Big Corporations and Short Term Thinking

BP's management, like that of many other large companies, seems to have been so focused on short term earnings and cost avoidance that it forgot an old adage:

You can pay me now or you can pay me [a lot more] later.

In the world of big corporations, thinking is driven by the fear of the effect that modestly reduced profits next quarter will have on the stock price. Corner cutting and risk taking, as well as ferocious lobbying to reduce the number and scope of applicable regulation, are a standard part of such short term thinking. They appear to have been major contributing factors to the Macondo oil well disaster and in several other incidents where BP has been involved.

It is only rarely that such behaviors result in an incident. When, however, things do go wrong, they go very badly wrong indeed and the costs are frequently extraordinarily high. Nor is the company the only one to bear the burden: many innocent bystanders also suffer. The Macondo oil well disaster is a classic case.

Regulation would not be necessary if honorable, far thinking, managers were to take it upon themselves to adopt state of the art safety practices and to take into account the real risks of their technologies and business models. The only government body needed, then, would be one that was charged with disseminating information about new and improved safety technologies and procedures. Perhaps even that would not be necessary if there were an enlightened industry association to do the job.

Few humans, however, are capable of thinking accurately beyond the short term. Further, since a positive attitude is a necessity for success in business, most employees grossly underestimate the risks that are being taken. As a result, the need for regulation cannot be avoided. Mere compliance with regulations, however, is insufficient even though compliance with applicable regulations is often offered as a defense in court.

Although it is not remotely possible to avoid all disasters, an attitude of "doing the right thing" for the benefit of all stakeholders can certainly reduce the frequency of such events and the unintended damage that is caused when the inevitable occurs. It is, however, a reality that those who focus on the risks being taken are regarded as merchants of gloom and doom, Cassandras, or just as undesirable negative influences. That they should be removed from the company as soon as conveniently possible is accepted by almost everyone.

Unfortunately, laws governing corporations require their directors and managers to act solely in the interests of shareholders. Worse, many courts have spoken in such a way as to interpret 'in the interests of shareholders' as 'in the very short term interests of shareholders' thus encouraging the very behaviors that too often leads to disaster.

So, at the very least, changes to corporate law and company by-laws are needed. A more radical thought would be to consider the abolition of corporations and a severe reduction in the limits of liability.

If Corporations were to be replaced by Limited Partnerships, there could be limited liability for passive investors. Senior executives, members of the Board, and owners of more than, say, ten percent of the company, would make up the General Partnership and be subject to unlimited liability. Little harm would likely occur if an exception to this rule were made for small privately held businesses.

Such a structure would remove many of the perverse incentives that encourage corporations, and their managements, to do the wrong thing.

Consider, after all, the generally constructive activities of Goldman Sachs when it was organized as a General Partnership. In 1999, the company became a corporation with its stock being publicly traded. The risks that it took, in search of quick profits, would have been unacceptable to the former Partners Committee of the company. When short term greed replaced long term greed, the consequences included a major contribution to the current financial crisis.

Your correspondent does not expect that corporations will soon be abolished. Instead, the dead hand of new regulators, and regulations, will impose procedures and costs that will have some impact although little of it will be positive.

It is the nature of big corporations to create problems. Since those problems can only rarely be addressed by regulation, it is reasonable to expect a regular stream of disasters whose underlying cause is short term thinking.

Unfortunately, we have little alternative other than to expect the worst. The Boy Scout motto "Be Prepared" provides a valuable road map.