Rothbard on Agency Problems

0:00So today I'm going to try to talk to you about Murray Rothbard on agency problems. It's a very technical topic. The point of my presentation is more or less the following. I'm trying to explain to what extent Rothbard is a precursor of modern agency theory, Particularly what we call the market mechanisms, which are these ones, and with regard to the role of the state as a cause of aggravating agency theory or creating new economic problems.

0:45So, let me make a quick footnote. To some extent, one could argue that Murray Rothbard's contribution is not very original or only very marginal, since another great Austrian economist also largely anticipated many of agency theory's development, this great economist is Ludwig von Mises. One of my dissertation chapters is on these topics, but I will argue therefore that the main contribution of Rothbard is on the role of government, the influences of government on agency problems, and the role of the entrepreneur.

1:32In the standard agency theory, there is no entrepreneur. On the other hand, in Rothbard theory, you can see the entrepreneur all over the place. So since it's a very technical subject, I'm going first of all to explain you quickly what is agency theory and what is the problem with which agency theory is dealing with. We call an agency relationship a relationship between two individuals. Typical relationship is employer-employee. And the employee can take an action when the employee is going to perform an action for the employer.

2:28is going to affect the welfare of the employer in order to satisfy his own interest. Traditionally, we argue that the employer, what we call the principal, is what we call an informed party. On the other end, the employee, what we call the agent, is the inform party. Let me take an example. I am working for a corporation.

3:17My employers are the shareholders and they are asking me to maximize the profit of the company, to maximize the sales, to make profit of the company. Well, instead of doing my job as well as I can, as best as I can, I will spend my whole day on the internet watching some websites, not very appropriate in general. Just like that. Some people know what I'm talking about, that's why I say that. This employee, the manager, are what we say, shirking. They are not doing what they should do.

4:07So the problem that the agency theory is asking is what will be how to induce the employee to perform the action in the best interest of the employers. Whether they are shareholders, whether they are simple employer, when you are a patient, or you will induce the doctor to find a cure for your disease or for your illness. That's the purpose of Eleiency Theory. There are two types of problems. The first one is what we call Moral Hazard. It's a hazard. It means that you cannot observe the action of your employees. Because observing the action of your employees, monitoring your employees, is costly. It takes time. You cannot be behind the back of each one of your employees.

5:02That's a more hazard problem. The other problem is what we call an adverse selection problem, also called hidden knowledge. It means that even if you can monitor your employees, you might not have the required knowledge to know if they are doing their job properly, appropriately. So the agency theory, which starts from the 70s, has analyzed different types of mechanisms to resolve this type of problem. to find solutions to these type of problems. We talk about explicit incentive mechanisms.

5:47The typical one is the contract, and we talk about implicit incentive mechanisms. And these implicit incentive mechanisms are property rights, reputation, competition, the institution, private institution, and of course, in some way, the entrepreneur. So, you can see that there is a broad, pretty famous people in the mainstream economy, like Armstrong, Milgram, Robert, Alsham, Dempsey, Grossman, Art, etc., etc. But on the other hand, you can see that Rothbard, in Man Economy and State, in Chapter 2, as Chapter 2, 9, 10, 12, mainly, has analyzed these different types of mechanisms.

6:43I will focus more on implicit incentive mechanism because for the contract the current literature is very technical and is based on particular assumptions like the form of your utility, preference curve, your aversion to risk, and what is the probability distribution, and what is the information available in the economy. On the other hand, when you look at property rights, in chapter 9, Rothbard largely anticipates Altschendam, Sepp Grossman and Art Amor in the following way. He's talking about the relationship between shareholders and managers.

7:32And he's saying the following thing, is that while in the large corporations, managers on the day basis, on the everyday basis jobs, they might have a great independence, but ultimately it is always the shareholders who make the most important decisions. He talks about decision-making function. The role of property rights for the shareholders is a decision-making function. They are able to decide where and to whom property rights should be, means of production should be allocated to.

8:22Who will be able to use the machine tools? Who will be able to use the money of the corporation? that we call, in modern decision, control residual rights.

8:44We all know, well, economists know, and they know that Altshain and Denset and Grossman are focused on this idea of decision control, residual rights, also talk about residual Residual Claimant, which is as an owner you have the right to decide what should be done with the property you own when it is not included in the contract. You are also the residual claimant which means you are the one who is going to receive the income stream, residual income stream that we call profit. The main idea for Agencies Theory and Rothbard is that shareholders are the residual risk bearers.

9:31They are the ones who are going to bear the consequences of inefficient actions taken by the, or made by the managers. So therefore, because they are the owners, they have the right to decide who is going to work for them and who is not going to work for them. That's an important right. And this is very, in modern agency theory, we decide who is going to own these property rights regarding to their ability to manage this property. It's a problem of incentive. Another important mechanism is reputation.

10:19The reputation in mainstream economics has come with game theory, particularly Kress and Fudanberg and Tirol, which is very technical. We talk about fault theorem, which is individuals have long-term interest in performing the action as best as they can for their employers, because if they break their contract, they are at risk not to find a job anymore. It's a sanction, it's a punishment-reward mechanism. Rothbard, on the other hand, acknowledges this kind of mechanism like reputation and incentive to do your job, because if you don't do your job, your reputation is going to be harmed.

11:17But on the other hand, all the contribution to the concept of reputation is the concept of blacklist and boycott. Since you are not the owner of your reputation, because reputation is not a physical good, first of all, and because reputation is what people think about you, you can exercise blacklisting and boycotting to sanction the people who are breaking the contract. If you don't do your job, you can tell to other people, you should not hire this person because he doesn't do his job very well. Blacklisting is the same thing. Other mechanism is what they call competitions. So there are several competitions. There is the labor market competition, the project market competition and the capital market competition.

12:09Fama, Oliver Holt, Thorsten, Mark Lupe, which is between mainstream and Austrian. We never know where he is actually. But he's certainly more Austrian in the concept of competition than most of the mainstream economists. argue that competition in general is an implicit incentive mechanism that will induce the agent to perform their action as better as they can. Because there is competition in the labor market, and particularly when you are in a situation where you have unemployment, well, there is always the ability to find somebody else who is able to do your job better than you. There is a competition between workers within the firm to get access to higher positions and between firms to get where you are going to pay the most.

13:08Rothbard talks about that in Chapter 10. Competition in the product market. Well, if your corporation doesn't do any profit, well, you are at risk to have what we call liquidation. And if you are in liquidation or if you are in bankruptcy, well, you lose your job. So, the product market competition gives you incentive to perform your job as best as you can. Because the ultimate criterion in any corporation, private corporation, is profit and loss. If you do good, if you do profits, you are going to keep your job, have a higher wage usually, you have an over-bonus. But if you don't do your job, your corporation is going to go in bankruptcy, liquidation, and you are going to lose your job.

13:58So, Rothbard talked about that. And probably the most important competition mechanism is the competition for corporate control. It's on the capital market. Corporate control is a very important mechanism, and Rothbard repeatedly, as well as Mises, Mises in Human Action, Human Action in Socialism, in Bureaucracy, in all these books, repeats all the time that capital markets are one of the most important mechanisms to resolve agency problems.

14:45The takeover mechanism is when if your corporation is inefficient, the share price is going to go down and therefore you will find what we call So, entrepreneurs, capitalist entrepreneurs, we are going to take over the corporation and change the management team to put a more performant management team. Private institutions, well, there are many mainstream economists who have come to analyze private institutions, which are different from public institutions like government, were able to complement this other mechanism to resolve agency problems.

15:37More famous ones are Meagrum, Roberts, Avner Greif, Che, Douglas North, and Professor Botchy, because he wanted to be on the left. But in Chapter 12, when Rothbard analyzed the impact of government intervention on the market, he also shows what are the other alternative private mechanisms to resolve this problem. When he's talking about problems like standard of quality and safety, or when he's talking about mostly about standard of quality and safety, When he's talking about private contract relations, he's explaining there's many private institutions, private enterprises, who come to complement and try to resolve these problems.

16:42Professor Daniel Klein wrote a couple of papers on that, and he showed there's plenty mechanisms, private institutions, who are able to play the entrepreneur role in providing information to the consumers. Government, that is probably the most important aspect in Rothbard's theory, is that in mainstream economics there is no real theoretical analysis of the impact of government on agency theory. Actually, like, a couple of weeks ago, I was reading a paper by Bent Armstrong, it was a paper on dynamics of agency problems, and he argues, and he says, clearly, there is no interest in analyzing the effects of government on agency problems.

17:36We should more analyze the inefficiency of the market system. Well, I would guess, I think it's Swedish, right? Professor Klein, is he Swedish? Yeah? Well, so he's a socialist, that's why probably. And he's teaching MIT too, so that's also why. They are also socialists at MIT. So, but empirically we have many studies like Peltzman, Kibb Discussive, we have repeatedly shown from an empirical point of view that government's intervention to attempt to resolve agency problems like moral hazards and adverse selection are totally inefficient. Rothbard on the other hand doesn't do very much empirical analysis, well he does a little bit, but he does more theoretical analysis and shows that every government action which should be understood as a violent action, which is an invasion of your property reduce the incentive of people to make the most efficient use of this property and therefore creates conflict of interest between individuals because interventionism or regulation is always giving privilege to somebody against somebody else so it creates conflict of

19:00Conflict of Interest, Conflict of Interest between the individuals. What is important in Rothbard in this chapter is that he makes the dichotomy between violent action or violent appropriation and voluntary appropriation or what we call contract. The theory shows that every time you have a violent action, whether it is the government or the mafia, it's like the same thing, you know, just one is legal, the other one is not legal. But the most important thing is every time you have a violent action, people are constrained to make use of their property that they would have not done on a free market system.

19:53So therefore, Vanet Action always aggravates agency problems or actually creates new agency problems. The typical example is what we call insurance deposit. I'm not going to talk too much about that because there is a professor, Salerno, and he is a specialist in monetary theory, and I'm not, so we will tell you about that. Insurance deposit creates an agency problem, a moral hazard problem, between the bank and the shareholders in general, and the customers too.

20:43I'm going to quickly finish on the role of entrepreneurship. Well, in agency theory, there is no such thing as the role of entrepreneur. There is no entrepreneur. Even cause in the theory, if one talks about the entrepreneur, it's like assimilating the entrepreneur to a simple manager. Fama doesn't talk about entrepreneur. He talks, oh, there is no entrepreneur, there is only managers. Rothbard emphasized the role of entrepreneurs at many levels. On every type of market, you have an entrepreneur on the market for capital, corporate control. The raiders are entrepreneurs who are able to perceive an efficiency in the management of a firm.

21:29They take over this firm and change the management team and try to improve this firm. It is true that you might have some problems, what we call in economics, free rider problems. Or it is true that some raiders or some management teams want to take over another company for prestige or to increase their wage. This is not a perfect mechanism. Rothbard talks about entrepreneurs in private institutions. All these consumer reports, all these corporations would try to provide information to the consumers about the safety of the quality of goods is largely emphasized in Rothbard.

22:16So the important idea, the important thing we have to remind in Rothbard theory, I believe that this important idea is the difference between government and market mechanism. Government intervention is always a violent action on the property rights of individuals, and it generates conflict of interest, aggravates agency problems, and sometimes creates new agency problems. On the other hand, market mechanisms, while they are not perfect, Rothbard is not like a typical mainstream economist saying, oh, we are in a perfect competition model, or the world should be perfect.

23:08Now, Rothbard is a realistic person, and knows that there is no perfect system, but the question Rothbard is always asking himself is which system is the least inefficient, or which system is the more efficient. And all Man Economy and State is to show that every time you have a government intervention in the market, and more intervention in the market, the more inefficient is the system. The more agency problems you will have on the system, the less intervention you have from the government on the market, the more efficient is the system. This is why Rothbard was an anarchist. This is why Rothbard was an anarcho-capitalist, because he believed that while the anarcho-capitalist system was not the perfect system, it was not heaven, it was certainly more efficient than any interventionist system.

24:05Thank you very much. I welcome any questions.