8 ms·

At a prior (very larger) company, someone described the path to career success as "Jumping into a lake, creating as big a splash as possible, and getting out of

At a prior (very larger) company, someone described the path to career success as "Jumping into a lake, creating as big a splash as possible, and getting out of the lake before the water comes down." I think that summarizes your point. :-) To answer, "How do we deal with it?" Make the owners and lenders of firms responsible. If a CEO or other employee screws up a company, take the shareholders to 0, then take the bondholders to 0, then take the counterparties to 0. People won't want to do business with people taking crazy risks. The market knew that AIG was gambling bigtime. If folks thought their trades might go to 0, AIG would have never been given so much rope. It's a tough issue though. There's game theory behind it too. If everyone makes the same high risk trade, and you don't, you can't win. If they're right - they get paid, and you get fired for underperformance. If they're wrong, the system collapses and nobody gets paid.

netcan 13y ago
I agree that too big to fail is an unacceptable piece of public "policy". If shareholders, bondholders & counterparties can't be taken to 0 without collapsing an economy, we have a dangerous moral hazard. But I think that assymetric risk and moral hazard is just a reality of the world sometimes. It can't be completely eliminated.
- analog31 13y ago
  I've seen "too big to fail" apply to projects within businesses as well.
  - mathattack 13y ago
    Yes. Sometimes people forget than money already spent is a sunk cost. This is endemic in IT projects. "We have to get this in, we've already spent $20 million, and they'll fire us if we have nothing to show for it." Famous last words...
- mathattack 13y ago
  They can't be eliminated completely, but it can be reduced. Think of the Lemon problem with cars. [1] The seller has a lot more information than the buyer. The buyer can never know as much as the buyer on what's wrong. In theory it becomes impossible to sell good cars because of the lemons. One way to solve this is to have laws where you can go back to the seller. Another way is to have a 3rd party provide a warranty. Similarly in Financial Markets, you can reduce the moral hazard with smart design. You'll still have some residual, but such is the nature of human interactions. [1] http://en.wikipedia.org/wiki/The_Market_for_Lemons http://en.wikipedia.org/wiki/The_Market_for_Lemons
rasur 13y ago
"someone described the path to career success as "Jumping into a lake, creating as big a splash as possible, and getting out of the lake before the water comes down."" In the UK, I've overheard the term "Seagull Management" used; "Fly in, shit everywhere, fly off".
- mathattack 13y ago
  You Brits don't have to worry about political correctness like us Americans. :-)
AnthonyMouse 13y ago
> Make the owners and lenders of firms responsible. Here's the trouble with that: You haven't solved the mundane version where a mid level manager destroys a division of a large corporation but not the entire corporation. In that case, shareholders losing a large chunk of money is what already happens today. They lose the value of the entire division, and they therefore have a large incentive to prevent it. But it still happens. The shareholders in general have devised no universally effective way to prevent it. If you increase their exposure, you haven't given them any new defense to the attack, so all you really end up doing is encouraging them not to invest in stocks because stocks now have increased risk over other investment securities. Your proposal is, essentially, to put incentives in place for the market to solve the problem, and then you assume without proof that with the right incentives the market will solve the problem. But someday somewhere you actually need a solution which parties wanting to avoid being damaged can employ to solve the underlying problem, ideally without overcompensating and causing parties to become unduly risk-averse.
- mathattack 13y ago
  In theory (stress theory) the shareholders (represented by the board) put a CEO in who establishes systems to minimize the risks of mini blow ups. But if the govt doesn't have to bail out a firm, who outside it should worry? If an overly ambitious marketing Manager at Colgate wastes 200 million dollars on a stupid idea, it's not my problem as an outsider. As a corporate insider I can encourage systems where people have the right balance between risk taking and risk aversion. (Most large companies are too risk averse. Try implementing a change initiative at one.)
  - AnthonyMouse 13y ago
    > In theory (stress theory) the shareholders (represented by the board) put a CEO in who establishes systems to minimize the risks of mini blow ups. In theory. But if that isn't what happens in practice then what good is it? > But if the govt doesn't have to bail out a firm, who outside it should worry? You don't have to worry about the shareholders of some individual mismanaged corporation, what you have to worry about is that the principle you're trying to apply to prevent systemic risk has an established track record of being ineffective when applied to prevent internal risk, and it is not clear why you should expect any different result. Again, the trouble is that you need a solution to the underlying problem. What "systems to minimize the risks" are there that corporations could cost effectively employ but are not already in place? How do you fix the problem that in a competitive market a company that spends resources on managing risks will be at a short-term disadvantage against a company that takes blind risks, and may consequently not survive long enough to see the day when its competitor has to pay the price for its risk taking?

netcan 13y ago

I agree that too big to fail is an unacceptable piece of public "policy". If shareholders, bondholders & counterparties can't be taken to 0 without collapsing an economy, we have a dangerous moral hazard. But I think that assymetric risk and moral hazard is just a reality of the world sometimes. It can't be completely eliminated.

analog31 13y ago
I've seen "too big to fail" apply to projects within businesses as well.
- mathattack 13y ago
  Yes. Sometimes people forget than money already spent is a sunk cost. This is endemic in IT projects. "We have to get this in, we've already spent $20 million, and they'll fire us if we have nothing to show for it." Famous last words...
mathattack 13y ago
They can't be eliminated completely, but it can be reduced. Think of the Lemon problem with cars. [1] The seller has a lot more information than the buyer. The buyer can never know as much as the buyer on what's wrong. In theory it becomes impossible to sell good cars because of the lemons. One way to solve this is to have laws where you can go back to the seller. Another way is to have a 3rd party provide a warranty. Similarly in Financial Markets, you can reduce the moral hazard with smart design. You'll still have some residual, but such is the nature of human interactions. [1] http://en.wikipedia.org/wiki/The_Market_for_Lemons http://en.wikipedia.org/wiki/The_Market_for_Lemons

rasur 13y ago

"someone described the path to career success as "Jumping into a lake, creating as big a splash as possible, and getting out of the lake before the water comes down."" In the UK, I've overheard the term "Seagull Management" used; "Fly in, shit everywhere, fly off".

mathattack 13y ago
You Brits don't have to worry about political correctness like us Americans. :-)

AnthonyMouse 13y ago

> Make the owners and lenders of firms responsible. Here's the trouble with that: You haven't solved the mundane version where a mid level manager destroys a division of a large corporation but not the entire corporation. In that case, shareholders losing a large chunk of money is what already happens today. They lose the value of the entire division, and they therefore have a large incentive to prevent it. But it still happens. The shareholders in general have devised no universally effective way to prevent it. If you increase their exposure, you haven't given them any new defense to the attack, so all you really end up doing is encouraging them not to invest in stocks because stocks now have increased risk over other investment securities. Your proposal is, essentially, to put incentives in place for the market to solve the problem, and then you assume without proof that with the right incentives the market will solve the problem. But someday somewhere you actually need a solution which parties wanting to avoid being damaged can employ to solve the underlying problem, ideally without overcompensating and causing parties to become unduly risk-averse.

mathattack 13y ago
In theory (stress theory) the shareholders (represented by the board) put a CEO in who establishes systems to minimize the risks of mini blow ups. But if the govt doesn't have to bail out a firm, who outside it should worry? If an overly ambitious marketing Manager at Colgate wastes 200 million dollars on a stupid idea, it's not my problem as an outsider. As a corporate insider I can encourage systems where people have the right balance between risk taking and risk aversion. (Most large companies are too risk averse. Try implementing a change initiative at one.)
- AnthonyMouse 13y ago
  > In theory (stress theory) the shareholders (represented by the board) put a CEO in who establishes systems to minimize the risks of mini blow ups. In theory. But if that isn't what happens in practice then what good is it? > But if the govt doesn't have to bail out a firm, who outside it should worry? You don't have to worry about the shareholders of some individual mismanaged corporation, what you have to worry about is that the principle you're trying to apply to prevent systemic risk has an established track record of being ineffective when applied to prevent internal risk, and it is not clear why you should expect any different result. Again, the trouble is that you need a solution to the underlying problem. What "systems to minimize the risks" are there that corporations could cost effectively employ but are not already in place? How do you fix the problem that in a competitive market a company that spends resources on managing risks will be at a short-term disadvantage against a company that takes blind risks, and may consequently not survive long enough to see the day when its competitor has to pay the price for its risk taking?