What’s fair?

In the comments of this post, Wally posted a video about how actual wealth distribution differs from what a group of people feel like is the ‘ideal’ wealth distribution.

I think the video provides a good example of the dangers of convoluted reasoning disguised as something that sounds intelligent.

For instance, in one part of the video, the narrator says that CEOs make as much in one hour as their average employees make in a month and suggests that is unfair.

When framed this way, the unfairness seems plausible. However, this framing is like a distraction used in a parlor trick, or a red herring.

He implies that a CEO should make some multiple of the wages of an average worker, but he doesn’t tell you why. He figures you get it. But, do you?

Most of the average workers who have young children make several orders of magnitude more than those children.Is that fair? People with kids may now realize the distraction.

It’s not a question of fairness. They understand that there isn’t necessarily a relation between what they make and what their children make. They understand that what they make is based on the value they create for their employers or client and what others are willing to do that for, as well.

Now, don’t get me wrong. I think most CEOs are overpaid. But, I don’t base that opinion on nonlogic like what I think a fair multiple is between some unrelated job and their job, no more than I think what a nurse is paid should be some multiple of what a painter makes, or what a professional baseball makes should be some multiple of what the beer vendor in the stands makes. That’s nonsense.

I think most CEOs are overpaid in part because their decisions do not increase the value of their company enough to cover the risks they take and because Boards of Directors aren’t interested enough to get find truly good business leaders.

The whole video is a red herring. It basically compares ‘an ideal’ wealth distribution to the actual wealth distribution and implies that something is unfair. But, it takes more than a red herring to convince this guy.

Try to use some logic. Let’s talk about the value the people at the low, middle and high ends of the distribution create. Let’s talk about their financial behavior, their investments in human capital, decisions they’ve made.

Let’s talk about the absolute wealth at each end. Should I care than Bill Gates doesn’t fit on his chart, if I’m living a life unimaginable by my even fairly recent ancestors?

Update: ‘Dude Where’s My Freedom”s comment reminded me of the lyrics from Tenacious D’s song, City Hall. After starting riots to overthrow government and now ruling, Jack Black and KG are issuing their decrees. Their third decree is,

No more rich people and poor people. From now on, we’ll all be the same…ummm…I don’t…I gotta think about that.

Funny and true.

Boards Beware

Today’s Wall Street Journal article, about the firing of Penney’s chief Ron Johnson, identifies clearly Johnson’s main problem:

The board’s decision ends a brief and turbulent career in the corner office for Mr. Johnson. He arrived at Penney to great fanfare in November 2011, but lost the confidence of directors and investors after he rolled out an ambitious plan to reinvent Penney’s stores without following the usual retail practice of testing the changes first.

Mr. Johnson was unapologetic about his decision not to test his strategy. Asked earlier this year if he would do things differently given a chance to start over, he replied, “No, of course not.”

That’s dumb. Boards of Directors should not hire these pompous jack-asses. Tests allow companies to discover what consumers want and prefer and evolve the business to serve their preferences.

This should be a standard question asked in an interview for a CEO, what do you think of testing? If the candidate doesn’t believe in tests, boards should stay away from these candidates.

Why?

Because what consumers want is not always obvious — even to consumers. Very few business ideas pan out, because they fail to deliver value to consumers — even if they sound really good. Tests are hedges against being wrong. They allow a company to discover if a new thing does what it is supposed to — provide what customers are willing to pay for.

What customers want isn’t often obvious. Even customers can rarely truly tell you what they want. They think they can, but what they say very often doesn’t match how they really behave. Economists call this the difference between stated and revealed preferences.

This is the reason why it’s rare that CEOs can divine what their customers want. Trial and error is how customers find out what they want and trial and error is typically how businesses figure out what customers value. Cut out the trial, and you set yourself up for a gigantic error. Small errors are better. Johnson has what economist F.A. Hayek called the Fatal Conceit. 

At least, in this case, from the Journal article we find out that one activist shareholder was the main reason Penneys went with Johnson and, thankfully, that shareholder took a bath for his foolhardiness. Perhaps he will learn a valuable lesson that discovering what customers want, rather than having a conceited fool like Johnson tell them, is a more effective approach running a business.

Consultants and Mass Transit

I recommend listening to these Freakonomics podcasts, I Consult, Therefore I Am and Mass Transit Hysteria.

Over the years, I’ve had the pleasure of working with management consultants from some of the biggest names in the business. Based on those experiences, I agree with much of what was said in this podcast.

I was amused at how a former consultant interviewed on the podcast relayed how the consulting gig was described to him by fellow consultants:

50% of the job is nodding your head at whatever is said. 30% of it is just sort of looking good and the other 20% is raising an objection, but if you meet resistance, then dropping it.

Steven Levitt described some lessons from his young consulting days. One lesson he learned was that the answers can’t always be found in the data and he said:

I [now] have this incredibly deep appreciation that the people in the middle and bottom of the organization absolutely know what’s going on and a lot of time the people at the top have no idea what needs to be done.

The show host, Dubner, explored the key question: Why hire management consultants? Especially when many of them are inexperienced recent grads, their recommendations are often obvious (or dumb) and there’s limited (actually none beyond low-hanging fruit) evidence that consultants actually help.

Why? Executives may want to gain legitimacy for stuff they want to do anyway or they may want to buy plausible deniability.

In my experience, it has been the latter. Being an executive is rough because every decision carries a job-costing risk. Paying McKinsey or Boston Consulting Group a million bucks to tell you what to do gains you a bit of finger-pointing potential when the Board of Directors start hammering about your lackluster performance.  “But these smart guys told me to do it.” The scapegoat doesn’t last long, but it often buys the exec one or two more shots. Of course the Board should point the finger right back at the manager and say, “But this smart guy hired them and followed their advice.”

I wrote more on the subject of consulting in my posts, …And that resulted in what? and Be leery of big words. I still like this paragraph from the latter:

Can you imagine what the owner of an NFL team would do if his head coach hired a consultant to tell him what strategy his team should use to win games?  That’s right.  And that’s what Boards of Directors should do to managers who do that in business.

Mass Transit

In the other podcast, they discuss something about mass transit that I rarely see mentioned: Actual ridership.

According to the guest on the podcast, when actual ridership is taken into account, cars are more energy-efficient than buses and trains aren’t much better.

That’s mass transit blasphemy, isn’t it?

Mass transit proponents like to present us with idealized scenarios of heavily loaded vehicles. But, it turns out in the real world that a train or bus that moves a lot of people in one direction in the morning and another direction in the evening, make a lot of return trips when they are empty.

Also, they are typically run on schedules throughout the day when ridership is very low.

An efficiency advantage our cars have is that they don’t drive around empty all day while they wait to carry us home.