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.

Leave SpongeBob aloooooooone!

I have to admit a certain bias here. I'm a big fan of Mr. Squarepants. I like the classic Fleischer look with the occasional Wolverton grotesque touches, the witty asides to the more sophisticated viewers, the sensibility that built the climax of the first episode around a Tiny Tim song and the cultural literacy to pick the lovely and wonderfully apt "Livin' in the Sunlight, Lovin' in the Moonlight" for the song in question (and, of course, the fact that in Bikini Bottom you can build a campfire under water).

SpongeBob has been all over the news lately, even making the teaser for at least one local station's 11:00 broadcast. The cause of the furor was a recent study, described here on All Things Considered:

"I would not encourage parents of a 4-year-old boy to have him watch SpongeBob right before he goes in for his kindergarten readiness assessment," Dimitri Christakis told Shots. He's a child development specialist at Seattle Children's Hospital who wrote a commentary on the new study, which was just published in the journal Pediatrics.

But fans of the optimistic denizen of Bikini Bottom can take solace in the fact that the new study comes with a boatload of caveats. Just 20 4-year-olds were tested after watching the popular Nickolodeon show, and they watched it for nine minutes. That's a very small sample size, and it hardly reflects the real TV-watching habits of young children, who commonly watch two to five hours a day of TV.


And the researchers, psychologists Angeline Lillard and Jennifer Peterson of the University of Virginia in Charlottesville, didn't measure if the problems with attention and executive function lasted. But they did compare the SpongeBob watchers to 20 children who watched Caillou, a slower-paced PBS show that features a sweet yet whiny preschooler. Another 20 colored for 9 minutes.

Neither of those groups had problems with the tests, which involved remembering a series of numbers, following rules, and delaying gratification. (That test asks the preschoolers to resist eating a plateful of Goldfish crackers for 5 minutes, which would be hard for many members of the NPR Science Desk.)

But the kids who watched SpongeBob, which changed scenes every 11 seconds, did significantly worse on the tests than either the children who colored, or those who watched educational TV. Caillou changed scenes every 34 seconds.

Other studies have found that children who watch a lot of TV as preschoolers have more problems with attention in the elementary-school years. Christakis, who has conducted several of those studies, says that the findings of the new study are consistent with what he's found. It's not SpongeBob himself who's the culprit, he says, but fast-paced or violent shows. "It's overstimulation that causes the problem," he says. The theory is that overstimulation while a child's brain is developing makes it harder to focus on sustained tasks later on.

This is the classic one-two punch of so much behavorial science: observational studies with data confounded to within an inch of its life* and little n experiments that answer a trivial (and in this case painfully obvious) question that relates only tangentially to the major issues.

This incredibly hyped study basically showed that small children have trouble concentrating immediately after they get wound up. This conclusion is not exactly news worthy. Anyone who has ever dealt with groups of pre-schoolers can tell you that the transition from squealing with laughter to sitting quietly can be difficult and that's really all this study tells us.

There has been a long history of research, going back at least to Seduction of the Innocent, built around puritanical disapproval of children seeking out stimulating entertainment. It is based on a vision of young people as miniature Roderick Ushers with constitutions so delicate that anything but lives of unrelenting blandness would damage them forever.

I don't buy it. Kids are remarkably resilient, often emerging relatively unscarred from some truly tough situations. It's difficult to believe that a few extra camera angles would cause them irreparable damage.

More importantly children have an evolutionary imperative to seek out stimulation. Their appetite for excitement and laughter matches and often exceeds their appetite for food and drink. There's a reason for this. Our creativity, our curiosity and our ability to organize and explore our world through narrative are all connected to that desire for fun.

This is not to say you should give your preschooler the remote any more than you should give a four-year-old free run of the refrigerator. Providing structure and maintaining balance are part of a parent's job, as is reading to your kids and taking them outside to play and any number of other things that everyone knows are important for a growing child. Television should certainly take a backseat to these things. You can even make a good case for eliminating it entirely.

Just make sure it's based on common sense, not questionable research.


*yeah, 'data' is plural -- what are you, the grammar police?

Logic on social security

Somehow, I doubt that this post will be influential:

Oftentimes, however, I see people on your television programs or your televised debates making reference to the idea that “younger workers” should divert some of our payroll tax money into some kind of private retirement accounts. At this point you, the national political reporter, absolutely must ask them how we’re going to pay current benefits of this happens. What privatizers want to say is that current retirees will keep getting benefits and future retirees will be okay despite our lack of benefits because we’ll have private accounts. But current retirees can’t get benefits if my money is in a private account. And my account can’t be funded if I’m paying benefits for current retirees.

The obvious answers are either a) we will stop paying benefits or b) taxes are about to hit a new and large high as we switch from Paygo to pre-funded accounts. If the answer is a), why do we trust these same people not to play games with the individual accounts when they start to become a major liability (i.e. have to be paid out)? I am not against option b) but it seems to be an unusual direction for the United States to go, and an enormous financial sacrifice for a fairly small policy gain.

I also think that the distinction between lending to the government, via a private savings account, and having a future claim on government revenues is a narrower difference than most people think. After all, playing with the tax rates on withdrawals from these accounts has the same effects as a benefit cut in social security (and both are within the easy ability of the government to accomplish).

How do you say Los Angeles

For the curious, Americans often pronounce the names of cities in interesting or unusual ways. It seems there was actually a risk Los Angeles could have ended up pronounced with a hard "g" (like angle instead of angel".

Loss AN-ju-less versus Loss AN-guh-less: did they pick correctly?

What is up with Arkansas?

Looking at the student loan defaults rates by state, one is struck by how much the defaults are concentrated in the South East. Why would this be so?

But nothing is as shocking as how badly the for-profit institutions do. I think some sober looks at these numbers make sense before we conclude that for profit is automatically better, especially given that student debt is large and can no longer be discharged by bankruptcy.

Medical spending as a zero-sum game

Marketplace has a good piece on the debate over hospital construction in Detroit. It raises real questions about creating new jobs by adding what seems to be unneeded capacity to the health care system.

Definitely worth a look.

Professionals and Advancement

A few years ago, a Fortune 500 company I was working with started worrying about retaining their technical people. The wages were competitive and the bonuses were good, but the concern was that statisticians, programmers and other people who were doing analytic work and who weren't interested in management really didn't have a career track. In other words, even with high salaries and incentive pay, it's difficult to hold on to good, highly skilled professions without offering some opportunity of advancement.

With almost all careers, we expect a certain level of ratcheting advancement. We generally assume that if we maintain a certain quality of work, we will see a more-or-less steady increase in either our compensation, our employability or our job security. This advancement can take all sorts of forms from traditional promotions to a salesman's contact list to a writer's readership, but whatever the form, it is exceedingly rare to find jobs where you start each year about where you started the last one and it's next-to-impossible to find one that would be considered a 'profession.'

(Of course, there are many freshwater economists who are deeply uncomfortable with this ratcheting effect, who would argue that an ideal labor market should have no memory, that the services provided by a long time employee should be treated no differently than any other commodity. Long time OE readers will probably know I don't agree with the idea that labor should be treated as just another market, but that's a topic for another time. For now we're talking about the way things are.)

The discussion of teacher compensation and job security has almost entirely ignored the larger question of advancement, looking at the unusual contractual protections afforded the profession but failing take into account the equally unusual limitations. Take a minute and try to think of professions that have the following career constraints:

Few opportunities to move up the org chart. Not only is the structure here relatively flat, but unlike many industries, the move to management is almost a complete break from your previous role. Thus 'rewarding' the best teachers by making them administrators is a questionable strategy. We obviously need exceptional principals but we can't have teacher career track focused on taking the best teachers out of the classroom;

Non scalable work. Even if you accept claims about class size not mattering (and there's a lot to dispute in the reasoning behind those claims), there are still hard limits to the number of fourth graders one person can teach in a year. Compare this to someone like a journalist who can, in a sense, sell the same piece of work a virtually unlimited number of times;

Bounded compensation. Though movement reformers talk a lot about different incentive pay plans, pretty much all of them are metric based and have pre-determined maximums;

Lack of entrepreneurial opportunities. It is true that administrators can go out and start their own charters but teachers can't start their own classes;

Limited chances for promotion through relocation. This does happen but it's discouraged with good reason. The winners tend to be high-income suburban schools. Add to this the logical results of movement reforms that effectively reduce job security for teachers in schools bad neighborhoods and you have a huge incentive to actually widen the achievement gap.

In other words, we have here another case of advocates for business-based solutions who don't understand how businesses actually operate. Not coincidently, this is also an area where conservatives with actual business experience (like Jim Manzi) tend to take more nuanced positions.

Appropriate Scales

Paul Krugman has a clever post about where to start a Y-axis of a graph from. He plots the temperature changes of New York . . . in kelvins. The result is a graph that makes it seem like New York has very small variations across the year.

On the other hand, very small variations can look large if the axes covers only the range of variation. The real piece of information that is missing is what is the size of a meaningful change. Maybe we should have graphs declare this extra piece of information so that this point can be discussed along with the variation shown in the graph, itself,

The Wisdom of Salmon

About ten minutes after putting up the last post, I came across this relevant passage from Felix Salmon:

What’s more, everybody wants to be invested in stocks when the market’s going up — just not when it’s going down. Is it possible to actively manage your 401(k) so that you try to go long stocks when they’re going up and then move to cash or bonds when stocks are falling? Well, you can try. But that’s called timing the market, and it tends to end in tears. You are not a hedge-fund manager, and even they get these things wrong. Don’t think you can time the market, because you can’t. So if you want to be invested in up markets, you have to be invested in down markets, too. And as the chart shows, your retirement account will tend to grow most of the time anyway.

The main reason for this is that we’re not just sitting back and hoping that the stock market will do all the heavy lifting. Every paycheck, we’re putting money into our 401(k) accounts — about 8.7% of what we earn, on average. And so every quarter, we see our balance rise not just because we’re great at investing, but also because we’re manually adding to the pot.

And in fact that second aspect of saving for retirement is significantly more important — and much more under our own control — than the first aspect. When it comes to our 401(k) plans, people tend to focus far too much on the quarter-to-quarter fluctuations in mark-to-market asset value, rather than trying simply to save as much money as they can for when they’re older. My advice is to think of a retirement account like a piggy bank: you put money in there on a regular basis, and eventually it grows to a substantial sum. Once it’s in there, of course, you try to invest in something reasonably sensible — target-date funds are a pretty good idea, so long as their fees are low. But you don’t have much control over the internal returns on your retirement funds; you do have control over how much you save. So concentrate on the latter more than the former.

The Growth Fetish

[This is a big topic so I'm just going to lay out the bare bones for now and flesh things out later, hopefully with a little help.]

It's obvious that our economy is suffering from a lack of growth but for a while now I've come to suspect that in a more limited but still dangerous sense we also overvalue growth and that this bias has distorted the market and sometimes encouraged executives to pursue suboptimal strategies (such as Border's attempt to expand into the British market).

Think of it this way, if we ignore all those questions about stakeholders and the larger impact of a company, you can boil the value of a business down to a single scalar: just take the profits over the lifetime of a company and apply an appropriate discount function (not trivial but certainly doable). The goal of a company's management is to maximize this number and the goal of the market is to assign a price to the company that accurately reflects that number.

The first part of the hypothesis is that there are different possible growth curves associated with a business and, ignoring the unlikely possibility of a tie, there is a particular curve that optimizes profits for a particular business. In other words, some companies are better off growing rapidly; some are better off with slow or deferred growth; some are better off simply staying at the same level; and some are better off being allowed to slowly contract.

It's not difficult to come up with examples of ill-conceived expansions. Growth almost always entails numerous risks for an established company. Costs increase and generally debt does as well. Scalability is usually a concern. And perhaps most importantly, growth usually entails moving into an area where you probably don't know what the hell you're doing. I recall Peter Lynch (certainly a fan of growth stocks) warning investors to put off buying into chains until the businesses had demonstrated the ability to set up successful operations in other cities.

But the idea of getting in on a fast-growing company is still tremendously attractive, appealing enough to unduly influence people's judgement (and no, I don't see any reason to mangle a sentence just to keep an infinitive in one piece). For reasons that merit a post of their own (GE will be mentioned), that natural bias toward growth companies has metastasised into a pervasive fetish.

This bias does more than inflate the prices of certain stocks; it pressures people running companies to make all sorts of bad decisions from moving into markets where you don't belong (Borders) to pumping up market share with unprofitable customers (Groupon) to overpaying for acquisitions (too many examples to mention).

As mentioned before we need to speed up the growth of our economy, but those pro-growth policies have to start with a realistic vision of how business works and a reasonable expectation of what we can expect growth to do (not, for example, to alleviate the need for more saving and a good social safety net). Fantasies of easy and unlimited wealth are part of what got us into this mess. They certainly aren't going to help us get out of it.

Dream a little dream for me

If you have a few minutes, listen to this episode of KCRW's Unfictional (sorry, I can't find a transcript) where neuroscience researcher Moran Cerf publishes a paper on brain machine interfaces in Nature then watches the popular press spin out a string of fantasies about dream recorders and the government monitoring your subconscious.

It's a funny story but it has a serious undercurrent. At the risk of sounding like an alarmist, I'm beginning to think that our discourse, our ability exchange and evaluate important information and use it to collectively make informed decisions is in serious trouble, and I'm not sure how you can run a democracy without that.

The decline in journalistic professionalism is a big part of that problem. There are some excellent journalists out there, but there are also far too many like the ones in this story. They nonchalantly build on each other's fictions. They unquestioningly accept claims from interested parties. They dodge responsibility for uncomfortable facts by hiding behind he said/she said stories.

As I've said before, I honestly believe that given good information, the American public tends to make good decisions but there's a corollary to that claim: given the crap we've been fed recently, it's a wonder we still have a country.

And now for a break from serious discussion

I would like to imagine that this could not happen in a modern roundtable, but it is just too close to reality:

Imagine a host talking to a panel of four pundits about someone about to roll a 6-sided die.

Host: What's your prediction for the big dice roll?

Judy: Well, Jim, I've knocked on thousands of doors in this province, and families everywhere are telling me the same thing. They like the number 1, so I expect it to do really well.

Bill: Remember, the big dice roll is taking place on a Sunday after church, so the smart money is on 3, the trinity. We all remember Easter Sunday 1985 when a three was rolled three consecutive times. History is on the side of 3.

Jim: Look at the data. An even number has come up on 9 of the last 13 rolls. You have to play the hot hand on this one and go for 2, 4, or 6.

Alice: I agree with Jim's data, but all that means is that odd numbers are due. Judy is right that 1 is the trendy pick, but I really like 5 as a dark-horse candidate.

[Off-screen a mathematician is sobbing].

And, I suppose, a casino operator is gloating . . .

401(k) plans

We have talked a bit about how personal finance and saving for retirement is hard. One reason that 401(k) plans have been able to charge high fees (management fees plus fees from the individuals mutual funds) is that they are tax free savings vehicles (and tax free covers a lot of sins). That is now being openly discussed:

The tax break for defined contribution retirement plans will cost the Treasury $212.2 billion between 2010 and 2014, according to the Joint Tax Committee. But the vast amount of that benefit - as much as 80 percent - goes to the top 20 percent of earners, according to estimates from the Tax Policy Center, a nonpartisan, but liberal-leaning, think tank.

For example, a person in the 35 percent tax bracket saves $35 in taxes every time he puts $100 in his 401(k), for a net cost of $65. Someone in the 15 percent bracket pays $85, after tax, for the same $100 contribution. The Pension Rights Center, which has favored traditional defined benefit pensions and other programs aimed at lower-income retirees, advocates rolling back the current $16,500 annual 401(k) tax-deferred contribution limit to the $10,500 level it was at before the Bush tax cuts, its director, Karen Ferguson, has said.

One way to address both the cost and the disparity is to change the deduction into a credit. William Gale, of the Brookings Institution, will present a plan like that to the Senate committee on Thursday. His plan would eliminate the deduction entirely and replace it with a federal match that would be deposited directly into workers retirement accounts. A match of 30 percent would be revenue neutral, he says.

Neither solution is ideal. Lowering the deduction limit makes these plans less able (even in theory) to store enough wealth for retirement. It also makes "catching up" after a period of unemployment or education more difficult.

Matches, on the other hand, are much easier to cut than tax breaks. Dropping the match from 30% to 28% is an easy cut that raises a lot of revenue. It may be harder to penalize post-tax withdrawals, which runs the risk of funds being emptied due to an unexpected job loss.

None of this would really matter if we were confident that social security would be around. It really is the key government anti-poverty program. But ponzi scheme comments are not helping build confidence in the long term health of the program.

Open Call

Consider this an open call for Mark, my co-blogger with a strong interest in education, to give his reactions to this piece on educational reform.

Personal Finance talk

There has been a lot of discussion of personal finances in the blogsphere this weekend, and several really good points have been made. I want to comment on the cool stuff at Worthwhile Canadian Initiative, but first let us consider two interesting posts by Karl Smith. One is on Apple:

Let’s add up how much of the iMac, iPod, iPhone, iBook and iPad profts have been paid out to the owners of Apple. Well lets think. . . oh yes I have it now, ZERO DOLLARS! Not one single penny.

So far is this really different from what Allen Stanford did? I hear some of his investors actually got redemptions. But, I am sure Apple investors will get their money some day, right.

They have the value of their share of the company, but that might very well be spent on other things before any dividends are paid. It's scary to consider.

Even worse is his discussion of Sir Alan Sanford:

You can do whatever you want to Allen Stanford. He is now broke. He got beat up in prison. He may very well spend the rest of his life there. But, he’s 61 years old now. These experience were his life. You can’t take that away.

Once you realize that, you realize the fundamental vulnerability that everyone has in handing over your assets to someone else. There is just no recourse against the other person consuming them.

You have to trust and that’s at the heart of what call The Big Externality.

That is a lot more scary. It really makes the idea of a government sponsored pension program way more appealing. And it definitely makes one skeptical about the ability of a typical investor to manage their assets. After all, I would not have seen Apple as an atypical investment vehicle, mostly because I like and consume their products. But if they are not paying dividends, then the idea behind getting money out of them is entirely to sell shares to somebody else.

But why would they want to buy them if they do not produce returns?