Man Without Qualities


Saturday, July 27, 2002


An Algorithm For Correcting Error 503

Many Blogger bloggers are having trouble posting because of "Error 503: Unable to load template file: /home."

The following little algorithm has almost always worked for the Man Without Qualities to correct Error 503.

1. Try to publish, but notice appears: "Error 503: Unable to load template file: /home."

2. Click on "Template."

3.Make no changes in your Template.

4. Click on "Save Changes." After a few moments' delay, this should return the screen to the original split-screen "Posts" setup, and a little yellow "Publish" button should appear on the far right in the middle of the screen.

5. Click on the yellow "Publish" button. Wait a few moments. [If "Publish" button is not there, bring your post up onto the upper half of the screen and click on "Post and Publish"]

6. Bring your post back onto the "edit" (upper half) of screen by clicking on "Edit" at bottom of stored post in lower half of screen. Do pot edit your post.

7. Click on "Post and Publish."

8. Wait a few moment or until little flipping pages stop. The "Error 503" message may appear again - that doesn't matter.

9. Check blog screen (you will likely need to "Refresh" it.)

10. If this doesn't make the post appear, repeat the whole algorithm. Sometimes it takes two or three interations to correct Error 503.


(1) comments

Friday, July 26, 2002


More Right Wing Agitprop

FURTHER UPDATE: Mr. Frantz may use the language and his intelligence as he sees fit. But most thoughtful people would not consider evidence that (rather weakly) suggests Howard Kurtz may be somewhat conservative demonstrates, or is even particularly relevant, to pegging him as a Republican National Committee "shill." Nor does evidence suggesting that Mr. Kurtz has more conservatives than others on his shows support such a thesis. Of course, Messrs. Frantz and Atrios are free to use "RNC shill" to mean someone who generally agrees with the RNC, or is simply generally more conservative than Messrs. Frantz and Atrios - which seems to be about the way they are using this word.

A demonstration that the New York Times editorial page, or its op-ed page, more often sides with the Democratic National Committee would not show those pages to be DNC "shills." Other examples among the liberal media and academics are so abundant there is no need to cite them. Not that Mr. Frantz's efforts should be called a "demonstration," and it is not necessary to discuss his more general "methodology" here.

Nor is it necessary for Mr. Frantz to broker Mr. Kurtz's views. Mr. Kurtz's writings are there for the reader to review every day. An archive of them may also be reviewed. Indeed, Mr. Kurtz will communicate with the reader in real time. The Man Without Qualities does not believe Mr. Kurtz is a "shill" - I don't even think it's arguable by reasonable people. That I leave the reader to her own intelligence to decide whether she agrees with me is not "assuming" anything other than that the reader has considerable intelligence. This appears to be an approach Messrs. Frantz and Atrios find baffling.

But as the great ancient South Asian mathematicians would demonstrate what we now know as the Pythagorean Theorem: "BEHOLD!"

________________________________________________________________________

UPDATE: Well, Atrios confirms that he does, in fact, literally thinks that Howard Kurtz is a National Republican Committee shill. And all the little Atriettes in the comment box agree with him, too. Better that they do. Otherwise, Atrios would be labeling THEM RNC shills. Gotta keep the prols in line!

And, no, there appears to be no trace of irony in the Atrios remarks. Perhaps it's just that the Man Without Qualities couldn't locate the trace. Maybe other people with sensitive irony geiger counters could scan the Atrios post.


____________________________________________________________


Howard Kurtz of the Washington Post, a noted National Republican Committee shill, writes:

Should [Robert] Rubin's conduct be carefully scrutinized? Sure. Enron had plenty of help with its shell-game accounting, and the companies that helped the Houston energy giant fool the public should be held accountable. The deals are incredibly complicated, but it's time to unravel them.

Watch out, Howard. Atrios and Counterspin may come gunning for you, you old party hack.

Link from InstaPundit.

And, if you adjust for tone and style, Mr. Kurtz in substance is beginning to sound a little like Andrew Sullivan on this point.
(1) comments


Vuja De

With a corporate reform bill that the President has pledged to sign having swept through Congress with majorities that would make even the cheek of Joe Stalin perhaps blush a bit, it is time for a preliminary examination of what the federal lawmakers have accomplished and, in a related move, to ask if anything constructive might have been done. This exercise may help one to contend with the awful sense of Vuja De, or the feeling one will be here later, another concept for which the French don't have a word.

Senator Mike Enzi, a Wyoming Republican who is a former accountant, described the legislation as "earthshaking," telling The Associated Press it had been approved with "tremendous speed." The Senate approved the package, 99 to 0, only hours after the House had approved it, 423 to 3, just a day after House and Senate negotiators bridged their differences on the legislation.

To begin with, the reader must be disabused of errant suggestions that this legislation, which purports to profoundly restructure all of American business and accounting practices, was rushed, ill-thought-out or excessive. Reports that the bill is based on a computer dump of some Google searches performed by one of Senator Leahy's aides given instructions to throw in every cockamamie securities, accounting and corporate restriction that's popped into anyone's head in the last fifty years are considerably overdone. The Man Without Qualities has in fact received assurances form knowledgeable sources on Capitol Hill that great care was taken to eliminate duplicate "hits."

And before any provision was inserted into the bill, it was carefully reviewed by conscientious Congressional aides each of whom was required to be at least 18 years old. Results were impressive. In one case, a provision which had been advanced by Senator Leahy's office to address a perceived failure of the SEC "Plain English Initiative" (which sought to clarify Commission filings by requiring them to be written in "plain English" instead of legalese) was deleted after a sharp-eyed aide brought to the Senator's attention that the provision's text, which read

(i) From this day on, the official language of the Securities and Exchange Commission will be Swedish.
(ii) In addition to that, all executive officers will be required to change their underwear every half hour.
(iii) Underwear will be worn on the outside so we can check.


was actually cribbed from an old Woody Allen movie. After some initial effort by Senator Leahy to retain the provision, he relented when reminded that Allen had been disgraced as a result of his quasi-incestuous affair with Soon-Yi Previn.

Now, it is true that certain doomy-gloomy types, such as economists Kevin Hassett of the American Enterprise Institute and Robert Shapiro, formerly of the Democratic Leadership Council, have found that the bill will "likely impose significant new costs on American firms with little likely benefit" while opening up companies and their managers to more litigation from trial lawyers. But in considering such conclusions the reader should also bear in mind that media coverage is also bereft of any report that a single reputable economist in the nation has actually gone on record as asserting that the legislation will do more good than harm. So it is safe to say that the matter is open to debate.










(0) comments


A Nice Gesture, Mr. Harrison, But Who's Your Lawyer?

According to the New York Times:

[S]enior executives of ... J. P. Morgan Chase, who told investors and reporters on Wednesday that their employees had done nothing wrong in helping Enron set up complicated financing vehicles that kept large amounts of debt off the company's balance sheet. They also pledged to spend their own money on J. P. Morgan's depressed stock: five of them bought a total of 85,000 shares, according to Kristen Lemkau, a spokeswoman.

Considering the nature of the accusations against Morgan, how likely is it that the purchase of 85,000 shares of Morgan stock by highly placed insiders was NOT predicated on material information not available to the general public. The purchase could also be construed as a device deliberately intended to manipulate the price of Morgan stock. In fact, wasn't that the actual intent?

Where the heck are the lawyers in all this bank mess?
(0) comments


Now About Those Enron/Andersen Prosecutions

A Gedanken Experiment for readers of the Man Without Qualities!

The reader is to imagine that she or he is a member of the Enron/Andersen prosecution task force at the United States Department of Justice. You have picked up your New York Times, where you read:

In a memo sent to Citigroup employees, Weill said Citigroup's transactions with Enron were legal, met accounting standards and reflected industry practices. ``And our people, relying on the advice of independent legal and accounting experts, believe they were doing the right thing,'' Weill said. [J.P. Morgan Chase Chief] Harrison delivered a similar message to the investment community Wednesday, saying that the acted ``properly and with integrity'' in all of its dealings with Enron ....

Now, how do you feel? Do you feel more confident that if you just run out and charge Enron and Andersen operatives with accounting, securities and bank fraud that things are going to fall your way in a criminal trial in which Messrs. Weill and Harrison and every other bank officer involved state from the witness stand that their products and dealings with Enron "were legal, met accounting standards and reflected industry practices?"

Do you think that in the face of that testimony that a jury will find BEYOND A REASONABLE DOUBT that the Enron/Andersen defendants "knew" exactly the opposite when they prepared Enron's financial statements?

See, you CAN do something with philosophy!

But would it make a good video game?
(0) comments


Unlimited Liability at Lloyds of London

Lloyd's lost $12.6 billion from 1988 to 1992, causing financial ruin for some investors ("Names") who had unlimited personal liability.

About 30 Names were reported to have killed themselves as a result of their losses.

(0) comments


WorldCom Indictments

In another example of how federal prosecutors usually proceed when they see what appears to them to be clear, serious and egregious fraud, prosecutors reportedly plan to criminally charge former officers of WorldCom Inc. sometime next week.

Of course, mere indictments aren't convictions.

But this is what federal prosecutors do when they feel they can win the case. The judge and jury often see things differently.

As Mr. Ebbers' lawyer points out, there is, in fact, a kind of "howling mob" out for these people. And that kind of thing can be a problem in securing justice.

But massive crimes normally produce howling mobs. That doen't mean the crimes weren't committed by the people charged.

(1) comments

Thursday, July 25, 2002


Rubin v Cheney

Some of the odder feedback to the comments that have appeared here regarding Robert Rubin has taken the form of assertions that it is "really" Vice President Cheney who has the potential False Statements Act problem.

Whether or not Mr. Rubin violated the False Statement Act will not be affected by whether or not Mr. Cheney violated that act. It's not as if there is some kind of political conservation principle at work here.

But, also, an investigation of the supposed Halliburton issues has begun, and Mr. Cheney has indicated he will cooperate with it. All that being noted, it does not look at this time as if the Halliburton matter is going to be very satisfying for Mr. Cheney's political critics. But time will tell. And the harsh interests of Mr. Cheney's critic's are no basis for not questioning or investigating.

What has been sought here at the Man Without Qualities is an investigation of Mr. Rubin's involvement in the very controversial Enron/Citigroup matter as revealed by the New York Times.

So it is remarkable that defenders of Mr. Rubin who are arguing so vigorously to forestall his questioning or investigation would be so foolish as to cite to Mr. Cheney's involvement with Halliburton.

Remarkable - and odd.
(0) comments


Invasion of the Soul Snatchers

Paul Krugman has been reduced to saying people he doesn't agree with are funny animals - Rhinoceroses, actually. That's not too disturbing. Any three-year-old can do it - it would be hard to find one who didn't do it.

What is a little more disturbing is that Mr. Krugman suggests that these people, including independent and perceptive, even quirky, types like Mickey Kaus, have succumbed to "conformity and the authoritarian impluse (sic)," in Mr. Krugman's words, an impulse apparently thought by Mr. Krugman to be roaming the world, seeking the ruin of souls.

And why does he stop where he does? Why not complete his thought and assert that Mr. Kaus and such types just fell asleep at an inopportune time and succumbed to absorbtion by alien plant pods? If one feels the need to sweepingly degrade one's intellectual opponents the way Mr. Krugman does here, by suggesting they have mental processes reflective not of their own personalities but of "conformity and the authoritarian impluse (sic)," why stop at the perimeter of the animal kingdom? Bean them, Mr. Krugman!

Except for Brad and Josh, of course, since of the thousands and thousands of bloggers out there, only these two bear reading today.

Touching.

Mr. Krugman also says:

"The most memorable scene is one in which the hero's friend (famously played by Zero Mostel) begins making excuses for his neighbors - maybe it's not so bad to be a rhinoceros, after all - and, as we watch, turns into a rhinoceros himself."

When he wrote this, Mr. Krugman surely was thinking about the many people who hae observed that Mr. Krugman began as a serious economist, but has now largely completed the conversion to empty polemicist.

Rhinoceros, anyone?

(1) comments


Take a Pill

It's interesting to watch certain of the more hysterical corners of the left come to the conclusion that they absolutely MUST stand up for investment banks and bankers.

When someone gets this hysterical trying to stop an inverstigation, even a questioning of Robert Rubin, where such steps are entirely consistent with New York Times revelations about Citigroup's transactions with Enron, it is likely that the hysteric feels deeply that his interests are threatened in a big way. In this case, the hysteric goes so far as to blast Slate reporter Timothy Noah for raising the obvious question "What About Bob Rubin?" and even links to Citigroup's own press release calling the New York Times story a big error. That neither of the New York Times nor Slate is generally considered to be partisan right wing rags seems to elude Counterspin, to whom they have become mere Republican hacks. Perhaps Counterspin will also want to update with an attack on Tony Adragna for writing right wing agitprop.

The Man Without Qualities has more than once stated that it is unlikely that the Citigroup or Morgan transactions constitute major wrongs. And I have also stated several times (here, here and here, for example) that it is premature to point acusations at Mr. Rubin. But that doesn't stop the hysteric behind the keypad at Counterspin from characterizing a clear need for an investigation as "accusation by innuendo, and implication," even though that very post says: "Mr. Rubin's statements should be carefully investigated and he should be charged or cleared as quickly as possible, as the evidence indicates." And in another post I wrote: "[T]he matter has not yet come to the point of identifying a particular supposedly false statement of Mr. Rubin to a particular government official. And I have not suggested the matter has come to that point. What I have suggested is that Mr. Rubin should be investigated. I have not accused Mr. Rubin of any crime."

Counterspin advances the most bizarre "defense' of Mr. Rubin's call to Peter Fisher that I have seen yet:

"Rubin ADMITS he called up Treasury and asked whether or not something could be worked out to avoid Moody's eventual downgrading Enron. The reason for this was obvious. Citigroup was orchestrating a merger between Enron and Dynegy, Inc."

It is unlikely that Mr. Rubin would make a call to the United States Treasury to advance a merger that Citigroup was orchestrating between Enron and Dynegy without first doing a thorough check on Enron and Citigroup's relationship with it. So Counterspin's argument would mean that at the time of the Fisher call Mr. Rubin had much greater knowledge of that relationship than Mr. Rubin's defenders have asserted. The more Mr. Rubin knew at the time of the call, the more vulnerable he may be under the False Statements Act for not revealing it.

It's fairly clear that Counterspin and like minded people oppose an investigation or questioning of Mr. Rubin, despite the ample basis for such steps, simply because of fears of what such an investigation or questioning might turn up.
(0) comments


Sandy Weill's Fall Guy?

Tony Adragna of QuasiPundit asks Is "The SEC Talking To Sandy Weill?" Mr. Adragna locates the ultimate likely source of Citigroup Enron culpability (if there is any) not with Robert Rubin, but with Sandy Weill. Of course, Mr. Weill almost certainly knew before hand of Mr. Rubin's attempt to shore up Enron and its credit rating. If Mr. Adragna's concerns (and at this point that is what they are, Mr. Adragna has not made any acusations) are born out, does that mean Mr. Weill failed to inform Mr. Rubin of all Mr. Weill knew before Mr. Rubin, for example, called the Treasury Department?

Are these two men still on speaking terms?

The full story of the Citigroup/Enron relationship is likely complex, and Mr. Adragna's concerns are not unreasonable.

What all this means is that there is a pressing need for a full-scale investigation of Citigroup and its higher management. Some of the loftiest heads in the nation may roll as a result of that investigation.

But at this point, the need is for investigations, not accusations and not speculation. Only hard facts can settle this increasing disturbance. And it is important to make it clear to Citigroup and everyone else that the investigation has started and has broad scope, or else there is a risk that people involved will destroy documents claiming that they did not know an investigation had begun - EXACTLY AS HAPPENED AT ENRON AND ANDERSEN.

So why is it that Senator Lieberman and the Senate Democrats are refusing to call Mr. Rubin to explain himself?

Mr. Lieberman says that he wants to go "right to the top" and talk to Citigroup's Chief Executive Officer. This is at the same time some of Mr. Rubin's defenders are arguing that because Mr. Rubin occupied such a high position at Citigroup he was unlikely to have any valuable knowledge of Enron-related operations.

So which is it: Is Mr. Rubin too high or too low in Citigroup management to be worth talking to?

Some of Mr. Rubin's supporters point out that he supposedly was not yet an officer at Citigroup when the most spectacular Citigroup/Enron deals were created. But that particular point in time is likely not the most relevant. After all, nobody is claiming that these deals were in themselves wrong. The problem comes up later, when choices have to be made as to how to account for and disclose the deals. Mr. Rubin was surely in place at Citigroup when the Enron financial reports incorporating the effects of the Citigroup transactions started to come in. And, if Citigroup didn't know how Enron was going to treat their product (highly unlikely, to say the least, for an "off balance sheet product"), Citigroup certainly found out when the first Enron financials were delivered.

And where the heck were the Citigroup lawyers while these squirrelly deals were being put together and, more importantly, maintained and administered? The Man Without Qualities does not know what law firm represented Citigroup in these transactions, but Shearman & Sterling is their long-time counsel. So assume for the purposes of this discussion that Shearman & Sterling (or some comparable firm) represented Citigroup in the Enron transactions. Many aspects of these transactions probably raised serious legal issues and risks that Shearman & Sterling had an obligation to point out to Citigroup. THAT MEANS THAT SHEARMAN & STERLING THEN WROTE MEMORANDA EITHER TO CITIGROUP OR TO ITS OWN FILES POINTING OUT THESE LEGAL RISKS AND/OR PROBLEMS. Those memoranda are supposed to still be in the corporate and law firm files.

Such memoranda are clearly subject to attorney-client privilege. As has been pointed out by the Man Without Qualities in the past, Citigroup's board of directors should have no problem waiving that privilege, given the current national unease. Those memoranda should provide a virtual roadmap either incriminating or exculpating Citigroup.

Reports are that the new "corporate governance" bill just passed by the Congress includes a provision requiring lawyers to report on wrongdoings by corporate clients. Asking Citigroup for its legal memoranda is something in the same spirit.



(0) comments

Wednesday, July 24, 2002


Traficant Congestion

The House of Representative on Wednesday expelled Rep. James Traficant, D-Ohio, for taking bribes and kickbacks. It was only the second time since the Civil War that it has removed a sitting member for unethical conduct. The vote was 420-1, with only Rep. Gary Condit, D-Calif., who was defeated in a primary for re-election after he was romantically linked with Chandra Levy, a government intern who was murdered, voting against Traficant's expulsion.

Preliminary reports are that the margin for passage of a subsequent resolution, to tar and feather Mr. Traficant and have him run out of town on a rail, was somewhat narrower, with Barbara Lee, D-CA, and Cynthia McKinney, D-GA, joining Mr. Condit to oppose that measure.
(0) comments


Reasonable Procedures

J.P. Morgan and Citigroup both say that they did no major wrong in their relationships with Enron.

The Man Without Qualities believes that is probably objectively correct, for all of the reasons described in previous posts. But both banks will have to contend with the obvious facts that the standards are being changed on them ex post facto.

Also, just because the banks probably did no major wrong doesn't mean they didn't know all about what Enron was up to, or that they didn't grasp the significance of what Enron was up to. To that extent the banks' current positions - which assert that they, too, were bamboozled by Enron - may ultimately result in a great deal of trouble for the banks and their representatives, including under the False Statements Act.

No, these banks and their representatives almost certainly knew everything they needed to know about Enron's finances and accounting, especially as to how the banks' own products were being disclosed. The banks may even have had doubts about Enron's disclosure. But they also probably concluded that a reasonable person could conclude that what Enron was doing was within the envelope of reasonable business judgement and procedures - relying in part on Arthur Andersen to reach that level of comfort. All of that is consistent with similar processes leading, say, the Enron board of directors to similar deferential conclusions. It's the same infinitely receding hall of mirrors that characterizes most serious questions of corporate responsibility.

Perhaps the board and these banks should have looked harder and thought more for themselves. They may have been negligent. Perhaps seriously negligent. They may be held accountable for more than that.

But it is interesting that while the feds are apparently towing away members of the Rigas family and their entourage by the truckload in handcuffs today for alleged bank fraud and the like, nobody at Enron or Andersen - and now Morgan and Citibank - has yet to be indicted.

How long has it been now?
(0) comments


Bad Business at Adelphia

Some members of the Rigas family, which controled Adelphia, have been arrested for bank fraud, among other things.

Nobody seems to be saying it was an option-driven "pump-and-dump."

The Rigases are said to have become crooked the old fashioned way. They controlled the company and allegedly took its money and cooked its books to cover that up.
(0) comments


Tom Daschle, Exempting

This is hilarious. Tom Daschle must almost literally have no shame.
(0) comments


Robert Rubin and the Federal False Statement Act II

With respect to the post below captioned "Robert Rubin and the Federal False Statement Act", Alex Frantz says "There is one trivial detail that's been omitted from this discussion of Mr Rubin's crimes: neither Musil nor Glenn provides a single example of a statement Rubin made that they believe to have been false."

Fair enough.

That post is separated by several others from an earlier one captioned "Butter Won't Melt In His Mouth," which in turn links to eight other posts in which the Man Without Qualities has expressed reasons to be concerned about Mr. Rubin's role and truthfulness in the Enron/Citigroup matter. Unless Mr. Frantz has been reading this blog consistently recently, he might easily have missed the earlier collection of links.

Andrew Sullivan has his own suspicions, which should be investigated. But whether or not Mr. Rubin was at Citigroup when certain Enron deals were put together, he was certainly there when Enron crashed and he made his call to Mr. Fisher. There is no indication in the media that Mr. Rubin mentioned any of Citigroup's questionable involvement with Enron when he requested Mr. Fisher's aid in pressuring the rating agencies. If Mr. Rubin knew about Citigroup's involvement at the time he called Mr. Fisher, Mr. Rubin may have misled Mr. Fisher in violation of the False Statement Act. Mr. Rubin is also reported to have spoken to various federal officials since making that call. But there are no reports that Mr. Rubin detailed Citigroup's deeper involvement, or any of the troubling deals that have recently surfaced. But Mr. Rubin does have a deep and justified reputation for acquiring vast information before taking important actions such as his call to Mr. Fisher and subsequent interviews with government investigators, and he does not move carelessly. There is therefore very good reason to ask "What did Mr. Rubin know about Enron and Citigroup's relationship with Enron when he spoke to Mr. Fisher and other government officials, and did he mislead them?"

For example, media reports imply that when Mr. Rubin requested Mr.Fisher's intervention Mr. Rubin suggested that a delay in a downgrade of Enron's debt might permit the company to get back on its feet. But the Citigroup transactions and involvement that have come to light recently indicate that Citigroup may have known Enron was doomed and was cooking its books with Citigroup help. The details of the Rubin-Fisher call have not been fuly disclosed. But if Mr. Rubin knew Enron was doomed but said otherwise to Mr. Fisher in an attempt to manipulate the rating agencies, that would be a very serious matter, not just a technical violation of the False Statements Act. And at this point, it looks like that may be just what happened. But we don't know exactly what Mr. Rubin said or knew when he called Mr. Fisher. Similarly, we don't know most of what Mr. Rubin said or knew when he thereafter talked privately to federal investigators about his call Mr. Fisher and Enron, or how it squares with the recent disclosures of the Citigroup/Enron relationship. But we know that Mr. Rubin was in a position to know a lot, and that he has a reputation for making sure he is fully informed when he acts. But we have no reports from Mr. Rubin, Citigroup or anyone else that he revealed any key transactions to the federal agents to whom he has spoken.

Mr. Frantz is quite correct that the matter has not yet come to the point of identifying a particular supposedly false statement of Mr. Rubin to a particular government official. And I have not suggested the matter has come to that point. What I have suggested is that Mr. Rubin should be investigated. I have not accused Mr. Rubin of any crime, nor has Glenn, nor has Mr. Frantz said that either of us have.
(0) comments


Warren Buffet and Options

Why does Warren Buffet keep making these same arguments about options , when they have been definitively answered?

Mr. Buffet continues to pretend that a sound and "honest" number can be chosen to represent the "expense" of employee options. But not even the FASB proposal which would require expensing options contemplates any such thing. Here's what the proposal says:

The fair value of a stock option or equivalent award would generally be estimated using an option-pricing model that considers the following factors:

* The current (grant date) price of the underlying stock;

* The expected volatility of the underlying stock (i.e., the expected variance of returns on the stock);

* The option or exercise price;

* The expected life of the option;

* Expected dividends on the stock; and

* The expected risk-free rate of return during the option life.

The proposed standard would not require use of a particular option- pricing model or approach, but does specifically identify Black-Scholes and binomial option pricing models as being appropriate. The method used to estimate fair value should explicitly incorporate each of the factors enumerated above. This is critical because the proposed accounting would require compensation expense and the value of the award be adjusted to reflect subsequent changes in the expected life of the option. To appropriately adjust for changes in this estimate, its role in the determination of fair value must be explicit. There are several relatively inexpensive software packages that value options based on user specification of these six input values. With the availability of these option-pricing packages, determining the appropriate assumptions to use as software inputs is expected to be the most difficult task in the valuation process.


So the FSAB proposal would allow companies to choose the pricing model. Which is fine, since most analysts would ignore whatever number was used anyway and substitute their own. For example, the comment above notes that the expected volatility of the underlying stock is key to determining the value of the option. Consider the behavior of the markets over the past few weeks. How comfortable does one feel that the "expected volatility of the underlying stock" could have been predicted - for any stock at all?


Mr. Buffet says: "I have a proposition: Berkshire Hathaway will sell you insurance, carpeting or any of our other products in exchange for options identical to those you grant yourselves."

That sounds nice. Suppose Mr. Buffet uses Black-Scholes to value the options in the trade. And suppose his counterparties choose another measure - a so-called "ex post measure." Well, one study has found that "based on a sample of 53 firms ... the Black-Scholes model overestimates compensation expense by approximately 39 percent relative to ex post measures." Mr. Buffet is a clear financial genius. And he will need every bit of that genius to close a 39 percent gap between asking and selling price for all that insurance, carpeting or other products.

And why in God's name does he keep saying things like "Chief executives frequently claim that options have no cost because their issuance is cashless?" If some CEO's are making the point in that crude, misleading language, Mr. Buffet should be campaigning for them to stop doing that and instead explain to their shareholders that options have dilutive effect that can be measured by different ways under different assumptions. But this is no excuse for Mr. Buffet to be urging his own misleading single-number, single-model misrepresentation as a replacement for another misrepresentation to which he objects.

Mr. Buffet has repeatedly and famously asked: "If options aren't a form of compensation, what are they? If compensation isn't an expense, what is it? And if expenses shouldn't go into the calculation of earnings, where in the world should they go?"

And the answers are pretty clear:

Options are a form of compensation that can be valued in different ways.

Compensation is an expense that can be given different dimensions depending on the model and assumptions chosen. And once those are chosen, " there are several relatively inexpensive software packages that value options based on user specification."

This kind of expense should go in a footnote to balance sheet earnings describing the alternative "pro forma" calculation of earnings using one or more options pricing models, together with an explanation that other models and assumptions can be used.

It is hard to understand why a mind as capacious and practical as Mr. Buffet's gets stuck on this odd little issue. It is not too hard to come up with various, unflattering and flattering possible motives for Mr. Buffet's position - but that would be speculation. The reader may speculate for hereself, if she wishes.

But whatever may be motivating Mr. Buffett, this issue sure isn't any part of what has the equities markets in a snit.

(0) comments

Tuesday, July 23, 2002


Robert Rubin and the Federal False Statement Act


The False Statement Act applies to every matter within the jurisdiction of every executive, legislative and judicial agency of the U.S. government. Under the act, it is a crime for any person:

* To knowingly and willfully falsify, conceal or cover up by any trick, scheme or device any material fact.

* To make any materially false, fictitious, or fraudulent statement or representation.

* To make or use any false writing or document knowing the same to contain any materially false, fictitious or fraudulent statement or entry.

Punishment for a violation may include fines and imprisonment for up to five years.

The False Statements Act applies to every matter within the jurisdiction of every executive, legislative and judicial agency of the U.S. government.

So the False Statements Act probably applied to Robert Rubin's bizarre and notorious telephone call to Peter Fisher, in which Mr. Rubin reportedly asked Mr. Fisher to pressure the bond rating agencies to delay the then-expected downgrade of Enron debt. It applies to any statements Mr. Rubin has made regarding his knowledge of Enron to federal bank regulators or to the Securities and Exchange Commission or to Congress

Mr. Rubin should be carefully investigated for violation of the False Statements Act.

Right now, his more intellectually dishonest apologists are able to charicature the increasing disturbing circumstances surrounding Mr. Rubin's Citigroup dealings (such as Andrew Sullivan's suspicions) as "string[ing] together a bunch of Rube Goldberg assumptions and implications to make his argument, rather than facts."

That should not be allowed to continue. It is not fair to Mr. Rubin or to the public. Mr. Rubin should be called to Washington, placed under oath and made to provide clear explanations for all of his Enron/Citigroup dealings, including the telephone call to Mr. Fisher. If he chooses, he may exercise his Fifth Amendment rights. Files should be opened, if that has not yet been done, at the Department of Justice, the Securities and Exchange Commission and the Federal Reserve (which is the chief regulator of Citigroup as a bank holding company). Mr. Rubin's statements should be carefully investigated and he should be charged or cleared as quickly as possible, as the evidence indicates.

Mr. Rubin is entitled to all that.

And so is the nation.

As most people now know from the Andersen trial, if Mr. Rubin violated the False Statements Act, then his guilt can be imputed to Citigroup.

______________________________________________________________

UPDATE: Glenn Reynolds says that if Mr. Rubin is at risk, "this is probably a testament to the excessive reach of the False Statements Act." I completely agree that the False Statements Act is too broad - and the recent certification rule imposed by the SEC is broader still with respect to SEC filings. Although a man who has violated that Act arguably shouldn't be occupying the position Mr. Rubin does at Citigroup, the main benefit of employing the False Statements Act here would be to obtain whatever additional information Mr. Rubin may have regarding the Enron/Citigroup connection, a connection which now appears to be every bit as substantial as the Man Without Qualities has suggested might be the case. Mr. Rubin's information (if it exists) might be damaging or exculpatory to Enron or Andersen or their operatives or to Citigroup - or to, say, their respective lawyers, including the two partners at Shearman & Sterling (Citigroup's long-time counsel) who granted Enron critical waivers while employed at the SEC. As noted here previously, Citigroup should have no difficulty waiving attorney-client privilege.

Mr. Rubin has made a career of possessing lots of information that he shares only when and to the extent he chooses. The False Statements Act might help to shift that choice to federal investigators. It might even help out the Enron task force at the Department of Justice, who seem stalled at the moment.

________________________________________________________


FURTHER UPDATE: The extent of the sweeping anti-business mindset now prevalent in the less responsible quarters of the American left can be seen in Atrios' assertion that the False Statements Act to him "sounds like an EXCELLENT basis for prosecuting just about everybody involved in the energy trading business who communicated with FERC during 2001."

It is certainly true that False Statements Act applies to communications with the FERC - and Justice Department prosecutors should consider enforcement actions under the Act in the energy sector if evidence supports such actions.

But Atrios' assertion that "just about everybody involved in the energy trading business" violated this federal statute if they spoke to FERC indicates just how sweepingly hostile towards business whatever part of the left it is that includes Atrios has now become. It is likely that the costs of such hostility on the national scale will be huge.

For example, Atrios' inclusion of just about the entire energy business among the criminal class certainly makes a mockery of the explanation of Erik Smith, Mr. Gephardt's spokesman, that the Minority leader's agenda has "drawn strong support from corporate officers".

Mr. Smith said: "What Mr. Gephardt and Democrats are saying is not anti-business, it is anticriminal behavior." But, refreshingly, Atrios' is having none of that Gephardtian double-speak. No "few bad actors" or "a small, corrupt minority" evasions for Atrios. He says "just about everybody involved" could be prosecuted for this federal crime. Atrios doesn't seem to think the distinction Mr. Smith is trying to draw means very much to Atrios, who - like many on the left - doesn't even understand, or at least admit, how generally and obviously hostile he is to business. Mr. Smith understands the need to cover the tracks Atrios brazenly leaves behind.








(0) comments (0) comments


Antidisestablishmentarianism Comes for the Archbishop?

The new Archbishop of Canterbury, Rowan Williams (no, not Robin Williams), advocates "disestablishment" — ending the Church of England's position as England's legally established church led by the Queen. Bishop Williams was appointed by a House of Commons widely believed to be totally dominated by Tony Blair, who is an Anglican.

The situation would be even more remarkable if the Prime Minister were actually Mr. Blair's wife, Cheri, who is a serious Catholic, who sends their children to a serious Catholic school in London.

Prospects such as a non-Anglican appointing the Archbishop of Canterbury seem to highlight the significance of disestablishment, and it is interesting that an advocate of disestablishmentarianism has now been appointed the head of the C of E. Of course, one doesn't know if he will change his official position on that issue now that he has been appointed to that particular office.

But such a conversion of the new Archbishop to antidisestablishmentarianism would be disheartening, if only because it would end the opportunity for text-based media to use a word one was duped in one's childhood into believing was "the longest word in the English language," only to later discover it had been edged out by the name of some dreadfully complex molecule or other.

Pity, that.

(0) comments

Monday, July 22, 2002


Democrats Get Down To Business

UPDATE: When Roger Altman, former deputy Treasury secretary in the Clinton administration, starts writing articles like this for the Wall street Journal, perhaps Mr. Gephardt and other anti-business jihadists may want to take the note and re-think their current strategy.

_________________________________________________________________________________


The New York Times apparently wants to reassure us that Democrats will be able to extract money from business, notwithstanding their current jihad against corporate America:

Mr. Gephardt, of Missouri ... has been working overtime on fund-raising... "Your resources will help us win races all over the country," he told a wine-sipping audience of 100 or so ... Guests included representatives of the airline, high-tech and automotive industries, and Washington lobbyists with many corporate clients. Mr. Gephardt's office declined to provide a list of people who attended ... Earlier this month, aides said, Robert W. Pittman, the AOL-Time Warner executive who resigned on Thursday, held a fund-raiser at his Manhattan apartment for Mr. Gephardt. Advisers to Mr. Gephardt reject any suggestion that his push for new business regulations should disqualify him from raising corporate donations. They say his agenda has drawn strong support from corporate officers. "What Mr. Gephardt and Democrats are saying is not anti-business, it is anticriminal behavior," said Erik Smith, his spokesman.

It is interesting that “[a]dvisers to Mr. Gephardt reject any suggestion that his push for new business regulations should disqualify him from raising corporate donations.” Who, exactly, has been making those suggestions? The Times doesn’t say. Don’t the reporters know?

And while the Times reporters interviewed various politicians, lobbyists and congressional aides, somehow the reporters weren't able to come up with a single, actual, live businessman to confirm that Mr. Gephardt's strident, nearly hysterical broadside attacks on business "have drawn strong support from corporate officers." Indeed, Gephardt's people wouldn't even give the Times a copy of the guest list from the fundraiser. Perhaps the Gephardtians were concerned about what one of the "guests" might say in that tender 24-hour interval after being fleeced under these circumstances.

And considering what AOL-Time Warner had in mind earlier this month for Mr. Pittman at the time he held that fundraiser for Mr. Gephardt, I'm not sure the Minority Leader should take that occurrence as an entirely positive gesture, especially since Mr. Pittman is being lined up to be assigned most of the blame for some possible AOL-Time Warner accounting irregularities.

But business can't just freeze Mr.Gephardt out completely. After all, regardless of his policies, the Party-Out-Of-Power (in this case, the Democrats) do tend to gain seats in mid-term elections. So there is a good chance Mr.Gephardt will be Speaker next year, just by the historical numbers.

Perhaps he lets those business leaders know that when he asks them to pay up.


(0) comments


Butter Won't Melt In His Mouth

Can the Robert Rubin who wrote this be the same person who is one of the highest executives in the company they're talking about here and here and here?

And now here and here?

And, of course, here and here and here and here and here, and here and here and here.

No. It just can't be. Nobody has THAT much cheek.
(0) comments


Confusing Options

In the ongoing Congressional brouhaha over executive options, some public discussion has become rather confused, at least in the opinion of the Man Without Qualities. It is in my view worth noting that the following are quite different criticisms of such options:

1. Not expensing options on company balance sheets allows companies to overstate earnings, leading to overpriced stock.

2. Executives compensated and incentivised with stock options will tend to engage in fraud and deceptive practices in order to boost apparent earnings and therefore the price of the stock. The executives will exercise their options and dump the stock while the market is artificially hot.

3. Because option holders enjoy the up side of stock price fluctuations, but not the down side, executives compensated and incentivised with stock options will tend to take more risk than the shareholders would like. This is sometimes called the "non-alignment (or disalignment) of interests" argument because it is based on the non-alignment of shareholder and option holder interests.

While reasonable minds may disagree, each one of these arguments is unpersuasive.

The first criticism fails because, as many people have now pointed out, it is well-known fact that once options are disclosed, investment professionals will simply evaluate the effect of the options on the company's financial condition by using any number of many, many methods of valuing the options. It is not that some of these methods are right and others are wrong. Rather, some methods are more appropriate than others under different assumptions. More Than Zero has made a similar point. To take a simple example: If the options have an exercise price of $1.00 and one assumes stock price will trade around $0.90 indefinitely, the value of the option will be very different if one also assumes either:

(i) that the stock will be highly volatile (in which case it will often be above $1.00, and represent a real dilution prospect and therefore a cost, to the company), or

(ii) that the stock price will always range between $.88 and $.92, in which case the option is worth zero, and the company faces no real expense.

How a particular analyst views the likely volatility of the company's stock under whatever circumstances the analyst is interested in will be key. For example, if the analyst is looking at hostile take-over scenarios, high volatility is likely. If a tender is unlikely, volatility will be determined by other market factors. This example varies just one assumption but implicitly uses the same methodology. But methodologies can also be properly varied, especially between the long and short term.

Simply put: Whatever number is used to reflect the expense of the options in the company’s balance sheet - no matter what that number is - will be wrong. So why do it? One can, of course, make certain "reasonable' assumptions about the factors most often used to value options in common methodologies - which amounts to saying that one assumes the future will be like the past - and require companies use a particular methodology and plug in such standard reasonable assumptions. That would probably produce the most "misleading' set of financial statements of all. Similarly, it is not that hard to imagine analogous "overstatements" of corporate earnings of unlimited degree and extent that do not represent any deception of the market at all and which should not be corrected simply because it is better to describe them in other terms and let the analysts evaluate their significance for themselves.

Nor does the second criticism really hold up. As a preliminary matter, it is worth noting that this incentive will exist if the prosperity of an executive is effectively linked by any means to the value of the corporation’s stock in a way that allows the executive to sever connections with the company and take the accumulated value away. So unless an executive is to become an indentured servant, it is not possible to solve this problem and still have the executive care about share value. Moreover, contrary to recent media coverage, there does not seem to be a very strong correlation between executive options and the recent spate of documented accounting scandals. Consider this formulation of the problem, by the op-ed writer for the New York Times article linked above:

Options, which are not counted as an expense and thus inflate earnings, bring with them a powerful incentive to cheat. They hold out the promise of wealth beyond imagining. All it takes is a set of books good enough to send a stock price soaring, if only for a while. If real earnings are not there, they can be manufactured — for long enough, in any case, for executives to cash out. This, in essence, is what happened at Enron, WorldCom, Xerox — indeed, at quite a long list of companies.

Except that nobody is saying that the scandals at WorldCom or Xerox were in any way connected with executives of those companies fraudulently inflating their stock prices so the executives could dump their option stock. Nor has either of the Adelphia or Global Crossing disasters been tied to "option dumping." For example, in 2000, Mr. Winnick, or companies he controlled, owned 78.9 million shares of Global Crossing stock as well as 8.56 million options. So if there was an incentive to boost the stock price at Global Crossing, it is hard to say that options – rather than simple stock ownership – were the cause of it.

In fact, the problems at Adelphia and WorldCom appear tied to the ways their executives were buying company stock, not dumping it. The Merck pseudo-scandal has not been assigned that likely causation. Not even the Im Clone disaster has been tied to options. The SEC and the Justice Department are reportedly investigating whether Computer Associates wrongly booked more than $500 million in revenue in 1998 and 1999, a time when three senior executives were enriched via stock payouts from the company – not options - that were triggered by stock price milestones, but that stock has for the most part not been sold. At Tyco, Mr. Kozlowski and other individuals have lots of problems, and some analysts and investors wondered if Kozlowski had approved some of the same accounting tactics as those allegedly used by Enron – but the “wondering” has not matured into serious civil or criminal charges. Further, if there are problems at Tyco, they are probably tied up with Kozlowski's sale of about $300 Million in company stock to the company prior to 1999 - a potentially dangerous issue, but not the same as option dumping. Problems at Qwest may be option-related, and Mr. Nacchio engaged in some alleged option dumping (although he denies that). But even here one has to contend with the fact that Mr. Anschutz was in ultimately charge there and he owned a 301 million-share stake in Qwest, where he sold about 3.3% of this stake during the questionable period. That doesn't sound like an option-driven problem.

Of the now rather long list of large companies tainted by accounting scandals recently, few other than Enron are even allegedly the product principally of option dumping. Of course some of these companies employed executive stock options - but that has not been reported as a major cause of the alleged scandals. So it's not surprising that the Times op-ed piece just omits the actual names on that "quite ... long list of companies" that have succumbed to this particular temptation. But it is Enron that caused the initial uproar, which may be why this criticism has gained currency. It is just hard to find a real pattern of executive options being the major issue with these companies, even assuming for the sake of argument that their irregularities are as serious as their critics contend.

It is also worth noting that this New York Times article says that that the accounting "fraud" suggested in that article has been going on for TWENTY YEARS AND THROUGHOUT THE MARKET. The reader can evaluate that probability for herself.

What is correct is that during the dotcom run up, many holders of executive options became fabulously rich by dumping option stock in companies with no earnings The shareholders in those companies eventually more or less lost everything, and that rankles still. But that's not today's problem - and there have been surprisingly few claims that the dotcom companies actually defrauded their investors. After all, each one of those IPO prospectuses pointed out the dotcom then going public had no earnings and a highly speculative "business plan." But this was a point made widely during the run up itself.

One might also point out that the great majority of companies using executive options have not been accused of improprieties. So if the incentive is so strong, why were more companies not affected?

Until there is some clear, widespread evidence that executives compensated and incentivised with stock options will tend to engage in fraud and deceptive practices there seems to be no reason to jump to that conclusion. After all, there are a great many anti-fraud and anti-insider-trading laws already on the books. Why assume the balance between the two sets of incentives (that is, incentive to cheat from options meets incentive not to cheat for fear of getting caught and punished) has been upset to the point it needs drastic overhaul? True, there may be a need to reassure the markets. But there is also the serious risk of overkill and overregulation, which is probably an even bigger risk to the markets. And let’s not forget that really serious restrictions on options could be a dagger pointed at the heart of the venture capital industry – thereby risking serious damage to one of the American economy’s greatest assets.

The third criticism is more subtle and interesting - but also ultimately unpersuasive in this crude form. For one thing exactly the same argument can be made about stock with respect to debt. Consider a company financed partially with a loan for, say, $100 Million. Suppose the directors perfectly represent the shareholders' interests. Suppose the company has two possible business plans: Plan A, which will yield exactly $100 Million and has a 100% chance of succeeding (that is, it's low risk), and Plan B that has a 50% chance of making $200 Million and a 50% chance of making $0 (bankruptcy). It is obvious that the board will choose Plan B, since the value of this Plan to the shareholders is $50 Million (.5 chance of success X [$200 Million return - $100 Million loan]) , where the "low risk" Plan A is worth nothing. But the lender would clearly prefer Plan A, since that Plan has a 100% chance of repaying the loan.

Does anyone think that this kind of "non-alignment of interests" argument as between debt and equity means that companies should not have both debt and equity? Of course not. Lenders protect themselves in such cases by including covenants in the credit agreement and structuring the loan in clever ways. Similarly, the structure of the option plan will be determinative in the executive option case.

But, more importantly, why should this third criticism matter much in the debate over legislative action. Yes, executive options can disalign shareholder and executive interests in the same way equity and debt holders are somewhat disaligned, and the interests of founders are somewhat disaligned from those of later shareholders. But most people understand that the founders, shareholders and debt holders also have many interests in common. Such disalignment is a factor for the investors to consider - not the Congress.




(0) comments


Now Please Don't Take This Personally

How much effect will the new SEC requirement that Chief Financial Officers and Chief Executive Officers of many large public companies "certify" their employer's financial statements? The Man Without Qualities has expressed doubts previously. And the Wall Street Journal correctly reports:

Some lawyers note the SEC action may not increase officers' criminal liability beyond what they already face for filing false statements with the SEC. "It's safe to say that the government already views a false filing as a potential violation of the False Statement Act," says Brian Lane, a partner at Gibson, Dunn & Crutcher in Washington and a former head of the SEC's corporate finance division.

That observation doesn't guaranty that the new rule will have no incremental beneficial effect, but it does suggest that any beneficial effect of the new rule will be marginal.

One possible gage of how well considered the new SEC "certification" rule might be to compare the rule with what the big boys do when they're in control. For example, what do the big commercial banks do when one of their borrowers wants to borrow more money? What kind of assurances does, say, Bank of America and Citibank get from their big borrowers when the borrower asks for, say, another Hundred Million Dollars? Do the banks make the borrower's chief executive officer, chief financial officer and maybe even the chairman of the board personally certify under penalty of perjury (at least to the best of their knowledge) that the last set of financial statements the borrower gave to the banks were good? After all, the banks know finance better than anyone else and they have the muscle to get the job done! We're not talking about some small, naive, personal investor here. We're talking about the Bank of America and Citibank! They must get the real thing from their borrowers, and there is nothing like the real thing.

The WorldCom banks are suing for fraud. The banks say they were defrauded by WorldCom when WorldCom drew down more than $2 Billion from an existing credit facility without telling the banks that the WorldCom financial statements were wrong.

What exactly did the WorldCom credit agreement require WorldCom to say when it borrowed all that money? Well, the credit agreement is an exhibit (Exhibit 10.1, to be exact) to WorldCom's filings with the SEC. That credit agreement did NOT require that for WorldCom to borrow any senior executive, or any individual at all, had to personally certify anything at all, the credit agreement only required that WorldCom as a corporation sign and deliver a notice of borrowing that included the following weak certification:

Borrower hereby certifies that the following statements are true and correct on the date hereof, and will be true and correct on the Borrowing Date specified herein after giving effect to such Borrowing ... all of the representations and warranties of any Borrower set forth in the Loan Papers are true and correct in all material respects (except to the extent that (i) the representations and warranties speak to a specific date, or (ii) the facts on which such representations and warranties are based have been changed by transactions contemplated or permitted by the Loan Papers); ... no Default or Potential Default has occurred and is continuing; and (d) the funding of such Borrowing is permitted by Law.

While the credit agreement did require that WorldCom deliver copies of its annual and quarterly financial statements to the banks that were certified in a manner similar to the certification required by the new SEC rule, the certification was not required to be made under oath or penalty of perjury (although such a requirement could have been included in the credit agreement), and could be signed by any senior vice president. And while the credit agreement also required that WorldCom to deliver to the banks copies of filings WorldCom made with the SEC, those copies did not have to be certified at all.

In short, the WorldCom banks, including Citibank and Bank of America, who have now sued WorldCom for fraud, required considerably less of WorldCom than the SEC has now generally imposed on most large public companies with that new rule. Does that suggest that the call for new regulation is excessive?

Mr. Lane's observation also again raises the question: Why hasn't the government indicted Mr. Fastow or any other Enron executive?

When the SEC first announced the rule, the Wall Street Journal interviewed lawyers who said "that a criminal case based on lying in a sworn statement is generally much easier to prove than a complex accounting fraud." But now we know from Mr. Lane, a former head of the SEC's corporate finance division, that the SEC and Justice department had what they needed all along.

And it has been a full month since the government said it picked up all that momentum from the conviction of Andersen, a display of prosecutorial team play that some might say is best compared with the earliest efforts of the New York Mets. The New York Times dismissed concerns that the prosecution was flawed, and reported:

[O]ver time, experts on white-collar cases said, those issues will wash away, and instead, the government will emerge the strategic winner, simply for not losing. Indeed, they said, the Andersen conviction provides prosecutors with critical momentum as they turn their attention to other potential defendants in the Enron debacle. Strangely, the fact that the Andersen case is now seen as weaker than previously believed could bolster government efforts, because potential witnesses will now recognize that these prosecutors, unlike some, are willing to move fast and go to trial even in cases where victory is not assured.

Perhaps a month is just not enough time for all those issues to “wash away”, as those "experts" predicted. Or perhaps the Enron team at the Department of Justice has been just too busy processing all those guilty plea offers and spontaneous confessions from Enron and Andersen operatives that were precipitated by the Andersen "win" to whip up a quick indictment or two Stranger things have happened, although I can't actually recall any at the moment.




(0) comments

Sunday, July 21, 2002


Awful and Terrible Words

Among the harassed population of Chief Financial Officers of American public companies, it is possible that at the moment the most terrifying words are "... as defined [or determined] in accordance with generally accepted accounting principles, as in effect from time to time."

Why should these words be terrifying? Because that phrase - and phrases similar or equivalent to it - appears in bank credit agreements, bond indentures, stock option grants, executive employment agreements, "permitted investments" definitions for mutual funds, corporate charters, shareholder agreements, state statutes and countless other repositories of financial text, each of which reflects a deal cut at a time options did not need to be expensed under generally accepted accounting principles. And now Congress is thinking of changing that.

Consider one example: Corporation has a bank loan. The bank credit agreement states that the loan will be in default, or new borrowings will not be permitted, or dividends will not be paid, or payments on debt subordinated to the bank loan will not be made, or any number of other contingencies will be triggered, if the corporation’s earnings drop below a certain stipulated number, where the credit agreement also states that the term "earnings" is defined [or determined] in accordance with generally accepted accounting principles, as in effect from time to time. Suppose the corporation is, say, a software company not in nearly as good shape as when the credit agreement was signed, a software company which has never expensed its executive options. If expensing those options would require reducing earnings below the point stipulated in the credit agreement, the corporation would be in default under its bank line. This might trigger defaults under other facilities (so called "cross-defaults") and any number of other dreadful consequences to the corporation, including a possible downgrade of any public debt it may have. So if Congress requires that generally accepted accounting principles be modified so that executive options must be expensed, that could have serious consequences for such a company.

Similarly, if an executive's employment agreement grants him bonuses or other compensation based on company earnings, and those earnings are defined under generally accepted accounting principles as in effect from time to time, such Congressional action will have serious consequences for the executive.

That seems like a high price to pay for a matter that is supposedly driven by disclosure considerations, especially since such a new definition will not provide useful additional disclosure. For one thing, there is no one way to value an option. That problem has already surfaced in connection with the proposed Congressional "reform" legislation: How much "expense" should the law require be reflected in the balance sheet for options? But the reason there is so much disagreement about valuing options is not that options are misunderstood, it's that they should be valued in different ways for different purposes and under different circumstances.

What this means is that regardless of what Congress does, analysts will simply replace the plug figure for options used in the official balance sheets with the analyst's own calculation, using whatever methodology the analyst thinks is appropriate. Once the parameters of the option are public, the rest is superfluous to equities analysts.

The above discussion provides at least one answer to KausFiles question:

[I]f nobody's fooled by burying the options in the fine print, and a change would have no effect, then why have so many corporations, especially in the tech sector, lobbied so furiously to maintain the current arrangement? Are they fools? Obviously it makes a difference to them -- presumably because many investors look at reported profits and don't recalculate them after reading the footnotes....It's not as if there was irrational overinvestment in tech or anything!

Moreover, the answer proposed above proceeds without the need to assume companies are crooks or investors are too stupid to have not recalculated earnings after reading the footnotes.

So why is it so important for Congress to re-write a million corporate deals in the name of additional disclosure that the investment community doesn't care about?

UPDATE: The differences between the positions of Warren Buffet and Jack Welch on the benefits of options are revealing. Mr. Buffet appears to favor relatively simple companies in which high-powered executives are not really needed, so that heavy reliance on stock options is not needed. Mr. Welch has busied himself more to the other end of that continuum.









(0) comments

Home