Do Companies Have a Duty to Satisfy Their Employees’ Best Interest?

Dear cafe patrons, I'm glad to introduce to you our new guest barista, Pramudya A. Oktavinanda. Pram, as he is called, is a lawyer at a well-known corporate law firm. He blogs too (see here or here). Oh, this "capitalist-lawyer" also tweets as @PramOctavy. Today Pram invites us to think about what is fair in employer-employee relation. Enjoy! - Kate

Do Companies Have a Duty to Satisfy Their Employees’ Best Interest?

by Pramudya A. Oktavinanda

Introduction

Imagine that you are a worker in a major telecommunication company that has two divisions, one is a land line division, which is getting smaller each year to due to a major decrease in demand, and the other is a mobile phone division, which is getting bigger each year and generating a huge profits for the company. Unfortunately, you work in the land line division.

Suppose that for this financial year, the company generates a net profit of more than US$100 million, and 99% was generated from the mobile phone division. The employees in such division receive a considerable amount of benefits including big bonuses and better salaries compared those in the land line division. In fact, the salaries of the land line division’s employees have not been increased for years - let alone receiving a bonus.

How about the management, i.e. the board of directors and board of commissioners? Since the company has performed so well, the shareholders have agreed to grant a fat remuneration in the total amount of US$10 million to the entire members of the management. So everyone is happy in the company, except for the employees of the land line division.

So, the worker in the land line division plans to conduct a strike, stopping the operation of the land line division until the company agrees to increase their employee benefits. They say it is not fair if the company has generated such a big profit yet only a small fraction of that profit is being used for the benefits of their employees, specifically in the land line division. In their opinion, the company has a duty to satisfy their employees’ best interest, including their well-being. The major question is, do you think the company has such kind of duty?

The Company Does Not Have a Fiduciary Duty to Its Employees

As cruel as it may seem, our law says that a limited liability company does not have any fiduciary duty to employees. Fiduciary duty to a party means a duty to act in good faith for the best interest of such party. In fact, the company management only has fiduciary duty towards the company (yes, not even the shareholders). And what’s the best interest of the company? Its survivability, which can only be maintained when the company is profitable. A management that does not work for the best interest of the company can be sued by the company shareholders for any losses that they or the company may face due to the management’s failure to adhere its duty.

Of course this is troubling to some of us. How can we say that it is fair for the employee in the land line division if the management does not have any duty to improve their well being despite having a large amount of profit? To answer this, I will move on from the legalese, and give you another case to think about.

Let us imagine that now you are acting as an employer to two persons in a small firm that produces cute necklaces. The first person almost contribute nothing to the business while the other one is very productive and has contributed a lot of necklaces that worth selling in the market. What will you do in this case? Will you differentiate the salary of these two guys? Will you give better payment to the more productive one?

Or try imagining other case where you and your two friends invest in a business. You and one friend invest 90% of the total capital while the other one only invest 10%. After the business generates nice profits, will you share more to the one who only invest 10%, or will you distribute them proportionately with the money contributed by each person?

I would assume that in both cases, you would agree that those who contribute more should receive better benefits than those who contribute less. So why don’t we apply that principle to our first case? The law regarding fiduciary duty of the company’s management is in line with the basic rule of efficiency, i.e. resources should be allocated to the ones who are able to put it to the most highly valued use. Wasting money for a non profitable business would be deemed inefficient and the management can be held responsible for that. Sadly, our case involves the lives of many people and this is where the dilemma comes.

Can The Government Intervene?

My first response is no. The difficulty lies within the baseline or the original position that we should held when we want the Government to involve in this kind of case. I know that our case can easily attract sympathy. After all, it’s the story about a greedy company/management that does not care about the well being of its employee. But suppose we change the story a bit, suppose we’re talking about a paging business. I am not sure whether there are still many people who remember the success of paging business, but around 10-12 years ago when mobile phones are still expensive, pager is a cheap and quick solution for companies who want to contact their employees whenever and wherever they are. Yet, technological advance and the growing of people’s income enable mobile phone producers to cut their prices significantly to the extent that almost all people can own their own mobile phone. The effect was disastrous for paging business. What started as a profitable business turned out to become a bleak one. And now, I am quite certain that not a single paging company in Indonesia survives the competition with mobile phone. The iron rule of efficiency once again wins.

In this case, since the paging companies were going bankrupt, most of their employees were layed off. Now, does the Government needs to help these poor guys? Do you find similarities with our first case concerning two separate divisions in a telecommunication company? Both types of employees suffer because of technological development, something that can’t be prevented by anyone (or what economists call “creative destruction”).

Indeed, this is what I call as a hard case. To find an all for one solution would be impossible. Asking the Government to force the company in our case to provide better benefits to its land line division would be ludicrous, and it is questionable whether the government should do the same for the other type of victims of creative destruction. If you are in the employer position, would you like to be forced to bear additional inefficient expenses?

But if the Government does not take any action, who will be responsible for all of these employees? Would it suffice to let them follow the flow of the market force? My initial answer is provide a better social security to the citizens but I would love to hear other people comments on this matter.

What the plagiarist and his/her host institution should do

Here is how the editor of respectable The Journal Economic Perspective dealt with the issue of cross-publishing by Bruno Frey: they sent a letter to him (in pdf), explaining the case carefully, and demand an apology from him to the related parties (the Journals).

And Bruno Frey humbly replied the letter, acknowledged and apologized for his fault, and did not let the responsibility pass beyond him.

As we all can see, the letter is also open to public, presumably because they believe that public deserve to know it as well as to show how they take it very seriously.

Now we have a plagiarism case here. It remains to be seen if the involved parties will take the same measure.

Nevertheless, the Cafe shares the strong opinion that plagiarism is not only deeply unethical but also a gross academic violation.

How to Kill Jakarta Traffic Jam, Economically Speaking (Part 1)

I am now reading an excellent book by Edward Glaeser of Harvard, Triumph of The City . It's about (great) life in cities and it brings me to the work of Gilles Duranton and Matthew Turner as well as William Vickrey.

Let us imagine a typical situation many of us face in Jabotabek. Every morning you ponder if you would drive your car to work. While taking a shower, you make a mental calculation on the benefit of driving your car (for example, comfort) and the cost of it (gas, time, car depreciation, etc). If the net is still higher than taking taxi, bus, or KRL train, off you hit the road by car.

You may feel good about yourself because you think you've done proper marginal benefit and cost analysis? Alas, it's not the case. You miss important point: your decision makes other drivers' cost of driving increase.

As now the road is one car more crowded, time to drive is longer. Your private cost and benefit analysis does not take into account social cost of having one more car, your car, on the road.

Econ 101 calls this a negative externality. It is more evident when we use resources with zero or artificially low price, such as road. Multiply such (private) miscalculation with hundred thousands of Jabotabek car owners, we have all too familiar traffic jam we see every morning in the city.

Jakarta's traffic jam can be maddening indeed. Out of your frustration, you may demand for building more roads. After all, it's just about supply for roads that doesn't meet the demand, so you think.

Alas, this might be not feasible for two reasons. First, there is space limitation in already crowded Jakarta. Second, even if technology can overcome this constraint (tunnels or fly-over, for example), we'll soon come across Duranton and Turner (2010) and their fundamental law of traffic congestion.

The law says that more roads will proportionately increases car's kilometer traveled. Why? Because it increases the current residents' as well as previously-beyond-road-network residents' car use. It also brings more travel intensive production activities in the city. As a result: more roads, same traffic jam.

OK, what about, you say, more public transportation in Jakarta?

It will reduce traffic jam only if substantial number of car owners shift to public transportation. But, you know that if I leave my car at home and take bus, road will be less congested and travel by car will be more pleasant.

The catch-22 is that I know it well, too. As a result, nobody gives up his/her car. After all, who wants to takes trouble by taking bus only to allow more pleasant travel of other car owners? Public transportation will just reach more non-car owners previously outside public transportation network to enter Jakarta.

We again may end up with more public transportation, same traffic jam.

So, what’s the solution? To know it, we need to see the late William Vickrey and his work on road congestion problem. But it has to wait for another blog posting.

Stay tuned.

So You Think You Can Dance Know What The Poor Wants?

Think again.

Let's say we provide the poor with cash money transfer, what do you think the poor would spend that money for? I bet that many of us would think that the poor would buy more basic staple food, like rice, or perhaps to pay for education fee for their kids, because, rightly so, the poor has low calorie and nutrition intake and low education status.

But suppose we found out that the money is spent for buying more cell-phone card credit, pulsa HP, what would you think?

Some, or perhaps many, of you would get mad and deem this act as unacceptable. The poor must buy more food or basic education, you insist, because it would help them out of poverty.

Let me take different view nonetheless. First, perhaps they're not as starving or badly in need for education as you think. Second, even if they indeed have low calorie intake and education status, in their calculation, ability to communicate with friends and relatives using cell-phone gives them more pleasures and utilities.

And I am OK with this. I believe that the poor knows what they're doing.

As simple as it may seems, you probably could not easily share this view -- you think you know what the poor has to do more than they do. Or even, you think the poor folks don’t know what needs to be done with that additional money.

In this interesting article, Abhijit Banerjee and Esther Duflo of MIT, with their extensive experience on poverty researches around the world suggests that such oversimplifying and paternalistic view on the poor is probably of little use. So is any well-intended poverty reduction reform based on that standpoint.

Yes, more nutrition and education would eventually lead to better productivity, hence income, and less poverty. But probably the poor has different expectation. There is one paragraph in that article that I would love to quote in full.

…We often see the world of the poor as a land of missed opportunities and wonder why they don't invest in what would really make their lives better. But the poor may well be more skeptical about supposed opportunities and the possibility of any radical change in their lives. They often behave as if they think that any change that is significant enough to be worth sacrificing for will simply take too long. This could explain why they focus on the here and now, on living their lives as pleasantly as possible and celebrating when occasion demands it… (Bold is mine)

Granted, their decision to buy more cell-phone credits, or TV set to watch infotainment, or to carry out lavish traditional and/or religious party is perfectly understandable.

Econ 101 tells you that if you want to maximize the recipient's utilities, you should not set any conditions on your money transfer -- and let them decide to buy whatever gives them higher utilities. But if the objective is to maximize your utility (as the giver), you can impose specific conditions for the recipient to get the money to make sure you get what you want – e.g you demand the poor spend the money to buy rice because it satisfies your belief that more calorie is what the poor needs.

Now a million dollar question would be which one matters more -- your utility or their utility?

What's new?

This:

Check it out here.
And no, this original blog is NOT dead :)

ACFTA again

Ten, fifteen days in a row - maybe more - the media is filled with heavy mercantilism again. It's about ACFTA. They say, Indonesian market is being flooded with Chinese cheap products: from textile to fruit to toys. All these destroy Indonesian producers. Not good.

Interestingly, no one mentions about the benefits to consumers: cheap prices are good. One article in Kompas (17/4) rightly quotes a small orange trader saying that Chinese oranges are good, the supply is reliable, and the quality is better - all with cheaper price than local oranges. So yes, some local businesses are benefited, too.

But they are rotten, say the complainers. Really? According to a news (also Kompas 17/4, same page), the Chinese exporters have started to adopt Indonesian National Standard. So?

A few note that the increase in Indonesia's trade deficit against China has a lot to do with yuan's and rupiah's appreciation against dollar. And because rupiah appreciation is relatively stronger than yuan appreciation, Chinese products become relatively cheaper to Indonesian importers than the other way around. So, this is not just between Indonesia and China. It also involves US. And all other countries, for that matter. You want to block China? Block everyone else too. Good luck with that.

Of course I'm not saying everything China is good. But when you find smuggle or illegal products, impose the correct punishment, not to burn the whole ship. Otherwise, you'll just be used by them inefficient, rent-seeking, protection-loving domestic producers. At the cost of consumers. And all the rest.

Law for Sale -- Revised Proposal

Pramudya Octavinanda has very interesting ideas on how to design anti-corruption policy in response to my earlier posting here. Let me start with his points that I agree with.

First, the main objective of penal sanction system should be to recover the state's assets corruptors stole as much as possible. Second, it also has to prevent corruptors to buy (il)legal protection and political position that allows them to steal in the first place and afterward. In other words, it should make bad guys miserably poor.

Yet, what I don't really agree with is the idea to link two or more anti-corruption agencies for the sake of efficiency. If you let this happen, what we would likely have is an anti-corruption monopolist. This monopolist can sell their services either to corruptor or to the state whichever pays higher price. So if you want them to work in favor of the state and arrest the corruptor, the state has to pay or provide incentive more than what corruptor can do. This is expensive.

So I think I'd still opt for competition amongst anti-corruption agencies.

Now let's discuss Pram's objection on this competition. He said that without (formal) case transferability, competition won't work. But this is actually the very basic premise of my proposal for more competition -- that is to increase transferability. In my idea of transferability, bad guys can not rely on one agency to get protected, because other agencies can still arrest them legally. Competition would remove privilege of one agency over another; and with this, a case can be "transferred" to any agency willing to arrest the bad guy.

As for incentive for these competing agencies, as also asked by Mova in his comment, I'm thinking to incorporate Pram's insight on making corruptors poor and maximizing state's stolen assets recovery in incentive structure as follows.

Let's make the state (say President, or the Ministry of Finance) determine how much money they want to see back to state's coffer. If there is 100 bn IDR state's loss in a corruption case, they can set, say, 90 bn IDR recovery target and announce this to the competing anti-corruption agencies. Any agency taking this offer has to provide 90 bn IDR to the state but can take the remaining receipt, i.e 5 bn IDR if the agency can make the bad guy repay 95 bn IDR to the state.

So the state doesn't need to add more resources (higher salaries, bonus, etc) to anti-corruption agency, but any residual outcome belongs to the winning agency.

Do you think it will work?

Law for Sale -- or Corruptor's Revealed Preference

I think it is good to have competition amongst anti-corruption squads or law enforcers. Think this way: a corruptor can bribe the police, but, in competition, the general attorney office or KPK will still be more than willing to arrest him/her - and vice versa.

Now you may want to say: what if the corruptor bribe them all? It's possible, but at least it is now more expensive to do so than with single anti-corruption office. The competition raises the corruptor's cost of wrongdoing and make anti-corruption more efficient.

Better yet if we can somehow set an competitive auction mechanism in which police, general attorney office, and KPK can bid to arrest a corruptor and force this corruptor repay the certain amount of the state's loss, and the office proposing lowest operational budget would win.

Who's afraid of such competition (a.k.a the loser)? First, the one from less efficient office. Second, and the foremost, the operation target, that is the corruptor him/herself. The non-corruptor would have no objection about this.

Now, if you know someone fiercely takes troubles and makes a lot of fuss on this competition among anti-corruption agencies, you may ask yourself and be suspicious if he/she is either from the less efficient agency or Mr/Ms Corruptor him/herself.

We economist call it his/her revealed preference -- regardless her/his stated preference as self-proclaimed anti-corruption bravados.

Kate Goes Randian

It's always nice to meet up Cafe's regular patrons outside the cafe itself and last I just met with a self-declared green-line youths, named after one of subway line here -- although some actually came from places way beyond regular subway system.

And, man, they're such a bunch of smart people. They know stuff that baristas could only wish to know - from Warkop to game theory to Mathematica to what's hot in Newbury street. What is initially a plan for simple dinner turned out a lively discussions on various stuff, including whether the illustration for Nash equilibrium in the Beautiful Minds film is really a Nash equilibrium -- it is not.

And of course on Emma Watson - and her plan to take 9 months leave from her study - and Natalie Portman. Alright, ladies, James Franco, too.

But after the Vietnamese spring rolls and main dishes were almost finished, they revealed their true motive for coming all the way to see yours truly in the last day before spring break. A classic question: "Who is Kate Salemba?"

I almost burst into laughter. Apparently they love you, Kate. And don't worry, quoting Aco's tweet, you remain discreet and elusive as we all knew it.

Unimportant Update

Uhm, hello.

It feels a bit awkward since it's been quite some times that I don't blog. The reason? I don't know. You may want to say Twitter, but I don't twit as many as other twitteratis do. Let us just say that I am busy doing something else -- or it is more costly to blog lately.

What is the "something else"? One of them, by default, is working on something economics. Like getting back to drawing board and trying to digest more on the financial crisis, both from micro and macro approach. The micro part is on theories for banking and financial market instrument, including strategic portfolio management. The macro part is on information problem and business cycle -- at this point, it's on how to model self-fulfilling proficiency and move from multiple to single equilibrium commonly found in the model of financial crisis.

And the more I learn about those stuff, the more I feel how stupid and slow I am.

The other thing is to enjoy an extended winter up here. More to come.