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It wasn’t long ago that I started thinking about corporations, specifically joint-stock companies, not long after I started thinking about wealth, and what I thought about most were the economic incentives surrounding corporations.
It didn’t take me long to realize that the incentives surrounding a corporation are bad.
You see, when an entrepreneur starts a company, and plans to own it until his death, he has an incentive to do what is best for the company in the long term. After all, if he owns the company for a long time, it is in his interest to see that the company makes him a living for a long time. As such, he is incentivized to run the company such that the company maintains good relationships with the communities it operates in and the governments it operates under.
The key here, though, is that a business owner gets money from profits, the honest reward for those who take risks. Thus, a business owner is incentivized to do those things that make people willingly part with their money; in other words, he is incentivized to provide value, i.e., not be an economic parasite.
But corporations are (usually) not directly run by the people who own them, the shareholders. Instead, they are run by executives whose incentives are to maximize their salary. They do this by providing returns for shareholders.
Now, returns for shareholders can come from profits in the form of dividends, but the most common form of returns for shareholders (as far as I am aware) is the growth of the stock price. Most shareholders want to buy stock when it is cheap and sell when it is expensive. That way, they make returns on the shares themselves, and in fact, since most companies use share sales as a way to raise investment money, shareholders tend to see shares as investment rather than ownership.
Thus, shareholders care about the stock price, which tends to correlate to profits, yes.
However, one easy way to increase profits is to grow the company’s reach, to get more people to buy the products. The bigger the market, the bigger the possible profits. And to reach a bigger market, a corporation tends to want to grow.
While an owner-run company would be incentivized to produce profits, corporations have incentives that almost require them to be greedy about the profits, and pure greed is never good since it brings bad motivations.
A greedy owner of a company could also have bad motivations regarding profits. That does not prove my argument wrong because my argument is about the incentives on the executives of corporations, not company owners.
And that’s saying nothing about the other effects on stock price like how many people want shares; if demand for shares is high, then the stock price will also rise. This means that company executives are also incentivized to drive up demand for the stock, rather than just directly pursuing profits. In turn, this means that executives have some incentives that do not incentivize them to provide value. Thus, at least some of what they are incentivized to do is to be somewhat of an economic parasite.
What This Means for Me
Since I may start a company soon, this applies directly to me.
You see, I am a programmer, and the easiest kind of company for me to start would be a tech startup, the kind of company designed to grow to astronomical sizes and make its founders filthy rich in a short amount of time.
Of course, in order to make gobs of money in short order, gobs of money are required for capital. And that means that startup founders need investment. Ludicrous amounts of investment. In turn, that means that the startup has shareholders, which then means that the startup founders have the same incentives that corporations executives do.
Now, I am firm believer in the power of capitalism to make a nation rich as a whole, but only when the incentives are correctly aligned and not perverse. Otherwise, pure greed takes over and capitalism is just as bad as socialism, communism, and other economic systems because all other systems have built-in perverse incentives. And when capitalism’s incentives are just as misaligned, it is just as bad.
Let me be clear: I am a firm believer in capitalism as the only economic system that can produce good incentives with imperfect people. All others require men to be angels, and that is not something I will put my faith in.
So I have a problem: I believe in capitalism, but if I were to found a startup, I would be perverting capitalism. Obviously, I cannot do that.
I will talk with my wife about what lifestyle we want to sustain, and I will build a company to sustain that and no further. And obviously, if she wants to be wealthy, I will be sure to share our wealth responsibly.
In addition, because I believe in capitalism when incentives are aligned, I will build my business such that my incentives are aligned with customers’ interests. In this way, I will go further than Google’s “Don’t Be Evil”; I will “Make Evil Impossible”.
Let’s be honest: Google has given up on that motto. But if I do what I say, I cannot give up on my motto; that would be impossible.
And that’s the point.