Ownership and Compensation Conflated: The Case of Bill Gates and Paul Allen at Microsoft

Paul Allen claims in his memoir that Bill Gates tried on more than one occasion to reduce Allen’s relative ownership interest in Microsoft. Of course, the veracity of Allen’s explanation can be questioned even if the ownership changes in percentage terms are a matter of public record. Whereas The Wall Street Journal focused on Allen's credibility in making his claim, I see a case study on the difference between ownership and compensation for labor.

Allen claims in his book that in the mid-1970's, when he and Bill Gates were two college dropouts based in New Mexico, Gates asked for 60% of their partnership because of his greater contributions to the creation of software for running the BASIC programming language on an early PC, the MITS Altair 8800. Allen insists he had assumed that the partnership was evenly split, but he agreed Gates' request anyway. Several years later when the two men established Microsoft as a formal partnership, Gates asked to change their respective shares in the business to a 64-36 split, a demand to which Allen again agreed. However, in the early 1980s, Gates rebuffed Allen after he asked for an increase in his own Microsoft shares because of his work on a successful Microsoft product called SoftCard. Allen writes that he was deeply disappointed in Gates’ response; after all, the two men had known each other since they were students at a prestigious private school in Seattle. "In that moment, something died for me," Allen writes in his memoir. "I'd thought that our partnership was based on fairness, but now I saw that Bill's self-interest overrode all other considerations. My partner was out to grab as much of the pie as possible and hold on to it, and that was something I could not accept." Allen recounts that he sucked it up and thought, "OK…but one day I'm out of here."[1]  Gates had put money above not only friendship, but also a stable, enduring partnership. 

In 1982, Allen eavesdropped on a discussion between Bill Gates and Steve Ballmer, who would go on to become the company's CEO, in the Microsoft offices in Bellevue, Washington. Allen claims in his memoir that he heard the two men talking about his recent lack of productivity and how they might dilute his equity in the company by issuing options to themselves and other shareholders. Allen said he burst into the room and confronted the two men, both of whom later apologized to him and backed down from their plan. "I had helped start the company and was still an active member of management, though limited by my illness, and now my partner and my colleague were scheming to rip me off. . . . It was mercenary opportunism, plain and simple."[2] To be sure, Allen admits that his work was limited by an illness. Gates's attempts to lower Allen's stake in the company reflected Gates' concerns that Allen wasn't working hard enough and wasn't committed to the company, say people familiar with the relationship.[3] That was one reason, those people say, why Gates had put a provision in the first partnership agreement that would allow him to buy out Allen if Gates thought there were irreconcilable differences. In his memoir, Allen refers to the provision but does not include a reason for it, or why it was not mutual. 

The link between productivity or work accomplished and ownership stake may, however, not sufficiently distinguish between compensation and ownership. To be sure, additional ownership shares can be part of a compensation package, but Gates sought to change the founding ownership agreement by reducing his partner's share of ownership, which attends to founding the company. In other words, Gates should arguably have gone after Allen's salary and additional stock options, for those are more oriented to the quality of work and productivity. If a person owns a business, he still owns it if he performs badly for a year; of course, what he could take out as salary might be less than the prior year. 

1. Nick Wingfield and Robert Guth, "Microsoft Co-founder Hits Out at Gates," The Wall Street Journal, March 30, 2011.
2. Ibid.
3. Ibid.

Anna Hazare: A Modern Incarnation of Gandhi?

On August 21, 2011 in New Delhi, India, tens of thousands marched in support of Anna Hazare, then in the sixth day of his hunger strike in support of the Jan Lokpal anti-corruption bill. He told the crowd, “Even if the prime minister comes, I will not withdraw my hunger strike until the [bill] is passed in the Parliament. I can die but I will not bend.”[1] What a unique and intriguing statement! To be sure, the man's “professed unwillingness to compromise,” as well as his “occasionally belligerent tone, . . . attracted criticism.”[2] Even so, he inspired mainly hope, particularly from the young. His main constituency, however, was the middle class, who felt alienated and unfairly treated. Hazare self-consciously embraced the model of Gandhi. That model, including the principled unbending, is no stranger in India, yet I am surprised that it took until 2011 for a societal figure so Gandhi-like to emerge and galvanize a mass protest using Gandhi’s methods. Of course, the likeness between the two men could be overstated. How much like Gandhi was Hazare and his political action? For example, would Gandhi have stopped eating simply out of preference for one of two bills before the Parliament? Putting a stop to widespread violence is arguably much more significant than reducing corruption. Also, the demand that conduct be changed is more direct than that a law be enacted unless to abolish an unjust one. 

                              

The uncompromising rectitude plays out differently in the two cases  Gandhi's underlying moral concern made his unwillingness to compromise laudable. Such stubbornness can fall on its face in a legislative context in which political compromise is inherent to the process. In appealing directly to the people for their malicious behavior to stop, Gandhi sidestepped the incrementalism of legislative politics. 

For a refusal to compromise to be a virtue, some pretty convincing principles must be at stake and a clear distinction must be drawn. In other words, a serious moral wrong must be involved. Typically, such a wrong involves great human suffering. Wide-scale  corruption, especially if it involves extortion of the poor and middle class incurs human suffering, but arguably not that which is involved in widespread societal violence that even results in death. In subjecting himself to death, Hazare may thus have been acting disproportionately. Taking up the mantle of Gandhi's method is perhaps not as simple as it may appear. 

1. Jim Yardley, “Thousands Back Antigraft Hunger Strike in New Delhi,” New York Times (August 22, 2011). 
2. Ibid.

On the United Technologies-Raytheon Merger: The Macro Level of Analysis

In analyzing a merger, incorporating the macro context is vital. For very large mergers, for instance, public policy concerns inevitably surface even if they are typically ignored not only in merger analyses, but also by in societal and even governmental public discourse. Analysis at this level takes a societal standpoint, including on the relationship of business and government. This does not diminish the salience of firm-level analysis, for even how the respective organizational cultures would mesh is very important to a functional merged company. This is even true regarding the respective business-ethics climates, for it is not a given that a healthy organizational culture dominates an unethical one.

In June, 2019, United Technologies “doubled down on the aerospace market with an all-stock deal to merge with defense contractor Raytheon Co., after UTC executives early chose to exit from the escalator and air-conditioning businesses.”[1] The anticipated combined company, “valued at more than $100 billion after planned spinoffs, would be the world’s second-largest aerospace-and-defense company by sales behind Boeing.”[2] The annual revenue for 2019 would be $74 billion. UTC’s CEO at the time estimated a billion dollars in cost-savings. Additionally, spending on research could be increased.

On the macro scale, the merger would intensify the consolidation in the aerospace and defense industry. Better terms from supplies and the Pentagon had been putting pressure on contractors “to cut costs and invest more of their own money in new technologies, such as space systems and cyber security.”[3] Consolidation has a major drawback, however, in that competition and thus trade can be stifled. Society, through its government, rather than consolidated industries must resolve anti-trust problems, and this is difficult when those industries have significant power over legislative bodies and regulatory agencies. Hence, for example, anti-trust law had not been applied to the five largest American banks even after their complicity in the financial crisis of 2008. In fact, the bankers were able to use government funds to pay themselves bonuses!  So the question can legitimately be raised whether anti-trust law even can be enforced when the consolidated company or industry is not in favor.

If very large consolidated companies can rebuff regulatory attempts to constrain or limit those companies, then even very unethical managements can enjoy perches of power that are worrisome from a societal standpoint. In the late 1990’s, for example, Hughes Aircraft merged with Raytheon Missile Systems. In 2002, dioxane, a carcinogenic chemical that Hughes Aircraft/Raytheon had been using as a solvent, was discovered in the ground water under South Tucson, Arizona. Previously, Hughes had used cancer-causing trichloroethylene since 1981, and several local residents had won settlements on that chemical from Hughes.[4] Perhaps Raytheon’s management fail to use adequate oversight over Hughes, especially given that company’s track record, or was the purchasing company tacitly involved. Something to ponder for a company on the cusp of growing substantially through another merger in 2019, for an environmentally callous group to be so big would indeed be a big deal.

At the company level, a board of directors subservient to management or even a sordid corporate culture, such as that of Enron, can be enough to thwart efforts to clean up from unethical conduct. Wells Fargo, for instance, faced an entrenched corporate culture in “efforts” to stop charging customers for unordered products. Plutocracy, or the rule of wealth, at a governmental level means that such companies can not only continue acting unethically but also extract monopoly or oligarchic rents. In the case of the defense industry, the increasing power of the major contractors can even result in pressure on lawmakers to go to war when diplomacy would have been a better route. Indeed, a government’s spending can become loop-sided in favor of defense because the major contractors are powerful enough to demand it because it is good business. Hence U.S. President Lyndon Johnson kept the Vietnam conflict going in large part because he was getting kick-backs from certain contractors. In short, from being able to evade anti-trust enforcement to being able to pressure or pay off presidents in favor of military engagements, consolidated defense contractors can be said to have too much power. 

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[1] Cara Lombardo and Doug Cameron, “Merger to Create Aerospace Giant,” The New York Times, June 10, 2019.

[2] Ibid.

[3] Ibid.

[4] Tony Davis, “South-side Tucsonans Mobilize for Another Water-Pollution Struggle,” Arizona Daily Star, April 16, 2017.

Hong Kong’s Chief Executive Capitulates on a Proposed Extradition Law

Facing huge violent protests, Carrie Lam, the chief executive of Hong Kong, a semi-autonomous region of China, decided on June 15, to indefinitely suspend her proposal to open extradition to mainland China and Taiwan. As the Chinese government demonstrated during the protests at Tiananmen Square decades earlier, holding a mass protest in China was not among the ways to impeded proposed legislation. Why, then, did Lam seem to cave into the popular protests in Hong Kong?

Perhaps it is naïve to claim that even in China, when popular protests are so large government officials cannot but conclude that enough of the people are advocating that Rousseau’s general will has spoken. Of course, a highly visible protest need not be from a majority of citizens. Often the political extremes show up to protest while the centrist majority stays home. In fact, the regularization or ubiquity of political protests in the E.U. and U.S. may dilute the ability to stand out in such a way that the intended change will happen. The Arab Spring’s mass protests in the Middle East demonstrate that even huge protests can be “regularized” within the control of a government. So I think the efficacy of protests has diminished as they have become increasingly hackneyed. It follows that the large, violent protests in Hong Kong in 2019 against the extradition bill were not decisive in the legislation’s untimely demise.

Alternatively, that local business leaders turned away from Lam on the issue could be said to be the decisive change that led to Lam’s decision to indefinitely shelve the bill. In the U.S. especially, the loss of support of corporate leaders could indeed stop legislation from progressing. The power by which corporations can use campaign contributions and lobbying in Washington, D.C. had indeed become formidable by 2019. In contrast, however, the Chinese government was relatively strong against the power of amassed private capital (i.e., large companies). With the support of the Chinese government, Lam could have handled the errant business elite, but did she have the central government’s support?

Government officials in Beijing “were starting to question her judgment in picking a fight on an issue that they [regarded] as a distraction from their real priority: the passage of stringent national security legislation in Hong Kong.”[1] So rather than yielding to the streets or the business sector, Lam yielded to the central government. The implication is that Hong Kong’s semi-autonomous status within a dictatorship could be questioned. In fact, semi-autonomous is an oxymoron in a dictatorship—that is to say, a façade.

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1. Keith Bradsher, “In Hong Kong, Leader Yields to the Streets,” The New York Times, June 16, 2019.

The Impact of Federalism on Corporate Power in American Legislatures: The Case of Health-Insurance Reform

Florida, like about a dozen other states, debated in 2009 a proposed amendment to its state constitution that would have blocked, at least symbolically, much of the federal health-care insurance overhaul on the grounds that it tramples individual liberty. Behind the amendments was an industry with a vested interest—an industry that made substantial campaign contributions to the supporters of the amendment. I contend that there is an ethical conflict of interest lurking here, even if it is constitutional (assuming that wealth constitutes free speech, which itself is a problematic assumption), but the main issue here is how the blockage of federal law applying in Florida (and other states) would have affected federalism. What would have been better for the American federal system: federal or state legislation, or perhaps a combination? 

It was not just ideology that united the proposal’s legislative backers in Florida. The amendment's 42 co-sponsors, all Republicans, were almost all recipients of out-sized campaign contributions from major health care interests, a total of about $765,000 in 2008 alone. Around the 2008 election, moreover, the groups that provided health care contributed about $102 million to state political campaigns across the U.S., surpassing the $89 million the same donors spent at the federal level. 

The conflict of interest for the 42 co-sponsors in the Florida legislature opened them and their health-insurance backers to attack by those who wanted the federal government to be involved in health-insurance. Indeed, those federalists argued that the magnitude of the health-care industry’s contributions demonstrated the dangers of leaving such a question up to individual states, where campaign finance and ethics rules varied at the time from strict to negligible. The industry had enormous power at the state level, those federalists contended, and very few states had state-level consumer groups that were able to lobby effectively against the industry-legislator nexus. 

On the other hand, federalizing health-insurance law contributed to the consolidation-tendency of the "extended republic" at the expense of its member republics, or states. Indeed, the matter of the U.S. Government’s enumerated (i.e. limited) powers was not lost on the state legislators of several states who  were opposed to a federal health-care law. “We are trying to prepare, and trying to send a message that there is no reason for those decisions to get made at the federal level,” said Representative Linda L. Upmeyer, a Republican who was leading efforts in Iowa's legislature to prevent the anticipated federalization by the federal president, Barak Obama.[1] Upmeyer and anti-federalists knew that without “opt-in” or “opt-out” provisions in the federal legislation, state constitutional amendments would be preempted even should Congress refuse to reform health insurance. 

To be sure, states opting out of the eventual Affordable Care Act could have compromised the economies of scale assumed by the federal cost-saving measures. However, not even the cost-efficiency of proposed federal legislation should always overrule the contribution of the bill on the system of federalism. This focus had been a factor in the trend since the 1860's toward the consolidation of power at the federal level at the expense of the diversity-expressive power of the states. Too much "one size fits all" with not enough taking into account the differences between the member-states in an empire-level political union leads to an unbalanced system of federalism and thus eventual demise of the union itself. This point is lost when the focus is on particular pieces of legislation, and more specifically on their respective redeeming cost-efficiencies. 

What if industry power over legislation is strongest at the state level? Would not another incremental movement towards political consolidation at the expense of federalism have the virtue of protecting democracy from the encroachment of plutocracy, the rule by wealth? Yet leading up to Obama's Affordable Care Act of 2010, the president dropped his public-option for health insurance when the lobbyist for the private health-insurance industry threatened to withdraw its support. Obama's political calculus was doubtless that the vote would be so close that he would need the industry's support--hence, as often is the case in American legislation--incrementalism is the rule and large packages like FDR's New Deal are the exception. 

Therefore, even though the member-state legislatures are perhaps more easily dominated by big business, the federal head is also capable of being controlled or steered. Perhaps part of the solution to the problem of industry dominance over government lies in enabling the state governments to be able to check the federal government, and vice versa. In other words, the worst enemy of corporate corruption of public officials at either government may be balanced federalism.

1.  David D. Kirkpatrick, “Health Lobby Takes Fight to the States,” The New York Times, December 28, 2009. 

Encroaching Political Consolidation: The Weakening of the U.S. Federal System

It is much easier to point out the sliver in the other person's eye than the plank in one’s own. Regarding the gradual political consolidation of power at the federal level in the U.S. at the expense of not only the member-state governments, but also the federal system itself, it is easier for a political party to dismiss its own contribution than to take a wider stance including the continued viability of the federal system, or federalism, itself. As a result, both of the major parties has contributed to the increasing political consolidation at the expense of the check-and-balance feature that a balanced federal system has.

Texas’s former governor, Rick Perry, wrote in his book, Fed Up!, “From marriage to prayer, from zoning laws to tax policy, from our school systems to health care, and everything in between, it is essential to our liberty that we be allowed to live as we see fit through the democratic process at the local and state level.”[1] If it is essential to the liberty of the people that these policy domains be legislated and enforced at the member-state level, then any backtracking on any of these areas would diminish freedom. Hence the considerable consolidation of power by the U.S. Government since the war between the U.S.A. and C.S.A. from 1861-1865 has come at a cost. 

For instance, U.S. Government can preempt state legislating on a given domain even if no federal legislation is even attempted. The citizens of Texas would be hamstrung should they want the Texas Government to legislate on what is a serious problem in Texas. Preemption ignores that a given societal problem can be worse in one of the member republics than in others. The E.U.'s doctrine of subsidiarity, wherein the lowest level of government in the federal system that can deal with a problem is preferred, gives the states the preference over the federal government. 

So too does the fact that the governors of the states sit on the European Council, which is roughly equivalent to the U.S. Senate, where senators can ignore their respective governments to vote in such a way that makes reelection more likely.[2] The interests of the citizens of Texas are not the same as the Texas Government. Given the change to popular election for U.S. senators, the member-state governments had no power at the federal level to stop the federalizing of health-insurance legislation (e.g., Obama's Affordable Care Act).[3] 

American federalism can be repaired and strengthened. I'm not sure how many people realize the extent to which the federalism has deteriorated. Even people such as Perry who have emphasized a more balanced federal system have advocated policies that would add to the encroaching consolidation. “In one of his more well-publicized shifts, Mr. Perry proclaimed that gay marriage was an issue for individual states to decide, but backtracked in [August 2011 and said] he supports a federal amendment banning gay marriage. He . . . also signaled support for various federal actions to restrict abortion rather than leaving the issue to states.”[4] The governor of a large U.S. state put an ideological agenda, even one that is popular with the Texas electorate, before his own warnings of political consolidation. If federalism is to be sabotaged even by its high-level advocates, the problem has indeed become intractable. 

More generally, if Republican office holders want to federalize “social issues” and expand the military-industrial complex while Democratic officials insist on federalizing health-insurance, housing, and food aid for the poor while both parties federalize large portions of criminal law, then not only is the federalism pushed further off from a federal-level/state-level balance, but also the blame can be pushed to others such that no party takes on the matter of fixing the federal system. Any given representative could claim that his or her desired federalization would not break the camel’s back (i.e., effectively keep the federal system from working given the consolidation). Don’t look at me; its the other guy.  

The truth may well be that no elected official at the state or federal level is truly interested in the long-term viability of the governance system; the motivation is more a function of what is politically expedient at the time. Each politician may authentically believe that his or her top issues should be made to apply to all Americans—in every member state. In terms of an enabling context, perhaps the American cultures had become too egoist and short-sighted to support the difficult decisions needed to repair the American federal system. In fact, the cultures may even have contributed to the problem itself being one of America's blind-spots. The result is that everything is federalized and the state governments can no longer operate as a check on the federal level. As each official is busy imposing what is most important to him or her on as many people as possible, the question needing to be asked may therefore be, who, exactly, is minding the store?

1. Rick Perry, Fed Up! Our Fight to Save America from Washington (New York: Little and Brown, 2010). A critique of Perry's book interpretation of federalism can be found in American and European Federalism, available at Amazon.

2. Since 1913, the American states have switched from their respective governments appointing U.S. senators to the popular election of them. If it still be claimed that the senators still represent their respective governments, then popular election sets up a conflict of interest. In my view, the U.S. Senate could strengthen the American federal system by having the governors represent their respective states, as is the case in the European Council. See Essays on Two Federal Empires: Comparing the E.U. and U.S., available at Amazon.

3. The U.S. Senate, like the E.U. Council would meet formally in summits and for occasional special purposes (e.g., confirmation hearings where necessary) rather than more often, given the workload of a chief executive and head of state. The Senate's staff, like its counterpart in the Council, and the respective staffs of the governors in the member-states would do much of the coordinating and other work.

4. Manny Fernandez and Emily Ramshaw, “As a States’ Rights Stalwart, Perry Draws Doubts,” New York Times, August 29, 2011. 

Facebook’s Mark Zuckerberg: Power beyond Corporate Governance

Facebook’s Mark Zuckerberg and Sheryl Sandberg did not attend a committee hearing at Canada’s Parliament on May 28, 2019 in spite of having received summons from Bob Zimmer MP, the committee’s chair. Instead, Facebook sent its director of public policy and its head of public policy for Facebook Canada. “Shame on Mark Zuckerberg and shame on Sheryl Sandberg for not showing up today,” Zimmer said toward the end of the hearing.[1] For sending two representatives rather than themselves, Zuckerberg and Sandberg faced the possibility of being held in contempt. They had testified before the U.S. Congress, so by sending two representatives the two leaders of Facebook may have acted rather dismissively concerning Canada’s federal legislature. At the time, Zuckerberg had virtually unchecked power at Facebook, including over the other stockholders. From his perch, the power may have been going to his head; even after two years of user-privacy scandals, Facebook’s CEO and Chairman of the Board may have determined that summons from legislatures where the company was operating were beneath him. Such a mentality is dangerous for a person with autocratic control of such a large company.

Corporate governance can pale up against a formidable CEO who also chairs the board whose raison d’etre is in part to hold the CEO accountable. Even that such a structural conflict of interest could be allowed persist at a company suggests that its corporate governance system is weak, with too much power going to the management at the expense of the non-management stockholders. In the case of Facebook, Zuckerberg founded it, and on this basis he doubtlessly believed he was justified in being the sole holder of class B stock, each share of which having 10 votes such that he was the majority stockholder. In a show of just how pathetic minority stockholder rights can be, Zuckerberg voted down stockholder proposals “to put checks on Zuckerberg’s ironclad grip on the company he founded.”[2] This took place just two days after Zuckerberg had failed to show up at the Canadian committee hearing.

Zuckerberg was doubtless awash in power, for he had refused a legislature’s summons and could easily control his company’s corporate governance. Lawmakers in Congress and even Facebook insiders were raising concerns not only about whether Zuckerberg had too much power, but also the company itself, given the scandals that had been going on for more than two years. Shareholders argued that Zuckerberg’s holding of the board chairmanship “contributed to Facebook missing, or mishandling, a number of severe controversies.”[3] Stockholders also believed that eliminating the Class B shares (i.e., 10 votes per share) would enable stockholders to limit Zuckerberg’s power and “hold management accountable.”[4] As scandals—even one at the time hinging on Zuckerberg’s refusal to take off a distorted video of Nancy Palosi, the Speaker of the U.S. House—came up, stockholders had no recourse to management, which could safely ignore the complaints even though stockholder value was being affected.

I submit that the business judgment rule accords corporate managements with too much power in corporate governance over non-management stockholders. At the broad policy-level in which boards of large corporations operate, business expertise, while relevant, should not push out the role of non-management stockholders being able to act as a check on a CEO’s power. Fundamentally, even beyond the value of business expertise, ownership of the corporate wealth supersedes its management. As stock options as “firm-aligned” compensation for executives becomes more popular, the role of non-management stockholders becomes more important if accountability, or a check, is to be part of the system of governance. In other words, boards of directors should not be controlled by their respective CEO’s. In the case of Facebook, its breaches of private information and its role in influencing political elections as well as politics suggest that the corporation’s system of governance should include accountability.

In such a case in which a company leaves a huge societal footprint, with a potentially dire downside, and yet the corporate governance is monopolized by one person, it is only natural to look to external accountability in the form of anti-trust enforcement. Sure enough, U.S. House Rep. David Cicilline the chairman of the Antitrust Subcommittee, had called for an antitrust investigation into Facebook, “with a focus on its acquisitions of Instagram and WhatsApp,” both of which had more than a billion users in May, 2019. Even Facebook’s cofounder, Chris Hughes, “called for Facebook to be broken up and raised concerns about Zuckerberg’s ‘unchecked power.’”[5] Alex Stamos, Facebook’s former chief security officer, said Zuckerberg should “give up” some of his power and hire a new CEO.[6] Awash with power, Zuckerberg could ignore such advice. As for the prospect of being broken up, Zuckerberg could use more of the company’s wealth to make political campaign contributions and help lawmakers in other ways. When the lack of accountability in a company senses no threat from corporate governance and the reach of governments, then the exercise of such power can become virtually unstoppable.

See Taking the Face Off Facebook: Strategic and Ethical Issues, available at Amazon

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[1] Donie O’Sullivan and Paula Newton, “Zuckerberg and Sandberg Ignore Canadian Subpoena, Face Possible Contempt Vote,” CNN.com, May 28, 2019.

[2] Seth Fiegerman, “Facebook Shareholders Pressed for Checks on Mark Zuckerberg’s Power. They failed,” Cnn.com, May 30, 2019.

[3] Ibid.

[4] Ibid.

[5] Ibid.

[6] Ibid.

President Obama Took Care of Wall Street below a Public Persona of Reform

In April, 2010, President Obama gave a speech in New York City to counter what he called “the furious efforts of industry lobbyists” geared to weakening or stopping the new financial regulations that Obama claimed would be needed to stave off a second Great Depression.[1]  It is telling that the banks that had contributed to the financial crisis of 2008 were trying to diminish or block any new regulation. The very legitimacy of industry calls for deregulation in the wake of a market failure caused in part by the industry flies in the face of the rationale for regulation. In short, the rationale for government regulation has to do with market failures, which includes fraud and over-zealous profit-taking at the expense of the public good. The root of the rationale is the difference between the interests of an organization and society (i.e., the public good). 

After the financial crisis of 2008, the U.S. President wanted more consumer protections, limits on the size of banks and the risks they could take, reforms on executive compensation, and greater transparency for controversial financial securities known as derivatives.  He maintained that each of these safeguards must be in any bill that he would sign. In giving the speech with some of the banking titans in the audience, the President wanted to confront the financial industry more directly through a sharp speech. After having castigated the bankers' “failure of responsibility” in recent years, he called on them to stop resisting tighter regulation through the army of lobbyists staked out then on Capitol Hill. The president’s address at Cooper Union in Lower Manhattan circled back to another speech he had given at the same location in March of 2008 warning of financial manipulation, market bubbles and the concentration of economic power.

Analysis:

At the time of his speech, the President was actually supporting the bills coming out of Congress. These bills would do nothing to forestall or minimize market bubbles and reduce the concentration of economic power.  The bills would not even limit or reduce bank size; instead, higher reserve requirements for the biggest banks was presumed a sufficient incentive for those banks to willing reduce their sizes. Although this approach, which would become law, incorporated the market mechanism (regarding financial disincentives), the assumption that empire-building Wall Street titans would reverse the "business logic" where in the opposite of growth is bankruptcy is very naive. It is remarkable that the president considered this approach as satisfying his requirement that the bill reaching his desk must include something limiting the size of financial institutions (especially when the systemic risk of one big bank failing and taking down the entire financial system had recently been lived through). Paul Volker, Chairman of the Federal Reserve under Reagan, was urging a decrease in the sizes of the five largest banks. 

I submit that Goldman Sachs' $1 million contribution to Obama's presidential campaign may have had something to do with it, as did Wall Street lobbying in Congress. On the eve of the President’s speech, Obama’s chief of staff had met behind closed doors with representatives of Wall Street firms. Fox News reported that Obama's message was the following: we’ve got to trash you in public, but know that we will take care of you in private.  While Fox News was at the time certainly no friend of the President, the account would explain why the President would eventually sign the Dodd-Frank Act of 2010, which except for staggered reserve requirements and a consumer-protection bureau is pretty kind to Wall Street.  

 

Recalling President Andrew Jackson, who successfully took on the bank of the U.S. by refusing to fund it in 1832, and Theodore Roosevelt, who supported the Sherman Anti-trust Act in 1911, we could certainly view Obama as not having been willing to take on the guys who not only had contributed to his 2008 campaign, but could be useful again in 2012 for Obama's reelection.  

1.  Peter Baker, "Obama Issues Sharp Call for Reforms on Wall Street," The New York Times, April 22, 2010.

On Fiat-Chrysler’s Merger Proposal to Renault: Too Broad?

 As Renault was considering Fiat Chrysler’s proposal to merge, industry executives and analysts believed “that carmakers must link up to share the cost of a transition from internal combustion engines to avoid being run over by fast-moving tech industry challengers like Tesla or Uber.”[1] To be sure, (b)y purchasing parts together, combining their manufacturing operations and sharing the cost of research and development,” the merger could “eventually save 5 billion euros per year,” according to Fiat.[2] The R & D would include funds spent on developing new models as well as on high tech oriented to the future. Although significant efficiency could be achieved due to under-used factories and all the money going into product development, the basic problem was one of insufficient scale (i.e., revenue) to support (i.e., finance) the very costly research and development needed on electric and/or self-diving cars. In its statement, Fiat Chrysler pointed to “the need to take bold decisions to capture at scale the opportunities created by the transformation of the auto industry in areas like connectivity, electrification, and autonomous driving.”[3] The insufficient scale was particularly troubling given the declining E.U. auto market at a time when Tesla, Google and Uber were making progress on electric and self-driving cars. Fiat Chrysler could really use the expertise at Renault and Nissan on electric cars. I'm not sure, however, that a merger was the optimal route forward.

As with nearly everything, potential downsides existed. First, the merger would dilute the shares that the state of France already had in Renault from being its largest stockholder. Second, political leaders in that state as well as Italy would doubtless “fight to preserve as many jobs” in the respective states as possible.[4] In its analysis, however, The New York Times claimed at the time that it would be difficult for the merged company to avoid job cuts, given that the companies’ respective companies were operating below capacity.

So perhaps the anticipated savings of €5 million were optimistic, which raises the question: why not an alliance to fund a shared R&D center where work would be done on high cost, future revenue electrification and self-driving cars? Pushing for a full-blown merger would risk clashing corporate cultures. Also, the inevitable politics as duplicate management positions are eliminated would not be cost-free. Furthermore, the alliance between Renault and Nissan, already strained, could suffer or break apart in the event of a merger but not another alliance.

The basic problem was not enough scale (i.e., revenue) in either company to finance the heavy cost of R&D without compensating revenue in the short or medium term. When the gains from other efficiencies are not the main point of a merger, an alliance or partnership focused on the main problem may have been a better fit.

The problem of scale in terms of having enough money to finance the high-tech research need not incur the disproportional costs that come with increased organizational size and complexity. The costs of integration organizationally, for example, increase disproportionately with organizational size (and complexity).[5] Empire-building, a political as much as economic propensity at the upper level of organizations, can give rise to optimistic forecasts of savings from various efficiencies from mergers while the financial downsides are minimized. We could note, for example, the skepticism regarding Fiat Chrysler’s claim that no jobs would be lost and no factories would be closed. If the urgency for the merger was due to the advances by Tesla, etc., then perhaps a better proposal would have been delimited by that main problem rather than blown up to the form of a complete merger.

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[1] Jack Ewing et al, “Renault Considering Fiat’s Offer to Merge Into a New Auto Giant,” The New York Times, May 27, 2019

[2] Ibid.

[3] Ibid.

[4] Ibid.

[5] James D. Thompson, Organizations in Action: Social Science Bases of Administrative Theory (London: Routledge, 2003).

Democracy Impaired in the E.U.: The State-Level Vortex

In interpreting exit polls released on May 26, 2019 on the E.U.’s Parliament election, The New York Times pointed to two issues, only one of which pertained to the federal level. “Observers looked to [the election] to gauge the popularity of the various anti-immigration, anti-elite, Euroskeptic parties across the union.”[1] Had the E.U. electorate focused on such a matter so central to the European Union itself, democracy at the federal level would have been nearly perfect. However, the encroachment of state-level politics in the federal election, the other point, contributed to the democratic deficit at the federal level. This takes away from the viability of the federal system itself.

Looking at the exit data pertaining to the federal-level issue, E.U. voters did not vote as much for the states’ rights parties as predicted. Even so, those parties made gains in the Parliament. On the left, the Greens did well. This means the mainstream E.U. parties lost some ground. To the extent that voters voted on the federal-level issue, the message was that the status quo was not working at the federal level. The states’ rights, or Euroskeptic, gain probably reflected the E.U.’s response to inflows of immigration during the previous session. The far-right also argued that their state-level needs were being too often overlooked at the federal level. I submit that a more serious problem at the federal level was that federal-level issues were being too often overlooked by E.U. citizens. It could be that the far-right gained in the E.U. because democracy was stronger at the state level. Ironically, this was true in part because even in democracy’s repository at the federal level, the European Parliament, the elections have not been predominately about federal issues!

In the E.U. state of France, for example, the unpopularity of the state’s governor, Emmanuel Macron, had an impact. His far-right rival, Marie Le Pen, called the federal election result “a vote for France, and for the people.”[2] The election was not about their state, but the European Union. Macron nonetheless “had put a lot of chips down on beating the far-right party led by Ms. Le pen, which was once known as National Front.”[3] The election was about Macron or Le Pen, two state leaders. Furthermore, that Macron got involved politically in the federal election doubtlessly muddied the water concerning the difficult task of voting on the basis of federal issues rather than to punish or “send a message” to the incumbent governor in France.

Regarding the state of Germany, The New York Times brazenly interpreted the exit polls in state-wide rather than federal terms. Even though people often confuse Lander with Staaten, Germany itself is a state from the perspective of the E.U. Deutschland ist ein Staat. At any rate, the Times reported the following concerning the federal election: “(T)the Greens did very well, becoming the main party on the left, while the Social Democratic Party did very badly, according to exit polls.”[4] Was the Green Party the main party on the left in the European Parliament, in Germany, or among the E.U. citizens residing in the state? The only one of these that is relevant to the election itself is the first. The Times went so far as to claim that the election results “will be seen as a judgment on the center-left Social Democrats, on the far-right Alternative for Germany and the new leader of the Christian Democrats, Annegret Kramp-Karrenbauer, who hopes to succeed Chancellor Angela Merkel.”[5] If true, the E.U. citizens residing in the state tended to vote on the basis of state politics rather than a federal-level issue. Ironically, as the election was for the E.U.’s Parliament rather than the German Bundestag, focusing so much on state-level politics was a waste of time, with a huge opportunity cost—what was lost in terms of democracy at the federal level by voters not voting principally on matters pertaining to the Parliament. 

If far-right E.U. voters were disappointed with the E.U., their own prerogative that, as Le Pen said, the election was a vote for France (or Germany) led to the self-fulfilling verdict. If E.U. citizens want more democracy at the federal level, then a certain amount of self-discipline will be needed to resist the temptation to cave into the usual state-level preoccupation and vote instead on which party in the Parliament has the most fitting platform on issues pertaining to the E.U. itself or its competencies.

See Essays on the E.U. Political Economy: Federalism and the Debt 

Crisis. For a comparison, see Essays on Two Federal Empires: Comparing the E.U. and U.S. 

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1. Steven Erlanger, “European Election Results: The Mainstream Loses Ground,” The New York Times, May 26, 2019.

2. Ibid.

3. Ibid.

4. Ibid.

5. Ibid.