Incorporated Men and Women

In my post on The Unincorporated Man “framing” writes:

Instead of saying that a corporation can own shares in your income, how about saying it is like a loan that you wont get into trouble ever paying back, but will have to pay more if you become rich.

Exactly. In fact, I have written about income-contingent loans before and how one of them got Bill Clinton through college. At the PSD blog Ryan Hahn also points to Lumni, a new firm that is investing in human capital in the developing world:

Lumni designs, markets and manages “Human capital funds”, an innovative investment vehicle for financing education. Students agree to pay a fixed percentage of their individual incomes for a predetermined number of months after graduation. The arrangement traspases part of the risk of investing in education from the student to the investor, who is in a better position to diversify it.

Lumni is the brainchild of economics professor Miguel Palacios.  Here is his book and Cato paper on human capital contracts.


Well, heck. If corporations can be juridical people, why not let people be juridical corporations? Turnabout is fair play, I say.

I've always thought something similar would happen: Corporations having their own "colleges." You know, go to Microsoft college, learn programming, business, and marketing and choose one as a focus. Then, you get placed in a position depending on what you're good at and how good you are at it. Or you could go work for some other software company.

Let's go further than that: invest in human traits through human genes. They are easily identifiable, demarcable and can be turned into property. Imagine good genes combining in a better human being thus giving better returns and better offspring. Imagine genes mutating into oblivion and traits disappearing completely. In this system - can I use my own genes as a collateral for obtaining a loan? How about collaterized debt obligation? Syntetic securities? Can we form a portfolio of stable, reliable AAA genes? How about rating agencies for genes?

Okay, should have previewed my last comment more thoroughly. Turns out your comment box doesn't like less than signs.

The last sentence of the first paragraph should read:

"For those who are reasonably confident that they will be earning enough to pay off a traditional loan at a cost of less than 4 percent, the deal would not hold much appeal."

Think about what this could do for the music industry.

This is how artists should operate. Let fans invest in them. They should sell off future album income streams to fans in exchange for income today. Fans could invest in artist that they like.

. . . and do you really want to take sunk costs and turn them into effective marginal taxes?

But if almost all of the benefit of education is relative...

Think about what this could do for the music industry.

Unless I'm mistaken, this is in fact how the music industry used to operate, before the Internet sucked all the money out of it. Agents or record labels would invest in artists in exchange for a cut of their future earnings.

The problem is that most artists turn out to be bad investments; on the other hand, the ones who do become successful soon become dissatisfied with their inequitable deals and demand to renegotiate their contracts.

I think you'd have a similar problem with investing in non-musical careers: in hindsight, someone always ends up feeling they got a raw deal.

A couple of issues/thoughts:

1) Whether or not one can sell a security interest in future earnings is a separate question from that of incorporation. Incorporation refers to an artificial entity's ability to enter into contracts and protect the owners of its shares from liabilities arising from its actions. Theoretically, a human being could sell security interests in his or her productive capacity without "incorporating".

2) A simple security interest against future income of an individual is not incorporation or a "stock" or "equity" interest (see point 4 below). Rather, it is more akin to either a) some sort of debt (such as the income-contingent loan discussed in Tyler's post), or b) some sort of a paid-forward insurance contract (the contract is essentially a hedge by an individual against poor future economic performance despite education and other inputs today).

3) That type of debt/insurance contract is not common with entities because it misaligns incentives. Structuring finance should be about giving the investee the right incentives to accomplish the goal whereby everyone is paid. There is an inherent conflict in the situation described in that the goal of the creditor or insurer is to maximize its return given the success of the individual, and as the benefits accruing to the individual in reaping the rewards of success are diminished, they have a diminished incentive for success (If I sell the right to 50% of my future salary, my incentives would align more with low-paid, low-stress work where the rewards are non-monetary than with the effort that goes into high levels of monetary success). This is dependent on the investment being in the form of debt/insurance, whereby the individual retains a certain amount of freedom to do whatever they want.

4) A security interest in the productive capacity of a human being differs from an equity interest in an enterprise in a very important respect. An equity interest (or shares of stock in an enterprise) is the right to the residual income of the enterprise after satisfaction of its liabilities. In other words, an enterprise adds up its income and other assets, subtracts its costs and other liabilities, and the equity holder has a right to what remains. If an equity investment in a human was similarly structured, the human could simply run up the liabilities (i.e., the costs of his or her existence, by acquiring stuff) leaving nothing for the equity holder to claim. There is nothing for the equity investor to claim on the basis of their equity, because nothing is left. Now, the equity holder could also have a *contract* with the human requiring them to live within certain means, but then that would start to make the investor liable for the actions of the individual (as the individual would then be the agent of the investor, because the individual is not allowed the discretion of free will but instead operates at the request of the investor), look more like a prohibited indentured servitude contract, and would defeat the whole purpose of the equity investment *in the individual*, and thus a more adequate structure is that as desribed in point 5 below.

5) As a result of points 3 and 4, the better way to structure an investment in a human enterprise (even when the enterprise consists of one person) is practically exactly as we usually structure it today: incorporate an entity that contracts with the individual or individuals that will make up the enterprise. The individual agrees through the contract to perform certain work for a certain set of remuneration (to include, in this case, education and other start-up costs), and probably through an equity incentive in the entity. This way, the investor a) maintains control over the liabilities of the enterprise, in that it can regulate through contract the enterprises costs, b) sets the right incentives, as the individual has a contractual obligation to the entity, and his or her only upside is through the success of the entity, and c) gives the investor a security interest in the assets of the entity if it were to dissolve, i.e. the bulk of the remuneration can be in the form of a house, car, etc. that the individual has access to while it honors its contractual obligations to the entity.

6) Such a structure allows the investor to make sure that the individual maximizes income. If they go off and do a great job, the investor reaps the rewards. If they don't, the investor can basically put the individual in the poor house. That's a pretty good incentive for the individual to try and keep the investor happy. Combined with good upside-incentives, that will do a better job of aligning incentives than a simple claim to future income (which would incentivize the individual to pursue goals that have non-monetary rewards).

7) All of this basically ignores securities laws, bankruptcy laws, and thirteenth amendment prohibitions on indentured servitude, aiong other things, all of which would make such a structure unfeasible in almost all circumstances, often for very good reasons. However, at a certain level of performance of the individual there are such structures, where basically the only asset of the limited liability entity in which one or more people have an equity interest is a contract with a certain high-performing individual. It's a very bad structure (because it is so easy to get out of for the reasons mentioned above) for a "venture" financing model of human investment, whereby we invest in unproven children. It is much better suited towards investments in talented individuals that require capital to expand the impact they would otherwise have, but where the investor has the downside protection that the individual is unlikely to break its contractual obligations because to do so would be damaging to the individual (for a hypothetical example: a minor-league athlete requires capital investment to cover the cost of expensive surgery to improve performance. The investor provides such capital to an entity that has a contract with the athlete that says that the athlete may only engage in professional sports through the entity, and the entity will provide for the athletes' basic sustenance so long as he is working towards professional sports success. The investor has a 51% share in the control of the entity, and the athlete has a 49% share, which allows the investor to control the contract with the athlete, and allows the athlete to share in the upside if he ever makes it pro. It works for the investor because the athlete still has a strong incentive to pursue professional success becuase the alternative is to do whatever failed athletes do).

I think the last thing we want to do is make more money available for the colleges to suck up in higher tuition charges.

pays a fixed percentage of their individual income for a predetermined number of months after graduation. Transgress the agreement of the risk of investing in the education of students for the investor, who is better able to diversify.

Comments for this post are closed