Man Without Qualities

Saturday, August 03, 2002

Big Mo In Film School!

Maureen Dowd, all by herself sounding like a hilariously silly converation beteen American Film Institute students, maybe overheard in a Los Feliz coffeeshop.

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Friday, August 02, 2002

The Games Europeans Play

Turkey just abolished the death penalty.

Nobody seems to think the Turks actually wanted to abolish the death penalty. But they had to abolish the death penalty to be considered for EU membership. Other countries who wish to gain access to the EU are also required to abolish the death penalty.

This is something to keep in mind when one hears the argument that because various countries have abolished the death penalty, the United States should do so, too.

Perhaps in the next round of world trade talks, the United States should demand that the EU free its member states to enact death penalty laws in accordance with the democratic decisions of their people, rather then tying this decision to unrelated commercial advantages.
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The Bush Critics Don't Have a Word for It, Either

Snopes sez that, contrary to the assertions of some of his more pedantic critics and a silly English politician, Bush did not proclaim, "The problem with the French is that they don't have a word for entrepreneur."

On the other hand, I rather enjoyed the thought.
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Expensing Options, Again ... and Again!

Yesterday, the Man Without Qualities questioned just how "reasonable" available options valuations techniques are for purposes of preparing balance sheets. The view here is that the assertion that because investment bankers value options (normally using a method derived from the spectacular work of Professor Merton), that such valuation is "reasonable," is as seductive and misleading as the famous assertion of Lord Justice Bowen that "The state of man's mind is as much a fact as the state of his digestion."

There is another aspect of yesterday's Wall Street Journal article of Zvi Bodie, Robert S. Kaplan and Robert C. Merton that I would like to address. That article makes the following rather absolute assertion, which pretty much forms the foundation of their argument:

When a company issues securities whose value can be reasonably determined, accounting principles require that this value be recorded in the company's financial statements.

The authors also note that in at least some important respects, "options are no different from any other class of financial assets such as stocks, bonds, mortgages, and widely-traded derivative securities."

So it seems worth while to ask if options are always treated in the way the authors rather absolutely assert. Now, it is a little strange that although the entire question under consideration is whether to expense options, the authors do not say that when a company issues securities whose value can be reasonably determined, accounting principles require that this value be expensed on the company's balance sheet. So this apparently absolute, foundational statement doesn't really have the axiomatic quality the authors suggest it has. There may be a good reason for that.

Options are not always expensed when issued, even where they are not employee incentive options, and even in a purely financial contect where there are plenty of reference points to determine their value far more precisely than can be done with employee options. For example, if a company issues a warrant to a lender in connection with a loan transaction, the company should record the warrant at its fair market value in the equity section of its balance sheet. The offset to the amount recorded as equity for the issuance of the warrant would be a discount to the liability for the loan. The discount would then be amortized through the P&L as additional interest expense on the loan over the term. For example, if the company obtains a cash loan of 100, and issues a warrant to the lender valued at 20, the company would record a liability of 100 and the receipt of cash of 100, and would also record a loan discount of 20 as an offset to the 100 liability (resulting in a net liability on the balance sheet of 80) and additional paid-in capital of 20. Then, the 20 discount would be amortized as additional interest expense over the term of the loan. The income tax treatment would be similar.

The accounting treatment of a convertible loan would be the same. The conversion privilege would be valued and recorded in the equity section, with the offset being a discount to the liability for the loan. The discount would then be amortized as additional interest expense through the P&L. However, for income tax purposes, the conversion privilege would not be valued separately from the liability (unlike a detachable warrant, which would be valued separately for tax as well as book purposes, as described above). Consequently, there would be no discount and no additional interest expense for tax purposes.

None of that sounds like up-front "expensing" of the kind urged by the authors of the Journal article. Of course, the above discussion pertains only to options issued in connection with loans and to convertible securities - which are derivatives the authors have suggested bear some important similarities to employee options (although not in this respect).

But it appears to the Man Without Qualities that options (and their brothers, convertibility features) are not always treated in the way the authors' academic algebra exercise asserts, even where the options are pure financial instruments issued into a free trading market.

I am not suggesting that the loan/converts treatment should or should not be a model for how employee options are treated. And even in that context, the option is eventually expensed. What I want to point out is that accounting principles as applied to options have been far more flexible than the Journal authors suggest.

More Than Zero offers some other comments on this article, comments which seem rather telling to the Man Without Qualities.
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The Charms of Insider Trading

Henry Manne, brilliant economic thinker and one of the most charming bomb-throwers on the scene, writes that executive options should be replaced or supplemented with insider trading. Good for what ails the market, he says.

Of course, French companies already do a lot of what Professor Manne suggests, de facto, but it's a bit more helter-skelter over there than what the good Professor recommends.
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Nobody Would Do That

Could these doings and these have anything to do with this?


Original nastiness noted by Jane Galt.

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Thursday, August 01, 2002

Corporate Governance in Disneyland

The Walt Disney Company says it is outlining steps aimed at making operations more transparent for investors, including a call for rules on expensing stock options and plans to reduce its board's size!

Not that Disney is going to start expensing its executive options. It just wants someone to say how everyone is to do that. Of course, nobody is going to do that anytime soon. So what Disney is really saying is "If the SEC or a complete sea-change in accounting practice makes us expense options, we will comply with the law or accounting mandates." They are such good people in Burbank! And you have to admire the spin.

And Disney is not saying it is going to make its board better, just smaller. The basic problem is that making Disney's board any better than it is would automatically provoke a crisis in the company, since any increase in Board quality is bound to trigger serious conflict with Michael Eisner.

In fact, the Walt Disney Company has one of the most notoriously passive boards of any major company in the country. With the exception of Roy Disney, who is quite sharp, independent and possessed of considerable personal charm, the board contains not one member who would dare challenge Eisner in any serious way, notwithstanding Eisner's now long track record for bad judgment and virtual disengagement from the company.

The more interesting aspect of the board shrinkage plan is: Will the board shrinkage remove Eisner's passive acolytes or strengthen even further the crushing grip of his long-dead hand?

It is now pretty obvious that the Disney-Second-In-Command, Robert Iger is to be soon disintegrated, whether he knows it or not:

"Disney's president, Robert Iger, and Mr. Eisner have been closely involved in the fall lineup. Executives close to Disney say that Mr. Eisner and Mr. Iger were recently at Mr. Eisner's Aspen home for a two-day retreat and had budgets faxed to them for review." Perhaps a budget for liquidating Mr. Iger's contract?

But will that buy Eisner any time? It shouldn't, but it probably will. Maybe Iger will go when the Board is shrunk.
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Tournament: Cheney v. Raines

Raines: GAME!

Raines: SET!


But is there more to come?
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Does Torricelli Understand?

Senator Torricelli's re-election race is now deemed a tossup. In the face of that, the Senator is fighting to stop the release of the Senate Ethics Committee file and the final summary report on his case prepared by US Attorney White. He hilariously argues that such a release would be an invasion of his privacy!

What can he be thinking? This is the time of year in which politicians with anything bad in the hopper try themselves to be the ones who release it. That way, it can be old and cold by November.

Nothing could be worse for Senator Torricelli's re-election effort than for the very documents he is struggling to keep secret to be released against his will in late September or October.

And, yet, that is exactly what he is almost guarantying will happen. Lots of people have access to those documents. The Bush Justice Department has access to those documents. Senate Republicans have access to those documents.

With the Senate likely in the balance, and few Democrats willing to defend him, can Senator Torricelli really think his legal maneuvering will keep those documents from being leaked at the worst possible time?
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Torricelli and the New York Times

The New York Times has now produced it's Torricelli editorial, and it's a beaut. There is the obligatory editorial handwringing over the Senator's apparent lies, probable bribe-taking and continued defiance.

But that all seems to be pretty small beer for the Times editors, who urgently - and irrelevantly - point out that it is now just "a few months before fall elections in which control of the Senate may hinge on whether Mr. Torricelli can win re-election." Thank God the Times has it's priorities straight. Better a louse in the cabbage than no meat at all!

The rest of the editorial amounts to a collection of helpful suggestions to the Senator as to what he must do to win re-election and, presumably, an endorsement from the Times! Unsurprisingly, the Senator is instructed to start with a big media pandering event:

"If he wants to put the Chang episode behind him, the first thing he should do is hold a press conference in which he answers any and all questions about his behavior."

Federal prosecutors appointed by the Clinton Administration, and the Senate ethics committee itself, have squarely and repeatedly asked the Senator every single one of the questions the Times editorial says the voters have a right to an answer to now. But the Senate letter of admonishment also squarely says the Senator has dissembled in reply. But, now, with just a press conference all will be forgiven! The Times says, for example:

The voters have a right to know, for instance, why Mr. Torricelli brought Mr. Chang along to a meeting with the South Korean prime minister, and to hear him answer charges by a former American ambassador that Mr. Torricelli embarrassed the embassy by lobbying hard for Mr. Chang's business interests.

So let's see. The Senator holds his press conference. He says he brought Mr. Chang along on that trip because he liked the guy, especially his ribald jokes that surely can't be repeated at the press conference. He apologizes for his crude sense of humor and "bad judgment" at enjoying such jokes - but notes that many men do even though the "puritans" don't approve. Then he says that he respectfully disagrees with the Embassy folks about how his favorable comments regarding Mr. Chang's business interests were construed. He also apologizes for not being sufficiently clear or for inadvertently giving the impression that he was strongly lobbying the ambassador. Mistakes will happen! That being taken care of, we can all just move on!

Oh, the Senator does have to give meaningful assurances that "he will steer clear of these conflicts in the future." And let's not forget that "there is something wrong somewhere, and so far Mr. Torricelli has done nothing to identify exactly what it is." So Mr. Torricelli will have to "identify exactly what it is" before he can get back to the business of helping to run the country.

The Times is so nice. Saint Francis couldn't have done any better. But, somehow, one doesn't pick up the suggestion elsewhere in the Times that, say, a crooked CEO or director of a public company should be returned to his or her position after identifying exactly what it is that was wrong with the accounting practices and then providing assurances that he or she "will steer clear of these conflicts in the future."

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Now, THIS Is Tragic.

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Wednesday, July 31, 2002

Expensing Options, Again

Zvi Bodie, Robert S. Kaplan and Robert C. Merton enthusiastically endorse the expensing of employee options in the Wall Street Journal today. Mr. Bodie is a professor of finance at the Boston University School of Management. Messrs. Kaplan and Merton are professors of accounting and finance, respectively, at Harvard Business School. Mr. Merton won the Nobel Prize in 1997 for his work on option pricing.

This is so much intellectual firepower that one wishes one could say that they really add something new, some insight more than their impressive credentials. But they don't. Worse, at least some of their arguments are downright disingenuous. For example, they argue:

Finally, some opponents of expensing employee stock options make two arguments that actually conflict with each other. First, they claim that it is enough to disclose the information in the footnotes to corporate financial statements as is done now. And second, they claim that to require that options be expensed would hurt companies, particularly high-tech firms that rely heavily on options as a form of compensation. But if deducting the expenses of options that are already disclosed in footnotes would drive a company's stock price down, then we have proof that the disclosure alone was inadequate to capture the underlying economic reality.

Well, ok. But what about people who argue that it is enough to disclose the information in the footnotes to corporate financial statements as is done now and don't think that to require that options be expensed would hurt companies that rely heavily on options as a form of compensation? It really doesn't take a Nobel Prize in economics to see that these distinguished authors have not answered the main argument, but have resorted to a disturbing and transparent rhetorical device to avoid it. It is even odd that this argument is placed at the end of the piece, since it is among strongest arguments offered by opponents of expensing.

The other arguments the authors spend most of their time refuting are almost straw men: grants of stock options do not involve cash outlays, expensing of stock options would be double counting, and employee stock options are worth less than publicly traded options because employees do not gain full ownership of the shares (do they mean "options," not "shares" here?) during their vesting period. Nor do the authors present the positions they are supposedly refuting in the best ways.

The authors' logic is simple, indeed it is exactly the same logic nearly every proponent of expensing options uses:

(1) "When a company issues securities whose value can be reasonably determined, accounting principles require that this value be recorded in the company's financial statements."

(2) The value of employee stock options can be reasonably determined.

(3) Therefore, value of employee stock options should be recorded in the company's financial statements.

What is most striking about the authors’ approach is the absence of any suggestion that expensing options as they advocate would actually bring additional useful information to the securities markets. Indeed, the approach seems to assume that expensing options would neither increase or decrease the amount of information conveyed, so that the matter may be treated as an academic algebra exercise culminating in the silly end of their article: "If the following true-or-false question appeared on an accounting exam, the answer is quite clear: Employee stock options should be expensed on a firm's income statement. True.". That final rhetorical flourish seems to reveal quite a bit more about the authors' thought processes than they appear to have intended.

I will set aside for other people the question of whether accounting principles have really been applied the way the authors suggest in connection with, say, convertible debentures. But I note that the authors seem to imply that the convertibility feature is expensed completely at the time the debenture is issued.

To apply their sylogism. the authors need to explain and do not explain - other than by assertion - why one or the other options pricing techniques is "reasonable" for purposes of preparing the balance sheet of a public company. It is surely not enough to argue as these authors do that investment bankers value options all the time and make important decisions based on those valuations, such as big mergers. Of course they do.

But that alone doesn't mean such valuation techniques provide a "reasonable valuation" for balance sheet purposes. "Reasonableness" in this context should require a consideration of how such valuations will be read and used by ordinary and professional investors. If the first will likely be misled by the inclusion of the valuation and the second will certainly disregard the valuation, how likely is it that the valuation is reasonable?

Simply put, the authors need to explain why in determining whether a "reasonable" valuation technique exists for purposes of applying the accounting principles to which they cite, no consideration should be given to the relative abilities of professional analysts to do their own calculation or the likely confusion expensing options would create in ordinary, non-professional investors.

All in all, an odd effort, in my humble opinion.

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Vuja De III

The Wall Street Journal now says about the new accounting oversight board:

The big losers are the accountants, for whom it is very hard to have any sympathy. American capitalism will live to fight another day.

The accountants are going to have to endure a new layer of government oversight as well as new conflict-of-interest restrictions. This is the price they're paying for trying to live like investment bankers off the federal audit mandate and for refusing to go along with former Fed Chairman Paul Volcker's proposals to fix the industry on its own.

If SEC Chairman Harvey Pitt is smart -- hope springs eternal -- he'll play it straight and resist the urge to pack the board with his accounting allies. The best way for the board to work is the way the NASD does with securities broker/dealers, as a credible, independent enforcer.

Even for accountants, however, it could have been worse.

Well, the Journal gets the last part of all that right. And NASD is hardly a narrow, "independent," government regulator.

Perhaps one might focus on an aspect of "regulatory capture" not particularly associated with George Stigler - the "life cycle":

Marver Bernstein in Regulating Business by Independent Commission (1955) ... develops the idea of a regulatory life-cycle. Regulatory agencies, he argues, go through four stages:

Gestation in which regulatory agencies are created, usually as the reaction to some perceived problem or crisis

Youth in which the agency is full of zeal, but is outmaneuvered by the regulated industry which usually has more experience to draw upon in conflicts with the agency

Maturity As political attention fades, the agency becomes less crusading, and co-operative relationships between the agency and industry are established. The agency becomes more sensitive to the needs of industry.

Old Age Priority is given to the needs of the industry, whose interests the agency begins to identify with as its own.

Both the Journal and Professor Coffee focus on the "Gestation" and "Youth" of the oversight board - and those periods could be annoying for the accountants. No one thinks of Winter when the grass is green.

But the accountants can look forward to the far future of, say, six months from now, when the events of this summer have passed beyond living memory of most of the electorate and investing class. Those can be seen as the beginning of the board's comfortable golden years of "Maturity" and "Old Age."

And the best thing for the big accounting firms is that the SEC will probably still not even have even worked out the new rules by the time Maturity, at least, sets in. Those firms should be cheerful, for surely:

"Bliss was it in that dawn to be alive/ But to be young was very heaven!"
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Regulatory Capture In Action

Democrats on a key Senate panel yesterday urged Federal Communications Commission Chairman Michael K. Powell "to take a more active role in steering the telecommunications industry out of the financial turmoil that has engulfed some of the sector's largest companies," as the New York Times gullibly put it.

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Senate Ethics Committee To Torricelli II

The New York Times found space and time to report on the Torricelli rebuke yesterday. But there is no editorial or op-ed piece on it today.

Perhaps the Times editorial page is too busy ginning up things like the misleading screed they just ran savaging Western Republican Senators for doing what Senator Daschle did to be concerned about a bribe-taking, rebuked, lying, unethical Democratic Senator from the state next door - a Senator so defiant and shameless that he does not even acknowledge that what he did was wrong.

Details, details. There's always tomorrow for these marginal issues. In the mean time, what about those Arizona trees?
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Hillary Furioso!

Senator Clinton says her husband's administration left the economy in great shape, and now the Republicans have messed it up:

"It's harder (sic) to imagine a faster, more heartbreaking turnaround than the one we've seen."

But according to the Commerce Department today: The revised figures for 2001 now show that instead of contracting for just the third quarter, the economy actually shrank — although modestly — for three straight quarters. The new figures show that the economy contracted by 0.6 percent in last year's first quarter, by 1.6 percent in the second quarter and by 0.3 percent in the third quarter.

Well, you've got to hand it to Hillary. With a recession starting the very day she and her husband left the White House, it is surely true that "It's hard to imagine a faster, more heartbreaking turnaround than the one we've seen." The "turnaround" just means the exact opposite of what Hillary suggests it means.

But, hey, who's counting those fiscal quarters? Certainly not the "mainstream media!"

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The BBC says Boeing is looking into it. Why does it seem right that this "invention" is Russian?
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An Options Article Worth Reading

... and thinking about.

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Tuesday, July 30, 2002

Still More Right Wing Agitprop

Senator Lieberman, edging dangerously close to becoming a Republican National Committee shill, now says that he will call Robert Rubin as a witness in the Enron matter "if Mr. Rubin would add something."

Well, if the good Senator is going to put it THAT way, surely Mr. Rubin will now be demanding to be heard!
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Who Says There's No Such Thing As Ghosts?

Surely it is a strange and wonderful thing that a fall in a supposed measure of consumer confidence can have an effect - or at least be thought to have an effect - on stock markets, even as many economic researchers are losing confidence in the very existence of "consumer confidence."
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Vuja De II

The Wall Street Journal reports on the new corporate governance bill just signed into law by the President:

Just how much change is triggered, and how effective it is, won't be known at least until the Securities and Exchange Commission works out rules implementing the law and appoints the newly created five-member oversight board with powers to investigate and punish. "Congress enacted some structural girders and then left it to the SEC to fill in all the remaining framework," says John Coffee, a law professor at Columbia University who worked with Senate staffers in drafting parts of the law. The biggest unresolved detail, he says: whether the oversight board appointees will be "people of stature and independence or flunkies and fellow travelers of the accounting industry."

Professor Coffee's comment is surprising, to say the least, since regardless of who the first oversight board appointees may be, the new "independent" nature of the oversight board greatly increases the chance of its eventual, simple regulatory capture by the accounting industry, especially the surviving "Big Four." In other words, regardless of who the first appointees are, in a little while the board is probably going to be dominated by "flunkies and fellow travelers of the accounting industry."

Why? Well, the new board is focused solely on accounting. It has a much narrower regulatory constituency than that of the Securities and Exchange Commission. The new board's "independence" should insulate it from the effects of the SEC's more general constituencies. Narrowing the board's regulatory constituency will likely, pursuant to the now-standard economic theory of "regulatory capture" developed in large part by George Stigler, over time make the "independent board" much more prone to such "capture" than is the SEC itself. One commentator described Stigler's theory this way:

In a well-known paper, 'The Economic Theory of Regulation', George Stigler shifted attention away from [the] 'public interest approach'. He looked at how the struggle over economic rents by interest groups would affect regulatory policy. The principal actors in his analysis, businesses and politicians are assumed to be self-interested income-maximisers and not at all concerned with the 'public interest'. Businesses use their resources to bargain with politicians to bring about policies that benefit them. They will favour regulation that reduces competition, and maximises economic rents.

...every industry or occupation that has enough political power to utilize the state will seek to control entry. In addition, the regulatory policy will often be so fashioned as to retard the rate of growth of new firms.

The kind of benefits that Stigler argues that the state can provide to industry include:

Barriers to entry to competitors, including tariff barriers
Aid to businesses producing complimentary outputs, and harm to businesses producing substitute products (think of bread as complimenting butter, and margarine as a butter substitute)

At the same time, there are a number of costs involved in acquiring legislation desirable to the industry. These include

The costs of securing agreement from, and co-ordinating a number of legislators sufficiently large to form a legislative majority/
The information and organisation costs to industry of becoming informed about, and acting upon measures that can potentially benefit them.
Individual consumers have relatively little to lose from anti-competitive measures (the costs are distributed throughout society so that the impact on a single individual is negligible). The benefits, on the other hand accrue to a relatively concentrated business group. Because of this, businesses have more incentive to meet the costs of making policies, and are therefore likely to get their preferred regulatory policies enacted. It is no accident that regulatory policies protect industry rather than consumers: they are designed that way.

By narrowing the constituency of the oversight board, the benefits will accrue to an even more concentrated business group.

Now, whatever else the accounting industry may lack, it does not lack for political activism and sophistication, and it has plenty of "political power to utilize the state." Indeed, with the obliging annihilation of Andersen by the Department of Justice, the accounting industry is now positioned as something approximating a good old fashioned oligopoly - complete with the new "independent oversight board" to serve as its monopolistic, rent seeking coordinator. Indeed, once the dust from the Andersen demolition job settles, it will be interesting to calculate the Herfindahl-Hirschman Index of the accounting market. Would the anti-trust division at the Department of Justice have allowed the big accounting firms to achieve by merger the same level of market concentration that the Department has itself imposed through prosecution of Andersen? A concentrated national oligopoly of a key industry with its own, private, independent regulator! How comfy cozy for the regulated.

Wasn't it nice of the Congress - and especially the Democrats in Congress - to do this for the big accounting firms, even as those firms pleaded with the Congress "please do not fling me in that briar patch."?

Brer Rabbit hollered out, "Born and bred in the briar patch. I was born and bred in the briar patch!" And with that he skipped out just as lively as a cricket in the embers of a fire.


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Senate Ethics Committee To Torricelli

Today the Senate Ethics Committee "severly admonished" Senator Robert Torricelli (Democratic - New Jersey) for accepting gifts from David Chang, a Torricelli friend, supporter, campaign contributor and businessman that the lawmaker aided. The committee said in a three-page letter to Torricelli:

"Your actions and failure to act led to violations of Senate rules – and related statutes – and created at least the appearance of impropriety." .... "[We are] troubled by incongruities, inconsistencies and conflicts, particularly concerning actions taken by you which were or could have been of potential benefit [to David Chang.]"

New Jersey voters decide in November whether Mr. Torricelli will continue to be their United States Senator.

If New Jersey voters can't figure this one out, that State deserves all the jokes the New Yorkers tell.

But will the New York Times editors be able to figure it out? That's not so clear.
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Who Does the Times Think It's Fooling?

The New York Times actually ran an editorial today asserting that:

"[T]here has been no stopping efforts by the timber industry and opportunistic politicians to exploit the fires for commercial and ideological gain. The latest and most cynical manifestation of this impulse is a proposal by several Republican senators from Western states to suspend basic environmental laws in order to permit logging on up to 24 million acres of national forest land. The senators describe this as necessary to prevent further fires."

This with no mention whatsoever that, as noted here in a prior post, the Washington Times had already reported:

"Senate Majority Leader Tom Daschle quietly slipped into a spending bill language exempting his home state of South Dakota from environmental regulations and lawsuits, in order to allow logging in an effort to prevent forest fires.The move discovered yesterday by fellow lawmakers angered Western legislators whose states were forced to obey those same rules as they battled catastrophic wildfires."

This kind of thing just has to raise questions about the New York Times. Is the intelligence of the editors going down, or is it just the editors' estimation of the intelligence of their readership that's going down? Either way, it's consistent with the Ellis Theory.

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Running In Place

The Washington Post today has a new state-of-the-art article about the latter days of Enron. It describes some wonderful, dark, priceless scenes:

A few days later, the [prominent Houston law firm, Vinson & Elkins LLP] reported to [Kenneth] Lay that no further investigation was necessary.

The deals that troubled [Enron vice president Sherron] Watkins did have "bad cosmetics" and carried "a serious risk of adverse publicity and litigation," V&E would write in a private report to Enron.

Still, "The facts disclosed through our preliminary investigation do not, in our judgment, warrant a further widespread investigation by independent counsel and auditors."

Talk about a dry sense of humor! Who knew Texas lawyers could compete in that arena?

But, overall, what is perhaps most striking about the Washington Post effort is how little it adds to what was already known about these matters say, four months ago.

And now it is Robert Rubin's actions in connection with Enron that are being described by some of his defenders as having "bad cosmetics," which nevertheless "do not, in our judgment, warrant a further widespread investigation," this time, by Congress. As the Note puts it:

We wonder when someone (in the press? in the Republican-controlled House?) will ask Bob Rubin for more about what he knew and when he knew it when he called Treasury looking for help for Enron; and we wonder if those White House and O'Neill sharpies have this serious push-back stratagem on their radar.

The Wall Street Journal ed board takes up just the corner of the Rubin matter, praising Treasury Secretary O'Neill for his Sunday Singapore Sling Slap at Rubin, but then reverting to form and saying what O'Neill really should have done was use the opportunity to call for more tax cuts.

The Washington Times editorial page continues its campaign to get Senator Joe Lieberman to call Rubin to testify. LINK , but we ask: why don't they call on House Republicans to do the same thing?

Of course, one possible answer to this last question is that if Mr. Rubin is asked the tough questions by a Republican controlled House committee, the Senate Democrat-controlled committee might be let off the hook, while the Democrats and the liberal media go off on a distraction riff about how poor, sweet, classy Robert was grilled by those horrid Republicans and made to say terrible things. All the better not to have to pay attention to the answers or evasive non-answers. The Washington Times may not want to provoke that situation (and, no, it is not necessary to suggest that the Washington Times and the House committee are working together on this, in case you asked).

Besides, it is by no means clear that Mr. Rubin will ever have to answer the tough questions from Republicans or Democrats, for the same reason J. Edgar Hoover never had to answer tough questions from Republicans or Democrats. HE MAY KNOW TO MUCH.

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And What Are They Up To?

Senators Edwards and Clinton are tying their wagons to the belief that they can talk about "fiscal responsibility" without saying they want to raise taxes or cut spending. And what do they do when people start pointing out all that money investors lost in the dotcom and telecom disasters she and her husband presided over, for example? Also, this negative approach will have to contend with an ending recession, assuming that continues. Maybe it will somehow work, but it all seems rather incoherent.

"Short sellers" sometimes attempt to "talk a stock down." That is, they spread negative information about the stock in the market to push its price down. They hope that the stock will remain low enough for them to cover the "short" positions they buy in the stock. But, "the shorts" often face a nasty problem: after initially responding to the flood of negative information, the stock's price often snaps back abruptly on the basis of its "fundamentals." That effect often puts "the shorts" in the position of figuratively and uncomfortably taking it in the shorts.

The recent snap back of the entire stock market appears similar in some key respects to the above sequence, but played out on an enormous scale. First, the significance of some important negative information (in this case, a few companies with falsified books) was wildly exaggerated. In fact, less than one percent of all corporate profits reported last year by American public companies were ever subject to suspicion. It is very hard to find a sense of true proportion in Democratic statements or much of the popular media coverage. The Democratic leadership, in particular, did much to exaggerate and inflame market-depressing information. Then they added the specter of new, oppressive and depressive regulation, which even they did not dare to implement. Probably the most significant aspect of the passage of the corporate governance bill just signed by the President is its indication that the Democrats won't have an opportunity to pass even more damaging laws in the near future. The media have been happy to play on the sensationalism. That whole period resembles the period in which "the shorts" attack a stock. In this case, the Democrats appear to want the anxiety-producing effects to continue to Election Day. And, as the statements of Senators Clinton and Edwards indicate, they are investing a lot in this approach. But the snap-back in the market over the past few days resembles the way a single stock reacts when the market finally figures out what the shorts have been up to.

The Democrats may find out just how uncomfortable it is to be a short seller once the market readjusts to fundamentals.

What about that new corporate bill? Will the Democrats be able to draw energy from that source? Well. that's not what Bill Lerach says. He's the San Diego lawyer who is lead attorney in an investor class-action lawsuit against Enron Corp., and he comes dismisses the bill as "the reenactment of the current law with a great deal of huffing and puffing. ... Not a single word will help a cheated investor get a penny back." Mr. Lerach is just part of a large chorus of people who just can't find major benefits in that bill. But a lot of people sure are finding plenty of costs.

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Monday, July 29, 2002

What Can They Be Thinking?

The Democrats are said by the New York Times to be trying out campaign themes:

``In the span of a year, this administration has turned fiscal responsibility on its ear,'' [Senator] Kerry said, ``turning a budget surplus into a budget with endless deficits spurred on by an irresponsible and unfairly structured tax cut.''

Are the Democrats going to campaign to raise taxes or not? If not, how long do they think they can talk about "an irresponsible and unfairly structured tax cut" before they have to say what they plan to do about it (that is, raise taxes). And if they do think it's a good idea to campaign to raise taxes, then why don't they say they are going to raise taxes? Are they proposing to raise taxes with the New York Times running a front page article yesterday warning of the risk of a "double dip" recession? Nothing like raising taxes going into a possible recession.

Maybe this mess is why the Times says what the Democrats are really doing is trying out themes for 2004. While they're at it, maybe they should try out some themes for 2012 - it would mean as much as the work they're doing now for 2004.

And, by the way, Senator Lieberman keeps turning up in such articles. Has anyone stopped to consider that the good Senator was chosen, and was as an asset to Gore, in 2000 because he is personally a good man, in contrast to the widespread public perceptions of the man Gore had served with for the preceding eight years. But, presumably, Mr. Clinton's erotic activities and possible federal felonies will not be an issue in 2004. So what does Senator Lieberman bring to the table? Polls show he was drubbed by Cheney in their one debate.
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The Clinton Way

There are reports that "smoking guns" have been found showing that the Internal Revenue Service was used in the Clinton Administrations to conduct politically motivated tax audits. This should be added to such events as the Livingston White House misappropriation of hundreds of FBI files, the "unauthorized leak" of Linda Tripp's records and the creation of a vast partisan databank with taxpayer money.

At this point, the new reports of IRS abuses should, coupled with prior evidence of the Clinton Administrations' willingness to exploit government files, further suggest that Harken-related mischief will not likely amount to anything significant. The Clintonites had eight years to exploit that set of facts, and plenty of opportunities and incentives. The new reports of IRS abuse are said to involve the Republican candidate for governor of California. But the Clinton-Gore administrations had Mr. Bush's two runs for governor of Texas and his run for Presidency as incentives to exploit whatever the Clinton Securities and Exchange Commission could come up with. The Democrats did use the Harken matter each time.

But even the Clinton SEC just couldn't bring itself to reactivate that investigation, nor could they find gold in the matter.

New revelations such as the current IRS nastiness suggest that failure wasn't because the Clintonites weren't willing to do what they thought they could get away with.
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"Expensing" Options

There is a very fine opinion piece by Robert Bartley in the Wall Street Journal regarding the pitfalls of "expensing" option a la Warren Buffet.

The bottom line of the Bartley argument is that "expensing options" would make the bottom line of corporate financials less reliable and more confusing, at least to "ordinary investors" who don't work with option pricing equations.

At the same time, the Journal runs a remarkably bad options piece by Susan Lee, which serves up arguments that have been made for months (decades, if one counts the pure academic discussions) in other quarters as if they were fresh. Sample quote: "Well, now comes Brian J. Hall, economics professor at the Harvard Business School, to explain. In a recent paper, Executive Compensation and Ownership Structure (, Mr. Hall argues that options are leveraged instruments."

Options are leveraged instruments? My goodness, we certainly need a nabob from HBS to tell us that! All those options traders in Chicago who have been pricing options using those Black-Scholes buttons on their calculators for the last few decades will just be decked!

It seems that Professor Hall and Ms. Lee think that options should be expensed because that would make it easier for companies to give their executives and employees restricted stock. Of course, no analysis is provided of any of the incentive problems created by restricted stock grants. No mention is made of what might be done in structuring the option program to reduce problems with option grants - but a board of directors that seriously represents shareholder interests can do a lot with such structuring. And if one posits a board of directors that does not represent shareholder interests (the real underlying issue here), might there be a little issue or two with allowing that board to grant large blocks of the already accumulated value of the company to existing management? Nor is there a word on the number of shares that have to go out the door as restricted stock to get the intended incentive effect. And while a few word are offered about the obvious if delicate need for companies to reprice or refresh options that have been submerged in appropriate cases, no criticism of the currently fashionable demonization of such practices is offered. How about a mention of the partial economic similarity of (i) options with a strike price less than stock price in effect on the day of the grant, on the one hand, and (ii) restricted stock grants, on the other hand (could that mean that options are more flexible and could capture many of the benefits of stock grants without some of their disadvantages)? No. I guess there just wasn't room for those details. Worse, because the Hall paper makes a virtual Marti Gras out of confusing objective economic incentives considerations with corporate "behavioral" considerations (read, "what boards who may or may not represent shareholder interests do"), it entirely confuses the separate issues of (i) what economic incentives are created by options as opposed to stock grants and (ii) how are boards of directors dealing with those incentives. The artificial and ad hoc concept if "option fragility" is arbitrarilly elevated by the paper to a position of supreme significance without serious evaluation of the economic fundamentals involved. In short, the paper is a complete mess.

Further, we are apparently to believe that public companies have never before seriously considered or understood the relative merits of these two standard compensation structures. For example, Kirk Kirkorian, who owns a solid majority of MGM GRAND, chooses to have that company grant stock options to its executives (who happen to be exceptionally clever). Are we supposed to believe that Mr. Kirkorian is just incapable of grasping the profound differences between options and restricted stock grants that Mr. Hall sees so clearly now?

The Man Without Qualities believes executive compensation issues are tough and unsettled. The matter has been discussed with much greater acuity than Professor Hall brings to the table by both Jane Galt and More Than Zero. I cannot understand why the Wall Street Journal runs a silly puff piece about an HBS professor's paper that appears to add exactly nothing to existing understanding of the matters it discusses. The author, Professor Hall, is no doubt a gifted person, and I do not want to be read as disparaging him generally and I think it's fine that he takes advantage of his opportunities. But in this instance the most objective thing that can be said about his paper is that it - together with the Journal's plump - should be good for some rich speaker fees at a good number of corporate and political lunches, and maybe a consulting contract or two.

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