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Views from the Prairie

May 16

Certainty vs Risk

Wall Street puts serious pressure on companies to "hit their numbers". In other words, many investors do not want risk. They want certainty with high reward. That is not possible in the long term. Attempts to get both actually take on systemic risks. This is especially true for when people get special freedom from taxation during hard times. Anytime a group of people feel like they have certainty of high profit at the cost of the rest of society, they incur the risk that the whole system will be overturned.

The realistic reward for certainty is a cost, not a reward. Anytime we are guaranteed a result, that result will cost us, not reward us.

The efforts of Wall Street financiers to get both certainty and high reward are putting the system at risk especially in how they are avoiding taxes.

Historically, organizations have gotten both high reward and certainty by using the political system to funnel tax money into the organization's coffers. That gives solid rewards and is very certain. But history is not kind to such efforts.

The East India Company had gotten into financial trouble in Bengal due to a plague and petitioned Parliament for help. Parliament responded with the Tea Act of 1773 which gave it freedom from the taxes on tea. The arrival of ships of untaxed tea in Boston at a price lower than the Boston smugglers could get from their Dutch suppliers was the impetus for the Boston Tea Party and the start of the Revolutionary War.

Prior to the French Revolution the nobility of France had gotten themselves exempt from taxation. Yet, the national government was badly in debt and needed more revenue. The refusal of the nobles to participate in the taxation became a major part of the push for revolution.

Likewise, in any business, when we push for certainty and high profit together, we put the business at risk.

A few years back, TXU was taken private in what was viewed then as a high certainty of good profit. The major risk seen at the time was whether or not the Texas regulators would put too hard of conditions on the transaction. As Texas was considered "business friendly", that was not seen as a high risk.

Today, as TXU is struggling in Bankruptcy Court, we can see the systemic risk that was ignored at the time. A technological advance in drilling destroyed the pricing that the TXU investors were counting on.

Similarly, in 2007, selling financial derivatives based on home mortgages was seen as a sure fire way to make huge profits. The collapse of that market nearly took down the world financial system.

The IMF has examined many of the proposals for limiting systemic risks to the banking system. The basic problem with all of them is that they operate without sufficient information. In most cases, governments will not know enough details to know in advance of any systemic risks. The best we have done is to use philosophy to guide government regulations.

Real Performance

As you walk out the door, you notice with pleasure that one employee is still working at her desk. It seems that every time you leave, that employee is still there. But is she really working all that hard? In many companies, the appearance of working hard is rewarded more than actual accomplishment. When management does not have a process for measuring actual accomplishment, those who accomplish much get discouraged and move on.

That person that is always on the run and appears to be always working hard might actually be working hard on the appearance instead of the results. The person who is always at her desk when you leave might be watching for you to leave and timing their departure a few minutes later.

Great performers make it look easy. Watch how a concert violinist makes those complex chords and runs seem so effortless. Watch how the top golf players seem to make playing the game to be easy. The same is true in business. The top performers make it seem that what they are doing is easy.

Measuring office productivity is challenging but is too important to be delegated to "productivity specialists". Any measure has to reflect the real goals of the company as well as being something straight forward to do. Both simple "hours at the desk" and labor cost measurements ignore other aspects of the business such as overhead and costs to other departments.

Some people are great at personal productivity. Others are great at making the whole team more productive. It is important to keep both aspects in mind when looking to measure office productivity.

Risky World

With instant "news", there is a real risk that the report is false. Several cases recently showed how quickly a false report became "news". Many media companies make money off of sensation rather than news and pass on these hoaxes before really investigating them. When making investment decisions, it is important to verify the news before acting.


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