35. TPR, Entrepreneurial Component, and Corporate Governance

James D. Yohe and Scott A. Kjar

One of Hans Hoppe’s most important contributions concerns his application of time preference rates to monarchical (private) government and democratic (public) government. Hoppe lays out his position in his seminal “The Political Economy of Monarchy and Democracy, and the Idea of a Natural Order,”¹ and clarifies and extends it in pieces including “Time Preference, Government, and the Process of De-Civilization: From Monarchy to Democracy.”² Hoppe argues that the time preference rates of private rulers (monarchs) will be lower than the time preference rates of democratic rulers, ceteris paribus. This difference is caused by each ruler’s relationship with present income and the present capital values of their respective realms.

In this article, we extend Hoppe’s argument to the corporate sector. We argue that Hoppe’s analysis of short-term and long-term interests vis-à-vis owners and managers can be applied to entrepreneur-managers and non-entrepreneur corporate managers. Further, we add an entrepreneurial component to Hoppe’s discussion of TPR to round out the differences between governments and corporations.

PRIVATE RULERS, DEMOCRATIC RULERS,
AND THE TIME PREFERENCE RATE

Both private rulers and democratic rulers generate present income, whether from taxation, monetization, agricultural or industrial production from the realm’s assets, or other sources. However, only the private ruler can accrue the present capital value of the realm, since only the private ruler possesses an ownership in the realm. A democratic ruler possesses the realm’s assets only during a specified term of office after which the ruler faces the possibility of electoral defeat, removal from office due to term limits, or other restrictions on the ruler’s temporal reign.

This implies that private rulers will tend to display lower discount rates in forming decisions regarding future endeavors. Their policies will encompass longer time horizons since the private ruler can expect to still rule at future times and can pass his realm on to his heir after death. By contrast, a democratic ruler will discount future benefits at a much higher rate that approaches infinity as the time horizon lengthens, both because of uncertainty over the ruler’s tenure and also because of the ruler’s inability to bequeath the realm to his heir.³ Hoppe writes:

The institution of private government ownership systematically shapes the incentive structure confronting the ruler and distinctly influences his conduct of government affairs. Assuming no more than self-interest, the ruler tries to maximize his total wealth, i.e., the present value of his estate and his current income. He would not want to increase current income at the expense of a more than proportional drop in the present value of his assets. Furthermore, because acts of current income acquisition invariably have repercussions on present asset values (reflecting the value of all future expected asset earnings discounted by the rate of time preference), private ownership, in and of itself, leads to economic calculation and thus promotes farsightedness.

While this is true of private ownership generally, in the special case of private ownership of government it implies distinct moderation with respect to the ruler’s drive to exploit his monopoly privilege of expropriation.⁴

As Hoppe makes clear, wealth-maximizing private owners, whether of governments or of land and capital goods, will not consciously reduce the present value of their assets disproportionate to increases in current income. In fact, if an increase in current income was needed that would disproportionately affect the present value of the assets, a private owner would be better off selling those assets in whole or in part on the market to acquire the current income at a less-than-disproportionate reduction in his net wealth caused by misusing the asset.

Each incentive a private ruler has to increase current expropriation to increase current income is met by an incentive to decrease current expropriation in order to increase long-term income and capital value of the realm. However, the democratic ruler’s incentives to increase current expropriation are not met by disincentives based on the realm’s capital value. That leads the public ruler to discount future states more heavily.

All other things being equal, the heavier discounting that public rulers assess to future income results in a reduced present value of the realm. Because a public ruler cannot sell or pass on the realm, the only accumulations to his own wealth come through increases in current income via taxes and other confiscatory acts. Thus, the public ruler has greater incentives for such confiscatory actions and fewer incentives for long-term husbanding.

TPR AND CORPORATE GOVERNANCE

We now apply Hoppe’s path-breaking analysis to corporate governance. After all, if the issues of present income and present capital value lead to different incentives for private rulers (owners) and public rulers (managers) of realms, it must follow that the same issues of present income and present capital value will lead to different incentives for entrepreneur-managers and non-owner corporate managers of businesses.

A private entrepreneur-manager faces a similar set of issues as does the private ruler. The entrepreneur-manager derives both the present income of a firm and the firm’s present capital value based on its long-term income and asset value. This gives the private entrepreneur-manager incentives to engage in long planning horizons, thereby driving a low time preference rate.

By contrast, the corporate manager cannot accrue the capital value. The corporate manager cannot sell the corporation’s assets for his own enrichment. Instead, the corporate manager’s compensation is based on increasing the present income of the firm, from which he may generate an increased salary. Absent an increased present income for the firm, there is not likely to be an increased present income for the manager. The corporate manager’s income is derived from his perceived benefit to the owners of the firm. It is through his usefulness in implementing the plans and policies of the corporate board that his employment and pay are based.

In the absence of certainty and neutral money, trust becomes an issue, as the board cannot be expected to possess the same information that the manager has. This includes the discount rate at which the manager discounts future earnings. Relative to the personal wealth of the entrepreneur-manager, the personal wealth of a corporate manager is less tied to the future earning of the firm, and thus less to the long-term capital value of the firm, than it would be if he were able to accrue the capital value as a private owner would.

Because the corporate manager is less tied to the future earnings, he has incentives to sell the firm’s long-term assets and use the funds to acquire more present-income-oriented assets. As a manager, he cannot simply sell the assets and consume the cash; all he can do is rearrange their composition to produce greater amounts of income in the nearer future. More roundabout means of production are reversed toward less roundabout means in the interest of more current revenue, but at the expense of the firm’s long-term capital value.

This leads to corporate managers attempting to maximize current income at a higher degree than they would as actual owners of a firm. This being the case, they also must discount future earnings at a higher rate relative to current income in the same manner as a democratic ruler would relative to a monarch.

UNCERTAINTY AND THE ERE

The Evenly Rotating Economy (ERE) is a fictitious system in which market prices always coincide with final prices. There are no price changes, and the same transactions are repeated day after day; tomorrow is no different from today, which itself is the same as yesterday. In the ERE, uncertainty regarding future prices and the available quantities of the production inputs are non-existent. The factors affecting the supply and demand for goods and services—the time preference rates of individuals—are known and do not change. Prices are stable in the ERE, and money is neutral, so there are no changes in the exchange ratio between goods and services caused by changes in the supply of money.⁵

In the ERE, because there is no uncertainty about the future, there is no role for entrepreneurs. Instead, natural resources, labor, and capital earn returns based on productivity and time preference. If the participants in an ERE economy have a high time preference rate, then the returns to factors of production will also be high at the margin; factors will not be utilized if their return is too low. If the participants in an ERE economy have a low time preference rate, then the returns to factors of production will be low at the margin because they will be utilized for low-returning projects.

In the ERE, the rate at which each factor of production is discounted over time is equal to the market rate of interest, and also to the originary rate of interest, which is derived from time preference. The originary rate of interest is

the ratio of the value assigned to want-satisfaction in the immediate future and the value assigned to want-satisfaction in remoter periods of the future. It manifests itself in the market economy in the discount of future goods as against present goods. It is a ratio of commodity prices, not a price itself. There prevails a tendency toward the equalization of this ratio for all commodities. In the imaginary construction of the evenly rotating economy, the rate of originary interest is the same for all commodities.⁶

In the ERE, then, the role of the entrepreneur is strictly limited to the inter-temporal organizing of the factors of production. This is not an entrepreneur in the normal sense of the word, since real-world entrepreneurs not only organize factors but also bear the uncertainty of the future states. As Mises points out,

Under the conditions of a market economy, the rate of originary interest is, provided the assumptions involved in the imaginary construction of the evenly rotating economy are present, equal to the ratio of a definite amount of money available today and the amount available at a later date which is considered its equivalent. The rate of originary interest directs the investment activities of the entrepreneurs. It determines the length of waiting time and of the period of production in every branch of industry.⁷

Thus, it is the rate of originary interest that ERE entrepreneurs use to compare future earnings, hence, present values with present earnings or income.

THE ROLE OF THE ENTREPRENEURIAL COMPONENT

However, in the real world, unlike the ERE, there is a substantial amount of uncertainty: uncertainty about future demand for goods and services, availability of factors of production, possible changes in the regulatory environment and the value of the currency, and much more. Such uncertainty leads to an important role for the entrepreneur.

The entrepreneur uses judgment to assess future changes and to prepare for them now. To the extent that he is successful in anticipating and adjusting for future changes, he is rewarded with economic profit. Economic profit is that received above the opportunity cost he bears. This entrepreneurial judgment extends not only to production but also to credit. As Mises notes, “The granting of credit is necessarily always an entrepreneurial speculation which can result in failure and the loss of a part or the total amount lent. Every interest stipulated and paid in loans includes not only originary interest but also entrepreneurial profit.”⁸

Because all action, including production, takes time, all productive activities involve a transaction of present goods for future goods. The only way one can evaluate the exchange of present goods and future goods is through the use of an interest rate. As noted above, in the ERE, this rate is obtained purely through time preference rates and is found on the market through the rate of originary interest and the interactions between buyers and sellers of present money and future money. However, when we leave the ERE, we recognize the element of uncertainty regarding the exchange. Thus, we must add an entrepreneurial component to the interest rate that is used to discount future goods into present goods.

In essence, the capitalist-entrepreneur is present in both equity ownership and in the granting of loans. The capitalist-entrepreneur that purchases capital goods directly with his own resources must weight this decision against all other possible uses for his funds. In this case, the opportunity cost of his action, ex ante, is the next best opportunity available to him. For instance, if one could invest $100,000 in the production of a house that was expected to sell for $110,000 in one year, or to invest that same $100,000 into the production of a car that would sell for $108,000 in one year, the opportunity cost of investing in the house would be the $108,000 that could have been earned by producing the car. In the ERE, in the absence of uncertainty, the originary rate of interest is equal to the rate of return in all commodities. When we violate the certainty assumption of the ERE, we remove the certainty associated with every day becoming like the rest, and we remove the central point about which the ERE rotates.

In the presence of uncertainty, the capitalist-entrepreneur performs two functions. First, it is his savings that fund the production process. In this sense, he acts as a capitalist. He believes that his money will be returned to him with an additional premium: the gross market rate of interest. The gross market rate of interest includes the originary rate of interest, plus an entrepreneurial component.⁹ As his repayment is uncertain, he must expect a return that compensates him for the uncertainty he must deal with regarding the repayment of the loan.

The market rates on loans are not pure interest rates. Among the components contributing to their determination there are also elements which are not interest. The money lender is always an entrepreneur. Every grant of credit is a speculative entrepreneurial venture, the success or failure of which is uncertain.¹⁰

Second, the entrepreneur takes on the additional task of dealing with several forms of uncertainty: the uncertainty associated with the completion of the project, the uncertainty regarding future prices in relation to the money costs of completing the project and the market, the uncertainty of the social and governmental conditions that are essential to the successful completion of the project, and the uncertainty of a return that exceeds the opportunity costs associated with the project. In choosing a project, an entrepreneur will evaluate future expected sales of his project and weigh them against the opportunity costs of the resources used to complete them. In this sense, the entrepreneur must discount future earnings to take into account their temporal distance from the present and the uncertainty that these revenues will occur at the prices expected by the entrepreneur in the future. In a world of money neutrality, the entrepreneur must form an interest rate based on this criteria by which he can discount future earnings. The rate at which he discounts future earnings includes an entrepreneurial component.

All of this is irrelevant to the corporate manager. The corporate manager, by not risking his own funds, has a very different relationship with future uncertainty. While the entrepreneur-manager (or capitalist-entrepreneur) puts up his own money and pays the opportunity cost of foregoing other investments with it, the corporate manager risks nothing. To the corporate manager, then, the discounted future stream of revenues associated with an investment is important only insofar as it generates his income; he does not have to weigh that stream against the other possible revenue streams he could have generated with the money. Instead, because he cannot capitalize increases in the present value of the firm, his wealth can only be increased with increases in the present cash flows of the firm, either through increased salaries and bonuses to himself, or through increased spending by the firm on things of which he approves. His spending will be geared toward assets that increase his current income and cash flows for the firm at a higher degree than if he were a private owner of the firm. The certainty of gains from earnings in the future is lessened in contrast to those he could expect to earn if he owned the firm. Thus, the uncertainty of income from more distant projects is greater for the manager than if he were the actual owner. Future earnings must be discounted at a higher rate by a corporate manager than by a private owner. Less capital accumulation and less roundabout methods of production will be preferred by a corporate manager relative to a private owner, ceteris paribus.

CONCLUSION:
TPR, THE ENTREPRENEURIAL COMPONENT,
AND CORPORATE GOVERNANCE

We have demonstrated that Hoppe’s path-breaking analysis of TPR and the distinction between monarchical (private) government and democratic (public) government can be applied to entrepreneurial (private) firms and corporate (public) firms. In both the government and the firm, the private owner, whether monarch or entrepreneur, benefits from both the present current income and the long-term capital value of the firm’s assets. Likewise, in both the government and the firm, the non-owner manager, whether public official or corporate manager, is not entitled to the long-term capital value of the asset; all additions to the wealth of such individuals come from present earnings. This necessarily drives discount rates of such non-owner managers higher relative to what they would be for the otherwise similarly situated owner.

The uncertainty of benefiting from future earnings decreases the importance of such earnings to corporate managers. Removal from their position and other factors not present to owner-entrepreneurs make future earnings less certain for non-owner managers; such future earnings are thus discounted at a higher rate by corporate managers.¹¹ This leads to a greater degree of capital consumption, as managers cannot sell assets and add the revenues from such sales directly to their current income. Instead, managers will exchange more roundabout methods of production for less roundabout means.

James Yohe (jyohe@gadsdenstate.edu) and Scott Kjar (scottakjar@yahoo.com) both studied under Hans-Hermann Hoppe at the University of Nevada, Las Vegas, during the early 1990s, Kjar as a graduate student and Yohe as an undergraduate. They were regular members of Hoppe’s weekly discussion of current events and political topics, affectionately (and descriptively) referred to as “drinking night” by its participants. Kjar and Yohe both subsequently earned their Ph.D.s in economics at Auburn University, with Hoppe serving on Yohe’s dissertation committee. Yohe is currently Economics Instructor at Gadsden State College in Gadsden, Alabama. Kjar is currently Visiting Assistant Professor of Economics at the University of Dallas in Dallas, Texas. Thanks to Jeff Barr and Lee Iglody for comment and discussion on this topic.

¹Hans-Hermann Hoppe, “The Political Economy of Monarchy and Democracy, and the Idea of a Natural Order.” Journal of Libertarian Studies 11, no. 2 (Summer 1995).

²Hans-Hermann Hoppe, “Time Preference, Government and the Process of De-Civilization: From Monarchy to Democracy,” in John V. Denson, ed., The Costs of War: America’s Pyrrhic Victories, 2nd ed. (New Brunswick, N.J.: Transaction Publishers, 1999).

³The fact that heirs sometimes get elected to the same position in no way negates this analysis. Further, such heirs are frequently temporally removed from their parents holding the same position. For example, John Adams did not bequeath the presidency to his son, John Quincy Adams. Rather, the son had to wait through the presidencies of Thomas Jefferson, James Madison, and James Monroe before he had his chance. Likewise, Richard J. Daley was Mayor of Chicago from 1955 to 1976, and his son, Richard M. Daley, has been Mayor of Chicago from 1989 to the present. Again, though, the elder Daley did not bequeath the position to his son, who had to wait through the mayoral regimes of Michael Blandic, Jane Byrne, Harold Washington, David Orr, and Eugene Sawyer before taking the position. George H.W. Bush did not bequeath the office of the president to his son, George W. Bush, and the latter had to wait through Bill Clinton’s two terms. Clinton did not leave the office to his wife, Hillary, who unsuccessfully sought the position in 2008. In no case did the ruler bequeath even the office, much less the realm, to his heir.

⁴Hoppe, “Time Preference,” p. 472; emphasis in original.

⁵See Ludwig von Mises, Human Action: A Treatise on Economics, Scholars Edition (Auburn, Ala.: Ludwig von Mises Institute, 1998), pp. 245–51.

⁶Ibid., p. 523.

⁷Ibid., p. 529.

⁸Ibid., p. 533.

⁹The neutrality of money assumption leads to a convergence of the market rate of interest that reflects the underlying originary rate of interest in society. Capitalist entrepreneurs who possess higher originary rates (time preference rates) will sell assets to capitalist-entrepreneurs with lower rates of originary interest. This sale would enable the higher-time preference capitalist-entrepreneur to increase his current income while not disproportionately decreasing the present value of the assets because it was sold to the entrepreneur with the lower time preference rate.

¹⁰Mises, Human Action, p. 536.

¹¹We do not address the measures by which corporate equity owners can try to alleviate this problem. To do so would require the breaking of the assumption of the non-neutrality of money in the real world, which would lead to a further divergence of interests from owners and managers. Rather, we choose to focus exclusively on the rates at which owners and managers discount earnings, without discussing the relationship between managers and actual owners of their firm. This is a different relationship, and is the subject matter for continued work on this core issue of entrepreneurs versus managers.