[fc-discuss] Financial Cryptography Update: The Tipping Point - How Good Companies Go Bad and Executives Become Rogues

iang@iang.org iang@iang.org
Fri, 7 Oct 2005 12:32:27 +0100 (BST)

 Financial Cryptography Update: The Tipping Point - How Good Companies Go Bad and Executives Become Rogues 

                            October 07, 2005




A new book by Sayles and Smith looking at governance from the angle of
Corporate Executives being the bad guys is worth a look.  It may do a
good job of documenting the problems occuring in US business at the
moment and the first chapter is online here:


To find their prescriptions one would presumably have to buy the book. 
I'm not sure I will as they are very keen to blame the executive, which
isn't really going to help.  Agency theory suggests that your employees
do what you incentivise them to do, and executives are no different. 
Look instead at the incentives that have been created would be my

By way of example, on the mutual funds scandal (one that I'm at least
passingly familiar with) they write:

What Could Management Have Been Thinking?  Here is an example of
executives "shooting themselves in the foot," deception and cheating
that comes back to whack the originator:

Numerous mutual funds destroyed their reputation by allowing a small
number of investors to misuse the funds (by overnight trading and
buying and selling at "stale" prices). Funds earned very modest extra
management fees by granting these special privileges to hedge funds and
a few "select" clients. Their corrupt trading and wrongful pricing cost
the other 99% of the funds’ investors dearly. When the corrupt
practices were revealed, some funds lost half of the investors’ money.
In one case, the value of a fund family to its owners dropped half a
billion dollars in a matter of weeks.

Yet as has been pointed out by the founder of Vanguard in his senate
testimony (who is to some extent credited with the invention of the
mutual funds industry) the problems started when greedy investors
forced mutual funds from percentage reward scales over to fixed reward
scales.  Has there been any suggestion that the funds industry go back
to percentage rewards and thus encourage the managers to think of the

Nope.  Expect more problems then.  And the title above is easily
answered:  Management was thinking of what you told them to think.

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