Tuesday, March 1, 2011

Lady Gaga, Hedge Funds, $1,000/hr lawyers -- and the Economic Theory of Superstars

Last month I wrote about the Economic Theory of Superstars in ROB Magazine.

In Sherwin Rosen's 1981 theory, the ultra high pay of certain entertainment superstars (and certain investing superstars, such as hedge fund managers) can be explained by the combination of two forces: imperfect substitution -- no two singers are the same, and twice as much singing by a bad singer will not satisfy an audience as half as much singing by a popular singer -- and joint consumption technologies, namely the ability for one recording session to yield a theoretically unlimited number of CDs or itunes downloads. The combo is what allows Lady Gaga to make tens of millions of dollars a year. Ditto the most popular hedge fund managers.

But even if all you've got going to for you is one of those factors, namely "imperfect substitution", you can still do rather nicely in certain fields. For example, the law. The creme of the crop of lawyers in New York, reports the WSJ, are now billing at rates in excess of $1,000 an hour.

My article on Superstars Theory is below -- but wait, there's more! In a future post, I'll return to this theme, and offer economist Moshe Adler alternative and more critical/skeptical version of how the superstar effect works -- which I couldn't get into here, for reasons for space. (Hey, it's old fashioned ink-on-dead-trees journalism. Ya only get 700 words).

Worth every billion

Friday, January 28, 2011
Lady Gaga, hedge fund managers and the Economic Theory of Superstars Tony Keller
Not long after the U.S. Treasury Department's pay czar ended his oversight of Citigroup's compensation practices, the bank hired a new head of global energy investment banking. Citi, which nearly went under in 2008 and was partly owned by the U.S. government until last December, lured Stephen Trauber away from rival UBS. It dug deep into the kitty to get him. Trauber reportedly will be paid $9 million a year (all currency in U.S. dollars).
You are no doubt appalled. Yeah, me too, I guess. But moral outrage, unlike i-banking, is easy. Let's consider a less demotic proposition: that Trauber's compensation, and that of some of his peers, is perfectly rational. It just might be, if you believe in the Economic Theory of Superstars.
Three decades ago, University of Chicago economist Sherwin Rosen set out to solve the riddle of why some people are paid so much more than the rest of us. He looked at the industry with the most extreme inequalities: the entertainment business. There are millions of starving artists in the world, like the singer at your local pub who can barely make rent. Yet Lady Gaga made an estimated $62 million last year. How come?
In Rosen's groundbreaking 1981 paper, "The economics of superstars," he explained why Lady Gaga doesn't have to be 5,000 times better than the local musician in order to earn 5,000 times more. He pointed to two factors: "imperfect substitution," which is our willingness to pay a lot more for that which is only a bit better, and "joint consumption technologies," which allow a popular musician's work to be purchased simultaneously by millions. Either one can lead to high pay. Together, they spell superpay.
Imperfect substitution is easy to understand. "Lesser talent," said Rosen, "is often a poor substitute for greater talent." Three mediocre singers won't satisfy an audience as much as one excellent singer. A major corporation facing a major lawsuit will likely hire the best lawyer; a lawyer who is 10% less competent can't compensate by working 10% more, or charging 10% less. As a result, said Rosen, "the demand for the better sellers increases more than proportionately."
Trauber is one of those better sellers. A classic i-banker, he helps energy companies do deals, especially mergers and acquisitions. He and his team at UBS have done 115 oil and gas deals over the past five years, worth $167 billion (according to Bloomberg). Other bankers brought in little or no business, and washed out of the profession. One of Trauber's last big transactions was the $11-billion sale of Smith International Inc. to Schlumberger Ltd. His UBS team advised Smith and collected a fee of $29.3 million.
Did Smith get its money's worth? The deal closed, and the company sold for a premium of 37.5% over its pre-deal share price, compared to an average premium of 26% in other recent oil and gas deals, according to Dealogic. The excess premium was worth about $1 billion to Smith shareholders. If Trauber was responsible for even a fraction of that - something that's hard to prove, or disprove - he earned his fee.
Yet i-bankers like Trauber aren't really full-fledged Rosen superstars. Unlike Lady Gaga and other star entertainers, Trauber does piecework. Each M&A is a one-off. Lady Gaga, in contrast, is software. She can earn a theoretically infinite amount of money from just one recording session: The resulting song can be purchased by millions of consumers worldwide. Or, as Rosen put it, in something close to English, "when the joint consumption technology and imperfect substitution features of preferences are combined, the possibility for talented persons to command both very large markets and very large incomes is apparent."
Which financiers are superstars? Hedge fund managers. They're pulling down Lady Gaga coin, and then some. They pool the money of many investors, because it's not much more time-consuming to manage billions than millions: That's joint consumption technology. And in a demonstration of imperfect substitution, they also charge much higher annual fees than mutual funds. The standard for hedge funds is "two and 20" - 2% of assets under management, plus 20% of returns. Result: In 2009, the 25 highest-paid fund managers earned a total of $25.3 billion.
One mogul, James Simons of Renaissance Technologies, has made more than $1 billion a year for the last half-decade by managing a huge pool and pushing imperfect substitution to the max: Renaissance's standard fee isn't two and 20, but five and 44.
Do hedge fund managers deserve their paycheques? Do i-bankers? In a moral sense, surely not. They planted no crops, educated no children, built no homes and saved no lives. Then again, neither did Lady Gaga. And the free market assigns compensation not on moral merit, but on supply and demand. As long as there are chart-topping songs, there will be chart-topping bankers. Ye have the poor always with you, said Jesus. And the superstar rich, said Rosen.
Tony Keller, a former editorial page editor of The Globe and Mail, is a visiting fellow at the Mowat Centre for Policy Innovation.

45 comments:

  1. I would agree with the above post and what you have written about the lawyers. Criminal Health Lawyer

    ReplyDelete
  2. This comment has been removed by the author.

    ReplyDelete
  3. This is a great article thanks for sharing this informative information. I will visit your blog regularly for some latest post. I will visit your blog regularly for Some latest post. Massachusetts top personal injury law firms

    ReplyDelete
  4. Although each and every individual makes up an organization, all of them have to work in a team environment in almost all of their tasks. Talent acquisition

    ReplyDelete
  5. Thanks for a wonderful share. Your article has proved your hard work and experience you have got in this field. Brilliant .i love it reading.
    appellate attorney

    ReplyDelete
  6. Finding independent reviews and eliminating any package with reports of functional or security problems quickly weeds out the chaff. our website

    ReplyDelete
  7. The economic actor is assumed to be constantly engaged in the rational pursuit of self interest. This is not a realistic model - merely a useful approximation.guarantor loans

    ReplyDelete
  8. this is truly decent to read..informative post is great to read..thanks a considerable measure! http://www.website.com

    ReplyDelete
  9. This comment has been removed by the author.

    ReplyDelete
  10. the laborers' pay legal advisor demonstrated work at low maintenance occupation and (b) was acting naturally utilized, steady with his capacity to work philly workers compensation law firm.

    ReplyDelete
  11. I wanted to thank you for this great read!! I definitely enjoying every little bit of it I have you bookmarked to check out new stuff you post. https://larsennash.com/

    ReplyDelete
  12. This comment has been removed by the author.

    ReplyDelete
  13. Your provoke reaction will likewise give your legal counselor enough time to go over your data and better set up his or her following stage. On the off chance that you are not ready to react rapidly for some reason, let your legal advisor know promptly.Traffic lawyer

    ReplyDelete
  14. This is highly informatics, crisp and clear. I think that everything has been described in systematic manner so that reader could get maximum information and learn many things.
    עו"ד תעבורה הכי טוב בארץ

    ReplyDelete
  15. The legal advisor ought to be an authorized individual from the State Bar Association and ought to have the qualification to go to for a case in the higher court too. In that way if the case is moved to a higher court, there likewise you can have a similar legal counselor.read here

    ReplyDelete
  16. This was a shocking post. It has some look at here fundamental data on this subject. Elia & Ponto Law

    ReplyDelete
  17. Hello, I have browsed most of your posts. This post is probably where I got the most useful information for my research. Thanks for posting, maybe we can see more on this. Are you aware of any other websites on this subject. dtslawfirm.com

    ReplyDelete
  18. In the event that a circumstance emerges when the lawyer needs to unveil the data as a legitimate commitment or as the customer's demand he may do as such. This is an imperative piece of the case since the lawyer needs the customer needs to completely open up to a lawyer before he can really encourage him.Click Here

    ReplyDelete
  19. On the off chance that you remember these tips when searching for an attorney, you ought to have a decent possibility of discovering one that won't baffle you.محام المرور

    ReplyDelete
  20. Thank you very much for this useful article. I like it. Bahamas lawyers

    ReplyDelete
  21. There are numerous online administrations that interface with nearby lawyers on various areas and relying upon the sort of lawful case that one may have.עורך דין תביעה ייצוגית

    ReplyDelete
  22. http://marshallgeisserlaw.com/ I want you to thank for your time of this wonderful read!!! I definitely enjoy every little bit of it and I have you bookmarked to check out new stuff of your blog a must read blog

    ReplyDelete
  23. In the event that the reserve portrayal discusses "beating the benchmark" or "chief ability" at that point it is effectively overseen. White Label Crowdfunding Software

    ReplyDelete
  24. My question is if the lawyers each have significant years of experience, why don't they say how much experience each lawyer has? Why? Because it sounds grander to use the combined figure.עורך דין תביעה ייצוגית

    ReplyDelete
  25. This article is an appealing wealth of informative data that is interesting and well-written. I commend your hard work on this and thank you for this information. You’ve got what it takes to get attention. jameslnowlin.com

    ReplyDelete
  26. Expenses will be incurred, professional fees will have to be paid and the usually lengthy process will have to be endured. More often than not, the costs of resolving a problem are far greater than the costs of preventing the problem. Holm Law Group San Diego

    ReplyDelete
  27. Try not to accept you need a major blue chip firm. I originate from a few major blue chip law offices. attorney medical malpractice

    ReplyDelete
  28. The law makes it mandatory for every one of the residents to act dependably and sensibly that some other individual would do whenever set in comparative circumstance. medical malpractice lawyers free consultation

    ReplyDelete
  29. You know your projects stand out of the herd. There is something special about them. It seems to me all of them are really brilliant! Best Forex Signals

    ReplyDelete
  30. The best bit of leeway to utilizing the Web for crowd funding is that it makes it feasible for data to make it all around the globe, adequately expanding mindfulness for the thought needing money related help. Crowdfunding Wordpress Plugin

    ReplyDelete
  31. I got too much interesting stuff on your post. I guess I am not the only one having all the enjoyment here! Keep up the good work. Custom Mailer boxes

    ReplyDelete
  32. I think this is an informative post and it is very beneficial and knowledgeable. Therefore, I would like to thank you for the endeavors that you have made in writing this article. All the content is absolutely well-researched. Thanks...
    Bath bomd boxes
    Custom Bath Bomb Boxes
    Custom Printed Boxes
    Wholesale Packaging Boxes

    ReplyDelete
  33. This comment has been removed by the author.

    ReplyDelete
  34. This comment has been removed by the author.

    ReplyDelete
  35. A very excellent blog post. I am thankful for your blog post. I have found a lot of approaches after visiting your post.
    Soap boxes
    Soap kraft boxes
    Custom Packaging Boxes
    Custom Boxes For Business

    ReplyDelete
  36. A very excellent blog post. I am thankful for your blog post. I have found a lot of approaches after visiting your post.
    Soap boxes
    Soap kraft boxes
    Custom Packaging Boxes
    Custom Boxes For Business

    ReplyDelete
  37. The best trades aren’t available every hour or even every day, so sometimes you might have to wait for days or even weeks for Accurate Trading Signals

    ReplyDelete
  38. The vendor has one card turned down that you simply can't see, denoted "?". Originally launched in the GEN2 putter lineup, the pyramid face pattern has been re-engineered for optimum efficiency. Based on Tour suggestions and R&D testing, 온라인카지노 the groove depth has been adjusted to optimize feel and initial ball velocity across the face. The updated face design additionally helps guarantee consistency in other significant components that have an effect on} roll similar to launch angle, spin rates, and skid distance.

    ReplyDelete