Good afternoon, everybody. I'm John Chapman. As Peter said, I'm at the American Enterprise Institute in Washington, D.C.
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.
That's a sore spot because the boy was a recent job.
That's right. That's right. But it was a... I did not settle land speed records in obtaining this degree.
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.
Research, but I, you know, want to go out and make money and sort of build a life in
the real world, so to speak, but approached age 40 and no wife and no kid and still love
this stuff, so I went back to school and I'm here thanks to Peter Klein because I discovered
the, you know, his line of research through the Austrian Economics Newsletter interview
he did years ago and that got me thinking, boy, this is the kind of stuff I've been thinking
about again as a practitioner.
We all make mistakes, John.
That's exactly right.
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.
in terms of utilizing the Austrian paradigm. I've got some specific examples, again, some
sort of real-world phenomena of, and how Austrian insights can deepen our thinking. And then
I've got some thoughts on opportunities for future research. So I'll start with several
years ago, Peter had a, we were in a discussion one day, and I think I was trying to read
some obtuse writing of Paul Samuelson or something and complaining about the irrelevance of it.
And Peter had this great quote, so I'm going to throw his wisdom back at us, but he said,
those of us who have grounding in Austrian theory have a hidden advantage unavailable
to mainstream economists.
We have the additional benefit of subtle, but often critical insights they're just not
aware of.
And at the time, yeah, I thought, well, that's interesting comment, it's true, but as the
years have gone on, I've never forgotten that because of the, and the key operative word
there is subtlety.
Some of you, I don't know, in this room, but certainly at this conference, attended the
the famous South Royalton Conference of Austrian Economics way back in 1974 and kind of the
rebirth in America and so forth and Milton Friedman came to that conference and famously
quipped there's no such thing as Austrian Economics, there's only good economics or
bad economics and there's certainly no congruence among those of us here as to what exactly
Austrian Economics is.
My own view of it is that nonetheless a reading of all the great Austrian literature provides
this framework and these subtleties that allow for the deeper and the rich insights.
And I'll give you a couple of specific examples of that.
And I would argue that, again, we don't have time to get into this today, but the big focus
has certainly been on the role and the nature of the entrepreneur, that there are many other
areas and traditionally, again, those of us who are thoroughgoing Austrians, we don't
make a distinction between micro and macro, but nonetheless, across the spectrum of economic
Analysis. There are insights that are derived uniquely from Austrian writers
that again provide additional insight and benefit in understanding real-world
phenomena today. As an example and just the quick story on entrepreneurship as
it relates to private equity, the common story of private equity that you get
from common mainstream management theorists and economists is that there
There are two types of private equity transactions. In my private equity here I refer to later
stage buyout investing mature companies as opposed to early stage venture capital. But
nonetheless we all here agree that there's a large entrepreneurial element in the bioworld.
So the common story is, from again the typical mainstream economist, that there are these
two types of transactions. There's the agency mitigation, this is the Michael Jensen literature,
and the insights that he spawned that the idea that these large companies, these behemoths
can be consolidated and there's rationalization opportunities, et cetera.
And then the other sort of the cost cutting, grow the bottom line by controlling costs.
The other, the sort of second canonical type of transaction is growth equity expansion,
grow the top line.
and typically smaller companies that have large market opportunities and need access
to capital and so forth.
So there's 150 papers in the private equity literature and 98% of them refer to these
two types of deals.
But there's really a, and this is again the subtle Austrian insight, is that there really
is a third type of transaction.
And for lack of a better term, I call it coordination improving.
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.
Or they see a discontinuity in the marketplace that others haven't perceived yet. So you get the Kirznerian Alertness Thief and so forth.
And so that in fact, when you sort of turn the corner on the idea that there is this third type of transaction,
Production, a whole new understanding of the value-add of private equity in the economy
is amenable to you.
And here are the several different ways in which private equity investors can add value
in these companies.
And when you...
So my point is that when you have this added subtle insight, all of a sudden, in any argument
with a typical mainstream economist who says private equity is merely a story of wealth
redistribution from Main Street to Wall Street, the deal-makers get rich, but the people out
in the small West Virginia company towns don't. The added benefit of Austrian thinking allows
you to say, no, there really is a deeper story here. Another example of this is in the area
of knowledge exploitation, the great theme of Hayek. And here, a current example would
be the story of Hewlett-Packard. Hewlett-Packard was run by Carly Fiorina, late of the John
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.
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.
So Mark Hurd came in from NCR in 2005. He looked back and has had a fantastic turnaround in the ensuing three, four years.
The share price is about $27 today from a high of $48, but on all other measures, notwithstanding, they've had a terrific run
and are now leading in many sub-markets of the information technology world that they were followers in.
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?
The subtle Austrian insight is that, in fact, Herd is a proto-Austrian without knowing it because he came into that company and understood,
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
The Typical Management Story.
In another example, again here a sort of a coordination of firm resources theme and here
I compare KKR, the largest and most famous buyout firm, to a typical large multinational
such as IBM or General Electric.
Now some of you, Peter mentioned market-based management, the Koch brothers and Koch Industries
are famous for that and they're the, I think the second largest privately held company
in the United States might also be a counter example to the way IBM and GE are run.
So again, the typical mainstream economist slash management theorist says, well KKR has
garnered 30 years of super alpha returns solely because of the sort of the institutional situation
they find themselves in.
They obviously, there were these agency mitigation opportunities in corporate America at the
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.
Well, in fact, again, the subtle Austrian insights provided by people like Kirzner allow us to dig deeper.
There's a very famous, I say famous, very well-known paper in the management literature by George Baker in City Montgomery, 1994.
It gives a guy like me hope because the paper's actually never been published.
But it's been cited. It's one of George Baker's most cited papers. It's great work.
He looked at KKR and he defined it as a privately held conglomerate, which is a great way to think about it.
If you think of KKR that way, it's about a Fortune 10 company, 600,000 employees, 21 businesses, whatever it is.
They've done 150 acquisitions in the last 30 years.
So he compared KKR as a management structure, as a governance structure, to a company like General Electric, a multinational diversified holding company.
Company, and he looked at the holding Company operations and the way in which strategies
formulated, the compensation governance mechanisms, etc.
And so again, without, you know, George Baker, if he were here today, he would say, I'm not
an Austrian, but in fact, he's read the literature and understands these types of insights, and
the fact is that KKR runs its business by zealously focusing on, or applying Austrian
Insights in terms of understanding how knowledge is created, disseminated, and the coordination
story.
So let me wrap up other examples we could give by just saying that the areas for research
I think are, and to go back to my original thesis of, you know, is there a solid place
for some, or the way Peter put it, are there new and both extensions to current and then
and holy new paradigms that we can develop by the application of Austrian theory to current
management research.
And I guess I'm sort of agnostic in answering that question, yes or no, one way or the other.
I prefer to think of it in terms of the sort of the subtleties that one can, that can be
derived from knowledge of this literature.
And again, there are 10 opportunities for future research we could name, but I think
a key focus is, or a key opportunity related to entrepreneurship is the growth and development
of small business.
And sort of fascinating factoid that I put in my own research is that if you believe
in modern financial theory and that capital markets are very efficient in the long run,
returns regress to the mean and so forth, but over the long term, in fact, we see very
different investment returns by size of transaction.
And in the leveraged buyout literature, the empirical literature in private equity is
is always done at sort of the top end of this pyramid, the large public companies where
the data is available. But in fact, there are rich insights to be gleaned by how these
small companies grow and develop.