On my vacation, which is coming to an end, the first book I read was Daniel Schulman’s Sons of Wichita. It’s subtitled “How the Koch Brothers Became America’s Most Powerful and Private Dynasty.” Written by an editor of Mother Jones, Sons of Wichita is, in my semi-informed opinion, largely fair.

I found this passage interesting:

“Koch has a pattern of delaying needed repairs and maintenance, often neglecting them entirely,” Linda Eads, the former Texas deputy attorney general, noted in a 2001 affidavit. “One reason for this failure to operate safe pipelines comes from Koch’s so-called Market-Based Management approach. For example, under this management philosophy, each section of the Koch pipeline must show a profit, and this profit must increase every quarter. Environmental and safety compliance does not pay off quarter by fiscal quarter, and thus employees are not rewarded or encouraged to strive for safety or compliance. Indeed, safety improvements are regularly delayed or ignored even when recommended by employees. Employees at Koch are told that every decision has to be judged by its economic effect and how the decision will affect the company’s profitability.”

I have 4 comments.

1. Eads showed herself to be a strong, to put it mildly, critic of Koch Industries. So we can’t assume that hers is an unbiased and accurate commentary on the issue of applying Market-Based Management.

2. I read Charles Koch’s book on market-based management several years ago and I didn’t bring it with me on my vacation. But my recall is that it was too loose a guide to making actual decisions. So I could imagine someone interpreting it her way and I could imagine someone interpreting it some other way.

3. I’m not saying I’m sure she’s wrong but it’s hard for me to believe that, as she says, “this profit must increase every quarter.” If you’re striving to maximize the value of a company, you will have quarters in which profit decreases. I agree with her that if you strive to increase profit quarter by quarter, you will make some very bad decisions. If drug companies did that, for example, they would, quarter by quarter, reduce research and development. But would Charles understand economics so badly that he would have, as a goal, profit increasing every quarter.

4. Notice the last sentence in the quoted passage. She seems to treat “its economic effect” as if an action has one effect. But, as noted in #3 above, an action can reduce quarterly profits but increase long-term profitability. Certainly, the Danielle Smalley case that Schulman discusses, in which a jury awarded $296 million in a wrongful death suit against Koch Industries, suggests that their failure to maintain a pipeline was not profit-maximizing. Of course, no one could have known up front that Koch Industries would face such a large award. Even the plaintiff had asked for “only” $100 million. But the point is that Koch’s management would know that it would face some probability of a wrongful death suit with a big payoff.