Bonuses instead of raises

Today's WP has a story about how more and more companies are using bonuses instead of pay raises to reward high-performing employees.  A survey for Aon Hewitt found that companies had reserved 15% of payroll for bonuses as opposed to 3% for raises.  From an employer perspective, this practice allows companies to target rewards and avoid getting locked into long-lasting salary commitments. Employers also think that performance-based rewards get employees to focus on behaviors that boost the bottom line.  

On the employee side, a bonus is better than nothing.  But companies are less likely to provide bonuses in years when financial performance is lackluster, so employees would do well not to count on bonuses year in and year out.  

Side thought: Companies rarely, if ever, cut salaries.  Why is this practice considered taboo?  Prices for everything else go up and down as the market demands, e.g., gasoline, groceries, housing.  Will we soon get to a point where wages and salaries can go down as well as up? 

Financial literacy is a real problem

A hot topic in economics research right now is financial literacy.  Survey after survey shows that most investors do not understand the most basic concepts.  Today's WSJ summarizes some research (gated) by Brigitte Madrian of Harvard and others.  The research focuses on three key concepts: the power of compounding interest, the impact of inflation on rates of return, and the importance of diversification.  In a survey of the general population, only 30% were able to demonstrate they correctly understood all three concepts. 

Why is this a problem?  First, financial choices facing individuals are becoming increasingly complex.  If the general public has a hard time with simple compounding, what are they to do about decisions about annuities or, heaven forbid, derivatives?  Second, companies are increasingly shifting investment decisions to their workers by emphasizing defined contribution pensions over defined benefit plans. 

I am currently working on a research project with three NC State colleagues that explores financial literacy and understanding of Social Security and private pensions at five large organizations.  The bad news is that although our sample is highly educated, the respondents do poorly on our survey about financial and pension knowledge.  The good news is that after attending retirement seminars offered by their employers, they know a lot more.  Also, it appears they rethink many decisions about retirement after obtaining this knowledge. 

Economic profits as a performance metric

Students in MBA 505 learn about pay for performance and economic profits.  Yesterday's WSJ reports that economic profits (total revenue less taxes, operating costs and the cost of capital) is increasingly being used as a metric in pay-for-performance plans.  In a recent PriceWaterhouseCoopers survey, 27% of the respondents said they were using economic profits, whereas only 19% were using stock prices. 

Why are economic profits becoming more popular as a measure?  After all stock price is what shareholders should be caring about, so stock grants and stock options would be the best way to align the interest of managers and shareholders.  However, stock prices are a forward looking measure taking into account a wide range of variables, many of which are outside the realm of control for middle or even top managers.  Economic profits are an indicator of cash flow, a variable that is much easier for managers to control, either through increased revenue or lower cost. 

One thing Pepsi and Coke have in common is that both reward execs using economic profits as the basis for bonus calculations. 

Facts on mortgage tax deductions

Tax reform has been one of the major issues in the presidential election.  One candidate says he can lower rates by chopping deductions, while another says that this cannot be done without hurting the middle class.  Last week NYT published a short piece laying out some under-reported data on who actually benefits from one of the biggest tax deductions of them all: home mortgages.  Some key facts that everyone, regardless of their political persuasion should know:

1. 70 percent of taxpayers do not itemize.
2. More than two-thirds of the benefits go to upper-income households ($100k plus) because they pay more interest on mortgages and have higher tax rates

The pols from both parties are unwilling to admit that there would be winners and losers if the deduction were to be capped or scrapped.  Those who do not itemize or who have small mortgage balances would come out ahead, whereas those who have just taken out jumbos will be less than pleased.  

Final thought: the subsidy provided by the home mortgage deduction encourages Americans to overinvest in owner-occupied housing.  That's why a recent NPR piece listed the deduction as one of six policies about which virtually all economists support and would drive most pols nuts (the others included ending the tax deduction for health care expenses, scrapping the corporate income tax, and taxing carbon). 

Google's turn for antitrust suit?

MBA 505 students will study monopoly and antitrust this coming week.  In discussing the economic consequences of monopoly power and reviewing some key cases (e.g., Alcoa, Microsoft), we will also be looking at Google's situation.  Numerous press reports (see this summary in Wired) indicate that the Federal Trade Commission is considering a suit before the end of the year and that the European Union is doing likewise.

Google has about two-thirds of the search engine market.  This might qualify as a monopoly in and of itself but it does not appear that regulators are concerned on this front.  There was a time not too long ago when Yahoo! was on the top of the heap; Google took Yahoo!'s place by having a better product. 

A key issue in the suit appears to be whether Google favors its own products in search results and thereby extends its monopoly in other product lines.  Examples cited by NYT include Google Shopping, Google Places, and Android. 

My take: I really doubt that Amazon, Yelp and Apple are worried about whether and how Google manipulates search results. Monopoly power in today's internet world is ephemeral.  Remember the big IBM monopoly?  Lotus 123? Microsoft Office/Windows?  It will take five or more years for any Google antitrust case to be settled and one has to seriously wonder what the world of search will look like at that time. 

University of Phoenix cuts back

The University of Phoenix grew to 400k students in its heyday, but the last couple of years have been tough; WSJ reported this week that Phoenix is now down to 328k, a 20% drop.  As in any other business facing reduced demand, the for-profit university now is cutting back on capacity.  Phoenix will close 25 of its main campuses and another 90 satellite learning centers.  Share prices for the Apollo Group, which owns Phoenix, dropped 22% upon the announcement. 

Why has enrollment dropped so much?  The tough economy has to be part of the story; students are strapped budget wise and fewer companies are providing tuition benefits.  For-profits also are dealing with unfavorable publicity as the public becomes more aware that completion rates are much lower than at not-for-profit schools. 

Affirmative action in the news

This week the Supreme Court heard arguments in a reverse discrimination case brought by a white female who had been denied admission to UT-Austin.  No doubt because the issue is once again in the news, Weekend WSJ ran a lengthy piece on recent research on the impact of affirmative action by a UCLA law professor who also happens to be an economist. 

As someone who entered college at a time when there were very, very few African-Americans on campus, there is no question that affirmative action has literally changed the face of higher education.  But being admitted to a great school under special preferences often be a mixed blessing.  The WSJ piece focuses on "mismatch" issues where the admitted student is significantly less prepared than most other students at a school.  The key finding:

There is now increasing evidence that students who receive large preferences of any kind—whether based on race, athletic ability, alumni connections or other considerations—experience some clear negative effects: Students end up with poor grades (usually in the bottom fifth of their class), lower graduation rates, extremely high attrition rates from science and engineering majors, substantial self-segregation on campus, lower self-esteem and far greater difficulty passing licensing tests (such as bar exams for lawyers).

The authors call for more transparency in admissions decisions and a sharply curtailed role for affirmative action.  I am sure WSJ will get letters pointing out that colleges still have a way to go to truly represent the full range of diversity we have in our society.  Tough issues, no easy answers.  

Hours cuts at Olive Garden

Prediction: it might start taking longer to get your second helping from the endless salad bowl at Olive Garden.  The Orlando Sentinel reports that Olive Garden restaurants in four different markets (including central Florida) have cut back significantly on full-time schedules.  To be precise, they are doing their best to make sure no one works 30 hours or more.

At a new Olive Garden in Stillwater, Okla., former busboy Keaton Hasty said employees were routinely limited to 29 1/2 hours.

"It was 29 1/2, and they'd kick you out," said Hasty, a college student who now works at a pharmacy. "They'd always print off a little slip every day and say who was getting close."

Darden Restaurants, the parent company of Olive Garden, Red Lobster, and Longhorn Steakhouse (among others) openly admits that they are doing this to reduce expenses on health insurance under the Affordable Care Act of 2010 (also known as Obamacare):

In an emailed statement, Darden said staffing changes are "just one of the many things we are evaluating to help us address the cost implications health care reform will have on our business. There are still many unanswered questions regarding the health care regulations and we simply do not have enough information to make any decisions at this time."

ACA requirements kick in for employees who regularly work 30 hours or more a week.  So Darden avoids having to provide health insurance (or pay the $3k fine for failure to provide health insurance) by cutting back on hours.  Darden outlet managers had best be prepared to deal with this dilemma: on nights when there is a bigger-than-expected crowd: do you add personnel knowing it may lead to higher insurance costs or do you lose business from disappointed customers get tired of waiting longer for tables and service?  (I bet you there are some MBAs who are working as we speak on algorithms to deal with this issue.  Click here for info on their internship programs in marketing and finance.) 

On poverty programs

A little over a year ago I posted about the jobs bill before Congress that would cost $447 billion and create 1.9 million jobs -- this boils down to $235k per job.  I then asked the question of whether the country would be better off if the funds were channeled directly to the 14 million unemployed workers, each of whom could receive a check of $32k. 

Harvard MBA and ex-CEO Gary MacDougal had an op-ed piece in yesterday's NYT that took a similar approach to our country's poverty programs.  He cites a recent Cato Institute study (caveat: Cato runs Republican to libertarian in its ideological bent) that found $1 trillion in federal, state and local spending on spread across 126 federal and countless more state and local programs.  There are an estimated 46 million Americans living in poverty.  So do the math: that boils down to $21,739 per person and $87k per four-person household.  Of course precious little of this money actually gets to those who need it. 

This raises a challenge that neither political party is addressing.  Obviously direct cash grants to the poor are not going to happen, but reductions in overhead need to be more carefully examined.   MacDougal, who was an advisor to former governor Jim Edgar (R, Illinois), suggests turning many of the federal programs into block grants to the states.  Consolidating programs is another possible approach.  A poor family has to deal with multiple agencies, all with different offices, forms and criteria -- could we not come up with a WalMart equivalent of "all programs under one roof" that would save the government money and make the lives of the poor better?  And wouldn't this be more constructive than Republicans focusing solely on budget cuts (except for defense) and Democrats standing up for Big Bird?

Hiring in startups is down, way down

Good news yesterday on the monthly jobs report.  Not so good news in Friday's NYT story reporting the findings of a Kaufman Foundation study on job creation in startups.  Previous Kaufman studies had found that job growth from startups was much slower in the 2000s than the 1980s and 1990s.  This new study finds that the typical startup in 1999 had 7.7 employees, whereas in 2011 the typical startup had 4.7 employees.  It also shows that the rate at which startups get started has fallen by 25 percent since 2006.  In other words, we have fewer startups and startups have become much smaller.

There has been growth in nonemployer businesses since 2000.  These one-person operations have become more prevalent as entrepreneurs take advantage of technology and a free-agent global market of available contractors.  Or maybe they choose this route because they cannot get financing. 

No matter how you cut the data, a consistent picture emerges: new companies, a key engine of economic growth, have not fared well since 2000.  

Today's jobs news

The September jobs report came out this morning.  Press accounts are trumpeting the drop in unemployment from 8.1 to 7.8 percent.  This number comes from the Current Population Survey, which examines 50k plus households each month.  According to the CPS, employment rose by 873k and unemployed persons dropped by 456k from August to September.  On net this implies that 417k persons who were not even in the labor force in August found jobs in September, which strikes me as implausible.  Lay persons should keep in mind that it is hard to extrapolate from 50k households to a labor force of 155 million.  Another sign of unusual volatility in the numbers: CPS data show declines in employment in July (-200k) and August (-100k) which probably were overly pessimistic, thereby making part of the big jobs gain in September a statistical correction.  

On a month to month basis, the monthly survey of establishments is a more reliable indicator of employment trends.  It shows a slow but steady increase in jobs of 100 to 180k each month over this period.  My take: the jobs recovery remains painfully slow but at least it is moving in the right direction.  Make whatever political hay you want out of that comment!

Will MOOCs radically change higher education?

A MOOC is a "massive open online course." Top notch schools like Harvard, MIT and Stanford are now making some courses available on a MOOC platform.  Will this democratize learning for the masses, or is this just going to be like correspondence courses 100 years ago?  Nicholas Carr discusses their likely impact in an MIT Technology Review article called "The Crisis in Higher Education." 

Much of the excitement centers on the potential for student engagement:

So what makes MOOCs different? As Thrun sees it, the secret lies in "student engagement." Up to now, most Internet classes have consisted largely of videotaped lectures, a format that Thrun sees as deeply flawed. Classroom lectures are in general "boring," he says, and taped lectures are even less engaging: "You get the worst part without getting the best part." While MOOCs include videos of professors explaining concepts and scribbling on whiteboards, the talks are typically broken up into brief segments, punctuated by on-screen exercises and quizzes. Peppering students with questions keeps them involved with the lesson, Thrun argues, while providing the kind of reinforcement that has been shown to strengthen comprehension and retention.

Artificial intelligence is being used to tailor the experience of each student to his or her own learning style.  Obviously this is in the early stages; will this be a breakthrough or just more hype?  Carr interviews an English and a history professor, both of whom turn out to be skeptics.  Some schools are using MOOCs as an alternative to face-to-face; others are using it instead of face-to-face for certain classes. 

For the meantime, I do not foresee amping the size of our online MBA program from 30-35 per class to 100,000. 

Nocera on rankings

I have been out of the country for a week and a half.  In catching up, I ran across a link on the NYU Stern website to this great article by NYT columnist Joe Nocera on the latest US News college rankings.  Schools like Harvard and Princeton come out on top because they are highly selective in admissions, have small classes, and spend lots of money thanks to huge endowments.  If a school like NC State wants to move up, it needs to make itself look more like Harvard and Princeton.  Money quote:

U.S. News likes to claim that it uses rigorous methodology, but, honestly, it’s just a list put together by magazine editors.

Or what used to be a magazine; US News stopped publishing two years ago.

Parents and students might want to ask themselves whether this is really useful information to guide their decision making.  Do you want to be in a small class listening to a very highly paid professor (or more likely, his graduate assistant) or do you want to be employed at graduation at a good salary with great prospects for the future?  The US News rankings of undergraduate programs give zero weight to employment outcomes, so you might need to check the WSJ rankings which come from employers. 
Interestingly, colleges can come up with salary and employment data for the graduates of their professional schools (including MBA), so why cannot they get this data for undergraduates as well?

Which discount rate?

This week we introduced the concept of discounting in MBA 505.  We approached it strictly from a private sector perspective -- how do households and organizations compare a dollar today with one in the future.  Of course the same concept gets used in public policy analysis.  For instance an investment in workplace redesign to promote safety costs dollars up front but yields long-term benefits, so a discount rate is needed to valuate the future payoff. 

The choice of the proper discount rate can raise some complex issues, as illustrated in a current NYT blog post on climate change.  In 2010 economists, lawyers and scientists from a dozen federal agencies determined that it would be wise to use a consistent discount rate across the board.  After careful analysis and discussion, they settled on 3 percent.  At this rate a ton of carbon imposes a cost of $21 on society (pollution, global warming, etc.). 

This finding has been challenged by a study that argued the real cost was much higher -- $55 to $266.  Why were these numbers so much higher?  Simple answer, the authors used much lower discount rates between 1 and 2 percent. 

The issue boils down to how much value to be place on the welfare of people who have not even been born yet.  On the one hand, we would expect them to be much better off than we are and quite capable of paying for some carbon abatement on their own.  On the other, there is uncertainty about how severe the consequences of global warning might be (which might dictate larger investments in abatement now to prevent Manhattan from turning into another Venice) as well as the ethical issue of taking responsibility for the type of planet we leave to future generations. 

Ultimately politicians and voters will determine whether increased investments in carbon abatement are worthwhile.  Until the economy recovers, I would bet that more people would be using a 3 percent rate than a 1 percent rate. 

On Government Motors

I am not following all of this 47 percent dependency society stuff.  I bet most voters did not know that each and everyone of us is a shareholder -- in General Motors!  The US government owns 26.5% of the one-time automotive titan.  Even though Chevy Volts are not exactly flying out the door, both the GM top brass and the feds are starting to look forward to the day when the government cashes in its stake.

But when is this deal going to go down?   WSJ reports that the government is in no hurry because if it sold its GM stock now it would end up losing $15 billion.  GM stock would have to go up to $53 for the government to break even; right now the stock is trading at $25.  

So what do we have to show for our $15 billion "investment" in GM?  GM currently employs 202,000 worldwide and about 68,500 in the US.  Of course, GM is part of a global supply chain, so there are parts and materials providers and auto dealers who also depend on their continued existence.  Let's propose that the bailout saved 200,000 US jobs (this is probably much too big a number; someone -- Toyota, Volkswagen, Honda? -- would have purchased GM's assets in bankrupcy and redeployed them).  Then it ended up costing US taxpayers $75k per GM job saved.  Each person can judge on his or her own the wisdom of that investment. 

Full-time MBA applications down

WSJ reports that applications to full-time, two-year MBA programs fell by 22% worldwide last year.  In the US, 62% of schools reported declines; we had a slight increase in full-time applications here at NC State. 

Some perspective is in order.  Schools had record high enrollments in 2009-2011 in the aftermath of the market crash and the Great Recession.  People who might have otherwise waited until now to start their MBA decided to start earlier because of the difficult labor market. 

Applications grew worldwide for part-time, online and executive MBA programs.  There also was growing demand for one year masters degrees in specialized business topics, degrees largely targeted toward those who have just completed their undergraduate degrees. 

Employer bias against the long-term unemployed?

Learned today about an NBER study done by three economists (one at Chicago Booth) on how employers react to job applications from the unemployed.  The researchers sent out identical resumes to employers with online postings in 100 cities that varied only on one critical dimension: number of months since the applicant's last job, which randomly varied between 1 and 36.  The key result: the odds of getting a callback dropped with the amount of time unemployed.  Persons reporting 8 months of joblessness had a 45% lower probability of getting a call than those reporting 1 month.  After 8 months, additional time unemployed had no effect on the odds of getting a call. 

The study took a more careful look at how local labor market conditions influenced the results.  They found that the relationship between months unemployed and callback odds was strongest in cities with tight labor markets (relatively more vacancies and low unemployment).  In cities with few vacancies and high unemployment, there was no strong relationship between months unemployed and callback odds.

These results indicate that employers use time out of work as a signal of productivity and motivation.  In tight labor markets, employers seem to think something must be wrong with the applicant if they have been out of work 6 months or more; in contrast, time unemployed does not seem to be an issue in areas where there are very few jobs.  The lesson: holding out for better job offers can be a self-defeating strategy. 

Welcome to QE3

Yesterday the Fed announced it would buy $40b of mortgage-backed securities each month and committed to keep interest rates low through mid-2015.  The idea is to reduce the supply of these securities and thereby push investment funds into other outlets such as the stock market, real estate, and corporate bonds.  The hope is that long-term interest rates will fall, the private sector will have more liquidity, the stock market will rise and good times will be here again. 

Will it work?  WSJ reports that economists are split: of 51 surveyed, 28 said that more quantitative easing will not help and 17 said that it would.  Not exactly a ringing endorsement, and not surprising either because (1) banks continue to hold unprecedented levels of excess reserves and (2) interest rates are already at historic lows.  People may want to make big-ticket purchases or re-finance their houses, but with a large share of consumers still carrying high debt burdens, their key issue will be qualifying for any loan, regardless of interest rates. 

Economics of the new iPhone

Today Apple announced the new iPhone 5.  The key features appear to be (1) the phone is thinner and lighter, (2) the display has a much higher resolution, (3) faster performance, (4) a smaller connector and (5) enhanced camera performance, including a tool for shooting panoramic photos.  All of this for $199! 

Sales are expected to be strong, so strong that GDP could get a significant boost in the 4th quarter.  WSJ reports that an economist at J.P. Morgan Chase estimates the phone will add 0.25 to 0.5 percent to economic growth.  That's 8 million phones times $400 value added ($600 price minus $200 imported components). 

Wireless carriers sell the phones at $200 but lock in customers with two year contracts that more than make up the $400 discount.  They have reacted, WSJ reports, by adding upgrade fees and more expensive data plans. 

I am still using a three-year-old iPhone 3, so I think I will be ready for an upgrade.  Will have to think awhile about the best carrier and data plan. 

Food truck rodeos

My wife and I went with another couple to our first food truck rodeo in Durham yesterday.  Turns out it was the biggest rodeo yet in the RTP area, with 44 trucks offering goodies ranging from American Meltdown's grilled cheese goodies to Valentino's meatballs.  We had Only Burgers (veggie for Linda) and Hawaiian ices; the burgers were superb, the ices not so much (where are you when we need you Matsumoto?).  Paid a visit to Fullsteam Brewery afterwards to enjoy their dog-friendly (even indoors!) atmosphere.

Food trucks are changing the business model for food away from home.  Owners benefit from much lower capital costs up front and the ability to move the restaurant to where the demand is.  Each truck specializes in a single food item or cuisine, simplifying preparation and building a reputation with customers.  Lower overhead results in lower prices.  Customers gain in a rodeo setting by being able to enjoy a variety of foods (our friends had Korean barbeque and a raw kale burrito).

Only two downsides that I could see from a customer standpoint.  First, the lines at many of the vendors were quite long; we were originally hoping to do a variety of small plates but two lines were enough for one afternoon.  Second, for those who want to create their own wine-food pairings -- too bad, the rodeo took place in Durham Central Park where adult beverages are not allowed.  Next time we will bring a tarp or beach towel as well.