The Greed Cycle

Article Review - "The Greed Cycle" By: John Cassidy

This article covers the progression of the modern day corporation. It covers that role that greed has played in the publicly traded company's evolution, as well as the relationship between managers and stockholders with compensation being the root of the issue.

According to the article, the first public company was founded in 1814 by Francis Cabot Lowell. With plans in hand, he could not afford the full construction of himself so he sold stock in his company to 10 people. Seven years later each of the stockholders received a return of more than 100 percent. Lowell had now created a new business model that would evolve into the stock market that we know today. (Cassidy 2)

Initial concerns over the new business model the relationship between the managers and the stockholders. What was going to keep the stockholders interest a forefront concern for managers? What would keep them treating everyday operations as if it was their own investment or even what was preventing them for taking some of the money as their own? Even with such concerns, financial necessity for large ventures such as the development of the railroad made this model the norm and the stock market grew. (Cassidy 2)

In 1929 when the stock market crashed activities such as insider trading, stock price manipulation, and diversion of corporate funds for personal use was uncovered. This led to the first government regulations. The Securities Act of 1933 was enacted to outlaw insider trading and attempts to manipulate the market. Additionally a year later in 1934 the Securities Exchange Commission was created to enforce the regulations. Public confidence slowly returned but the problem was fully resolved and many issues pointed to the compensation of the managers. The pay of CEO's was typically equivalent to the size of the firm. During this period it was more about rapid expansion, in most cases a bigger company equaled larger salary. Money was being mismanaged and spent on lavish offices and trips versus the company's profitability. The issue of managers not keeping the best interest of the stockholders a priority still lingered. (Cassidy 3)

Per the article is was financial economists Michael Jensen and William Meckling who began to argue the it wasn't the employees or managers that were the most important factor in a public firm, but the stockholders. This is where the "principal-agent problem" came into question. In the case of public firms, how could the stockholders ensure and guarantee that the managers hired to run the company act in the best interest of the shareholders? It became a struggle of power and a principal-agent problem. Jensen and Meckley insisted that that is was near impossible to ally the interests. There consensus was that managers would destroy values of organizations. Eventually their logic was heard and the principal agent theory led the decision to reward executives for acting in the best interests of the stockholders. This was in hopes of maximizing the value of the firm. (Cassidy 4)

With the value of the shareholder in the spotlight many private investors were drawn in by greed and the concept of hostile takeovers started to occur. Leveraged buyouts or LBO's became common. In an LBO, an investor would buyout public stockholders and in turn run that company as if it were a private firm. Non profitable divisions