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Noah asks a provocative question: What if businesses came with expiration dates?

Nobody wins forever. It just doesn’t happen.

What we see in reality are millions of corpses of businesses and ideas that have made their impact (or not) and then petered out into oblivion without leaving much more than a memory. Some of them get bought and swallowed by a bigger company, others have their ideas copied and commodotized and many just don’t have the business or financial chops to make it all work for more than a few years.

So what if instead of worrying about all that you just decided at the beginning you were going to end it all six years in?

I love questions like this, and Noah is great at asking them.  He suggests that such an arrangement may solve the problems that arise when management sacrifices the long-term interests of the company for the short-term, making decisions that optimize their current job security but may create problems for the firm down the road:

Company management doesn’t know how long the company will last, so they optimize for the now (they also don’t know how long their jobs will last, but I’ll get to that in a minute). It may be overly hopeful, but as long as one choose a reasonable time-frame (5-10 years) I wonder if you couldn’t lift the decision-making out of the immediate.

It is an interesting idea, but I think that what Noah is mostly interested in here is a shift in how employment is structured (i.e. knowing up front when one’s job will terminate), rather than how businesses as a whole are set up.   (If the business will shutter its doors in 10 years what precisely are the long-term interests of the firm?)  Additionally, he focuses more on the employment issue towards the end of the post.  In either case, I think that on the whole the uncertainty that exists in terms of business and employment termination is superior to expiration dates.  Here’s why: If businesses were set up at the outset with a planned time frame at the end of which the business would wind down it would likely play havoc with their ability to compete in the marketplace. Additionally, the beneficial economic conditions that obtain through competition would be warped. Why? Because businesses would not have to operate in the shadow of the future.

The shadow of the future is a concept that comes from game theory and relates to how actors’ incentives and behaviors change depending on whether they are playing a game that ends after only one round or if it will go on indefinitely.  In a single-round prisoner’s dilemma, each actor knows that they will not have to interact with the other after they make their decision to either stay quite or rat their partner out.  Since they’ll never interact again, their preferred choice will be to rat the other out in the hopes that they receive a mild sentence or get to go free.  In an iterated prisoner’s dilemma, the same choices will obtain unless the players are unaware of when the game will end.  The fancy term for this is backwards induction, but basically the idea is that if players know when the game will end it will create the same incentives as if the game was only one round.  However, if the game is repeated indefinitely, if players must operate within the shadow of the future, then cooperative behavior is more likely to evolve.

Businesses

In a market, we do not want businesses cooperating too closely.  Partnerships, licensing deals, sure.  But we abhor collusion.  Why?  Because it distorts the very market dynamics that are supposed to give rise to all the benefits of a market economy.  Open competition by individual businesses will lead to better products for lower prices.  Collusion amongst businesses or the formation of monopolies works against this.  And while collusion is to be feared, so to should any development that threatens the existence of competitive pressures on businesses.  If dominant businesses in a market are known ahead of time to be set to expire after, say, 6 years, other businesses that have not set an expiration date will feel little pressure to improve their product or service.  Why?  Because they realize that in a few years consumers will not have the superior products or services to turn to.  This being the case, the businesses that will survive the expiration of the dominant businesses will have no incentive to bring their performance up to the level of the best businesses.  When businesses are unsure as to the viability of their competitors they must assume continued competition and therefore better manage their firms in order to compete and survive.  Artificial expiration, particularly that which is decided up front, would likely decimate the competition mechanism.

Employees

But what about employees?  Would management and other employees make better decisions, decisions geared towards the long-term interests of a firm, if they knew ahead of time when their tenure would come to an end?  This argument has been floating around for some time, particularly with regards to GM’s in professional sports.  While GM’s are given long-term contracts, they can be fired at any time.  Towards the end of their contracts the amount of money due to them decreases and therefore the amount of money the team would have to eat if they fired the GM also decreases.  This can create perverse incentives to create short-term success at the expense of long-term competitiveness.  Think of a baseball team where a GM is on the hot seat.  If they don’t produce a playoff team the following year they will likely be fired.  One option is to empty the farm system in order to trade for older, proven players.  By bringing in proven talent, the GM increases the chances that the team will perform better in the short-term, securing their job and possibly another contract.  But by emptying the farm system the GM risks crippling the team in the long-term.  They will have less low-cost talent to deploy while having taken on large, guaranteed contracts which will reduce the team’s ability to build competitive teams in the future.

So what if management doesn’t have the uncertainly of a new contract hanging over their head?  Would they then shift to making decisions that are in the long-term interests of their companies (this assumes the firm has no expiration date)?  I am not so sure.  Since no new contract is possible, employees in this scenario would likely be motivated by reputation.  Their legacy becomes more important than short-term financial incentives.  But the problem with the long-term is that, well, it’s long-term.  It could be 15-20 years or more down the road.  The farther away we get from decisions the harder it becomes to connect future results with previous policies.  Whether or not the long-term fortunes of the company will be associated with the legacy of a former employee becomes less of a clear-cut issue.  So while expiration dates for management may not increase incentives for selfish short-term behavior, it may not decrease them either.  Incentivizing long-term decision-making requires creating the shadow of the future for employees, even after they’ve left the firm.  Stock options that are valued and redeemed years after management has left is one potential (but not unproblematic) mechanism.

All of this is not to say that the answer to Noah’s question is that it’s a bad idea.  However, I think that, on balance, there must be a prominent role for the shadow of the future in order to prevent the market from being distorted.

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