Tech

'The Global Semiconductor Value Chain: A Technology Primer for Policy Makers' (Stiftung Neue Verantwortung Policy Brief) by Jan-Peter Kleinhans and Nurzat Baisakova comments 

 Semiconductors such as memory chips or processors are a foundational technology and the backbone of modern society. Not only are they a prerequisite for any endeavors into emerging technologies, such as artificial intelligence, quantum computing, autonomous vehicles and many more. But every industry relies on access to those chips. As a result, semiconductors are at the heart of the intensifying US-China technology rivalry. China is highly dependent on US-origin semiconductor technologies and the US government uses its export control regime to curb the technological advancements of certain Chinese companies. These export control measures work especially well in the semiconductor value chain because of strong interdependencies due to high divisions of labor. 

The semiconductor value chain is defined by a few key countries – United States, Taiwan, South Korea, Japan, Europe and, increasingly, China. None of these regions have the entire production stack in their own territories since companies often specialize on particular process steps (design, fabrication, assembly) or technologies (memory chips, processors, analog semiconductors, etc.) in pursuit of economic efficiency. Ultimately, no region has achieved “strategic autonomy”, “technological sovereignty” or “self-sufficiency” in semiconductors. In fact, the semiconductor value chain is characterized by deep interdependencies, high divisions of labor and close collaboration throughout the entire production process: US fabless companies rely on Taiwanese foundries to manufacture their chips. The foundries themselves rely on equipment, chemicals and silicon wafers from Japan, Europe and the US. The semiconductor value chain is thus highly innovative and efficient but not resilient against external shocks. 

Such a complex and interdependent value chain creates three challenges for policy makers: First, how to ensure and secure access to foreign technology providers through trade and foreign policy? Since any of the above-mentioned countries could severely disrupt the value chain through export control measures, foreign and trade policy plays a key role to ensure continued access to foreign technology providers. Second, how to build leverage by strengthening domestic companies through strategic industrial policy? Since no region will be able to have the entire production stack within their own territory, governments should support their domestic semiconductor industry to maintain key positions within the value chain. Third, how to foster and support a more resilient value chain? In certain parts, such as contract chip manufacturing, the value chain is highly concentrated and needs to be diversified to lower geographical and geopolitical risks. 

This paper provides a first analytical basis for policy makers. It gives an overview of the global semiconductor value chain, its interdependencies, market concentrations and choke points.

Dirigisme

'From Industrial Policy to National Industrial Strategy: An Emerging Global Phenomenon' by Thomas A. Hemphill in (2020) Bulletin of Science, Technology and Society comments

In February 2019, the German federal government announced its new “National Industry Strategy 2030.” Many economies — including the United Kingdom (2017), European Union (2017), and Saudi Arabia (2018) — have announced national industrial strategies addressing the competitive threat of the People’s Republic of China’s 2015 “Made in China 2025” 5-year economic plan to become a global leader in 10 advanced technology manufacturing sectors. The use of the 20th-century term “industrial policy” heralds back to public policy antecedents of what is now evolving globally in the 21st century as national “industrial strategy,” a concept explored in this article. Unlike traditional 20th-century efforts at industrial policy (which focused on public policy efforts to maintain domestic primacy of declining, older industries), national industrial strategy recognizes (and generally accepts) the international global economy as a foundation of competition. Most importantly, national industrial strategy focuses on technologically emerging industries as well as the national government working collaborative in a partnership with these emerging industries to meet future growth challenges and opportunities

Anxieties

'The History of Technological Anxiety and the Future of Economic Growth: Is This Time Different?' by Joel Mokyr, Chris Vickers, and Nicolas L. Ziebarth in (2015) 29(3) Journal of Economic Perspectives 31-50 comments 

Technology is widely considered the main source of economic progress, but it has also generated cultural anxiety throughout history. From generation to generation, literature has often portrayed technology as alien, incomprehensible, increasingly powerful and threatening, and possibly uncontrollable (Ellul 1967; Winner 1977). The myth of Prometheus is nothing if not a cautionary tale of these uncontrollable effects of technology. In Civilization and its Discontents, Sigmund Freud (1930 [1961], pp. 38–39) assessed what technology has done to homo sapiens, making him into a kind of God with artificial limbs, “a prosthetic God. When he puts on all his auxiliary organs he is truly magnificent; but those organs have not grown onto him and they still give him much trouble at times.”

So it is surely not without precedent that the developed world is now suffering from another bout of such angst. In fact, these worries about technological change have often appeared at times of flagging economic growth. For example, the Great Depression brought the first models of secular stagnation in Alvin Hansen’s 1938 book Full Recovery or Stagnation? Hansen drew on the macro economic ideas of John Maynard Keynes in fearing that economic growth was over, with population growth and technological innovation exhausted. Keynes was also drawn into the debate and offered a meditation on the future of technology and unemployment in his well-known essay, “Economic Possibilities for our Grandchildren".

This was originally written as a set of lectures in 1928 after a decade of dismal economic performance in the United Kingdom and then revised in 1930 to incorporate remarks about the Great Depression (Pecchi and Piga 2008, p. 2). Keynes (1930) remained optimistic about the future in the face of staggering unemployment, writing: “We are suffering, not from the rheumatics of old age, but from the growing-pains of over-rapid changes, from the painfulness of readjustment between one economic period and another. The increase of technical efficiency has been taking place faster than we can deal with the problem of labour absorption; the improvement in the standard of life has been a little too quick.” More recently, Winner’s (1977)  Autonomous Technology: Technics-out-of-Control as a Theme in Political Thought was published during the economic doldrums of the mid and late 1970s. Today, distinguished economists such as Lawrence Summers (2014), in a speech to the National Association of Business Economists, can be heard publicly musing about the possibility of secular stagnation. In his Martin Feldstein lecture, Summers (2013b) discussed a downright “neo-Luddite” (that famous protest movement against technological innovation in nineteenth century England) position on the effects of technology for long-term trends in employment.

Anxieties over technology can take on several forms, and we focus on what we view as three of the most prominent concerns. The first two worries are based on an “optimistic” view that technology will continue to grow and perhaps accelerate. First, one of the most common concerns is that technological progress will cause widespread substitution of machines for labor, which in turn could lead to technological unemployment and a further increase in inequality in the short run, even if the long-run effects are beneficial. Second, there has been anxiety over the moral implications of technological process for human welfare, broadly defined. In the case of the Industrial Revolution, the worry was about the dehumanizing effects of work, particularly the routinized nature of factory labor. In modern times, perhaps the greater fear is a world like that in Kurt Vonnegut’s 1952 novel Player Piano, where the elimination of work itself is the source of dehumanization (for example, Rifkin 1995). As Summers said (as quoted “not perfectly verbatim” in Kaminska 2014), while “[t]he premise of essentially all economics . . . is that leisure is good and work is bad. . . . economics is going to have to find a way to recognize the fundamental human satisfactions that come from making a contribution . . .” A third concern cuts in the opposite direction, suggesting that the epoch of major technological progress is behind us. In recent years, even in the face of seemingly dizzying changes in information technology, pessimists such as Gordon (2012), Vijg (2011), and Cowen (2010) have argued that our greatest worry should be economic and productivity growth that will be too slow because of, for example, insufficient technological progress in the face of “headwinds” facing western economies. Some of these so-called “headwinds,” including slow productivity and population growth, formed the basis of Hansen’s (1939) secular stagnation hypothesis. The argument of this paper is that these worries are not new to the modern era and that understanding the history provides perspective on whether this time is truly different. The next section of the paper considers the role of these three anxieties among economists, primarily focusing on the historical period from the late 18th to the early 20th century, while the final section offers some comparisons between the historical and current manifestations of these three concerns.

Costs

Full disclosure in the the PE space? 'Beware of Venturing into Private Equity' by Ludovic Phalippou in 2009 comments

Because a buyout fund buys 100 percent of the company and controls it, it has often been argued that buyout funds reduce the problems created by a separation of ownership and control. Buyout funds are in full control of companies but minority shareholders. The majority of the shareholders are the investors in the funds. This new governance structure may introduce new agency conflicts and preserve some of the old ones. To understand whether buyout funds reduce overall agency conflicts, we need to better understand the relation between buyout funds and their investors. As a step in this direction, this paper describes the contracts between funds and investors and the return earned by investors.

The average fund charges the equivalent of 8 percent fees per year despite a return below that of the Standard and Poor's 500. This excessive rent raise the question of why does the marginal investor buy buyout funds? I explore one potential - and probably the most controversial - answer: some investors are fooled.

I show that the fee contracts are opaque and difficult to quantify. In addition, compensation contracts imply lower fees at first sight than in reality. What generate large fees are some details of the contracts, not the big headline. Investors may thus underestimate the impact of fees. I also show the different aspects of the fund raising prospectuses that can be misleading. I then discuss whether investors can learn or whether this situation may persist. Finally, to further understand the potential agency conflicts between buyout funds and their investors, I discuss a few features of buyout contracts that exacerbate conflicts of interest, rather than mitigate them. For example, several contract clauses provide steep incentives that distort the optimal timing of investments, their leverage, their size and the number of changes operated in portfolio companies.

Phalippoustates

A large literature has pointed out that publicly owned companies may suffer from a separation of their ownership by dispersed shareholders and their day-to-day control by managers. This separation of ownership and control leads to a number of so-called agency conflicts, in which management may not act in the best interests of shareholders.

Because a private equity fund buys 100 percent of the company and controls it, it has often been argued that the arrangement will reduce these agency problems (Jensen, 1989; Shleifer and Vishny, 1997). But while private equity funds have full control of companies, the fund itself is acting on behalf of outside investors. In a typical scenario, a private equity buyout fund buys a company by borrowing money from banks and by using cash provided by a small group of large investors such as university endowments or pension funds. The companies targeted for buyout could be listed on a stock exchange (for example, Nabisco in 1989 or Hospital Corporation of America in 2006) or be privately held (Hertz Corp. bought from Ford in 2005 or Warner Music bought from Time Warner in 2004). This new private equity fund governance structure may ameliorate some agency conflicts, but it may also introduce new ones. As a step towards understanding whether private equity buyout funds reduce overall agency conflicts, this paper describes the contracts between funds and investors and the return earned by investors.

The paper sets the stage with a puzzle: the average performance of private equity funds is above that of the Standard and Poor’s 500 – the main public stock market index – before fees are charged, but below that benchmark after fees are charged. This fact leads naturally to a discussion of the institutional background of buyout funds, beginning with the compensation contracts between the fund and the investors. Next, it covers how buyout funds report their returns, explaining terms like “multiples” and “internal rates of return.”

The average private equity buyout fund charges the equivalent of 7 percent fees per year, despite a return below that of the Standard and Poor’s 500. Why are the payments to private equity funds so large? Why does the marginal investor buy buyout funds? I explore one potential – and probably the most controversial – answer; that is, some investors are fooled. I show that the fee contracts are opaque. The compensation contracts for buyout funds typically imply lower fees at first sight than actually occur. The larger fees are generated by what seem like minor details in these contracts. Investors may thus underestimate the impact of fees. I also show the different aspects of the fund raising prospectuses that can be misleading for investors. I then discuss whether investors in private equity funds learn over time or whether the “low performance – high fee” situation may be persistent. Finally, to further understand the potential agency conflicts between buyout funds and their investors, I discuss a few features of buyout contracts that exacerbate conflicts of interest, rather than mitigate them. For example, several contract clauses provide incentives that can distort the optimal timing of investments, of their leverage, and of their size.

The conclusion emphasizes that these problems with buyout funds should perhaps not be considered too surprising, given that similar issues arise in other common investment vehicles like many mutual funds and hedge funds.

 Pinto again? 'The Use of Economics in Defense of General Motors’ Decision Not to Fix Faulty Ignition Switches Demonstrates that Economics Is Not A Moral Theory' by Daniel Isaacs in (2015) Connecticut Law Review [PDF] comments

The General Motors’ Company recently faced problems with a faulty ignition switch. One might think that GM’s handling of its ignition problem was obviously disastrous, as it killed and maimed many innocent people. Leading law and economics scholar Eric Posner disagrees. He maintains that GM’s actions may have been reasonable if the cost to GM to fix the defect was less than the amount the ordinary person would pay to avoid the risk. His perspective is important and dangerous, because it will encourage similar behavior. Nonetheless, he offers an argument that on the surface seems persuasive. In this Essay I propose to show how Posner is wrong and what makes GM’s actions wrong. Moreover, I offer a different model to understand how companies like GM should approach similar problems.

 Isaacs states General Motors

engineers knew for years that the company installed faulty ignition switches in its vehicles. The switches, when jostled, caused the cars to stall, leaving drivers unable to maintain their speed and disabling air bags. Nevertheless, in meeting after meeting, and despite a toll of numerous deaths and many injuries, those with the authority and responsibility to fix the problem failed to act.

To most people, GM’s actions were clearly wrong. However, Eric Posner, a leading law and economics scholar, disagrees and argues that the public may be asking the wrong question in condemning GM. He maintains that his application of economics as a moral theory demonstrates that GM may have acted properly.  He contends that a manufacturer’s decision as to whether to fix a defective component should turn on whether the cost of fixing the component exceeds what the “ordinary person” would pay to avoid the risk. That is, Posner asserts that if it would cost the manufacturer more than the amount the ordinary person would pay to avoid the risk, the manufacturer would be morally justified in keeping its defective product in the stream of commerce.

I disagree, and maintain that economics is a poor tool for making normative decisions like the ones GM faced. Economics does have the advantage of giving definitive answers to difficult questions, and Posner’s argument has some facial appeal. The problem is that he and GM are wrong and other businesses may be following GM’s lead in using economics to make normative decisions. That is why Posner’s perspective is so important and yet dangerous. GM’s lawyers say that everyone was responsible, but no one took action.  However, economics is not a measure of human responsibility to others or to society and it is, therefore, a poor tool for making the normative decisions that GM faced.

... Posner argues that we should not be so quick to condemn GM for its failure to recall its cars with faulty ignition systems. Based on economic theory, he maintains that GM may have acted properly.  While Posner maintains that it is hard to know whether GM acted reasonably or not, his economic argument as to how to analyze the question is flawed. His argument is based on the hypothetical amount that people would pay to avoid the risk of death as a result of GM’s faulty ignition system. Posner also argues that the public should not focus on the claim that it would have cost GM fifty-seven cents per car to fix the ignition switch defect. Instead, he calculates that the risk of being killed as a result of a faulty ignition switch is extraordinarily low, “.0000007 . . . . [t]hat’s less than one in a million.” He reasons that during the same time period the defect increased the risk of death in 2002 “(by .0000007) from .0000567 [in other GM cars] to .0000574.”

He then applied:

a concept known as the “value of a statistical life,” which is derived from studies of how much people need to be paid in order to accept a slightly greater risk of death. . . . The current standard is $7 million. The $7 million figure implies that an ordinary person would be willing to pay about $5 to avoid a .0000007 risk of death in a given year.

Doing the math, Posner calculates that GM “should have fixed the ignition switch if the cost was less than $5 per car, multiplied by the number of years left in the car’s useful life.” Based on the value of a statistical life analysis, Posner argues that GM should have paid “$40, or $5 per car multiplied by the average eight years of remaining time on the road.” GM claims that in 2007 it would have cost $50 to fix each car, so  Posner recognizes that: GM may have known of the problem as early as 2001 but believed that a design change fixed the problem. It revisited the issue in 2004 after receiving a complaint from a customer that the vehicle ‘can be keyed off with knee while driving.’ In 2005 engineers concluded that possible fixes were too costly or inadequate, and later GM told dealers to tell customers to remove heavy items from key rings. Also in 2005, a fatal accident occurred that may have been caused by the ignition switch problem. In 2006 GM began installing modified ignition switches in 2007 models. Over the ensuing years, more fatal accidents occurred and GM conducted additional investigations.

Posner concluded that although “it’s close . . . if it cost $50 to repair an ignition switch, then GM acted reasonably by saving this money rather than recalling cars for the sake of a benefit of $40.”...

Posner’s argument with respect to the proper moral theory GM managers should have applied in determining whether to recall the faulty ignition systems is flawed for three main reasons. First, with respect to a known defect, like the one at issue at GM, the analysis should not be based on the amount “the ordinary person” would pay to avoid the risk compared with the cost to the employer to make the repair. GM was not dealing with random events. Instead, Posner is considering a known defect that manifested in personal injuries and deaths. The rate of injury and cost of repair are immaterial when the actions at issue are known ones, as they were in the case of GM’s actions concerning the faulty ignition switch. For example, if I were to swing a bat in a public space (even if I were blindfolded) I would not know who I am going to hit, but eventually, I am likely to injure someone. When I do, factors such as my costs of not swinging the bat, the amount of time people are in the area, or the amount of money people would pay to avoid the risk of being hit are irrelevant to the question of whether I am morally justified in swinging the bat. Once GM knew that the ignition switch was defective, and that it could cause the airbags to fail to deploy, Posner’s cost-based analysis is, at best, a barometer of the improper behavior—a measure of how bad the action is—but it is irrelevant to the moral questions the company faced because he offers a measure that begins above the threshold line of unethical behavior. As a matter of business ethics, if a company knows that a component is defective, and is on notice that the defect caused injury, it should fix the defect—or not sell the product—not balance the cost of fixing the defect against the amount the average person would pay to avoid the risk so as to see whether it should do so as Posner advocates.

Second, Posner does not claim that GM actually conducted a hypothetical “value of a statistical life” analysis with respect to the GM customers who purchased vehicles with faulty ignition switches; and he recognizes that his calculations exclude the costs of personal injuries, the damage to property, and the possibility that GM knew about the defect earlier than it claims. Similarly, it is odd that Posner accepts 2007 as the date to conduct the risk benefit analysis, when GM appears to have known about the problem much earlier.

Third, no one appears to have actually disclosed the risk of death or injury to GM’s customers before they purchased their vehicles or actually paid them to avoid the risk. Specifically, it does not appear that GM told potential purchasers that their cars may stall in the middle of an intersection, that their airbags would not deploy, and that GM may have known that a faulty ignition switch would cause injuries or death to some of them and that they, for a price, could avoid the risk by purchasing a product that did not contain the defect.

Relying on Posner’s economic theory is akin to holding someone to a hypothetical contract that provides that where the cost to the company of repairing a known defect is less than the amount the consumer would pay to avoid the risk, the manufacturer would have no duty to make the repair.

Corporations

'The mortality of companies' by Madeleine Daepp, Marcus Hamilton, Geoffrey West and Luís Bettencourt in (2015) 12(106) Interface comments

The firm is a fundamental economic unit of contemporary human societies. Studies on the general quantitative and statistical character of firms have produced mixed results regarding their lifespans and mortality. We examine a comprehensive database of more than 25 000 publicly traded North American companies, from 1950 to 2009, to derive the statistics of firm lifespans. Based on detailed survival analysis, we show that the mortality of publicly traded companies manifests an approximately constant hazard rate over long periods of observation. This regularity indicates that mortality rates are independent of a company's age. We show that the typical half-life of a publicly traded company is about a decade, regardless of business sector. Our results shed new light on the dynamics of births and deaths of publicly traded companies and identify some of the necessary ingredients of a general theory of firms.

The authors state

Publicly traded companies are among the most important economic units of contemporary human societies. As of 2011, the total market capitalization of firms in the New York Stock Exchange was 14.24 trillion dollars, comparable to the entire gross domestic product of the USA. While researchers have devoted considerable attention to the distribution of firm size, the distribution of firm lifespan has been the subject of far fewer studies. Thus, despite the availability of much quantitative information, our understanding of the way public companies live and die remains limited.

At present, there are several arguments addressing the statistics of company lifespans that have led researchers to a range of different conclusions. Some of these considerations hinge on the interpretation of the meaning of the death event for a company. In the framework of this paper, definitions of ‘birth’ and ‘death’ are based on the sales reports available in the Compustat database; details can be found in §4. While liquidation is often responsible for firm deaths, a much more common cause of death relates to the disappearance of companies through mergers and acquisitions. Thus, in our definition, firms may ‘die’ through a variety of processes: they may split, merge or liquidate as economic and technological conditions change. This raises the question of what characteristics of firms may initiate such events. In particular, it has often been suggested that the mortality rates of firms are age-dependent, a proposition that offers significant insight into the forces that determine firm survival. We address this question using a comprehensive database of over 25 000 publicly traded North American companies covering a large spectrum of business sectors over the period 1950–2009. The present analysis provides one of the largest studies of this kind, both in terms of numbers of firms and timespan.

There is a great diversity of perspectives on a theory of the firm, focusing on different aspects of their costs, organization and evolution. In modern economic theory, the existence and boundaries of firms are understood in counterpoint to the dynamics of self-organization in markets. Economists such as Coase and Williamson proposed that firms exist in order to minimize (positive) market transaction costs involved in the production of goods and services. In situations when, for example, there is particular specificity of goods and services exchanged between two economic agents, such transactions may be best organized internally to an organization rather than negotiated in the open market. As such, firms may split, merge or liquidate in response to economic agents evolving new and better ways of dealing with the various costs and revenues of production and exchange. Therefore, at least on the average, the merger of existing companies should be approximately neutral in terms of the balance between costs and benefits. However, this relatively simple picture becomes more complex in the light of behavioural studies of the impact of decision-making and management practices on the growth and viability of actual firms.

A perspective more directly tied to the demography of companies is organizational ecology. In the framework of organizational ecology, organizations that vary in their structure and relationships are modelled as competing for finite resources within a complex ecology of economic interactions. In this approach, which emerged from economic sociology, companies are seen as units of selection in markets and their longevity is the result of their successes of learning and adaptation in these environments. Similar to this approach, we employ mathematical models from theoretical ecology to examine the lifespans and mortality of companies.

Among the most widely replicated results relating to the mortality of firms is Stinchcombe's liability of newness. This is the expectation that young establishments experience higher mortality rates. This scenario is supported by observation of US manufacturing plants, Argentinian and Irish newspaper companies and other types of businesses. Theoretical grounding draws from the adaptive requirements of market entry; it takes time for young companies to gain the competencies and build relationships that will ensure their ability to survive [29,30]. Moreover, new companies are likely to be smaller and less experienced and thus more susceptible to market shocks. Knott and Posen stress the evolutionary character of these arguments by suggesting that liability of newness is evidence for market-based selection.

However, more recent evidence begins to diverge from this hypothesis. In a study of West German business enterprises, Bruderl and Schussler find that companies are, in fact, protected from mortality in the immediate period after founding. This liability of adolescence likely results from the buffer a firm acquires via its capital endowment at birth, which is also a characteristic of firms that have recently entered financial markets. As their initial capital stock is expended, less profitable companies become more vulnerable to environmental changes in market conditions.

A third perspective suggests that mortality rates increase as companies age. This idea is based upon two related concepts: the first is liability of senescence, the idea that as companies age, they accumulate rules and stagnating relationships with consumers and input markets that render them less agile and that re-configuration is increasingly expensive. Arguing instead for a liability of obsolescence, Sorenson and Stuartsuggest that environmental requirements change over time and that, although firms may improve in competence and efficiency with age by becoming more specialized, these specific adaptations also increase the companies’ risk to new kinds of external shocks that will inevitably beset them.

Finally, Coad has argued that these assorted liabilities constitute small deviations, at the tails, from an aggregate lifespan distribution that is generally well approximated by an exponential distribution. This proposition has been confirmed in Italian, Spanish and French firms. As noted by Amaral et al. and Coad, the statistical patterns of firm entry and exit will affect the distribution of firm sizes in any given year and set its form and temporal stability. Thus, a better understanding of the mortality risk of firms is necessary to generate new insights on the empirically observed scaling regularities in firm size frequency distributions.

In this paper, we test these alternative hypotheses of firm lifespan and mortality risk by analysing a large database of North American publicly traded companies between 1950 and 2009. We confirm the hypothesis of an approximately constant mortality rate, finding that the exponential distribution of firm lifespans holds across business sectors and causes of mortality. We apply survival analysis to estimate in a variety of ways that the firms in our dataset have a half-life of approximately 10 years, regardless of age.

Investment

'Corporate Investment and Stock Market Listing: A Puzzle?' by John Asker, Joan Farre-Mensa and Alexander Ljungqvist reports

sizeable and surprising differences in investment behavior between stock market listed and privately held firms in the U.S. using a rich new data source on private firms. Listed firms invest substantially less and are less responsive to changes in investment opportunities compared to matched private firms, even during the recent financial crisis. Ex ante differences between public and private firms such as lifecycle differences at most explain a third of the difference in investment behavior. The remainder appears most consistent with a propensity for public firms to suffer greater agency costs. In particular, evidence showing that investment behavior diverges most strongly in industries in which stock prices are particularly sensitive to current earnings news suggests public firms may suffer from managerial myopia. 

The authors comment that

 This paper compares the investment behavior of stock market listed (or ‘public’) firms to that of comparable privately held firms, using a novel panel dataset of private U.S. firms covering more than 400,000 firm-years over the period 2001-2011. Almost everything we know about investment at the micro level is based on evidence from public firms, which number only a few thousand, yet private firms form a substantial part of the U.S. economy. We estimate that in 2010, private U.S. firms accounted for 52.8% of aggregate non-residential fixed investment, 68.7% of private-sector employment, 58.7% of sales, and 48.9% of aggregate pre-tax profits. Nearly all of the 5.7 million firms in the U.S. are private (only 0.06% are listed), and many are small, but even among the larger ones, private firms predominate: among those with 500+ employees, for example, private firms accounted for 86.4% in 2010. 

Our empirical tests unearth two new patterns. First, private firms invest substantially more than public ones, holding firm size and industry constant. The average investment rate among private firms is nearly twice as high as among public firms, at 6.8% versus 3.7% of total assets per year. Second, private firms’ investment decisions are more than four times more responsive to changes in investment opportunities than are those of public firms, based on standard investment regressions in the tradition of tests of the Q theory of investment (see Hayashi (1982) or, more recently, Gomes (2001), Cummins, Hassett, and Oliner (2006), Bloom, Bond, and van Reenen (2007), and Bakke and Whited (2010)). This is true even during the recent financial crisis. 

We find similar patterns when we exploit within-firm variation in listing status a sample of firms that go public without raising new capital and so change only their ownership structure: IPO firms are significantly more sensitive to investment opportunities in the five years before they go public than after. Indeed, once they have gone public, their investment sensitivity becomes indistinguishable from that of observably similar, already-public firms. We also find similar results when we instrument a firm’s listing status with plausibly exogenous variation in the supply of VC funding across U.S. states and time. 

What would cause public and private firms to invest so differently? One possibility is that the striking difference in investment sensitivities is simply an artifact of our sampling, measurement, or methodological choices. However, extensive robustness tests show that our samples are representative, that our results are robust to various alternative matching approaches, and that the difference in investment behavior does not appear to be driven by how we measure investment opportunities. 

This suggests that we need to look to more fundamental economic differences between public and private firms for an explanation. Lifecycle differences between public and private firms play only a limited role in explaining our results, accounting for less than a third of the difference in investment sensitivities. After ruling out other systematic differences between public and private firms (such as investment in intangibles, tax treatment, and accounting choices), we are left with differences in ownership and agency problems as the leading candidate explanation. 

The corporate finance literature has long argued that stock market listed firms are prone to agency problems. While listing a firm on a stock market provides access to a deep pool of low cost capital, this can also have two detrimental effects. First, ownership and control must be at least partially separated, as shares are sold to outside investors who are not involved in managing the firm. This can lead to agency problems if managers’ interests diverge from those of their investors (Berle and Means (1932), Jensen and Meckling (1976)). Second, liquidity makes it easy for shareholders to sell their stock at the first sign of trouble rather than actively monitoring management – a practice sometimes called the ‘Wall Street walk.’ This can weaken incentives for effective corporate governance (Bhide (1993)). 

Private firms, in contrast, are often owner-managed and even when not, are both illiquid and typically have highly concentrated ownership, which encourages their owners to monitor management more closely. Indeed, analysis of the Federal Reserve’s 2003 Survey of Small Business Finances (SSBF) shows that 94.1% of the larger private firms in that survey have fewer than ten shareholders (most have fewer than three), and 83.2% are managed by the controlling shareholder. According to another survey, keeping it that way is the main motivation for staying private in the U.S. (Brau and Fawcett (2006)). As a result, agency problems are likely to be greater among public firms than among private ones. 

There are three strands of the agency literature that argue public firm’s investment decisions might be distorted due to agency problems. First, Baumol (1959), Jensen (1986), and Stulz (1990) argue that managers have a preference for scale which they satisfy by ‘empire building.’ Empire builders invest regardless of the state of their investment opportunities. This could explain the lower investment sensitivity we observe among public firms. 

Second, Bertrand and Mullainathan (2003) argue the opposite: managers may have a preference for the ‘quiet life.’ When poorly monitored, managers may avoid the costly effort involved in making investment decisions, leading to lower investment levels and, presumably, lower investment sensitivities. 

Third, models of ‘managerial myopia’ or ‘short-termism’ argue that a focus on short-term profits may distort investment decisions from the first-best when public-firm managers derive utility from both the firm’s current stock price and its long-term value.4 If investors have incomplete information about how much the firm should invest to maximize its long-term value, managers may see underinvestment as a way to create the impression that the firm’s profitability is greater than it really is, hoping to thereby boost today’s share price (Stein (1989)). This would lead managers to use a higher hurdle rate when evaluating investment projects than would be used absent myopic distortions, resulting in lower investment levels and lower sensitivity to changes in investment opportunities. Importantly, this would occur even if investors can perfectly observe actual investment (Grenadier and Wang (2005)). The fact that we find lower investment levels among public firms seems inconsistent with empire building. On the other hand, both the quiet life argument and short-termism predict underinvestment, thus fitting the empirical facts we document. To shed further light on what drives the observed investment difference between public and private firms, we explore how it varies with a parameter that plays a central role in short-termism models: the sensitivity of share prices to earnings news. As we explain in Section 4, under short-termism a public-firm manager has no incentive to underinvest if current earnings news has no impact on the firm’s share price, in which case we expect no difference in investment behavior. But the more sensitive share prices are to earnings news, the greater the incentive to distort investment and hence the greater the difference in public and private firms’ investment sensitivities. 

To test these predictions, we follow the accounting literature and measure the sensitivity of share prices to earnings news using ‘earnings response coefficients’ or ERC (Ball and Brown (1968)). For industries whose share prices are unresponsive to earnings news (ERC = 0), we find no significant difference in investment sensitivities between public and private firms. As ERC increases, public firms’ investment sensitivity falls significantly while that of private firms remains unchanged. In other words, the difference in investment sensitivities between public and private firms increases in ERC, and this increase is driven by a change in public-firm behavior. In addition, we show that investment sensitivity is especially low among public firms with high levels of transient (i.e., short-term focused) institutional ownership and a propensity to “meet or beat” analysts’ earnings forecasts. These cross-sectional patterns are consistent with the notion that short-termist pressures induce public firms to invest myopically. 

Our paper makes two contributions. First, we document economically important differences in the investment behavior of private and public firms. Because few private firms have an obligation to disclose their financials, relatively little is known about how private firms invest. A potential caveat is that our analysis focuses on public and private firms that are similar in size, so we essentially compare large private firms to smaller public firms. To what extent do our results extend to larger public firms? We show that the low investment sensitivity among smaller public firms is typical of the investment behavior of all but the largest decile of public firms, which are substantially more sensitive to investment opportunities than the public firms in the other nine deciles. 

Second, our analysis suggests that agency problems in public firms, and in particular short-termism, are a plausible driver of the differences in investment behavior that we document. This finding adds to existing survey evidence of widespread short-termism in the U.S. Poterba and Summers (1995) find that public-firm managers prefer investment projects with shorter time horizons, in the belief that stock market investors fail to properly value long-term projects. Ten years on, Graham, Harvey, and Rajgopal (2005, p. 3) report the startling survey finding that “the majority of managers would avoid initiating a positive NPV project if it meant falling short of the current quarter’s consensus earnings [forecast].” This is not to say that effective corporate governance cannot reduce public-firm managers’ focus on short-term objectives. Tirole (2001) argues that large shareholders have an incentive to actively monitor managers and fire them if necessary, while Edmans’ (2009) model shows that the presence of large shareholders can reduce managerial myopia. But it is an empirical question whether these mechanisms are sufficiently effective on average. Our evidence suggests that, at least on the dimension of investment, this may not be the case. 

The paper proceeds as follows. Section 1 reviews related literature. Section 2 introduces a rich new database of private U.S. firms created by Sageworks Inc. Section 3 establishes our main empirical results, that public firms invest less and are less responsive to changes in investment opportunities than private firms. Section 4 investigates possible explanations for these findings. Section 5 examines the extent to which our results might be driven by the endogeneity of a firm’s listing status. Section 6 concludes.

Californication

Richard Barbrook, one of the more perceptive critics of internet utopianism, queried the vision that in the future we'll all be rich, hip and californian.

The unpersuasive and exceptionalist 'How Law Made Silicon Valley' by Anupam Chander in Emory Law Journal (Forthcoming) presumably exhorts us to try harder, commenting that

 Explanations for the success of Silicon Valley focus on the confluence of capital and education. In this article, I put forward a new explanation, one that better elucidates the rise of Silicon Valley as a global trader. Just as nineteenth century American judges altered the common law in order to subsidize industrial development, American judges and legislators altered the law at the turn of the Millennium to promote the development of Internet enterprise. Europe and Asia, by contrast, imposed strict intermediary liability regimes, inflexible intellectual property rules, and strong privacy constraints, impeding local Internet entrepreneurs. The study challenges the conventional wisdom that holds that strong intellectual property rights undergird innovation. While American law favored both commerce and speech enabled by this new medium, European and Asian jurisdictions attended more to the risks to intellectual property rights-holders and, to a lesser extent, ordinary individuals. Innovations that might be celebrated in the United States could lead to jail in Japan. I show how American companies leveraged their liberal home base to become global leaders in cyberspace. Nations seeking to incubate their own Silicon Valley must focus not only on money and education, but also a law that embraces innovation.

Chander goes on to discuss privacy as follows -

European Union – Privacy 

As James Whitman describes, European privacy law is a world away from the American laissez faire approach.  In October 1995, at the same time that the Clinton Administration was declaring its support for industry self-regulation, the European Union was announcing its elaborate and demanding Data Protection Directive.  The 1995 Directive requires “unambiguous” consent before the automated processing of personal information.  It further requires that information that is gathered must be “collected for specified, explicit and legitimate purposes and not further processed in a way incompatible with those purposes.”   Rather than a sectoral approach imposing obligations on certain health care and financial providers, European law offers omnibus protections covering all personal information. Certain categories of information processing—political, health, or sex-related information—are regulated even more tightly.  The Directive requires that data controllers secure personal data against accidental or unauthorized disclosure.  This Directive posed significant constraints on Web 2.0 enterprises, limiting their information gathering and sharing functions. 

A 2002 directive, the Privacy and Electronic Communications Directive (the “E-Privacy Directive”), added yet more constraints. The E-Privacy Directive included a broad requirement to ensure the confidentiality of communications, and banned the “surveillance of communications” without the consent of the user.  The Directive required “clear and comprehensive information” before a company could store information such as cookies (used to track web behavior), and required the site to offer opt-out of cookies. Such rules complicated the behavioral monitoring necessary for targeted advertising. They made it difficult to garner the datasets about an individual that might enable companies to know better how to cater to his or her interests (and means). Over the years, the E-Privacy Directive was interpreted and amended in ways that largely confirmed its constraints on tracking and information gathering, thus disabling sophisticated marketing capabilities. 

The astonishing reach of the Data Protection Directive can be seen in the case known as Criminal Proceedings Against Bodil Lindqvist. Lindqvist was a Swedish parishioner who published a website to assist fellow churchgoers in their confirmation process. She published personal information about her fellow parishioners on this site without their consent, including the fact that one person had “injured her foot.” For this, she was criminally prosecuted under the Swedish law implementing the Data Protection Directive. The European Court of Justice held that Lindqvist had indeed violated European privacy law because she had processed personal information about others (by making it available on the web), without their permission. What would have been readily protected under the First Amendment in the United States was subject to criminal prosecution in Europe.

In another notorious case, Google executives were convicted in Italy of crimes against privacy for not taking down rapidly enough a video ridiculing a disabled child. The executives were convicted specifically of the crime of “illicit treatment of personal data” (trattamento illecito dei dati) because “with the purpose of obtaining a gain they participated in the processing of the video [by distributing it through YouTube] containing health data of the disabled teenager without his consent.” The February 2010 convictions were overturned on appeal in December 2012,  but the convictions demonstrated the ambiguities of a a law that might sentence internet executives for not policing their services sufficiently. This case again demonstrates what James Whitman describes as the “‘radically different’” laws on both sides of the Atlantic on the liability of Internet providers for privacy offenses. 

South Korea – Privacy 

South Korean law offers substantial omnibus protections for privacy online. South Korea’s 2001 Act on the Promotion of Information and Communications Network Utilization and Information Protection (the “Network Act”) was modeled in part on the OECD Guidelines, as well as the German Online Service Data Protection Act (Teledienstedatenschutzgesetz) of 1997, which was itself passed to implement the 1995 European Data Protection Directive. The Network Act requires data processors to “obtain as little amount of personal data as required for the provision of the services,” obtain consent of the data subject for data processing, and safeguard security of the data. Failure to comply can result in fines, imprisonment or both. (By contrast, even the United States Children’s Online Privacy Protection Act does not include criminal sanctions.) In 2011, Korea passed an additional data protection law, the Personal Information Protection Act, which, among other things, established a right to file class actions in court over alleged violations of the law. The new law requires privacy assessments by large database developers. Wherever there is an overlap between PIPA and other privacy protections, the stronger provisions will apply.

Korean privacy law is not a paper tiger. The law establishes a standing committee to mediate personal information disputes, with the power to award enforceable awards once mediation is selected. The committee awards compensatory damages “in almost all cases” where a privacy breach is found, with damages typically ranging from U.S. $100 to U.S. $10,000. The Korean authorities receive more than 17,000 complaints per year. 

Japan – Privacy 

Japan enacted an omnibus privacy statute, the Personal Information Protection Act, in 2003. While explicit consent does not seem to be required before the collection of personal information, businesses cannot obtain information personal information from individuals by “fraudulent or other unfair means.” The data collector must provide notice of the intended uses of the data. If plans change for the use of the information, “the change must not exceed the scope ‘reasonably recognized as having an appropriate connection with the original [p]urpose of [u]se.’” Businesses cannot share personal information with third parties without the consent of the data subject. Businesses also have security obligations with respect to the personal data. Japan does not provide a private cause of action for data privacy violations, and even though consumer centers and the government receive over 12,000 complaints per year, the enforcement record remains unclear.

Bubbles

'Melbourne’s High Rise Apartment Boom' [PDF] by Bob Birrell and Ernest Healy of the Centre for Population and Urban Research at Monash University foreshadows pain for the stacked dogboxes - little boxes, little boxes, and they're all made of tickytacky etc - at Docklands and similar locations in Melbourne.

The authors comment

There has been an unprecedented surge in high-rise apartment completions in Melbourne since the late 2000s – far more than in Sydney, which was once the epicentre of such development. They are located primarily in the inner city, particularly the City of Melbourne (COM) and suburbs on the fringe of the COM.

The apartment surge is just beginning. The inner-city skyline was transformed in the three years 2010-2012 when 22,605 apartments were completed. This transformation will accelerate in the next few years when around 39,000 additional apartments are likely to be completed. These are all apartments which have been released for sale (that is, part of developments where off-the-plan marketing has begun) or where construction has commenced.

The apartment boom is driving Melbourne’s extraordinary share of Australia’s dwelling approvals. In 2012-13 they constituted 24.3% of the Australian total. Yet Melbourne’s share of Australia’s population in mid-2012 was 18.5%.

Does this mean that households in Melbourne are embracing inner-city apartment living? Our analysis indicates that it does not. Rather, it is an investor rather than an occupier driven boom. Investors are responding to financial incentives, including those deriving from negative gearing.

Apartment residents remain overwhelmingly young singles or couples who are renters. As in the past, they are transients who will move into family-friendly housing when they decide to raise a family. Most of the growth in new households in Melbourne will be looking for such housing. There is no large potential source of apartment occupiers (including empty nesters) come near to filling the expansion in the apartment stock expected.

Melbourne is not like Sydney, where restrictions on outer suburban expansion have compelled 11% of households (including some families with children) to occupy apartments. In Melbourne, there are huge tracts of outer suburban land zoned for the development. Detached houses can be bought for far less than two bedroom apartments in the inner city. By 2011, only 4% of households in Melbourne lived in apartments of four stories or more.

In the case of the COM, there has been an increase in the number of those who live and work there. Nevertheless, by 2011, they comprised just 27,912 of the 344,790 persons who worked in the COM. Overseas students have also been an important source of apartment occupiers. In addition, to our surprise, there has been an increase in the number of those who live in the COM and work outside it. They increased by 5,246 between 2006 and 2011 to 19,108.

There will have to be massive increases in the numbers in each of these categories if they are to approximate the expected surge in apartments on the market. Local apartment developers, who dominate the inner suburb apartment market are backing off on new proposals. Overseas developers are undeterred. They have the resources to outbid locals for sites in the inner city and are likely to approach 100% of completed apartments in this area by 2016. They are responsible for the recent surge in proposals for CBD apartment towers.

The authors argue that

Melbourne is a more attractive to developers than Sydney because there are more potential sites for high-rise apartment projects which can be developed at prices affordable to most investors (less than $500,000). These pricing priorities are also responsible for the increasing share of apartment projects comprising tiny apartments (mostly sub 50 square metres in net living area).

Inner Melbourne has also attracted because of its amenities. These have been enhanced by massive State Government and COM investment in infrastructure (including CityLink and Southern Cross Station), public spaces (Federation Square), parks (Birrarung Marr) and laneways. This investment was intended to enhance Melbourne’s prospects of becoming a centre of knowledge-intensive industries by enhancing the city’s liveability. It was hoped that this would attract the ‘creative class’ believed to drive this transformation. For its part, the COM has long wanted to transform the CBD and surrounds into an inviting mix for residence, work and entertainment.

This investment has helped in the fashioning of a ‘Melbourne Story’, which has been particularly attractive to Asian developers and investors.

However the apartment boom is squandering this investment. It is delivering tiny, poor quality apartments that will repel rather than attract the ‘creative class’. The COM planners have recently issued a withering critique of the outcome. The chief advocate of the COM’s original vision, Rob Adams, has declared that the current ‘flood’ of apartments has gone too far.

Despite warnings of an apartment glut the State Government and the COM are pressing on with plans to facilitate further urban renewal. They include Fishermans Bend and the City North and Arden-Macauley precincts of the COM to the north of the CBD. The COM’s planning blueprint assumes that the number of dwellings in the COM will increase from 67,533 in 2012 to 110,533 in 2031.

The State Government wants the apartment boom to continue because it is one of the few bright lights of the current Melbourne economy. It can ignore the COM planners’ concerns because it holds the planning authority for apartment towers in excess of 25,000 square metres floor space. It is approving almost all proposals put to it. The outlook is that the investment in the city’s amenities will be squandered. The city is heading towards becoming a dormitory rather than a centre for knowledge-intensive industries. The balance between apartments and offices in the CBD is swinging rapidly towards the former with the prospect that apartments will crowd out sites for offices in prime CBD locations.

In the three years 2013 to 2015 there will be three times the amount of floor space completed for apartments in the CBD and Docklands for new office space. The planning elites shaping Melbourne’s future are ignoring the disconnection between the investor driven apartment boom and real housing preferences. Their plans for the inner city’s expansion and for its economy are based on a property boom that our analysis indicates will implode.

 They go on to suggest that the COM case for massive inner-city growth is unconvincing

The COM commissioned two consulting firms to advise it on the city’s economic prospects. The first by ACIL Tasman puts some flesh on the widely disseminated claim that the COM is already a thriving knowledge city. The report is optimistic that the COM is well placed to contribute to the long-standing State Government ambition to make it a focal point of knowledge industries in Victoria. It states that the COM already has recognized strengths in fields ‘such as advanced manufacturing, biotechnology, creative industries (particularly design) event management, financial services’ and so on. It also has key ‘World Class’ assets including the Walter and Eliza Hall Institute and the University of Melbourne.

ACIL Tasman repeats the Florida thesis discussed earlier in the context of the Victorian Government’s original vision for Docklands. It states that:

Melbourne has many of the attributes that Richard Florida (the leading international theorist on what attracts creative people to certain locations) believes the “the creative class” attaches much importance to, such as a vibrant and diverse street life; compact, distinctive and authentic neighbourhoods with a diversity of buildings; a finely meshed street pattern; and pedestrian-friendly public spaces.

The Report provides a good account of the kind of economy so many of Australia’s leaders aspire to create, now that the impetus from the mining investment boom is waning. The hope is that the exports of services into Asia will fill the gap. Unfortunately, the Report does not document the COM’s achievements so far. There are no case studies of successful start-ups, for example, in bio-technology. It does not acknowledge that the ‘World Class’ assets, including the Walter and Eliza Hall Institute are mainly academic research institutes almost totally dependent on Commonwealth and State government support. The Institute does indeed have a fine research record, but the revenue it generates from royalties or other commercial offshoots is minimal (just $2.5 million in 2011).

This is not to knock these aspirations. It is vital for Victoria that new knowledge industries do emerge in the Asian Century. The point is rather that the aspirations expressed in the ACIL Tasman Report and the COM’s own claims to be a knowledge city are a flimsy base for the COM’s dwelling and population growth projections. The second report commissioned by the COM was by SGS Economics & Planning (SGS). It is entitled, Understanding the property and economic drivers of housing and was released in January 2013. It offers an interpretation of the factors generating the surge in job creation in the city between 2006 and 2011. It argues that these factors will continue to drive job creation in the COM and that many of those attracted to these jobs will be interested in residing in the COM.

The SGS report shows that, over the thirty years 1961 to the early 1990s, there was little growth in employment in the CBD or in the COM. Thereafter, job growth was rapid, except for a slowdown in the early 2000s. As noted earlier, an unprecedented 46% of all job growth in Greater Melbourne occurred in the COM over the years 2006-2011.

The report makes a convincing case that this job surge in the COM since early the 1990s was a consequence of successive Hawke and Keating Government economic reforms. They included the floating of the Australian dollar, the dismantling of restrictions on foreign financial firms operating in Australia and on international financial transactions and tariff reductions which forced Australian-based enterprises to compete in the international marketplace.

The result was a massive increase in trade, information and of commercial interchange with the global economy. SGS argue that Sydney and Melbourne have been the main beneficiaries of this process. They have provided the dominant sites for the international and domestic firms engaged in this interchange. Also, their size has generated agglomeration effects which SGS puts great store on. These refer to the synergies and efficiencies which emerge when there is a high concentration of professional service firms clustered around the main domestic and international institutions in the service economy (like the big four banks and Telstra). According to SGS, these agglomeration advantages will become more pronounced as Sydney and Melbourne continue to grow.

Though to some degree in Sydney’s shadow, Melbourne has done relatively well in recent years because it has provided more space for office expansion (Docklands), much cheaper rents than are available in Sydney and improvements in ease of access to the CBD (CityLink and the Ring Road), again by comparison with Sydney. SGS argue that:

For Melbourne, the ongoing shift in global trade is likely to mean continued growth of the knowledge intensive and Advanced Business Service sector. This is one key area in which Melbourne is internationally competitive… Given Melbourne is a location with high liveability and a highly skilled work force, it is very likely it will continue to be an attractive location for such firms in the long term, provided, of course, the city can maintain the competitive strengths inherent in its urban quality and functionality.

Interestingly the SGS report does not play up the ‘knowledge city’ factor. It merely suggests that, with continued growth in the finance sector and associated professional services, this will attract more professionals and in the process generate demand for a range of supporting services in retail, cafes etc. SGS goes on to say that: ‘The amenity that this creates will also attract some firms e.g. creative architecture/ IT/ start-up firms into the surrounding areas.’ The operative word is ‘some’.

The SGS report is much thinner on the prospects of the additional workers it believes will work in the COM deciding to reside in the COM. It asserts that the ‘shift towards inner city living is likely to continue’. It cites international evidence that well paid knowledge workers like to live in ‘dense urban environments and large cities, reside in well-established knowledge communities and seek cultural and education opportunities as well as affordable housing’. But, there is no probing into whether the kind of apartment stock being added to the COM will be attractive to these knowledge workers. Nor does SGS grapple with the recent evidence, cited above, that only a minority of the extra persons employed in the COM were resident there by 2011.

The weak point in the SGS report is that it does not substantiate its argument that the COM is now ‘internationally competitive’ in the provision of services. The COM has undoubtedly benefited from its role as a financial mediator between Australia and the rest of the world. But, the main impetus to employment in the COM in recent years has been the provision of financial and professional services within Australia which are linked to Australia’s rapid economic and population growth during the 2000s and the increased income of most its residents.

Employment growth in the COM has already diminished, with the peaking of the mineral investment boom and the overall slowdown in the Australian economy. As credit growth has slowed, the big banks and finance enterprises are no longer taking on new staff. Rather, some are looking to augment their profits by aggressive outsourcing and offshoring. As a consequence, the Melbourne office market is softening. According to BIS Shrapnel, Melbourne faces a ‘bleak’ two year period.

One indicator is that the net absorption of office space in the Melbourne CBD contracted slightly in the year to July 2013.

There is reason to believe that there will be no rapid revival of the housing and consumption boom of the 2000s. As a number of economic commentators have pointed out, during the commodity price boom of the past decade, nearly half of the increase in Australian residents’ real income came from the improvement in Australia’s terms of trade. As a consequence residents were able to buy more imported stuff per Australian dollar than before.

This source of real income growth has come to an end with the slump in commodity prices and decline in the value of the Australian dollar. Maybe it is just a short-term phenomenon. Nonetheless, its impact will be significant while it lasts because, if the terms of trade do continue to fall, the impact will be felt as a contraction of real income. The outlook, according to the Australian Treasury, is that Australia’s terms of trade will decline steadily over a prolonged period to 2029-30.  If this is the case, one major source for the property boom of the 2000s, according to the Reserve Bank and other authorities quoted earlier, will diminish. This is the increase in real household income which made it possible for households to take on high levels of mortgage debt and the mortgage payments resulting.

If SGS is correct, the situation will be rescued by Melbourne’s ‘internationally competitive’ knowledge-intensive industries. However, the recent record is not encouraging. The education industry has been by far the largest exporter of services in Victoria. This derives from the expenditure of overseas students on fees and expenses while in Australia. The COM has been an important site for this industry, not just via enrolments at RMIT and Melbourne University but also by branches of regional universities, notably Central Queensland University. It has also been a focus for TAFE institutions offering hospitality courses. At its peak in the late 2000s, there was a string of kitchens and hairdressing salons in the COM providing such courses. Most are now gone. As noted earlier, enrolments in the higher-education sector have also declined. The export of education-related services from Victoria, which peaked at $5.5 billion in 2009-10 have since been estimated to have fallen to $4.4 billion in 2011-12.

Official estimates for the export of telecommunication and business services from Victoria indicate that the level is low relative to NSW and declining. The peak year for the export of business services (which includes legal, accounting and management consulting as well as architectural, engineering and scientific services) was in 2008-09 when they reached $1.93bn (compared with $4.4bn in NSW). After falling sharply in 2009-10, they have since increased to $1.87bn in 2011-12.  We conclude that there is no convincing case that the COM will repeat the jobs boom of the period 2006-2011 in the medium term. If this is the case, it is unlikely that this important driver of demand for apartments will continue as in the recent past.

We conclude the warnings by BIS Shrapnel and others are correct. The massive number of apartment completions to be completed from already released projects plus those soon to be released by overseas developers in the CBD and vicinity is far more than is likely to be needed.

Copyright CEOs

CEO Compensation in the Copyright-Intensive Industries [PDF], a 53 page report by Jonathan Band and Jonathan Gerafi at InfoJustice notes that -

In June 2013, we produced a study on the profitability of copyright-intensive industries. We compared the performance over the past ten years of five leading firms in three copyright-intensive industries -- motion pictures, publishing, and software -- with the performance of five leading firms in three other industries: construction, transportation, and mining. We found that the firms in the copyright-intensive industries were more profitable than the firms in the other industries in every period examined.

In this study, we compare the compensation of the chief executive officers of these same 30 firms over the past six years. We found that in each year, the CEOs of the firms in the copyright-intensive industries received significantly higher compensation than the CEOs of the firms in the other industries. For example, in 2012, copyright-intensive industry CEOs received $22.9 million in compensation on average, while the CEOs in the other industries received $7.4 million on average. In other words, the 2012 compensation of copyright-intensive industry CEOs was more than triple the compensation of CEOs in the other industries. During the entire six-year period, copyright-intensive industry CEO compensation on average was 2.8 times higher than CEO compensation in the other industries. Moreover, between 2007 and 2012, CEO compensation in the copyright-intensive firms grew by 45%, while it increased by only 8% in the other industries.

Additionally, CEO compensation as a percentage of revenue was more than twice as high in the copyright-intensive industries as in the other industries. CEO compensation as a percentage of revenue in the publishing industry was four times higher than in the transportation industry, almost three times higher than the non-copyright average, and twice as high as in the motion picture industry.

In the copyright policy debates, the labor unions representing workers in copyright-intensive firms have joined with management in demanding greater intellectual property protection. Indeed, copyright policy is one of the few areas where the AFL-CIO and the U.S. Chamber of Commerce routinely agree with one another. They contend that copyright infringement is causing job loss in the United States. Nonetheless, during this period when the copyright-intensive industries purportedly are losing jobs because of attacks by pirates, CEO compensation has increased dramatically, both in absolute terms and relative to CEO compensation in other industries. These generous compensation packages belie the suggestion that the copyright industries confront an existential threat from infringement. Moreover, these upwardly trending compensation levels demonstrate that the copyright-intensive industry CEOs are not sharing the pain infringement allegedly causes their employees.

Corporate Persona

'Corporate Personhood and Corporate Persona' [PDF] by Margaret Blair in (2013) University of Illinois Law Review 785-820 argues that

In 2010, the U.S. Supreme Court held in Citizens United v. FEC that restrictions on corporate political speech were unconstitutional because of the First Amendment rights granted corporations as a result of their status as “persons” under the law. Following this decision, debate has been rekindled among legal scholars about the meaning of “corporate personhood.” This debate is not new. Over the past two centuries, scholars have considered what corporate personhood means and entails. This debate has resulted in numerous theories about corporate personhood that have come into and out of favor over the years, including the “artificial person” theory, the “contractual” theory, the “real entity” theory, and the “new contractual” theory.

This Article revisits that debate by examining the various functions of corporate personhood including four functions I have identified in previous work: (1) providing continuity and a clear line of succession in property and contract, (2) providing an “identifiable persona” to serve as a central actor in carrying out the business activity, (3) providing a mechanism for separating pools of assets belonging to the corporation from those belonging to the individuals participating in the enterprise, and (4) providing a framework for self-governance of certain business or commercial activity. In this Article, I focus on the historical evolution of the corporate form, and specifically on how and why corporations have tended to develop clearly identifiable corporate personas. This corporate persona function is highly important to today’s corporations and, because of this func-tion, corporations can become more than simply the sum of their parts. This Article suggests that scholars should keep the corporate persona function in mind in evaluating corporate personhood theories, and return to a theory that sees corporations as more than a bundle of contracts.

Blair concludes -

In much of my prior work, I have, in one way or another, explored the idea that successful business corporations are, and should be treated by the law as, more than just bundles of assets that belong to shareholders. While the role of shareholders in corporations is not trivial — without financial capital, few business enterprises could get out of the starting block — it is the efforts and vision of the entrepreneurs, managers, and key employees, as well as business practices that cultivate innovation and collaboration in teams, that create corporations whose value greatly exceeds the value of the financial capital that has been put in them. The real entity theory of corporations provided a vocabulary that embraces and acknowledges these self-evident facts. But numerous legal scholars since the 1980s have rejected the real entity view of corporations in favor of a theory that dismisses the idea that a firm is more than the sum of the contracts it embodies. 

Legal scholars started down this path by adopting the frameworks that had been developed by economic theorists to provide insight into key relationships within firms and by applying these reductionist models to the law of corporations. Beginning in the 1980s, they produced a substantial literature that starts from three simplifying premises that economists had adopted: (1) that shareholders are the “owners” of corporations, which are simply bundles of assets owned collectively by shareholders; (2) that directors and managers are the agents of shareholders and therefore are supposed to apply themselves to maximizing the value of the shares; and (3) that the best way to achieve higher value for shareholders is to give shareholders more power and control rights so that they can compel managers and directors to maximize share value. 

Frank Easterbrook and Daniel Fischel, for example, wrote a series of articles together in which they developed the implications for corporate law of the idea that corporations are essentially a contracting device with no separate existence and embodying no distinct rights and interests apart from the individuals who contracted together through the corporations. They focused especially on what they thought of as the central or most important contract in any corporation, the principal-agent contract between shareholders and directors/managers. 

Other legal scholars followed this lead, and within a few years, the legal literature on corporations as contractual devices and managers as agents of shareholders exploded. In an insightful analysis of this transformation of legal thinking about corporations, William Bratton notes that the real entity theory of the corporation was essentially “managerialist” — it accepted and legitimized the large corporation in which a managerial hierarchy exercised control. The new nexus of contracts theory, by contrast, was antimanagerialist, emphasizing that managerial authority is derived from the agency relationship with shareholders and that managers serve at the behest of shareholders. It is beyond the scope of this Article to explore all of the reasons why corporate law scholarship began to tilt so strongly in an antimanagerialist direction in the 1980s, after having been quiescently managerialist for nearly half a century. But the 1980s was a period in which many leading thinkers in the United States believed that the country was in decline and that the decline probably had to do with the failures of the bureaucratic and sclerotic corporations that dominated so many industries. “[I]n the 1980s national economic decline-revival became one of the foremost domestic issues, a new and uncomfortable prospect for Americans,” wrote historian Otis Graham.  By the latter half of the decade, vigorous public discussion had melded an impressively broad consensus that the erosion of U.S. economic strength was a reality, that it had not been and would not be stemmed by the Reaganite reforms, and that both relative and in some cases absolute decline had continued through even the remarkable years of expansion in 1983–1990. 

Concern about decline manifested itself in a number of ways. The most salient for our purposes was the idea that executives in the corporate sector, on the whole, had become uncreative, unwilling to take risks, self-serving, empire building, and unaccountable. The new antimanagerialist contractual theory of the firm may have been attractive because it offered a framework for thinking about how the law could help to un-seat these executives and bring in new industrial leadership. The new literature on the nexus of contracts theory of the corpora- tion also offered a way to think about the legal and policy issues raised by a phenomenon then sweeping the financial markets — hostile takeo-vers.  According to the theory, corporate managers cannot be expected to always work tirelessly to maximize the value of a corporation’s stock because they are merely hired agents with their own preferences that are not necessarily the same as the preferences of their principals, the shareholders. If managers fail to maximize the value of the shares of their company, however, the stock price of the company will be lower than its potential, and there will be an incentive for an outside investor to buy up a controlling position in the corporation, then proceed to fire manage- ment or otherwise compel the company to cut its costs or redirect its as- sets so that they have a higher value. 

This story line made the investors who were actively bidding for control of numerous corporations in the 1980s into heroes who were adding value, rather than greedy raiders (as corporate executives initially tried to portray them) who were opportunistically stripping value out of the corporations by ending employee pension plans, renegotiating contracts with unions, or closing plants and shipping production overseas — all while paying themselves large bonuses. Not surprisingly, the image of financiers as the heroes rather than the villains was congenial to corporate finance practitioners and scholars, and scholarship exploring and testing these ideas soon dominated the finance literature as well as the corporate law literature. The nexus of contracts/principal-agent model has thus formed the framework for a large part of the theoretical and empirical scholarship of both finance and corporate law over the last three decades. 

This literature includes arguments that corporate boards and man- agers should be required to be passive in the face of hostile offers so that shareholders could take advantage of the opportunity to sell their shares at a higher price. Similar reasoning has been applied to consideration of a long list of takeover defenses, which generated a large body of literature during the 1980s arguing that takeover defenses reduced the value of corporate shares and that they should therefore be disallowed or con- strained. Arguments were also made that managers and directors should be paid in stock options or other equity claims so that their interests would be more closely aligned with the interests of shareholders.  The corporate bar initially defended corporate directors and managers on the question of takeover defenses. But over time, as managers and directors increasingly adopted compensation packages based on stock options, these had the predicted effect of focusing the attention of directors and managers at firms across the economy — so that most directors and managers now say that their primary duty is to maximize the value of the equity shares of the corporations they run. 

The view of corporations as simply contracting devices has also permeated corporate finance, with practitioners and scholars learning to use the corporate form of organization in a whole new way, as a pure asset-partitioning device that does not implicate any of the other three functions of corporate personhood (continuity in property and contract; self-governance; and the development of intangible assets attached to a corporate persona). So called “special purpose vehicles” (SPVs), or sometimes “special purpose entities” (SPEs) or “structured investment vehicles” (SIVs), are corporations that have no employees, no operations, and no products. Their sole purpose is to facilitate “securitization” of financial assets by allowing the sponsoring corporation to isolate a bundle of financial assets, such as mortgages, car loans, other consumer debt, or commercial debt instruments, and issue debt securities that are claims to the cash flow solely from those assets.  By creating a separate corporation to hold the assets and liabilities of the SPE, the sponsoring financial firm that creates the entity attempts to protect itself from default or bankruptcy if the assets behind the securities fail to generate the projected amounts of cash flow. These entities thus resemble pure nexuses of contracts for the purpose of partitioning assets into entities that have none of the elements that we have identified as part of a corporation’s persona. But it turns out that, without a persona component,  the value of these entities nearly collapsed during the financial crisis when the assets that had been isolated in them lost value. In response, many of the financial firms that created these entities stepped up and took responsibility for making good on the debt securities that had been issued by them, although the terms of the contracts that had created them did not require this. Why? Because the sponsoring firms had something to lose, which the individual SPVs did not have, a corporate persona with substantial reputational value at risk. In other words, some of the value that those entities had was due to an asset of the sponsoring firm that was not listed on the balance sheet of either the sponsoring firm or the SPE. That asset could have been badly damaged if the sponsoring firm had, in fact, allowed the SPEs to fail. Theories that try to explain value creating corporations in pure contract terms, without acknowledging the role of reputational and other noncontractual relationship assets that contribute to value and that are tied to the corporate persona, may fail to explain aspects of corporations that matter most. 

The dominant theory of corporations in the last few decades in finance and in law has been a reductionist, finance inspired approach that regards corporations as mere contractual devices, with no truly separate existence, for which it is misleading and even foolish to speak of such things as the goal, reputation, will, or moral duties of the corporation apart from its contracting agents. The effort by financial market players in recent years to create value by simply repackaging the assets and liabilities of corporations without regard to the impact of such maneuvers on reputation and trust in the entity as a whole, let alone on the financial markets as a whole, it seems to me, is one expression of this mentality. 

But while legal and financial scholars seem to have no use for corporations that have any personality, some of the most successful value creating entrepreneurs of the last decade — Larry Page, Sergey Brin, and Eric Schmidt at Google, and Mark Zuckerberg at Facebook, among others — have emphasized the importance of such factors as “culture” and “reputation” and “innovativeness” in the value creating process at their corporations, and have expressed concern that financial markets excessively discount the importance such factors. Perhaps it is time for financial and legal economics to rethink the contractarian theories and models that have been guiding much corporate law scholarship in recent years and reconsider the view that corporations are, or can be, substantially more than the sum of their contractual parts. The idea that corporations can have a separate persona would be a useful part of that inquiry.

Corporate Socialisation

'Why Culture Matters in International Institutions: The Marginality of Human Rights at the World Bank' by Galit Sarfaty in (2009) The American Journal of International Law 647-683 [PDF] considers the World Bank's corporate culture and explores why the Bank has not adopted a human rights policy or agenda.

Sarfaty asks

Why do international institutions behave as they do? International organizations (IOs) have emerged as significant actors in global governance, whether they are overseeing monetary policy, setting trade or labor standards, or resolving a humanitarian crisis. They often execute international agreements between states and markedly influence domestic law, which makes it important to analyze how international institutions behave and make policy. Conducting an ethnographic analysis of the internal dynamics of IOs, including their formal and informal norms, incentive systems, and decision-making processes, can usefully aid in understanding institutional behavior and change. This article analyzes the organizational culture of one particularly powerful international institution - the World Bank (the Bank) - and explores why the Bank has not adopted a human rights policy or agenda.

Established on July 1, 1944, the World Bank has become the largest lender to developing countries, making loans worth over $20 billion per year. Its more than ten thousand employees (including economists, sociologists, lawyers, and engineers, among others) are engaged in the Bank’s mission of poverty reduction, which it primarily carries out through its development lending. While the institution has adopted various social and environmental policies and works on issues as diverse as judicial reform, health, and infrastructure, it has not instituted any overarching operational policy on human rights. Human rights concerns are not systematically incorporated into the everyday decision making of the staff or consistently taken into consideration in lending; incorporation of human rights is ad hoc and at the discretion of employees. In addition,many employees consider it taboo to discuss human rights in everyday conversation and to include references to them in their project documents. The marginality of human rights stands in contrast to the Bank’s rhetoric in official reports and public speeches by its leadership, which have supported human rights.

What do I mean by saying that human rights is a marginal issue within the Bank? In general, it means that the Bank maintains no comprehensive or consistent approach on the policy and operational levels. In more specific terms, it means that the Bank lacks at least the three following provisions/safeguards: (1) a staff policy to mitigate the impact of its projects on human rights; (2) a requirement to consider countries’ obligations under international human rights law when its employees engage in country dialogues or draft Country Assistance Strategies; and (3) guidelines on when it would suspend operations because of human rights violations. Why should we be surprised that human rights are such a marginal issue at the World Bank? I find a few compelling reasons why the Bank’s approach to human rights (or lack thereof) appears counter intuitive. First, other institutions involved in poverty reduction, including the United Nations Development Programme, the United Nations Children’s Fund, and the United Kingdom’s Department for International Development, have adopted human rights policies or a rights-based approach to development. Second, the Bank has been pressed by civil society organizations and internal advocates to integrate human rights considerations into its projects and programs. Third, private financial institutions have begun to address human rights more openly out of concern for their public image and the reputational risk of committing human rights abuses. Even the International Finance Corporation, the Bank’s private-sector arm, has openly adopted human rights as part of a risk management approach, although its engagement in selective human rights has been subject to criticism by nongovernmental organizations (NGOs). Despite these three factors, the Bank has not adopted a strategy on human rights. Whether and how the Bank should adopt human rights has been discussed at length by academics and civil society advocates. This literature primarily focuses on legal arguments for binding the Bank and its member countries to international human rights obligations. It does not investigate the internal workings of the bureaucracy so as to understand why the Bank has yet to adopt and internalize human rights norms. This article offers an empirical analysis of the Bank’s organizational culture based on extensive ethnographic field research at the institution itself, including personal interviews, participant observation, and analysis of Bank documents. This research sheds light on why organizational change has not occurred and suggests conditions under which it could happen. I selected this case because the Bank has neither adopted nor internalized human rights norms despite external pressure over the past two decades and repeated attempts by insiders to push the human rights agenda forward.

I have found that the ways norms become adopted and ultimately internalized in an institution largely depend on their fit with the organizational culture. When a new norm is introduced, employees from different professional groups within the Bank often have distinct interpretive frames that they use to define the norm, analyze its relevance to the Bank’s mission, and apply it in practice. Proponents of a norm must take internal conflict over competing frames into account when trying to persuade staff members to accept it. They must also consider the operational procedures, incentive system, and management structure of the organization when determining the most effective strategy of implementation. Thus, to bring about internalization, actors must adapt norms to local meanings and existing cultural values and practices - that is, they must “vernacularize” norms.

This article proceeds as follows. In part I, I argue that theories of international institutions should account for the internal dynamics within organizational cultures, which shape how institutions change and influence state behavior. Ethnographic research can help us analyze the conditions under which norms are internalized, including the degree to which they should be legalized. In part II, I consider why human rights have remained such a marginal issue at the Bank. I review legal constraints in the Bank’s Articles of Agreement (or Articles) and failed efforts from the early 1990s through 2004 to introduce a human rights agenda at the Bank, as well as the uncertain legal status and limited impact of a 2006 legal opinion on human rights. Part III analyzes the Bank’s organizational culture, including formal and informal processes of norm socialization and power dynamics between professional subcultures, and focuses on the prestige of economists and the lower status of lawyers in the Legal Department. In part IV, I emphasize the importance of framing norms to adapt to organizational culture, examine battles between Bank lawyers and economists over defining human rights norms and relating them to the Bank’s mission, and discuss the most recent attempt to introduce human rights into the Bank’s work. The conclusion analyzes the risks of achieving norm internalization at the Bank by “economizing” rather than legalizing human rights.

Sarfaty concludes

Analyzing organizational culture contributes usefully to understanding organizational change and predicting how IOs will behave. The conditions under which norms are adopted and internalized in an organization are shaped by its culture, including its mission, management structure, incentive system, and decision-making process. Internalization occurs when actors vernacularize norms, or adapt them to local meanings and existing cultural values and practices. There is no universal recipe for bringing about internalization in IOs. Rather, an institutional fit for norms must be found. They must be framed to be adaptable to the structural, functional, and cultural distinctiveness of each institution.

The recent initiative to push human rights forward at the Bank offers insights on how to bring about organizational change. Internal advocates attempted to appeal to the dominant subculture of economists by framing human rights as quantifiable and instrumentally valuable to achieving the economic development goals of the Bank. They called for pursuing an incremental strategy from the bottom up through country-level pilot projects, rather than a topdown official policy. By late 2006, the strategy became public and no longer under the radar, but it is too early to gauge its success. This approach represents one potentially effective way of bringing human rights norms into the Bank’s work. Another may be to alter the existing distribution of power within the institution (and thus the organizational culture) so that lawyers have more decision-making power and status in relation to economists and other professional groups. A radical change of this nature, however, would probably take many years and would require support from the leadership.

Human rights are a particularly difficult set of norms to incorporate into an economic institution because doing so forces employees into a struggle between principles and pragmatism — that is, it creates a tension between normative, intangible values and goals, and practical ways to solve problems (which may make it necessary to reconcile competing principles). In an environment like the Bank where most issues are subject to cost-benefit analysis, employees may be ambivalent about principles that appear to be non-negotiable or subject to trade-offs. They may perceive potential costs in trying to render seemingly incommensurable values commensurate.

What are the consequences of economizing rather than legalizing human rights? Some critics fear that although legalizing human rights norms may limit their persuasiveness within the Bank, an economic framework would dilute their meaning and serve as a ceiling for future human rights standards of other development agencies. Therefore, injecting human rights too far into the existing power structure involves risks. As an anthropologist has observed, if human rights “are translated so fully that they blend into existing power relationships completely, they lose their potential for social change.” This co-option is part of the dilemma of human rights framing and vernacularization strategies: they will not induce radical, long-term change if they do not challenge existing power structures and are too compatible with dominant ways of thinking. At the same time, they need to resonate with local cultural understandings if they are to appear legitimate and appealing, and thus become part of local rights consciousness. This conundrum raises important questions: Can human rights be so extensively vernacularized that they lose their essential core, or even contradict their fundamental meanings? Must human rights remain connected to a legal regime (and be linked to state obligations deriving from international law) to continue to be considered “human rights” and not another concept like “empowerment”? Ethnographic studies can illuminate the process of internalizing norms within international institutions and thus help determine how to resolve such issues and devise an appropriate strategy for organizational change.