Capitalist Discipline

On the orchestration of Corporate Games

Arthur Wassenberg

• Editorial: Palgrave Macmillan
• Año: 2013
• ISBN:
  9781137339843
• Categoría: Economía
• Categoría: Econometría

This book is not just about corporate strategies and stratagems: it is about the 'Faustian' pact between real and financial powers, governed by the rules of 'minimizing the costs to oneself of imposing losses upon others'. It is more than about limited rationality and irrationality: it is about unlimited rationalisations and limited accountability.

1

The Quest for Discipline

When prophesies of coordination fail

In 2002, in the slipstream of a series of major corporate scandals (Enron, Tyco, Worldcom) the US House of Representatives and Senate passed an Act. This bill came to be known as Sarbanes–Oxley, after the chairmen of the Senate Banking Committee and the House Financial Services Committee. When, after fierce partisan opposition from within and obstruction from outside the House and Senate, the bill managed to reach the White House for signature, it was seen to be aimed at:

• Strengthening the regulatory system by rebuilding the objectivity and reliability of accountants and credit rating agencies.

• Creating a public accounting oversight board for developing and enforcing strict accounting standards.

• Making the system less dependent on self-monitoring by the industry;

• Establishing codes of ethics to make chief financial officers responsible for full and timely disclosure and chief executive officers to certify personally financial statements with criminal penalties for failure to do so;

• Tightening insider trading rules.

• Empowering the Securities and Exchange Commission (SEC) to adopt rules addressing conflicts of interest for securities analysts and other “reputational intermediaries” that keep the financial system running.

(Gourevitch and Shinn, 2007: 256–8)

Two years later, on April 28, 2004, a lobby of five leading US investment banks, including Goldman Sachs, headed by Henry Paulson Jr., who later became the 2007 US Treasury Secretary, persuaded the SEC to exempt these banks from the Sarbanes–Oxley regulation that limited the amount of debt the banks were allowed to take on – which allowed them to release billions of dollars in cash, securities, credit derivations and other exotic vehicles (International Herald Tribune, October 4, 2008). Barely three years later, on June 26, 2007, at the eve of the implosion of the international credit bubble, Treasury Secretary Henry Paulson Jr. attended a dinner with some of Wall Street’s most powerful bankers. In his memoir, On the Brink, Paulson remembers: “All were concerned with excessive risk taking in the markets and appalled by the erosion of underwriting standards”. James Pressley, editor in chief for the Bloomberg Press, recounts Paulson’s story: “[The bankers] felt forced by competitive pressures to make loans they didn’t like … ‘Isn’t there something you [Paulson] can do to order us not to take all these risks’, was the gist of a question posed by [one of the bankers]”. That quote, says Pressley, encapsulates the “bizarre tango that enveloped Paulson as he struggled along with Bernanke [the Federal Reserve chairman] and Geithner [the then New York Fed chief] to save the free-market system from itself. Banks, hedge funds and other financial institutions were playing a game of chicken, the economic equivalent of the Cuban Missile Crisis. Paulson’s mission was to prevent mutually assured economic destruction” (Bloomberg, “Books”, February 1, 2010).

Another example of coordination failure is the case of Iceland. According to a 2,300 page report by an independent “truth commission”, set up by the Parliament of Iceland, the implosion of the country’s financial system – until March 2008 still granted a triple-A rating – has to be seen as the result of “a complacency that spread from the bank headquarters to the regulators, central bank, government and, ultimately, the Icelandic public, most of whom were happy to share in the spoils of the financial boom” (Financial Times, April 13, 2010).

Both examples show the “domino” features of the collapse of financial institutions and its aftermath in the real economy worldwide. They illustrate how micro-rationales – “sharing the spoils” – may entail macro-irrationalities that threaten the survival of the system as a whole. The request addressed to Paulson, to intervene in order to prevent systemic failure, raises the question of coordination and the causes of its eventual failure.

The issue of coordination is related to strategic dilemmas the actors in socio-economic systems face. They find their origin in the split between individual rationales and systemic rationality.

Strategy traps

Rival states and rival firms face a double-bind. First there are the shadows of the past. In order to survive, firms and nations specialize. However, yesterday’s advantage from specialization may become today’s hindrance and result in a competitive disadvantage for the day after tomorrow. Whether a distinctive competence turns into a distinctive disadvantage depends on what others do. This contingency is the competence trap. It refers to the switching of costs by early movers who see their advantages being snatched away by new entrants. Past investments may stand in the way of a flexible response to new challenges. Yesterday’s decisions bind: financially, institutionally and in terms of “sunk” beliefs.

Looking ahead, one then sees the shadows of the future. When nations and firms invest in new ventures they must make sure that there will arise a critical mass of suppliers and customers. Competing for tomorrow means mobilizing an infrastructure of supporters and sponsors. Even if nations and firms imitate others when investing in new activities, they typically will try to prevent others from imitating them. Suppliers and clients, however, prefer as many alternative providers as possible. Given these opposing preferences, imitators or innovators will always be uncertain about the sustainable exclusivity of their investments. In other words, whether a new activity pays depends, again, on what others do. The latter contingency may be called the competition trap. This refers to the costs of anticipating what rivals and supporters will decide to do. The future is binding too.

The double-bind may be summarized as the strategy trap. Countering this strategy trap implies the development of distinctive competences without being entrapped in past choices and minimizing the imitability of future choices. Both varieties are manifestations of the same phenomenon: the split between individual and shared rationality. As will be argued extensively below, the split applies both to rival firms and rival states, although they differ in the means and modes of coping with it.

Two generic types of this split between individual rationales and collective rationality can be distinguished. One is the dilemma known as “the tragedy of the commons”. In Hardin’s (1968) original, somewhat apocalyptic, wording: “Ruin is the destination toward which all men rush, each pursuing his own best interest in a society that believes in the freedom of the common. Freedom in a common brings ruin to all”. In Hardin’s parable the fear of overgrazing the collectively held village grounds – the “commons” – can induce pre-emptive grazing by the neighbors. The “tragedy” is that the mere threat of a “pre-emptor” will trigger the self-fulfilling prophecy the commoners are afraid of: “The common will be overgrazed and destroyed as a public resource because each citizen will pre-emptively graze his/her sheep rather than risk being a victim of the free riders” (Best, 1990: 239).

The concept has been applied, convincingly, to a variety of “common pool” resources problems, ranging from over-fishing and the insufficiency of quota “solutions” (Dubbink and van Vliet, 1996) to the politics of pollution and natural resources management (Ostrom, 1990; Schelling, 1993; Weissing and Ostrom, 1993). The idea looms up in the economics of a non-fixed-resources world as well: “the awareness that a rival can respond to unsold goods in the market by expanding supply and dropping prices, may be enough to engender a pre-emptive price drop and lead to a price war. For the follower will be at a double disadvantage: the early bird will enjoy economies from increased market share, and the follower will suffer diseconomies with reduced sales” (Best, 1990: 75).

Being the opposite of the first, the second archetype of the gap between individual and encompassing rationality may be called the “tragedy of the fallows”. Three sub-types can be distinguished. One refers to the problem of “under-” or “non-exploited” resources originating from the propensity to refrain from investments as long as there is no certainty that others will follow in a complementary or confirmative fashion. In the alternative case, large, established firms try to smother the breakthrough of smaller, innovative players by annexing or allying with the new entrants in order to protect their sunk investments and market position. A third manifestation of under- or non-exploited opportunities is the case in which commitments are postponed or dissolved because each expects that his or her counterparts, sooner or later, will give in and accept the burden of taking the lead in bringing about some form of comprehensive rationality. Under each of these conditions, corrective arrangements are required to offset the bounds of narrow-minded “local” rationality (Nelson, 1995). The politics of standardization serve as an example. New processes and products will only be a commercial success if they are applied at a sufficiently large scale. Large scale application requires compatibility with related products and practices or interchangeability combined with low switching costs for the users of existing products and production processes. As a rule, each firm wants to see its own innovations become the patented standard for the sector as a whole. However, as long as rival firms are reluctant to be the first to sacrifice the potential profits of their exclusive innovation by conceding to a common norm, each of them will be worse off. The trade-off between rational “chauvinism” and some form of shared rationality ascertains that a collective optimum will remain out of reach.

Whatever the type of split between rational individualism and other-directedness, the remedy against overgrazing and/or undergrazing turns out to be some form of shared anticipation, followed by a critical minimum of coordination. Box 1.1 offers a case in point.

Box 1.1 “Rational” utilities

The large scale production and distribution of electricity illustrate the puzzles of anticipation and coordination when “myopic” or chauvinist rationality clashes with “non-myopic” or comprehensive rationality.

Two developments, one of a political and the other of a technological nature, eroded around the turn of the last century the monopolistic position of the six regional electricity producers in the Netherlands. Liberalization of the energy market opened possibilities of importing electricity from abroad and the introduction of smaller, less-polluting, heat-power facilities resulted in a larger and less-centralized supply of electricity. The new technology could thrive because of a close harmony of interests between electricity distributors and energy-intensive users, such as the chemical industry, and the producers of artificial fertilizers and salt. The heat (steam) that this type of firm needs for its own production generates an electricity surplus that is channeled back into the public net of distributors. The eclipse of the regional producers’ monopoly and the rise of a technologically and environmentally superior substitute radically enhanced the bargaining position of both distributing firms and big end-users. The individual rationales of the producers (looking for economies of scale and the prolongation of their privileged position) and the individual rationales of distributing firms and clients (looking for reduction of their dependence on monopolistic suppliers and high tariffs) resulted – however contrary their strategic intents – in a collective outcome of structural excess capacity for the sector as a whole. Even worse, the surplus was generally expected to grow – partly by the path-dependent nature of past investments (the competence trap) and partly through the adversarial and imitative nature of current and future investments (the competition trap) – at least until 2004. Excess capacity follows the logic of overgrazing, as explained in the parable of the commons, that is, it results from individually rational moves (intended to break a monopoly) and the absence of a non-myopic (sector-encompassing) rationality, thus fulfilling the prophecy that each of the players fear. (The tragedy-of-the-commons eventually mutated into a tragedy-of-the-fallows as persistent excess capacity discouraged the breakthrough of alternative, possibly superior, technological-institutional substitutes.)

When rationalities clash

In my research I aim at unraveling the forces that govern the swings of political and economic order. How can the disorder in the financial system that “started” in 2006 be understood? The lack of strictness of financial regulation per se does not offer an adequate explanation. Initially no wave of financial scandals of corresponding proportions broke out in Europe, and the scandals that did occur appear to have had American roots (Vivendi, Ahold, Adecco): “Given the higher level of public and private enforcement in the United States for securities fraud, this contrast seems perplexing” (Coffee, 2005). Neither is it merely size or “bigness” that explains the “tango” of regulatory permissiveness and the subsequent bailout of the major players – as some “too big to fail” narratives like to suggest (Sorkin, 2010). The downfall of Lehman Brothers on the one hand, a big financial player, and the collapse of Iceland and Greece, relatively minor players in the international financial system, on the other, suggest where we might look for a more convincing explanation. The “sharing-the-spoils” mechanics of the Icelandic scenario may serve as an instructive first cut.

Sharing the spoils is not the outcome of a deliberately coordinated public or private consensus nor a specimen of the epidemics of herd behavior (cf. Keynes’ infamous “animal spirits” (Keynes, 1936: 161–2); more about them in chapter 9). It has to do, instead, with a train of implicit understandings: a tacitly shared sequence of sous-entendues (tacit understandings) that sets the deceptive domino into motion. The mechanism entails, apart from auxiliary conditions that will be explored later, the willing suspension, if not outright suppression, of the spread of corrective skepticism. As we will show later, the how of the suppression of disbelief and the delay of timely corrections originate inside organizations: the culture of ignoring applies not only in firm-to-firm, firm-to-state and firm-to-regulatory agency relationships – the “functional” conspiracy of blindness is a structural property in executive versus non-executive relations and further down the ranks inside firms and public agencies as well.

Box 1.2 Conspira...

Índice

• Cover
• Title
• 1 The Quest for Discipline
• 2 The New Industrial State Revisited
• 3 The Masks of Rationality
• 4 Cohabitation
• 5 The Framing of Discipline
• 6 Conditions: The Anatomy of Negotiating Power
• 7 Diplomacy: Houdini meets Ulysses
• 8 Commitments: The Essence of Discipline
• 9 Consequences: On the Drift of Discipline
• Epilogue
• References
• Index