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Perishable Thoughts

Jim Prevor’s Perishable Pundit, September 26, 2008

A hat tip to Tim York, President of Markon Cooperative, based in Salinas, California, who sent a quote perfect for reflecting on a financial meltdown:

“Success is a lousy teacher. It seduces smart people into thinking they can’t lose.”

The Road Ahead
By Bill Gates, Nathan Myhrvold, Peter Rinearson
Published by Viking, 1995
Page 38

The quote appears in Chapter 3, “Lessons from the Computer Industry,” and continues with these next sentences: “And it’s an unreliable guide to the future. What seems to be the perfect business plan or the latest technology today may soon be as out-of-date as the eight-track tape player, the vacuum tube-television or the mainframe computer.”

There is no question that one learns more from failure than success and, as the quote implies, success can be positively dangerous. Few things worse can happen to a young man than to win a lot of money the first time he goes to a racetrack or a casino.

Indeed the arrogance of the “Masters of the Universe” played a big role in the actions leading to the credit crisis. Yet in our current situation, we are not so sure we would accept chalking it up to hubris born of success; in many cases it strikes us as a function of the way people were paid.

It is a truism in management that you get what you pay for. So if you pay a CEO based on that year’s stock price or return on capital, you are going to get a focus on boosting short-term earnings. Equally, if the upside is divided between the company and the employee so as to give the employee an incentive, whereas the downside is strictly limited for the employee, you will get wild gambles. In other words, if a trader makes the firm a billion dollars and his cut is $200 million, but if he loses a billion, all that happens is that he gets fired; the incentives are being set up, overwhelmingly, to encourage speculation.

One thing that has been missing from news reports is any notion of employees in the mortgage arena giving back their bonuses. Doubtless the employment agreement didn’t call for it but, obviously, if a person running mortgages makes a profit for the company of $100 million a year for four years and then loses a billion in year five, there is something wrong with a compensation plan that results in this manager getting paid millions in bonuses for his “great success” in running the mortgage division.

Success can breed arrogance and controlling that is hard enough. We shouldn’t add to the problem by designing compensation packages in a manner that distorts what true success actually means.

That is something to reflect on in the current climate as well.

*****

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