Gekko

How much confidence do we have in knowing who is in charge?

The movie Wall Street is a wonderful Oliver Stone portrait of insider trading in the 1980s. Remember Ivan Boesky? It was a fictional depiction of a cultural moment.

Like any brilliant artist, Stone has a voice. His dialogue is impeccable. Here is a snippet from the “Greed is good” speech.

“Gekko: Well, ladies and gentlemen, we're not here to indulge in fantasy, but in political and economic reality. America, America has become a second-rate power. Its trade deficit and its fiscal deficit are at nightmare proportions. Now, in the days of the free market, when our country was a top industrial power, there was accountability to the stockholder. The Carnegies, the Mellons, the men that built this great industrial empire, made sure of it because it was their money at stake. Today, management has no stake in the company!

“All together, these men sitting up here [Teldar management] own less than 3 percent of the company. And where does Mr. Cromwell put his million-dollar salary? Not in Teldar stock; he owns less than 1 percent.

“You own the company. That's right -- you, the stockholder.

“And you are all being royally screwed over by these, these bureaucrats, with their steak lunches, their hunting and fishing trips, their corporate jets and golden parachutes.

“Cromwell: This is an outrage! You're out of line, Gekko!

“Gekko: Teldar Paper, Mr. Cromwell, Teldar Paper has 33 different vice presidents, each earning over 200 thousand dollars a year. Now, I have spent the last two months analyzing what all these guys do, and I still can't figure it out. One thing I do know is that our paper company lost 110 million dollars last year, and I'll bet that half of that was spent in all the paperwork going back and forth between all these vice presidents.”

Cromwell is the CEO of the target of Gekko’s activism, a company called Teldar Paper. Two hundred thousand dollars in 1987 is equivalent in purchasing power to over five hundred thousand dollars today.

This is the principal-agent problem in a nutshell.

“Common examples of this relationship include corporate management (agent) and shareholders (principal), elected officials (agent) and citizens (principal), or brokers (agent) and markets (buyers and sellers, principals).^[4] In all these cases, the principal has to be concerned with whether the agent is acting in the best interest of the principal. Principal-agent models typically either examine moral hazard (hidden actions) or adverse selection (hidden information).

“The principal–agent problem typically arises where the two parties have different interests and asymmetric information (the agent having more information), such that the principal cannot directly ensure that the agent is always acting in the principal's best interest, particularly when activities that are useful to the principal are costly to the agent, and where elements of what the agent does are costly for the principal to observe.

“The agency problem can be intensified when an agent acts on behalf of multiple principals (see multiple principal problem). When multiple principals have to agree on the agent's objectives, they face a collective action problem in governance, as individual principals may lobby the agent or otherwise act in their individual interests rather than in the collective interest of all principals. The multiple principal problem is particularly serious in the public sector.”

Gekko is speaking to a group of the largest, most involved owners at the annual meeting as a dissident. He decries what he sees as a bloated management structure running the company in their own interests, exploiting the informational asymmetry between those in the day-to-day mix and the investors who are passive. The shareholders may own the car, but it is management who drives it and determines where it will go, notwithstanding the shareholders’ directions.

In essence, Gekko accuses the management team of siphoning value for their own benefit in ways that diminish the market capitalization.

The more shareholders there are, the more difficult it is for them to coordinate their actions. Teldar Paper is a public company with open annual meetings and a higher standard of corporate governance, but it’s still tough for Gekko to get them to punish management. It’s not impossible. But it’s not easy. This is the multiple principal problem.

I have a friend who was part of a large group of investors in a restaurant. There were more than a hundred investors (let’s say). Each of them wrote small checks. The largest check was probably no more than fifty thousand dollars. Their money funded the refurbishment of a large space (and the capital necessary to underwrite the lease) in a prime location in New York City. Most of the investors were successful professionals: lawyers, doctors, dentists.

The restaurant was a roaring success. It had a terrific location. It was always full. They charged top dollar for their meals. The overpriced alcohol flowed easily.

Yet, there was no money for the investors. They expected dividends. They expected cashflow to return to them in multiples of their original investment. Instead, they received nothing but empty excuses.

It turns out that they had hired one or two fellows to manage the place and these middlemen had been skimming from the top all along. Pretty much all the free cash flow was being siphoned by these agents. A cursory investigation by several of the more savvy investors made this clear.

It would have been straightforward to go to the police or to try to get the money back, but this required coordination. This required consent. The managers knew this; they were brazen with their, “what are you going to do about it” attitude.

The group couldn’t get there. They fretted about the cost and the reputational damage.

As Jordan Belfort says in the movie The Wolf of Wall Street (another movie about fraud in US securities markets), “The show goes on.”

The ultimate multiple principal problem is the US federal government. There are hundreds of millions of voters, each with an equivalent stake. Good luck coordinating them. It’s hard enough to get elected to office. Even then, there are fresh elections every four years.

The civil servants, the equivalent of the vice presidents of Teldar Paper, have permanent employment status, or at least they did until Musk & Co. appeared on the scene. They can wait out any elected official. Twenty years is greater than four years, after all. The elected officials can try to tell the civil servants where to drive the car, but that doesn’t mean it will happen, or it will happen anytime soon. They can slow walk the implementation.

But it may be worse than that.

It may be the case that there are (at least) two additional layers of obfuscation of the principal-agent relationship: consulting firms and NGOs.

Government agencies outsource a tremendous amount of work to these groups. Here’s the FT discussing the cuts to consultancies.

“Consulting firms have long thrived on the inefficiencies of the public sector. In the US, they are called in to help the government perform all kinds of functions, from beefing up cyber security for the Department of Homeland Security to streamlining the websites used by student borrowers. Between 2019 and 2023, Uncle Sam paid $500bn in consultancy fees. But the consultancy industry now faces a reckoning. A chainsaw-wielding Elon Musk and his so-called Department of Government Efficiency (Doge) have pledged to cut $1tn out of the federal budget. The slash-and-burn approach has already resulted in thousands of federal lay-offs. Management consulting contracts may be next on the chopping block.”

And here’s the Times of India on NGOs and DOGE:

“During the Fox News interview, Musk asserted that many NGOs receiving federal funds function as mechanisms for financial mismanagement and political favoritism. He described them as ‘fake charities’ that primarily benefit Democratic operatives, though he acknowledged occasional bipartisan involvement.”

So, here we have it: the accusation that consulting firms and NGOs not only earn hefty fees, but that they potentially exert control over government agencies. Layering things in this way isn’t the principal-agent problem; it’s the principal-agent problem squared or cubed.

Our political governance is a thin layer of pretense while the real action happens two or three levels below, without accountability, in this version of events.

Democracy dies in darkness, indeed.