Good Ole Governance
Vol #72 - March 4th, 2022
I have a distinct memory of packing a car for a camping trip with my uncle, and when I offered to help, this was his advice: “I believe in committees of one.”
When trying to jam backpacks, tents, and stoves into a small rental station wagon, there can definitely be too many cooks in the kitchen. More opinions mean the packing takes longer than necessary and there’s a high risk of tempers flaring.
On the other hand, there’s an old proverb that says if you want to go fast, go alone, but if you want to go far, go together. For complex, long duration projects, getting lots of help is important.
Different people provide different perspectives, skills, and resources. As the world becomes increasingly complex, this is even more true. Not since the Renaissance man could any single person do it all.
When starting a business or a project, some of the most significant decisions you make are in hiring. The wrong combination of personalities or talent will doom a project from the start. The best talent and engagement from your community is geometrically more powerful than the median.
How businesses are formed continues to evolve over time. In a much simpler time, there was simply a boss, and his employees. Romulus’s Pottery Shop was owned by Romulus, or maybe his sons. Ownership was limited to a single person because the operations were relatively limited, and the legal structures didn’t exist to diversify risk and ownership.
As operations grow more complex, they need both financial and human resources. Good investors and positive partnerships allow 1+1 to be greater than 2.
Some of the first records of these ventures come from the Song and Tang dynasty in 11th and 12 century China. Initially “heben” were formed which allowed for a passive investor to give capital to an active manager, and this eventually led to larger pools of shareholders and profit sharing allocations.
In 12th century France the Bazacle Milling Company offered 96 shares of its mills, which traded at their relative profitability. A similar structure existed at the Swedish firm Stora where the copper mining company’s land was divided into eighths.
As time passed, the enterprises became bigger. In the late 16th century the most enterprising folks were looking beyond their borders and overseas for trade opportunities. These long voyages were as risky as they were potentially profitable. No better structure exists for sharing risk and splitting profits than the joint stock company.
Introducing the concept of limited liability was revolutionary for raising capital. Under a simple partnership, the debts of the organization are also the debts of the partners. This limited the scope of what a company might do, as individual liability was most likely to be taken by owner-operators.
Perhaps the most famous of the early joint stock companies was the East India Company. They were granted a charter by Queen Elizabeth to establish trade on the Indian subcontinent, and quickly expanded their enterprises - and notoriety.
Another benefit of joint stock companies is that they have shares which can become liquid, allowing investors to dispose of their capital. The value of a liquid ownership stake is far greater than an illiquid one, and trading activity boomed on the Amsterdam Stock Exchange.
Most of the corporate legal structures we’re familiar with today evolved around this time. Beyond just the liquidity and limited liability, boards represented the interests of shareholders, companies existed for a “perpetual lifetime”, and even corporate taxation came into existence.
While it took until the 20th century for academics to define this specifically, I suspect they also were concerned about the principal-agent problem. As soon as you hand over control of something to another party to manage, conflicts of interest arise.
If a manager is paid a salary but does not hold equity, he or she is incentivized to ensure the longevity of their wages rather than the maximization of profits. On the other hand, when executives are granted equity and options to align their interests with shareholders, they then might make perverse decisions to pump their bags in the short term.
The concept of ownership gets complicated as you have larger and larger groups. A committee of one, Romulus didn’t have to ask anyone what kind of clay to buy, or get approval from Larry Fink on the ethics of excavating his raw materials.
The most powerful shareholders today aren’t even individuals, but large firms like Blackrock (helmed by Fink) who manage ETFs on behalf of investors. Most individual shareholders don’t tend to vote their shares even if they are held directly.
As finance pushes into the digital realm, these same concepts are being tackled anew. When the only law is code, there are new problems and solutions. Projects want investors to stick around, but they can only use certain types of incentives.
A common solution to increasing participation is to tie rewards and interest on loans to long term participation. The pioneer of this was Curve, who created a locking mechanism whereby pledging your rewards for longer durations gave you more “voting escrow” tokens, which were currency in a weekly vote on where to allocate protocol revenue.
This virtuous flywheel means that the largest investors who are committed the longest, get to direct profits to their pools. Other protocols have adopted this same structure, or continue to experiment with other variations of locking.
While that tackles the financial aspect of incentives, the struggle continues for how to get the human side of capital involved. Just as dating has become more transactional in a digital world, online communities can be fleeting. DAOs (Decentralized Autonomous Organizations) often have engagement problems, and small vocal minorities can dominate conversation and project direction.
Business people have faced the same problems for centuries. Incentivizing participation - healthy, proactive, and significant participation - is what makes the difference that allows an endeavor to blast into orbit.
Programming Note:
The Till will be off next week, returning March 18th.