Enlightened Regulation, or How Not To Do It

(Whew! Need to blow the dust off of this here blog. It's been a while, but I hope to get back into the swing of things. Onward!)

Lots of people have Employee Stock Option Purchase plans (ESOPs) through their employers. Have you ever wondered why companies provide them?

I happen to have just sat through a presentation for one of our client companies on putting an ESOP in place. The short version is that an ESOP plan is a way for the founders of a company to sell their shares to their employees over several years, and avoid paying taxes on the proceeds almost entirely.

"Why, those dastardly greedy capitalists!" you might exclaim. Well, not quite. If owners of a successful company simply sold their shares without sheltering the proceeds from taxation, they would lose around half to the government, state and federal. These owners consider that outcome a poor reward for their many years of sweat and toil, and would like a way around it.

And a battery of lawyers and other middlemen are happy to provide such a way.

One can find many similar cases where government regulations will create a perverse result, until specialist middlemen such as attorneys or financial services people or others find a way around the regulations. The net result is simply to raise transaction costs for everybody, and to penalize those people who try to do it the "normal" way. With enough government regulation, the "normal" way becomes the sucker bet. Those who find the loopholes (specially built into the law just for them!) are the real winners.

The presentation today reminded me of a story I heard about a year ago from a friend of mine, who is a lobbyist for the garment industry. I may be remembering the details wrong, so forgive me, but the story is that back in the 1950s or so, a number of children were burned when they were groping around near open flames at night and their pajamas caught fire. This created something of a scandal, so the government dutifully decreed that all children's pajamas had to be resistant to fire.

But how?

It turns out that while it was possible to use a tighter weave for the cloth, the new weave was prohibitively expensive (and continues to be so, in most cases). The industry found that there was only one good way to meet this requirement: by dousing the pajamas with flame-retardant chemicals. Alas, it turned out several decades later that the chemicals in question were toxic and caused cancer.

So a new chemical was found, and children's pajamas today continue to be doused with it. My friend mentioned one sad case where the maker of natural, organic pajamas had her stock confiscated for failing to use the appropriate chemicals.

Meanwhile, the world has changed. Open flame is no longer found in most households where children can get at them, particularly not in the middle of the night, thanks to the spread of electronics and electric kitchen appliances. So the original purpose of the regulation in question has vanished, leaving in its wake many young cancer patients.

And some clothing manufacturers have responded by producing new lines of "lounge wear," or some other euphemism, which is essentially children's pajamas under another name, and not subject to the regulations. To get away with this, the companies generally need some good lawyers on staff and connections with the regulators. So, all that the regulations have done is punish those who act straightforwardly, reward those who create new loopholes and their middlemen, and harm whole generations of children.

But why don't the garment companies simply lobby for the rule to be repealed? That would seem the sensible move, yes? I asked my friend this, and he told me that no company could dare be the first, because it would be pilloried as wanting children to burn to death to protect its profits. Thus, no action is taken.

Such stories of woe are shot through the vast regulatory morass of our government. Laws remain on the books long after they have ceased to help, and begun to hurt. Other laws have no chance of ever achieving their stated goal, and are merely yet another cudgel for the "in-crowd" to use against those not willing to keep lawyers on retainer. Yet the regulations continue. They can't be bargained with. They can't be reasoned with. They don't feel pity, or remorse, or fear. And they absolutely will not stop, ever, until... what?

What happens next?