Company Policy

Why do big companies exist?

It’s not a trivial question. In theory, we could all work as independent contractors, offering our labor to one another and gaining by exchange. But we would have to devote a lot of time to finding markets for our work, negotiating prices, and getting paid—administrative tasks that aren’t productive. Those kind of transaction costs act like sand in the gears of an economy, and companies eliminate them, or at least reduce them to a minimum through their organization.

Still, it’s a paradox that big companies exist. After all, big government organizations are often massively inefficient. But big companies often pride themselves on their efficiency, with just-in-time manufacturing and modular shipping reducing costs to their minimum. So why are big companies effective, while big government is frequently a joke?

The answer to this has to do with goals and accountability. In the U.S. corporations have one explicit goal: to maximize the long-term financial return due to their owners. Their performance on this metric is constantly monitored, and if they fail to produce a return, their owners can reorganize or just shut down the enterprise and sell off the assets. There’s a Darwinian process that eliminates inefficient organizations.

By contrast, governments have multiple goals: law and order, national defense, enforcing contracts, regulation, education, maintaining a social safety net, and so on. With so many disparate goals, inefficiency is endemic to the enterprise. And finding more efficient ways to deliver services isn’t always the highest priority.

That’s why people usually aren’t surprised by bureaucratic waste in government. And why we need to be careful with government-related investments—because what government gives, it can easily take away.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

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