Sunday, November 13, 2005

In Defense of High Gas Prices

Last week saw another sad grandstanding display by our elected politicians. Trying to respond to the public clamor over high gas prices, the Senate dragged in executives from five major oil companies to demand answers. These hearings demonstrate a disturbing trend in our polity.

The underlying premise of the entire hearings misconceives the role of corporate employees, like CEO. Simply put, the Senators are calling these executives to task for doing their jobs. Consider the following questions- What exactly should these execs have done in the face of a rise in demand for their product? Do you realize that these people have jobs appointed by the board of directors with the purpose of enhancing shareholder value? Should they have charged less than the market rate (market rate= rate that they could obtain from the market) just because it is in the interests of some Americans? In fact, if oil executives failed to raise gas prices, their board of directors should fire them on the spot, and the company’s shareholders should sue them for breach of fiduciary duty.

If the government wants to subsidize people in their consumption of gas, they should give out a tax break or hand out a voucher for gas. This would be horrible and near-socialist, but it is miles better than calling in private businessmen who are violating no law and doing their jobs, and demanding that they sacrifice the interests of their employers for the sake of the so-called “public interest.”

25 comments:

Charles Iragui said...

Misha,

Demogogery on the part of the Senate, yes. Breach of fiduciary responsibility if the execs don't make the most of every pricing opportunity, no. Reputation risk is significant here and, as we have seen, political risk, too. It would be perfectly reasonable for the execs to argue that the shareholders' ECONOMIC interests are served by charitable gestures.

I agree that the threat of gouging (profit maximization during temporary shortages in regional markets) is questionable and that high oil co profits are the ONLY signal to produce more oil and to develop substitute products.

Grandstanding may be an expedient action in the face of public hysteria - appear to be doing something but do nothing actually. Unfortunately, like stealth Supreme Court candidates, if politicians won't make the arguments for sound policy, the people will eventually follow the demagogs.

Charles

Misha Tseytlin said...

Charles, if they kept their prices lower with the GOAL of being nice to consumers, i think this would be a breach. Obviously, they could come up with some other rationale for any action...

Sarah Kohrs said...

I'm no economist here, but isn't this exactly how the market is supposed to respond? There's an increase in demand, prices go up. For those of us who still believe in capitalism, this creates the most efficient allocation of resources. Why should anyone be penalized for being part of such a system? And they are in business to make a profit, after all.

Perhaps there are some facts I'm missing, but I agree with Misha; this just seems ridiculous.

AJ said...

Mish, stick to con law and fantasy football.

The business judgment rule clearly covers price setting. No shareholder would even make it past the demand rules. Further, it is well established that Directors can consider more than short-term value (and even other stakeholders ala other constituency statutes). If there is a case for gouging (I don't know if there is), then violating anti-trust regulations could be a violation of the duty of care. This is the law Mishenka.

I think what you are trying to do is twist the law to produce results with your Laissez-faire beliefs, beliefs which I agree with. But in this case, I think the law hates you.

Misha Tseytlin said...

I am well aware that this suit would be a loser. The BJR is a standard of deference, which is almost impossible to prove. Even though it is not provable in court, i DO think that a decision not to raise prices just do to a "good thing" for the american people (if that is your ACTUAL purpose) is a violation of the duty a CEO has to the shareholders. Where you got confuse is between the judicial doctrine of not wanting to second guess managers and the actual fiduciary relationship that exists.

Misha Tseytlin said...

a close analogy to con law is the supreme court doctrine of rational basis. Even though a court will not strike down a law in economic regulation unless it is irrational, it does not mean that the law is itself constitutional. All it means is that the court recognizes its limited role. In the same way, courts realize they have a limited role in the policing of the fiduciary relationship between shareholders and CEOs. The best remedy, obviously, would be to fire the CEO....

AJ said...

BJR is more than a judicial doctrine not to second guess directors, it is part of a system of rules which MANDATES the seperation of ownership and control.

And as I said before, there is law out there which says Directors can take into account things other than shareholder value, like other constituency statutes, some of which say you can take into account the good of the local community. And as far as I know, there are no exceptions within those laws if a Directors has absolutely no business purpose. And that makes sense simply because in the end, anyting a director does will have an effect on the business.

Charles Iragui said...

AJ,

I don't believe that BJR mandates separation of ownership and control. The managers could be control-stake owners and still be subject to suit by non-control shareholders. It is rather a recognition that courts simply cannot usefully review business decisions except in the most egregious cases.

So long as a plausible explanation is given by the managers, they should not be second-guessed by judges of the Delaware Court of Chancery.

The political threat (confiscatory excise taxation or industry regulation) is real and mitigating it through goodwill gestures is not incompetence but, in this socially sensitive product, prudent business judgment. Have you ever noticed the ads oil companies put on TV about how they're working to save the environment? Money well spent.

Sarah,

I agree with you and Misha! The Senate witch trial is an exercise in humoring the misguided anger of many. Corporate profits are taxed at a crazy 35% rate and dividends further taxed at 15%. The massive profits end up in good part in the federal government's coffers...

AJ said...

I think BJR is a part of a broader set of rules, that as a whole, made seperation. Think of it this way: in the case of BJR the law mandates seperation even if it is clear that director performance has degraded from shareholder expectations because it was a "business decision". Shareholders control what?!? Their interests matter when?!?!

Misha Tseytlin said...

AJ- you are mistaken. Think about the relationship between shareholders and managers. It is a fiduciary relationship. That means, the only job of the fiduciary is to enhance the wellbeing for the party they are acting for. In this case, there is a separation between management and control, but that does not go to what the DUTIES of the CEOs are in this case. Here, the duty is simple and unambiguous- the CEO must increase the value of the shares of the shareholders (seen either in short term or long term) as long as it is within the bounds of the law (this is a bit of an over simplification, but its generally correct).

My proposition was simply this: refusing to raise oil prices for the SOLE purpose of helping the American people is a violation of the fiduciary duty an manager owes to his shareholders. I think this is incredibly uncontroversial once one understands that the CEO are acting as agents for the good for the shareholders, not the America people.

D said...

Misha and Sarah,

You just love the free market eh? To paraphrase Ghandi on another subject -- the free market sounds like a great idea, we should try it sometime. We could start by getting rid of the tax deduction for business expenses. Right?

-Dave Lane

Misha Tseytlin said...

If you are willing to agree to a flat tax, sure, i would be up for eliminating all deductions. You cant do one without the other though....

Charles Iragui said...

Dave,

I would have thought the target of your skepticism would have been "corporate welfare". A good example of this is the direction of tax break to... the energy industry. It is unfortunate that business can profitably expend resources on playing politics.

I don't think this justifies the "show" that took place last week. Two wrongs don't make a right.

Opening ANWR is an example of enlightened energy policy. It does not involve a giveaway to industry but rather an environmentally regulated production of an economically vital input. Sad that it will probably be (again) traded away at the political poker table.

Charles

D said...

Charles,

It is absolutely correct that corporate welfare undermines the whole 'free market' argument. I chose business expenses to point out how fundamentally our society is based on a controlled, rather than free, market.

Misha,

I'll give you the flat tax if you agree to get rid of law enforcement and the armed services--both of which are primarily charged with protecting the wealth of the wealthiest. Heck, let's really go for that free market you love so much! I'd like to see how that top .001% of wealthy folks makes out against the throngs of poor people in this country.

Misha Tseytlin said...

Dave, I am sorry but you have gone off the considerable deep end with that statement. In ancient times, rich people could afford their own private security to protect their property, while poor people only had the ability to hold onto what they could. Law enforcement for everyone allows rich and poor to be protected from murder, theft, rape ect.

And lets do a little flat tax analysis. Say Rich Man X makes 1 Million dollars a year; and Poor Man Y makes 10,000 dollars a year. Now lets say there is a 10% flat tax. The X pasy 100,000 dollars, while Y pays 1,000 dollars. Do you really think the police/military protect the rich man's life and liberty more than ONE THOUSAND times more than they protect the life/liberty of the poor man? I think the honest answer to that question is obvious. Honestly, do you think that the police invest moe than one thousands dollars to protect rich people for every dollar they invest to protect poor people? You are a smart guy, you cant believe such foolishness

ed said...

Do you really think the police/military protect the rich man's life and liberty more than ONE THOUSAND times more than they protect the life/liberty of the poor man?

Well, I'm pretty sure $100,000 is one hundred (not ONE THOUSAND) times $1,000. But with that correction, and adding in the fact that the state putatively protects not only life & liberty but also--and primarily--property, the answer to your question is essentially yes, at least in terms of presumable revealed preferences (which is the only way I can think of to measure something like this).

If you change your figures from annual income to net worth to make the illustration simpler, Y should be willing to pay up to $9999.99 to protect his property, and X should be willing to pay up to $999,999.99. Protection of his property, in other words, for X is worth 100 times what it's worth for Y. Fairly basic economics, no?

Charles Iragui said...

Ed,

Basic economics: marginal utility of wealth. The value of $1 to a person with $10K is much greater than the value of that same $1 to a person with $1M. Hence, the desire for police protection of PROPERTY may be more similar from person to person than you propose. If you steal a car, you harm a poor owner more than a rich one...

Misha must be right that the poor suffer more from lack of legal protection, for instance in Latin America or Russia, than do the rich. This holds true for the protection of property, liberty and life.

Charles

Misha Tseytlin said...

my math was indeed off, but my general analysis is correct. This is not some theoretical ivory tower example- there was a time when there was no police forces, and no government-controlled armies. The poor were a lot worse off then, and the rich were still very rich. I guess its easier hiding behind marxist theories of government than to confront historical facts.

Misha Tseytlin said...

also, how much is a person's life worth to them? I guess its easier if you try to ignore that aspect of what police/military does.

ed said...

The value of $1 to a person with $10K is much greater than the value of that same $1 to a person with $1M. Hence, the desire for police protection of PROPERTY may be more similar from person to person than you propose.

This is nonesense. By hypothesis, both people are contemplating the loss of their property. The marginal utility of a dollar to two people in contemplation of the eventuality of having their net worth reduced to a dollar is the same.

This is not some theoretical ivory tower example- there was a time when there was no police forces, and no government-controlled armies. The poor were a lot worse off then, and the rich were still very rich.

Right. Which supports my point. The rich value security forces more than the poor do, as evidenced by the fact that they pay for them privately when the state does not provide them. I never suggested the poor would be better off without state-provided protection, merely that it is worth less to them than it is to the rich.

I guess its easier hiding behind marxist theories of government than to confront historical facts.

Huh?

also, how much is a person's life worth to them? I guess its easier if you try to ignore that aspect of what police/military does.

How on earth does that change the economic analysis? Even if you assume the poor and the rich value their lives equally (a dubious assumption on any meaningful measure), that's a wash on the rich vs. poor comparison.

Charles Iragui said...

Ed,

You said:

"This is nonesense. By hypothesis, both people are contemplating the loss of their property. The marginal utility of a dollar to two people in contemplation of the eventuality of having their net worth reduced to a dollar is the same."

Before you call something nonsense you should attempt to understand it.

Declining marginal utility is not about TOTAL loss of wealth or the value of ALL of a person's wealth (what I take it you mean by "reduced to a dollar"). The BASIC (your jibe, sorry) economic concept of marginality is the value of the LAST unit (the unit, here $1, "at the margin"). This is one of the more intuitive economic concepts: that $1 to a rich guy is worth less than to a poor guy.

Applying the concept to risk of crime, it seems inescapable that people who have little savings are more afraid of getting ripped off than those who are rolling in dough. You haven't mentioned my car example, which seems apt. The poor man worries about getting to work the next day while the rich man just rolls out his second beemer.

Given the plutocratic reality of life in Latin America, we don't have to imagine what Misha has evoked. The rich can afford to privatize state functions, actually saving themselves money because they cover only themselves, not the peons.

Our current progressive taxation system (one I, unlike Misha, support) means that the rich are forced to bankroll state service which do not really accrue back to themselves. Or maybe life IS pretty good in the US (I think so) and the positive externality of all that lost lucre to the rich actually comes back to them. But relative to what things would be like if everyone had to fend for himself, the poor benefit more from soaking the rich than the rich do. Ask a Peruvian.

Charles

Misha Tseytlin said...

"
also, how much is a person's life worth to them? I guess its easier if you try to ignore that aspect of what police/military does.

How on earth does that change the economic analysis? Even if you assume the poor and the rich value their lives equally (a dubious assumption on any meaningful measure), that's a wash on the rich vs. poor comparison. "

Ok, so since its a wash- and rich people pay way more than poor people in a flat tax scheme (100 times more in my example, as you properly pointed out), that illustrates my point that the rich would not unjustly benefit in terms of law enforce/military protection in a flat tax system.

D said...

Misha,

Not to dodge, but I don't have a lot of time to post right now. Suffice to say that I was making the point that a "free market" has never and will never exists. Once you admit that, we can have an honest debate about various market regulations. The very existence of societal institutions renders the market less than free.

ed said...

You haven't mentioned my car example, which seems apt.

It may seem apt, but it isn't. If were were stipulating that the security apparatus of the state could, at most, potentially protect people at most from car theft, it would be apt, and you'd be closer to correct. But we're not stipulating that. The state potentially protects much more than that, so marginal utility effects vanish at the far extent of the potential protection.

To put it more simply: the rich have more to lose than the poor, and thus they gain more from its protection.

Ok, so since its a wash

Apparently I wasn't clear enough in my last comment. What I thought was clear was that, at best, it's a wash in terms of protection of life (under the dubious assumption that rich and poor value their lives equally). The value of protection of property remains higher for the rich than for the poor, so the overall value of state protection is in no way a wash.

Charles Iragui said...

Ed,

You are right: the rich have more. This is tautological. You refuse to address (acknowledge and rebut) any of the arguments that Misha or I have suggested.

Misha's succint point is the best one: the rich can afford to PROVIDE THEMSELVES protection. The rest must depend on the state for effective protection. The medieval fortresses of the nobles and monasteries in Europe are testimony to this predicable truth.

Suggestion: go to the Farragut North Metro station and look for the Yellow Triangle people. This is a relic of the worst days of the Barry admin: private individuals took over basic gov services. Great for them, not so good for the multitude dependent on the gov to provide services...

The careful reader will note that both Misha and I have been advocating the benefits of having a state. What Ed and Dave are advocating is unclear. Sweden, a highly socialized country, also has highly profitable corporations.

Charles