Markets versus firms
The whole point of free market capitalism is that actions are directed by market prices and that this in turn ensures an efficient economy. But consider this: when a business firm instructs an employee to transfer from one department to another the employee is not obeying market prices, he transfers because he is told to. This is not free market capitalism. So why does it happen?
This question was asked by the British economist Ronald Coase who won the Nobel prize in economics in 1991 based on his research on the matter. I first read about this fascinating idea in last week's The Economist magazine. I found it fascinating, not least because it gave me some insights into the perennial question of whether large state owned enterprises (SOEs) and government related entities (GREs) should exist, at least at their current sizes, in an efficient economy. Here I am talking simply about the economics and efficiency of the market and not about any other policy matters. These ideas are based on Mr Coase's work but do not necessarily reflect his thinking.
The idea of an efficient market was introduced by Adam Smith, the Scottish philosopher considered to be the father of modern economics. Smith used the phrase “invisible hand” to describe the theory that if each consumer is allowed to buy whatever they want and each producer is allowed to sell whatever they want then this would result in an optimal allocation of resources and setting of prices that would benefit the economy as a whole. This optimality is what is now known as Pareto optimal, ie any reallocation of resources that makes one market participant better off would necessarily make at least one other participant worse off.
From this definition we see that for each consumer to buy what they want and each producer to sell what they want it would imply that each person works as an individual contractor and that they would contract with other market participants whenever they needed a good or service. This leads to Mr Coase’s question: why, then, do firms exist?
His answer is that firms exist when there are high costs to using the market. For example, in many countries it is legal and common for taxi drivers to be self-employed. The quality of the service is clear before a client gets in the car, indeed most markets require standardised cars. The fares are standardised and clear, visible on a meter. Client acquisition is simple, drive around until someone hails you. There might be benefits from collective bargaining, say on insurance, but there is no reason to believe that if there are enough self-employed taxi drivers then there won’t be competition amongst insurers to provide for this client segment. The costs of using this market are therefore low.
But what happens if we remove standardisation? At its most basic level, what happens if instead of employing people full time we employ them for specific jobs? If you’ve ever had to hire a consultant, individual or firm, you will understand the concept of the scope of work which outlines in detail what is required from the contractor. This has to be developed and negotiated on a case by case basis. There is also a listing of legal rights and responsibilities, with remedies and indemnification if anyone’s rights are breached. This also has to be negotiated on a case by case basis.
These costs would simply take up all of a person’s time. They would not be able to actually do productive work. This is why employment contracts do not specify in full detail all of these points, it would be exhausting to renegotiate every time an employee’s job changes. This is where markets fail, when there is no standardisation or there is uncertainty. An employment contract has to therefore be relatively vague if it is to be efficient and both employee and employer have to trust the contract. This is why a firm exists, to regulate non market compliant but nevertheless efficient transactions.
Consider a large endowment, fictional for this exercise. This endowment is managed by a sophisticated investment office (IO) and overseen by a board of trustees (BoT). The IO has previously submitted a plan to the BoT which was to develop a multi-strategy multi-asset class portfolio via allocations to investment managers (IMs) globally. Over the years the portfolio has done well, but the IO realises that they are paying away large amounts of fees, often 2 per cent of assets and 20 per cent of profits. These are high transaction costs. So why not expand the firm to internalise the investment managers and therefore reduce these high transaction costs?
The IO submits a plan to the BoT, who approve, and the IO starts to hire in IM teams to directly invest in the global markets. As the years pass, the performance of the portfolio starts to deteriorate. There are more and more internal portfolio blowups. What is happening?
Well, although the firm can reduce transaction costs, remember that it is the market that imposes efficiency. When an IM is external, they have to compete with other IMs for allocation. This incentivises them to keep innovating and to remain efficient. Once the IMs are internalised then they no longer have an incentive to innovate, the money is locked in. So the portfolio performance deteriorates. Perhaps one way to motivate the internal IMs is to pay them 2/20 again. It invariably always happens.
The more frightening issue is why are there portfolio blowups in which large amounts of money are lost in a short amount of time. An internal audit and review highlights something that was completely missed by the IO’s plan: governance. When the IMs where external then the IO acted in a governance capacity, performing regular due diligence on the IMs and holding them accountable. In addition, other investors are performing due diligence on the external IMs so there is an even higher probability of negative issues being highlighted.
When the IMs are internalised the IO becomes the IM. The IO attempted to create a risk function, but you know how it is. The IMs kept complaining that the risk function is holding them back. You see, the chief executive does not control the investment portfolio, the chief investment officer (CIO) does. I should know, I’ve been CIO three times in my life.
The BoT, who are supposed to only be responsible for the corporate governance of the IO, are now also responsible for the investment governance since the IO forgot that its responsibility was to protect the portfolio and not enrich themselves.
Thankfully this is an account of a completely fictional endowment.
The lesson here is that as the size of a firm increases, its transaction costs increase but its innovation and efficiency decrease. There is a happy equilibrium at some point. For an economy of our size, I’d be guessing wildly if I said that this equilibrium is probably well south of US$10 billion for a directly managed balance sheet, although the amounts managed externally can be unlimited.
Importantly, a firm should either be a manager of managers or a single, direct operator. The corporate governance and risk management can otherwise be weakened, severely.
U19 WORLD CUP, WEST INDIES
UAE group fixtures (all in St Kitts)
Saturday 15 January: v Canada
Thursday 20 January: v England
Saturday 22 January: v Bangladesh
UAE squad
Alishan Sharafu (captain), Shival Bawa, Jash Giyanani, Sailles Jaishankar, Nilansh Keswani, Aayan Khan, Punya Mehra, Ali Naseer, Ronak Panoly, Dhruv Parashar, Vinayak Raghavan, Soorya Sathish, Aryansh Sharma, Adithya Shetty, Kai Smith
The specs
BMW M8 Competition Coupe
Engine 4.4-litre twin-turbo V8
Power 625hp at 6,000rpm
Torque 750Nm from 1,800-5,800rpm
Gearbox Eight-speed paddleshift auto
Acceleration 0-100kph in 3.2 sec
Top speed 305kph
Fuel economy, combined 10.6L / 100km
Price from Dh700,000 (estimate)
On sale Jan/Feb 2020
Rooney's club record
At Everton Appearances: 77; Goals: 17
At Manchester United Appearances: 559; Goals: 253
What is Reform?
Reform is a right-wing, populist party led by Nigel Farage, a former MEP who won a seat in the House of Commons last year at his eighth attempt and a prominent figure in the campaign for the UK to leave the European Union.
It was founded in 2018 and originally called the Brexit Party.
Many of its members previously belonged to UKIP or the mainstream Conservatives.
After Brexit took place, the party focused on the reformation of British democracy.
Former Tory deputy chairman Lee Anderson became its first MP after defecting in March 2024.
The party gained support from Elon Musk, and had hoped the tech billionaire would make a £100m donation. However, Mr Musk changed his mind and called for Mr Farage to step down as leader in a row involving the US tycoon's support for far-right figurehead Tommy Robinson who is in prison for contempt of court.
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MOST%20POLLUTED%20COUNTRIES%20IN%20THE%20WORLD
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more from Janine di Giovanni
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The years Ramadan fell in May
Super Bowl LIII schedule
What Super Bowl LIII
Who is playing New England Patriots v Los Angeles Rams
Where Mercedes-Benz Stadium in Atlanta, United States
When Sunday (start time is 3.30am on Monday UAE time)
The Little Things
Directed by: John Lee Hancock
Starring: Denzel Washington, Rami Malek, Jared Leto
Four stars
Company%20profile
%3Cp%3E%3Cstrong%3EName%3A%3C%2Fstrong%3E%20Belong%3Cbr%3E%3Cstrong%3EBased%3A%3C%2Fstrong%3E%20Dubai%3Cbr%3E%3Cstrong%3EFounders%3A%3C%2Fstrong%3E%20Michael%20Askew%20and%20Matthew%20Gaziano%3Cbr%3E%3Cstrong%3ESector%3A%3C%2Fstrong%3E%20Technology%3Cbr%3E%3Cstrong%3ETotal%20funding%3A%3C%2Fstrong%3E%20%243.5%20million%20from%20crowd%20funding%20and%20angel%20investors%3Cstrong%3E%3Cbr%3ENumber%20of%20employees%3A%3C%2Fstrong%3E%2012%3C%2Fp%3E%0A
The specs: 2018 Mercedes-Benz GLA
Price, base / as tested Dh150,900 / Dh173,600
Engine 2.0L inline four-cylinder
Transmission Seven-speed automatic
Power 211hp @ 5,500rpm
Torque 350Nm @ 1,200rpm
Fuel economy, combined 6.4L / 100km
Global state-owned investor ranking by size
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United States
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China
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3.
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UAE
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4.
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Japan
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5
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Norway
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Canada
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Singapore
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Australia
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Saudi Arabia
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South Korea
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F1 The Movie
Starring: Brad Pitt, Damson Idris, Kerry Condon, Javier Bardem
Director: Joseph Kosinski
Rating: 4/5
Everton%20Fixtures
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What can victims do?
Always use only regulated platforms
Stop all transactions and communication on suspicion
Save all evidence (screenshots, chat logs, transaction IDs)
Report to local authorities
Warn others to prevent further harm
Courtesy: Crystal Intelligence
Honeymoonish
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Breast cancer in men: the facts
1) Breast cancer is men is rare but can develop rapidly. It usually occurs in those over the ages of 60, but can occasionally affect younger men.
2) Symptoms can include a lump, discharge, swollen glands or a rash.
3) People with a history of cancer in the family can be more susceptible.
4) Treatments include surgery and chemotherapy but early diagnosis is the key.
5) Anyone concerned is urged to contact their doctor
History's medical milestones
1799 - First small pox vaccine administered
1846 - First public demonstration of anaesthesia in surgery
1861 - Louis Pasteur published his germ theory which proved that bacteria caused diseases
1895 - Discovery of x-rays
1923 - Heart valve surgery performed successfully for first time
1928 - Alexander Fleming discovers penicillin
1953 - Structure of DNA discovered
1952 - First organ transplant - a kidney - takes place
1954 - Clinical trials of birth control pill
1979 - MRI, or magnetic resonance imaging, scanned used to diagnose illness and injury.
1998 - The first adult live-donor liver transplant is carried out
Top financial tips for graduates
Araminta Robertson, of the Financially Mint blog, shares her financial advice for university leavers:
1. Build digital or technical skills: After graduation, people can find it extremely hard to find jobs. From programming to digital marketing, your early twenties are for building skills. Future employers will want people with tech skills.
2. Side hustle: At 16, I lived in a village and started teaching online, as well as doing work as a virtual assistant and marketer. There are six skills you can use online: translation; teaching; programming; digital marketing; design and writing. If you master two, you’ll always be able to make money.
3. Networking: Knowing how to make connections is extremely useful. Use LinkedIn to find people who have the job you want, connect and ask to meet for coffee. Ask how they did it and if they know anyone who can help you. I secured quite a few clients this way.
4. Pay yourself first: The minute you receive any income, put about 15 per cent aside into a savings account you won’t touch, to go towards your emergency fund or to start investing. I do 20 per cent. It helped me start saving immediately.
Key facilities
- Olympic-size swimming pool with a split bulkhead for multi-use configurations, including water polo and 50m/25m training lanes
- Premier League-standard football pitch
- 400m Olympic running track
- NBA-spec basketball court with auditorium
- 600-seat auditorium
- Spaces for historical and cultural exploration
- An elevated football field that doubles as a helipad
- Specialist robotics and science laboratories
- AR and VR-enabled learning centres
- Disruption Lab and Research Centre for developing entrepreneurial skills
RACE CARD
6.30pm: Baniyas Group 2 (PA) Dh 97,500 (Dirt) 1,400m.
7.05pm Maiden (TB) Dh 82,500 (D) 1,200m
7.40pm Maiden (TB) Dh 82,500 (D) 1,400m
8.15pm Handicap (TB) Dh 82,500 (D) 1,400m
8.50pm Rated Conditions (TB) Dh 120,000 (D) 1,600m
9.25pm Handicap (TB) Dh 95,000 (D) 1,200m
10pm Handicap (TB) Dh 85,000 (D) 2,000m
Company%20Profile
%3Cp%3E%3Cstrong%3ECompany%20name%3A%3C%2Fstrong%3E%20Hoopla%3Cbr%3E%3Cstrong%3EDate%20started%3A%20%3C%2Fstrong%3EMarch%202023%3Cbr%3E%3Cstrong%3EFounder%3A%3C%2Fstrong%3E%20Jacqueline%20Perrottet%3Cbr%3E%3Cstrong%3EBased%3A%3C%2Fstrong%3E%20Dubai%3Cbr%3E%3Cstrong%3ENumber%20of%20staff%3A%3C%2Fstrong%3E%2010%3Cbr%3E%3Cstrong%3EInvestment%20stage%3A%20%3C%2Fstrong%3EPre-seed%3Cbr%3E%3Cstrong%3EInvestment%20required%3A%3C%2Fstrong%3E%20%24500%2C000%3C%2Fp%3E%0A
Benefits of first-time home buyers' scheme
- Priority access to new homes from participating developers
- Discounts on sales price of off-plan units
- Flexible payment plans from developers
- Mortgages with better interest rates, faster approval times and reduced fees
- DLD registration fee can be paid through banks or credit cards at zero interest rates
UAE currency: the story behind the money in your pockets
Killing of Qassem Suleimani
Killing of Qassem Suleimani
MATCH INFO
Maratha Arabians 107-8 (10 ovs)
Lyth 21, Lynn 20, McClenaghan 20 no
Qalandars 60-4 (10 ovs)
Malan 32 no, McClenaghan 2-9
Maratha Arabians win by 47 runs
UAE currency: the story behind the money in your pockets
MATCH INFO
Uefa Champions League semi-final, first leg
Tottenham v Ajax, Tuesday, 11pm (UAE).
Second leg
Ajax v Tottenham, Wednesday, May 8, 11pm
Games on BeIN Sports
'THE WORST THING YOU CAN EAT'
Trans fat is typically found in fried and baked goods, but you may be consuming more than you think.
Powdered coffee creamer, microwave popcorn and virtually anything processed with a crust is likely to contain it, as this guide from Mayo Clinic outlines:
Baked goods - Most cakes, cookies, pie crusts and crackers contain shortening, which is usually made from partially hydrogenated vegetable oil. Ready-made frosting is another source of trans fat.
Snacks - Potato, corn and tortilla chips often contain trans fat. And while popcorn can be a healthy snack, many types of packaged or microwave popcorn use trans fat to help cook or flavour the popcorn.
Fried food - Foods that require deep frying — french fries, doughnuts and fried chicken — can contain trans fat from the oil used in the cooking process.
Refrigerator dough - Products such as canned biscuits and cinnamon rolls often contain trans fat, as do frozen pizza crusts.
Creamer and margarine - Nondairy coffee creamer and stick margarines also may contain partially hydrogenated vegetable oils.
MATCH INFO
Fixture: Thailand v UAE, Tuesday, 4pm (UAE)
TV: Abu Dhabi Sports