Luis Enrique and I pulled up The Guardian\’s economics leader writer yesterday for making a hash of an economic explanation. Getting very confused between principal/agent problems and who actually is the principal with which the agent will have problems.
He\’s come back and answered us:
TimWorstall and LuisEnrique: thanks for your responses. You both make great points but you\’re failing to look at the PA problem as an historical argument. The debates about why principals and agents want different things and how to structure incentives so as better to align their objectives have been knocking around for ages — but they really took off in the 70s and 80s in America with academics like Michael Jensen and William Meckling. And what they were arguing was that the shareholders were unambiguously the most important or even solely important part of the equation and that the vital question was how to rearrange corporate governance to reflect. So the two parts of the argument that you tease out were to all intents and purposes one.
Now, we can argue over the rights and wrongs (but i suspect we both know where the other would stand), but the point is that this way of thinking came as a real shock to the orthodoxy of management and that;s the point Ho makes very well
LuisEnrique, you raise the valid point about what all this has to do with economies. The point about Jensen\’s argument was that it was based on the efficient-markets hypothesis, and so therefore was scalable well beyond firm-level. Justin Fox lays this out in his recent book, The Myth of the Rational Market:.
This is what is known as doubling down.
And no, he doesn\’t win either. Here\’s the paper he\’s talking about.
And, err, no, it doesn\’t have anything to do with the efficient markets hypothesis. Which is, as we all recall, simply that markets, when pricing something which is being priced in markets, are efficient at processing the information about what the price should be in said market (the weak version says all public information, the strong that private information is included as those without said private information react to the actions of those with it).
Oh, and as that principal/agent thing coming as a shock to all sorts of people? Allow me to use the quote with which the paper itself actually opens:
The directors of such [joint-stock] companies, however, being the managers rather of other
people’s money than of their own, it cannot well be expected, that they should watch over it with
the same anxious vigilance with which the partners in a private copartnery frequently watch over
their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not
for their master’s honour, and very easily give themselves a dispensation from having it.
Negligence and profusion, therefore, must always prevail, more or less, in the management of the
affairs of such a company.
— Adam Smith (1776)
Such a shock to economists that the point is made in the founding document of the discipline.