Dismissals and CEO incentives

CEO's face relatively stronger incentives from their compensation package than from the threat of dismissal, so a firm should put a lot of time and effort into getting that package right.

Common ownership, competition, and top management incentives

An interesting looking revised version of a working paper from the Cowles Foundation for Research in Economics at Yale University on "Common Ownership, Competition, and Top Management Incentives" (pdf). The paper is by Miguel Antón, Florian Ederer, Mireia Giné, and Martin Schmalz.

The abstract reads:

We show theoretically and empirically that managers have steeper financial incentives to expend effort and reduce costs when an industry’s firms tend to be controlled by shareholders with concentrated stakes in the firm, and relatively few holdings in competitors. A side effect of steep incentives is more aggressive competition. These findings inform a debate about the objective function of the firm.

The basic conclusion of the paper is,

We found that the sensitivity between top managers’ wealth and their firm’s performance is weaker when the firms’ largest shareholders are also large shareholders of competitors. The wealth-performance relation for managers is steeper when firms are owned by shareholders without significant stakes in competitors.

Thus you will get more competition when a firm is owned by shareholders without significant stakes in competitors.

Civil asset forfeiture, crime, and police incentives

Yes the police, like criminals, respond to incentives.

A new NBER working paper makes this point.

Civil Asset Forfeiture, Crime, and Police Incentives: Evidence from the Comprehensive Crime Control Act of 1984

Shawn Kantor, Carl Kitchens, Steven Pawlowski

The 1984 federal Comprehensive Crime Control Act (CCCA) included a provision that permitted local law enforcement agencies to share up to 80 percent of the proceeds derived from civil asset forfeitures obtained in joint operations with federal authorities. This procedure became known as “equitable sharing.” In this paper we investigate how this rule governing forfeited assets influenced crime and police incentives by taking advantage of pre-existing differences in state level civil asset forfeiture law and the timing of the CCCA. We find that after the CCCA was enacted crime fell about 17 percent in places where the federal law allowed police to retain more of their seized assets than state law previously allowed. Equitable sharing also led police agencies to reallocate their effort toward the policing of drug crimes. We estimate that drug arrests increased by about 37 percent in the years after the enactment of the CCCA, indicating that it was profitable for police agencies to reallocate their efforts. Such a reallocation of effort, however, brought an unintended cost in the form of increased roadway fatalities, seemingly from reduced enforcement of traffic laws.

Enforcement goes where the money is, not where the need is.

Incentives matter: shipping file

Research summary: We explore captain-ownership and vessel performance in eighteenth-century transatlantic shipping. Although contingent compensation often aligned incentives between captains and shipowners, one difficult-to-contract hazard was threat of capture during wartime. We exploit variation across time and routes to study the relationship between capture threat and captain-ownership. Vessels were more likely to have captain-owners when undertaking wartime voyages on routes susceptible to privateers. Captain-owned vessels were less readily captured than those with nonowner captains, but more likely to forgo voyage profits to preserve the vessel's safety. These results are consistent with multitask agency, where residual claims to asset value rather than control rights influence captain behavior. This article is among the first to empirically isolate mechanisms distinguishing among major strands of organizational economics regarding asset ownership and performance.

This is the abstract of a new paper in the Strategic Management Journal (Volume 38, Issue 4 April 2017 Pages 854–875) entitled Asset ownership and incentives in early shareholder capitalism: Liverpool shipping in the eighteenth century. The paper is by Brian S. Silverman and Paul Ingram.

The interesting points made by the paper include the obvious, incentives matter, captain-owned ships were less likely to be captured by privateers. The results also suggest that the incentives provided by income rights are weaker than those provided by asset ownership. Of course the protection of assets, the ship, made just be a way of protecting future profits at the expense of current profits.

Kevin Bryan on Bengt Holmstrom and the black box of the firm

Kevin Bryan writes at VoxEU.org on the key contributions of Bengt Holmstrom to the theory of contracts and its application to the theory of the firm. Bryan opens by saying,

Holmström’s contribution lies most centrally in the area of formal contract design. Imagine that you want someone – an employee, a child, a subordinate division, an aid contractor or, more generally, an ‘agent’ – to perform a task. How should you induce them to do this?

If the task is ‘simple’ – meaning that the agent’s effort and knowledge about how to perform the task most efficiently is known and observable – you can simply pay a wage, cutting off payment if effort is not being exerted. When only the outcome of work can be observed, if there is no uncertainty in how effort is transformed into outcomes, knowing the outcome is equivalent to knowing effort, and hence optimal effort can be achieved via a bonus payment made on the basis of outcomes.

All straightforward so far. The trickier situations, which Holmström and his co-authors have analysed at great length, are when neither effort nor outcomes are directly observable.

Consider paying a surgeon. You want to reward the doctor for competent, safe work.

Perhaps a real world example of such a contract may help illustrate that is happening here. Below are details of the contract for surgeons on the ships that transported colonists to the province of Canterbury in New Zealand in the 1850s.

So real people where into incentives contracts long before economists started formal investigation of them!!!

The British economist Edwin Chadwick was also thinking about  about such issues in the mid-1800s. Chadwick pondered the question of incentives for the transportation of prisoners from the UK to Australia. Chadwick noted:

​[I]n the first instance, a capitation payment was made on embarkation, and this resulted in the loss of half the conve​cts put on board ; by degrees that loss was reduced to one-third ; but when, under the auspices of a new colonial administration, the system was altered to a capitation payment for all the convicts that were landed at their destination, the contrast was ​very​ ​ striking indeed, and tho owners of the vessels carried surgeons, and the best means were devised for landing the largest possible number at the port for which they were bound.

But as Byran notes that Holmstrom was aware that in general, in the modern case, it is very difficult to observe perfectly what the surgeon is doing at all times, and basing pay on outcomes has a number of problems:

1. First, the patient outcome depends on the effort of not just one surgeon, but on others in the operating room and prep table. Team incentives must be provided.
2. Second, the doctor has many ways to shift the balance of effort between reducing costs to the hospital, increasing patient comfort, increasing the quality of the medical outcome, and mentoring young assistant surgeons. So paying on the basis of one or two tasks may distort effort away from other harder-to-measure tasks. There is a multitasking problem.
3. Third, the number of medical mistakes, or the cost of surgery, that a hospital ought to expect from a competent surgeon depends on changes in training and technology that are hard to know, and hence a contract may want to adjust payments for its surgeons on the performance of surgeons elsewhere. Contracts ought to take advantage of relevant information when it is informative about the task being incentivised.
4. Fourth, since surgeons will dislike risk in their salary, the fact that some negative patient outcomes are just bad luck means that you will need to pay the surgeon very high bonuses to overcome their risk aversion. When outcome measures involve uncertainty, optimal contracts will weigh ‘high-powered’ bonuses against ‘low-powered’ insurance against risk.
5. Fifth, the surgeon can be incentivised either by payments today or by keeping their job tomorrow, and worse, these career concerns may cause the surgeon to waste the hospital’s money on tasks that matter to the surgeon’s career beyond the hospital.

Holmström wrote the canonical paper on each of these topics. His 1979 paper shows that any information that reduces the uncertainty about what an agent actually did should feature in a contract, since by reducing uncertainty, you reduce the risk premium needed to incentivize the agent to accept the contract.

It might seem strange that contracts in many cases do not satisfy this ‘informativeness principle’. For example, CEO bonuses are often not indexed to the performance of firms in the same industry. If oil prices rise, essentially all oil firms will be very profitable, and this is true whether or not a particular CEO is a good one. Bertrand and Mullainathan (2001) argue that this is because many firms with diverse shareholders are poorly governed.

Bryan continues,

Much of Holmström’s work in the 1980s and 1990s tried to square the gap between theory and empirics by finding justifications for the simplicity of many real world contracts that can be rationally justified.

Written jointly with Paul Milgrom, the famous ‘multitasking’ paper published in 1991 notes that contracts shift incentives across different tasks in addition to serving as risk-sharing mechanisms and as methods for inducing effort. Since bonuses on task A will cause agents to shift effort away from hard-to-measure task B, it may be optimal to avoid strong incentives at all (just pay teachers a salary rather than a bonus based only on test performance) or to split job tasks (pay bonuses to teacher A who is told to focus only on mathematics test scores, and pay salary to teacher B who is meant to serve as a mentor).

That outcomes are generated by teams also motivates simpler contracts. Holmström’s 1982 article on incentives in teams points out that if both my effort and yours is required to produce a good outcome, then the marginal product of our efforts are both equal to the entire value of what is produced, hence there is not enough output to pay each of us our marginal product. What can be done?

Alchian and Demsetz had noticed this problem in 1972, arguing that firms exist to monitor the effort of individuals working in teams. With perfect knowledge of who does what, you can simply pay the workers a wage sufficient to make the optimal effort, then collect the residual as profit.

Holmström notes that the monitoring isn’t the important bit; rather, even shareholder-controlled firms where shareholders do no monitoring at all are useful. The reason is that shareholders can be residual claimants for profit, and hence there is no need to distribute profit fully to members of the team.

A brief discussion of a simple version of Holmstrom's 1982 paper, due to Kim C. Border, and its relationship to Alchian and Demsetz's work is given in chapter 4 of The Theory of the Firm: An overview of the economic mainstream.

Bryan goes on:

Free-riding can therefore be eliminated by simply paying team members a wage of X if the team outcome is optimal, and zero otherwise. Even a slight bit of shirking by a single agent drops their payment precipitously (which is impossible if all profits generated by the team are shared by the team), so the agents will not shirk. Of course, when there is uncertainty about how team effort transforms into outcomes, this harsh penalty will not work, and hence incentive problems may require team sizes to be smaller than that which is first-best efficient.

A third justification for simple contracts is career concerns: agents work hard today to try to signal to the market that they are high-quality, and do so even if they are paid a fixed wage. This argument had been made less formally by 2013 Nobel laureate Eugene Fama, but Holmström in a 1982 working paper (finally published in 1999) showed that this concern about the market only completely mitigates moral hazard if outcomes within a firm are fully observable to the market, or the future is not discounted at all, or there is no uncertainty about agent’s abilities. Indeed, career concerns can make effort provision worse; for example, agents may take actions to signal quality to the market that are negative for their current firm.

A final explanation for simple contracts comes from Holmström’s 1987 paper with Milgrom. They argue that simple ‘linear’ contracts, with a wage and a bonus based linearly on output, are more ‘robust’ methods of solving moral hazard because they are less susceptible to manipulation by agents when the environment is not perfectly known. [...]

These ideas are reasonably intuitive, but the way Holmström answered them is not. Think about how an economist before the 1970s, like Adam Smith in his famous discussion of the inefficiency of sharecropping, might have dealt with these problems. These economists had few tools to deal with asymmetric information, so although economists like George Stigler (1961) analysed the economic value of information, the question of how to elicit information useful to a contract could not be discussed in any systematic way.

These economists would also have been burdened by the fact that the number of contracts one could write are infinite. So beyond saying that under a contract of type X does not equate marginal cost to marginal revenue, the question of which ‘second-best’ contract is optimal is extraordinarily difficult to answer in the absence of beautiful tricks like the revelation principle, partially developed by Holmström himself.

And when thinking about agency costs and innovation Bryan writes,

Holmström’s work is brilliant in how it clarifies many puzzles that are tricky to understand without thinking about incentives within a firm. For example, why would a risk-neutral firm not work enough on high-variance moonshot-type R&D projects? This is a question Holmström asks in his 1989 paper. Four reasons:

• First, in Holmström and Milgrom’s 1987 linear contracts paper, optimal risk-sharing leads to more distortion by agents the riskier the project being incentivised, so firms may choose lower expected value projects even if they themselves are risk-neutral.
• Second, firms build reputation in capital markets just as workers do with career concerns, and high-variance output projects are more costly in terms of the future value of that reputation when the interest rate on capital is lower (for example, when firms are large and old).
• Third, when R&D workers can potentially pursue many different projects, multitasking suggests that workers should be given small and very specific tasks so as to lessen the potential for bonus payments to shift worker effort across projects. Smaller firms with fewer resources may naturally have limits on the types of research a worker could pursue, which surprisingly makes it easier to provide strong incentives for research effort on the remaining possible projects.
• Fourth, multitasking suggests that agent’s tasks should be limited, and that high-variance tasks should be assigned to the same agent, which provides a role for decentralising research into large firms providing incremental, safe research, and small firms performing high-variance research. A deep understanding of how these types of internal incentives aggregate into explanations for why firms appear the way they do can best be achieved by a thorough reading of Holmström and Milgrom’s beautiful 1987 paper, “The Firm as an Incentive System”.

Incentives matter: Adam Smith and teaching file

James R. Otteson reminds us of this point made by Adam Smith on incentives and teaching:

"In other universities the teacher is prohibited from receiving any honorary or fee from his pupils, and his salary constitutes the whole of the revenue which he derives from his office. His interest is, in this case, set as directly in opposition to his duty as it is possible to set it. It is the interest of every man to live as much at his ease as he can; and if his emoluments are to be precisely the same, whether he does, or does not perform some very laborious duty, it is certainly his interest, at least as interest is vulgarly understood, either to neglect it altogether, or, if he is subject to some authority which will not suffer him to do this, to perform it in as careless and slovenly a manner as that authority will permit. If he is naturally active and a lover of labour, it is his interest to employ that activity in any way, from which he can derive some advantage, rather than in the performance of his duty, from which he can derive none."

--Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (1776), V.i.f.7.

Incentives matter: tobacco file

One of the great things about prices is that they provide incentives.

The graph above shows the effects of the introduction of a tax on tobacco. Prior to the law’s enactment in 2009, the tax rates on roll-your-own tobacco and pipe tobacco were the same. One effect of the new law was to make the tax rate on roll-your-own tobacco over US$20 per pound higher than the tax on pipe tobacco.

You can see what happened. Consumers, not very surprisingly, substitute from the dearer product to the cheaper product, changing the demand for both products, and in this case potentially undoing some of the public health benefits the tax was intended to encourage. How did politicians not see this coming?

HT: Marginal Revolution.

Incentives matter: university file

From a column at VoxEU.org.

In the early 2000s several European countries passed new laws that ended the ‘professor’s privilege’, under which university researchers had enjoyed full rights to their innovations. This column shows that the reform in Norway was followed by a 50% decrease in both startup and patenting activity by university researchers. Measures of startup and patenting quality also declined. The reform, which sought to spur university-based innovation, appears to have had the opposite effect.

Anyone thinking in terms of incentives may well have argued that taking ownership rights away from the researchers would result in a reduction in effort and thus in startups and patents. But the size of the reduction, I think, would come as a surprise.

The column makes the point that,

A theoretical perspective that may explain the findings emphasises the problem of university researcher incentives, and how these can be balanced with any rights given to the university itself. How to balance ownership rights between investing parties is a classic question in economics and also provides canonical perspectives in studies of innovation [...]. The ‘professor’s privilege’ reform is a large shock to the rights regime. Recognising the potential importance of investments by both the university researcher and the university itself, one can motivate a royalty sharing regime that favours balancing rights across parties rather than giving all royalties to one party, as under the professor’s privilege. The basic presumption here is that university-level investments are important and cannot be easily replicated by the university researcher. However, under circumstances where the university-level investments are much less important than researcher-level investments, royalty shares would be optimally balanced toward the university researcher.

In short, when human capital matters giving ownership rights to that capital can make sense.

To eat the rich, first they must stay still

Taxation is always a problematic issue but the taxation of very high income earners is becoming an even more controversial subject in a number of countries. One problem with high tax rates is that it could lead high earners to move abroad. A new column at VoxEU.org suggests that top-tier inventors are significantly affected by top tax rates when deciding where to live. It is argued that the loss of such highly skilled agents could entail significant economic costs in terms of lost tax revenues and less overall innovation.

There is much debate, but little evidence, about the effects of high tax rates on high earners. The anti-tax side argue that higher top tax rates will cause an exodus of valuable, high income and highly skilled economic agents. They claim that high tax rates will unavoidably lead to a brain drain and an exodus of the most qualified people, especially as barriers to labour mobility between developed countries are reduced. The pro-tax side maintain that migration decisions are driven by other (possibly non-economic) considerations and would not respond very much to higher taxes.

It is generally acknowledged that non-human capital is highly mobile in a globalised world. This fact is used to justify lower taxation on capital. Much less is known about the mobility of human capital in response to taxation.

In their article, The effects of top tax rates on superstar inventors, Ufuk Akcigit, Salome Baslandze and Stefanie Stantcheva argue that inventors are highly valuable economic agents as creators of innovations and potential drivers of technological progress.

A group of highly valuable economic agents that policymakers perhaps might worry about is inventors, the creators of innovations and potential drivers of technological progress. Inventors may well be important factors for a country’s development and competitiveness – highly skilled migration has been shown to be both beneficial for a receiving country’s economy and to disproportionately contribute to innovation [...].

Consider Alexander G Bell, the inventor of the telephone; James L Kraft, who patented a pasteurisation technique and founded Kraft Foods; Ralph Baer, the inventor of the first home video gaming console that contributed to the expansion of the video gaming industry; or Charles Simonyi, a successful product developer at Microsoft. In addition to being very prolific inventors, they had something else in common: they were all immigrants. This is not very surprising given that migration rates increase in skill [...] and inventors are ranked very highly in the skill distribution.

It’s true, however, that inventors vary vastly in their quality and innovativeness. The big question is to do with the behaviour of the 'superstars': Do 'superstar' inventors respond to top tax rates?

In recent research (Akcigit, Baslandze, and Stantcheva 2015) we study the international migration responses of superstar inventors to top income tax rates for the period 1977-2003 using data from the European and US Patent offices, as well as from the Patent Cooperation Treaty [...]. Our focus is on migration across eight technologically advanced economies: Canada, France, Germany, Great Britain, Italy, Japan, Switzerland, and the US. To abstract from capital and corporate taxes as much as possible, we restrict our attention to inventors who are company employees and are not the owners (‘assignees’) of their patents.

Superstar inventors are those in the top 1% of the distribution of citations-weighted patents in a given year and ‘stars’ are inventors who are just below superstars in terms of quality and are in the top 1-5% of the citations-weighted patent distribution.

From outside survey evidence, we know that superstar inventors are highly likely to be in the top tax bracket and, hence, directly subject to top tax rates. Stars or inventors of lower quality are much less likely to be in the top bracket. The top tax rate, which can also be viewed as a ‘success tax’ can also have either an indirect motivating or discouraging effect on inventors in general, even on those who are not yet in the top bracket.

There has is a strong and significant correlation between top tax rates and those inventors who remain in their home countries. The relation is strongest for superstar inventors. [Results] show that superstar inventors are highly sensitive to top tax rates. The elasticities imply that for a ten percentage point reduction of top tax rates from 50% to 40%, a country would be able to retain on average 3.3% more of its top 1% superstar inventors. This relation weakens as one moves down the quality distribution of inventors – the top 25-50% or the bottom 50% of inventors are no longer sensitive to top tax rates.

[...]

At the individual inventor level, we have developed a detailed model for location choice. This wasn’t easy for two reasons. First, location choices are clearly also driven by factors other than taxes – such as language, distance to one’s home country, and career concerns – for which we include controls. Second, inventors may earn different pre-tax wages in different countries. This is a counterfactual we cannot observe and have to control for through a detailed set of proxy measures.

The results highlight that superstar top 1% inventors are significantly affected by top tax rates when deciding where to live. For instance, our results suggest that, given a ten percentage point decrease in top tax rates, the average country would be able to retain 1% more domestic superstar inventors and attract 38% more foreign superstar inventors.

[...]

We also consider long-term mobility, defined as a one-way move abroad. It turns out that long-term mobility is still affected by taxes, but to a lesser extent. This seems to imply that there are some adjustment costs to moving that might prevent inventors from moving back once they leave due to higher taxes.

What is the influence of companies on inventors’ migration responses to taxes?

One would expect companies to have an important influence on the inventor’s decision to move abroad. For instance, working for a multinational company might facilitate an international move, both directly within the company and indirectly by providing international exposure. Depending on the bargaining power between employer and employee, the relocation decision might well be driven by the former rather than by the latter. In that case, and if the employer has other considerations than personal income tax, we would observe a dampened migration effect of taxes in the data. Note, nevertheless, that employers should take personal income taxes into account to some extent, if competition for superstar inventors forces them to pay higher wages as a compensation for higher taxes.

We find that inventors who have worked for a multinational company are more sensitive to tax differentials in their location choice. On the other hand, inventors whose company has a significant share of its innovative activity in a given country are less sensitive to the tax rate in that country. This seems to suggest that career concerns can outweigh tax considerations. It could also signal that companies with very geographically localised research and development activities will strongly prefer to keep their superstar inventors at the main research location and dissuade them from moving to lower tax countries.

The upshot of all of this is that labour, like capital, might be internationally mobile and respond to tax incentives. The loss of highly skilled agents such as inventors might entail significant economic costs, not just in terms of tax revenues lost but also in terms of reduced positive spillovers from inventors and, ultimately, less innovation in a country.

Ref.:

• Akcigit, U, S Baslandze and S Stantcheva (2015), “Taxation and the International Mobility of Inventors”, Working Paper 21024, National Bureau of Economic Research.

Incentives matter: drug mules file

This is the abstract of a new paper The market for mules: Risk and compensation of cross-border drug couriers by David Bjerk and Caleb Mason in the International Review of Law and Economics, Volume 39, August 2014, Pages 58–72.

This paper uses a unique dataset to examine the economics of cross-border drug smuggling. Our results reveal that loads are generally quite large (median 30 kg), but with substantial variance within and across drug types. Males and females, as well as U.S. citizens and non-U.S. citizens are all well represented among mules. We also find that mule compensation is substantial (median $1313), and varies with load characteristics. Specifically, for mules caught with cocaine and meth, pay appears to be strongly correlated to expected sentence if caught, while pay appears to be primarily correlated with load size for marijuana mules, who generally smuggle much larger loads than those smuggling cocaine and meth. We argue that our results suggest that this underground labor market generally acts like a competitive labor market, where a risk-sensitive, reasonably well-informed, and relatively elastic labor force is compensated for higher risk tasks.

Incentives matter: manager file

A new paper forthcoming in the Scottish Journal of Political Economy. "Base Salaries, Bonus Payments, and Work Absence among Managers in a German Company" by Christian Pfeifer. The abstract reads:

This paper provides scarce insider econometric evidence on the structure of management compensation and on the incentive effects of fixed base salaries and bonus payments. Six years of personnel data of 177 managers in a German company are analyzed with special emphasis on the highest achievable bonuses under a Management-by-Objectives (MBO) incentive scheme. The main finding of panel negative binomial regressions is that higher achievable bonus payments are correlated with fewer absent working days, which supports the incentive effect of performance pay for managers. The fixed base salary component is, however, not significantly correlated with managers’ work absence. (Emphasis added.)

So if you give people a reason to be a work, they are at work. Seems reasonable.

Incentives matter: colonisation file

From A Licence to Trade: A History of the English Chartered Companies by Percival Griffiths, London: Ernest Benn Limited, 1974, p.215.

It is interesting to note that the two Companies organized initially by philanthropists rather than businessmen-the Sierra Leone Company and the New Zealand Company-were badly managed and were a financial failure though they served a useful purpose. The other two companies were efficiently run on business methods.

The economics of conscription

One of the many things economist Milton Friedman was well known for was his oppression to the draft. In this article another University of Chicago economist, Allen Sanderson, discusses the economics and political economy of conscription. In part Sanderson writes,

After a few weeks of class, any Economics 101 student should be able to demonstrate that the lowest cost way to provide a military force is our current “volunteer” or free-market army, a system we have employed since 1973.

Why? Because only those whose opportunity cost is at or below the established market wage rate, plus those who are extremely patriotic, will enlist. By contrast, drafting LeBron James may appear cheaper on the Pentagon’s budget by paying him a draftee’s salary, but that entails—to him and to the economy—an implicit tax of several million dollars a year (that is, what he would have earned, and would now be forgoing, as a member of the NBA Miami Heat).

In addition, a volunteer force is more likely to have higher morale as well as lower turnover and training costs because these recruits want to be involved in defending the nation rather than serving grudgingly because they were taken away from family, friends and other preferred options.

Opportunity cost and incentives come to the fore in this issue as with so much of economics. I do wonder however just how many econ 101 students - or politicians for that matter - could actually could give this analysis of conscription.

Incentives matter: ABBA file

From the Guardian

Abba admit outrageous outfits were worn to avoid tax [...]

The glittering hotpants, sequined jumpsuits and platform heels that Abba wore at the peak of their fame were designed not just for the four band members to stand out – but also for tax efficiency, according to claims over the weekend.

[...]

And the reason for their bold fashion choices lay not just in the pop glamour of the late 70s and early 80s, but also in the Swedish tax code.

According to Abba: The Official Photo Book, published to mark 40 years since they won Eurovision with Waterloo, the band's style was influenced in part by laws that allowed the cost of outfits to be deducted against tax – so long as the costumes were so outrageous they could not possibly be worn on the street.

Kling on non-profits

Arnold Kling writes,

James Piereson writes,

For much of U.S. history, nonprofits have operated as a check on government by providing private avenues to serve the public interest. Unfortunately, American charities—and more broadly, the entire nonprofit sector—have become a creature of big government…

The publication Giving USA, which tracks charitable spending, reports that the government now supplies one-third of all funds raised by not-for-profit organizations.

… According to a recent report by the Chronicle of Philanthropy, government funding of such charities grew by 77% between 2000 and 2010, while private support for such groups grew by just 47%.

I keep emphasizing that the main difference between non-profit and for-profit is that non-profits are accountable to donors and for-profits are accountable to customers.

While I agree that non-profits are not accountable to their "consumers" I don't agree that they are accountable to their donors. If they were for-profit status would work. In fact the use of non-profit status is largely because they are not accountable to donors, the non-profit status is a way of signalling to donors that they will not (or are less likely to) be ripped off.

Imagine that you are a possible donor to a firm the outputs of which you can't easily verify. If the firm is for profit then the profit maximising thing to do is take the donor's money and do nothing at all. Remember the donor can't verify what you have done with their money. The donor's money is then pure profit, you have no costs since you haven't actually done anything. You just tell the donor you have done lots of things. The revenue from the donor is then profit. If you are non-profit then you can't capture profit in this way since there are no profits to be distributed by definition. This gives a lesser incentive to rip a donor off since any rent seeking must be done via other higher costs methods

Now this is just stupid 2

A reading of Henry Hansmann's 1996 book "The Ownership of Enterprise" may be worthwhile for Geoff Bertram. When discussing the Spanish cooperative Mondragon Hansmann writes,

The wage structure has been among the most contentious issues at Mondragon. Initially, the systemwide top pay index-the maximum permissible ratio of highest to lowest rate of pay-was three to one. Over the years, this ratio has been increased to attract and hold talented executives.

Hansmann notes that the ratio had been increased to 4.5 to 1 and then to 6 to 1 in a effort to keep good managers.

A firm with a very constrained  pay scale will not be able to keep its "best and brightest". I used this basic argument in a paper to help explain why you don't see player-owned teams in professional sport,

Another (more usual) example of a human-capital based "firm", but one where labour-owned firms are seldom, if ever, found, due to the heterogeneity of the human-capital involved, is that of the professional sports team. Here we have a situation where human capital, talent at playing a particular sport, is the basis for the “firm” but ownership by the human capital, the players, is extremely rare since a worker-owned team would be at a disadvantage relative to a player-as-employee based team.

Heterogeneity among playing talent and thus earning potential acts as a disincentive to the formation of a worker cooperative, which involves (rough) equality in payment, since those players with the greatest earning potential, the largest outside options, will transfer away from the cooperative to maximise their income stream. Differential payment schemes can occur, especially within partnerships, but they require that the individual employee productivities are sufficiently easy to measure so that a relatively objective method of productivity related pay is possible. Given the team production nature of team sports productivities are difficult, if not impossible, to estimate and thus payment by productivity is not feasible, which argues in favour of equality in payments. Thus a worker-owned team would have few, if any, star players, a handicap in the winner-takes-all world of professional sports.

Now this is just stupid (updated)

Kiwiblog writes,

Simon Collins reports:

The Government should stop giving contracts – and knighthoods – to companies that pay their bosses more than three times their lowest-paid workers, an economist has suggested.

Dr Geoff Bertram, a retired Victoria University economist who inspired a Labour Party plan to force down electricity prices, made the proposal at a conference on inequality in Wellington yesterday.

Seriously I find it hard to believe an economist could come out this such an idea, after all as Steven Landsburg pointed out back in 1993,

Most of economics can be summarized in four words: "People respond to incentives." The rest is commentary.

Has Bertram really thought about the incentives in his idea? If he had he would know that they are all bad. These ideas have been tried and failed. Many worker cooperatives have payment schemes which limit the ratio of the highest paid person to the lowest, e.g. 3 to 1, 6 to 1 etc, in an effort to create a more equal division of the firm's residual. Ricketts (1999: 20) outlines the general problem with this as '[...] to minimise antagonism a rough equality in the division of the residual will be necessary and this may conflict with outside opportunities. Those with high transfer earnings reflecting high productivity elsewhere will desert the co-operative. It is for these reasons that control of the firm by its labour force is usually found in circumstances which permit a high degree of common interest'. Jossa (2009: 709-10) explains the basic issue in terms of the management of capitalistic versus co-operative firms: '[g]iven the tendency of cooperatives to distribute their income equitably among all the members, it is difficult to deny that few cooperatives are in a position to pay the high salaries that able managers can expect to earn in capitalistic firms. Whenever a group of people resolve to work as a team-we may add-the member who outperforms the others in initiative and organizational skills will inevitably take the lead. The crux of the matter is that such a person has no incentive to establish a cooperative and share power and earnings with others. He or she will prefer to found a capitalistic firm, where he or she will hold all authority and, if sole owner, appropriate the whole of the surplus [references deleted]'.

In other words having a payment scheme which imposes a tight limit on the payments to the most able within the firm gives an large incentive for these people to leave. And these are the very people the firm needs to succeed.

Update: Eric Crampton also seems to see some problems with the Bertram suggestion while Matt Nolan thinks Bertram's being "reasonably disingenuous".

Incentives matter: physician motivation file

Using Performance Incentives to Improve Medical Care Productivity and Health Outcomes

Paul Gertler, Christel Vermeersch

NBER Working Paper No. 19046
Issued in May 2013
NBER Program(s): CH DEV HC HE LS

We nested a large-scale field experiment into the national rollout of the introduction of performance pay for medical care providers in Rwanda to study the effect of incentives for health care providers. In order to identify the effect of incentives separately from higher compensation, we held constant compensation across treatment and comparison groups – a portion of the treatment group’s compensation was based on performance whereas the compensation of the comparison group was fixed. The incentives led to a 20% increase in productivity, and significant improvements in child health. We also find evidence of a strong complementarity between performance incentives and baseline provider skill.

Incentives matter: tax file (updated)

From the New Zealand Herald.

France's leading actor Gerard Depardieu says he will give up his French passport after the prime minister called him "pathetic" for trying to avoid taxes by moving to Belgium.

and

Depardieu has joined some of France's wealthiest business figures in Belgium following moves by President Francois Hollande's Socialist government to tax annual incomes above one million euros ($NZ1.6 million) at 75 per cent.

and

"I am leaving because you consider that success, creation, talent, anything different, must be punished," he [Depardieu] said.

Update: Mark Hubbard notes that Tax Them, And They Will Leave.

Incentives matter: recycling file

The Conversable Economist, Timothy Taylor, writes

If we want people to be serious about recycling, having a policy of 5-10 cents for returning cans and bottles is likely to be a more effective tools than curbside recycling.