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Capitalism 2.0: Speculator vs. Creator

Posted on Friday, Apr 3rd 2009

One of the flaws I see in Capitalism 1.0 is that speculators get compensated at a substantially higher rate than value creators. As a result, I am hearing from more and more entrepreneurs, CEOs, senior executives – the builders, so to speak – that they are no longer willing to work 60-80 hour weeks. They feel that the system is becoming unfair. This is one of the most severe bugs in Capitalism 1.0.

I have talked about this before in multiple different posts, the most notable of which was the VC-Entrepreneur Compensation Disbalance, where we discussed how the 2:20 compensation structure of the venture capital industry pushes talent toward venture capital, and away from entrepreneurship. Yet, VCs can only exist as parasites, feeding on entrepreneurs’ creation. If the entrepreneurs don’t want to work with VCs, the industry will die. Not desirable either, because I firmly believe that venture capital is a fundamentally important tool of capitalism, and needs to be adjusted to a functional model in capitalism 2.0. Probably, the adjustment will need to happen with the 2:20 rule, changing such that management fees go down significantly and the compensation structure becomes more of true pay-for-performance.

Ayn Rand writes on “The Soul of an Individualist”: “Men have been taught that the highest virtue is not to achieve, but to give. Yet one cannot give that which has not been created. Creation comes before distribution—or there will be nothing to distribute. The need of the creator comes before the need of any possible beneficiary. Yet we are taught to admire the second-hander who dispenses gifts he has not produced above the man who made the gifts possible. We praise an act of charity. We shrug at an act of achievement.”

Rewarding the speculator so far above the creator is actually much worse.

Here’s another great Rand passage also about the creator: “Throughout the centuries there were men who took first steps down new roads armed with nothing but their own vision. Their goals differed, but they all had this in common: that the step was first, the road new, the vision unborrowed, and the response they received—hatred. The great creators—the thinkers, the artists, the scientists, the inventors—stood alone against the men of their time. Every great new thought was opposed. Every great new invention was denounced. The first motor was considered foolish. The airplane was considered impossible. The power loom was considered vicious. Anesthesia was considered sinful. But the men of unborrowed vision went ahead. They fought, they suffered and they paid. But they won.

No creator was prompted by a desire to serve his brothers, for his brothers rejected the gift he offered and that gift destroyed the slothful routine of their lives. His truth was his only motive. His own truth, and his own work to achieve it in his own way. A symphony, a book, an engine, a philosophy, an airplane or a building—that was his goal and his life. Not those who heard, read, operated, believed, flew or inhabited the thing he had created. The creation, not its users. The creation, not the benefits others derived from it. The creation which gave form to his truth. He held his truth above all things and against all men.

His vision, his strength, his courage came from his own spirit. A man’s spirit, however, is his self. That entity which is his consciousness. To think, to feel, to judge, to act are functions of the ego.

The creators were not selfless. It is the whole secret of their power—that it was self-sufficient, self-motivated, self-generated. A first cause, a fount of energy, a life force, a Prime Mover. The creator served nothing and no one. He lived for himself.

And only by living for himself was he able to achieve the things which are the glory of mankind. Such is the nature of achievement.”

In these times of confusion, let us not forget the needs of the creator. One of those needs is Justice.

This segment is a part in the series : Capitalism 2.0

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Exceptionally presented topic! Thank you! It is open-minded, creative thinking, from Ayn Rand to Richard Florida that will help us all embrace our invevitable evolution to VALUING innovation and those who are willing to stick their necks out for change.

Pamela Hoke Friday, April 3, 2009 at 8:53 AM PT

Reviewing the economics….

Hi Sramana, if indeed there are fewer and fewer people attracted to entrepreneurship, and more attracted to VC, wouldn´t the decreased supply for enterprenours and increased supply of VCs balance things out ?

I empathize with the feeling of injustice, but sometimes, it seems Nature
is doing Justice in front of our eyes and we aren´t seeing it. For instance
much of the financial crisis, is, in my view, a market adjustment telling speculators
how much they are really worth it(nothing). Maybe the way the market adjusts VCs is alike,
even though they are obviously worth more than speculators.

Rafael Friday, April 3, 2009 at 11:53 AM PT

Hi Rafael,

Nature and the Market are taking care of some of the issues: http://blogs.wsj.com/venturecapital/2009/04/03/venture-capital-fund-raising-nosedives/.

But there are structural flaws that need to be tackled from a system design point of view. I will start addressing some of them in subsequent pieces.

Sramana Mitra Friday, April 3, 2009 at 12:22 PM PT

It is interesting that you have not mentioned the role of Sarbanes Oxley in stifling innovation. How many IPOs have come out after this pernicious legislation was introduced? Also, the mark-to-market rules brought about by this legislation has almost destroyed the financial industry. Expensing of stock options has lowered compensation for entrepreneurs and has made a career in a venture capital firm more rewarding. Venture capitalists are not risk-averse, they just don’t see how returns can be earned when the IPO market is closed off.

I continue to be frustrated by your tendency to mouth socialist rants which I don’t expect from an Ayn Rand fan. She was a brilliant proponent of free markets and instinctively understood how Governments mean well but all the while they are screwing up entrepreneurship. Please, stop this.

Kishore Jethanandani Friday, April 10, 2009 at 1:59 PM PT

Ayn Rand doesn’t deal with innovation, and she existed before the venture capital industry was born. You can be frustrated with me, you can be frustrated with reality.

I don’t believe in pretending that reality doesn’t exist.

As far I recall, Rand doesn’t either.

Sramana Mitra Friday, April 10, 2009 at 2:05 PM PT

Well said but somewhere I think Sramana has a lot more (from her own research) to say on this which she would sooner.

Partha Das Chowdhury Monday, April 13, 2009 at 5:41 AM PT

To have wealth redistribution you first must have wealth creation. It seems to me that what the government is doing is squelching wealth creation with many of their policies. The ultimate result will be no wealth to redistribute. That is reality. In fact we are almost reversing roles with China in terms of wealth suppression vs. wealth creation. So the first thing the government and financial institutions must do is support wealth creation. I think this is one of the underlying messages of your article and what must be a clear construct of Capitalism 2.0 . Capitalism 2.0 must reward the innovators through the natural capitalistic process which would then penalize the speculator. Although one must be careful here since the speculator can also be the innovator. The government’s role, as you stated, is to facilitate the infrastructure for wealth creation.

Jim Healy Wednesday, April 15, 2009 at 10:06 AM PT

Speculators are compensated more than value creators because they negotiate more lucrative terms in their contracts. Bankers are compensated more than producers because they have united in their lobbying efforts that granted them laws favoring them in a negotiation. Depending upon the relative power of labor vs. management, the more highly skilled negotiator wins more favorable terms.
Ayn Rand’s protagonists make a point of NOT negotiating, of NOT compromising their ideals. Her rather naive “if you build it (a desirable product), they will come” thesis flies in the face of reality. The fundamental difference between Raynd’s fiction vs. reality that the Jim Taggart to John Gault ratio is about a bazillion to one. In Ayn Rand’s, The Fountainhead, antagonist Ellsworth Toohey is told by his aunt, “You’re a maggot, Elsie. You feed on sores”. His reply, “Then I’ll never starve”. Look at the multiplicity of maggots reaping rewards today.
Sramana, you see the diamonds in the rough and fight a heroic battle to find polish for those stones. What a brilliant world this could be if each individual found their own heroism. But there are fundamental cultural issues that need to be addressed if Capitalism 2.0 is to succeed. Issues that place a higher value on bling than the real thing; on style over substance; on perception over reality. I fear for a people who have lost the true meanings of production, achievement, selfishness and greed, and the concepts of individuality and freedom. And I mourn for fallen heroes.

Pete Kepf Wednesday, April 15, 2009 at 10:59 AM PT

Well said, Peter. We mourn together, then.

And we mourn together for a world where leeches and maggots ride in private jets and inhabit their 18 mansions.

While heroes toil in relative obscurity.

Sramana Mitra Wednesday, April 15, 2009 at 11:14 AM PT

Obvious: Current economic models are flawed
Non-Obvious: What’s the next economic model?
My bet: It will be a long-tailed model primarily, even for the Venture Capital industry

Vishal Chandra Tuesday, April 21, 2009 at 9:20 PM PT

But banks, IB and VC have either lost vast amounts or made minimal profits for the last several quarters . You do need to look at normalized returns over a cycle, not just peak returns.

The lack of profits in VC and PE have caused both those industries to suffer a recent drought in fund raising . The market to some degree is equilibratng

joofer Wednesday, May 27, 2009 at 8:45 AM PT

Indeed, and Amen.

Markets do work for the most part, and that’s a great thing.

Sramana Mitra Wednesday, May 27, 2009 at 8:52 AM PT

[…] 21. November 2009 um 11:28 · Gespeichert unter Uncategorized and Getagged: http://sramanamitra.com/2009/04/03/capitalism-20-speculator-vs-creator/ One of the flaws I see in Capitalism 1.0 is that speculators get compensated at a substantially higher rate than value creators. As a result, I am hearing from more and more entrepreneurs, CEOs, senior executives – the builders, so to speak – that they are no longer willing to work 60-80 hour weeks. They feel that the system is becoming unfair. This is one of the most severe bugs in Capitalism 1.0. http://sramanamitra.com/2009/04/03/capitalism-20-speculator-vs-creator/ […]

Capitalism 2.0: Speculator vs. Creator « Site Eins Saturday, November 21, 2009 at 3:54 AM PT

I would no more think of paying too much to a venture capitalist than I would pay too much for a cleaner or a cup of coffee. Speculators are there to provide a service, and if Creators pay them too much, then the Creators either undervalue their own contribution or overvalue what they need.

Since you are an admirer of Rand, I have to ask, why are you even thinking about doing deals with VCs at all?

Gordon Rae Saturday, November 21, 2009 at 3:59 AM PT