Wednesday, January 13, 2016

Market incentives



That's was how I answered a question about "the effects of market incentives", it was a course about social and ethical responsibilities in my MBA program.
I do completely agree with the statement: “profit is the reason for businesses to exist” and the only way to explain why is with examples.
The most powerful stakeholders who influence the business decision making are those who finance it; shareholders, and their ultimate goal from investing money in business is to generate return on their investment, if there’s no satisfactory return, the decision makers in the company will face the possible threat of shareholders withdrawing their investments.

 
I recall a story a professor told me about the German friar Martin Luther in the 15th -16th century when he fled to what’s known now by Netherlands to escape the anger against his opinions that anyone can pray anywhere at any time without the need for a priest to be as a connection between him and God, that opinion that pissed the Pope in Rome, but the princes in Holland gave him protection in order to write a bible for them, and the Lutheran method was evolved then. They actually had no interest in religion or prayers, they didn’t care about the social benefits or negative impact that will result from this method, they only wanted to split from the authority of Rome and avoid the heavy annual taxes paid in gold, finding a way out of Rome’s authority that will save them a fortune, and that profit was the only motive to act. I am giving the example to show that an organization (a government in the example) will do anything to maximize profit, regardless of the effects on society then, and I am not issuing an opinion here about the Lutherans, because it’s not our subject here.
Another example here, is the fracking techniques
in drilling for oil, the environmental damage is phenomenal, yet the returns for the companies are phenomenal as well, first they get oil from deeper levels for a very low cost, that’s a huge financial benefit for the oil corporations in the United States; because it will be better to invest in the United States and save transportation costs, and the potential risks from investing in politically unstable areas, and to get oil for lower expenses means bigger profit margin from operations. At the same time the companies will get unlimited support from the government, because the government wants to be independent regarding energy resources, and maybe achieve other political goals, and that governmental support can be translated in financial language; by facilitating operations or even psychologically when the leaders know that they can simply tolerate some environmental threats, without fear of public outrage. The profit maximization here affects the environment in a negative way.
The stakeholders’ theory of the firm argues that there’s a greater purpose of the firm’s existence; to serve the society it exists in and to create value for that society, but the fact is, practically when a company is making any thing that serves the society without any profit expected, there’s actually a profit to increase the company’s value on the long term by giving a better image in the public view, and people will gradually look at that firm as if the main purpose for it to provide a great service to the society, but let me explain something, when Boeing provided the 747 with the new greener turbofans, the main purpose was to attract airlines that want to save fuel money after the financial crisis, not to save the polar icebergs from melting down, and that’s why the 747-8 was a good product and it did generate big return without the need to spend several years and billions to develop an entirely new aircraft like the airbus did with the A380, they just used the old airplane, replaced the engines (they just purchased from GE so they didn’t develop these either) then made some changes with the materials for greater stiffness and less weight, refurbished some old technologies, invested the time on improving what they already have of electronics and safety equipment. It seems like a very good goal that the company is concerned about passengers comfort, or polar bears’ survival; but they actually had a huge return on this program.
I think this subject will need a follow-up, so I might be writing more about this.

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