Sunday, January 04, 2015

Who bears risk?

There's one aspect of the collapse of City Link that deserves more attention than it gets - that it undermines the conventional idea that firms' owners are risk-takers.

Better Capital's stake in the firm took the firm of a secured loan, which means they'll get first dibs on its residual value. Thanks to this, Jon Moulton, Better Capital's manager claims to stand to lose only £2m - which is a tiny fraction of his £170m wealth.

By contrast, many of City Link's drivers had to supply capital to the firm in the form of paying for uniforms and van livery, and are unsecured creditors who might not get back what they are owed. Many thus face a bigger loss as a share of their wealth than Mr Moulton. In this sense, it is workers rather than capitalists who are risk-takers.

This point is not, of course, specific to City Link. Most decent-sized businesses represent only a small fraction of a diversified portfolio for their capitalist owners, whereas suppliers of human capital usually have to put all their eggs into the basket of one firm; only a small minority of us have "portfolio careers" . All that stuff they teach you about the benefits of diversification applies in the real world to capital, not labour.

There are two implications of all this.

First, it means that the idea that capitalists are brave entrepreneurs who deserve big rewards for taking risk is just rubbish. As Olivier Fournout has shown, the idea of managers as heroes is an ideological construct which serves to legitimate power and rent-seeking.

Secondly, it suggests that ownership might in some cases lie in the wrong hands. Common sense tells us that those who have most skin in the game should have the biggest say simply because they have the biggest incentive to ensure that the firm succeeds. As Oliver Hart - who's hardly a raving lefty - says: "a party with an important investment or important human capital should have ownership rights." This is yet another case for worker ownership.

This in turn reminds us of a cost of inequality; sometimes, ownership is in the wrong hands simply because the most efficient owners can't afford to buy the firm.

[See the article at the link for suggestions on how to solve this problem.]

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