Agency Theory Meets COVID
Agency theory was developed as a framework to align principals with their agents. Using agency theory in a business context, consider the shareholders as the principals (owners) and agents as the managers hired to run a company. A tenant of agency theory is that agents will be motivated by their self-interest and, without proper alignment, might engage in adverse actions, reducing the principle’s outcome. In the 1980s, companies started to embrace agency theory, resulting in an over-reliance on stock options to align managers with shareholders.
As a senior leader in a company, the easiest way to maximize your compensation is to focus on raising the stock price at all costs. One could make the case that many public companies shifted to an extreme focus on short-term thinking over long-term planning. In other words, the exact opposite of a focus on customer service and sound product development occurred.
As leaders were awarded massive stock options, “just in time manufacturing” was widely adopted within the United States. Reduced costs associated with not purchasing and holding inventory months before it was needed improved a company’s bottom line. The quest to streamline costs had companies betting there would never be supply chain issues that lasted more than a few days. It was about maximizing the value of the company today. Like the successful roulette player who continues to “bet on red,” eventually, the ball landed on green sometimes. In early 2021, demand returned, accelerated by money saved from the lockdowns and money injected into the economy to the degree that would have made John Maynard Keynes blush—and the fragile, narrow supply chains failed.
According to CNBC, the chip shortage was expected to cost the auto industry $210 billion in revenue, and over 7.7 million units of production were delayed, or the orders were canceled in 2021 (https://www.cnbc.com/2021/09/23/chip-shortage-expected-to-cost-auto-industry-210-billion-in-2021.html).
Every industry, from toys to expensive automobiles, was affected by profound and generational consequences. Given the critical nature of chips to the manufacturing of automobiles, this short-term thinking embraced over the previous decades cost every industry far more than the cost of stockpiling emergency supplies of microchips would have. Extend that point to every definable industry in existence. Of course, the executives responsible for the decisions of the past decades did very well themselves. But the practices of optimizing supply chains for short-term profitability and the ubiquitous assumption that there would never be a significant supply chain disruption that lasted more than a few days would have to be the worst nightmare of any respectable de Medici patriarch.
As the effects of the last two years on organizations manifested through layoffs, depressed financial value, social unrest, and most significantly lost time, other unexpected situations surfaced. For example, in February 2021, Forbes reported, “After passenger airlines received $25 billion to cover airline workers’ salaries, American Airlines and United furloughed more than 32,000 workers in October” (https://www.forbes.com/sites/jackkelly/2021/02/01/airlines-lost-over-40000-workers-united-airlines-announced-another-14000-jobs-may-be-lost/?sh=404a02fb24b3). In November 2020 CNBC reported that Disney increased layoffs to 32,000 due to the pandemic (https://www.cnbc.com/2020/11/26/disney- increases-layoffs-to-32000-amid-coronavirus-pandemic.html). Disney also shut down numerous construction projects that were in preparation for their 50th anniversary that would begin October 1, 2021.
It takes years to build teams, cultures, and processes. Yet there was no thought on how they would restart these businesses efficiently. In July 2022, airline tickets had skyrocketed 38% over the previous 12 months, airline delays were up by 50%, and cancellations were up by 18% compared to pre-pandemic (https://www.politico.com/news/2022/07/01/air-travel-july-fourth-00043643). Yet the airline industry received a $54 billion COVID-19 government lifeline (https://www.reuters.com/business/aerospace- defense/us-airlines-defend-54-billion-covid-19-government-lifeline-2021-12-15/). Farcically, the industry proudly claims that the personnel lost was due to voluntary retirements.
The baby formula shortage is another example of short-term thinking; That one factory shutting down could impact so many families is a disgrace on many levels. Shame on the company’s management, which provided a product that was critical for so many families but allowed this critical supply chain to become so narrow. Our political leaders should be taking steps to ensure that we have multiple sources in a diversity of stable and accessible locations that can produce baby formula and other life-critical products that satisfy the most basic of fundamental customer needs. It’s time to reconsider the pervasive and dangerous domination of the monopoly players in nearly every industry in Western civilization. One company may be primarily responsible for families traveling to other countries to acquire necessary baby formula but virtually every industry that comprises critical production and infrastructure has the same types of narrow supply chains.
Information Technology Understands Being Prepared for the Unexpected
If the system architect and database administrators had been tasked with preparing the company for an unexpected disruption in the supply chain, the airline industry would not be in the mess it is today. If senior leaders were more focused on building strategic solutions and their compensation was intrinsically linked to that long-view success, versus the current focus on short-term profitability and near-term stock price, these systemic issues would be solved shortly. The long-term disruption in the supply chain caused by the government’s reaction to the perceived dangers of the pandemic has lingering effects that are likely generational but were not predetermined. These effects were created by festering short-term thinking and irresponsible consideration of what IT professionals refer to as the inevitable system failures that can be recovered from with proper backup, restore, and recovery planning. The challenge of 2020 was how to apply reductions of cost overrides needed to ensure the business survived and at the same time prepare the business for the day it will need to scale back up. Information technology gets an A for being prepared for the unexpected; the airline industry and many others let their customers and the world down.