WEBVTT NOTE The Place of Austrian Economics in Management Research, Education, and Consulting 1 00:00:00.000 --> 00:00:05.200 Good afternoon, everybody. I'm John Chapman. As Peter said, I'm at the American Enterprise Institute in Washington, D.C. 2 00:00:05.200 --> 00:00:10.700 And one correction, Peter said I recently received my Ph.D. That's a sore spot. I did get it a couple of years ago. 3 00:00:10.700 --> 00:00:13.400 That's a sore spot because the boy was a recent job. 4 00:00:13.400 --> 00:00:19.400 That's right. That's right. But it was a... I did not settle land speed records in obtaining this degree. 5 00:00:19.400 --> 00:00:28.700 But the quick story on me is that I was always a fan of Austrian economics, dating to about 8th or 9th grade and all through high school and college. 6 00:00:28.700 --> 00:00:33.180 Research, but I, you know, want to go out and make money and sort of build a life in 7 00:00:33.180 --> 00:00:37.860 the real world, so to speak, but approached age 40 and no wife and no kid and still love 8 00:00:37.860 --> 00:00:43.340 this stuff, so I went back to school and I'm here thanks to Peter Klein because I discovered 9 00:00:43.340 --> 00:00:48.780 the, you know, his line of research through the Austrian Economics Newsletter interview 10 00:00:48.780 --> 00:00:52.740 he did years ago and that got me thinking, boy, this is the kind of stuff I've been thinking 11 00:00:52.740 --> 00:00:54.540 about again as a practitioner. 12 00:00:54.540 --> 00:00:56.260 We all make mistakes, John. 13 00:00:56.260 --> 00:00:57.260 That's exactly right. 14 00:00:57.260 --> 00:00:58.260 That's exactly right. 15 00:00:58.260 --> 00:01:28.260 So what I want to do is continue the discussion is again sort of in line with my personal background and I'm up in Washington DC turning my dissertation research on private equity and entrepreneurship into a book and then have a few follow on projects alongside that but is focused on this issue of how and why Austrian economics matters and provides insight into management research and consulting from a practitioner viewpoint. So I'll discuss very quickly how the framework applies. 16 00:01:28.260 --> 00:01:34.260 in terms of utilizing the Austrian paradigm. I've got some specific examples, again, some 17 00:01:34.260 --> 00:01:41.140 sort of real-world phenomena of, and how Austrian insights can deepen our thinking. And then 18 00:01:41.140 --> 00:01:46.380 I've got some thoughts on opportunities for future research. So I'll start with several 19 00:01:46.380 --> 00:01:50.660 years ago, Peter had a, we were in a discussion one day, and I think I was trying to read 20 00:01:50.660 --> 00:01:57.100 some obtuse writing of Paul Samuelson or something and complaining about the irrelevance of it. 21 00:01:57.100 --> 00:02:00.460 And Peter had this great quote, so I'm going to throw his wisdom back at us, but he said, 22 00:02:00.460 --> 00:02:03.620 those of us who have grounding in Austrian theory have a hidden advantage unavailable 23 00:02:03.620 --> 00:02:05.280 to mainstream economists. 24 00:02:05.280 --> 00:02:08.180 We have the additional benefit of subtle, but often critical insights they're just not 25 00:02:08.180 --> 00:02:09.180 aware of. 26 00:02:09.180 --> 00:02:13.460 And at the time, yeah, I thought, well, that's interesting comment, it's true, but as the 27 00:02:13.460 --> 00:02:17.340 years have gone on, I've never forgotten that because of the, and the key operative word 28 00:02:17.340 --> 00:02:19.740 there is subtlety. 29 00:02:19.740 --> 00:02:24.260 Some of you, I don't know, in this room, but certainly at this conference, attended the 30 00:02:24.260 --> 00:02:29.700 the famous South Royalton Conference of Austrian Economics way back in 1974 and kind of the 31 00:02:29.700 --> 00:02:34.800 rebirth in America and so forth and Milton Friedman came to that conference and famously 32 00:02:34.800 --> 00:02:37.820 quipped there's no such thing as Austrian Economics, there's only good economics or 33 00:02:37.820 --> 00:02:45.420 bad economics and there's certainly no congruence among those of us here as to what exactly 34 00:02:45.420 --> 00:02:46.540 Austrian Economics is. 35 00:02:46.540 --> 00:02:53.580 My own view of it is that nonetheless a reading of all the great Austrian literature provides 36 00:02:53.580 --> 00:02:58.540 this framework and these subtleties that allow for the deeper and the rich insights. 37 00:02:58.540 --> 00:03:01.400 And I'll give you a couple of specific examples of that. 38 00:03:01.400 --> 00:03:05.700 And I would argue that, again, we don't have time to get into this today, but the big focus 39 00:03:05.700 --> 00:03:11.380 has certainly been on the role and the nature of the entrepreneur, that there are many other 40 00:03:11.380 --> 00:03:15.340 areas and traditionally, again, those of us who are thoroughgoing Austrians, we don't 41 00:03:15.340 --> 00:03:20.260 make a distinction between micro and macro, but nonetheless, across the spectrum of economic 42 00:03:20.260 --> 00:03:26.620 Analysis. There are insights that are derived uniquely from Austrian writers 43 00:03:26.620 --> 00:03:31.420 that again provide additional insight and benefit in understanding real-world 44 00:03:31.420 --> 00:03:37.460 phenomena today. As an example and just the quick story on entrepreneurship as 45 00:03:37.460 --> 00:03:44.940 it relates to private equity, the common story of private equity that you get 46 00:03:44.940 --> 00:03:49.540 from common mainstream management theorists and economists is that there 47 00:03:49.540 --> 00:03:53.700 There are two types of private equity transactions. In my private equity here I refer to later 48 00:03:53.700 --> 00:03:59.500 stage buyout investing mature companies as opposed to early stage venture capital. But 49 00:03:59.500 --> 00:04:05.820 nonetheless we all here agree that there's a large entrepreneurial element in the bioworld. 50 00:04:05.820 --> 00:04:10.460 So the common story is, from again the typical mainstream economist, that there are these 51 00:04:10.460 --> 00:04:14.500 two types of transactions. There's the agency mitigation, this is the Michael Jensen literature, 52 00:04:14.500 --> 00:04:19.420 and the insights that he spawned that the idea that these large companies, these behemoths 53 00:04:19.420 --> 00:04:23.600 can be consolidated and there's rationalization opportunities, et cetera. 54 00:04:23.600 --> 00:04:31.600 And then the other sort of the cost cutting, grow the bottom line by controlling costs. 55 00:04:31.600 --> 00:04:36.980 The other, the sort of second canonical type of transaction is growth equity expansion, 56 00:04:36.980 --> 00:04:38.980 grow the top line. 57 00:04:38.980 --> 00:04:44.700 and typically smaller companies that have large market opportunities and need access 58 00:04:44.700 --> 00:04:45.700 to capital and so forth. 59 00:04:45.700 --> 00:04:52.900 So there's 150 papers in the private equity literature and 98% of them refer to these 60 00:04:52.900 --> 00:04:54.860 two types of deals. 61 00:04:54.860 --> 00:05:00.740 But there's really a, and this is again the subtle Austrian insight, is that there really 62 00:05:00.740 --> 00:05:02.820 is a third type of transaction. 63 00:05:02.820 --> 00:05:06.340 And for lack of a better term, I call it coordination improving. 64 00:05:06.340 --> 00:05:16.340 And these are companies that are fundamentally sound. They've got maybe good profits, good revenue streams, solid management, but they lack resources of one type or another. 65 00:05:16.340 --> 00:05:26.340 Or they see a discontinuity in the marketplace that others haven't perceived yet. So you get the Kirznerian Alertness Thief and so forth. 66 00:05:26.340 --> 00:05:32.340 And so that in fact, when you sort of turn the corner on the idea that there is this third type of transaction, 67 00:05:32.340 --> 00:05:38.580 Production, a whole new understanding of the value-add of private equity in the economy 68 00:05:38.580 --> 00:05:39.580 is amenable to you. 69 00:05:39.580 --> 00:05:44.460 And here are the several different ways in which private equity investors can add value 70 00:05:44.460 --> 00:05:45.460 in these companies. 71 00:05:45.460 --> 00:05:46.460 And when you... 72 00:05:46.460 --> 00:05:51.540 So my point is that when you have this added subtle insight, all of a sudden, in any argument 73 00:05:51.540 --> 00:05:56.660 with a typical mainstream economist who says private equity is merely a story of wealth 74 00:05:56.660 --> 00:06:01.100 redistribution from Main Street to Wall Street, the deal-makers get rich, but the people out 75 00:06:01.100 --> 00:06:08.380 in the small West Virginia company towns don't. The added benefit of Austrian thinking allows 76 00:06:08.380 --> 00:06:15.000 you to say, no, there really is a deeper story here. Another example of this is in the area 77 00:06:15.000 --> 00:06:21.020 of knowledge exploitation, the great theme of Hayek. And here, a current example would 78 00:06:21.020 --> 00:06:25.820 be the story of Hewlett-Packard. Hewlett-Packard was run by Carly Fiorina, late of the John 79 00:06:25.820 --> 00:06:49.820 and the John McCain campaign. Another knock against her. So from 1999 to 2005 Carly Fiorina ran Hewlett-Packard and she had a very traditional understanding of the CEO's role, command and control, and her approach to leadership and strategy formulation was top down. 80 00:06:49.820 --> 00:06:57.320 So the common story is that, well, she was a lousy leader and manager and didn't really understand how to run a big company. 81 00:06:57.320 --> 00:07:05.820 So Mark Hurd came in from NCR in 2005. He looked back and has had a fantastic turnaround in the ensuing three, four years. 82 00:07:05.820 --> 00:07:16.820 The share price is about $27 today from a high of $48, but on all other measures, notwithstanding, they've had a terrific run 83 00:07:16.820 --> 00:07:25.820 and are now leading in many sub-markets of the information technology world that they were followers in. 84 00:07:25.820 --> 00:07:34.820 And so the question is, what really drove that there? Was it really just a story of a personnel change from a bad manager to a good manager? 85 00:07:34.820 --> 00:07:42.820 The subtle Austrian insight is that, in fact, Herd is a proto-Austrian without knowing it because he came into that company and understood, 86 00:07:42.820 --> 00:08:12.820 Hey, here's a vast empire that operates in 20 different businesses. I can't possibly understand them all, but through a revamp of the compensation, incentive plans, a thoroughgoing rework of the culture within HP to more of, again, trial and error, use of local knowledge and local circumstances and so forth, and so again, there's a much deeper story there than has been afforded by the typical 87 00:08:12.820 --> 00:08:16.100 The Typical Management Story. 88 00:08:16.100 --> 00:08:25.100 In another example, again here a sort of a coordination of firm resources theme and here 89 00:08:25.100 --> 00:08:31.220 I compare KKR, the largest and most famous buyout firm, to a typical large multinational 90 00:08:31.220 --> 00:08:32.500 such as IBM or General Electric. 91 00:08:32.500 --> 00:08:37.620 Now some of you, Peter mentioned market-based management, the Koch brothers and Koch Industries 92 00:08:37.620 --> 00:08:41.500 are famous for that and they're the, I think the second largest privately held company 93 00:08:41.500 --> 00:08:48.500 in the United States might also be a counter example to the way IBM and GE are run. 94 00:08:48.500 --> 00:08:54.040 So again, the typical mainstream economist slash management theorist says, well KKR has 95 00:08:54.040 --> 00:09:02.300 garnered 30 years of super alpha returns solely because of the sort of the institutional situation 96 00:09:02.300 --> 00:09:03.300 they find themselves in. 97 00:09:03.300 --> 00:09:10.660 They obviously, there were these agency mitigation opportunities in corporate America at the 98 00:09:10.660 --> 00:09:28.660 and the high-end and then also the sort of leveraged investing model and so it's really a very simple cut-and-dried story and some would even argue that it's not even right or appropriate to compare the way KKR runs its businesses to a large multinational conglomerate like General Electric or IBM. 99 00:09:28.660 --> 00:09:36.660 Well, in fact, again, the subtle Austrian insights provided by people like Kirzner allow us to dig deeper. 100 00:09:36.660 --> 00:09:43.660 There's a very famous, I say famous, very well-known paper in the management literature by George Baker in City Montgomery, 1994. 101 00:09:43.660 --> 00:09:46.660 It gives a guy like me hope because the paper's actually never been published. 102 00:09:46.660 --> 00:09:50.660 But it's been cited. It's one of George Baker's most cited papers. It's great work. 103 00:09:50.660 --> 00:09:59.660 He looked at KKR and he defined it as a privately held conglomerate, which is a great way to think about it. 104 00:09:59.660 --> 00:10:05.660 If you think of KKR that way, it's about a Fortune 10 company, 600,000 employees, 21 businesses, whatever it is. 105 00:10:05.660 --> 00:10:09.660 They've done 150 acquisitions in the last 30 years. 106 00:10:09.660 --> 00:10:18.660 So he compared KKR as a management structure, as a governance structure, to a company like General Electric, a multinational diversified holding company. 107 00:10:18.660 --> 00:10:25.620 Company, and he looked at the holding Company operations and the way in which strategies 108 00:10:25.620 --> 00:10:30.100 formulated, the compensation governance mechanisms, etc. 109 00:10:30.100 --> 00:10:33.740 And so again, without, you know, George Baker, if he were here today, he would say, I'm not 110 00:10:33.740 --> 00:10:38.500 an Austrian, but in fact, he's read the literature and understands these types of insights, and 111 00:10:38.500 --> 00:10:48.140 the fact is that KKR runs its business by zealously focusing on, or applying Austrian 112 00:10:48.140 --> 00:10:55.940 Insights in terms of understanding how knowledge is created, disseminated, and the coordination 113 00:10:55.940 --> 00:10:56.940 story. 114 00:10:56.940 --> 00:11:03.580 So let me wrap up other examples we could give by just saying that the areas for research 115 00:11:03.580 --> 00:11:09.940 I think are, and to go back to my original thesis of, you know, is there a solid place 116 00:11:09.940 --> 00:11:16.900 for some, or the way Peter put it, are there new and both extensions to current and then 117 00:11:16.900 --> 00:11:23.140 and holy new paradigms that we can develop by the application of Austrian theory to current 118 00:11:23.140 --> 00:11:24.140 management research. 119 00:11:24.140 --> 00:11:27.140 And I guess I'm sort of agnostic in answering that question, yes or no, one way or the other. 120 00:11:27.140 --> 00:11:31.500 I prefer to think of it in terms of the sort of the subtleties that one can, that can be 121 00:11:31.500 --> 00:11:34.100 derived from knowledge of this literature. 122 00:11:34.100 --> 00:11:38.460 And again, there are 10 opportunities for future research we could name, but I think 123 00:11:38.460 --> 00:11:43.700 a key focus is, or a key opportunity related to entrepreneurship is the growth and development 124 00:11:43.700 --> 00:11:45.380 of small business. 125 00:11:45.380 --> 00:11:50.860 And sort of fascinating factoid that I put in my own research is that if you believe 126 00:11:50.860 --> 00:11:56.780 in modern financial theory and that capital markets are very efficient in the long run, 127 00:11:56.780 --> 00:12:01.620 returns regress to the mean and so forth, but over the long term, in fact, we see very 128 00:12:01.620 --> 00:12:07.340 different investment returns by size of transaction. 129 00:12:07.340 --> 00:12:13.660 And in the leveraged buyout literature, the empirical literature in private equity is 130 00:12:13.660 --> 00:12:18.380 is always done at sort of the top end of this pyramid, the large public companies where 131 00:12:18.380 --> 00:12:23.620 the data is available. But in fact, there are rich insights to be gleaned by how these 132 00:12:23.620 --> 00:12:25.940 small companies grow and develop.