WEBVTT NOTE Rothbard on Agency Problems 1 00:00:00.000 --> 00:00:09.000 So today I'm going to try to talk to you about Murray Rothbard on agency problems. 2 00:00:09.000 --> 00:00:17.000 It's a very technical topic. The point of my presentation is more or less the following. 3 00:00:17.000 --> 00:00:26.000 I'm trying to explain to what extent Rothbard is a precursor of modern agency theory, 4 00:00:26.000 --> 00:00:45.000 Particularly what we call the market mechanisms, which are these ones, and with regard to the role of the state as a cause of aggravating agency theory or creating new economic problems. 5 00:00:45.000 --> 00:01:10.000 So, let me make a quick footnote. To some extent, one could argue that Murray Rothbard's contribution is not very original or only very marginal, since another great Austrian economist also largely anticipated many of agency theory's development, this great economist is Ludwig von Mises. 6 00:01:10.000 --> 00:01:32.000 One of my dissertation chapters is on these topics, but I will argue therefore that the main contribution of Rothbard is on the role of government, the influences of government on agency problems, and the role of the entrepreneur. 7 00:01:32.000 --> 00:01:42.000 In the standard agency theory, there is no entrepreneur. 8 00:01:42.000 --> 00:01:48.000 On the other hand, in Rothbard theory, you can see the entrepreneur all over the place. 9 00:01:48.000 --> 00:01:58.000 So since it's a very technical subject, I'm going first of all to explain you quickly what is agency theory 10 00:01:58.000 --> 00:02:04.000 and what is the problem with which agency theory is dealing with. 11 00:02:05.000 --> 00:02:11.000 We call an agency relationship a relationship between two individuals. 12 00:02:11.000 --> 00:02:14.000 Typical relationship is employer-employee. 13 00:02:14.000 --> 00:02:27.000 And the employee can take an action when the employee is going to perform an action for the employer. 14 00:02:28.000 --> 00:02:40.000 is going to affect the welfare of the employer in order to satisfy his own interest. 15 00:02:40.000 --> 00:02:56.000 Traditionally, we argue that the employer, what we call the principal, is what we call an informed party. 16 00:02:56.000 --> 00:03:09.000 On the other end, the employee, what we call the agent, is the inform party. 17 00:03:09.000 --> 00:03:12.000 Let me take an example. 18 00:03:12.000 --> 00:03:17.000 I am working for a corporation. 19 00:03:17.000 --> 00:03:31.000 My employers are the shareholders and they are asking me to maximize the profit of the company, to maximize the sales, to make profit of the company. 20 00:03:31.000 --> 00:03:48.000 Well, instead of doing my job as well as I can, as best as I can, I will spend my whole day on the internet watching some websites, not very appropriate in general. 21 00:03:50.000 --> 00:03:55.000 Just like that. Some people know what I'm talking about, that's why I say that. 22 00:03:55.000 --> 00:04:07.000 This employee, the manager, are what we say, shirking. They are not doing what they should do. 23 00:04:07.000 --> 00:04:22.000 So the problem that the agency theory is asking is what will be how to induce the employee to perform the action in the best interest of the employers. 24 00:04:22.000 --> 00:04:36.000 Whether they are shareholders, whether they are simple employer, when you are a patient, or you will induce the doctor to find a cure for your disease or for your illness. 25 00:04:36.000 --> 00:04:43.000 That's the purpose of Eleiency Theory. There are two types of problems. The first one is what we call Moral Hazard. 26 00:04:43.000 --> 00:05:00.000 It's a hazard. It means that you cannot observe the action of your employees. Because observing the action of your employees, monitoring your employees, is costly. It takes time. You cannot be behind the back of each one of your employees. 27 00:05:02.000 --> 00:05:09.000 That's a more hazard problem. The other problem is what we call an adverse selection problem, also called hidden knowledge. 28 00:05:09.000 --> 00:05:25.000 It means that even if you can monitor your employees, you might not have the required knowledge to know if they are doing their job properly, appropriately. 29 00:05:25.000 --> 00:05:38.000 So the agency theory, which starts from the 70s, has analyzed different types of mechanisms to resolve this type of problem. 30 00:05:38.000 --> 00:05:47.000 to find solutions to these type of problems. We talk about explicit incentive mechanisms. 31 00:05:47.000 --> 00:05:57.000 The typical one is the contract, and we talk about implicit incentive mechanisms. 32 00:05:57.000 --> 00:06:11.000 And these implicit incentive mechanisms are property rights, reputation, competition, the institution, private institution, and of course, in some way, the entrepreneur. 33 00:06:11.000 --> 00:06:27.000 So, you can see that there is a broad, pretty famous people in the mainstream economy, like Armstrong, Milgram, Robert, Alsham, Dempsey, Grossman, Art, etc., etc. 34 00:06:27.000 --> 00:06:43.000 But on the other hand, you can see that Rothbard, in Man Economy and State, in Chapter 2, as Chapter 2, 9, 10, 12, mainly, has analyzed these different types of mechanisms. 35 00:06:43.000 --> 00:07:10.000 I will focus more on implicit incentive mechanism because for the contract the current literature is very technical and is based on particular assumptions like the form of your utility, preference curve, your aversion to risk, and what is the probability distribution, 36 00:07:10.000 --> 00:07:14.000 and what is the information available in the economy. 37 00:07:14.000 --> 00:07:20.000 On the other hand, when you look at property rights, in chapter 9, 38 00:07:20.000 --> 00:07:27.000 Rothbard largely anticipates Altschendam, Sepp Grossman and Art Amor in the following way. 39 00:07:27.000 --> 00:07:32.000 He's talking about the relationship between shareholders and managers. 40 00:07:32.000 --> 00:08:01.000 And he's saying the following thing, is that while in the large corporations, managers on the day basis, on the everyday basis jobs, they might have a great independence, but ultimately it is always the shareholders who make the most important decisions. 41 00:08:01.000 --> 00:08:05.600 He talks about decision-making function. 42 00:08:05.600 --> 00:08:10.600 The role of property rights for the shareholders is a decision-making function. 43 00:08:10.600 --> 00:08:22.400 They are able to decide where and to whom property rights should be, means of production should be allocated to. 44 00:08:22.400 --> 00:08:26.500 Who will be able to use the machine tools? 45 00:08:26.500 --> 00:08:30.300 Who will be able to use the money of the corporation? 46 00:08:30.300 --> 00:08:37.300 that we call, in modern decision, control residual rights. 47 00:08:44.220 --> 00:08:51.140 We all know, well, economists know, and they know that Altshain and Denset and Grossman 48 00:08:51.140 --> 00:08:57.460 are focused on this idea of decision control, residual rights, also talk about residual 49 00:08:57.460 --> 00:09:04.820 Residual Claimant, which is as an owner you have the right to decide what should be done 50 00:09:04.820 --> 00:09:11.660 with the property you own when it is not included in the contract. You are also the residual 51 00:09:11.660 --> 00:09:17.940 claimant which means you are the one who is going to receive the income stream, residual 52 00:09:17.940 --> 00:09:21.380 income stream that we call profit. 53 00:09:21.380 --> 00:09:31.380 The main idea for Agencies Theory and Rothbard is that shareholders are the residual risk bearers. 54 00:09:31.380 --> 00:09:42.380 They are the ones who are going to bear the consequences of inefficient actions taken by the, or made by the managers. 55 00:09:42.380 --> 00:09:53.380 So therefore, because they are the owners, they have the right to decide who is going to work for them and who is not going to work for them. 56 00:09:53.380 --> 00:09:56.380 That's an important right. 57 00:09:56.380 --> 00:10:13.380 And this is very, in modern agency theory, we decide who is going to own these property rights regarding to their ability to manage this property. 58 00:10:13.380 --> 00:10:19.380 It's a problem of incentive. Another important mechanism is reputation. 59 00:10:19.380 --> 00:10:28.380 The reputation in mainstream economics has come with game theory, particularly Kress and Fudanberg and Tirol, which is very technical. 60 00:10:28.380 --> 00:10:43.380 We talk about fault theorem, which is individuals have long-term interest in performing the action as best as they can for their employers, 61 00:10:43.380 --> 00:10:49.380 because if they break their contract, they are at risk not to find a job anymore. 62 00:10:49.380 --> 00:10:54.380 It's a sanction, it's a punishment-reward mechanism. 63 00:10:54.380 --> 00:11:17.380 Rothbard, on the other hand, acknowledges this kind of mechanism like reputation and incentive to do your job, because if you don't do your job, your reputation is going to be harmed. 64 00:11:17.380 --> 00:11:25.380 But on the other hand, all the contribution to the concept of reputation is the concept of blacklist and boycott. 65 00:11:25.380 --> 00:11:32.380 Since you are not the owner of your reputation, because reputation is not a physical good, first of all, 66 00:11:32.380 --> 00:11:36.380 and because reputation is what people think about you, 67 00:11:36.380 --> 00:11:43.380 you can exercise blacklisting and boycotting to sanction the people who are breaking the contract. 68 00:11:43.380 --> 00:11:53.380 If you don't do your job, you can tell to other people, you should not hire this person because he doesn't do his job very well. 69 00:11:53.380 --> 00:11:56.380 Blacklisting is the same thing. 70 00:11:56.380 --> 00:11:59.380 Other mechanism is what they call competitions. 71 00:11:59.380 --> 00:12:01.380 So there are several competitions. 72 00:12:01.380 --> 00:12:09.380 There is the labor market competition, the project market competition and the capital market competition. 73 00:12:09.380 --> 00:12:18.380 Fama, Oliver Holt, Thorsten, Mark Lupe, which is between mainstream and Austrian. 74 00:12:18.380 --> 00:12:22.380 We never know where he is actually. 75 00:12:22.380 --> 00:12:29.380 But he's certainly more Austrian in the concept of competition than most of the mainstream economists. 76 00:12:29.380 --> 00:12:34.780 argue that competition in general is an implicit incentive mechanism 77 00:12:34.780 --> 00:12:39.380 that will induce the agent to perform their action as better as they can. 78 00:12:39.380 --> 00:12:42.780 Because there is competition in the labor market, 79 00:12:42.780 --> 00:12:46.580 and particularly when you are in a situation where you have unemployment, 80 00:12:46.580 --> 00:12:53.180 well, there is always the ability to find somebody else who is able to do your job better than you. 81 00:12:53.180 --> 00:12:58.580 There is a competition between workers within the firm 82 00:12:58.580 --> 00:13:08.580 to get access to higher positions and between firms to get where you are going to pay the most. 83 00:13:08.580 --> 00:13:11.580 Rothbard talks about that in Chapter 10. 84 00:13:11.580 --> 00:13:14.580 Competition in the product market. 85 00:13:14.580 --> 00:13:22.580 Well, if your corporation doesn't do any profit, well, you are at risk to have what we call liquidation. 86 00:13:22.580 --> 00:13:27.580 And if you are in liquidation or if you are in bankruptcy, well, you lose your job. 87 00:13:27.580 --> 00:13:34.580 So, the product market competition gives you incentive to perform your job as best as you can. 88 00:13:34.580 --> 00:13:42.580 Because the ultimate criterion in any corporation, private corporation, is profit and loss. 89 00:13:42.580 --> 00:13:50.580 If you do good, if you do profits, you are going to keep your job, have a higher wage usually, you have an over-bonus. 90 00:13:50.580 --> 00:13:58.580 But if you don't do your job, your corporation is going to go in bankruptcy, liquidation, and you are going to lose your job. 91 00:13:58.580 --> 00:14:03.580 So, Rothbard talked about that. 92 00:14:03.580 --> 00:14:10.580 And probably the most important competition mechanism is the competition for corporate control. 93 00:14:10.580 --> 00:14:29.580 It's on the capital market. Corporate control is a very important mechanism, and Rothbard repeatedly, as well as Mises, Mises in Human Action, 94 00:14:29.580 --> 00:14:45.580 Human Action in Socialism, in Bureaucracy, in all these books, repeats all the time that capital markets are one of the most important mechanisms to resolve agency problems. 95 00:14:45.580 --> 00:15:00.580 The takeover mechanism is when if your corporation is inefficient, the share price is going to go down and therefore you will find what we call 96 00:15:00.580 --> 00:15:15.580 So, entrepreneurs, capitalist entrepreneurs, we are going to take over the corporation and change the management team to put a more performant management team. 97 00:15:15.580 --> 00:15:28.580 Private institutions, well, there are many mainstream economists who have come to analyze private institutions, which are different from public institutions like government, 98 00:15:28.580 --> 00:15:37.580 were able to complement this other mechanism to resolve agency problems. 99 00:15:37.580 --> 00:15:47.580 More famous ones are Meagrum, Roberts, Avner Greif, Che, Douglas North, and Professor Botchy, because he wanted to be on the left. 100 00:15:47.580 --> 00:16:02.580 But in Chapter 12, when Rothbard analyzed the impact of government intervention on the market, 101 00:16:02.580 --> 00:16:08.580 he also shows what are the other alternative private mechanisms to resolve this problem. 102 00:16:08.580 --> 00:16:27.580 When he's talking about problems like standard of quality and safety, or when he's talking about mostly about standard of quality and safety, 103 00:16:27.580 --> 00:16:42.580 When he's talking about private contract relations, he's explaining there's many private institutions, private enterprises, who come to complement and try to resolve these problems. 104 00:16:42.580 --> 00:16:56.580 Professor Daniel Klein wrote a couple of papers on that, and he showed there's plenty mechanisms, private institutions, who are able to play the entrepreneur role in providing information to the consumers. 105 00:16:56.580 --> 00:17:17.580 Government, that is probably the most important aspect in Rothbard's theory, is that in mainstream economics there is no real theoretical analysis of the impact of government on agency theory. 106 00:17:17.580 --> 00:17:22.680 Actually, like, a couple of weeks ago, I was reading a paper by Bent Armstrong, 107 00:17:22.680 --> 00:17:27.780 it was a paper on dynamics of agency problems, 108 00:17:27.780 --> 00:17:36.780 and he argues, and he says, clearly, there is no interest in analyzing the effects of government on agency problems. 109 00:17:36.780 --> 00:17:41.080 We should more analyze the inefficiency of the market system. 110 00:17:41.080 --> 00:17:44.580 Well, I would guess, I think it's Swedish, right? 111 00:17:44.580 --> 00:17:51.580 Professor Klein, is he Swedish? Yeah? Well, so he's a socialist, that's why probably. 112 00:17:51.580 --> 00:17:59.580 And he's teaching MIT too, so that's also why. They are also socialists at MIT. 113 00:17:59.580 --> 00:18:08.580 So, but empirically we have many studies like Peltzman, Kibb Discussive, we have repeatedly shown from an empirical point of view 114 00:18:08.580 --> 00:18:17.580 that government's intervention to attempt to resolve agency problems like moral hazards and adverse selection are totally inefficient. 115 00:18:18.580 --> 00:18:23.580 Rothbard on the other hand doesn't do very much empirical analysis, well he does a little bit, 116 00:18:23.580 --> 00:18:32.580 but he does more theoretical analysis and shows that every government action which should be understood as a violent action, 117 00:18:32.580 --> 00:18:42.100 which is an invasion of your property reduce the incentive of people to make 118 00:18:42.100 --> 00:18:47.900 the most efficient use of this property and therefore creates conflict of 119 00:18:47.900 --> 00:18:52.900 interest between individuals because interventionism or regulation is always 120 00:18:52.900 --> 00:19:00.180 giving privilege to somebody against somebody else so it creates conflict of 121 00:19:00.180 --> 00:19:13.180 Conflict of Interest, Conflict of Interest between the individuals. 122 00:19:13.180 --> 00:19:28.180 What is important in Rothbard in this chapter is that he makes the dichotomy between violent action or violent appropriation and voluntary appropriation or what we call contract. 123 00:19:28.180 --> 00:19:33.180 The theory shows that every time you have a violent action, whether it is the government or the mafia, 124 00:19:33.180 --> 00:19:38.180 it's like the same thing, you know, just one is legal, the other one is not legal. 125 00:19:38.180 --> 00:19:45.180 But the most important thing is every time you have a violent action, 126 00:19:45.180 --> 00:19:53.180 people are constrained to make use of their property that they would have not done on a free market system. 127 00:19:53.180 --> 00:20:12.180 So therefore, Vanet Action always aggravates agency problems or actually creates new agency problems. 128 00:20:12.180 --> 00:20:16.180 The typical example is what we call insurance deposit. 129 00:20:16.180 --> 00:20:31.180 I'm not going to talk too much about that because there is a professor, Salerno, and he is a specialist in monetary theory, and I'm not, so we will tell you about that. 130 00:20:31.180 --> 00:20:43.180 Insurance deposit creates an agency problem, a moral hazard problem, between the bank and the shareholders in general, and the customers too. 131 00:20:43.180 --> 00:20:48.180 I'm going to quickly finish on the role of entrepreneurship. 132 00:20:48.180 --> 00:20:52.180 Well, in agency theory, there is no such thing as the role of entrepreneur. 133 00:20:52.180 --> 00:20:54.180 There is no entrepreneur. 134 00:20:54.180 --> 00:20:57.180 Even cause in the theory, if one talks about the entrepreneur, 135 00:20:57.180 --> 00:21:01.180 it's like assimilating the entrepreneur to a simple manager. 136 00:21:01.180 --> 00:21:04.180 Fama doesn't talk about entrepreneur. 137 00:21:04.180 --> 00:21:07.180 He talks, oh, there is no entrepreneur, there is only managers. 138 00:21:07.180 --> 00:21:14.180 Rothbard emphasized the role of entrepreneurs at many levels. 139 00:21:14.180 --> 00:21:22.180 On every type of market, you have an entrepreneur on the market for capital, corporate control. 140 00:21:22.180 --> 00:21:29.180 The raiders are entrepreneurs who are able to perceive an efficiency in the management of a firm. 141 00:21:29.180 --> 00:21:34.180 They take over this firm and change the management team and try to improve this firm. 142 00:21:34.180 --> 00:21:42.180 It is true that you might have some problems, what we call in economics, free rider problems. 143 00:21:42.180 --> 00:21:52.180 Or it is true that some raiders or some management teams want to take over another company for prestige or to increase their wage. 144 00:21:52.180 --> 00:21:56.180 This is not a perfect mechanism. 145 00:21:56.180 --> 00:22:01.180 Rothbard talks about entrepreneurs in private institutions. 146 00:22:01.180 --> 00:22:16.180 All these consumer reports, all these corporations would try to provide information to the consumers about the safety of the quality of goods is largely emphasized in Rothbard. 147 00:22:16.180 --> 00:22:41.180 So the important idea, the important thing we have to remind in Rothbard theory, I believe that this important idea is the difference between government and market mechanism. 148 00:22:41.180 --> 00:22:54.180 Government intervention is always a violent action on the property rights of individuals, and it generates conflict of interest, aggravates agency problems, and sometimes creates new agency problems. 149 00:22:54.180 --> 00:23:08.180 On the other hand, market mechanisms, while they are not perfect, Rothbard is not like a typical mainstream economist saying, oh, we are in a perfect competition model, or the world should be perfect. 150 00:23:08.180 --> 00:23:15.620 Now, Rothbard is a realistic person, and knows that there is no perfect system, but the question 151 00:23:15.620 --> 00:23:21.340 Rothbard is always asking himself is which system is the least inefficient, or which 152 00:23:21.340 --> 00:23:24.900 system is the more efficient. 153 00:23:24.900 --> 00:23:30.620 And all Man Economy and State is to show that every time you have a government intervention 154 00:23:30.620 --> 00:23:36.780 in the market, and more intervention in the market, the more inefficient is the system. 155 00:23:36.780 --> 00:23:46.780 The more agency problems you will have on the system, the less intervention you have from the government on the market, the more efficient is the system. 156 00:23:46.780 --> 00:24:05.780 This is why Rothbard was an anarchist. This is why Rothbard was an anarcho-capitalist, because he believed that while the anarcho-capitalist system was not the perfect system, it was not heaven, it was certainly more efficient than any interventionist system. 157 00:24:05.780 --> 00:24:10.940 Thank you very much. I welcome any questions.