Archive for July 2011

Corporate form and pay-for-performance contracts

"The Case for For-Profit Charities"
Anup Malani and Eric Posner
http://www.virginialawreview.org/content/pdfs/93/2017.pdf

Eric Posner (the son of Judge Posner) writes about an interesting discrepancy in tax treatment of for-profit and nonprofit firms. Nonprofits that perform social services, meaning services that are not designed primarily for the purpose of generating profit for the firm's owners, receive a tax break. When nonprofits engage in commercial services, however, that tax break is withdrawn; they are treated, effectively, as for-profit firms. For-profits that engage in social service work, however, do not receive the same tax breaks that nonprofits do when they engage in the same activity. The tax breaks ascribe to the corporate form rather than to its function. Posner argues that the function should control the tax breaks.

However, as Posner points out, some for-profits receive financial incentives from the government for delivering some public goods. For example, the government subsidizes alternative energy producers.

It's interesting to examine how the agency theory, which Posner describes in the article, pertains to social impact bonds. Agency theory says that in a model with an entrepreneur, a donor, and a beneficiary, if the entrepreneur runs a for-profit firm, then the money she she has the incentive to keep as much as possible of the money she receives from the donor to deliver as a product to the beneficiary. If the donor gives the entrepreneur $100, with the understanding that the entrepreneur will keep $10 for herself, spend $10 on operations, and deliver $80 to the beneficiary, then the entrepreneur wants to keep more than $10, which means either delivering less than $80 or spending less than $10 on overhead, or both. In a nonprofit, however, the entrepreneur does not get to keep the profit, and therefore has less incentive to underdeliver on the services that she provides to the beneficiary.

Posner writes about the problematic agency relationship: "Technically speaking, this means the entrepreneur sells a product (transferring charitable money to a beneficiary) whose quality (getting 80% to the beneficiary) is nonverifiable, that is, cannot be stipulated in a contract that is enforceable by a court" (p. 2032).

Now imagine an entirely different model, one describing ex-post payment for performance.  In this model, the donor announces his intention to pay to any entrepreneur $100 for each $80-worth of service that she can deliver to the beneficiary.  One example can be a donor willing to pay a company $100 for each $80 vaccine that the latter will purchase, deliver, administer, and document in a developing country.  The entrepreneur has not yet incorporated her efforts in either a nonprofit or for-profit corporate form.  The question of which form to choose now seems less relevant to her.  If she thinks that she can carry out the task by spending, say, $17, then she should expect to get a profit of $3.  If this profit is above her expected opportunity cost (presumably she is choosing from among several projects), then she will take the donor up on his offer; the lower she expects her overhead to be, the greater her profit and the more incentive she has to take the offer.  She should become agnostic about corporate form, since she will simply set her salary at the $100 less the expected overhead.  The only concern is that the salary will appear excessive.  But that seems to be the donors concern, since he is the one who would have lost money he could have otherwise saved by mispricing his offer.

While the entrepreneur is now agnostic about corporate form, the donor is not.  The donor can deduct his gift to a nonprofit, but not to a for-profit, and therefore prefers that the entrepreneur's efforts take the latter form.  

Bosses

Rob #1 interviewed on NPR recently;
EPA Issues New Standards For Coal-Burning Plants : NPR.

Rob #2 interviewed for the upcoming Trinidad energy conference. The conference will also feature his op-ed on the CDM mechanism, which I helped with.

"What if there was an international policy on how countries should deal with emissions? Robert C. Stowe, executive director of the Harvard Environmental Economics Program and Manager of the Harvard Project on international climate agreements said there must be partnering when it comes to solving the problem of climate change. He contends though, that the greatest challenge to collective action lies in designing an international policy. Substantiating his point and referring to the United Nations Framework Convention on Climate Change (UNFCCC) he said though he was disappointed with the outcome, the Copenhagen Accord, which came out of the conference was: “an important step forward for international climate policy. Commenting further on UNFCCC he said the results “fell short of expectations at the Copenhagen Summit last December. Many were hoping for solid progress toward an agreement to succeed and go beyond the 1997 Kyoto Protocol. Instead, the Copenhagen Accord simply recognises climate change as a challenge and concluded that action is needed to limit global temperature increases.

A manager of the Harvard Project on climate agreements since 2007, Dr Stowe said the project’s goal is to identify public policy options for addressing global climate change. The project conducts research on policy architecture, key design elements and institutional dimensions of domestic climate policy and a post-2012 international climate policy regime. Referring to the Caribbean, Dr Stowe said emissions from the Caribbean are not really a big part of the climate change problem “There are opportunities in the Caribbean for expanding participation in so-called "offset programs"--the most important of which is the Clean Development Mechanism,” he said. Dr Stowe would be part of a panel discussion on DAY Two."
http://www2.guardian.co.tt/business/2011/02/06/themes-energy-conference-2011

Bill Keller on why we write

"Writers write them for reasons that usually have a little to do with money and not as much to do with masochism as you might think. There is real satisfaction in a story deeply told, a case richly argued, a puzzle meticulously untangled. (Note the tense. When people say they love writing, they usually mean they love having written.)"


"Let’s Ban Books, or at Least Stop Writing Them"
Bill Keller
July 13, 2011


I disagree with Bill Keller's parenthetical observation.  Writers often love the finished product, and undoubtedly strive to it, but many, including me, love the process of writing itself.  Stanley Fish, another New York Times columnist and professor of many things including English, once wrote how one author recalled during an interview his reason for writing.  I just love composing words into sentences, the writer said.  And there you have it: the process, rather than only the finished product, drives this man.  (Stanley Fish also recently wrote How to Write a Sentence.) 

There is a power in a sentence--and power, too, in crafting one.  How many writers pen sentences only to strike them and try, try again.  How many more are in the throes of writing rather than the relaxed state of completion.  So perhaps Bill Keller's observation should be not that real satisfaction exists in a "story deeply told," but rather in the telling.

Nancy Lublin's Advice to Nonprofits

The Economist recently interviewed Nancy Lublin, who founded Dress for Success and runs dosomething.org, about nonprofits. I disagree with the way Nancy characterizes one piece of advice that she gave to her listeners. She suggests, toward the end of the interview, that nonprofits do a good job of breaking out their SG&A, the sales, general and administrative costs that they incur as part of their normal operations, whereas for-profits are opaque and report them as one lumped category.

First, if a for-profit's financial statements to the SEC, the 10-K and the 10-Q, do not break out SG&A, that does not mean that the company does not break out these costs in internal memos to its employees.  Companies could, and I am sure that some do, explain some expenses internally at a greater length than they explain them to outsiders.

Second, the extent to which nonprofits must break out their administrative expenses on their 990 forms to the SEC is regulated by law.  The detail into which nonprofits go, therefore, is not necessarily the detail to which they would have liked to go if they had been given the choice.

Third, I doubt that many nonprofits distribute the 990s to their employees, teach them how to read those forms, or even that all employees of large nonprofits are aware that these forms exist.  These forms are not the most complex financial disclosure documents, but they do require a level of financial literacy to understand (plus one must know where to find these forms).  Therefore, it is not necessarily the case that nonprofit employees know how much their organization spent on, say, postage, as Nancy Lublin claims.

Overall, although greater financial disclosure does offer some benefits -- such as keeping runaway spending in check -- nonprofits are not the shining beacon of financial disclosure that Nancy, for a brief second, made them appear to be.