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