After incurring losses of $1.22 billion in 2001 and $1.27 billion in 2002, the senior executives of Delta Airlines quietly funded a special account to ensure that their own pensions would be completely protected in the event of that airline's then widely anticipated bankruptcy. As to the pensions of all other employees, their level of underfunding rose from $2.4 billion to $4.9 billion during 2002. In the event of bankruptcy, the funding of their pensions would be left to the vagaries of the legal process ("Delta Air Moves to Secure Pensions of Struggling Carrier's Executives," Wall Street Journal, March 26, 2003, C7). This story suggests the theme of this paper. Just who, in out deregulated form of hyper-capitalism, are the risk takers? Additionally, are the actual risk takers of our age being compensated for the risks they routinely undertake with additional rewards?
As the Delta Airlines example suggests, the shifting of risk does not necessarily take place through "voluntary" or "compensated" transactions, as the finance textbooks would lead us to believe. Yes, it is true that risks are often traded by firms and individuals in complex commodities, bond, asset, and derivative markets. Yet it is also evident that in the event of unequal bargaining power, legalized protections, and asymmetric information we also experience a tendency for a separation of reward from risk. To be specific, we have seen, and can expect to continue to see, the systematic shifting of risks toward those who cannot afford them, cannot control them, and do not want them.
Admittedly, the size and scope of this shift is difficult if not impossible to quantify. The reason is that these shifts are infrequently the result of explicit negotiations or market transactions. But a lack of easy quantification should not, as it too often is in economics, be taken as evidence that the phenomenon in question is not occurring. Indeed, the continuing divorce of risk from reward represents an important contributor to the sense of insecurity that is increasingly evident among so many middle and working class Americans.
Deregulation in general, and financial deregulation in particular, is valued by its beneficiaries in part for its ability to separate risk from reward. Modern financial markets enable management, major shareholders, and other of the firm's "insiders" to shift risks away from themselves. While professional insurers, speculators, and hedgers may accept these risks for a fee, it is clear that some of these risks can also be shifted toward smaller and less informed stockholders, bondholders, employees, customers, and other stakeholders, including the general public. These latter groups, if they understand these risks at all, are generally less willing and frequently less able to bear the risks they are being forced to shoulder. Sadly, it is often the case that they are not even aware that they are being subjected to them. (1)
The Economics of Shifting Risk
Consider, in light of the above, the following statement from a conventional finance textbook:
These considerations of risk and expected return lead to a general principle of great importance. Investors will make a risky investment only if they believe that the expected return justifies the risk. That is the key idea of the risk/return (or more exactly, the risk/expected return) trade-off. It is simply a fact of life that high expected return and high risk normally go together. (Kolb and Rodriquez 1992, 10, italics added) This now-conventional understanding of the relation between risk and reward depends upon a crucial premise: that the risks in question be entirely and voluntarily borne by either (1) the party whose activities and decisions are creating the risks in question or (2) by another party who has contracted with the first party, either directly or through one or more intermediaries, to accept the risk in question for an explicit fee. But what happens to the validity of this conventional perspective in the event that one or more of its crucial, and generally unstated, premises rail to hold? Indeed, there are several substantial reasons to suppose that in the American economy risks will be separated from rewards and shifted away from decision makers and the economically powerful.
In American capitalism decision makers routinely, if not typically, enjoy legal protection from full responsibility for the risks they generate. This is most apparent when we consider the legally limited liability that has been awarded to shareholders and managers of incorporated firms (Eeghan 1997).
In the event that a firm with legally limited liability faces a financial debacle, its creditors can demand, at most, the sale or liquidation value of the firm's assets unless they can prove fraud or criminal negligence (a nontrivial task). The private assets of shareholders and managers, beyond what they have invested in the firm, are legally protected from...