25/4/18: Tesla: Lessons in Severe and Paired Risks and Uncertainties

Tesla, the darling of environmentally-sensible professors around the academia and financially ignorant herd-following investors around the U.S. urban-suburban enclaves of Tech Roundabouts, Silicon Valleys and Alleys, and Social Media Cul-de-Sacs, has been a master of cash raisings, cash burnings, and target settings. To see this, read this cold-blooded analysis of Tesla's financials: https://www.forbes.com/sites/jimcollins/2018/04/25/a-brief-history-of-tesla-19-billion-raised-and-9-billion-of-negative-cash-flow/2/#3364211daf3d.

Tesla, however, isn't that great at building quality cars in sustainable and risk-resilient ways. To see that, consider this:

1. Tesla can't procure new parts that would be consistent with quality controls norms used in traditional automotive industry: https://www.thecarconnection.com/news/1116291_tesla-turns-to-local-machine-shops-to-fix-parts-before-theyre-installed-on-new-cars.
2. Tesla's SCM systems are so bad, it is storing faulty components at its factory. As if lean SCM strategies have some how bypassed the 21st century Silicon Valley: http://www.thedrive.com/news/20114/defective-tesla-parts-are-stacked-outside-of-california-machine-shop-report-shows.
3. It's luxury vehicles line is littered with recalls relating to major faults: https://www.wired.com/story/tesla-model-s-steering-bolt-recall/. Which makes one pause and think: if Tesla can't secure quality design and execution at premium price points, what will you get for $45,000 Model 3?
4. Tesla burns through billions of cash year on year, and yet it cannot deliver on volume & quality mix for its 'make-or-break' Model 3: http://www.thetruthaboutcars.com/2018/04/hitting-ramp-tesla-built-nearly-21-percent-first-quarter-model-3s-last-week/.
5. Tesla's push toward automation is an experiment within an experiment, and, as such, it is a nesting of one tail risk uncertainty within another tail risk uncertainty. We don't have many examples of such, but here is one: https://arstechnica.com/cars/2018/04/experts-say-tesla-has-repeated-car-industry-mistakes-from-the-1980s/ and it did not end too well. The reason why? Because uncertainty is hard to deal with on its own. When two sources of uncertainty correlate positively in terms of their adverse impact, likelihood, velocity of evolution and proximity, you have a powerful conventional explosive wrapped around a tightly packed enriched uranium core. The end result can be fugly.
6. Build quality is poor: https://cleantechnica.com/2018/02/03/munro-compares-tesla-model-3-build-quality-kia-90s/.  So poor, Tesla is running "reworking" and "remanufacturing" poor quality cars facilities, including a set-aside factory next to its main production facilities, which takes in faulty vehicles rolled off the main production lines: https://www.bloomberg.com/view/articles/2018-03-22/elon-musk-is-a-modern-henry-ford-that-s-bad.
7. Meanwhile, and this is really a black eye for Tesla-promoting arm-chair tenured environmentalists, there is a pesky issue with Tesla's predatory workforce practices, ranging from allegations of discrimination https://www.sfgate.com/business/article/Tesla-Racial-Bias-Suit-Tests-the-Rights-of-12827883.php, to problems with unfair pay practices https://www.technologyreview.com/the-download/610186/tesla-says-it-has-a-plan-to-improve-working-conditions/, and unions busting: http://inthesetimes.com/working/entry/21065/tesla-workers-elon-musk-factory-fremont-united-auto-workers.  To be ahead of the curve here, consider Tesla an Uber-light governance minefield. The State of California, for one, is looking into some of that already: https://gizmodo.com/california-is-investigating-tesla-following-a-damning-r-1825368102.
8. Adding insult to the injury outlined in (7) above, Tesla seems to be institutionally unable to cope with change. In 2017, Musk attempted to address working conditions issues by providing new targets for fixing these: https://techcrunch.com/2017/02/24/elon-musk-addresses-working-condition-claims-in-tesla-staff-wide-email/. The attempt was largely an exercise in ignoring the problems, stating they don't exist, and then promising to fix them. A year later, problems are still there and no fixes have been delivered: https://www.buzzfeed.com/carolineodonovan/tesla-fremont-factory-injuries?utm_term=.qa8EzdgEw#.dto7Dnp7A. Then again, if Tesla can't deliver on core production targets, why would anyone expect it to act differently on non-core governance issues?

Here's the problem, summed up in a tight quote:

Now, personally, I admire Musk's entrepreneurial spirit and ability. But I do not own Tesla stock and do not intend to buy its cars. Because when on strips out all the hype surrounding this company, it's 'disruption' model borrows heavily from governance paradigms set up by another Silicon Valley 'disruption darling' - Uber, its financial model borrows heavily from the dot.com era pioneers, and its management model is more proximate to the 20th century Detroit than to the 21st century Germany.

If you hold Tesla stock, you need to decide whether all of the 8 points above can be addressed successfully, alongside the problems of production targets ramp up, new models launches and other core manufacturing bottlenecks, within an uncertain time frame that avoids triggering severe financial distress? If your answer is 'yes' I would love to hear from you how that can be possible for a company that never in its history delivered on a major target set on time. If your answer is 'no', you should consider timing your exit.

22/4/17: Two Regimes of Whistle-Blower Protection

“Corporate fraud is a major challenge in both developing and advanced economies, and employee whistle-blowers play an important role in uncovering it.” A truism that is, despite being quite obvious, has been a subject of too little research to-date. One recent study by the Association of Certified Fraud Examiners (2014), found that the average loss to organisations experiencing fraud that occurs due to financial statement fraud, asset misappropriation, and corruption is estimated losses from impact of corporate fraud globally at around $3.7 trillion. Such estimates are, of course, only remotely accurate. The Global Fraud Report" (2016) showed that 75% of surveyed senior executives stated that their company was a fraud victim in the previous year and in 81% of those cases, at least one company insider was involved, with a large share of such perpetrators (36%) coming from the ranks of company senior or middle management.

Beyond aggregate losses, whistleblowers are significantly important to detection of fraud cases. A 2010 study showed that whistleblowers have been responsible for some 17 percent of fraud discoveries over the period of 1996-2004 for fraud occurrences amongst the large U.S. corporations. And, according to the Association of Certified Fraud Examiners (2014), “employees were the source in 49% of tips leading to the detection of fraud”.


In line with this and other evidence on the impact of fraud-induced economic and social costs, whistleblower protection has been promoted and advanced across a range of countries and institutional frameworks in recent years. An even more glaring gap in our empirical knowledge arises when we attempt to analyse the extent to which such protection has been effective in creating the right legal and operational conditions for whistleblowers to be able to provide our societies with improved information disclosure and corporate governance and regulatory enforcement.

Somewhat filling the latter research gap, a recent working paper, titled “Whistle-Blower Protection: Theory and Experimental Evidence” by Lydia Mechtenberg, Gerd Muehlheusser, and Andreas Roider (CESIFO WORKING PAPER NO. 6394, March 2017) performed “a theory-guided lab experiment in which we analyze the impact of introducing whistle-blower protection. In particular, we compare different legal regimes (“belief-based" versus “fact-based") with respect to their effects on employers' misbehavior, employees' truthful and fraudulent reports, prosecutors' investigations, and employers' retaliation.”

In basic terms, there are two key approaches to structuring whistleblowers protection: belief-based regime (with “less stringent requirements for granting protection to whistle-blowers”) and fact-based regime (with greater hurdles of proof required from whistleblowers in order to avail of the legal protection). The authors’ “results suggest that the latter lead to better outcomes in terms of reporting behavior and deterrence.” The reason is that “when protection is relatively easy to (obtain as under belief-based regimes), fraudulent claims [by whistleblowers] indeed become a prevalent issue. This reduces the informativeness of reports to which prosecutors respond with a lower propensity to investigate. As a consequence, the introduction of such whistle-blower protection schemes might not lead to the intended reduction of misbehavior. In contrast, these effects are mitigated under a fact-based regime where the requirements for protection are more stringent.”

In a sense, the model and the argument behind it is pretty straight forward and intuitive. However, the conclusions are far reaching, given that recent U.S. and UK direction in advancing whistleblowers protection has been in favour of belief-based systems, while european ‘continental’ tradition has been to support fact-based thresholds. As authors do note, we need more rigorous empirical analysis of the effectiveness of two regimes in delivering meaningful discoveries of fraud, while accounting for false cases of disclosures; analysis that captures financial, economic, institutional and social benefits of the former, and costs of the latter.