Steven Kyle wrote a post yesterday entitled ”Incompetence at the Top”. This post is an attempt to use his title for a more general purpose. Y’all might recall I had a post recently in which I discuss estate taxes. One problem with inheritance, as a concept is that it can lead to incompetence at the top.
To quote Warren Buffet, repealing the inheritance tax is similar to “”choosing the 2020 Olympic team by picking the eldest sons of the gold-medal winners in the 2000 Olympics”.
But you don’t really have to repeal the inheritance tax to get that result – in effect, we are more or less at that point already. As an example… I used to work for a Fortune 500 Company. While I was there, the CEO retired, and a new CEO was appointed. The new CEO was young – I believe he was in his 30s. I never actually met him, but I don’t get the impression he knew much about the industry. From what I can tell, his primary qualifications for the position were that his father was the previous CEO, and his grandfather was the CEO before that.
Now, even someone ignorant, inexperienced and incompetent can be a good CEO if he or she has good advisors. (This was the argument we were given for GW, you may recall.) The problem with this is that person who is ignorant, inexperienced and incompetent is unlikely to know the difference between good advisors and poor ones. And who picks those advisors? Those advisors in turn pick their subordinates. If the advisors were selected by someone incompetent, the odds that they are incompetent are higher, and thus the odds increase that the subordinates they themselves select are incompetent. The process continues on down the corporate hierarchy.
Now the basic Econ 101 story here would say that companies that are run this way will go out of business, driven out by their more efficient competitors. The problem is that if you pick your Olympic team from the eldest sons of your previous Olympic team, your team might be good relative to other teams if they select their team the same way. It seems that one of the big requirements to be CEO is having a parent who is a member of Augusta or a first name like Carlton or Reed.
I note that the company for which I worked had plenty of very, very competent and knowledgeable people in the lower levels of upper management. (Corporate Vice Presidents.) There were also plenty of incompetent ones – as I noted earlier, being competent isn’t necessarily a virtue when the folks who evaluate you can’t tell the difference between those who know what they’re doing and those who don’t.
This means that a CEO that rises from the ranks isn’t necessarily competent either. That person may simply good at the things that people who are members of Augusta or have first names like Carlton or Reed value, namely the ability to interact with people who are members of Augusta or have first names like Carlton or Reed.
Now, there are some advantages to a system like the one I describe. One is that it makes negotiations with other companies and the investment banks (same gene pool) and government (political power often devolves to the same group) easier if your CEO comes from the same circle. And this makes for quite a barrier to entry against companies run by potentially more competent outsiders. A second (and this is another Econ 101 argument) is that presumably, the members of the Augusta, the Carltons and the Reeds own the biggest blocks of shares. Since they have more at stake, the argument goes, they will work harder to ensure the company does well that anyone else would. (I’ll be covering this issue in another post – I’ll try to write it up later today or in the next couple of days.)
So, what do you think? Is this view of corporate America too cynical?