Fathers and Sons
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There's never been an American war quite like this one. With
oil prices soaring and the economy seemingly fragile, it is
striking just how greatly the situation resembles that of 1991,
on the eve of the Gulf War. There are plenty of differences, of
course, but the similarities are greater. One of these is likely
to overwhelm all the others in the history books.
This is the only modern war in which a son has undertaken to
carry through to completion what his father before him had failed
to achieve.
With that in mind, let me tell a seemingly-unrelated story of
intergenerational competition and cooperation, one which is
continuing to unfold in a very different realm, just at the edge
of the news. The idea is to get some feel for how these
father-son successions can work.
Begin with the current issue of Harvard Business Review.
There Zvi Bodie, of Boston University's School of Management,
and Robert Kaplan and Robert Merton, of Harvard Business School,
come out about as strongly as it is possible to do so in favor
of estimating the cost to companies of the stock options they
grant to favored employees, in order to carry them on their
books.
Since the generous issue of options is thought to have done
much to pump up the recent bubble in stocks, it is a matter of
much controversy
Currently, the authors note, options are not recorded as an
expense on companies' books -- meaning there is little effective
brake on the practice. This one form of executive and employee
compensation is thus favored over all others. But the arguments
for this special treatment don't stand up, they say. "Let's end
the charade. The time has come to end the debate."
This is a remarkable brief, and it appears just as the
Financial Accounting Standards Board is about to begin a final
round of hearings before making a new ruling on the practice.
Bodie, Merton and Kaplan -- two finance professors and an
accounting authority -- list four fallacies among current
arguments.
Options-jockeys claim that stock options do not represent a
real cost; that their cost cannot be estimated; they their cost
already is adequately disclosed; and that expensing them will
hurt young businesses.
All wrong, say the professors. They marshal one argument after
another to show why -- beginning with Warren Buffet's cheerful
offer last year to take options in lieu of cash in return for the
goods and services his companies sell to other corporations,
prima facie evidence if ever there was that those options
represent a real, calculable cost to issuers.
There's something of the last word about this piece. It
brooks little dissent, especially from those who have trooped to
the editorial pages of The Wall Street Journal in the past year
to defend the current practice. They included former American
Express CEO Harvey Golub and economists William Baumol and Burton
Malkiel. Bodie and Merton's original piece appeared there as
well.
Part of the authority with which they write is personal. It
derives from the fact that it was Merton himself who, along with
Fischer Black and Myron Scholes, devised the options-pricing
formula in 1973 that stimulated the enormous growth in markets
for options of all kinds.
Those markets in turn facilitate the widespread use of options
grants to compensate executives and employees. Ten million
persons received stock options in 2000, up from one million a
decade earlier. The current rule governing the reporting of
executive stock options dates back to 1972, the year before the
Black-Scholes formula appeared.
Yet the main force of the Bodie-Kaplan-Merton argument derives
from the essentially gladiatorial nature of the contest. These
are questions to which there are right answers, not two or three
different ways of looking at the problem, as for example, the
significance of budget deficits. The case for expensing options
is "overwhelming," they say. In effect, they dare others to take
issue with them; they invite dissenters to duel.
The Nasdaq Stock Market has weighed in on behalf of current
practices, gauzily comparing stock options to the Homestead Act,
invoking Hernando DeSoto's "The Mystery of Capitalism." But no
one, least of all the accountants, want to do away with options
altogether. All recognize the device is a powerful tool for
motivating managers and employees and aligning their interests
with those of their investors.
So, when the smoke clears, you can confidently expect that
"prepaid compensation expense" to be a new category on income
statements and balance sheets. Complicated? Yes. It will be
another matter for experts, decided by experts.
Now as it happens, Merton's father died of lung cancer last
Sunday, not long after the article appeared. He was 92, at the
end of a remarkable career as a Columbia University professor.
But he was not an expert at anything, at least not in the sense
his son is. He was a sociologist, and an old-fashioned one at
that, meaning one who was content for the most part to be smart.
Robert K. Merton was born poor in Philadelphia in 1910. At 14,
he abandoned his birth name, Meyer Schkolnick, in the pursuit of
whole-hearted assimilation. Who was going to hire an aspiring
free-lance magician named Schkolnick? He availed himself of the
many public institutions of that Quaker city to win a scholarship
to Temple University. Thereafter he traveled to Harvard
University, where he wrote a dissertation on the rise of science
in 17th-century England for Pitrim Sorokin in the
newly-organizing department of sociology.
He later recalled, "An abundance of monographs dealt with the
juvenile delinquent, the hobo and saleslady, the professional
thief and the professional beggar, but not one dealt with the
professional scientist."
During World War II, with a deceptively short and simple paper
called "A Note on Science and Democracy," Merton became the prime
mover in a sweeping redefinition of science as the carrier of a
particular social structure. Just as Reinhold Niebuhr adduced
the existence of a "Judeo-Christian ethic" in a series of
scholarly studies in those years in order to present a united
front against potted Nazi doctrines of the origin of Western
ideals, so Merton emphasized the ethical content of science as an
alternative to totalitarianism.
It consisted largely, he wrote, of four imperatives --
universalism, communism, disinterestedness and organized
skepticism. That is, Merton wrote, science acknowledged no
national loyalties higher than to the truth. It aimed to create
public knowledge, meaning the scientist could not hope to benefit
until he had published his results, in effect giving them away
(today in computer software we call this "open source"
development). Because of its internal checks and balances, it was
virtually devoid of fraud (a finding that occasionally has been
bitterly challenged over the years as being excessively
complacent). And it purposefully rewarded doubt and devalued
"school spirit."
Merton had little to say about how science proceeded -- the
ever-thinner slicing, the shrug in the face of complex problems
in favor of the simpler ones that are susceptible to solution.
But the effect of the spotlight he put on its normative structure
was to elevate science to a higher moral plane just as thousand
of European refugees arrived from Europe to take positions of
responsibility in American institutions. The basic tenets of
American democracy were reaffirmed in a surprising and effective
fashion. "Melting pot" ideals were reinforced.
Merton's work and that of others who joined him became the
organizing core of a vibrant sociology of science that flourished
after the war. But gradually university sociology swept around
Merton and others like him on its way to becoming more narrow,
more various, more precise -- and much more critical of existing
institutions.
Merton, meanwhile, didn't seem to care. He extended his
interests further and wider, establishing with his friend Paul
Lazarfeld the Bureau of Applied Social Research, where the
focus-group concept originated, writing studies of integrated
communities that became part of the underpinning of the
government's brief to the Supreme Court in Brown vs. Board of
Education.
By 1960, the year he was lionized by journalist Morton Hunt as
"Mr. Sociology" in a profile in The New Yorker, he was on the
verge of becoming "Mr. Irritating" to insiders -- a little like
Joseph Schumpeter or John Kenneth Galbraith among the economists.
Catchy phrases tumbled from his typewriter -- "self-fulfilling
prophecy" is the best remembered -- but new works of galvanizing
interest to the profession eluded him.
Moreover, in 1962 physicist-turned-historian Thomas Kuhn
extensively reorganized the field with a book he called "The
Structure of Scientific Revolutions." Soon, departments dedicated
to the history of science were sprouting in the best
universities; sociologists were shouldered into the background.
Merton later gave a good account of some of the circumstances
surrounding this birth of a new discipline in a book called "The
Sociology of Science: An Episodic Memoir."
Then in 1965, Merton published his best-known book, "On the
Shoulders of Giants: A Shandean Poscript," a garrulous and
playful meditation on the nature of scholarship in the form of a
history of Isaac Newton's famous epigram -- "If I have seen
farther, it is by standing on the shoulders of giants."
"The strange thing about RKM is that he is held in such
greater regard outside sociology than within the field," says his
old friend and editor Peter Dougherty. "Economists who know his
stuff just love it. Sociologists have been writing him off for
at least two generations.
"They always wanted to minimize his influence; put him in a
smaller patch than he deserved. But he sprouted outwards beyond
the constraints of sociology--in economics, history of ideas,
science, applied social research, literary analysis--marketing,
for goodness' sake. Some young sociological whippersnapper will
have to reinvent Bob, I guess," says Dougherty.
Meanwhile, Merton's son -- he has two daughters as well --
had begun studying mathematics, first at Columbia, than at
Caltech. In 1967, he enrolled as a graduate student in economics
at the Massachusetts Institute of Technology, studying with his
father's old friend Paul Samuelson. Before long the two were
working on warrant pricing. It would be hard to exaggerate how
different was the work of the son at that point from that of the
father -- tight models described in abstruse calculus instead of
"theories of the middle range."
In 1973, the younger Merton published "The Theory of Rational
Option Pricing" in the Bell Journal of Economics, almost
simultaneously with the famous Black Scholes paper in the Journal
of Political Economy, whose submission had preceded it. The two
approaches to valuation reinforced each other and turned out to
be of enormous practical significance. Huge new markets in
"derivatives" arose on the basis of them. And in 1997 Robert C.
Merton and Scholes shared the Nobel Award in economics the year
after Fischer Black died, for the new method they had devised.
In short, Robert C. Merton became everything that Robert K.
Merton had not been -- a scientists' scientist, founder of a
field that never would fade away. And yet, whatever cross words
passed between them in the brief period of youthful rebellion in
the 1960s, the two men became each others' best friends, a mutual
admiration society practically without equal in the social
sciences.
The father continued to be influential in learned circles, but
at a certain point he began signing himself "father of the
economist." His wife, the sociologist of science Harriet
Zuckerman, in 1977 wrote a well-received study of American Nobel
laureates, "Scientific Elite."
The forced liquidation in 1998 of Long Term Capital
Management, the enormous hedge fund in which Robert C. Merton was
a principal, put a dent in this happy story, mainly insofar as it
damaged his credentials as a reformer of financial markets,
espousing "functional finance," following in his father's
footsteps. So did a divorce.
Otherwise, a fat pink cloud hung over the Merton family.
Robert K. Merton continued to work on a book on serendipity, a
subject long close to his heart. He completed it. It was
published in Italy and its US publication arranged. Even when he
died last week, there was a sense that nothing more could have
been asked of life except that there should be more of it. But
then as the old proverb has it, there is always more time than
life.
So what's the point? What about the impending war in the
Middle East? The businesses of the Merton and Bush families
couldn't be more different -- scholarship vs. politics. What's
the moral? What do Dubya and RCM have in common -- besides the
fact that they carry their father's names?
Just this. The relationship between father and son takes
precedence over almost everything else in their story. Sure,
there's a crucial point of differentiation. Robert C. Merton's
choice of mathematical economics involved a rejection of his
father's path. And George W. Bush's populist Texas Ranger act
contrasts sharply with his father's patrician
Establishmentarianism. So does his history of elective rather
than appointive politics. And his preference for go-to-hell tax
cuts on the eve of war stands in sharp contrast to his father's
prudent budget-balancing.
But in almost every other sense, the younger Bush is following
in his father's footsteps. His administration regards a
shaking-up of governments in the Middle East as a necessary
pre-condition to establishing a new post-Cold War stability
there. Equally clearly, the White House regards a strong foreign
policy as being the key to a durable economic recovery.
The Wall Street Journal last week reported the existence of a
draft "roadmap" to a Palestinian state within a year. It was
drawn up in December at the President's request by a shadowy
"Quartet" of planners consisting of representatives from the US,
the European Union, Russia and the UN, according to reporters
Neil King Jr. and Jeanne Cummings. The draft document calls for
a freeze on Israeli settlement activity and Palestinian elections
within six months -- as long leadership is acting decisively
against terror.
Depending how the showdown with Iraq turns out, the plan could
be firmly on the tables of Israeli and Palestinian leaders by the
fall -- with a good deal more action to follow, in international
oil markets, domestic budget negotiations and all the rest.
Mideast leaders don't much like the scheme, the Journal reported.
But then if Saddam Hussein is forcibly removed from Baghdad, the
calculus of power in the region will have changed again
dramatically.
In the face of an audacious and hard-to-assess gamble, it
probably makes sense for the near term to sit tight and pay
attention. That is what the story of the Mertons, RKM and RCM,
would suggest about how to think about the Bush family.
David Warsh
(Various links can be found at www.economicprincipals.com .
The Economic Principals project is sponsored by the Sabre
Foundation and supported by readers like you.)
--
Michael Perelman
Economics Department
California State University
Chico, CA 95929
Tel. 530-898-5321
E-Mail [EMAIL PROTECTED]
