Fumpin' & Bumpin'

More matter with less art.
July 3

Rent extraction/moral hazard in the labor market

  • The following is a conversation btw James Partridge & I about rent extraction/moral hazard in the labor market. Comments appreciated...
  • James: Mike
  • how are you brother?
  • ...
  • James: Since, for the sake of argument, we all work about 40 or so hours per week, do you think that it is completely fair for an employer to take home more than his employees?
  • 1: 04 PM when some of that revenue isn't coming from the expertise of the employer, or from the physical capital, but straight from the labors of the employee
  • me: Yes but only if the employer's compensation can be clawed back in the event of failure
  • James: just a little subject shift, sorry, haha
  • me: for example my boss makes many multiples of my compensation but 80% of his net worth is invested in the fund so if we fail... he loses almost everything
  • James: but your boss, he makes money from the fact that you are working there, right?
  • me: sure
  • James: and of course, your labors are much more valuable since you have his management expertise
  • me: absolutely
  • 1: 07 PM and if I make an investment in the portfolio and it turns out to be a disaster, I dont really lose anything
  • perhaps my job
  • but he loses considerably more
  • James: ok, but i'm talking about the fact that you, yourself, make a certain sum of money for the company
  • me: sure
  • 1: 09 PM but my boss takes the counterfactual risk
  • and in fact many companies dont have that
  • James: the quantity of which is greater than what it would be if you were just alone, without the boss putting in his time and energy into supervising you
  • me: most dont... ceo's get paid on the way up and dont lose anything on the way down
  • 1: 10 PM yes
  • James: ok, i see
  • me: so if theres proper risk sharing I advocate for a difference in compensation
  • 1: 11 PM although its a slippery slope in many instances
  • because theres continued divergence
  • corporate boards advocating for higher and higher disparity
  • even though theyre supposed to be independent
  • James: is it the case that the compensation that you receive is lesser than the value of your labor in and of itself, that is, when controlling for the added value that your boss contributes to your labor
  • ?
  • and if so, do you believe that that is fair?
  • 1: 14 PM (this question could be posed to any person working for an employer)
  • (in a profit-making enterprise)
  • me: I think that is perhaps the case, but I think it is fair given that (1) without my boss' efforts my job wouldnt exist, (2) the risk/reward dynamic I mentioned earlier & (3) the added value you mention is not just limited to the labor ive historically contributed, it's made me permanently a better suited person for the job I want to do
  • 1: 16 PM Now these are all reasons why i very much enjoy my job
  • and feel good about the dynamics of the company
  • and my guess is that those dynamics (especially #2 & increasingly #3) dont exist in most companies
  • James: of course
  • me: but I would point to the risk reward (no-claw back) relationship & the poor oversight of independent boards for the excessive and unfair disparity in compensation
  • which limits social mobility and increases inequality
  • which are generally both negative
  • 1: 19 PM and i would add
  • there are a few diamonds in the rough
  • ceos who are huge value creators who work 100+ hrs/week
  • 1: 20 PM really having massive impact
  • but there usually is little differentiation btw the way theyre paid and the mediocre ceo
  • James: right -- they increase the value of their employees' labor by a large magnitue
  • me: which is unfortunate
  • James: aside from the time and skill that bosses put into the job, they supply the physical plant
  • 1: 23 PM and obviously the revenue that comes from that, the bosses deserve
  • me: welll thats not exactly true... the owners of the business do
  • James: well, that's who i'm referring to, the employer
  • me: okay
  • this is a totally different topic
  • 1: 24 PM but one of the problems with excessive pay is that ceo's/boards arent the owners of the business
  • or I should say one of the problems that lead to excessive pay
  • James: ok
  • let me ask you
  • 1: 26 PM why does the existence of your job and the training you receive have to be contingent upon your boss taking some of the value per se of your labor?
  • 1: 27 PM isn't it incentive enough for him to get paid for the massive amount of value that he directly creates, both himself, and by means of making your labor more valuable?
  • me: well arguably you can say that I am capturing some value by gaining skills that I can take with me
  • and its some exchange for that value
  • James: what about people who work in jobs where no such value exists, like manual laborers?
  • me: thats probably true then
  • 1: 30 PM although I would bet that a lot of manual laborers do in fact gain skills that make them economically marketable for other jobs
  • but then again
  • in the case of manual laborers
  • I would look more towards the agency issue
  • 1: 31 PM of why the pay is disproportionate
  • James: ok, the labor of a person who can plan and do strategy and whatnot -- that is more valuable than the ability to dig ditches
  • me: I would say only bc there are a lot more people who can dig ditches effectively
  • 1: 34 PM now the problem is
  • planning and executing corporate strategy effectively
  • can only be evaluated over a multi-year multi-cycle period
  • 1: 35 PM and so there exists a lot of room for abuse in that regard
  • which is why there should be compensation clawback
  • James: ok, that's fine
  • we do not know what the value of a CEO's work is until a few years down the line
  • 1: 41 PM but as for the ditch-digger -- do you think that just because the labor market is full of ditch diggers that people who employ ditch diggers should get to take home revenue that exists solely because of the labor of that ditch digger, even when controlling for the increased value from the agency of the employer?
  • me: Only in the case that theyre baring some sort of risk of enterprise/ownership
  • if not than I cant say so
  • James: so it's all about risk
  • the employer's risk is commensurate with his right to reduce the pay of his laborers
  • me: yes
  • but most often the reduction is unwarranted
  • bc the employer is paying himself for risk that hes not actually taking
  • James: which is akin to wage-theft
  • me: rent capture
  • yes
  • James: as for interest on a loan, i suppose the same rationale
  • but what about taking rent from one's tenant?
  • when one's time and investment has already been recouped?
  • what the fuck is the justification for that?
  • me: well interest on a loan is different in practice
  • James: how is that not theft?
  • 1: 48 PM but the bank deserves to be compensated for the risk it takes
  • me: but the cost of debt capital fluctuates so drastically in market cycles
  • that making high risk adjusted loans or investments is very possible
  • or doing the inverse
  • 1: 49 PM but theoretically its the same dynamic
  • often it comes down to prudence
  • and what do you mean?
  • taking rent from one's tenant
  • 1: 50 PM youre giving up space
  • James: so profiting from an employee and receiving interest is the fair compensation for a risk borne
  • me: if the rent is too high people move out
  • James: but i take cash, buy a building, and charge people to stay there
  • 1: 51 PM once i have recouped my initial investment, why do i get to keep charging people?
  • what am i getting paid to do?
  • 1: 52 PM there's no risk, is there? or not the same magnitude as, say, giving a loan
  • me: well you bought the building to make a return beyond the period of recoupment
  • and you took risk to buy the building in the first place
  • and you should be doing maintenance on the building
  • and making sure its a fit place to live
  • 1: 53 PM the risk and reward periods arent lockstep time-wise
  • or not neccessarily
  • and im not saying this relationship should not be regulated
  • the apartment market in germany is a good example
  • 1: 54 PM very heavily regulated
  • in terms of maintenance and standards of living that have to be upheld
  • and limitation on raising rent excessively but because of this vacancy rates are very low (even through the financial crisis)
  • 1: 55 PM and most owners can enjoy good returns on investment
  • not great but its less risky
  • James: so risk is essentially what justifies profit, interest, and rent
  • ok
  • thanks
  • me: but I would just add that all risk is not the same
  • James: i've been wondering why i have to pay somebody more money than they paid me
  • lent*
  • 1: 57 PM more money than they paid for the house i'm in
  • me: yes
  • volatility is a common measure of risk
  • James: and why i don't get paid exactly what the value of the work i do
  • me: but more important in my opinion is the risk of permanent impairment of capital
  • 1: 58 PM but thats another topic