Supply and demand

This is Joseph

I'm often talking about how direct supply and demand relations seem to have broken with respect to managerial salaries (why aren't we outsourcing CEOs to India?).  In these cases, I am often skeptical that the high wages paid to senior managers are really required to attract a competent candidate.  But Cathy O'Neil points out that this issue is happening in reverse with entry level workers, where raising wages is seen as a taboo:

Of course, $50K isn’t nothing. But on the other hand, truckers have to be trained, competent, and regularly spend many days on the road. Moreover, the current surveillance technology has severely degraded their quality of life, which I learned by reading about Karen Levy’s work on the industry. Also, new truckers probably make substantially less than $50K when they start.

Partly the surveillance arose from the very real risk of truckers driving too much per day – it was an attempt to make sure truckers were driving safely. But since the technology has been installed in many large-company fleets, the companies have used it to essentially harass their drivers, telling them when break is over and so on. This has worked, in the sense that larger companies with more surveillance have managed to lower costs, pushing out smaller and individual truckers. And that means that truckers who used to own their own business now reluctantly work for huge companies.

And consider:

When you make your workers lives worse, and you don’t compensate them with cash money to make up for it, you find your workers quitting. That’s what’s happening here.

In the comments we also have:

There’s no shortage of older, experienced drivers who publicly contemplate getting out of the business in response to the micromanagement of their workday. It’s not that the drivers don’t want to comply with the rules, though many of them do think many of the new rules make no sense, it’s that what they have to do to comply is often unrelated to real time conditions and circumstances and is often the wrong thing to do for both safety and efficiency. I often hear that they are blamed for not meeting schedules or other metrics even though they have no ability to do the things that would allow them to do so due to controls on both their driving and the engines of their trucks.

Taken as a whole, I think that these issues are illustrative of a complete failure of industry to pay attention to the basic rules of supply and demand.  If you offset the costs of training onto workers (get a license first), make the working conditions poor (constant surveillance), and then don't raise wages then it is unsurprising that you suddenly have worker shortages.  Raise wages and give fixed term contracts (to make sure employment covers the cost of obtaining a license) -- then you might see the worker shortage vanish instantly.

It is remarkable that companies are acting like this and not addressing shortages with wages.  It makes me suspect that there is some sort of "moral virtue" in paying workers less (or a political point about not wanting to pay people).  Part of it is likely the "something for nothing" game -- if you don't count the costs of your new system on employee retention/morale then it looks like free productivity gains.  Since people are "sticky" (it takes time to find a new job and the employees may hope that the bad plan will go away), there is a lag between the implementation and the subsequent HR issues.

The proposed solution to reduce the criterion for licenses is a short term fix that won't hold in the long run.  A sufficiently bad job (high stress, low autonomy, moderate pay, much travel) is simply going to have to pay more to be competitive.  If you don't believe me, double wages and see what happens. 

However, the big point I want to make is that is appears that these companies don't seem to believe in the market economy, except when it is helpful to them.  Otherwise they would respond to changes in worker supply by paying more for workers (essentially passing down some of the efficiency gains in the form of increased wages).  Since this approach would also improve domestic demand that the time that the economy is a bit stagnant, it would probably be good for everyone. 

More on Executive Compensation

I do not agree with the amount of vitriol in the linked post, but Joshua Brown has a very strong set of feeling on the decision to pay two low level executives at Bank of America an $11 million dollar severance package:

You pay fired executives more in severance than the average American worker will earn in a lifetime. For most people on the outside looking in, this seems like it's from outer space, another world entirely. These numbers just do not exist to regular human beings, they cannot be fathomed.

He also points out the bad timing:

It's not that this isn't your prerogative as a private company - it is. But seriously, numbers like these at a time when you're instituting added fees on customer accounts just sound farcical, almost like you're making these payments to get a reaction out people.

I have been interested in this dynamic for a while. Mostly because I am beginning to see executive compensation as an intriguing form of market failure. After all, let us consider the example of these two executives. What are they being compensated for?

Do executives at banks really add so much value that $5.5 million dollar severance packages are just a way of saying thank you? Is there really no competitive pressure on salaries? Is the supply of potential bankers really this low? Supply side issues seem to be dubious. Are these skills really so rare (and, if they are, how do banks really select for them because the rest of us want to know).

Or is it due to the risk of taking a corporate job instead of being a school teacher? Well, these two executives are not really taking any real risk. Even if this is the last job either one ever holds. they are already well above the typical lifetime earnings curve based on this severance package alone. Debts required to reach this position (like School debt) are simply dwarfed by the size of the payout.

It is a very interesting problem.

Market Efficiency

For a long time now I have been hearing about how markets set salaries based on the productivity and value of an employee. The ideal was that increases in executive pay were a function of the greater influence a top executive could have in the information age. It was a nice story. Unfortunately, it also seems to be untrue:

Companies have long hid the way they set executive pay, but in late 2006, the Securities and Exchange Commission began compelling companies to disclose the specifics of how they use peer groups to determine executive pay.

Since then, researchers have found that about 90 percent of major U.S. companies expressly set their executive pay targets at or above the median of their peer group. This creates just the kinds of circumstances that drive pay upward.

Moreover, the jump in pay because of peer benchmarking is significant. A chief executive’s pay is more influenced by what his or her “peers” earn than by the company’s recent performance for shareholders, according to two independent research efforts based on the new disclosures. One was by Michael Faulkender at the University of Maryland and Jun Yang of Indiana University, and another was led by John Bizjak at Texas Christian University.

As Kevin Drum observes:

Adjusted for inflation, cash compensation for line workers has actually decreased over the past few decades, and even when you include healthcare compensation it's grown only about 30% or so. In contrast, executive compensation over the same period has more than quadrupled.

This is clearly a result of market failure. It also suggests that the reasons for increases in executive compensation are entirely due to poorly designed compensation system and not because of market forces. Examples like this one are worth keeping in mind when considering whether a market-based outcome is really utility maximizing or not.

Principal agents

I suspect that this reaction to a press release by the CEO of Netflix is just a principal agent problem:

In classical economics AOL should have died. Borders should have died.They should have spun every dime out to the shareholders who could have invested in the next big thing themselves.

However, Hastings is specifically saying this is the mark of a bad CEO and everyone nods there heads. He is saying that we should burn shareholder profits in an effort to move away from what made the company great.

Shareholders are diluted across thousands of mutual funds and cannot easily exercise control. Returning money to these people also means no longer being the CEO of Borders or AOL. Management loses access to resources and are looking for jobs with less experience. If there was a cultural sense in which winding down the firm made an executive more employable at a later firm, that would be different.

But, as it is, why would an executive ever decide to walk away from the resources of managing a large company when they could profit from spending down the corporate resources. It is not like they can be held accountable by the shareholders, in any meaningful sense. They merely need to promise that, in their judgement, they can invest the money more effectively than the shareholders and keep going.

Heck, how many people working for a large firm consider themselves as working for a shareholder pool as opposed to working for the CEO? After all, only one of these two groups has any day to day authority in the company and access to complete information.