If You’re For (Or Against) Gov’t Regulations, This Post Is For You
The Real Force Driving Government Regulations Isn’t Left-Wing Ideology. The prime driver behind government regulations is human nature, the normal human response to a negative stimulus.
By David Grace
People Respond To A Negative Stimulus
Stick a pin in someone’s finger and they will pull their hand away.
If enough people get stung by enough bees, they are going to want to “do something” about the bees. It might be something stupid. It might be something extreme. It might be something that is substantially ineffective or even detrimental, but they are going to want to do something.
That’s human nature.
“Bad” Business Behavior Stimulates A Demand For Regulation
Put a tax on some behavior and people will shift their activities in an attempt to avoid it.
Add what is seen as an excessive fee to some common activity and consumers will demand that the government make that fee illegal.
If some businesses are seen as engaging in practices that appear to be unfair, excessive, unreasonable, overreaching, etc. that activity will stimulate a reaction, namely, people will lobby for laws making those “bad” activities illegal.
If enough people feel that they have been screwed by some business practice then they are going to try to get the government to “do something” about that practice.
You can complain about it all you like.
You can claim all day long that some kind of Market force will automatically fix the problem on its own (which is an anarchist fantasy — the real world doesn’t work that way) but your complaints won’t change human nature.
If you have a bunch of businesses being seen as screwing their customers or employees or the public then that’s going to stimulate a reaction in the form of government regulation. That’s the real world and if you don’t want those regulations then you need to find a mechanism that will prevent the “screwing people” behavior from occurring in the first place.
Self-Regulation Is A Myth
But, you ask, don’t businesses act in their own enlightened self-interest? Won’t they resist the temptation to increase short-term profits derived from screwing their customers/employees/neighbors/public and thus avoid triggering the demand for government action?
No, they won’t.
Because of that damn human psychology again.
Certain Short-Term Profit Trumps Theoretical Long Term Loss
If you guarantee someone an immediate and certain reward for good behavior versus an immediate and certain punishment for bad behavior, adults will be more motivated by the certainty of punishment than by the certainty of reward and they will seek to avoid the bad behavior.
But in business, rewards for bad behavior are immediate and calculable while punishments for that same bad behavior are uncertain in both imposition and amount and are indefinite in time.
Humans are very time sensitive. A known reward today is a far more powerful incentive than the threat of a potential, unquantified punishment at some indefinite date in the future.
Think about how the class of people who have no ethical objection to stealing make decisions. You tell them , “If you burglarize this house you will have money today, but if you burglarize this house you might possibly be locked up for some unknown amount of time a year or two in the future.”
What are they going to do?
They are going to burglarize the house.
If you don’t have any moral qualms against doing something then for many if not most people profit today from doing that thing will always be a stronger incentive to do it than the threat of a potential, unspecified punishment at some indefinite date in the future will be an incentive not to do it.
Let’s apply this principle to how businesses work.
Consider these competing messages sent to the executives running a company:
1) “Screw your customers/employees/public and the company will make this much more money in the next six months” and
2) “Screw your customers/employees/public and the company will have some unknown possibility of losing some unknown amount of money at some unspecified date in the future.”
Between these two competing alternatives the executives are vastly more likely to pick option “1” than option “2”. They are far more likely to try to make more money in the short term by cheapening quality, degrading customer support, increasing fees, failing to honor warranties, cutting corners on safety, etc. than they are to abstain from those actions because they are threatened with the potential loss of an unknown level of sales or profits at some unspecified date in the future.
Absent moral qualms, given the two choices — screwing the customer and gaining a known increase in short-term profits and not screwing the customer and avoiding a potential unknown decrease in profits four or five years from now — many if not most humans most of the time will choose door number one.
Executives’ Have A Personal Financial Incentive To Increase Short-Term Profits
The executives who make these choices know that they may not even be working for the company when the chickens come home to roost. And even if they are still with the company they will have already gotten their bonuses and cashed in their stock options by the time the company suffers the penalties from those “bad” actions. On top of that, the injury to the company will not necessarily affect their personal finances.
Their “bad” decisions will enrich them via bonuses and cashed-in options in the short term while they will not have to pay anything out of their own pockets for the company’s long-term losses. These executives know that they are playing a “heads I win, tails you lose” game. Is it any wonder that GM executives refused to spend the relatively trivial amount of money that would have been required to fix the ignition switch defect? Are you surprised that years ago Volkswagen executive engaged in massive fraud in order to sell a few more cars? Do I need to say more than “Countrywide, Lehman Brothers, Bear Stearns, Enron, BP and Arthur Anderson”?
Do you expect business executives to be immune from the rules that govern normal human behavior? Really? They are not. So, that’s reason Number One why businesses often engage in “bad” behavior even though that behavior will likely generate losses in the future and incite new government regulations.
The idea that businesses will self-regulate themselves, will self-police themselves, is so ridiculous it’s laughable. If “screwing the customer/employees/public” behavior will make the company and the executives money now and that same behavior will not personally cost those same executives money later then, of course, they will do it.
Structural Factors Drive The Lust For Short-Term Profits
Naturally, a critical factor in this equation is the intensity of the executives’ desire to increase short-term profits and short-term stock prices.
The more important it is for a company to increase short-term profits the more likely it is that the executives will choose “bad” behavior policies that may eventually stimulate the adoption of government regulations.
There are reasons why the incentive for higher short-term profits has vastly increased over what it was several decades ago. If I may use a sexual scale, the desire for higher short-term profits has grown from a mere fond longing to a burning, savage lust.
The Factors Driving The Pursuit Of Short-Term Profits
1) Executives in most publicly-listed companies have one prime metric for success — quarterly and annual bottom-line profits. These profits are most easily and quickly increased through “bad” behavior and decreased through “good” behavior. Fixing a problem, improving a product, and servicing your customers all lower this quarter’s profits. Not doing those things increases this quarter’s profits.
2) Executives misunderstand the term “Shareholder Value.” They think that (A) there is only one kind of shareholder, namely, the speculators who use their stock as a gambling vehicle, and (B) that the day-to-day price of their shares is an accurate reflection of the value of the company and that (C) they have a fiduciary duty to increase the day-to-day stock price as quickly as possible.
In my view all three of these ideas are factually wrong. For a contrary view see my post, “Shareholder Value Isn’t What You Think It Is”
3) Executives are often compensated with short-term stock options. The more the price of the stock rises during the short vesting period the greater the personal profit the executive realizes. Short-term stock options encourage executives to do whatever is necessary to increase short-term profits regardless of the negative effect those actions may have on long-term profits.
Are There Any Solutions?
I can suggest a few. There are probably better solutions but I don’t know what they are. I’m going with the “It’s better to light one candle than curse the darkness” idea in making these proposals.
1) Abolish granting short-term stock options to executives. I’ve proposed a long-term option mechanism in my post, “A Replacement For Incentive Stock Options — A New Long-Term Incentive Tool For Executives — Abolish ISOs In Favor Of PIUs (Profit Incentive Units)”
2) Include the concept of vesting in connection with shareholder voting rights for all shares not purchased directly from the company, namely, that people who buy shares on an exchange can only vote those shares pursuant to a vesting schedule. I proposed a four year cliff and proportional vesting of voting rights over the subsequent three years after that in my post, “Shareholder Value Isn’t What You Think It Is.”
3) Have some organization, perhaps the body that adopts GAAP rules, I don’t know, redefine “Shareholder Value” as explicitly not the stock price but rather as a combination of factors relating to the overall value of the company as a going enterprise.
That value would include the quality of the company’s products, the expertise, productivity, loyalty and morale of its work force, the company’s reputation and good will both among its customers and the public at large, the long term outlook for its products and market segment, and the like.
Yes, these things are difficult to quantify but there are probably mechanisms that smart people could come up with to implement this idea.
4) Abolish the rule that executives have a fiduciary duty to Wall Street speculators to increase the day-to-day stock price. Replace that theory with the principle that executives have a fiduciary duty to the company’s (1) customers to provide the best products and services possible; (2) employees to provide a good work environment; (3) neighbors and public to responsibly operate the company and (4) shareholders to grow the company’s overall value over the next ten or twenty years through the policies that are compatible with points “1” through “3” above.
Perhaps Jeff Bezos could offer some advice on this topic.
5) Since item “4” above is so difficult to achieve, create alternative forms of business organizations and business financing to at least partially replace the current publicly-traded corporate structure.
In my post, “A New Form Of Business Organization. Replacing The Public Corporation With A Customer Controlled Company” I proposed a business entity whose management was elected and removed by the votes of its customers (each $1 in purchases over the preceding twelve months = 1 vote) without having any equity owners at all. The executives running an organization structured in this way would have an incentive to strive to provide better products and services rather than a drive to increase short-term profits. How would such an organization or any organization that wanted to ignore day-to-day stock prices be financed? In my post “A New Financial Instrument — Not Debt — Not Equity — A Different Form Of Investment Product” I proposed a new financing instrument that did not give investors any voting rights. This financing instrument could also be used as an alternative form of long-term executive compensation to avoid the problems associated with granting executives short-term stock options.
My points are:
1) Short-term profit pressures drive bad business behavior (poor quality, poor service, excessive fees, dangerous conditions, pollution, poor working conditions, etc.)
2) Bad business behavior drives the demand for more government bureaucracy and regulation
3) A shift in emphasis from increasing short-term profits and short-term stock prices to increasing product quality and employee morale will decrease the incidence of corporate “bad” behavior and lessen the motivation for and the need for more government regulation.
Put another way, these sorts of changes might result in some realistic hope for effective self-regulation and self-policing so that the government doesn’t end up having to do it.
Essentially, I’m advocating a cultural shift from executives believing that their principal fiduciary obligation (or in fact that there is any fiduciary obligation at all) to increase short-term profits and short-term stock prices instead to believing that they have a fiduciary obligation to increase product quality, customer satisfaction, employee moral, and the company’s reputation with its employees, customers, vendors, neighbors and the public at large and that these fiduciary obligations far outweigh the value of increased short-term profits.
To achieve that kind of cultural change you need to change how executives are trained, how they are compensated, how they are elected, and how their companies are financed.
To the extent these changes can be achieved the stimulus for and the need for government regulations can be materially decreased.
If not, the escalating negative feedback between “bad” business behavior and the increasing scope and complexity of government regulations will remain the same or get worse.
— David Grace
My Website: WWW.DavidGraceAuthor.com