ericjwang.com

Ruler and minister

tl;dr:

大道廢，有仁義。
智慧出，有大偽。
六親不和，有孝慈。
國家昏亂，有忠臣。

When the Great Way was abandoned,
there appeared benevolence and righteousness.
When wisdom and shrewdness emerged,
there appeared great pretension.
When family relations fell into disharmony,
there appeared tenderness and filial piety.
When states fell into disorder,
there appeared loyal ministers.

Laozi 18 (c. 600 BC)

Consider the following three manifestations of principal-agent problems in organizations.

How may we eliminate such problems effectively? The laziest and least effective approach would be to hector people for responding rationally to incentives.

One frequently encounters people who believe that man is faced always with the opportunity to profit at the expense of the whole, and that society functions precisely because he chooses not do this for higher reason. In this model, it is the public virtue of many individuals that holds society together, sociopaths can get ahead simply by compromising their moral principles, and cultural changes corrosive to this virtue are highly dangerous. Whenever outcomes fall short of expectations, it is ascribe to a deficit of virtue in the people involved.

It is easy to lodge objections to this worldview. Empirically, it seems that unlike opportunities for sin, opportunities for significant private profit at public expense are difficult to come by; more often, they are hallucinated by people trying to explain their relative lack of success. Moreover, it seems like we already live in a culture without shared moral values, where most people more concerned with their own interests than in a quest to realize their ideals of selflessness. Most importantly, I would argue that widespread striving for public virtue over private interest an essentially poisonous ideal that cripples man’s ability to exercise his own judgment.

Consider the following gloss of Laozi 18 above:

What the Laozi argues is that public virtue and exploitation are coextensive. This is especially clear in American capitalism, where an organization’s legitimacy derives from its ability to maximize shareholder value, and any other “mission” is a convenient fiction. The modern exemplar of public-spiritedness is the long-suffering infrastructure engineer who is beset by endless obligations and commitments to teams and services that “depend on him,” who is kept on his treadmill of misery by a carefully timed trickle of badges and raises, and who can only cry himself to sleep when reflects on the endless bureaucratic nightmare his life has become.

What virtue is loyalty in conditions like these? Man is not ruled entirely by self-interest — but this may not be a good thing.

Public virtue arises in the gap between the interest of the parts and the interest of the whole; it is a ramshackle mechanism, cobbled together from prehistoric reciprocity norms, that convinces individuals to identify their interests with those of the organization around them. That public virtue is an ostensibly universal ideal symptomatizes a deep, longstanding, and all-pervading plague of dysfunctional organizations that are out of alignment with the people they contain — the “abandonment of the Way.”

Consider the implications for tech startups. When a founder sets out to build an startup on public virtue rather than private interest, and seeks to hire “loyal” employees over “strategic” ones, he commits to a dangerous course — to the mediocrity of hires who can’t act effectively in their own interest, to the evil of deceiving people to act against their self-interest as a matter of policy, and to the fragility inherent in a system that depends on continual exploitation. In a spiral of mutually reinforcing effects, dysfunction proliferates endlessly: mediocrity enables greater evil, evil deepens fragility, and fragility perpetuates mediocrity to protect itself. It is no coincidence that the capitalists who most value public virtue create the most tyrannical environments.

Reader, man is better governed by interest than by moralism. Incentives must be structured correctly from the beginning. Organizational dysfunction is not an individual vice, but a systemic one; when the incentive structure of an organization is compromised, virtue can only delay its collapse. And to hang an organization’s fate ex ante on irruptions of public-spiritedness is not just imprudent but actively harmful.

It is indeed difficult to envisage the exaltation of bureaucratic expertise in any culture in which the connection between practical intelligence and the moral virtues is deeply established.

Alasdair MacIntyre, After Virtue (1981)

How, then, might we build an organization in which public virtue and private interest are one?

We begin by recognizing the importance of the chief executive, who has discretionary control over the resources of the organization. This gives him maximal control over the system of incentives; he is limited only by the investors, the law, and the size of the organization’s bank account. Because the incentive system is most easily changed by the chief executive, the chief executive should be responsible for maintaining these incentives; because most other functions can be delegated to specialists, maintaining the incentive system should be the chief executive’s main responsibility.

Maintaining incentives involves maintaining high standards for projects that are undertaken, and rigidly holding people accountable to those standards with the “two handles” of reward and punishment. In a mature bureaucracy, this means keeping KPI targets inflexible, collecting detailed statistics on progress toward those targets, and assessing outcomes impartially. In an early-stage company, this means fostering a culture of high standards by readily evaluating and acknowledging the difference between good and bad work.

Armed with sufficient capital and resolve1, there is very little the executive needs to do besides enforcing standards. One can exploit any opportunity, no matter how undefined, simply by selecting a team of capable people and relentlessly, impartially aligning their incentives with those of the business. Being a skilled chief executive is therefore entirely a matter of discernment and grim courage — having the perceptive power required to understand the flow of incentives through the organization, the general knowledge required to evaluate the open-ended work produced in the early stages of the company, and the determination to apply incentives even when personally painful — e.g. firing one’s own brother.

In particular, the CEO need not be creative or clever — the beast of capital has a creativity of its own, issuing forth an endless froth of possibilities and proposals, and the CEO’s only job is to tame this beast with the consistent application of standards, rewards, and punishments.

There are many good examples of this in business textbooks, so here’s a bad one. I recently heard an account of a deal-making business run by a famous founder-investor with a reputation for disagreeableness and operational excellence. The employees of this company are on call apparently at all hours; direct, urgent missives come down from the CEO on Sunday evenings, demanding thorough responses.

This working situation, though unpleasant, also represents the situation of the business. Just as failing to respond quickly and properly to the external party could cost the business millions in revenue, failing to respond quickly and properly to the CEO’s message would be painful for the email’s recipient, who will have to deal with a screaming superior the next morning. Thus, by being disagreeable, the CEO translates downside for the business into downside for the employees, which is counterbalanced by a healthy pay bump to the upside that the business has the capital to afford. (A large slice of high finance also seems to work like this.)

Once incentives are aligned like this, decisions can be made with a much greater degree of transparency. When the interests of the business are aligned with the interests of the employees — that is, when the relationship between capital and labor is not always-already exploitative — there is little sense in withholding information from the employees. After all, an employee who properly understands that the Sunday-afternoon email comes not from the CEO but from the business itself, and by extension from the stock options vesting comfortably in their name, will not resent the chief executive for acting as the messenger of their own financial interest.

When the returns on organizational politics are low, employees will spend less time forming schemes or defending against them. When it is impossible to get ahead by overpromising and underdelivering, employees will promise only what they know they can deliver. When doing one’s work well carries a credible promise of fair reward, employees will no longer be concerned with reconnoitering their colleagues in fear of being unjustly passed over in their favor.

In a well-functioning organization, one could say:

God’s in his heaven—
All’s right in the world;

the world is just, there is only one way to get ahead, and that way has a credible promise of reward. Rather than praying for a world of universal public virtue, or deceiving his subordinates into a misguided loyalty, the leader of an organization should act to create an organization where moral and intellectual virtues form a unity — where the incentives to do good work are arranged so perfectly that employees, finding it pointless to think about them, can finally focus on doing their job well.

  1. I have some thoughts on CEO accountability and incentive structure, but I don’t think I can fit them in here. Maybe some other time? ↩