Boards are stuffed with long-serving directors, UK members with 9+ no longer classified as independent

UK code of practice that stipulates that if a director has served more than nine years on a board they are no longer classified as independent.


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Google’s parent Alphabet and Warren Buffett’s Berkshire Hathaway head a list of more than 800 US companies that could come under pressure to refresh their boards, under new guidelines being floated among shareholders.

ISS, the influential corporate governance adviser, is considering targeting companies where boards are stuffed with long-serving directors or where there have been no new members for years.

In its latest annual survey ISS is asking clients their opinions of boards that have failed to appoint a new director in five years, where the average tenure of directors exceeds 10 or 15 years, or where more than 75 per cent of directors have served 10 years or longer. Its findings could form the basis for changes in its investor voting guidelines.

A Financial Times analysis of data from ISS Analytics, the company’s research arm, reveals that more than one in four of the 2,900 US boards closely tracked by ISS would fail on at least one of the mooted measures, including nearly 200 companies that have an average director tenure greater than 15 years.

Alphabet and Berkshire are the largest companies to fail on two, but the list of double-offenders also includes retailer Bed Bath & Beyond and Intercontinental Exchange, owner of the New York Stock Exchange.

On Berkshire’s board, Bill Gates, at 11 years, is one of the company’s freshest appointments, while four others have served more than 20 years. At Alphabet, five directors have served more than 15 years, including Google founders Larry Page and Sergey Brin.

Questioning the effectiveness of “male, stale, frail” boards reflects growing investor interest in improving director diversity, with shareholders increasingly demanding a portion of new directors as well as a formal board refreshment process.

Potential sanctions ISS could consider include voting against the chair of the board’s nomination committee or against long-tenured directors. If a consensus emerges, it could still be several years before voting guidelines are changed.

“The issue with board refreshment practices is not that one or two directors have been on the board for a longer period, but that the board doesn’t refresh periodically enough to add new blood,” said Marc Goldstein, head of ISS’s policy steering committee. “If there’s a mixture, that’s of less concern.”

The absence of a formal corporate governance code in the US, unlike in most markets, has been cited by investors as the reason American directors tend to be older, longer serving and less likely to be women than in many other countries.

The voting guidelines from ISS and Glass Lewis, its rival advisory service, are the nearest the US comes to a code of best practice, and they hold considerable sway because public pension funds and institutional investors follow their recommendations.

The Big Read

US board composition: male, stale and frail?

An FT analysis of directors at 5,000 companies in 30 markets


How male, stale and frail is your company?

Search to see how your board compares against 5,000 companies in the FT/ISS Analytics database

At Alphabet and Berkshire, more than three-quarters of the directors have served more than 10 years, and the average tenure is greater than 12 years. Both have, however, appointed directors in the past five years, unlike 100 other companies in ISS’s data set. Alphabet and Berkshire declined to comment.

Paula Loop, leader of PwC’s governance insights centre, said senior directors can bring tremendous value, having a “complete picture” of a company. “But you also want new people. They’ll ask new questions, things that might be obvious, that no one else would ask, and it brings out good debate,” she said. “If the majority of your board is long tenure, I think you’re missing out on important insights.”

Corporate governance codes in most markets assume that long-tenured directors are less independent after years of working with a company and its management. Their removal also offers an opportunity to increase board diversity in age, gender, race and skill sets needed today such as cyber security, Mr Goldstein said.

The findings come shortly after an FT analysis that showed the diversity of US boards lagged behind Europe’s in regards to age, tenure and gender. In Britain, for example, there is a UK code of practice that stipulates that if a director has served more than nine years on a board they are no longer classified as independent.

High CEO Pay = Lower Stock Returns

High CEO Pay = Lower Stock Returns

boardmember alberto balatti ceo compensation

For any issue regarding your Board, Compensation Committee, or “C”suite ask to MALTAway

“Companies that awarded their Chief Executive Officers (CEOs) higher equity incentives had below-median returns.” This is how MSCI started a report on CEO compensation.
The idea of awarding CEOs equity in the companies they oversee was originally pitched as a way to align the interests of corporate executives with those of shareholders. If the stock fared well, shareholders would benefit and CEOs would be rewarded for driving up the stock price. Yet this has not been the case for many companies.
“If the total summary pay figures were effective in incentivizing superior future performance, we would expect to see a strong correlation between higher pay figures and 10-year TSRs (total shareholder returns). However, we found very little statistical evidence to support this; in fact, we found a small but consistently negative relationship, a possible indicator that superior performance may have been linked to lower rather than higher pay awards,” wrote Ric Marshall and Linda-Eling Lee of MSCI’s ESG (environmental, social and governance) research team.
During the period of 2005 through 2014, shareholders of companies with the lowest CEO pay realized 39% greater total returns than shareholders of companies with the highest CEO pay. Put another way, investing $1.00 in the companies whose CEO compensation ranked in the bottom 20% would have grown into $3.67. Investing the same $1.00 in the highest CEO-paying quintile of companies would have only turned your investment into just under $2.65. When Marshall and Lee analyzed companies by their sector allocation, the same inverse relationship appeared: higher CEO pay meant lower shareholder returns.
Given this, it would seem logical that shareholders would use “Say on Pay” votes to express their displeasure. The exact opposite has occurred, with approval rates exceeding 90% for many companies. Setting aside issues about the proportion of shareholders either not voting their shares or simply going along with the board of directors’ recommendations, there is a hurdle to figuring out exactly how much the CEOs are getting paid. An investor looking at a proxy filing (SEC filing DEF 14A) has to combine data from several different tables to calculate the CEO’s compensation.
Even compiling the data mandated to be disclosed isn’t enough to grasp the full picture. Marshall and Lee point to the lack of cumulative realized pay—what the CEOs actual take home from stock and option grants—in SEC filings. They also point out that shareholders don’t know how much compensation CEOs have realized over the course of their tenure or how the cumulative compensation compares to stock performance.
Making matters worse is that the compensation committees often base CEO compensation on what other companies are paying their executives. It’s akin to what’s happened in the world of sports, where salaries have soared as athletes use their peers’ compensation to negotiate better deals. These contracts are often announced by the media with no analysis about how much extra ticket sales, television viewership or merchandise sales the high-priced player will bring. Texas Rangers fans have found this out with Prince Fielder, who is due $96 million through the 2020 season according to CBS Sports. The first baseman is incurring his second injury-shortened season in three years and questions are now being legitimately being raised about how well he’ll play when he returns in 2017.
Ironically, the same day MSCI released its report, The Wall Street Journal published an article discussing how companies are trying to woo individual investors to vote. Railroad operator CSX (CSX) is going as far as to plant a tree for every shareholder who votes. The reason? According to the article, individual investors overwhelmingly side with the company’s management and can be a helpful swing vote in close corporate elections.
Companies should not count on our support. We shareholders are owners. It’s up to us to look out for financial interests, which can mean disagreeing with the board of directors’ proxy recommendations as well as voting against Say on Pay proposals.

BREXIT wrap up and actions

BREXIT wrap up and actions

maltaway brexit

After a heated political campaign, voters in the United Kingdom decided by a slim margin, on June 23, to exit the European Union, leading to a change in government. Now that a new prime minister has taken over, the next big question looms: How will the UK and EU negotiate their split?

I have spent almost 20 years researching, teaching, writing about, and advising companies and governments on how to negotiate when things seem impossible. In this article I offer an analysis of the negotiation landscape facing UK and EU negotiators, along with advice on how they might navigate the process more effectively. For the record, I have not (at the time of this writing) been asked by either side to advise on the negotiations.

I structure the analysis in much the same way as I would approach any complex deal where I was asked to lead (or advise on) the negotiations. I examine important elements of the process, the key interests and issues to be negotiated, the leverage each side has, some of the barriers to reaching a deal, potential outcomes, and strategic options on both sides of the table.

You can learn more about the history and factors leading up to the British referendum here and here.


What Is the Brexit Process?

The clock only starts when Article 50 is formally invoked by the UK.

It’s important to remember that the British referendum is not legally binding: The UK government must initiate “Brexit” by invoking Article 50 of the Treaty on European Union. There seems to be an emerging consensus that Members of Parliament will respect the wishes of voters if called to vote on the matter, despite the fact that most MPs were against leaving the EU. Moreover, Theresa May, the new UK prime minister, has made it clear that “Brexit means Brexit,” and that she intends to oversee the process.

Once Article 50 is invoked, the EU and the UK have two years in which to negotiate a withdrawal agreement and the UK’s future relationship with the EU. Any agreement being accepted by the EU requires the assent of a “qualified majority,” which means that 72% of the member states, representing at least 65% of the population of the EU, must vote in favor of the agreement.

If an agreement is reached, the treaties that currently govern the relationship between the EU and the UK (as a member state) will expire. If no agreement is reached, the treaties will automatically expire two years from when Article 50 was invoked.

Because the clock only starts when Article 50 is formally invoked by the UK, there has been some wrangling over when it should occur. There is an option of extending negotiations beyond the two-year time limit, but it requires the consent of all countries in the EU.

Two other points of process are worth mentioning. The first is that many parties within the EU are involved, and because a member state has never exited before, the internal process on the EU’s side of the table is itself being negotiated. The key groups are the European Council, the European Parliament, and the European Commission. (See here to learn more about these three institutions, and here for more information on the role they are expected to play in the negotiations.)

The second issue is more crucial. If the agreement reached between the EU and the UK is broad enough in scope to be considered a “mixed agreement” — which it certainly will be if the parties negotiate not only trade but also security and foreign policy issues — then the agreement will need to be ratified by the parliament of every member state, which means every EU country would have a veto. From a negotiation perspective, this not only increases the amount of time needed to reach a comprehensive agreement but also lessens the likelihood of a deal.


What Are the Major Issues?

The EU is based on the idea of a single market, characterized by four freedoms. They are the free movement, across borders, of goods, services, capital, and people.
Protestors demonstrating against Britain’s proposed membership of the European Economic Community, January 22, 1972. The UK joined the EEC the following year.

Let’s start with some context. The European Union is based on the idea of a single market, characterized by four freedoms. They are the free movement, across borders, of goods, services, capital, and people.

There are three consequences of this arrangement that are of particular relevance to Brexit negotiators: free trade between EU member states (think “tariff free”); businesses in the member states being subject to EU regulations; and citizens of any member state being able to move to another member state to live or work there. All of these were important factors leading up to the Brexit vote, and they are central to the negotiations that will take place between the UK and the EU.

Trade and immigration. Two of the most important issues are trade and immigration. It is worth considering them together because doing so helps to highlight a key conflict in the negotiations. Simply put, the UK wants to keep the trade relationship with EU members as it is today (free trade) but significantly change the rules surrounding the free movement of people between the EU and the UK. Roughly half of the immigrants to the UK come from the EU, and polls conducted in the run-up to the referendum suggest that over 50% of those who supported Brexit considered immigration their biggest concern.

David Davis, who was appointed Secretary of State for Exiting the European Union by PM May, believes both of these goals are achievable: “The ideal outcome (and in my view the most likely, after a lot of wrangling) is continued tariff-free access. Once the European nations realize that we are not going to budge on control of our borders, they will want to talk, in their own interest.”

Unfortunately, this is not at all how the EU sees it. Donald Tusk, president of the European Council, has made clear that for the UK to have access to the single market “requires acceptance of all four EU freedoms — including freedom of movement. There can be no single market à la carte.” Other EU leaders have made similar pronouncements. How much wiggle room there is, and what kinds of concessions might be made on trade and immigration, remains to be seen (and negotiated).

Money paid to the EU. The UK pays more into the EU budget than it gets back in rebates and other payments to sectors of the UK economy. Leave campaigners and supporters argued that the money saved through Brexit could be used elsewhere (e.g., to enhance the UK’s National Health Service). Here, we see the same conflict: From the EU perspective, if the UK wishes to have continued access to the single market, it will be required to pay dues.

There is clear precedent for this stance. Norway, which is not a member of the EU, pays into the EU budget in order to have access to the single market. The precise amount that the UK would pay will have to be negotiated.

Regulations. Leave supporters complained about onerous regulations imposed by the EU, including environmental standards, product safety rules, and minimum working conditions for employees. Although Brexit would put an end to EU-imposed regulations, there are two important factors to keep in mind. First, many (perhaps most) regulations will continue because they or similar ones are important for the UK, even if the EU is not imposing them. The UK will not, for example, abolish all product safety or environmental regulations after Brexit. Second, the EU could continue to impose certain regulations after Brexit in exchange for the UK’s access to the single market. Again, this is consistent with the Norway precedent, although UK negotiators will want to avoid regulatory influence from the EU.

Free movement of people. Much of the Leave campaign’s rhetoric was aimed at stemming the tide of immigrants from Europe, but barriers to free movement of people would hurt both sides in the negotiation. Millions of UK citizens live and work in Europe, and even the loudest proponents of Brexit want them to retain their rights. Former mayor of London Boris Johnson, a leading voice in the Leave camp who now has been appointed foreign secretary, promised as much in anopinion piece he wrote following the referendum: “British people will still be able to go and work in the EU; to live; to travel; to study; to buy homes and to settle down. As the German equivalent of the CBI — the BDI — has very sensibly reminded us, there will continue to be free trade, and access to the single market….The only change — and it will not come in any great rush — is that the UK will extricate itself from the EU’s extraordinary and opaque system of legislation.”

The desire to address the anxiety of the British people is understandable. What is difficult to understand is how the foreign secretary intends to secure the rights of British citizens to free movement without offering reciprocal rights to citizens of other EU member states (or, for that matter, without offering any concessions at all).

Financial services. A particular concern for the UK in these negotiations is the fate of London’s financial services sector. It plays an outsize role in the broader EU financial industry, where it has a trade surplus of almost £20 billion with the rest of Europe. (The threat to this important sector of the UK economy is explained in some detail here and here.) How far the UK is willing to go (or be lobbied to go) to protect the sector — or, put differently, how much the EU is able to extract in exchange for concessions to City — is an open question.


What Leverage Does the EU Have?

Because the EU needs to deter future exits, threats to walk away even from economically attractive deals become credible.
Euro stars on the glass doors of the main portal to the Palais de l’Europe, the European Parliament in Strasbourg.

There are four important sources of leverage for the EU.

The economics of trade. Leave supporters have made the argument that the UK will be negotiating from a position of strength because the EU exports more to the UK (around £290 billion) than the UK exports to the EU (around £220 billion).

The argument is a flawed assessment of the actual state of economic leverage. The key is to look beyond absolute numbers and consider the percentage of total exports they represent for each party. While the UK exports a lower nominal amount to the EU, these exports represent about 44% of total UK exports. In contrast, exports to the UK are only about 10% of total EU exports. By this measure, a “no deal” (or a deal that hurts trade, to be more precise) is much worse for the UK than it is for the EU.

This doesn’t mean that a good deal is impossible for the UK to achieve, but it does mean that putting too much weight on this political talking point would be unwise for negotiators.

The need to deter future exits. If the only players in this story were the UK and a firmly united EU, the UK would have more room to demand concessions. But the EU is not monolithic. One of the biggest concerns of EU negotiators will be the risk of setting a costly precedent. This deal will be closely watched by nationalist parties in other countries. If the UK is able to negotiate terms that give it a better deal than it had when it was a member state, that could encourage additional exits, which could jeopardize the union’s very existence.

As a consequence, there may be several agreements that the EU is tempted to accept on purely economic grounds (preferring them to “no deal”) but that are off the table because they could incentivize other defections from the EU. Because the EU needs to deter future exits, threats to walk away even from economically attractive deals become credible. This gives the UK leverage, albeit at the cost of making “no deal” more likely. As Martin Schulz, president of the European Parliament, has stated, “There is no intention to ensure that the UK receives a bad deal, but it is clear that there can be no better deal with the EU than EU membership. The EU moreover must look out for its members’ interests and uphold its founding principles. The single market, for example, entails four freedoms (capital, goods, services, persons) and not three, or three and a half.”

Too many veto players. As mentioned previously, any final deal will require agreement from a qualified majority of EU member states, or unanimity in the event of a mixed agreement. This potentially gives veto power to many small coalitions of member states — or to every individual state if there is a mixed agreement. It narrows the zone of possible agreement but also allows the EU to credibly say that the UK will have to make significant concessions to bring enough EU votes on board.

The psychology of precedents. Although it’s a smaller factor than those listed above, the psychology of deal making is currently working against the UK. All of the precedents in place — Norway, Switzerland, and even Canada — instantiate the European claim that there can be no “sweetheart deal,” and that it is not possible to get access to the European market without serious conditions and contributions.


What Leverage Does the UK Have?

A number of the most influential countries in the EU are the ones that are most dependent on trade with the UK.
British businessman and politician Oliver Smedley (1911–1989) leaving to demonstrate in Rome as part of his Keep Britain Out campaign to oppose British membership of the EEC, 1967.

UK negotiators also have at least four sources of leverage, although I do not wish to imply that this means both sides have equal leverage (as I discuss below).

Economic impact on the EU. Albeit less than what the UK stands to lose, the EU would lose financially in the event of a deal that is bad for trade (e.g., high tariffs). While this might not be sufficient leverage on its own, it does help to chip away at the problem for the UK.

Influence over key players. It is important to note that EU-level data masksconsiderable heterogeneity that exists across EU nations with regards to the balance of trade with the UK. Notably, a number of the most influential countries in the EU (such as Germany) are the ones that are most dependent on trade with the UK.

How these relationships are managed and how they can be used to influence the Brexit negotiations with the EU will be crucial considerations for the UK. I disagree with those who think the UK’s leverage vis-à-vis Germany is all that matters, and that this one trade deficit ensures a good UK-EU deal — but it certainly will play a role in the negotiations.

Security concerns. If the only issues on the table are trade and immigration, the EU arguably is in a strong position. But if the UK can make a strong case that a bad deal with the EU would threaten cooperation on other matters (e.g., security), that could help tip the scales. Such a threat ought not to be credible: In my view, two centuries of UK history show that every time the British have moved further away from Europe, they eventually have regretted the decision — and have had to return when things unraveled on the continent.

Everyone loses when the UK and EU drift apart on matters of security. And yet there are reasons that Europeans should take the threat to strategic cooperation seriously. The recent referendum shows a strong isolationist attitude in the UK, and the EU might want to consider the degree to which relationships might deteriorate if the eventual deal is perceived as one-sided (or punitive) by the British people.

Timing of invoking Article 50. The number of European leaders who are urging the UK to invoke Article 50 without delay is long and comprehensive, including European heads of state, the EU president, the European Commission president, and the European Parliament president. Meanwhile, the UK governments seem to be in no rush to pull the trigger, not least because there appears to be no negotiation strategy currently in place.

Only the UK can invoke Article 50. When everyone wants something that only you can provide, you have leverage. This raises the possibility of the UK agreeing to invoke Article 50 sooner in exchange for concessions. Given the order of events (Article 50 will be invoked before substantive negotiations get under way), any concessions demanded from the EU likely would have to focus on the process of eventual negotiations (timetables, sequencing, etc.) or on an agreement on principles that would frame the negotiation. This does not mean that the UK should invoke Article 50 before it’s prepared, but it does suggest that there may be some scope for a trade.

There are risks to using this point of leverage, however. If the EU decides to punish delays (or threats of delays) to the process, things could escalate and get ugly. The EU has the option of invoking Article 7 of the Treaty on European Union, which would take away the UK’s voting rights in the EU on the premise that the UK has committed a “serious and persistent breach” (or is at “clear risk of a serious breach”) of EU values, as specified in Article 2. Arguably, the values listed in Article 2 would not be breached simply because the UK is dragging its feet on Article 50, but such is the nature of escalation: Both sides could get into a death spiral of unhealthy and unreasonable tit-for-tat.


A Key Barrier: False Promises

The EU might come to the conclusion that since any deal is going to fall short of the extreme promises made in the UK, it is not worth giving any special concessions at all. The UK government will have to find a way to sell a lesser deal, or end up with no deal at all.

From a leverage perspective, one factor cuts both ways. The Leave campaigners, in their enthusiasm for Brexit, seem to have promised more than they can plausibly deliver. And, in many cases, they appear to have done so with little regard for facts, data, or statistics. To name a few examples, the amount of money going to the EU was overstated; the ability to limit contributions to the EU following Brexit was exaggerated; the impact of immigrants on the economy wasmisstated; the ability to control immigration after a deal was inflated; and how much the National Health Service would benefit from a Brexit windfall was so inaccurate that the promise was walked back literally the day after the Brexit vote.

Almost none of what was promised is actually possible — especially given the EU’s leverage and other constraints — which means the UK government will have to find a way to sell a lesser deal, or end up with no deal at all. But remember: Constraints can be a source of leverage. UK negotiators might be able to credibly say that they can’t possibly go back to their supporters with significantly less than what they promised on the eve of the referendum. In other words, the EU will need to make more concessions to avoid no deal.

But the situation is a double-edged sword: The EU might come to the conclusion that since any deal is going to fall short of the extreme promises made in the UK, it is not worth giving any special concessions at all.


Two Looming Strategic Issues for the UK

Could the different parts of the UK (England, Wales, Scotland, and Northern Ireland) each negotiate a different relationship with the EU? And will the UK leave the EU customs union?
Map of England in the ninth century from A Short History of the English People, by John Richard Green, published by Macmillan and Co., 1911.

The problem of Scotland. While a majority of all voters in the United Kingdom voted to leave the EU, a majority of voters in Scotland voted to remain. This is a problem for the government in England, which lives under a constant latent threat that Scotland might vote to leave the UK. A referendum in 2014 resulted in a majority of Scottish voters choosing to stay within the UK, but a second referendum is now being openly discussed.

While Scotland cannot legally veto UK’s exit from the EU, it can exercise leverage over PM May, who is faced with the delicate task of trying to keep the UK together. When it comes to Brexit negotiations, Nicola Sturgeon, first minister of Scotland, has made clear that she wants to ensure “Scotland is playing a very full part…including having the ability to put forward options for Scotland that would respect how Scotland voted.” To this end, she has suggested the possibility that the different parts of the UK (England, Wales, Scotland, and Northern Ireland) might each negotiate a different relationship with the EU.

The leaders of Wales, Northern Ireland, and Scotland recently have called for each of their devolved parliaments to be allowed to vote on any Brexit agreement. Even if nothing comes of this legally, the threat of a break-up over Brexit creates a problem for UK negotiators and further limits the set of deals that everyone can live with. Managing these relationships ought to be a first order of business for the UK.

Whether to leave the EU customs union. In order for the UK to negotiate its own trade deals with non-EU countries, it has to leave the EU customs union, which requires all members to accept the same rules when it comes to trading goods (though not services) with outsiders. (Learn more about the difference between a customs union and a free trade area here.)

Although it might seem obvious that Brexit would entail leaving the customs union, the two do not go hand in hand. Turkey, for example, is part of the EU customs union without being part of the EU. Leaving the customs union would make it harder and more costly for the UK to export goods to the EU, especially for goods that are made partially outside the UK.

Another problem is that leaving the customs union would raise serious concerns in some parts of the UK that already are against Brexit — most notably Northern Ireland, which would have to erect a customs barriers on the border with Ireland, something few would like to see. The issue will need to be decided soon, and iscurrently being debated. Some Leave supporters seem confident that the freedom to negotiate trade deals is worth the costs, while others are less convinced.

It remains to be seen how well the UK can actually negotiate non-EU trade deals. On the one hand, it will be able to negotiate without the constraints imposed by the demands of other EU countries; on the other hand, the UK’s economy is much smaller than the EU’s, so it has less to offer (meaning less leverage) in these negotiations.


What Are the Possible Outcomes?

The possibilities are many, from the Norway model to a unique UK deal to the chance that Brexit might not happen at all.
May 1, 1975: Government documents about to be published for the British Common Market Referendum vote on June 5.

There’s an infinite number of potential outcomes in a negotiation like this one, but it’s useful to keep in mind a few salient possibilities.

No deal = WTO rules. If no agreement is reached within two years and the EU treaties expire, the default is that the UK and EU would trade according to World Trade Organization rules. Notably, these rules cover only trade, not the many other issues the two sides need to negotiate. The problem (i.e., cost) of the WTO outcome is that trade barriers, such as tariffs, would emerge where none existed before, hurting all sides, but especially the UK.

The Norway model. There already is a model in place for European countries that do not wish to join the EU but want access to the single market. Norway accesses the market through the European Economic Area. In exchange, Norway agrees to many conditions, including the free movement of people, most EU regulations, and financial contributions to the EU.

In other words, using the Norway model would mean the UK would accept roughly the same conditions as those prior to Brexit but with an additional cost: losing a vote in the EU halls of power.

The Norway model does allow for a bit of wiggle room to opt out of certain EU policies. The question would be how much wiggle room the UK would be allowed.

Other national models. Other models to follow include those used by Switzerlandand Canada. Switzerland, instead of negotiating a treaty with the EU, has negotiated separate relationships with each member state (using over 100 bilateral treaties cobbled together over decades). The Swiss are also subject to some EU policies and contribute to the EU, but not to the same degree as Norway. Canada has an even more remote relationship with the EU. It includes trade agreements, and while it allows for certain carve-outs and exceptions, it comes with its own constraints.

Neither of these models are great for the UK, and both would take longer to structure and implement than a Norway-style deal, but negotiators would be wise to look at these options carefully. They may find precedents they can point to that allow them to legitimize some of the concessions they need.

A unique UK deal. A one-of-a-kind deal is what the UK government will push for, but it would be foolhardy to think that any UK deal will ignore precedents or allow London to get all of what it wants without significant concessions in other areas.

A partial deal. Any extension to the negotiations beyond the two-year time period will require unanimous consent from the 27 EU nations remaining. Because divisions and disagreements regarding how things are shaping up are likely to emerge during the two years, the possibility that one or more countries would cite domestic pressure to vote against an extension — or use the threat of a veto to demand excessive concessions — should not be ignored. The UK and EU negotiators would be wise to wrap up whatever portions of a broader agreement they can before having things go to a vote on extending talks. Although there are costs to negotiating a deal piecemeal (e.g., trading across issues is difficult), in this case it would be wise to think carefully about whether and how to partition the full set of issues into those that are crucial to finalize before the risk of deadline pressure and those that should remain open until there is a full, final agreement.

Not following through on Brexit after all. Currently this option is not on the table — but once you consider each side’s leverage and how difficult it will be to achieve a “good” deal (especially for the UK), negotiators might want to keep this option alive (albeit unspoken) as they assess their bargaining power and craft their strategy.


Who Has the Greater Leverage?

A “no deal” scenario is still possible.

Analytically speaking, this is a trick question. On the one hand, when you look at the alternatives to reaching a deal, it seems that the EU has significantly more leverage than the UK because it is bigger economically and because it can credibly threaten to veto any deal that would make the exit option attractive to other member states.

The real problem, however, is that when you think about the interests and constraints of both sides, it becomes hard to envision any deal that all parties can accept — unless UK negotiators are able to go back to their constituents and sell a deal that falls well short of what was initially promised. This has a few implications:

  • A “no deal” scenario is very possible.
  • If a deal is going to happen, it will require tremendous creativity as well as sensitivity to the needs of the other side. Both sides will have to make as many concessions as they possibly can. The UK will have to ask for what it wants in ways that allow the EU to make concessions without setting dangerous precedents. The EU will have to make symbolic concessions that allow UK negotiators to sell the deal internally to a potentially disappointed audience. A unique UK deal is possible, but it is unlikely to meet the aspirations of Leave voters.
  • Given the fact that a “no deal” is possible and that a deal might disappoint UK voters anyway, might there not be a path toward reversing Brexit? There may come a time when the only outcome that allows all parties to declare victory entails no Brexit. EU negotiators obviously would be happy. PM May could say she tried but would not accept the EU’s likely terms (or the dismantling of the UK). Leave campaigners in the government could resign in protest — or gain in popularity for opposing the outcome.


In Conclusion

Smart negotiators know that the goal is not to “win” but to achieve their objectives.

In writing this analysis, I have tried my best not to take sides, nor to make unnecessary predictions. This is in part because there are limitations to doing a truly comprehensive or definitive analysis in a situation where all of the facts are not in the public domain. It is also because there are many paths forward and the outcome will be determined by how each side plays the hand it has been dealt.

The worst mistake either side could make right now is to take aggressive unilateral steps to improve its bargaining position without taking into accounthow this might cause the other side to escalate further. While EU leaders have seemingly ruled out any talks, however informal, before Article 50 is invoked, I find it hard to believe that back-channel conversations are not under way. (And if they are not, they should be.) Even if no substantive aspects of the negotiation are discussed, these conversations are opportunities to shape expectations, coordinate on process, build rapport, and create trust before deal making shifts to the media spotlight. These early moves could pay huge dividends when substantive deal making gets started — or reveal the need to revisit currently unpopular options (e.g., reversing Brexit).

As I write about in Negotiating the Impossible, if there is one lesson we can learn from some of the worst conflicts and deadlocks in history, it is that even seemingly impossible situations can be handled well if negotiators stay cool, prepare systematically, strategize with an eye on all relevant factors, have empathy for the needs and constraints of the other side, and understand that the goal is not to “win” but to achieve their objectives.

Sovereign Risk Index

Sovereign Risk Index

Sovereign Bond Risk Index July 2016

Drawing on a pool of more than 30 measures spanning financial data, surveys and political insights, the BlackRock Sovereign Risk Index (BSRI) provides investors with a framework for tracking sovereign credit risk in 50 countries.

The BSRI breaks down the data into four main categories that each count toward a country’s final BSRI score and ranking: Fiscal Space (40%), Willingness to Pay (30%), External Finance Position (20%) and Financial Sector Health (10%). For full details, seeHOW IT WORKS below

Quarterly Update – July 2016

  • The U.K. suffered a hefty decline in its Willingness to Pay score in the wake of its vote to leave the European Union. Political risks have risen on a change in political leadership and uncertainties over the Brexit process. The UK’s overall ranking held steady at 18th place, but its Fiscal Space will come under scrutiny as the Brexit aftermath unfolds.
  • China posted the biggest rankings decline with a three-notch fall to 32nd place. This was mostly a result of shuffles of its close neighbours in the index. China’sFinancial Sector Health score slumped against a backdrop of rapid credit growth. Norway was another notable mover. Its score declined as falling oil revenues eroded its fiscal surplus, but the country remains the leader of the BSRI pack in rankings terms.
  • Greece climbed two notches to 47th place, its highest position since the index’s launch in 2011. An improvement in Fiscal Space amid fiscal austerity measures was the big driver. Venezuela, already at the bottom of the index, posted the largest score decline. Its scores fell across all four BSRI metrics on falling growth projections, weak oil prices and poor government effectiveness.


  • Fiscal Space—This category assesses if the fiscal dynamics of a particular country are on a sustainable path. It estimates how close a country is to breaking through a level of debt that will cause it to default (i.e., the concept of proximity to distress), and how large of an adjustment is necessary in order to achieve an appropriate debt/GDP level in the future (i.e., the concept of distance from stability).
  • External Finance Position—The factors in this category measure how leveraged a country might be to macroeconomic trade and policy shocks outside of its control.
  • Financial Sector Health—This category considers the degree to which the financial sector of a country poses a threat to its creditworthiness, were the sector were to be nationalized, and estimates the likelihood that the financial sector may require nationalization.
  • Willingness to Pay—In this category we group factors which gauge if a country displays qualitative cultural and institutional traits that suggest both ability and willingness to pay off real debts.

BITCOIN thoughtful considerations and feedback

  • imagesThe

    Bitcoin world is full of people who know nothing about economics or cryptography; they only know that they could have made millions if they had not sold at the bottom. These people tell themselves that they are redeemable, that Bitcoin is just the MySpace of cryptocurrencies, that they will have another opportunity to get in early on some other revolution. These people can be dangerous, but most of them are easily preyed upon.

    I think this may explain the origin of “blockchain technology”. It lets people talk as if clones of Bitcoin are important without having to remind themselves of Bitcoin. If someone says “blockchain technology” to me I give him the benefit of the doubt and write him off as someone who doesn’t know what he’s talking about. If I find out that he’s intelligent, then he’s most likely a con artist.1

    When people say “blockchain technology” to you, you can often replace it with “mana”, or “chakras”, or “quantum” and it makes sense the same way. “Blockchain technology” has evolved into a sound Bitcoiners use to extract money from venture capitalists and one another, similar to the way that male birds use a song to attract females. It’s a phrase for people who know there is a lot of money around, but don’t exactly know where it’s coming from.

    I don’t see that there is a lot of use for some kind of general “blockchain technology” outside of its application in Bitcoin. In Bitcoin, the blockchain is a way of solving the double-spending problem without privileging any party as to the creation of new units or of establishing a consistent history. This is an extremely costly and complicated way of maintaining an accounting ledger. How often do I really need to do my accountancy in this way? I would say that it is only a good idea when the game being played is so important that no one can safely be put in the position of referee. There are not a lot of things that I would really need that for, but I think there is a good argument to be made that a blockchain is a reasonable alternative to the monetary system under which the rest of the world is currently oppressed. Otherwise I’d really rather be able to keep my accounting records to myself rather than leaving them out in public.

    There are no applications of blockchains which do not involve a double-spending problem. A blockchain that was used for an application with no double-spending problem is nothing more than a database, so you could just replace it with a distributed hash table. People have also used the blockchain for timestamping. This only works because Bitcoin has become well-known as a point of reference. If you had a need for timestamps, you certainly wouldn’t invent a blockchain to do it.

    Yet people are running around everywhere in the Bitcoin world screaming “blockchain blockchain blockchain” for all kinds of non-intuitive purposes until they’re buried under piles of money. I can’t believe how long it’s taking for people to get wise to this ruse, but I hope it won’t last too much longer. A blockchain does not have a wide range of applications. However, there is one application2, namely that of being a currency, which is overwhelmingly important.

    Money as a Hallucination

    The foundational fallacy about money is to explain in physical terms what is really a sociological phenomenon. Money is about macroeconomics even if we’re talking about a small currency like Bitcoin. Gold is not valuable because it is durable, fungible, portable, and scarce; it is valuable because of a beneficial and self-sustaining tradition in which it has a special place. The physical properties of gold make such a tradition possible, but they do not determine that it will arise; other goods with similar properties may also become the traditionally established good. Bitcoin is the same way, of course. It could not run without the technology behind it, but its value is what makes it important. People who think “blockchain technology” is important are making the same kind of mistake as the people who think gold has intrinsic value.

    What’s weird to me is that I know I have heard many people express correct ideas about what money is and then look at me like I’m crazy when I seriously consider the implications of what they said. I have heard people say to me things like, “money is just a shared hallucination” or “the value of money is whatever we all agree it is”. Yes! That is correct. That’s exactly what I’m saying. And if money is a shared hallucination, then you can’t replicate Bitcoin’s value by replicating the technology. You would have to also replicate the hallucination, which you can’t. You’ll have two blockchains, but only one of them has a shared hallucination. This makes one of them valuable, the other worthless.

    If that seems like a strange claim, think about the alternative: it means that it should be possible to create value for essentially no work. Every new blockchain ever produced was built on the premise that you can create a valuable investment that offers no income for the fixed cost of copying Bitcoin with alterations.

    There is nothing magic here. Human behaviors have real costs and benefits. Money may be little other than a bunch of people attributing value to something without much direct use. It doesn’t matter if this sounds ridiculous; if there is a behavior that corresponds to this belief which benefits people, then they will keep behaving that way. Other people had better understand what they’re doing or else they will become relatively poorer.

    Money as a Behavior

    The overwhelmingly most popular thing to do with gold is to store it away and leave it for long periods of time. Therefore, an explanation for the price of gold should mostly depend on the reasons someone would want something that is good for being stored away, with some minor additions due to gold’s use as jewelry and in industry. We can study money as behavior by abstracting away all the uses of money other than that of storing it. No matter how silly that sounds, we know that it must be good for something because people actually do it and have been for some time.

    When I talk about money as a behavior what that means is that everybody has a socially established number that is objectively associated with them. They can show other people how much they have, and everyone will agree as to what the number is. People can do something which subtracts from this number and adds to another person’s number. Also, people demand to have higher numbers. This means that they are willing to give up other things in order to increase their number. If we know the costs and benefits of increasing the number, then we can understand the price of these numbers on the market.

    There could be many reasons that people are able to behave in this way. The numbers could correspond to amounts of a physical good, like gold or wampum, which people physically pass among one another. They could correspond to numbers which are managed and guaranteed by an institution, like dollars or World of Warcraft gold; or it could be numbers that are stored in a blockchain as in Bitcoin; or maybe we all just use the honor system and keep track of our own balances and don’t cheat.

    Often, economists define money in a way that makes money a unique good in an economy. I do not define money this way. There could be more than one good which acts like money. Instead, I will show that in the long term I would expect a single money to dominate.

    The Risk of Money

    Money is often explained in terms of the inconvenience of trading in a barter system.3 While bartering might well be inconvenient, that alone is not enough to explain the existence of money. It would certainly be nice if we could all settle on a good to use as money. However, there is no guarantee that everyone will be nice enough to do that. It is possible to imagine a tribe of people who are all very good economists and who all understand and like the idea of money, without having enough confidence in one another as to get it working for real. The first person among them would be taking a risk because he would have to work or sell his property in exchange for something that’s good for not much other than being stored. His risk would only pay off if everyone else was willing to follow suit, and how could they possibly guarantee to him that they really would do so?

    For almost a year, this was what it was like in Bitcoin. Although Bitcoiners suspected that Bitcoin could be money some day, its price was zero. Consequently, it was completely useless as a form of money. For a long time, Bitcoiners wanted the price to be higher than zero, but they could not make it so just by wanting it. Bitcoin did not fundamentally change as a piece of software when it first developed a price; the only thing that changed was people’s’ willingness to trade dollars for it.

    In general, there is always an individual cost to accepting money, even when the use of money is very widespread. If I work in exchange for money, how do I know that money will still be valuable by the time work is out and I am ready to do my shopping? If I work for something I can directly consume then at least I can get some utility out of it no matter what. But if I accept something whose main use is as a medium of exchange, then I am depending on there being future people willing to accept that money later.

    This is why people can’t just will money into existence and why the inconvenience of a barter system cannot explain the existence of money. There’s a risk. In order to explain why people would use money, we need an individual benefit to match with the individual cost; otherwise people would never prefer to use money no matter how socially beneficial it was.

    The Utility of Money

    There is an individual benefit to using money, and it’s very simple. The person who accepts money gets to defer his decisions about what to buy to a later time. Someone who does not want to use money must have a better idea about what he is going to do with the goods he receives in payment than the person who accepts money. When one has money, then one is not committed. If I am the first person to accept money in payment and my bet on it pays off, then I have the option to choose what I want later, and I do not have to choose based on the limited information I have now. This benefit explains why someone would want something that is good for keeping in storage. If he wants to keep his options open, then he can open his vault the moment that the right opportunity comes along.

    I have now provided a trade-off which, I contend, explains the value of money. I have not proved that there are no other costs and benefits to using money, but I don’t know of any others. If someone can show me that there is another reason to hold money, please do. Now I’ll talk about what this tradeoff implies for the value of money.

    The Value of Money

    In this article, I mean value in the investment sense. So the value of money is the purpose it serves in your portfolio and how much you would want. For the investor, the value of money is determined by the tradeoff of commitment versus optionality. If he wants more deferred choices, then he needs more cash. If he wants more income, then he should get stocks or bonds.

    The reason someone might want to defer his choices is because there are limited periods of time in which investments go on sale. A difficult thing about business is that it is easy to make mistakes whose consequences are not evident until long after they are unavoidable. When that happens a business needs cash in order to survive long enough correct itself. During these times, good businesses can be bought cheaply for limited periods of time. This is why an investor wants a cash balance ready to spend. You never know what is coming, but if you have cash you are prepared for whatever it is. Holding a stock is a commitment to a particular enterprise, whereas cash keeps your options open.

    The reason that buying an investment is a commitment is that you cannot always sell an investment easily for cash. It might go on sale, just as in the previous paragraph, and then the investor cannot get the same amount of cash back that he put into it. If there is a crash, the investor might not be able to follow through on his commitment and must sell at a loss. On the other hand, an investor who can realistically make the commitment won’t care so much if there is a recession because he is prepared to weather safely through any bad times.

    The interesting thing about the tradeoff of optionality versus commitment is that changes in the overall use of money in an economy can change the nature of that tradeoff for an individual person. The more demand for money there is, the less risky it is for an individual person to hold money. If you were the first person to sell goods or labor for money, then you would probably look insane or immensely stupid to bet that other people would want this stuff in the future. On the other hand, if many people are using money, then you are merely depending on there not being a hyperinflationary event in the immediate future. In that case, you might look insane or stupid for worrying about such a remote possibility at all.

    In short, money becomes more useful the more people use it.

    This may seem like a very obvious conclusion given how many words I took to arrive at it, but it has some funny implications that are hard for a lot of people in Bitcoin to accept because they have money riding on a presumption that the opposite is true. As more people begin to hold money, the rational response of everyone else is to try to hold more than they already have. Everyone, therefore, will try to increase his cash balance at the same time, and they will do this by bidding larger amounts of other goods in exchange for it. In other words, all prices tend to go down, and money becomes more valuable. Effectively, everyone ends up with more money, except that they end up with more valuable units of money rather than higher sums of it; and furthermore they end up with larger fractions of their portfolio in money as well.

    The Network Effect

    This is the opposite of how most investments work. If the price of a stock goes up, then the value decreases because its dividend yield is smaller in proportion to its price. If the price goes up too much, an investor would eventually want to sell for something cheaper. By contrast, $100 worth of bitcoins today has a better value than $100 worth several years ago, even though the price of bitcoin is much greater. The value is better because there are more opportunities to unload the bitcoins at the owner’s discretion.

    A positive feedback between price and value implies that the growth or shrinkage of money can be self-sustaining. One might well find this conclusion hard to accept. Afterall, value in a business is built by hard work and careful strategy, whereas money can somehow drive its own value according to me. I would invite anyone to explain Bitcoin’s value any other way. And saying “bubble” doesn’t count because that’s virtually the same thing. Money is basically a self-sustaining bubble. We don’t yet know if Bitcoin will arrive at a self-sustaining state, and even if it doesn’t the “blockchain tech” people are still wrong because in that case there would be no good blockchains rather than one.

    What would a self-sustaining bubble look like? Naturally, there must be a limit to the growth of money. As the value of money increases, eventually the individual benefits of holding more of it will go down. This happens as the market cap of currency becomes a larger and larger fraction of the whole economy. There are only so many errors that the economy produces for a cash-holder to take advantage of. The economy becomes saturated with money once there are enough investors sitting around with piles of money such that they are able to catch all the errors that are worthwhile. At that point it is no longer individually beneficial to hold more money even if the value of money has gone up. This prevents the value of money from going up further until more people or businesses are added to the economy.

    This limit is independent of the underlying technology of the money. If people were sufficiently honest, it could run on nothing but the honor system. Thus, the value of money is a macroeconomic phenomenon, even for a tiny, quirky cryptocurrency like Bitcoin. This is the reason why Bitcoin can be worthless one year and valuable the next without a fundamental change to the software or protocol, and why it can range in price by enormous margins over short periods of time for reasons that seem inscrutable. It’s because the value of money is a shared hallucination, and the price is caused by the vividness of that hallucination.

    How Bitcoin’s Value Was Created

    For a year after Bitcoin was first released, it had no price and was quite worthless. Therefore, the value was not created when the software was originally developed. It was caused by step-by-step investments that came later. Since it first gained a price, Bitcoin has had periods of rapid price increases. There can be events which are set off for no apparent reason in which Bitcoin’s price drives itself rapidly up or down. A small price increase is interpreted as an increase in demand. An increase in demand would mean that bitcoin is becoming more useful and therefore more valuable. Hence, more people buy in and cause another price increase. These manias make people outside wonder if Bitcoin is for real. They make people who previously thought that Bitcoin was stupid to think that they should maybe buy a little bit just in case there could actually be something to it. In other words, they are starting to think that Bitcoin is good for the only thing that money is actually good for, which is to be kept just in case.

    Above I wrote about the hypothetical idea of a tribe of economists who all wanted to develop a money economy but could not because each felt the investment to be too risky. Here is how they could solve that problem. They could go around in a circle and take turns investing tiny amounts. Then none of them has to take a big risk. Their economy would not be monetized after one round, but they could see who among them was willing to take a small risk. If they had all shown themselves willing to invest a little bit, then many of them would be willing to risk a second round. If the game should proceed well, the economists would start to think about how wealthy each would be if they managed to get more than the rest. Soon the game would cease to be orderly as they all tried to sell as much as possible in order to buy the new money while it was cheap.

    Bitcoin did not arise out of a barter system. The dollar and the other state-managed currencies had long since subsumed nearly all trade. However the calculation of the initial investors to Bitcoin was very similar to that which faced the economist tribesmen. It was clear to many that Bitcoin would be cool if you could actually buy things with it. However you can’t buy anything with it and its investment prospects depend on the presumption that it somehow one day will be demanded in exchange for goods. How could one even estimate the risk of such a possibility? The fact that other currencies already existed does not change the problem. From the perspective of a Bitcoin investor, Bitcoin might well have existed in a barter system in which Dollars, Yuan, Euro, Pound, and Yen were traded rather than tea, silk, salt, and flint. The only difference is that the national currencies are better competitors than tea or salt, so the risk is greater than if Bitcoin had arose in a real barter system.

    Competing Currencies

    I’m not against competing currencies in the sense of thinking people should be physically prevented from creating them. I am against competing currencies in the sense that I think currency competition is inherently monopolistic and that it is extremely dishonest or stupid to promote a new currency as an investment without taking this reality into account. So I am against competing currencies in the sense that someone who creates a new currency had better be able to present a case that his idea is capable of replacing the current system, and should be treated as a con artist otherwise.

    The fact that money has a positive feedback between demand and value implies that there cannot normally be a stable equilibrium between two moneys. Any initial imbalance between them would tend to expand. If one currency was slightly more preferred than the other, people would react to this by demanding slightly more. This makes the preferred even more preferable than before. Any two moneys will interact in this way, thus leaving one to dominate the rest.

    Many people get fooled upon first entering Bitcoin because they think diversification is important. The problem with diversification is that it is possible to create an infinite amount of bullshit at no cost, and if you diversify into that you lose everything. Diversification only makes sense among investments which are not bullshit. If we were looking at a bunch of stocks that all already paid dividends, then diversification would make sense. On the other hand, there are potentially an infinite number of scamcoins. During late 2013 and early 2014, new ones were being produced and hawked every day. They can be produced at this rate until everyone who thinks diversification is a good idea goes broke. Now that all the dumbest people have gone broke, the focus has shifted to using “blockchain tech” to exploit ignorant venture capitalists.

    There is always some risk in accepting money in payment, even something very well-established like dollars. If everyone settles on the same money, then they have coordinated so as to reduce that risk as much as possible. If you expect people to use two currencies, you have to have some reason that both would offset risk in different ways. I have never seen an altcoiner or “blockchain tech” enthusiast come anywhere near to addressing this issue. Clearly, if two currencies are virtually identical, such as Bitcoin and Litecoin, then whichever currency is bigger has the advantage. Recently, Litecoin’s price has decoupled from Bitcoin’s somewhat, so maybe people have finally figured this out. Once Litecoin loses its shared hallucination, no amount of sloganeering will bring it back.

    Litecoin prices, all-time (via CoinMarketCap)

    But what about something more elaborate? Let’s pretend for a moment that Ethereum actually worked and was actually something that competed with Bitcoin on some level. Do its smart contracts give it a serious advantage over Bitcoin? I don’t see how Ethereum’s smart contract system would tend to bring in opportunities to unload ethers which are superior to the opportunities provided by Bitcoin. No matter how cool smart contracts sound, they make Ethereum just another appcoin, and as with other appcoins, people will reduce the risk of holding them by not holding them, or holding them for as short a time as possible. This willdrive the price down until they are useless in trade.

    By the way, I would prefer to be called a “Bitcoin minimalist” rather than a “Bitcoin maximalist” because the other blockchains appear useless and are easliy eliminated.

    Bitcoin Versus the Dollar

    On the other hand, Bitcoin improves over the dollar (and other fiat currencies) where it actually counts. The dollar is not very good for storing “just in case”. Over long periods, it loses value due to inflation. You can’t carry cash around or the police will take it, and if you leave it in a bank, you can have your account frozen and the money drained if you use it for purposes deemed unacceptable. You cannot own dollars the way that you can own bitcoins. It is not that Bitcoin comes at no risk; it is rather that you can always expect to have the same fraction of the total later on, if you secure them properly.

    The national currencies are affected by forces which are beyond your knowledge or control. They are managed by committees serving the governments issuing them. The people on these committees speak in a jargon that is not only incomprehensible to most people, but unbearably dull even to those who do understand it. Everyone is affected by them, but most people will not bother to learn to understand them. They manage the currency in the national interest, which is not always the same thing asyour interest. They can change the rules about how the currency can be spent you can use them or increase the government’s supply. 4 It is usually not possible to predict what they will do, at least over long time spans.

    This is not possible under Bitcoin’s current rules, and it would be difficult to change them in ways that might eventually enable anything similar. Although many new bitcoins will be created in the future, the release schedule is publicly known, and is therefore already priced into current Bitcoins. Therefore Bitcoin will not lose value as a result of inflation. It might lose value as a result of losing popularity, and this risk is greater than that of the dollar’s (at the moment).

    Thus there is a genuine qualitative difference between Bitcoin and the dollar, from an investment standpoint. It doesn’t mean that Bitcoin will necessarily defeat the dollar. It just means that Bitcoin has a relevant competitive edge. There are still significant disadvantages to Bitcoin; it is slow to confirm and difficult to maintain anonymity. However, Bitcoin has done well against the dollar so far and there is real-world commerce that has grown to rely on it. In addition, every time bitcoin grows, its risks decline relative to the dollar’s.

    Final Thoughts

    The reason, therefore, that the monetary aspects of Bitcoin are particularly interesting is the possibility that Bitcoin could become the preferred good for being stored away. If it did, then its value would grow until it was a significant part of the world economy. That would be a significant change for the world and for Bitcoin’s early adopters. Call me crazy, but I think that possibility has more portent than the possibility of applications of blockchains outside of Bitcoin, and is a lot more likely, too.

    Bitcoin the protocol is like a great work of engineering. Its pieces are all adapted to its function. It is not the technology, but what the technology enables, that is most interesting. The blockchain as a concept had no reason to escape the esoteric circles of developers and engineers. Yet when people looked at Bitcoin, the only terms by which they knew how to understand it was as a new technology. But Bitcoin is more like a new tradition than a new technology. It is as if a small section of the crowd in a packed stadium has started to do the wave, and you can bet on whether the wave will eventually fill up the entire stadium.

    If someone says “blockchain tech” to you, you might as well walk away right there.5 They’re just trying to sell you on their new decentralizedcrowdfunded blockchain tech internet of bitthings appscam. You knowthat they’re lying because everyone who acts like them is a liar and someone who was not a liar would actually do something to distinguish himself from them. Someone who knew what he was talking about would know that you can’t just string a bunch of buzzwords together in order to generate an idea that makes sense. Unfortunately, if a lack of basic critical thought is widespread, and if everyone becomes invested in everyone else’s stupidity, then nobody wants to know either, at least not before they’ve found a favorable time to exit their position. This will probably never happen because although they may think they’re preying on other people’s stupidity, they are more likely being preyed upon instead.

    1. On the other hand, just because someone is dumb does not mean that he is not a con artist. Based on my experience in Bitcoin, I think that many con artists have an instinct to remain as stupid as possible about how they get money so that they can keep believing that they are brilliant entrepreneurs. 
    2. do one thing and do it well” 
    3. When Austrian economists say barter system all they mean is an economy in which no good is used as money, even though the term has much more specific connotations for many people. 
    4. In the US, it is really congress and the executive branch changing the rules, and the Federal Reserve changing the supply. This distinction doesn’t really matter for the purposes of this article, but some people think it’s important because the federal reserve is designated as a private institution, whereas congress is composed of elected representatives. 
    5. This includes Hillary Clinton

    “Blockchain technology” has evolved into a sound Bitcoiners use to extract money from venture capitalists — Love it…. This is so spot on…

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    Yes, in theory, Bitcoin should be insurmountable as digital money. Unfortunately, in practice, it is losing its network effect to other digital currencies for a number of reasons, principally because control of the Bitcoin network has gone over to a company whose business interest is to force transactions off of Bitcoin onto their own platform (yet to be delivered), supported by a censorious scammer who bans and deletes anyone who complains about the direction Bitcoin is headed on /r/Bitcoin or bitcointalk.

    People are talking about blockchains because Bitcoin has foundered upon the shoals. Were it not for the failed leadership of Blockstream, your “hyperbitcoinization” prediction would most likely have already happened. Instead, the last new high for Bitcoin was almost three years ago! Now what is increasingly likely to happen is that a Bitcoin 2.0 platform designed for speed and scalability is very likely to suck the market cap right out of Bitcoin on its way to world domination. Ethereum is the most likely candidate, despite their current issue with the DAO theft.

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      “Unfortunately, in practice, it is losing its network effect to other digital currencies for a number of reasons”

      False, the bitcoin domination index has not dropped below 80%, EVER…Other coins have been gaining momentum which is fine, bitcoin can’t do everything, there is much left to invent. However the problem of sending value from A to B has been solved with bitcoin and NO other coin comes close to it’s security.

      “People are talking about blockchains because Bitcoin has foundered upon the shoals. ”

      False, people are talking about blockchains because wallstreet hates to use the word bitcoin.

      “Were it not for the failed leadership of Blockstream, your “hyperbitcoinization” prediction would most likely have already happened. ”

      False, pure speculation. Blockstream and Core continue to push out innovative technology from segwit, to schnorr, to lightning, thunder, bolt, falcon and beyond. It’s getting hard to keep up with all the scaling technology being built. However it takes a while to actually be implemented and be used by the ecosystem. Within 2 years time the scaling debate will be a distant memory.

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      You are probably giving too much importance to the owner of… most people don’t ever visit that site, nor they go to /r/Bitcoin. I read in there a couple of times, then I didn’t really need it. People don’t care about the technology behind Bitcoin, not while it’s beginning to spread so quickly. It was important in the beginning, now it’s not. I can bet 999 people on 1000 don’t give a damn about Satoshi Nakamoto or the owner of, they just see there’s so much traffic, trading, value, so they know it’s solid to an extent, so they enter the circuit.
      On the other side, you talk about Ethereum, which has far a smaller base than Bitcoin, far less investment and is far less known. You can’t still buy shit with it anywhere, and the first flag app was a failure. Yet you promote it. And here it looks like a Cognitive Dissonance problem: you have proof that quakes shake Bitcoin and Bitcoin is still on the wave, and you have proof that the first quake happened to Ethereum practically killed it, and still you are fan of it.
      I will agree that if there’s a coin that can compete with Bitcoin it’s Ethereum, but that’s all but sure. Bitcoin is like what Windows was in the past: Windows was crap in respect to AmigaOS or MacOS, but it was THE STANDARD. Everybody had it, it worked everywhere, it wasn’t dedicated.
      Bitcoin is in the same situation: it came first, it’s world spread.
      Ethereum has still to born, nothing is around that uses Ethereum, NOTHING. At the moment it’s vaporware, while Bitcoin has been adopted by some millions of people and its growth is going up geometrically.

      see more

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    Daniel Krawisz’ article has sent me into self-reflection and considerable thought. I am a columnist and consultant that believes strongly in blockchain-based solutions–and NOT just to solve the double-spend problem.

    I was host and MC of The Bitcoin Event (New York). This Fall, I am teaching Blockchain concepts at several New England schools. I am also co-chair of The Cryptocurrency Standards Association. I recently wrote an article that strongly criticizes the rush to invest in or announce blockchain-based services that are not both permissionless and fully distributed among users who generate or “own” the data: Is a Blockchain a Blockchain if it Isn’t?

    The article is cautionary—it warns that many Blockchain proposals convey little or no advantage—But it falls far short of claiming that a Blockchain is useful only for Bitcoin or applications with a double-spend problem. This just isn’t the case! I think that Krawisz may be limited by narrow vision…

    The statement about the double-spend problem may be technically correct, but what Krawisz fails to consider is that many processes and mechanisms are substantively analogous to this same problem.

    Some prescient organizations (IMO, most are entrepreneurial, but a few are big legacy companies) will reap rewards from their ability to recognize *which* problems in affairs of business, social interaction, scientific research and politics can be positively transformed by injecting a Blockchain database or other distributed, permsionless, crowd-sourced, authoritative component.

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      the desire to turn anything and everything into capital has a meeting with destiny. Bitcoin value tokens are a commodity, the Bitcoin protocol is a consensus mechanism which is rat poison to capital finance – they want the technology that produces the value tokens (because it is money) but, yet, it is their nemesis. As soon as you run a meaningful blockchain it is based on – and enforced by – consensus, then who needs the “runner” of that blockchain? If the consensus is only that of a centralized party, then a SAP database is both cheaper and faster – the R3 (or IBM or Fed) “blockchain” is only a pretence.

      Commodity charts go up and down according to social mood and with no observable correlation to news or fundamentals. Not only is Bitcoin a citizen programmable money, its a paradigm shift with revolutionary bias in favor of the non-centralized.

      Good luck to them, they’re consuming large doses of a power laxative that Satoshi designed with the centralized authority, specifically, in mind.

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      Ellery Davies – Could it be that you believe blockchain technology has as yet untapped, but profound, value because the alternative would leave you with no career?

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    Who should NPR Planet Money call about the Bitcoin they sent but it never showed up?…

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    Great article Daniel !

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    “…you could just replace it with a distributed hash table.”

    Isn’t the blockchain the only known way to “perfectly” secure the values in an always-on peer-to-peer hash table? Isn’t “double spend” just a specific example of its ability to not have “accidental” overwrites in the database?

    “There is an individual benefit to using money, and it’s very simple. The person who accepts money gets to defer his decisions about what to buy to a later time.”
    Another benefit is that it allows system-wide intelligence if it can be used only (or primarily) under the conditions required by the governing legal system. This enables society to reduce or prevent monopolies, tragedy of the commons, externalities, and wealth concentration (democracy resulting in progressive taxation for community benefits). This is why smart contracts are a smart companion to currency and why currencies are on a per-nation (legal force) basis. This is key to the Euro’s problems.

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    No mention of the crippling 3tx/s capacity limit….The author should stop projecting so much.

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      As a value repository, that limit is more than enough. Most transactions to day are done by traders. Bitcoin is, today, like a reserve currency. It’s network is not good to make everyday shopping, but it’s more than enough to save your wealth from your failing currency if you live in Venezuela or in Russia in example.
      So just don’t make the mistake to consider Bitcoin as a method of payment: it’s not. It’s not NOW and it’s not necessary now. People look at it as different things: investment, wealth saving, mostly.
      So that limit is unimportant. And the proof of this is that adopters keep growing despite that limit.

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        “As a value repository, that limit is more than enough.”

        That is a fallacy.

        The “value repository” function requires capacity too.

        The 3tx/s limit, inherently cripples all the potential this system have, because it limits the number of participants who can transact.

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          You are wrong. I have some BTC and I am not touching them, and like me, there’s millions of people out there already that have bought into it.
          And until we are here, and there’s no reason why we shouldn’t, Bitcoin will have value, and until that day, more people will buy it.
          I don’t need to make transactions with it, not now. I bought it as an investment. People from countries in crisis like Venezuela or Brasil or Russia or China are buying it also to escape their countries currency inflation.
          We don’t need more than that number of transactions.
          And the proof of what I say is that the userbase keeps expanding.
          Maybe Bitcoin will never become a network to make real time payments, also because while the userbase expands, transaction time probably will increase, but it will surely hold up as a repository of value, there’s no escape to that, nothing in the world can beat it.
          There are a couple of ways to destroy it, one is to cut off internet, the other I won’t say here and to nobody, but it’s very unlikely to happen anyway.

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            Currently there are way less than 10M Bitcoin owners….if only a fraction of the potential users (internet connected people) wanted to obtain BTC we would experience a week or not months long backlog rendering the system useless.

            Also, there is no such thing as sitting on an asset indefinitely. I’m not even sure how people imagine this to work?

            Bitcoin is valuable because it’s useful. The store of value function distills from it’s usefulness.

            If you cripple the network, you destroy the store of value aspect on the long term.

            Bitcoin is a payment system, a new form of money. Small blockers go against the very fundamentals of the system.

            The reason small blockers didn’t create their own “store of value scheme” is the fact that it would fail because it would lack network effect and utility.

            Also, you seem to think that Bitcoin exists in a vacuum. While nobody would be incentivized to own bitcoin (more like cripplecoin currently), while there is another system which has a cap on issuance AND utility.

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              I’ve actually written a book about Bitcoin, so, no, I don’t think it “exists in a vacuum”.
              Still, the network is there, inefficient, and Bitcoin is gaining adopters. You can’t deny it, so what are you talking about?
              I see a Cognitive Dissonance problem here: you have PROOF that Bitcoin is being adopted, with all its network problems, and despite this you WISH Bitcoin sucks because the network is not so efficient.
              My dear, Bitcoin is efficient enough for its actual function: subtract people from central banks shit fiat currency. People buy it as an investment, they don’t need to exchange over and over.
              That problem may arise in the future, but solutions are being designed already, as you probably well know.
              Your opinion is different, ok, but I really see a Cognitive Dissonance problem here.

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                I’m talking about the stone wall front of adoption in the form of the 1MB limit.

                Not sure why can’t you comprehend the implications of a 3tx/s limit.

                You are the one who is delusional if you think that it’s ok.

                “. People buy it as an investment, they don’t need to exchange over and over.”

                But that needs capacity as well (to obtain it, and to use it when needed). Also, only a very few people can afford to sit on an asset infinitely.

                The people who have savings keep them to:

                1.) Have wealth to fall back on

                2.) Spend it time to time on things they need

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                  No you are the delusional one, or just plain idiot, because Bitcoin is not going to hell, it’s growing and despite this you insist that there’s a problem.
                  There’s no problem.
                  People like it like it is, as I wrote (but Cognitive Dissonance doesn’t allow you to see that), they keep adopting it, it’s spreading everywhere, slowly, but it’s happening.
                  Now I say goodbye to you, because you are just a waste of time. Hold onto you fiat currency, don’t buy Bitcoin, I really don’t give a damn🙂

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    In my opinion LTC has a lot of potencial for the sole reason that BTC price will grow beyond of the economic power of average Joe so when people realize they can’t afford bitcoin then LTC comes in scene like second safe heaven just like gold and silver do.

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      Doesn’t make sense.
      While Bitcoin will keep growing, like the article explained, other coins will keep losing ground.
      People will invest on the coin that grants more stability and growth.
      If it’s Bitcoin, and it is, people will migrate on it.
      People that have LTC now will slowly sell it and buy BTC. There’s no escape from this process, unless Bitcoin had to suffer some absurd drama.

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      If it grows more and can retain value over time, it won’t be a “gamble” anymore but a safe haven investment, which is also very good. Also, we’ll probably deal mainly in mBTC denomination in the future if the price goes very high.
      Altcoins will probably retain their value over trading or because they are tied to particular services, but not much more.

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    Seriously, no. You write things like ‘global macro-economics’ but completely misinterpret the implications. I don’t even know where to start. This “institution” has jumped the shark. Tell me how you write about the implications of a new gold standard and the macro-economic aspects and don’t at all refer to 20 years of lectures and writing on the subject by the world’s leading thinking/speaker on Ideal Money, John Nash.

    How do you think you are smart when you ignore this? How can you claim to be reasonable when you completely go against the reasoning and rationality he laid forth?

    You have to do your homework sir.

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      That’s not an argument, sir.

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        “The fact that money has a positive feedback between demand and value implies
        that there cannot normally be a stable equilibrium between two moneys. Any
        initial imbalance between them would tend to expand. If one currency was
        slightly more preferred than the other, people would react to this by
        demanding slightly more. This makes the preferred even more preferable than
        before. Any two moneys will interact in this way, thus leaving one to dominate
        the rest.”

        Do you find this statement true in regard to reality? Do we not function in a world today with many and multiple currencies?

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          I find it true. We have many currencies only insofar as we have many countries and each demands taxes in their own fiat currency. Think of all fiat currencies as one currency bc in effect that is what it is: different flavors of the same currency. What are your currency options for paying for something within a country? Usually just one. Bitcoin is the first really new choice that achieved any kind of scale.

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            Ya, of course the point holds true when you start grouping separate currencies as “one”, but like I point out, that’s not observable reality and its irrational as an argument.

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              I’m only grouping fiat currencies as one currency for my argument because they are the exact same thing and serve the same purpose relative to the country they’re in. If the whole world were one county that used, let’s say, the dollar, you wouldn’t see rival fiat because of the phenomena the author describes.

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                Just to be clear, you are saying that if the whole world used one currency you wouldn’t see a rival fiat?

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                  I am saying if there were one world government with one fiat currency that was used for all taxes everywhere, as fiat is, then you would not have competing currencies. You would still have commodities, and WoW money, and others but you would only have one currency that you could go to any merchant and use to buy goods and services.

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                    And you really can’t see how your premise is your conclusion in that statement?

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                      The premise is that there is one fiat currency used worldwide as part of a one-government world. The conclusion is that this currency would “dominate the rest”, as was first stipulated. Perhaps it was too much to say there would not be competing currencies but I do agree that any other currencies would be dominated by the one fiat.

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                        Your premise of one fiat currency used world wide is identical to your conclusion that suggests such a currency would dominate.

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                          Not really, because we’re talking about things happening over time, and the important point is that such a currency would CONTINUE to dominate for the reason stipulated, if ever the situation of one global fiat arose.

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                            You feel that your conclusion, which is a re-statement of your premise, becomes valid when time is introduced to our inquiry of observable reality?

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                              Yes. Think in terms of the currencies being like cars in a race that has no ending and new cars can enter the race at any time. With a premise of One-World Fiat being the only car at the beginning of the race, the conclusion that One World Fiat will always dominate any new entries to the race is not circular reasoning, if that’s what you were implying.

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                          So what? If that currency is better than all the other ones, this could happen.
                          The only “obstacle” would be that you have to trade “stuff” for that currency, thus another widespread good of exchange would be around anyway, like gold in example.
                          But here we are talking in absolute terms, not in real terms.
                          There will always be some other commodities, but Bitcoin is the “perfect” currency for a number of reasons.
                          You probably know this well already, so why are you insisting like this?

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          All those currencies are mandatory for each country. They are a method of control of population and of countries economy. Wasn’t it for countries lines, there would be a single currency. And Bitcoin goes exactly past those lines.

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            The division of the globe into nations, and the currencies that support such divisions, are necessary in order to foster economic diversity and global sustainability.

            Bitcoin goes past those lines, but it does not erase them. And it does not preclude national money systems.

            Thats a fallacy insincere players like Andreas A. passed around.

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              Bitcoin goes past those lines, and does not need to do anything else.
              Also, Bitcoin IS money, and it’s quite ideal, much more ideal than all the other forms we have had up until now.

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    Your style of writing really gives away the fact that you like to sound a lot smarter than you really are. If you do not see the value of smart contracts then you are just an idiot with an opinion… Seriously. Also, if you think bitcoin is going to replace fiat you are wrong there as well. Bitcoin is evolving into more of a commodity than a currency due to the fact that it is very illiquid, I don’t see that changing anytime soon.

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      Regarding BTC being illiquid, is it easier to pay $98.76 in cash or credit card ? Some (self?) education on the part of the seller and customer is needed for sure but wouldn’t it be easier to pay in BTC than via credit card (,especially with the rapidly improving UI) ?

      Other reasons are

      1. Government compliance that can be bypassed like KYC norms.
      2. Paperwork and other hoops required to jump through tie up with a credit card company (or private sector compliance).
      3. No need for credit history for either party.

      BTC has both the advantages of cash and credit card. The only disadvantage it shares with credit cards is the need for electricity and data transmission connectivity.

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      Why should a smart contract have to reside on a blockchain ? It could easily reside on a redundant array of independent disks on servers around the world.

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      This article made me realize that the nakamoto institution is a sham not based on reason and logic.

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      McDolans – I agree with the commodity/illiquidity aspect of BTC. For now. But that can change in a very short time. This “commodity” could surpass the liquidity of the USD, or any other fiat currency quite soon.

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      McDolans: To whom are are you referring? -To the original author? -Or to reader feedback in one of these comments?

CEO Pay is a Shareholders Issue !!!

CEO Pay is a Shareholders Issue !!!

Meeting-room board alberto balatti maltaway

Presidential candidates once campaigned on taxes, government spending, and foreign policy. But more recently, executive compensation has suddenly become a hot topic for winning the public’s approval. In the U.S., Donald Trump has called high CEO pay “a total and complete joke” and “disgraceful,” arguing that CEOs stack boards with their buddies who rubber-stamp excessive pay. Hillary Clinton has lamented that “There’s something wrong when the average American CEO makes 300 times more than the typical American worker.” And in the UK, Theresa May launched her ultimately successful campaign to become Prime Minister with a speech that proposed to curb executive pay.

Politicians typically make two suggestions for pay reform. First, to cap, or at least force the disclosure of, the ratio of CEO pay to median employee pay. Second, to put pay packages to an employee vote, or as May suggests, put workers on boards.

While I agree that a) in many companies, pay is far from perfect and ought to be reformed, and b) that political leaders are right to be concerned about how wealth is distributed in society, there are a number of problems with the proposed approaches.

It is shareholders who bear the costs of paying the CEO, and so it is unclear whether the government should intervene. A common argument is that high pay has indirect costs — in particular, it incents CEOs to take actions that hurt society. However, there is no evidence that the level of pay indeed has these effects.  While it’s the level of pay that captures politicians’ (and the public’s) attention, it’s the structure of pay which matters more for firm value – for example, whether it vests in the short-term or long-term. Vivian Fang, Katharina Lewellen, and I find that, in quarters in which significant equity vests, CEOs cut R&D and capital expenditure in quarters in which significant equity vests. The electorate will be more impressed by a politician who proposes a headline-grabbing law to halve a CEO’s salary than a politician who extends the vesting horizon from three years to seven years, even though the latter will have a far greater impact on long-term value creation. Moreover, even shareholders didn’t take into account the effect of poorly-designed contracts on CEO actions; it’s not clear why the government should regulate pay rather than these actions themselves – surely the most direct route to curtailing them.

A second motivation to lower pay is to reduce inequality. However, attempts to curtail pay through regulation may backfire. Kevin J. Murphy describes how the entire history of executive compensation regulation is filled with unintended consequences. For example, the forced disclosure of perks in 1978 increased perks as CEOs could see what their peers were receiving; the 1984 law on golden parachutes – a response to a single contract at one firm — catalyzed the adoption of golden parachutes by alerting CEOs without them to their existence; and President Bill Clinton’s $1 million salary cap led to CEOs below the cap raising their salaries to above it, and those above merely reclassified salary as bonus.

Thus, while the motivation to reduce inequality is sound, a focus on pay ratios may have similar unintended consequences – and could even increase inequality. A CEO might reduce his company’s pay ratio by firing low-paid workers, converting them to part-time status, or increasing their cash salary but reducing their non-financial compensation (such as on-the-job training and superior working conditions). A cap could also lead boards to focus on the “optics” of pay (e.g. a low ratio) and ignore more important dimensions, such as performance targets being long-term rather than short-term.

So if capping the pay ratio wouldn’t work, what about putting workers on boards, or submitting CEO pay packages to an employee vote? There are reasons to be skeptical here as well. An employment contract is an extremely complex issue and cannot be whittled down to a simple number such as a pay ratio, which the vote might focus on. It covers topics such as the optimal vesting schedule, the appropriate mix of stock vs. options vs. salary vs. pensions vs. bonuses, whether industry performance be filtered out and, if so, how (indexed options? indexed stock? options on indexed stock? Stock with indexed performance vesting thresholds?) Confused? Well, so might employees be, should CEO pay contracts be put up for a vote.

Companies already have natural incentives to treat employees as valued partners to the business – one of my own studies showed that firms with high employee satisfaction beat their peers by 2-3%/yearEven if boards only cared about maximizing shareholder value, they should be consulting with employees and looking for ways to keep them happy. But there’s a big difference between consulting employees and putting them on the board. Firms do market research consulting customers, but don’t put them on the board. Indeed, Gary Gorton and Frank Schmid found that worker representation on German boards is associated with lower profitability and firm value.

Is the message to do nothing? Far from it. It’s to leave the decisions to major shareholders, who have the expertise and incentives to get these decisions right. After all, high CEO pay comes straight out of shareholder returns, and if the contract causes the CEO to take bad decisions – or demoralizes employees and customers – shareholders suffer the consequences. Unlike regulation, which is one-size-fits-all, shareholders can decide what the optimal pay package is for that particular firm.

And things are being done. We’ve indeed seen a substantial increase in shareholder power. 11 countries have passed say-on-pay legislation since 2002; Ricardo Correa and Uger Lel show in a forthcoming paper in theJournal of Financial Economics that such legislation has led to a significant reduction in pay and an increase in pay-performance sensitivity. We have also seen innovation in other dimensions of pay that are more important than ratios – for example, the lengthening of vesting horizons (to encourage the CEO to think for the long term) and paying executives with debt rather than just equity (to dissuade excessive risk-taking).

Moreover, when pay is inefficient, it is often a symptom of a more underlying corporate governance problem, brought on by conflicted boards and dispersed shareholders. Addressing pay via regulation will solve these symptoms; encouraging independent boards and large shareholders will. That will improve not only pay, but other governance issues.

What about equality? Steven N. Kaplan and Joshua Rauh showed that high CEO pay has actually not been a major cause of the rise in inequality – it’s risen much more slowly than pay in law, hedge funds, private equity, and venture capital. If inequality is truly the concern, it may be better addressed by a high rate of income tax and closing loopholes that tax investments at a lower rate. This will address inequality resulting from all occupations (including sports, entertainment, and trust funds); it’s not clear why CEOs should be singled out.

The bottom line is that, to the extent pay is a problem, it should be shareholders, not politicians or employees, who fix it.

Software is eating the world and the Corporate Boards as well

Software is eating the world and the Corporate Boards as well

  • Less than one in five directors fully understand how the industry dynamics of their companies are changing
  • Board members must increase their Digital Quotient to meaningfully engage senior management
  • We present four guiding principles to close the knowledge gap and drive organizational success

software board maltaway

“Software is eating the world,” veteran digital entrepreneur Marc Andreessen quipped a few years back. Today’s boards are getting the message. They have seen how leading digital players are threatening incumbents, and among the directors we work with, roughly one in three say that their business model will be disrupted in the next five years.

In a 2015 McKinsey survey, though, only 17 percent of directors said their boards were sponsoring digital initiatives, and in earlier McKinsey research, just 16 percent said they fully understood how the industry dynamics of their companies were changing.1In our experience, common responses from boards to the shifting environment include hiring a digital director or chief digital officer, making pilgrimages to Silicon Valley, and launching subcommittees on digital.

Valuable as such moves can be, they often are insufficient to bridge the literacy gap facing boards—which has real consequences. There’s a new class of problems, where seasoned directors’ experiences managing and monetizing traditional assets just doesn’t translate. It is a daunting task to keep up with the growth of new competitors (who are as likely to come from adjacent sectors as they are from one’s own industry), rapid-fire funding cycles in Silicon Valley and other technology hotbeds, the fluidity of technology, the digital experiences customers demand, and the rise of nontraditional risks. Many boards are left feeling outmatched and overwhelmed.

To serve as effective thought partners, boards must move beyond an arms-length relationship with digital issues (exhibit). Board members need better knowledge about the technology environment, its potential impact on different parts of the company and its value chain, and thus about how digital can undermine existing strategies and stimulate the need for new ones. They also need faster, more effective ways to engage the organization and operate as a governing body and, critically, new means of attracting digital talent. Indeed, some CEOs and board members we know argue that the far-reaching nature of today’s digital disruptions—which can necessitate long-term business-model changes with large, short-term costs—means boards must view themselves as the ultimate catalysts for digital transformation efforts. Otherwise, CEOs may be tempted to pass on to their successors the tackling of digital challenges.

At the very least, top-management teams need their boards to serve as strong digital sparring partners when they consider difficult questions such as investments in experimental initiatives that could reshape markets, or even whether the company is in the right business for the digital age. Here are four guiding principles for boosting the odds that boards will provide the digital engagement companies so badly need.

Close the insights gap

Few boards have enough combined digital expertise to have meaningful digital conversations with senior management. Only 116 directors on the boards of the Global 300 are “digital directors.”2The solution isn’t simply to recruit one or two directors from an influential technology company. For one thing, there aren’t enough of them to go around. More to the point, digital is so far-reaching—think e-commerce, mobile, security, the Internet of Things (IoT), and big data—that the knowledge and experience needed goes beyond one or two tech-savvy people.

To address these challenges, the nominating committee of one board created a matrix of the customer, market, and digital skills it felt it required to guide its key businesses over the next five to ten years. Doing so prompted the committee to look beyond well-fished pools of talent like Internet pure plays and known digital leaders and instead to consider adjacent sectors and businesses that had undergone significant digital transformation. The identification of strong new board members was one result. What’s more, the process of reflecting quite specifically on the digital skills that were most relevant to individual business lines helped the board engage at a deeper level, raising its collective understanding of technology and generating more productive conversations with management.

Special subcommittees and advisory councils can also narrow the insights gap. Today, only about 5 percent of corporate boards in North America have technology committees.3While that number is likely to grow considerably, tomorrow’s committees may well look different from today’s. For example, some boards have begun convening several subject-specific advisory councils on technology topics. At one consumer-products company, the board created what it called an advisory “ecosystem”—with councils focused on technology, finance, and customer categories—that has provided powerful, contextual learning for members. After brainstorming how IoT-connected systems could reshape the consumer experience, for example, the technology council landed on a radical notion: What would happen if the company organized the business around spaces such as the home, the car, and the office rather than product lines? While the board had no set plans to impose the structure on management, simply exploring the possibilities with board members opened up fresh avenues of discussion with the executive team on new business partners, as well as new apps and operating systems.

Understand how digital can upend business models

Many boards are ill equipped to fully understand the sources of upheaval pressuring their business models. Consider, for example, the design of satisfying, human-centered experiences: it’s fundamental to digital competition. Yet few board members spend enough time exploring how their companies are reshaping and monitoring those experiences, or reviewing management plans to improve them.

One way to find out is by kicking the tires. At one global consumer company, for instance, some board members put beta versions of new digital products and apps through the paces to gauge whether their features are compelling and the interface is smooth. Those board members gain hands-on insights and management gets well-informed feedback.

Board members also should push executives to explore and describe the organization’s stock of digital assets—data that are accumulating across businesses, the level of data-analytics prowess, and how managers are using both to glean insights. Most companies underappreciate the potential of pattern analysis, machine learning, and sophisticated analytics that can churn through terabytes of text, sound, images, and other data to produce well-targeted insights on everything from disease diagnoses to how prolonged drought conditions might affect an investment portfolio. Companies that best capture, process, and apply those insights stand to gain an edge.4

Digitization, meanwhile, is changing business models by removing cost and waste and by stepping up the organization’s pace. Cheap, scalable automation and new, lightweight IT architectures provide digital attackers the means to strip overhead expenses and operate at a fraction of incumbents’ costs. Boards must challenge executives to respond since traditional players’ high costs and low levels of agility encourage players from adjacent sectors to set up online marketplaces, disrupt established distributor networks, and sell directly to their customers.

The board of one electronic-parts manufacturer, for example, realized it was at risk of losing a significant share of the company’s customer base to a fast-growing, online industrial distributor unless it moved quickly to beef up its own direct e-commerce sales capabilities. The competitor was offering similar parts at lower prices, as well as offering more customer-friendly features such as instant online quotes and automated purchasing and inventory-management systems. That prompted the board to push the CEO, chief information officer, and others for metrics and reports that went beyond traditional peer comparisons. By looking closely at the cycle times and operating margins of digital leaders, boards can determine whether executives are aiming high enough and, if not, they can push back—for example, by not accepting run-of-the-mill cost cuts of 10 percent when their companies could capture new value of 50 percent or even more by meeting attackers head-on.

Engage more frequently and deeply on strategy and risk

Today’s strategic discussions with executives require a different rhythm, one that matches the quickening pace of disruption. A major cyberattack can erase a third of a company’s share value in a day, and a digital foe can pull the rug out from a thriving product category in six months. In this environment, meeting once or twice a year to review strategy no longer works. Regular check-ins are necessary to help senior company leaders negotiate the tension between short-term pressures from the financial markets and the longer-term imperative to launch sometimes costly digital initiatives.

One company fashioned what the board called a “tight–loose” structure, blending its normal sequence of formal meetings and management reporting with new, informal methods. Some directors now work in a tag team with a particular function and business leader, with whom they have a natural affinity in business background and interests. These relationships have helped directors to better understand events at ground level and to see how the culture and operating style is evolving with the company’s digital strategy. Over time, such understanding has also generated greater board-level visibility into areas where digitization could yield new strategic value, while putting the board on more solid footing in communicating new direction and initiatives to shareholders and analysts.

Boardroom dialogue shifts considerably when corporate boards start asking management questions such as, “What are the handful of signals that tell you that an innovation is catching on with customers? And how will you ramp up customer adoption and decrease the cost of customer acquisition when that happens?” By encouraging such discussions, boards clarify their expectations about what kind of cultural change is required and reduce the hand-wringing that often stalls digital transformation in established businesses. Such dialogue also can instill a sense of urgency as managers seek to answer tough questions through rapid idea iteration and input gathering from customers, which board members with diverse experiences can help interpret. At a consumer-products company, one director engages with sales and marketing executives monthly to check their progress against detailed key performance indicators (KPIs) that measure how fast a key customer’s segments are shifting to the company’s digital channels.

Risk discussions need rethinking, too. Disturbingly, in an era of continual cyberthreats, only about one in five directors in our experience feels confident that the necessary controls, metrics, and reporting are in place to address hacker incursions. One board subcommittee conducted an intensive daylong session with the company’s IT leadership to define an acceptable risk appetite for the organization. Using survey data, it discovered that anything beyond two minutes of customer downtime each month would significantly erode customer confidence. The board charged IT with developing better resilience and response strategies to stay within the threshold.

Robust tech tools, meanwhile, can help some directors get a better read on how to confront mounting marketplace risks arising from digital players. At one global bank, the board uses a digital dashboard that provides ready access to ten key operational KPIs, showing, for example, the percentage of the bank’s daily service transactions that are performed without human interaction. The dashboard provides important markers (beyond standard financial metrics) for directors to measure progress toward the digitized delivery of banking services often provided by emerging competitors.

Fine-tune the onboarding and fit of digital directors

In their push to enrich their ranks with tech talent, boards inevitably find that many digital directors are younger, have grown up in quite different organizational cultures, and may not have had much or even any board experience prior to their appointment. To ensure a good fit, searches must go beyond background and skills to encompass candidates’ temperament and ability to commit time. The latter is critical when board members are increasingly devoting two to three days a month of work, plus extra hours for conference calls, retreats, and other check-ins.

We have seen instances where companies choose as a board member a successful CEO from a digitally native company who thrives on chaos and plays the role of provocateur. However, in a board meeting with ten other senior leaders, a strong suit in edginess rarely pays off. New digital directors have to be able to influence change within the culture of the board and play well with others. There are alternatives, though. If a promising candidate can’t commit to a directorship or doesn’t meet all the board’s requirements, an advisory role can still provide the board with valuable access to specialized expertise.

Induction and onboarding processes need to bridge the digital–traditional gap, as well. One board was thrilled to lock in the appointment of a rising tech star who held senior-leadership positions at a number of prominent digital companies. The board created a special onboarding program for her that was slightly longer than the typical onboarding process and delved into some topics in greater depth, such as the legal and fiduciary requirements that come with serving on a public board. Now that the induction period is over, she and the board chairman still meet monthly so she can share her perspectives and knowledge as a voice of the customer, and he can offer his institutional insights. The welcoming, collaborative approach has made it possible for the new director to be an effective board participant from the start.

Organizations also need to think ahead about how the digital competencies of new and existing directors will fit emerging strategies. One company determined that amassing substantial big data assets would be critical to its strategy and acquired a Silicon Valley big data business. The company’s directors now attend sessions with the acquired company’s management team, allowing them to get a grounding in big data and analytics. These insights have proven valuable in board discussions on digital investments and acquisition targets.

Board members need to increase their digital quotient if they hope to govern in a way that gets executives thinking beyond today’s boundaries. Following the approaches we have outlined will no doubt put some new burdens on already stretched directors. However, the speed of digital progress confronting companies shows no sign of slowing, and the best boards will learn to engage executives more frequently, knowledgeably, and persuasively on the issues that matter most.

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