What Business Management Is and What It Is Not, Ludwig von Mises
It is a serious mistake to identify entrepreneurship with management as in the popular antithesis of "management" and "labor." This confusion is, of course, intentional. It is designed to obscure the fact that the functions of entrepreneurship are entirely different from those of the managers attending to the minor details of the conduct of business. There is furthermore a readiness to confuse the manager with a bureaucrat. FULL ARTICLE
Comments (18)
Mac
Look at the ninth paragraph:
He also says:
1) "A successful corporation is ultimately never controlled by hired managers."
2) The shareholders is not idle and useless; they don't just harvest what the managers have sown. Ultimately, the shareholders decide "how much capital is available for the conduct of each corporation's business; it creates a state of affairs to which the managers must adjust their operations in detail."
3) He points out that making that, "it would be nonsensical to give 'labor,' as a popular slogan demands, a share in management. The realization of such a postulate would result in syndicalism."
So 60 years ago Mises points out the problem of "alignment" that shareholders and owners had with the management of an enterprise. Isn't this what many of the Wall Street firms and major corporations have been going through recently? When Alan Greenspan suspended his disbelief that Wall Street firms would take risks irrationally: That capitalism had a "flaw"?
My other question. What about the giving of stock options to employees and pension funds buying shares in a corporation (either their own corporation, or another corporation)? Does this lead to a "moral hazard" if the employees/labor become the entrepreneur/capitalists? Don't we want people to be able to own stock? Too many implications.
I need some knowledgeable people to help me out.
Cheers
Published: June 5, 2009 10:10 AM
Byzantine
There are two government externalities at work in publicly traded corporations: the preferential tax treatment of capital gains, and the effectively "forced investment" under IRA's, 401k's, etc.
The former skews executive compensation and finance to their benefit and not to the benefit of the enterprise.
The latter leads to an extremely attenuated form of ownership. Fund managers get to play with other people's money who give it to corporations to play with. Under an inflationary regime with confiscatory levels of taxation, the poor working schlep perceives that all he can do is turn over his savings to a bunch of MBA's and hope for the best.
I submit that in the absence of an income or capital gains tax and their innumerable "shelters," corporations would have to compete much harder for investment dollars by promising higher dividends.
Really, the whole idea of capital gains-oriented (i.e., "greater fool") investing is ridiculous. Stock prices don't rise perpetually to the heavens.
Published: June 5, 2009 10:28 AM
fundamentalist
Mises: “It is precisely when he is rewarded by a share of the profits that he becomes foolhardy because he does not share in the losses too.”
This is brilliant. I read Human Action, but missed this. I guess like all great literature you need to read it several times to get all of the wisdom nuggets. I never stop learning from it.
Mises: “It is a serious mistake to identify entrepreneurship with management as in the popular antithesis of "management" and "labor." This confusion is, of course, intentional. It is designed to obscure the fact that the functions of entrepreneurship are entirely different from those of the managers attending to the minor details of the conduct of business.”
Socialists are masters of obfuscation. When they have confused people enough, they then turn around and offer them a way out of the confusion that socialists have created. If a similar confusion was applied to government, then we would collapse the roles of the roles of the voter and the legislature and decide that voting is totally unnecessary.
Published: June 5, 2009 10:29 AM
fundamentalist
Mac, I think Mises answers some of you questions later in the piece. Entrepreneurs ultimately control management through their allocation of capital. Managers must make some effort to please stock and bond holders or those people will sell their holdings and invest in other businesses. A shortage of capital will management to pay higher interest rates or raise more equity capital if they don't change their ways.
Investment banks are a good example. When they were privately owned they were very conservative. When they became public corporations with management bonuses and stock options, they acted very irresponsibly and destroyed their companies. But management didn't lose anything; stock and bond holders took all of the losses.
I don't think that any of this shows that the markets have failed. Mainstream econ thinks that any business failure is a market failure. But in the Austrian view, business failures are a sign that the market is working as it should. Poor decisions by entrepreneurs or management should be punished with failure in the marketplace.
Published: June 5, 2009 10:38 AM
greg
The flaw in management is that very few managers actually understand accounting principles. Supervisors to mid level managers run their departments on performance guidelines that have nothing to do with profit and loss. A CPA auditor will go into a company, perform their quarterly audit and come out with a profit number. If that number does not fit their projections, the auditor will need to go back and review his numbers.
Management will perform on what is measured. For example, if on time deliveries is a key measure, managers will spend what ever it takes to meet or exceed their required level. I saw companies spend more to ship a product then the total value of the item.
Bank managers were paid on the number of loans and loan fees they produced, not the quality of the loans. No one cared about the quality because the people taking the loans out were paying for the mortgage insurance. And you know the end results of those actions.
As these corporations grow, the disconnect between management and its ability to manage on a true profit and loss basis. And this failure leads to greater abuses and the ability to catch problems early is reduced.
As far as I am concerned, most major corporations run their business no better than the government would. And that is the problem!
Published: June 5, 2009 10:45 AM
Mac
@Fundamentalist: Yep, I follow that. But it puzzles me is this: When they were privately owned, the owners were the managers, right? How did they avoid the problems of the merging of the entrepreneurial and managerial functions?
When they became publicly owned, the managers corrupted the boards by getting on them, and setting their own pay, and ignoring risks. The losses were going hit the bondholders and shareholders, not them. They did what Mises said they would 60 years ago.
Published: June 5, 2009 10:48 AM
David Spellman
This excerpt brilliantly explains why true businesspeople (entrepreneurs) do not invest in the stock market. Control of corporations has been usurped by self-interested managers who loots the enterprise and leave the suckers,er, shareholders with a pittance. Real businesspeople own and control their business themselves and the management works for them and does what the owner tells them.
The Pakistani family that immigrated and bought the convenience store by your house is a real business enterprise. Your 401K is tied up in stock in companies under the control of managers who skim the lion's share of profit for themselves. Thats why the Pakistani guy drives a Mercedes and you drive a Ford.
When retirement time comes, the Pakistani guy will let his son manage the store and drive the Mercedes while he relaxes by the pool with a drink in his hand. You, on the other hand, will find your retirement gutted and socialized and wind up grateful to take orders at McDonald's or greet the Pakistani family when they come to Walmart.
Some people and cultures understand business, but Americans have lost their appreciation for profit. The average American has been brainwashed to believe that corporate slavery is the good life. What little wealth they can accrue they naively believe should be shoveled back into the cesspool of corporatism through mutual retirement accounts. The baby boomers are about to find out that they have worked all their lives and accumulated absolutely nothing while their "managers" absconded with it all. Cattle waiting for the slaughter have a brighter future.
America is bankrupt--financially, intellectually, and morally. The structure is nothing more than a veneer of paint showing the outlines of what has long since been hollowed out by internal decay. A strong wind will collapse it all, and the winds of change are blowing. Obama was sort of correct when he made change his catch word, but the truth is that we face change we can die of, not live with.
Published: June 5, 2009 11:43 AM
Michael A. Clem
As far as I am concerned, most major corporations run their business no better than the government would. And that is the problem!
greg, are you talking about companies in general, or just corporations? I think we've had the discussion about the validity of corporations a few times in these blogs. And of course, any government regulation that takes away the company's ability to focus on their profits, such as Sarbanes-Oxley, is going to skew the management of the company.
Published: June 5, 2009 11:44 AM
fundamentalist
Mac, I don't think there is a problem with merging the role of entrepreneur and manager. Problems appear when they are separated, as is the case with large corporations. Corporations don't work as they were intended. As the late Peter Drucker used to say, the boards of corporations are asleep at the wheel for the most part. They don't uphold their fiduciary responsibility.
That leaves the entrepreneurs/owners with just one tool for controlling companies--their allocations of capital. They punish bad managers by taking away capital. But not all entrepreneurs are as wise as Warren Buffet. Sometimes, as in the cases of Enron and the investment banks, they get fooled by high short term yields or unscrupulous managers and they suffer as a result. Most handle the problem by being well-diversified.
Published: June 5, 2009 11:50 AM
Mac
@Fundamentalist: I take your Drucker comment well, and your previous one. Capital allocation is a better word for what I was asking, when I meant the entrepreneurial function.
My confusion is more about how to reconcile the two functions to work "optimally" (if I can say that) in a business. So while the entrepreneur allocates capital, and while the manager makes the most productive use of that capital, what happens when we consider the alternative capital allocation arrangements of these two functions? The alternative arrangements are, for example,
1) employee pension funds owning their own portions corporation and installing their own board members, who presumably make employees feel like they have a stake in the company by telling their bosses what to do (it looks like a union in disguise to me);
2) employees who own stock/profits directly (e.g. stock options, profit sharing), and in theory would work harder to keep the company profitable because they have an interest in it;
3) unions owning the company, like at GM now;
4) etc.
I get the feeling that these probably don't really work in the long run. Something about pension fund "socialism" seems unworkable to me. What Mises is saying makes much sense, but I also think it has a lot more implications, of which he doesn't tackle directly; probably, because these alternative capital allocation arrangements didn't become so influential until much later.
There are plenty of biz books that encourage "employee participation," profit sharing, open-book management, and who knows what else to encourage business growth and labor relations. I'm just wondering if Mises's explanation of the entrepreneurial and managerial functions has any other insights.
BTW, thanks for helping out and hopefully my query isn't too much trouble than its worth.
Cheers
Published: June 5, 2009 1:36 PM
Mac
@Dave Spellman:
I know that Pakistani fella. Really nice guy; owns a store near my house. Although I'm sure his kid has lost all his work ethic and business acumen. He's probably thinking of more glamorous vocations like the ones all the other kids see on TV. Any idea of business the kid has is probably closer to what he sees on The Apprentice or CNBC.
It happens to everyone in America these days. It's fortunate that a few immigrants learn the lessons of America before they get here. At least they'll keep reminding us until we wake up out of our slumber.
Cheers
Published: June 5, 2009 2:04 PM
fundamentalist
Mac, Mises addresses all of those in Human Action, but my memory isn't good enough to tell you where. I'll see if I can find them over the weekend.
Just going from memory of what Mises wrote, I believe he agreed with you that the conflict of interest in most of those situations dooms the business.
Also, people assume that anyone can be an entrepreneur. It's probably the biggest fantasy running around the country. But Mises and others spend a great deal of time explaining the unique qualities of good entrepreneurs. They're actually quite rare, more rare than good managers. Pension funds, employees and unions owning companies run into the problem that they're not good managers, let alone good entrepreneurs.
Does anyone remember the Yugo? That was the great white hope for employee-owned businesses.
Published: June 5, 2009 3:08 PM
N. Joseph Potts
The Great Man's portrayal of "profit centers" and "intrapreneurism" is woefully simplistic in this otherwise insightful excerpt. As portrayed here, his theory of the firm is naive compared with, say, Murray Rothbard's.
His depiction of subdivisions of an enterprise being susceptible to p&l evaluation silently assumes the ability to develop accurate transfer prices for goods and services provided to one division by another. Doing this is virtually impossible if the goods or services don't happen to be duplicated by something traded actively in an open market, in which case the justification for internal trading comes under review for that very reason.
His references to "double-entry bookkeeping" for divisions also ignores actual practice where "profit centers" are used, and that is that while the profit centers usually calculate and report profit-and-loss statements, they rarely maintain their own balance sheets. Without the use and maintenance of a balance sheet, the division's bookkeeping cannot be described as "double-entry bookkeeping." It is, in fact, SINGLE-entry bookkeeping, a MUCH less-complete method of reckoning actual profitability.
Published: June 5, 2009 9:19 PM
Gil
Interesting thought D. Spellman. :/
Published: June 5, 2009 11:04 PM
newson
frb favours credit over equity-financing through indirect subsidy. in a sound monetary order, entrepreneurs are more likely either to be self-financed or to have equity partners than to rely on bank financing.
david spellman: american chronicler!
Published: June 6, 2009 5:35 AM
Daniel
"2) employees who own stock/profits directly (e.g. stock options, profit sharing), and in theory would work harder to keep the company profitable because they have an interest in it;"
As someone else mentioned above, not everyone can be a successful entrepreneur. Sure, the employees of the employee-owned company will make decision that favor the employees, but they need to have the profit-seeking capitalist mentallity to be successful. However, I doubt that they will put profit ahead of everything else. For example, they might institutite that all employees have one-month paid vacations, only work 6 hours a day, have 2-hour lunch breaks, have unnecessary safety standards, and ridiculous fringe benefits. I understand the value-being-subjective fallacy in my example, but the point is that they are not focusing on profit and will eventually go bust.
Published: June 6, 2009 12:36 PM
Daniel
Also, I would like to submit that this is probably why people such as Andrew Carnegie and the other so-called robber barons were so succesful. They weren't forced to make decisions that were dictated by outside people. Andrew Carnegie, in particular, never let anyone know what he was going to do next.
Published: June 6, 2009 12:40 PM
Nathan
Mac,
Yes, there's a major implication that is missed here!
"It is precisely when he is rewarded by a share of the profits that he becomes foolhardy because he does not share in the losses too"
In the US, anyway, this doesn't only apply to "managers"; it applies to shareholders. There is limited liability. As a shareholder, my losses are capped at whatever I paid for my shares, whereas my gains are not. Contrast this to a conventional entrepreneur who stakes his entire fortune. The sad reality is that *everyone* is just a manager under the modern corporation. I think you'd very quickly see different outcomes emerge (and different shareholders) if instead of having my losses capped, owners were personally on the hook for their share of the corporation's losses.
But since this isn't the case, I'm not sure how much more of a problem things like gainshare bonuses, employee stock options, etc pose -- the problem Mises suggests that they would create already exists.
@N. Joseph Potts. Interesting thought on single-entry bookkeeping. I'm going to have to ponder that.
Published: June 8, 2009 12:31 PM