The Green Gap

In the Cold War, we feared a Missile Gap was a strategic weakness. Nowadays, we must awaken to the fact that the Green Gap is true strategic weakness: the nations whose economies will thrive in the coming years will not be those with the biggest factories, but those with the most sustainable, efficient, and ecological markets. What we require is a Strategic "Green Reserve" of ecological design to weather the coming changes that both climate and resource scarcity will force on the international economy.

Monday, 7 March 2011

End of the Profit Motive

I'm a reasonably staunch capitalist, and as such, I think the profit motive can be quite useful. Notice I say "useful" and not "good". A hammer is always useful, but only good if it hammers nails. It's evil if it hammers people. Same thing goes for profit motive.

A lot of people blame a lot of corporate greed and malfeasance - especially the most recent economic scams, from Enron to Goldman Sachs - on the profit motive. This blame is partly misplaced. Corporations no longer exist based on the profit motive. The profit motive exists in people - not in corporations. Corporations are made of people with a profit motive. Shareholders want to make the most money they can for themselves. They choose a CEO and structure his salary so that he's got a base income, share price incentives (so he gets paid more when share price goes up), and some stock options of his own. CEO Maxwell wants to make the most money he can for himself. He gets a salary and a bonus based on share performance, and a pile of company shares. He will have only a short time in his position - maybe 6.5 years, perhaps closer to the average 540 days of the last few Goldman Sachs CFOs. How does he maximise his profit in that framework?

Well, for one, he can increase share value. It makes sense. The board of shareholders wants share price to increase, and the CEO's salary is structured to privilege increasing share prices. It's a no-brainer. Button up, stop the outflow of cash, streamline, conquer new markets, widen the profit margin. What a great story to put in Maxwell's next quarterly report!

But all the work is only occasionally noticed. As a matter of fact, Maxwell starts to realise that - no matter what he does - his shares only really move when something good or bad is reported about the company. What good is it if people don't know about all the cost-cutting measures Maxwell is implementing? So the next step is a no-brainer. Invest in a sweet communications strategy. Press releases! Ads! Focus groups! Surveys!

Then Maxwell relises that everyone is doing that. The ecology is full of press releases and most don't get published or noticed at all. It's supply and demand, Maxwell! The greater the supply, the lower the relative demand - in this case, for information. Poor Maxwell... he increased his costs for only marginal share value increases. He did learn something though: he learned that shares start moving when the news does. He learned that share value has little to do with profit, cost-cutting, or market viability. Shares are a speculation based on information, not fundamentals. CEO Maxwell has a control of the fundamentals from his mighty helm in the boardroom - but he can't control the news.

Or can he?

He has the regular forum of the quarterly report. Since that's numbers, nobody could fudge that in a way that the shareholders wouldn't notice, right?

Right?, maybe what I'm saying here is that - if you look at it from a human perspective - the current system incentivises financial fraud. Profit motive is a human trait, not a corporate trait. Corporations do what their humans tell them to. The humans who own corporations own them through shares. The share owners want their value to increase. They create incentives for their helmsmen to increase share value. The helmsmen discover that share values aren't based on facts, they are based on interpretations. The helmsmen then set about manipulating those interpretations.

All of a sudden we've gone and given CEO Maxwell a silver hammer.

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