There's never been a better environment to foster achievement as an entrepreneur, and as long as you have the intelligence, work ethic, risk tolerance and the determination to persist despite bad luck.


It's a miracle Europe and Japan haven't collapsed, what with their largely government-run health care systems and strong unions.

Yeah, their standard of living and economic growth have been just marvelous compared to the American equivalents over the last 25 years. Jesus, you're just winging it again, aren't you?

Bonus points for throwing in a completely arbitrary segue into Health Care! Next up, Kyoto and gun laws! Your leftwing talking points generator needs a new battery.

[Jason McCullough]

I don't know why I try to have a conversation with you when you're consistently such a dick.

[Desslock]

If you think a more equitable distribution of wealth == communism you really need to brush up on your politics and economics.

Although I have no doubt you and I have substantial differences over what a more "equitable" distribution of wealth means, I'm all for it, so you misread my statement, which was just that Jason's desired outcome would result the sort of standard of living improvements the Soviet Union enjoyed.

[lesslucid]

Yeah, their standard of living and economic growth have been just marvelous compared to the American equivalents over the last 25 years. Jesus, you're just winging it again, aren't you?

Well, I'm less sure about Japan, but there's certainly an argument to be made that for the majority of the population (let's say, those on the median income and below) things both are better and have been improving faster for Europeans than for Americans.

The following rather interesting chart:
http://www.stateofworkingamerica.org/tabfig/01/SWA06_Fig1K.jpg

...shows that in America there has been almost no income growth for people on the 20th percentile since 1980, and relatively very little growth for people in the middle. I will look around for an equivalent chart for "Europe", but it may end up being a collection of different charts for different countries...

[SmokeyNecrosis]

Los Angeles is not the rest of the U.S., but I heard only 12% of the households in LA county can afford the median priced home, which is pretty much a dump. Things might be a little better with this housing crisis, but not that much.

When I first moved to LA 15 years ago, I was able to buy a reasonable condo at 2X my starting law firm salary. The firm I worked for was a small 15 man operation, so we are not talking a huge starting salary.

That condo, which still exists in substantially the same form, is currently, even in this downturn, going for about $500K. There is no way starting law firm salaries are now $250K, even in one of the mega firms.