Archive for the ‘profits’ Category
Should Workplaces Ban Lotteries?
Filed under: employees, honesty, pay, pricing, profits, values |
Comments (10) Should workplaces ban lottery pools? Lots of offices feature “pools” of various kinds, with groups of employees joining together collaboratively or competitively to speculate on, e.g., the outcome of the NFL playoffs. Very likely lots of managers regard it all as harmless fun, boosting morale by giving employees a break from the tedium of their cubicle farms. But a lottery pool is unlike, say, a hockey or football pool. In a hockey or football pool, there are winners and losers, but typically the dollar amounts are pretty small. But when employees band together to buy lottery tickets, the possibility is there for all hell to break loose.
To see what I mean, take a look at this story, from the CBC: More claiming share of $50M lottery prize
Some of the claimants to the disputed $50-million Lotto Max jackpot were at the Ontario Lottery and Gaming prize centre on Wednesday being questioned about the win.
The original claimants — 19 Bell Canada call centre workers from east Toronto — validated the winning ticket on Monday, said OLG spokeswoman Sarah Kiriliuk.
But since then, several more people have come forward to say they should have a share of the prize, said Kiriliuk, although she refused to say exactly how many….
Clearly, this is an anxious moment for the winners. But it’s also surely a rather anxious moment for their employer, telecommunications giant Bell Canada.
My friend Andrew Potter (author of The Authenticity Hoax) suggested to me that there are at least a couple of reasons reasons why employers might legitimately choose to ban lottery pools.
The first reason Andrew suggests is the potential for a highly disruptive exodus of an entire group of employees in the event of a lottery win. Most people, when asked, say that the first thing they would do if they won the lottery is quit their jobs. Losing a good employee can be a bad thing. So what happens when a dozen or 20 employees win together, and very likely depart en mass? Clearly, employers have a significant interest in avoiding such an outcome. Of course, the odds against such a thing happening are, well, tiny…one in many millions. How tiny do they have to be for us to say that the employer would be out of line to try to prevent it?
Second, and I think more significantly, Andrew suggests that employers might have a strong interest in avoiding the possible legal troubles that could result from a group of employees winning a lottery. Even for a win much smaller than the $50 million win in the story above, there’s the chance that employees will come forward who say they were unfairly excluded for one reason or another. And with money on the line, lawsuits are far from unlikely. And when lawsuits happen, chances are that everyone is going to get sued, including the employer. After all, an excluded employee can reasonably claim that the employer was effectively hosting the lottery pool, and hence bears some responsibility for making sure that it is run fairly. Even if the dollar amounts are too small to result in lawsuits, I can imagine considerable disruption of the working environment when there’s disagreement over a lottery win. Just take the usual petty office grievances and multiply them by a few tens of thousands of dollars, and then a win for employees equals trouble for their employer.
Now, I’m not sure there’s a huge risk here, but I think it’s an interesting question. Obviously, it behooves employers to allow employees a little breathing room when it comes to lunch-break entertainment. In general, it’s good for employers to respect employees’ privacy and autonomy, and that might include the freedom to engage in things like office pools. For most of us, our employers already dominate our lives in ways that are at least sometimes regrettable, so employers should be cautious about imposing unnecessary constraints. But given that lotteries are already widely-criticized as a regressive form of taxation (or, more bluntly, as a ‘tax on the inability to do math’), it might well be that eliminating office lottery pools would be a reasonable move.
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Addendum: it’s a little-known and sad fact that a relatively high proportion of lottery winners eventually file for bankruptcy. [URL updated Aug. 2011]
Ethics of Insider Trading
Filed under: conflict of interest, decision-making, ethics, finance, governance, honesty, profits, shareholders, Uncategorized |
Comments (13) “Insider trading” is one of those phrases that most adults have heard (at least on the nightly news), but that relatively few understand. (Perhaps the most famous case: Martha Stewart was originally charged with insider trading in the ImClone case.) I imagine few people even know what it really refers to. Well, it refers to situations in which corporate “insiders” (executives, directors, etc.) buy or sell their company’s stock on the basis of significant corporate information that is not available to the investing public more generally. (For more details, see the Wikipedia page on insider trading.)
But even if we don’t all know just what insider trading is, we all know insider trading is bad, and must be stopped. Right? But it’s hard to stop something that’s hard to define. In that regard, see this nice piece by Steve Maich, Editor of Canadian Business: “Chasing our tails while we chase insider trading.”
In case you hadn’t noticed, we are in the midst of a crackdown. Or rather, another crackdown. The crime du jour is an old favourite: insider trading….
There are obvious benefits to these shows of regulatory force. Seeing hedge fund managers and lawyers in handcuffs not only produces a nice dopamine rush, it’s also meant to demonstrate the integrity of the capital markets. But the costs are frequently overlooked. Like most crackdowns, this one seems likely to deepen cynicism, erode confidence and lob more grenades at shell-shocked markets….
Maich is undertandably cynical about these enforcement efforts:
Despite the periodic efforts of regulators to stamp it out, insider trading runs as rampant as ever, and that isn’t going to change. This is in part because it’s notoriously difficult to prove, but also because we have never definitely solved the fundamental puzzles at the heart of this supposed crime….
It’s worth adding that there is genuine disagreement over just why insider trading is unethical. (Some people even think it’s not unethical at all, because the executive who trades on “inside” information ends up indirectly bringing that information to the market, rendering the latter more efficient.) And if we’re not entirely sure why it’s unethical, it makes it that much harder to figure out in which cases it’s unethical.
The only scholarly article I’ve read on the ethics of insider trading is by Jennifer Moore, and is called “What Is Really Unethical About Insider Trading?”* Moore looks at a number of arguments against insider trading — arguments rooted in fairness, in property rights, and in the risk of harm to investors — and finds most of them lacking. Moore ends up arguing — plausibly, in my view — that the real reason insider trading is unethical is that it jeopardizes the fiduciary relationships that are central to business. If insider trading were permitted, that would put corporate insiders in a conflict of interest. Basically, the interests of corporate insiders would stop being well-aligned with the interests of the shareholders they are supposed to serve. And if the interests of corporate insiders aren’t aligned with the interests of shareholders, then people are much less likely to be willing to buy shares (i.e., to invest) in companies. And that wouldn’t be good for the firm, for its shareholders, or for society in general.
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*Jennifer Moore, “What Is Really Unethical About Insider Trading?” Journal of Business Ethics, Volume 9, Number 3, 171-182.
Intellectual Property and the Chilean Miners
Filed under: contract, ethics, honesty, intellectual property, international, law, profits, workplace safety |
Comments (1) Last month I posted about some Ethical Issues for the Chilean Miners. There, I pondered the moral force of the contract that the 33 trapped miners signed while still underground, promising each other to share equally the eventual profits of any future publicity. This month, I’m quoted in an article on that same topic, in Canadian Business. Here’s the online version: Intellectual property: Underground dealing in Chile, by Angelina Chapin
The story of “los 33,” the Chilean miners stuck underground for 69 days has all the makings of a good narrative: complication, action, mystery and a happy ending. Presciently, the miners made a pact while they were underground to share whatever profits come from telling their story and are rumoured to have decided to collectively author a book. According to The Guardian, they even had a lawyer send down a contract to make the “blood pact” legal, meaning when Hollywood producers come knocking, they’ll have a whole group to bargain with.
Not much is known about its content, but the circumstances under which the contract was signed have experts wondering about its validity and whether the specifics should be abided by now that they’ve survived the rescue….
The article gives the last word to Toronto-based lawyer Calin Lawrynowicz, who makes a simple, practical suggestion: rather than wonder about the force of the subterranean contract, the miners ought to sit down to talk about it:
Lawrynowicz says, since the miners don’t have 33 lawyers explaining their individual rights, the group should reconvene with an arbitrator to make amendments to the contract, allowing for reductions and benefits in terms of the wealth distribution.
“It’s like a shotgun wedding in Vegas,” he says. “You may be able to have a great relationship after the fact, but have to reconfirm why you got together in the first place.”
Walmart & Free Shipping: Who Will Suffer?
Filed under: competition, consumers, CSR, internet, marketing, pricing, profits, retail, SME, strategy |
Comments (7) 
Once again, Walmart is making headlines with a business practice that will be good for its customers, and bad for its competitors. Here’s the story, by Stephanie Clifford for the NYT: Wal-Mart Says ‘Try This On’: Free Shipping
For years, Wal-Mart has used its clout as the nation’s largest retailer to squeeze competitors with rock-bottom prices in its stores. Now it is trying to throw a holiday knockout punch online.
Starting Thursday, Wal-Mart Stores plans to offer free shipping on its Web site, with no minimum purchase, on almost 60,000 gift items, including many toys and electronics. The offer will run through Dec. 20, when Wal-Mart said it might consider other free-shipping deals….
Not surprisingly, Walmart’s competitors are alarmed. Smaller on-line businesses don’t get the kinds of sweet shipping rates that Walmart gets from UPS and FedEx, and they don’t have the regional distribution centres that allow Walmart to keep its shipping costs low. It’s pretty clear that this move by Walmart is going to put serious pressure — maybe even fatal pressure — on some of its competitors.
Just 2 quick points to make:
1) It’s worth noting (for the benefit of those who don’t know) that Walmart’s profit margins are already razor-thin. Yes, the make big profits overall, but that’s due to their mind-bogglingly huge volume of sales. On a per-sale basis, their profit is very small. So the money for shipping a given product (for free) isn’t coming out of the profits on sales of that product — the profits just aren’t there. Something has to give. One possibility is that it really is a short-term gimmick, perhaps intended precisely to drive competitors out of business. That would potentially count as an instance of predatory pricing, which would be at least arguably unethical and potentially illegal — in spite of the short-term benefits to consumers.
2) Normally when we think about Walmart’s effect on competitors, we think about its effect on its very small competitors, the ‘mom & pop’ operations. But I wonder whether that’s the case here. I’m no expert on the structure of the industry, but it seems that the companies most likely to be hurt are Walmart’s large and mid-sized competitors, i.e., companies that occupy roughly the same strategy space as Walmart. It seems to me (and it’s just a hypothesis) that most small retailers will have significantly different business strategies than Walmart, and hence won’t be competing directly with Walmart in ways that would let them fall victim to this latest maneuver. If I’m right, then if Walmart really can sustain this free shipping policy (and they haven’t claimed they’ll even try to) it would be very bad for its medium-sized and large competitors. If that’s the case, will people have the same kinds objections as they tend to have when Walmart’s consumer-friendly strategies are instead bad for small businesses?
Wall Street (1987) — “Greed is Good”
Filed under: boards, competition, corporations, finance, governance, management, pay, profits, shareholders, stakeholders |
Comments (13) 
I just re-watched the original 1987 film, Wall Street. (The sequel, Wall Street: Money Never Sleeps, is in theatres now, and apparently doing very well.)
In the original Wall Street, Michael Douglas’s character, Gordon Gekko, is a corporate raider — essentially, he buys up underperforming companies, breaks them up and sells their parts at a healthy profit. What drives him? Greed, pure and simple. In one scene, Gekko appears at the annual shareholders’ meeting being held by Teldar Paper. Gekko owns shares, but wants more. He wants control of the company, though his motives for doing so are hidden. It is there that he delivers the speech that includes the movie’s most famous line. “Greed,” he tells the shareholders of Teldar, “is good.”
That line is the only thing a lot of people alive in the 80’s remember about Wall Street. And that’s a shame.
Here’s Gordon Gekko’s famous “Greed is good” speech, in its entirety:
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. The new law of evolution in corporate America seems to be survival of the unfittest. Well, in my book you either do it right or you get eliminated. In the last seven deals that I’ve been involved with, there were 2.5 million stockholders who have made a pretax profit of 12 billion dollars. Thank you. I am not a destroyer of companies. I am a liberator of them! The point is, ladies and gentleman, that greed, for lack of a better word, is good. Greed is right, greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all of its forms; greed for life, for money, for love, knowledge has marked the upward surge of mankind. And greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the USA. Thank you very much.
The first thing to note about this speech is how little of it is actually about greed — roughly the last third of the speech. The first two thirds is a critique (disingenuous, as it happens, but not therefore off-target) of the complacency of overpaid corporate executives. Gekko is advising Teldar’s shareholders that the people responsible for protecting their interests — Teldar’s executives and Board — have been doing a bad job.
How does that first part relate to the final third of the speech, the part about greed being good? Well, it’s worth noting that when Gekko first uses the word “greed,” he does so “for lack of a better word.” And Gekko, one-dimensional character that he is, probably does lack a better word for it. For him, it really is greed — the unseemly and excessive love of money. But Teldar’s shareholders don’t need personally to embrace greed in the Gordon Gekko sense. All they need to do is to see that their interests are not being served well, and to understand that Gekko’s own greed is likely to serve them better: he wants to make a killing on the Teldar deal, and if they let him do so, they’ll all make a little money themselves, along the way. His greed is good for them.
Is Gekko’s greed a good thing over all? Well, Gekko says nothing, in his speech, about the interests of other stakeholders in Teldar Paper, stakeholders such as the company’s employees for example. If Gekko breaks up the company, shareholders may benefit but employees will lose jobs. That’s a bad thing, but it’s also sometimes inevitable. Not all companies should stay in business.
No, greed is not good. But the point — the grain of truth in Gordon Gekko’s Machiavellian speech — is that if shareholders allow executives and Boards to operate inefficiently, rather than using what little power they have to improve their lot, then they are suckers, being taken for a ride. And there’s no particular virtue in that.
California’s Marijuana Industry: Ethical Issues
Filed under: competition, consumers, CSR, employees, health, law, natural, pharma, politics, product safety, profits, regulations, retail, snacks, wages |
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I’ve blogged about the insurance industry, the mining industry, the auto industry, even the donut industry. But the pot industry? Yes, it’s time.
From the Sacramento Bee: Growth of California’s Pot Industry is Good News for Unions
As Californians prepare to vote on a November ballot initiative that would expand legalization to recreational pot use, labor groups see the potential for perhaps tens of thousands of unionized jobs.
United Food and Commercial Workers Union, Local 5, which has 32,000 members in California working in trades including the grocery and food processing industries, began organizing marijuana “bud tenders,” greenhouse workers, packagers and laboratory technicians last spring….
So, here a budding industry, built around a controversial product that is illegal in most jurisdictions. There’s plenty of grass-root support for broader legalization (both for medicinal and recreational use). But there may be enough opposition to blunt the enthusiasm of law-makers about sudden moves. The support of politically-powerful unions is another ethically-significant factor — as is the potential capture of this new industry by unions.
This is such a rich and interesting story that there’s too much in it for me to try to hash it out by myself without resorting to quick, potted answers. So here are a handful of questions to seed the discussion. I’ll let you weed the good from the bad.
- Ryan Grim reports that “The teachers union, citing the revenue that could be raised for the state, is also backing the initiative.” Is that sufficient reason? You don’t have to be an anti-pot puritan to worry about anything that might (inadvertently) encourage use of pot by school-age kids.
- What business ethics issues are faced by producers and sellers of pot in the illegitimate parts of the drug industry? What new issues will the newly-legitimized industry face?
- What CSR-type responsibilities does the (expanding) legal marijuana industry have?
- Why are California Beer & Beverage Distributors lobbying against the proposed change? (See useful discussion over at Marginal Revolution).
- What sorts of regulations should the industry seek? What motives will be foremost in industry’s mind in his regard — protecting revenues? protecting its image? protecting consumers?
- Will the other drug industry — the pharmaceutical industry — move into this line of business? Why or why not?
- Is the unionization of this industry generally a good or bad thing? Unionization improves the lot of workers, but also tends to raise prices. Since unionization itself is controversial, let’s ask it this way: is the case for unionization stronger or weaker, with regards to the marijuana industry?
I’ll open the floor for discussion.
Symantec Directors: $250,000/Year Not Enough to Log in to Annual Meeting
Filed under: accountability, boards, corporations, governance, profits, shareholders |
Comments (2) 
The shareholders of a public company are sometimes said to own the company. That’s not literally true, for lots of reasons. (See: Do Toyota’s Shareholders Own the Company?) What shareholders really own is the right to part of a company’s profits (if any) after all of its other expenses are paid. At any rate, the fact remains that shareholders are crucially important, and they are in many ways vulnerable. The legal rights of shareholders are relatively few, and relatively weak. That’s what makes corporate governance so important. Shareholders elect the Board of Directors, and the Board of Directors is responsible for hiring the CEO and helping set the overall strategic directo of the firm. For most shareholders, there are precious few ways to interact with, let alone influence, the Board of Directors. The Annual Shareholder Meeting is critical, in that regard.
That’s what makes it so striking when any company degrades its Annual Shareholder Meeting in the way Symantic did this year by switching to an all-virtual, audio-only meeting. See this opinion piece, by Gretchen Morgenson, for the NYT: Questions, and Directors, Lost in the Ether. Check out this juicy bit:
…because the Webcast provided no video, shareholders may not have realized that several directors had not bothered to attend the meeting, even virtually. When asked about directors’ attendance, [Symantec spokeswoman] Ms. Haldeman said 8 of the 11 showed up.
Attending annual meetings seems a pretty basic requirement of a director, don’t you think? Sure, such gatherings may seem a corporate equivalent of root-canal therapy, but a duty is a duty. Directors are paid for their service, after all, sometimes very handsomely. According to Symantec’s most recent proxy materials, directors get around $250,000 a year in cash and stock.
So which directors had neither the time nor the inclination to log on to their computers last Monday to hear from the shareholders they have an obligation to represent? Ms. Haldeman refused to identify those who were AWOL.
Now, it’s worth pointing out that the 3 directors who didn’t “show up” could well have had very good reasons. But if that’s true, Symantic’s shareholders deserve to know it. The little power shareholders have can only be exercised effectively if boards of directors take their duty of accountability seriously.
When Companies “Play Games” With Prices
Filed under: advertising, consumers, food, pricing, profits, retail |
Comments (10) 
Is it ethical for companies — without deception — to make use of well-documented human tendencies and weaknesses in order to get us to buy more? Social scientists have long been aware that humans are subject to a range of cognitive biases that affect the way they think in fairly predictable ways. And, apparently, smart marketers know it, too.
For instance, check out this critique of Apple’s pricing, by Ben Kunz: “How Apple plays the pricing game”
Economist Dan Ariely, author of Predictably Irrational, gives the classic example of a Realtor who shows you a home that needs a new roof, right before taking you to a higher-priced house she really wants to sell. It’s hard to tell if a $400,000 colonial is a good deal – but compared with a $380,000 home that needs work, it looks quite good. Now consider, $499 for an iPad? Well, compared with a smaller one with fewer features, it suddenly looks great.
Decoys explain why Apple often sells each gadget in a pricing series, such as the new iPod Touch’s $229, $299, and $399 price points for different storage capacities. You may gladly spend $229 to get a hot media player, thinking it’s a deal compared with the highest-priced version and not blink that you could instead buy an iPhone 4 at the lower price of $199 with more features.
(Don’t put too much stock in the details of the prices quoted — as one of the comments under the article points out, Kunz may be comparing apples & oranges by comparing retail prices for iPod Touch to the discounted iPhone price that you get when you sign a 3-year contract with a phone company.)
At any rate, practices like the ones Kunz describes are by no means unique to Apple. Many restaurants, for example, will include one or two high-priced entrees. I’ve heard it said that those, too, are “decoys.” The restaurant doesn’t expect to sell much of the $35 Surf’n’Turf, but the fact that there is a $35 entree makes the $25 entrees look very reasonably-priced. Now notice that there’s no actual deception, here…just a reliance on the fact that most people will have their choices swayed by such pricing.
Here’s the short version of the case for such practices: Look, there’s no deception here. And consumers still have free will. And there’s no clear difference between using this kind of so-called “trick” and the “trick”, known by salesmen since time immemorial, that people will buy more stuff if you smile and are polite to them. The relationship between buyer and seller is an adversarial one, so buyer beware. (Notice also that a company can accidentally, unintentionally engage in such pricing. Maybe the restaurant really thought the #35 Surf’n’Turf would sell well. But it didn’t, and so the net effect is that the dish ends up acting as a decoy, but it’s hardly something you can blame the restaurant for.)
Here’s the short version of the case against such practices: The cognitive biases that such pricing preys upon are so strong that they effectively limit consumer autonomy. Preying upon them is therefore wrong. We put limits on marketing to young children, because we realize that young children aren’t fully capable of filtering messages, evaluating options, and choosing rationally. But the (sad) news from the psychological literature is that adults are likewise limited. We just aren’t as rational or autonomous as we think we are. Selling crack to a crack addict is unethical in part because the addict has no choice but to buy. She doesn’t rationally choose to buy the crack: her addiction ensures the sale. Now, cognitive biases of the kind describe above aren’t quite like addictions. But if a given cognitive bias is only effective “most” of the time (as opposed to an addiction’s near certainty) doesn’t the fact remain that the person doing the selling is relying on a kind of human compulsion, rather than on a rational choice that is likely to satisfy the consumer’s needs?
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If you’re interested in this stuff, I highly recommend Dan Ariely’s book, Predictably Irrational. See also Judgment under Uncertainty: Heuristics and Biases, by they guys who basically invented the field, Daniel Kahneman, Paul Slovic, and Amos Tversky.)
Venture Capital: Lessons for Business Ethics (part 2)
Filed under: finance, governance, management, profits, shareholders, SME |
Comments (2) Yesterday I posted the first of two blog entries on Ethics in Venture Capital. This is the second.
I noted yesterday that the relationship between venture capital (VC) firms and entrepreneurs is fraught with ethical challenges related to bargaining, information, control, and short term-ism. Those worries tell us something about the world of venture capital; but what do they tell us about business ethics more generally?
The key lesson, I think, is one I learned from Gary Pisano’s book, Science Business, though it isn’t a major theme of that book. The lesson is this: a funding model is also typically a governance model. This insight is at a very coarse level summed up by the old aphorism that “he who pays the piper calls the tune.” In business terms, providing financing means paying the piper. Governance is about getting to call the tune.
This is closely linked to the core lesson from another favourite book of mine, Henry Hansmann’s The Ownership of Enterprise. Hansmann’s book is an attempt to explain the patterns of ownership and control we observe when we look at the range of business firms that populate a market economy. When you look around at complex organizations like modern corporations, most of them tend to be owned by shareholders but managed by professional managers. What is it that explains how pervasive that particular setup is? Lots of other models are possible — partnerships, employee co-operatives, consumer co-ops, and so on. Law and even tax policy in most modern economies both permit and sometimes even encourage these other models, yet the shareholder-driven corporation dominates in most industries. Why? To make a long story short, Hansmann’s thesis is basically that the patterns of ownership we see can best be explained in terms of different stakeholders a) interest in, and b) ability efficiently to accomplish, effective oversight of managers.
So, back to VC. When VCs invest in firms, they often essentially assume ownership: they buy an equity stake in the firm and exercise control (via Board membership, among other mechanisms). But why are VCs involved at all, rather than other sources of funding, like employees or banks or non-expert shareholders? Basically, in Hansmannian terms, because VCs are better able to a) bear the risk involved in ownership of a startup company, and b) exercise the kind of knowledgeable control over the company (via supervision & sometimes appointment of managers) to make the risky investment worthwhile. But as I noted yesterday, the specific kind of (short-term) interest that VCs have in the firms they invest in raises a special set of ethical issues that look somewhat different from the issues faced in firms funded in other ways.
The lesson: if we want to understand the ethical challenges firms face, and why they do the things they do, we need to think in a detailed way about who owns them, the goals those owners have, and the extent to which the owners are exercising effective control.
Ethics in Venture Capital
Filed under: conflict of interest, finance, management, profits, SME, technology |
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This is the first of two blog entries on ethical issues in venture capital.
Venture capitalists are investment companies that specialize in careful investment in high-risk ventures that provide the possibility of exceptionally high returns, typically in specialized technology-driven industries like biotech and information technology. Venture capitalists (VCs) are a source of funding for small companies that need a serious infusion of cash (typically from a few hundred thousand dollars to a few million dollars) but that are too small (and with too little short-term promise of profit) to raise money via the stock market. In addition to providing funding, VCs typically provide startup companies with mentoring, providing advice, business connections and management expertise that might otherwise be lacking.
The relationship between VCs and the entrepreneurs they provide funding to raises some special ethical challenges. Here are just a few:
1) Bargaining power. VCs typically provide funding to companies that are fairly desperate for money. Add to that the fact that VCs are typically seasoned industry insiders, whereas the entrepreneurs seeking funding may never have been in business before at all. He or she might, for example, be a university scientist who knows a lot about cancer drugs, but nothing at all about the world of business and finance. As a result, there’s a worry that VCs will often be able to impose conditions that are highly advantageous to themselves, and much less good for the entrepreneur. Whether that imbalance ends up being unfair is a matter for debate.
2) Information. The companies VCs invest in are typically recent start-ups; often all they’ve got going for them are a few smart people and what they take to be a great idea. In order to justify investing, VCs engage in an intensive process of due diligence, essentially insisting on a level of access to information otherwise reserved for insiders. Sometimes they sign non-disclosure agreements, but sometimes they don’t. The result is that VCs end up with inside information not just about the companies they actually invest in, but also about the companies they consider investing in — and some VCs will look at proposals from several hundred companies per year. This raises obvious risks related to confidentiality, insider trading, and the protection of intellectual property.
3. Control. Because their investments are so risky, they typically insist on being given considerable control in exchange for their investment. For example, VCs may insist on being given seats on the company’s Board of Directors. This raises questions of loyalty and conflict of interest. VCs seek Board seats in order to protect their interests; but Board members have fiduciary obligations to promote the interests of the company as a whole, which may at times be different from the interests of the VCs.
4. Short Term-ism. The time-horizon for VCs is relatively short. Their investments typically take the form of cash in exchange for shares (often preferred shares) in the company. The idea is generally to nurture the company through early-stage growing pains, help it grow into a company that can either go public (via IPO) or be bought out by a bigger, wealthier company. Typically VCs cash out in 3-5 years; if things have gone well, they reap a very significant profit. The result is that VCs have a pretty short-term interest in the companies they invest in. They care about growing the company, making a profit, and getting out. They are typically seen as having very little interest in the long-term interests of employees or other stakeholders. This is the source of the common joke that “VC” actually stands for “vulture capital.”
In my next blog entry, I’ll consider what we can learn about business ethics more generally by thinking about ethical issues that arise in the world of venture capital.
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Links:
Here’s the Wikipedia page on venture capital.
One of the few scholarly works on VC ethics: Yves Fassin, “Risks in Business Ethics and Venture Capital,” in Business Ethics: A European Review, Volume 2, Issue 3, pages 124–131, July 1993
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Addendum (Aug. 12, 2010)
A friend of mine who is a venture capitalist suggested the following excellent clarifications regarding timelines. First, the 3-year time horizon mentioned above is mostly for later stage deals. VCs that invest at earlier stages usually have 5+ year time frames. VCs that invest in start-ups have 7-9 year time frames. Second, even the 3-year time horizon for later-stage deals is not all that short — not compared to the even shorter time horizons of stockholders in publicly-traded companies, which are typically under pressure from Wall Street to produce quarterly results.
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