LCD Soundsystem, Ticket Pricing, and IPOs

LCD Soundsystem is one of my favorite bands, and the favorite band of Stone Soup guest blogger Thomas. Unfortunately, they will no longer be producing music together, and planned a final, farewell show at Madison Square Garden. This farewell show is the subject of much media frenzy because, apparently, no one was able to get tickets for it. One Slate writer recounts her experience trying/failing to get tickets:

At 11 a.m. on Friday, Feb. 11, Ticketmaster was scheduled to put tickets to the show on sale. At exactly 10:50 a.m. on Friday, I went to Ticketmaster’s site and set up the appropriate purchase page. At 10:58, I started refreshing constantly. At 11, poised and ready, I got … nothing. The site said there were no tickets available. I reloaded the page madly, and then tried with a new browser window. No tickets. Not even in the nosebleed section.

Twitter was abuzz with chatter on how it was impossible to obtain LCD Soundsystem tickets. The Onion’s AV Club joked, “Anyone who’s glanced at their Twitter feeds this morning knows that the inability to purchase tickets to LCD Soundsystem’s Madison Square Garden farewell show rivals Mubarak’s exit for topic du jour.”$50 tickets appeared shortly thereafter for thousands of dollars apiece on reseller websites like StubHub. As the Slate article explains, and as the LCD Soundsystem frontman James Murphy ranted about, the problem was caused by scalpers who used computer programs to circumvent Ticketmaster’s [pathetic?] Captcha system and snap up all the tickets within seconds of release. A few pre-sales, and hold-backs from the band and venue, may have reduced the actual ticket supply. The illegality of paperless tickets (in New York)–where fans must present the purchasing credit card on the night of the concert–eliminated one method of solving the scalping problem. Anyway, Murphy mitigated the problem by announcing the band would play four additional shows at Terminal 5 before the MSG concert, which he hoped would depress ticket prices for the MSG show and, in an ideal world, screw over the scalpers a little bit.

A lot of people have mourned the naivete of James Murphy, and called for an auction-based system where fans could buy tickets closer to their actual value. Matthew Yglesias writes:

Optimal allocation of LCD Soundsystem tickets requires demand-responsive ticket pricing. But good rock bands are not composed of narrow-minded amoral profit-maximizers. Consequently, they’re motivated to price tickets at a lower level than the market will bear leading, in turn, to middlemen getting the rents. What’s needed is a way for bands to price tickets at demand-responsive levels in a way that’s consistent with the norm that the guys in a cool band shouldn’t be narrow-minded profit-maximizers. The best solution here, I think, is charity. Someone (Bono?) needs to set up a trust fund to which bands will allocate the excess revenues that accumulate when the market price of concert tickets exceeds the “fair” price as determined by the bands’ moral intuitions. In that case, instead of a situation where “[t]ickets with a face value of $49.50 were going for 12 times that” on a secondary market you’d have a scenario where tickets are going for $500 and $450 out of that goes to the trust fund. The fund could take the money and give it to poor people in Africa and India.

In fact, I don’t think there’s anything suboptimal about the ticket pricing. The goal of selling tickets is not merely to make money, or even to ensure your fans can see you, but to generate buzz about your music/record and in so doing increase sales. Buzz is created when there is high demand for a scarce product–when tickets are unobtainable, not when the price is set high enough that just enough people buy them to fill the venue.

Felix Salmon blogs about this (coincidentally I had the same idea and started writing this post on the 17th, but I was too lazy to finish it, and he published it on the 19th) and compares it to IPO pricing.

People sympathetic to the band, like Rob Cox, claim that LCD Soundsystem and its promoters didn’t understand the economics of scarcity when they put the MSG tickets on sale. I, by contrast, think they understood the economics of scarcity all too well — and successfully used it to generate buzz and publicity. What really happened here, I think, is akin to the IPO of theglobe.com back in 1998, where the supply of new shares was so tiny that the price soared from $9 to $97 on the first day of trading. In turn, that generated lots of headlines, and ensured that the number of people who had heard of the website increased by orders of magnitude.

Supply and demand for concert tickets aren’t static numbers which then get reflected in prices. There are complex feedback loops here too: scarcity and price mechanisms can feed back into increased demand for tickets. Certainly this story has meant a large increase in the number of people who know that LCD Soundsystem is playing its last-ever gig at MSG in April. It’s surely naive to think that all the second-order effects here were completely unintended.

In fact this occurs all the time in IPOs. For an investment bank (underwriter), setting the price for an IPO can be tricky because since there is no existing trading of shares, it can be hard to value the company and decide how much to pay for an unknown quantity. In a phenomenon called “underpricing”, the share of an IPO will tend to jump up significantly within the first day of trading, i.e. there is a large percentage difference between the “offer price” and the share price traded on the first day:

Since the 1960s, this ‘underpricing discount’ has averaged around 19% in the United States, suggesting that firms leave considerable amounts of money on the table. Underpricing has tended to fluctuate a great deal, averaging 21% in the 1960s, 12% in the 1970s, 16% in the 1980s, 21% in the 1990s, and 40% in the four years since 2000 (reflecting mostly the tail-end of the late 1990s internet boom). Clearly, underpricing is costly to a firm’s owners: shares sold for personal account are sold at too low a price, while the value of shares retained after the IPO is diluted. In dollar terms, IPO firms appear to leave many billions ‘on the table’ every year in the U.S. IPO market alone.

There are many theories rationalizing this apparently irrational phenomenon (many addressed in the paper linked to above), and they can also be made to apply to concert ticket pricing. Julian Franks argues that it is advantageous for the pre-IPO shareholders to underprice because it leads to oversubscription and rationing–an investment bank will have to reduce the block size of shares sold to their customers because so many of them want to purchase the IPO, and the bank wants to satisfy many customers. This rationing can create diffuse shareholder rights, and discrimination on who is sold large shares of the company. From a band’s point of view, cheap ticket prices may be better if you want the opportunity for poorer, younger, and more hip/exciting fans to predominate in the audience rather than wealthier, but more subdued fans–Brooklyn vs. Westchester. They’d rather have fans willing to camp out for tickets, than those who will only click a button to pay higher prices.

Underpricing is also beneficial for the underwriters of an IPO. The paper cites a study which “find[s] that overpricing (but not high levels of underpricing) lead to a decrease in the lead underwriter’s own stock market value, whereas moderate levels of underpricing are associated with an increase in stock market value”. One explanation is that underpricing and the subsequent rise in stock price enhances the reputation of the underwriter because the IPO went really well, and future companies will seek to go public with that underwriter. Similarly, a sold-out venue or sky-high ticket prices is much more beneficial to the reputation of a band manager or concert organizer than an event that is full, but with no additional demand for tickets.

So when LCD Soundsystem and other bands decide to offer their tickets at low face-value prices, they’re making a strategic economic decision that is mirrored by companies like VISA and I-banks like Goldman Sachs–hardly the stuff of charitable fools. Even if paperless tickets were made legal, or some perfect Captcha system emerged to prevent any scalper from purchasing a large quantity of tickets (but secondary markets like StubHub would still exist), bands and band managers would/should still endeavor to underprice their tickets.

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Constitutionality of the Individual Mandate, and Regulating “Economic Inactivity”.

A friend of mine had dinner last week with one of her friends who was in town for the American Conservative Union’s Conservative Political Action Conference (CPAC), and asked for some tips on talking to a hard-core conservative about health care reform, especially in light of two rulings from federal judges in VA and FL that invalidate ACA in part, or in toto. Instead of sending her a list of articles that I had read, I thought I’d summarize my impressions in a blog post. (Apologies if you’ve read all these arguments elsewhere, already.)

For many conservatives, the central problem with the Affordable Care Act is the “individual mandate”. Prof. Randy Barnett, of Georgetown Law, wrote early on in an op-ed in the Washington Post:

But the individual mandate extends the commerce clause’s power beyond economic activity, to economic inactivity. That is unprecedented. While Congress has used its taxing power to fund Social Security and Medicare, never before has it used its commerce power to mandate that an individual person engage in an economic transaction with a private company.

But, as many more qualified legal scholars have noted, Congress does not rely on the Commerce clause alone. The power to “to regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes”, while broadly conceived in such cases as Wickard and Raich, is being used to regulate the insurance industry–to create health care exchanges, to prohibit discrimination against preexisting conditions, etc. The idea that in order to have insurance we must have everyone participate–the so-called “individual mandate”–is empowered by the Necessary and Proper clause.

The owner of this home was taxed for inactivity.

Universal participation in health insurance was deemed necessary by Congress for the effective operation of that scheme, that is, the risk pool will be insufficiently large, or the elimination of preexisting conditions limits would encourage selection bias. As Prof. Tribe points out in a recent op-ed, it was necessary to Scalia, concurring in Raich, when the federal government quashed even small, purely intrastate marijuana operations: “Our cases show that the regulation of intrastate activities may be necessary to and proper for the regulation of interstate commerce in two general circumstances.” In the landmark case McCulloch, Chief Justice John Marshall writes: “Take, for example, the power ‘to establish post-offices and post roads’ [an enumerated power of Congress]. This power is executed by the single act of making the establishment. But, from this has been inferred the power and duty of carrying the mail along the post-road, from one post-office to another. And, from this implied power, has again been inferred the right to punish those who steal letters from the post-office, or rob the mail.” So even though postal carriers were not mandated by the Constitution, and even though Congress is not supposed to deal with intrastate commerce, both of those things are necessary to the achievement of Congress’ constitutional ends. That is, Marshall explained, if “the end be legitimate,” then “all means which are appropriate, which are plainly adapted to that end… are constitutional.”

Of course, as many people have pointed out, the government is not creating a “mandate” in the sense that it will jail you for your “economic inactivity”. It is going to tax your income if you aren’t paying health insurance premiums. So the part of the Constitution that specifically relates to the individual mandate is in fact the General Welfare Clause, whereby “Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States…” And the decision on what constitutes “general welfare” is for the democratically-elected Congress to decide, not activist judges. Justice Cardozo wrote in Helvering v. Davis:

“The line must still be drawn between one welfare and another, between particular and general…There is a middle ground or certainly a penumbra in which discretion is at large. The discretion, however, is not confided to the courts. The discretion belongs to Congress, unless the choice is clearly wrong, a display of arbitrary power is not an exercise of judgment. This is now familiar law.”

So far we’ve talked about whether the government can regulate your “economic inactivity”, I also wanted to give an example in which government clearly does regulate your “economic inactivity”.

One example is blight law. In Virginia, for example, if a property is vacant, or subject to many complaints, or is in a dilapidated condition or lacks normal maintenance or upkeep, it may be subject to a blight declaration:

After the owner is notified that the property is blighted if the property owner does not remove the blight or present an acceptable plan to cure the blight within a reasonable period of time, under powers granted under the Code of Virginia, the County can declare, by ordinance, any blighted property as a nuisance and then compel the abatement of the nuisance.

If the owner or owners fail to abate the nuisance, the County may do so and charge and collect the cost thereof from the owner of the property in any manner provided by law for the collection of state or local taxes.

In San Francisco:

But if the property is privately held, the DPW will have to determine the owner’s name and then contact that person about the applicable code violations. The owner will receive a notice from the city giving him or her 30 days to clean up and/or repair the property. If the owner does not respond or comply, the DPW may go there and do the work, billing the owner for the services or placing a lien against the property for repayment.

Mike Dorf pointed out that governments can also mandate positive actions in other arenas: jury duty, schooling your children (state gov.), Selective Service, and even vaccination. Jury duty, for example, is necessary if the federal government is to provide the juries alluded to in the Bill of Rights, in the course of prosecuting federal crimes. And for the originalists out there, as early as 1792, Congress passed a militia act (since repealed) that required citizens between 18 and 45 to “provide [themselves] with a good musket or firelock, a sufficient bayonet and belt, two spare flints, and a knapsack, a pouch, with a box therein, to contain not less than twenty four cartridges, suited to the bore of his musket or firelock, each cartridge to contain a proper quantity of powder and ball; or with a good rifle, knapsack, shot-pouch, and powder-horn, twenty balls suited to the bore of his rifle, and a quarter of a pound of powder”.

In the blight example these are state laws, but they derive that power from the same type of police or taxation powers as the federal government, and philosophically the theory is the same. So it’s clear that “economic inactivity” is still “activity” in the sense that your inaction can effect commerce generally–an unwillingness to maintain your property can be a nuisance and eyesore for a community, an unwillingness to educate your kids creates dumb citizens, and an uninsured person will impact the health care system by going to emergency rooms when they do get sick, or relying on family and friends to support them when they get ill. A 2008 Kaiser study finds that “the uninsured will spend $30 billion out-of-pocket for health care in 2008 while receiving $56 billion in uncompensated care, three quarters of which will be from government sources.” It is equally clear that the government can, and currently does, regulate “inactivity”, the government can compel behavior, and at the very least, the government can tax.

In Defense of Farm Subsidies

A while ago I thought it would be fun to have an “In Defense Of” series that would present arguments for some oft-not-supported causes. Stay tuned for Defenses of Robert Bork and Clarence Thomas…

While debating for Columbia, Josh and I were also responsible for teaching debate to interested students. One aspect of the style we participated in was that the government team proposed the “case” in each round, and unlike [m]any high school debate formats, the “case” was unrestricted by any previously determined resolution. However, there were a handful of prohibitions designed to keep the rounds fair, and one of these was the injunction against “tight cases”–ideas that were so obviously true or one-sided that no matter how well the opposition side argued, they wouldn’t be able to defeat the case. A good example, often used in philosophy, of this is the moral proposition that “we should not torture innocent babies for fun”. Another common example used in illustrating a “tight case” was “the government should end farm subsidies”.

There is a litany of reasons against farm subsidies, which I will briefly mention. Budget hawks harp on their enormous expense. Direct aid to farmers totals around $15-20 billion each year, and one report that aggregated indirect subsidy (i.e. programs for irrigation, export credits, nutrition food aid and loan guarantees) claimed that total direct and indirect aid exceeded $180 billion. Health-conscious critics like Mark Bittman will point out that overproduction of corn allows the cheap production of high fructose corn syrup and all the sugary, diabetes-causing products it engenders, not to mention the corn-fed snack industry. For those who oppose the conglomeration of power in the hands of a few, the Farm Bill disproportionately pays out to large agribusinesses, and not small farmers. Overproduction of wheat, corn, livestock require oil-based fertilizers that destroy the soil and environment. And finally, though I may be missing a few reasons, farm subsidies allow American food producers to dump cheap wheat and corn on the world market, and destroy the livelihood of local farmers in developing countries where agriculture is the primary comparative advantage. Without food subsidies, the argument goes, these local farmers would either be self-sufficient feeders, or could sell their foodstuffs in the market at the same price as American companies.

Let’s look at the last point a little bit. I found a website that showed world production of the three most important cereals: corn, wheat, and rice. (albeit from 2003).

Corn Total Production, Mt %world prod. yield, Mt/ha
World 637,444,480
United States 256,904,560 40.3 8.92
China 114,175,000 17.9 4.85
Brazil 47,809,300 7.5 3.7
Mexico 19,652,416 3.1 2.53
Argentina 15,040,000 2.4 6.47
Wheat
World 549,433,727
China 86,100,250 15.7 3.91
India 65,129,300 11.9 2.62
United States 63,589,820 11.6 2.97
Russia 34,062,260 6.2 1.71
France 30,582,000 5.6 6.23
Rice
World 588,563,933
China 166,417,000 28.3 6.07
India 132,013,000 22.4 3
Indonesia 52,078,832 8.8 4.54
Bangladesh 38,060,000 6.5 3.43
Vietnam 34,518,600 5.9 4.63

One thing I found interesting was theyield, or metric tons of a commodity produced for each hectare planted. The United States, for example, produces 8.92 metric tons of corn per hectare, but the productivity ranges widely, down to Russia’s meager 1.71 metric tons of wheat per hectare. It seemed to me that richer countries generally had higher yields than poorer countries, and in fact a country like Eritrea yielded only 0.24 Mt/ha for wheat and 0.33 Mt/ha for corn. Kuwait and Qatar, on the other hand, have double digit yields of 20 and 12.5, respectively, for corn, despite not being known as particularly fertile places. This makes sense, because a major component of your yield is whether you can afford fertilizer, pesticides, genetically modified crops, or modern machinery. This is not to say that some poorer developing countries do not have excellent climates for agriculture–Egypt, for example, has corn:wheat:rice yields of 7.71, 6.15, and 9.43. Clearly it has retained its historic reputation as a regional breadbasket.Yet even in Egypt, after the building of the Aswan dam, cereal production hasn’t been the same and the country is now the world’s largest importer of wheat.

Just as obviously, it is not so that developing countries have a comparative advantage in agriculture. It seems foolish, in retrospect, to lump together countries like Egypt and Eritrea, which has less than 0.5 yields for both corn and wheat. Even though agriculture is the main economic activity of that latter country, it is subsistence agriculture at best–plagued by manmade disasters like war and deforestation, but also by erosion, drought, and insect infestations. Comparative advantage should not be measured in terms of what uneducated people with time on their hands can traditionally do–modern agriculture is for those with good soil, temperate climate, adequate rainfall, and the technology to maximize those geographical advantages. Nor is it profitable to be an agrarian society, where the majority of people are involved in farming; on the contrary, a nation of small farmers is usually quite impoverished. The fact that America feeds poor people in Africa through cheap corn and wheat, brought about by farm subsidies, is a good thing for countries that don’t have the god-given nor man-made tools to grow as efficiently, and their real comparative advantage is not time for agriculture, but cheap labor galvanized into factory work (think China, Thailand). (note: some Western African countries have a comparative advantage in cotton, but, as far as I know, not wheat/corn/rice).

The other thing I found interesting was that the United States is a Top 5 Producer of both Corn and Wheat, and ranks 11th in terms of Rice. The corn production is astounding: over 40% of the global supply! Recent news has been dominated by coverage of political protests in Egypt and Tunisia, and the specific timing is often attributed to rising food prices. Indeed similar riots occurred in Egypt in 2008, when there was also a wheat shortage, and food prices are higher in 2011 than in 2008, in fact the highest ever since the UN’s Food and Agriculture Organization began indexing prices in 1990. Already, half the Egyptian family’s budget is spent on food. Other Middle Eastern rulers are taking heed. In Bahrain, King Hamad raised government subsidies on flour, poultry, and meat. “Algeria, Libya and Jordan have either relaxed food taxes or duties on food imports or cut prices of staple food. Elsewhere in the Gulf, Kuwait recently introduced a generous stipend and free food for its citizens until March 2012 to ease the pain of higher costs.” Note the benevolence of these dictators is targeted toward food.

Why are wheat prices suddenly so high? The heat wave and fires in Russia/Ukraine, combined with floods in Australia severely diminished the harvests of those major exporters. India and Pakistan both suffered flooding as well. Russia, the world’s 6th largest exporter of wheat, canceled exports. Now China may also be contributing to the problem, as major agricultural regions face the worst drought in centuries, as reported yesterday in the NYTimes. China is a self-sufficient nation with very little exporting or importing, though with many mouths to feed, and a poor harvest could make China’s rich government, with $2.85 trillion in foreign exchange reserves, a big buyer in the international arena, raising prices in an already unstable market.

What does this have to do with farm subsidies? They were originally created in the U.S., in response to the Great Depression, to combat boom-and-bust pricing patterns for agriculture. In bumper years, prices would plummet and it’d be hard to make a profit in an oversaturated market. In lean years, farmers would lose their harvests and need to take on loans just to replant, while the consumer suffered from fluctuating prices. Government subsidies provided a price floor, and income was guaranteed no matter how low prices got. In return, farmers were incentivized to overproduce–there was, after all, a buyer of last resort–and food became cheap and plentiful.

Now in the United States we don’t worry about expensive food; our problem is overeating. But the food riots across in the world, in Manila and Mexico, Cairo and China, remind us why we spend in order to have years of plenty. If America stopped its farm subsidies and American farmers produced only what was domestically needed and a little more, no longer flooding the world market with cheap wheat and corn, would this unpredictable world food crisis have been even more severe? Would the food crisis be better if the U.S. had never had farm subsidies to begin with, and there were small farmers in developing countries trying to feed the Sphinx and the Dragon? Food protectionism costs a lot, no question. But in these modern times with poor countries developing slower than their populations are growing, food security affects global stability. America is no longer merely protecting itself from hunger, but, as an able producer of surplus food, serves as bulwark against global hunger–the farmer of last resort.

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