Arnold Kling  

The Zorn Effect

Financial Panic... Scary Words from Bernanke...

Management systems degrade. As a manager or a regulator, if you stand still you fall behind.

This year, the Washington Redskins hired a new coach, Jim Zorn. They started out 6-2, but they have since lost 5 out of 6 games. For the purpose of metaphor, I am going to assume that Zorn's management system started out well but degraded rapidly. Note to commenters: I could not care less about the real reason for the Redskins' collapse. Take your insights about football to Sports Talki 980. I just want to talk about management systems degrading in general, using Zorn as a metaphor.

Management systems can degrade externally and internally. Externally, your competitors copy your strengths and exploit your weaknesses.

Internally, your motivational tactics, including compensation systems, lose their effectiveness. Your goal is to get maximum impact on worker behavior for minimum pay, and your employees want the reverse. Over time, they learn to game your compensation system, and your management effectiveness degrades.

In health care, there is a lot of talk about reforming the compensation system. One thought is to move away from paying for procedures and moving toward paying for outcomes. Given that doctors have had fifty years to adapt to a system of pay for procedures, a sudden change might lead to a more cost-effective health care system in the short run. Pretty soon, however, doctors would figure out how to game an outcomes-based system. So my guess is that we would see a strong Zorn effect.

In finance, after the S&L crisis, we instituted a great regulatory system to prevent a repeat of that crisis. We hamstrung depository institutions, particularly with respect to holding mortgages. The result was a mortgage finance system that relied heavily on securitization, even to the point of absurdity, with banks required to hold less than half the capital for mortgage securities that they had to hold for plain old-fashioned loans. Over the past year, we have seen how that regulatory system degraded--another illustration of the Zorn effect.

COMMENTS (8 to date)
Luke G. writes:

I wonder how the coach would feel is somehow “the Zorn Effect” became standard economic textbook nomenclature.

Alan Watson writes:

Thank you for an excellent insight, clearly stated. But how about a brief outline, or a pointer to another post, to help the less educated among us understand how post S&L regulations lead to excess securitization?

Arnold Kling writes:


Brad writes:

I think there's something called the "Red Queen" effect already: "You have to run faster and faster just to keep up."

Would it be counted as degradation if you just stood still or jogged along, but got behind?

Pavel, Arlington writes:

OK, the problem in DC is not Zorn. The problem is the front office. Daniel Snyder simply sucks. Even the middle of the road Washington Post today called for his ouster. They are right. What the team now needs is a football person, not a business person. Zorn can lead, but he needs the players to make it happen.

diz writes:

I think we tend to discount random chance.

It's possible the Redskins are just a .500ish quality team who got off to a good start.

Billy Doyle writes:

"Over the past year, we have seen how that regulatory system degraded--another illustration of the Zorn effect."

Is the Zorn effect inevitable? Firms and individuals will always seek to game the system. Is the solution, then, regulation that evolves faster than the players? Or that an ungame-able regulatory system is achieved?

Arnold -

Ten years ago next month, I launched my own financial research firm. That wasn't what I had in mind when I started, of course. I was simply looking to make a living doing what I loved -- researching equities.

Today Stansberry Research has more than a million readers in about 130 countries. We also provide a good living to about 60 employees.

Outside of my own research and writing, I spend most of my time working on incentives. Besides capital allocation, incentives are the single most important decision a CEO makes. Almost everyone gets it wrong. (Notably, Buffett gets it right, charging a tax for capital employed and giving a bonus based on capital returned.)

Since I began my company, my strategy for compensation has always been the same:

1. Pay slightly more than you should in salary -- perhaps 10% more than comparable wages.
2. Wherever possible, insist on a contractual bonus that's based on objective performance - profits. Always use fixed rates. Pay the same amount of bonus on the first dollar of income as the last. Both are equally important to the business. Both are equally difficult to earn.
3. Pay every employee a bonus. We use a fixed % of net income to produce a bonus pool. The pool is allocated according to salary, experience and, from time to time, exceptional contributions. I personally allocate the pool.
4. Fire at least 10% of your staff each year. No one wants to work with lazy deadbeats. If you're not one of the top nine people (out of ten) at your job, you don't deserve the opportunity.

These policies seem to prevent the "Zorn Effect." At least, they have so far.

The NFL would be a lot more interesting to watch if every employee's contract could be voided at the team's discretion if their team didn't make the playoffs.

You can imagine what the union would say about that...


Porter Stansberry

P.S. Huge fan of your blog

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