Kudos to Hewlett-Packard

On September 22, computer equipment maker Hewlett-Packard Co fired their president and CEO and replaced him with former EBay CEO Meg Whitman. (See the Reuters article) While we pass no judgement on the hiring of Ms Whitman, we applaud the decision to fire Leo Apotheker. It’s not that we have anything against Mr. Apotheker, but he was responsible for the bad decisions made at HP over the last few years – whether he made the decisions or not. The result of those decisions has been a steady erosion of shareholder wealth. The chart below shows the adjusted closing prices of HP stock on the NYSE since late 2009.

One aspect in the theory of the firm is that there must be an ultimate monitor. Given the choice of working or ‘shirking’ (not being productive on the job), employees will always opt to shirk since it maximizes utility. To ensure that employees don’t shirk, a firm must employ monitors to ensure productivity. An employee that is caught shirking faces a punishment so that there is a cost to shirking and a benefit to working. Workers then become more productive. 

The argument can also be made for the monitors of the workers. What ensures that they do not shirk in their monitoring duties? The solution to this is another level of monitors whose job it is to monitor the monitors. The same kind of penalty must apply to monitors that shirk. Each successively higher level of monitors receives a higher level of compensation which increases the penalty of shirking.

Ultimately, there must be one person that monitors everything. That person is the President/CEO. The President acquires information about the firms operations and opportunities and makes the decision as to what is to be done and how it is to be done. If something goes wrong, it is the fault of the ultimate monitor. If bad information was received by the President, then someone below him did not do their job, and the ultimate monitor must take responsibility.

HP made two decisions lately that suggest the President made choices based on inaccurate information. One was the acquisition of Palm, the second the foray into the tablet market. Both decisions cost shareholders dearly. It was the President’s fault, he had to take the fall.

Anyone interested in the role of monitoring are encouraged to read the paper by Alchian and Demsetz listed below.

One final thought:

While writing this blog, a newsarticle popped up on the computer screen saying that the President of the Swiss banking firm UBS has resigned as a result of the $2.3 billion loss associated with a rogue trader at their London England branch. (See the Globe and Mail article) 

Alchian, Armen A. and Harold Demsetz  Production, Information Costs, and Economic Organization   The American Economic Review, Vol. 62, No. 5 (Dec 1972)  pp 777-795

A Canadian Institution Succumbs to Technological Change … Finally

The Canadian government has recently announced that it has halted the Canadian Wheat Board’s role as the monopoly seller of Canada’s wheat and barley production. See the Globe and Mail article for all the details. 

Farming conditions in the 1930’s were very different than they are today. Small family owned farms were the norm and farming was a labour-intensive industry. Communications technology made transactions costs relatively high and limited access to financial markets made risk management techniques expensive. Transportation technology also made long distance movement of grains expensive and access to the railway was required in every community. 

As a monopsonistic buyer, the CWB was able to act as an insurer of farm incomes. By managing grain inventories from year to year, the CWB was able to control prices, paying below market prices in some years and above market prices in others. As a monopolistic seller of Canadian wheat and barley they could capture the economies of scale in communication that were not available to individual farmers. As the owner of rail cars, they could reduce transportation costs and insure that all farmers could get their product to market. 

Technology has changed however. Farmers in Leader Sask. can check prices on the ICE Futures Exchange (formerly the Winnipeg Commodities Exchange), the Kansas City Board of Trade, the Chicago Mercantile Exchange and the New York Mercantile Exchange (a division of the CME Group). These exchanges also offer futures and options that can be used to hedge the risk of fluctuating prices. Farmers can even purchase financial derivatives based on the weather. 

Changes in materials and engine technologies have caused the price of capital to decrease relative to labour and farming has become more capital intensive. This has lead to the demise of the family farm and the rise of commercial farming. Larger operations are able to capture the economies of scale provided by bigger and faster harvesters. Transportation technologies have also decreased the price of transporting grains by truck to main railway lines. 

All of the CWB’s reasons for existence have been overcome by technological changes. That doesn’t mean that everyone is happy. Small farmers will no longer be able to compete with the agricultural conglomerates. This leaves them with two choices: continue as they are and bear the costs of their operations, or sell their land to a larger producer. 

Technological change is generally a good thing though it does not affect everyone in the same way. The farms around Leader Sask. will continue to produce food, thought the town of Leader may eventually fade away.