Posted by Marc Hodak on July 12, 2007 under Invisible trade-offs | 
Only the worst managements do it. It’s a recipe for unintended consequences, like pushing for higher sales, and ending up with crappy profits because you gave up too much secure the sales. Or pushing for higher profits and ending up with crappy returns on investment because you invested too much to gain those profits. I see it all the time.
Guess what? You do too, when watching those managing our country:
“The longer I’m here, the more I’m persuaded that Iraq cannot be analyzed by these kind of discrete benchmarks,” [Ryan C. Crocker, U.S. ambassador to Iraq] said.
After the Iraqi government drew up the first list of benchmarks last year, American officials used them as their yardstick, frequently faulting the Iraqis for failure to act on them…
Measured solely by the legislative benchmarks, he said, “you could not achieve any of them, and still have a situation where arguably the country is moving in the right direction. And conversely, I think you could achieve them all and still not be heading towards stability, security and overall success for Iraq.”
The point here is not to support or criticize our position in Iraq. I’d like to avoid that verbal quagmire. The point here is how similar this sounds to Red Auerbach, former coach of the Boston Celtics.
For those of you not into basketball history, Red Auerbach was a heck of a coach. His Celtics won eleven NBA titles in 13 years. Maybe you remember how dominant the Chicago Bulls with Michael Jordan and Phil Jackson were the ’90s. Those Bulls would have had to win another five straight championships to match Auerbach’s record.
So, Red didn’t trust benchmarks, or “the stats” as he called them. Like all great coaches, Auerbach had a mental framework for what it took to win at his game: The person with the best shot should take the shot; the team should ensure that that person gets the ball; the team should prevent their opponents from getting good shots… Pretty straightforward. All that mattered to him was the score at the end of the game. He stayed away from the stats, especially as they applied to individual performers.
There’s only one stat I was ever concerned about. When this guy’s in the game, does the score go up in our favor or go against us? The Boston Celtics never had a league’s top scorer. We won seven championships without ever placing one Celtic in the top ten.
No Celtic got rated according to how many points or rebounds or assists or anything else he might have compiled. Each man was assessed according to his contribution toward making us a better team. That’s all I cared about. In our system, the guy who sets the good pick was just as important as the guy who made the shot.
How did Auerbach assess that while the game was being played? By watching. By being there.
Now, imagine his coaching task if, before every game, he went behind a curtain and could only manage his team by receiving stats and the play-by-play announcement? The inherent limitation of “managing by the numbers” becomes quite plain.
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Posted by Marc Hodak on July 11, 2007 under History |
My dad was the first to call this morning to wish me a happy birthday. I figured he was the first person to wish me that when I came into the world, but he reminded me that things were different then. The father typically paced the waiting room until a doctor came out to announce, “Congratulations, it’s a boy.” After a while, the dad would be taken to a window behind which were an array of newborns that all looked much less like him than his bald, crotchety Uncle Saul. My case was complicated, my dad told me, by the fact that the doctors found the umbilical cord around my neck, and had to cut my mom to get me out which, at that time, was still a serious operation.
In contrast, when my big guy was born on this same day 18 years ago, I was in the operating room to see him emerge. (Like me, a generation earlier, he decided he wouldn’t leave his mother without a scar for her trouble.) So, like every year since, we wished each other a happy birthday.
Actually, it’s birthday week. My best friend was also born this day, and my wife on Monday. I took her out then, and she’s taking me out tonight. Neither of us is that into growing older, but I always remind her that it’s better than the alternative.
Which reminds me of the lady who brought me into the world. She was a 22 year old girl when the doctors cut her. Year’s afterward, she often showed me her scar to remind me of the day I started causing her trouble–probably the weakest attempt at Jewish mother guilt I’ve ever seen. No doubt, the biggest trouble I caused her–also no fault of mine–was my near death due to illness just a few months after I was born. The doctors plainly told my parents that my survival was a miracle. My dad, who was hunted by Nazis as a child in France, probably took it as just another bit of good luck in an outrageously lucky life, but event clearly traumatized my mom. I believe it contributed to her unadulterated sincerity every time she wished me happy birthday thereafter. I’ve missed her calls very much these last few years.
Posted by Marc Hodak on July 10, 2007 under Patterns without intention |
The McKinsey Quarterly features an interesting article on organizational complexity, offering the following advice:
Executives should distinguish between two types of complexity—institutional and individual. The former concerns the number and nature of interactions within a company, the latter the way individual employees and managers experience and deal with complexity.
This is similar to the powerful distinction of internalizing complexity. That’s when an organization takes on additional work processes in order to spare individuals from having to deal with them. For example, consider where electricity comes from. For the producer, it comes from a bewilderingly complex system of plants, wires, engineers, etc. And behind that, the complexity mushrooms into coal suppliers, an educated labor pool, ad infinitum. But for you and me, it comes from a wall outlet. Where does water come from? The faucet. Where does your friend’s voice come from? The cell phone. How does a car move? Push down on the accelerator.
One of the things that markets do extremely well is simplify our lives. Complexity has a cost, and producers compete on minimizing costs to their customers. So, if a producer has a choice between complicating their own life versus that of their customer, the producer will tend to absorb the complexity. Only then will they seek ways to minimize complexity within their organization so it can function more efficiently. Disney World is a notoriously difficult place to work precisely because it’s a seamless paradise for kids and families. All the complexity required to produce the “Disney Magic” is absorbed by the folks behind the scenes.
Contrast that with how well government “services” internalize complexity–or not.
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Posted by Marc Hodak on July 9, 2007 under Revealed preference |
If you wanted to enhance the credibility of the teaching of good governance, wouldn’t you go to an organization like the U.N.? Of course. That is why the U.N. has endorsed certain guidelines for business school education such as:
We will incorporate into our academic activities and curricula the values of global social responsibility as portrayed in international initiatives such as the United Nations Global Compact.
Since I think the U.N. should be taken at its word, I have begun to think about cases that can be used to teach these principles. For example, Principles 1 and 2: “Businesses should support and respect the protection of internationally proclaimed human rights; and make sure that they are not complicit in human rights abuses” could be illustrated with examples of how the U.N. has built its organizational capability to clean up human rights abuses. Or Principle #10: “Businesses should work against corruption in all its forms, including extortion and bribery” could be illustrated with this.
Gee, if I wasn’t so busy preparing for my course on corporate scandals, I’m sure I could dig up lots of examples of U.N. initiatives to illustrate good governance.
Posted by Marc Hodak on July 8, 2007 under Invisible trade-offs |
Isn’t it ridiculous that homeland security funds are being taken away from New York and given to terror targets like Louisville, KY, or Omaha, NE? That’s the understandable reaction of New York politicians.
“Why do they persist in giving money to places that need it a lot less than New York City?” said [New York Senator Charles] Schumer, a Democrat.
“They still just don’t get it,” said [New York Rep. Peter] King, the ranking Republican on the House Homeland Security Committee. “New York is by far the No. 1 terrorist target in the country, and no one else is even a close second.”
As a New Yorker, here is what I don’t get: Why should I expect people from Nebraska or Kentucky to pay for my security in New York any more than one should expect me in New York to pay for security in Nebraska or Kentucky? In other words, why should these tax dollars be funneled through Washington at all? It’s not like New York is a poor state. It’s not as if New Yorkers don’t choose to live there, acutely conscious of the risks of terrorism. It’s not like God said that New Yorkers and non-New Yorkers in middle America are bound to cross-subsidize each other on matters of local protection, even from foreign enemies. Politicians playing God have decreed that, but it doesn’t mean it has to be that way.
Everyone knows that the only reason Kentucky or Nebraska is getting Homeland Security funds at all, which include taxes collected from Kentuckians and Nebraskans as well as New Yorkers, is that (1) every state has representation in Congress, (2) Congressional representatives are in the business of getting the most for their respective constituencies, and (3) by just saying the right thing like, “Hey, terrorists can strike ANYWHERE,” congressmen can enlarge that tax pool, then dip into it to spread the wealth around. That’s what politicians do.
Now, I can see that if New York, or any state, were being attacked by a foreign army then, yeah, we all chip in for the common defense. I’m sure President Bush and the fear-mongering hawks on both sides of the aisle will say, “Well, Hodak doesn’t get it. This IS a war! Anyone who wants to treat terrorism as a criminal matter is basically surrendering to the enemy.”
Hmm, “war” or “criminal matter?” Politicians benefit from eliminating useful distinctions, like the possibility that the fight against terror could be viewed as both a war and a criminal matter. If they bought into that distinction, then they could allocate money to the military for the “war” aspect of this fight, i.e., hitting terrorist bases in Afghanistan or wherever, and allow the states to carry on the domestic, “criminal” aspects of the fight, like car bombs and shootings, ideally coordinating with the Feds rather than getting into pissing matches over turf.
In other word, they don’t have to funnel all that homeland security money through Homeland Security in Washington. Congress could allow local politicians to raise what they need locally to defend their localities from acts that are materially indistinguishable from crimes. In other words, we don’t have to impose a beggar-thy-neighbor system for local spending. Congress doesn’t have to bribe us with our own money to do what we need to in order to defend ourselves.
Posted by Marc Hodak on July 6, 2007 under Patterns without intention |
New York, the bluest city in the among the bluest states, whose people love taxes, is phasing out taxes on apparel and footwear by next year.
Interestingly, just a couple months ago the NY Times had an article about how popular destinations like New York were socking it to their tourists in the form of out-of-control hotel and rental car charges, telling visitors in essence to, “suck it up, you don’t vote here.” But even New York got embarrassed by their 20 percent tax rate on hotel rooms when the joke among travel agents became, “stay for four days, pay for five.” New York has since backed down to about a 14 percent rate, at the lower end of the range among major cities. Tax competition.
Now, politicians seem to be singing a very different tune:
The repeal of this tax will enhance the City’s attractiveness as a tourist destination, particularly to individuals from outside the United States who wish to take advantage of the current exchange rates. Eliminating the city’s portion of the sales tax will encourage consumer spending, which will help to stimulate economic activity and create and preserve jobs in New York.
Tax competition.
Where will it end? I predict, in the distant future, a uniform rate on consumption and earnings–all in–somewhere between 10 and 15 percent. That’s the rate that would justify a political entity’s ability to secure the rights of those transacting and owning property within its territory, and ancillary services most efficiently produced by a polity rather than a market. Everything else will be competed away–the graft, the logrolling, the favors to special interests that come at everyone else’s expense, the looting of those who can afford to pay. Tax competition. The very people who hate it will be disciplined by it, as surely as water runs downhill.
Posted by Marc Hodak on under Executive compensation |
First Chanos, the short-seller made famous by his Enron call, and now ISS. Chanos is concerned that Macquarie might be creating a false impression of high and growing earnings which may not be sustainable. ISS’s complaint is that Macquarie’s executives don’t have the right incentives to sustain those earnings. I can’t evaluate Chano’s concern, but I can shed some light on ISS’s:
Should the gains prove fleeting, an executive would have little exposure to that future downside risk…
ISS also criticizes the company for giving executives 74.2% of their total pay as cash. ISS argues that corporate executives should receive a bigger chunk of [it] in company stock that can’t be sold right away — an incentive for them to keep earnings growth brisk.
Of the US$25.6 million that Macquarie Chief Executive Allan Moss was paid in the fiscal year that ended on March 31, 87% was in his bonus check and 4.2% in Macquarie stock. By contrast, of Citigroup Chief Executive Charles Prince’s $25.98 million, nearly 44% was in Citigroup stock.
And what, exactly, is driving Mr. Moss’s bonus? According to Macquarie’s Remuneration Report, their executives’ bonus plan is based on “growing net profit after tax and sustaining a high return on equity.” ISS’s concern is accountability for future earnings, but Macquarie’s incentive plan has been relatively unchanged since 1985; their performance standard is highly likely to be net profit and ROE for the foreseeable future. Sounds pretty shareholder-friendly to me. In fact, such a results-focused plan is exactly what research shows yields the best results for shareholders. And Macquarie has done extremely well with their plan, better than Citigroup or any of it’s major peers.
Macquarie’s bonus plan stands in stark contrast to Citigroup’s. Prince’s bonuses are based on multiple financial and non-financial criteria, subjectively assessed by the board. The criteria and performance thresholds get reviewed each year and are subject to change. This is the type of unfocused, discretionary, shifting plan that the same research shows to be of least value to the shareholders. Furthermore, unlike Mr. Prince’s bonus, a good portion of Macquarie’s is deferred and forfeitable. Mr. Prince may elect to defer some of his cash, but he can’t lose any of it, even if he leaves involuntarily.
Perhaps ISS’s qualm is that Macquarie’s executives should have more equity. So how much equity does a CEO need? Macquarie’s chief has nearly one million shares and options. Is that enough? A five percent gain or loss in Macquarie’s stock price would swing his personal wealth by about $4 million. Citibank’s Prince has 2.6 million shares. So, how much difference does it make to his alignment that he got another 0.2 million last year?
By the way, most of Prince’s equity grant was not performance-based. The board awarded it to “increase retention.” I suppose that means they needed to give him that award to keep him at the helm versus, say, jumping over to JP Morgan, or retiring. As if. And, unlike Citibank, Macquarie’s guidelines prohibit hedging of executive’s shares.
So what exactly does ISS have against Macquarie’s incentive compensation that they might want it to look more like Citigroup’s?
Posted by Marc Hodak on July 4, 2007 under History |
How many people know what the Declaration of Independence actually says? My son, who just got back from a course at FEE (he loved it) read it yesterday because he figured it was probably worth knowing first hand.
Much of what we know about the drafting of the Declaration comes from John Adams. Adams had agitated for a formal declaration. He pushed through the formation of a subcommittee to write it and the quiet, young Jefferson as a member of that subcommittee. Here is his famous recollection of the argument with Jefferson over who should draft it.
The subcommittee met. Jefferson proposed to me to make the draft.
I said, ‘I will not,’ ‘You should do it.’
‘Oh! no.’ ‘Why will you not? You ought to do it.’
‘I will not.’
‘Why?’
‘Reasons enough.’
‘What can be your reasons?’
‘Reason first, you are a Virginian, and a Virginian ought to appear at the head of this business. Reason second, I am obnoxious, suspected, and unpopular. You are very much otherwise. Reason third, you can write ten times better than I can.’
‘Well,’ said Jefferson, ‘if you are decided, I will do as well as I can.’
Most schoolchildren, who these days are often told that Jefferson was just another white slaveholder, don’t know that some of the most impassioned rhetoric in his original draft included an invective against “negro slavery.” Jefferson was bitterly disappointed (though not surprised) that this passage was struck by the South Carolina and Georgia delegates.
The Declaration ends with the famous pledge by the signers of “our Lives, our Fortunes, and our Sacred Honor,” but few people understand how dangerous the Declaration really was for it’s signers. Up until July of 1776, members of the Continental Congress could hold out some hope for a negotiated settlement with the Crown, whereby they might get the King to see the errors of his ministers in provoking the colonies, and perhaps be spared from hanging for treason. The colonies were in a state of rebellion for over a year by then. The Continental forces had lost every battle thus far, and was steadily approaching desperation.
Against this backdrop, the Declaration was drafted and passed, personally calling the King a “tyrant” and completely severing the bond to England. This was the point of no return. To every practical person alive that day, each signer of the Declaration had basically signed his death warrant. It wasn’t until the following Christmas eve that there arose the first glimmer of hope among the colonists to be free of the Crown, and among the signers of living to an old age, when General Washington would win his first battle in his surprise attack on Trenton after crossing the Delaware.
The Declaration was originally passed on July 2nd when most delegates were in a rush to get out of Philadelphia. John Adams sent a letter to his wife the next morning predicting the celebrations that continue to this day, kind of:
The Second Day of July 1776 will be the most memorable Epocha, in the History of America. . . . It ought to be solemnized with Pomp and Parade, with Shews, Games, Sports, Guns, Bells, Bonfires, and Illuminations from one End of this Continent to the other from this Time forward forever more.
As it turns out, the Congress debated a few more changes in the final draft on July 3rd and 4th before finally approving the document. Thus history fixed the date joining Adams and Jefferson in history forever as the 4th of July. Adams and Jefferson both died on July, 4, 1826.
Posted by Marc Hodak on July 3, 2007 under Collectivist instinct |
Check out this lede:
The government regulates real-world commerce and crime. But as virtual worlds become more complex, should the government regulate virtual life?
Did it come from The Onion or the MSM?
Posted by Marc Hodak on July 2, 2007 under Executive compensation |
Instead, I’m concerned.
The adversary is Towers Perrin, the embodiment of everything that is wrong with compensation governance. Towers’ outmoded, feel-good HR model places too much emphasis on “competitive” pay and too little on aligning managers and owners. They’re responsible for entire HR bureaucracies focused on rewarding strategies instead of results. They don’t offer shareholder-friendly incentives.
The government suspects this failure is the result of the corrupting influence of managers who resist the accountability of such incentives, but I believe that suspicion is misplaced. No, Towers fails to offer useful incentives because their clients, including the most conscientious boards of directors in America, don’t want them. Useful incentives require innovation, and boards are not in the mood. Instead, HR firm clients rely on their consultants’ experience to give them an incentive plan just like everyone else’s. No one will pay Towers, or Mercer, or Hewitt, or Watson Wyatt–what you might call Big HR–for any incentive plan that will differentiate their company, so Big HR doesn’t develop them.
Consequently, Big HR is intellectually stunted with regards to leading edge, value-focused incentives. Their consultants are uninformed in modern financial economics–the main vein of research relating incentives to shareholder value. Their analysis is schlock, based on reticent hypotheses, yielding conclusions of questionable validity. To the extent they keep up with developments in incentive compensation at all, it’s by stealing the ideas of people who bridge the gap between research and practice. Some of us have a foot in academia and a hand on the pulse of actual clients. Firms like Towers Perrin have both arms around their clients, and legs, furiously shaking to loosen up some more dollars to meet their shareholders’ quarterly expectations.
So, I should be happy that Towers is feeling the heat of a congressional committee seeking all of their sensitive client information. But, I’m not. Perhaps it’s my sense of history. Perhaps it’s because, for all their faults, Towers Perrin doesn’t scare me.
