Fixing the Game

There is a great summary article in Forbes of this book by Roger Martin.  Having run a public company for several years, the thesis here resonated with me immediately.  Executives spend way too much time managing the Expectations Market (i.e., the stock market) as opposed to building value in the Real Market (i.e., goods and services used by your customers).  And, because the Expectations Market exists, hedge funds and activist investors have a platform.  To change the focus back to the Real Market, Martin has several suggestions, including:

• Repeal safe harbor, thus eliminating earnings guidance and forward speculation.
• Eliminate stock-based compensation.
• Regulate hedge funds.

I have had a related theory for a long time:  that the tax system is unfairly structured to favor the Expectation Market.  You pay lower taxes on Expectations Market gains (capital gains) than you do on Real Market gains (gains tied closely to the production of Real goods).  The further a financial instrument gets from the Real Market, the higher the taxes on it should be.  Hedge fund gains, or credit default swaps, should be taxed at a higher rate than income tax.  Of course, money is the lubricant for the Real Market, so we would have to ensure that direct investments that are "close to the Real" still had a tax advantage.  However, by increasing taxes based on the "derivative level" of an instrument, we would encourage people to spend more time in the Real world.