Tuesday, August 11, 2009
Recouping Executive Bonuses
Executive bonuses are in the news again, with the SEC complaint against Bank of America for allowing Merrill Lynch to pay up to $5.8 billion in discretionary bonuses, despite proxy statements suggesting that no bonuses would be paid. Bank of America and the SEC agreed to a settlement, but these settlements are subject to judicial approval for being "fair, reasonable and adequate." Judge Rakoff of the SDNY refused to approve it without a hearing, held yesterday, in which he called for more information. A few thoughts:
First, the coverage seems to focus on whether TARP money was used to pay the bonuses, and outrage because $33 million seems small in comparison to the billions paid out. But we should also be asking the usual question about corporate penalties: Where is that $33 million coming from and where is it going? Is the penalty being paid with TARP funds? (Is there any way to distinguish the source of money?) Who gets the money? In other words, maybe the cash is going from taxpayers to the Treasury, minus administrative costs. Or the penalty could be distributed to injured shareholders through a Fair Fund. It complicates the "bigger is better" account.
Tuesday, July 21, 2009
Monitoring External and Internal Corporate Security
The WSJ law blog has a new story up about a corporate security scandal at Deutsche Bank, wherein the Bank's private detectives engaged in a number of acts that, in retrospect, sound either loopy (sending a dead microphone hidden in flowers to the COO to see if he would notice it) or more serious (spying on a board member suspected of leaking information to a journalist). Similar to the Hewlett Packard pretexting scandal, which I discuss here, Deutsche Bank relied on private detectives to do much of its "security work" (although the head of internal corporate security has reportedly left the company in light of the scandal). As was the case with HP, the Deutsche Bank scandal demonstrates some of the problems with corporate -- private -- policing. The company's internal security apparatus is asked to investigate a problem and then relies on external investigators to do its dirty work. As a result, the company has to monitor both its internal security and external security to ensure that both ethical and legal norms are met. This can be extremely difficult when some of the company executives are unfamiliar (as was the case in the HP scenario) with the techniques that the security professionals are using.
In any event, this all occurred in the past, between 2001-2007, when corporations - and corporate security departments -- had more money to spend. Now, in a world of vastly reduced resources, corporate security (along with corporate compliance) may well get the short shrift. In this case, reduced resources promises mixed consequences. On one hand, companies may have fewer resources to identify internal theft and fraud. On the other hand, it may spell an end to the corporate "surveillance" measures that are, at best, unethical and at worst, plainly illegal.
Friday, July 03, 2009
Thinking Like an Entrepreneur or a Lawyer?
If you are interested in the intersection of entrepreneurship and the law, the Kauffman Foundation, the leading sponsor of entrepreneurship development in the country, has funded an Entrepreneurship Law resource on its website, www.entrepreneurship.org. This includes teaching materials. (I think I contributed something, but I just registered myself so I'm not sure.)
For many of the same reasons expressed in my last post (and based on a fair amount of experience in the area), my reaction to "entrepreneurship law" is something like my reaction to my own travails as an athlete, which is that I think too much (this is known as "paralysis by analysis"). For a short sample of my contrarian view on this subject, see Why the Law of Entrepreneurship Barely Matters, the gist of which can be boiled down to this excerpt:
The entrepreneur . . . sees the world as a moveable feast of phenomena, posing danger and opportunity to be seized and exploited, and choices to be made, over and over again. One entrepreneurship scholar sees the entrepreneur's mode of reasoning as effectual rather than causal: while causal reasoning posits a goal and seeks means to the goal, effectual reasoning "begins with a given set of means and allows goals to emerge contingently over time from the varied imagination and diverse aspirations of the founders and the people they interact with."
The essence of thinking like a lawyer is causal reasoning, and not surprisingly, lawyers and entrepreneurs tend to be ships passing in the night. (For a far more scathing assessment of the constricted scientific paradigm - in a Kuhnian sense - of legal academia, see Pierre Schlag's essay on spam jurisprudence and air law, and Richard Posner's bemused but ultimately mild concurrence.)
The scholar referred to in the block quote is Saras Sarasvathy (pictured, left), who is at the Darden School of Business at the University of Virginia, and who established her chops working with Nobel Prize winner Herbert Simon (he of behavioral economics fame). I had the pleasure of chatting with Professor Sarasvathy for a few minutes when she was in Boston last December, and I was delighted to find a couple days ago that a site to which I subscribe, Big Think, had a series of online interviews with her. Enjoy!
Thursday, July 02, 2009
Complexity, Judgment, and the Subprime Crisis - The Hedgehog's View
At the end of April, Dave Hoffman and two of his colleagues at Temple, Jonathan Lipson and Peter Huang, organized a fascinating day-long colloquium on issues of complexity arising in the current financial crisis. Among other presentations, Barry Schwartz from Swarthmore gave a talk on "the paradox of choice" (i.e., more choice, or more complex choice, doesn't necessarily make consumers happier), and Joe Grundfest gave a luncheon keynote. One of the questions that kept occurring to me was the context of the complexity issue - what exactly were we trying to fix, if anything? My analogy was this: if law is a "science," and something about the financial crisis (whether complexity or something else) reflects a disease, then what is the relationship between what we know about the disease and the regulatory medicine we would want to prescribe? I liken financial boom-and-bust to bipolar disorder - is there a regulatory equivalent of lithium that we are assured will tamp down the peaks and valleys? And even if there is, do we want to prescribe it? Maybe we like the booms enough to bear the busts! To keep the analogy going, there's a good chance Tchaikovsky and Van Gogh were bipolar - would we have their art if they had been medicated?
More on the hedgehog below the fold.
One of my most treasured Suffolk colleagues has suggested that I am a hedgehog, in the sense of the Greek saying (appropriated by Isaiah Berlin) that the fox has many clever ideas, but the hedgehog has one big one. My big one (such as it is) is placing the canard "thinking like a lawyer" into the broader category of how people make sense of the world. (This comes, I think, from spending so much of my professional life as a lawyer not surrounded by other lawyers.) Nothing provokes this kind of reflection like great calamities, whether they are oceanic or financial tsunamis. In a nutshell, the question is how we assess what happened against two very different kinds of "oughts": (a) the normative "ought" of our sense of the way a just world should work, and (b) the descriptive "ought" that a scientist imagines when she comes up with a hypothesis of explanation that has yet to be borne out by experiment. My working thesis is that thinking like a lawyer - somewhere between advocacy and truth-seeking - gets this all jumbled up. What lawyers do mostly is look backwards and assess cause-and-effect in a particular way, and make implicit (and not necessary correct) assumptions about predicting the future from what happened in the past. To put it otherwise, my hedgehog concern deals with difficulties in forward-looking judgment, namely, the difference between looking backward and assessing causation as a matter of attributing blame, and understanding what is going on as a descriptive matter sufficient to make a good forward-looking decision in real time under conditions of significant uncertainty.
The result (how I spent my summer vacation) is The Epistemology of the Financial Crisis: Complexity, Causation, Law, and Judgment, in which I've argued this is mostly an epistemological crisis - a crisis of faith in science and algorithm as against the ongoing irreducibility of judgment, whether our own or those to whom we delegate it. In short, it's scary when we thought we had it nailed, and it turns out we don't know what we don't know. (I apologize for the use of the word "epistemology" but I like it, despite the warning of a good friend that it's a signal of a high "crap factor.") There's a little something for theorists of all kinds in there, including a critique of Michael Moore's new book Causation and Responsibility (the first extended treatment of causation in the law since Hart and Honore), Adrian Vermeule's Judging Under Uncertainty, and Richard Posner's A Failure of Capitalism.
Wednesday, July 01, 2009
The Vacuous Private Law of Homeowners' Associations (Below the Fold) After Vacuous Reflections About My Vacuous Life
Here we are, back for the fourth summer stint on PrawfsBlawg. It's hard to believe, when Dan first invited me to do this, in July, 2006, I was an outsider to the legal academy looking in (per Bob Uecker, "gosh, they're having fun in there.") Also, Twitter was unknown. Twitter has done a lot to focus my blogging, because, call me an old whatever, but I can't believe anybody gives two hoots about the mundane details of my life, whether by blog entry or tweet, something I wasn't considering back in 2006 while in a New Orleans carwash watching what looked like melted rainbow sherbet ooze all over my car. Steve Bainbridge seems to be able to get away with food and wine, but he seems to know what he's talking about. I try to maintain a connection to something legal (or, if not legal, funny).
If I were inclined to vacuous reflections about life, however, I would extol the pleasures of not of litigating, but of home brewing beer, a subject touched upon in these parts recently. My son, Matthew, and I are on our third batch of the summer, having invested $100 in the basic tools of the trade. Our first 43 bottles were an Irish stout recipe, which we named "Max and Annie's Jewish Stout," after our two dogs. We've since moved on to "Max and Annie's Michigan Porcupine Pale Ale" (a Sierra Nevada Pale Ale recipe), and "Charlevoix Steam Beer," which is presently fermenting in the crawl space where it is cool. Our plan is to lay down a carboy full of mead for a full year in a few weeks. This is a stretch but the legal connection is that I can't post the labels, because I am positive at least the second two violate a whole raft of copyright and trademark rights.
But enough of me. Let's go below the fold where YOU can hear me whine about the governance of homeowner's associations.
We spend the summers in Charlevoix, Michigan, where we bought a lot sixteen years ago, and built a house twelve years ago. In Michigan, there is something called a "site condominium," which is basically another way of imposing regulations in a subdivision of free-standing homes, and that's what we have. There are thirty-six lots, and common elements, which consist of two roads and landscaping, and a beach lot with a removable "Brock Dock" through which residents not on the lakeshore itself have access to the lake. You own your own lot and house in fee simple absolute, but the lot is established pursuant to a master condominium deed, which contains the property rules, and which incorporates a set of recorded bylaws, which establish the five-person Board of Directors (classified board - two and three seat classes, elected for two years) and the architectual review board, empower the collection of assessments for the maintenance of the common elements, and set use restrictions such as no short-term leasing, no open garage doors, and no boats, trailers, RVs, etc. left in the driveways.
If you want to experience the thrills of corporate governance in a microcosm, do as I have done and be a member of the condominium association Board of Directors for going on fifteen years. I would have resigned long ago, except that nobody is as anal about the record-keeping as I am, and so I've been the secretary (and now webmaster) for all these years. The lesson I take from the experience, as a legal theorist, is the tenuous (vacuous?) relationship among (a) the actual private law of the association as reflected in its governing documents, (b) what people think their actual rights are, and (c) how, when it comes to asserting and defending one's interests as between the law and the lore (or custom), a foolish consistency is the hobgoblin of little minds (see Prawfs guest blogger Brian Tamanaha on Law as a Means to an End). Take, for example, a matter of no small interest: the ability to see the lake from your living room if you have a house that is not on the lakeshore. There are local zoning rules that define setbacks, as well as an architectural review board within the condominium association, but it has been almost impossible to restrain the lakeshore residents from building setback to setback (i.e., very large homes on relatively small lots), so that the space between the houses is a mere sixty feet, filled with fast growing (and kind of ugly) white pines that the original developer planted at the lot lines to keep the place from looking like a landing strip. But there is no legal right anywhere in the documentation that says you have a property right in your view of the lake. The only way to control this is through community controls on landscaping (which doesn't help with the stuff that was here before) or an appreciation of the Prisoner's Dilemma we find ourselves living in, and the ensuing need to cooperate. Nevertheless, I find myself educating a neighbor every year on the fact that there is no legal right to a "view corridor" as it has come to be known. If there were, I would have already done something about the forest of scrubby white pines that block my view.
Then there is the question of the separation of ownership and management. We just issued a rule to the effect that there were to be no permanent firepits built on the beach. You can have fires, but you have to use a portable firepit (they exist), which means that you clean up after yourself, and there's no lingering hot embers for a kid to fall into. My publication of this rule prompted the following "Berle and Means" response from a neighbor (otherwise, a very nice person - beware the pitfalls of the inference one draws from e-mail): "Does the board act and make rules based on the good of the people that live here?"
Well, I could go on, but there is shameless self-promotion yet to be written.
Tuesday, June 09, 2009
The Chrysler Bailout: Who Wins with Failure?
David Zaring offers up his as-always savvy analysis on the Supreme Court's grant of a stay in the Chrysler bailout. Here are some quick thoughts:
- Fiat can pull out if the deal is not wrapped up by June 15. Would Fiat pull out? It's unclear what has changed. Perhaps the continuing toll of bankruptcy uncertainty would weaken Chrysler too much. Or perhaps Fiat's having buyer's remorse.
- It is assumed that the failure of this deal would be a blow to the Obama Administration. But who wins and who loses, at this point, if the deal blows up now? Ford and GM are better off without Chrysler around. The Chrysler creditors would lose their deal and fall back into the morass of a liquidation. This might chasten the GM creditors. Moreover, the Obama administration would be able to say it had tried its hardest to save Chrysler without incurring the expense and risk of actually bailing out the company. So perhaps the best thing for the administration would be a stay that gives Fiat an out. Fiat walks away, the deal blows up, and the Supreme Court then dismisses the case as moot, at least until the GM bankrupcty is resolved. And maybe those creditors get a bit more of a buyout -- just enough to persuade them not to appeal. This theory was influenced by Mickey Kaus, who wrote on Saturday: "You have to wonder if the Obama team knows the FIAT deal it promoted won't work, and arranged it simply as a way to delay the inevitable--while it actively avoided a merger that would foist Chrysler on GM, because GM does have at least a chance to survive after bankruptcy and doesn't need Chrysler's baggage. (Why make Chevy responsible for the Sebring?)"
The big losers if the deal blows up would be Chrysler workers and management. The shutdown of the Studebaker factory is widely regarded as a catalyst for the creation of ERISA. Might the collapse of Chrysler, and its devastating impact on its employee and retiree health care coverage, serve as a catalyst for national health care reform?
Monday, June 01, 2009
The Chrysler bankruptcy case & Indiana's "takings" lawsuit
Last night, Bankruptcy Judge Arthur Gonzales approved the section 363 sale of Chrysler to Fiat. This morning, Judge Gonzales refused to transfer Indiana's constitutional claim against the deal to federal district court. Here's a question for the prawfs interested in takings: Is there any merit to the Indiana pension funds' claim that, by ignoring the absolute priority of secured creditors, the bankruptcy court has "taken" those creditors' security interest without just compensation in violation of the Fifth Amendment?
The claim has inspired the usual outrage or applause from the usual suspects: George Will praises Indiana's lawsuit as plucky opposition to Obama's confiscatory Leviathan, and the Daily Kos praises the Chrysler deal as a bold move to save rust belt industry. But suppose that, just for the heck of it, one gave the ideological hand-waving a rest and instead analyzed the legal merits of Indiana's claim: is there anything to it?
For what it is worth (not much, as I am no bankruptcy scholar), my first instinct is to agree with David Zaring's analysis: Since 1937, takings-based objections to bankruptcy dispositions are generally doomed. And rightly so: After all, the essential assumption of bankruptcy is that creditors, secured or otherwise, are going to lose property. The question of how much, in what order of priority, is a matter of policy for the discretion of policy-makers, not judges.
But here is one reason to pause: In the usual post-1937 bankruptcy case in which creditors raise takings claims, the federal government itself is not one of the creditors, no? The bankruptcy disposition, therefore, is the result of an impartial referees' arbitrating between rival claimants. After TARP's investment in Chrysler, this is no longer the case (right?) Should the analysis, therefore, be different and more rigorous, when the feds themselves or their proxies budge ahead of other creditors?
The classic analysis of this distinction is Joseph Sax's old article, Takings and the Police Power, 74 Yale L. J. 36 (1964), in which Sax distinguishes between exercises of the police power that enhance the government's own entrepreneurial enterprises and exercise of the police power that impartially arbitrate between rival private parties. The former should be regarded with more skepticism than the latter, according to Sax.
I do not automatically endorse the analogy between regulatory takings of real property and claims that security interests have been taken: I have not given the question enough thought. Nor do I suggest that TARP automatically puts the feds in the position of an interested party or that the actual 363 disposition constitutes self-interested action by the feds (whatever that means). But I have an uneasy feeling that Zaring's analysis might be missing Sax's distinction. When the rest of the creditors are arguably bought off with TARP funds and when the feds themselves retain an equity interest in the firm that results from a section 363 sale, then there is a sense in which the takings claim becomes a bit more powerful to my mind. Given that the statutory merits of this section 363 seem a bit shaky, I'd be interested in hearing a more informed person explain to me whether and to what extent Indiana's taking claim is bunk.
Tuesday, April 28, 2009
Online Antitrust Symposium at Truth on the Market
The folks over at the Truth are having a three-day online symposium entitled: "Section 2 and the Section 2 Report: Perspectives and Evidence." Here's the relevant info:
The proceedings will begin on May 4 and continue officially through May 6. We’ve organized the symposium across the three days so that each day will have a different emphasis. The first day, Monday the 4th, we’ll discuss some introductory themes and set the context with some more-broadly-oriented perspectives on the Section 2 Report, including the enforcement perspective from inside the antitrust agencies and economists’ views, among others. The second day, Tuesday the 5th, we’ll devote to the general Section 2 standards debate. And we’ll finish up on Wednesday the 6th focusing on specific substantive areas, tracking the Section 2 Report and its substantive content in greater depth and detail.
The participants are: Alden Abbott, FTC; Tim Brennan, University of Maryland; Dan Crane, Cardozo/Michigan Law; David Evans, LECG/UCL/Chicago Law; Herbert Hovenkamp, Iowa Law; Keith Hylton, BU Law; Bruce Kobayashi, George Mason Law; William Kolasky, WilmerHale/former DAAG; Thom Lambert, Missouri Law/Truth on the Market; Tad Lipsky, Latham & Watkins/former DAAG; Geoffrey Manne, LECG/Lewis & Clark Law/Truth on the Market; Howard Marvel, Ohio State; Bill Page, Florida Law; Michael Salinger, BU/LECG/former Director, Bureau of Economics, FTC; and Josh Wright, George Mason Law/former Scholar-in-Residence, FTC/Truth on the Market.
It's a terrific group of participants -- congrats to Geoff and Josh on putting together a great event.
Tuesday, March 31, 2009
Lyondell Chemical Co. v. Ryan and Delaware's (Counter-)Cyclical Jurisprudence
Larry Cunningham has posted on the recent Lyondell Chemical Co. v. Ryan opinion from the Delaware Supreme Court. (The title of his post reminds me of this.) He calls the opinion "refreshingly lucid and terse" and states that "for now, Lyondell puts the notion of good faith in something of a coma. Not dead, but nary alive."
There has been lots of great commentary on the opinion: I'll crib from Larry and point you to Steve Bainbridge; Jeff Lipshaw; Gordon Smith; and Andrew Lund's paper on the subject. There's one angle that I haven't yet seen mentioned, however, and that's the counter-cyclical nature of the opinion.
There's a standard meme in corporate law that Delaware courts are worried about encroachment from federal law, and so their jurists are motivated to shape the law in accordance with the prevailing political winds. As the abstract for Mark Roe's Delaware's Competition explains:
Delaware's chief competitive pressure comes not from other states but from the federal government. When the issue is big, the federal government takes the issue or threatens to do so. Delaware players are conscious that if they mis-step, federal authorities could step in. These possibilities of ouster, threat, and consciousness have conditioned Delaware's behavior.
The Disney case is often held up as an example of this, as sketched (in simplified form) by this timeline:
1998 [pre-Enron]: Chancery Court dismisses claims
2000 [pre-Enron]: Supreme Court affirms as to most counts, but remands for dismissal without prejudice
2003 [post-Enron]: Chancery Court finds good faith claim has been stated and rejects motions to dismiss
2005 [post-post-Enron]: Chancery Court criticizes Eisner but finds no violation of good faith
2006 [post-post-Enron]: Supreme Court affirms
Of course, this simplification does no justice to the actual opinions and their complexities. But it is an illustration of the (cynical) explanation of Delaware's relationship with D.C.: Delaware judges do what they need to do to satisfy the feds but no more.
Recent cases from the Chancery Court have been somewhat in harmony with this thesis. In the AIG case, Vice Chancellor Strine called AIG a "criminal enterprise" (under the facts as alleged in the complaint) and allowed the case to move forward. In Citigroup, Chancellor Chandler dismissed the Caremark claims but did allow a excessive compensation-waste claim to go forward - a fairly unusual event. (But cf. Jay Brown's criticisms of Citigroup here.)
However, Lyondell seems like a pretty clear victory for the deregulatory side. It cuts back on the fiduciary duty of good faith in straightforward and dramatic terms, using adverbs like "completely" and "utterly" that provide little wiggle room. Moreover, this near-elimination of good faith was arguably unnecessary to the resolution of the case. (See Andrew Lund's comment here.) Given the regulatory mood in Washington and across the country, Lyondell seems to be radically out of step with the prevailing political winds.
So does this mean that the "federal competition" explanation of Delaware jurisprudence is wrong? Maybe it was right before but the equilibrium has changed? Or is this case just an exception?
Wednesday, March 25, 2009
Do Cities Have Any Role in Regulating Executive Comp?
A combination of recent headlines and Richard Schragger's recent piece "Mobile Capital, Local Economic Regulation and the Democratic City" (which suggests, among other things, that "[t]he new 'regulatory localism' challenges the proposition that industrial policy, redistribution, and other responses to global economic restructuring must be addressed at the national level") prompt me to wonder about the role of cities in economic regulation.
I'm sure the answer depends on a rigorous definition of "economic regulation," which I don't claim to offer here. So let me just raise a specific question I'm intrigued by: the role of the city in regulating executive compensation. Should it or can it have any role at all? At the very least, we can say that the interests of the different levels of government as to executive compensation may be different. The AIG bonus example plays out on the national stage (e.g., 90% taxation of the bonuses) and at the state level (the New York Daily Newssuggestively quotes Attorney General Andrew Cuomo as saying that "If a person returns the money, I don't believe there's a public interest in releasing their name."). At the city level, though, Mayor Bloomberg apparently warned that "[e]ven if you think that it's fair to take [the bonuses] away, just recognize that we're going to have to make up that tax gap, that reduction, by taxing the rest of us."
Tuesday, March 10, 2009
Will the "Systemic Risk Authority" be the new sheriff in town?
Proposals for regulatory consolidation are not new - our multiple financial regulators can be thought of as chaotic, redundant and burdensome or as an beneficial source of regulatory competition and an experimental laboratory. But Bernanke's speech to the Council on Foreign Relations today is potentially a bid to emerge as a new macro-regulator, a "systemic risk authority."
[B]ecause the goal of any systemic risk authority would be to have a broader view of the financial system, simply relying on existing structures likely would be insufficient. For example, a systemic risk authority would need broad authority to obtain information--through data collection and reports, or when necessary, examinations--from banks and key financial market participants, as well as from nonbank financial institutions that currently may not be subject to regular supervisory reporting requirements. A systemic risk authority likely would also need an appropriately calibrated ability to take measures to address identified systemic risks--in coordination with other supervisors, when possible, or independently, if necessary. The role of a systemic risk authority in setting standards for capital, liquidity, and risk-management practices for the financial sector also would need to be explored ....
Notice echoes of pre-financial-meltdown consolidation proposals in the Treasury's Blueprint for a Modernized Financial Regulatory Structure....
Tuesday, March 03, 2009
Shareholder Pandering and the End of the Economy
I just read this interesting paper by Larry Mitchell that seems particularly on point these days. As a former denizen of Wall Street (Morgan Stanley Public Finance & Chemical High Yield), I can report that just about everyone I worked with knew that the stock market created an irrational focus on the price of equity in the short term -- whining stockholders are the bane of every good business executive with a decent long-term business plan. But most of us assumed that was the price corporate America had to pay for all the equity that stockholders pumped into the market. They'd made their deal with the devil and, well, at least the devil paid pretty well. Right? Wrong.
With extensive historical data, Mitchell demonstrates that shareholders are actually bringing increasingly little to the table -- in fact, they haven't brough much for a long, long time. Here's a particularly nice graph from the paper:
Modern industry runs on debt, not equity. In fact, Mitchell argues, the decline of equity is one of major untold stories of the last century. If he's right -- and I'll believe him until someone shows me better data -- then this turns the standard model of modern markets on its head. Shareholder empowerment not only has major downsides, it has little or no upside, and the irrationality of our focus on equity is a lot worse than most of us imagined. The takeaway: shareholder empowerment actually hurts both business and the serious investor, all for the sake of short-term speculation. (As this is one of the few really good fights in corporate law, I'll be very curious to see how Bebchuck and other defenders of shareholder empowerment respond to this new data.)
Thursday, January 15, 2009
Down goes Geithner?
TaxProf has been all over the Geithner tax-payment story, which has morphed from a Zoe-Baird-esque household-help issue into a much bigger catastrophe. His failure to pay taxes from his IMF income seems more and more troubling as details come out. These revelations from Byron York seem particularly damning:
Documents released by the Senate Finance Committee strongly suggest that Geithner knew, or should have known, what he was doing when he did not pay self-employment taxes in 2001, 2002, 2003, and 2004. . . .
The IMF did not withhold state and federal income taxes or self-employment taxes — Social Security and Medicare — from its employees’ paychecks. But the IMF took great care to explain to those employees, in detail and frequently, what their tax responsibilities were. First, each employee was given the IMF Employee Tax Manual. Then, employees were given quarterly wage statements for the specific purpose of calculating taxes. Then, they were given year-end wage statements. And then, each IMF employee was required to file what was known as an Annual Tax Allowance Request. Geithner received all those documents.
. . .
At the end of the tax allowance form were the words, “I hereby certify that all the information contained herein is true to the best of my knowledge and belief and that I will pay the taxes for which I have received tax allowance payments from the Fund.” Geithner signed the form. He accepted the allowance payment. He didn’t pay the tax. For several years in a row.
. . .
In a conversation today with sources on Capitol Hill who are familiar with the situation, I asked, “Was Geithner made whole for tax payments that he didn’t make?”
“Yes,” one source answered. “He was getting the money. He was being paid a tax allowance to pay him for tax payments that he should have made but had not.”
As the New York Times opined: "As much as Mr. Obama and his team may wish it, however, the disclosures cannot be dismissed so easily, or papered over. The just-the-facts report of Mr. Geithner’s tax transgressions, compiled and released by the Senate Finance Committee, paints a picture of noncompliance that is considerably more disturbing than his supporters are acknowledging." Lest anyone forget, here is the organizational chart of Treasury -- notice the little agency on the lower left. (It's next to the Bureau of Engraving and Printing.)
Despite these problems, the Intrade market seems unfazed; when I last looked, Geithner shares were trading at around 93. Perhaps Geithner's special skills are enough to outweigh the obvious concerns about his tax compliance.
Sunday, January 11, 2009
The Difficulties of Law and Finance: An Update from Roberta Romano
In a 2005 article entitled After the Revolution in Corporate Law, Roberta Romano said that an economics Ph.D. was not the "best match" for business law scholarship. Romano argued that finance, not economics, was the future for corporate law scholarship, and that empirical work was more important than modeling. She wrote:
[T]he building blocks of the revolution in corporate law originate most prominently in modern finance, which (as hopefully is clear) is a specialized field of economics. As a consequence, there is a highly imperfect match between the body of knowledge imparted in an economics Ph.D. program and that which is critical for analyzing corporate law issues, and particularly for the direction in which the field has been moving, using quantitative methods.
To this end she discussed a new Yale program, combining a J.D. with an accelerated finance Ph.D. program, as a way for the next generation of corporate scholars to get that training. A brief blurb about the program can be found here.
This past Saturday, at a fascinating AALS Business Associations panel, Romano provided an update on the Yale program. Romano had been disappointed, she confessed, about participation in the program. While she had initially hoped for one or two students a year, it appeared that only one student would be graduating from the first few years of the program. Although three students had signed up, two had subsequently dropped out. Romano mentioned the difficulties of being a lone law student in a class of finance Ph.D students, many of whom had foreign training. The rigors of the math, together with the attraction of law school "extracurricular activities," had made the joint JD/Finance Ph.D less popular than expected.
Romano's comments added an intriguing subplot to the panel, which was on the potential for synergies between finance and corporate law. The finance folks on the panel lamented the failures of their models, while the law professors talked about the problems of regulating without reliable empirical findings. Bankruptcy and Madoff featured prominently. Despite the gloomy tone, however, the panelists remained upbeat about the potential for collaboration between the two disciplines. I'd love to hear thoughts from folks out there. After fall 2008, are we now in the post-post-revolution period?
Monday, November 03, 2008
SEIU & Election Politics
If you have a hankering for election-related content, here is a story you might have missed. It's a traditional story about union politicking for a particular candidate -- in this case, SEIU's work for Barack Obama. Some details from SEIU's website:
Through October 30, SEIU's members have:
- Knocked on 1,878,421 doors.
- Made 4,405,136 phone calls.
- Sent 2,562,689 pieces of mail.
- Registered 85,914 voters.
- Helped more 10,982 people vote early.
- Distributed 52,005 workplace flyers.
- Made workers' voices heard by investing $13 million in independent expenditure ads that have run more than 10,000 times
The website clains: "No single organization has done more than SEIU to make sure that Barack Obama is our next president." (Even the Democratic Party?)
It makes sense for SEIU to be making noise about its role in Obama's election. The union is hoping for support for the Employee Free Choice Act (EFCA), which would allow employees to join unions by signing cards rather than requiring a secret ballot. Politicos seem to think that the EFCA would be among the first pieces of legislation passed by an Obama administration and Democratic Congress. Perhaps because of this, EFCA opponents have ratcheted up their public campaign against it. (See George McGovern inveighing against it here.)
If you're interested in reading more about SEIU and union politics, I just have posted the final version of my paper, Mother Jones Meets Gordon Gekko: The Complicated Relationship between Labor and Private Equity (forthcoming Colorado Law Review). The paper discusses how SEIU's political influence is part of its overall bargaining strategy -- particularly in its recent dealings with private equity. One of the article's overall normative claims is that unions should be allowed to play politics like other businesses. The effect of this election on the EFCA's chances is solid proof, in my view, of the importance of politics to the business of unions.
Wednesday, October 29, 2008
"Run on the Bank"
A radio interview describing the creation of the FDIC has me thinking about runs on banks. (NPR interview with author Timothy Egan here.) In 1933, Roosevelt closed banks for a five-day "bank holiday" to slow panicked withdrawals. FDIC insurance was part of the response to bank closures and runs on banks. Apparently Roosevelt later said that, if there had been a widespread run, the insurance could not have covered all of the deposits. The (unsurprising?) lesson may be that public perception - even when unrealistic - is central to fixing our financial problems (or at least avoiding new ones).
Roosevelt and his aides seem to have recognized that investor confidence was key. In his first "fireside chat," in 1933, Roosevelt said that "[a]fter all, there is an element in the readjustment of our financial system more important than currency, more important than gold, and that is the confidence of the people." And, as one of his advisors put it: "We knew how much of banking depended upon make-believe or, stated more conservatively, the vital part that public confidence had in assuring solvency."
One more tidbit on "runs on the bank": the phrase - and probably the accompanying fear - has been around since the late 1600s. A 1697 text said that "Any jealousie or suspicion that they shall not have Money for such Bills on Demand, will occasion a general run." And the phrase pops up again over the years. My favorite is from Adam Smith, The Wealth of Nations: "When a run comes upon them, they sometimes endeavor to gain time by paying in sixpences." A practical solution. (More from the OED here.)
Tuesday, October 28, 2008
Who Are Investors?
In the context of possible new regulation in the financial markets, it's worth asking an old and fundamental question: who are the investors? The type of regulation we choose turns in part on the answer. Our current financial woes put pressure on this question, but so does the longer-term trend of institutionalization or "deretailization" of the US markets. In other words, while our system is rooted in protection of retail investors and much of the political rhetoric reflects this ("mom-and-pop" investors), institutions such as mutual funds, pension funds, etc. increasingly play a role.
My modest aim here is to point you to some "food for thought." First, identifying the investors comes up even in the most mundane of contexts. Take the SEC website. Featured at the top of the page these days is the headline "SEC Protecting Investors, Markets During Credit Crisis" and a link to the "SEC Actions During Credit Crisis." What audience does this target? Sophisticated investors don't need to read it. I suspect Congress has heard it in other forms. The press? Do retail investors really read it or care?
Second, Donald Langevoort has a paper called The SEC, Retail Investors, and the Institutionalization of the Securities Market recently posted to SSRN. In a passage that is almost an aside, he complicates the debate over how institutionalization should influence regulatory choices:
I am convinced that part of the motivation for the substantive and procedural disclosure requirements of US securities regulation increasingly is disconnected from shareholder or investor welfare per se, and instead relates to the desire to impose norms that we associate with public governmental responsibility - accountability, transparency, openness and deliberation - to institutions that have comparable power and impact on society. It is a familiar point that many large corporations have more economic power than many counties and cities, perhaps even a handful of states.
Monday, October 27, 2008
Greg Mankiw threatens work stoppage if Obama is elected
From Greg Mankiw's blog:
Here is a question that you may have been thinking about: How do the different candidates' tax plans affect Greg Mankiw's incentive to work?
* * *
Let me start with my personal situation: I am a pretty lucky guy. I have a comfortable, upper middle class life style that includes one house, two cars, three kids, a wife, and a dog. I am fortunate enough that I don't have trouble keeping that going. I am also fortunate enough that I don't crave much more than I already have. I don't particularly want to own multiple houses or drive a Ferrari or wear Armani suits. You might say that I am close to being sated.
On a regular basis, I am offered opportunities to make some extra money. It could be giving a talk, writing an article [ed. note - !], editing a journal, and so on. What incentive is there to put forward that extra work effort?
To a large extent, the beneficiaries of that extra effort are my kids. My lifestyle is, as a first approximation, invariant to my income. But if I make an extra few dollars today, I will leave more to my kids when I move on. I won't leave them enough so they can lead lives of leisure, but perhaps I will leave them enough so they won't have to struggle too much to afford a downpayment on their houses or to send their own kids to college.
Do you notice a rather big part of Mankiw's income that isn't discussed here? Isn't he a professor somewhere? I imagine if the H decided to cut all professors' income by half or decided to fire the good professor, he would find that his "lifestyle" is perhaps not so " invariant to [his] income." But that couldn't happen, could it? He's tenured at a very wealthy university. The chances that this economic downturn will affect him directly are pretty slim. Nice!
Anyway, he continues.
Let me try to put each tax plan into a single number. Let's suppose Greg Mankiw takes on an incremental job today and earns a dollar. How much, as a result, will he leave his kids in T years?
The answer depends on four tax rates. First, I pay the combined income and payroll tax on the dollar earned. Second, I pay the corporate tax rate while the money is invested in a firm. Third, I pay the dividend and capital gains rate as I receive that return. And fourth, I pay the estate tax when I leave what has accumulated to my kids.
Notice how he slips the corporate tax rate in there, because he assumes that he will invest all of his children's future money in stocks. T-bills too safe, huh?
Let t1 be the combined income and payroll tax rate, t2 be the corporate tax rate, t3 be the dividend and capital gains tax rate, and t4 be the estate tax rate. And let r be the before-tax rate of return on corporate capital. Then one dollar I earn today will yield my kids:
I guess he assumes that he'll do no estate planning.
For my illustrative calculations, let me take r to be 10 percent and my remaining life expectancy T to be 35 years.
If there were no taxes, so t1=t2=t3=t4=0, then $1 earned today would yield my kids $28. That is simply the miracle of compounding.
Ah, yes. They should really get the $28. Anything less is socialism.
Under the McCain plan, t1=.35, t2=.25, t3=.15, and t4=.15. In this case, a dollar earned today yields my kids $4.81. That is, even under the low-tax McCain plan, my incentive to work is cut by 83 percent compared to the situation without taxes.
Under the Obama plan, t1=.43, t2=.35, t3=.2, and t4=.45. In this case, a dollar earned today yields my kids $1.85. That is, Obama's proposed tax hikes reduce my incentive to work by 62 percent compared to the McCain plan and by 93 percent compared to the no-tax scenario. In a sense, putting the various pieces of the tax system together, I would be facing a marginal tax rate of 93 percent.
The bottom line: If you are one of those people out there trying to induce me to do some work for you, there is a good chance I will turn you down. And the likelihood will go up after President Obama puts his tax plan in place. I expect to spend more time playing with my kids. They will be poorer when they grow up, but perhaps they will have a few more happy memories.
Is this tongue-in-cheek? I hope so. The fact that he's writing this on a blog that has no advertising only increases the sense of irony. (Perhaps his blog header should be: "I'M BLOGGING AWAY MY CHILDREN'S INHERITANCE.") But if this is all a joke, apparently Instapundit isn't in on it.
Thursday, October 23, 2008
Jeff Lipshaw has a great post on the value of lawyers in business deals. He posits (in part) that lawyers are not making the pie bigger in many cases, and that if lawyers always made the pie bigger then we would see them used more often on smaller deals. He sees a different and interesting reason for lawyers:
My equally non-testable theory is that lawyers sometimes add value to deals, sometimes subtract value, and appear most of the time during the deal for the same reason neckties do: it's part of the ritual. There is no intrinsic reason they have to be there. Lawyers, like neckties, have value, not because they necessarily make the pie bigger, any more than neckties make the pies bigger, but because somebody values the lawyer enough to pay more for her to be there than it cost for her to get there (marginally speaking, of course).
I think his theory has legs, perhaps in big business deals where he has experience. For example, he notes that representations and warranties often expire at closing, significantly limiting their value in comparison with the lawyering cost of negotiating those clauses.
That said, I think the cockfighting necktie theory goes a bit far - lawyers can add real value in ways I discuss after the jump.
I'll admit that I have very little experience on large public company deals, though I have worked on a few. Most of my experience comes from working on smaller deals (big company down to individual) and also litigating such deals when they go bad. And that, I think, is where lawyers can add the most value - foreseeing how deals might sour.
Two specific points:
First, good lawyers have a wealth of experience on a variety of transactions. They know contract language that worked and didn't work, they know business terms that worked and didn't work, they know representations and warranties that are likely to give problems, they can recognize assets that need examination (for example, in intellectual property). Even the most experience business person likely works on a fraction of the number of transactions that a lawyer will work on, and certainly not with the same variety of transactions, parties, and industries. When good lawyers quibble over seemingly small terms, it is because they have seen the small terms turn into large future costs.
This leads to second, just because small deals didn't involve lawyers doesn't mean that a lawyer wouldn't have added value. Having worked in litigation and transactions, I can say with a certainty that a large percentage of business disputes I saw in litigation could have been avoided if a good lawyer had been involved in the transaction. It is true that most deals don't sour, but enough do that I wouldn't write off the importance of a quick contract review to minimize risk if things go bad. I think that lawyers are often not used not because they don't bring value, but because a) potential clients don't know they won't bring value, b) potential clients have not had good lawyers in the past, or c) attorney access is limited due to cash, status, retainer, etc.
Note that I use the proviso "good lawyers." There are plenty of bad lawyers, who negotiate just for the sake of minor victories, who use cookie cutter forms without modification rather than understanding why provisions are needed, and who don't recognize when the cost of the negotiation is exceeding the value of the requested change. I would definitely agree that these lawyers are not making the pie bigger or decreasing transactions costs. Perhaps there are more bad lawyers than good, and maybe that's the difference between fact and theory.
Monday, October 13, 2008
Macey on Corporate Governance
Jonathan Macey's new book Corporate Governance: Promises Kept, Promises Broken arrives this week. It is available now on Amazon. Here is the publisher's blurb.
In the wake of the Enron meltdown and other corporate scandals, the United States has increasingly relied on Securities and Exchange Commission oversight and the Sarbanes-Oxley Act, which set tougher rules for boards, management, and public accounting firms to protect the interests of shareholders. Such reliance is badly misplaced. In Corporate Governance, Jonathan Macey argues that less government regulation--not more--is what's needed to ensure that managers of public companies keep their promises to investors.
Macey tells how heightened government oversight has put a stranglehold on what is the best protection against malfeasance by self-serving management: the market itself. Corporate governance, he shows, is about keeping promises to shareholders; failure to do so results in diminished investor confidence, which leads to capital flight and other dire economic consequences. Macey explains the relationship between corporate governance and the various market and nonmarket institutions and mechanisms used to control public corporations; he discusses how nonmarket corporate governance devices such as boards and whistle-blowers are highly susceptible to being co-opted by management and are generally guided more by self-interest and personal greed than by investor interests. In contrast, market-driven mechanisms such as trading and takeovers represent more reliable solutions to the problem of corporate governance. Inefficient regulations are increasingly hampering these important and truly effective corporate controls. Macey examines a variety of possible means of corporate governance, including shareholder voting, hedge funds, and private equity funds.
Corporate Governance reveals why the market is the best guardian of shareholder interests.
Wednesday, October 08, 2008
Reports of the Death of Big Government Have Been Greatly Exaggerated
Thursday, October 02, 2008
Why We Need the Bailout
We, as a nation, are facing a critical choice: Should we give Wall Street something in the neighborhood of a trillion dollars so that it can continue doing the outstanding job it’s doing? Or should we let Wall Street collapse and see if the rest of America can get by without all those "financial services" that Wall Street provides?
To help you, and all Americans, understand why we need this bailout package – and we urgently do – I’ve decided to answer all your questions. Right here, right now.
Why should we give this money to Wall Street? I mean, if the economy needs to be spurred by an injection of billions of dollars, why not give it to us?
That’s a funny question. You already have it! Ha ha! What sense would it make to take money from taxpayers and give it straight back to taxpayers? That’s just silly. The whole point is to take the money from taxpayers and give it to someone else – preferably some hedge-fund manager who doesn’t pay taxes at all thanks to his tax-sheltered yacht parked off Antigua. I know it’s hard for you to understand, but the fact is that, after all is said and done, the money actually will come back to you, the taxpayer. How? As a result of rescuing Wall Street, banks and yacht captains will be able to extend loans to people on Main Street. That way, Main Street businesses will be able to make the investments that are needed to keep the economy going.
If the problem is that people on Main Street need loans, then why don't we just loan the money directly to them, instead of giving away it to the people on Wall Street?
You need to look at the broader picture. Farmers need to buy seed for their fields, ranchers need to buy feed for their cattle, and bankers need to buy drinks for their congressmen. Everybody plays their part. That’s how the economy works.
I completely fail to understand why it helps anything to buy bad loans from banks. If banks made bad loans, shouldn’t the banks suffer the losses?
The problem, with all due respect, is that you simply don’t understand enough about economics and finance to form your own judgment about these sorts of things. Don’t forget that officials in the Bush administration have carefully thought this through. Do you think you could have done a better job evaluating pre-war intelligence from Iraq? Or deciding exactly how many days to wait before sending help to New Orleans after Hurricane Katrina? I’m sure you don’t.
More importantly, you need to realize that this situation is not the fault of the bankers. Everybody thinks they can Monday-morning quarterback the whole situation, but that’s unfair. It’s easy now to say, “Well, you shouldn’t have accepted loan applications filled out in crayon.” Or, “It was a mistake to give five mortgages to a single 19-year-old who listed his employment as ‘watching Flip That House! on cable tv.’” The fact is, it’s not productive to look backward. We need to reject the impulse to lay blame, and we need, instead, to figure out how we are going to solve this crisis.
Hmmm. Let me see. Um. Oh! I’ve got it! How about we keep our money and just see how things go?
That may seem like a tempting course. But we simply cannot wait. As the Bush administration has explained, without the bailout, Wall Street will collapse, and the misery will quickly spread to Main Street.
How? How exactly will the misery spread from Wall Street to Main Street?
Think about it this way: If Wall Street collapses, tens of thousands of investment bankers, stock brokers, and other financial-industry professionals will be out of a job. While they will retain their education, skills, and knowledge, the companies they work for will no longer be able to pay their salaries. At that point they will be forced to leave Wall Street and come to your town looking for work.
Do you really want them to set up a hedge fund inside your local Wal-Mart between the optical center and the portrait studio? I didn’t think so. You wouldn’t be able to get from the self-checkout to the greeter table without some pinstriped MBA trying to sell you a collateralized derivative-backed forward-swap debenture. And believe me, you don’t want that. It’s worth however many hundreds of billions we have to pay to keep these people in lower Manhattan, where they just sell these things to each other.
Okay, you’ve convinced me. How can I help?
Please, support the bailout by writing or calling your congressional representatives as soon as you read this. Do it first thing in the morning. If you wait until 3 p.m. in the afternoon, they’ll probably have already left to go drinking with the bankers.
[cross-posted on The Backbencher]
Wednesday, September 24, 2008
"Bad Apples" and the Financial Meltdown - Does the SEC Have a Role Absent Fraud?
Financial meltdowns often seem to lead media and regulators to look for illegal activity, which is why I was not surprised to read that the FBI is investigating Fannie Mae, Freddie Mac, Lehman and AIG for potential fraud. (New York Times story here). This focus on illegal activity has happened elsewhere - in the wake of rising gas prices, for instance, the CFTC investigated price manipulation and fraud. And here an anonymous government official told the Times that it was "logical to assume" that these companies would be investigated, given the questions surrounding their collapse.
Two thoughts on this. First, the danger of focusing on "bad apples" is that it excuses us from rethinking the system and potential regulation. To date, the focus seems to have been on systemic problems and on greed, without linking that to illegal behavior. Let's not get distracted by the FBI.
Second, what are the roles of the various government actors? The FBI's actions seem like a reasonable expression of its responsibilities, although I'm willing to be told differently. But where is the SEC? In the context of the recent collapses and bailouts, the SEC's announcement of a "sweeping investigation ... into possible market manipulation in the securities of certain financial institutions" seems besides the point. As David Zaring points out in excellent posts here and here, the SEC is MIA. Does this mark a shift from looking to lawyers for expertise to looking to economists? Is the SEC like the FBI in that prosecution is its main tool? The SEC has been examining and reporting on credit rating agencies, which could be a hook for SEC action. Or maybe just the basis for another critique....
Wednesday, September 17, 2008
Hey You! Yes, You. You own AIG!
Congratulations! You are now a proud owner of AIG stock. You might want to start learning more about your investment. Here's AIG's website. Here's the Yahoo financial page; hey, it looks like the stock is starting to go back up! You also might want to learn a little something about credit default swaps; here's a brief primer (including economic models!).
You say you wanted to avoid equity investments in this unsettled time? Well, sorry -- the Fed has purchased a 79.9% stake in the insurer on your behalf. Trust us -- it's for your own good.
Too Big to Be Illegal?
David Zaring, the legal blogosphere's expert on the Fed, has been all over the developments in the financial markets of the last few days. His latest post on the AIG bailout/takeover/bridge loan is a must read. In questioning the legality of the discount-window-loan-for-equity deal, he writes:
There's really no statutory authority for the AIG takeover (the Fed and Paulson went to the Hill, and got nothing, not that they possibly could have in a couple of Tuesday evening hours). I won't bother noting that the DC Circuit, were it to sit in judgment on whether the Fed could buy the world's largest insurer, would undoubtedly conclude that the plain language of its governing statute (which is to make emergency loans, not require takeovers in exchange) would not permit the takeover under Chevron USA v. NRDC.
So is there any legal rationale for the Fed's actions? Well, he tries: "emergencies are emergencies, and when that happens the rules go out the window, and hopefully regular elections mean that the officials the people trust are dealing with the emergency. Abraham Lincoln adopted that reasoning, and he won the Civil War. " Umm, so we're saying that the Fed's bailout is the equivalent of the suspension of habeas corpus?
Meanwhile, on CNBC John Snow is comparing the U.S. economy to New England quarterback Tom Brady. He also says "we" were "too loose" with lending, saying "We forgot to ask the fundamental question: How will we get repaid?" Indeed. Let's hope the Fed didn't forget to ask that question.
Monday, September 15, 2008
Neighborhood Shocked as Feds Let Family Slip Into Bankrupcty
The neighborhood of Shady Groves was shocked this morning when it learned that the Lemon family was going to slip into bankruptcy based on massive mortgage debt. Although the Lemons' financial troubles were well known throughout the neighborhood, the community expected the Federal Reserve to step in to save the family with last-minute financing. Instead, the family will now be forced to declare bankrupcty and will likely lose their home.
"We all figured they were too big to fail," said Helga Humphrey, who lives next door to the Lemons. "They are the only four-bedroom house on this block. I can't believe Bernanke let this happen."
The community was particularly surprised that the Fed failed to step in after it had helped save the home of the Smith family just a few months ago. In March, the Fed provided an emergency loan to the Smiths and helped them restructure their mortgage by guaranteeing their debt. Ultimately, the Smiths were forced to move from their neighborhood, but they avoided bankruptcy.
However, Fed watchers are not surprised by the Reserve's tougher stance. Analysts predicted that the Fed did not want the Smith bailout to be seen as a precedent. President George W. Bush has also signaled that the government would not continued to bail out Shady Groves residents, saying only that "we are working to reduce disruptions and minimize the impact of the Lemons' difficulties on the rest of Shady Groves."
This tough talk did not sit well with Shady Groves residents. "It's clear we're one step away from a financial meltdown," said Ariel Hamer, a neighbor of the Smiths. "Can't they see that we need emergency funding to prevent a global crisis?"
The news for Shady Groves was not all bad, however. The Fed did announce that it would be opening its discount window to Shady Grove homeowners. Many are looking forward to shoring up their financial positions, especially in light of their adjustable-rate mortgages. "You know, I'm thinking of getting an emergency loan to help with that kitchen addition we've been considering," said J.P. Grable. "I think it will really help the neighborhood's confidence to see new construction taking place in this economic climate."
Thursday, September 11, 2008
Efficient Capital Markets -- Now Automated for Your Convenience
The WSJ has a fascinating follow-up to the story about the United Airlines phantom bankruptcy (discussed here). It seems that the 2002 Sun-Sentinel story that resurfaced might not have fooled humans, but rather automated search robots that troll for stock information. As the WSJ reported:
The damage was exacerbated by the growing use on Wall Street of automated programs that trigger stock trades without any human interaction. The so-called algorithmic trading mechanisms, which buy and sell stocks based on news headlines and earnings data, were responsible for roughly a quarter of New York Stock Exchange trades in the last week of August.
From a legal perspective, this raises all sorts of questions about causation. The Sun-Sentinel story could be characterized as misleading, since it did not have a date on it and arguably implied the bankruptcy discussions were taking place now. Is it a misrepresentation if the story was literally untrue, but any human would have picked up on the error? More important, perhaps, are the ramifications for market theory. If 25% of NYSE trades are triggered by the findings of computer programs, are the markets becoming more efficient or less?
HT: Sam Blumoff
Monday, September 08, 2008
Efficient Capital Markets?
From Reuters (via Yahoo):
A nearly 6-year-old news story on the 2002 bankruptcy filing of UAL Corp (UAUA.O) resurfaced on the Internet on Monday, clobbering the airline's shares briefly as some traders mistook the report as current and plausible news. . . .
UAL shares fell 76 percent to $3 after the article was posted on the Bloomberg financial news service. The magnitude of the decline may underscore the lack of confidence investors have in UAL and the troubled airline industry in general.
Apparently, the article appeared on the Florida Sun-Sentinel web page and was then posted on Bloomberg by investment advisory firm Income Securities Advisors. So which of these entities might be sued: the Sun-Sentinel, Bloomberg, ISA, all of the above, or none of the above?
And what does this say about efficient markets? Are investors really that quick to jump on a Bloomberg report?
One additional angle: the Sun-Sentinel has not yet determined why the article appeared, leading the ISA president to opine: "It's very suspicious."
Tuesday, September 02, 2008
Who "owns" airport access?
The brawl among administrative agencies over who controls valuable airport access continues. (See my prior post about Auctioning Airport Slots here .) Part of the story's attraction is that it pits local/regional authorities against federal ones - the Port Authority of New York and New Jersey against the Federal Aviation Administration.
The latest moves include the FAA's announcement that slots at Newark Airport will be auctioned on September 3 - tomorrow - with bids accepted immediately. The Port Authority has moved to intervene in an existing suit filed against the FAA to stop the auction. It argues that the FAA lacks congressional authority and that it started but didn't complete a rulemaking process proposing slot auctions. The FAA seems to be relying on procurement statutes and regs that allow it to lease property. But whose property?
Tuesday, August 26, 2008
Why are non-profits, well, not for profit?
I've started a few blog posts on non-profits and politics, but it's hard to get far into that swamp before you end up asking the question, "Hey, what's the point of having these non-profits around, anyway?" So maybe it makes more sense to start at that end. The classic economic account, per Henry Hansmann, is that some firms must find a device for credibly signaling that they will not shirk. For example, since no one can tell easily whether health care is of high or low quality, customers will be reluctant to pay for it unless they have some guarantee the hospital won't cut corners in order to maximize revenues. So non-profit status is a commitment device for providers of credence goods. Since the pledge makes it hard to raise capital, these goods can only be provided if they come with a subsidy.
Recently, Malani and Posner have cast some doubt on Hansmann's story by pointing out that many non-profits seem uninterested in advertising their non-profit status. They then leverage this insight into a claim that the subsidy for charitable works should be open to for-profit firms. One could quibble with Malani & Posner's premise here. For example, their big example is hospitals, but it may be that hospitals were overwhelmingly non-profit for so long that customers now assume they are for-profit, or that hospitals choose names, like "City Hospital" or "University Hospital" or "St. Jude's" that themselves signal a commitment to health care over profit.
In any event, there are a couple of other strong economic justifications for the non-profit sector, and I think they both demand that subsidy recipients be non-profits. Neither would be undermined by the Posner/Malani claim that non-profits do not signal their status. Both are, like Hansmann, market failure stories. The first is a coordination problem.
What do I mean, coordination problem? Well, as Acemoglu et al. point out in their neat LEO piece from last year, "Incentives in Markets, Firms, and Governments," there are times that a firm would actually prefer that the incentives it offers its employees be low-powered -- that is, produce only weak motivation. Their key example is the Freakonomics tale of teacher testing -- give teachers strong reasons to improve test scores, and they teach to the test or cheat. This "bad" effort in response to incentives may crowd out or swamp any beneficial effects from increasing "good" effort.
Here's the problem (as I see it; Acemoglu et al. are a little sketchy on this part). It's hard for a firm acting alone to offer only low-powered incentives. If my rivals can offer a share of profits, I'm likely to be outbid for the best talent; high performers will want to get large rewards for doing better than others, so that my low-powered compensation scheme selects for workers who see themselves as less able. In order for anyone in the industry to offer low-powered incentives, they all have to commit to that compensation scheme.
The U.S. scheme for subsidizing and regulating the non-profit sector could be a way of getting to that result: a whole industry committed to low-powered (e.g., not profit-based) compensation. And, as it turns out, the sectors where this tactic is necessary look a lot like Hansmann's description of what should be a non-profit, because a key component of the "bad" incentives dilemma is that we're trying to produce goods where the quality is hard to measure, so we have to use imperfect incentive schemes.
Is this making sense to anyone so far?
Friday, August 22, 2008
PCAOB is constitutional
Thursday, August 21, 2008
Boilerplate in Law Enforcement Contracts (Part Two)
I want to follow up on my last post on boilerplate by suggesting that boilerplate in law enforcement may function as an alternative to rulemaking and as a way to avoid more formal processes.
Below are the two SEC settlement provisions that first sparked my interest. Here's the problem these provisions address: since 2002, money penalties collected by the SEC can be distributed to injured investors in the form of "Fair Funds," raising the possibility that the money will be treated as damages rather than civil fines. The category matters because it affects rules about offsetting against private damages, how the money is taxed, whether claimants to the fund have a say in distribution, etc. In other words, there's real money at stake.
The SEC responded through recurring provisions in settlement agreements, including:
“Regardless of whether any such Fair Fund distribution has been made, amounts ordered to be paid as a civil penalty ... shall be treated as a penalty paid to the government for all purposes, including all tax purposes.”
“To preserve the deterrent effect of the civil penalty, Defendant shall not ... argue [in any related civil action] that he is entitled to ... offset or reduction of such compensatory damages award by the amount of any part of Defendant's payment of a civil penalty in this action.”
On the one hand, these seem perfectly sensible. They protect the deterrent effect of the penalties by preventing deduction and offset and they anticipate issues that are bound to come up. Moreover, using these terms is fast and flexible. After all, boilerplate can be abandoned in future agreements if the situation or policy changes. On the other hand, these provisions make rulemaking unnecessary or at least less pressing, so using boilerplate may be a way to avoid the contention inherent in more formal processes. In terms of content, it also seems odd to me that the SEC can determine tax treatment, although tax scholars may know better.
Tuesday, August 12, 2008
Executive Compensation and the NFL
In a story that mixes sports, tax, non-profits, agencies, executive compensation, and questions about federalism, the New York Times reports today that the NFL is lobbying Congress for an exemption from a new IRS requirement that salaries over $150,000 be publicly disclosed. This requirement is part of a larger move to apply Sarbanes-Oxley-type corporate governance measures to the non-profit sector, raising questions about the purposes of disclosure in the two contexts and whom the non-profit serves. (Dana Brakman Reiser and others have written in this area.)
The IRS requirements about executive compensation likely come in for some of the same critiques as the increased SEC requirements on the for-profit side, including:
- That disclosure has the perverse effect of escalating salaries as employees use the available information to negotiate salary and raises.
- That executive compensation is not just a salary figure. In the for-profit world, at least, and in the high-profile Richard Grasso/NYSE non-profit case, much of the "compensation" comes from complex formulas of retirement income. So it matters how these figures are disclosed and what counts as compensation.
- And, more generally, that these rules federalize corporate governance, traditionally the domain of states, moving corporate governance to the SEC (for-profit) and IRS (non-profit).
So far, it looks like the NFL has argued that it's a trade association rather than a charity. The NFL's lobbying memo apparently says that "We believe that people who need to know about salaries paid to N.F.L. staff are the owners, who already can access that information. No valid purpose is served to supply the same information to the general public.” True?
Thursday, August 07, 2008
Public Agencies and High Stakes ($7 Billion) Investor Compensation
The New York Times reports today that Citigroup is on the brink of settling claims that it misled clients about investments in auction-rate securities. According to the Times, the settlement is with state and federal regulators and includes a buy-back of more than $7 billion of these securities from individual investors. How to handle institutional investors is apparently still up in the air or at least has not been leaked/reported. The settlement also includes civil fines: reportedly a $100 million fine to the New York attorney general and $50 million each to twelve state regulators, led by the Texas State Securities Board.
This strikes me as a good example of a growing role of public agencies in investor compensation (here through the buyback and possibly the fines) that I pointed to in my article Fair Funds and the Compensation Conundrum. There I introduced the concept of "public class counsel" - the public counterpart to the private attorney general - to describe public actors concerned with compensation as well as deterrence. My focus was on the SEC's role in investor compensation, which has intensified in recent years as the Sarbanes-Oxley "Fair Fund" provision allows it to distribute money penalties to injured investors. Whereas this Citigroup settlement does not involve an SEC penalty - according to the Times, the SEC participated but any SEC penalty is on hold pending the agency's own investigation - it does provide a good example of public class counsel at work. This in turn suggests that, as the story develops, we should keep our eyes not just on the interesting consortium of regulators negotiating the settlement, but also on who gets the penalty money down the line.
Tuesday, August 05, 2008
Auctioning Airport Access
Anyone who has flown into a New York airport knows that getting stuck in a traffic jam is not just a problem for ground transportation. Moreover, the ripple effects of New York delays make them a national concern. In response, the Department of Transportation has proposed auctioning slots for landing and take-off at some of the country's busiest airports, as a recent New York Times article reports. Port Authority, the owner and operator of the airports, just made a proposal to block these auctions by excluding airlines that use an auctioned slot.
I'm intrigued by this story in part because auctions seem to be touted as the free market solution to sometimes intractable problems. I wonder if the romance with auctions sometimes masks thornier issues of allocation and, in this case, agency power. As I suggested in my post last week, "Markets for Space in Law School Classes", sometimes auctions are just one of several possible market solutions or even an alternative to an existing market. In the NYU law students case, students generated an informal market in classroom slots. The reason to replace it with an auction system was not because the auction was the only market solution. Instead, it was likely because of concerns with fair access and a law school's policing of student activity. In the airline case, some market in slots may already exist: the Port Authority talks about slots that airlines acquire from each other by "sale, trade, lease or transfer transaction." So the question is not what is the one market solution. The big underlying question may simply be who gets the money.
It's also worth keeping an eye out for litigation, which will likely raise messy questions about the relative powers of these agencies. The list of players (and potential litigants) is large, and includes the airline carriers, the Port Authority of New York and New Jersey, Congress, the U.S. Department of Transportation and the Federal Aviation Administration. Some directions for litigation are suggested by the Port Authority's notice of proposed action, which sometimes reads like a legal brief. It considers the auction plan illegal absent congressional authority and claims "proprietary right and responsibility to allocate gate and terminal facilities." The Senate has also stepped in, with a provision of the transportation appropriations bill that would ban slot auctions. Keep tuned.
Monday, August 04, 2008
Why tax entities?
Over at Conglomerate this week, they're discussing Heather Field's fine and ambitious new paper, "Checking in on Check the Box." One of the many tough questions Heather takes on is whether there should be a separate layer of tax for entities -- that is, whether we should tax corporations at all. (In contrast, partnerships and certain small corporations are generally not taxed directly -- their equity holders pay tax as individuals on their share of profits). Corporate tax is complicated, as the intricacy of Heather's other arguments shows, and most economists would tell you the corporate tax inefficiently influences business decisions. So why bother? It's hard to improve on the work Reuven Avi-Yonah has done on this, but let me throw out a couple of other possibilities.
(Ok, this is tax greek central, but you'll find it strangely interesting, I promise. Go ahead and click for more...)
One reason I see is precisely to influence business decisions. If, as seems likely, there's slack in shareholder control over managers, the managers won't be fully concerned with individual-level taxes. This suggests that, if we want to use tax as a corporate regulatory tool with maximal effectiveness, we need a corporate tax. For example, one might think of the entire regime of the federal law of nonprofit organizations as a corporate regulatory tool that can exist only because of the threat of a corporate tax for noncompliance. It's possible that the welfare gains from using tax as market-failure corrective, rather than the second-best regulatory regime exceed the welfare losses of the corporate tax.
Next, and sticking with efficiency, consider corporate-form neutrality. (This point is inspired by Chris Sanchirico's work on "carried interest"). Our tax system doesn't count as income goods and services that a person -- or an entity -- provides to herself or itself. If Beyonce sings in the shower, she doesn't have to pay tax on the price of a front-row ticket. When integrated firms exchange information, pass a product along from factory to retailer, or do their own books, they (generally speaking) don't report any of that value as income. The value does get taxed later, as corporate revenue, but revenue gains often arise long after the value was first generated. This means there is a tax advantage -- the time value of this implicit income -- in integrating the function, rather than contracting with a third part. Tax therefore may distort the basic Coasian decision whether to contract or incorporate. The corporate tax should, at a minimum, be set at a level that would leave firms tax-indifferent between the two choices.
But, as Larry Solum would say, read Field! (Also, I admit, this post wasn't strangely interesting. But was the Beyonce example at least a little funny? Funny for tax?)
Sunday, August 03, 2008
Corporate charter competition through the mirror
Why don't non-profit firms reincorporate in other states? We know, of course, that states compete to offer the most enticing set of corporate law rules (along with fees for incorporating) to for-profit firms, who can "charter" in any state. There's a long-standing debate about what drives the competition -- is it market pressure for efficient rules, producing a "race to the top" for the best state laws, or something else, such as self-serving managers? I tend to agree with Bebchuk and others that the second story makes more sense, given available evidence.
But how can we reconcile this result with the fact that (as OSU's Garry Jenkins described last year) non-profit firms do not appear to shop around for favorable state laws? The efficient market hypothesis looks like a much better description of the non-profit sector. After all, non-profit managers can be just as self-serving as managers in for-profit firms. Unless there's something a lot different about the non-profit sector we're overlooking, it seems like the absence of charter competition undermines the managerial rents story. Plus, n/p's aren't as subject to market pressures, so the absence of competition in that sector is consistent with the efficiency theory. Of course, there are lots of other things that are unique to the n/p sector that could explain the difference. More after the jump...
1. The supply side. Maybe states don't bother producing attractive n/p law because, by definition, they cannot extract tax from the tax-exempt sector. I'm not sure I buy this. There's nothing that requires states to exempt n/p's from all taxes (and, for instance, lots of n/p's pay sales tax, fees, and the like). If state law can add to firm value, why wouldn't a state try to get some of that value back? But maybe, given the small revenues of many n/ps, the added value is small, so that the likely revenues would be smaller than the costs (including legislators' opportunity costs) of developing new laws. Also, many legal innovations are easy for other jurisdictions to copy (about which, more next week); unless there are big returns, there might be little incentive for any one jurisdiction to innovate. So perhaps races like the competition for charters are rarer and more fragile than we've thought.
2. The demand side. Why don't n/p managers seem to seek out laws favorable to them, whatever the benefit to their firm? If managers can offer large enough rents to officials, then their demand should generate an incentive to supply laws, too. One possible answer here is that state n/p law is already almost meaningless. Most states do not permit suits against managers and board members except by the board or the state attorney general. (And there seems little market for more expansive standing rules, probably for the reasons I just mentioned above.) AG's are notoriously disinterested enforcers. So maybe the substantive law just doesn't matter often enough to be worth paying rents, and explaining transaction costs to other stakeholders. Also, it's possible that federal tax law is the dog and state law the tail, or even just the fleas -- but there, too, enforcement is exceedingly rare.
Bottom line, I think it's hard to say that the evidence from the n/p sector clearly tells us anything about the for-profit sector. But these are testable hypotheses. For instance, if the managerial rent-seeking theory is right, then n/p's should seek new charters in those rare instances where the managers might plausibly face suit.
Monday, July 21, 2008
Yahoo's board has reached an agreement with investor-advocate Carl Icahn. Icahn will drop his proxy challenge, and he and two others will join the Yahoo board. One member of the current board will exit and two new board slots will be created, moving the board from nine members to eleven. Icahn and former AOL CEO Jon Miller have been tabbed to join, leaving a slot for one of Icahn's original slate of ten.
Silicon Alley Insider tries to put a good spin on the move:
If you're so inclined, you could view this as Jerry and co caving: If they were ultra-confident that they were going to win the proxy vote next month, they wouldn't have given Carl a thing. On the other hand, they can now go back to the business of trying to fix/save Yahoo, and get an experienced Internet mind (Miller's) to offer some advice. That seems like a pretty good trade to us.
Plus, they hopefully can keep Icahn from his officious meddling. To me, that's the best reason for the deal -- quiet things down and get the spotlight off of management. Also, Icahn won't be looking to sell his big stake as soon as possible. But the move may also signal Yahoo's willingness to sell itself.
Regardless, I'm disappointed that Icahn's inept proxy battle has ended with him on the board. What message does that send? It must be demoralizing to Yahoo employees. They have no real voice in the company's future, but they have to sit on the sidelines and watch as a wealthy investor buys some stock, trashes the company, and gets put on the board -- all in the space of two months. And he doesn't even use email.
Of course, the question now becomes: who from the slate of Icahn directors will take the one remaining spot? As a professor, I hope Lucian Bebchuk is the nominee. But part of me hopes it's Mark Cuban. After all, I'd love to keep using this quote: "Is there anything more fun than sitting around, growing your hair, drinking a Bud while listening to Jethro Tull and pondering how to change the balance of power in the search world and unseat Google ?"
Friday, July 18, 2008
Johnny Sack is a Union Boss, Apparently
You may remember Vincent Curatola from "The Sopranos" -- he played a rival boss to Tony who suffered the indignity of attending his daughter's wedding in federal custody. Now, Mr. Curtola is still living off his Sopranos fame by portraying a mobster. Well, at least he seems to be a mobster. Watch the video and judge for yourself.
Problem is, Mr. Curatola is also portraying a union leader. The gist of the ad, sponsored by the innocently named "Coalition for a Democratic Workplace," is that workers will be threatened and intimidated by mobbed-up union bosses if Congress passes card-check legislation. Mickey Kaus is a big fan of the ad, posting that it "seemed effective to me, but I'm pre-convinced." But to me, the ad is an absurd caricature of unions and their leaders. Frankly, I find it offensive.
I've posted before about the Employee Free Choice Act -- the legislation that would require employers to recognize a union if a majority of employees fill out cards attesting to that desire. Providing a statutory mechanism for unions to be recognized through card-check would put unions on the same playing field as other service providers. The current system of the NLRB secret-ballot elections allows employers to initimidate their workers through captive-audience speeches and predictions about a dire future. (Employers are, as Catherine Fisk memorably put it, the "anti-seller" in this market.) There is a lot if research out there about the effects of this employer intimidation. The scholarly literature has much less discussion of union intimidation, particularly mob-related intimidation. This is not to deny that the mafia has had control over certain unions. But there is little evidence that mob bosses would use card-check certification to expand their reach.
There is room for concern about union intimidation. As I have written, there is also room for concern that employees are not getting the information they need in the course of a representation campaign. A recent essay by Sen Arlen Specter and Eric Nguyen provides some hope that compromise legislation is possible here. But the efforts to reach a sensible solution will be harmed, not helped, by ads such as the one above.
Tuesday, July 15, 2008
Media starting to rethink their Icahn summer romance
As I've noted several times before, I've been surprised about the kid-gloves used when discussing Carl Icahn's Yahoo proxy bid. His Time-Warner proxy bid flamed out so spectacularly that I expected folks to remember when he started up at the same game. But instead, Icahn was hailed as a savvy corporate alchemist who would turn Yahoo shares back into gold.
The tide is finally starting to turn. The tipping point appears to have been Microsoft's 24-hour sudden-death search-engine offer -- an offer allegedly crafted by Icahn and Steve Ballmer. Here are some reactions to the bid:
- Andrew Ross Sorkin: "The deal was so ridiculous — it called for Yahoo to sell its search business to Microsoft and for Mr. Icahn to take over the board of what was left of the company after assets were spun off and dividends paid out — that when the moguls here started to learn the details, it actually began to change the perception of Mr. Yang’s predicament."
- Henry Blodget: "In our opinion, this was not a serious offer. We think it was designed simply to give Microsoft and Icahn more to complain about in the weeks leading up to the shareholder meeting."
And in turn, this is leading to reassessments of Icahn:
- Sorkin: "Think about it: 'What global company in their right mind formally teams up with Mr. Icahn?' as one invitee asked. Mr. Icahn may be a brilliant investor — he actually doesn’t get enough credit or respect for that [!] — but let’s be honest, he doesn’t use a computer, let alone know how to run Yahoo. And what does it say about Microsoft? The notion that Yahoo’s board would sell the crown jewel, its search business, to Microsoft and then hand over the scraps of the company to Mr. Icahn is, as Roy Bostock, Yahoo’s chairman, said, 'absurd and irresponsible.'"
- Blodget: "So here's what we think happened: We think Carl Icahn's personal agenda screwed up what otherwise might have been a reasonable search offer from Microsoft. (This is one hazard of having a deal-broker who also has major skin in the game.) We think Microsoft has since recognized this and is running as far from Carl as it can."
Blodget delivers this final analysis: "It's over: Carl Icahn has lost. Yahoo will win the shareholder vote." Hopefully, Yahoo can now turn its attention to righting its storm-tossed ship. Perhaps Yang will resign or be kicked upstairs into something akin to the Bill Gates role. Perhaps a merger or sale will take place. But it's unlikely that Yahoo shareholders will reminisce fondly about Icahn's endeavor.
Tuesday, July 08, 2008
Icahn's Twelve (now with special guest star Steve Ballmer)
Carl Icahn's crusade against the Yahoo board has taken another bold step forward with his release of a letter yesterday to Yahoo shareholders in support of his slate. In the letter, Icahn reveals that he has "spoken frequently with Steve Ballmer, CEO of Microsoft," and that "[s]everal of our conversations have lasted as long as an hour." (Gulp.) The upshot is that Ballmer & co. are unwilling to deal with the current Yahoo board, and thus the only way to the land of Microsoft and honey is through an Icahn victory. Microsoft has backed this up with a press release of its own (waiting at the ready?), stating that "[w]e have concluded that we cannot reach an agreement" with the current Yahoo board but that "after the shareholder election Microsoft would be interested in discussing with a new board a major transaction with Yahoo!."
Icahn could not have planned this any better -- for Microsoft. Part of me thinks he must have a huge hidden position in the Borg. At every turn, his machinations have worked in Microsoft's favor:
- Icahn only got into the mix after Yahoo had successfully killed the Microsoft offer.
- He immediately made it clear that selling the company to Microsoft was the only viable opportunity.
- He trumpeted that Yahoo's board had "botched" the Microsoft opportunity, and he set about undermining the board at every opportunity.
- He proposed a full board slate with a somewhat hodge-podge collection of directors, including a man who had been humiliated when Icahn proposed him as a potential Time Warner CEO.
- He claimed that Yahoo shares were worth $34.75 -- a number seemingly picked out of thin air.
- In a surprising reversal, Icahn claimed that Yahoo's proposed deal with Google "might have some merit" before apparently changing his mind once again.
- In the two months Icahn has been waging his battle, Yahoo shares have dropped from the $28 range to the $20-24 range.
And now comes the worst part -- he is buddying up to the person that he will be negotiating against should his proxy battle prove successful.
I just don't understand how Icahn can think that prostrating Yahoo before Microsoft helps Yahoo shareholders. Here are the possibilities -- the fruits, as it were, of Icahn's laboring in the Yahoo vineyards:
- Icahn's proxy slate fails. If this happens, the Yahoo board has been sufficiently bloodied that the stock will probably drop even further. And who has done the bloodying? Yahoo will then limp along, hoping for some change in its public perception, or it will be taken over (de facto or de jure) by Google, Microsoft, News Corp., or some other entity for 50 cents on the dollar.
- Icahn's proxy slate wins! Then what happens? Apparently, Icahn's plan is to immediately start negotiating with Microsoft. (From his letter: "If and when elected, I strongly believe that in very short order the new board would, subject to its fiduciary duties, be presenting to shareholders either a purchase offer for the whole company or a very attractive offer to purchase 'Search' with large guarantees.") But what will Microsoft do? Ballmer knows that Icahn is backed into a corner -- Yahoo would have to accept whatever Microsoft offers. Microsoft would probably try to buy the search engine on the cheap. Will Icahn see anything close to his $34.75 per share? As Henry Blodget put it: "[D]on't think for a minute, of course, that even if Microsoft is persuaded to buy Yahoo outright, that it will do it for $33. Microsoft refused to speculate about price, but at this point, there's no reason in the world they should pay more than $25-$27."
Common sense compels me to acknowledge that, hey, he is Carl Icahn and I'm a professor. But for the life of me, I can't understand why Icahn continues to get good press. One recent article explains "Why Yahoos [sic] shouldn't underestimate Icahn". I would agree, if the meaning is underestimate the damage Icahn can do to the company.
One final note. Oddly enough, Icahn's big argument for his proxy slate is that it can get a deal done with Microsoft. But -- according to Icahn -- this is the reason why Microsoft won't deal with the Yahoo board:
Steve [!] made it abundantly clear that, due to his experiences with Yahoo! during the past several months, he cannot negotiate any transaction with the current board. His logic is simple. If and when a transaction was consummated, Microsoft would be guaranteeing a great deal of capital at closing. However, a transaction could take at least nine months and perhaps longer to obtain regulatory clearance in the U.S., Europe, and elsewhere. During that period, if the current board and management team of Yahoo! mismanage the company (and their recent track record is far from reassuring), Microsoft would be putting its money at risk and a great deal could be lost.
So here's my question for Yahoo shareholders. Suppose Icahn's slate wins. Are you prepared to live with the Icahn board for at least nine months? Nine months in which Microsoft may well be looking to chip down the price as much as possible? (You can bet Microsoft wouldn't repeat the Time Warner "no collar" mistake.) And that's assuming a deal is struck immediately. Nine months?
Well, I guess Yahoo shareholders could look forward to this, from potential Icahn director Mark Cuban: "Is there anything more fun than sitting around, growing your hair, drinking a Bud while listening to Jethro Tull and pondering how to change the balance of power in the search world and unseat Google?"
Tuesday, July 01, 2008
An Anheuser-Busch Puzzle: When is a Classified Board No Longer Classified?
The potentially hostile takeover battle between Belgian brewing giant InBev and American brewing giant Anheuser-Busch is heating up. Last Friday A-B rejected InBev's offer of $65 a share, while at the same time initiating a new plan of cost-cutting and value creation designed to placate shareholders. The rejection has prompted the typical shareholder suits, alleging that the A-B directors may be "entrenching themselves and causing the company to take unreasonable and disproportionate defensive measures." However, another suit filed by InBev seeks to illuminate a much more unusual -- and, in my view, puzzling -- question of Delaware corporate law.
In its suit (complaint downloadable here), InBev seeks a declaratory judgment as to the ability of A-B shareholders to remove the A-B directors without cause through a written consent. Delaware Code Title 8, Section 141(k) provides:
Any director or the entire board of directors may be removed, with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directors . . . .
However, there is an exception for classified boards:
(1) Unless the certificate of incorporation otherwise provides, in the case of a corporation whose board is classified as provided in subsection (d) of this section, shareholders may effect such removal only for cause . . . .
In most cases, the determination of whether shareholders can remove directors is straightforward: if the board is classified, they need cause; if not classified, there is no need for cause. The A-B board, however, is in a period of transition. In 2007, the Board and shareholders amended the A-B charter to declassify the board. Thus, beginning with the 2007 shareholders meeting, directors would be changed over from classified three-year terms to annual elections.
As of now, eight of the thirteen directors have been changed over from classified to annually elected. The remaining five will be elected to one-year terms at the 2009 shareholders meeting. However, as of now they are serving out their last classified term of three years. So -- are they still classified or not? In its complaint, InBev says that the 2007 amendment rendered all of the directors unclassified, as of the time of the amendment. But it appears that A-B -- despite some confusion -- will maintain that those five are still classified. And if the five are still classified, then they could only be removed for cause. More importantly, these five would choose eight replacement directors if the eight non-classified board members were removed through a written consent.
I don't see an easy answer to this question. On the one hand, the 2007 amendment did seemingly render the board no longer classified. On the other, the five directors are still serving out a three-year term -- a classified term. I haven't done a great deal of research on this, but it doesn't seem like there's clear precedent on the point.
It may be this legal issue will have little importance to this deal; as Deal Journal points out, the possibility of director removal through shareholder consent seems remote. But this particular legal issue raises an interesting question of statutory interpretation, suffused with policy issues surrounding the pros and cons of classified boards. Perhaps one of the fine chancellors will get a chance to grapple with it.
UPDATE: In my initial post, I neglected to reference this post by the Deal Professor on the subject. As he notes: "I am not aware of any Delaware case law on this. But the Delaware courts are rather protective of the shareholder franchise. They have also repeatedly endorsed the validity of the staggered board. The two principles here clearly collide and, to my knowledge, there is no direct case law on the topic."
Monday, June 16, 2008
Linguistic Communities, Intellectuals and Dilbert
Several weeks later, I am still pondering the "anti-intellectualism" debate Rick Hills stirred up, and some of the comments to my post on the subject. What got me going this morning was reading the introduction to Stephen Finlay's Four Faces of Moral Realism, which Larry Solum was kind enough to spotlight today. This is by no means a criticism of that article, which is a helpful summary, but a reflection of my own internal translation of the jargon (are moral principles real or unreal, natural or non-natural, reducible or irreducible?) into conversational English. It's also not a criticism of the jargon (which I think I do understand), but an observation on the "insider/outsider" nature of it.
I've been the member of several linguistic communities, and I'm pretty sure that the only reason intellectual jargon gets this kind of attention from intellectuals is that intellectuals are the ones who think about it by the very nature of being an intellectual. When business jargon gets this kind of attention, it results in Dilbert. (There is, of course, the occasional cross-over, like this parody of the Harvard Economics Department Recruitment video. The funnier "outtake" version I see has been removed from YouTube.)
For example, when I moved from the law firm to an in-house job at AlliedSignal, I kept a log of business jargon and acronyms in my Franklin Planner as a kind of curiosity. The fact is, you almost couldn't understand what was going on without something like it, even though there was very little in the business that was otherwise not reducible to common parlance. Some areas were more difficult than others. To this day, I cannot deal with any discussion of derivative investments (hedges, options, puts, calls, straddles, swaps, swaptions, etc.) without slowly and methodically translating it back into plain English. I've long since lost the Franklin Planner, and the list is gone, but here are a few:
The Deck: (n) the stack of PowerPoint slides sitting in front of everybody at the meeting.
STRAP: (n) the Strategic Plan. This was all-consuming for most executives of the company from about April through the end of July, culminating in a Deck that was about three inches thick, and which was the subject of week-long turgid meetings in which the managers of individual businesses explained EVERYTHING they knew about anything, usually in the hope that senior management would leave them alone.
Roll-out: (n) the process by which a new initiative is introduced to the organization. Initiatives rolled out by functional departments were generally despised by line management, once they cascaded down. "The roll-out of the required STRAP financial templates will take place on April 5, 1998."
Cascade down: (v) with respect to information, to flow from the higher to the lower rungs of the organization. Generally, it is the opposite of bubble up. This might, for example, include annual OP goals (i.e. the operating income necessary to create earnings to support a trailing P/E that would be attractive enough to cause the sell-side analysts to issue strong buy recommendations. The information in a roll-out might also cascade down.
Bubble Up: (v) with respect to information, to flow from the lower to higher rungs of the organization. Generally, it is the opposite of cascade down. After the annual OP goals set by senior management (also known as deliverables) cascaded down to the SBUs (strategic business units), and the SBUs realized they bore no resemblance to what they had said about the capabilities of their businesses in their STRAPs, questions or complaints might bubble up to senior management. If sufficiently obnoxious, the comments might cause a manager to move from seasoned professional, or even hi-po (high potential) to manage-out in the next MRR (management resources review).
Note the linguistic issues here. Even Dilbert, who makes fun of this stuff, has to do it in plain English so that ordinary readers can understand it. Indeed, is Dilbert to business what anti-intellectualism is to the academy?
Friday, June 13, 2008
Fourth Annual Conglomerate Junior Scholars Workshop
The folks over at the Glom are hosting their fourth annual Conglomerate Junior Scholars Workshop for untenured law professors or candidates entering the law teaching market this fall. The submission deadline for completed papers is June 30, 2008. Here's some additional info from Christine Hurt:
The Conglomerate has now hosted this workshop for the past three summers, and we have come to believe that the workshop provides a great service of matching junior authors with more senior experts in their field and also with other readers inside and outside of the academy.
The Junior Scholars Workshop will be live online around July 28, 2008, with allowance for the schedules of our commentators. We will host one or two papers each week, with the paper and solicited comments posted the morning the paper is showcased. We anticipate hosting no more than five papers to ensure reader participation and attention for the duration of the workshop.
The workshop is a terrific opportunity for junior scholars to get detailed feedback from experienced commentators. It's a lot of work, and Christine and her fellow bloggers are to be commended for the time, energy, and insight they put into it.
Let Christine know if you'd like to present a paper or serve as a commentator.
Thursday, June 12, 2008
Yahoo's "Unconscionable" Employee Severance Plan
The press continues to give Carl Icahn a big platform for his ongoing pronouncements about Yahoo. Here, for example, Icahn claims that Yahoo shares are worth $34.75. I'm not a negotiation expert, but it seems to me that putting out a public price will only weaken both Yahoo and Icahn in the negotiations. You also have to love this Icahn quote: "Microsoft and Yahoo! are sort of a marriage made in heaven, even though they sort of hate each other. Some marriages are good when they hate each other." I've said this before, but I think the press should be a little more skeptical of Icahn's machinations, given how his Time Warner proxy battle ended up. (This piece, at least, pokes a little fun.)
Icahn also expressed his outrage about the Yahoo employee severance plan that recently came to light. Calling the plan "unconscionable" and "reprehensible," Icahn said the plan was "a complete, total ... I don't want to use bad words ... a travesty. The very people Microsoft wants to keep, it will make it easier for them to leave." Um, this may be news to Icahn, but the point of the plan is not to let Microsoft keep Yahoo employees -- it's to help Yahoo keep Yahoo employees in the face of a potential takeover.
I'm being a bit glib. Icahn's view roughly correlates in tone, if not in volume, with the CW about the Yahoo plan. The plan has been characterized as a just another creative poison pill that has nothing really to do with employees and everything to do with keeping out Microsoft. Forbes has even deconstructed the Yahoo Q&A to employees about the plan, interspersing its own skeptical commentary.
Here's what's suspicious about the plan:
- It was apparently adopted in response to the Microsoft offer.
- It was apparently adopted in secret.
- Yahoo's efforts to make it seem like a genuine, employee-oriented plan now look disingenuous.
However, I think beneath the cynicism there is potential for this plan and plans like it. Other companies could use this plan as a starting point for more beneficial opportunities down the road.
Here is what is good about the plan:
- It does address a genuine concern: employee retention in the face of a potential buyout. In the case of Yahoo, there's a double whammy. In most buyouts, employees fear that they might lose their jobs, and thus are more likely to jump to another company before the buyout takes place. (And a buyout might end up not even happening.) In Yahoo's case, however, if the employees actually keep their jobs, they will then be working for Microsoft. (Known in some circles as "the Borg.") So Yahoo might end up losing a bunch of employees who fear that a buyout might happen -- even if it never happens.
- Thus, the plan is designed to protect employees against the possibility of a Microsoft buyout. They will get severance if they lose their jobs or if their job responsibilities change. This gives the employees more power -- they have some degree of control over whether they want to keep working or instead get a severance. (It's almost akin to a "no-trade" clause in pro sports.) Of course, this makes the plan more expensive for any buyer, but it's not gratuitous. It's based on a legitimate employee concern: losing out post-merger by having to do a substantially different (and less desirable) job and not being able to get the severance package.
- The plan applies to all employees. Some have criticized this part of the plan as "nuts." But I think it's a welcome signal that all of a company's employees have meaningful contributions to add. Why shouldn't a company seek to retain all of its employees? I think this plan is a welcome change from the notion that only top-level executives add value to a company.
I hope this plan is just a starting point for plans like this in the future. There is an opportunity for employee-oriented companies (like Southwest and Budweiser, perhaps?) to create a plan like this that might be more genuinely oriented towards employee interests. In addition, I think there's an opportunity for creative unions (such as SEIU) to seize on these plans as a win-win for employees, management, and long-term shareholders.
It will be interesting to see how pension funds such as CalPERS respond to the Yahoo severance plan. I hope that instead of seeing it as an anti-shareholder scheme, they will focus on its positive attributes as a way of protecting their companies' "employee capital." Hopefully there will be more to come on this.
More on Lawyers and Entrepreneurs
In comments to my last post about Bill Henderson and the ISBA small firm workshop, Hillel Levin and "PA" pose questions about what you can teach in a law school classroom.
"Law and entrepreneurship" is a nice place to explore what you can reduce to process capable of being replicated, much less taught. Over at Conglomerate, it happens Gordon Smith reported in a few days ago from a conference in Madison entitled "Technology Entrepreneurship and Institutions," which University of Wisconsin INSITE Executive Director (and Professor) Anne Miner kicked off by asserting "there is no secret sauce" to entrepreneurship.
This has macro and micro implications, and hers appears to concern the former. Certainly the last two places I lived (Ann Arbor and Indianapolis) had the usual government plus industry plus university triads seeking to turn those communities into Silicon Valley-like hotbeds of entrepreneurial development. Josh Lerner at MIT has commented on the foolishness of letting politics, rather than the merit of the business, dictate the disbursement of governmental or other seed money. Entrepreneurial communities are clusters, and even if wanting it to be so could make it so, then you have to concentrate the effort in, say, Indianapolis, and not give into the desire of Fort Wayne, Evansville, Gary, and Muncie to get in on the gravy train. Wanting it to be so doesn't make it so, and Professor Miner's observation seems wise to me. There is a lot of serendipity in the creation of new industrial centers, whether it's Silicon Valley in the 1980s, or Detroit at the turn of the 20th century.
My particular interest is in the micro view, particularly the exploration of my intuition that private law (versus other norms or the "rule of law") is not a particularly powerful force in entrepreneurship (as I observed in the thought piece Why the Law of Entrepreneurship Barely Matters). Or to put it another way, not only is there no macro secret sauce, there's not much micro secret sauce either, at least for lawyers.
I've been intrigued by some empirical data on this subject, particularly that gathered by Professor Saras Sarasvathy at Virginia's Darden School about what she thinks might be the derivable and teachable micro secret sauce, at least for the entrepreneurs, and more follows the jump.
Professor Sarasvathy wrote a paper called "What Makes Entrepreneurs Entrepreneurial?" based on research she undertook with thirty successful entrepreneurs (their companies ranged from $30 million to $6.5 billion in sales), giving them each an identical seventeen-page business problem to solve. Her conclusion was that there was a teachable set of principles involved:
This set of principles, when put together, rested on a coherent logic that clearly established the existence of a distinct form of rationality that we have all long recognized intuitively as “entrepreneurial”. For reasons that will become clear in the next section, I have termed this type of rationality “effectual reasoning”.
* * *
The word “effectual” is the inverse of “causal”. In general, in MBA programs across the world, students are taught causal or predictive reasoning – in every functional area of business. Causal rationality begins with a pre-determined goal and a given set of means, and seeks to identify the optimal – fastest, cheapest, most efficient, etc. – alternative to achieve the given goal. The make-vs.-buy decision in production, or choosing the target market with the highest potential return in marketing, or picking a portfolio with the lowest risk in finance, or even hiring the best person for the job in human resources management, are all examples of problems of causal reasoning. A more interesting variation of causal reasoning involves the creation of additional alternatives to achieve the given goal. This form of creative causal reasoning is often used in strategic thinking.
Effectual reasoning, however, does not begin with a specific goal. Instead, it begins with a given set of means and allows goals to emerge contingently over time from the varied imagination and diverse aspirations of the founders and the people they interact with. While causal thinkers are like great generals seeking to conquer fertile lands (Genghis Khan conquering two thirds of the known world), effectual thinkers are like explorers setting out on voyages into uncharted waters (Columbus discovering the new world). It is important to point out though that the same person can use both causal and effectual reasoning at different times depending on what the circumstances call for. In fact, the best entrepreneurs are capable of
both and do use both modes well. But they prefer effectual reasoning over causal reasoning in the early stages of a new venture, and arguably, most entrepreneurs do not transition well into latter stages requiring more causal reasoning.
If what MBAs normally do is causal reasoning, then what lawyers do is causal reasoning par excellence. This particular comparison struck home: "While causal reasoning urges the exploitation of pre-existing knowledge and prediction, effectual reasoning stresses the leveraging of contingencies." In short, the usual business lawyer's job is to use past circumstances to predict and minimize the risk in a contingent future; the entrepreneur views that very contingency as stock in trade. Again, to plug a piece of my work: Contingency and Contracts: A Philosophy of Complex Business Transactions, 54 DePaul L. Rev. 1077 (2005).
What is intriguing about this theory is how it further divorces law from the creative process. In the "Why...?" essay, I speculate that entrepreneurs simply have a different orientation to rule-following practice than lawyers. Professor Sarasvathy is suggesting it's more than that: causal and effectual reasoners aren't even processing the same data.
Tuesday, June 03, 2008
Is and Ought's Excellent Adventure (Part 1): Ontological Confessions of a Wishy-Washy Lawyer
Several days ago, Rick Hills criticized legal scholars who use David Hume's famous "is-ought" quotation in the same way they might add a string cite for summary judgment standards in a brief. I don't want to quarrel with that criticism, but the rest of his post implied that point of the is-ought distinction itself was somehow passe, or another Enlightenment relic, and put to rest by Hilary Putnam's critique (or, at least, eaten up in the legal academy once the analytic philosophy predators invade the eco-system). I don't agree with that implication, and rather than bore everyone to tears with philosophical musings (I'll do that later), I offer some anecdotes and some practical advice on the matter of "is" and "ought" in the life of a real lawyer, using Hillary Clinton's "fight or concede" dilemma as an example.
I'll start with the confession. I was a wimp as a corporate lawyer, at least in the sense that scorched earth tactics in any setting just weren't my cup of tea. When I was practicing in a law firm in Detroit, there was a very smart fellow at one of the other big firms who made his reputation by being simply the most unpleasant litigator in town. Even if conventional general counsel wisdom said that we would do better by hiring people like that to handle our litigation (once I was a buyer rather than a seller), I had a hard time with it. I hated the tipping point where we had to decide to escalate.
This was all capsuled in one short exchange I had while I was interviewing for the job of vice president and general counsel of AlliedSignal's automotive division in 1993 (AlliedSignal is now Honeywell). I had left a law firm partnership the year before to become an AlliedSignal "senior counsel" on the prospect that this other job would be opening up. But there were no guarantees. Because the new position was at the divisional C-level, the last hurdles were interviews with Larry Bossidy, the CEO and chairman, and Alan Belzer, the about-to-retire president, and a crusty old veteran of the chemical industry (the "Allied" in the name came from Allied Chemical, founded in 1924 by among others, Eugene Meyer, Katherine Graham's father, and for years the New Year's ball in Times Square was atop the Allied Chemical building.) Talking with Bossidy was like talking to the wisest grandfather in the world (somehow I managed to mention God, Torah, and Israel, the three foundations of Judaism, and did it smoothly enough to get the job). Belzer, on the other hand, I think, enjoyed yanking the chain of this obviously too-young-and-inexperienced candidate, and our conversation follows the jump.
Alan congratulated me on a short essay I had written about why I thought I should get the job. Then:
ALAN: Okay, I'm going to ask you a question you may not like very much.
JEFF (smiling charmingly): That's fine, Alan, hit me with your best shot.
ALAN: I don't want to hit you.
JEFF: I don't mind a tough question.
ALAN: Okay, but there are rules. You cannot answer "it depends."
JEFF: I can't answer "it depends"?
ALAN: You can't answer "it depends."
ALAN: Alright. Here's the question.
ALAN: Fight or settle?
JEFF: Fight or settle?
ALAN: Yes, fight or settle.
JEFF: And I can't say it "it depends"?
JEFF: Then you settle.
ALAN (coming out of his chair): BUT WHAT IF THEY ARE BASTARDS?
JEFF: Then you fight.
I didn't realize at the time this was really a discussion about the "is" and the "ought." We are faced all the time with considering what really is the case, what we think ought to be the case in the best of all possible worlds, and what we ought to do about it if they are not the same. Think about Hillary Clinton's dilemma over the last few days. Fight or settle? What is true and what is right? Some things really are a matter of simple analytic truth, and unquestionably objective.* Obama has X elected delegates and X superdelegate commitments. Some things are a matter of a possible but unrealized state of the world, and one that might even be the best of all possible worlds. She says "I ought to be the nominee because I am more electable." Finally, there is the question of action - what ought we do? This doesn't involve the question of "is" at all, except to the extent that the gap between what is and what ought to be impels us to action. The dilemma of the wishy-washy corporate lawyer is just like Hillary's dilemma - one principle of what ought to be demands that I fight to the bitter end to change the "is;" another principle says that the party (or the company) is better off if we compromise or concede.
How do you decide? Hume kind of shrugged his philosophical shoulders, observing, however, that you would undoubtedly employ your reason to get you to the result that made you happiest. Kant acknowledged that was a problem, but thought you could reason your way to the right thing to do by figuring out what duty would require everyone in that situation to do.
People have been debating the is-ought issue forever, and I'm skeptical anybody, even Hilary Putnam, has the silver bullet as a philosophical matter. I also don't think there's a silver bullet (as I will discuss in the next post) that resolves the dilemma of data versus intuition. What seems pretty clear to me is that we have to engage the questions as lawyers all the time, even if not in academic lingo, and even if we avoid the ontological musings.
* Synthetic truths, like the number of delegates it takes to secure the nomination, or the structure of DNA, are another matter, and that is where Hilary Putnam's critique comes in. More on that to follow in my upcoming post "How Many Superdelegates Does It Take to Screw In a Lightbulb?"
Monday, June 02, 2008
Tribal Communities, Corporate Boards, and Lawyers
I'm working on a case book revision (joining the incumbent author in a new edition), and dealing with a chapter I never taught is like class prep, so any excuse to procrastinate suffices for me. Today's inspiration is Eduardo's post about lawyers (or the lack thereof) on desert islands or space stations. I have never seen Lost or Survivor (this is not a claim of some kind of intellectual superiority; I'm big into all sorts of weird mind-numbing channel surfing, like Modern Marvels on The History Channel, almost anything on Turner Classic Movies, and watching the Versus Channel's coverage of the Tour de France). Nevertheless, as the Law & Society Association meeting has just wound up, it's appropriate to theorize why doctors and not lawyers show up in space stations and desert islands.
As Ferdinand Tönnies, one of the founders of modern sociology (and the handsome guy on the right), suggested, this is an issue of Gemeinschaft (community) and Gesellschaft (organization). Gemeinschaft is best exemplified by the tribe, a community bound together by ties of family, mutual regard, common neighborhood - in short, a pre-modern rural society. I like the Wikipedia author's description of Gesellschaft: "groups that are sustained by it being instrumental for their members' individual aims and goals. . . . Gesellschaft relationships arose in an urban and capitalist setting, characterized by individualism and impersonal monetary connections between people. Social ties were often instrumental and superficial, with self-interest and exploitation increasingly the norm."
What a fine description of modern law and lawyers, and why you wouldn't want too many of them in your ashram! Healers, on the other hand, have always been around. (Bones McCoy after curing the big rock: "Jim, I'm a healer.") Now that I think about it, I also waste time by watching old movies over and over again: Gandhi had an ashram and he was a lawyer, but I think this just proves the distinction between theoretical sociology and applied sociology. We never completely achieve either in the real world.
Think about all the institutions we create in which reside remnants of tribal-like communities with tribal-like behavior (to Rick Hills' point, I won't say anything about Geertz and Balinese cock-fighting because I've never read it, but I will nominate it for the Hegel Award): law firms, corporate boards, faculties, Congress, the AALS. This is why I've always been skeptical of the capability of more and better Gesellschaft-rules to govern behavior of people within institutions. You can fully constitute the institution through rules (like the rules of chess or football or Survivor), but you can never fully regulate tribal behavior (see Sarbanes-Oxley and the corporate governance debate) that way.
Thursday, May 29, 2008
Bear Stearns Buyout Approved
The deal's approval comes as no surprise -- since offering to take over the firm two-and-a-half months ago at the behest of the U.S. government, JPMorgan Chase & Co. has purchased nearly half of Bear Stearns Cos. stock, virtually guaranteeing shareholder approval. JPMorgan also upped its initial offer of $2-a-share to $10-a-share after outcry from Bear Stearns shareholders, many of whom are employees that JPMorgan intends to keep on staff.
The $10 was apparently enough to buy off those shareholders with other interests to pursue. Perhaps those interests -- such as employees worried about their jobs -- were taken care of as well.
Tuesday, May 27, 2008
Employee Primacy at Southwest
On Saturday Joe Nocera had a nice column on the retirement of Herb Kelleher, long-time chief at Southwest Airlines. The fest came at Southwest's annual meeting, which overflowed with shareholders and employees expressing their admiration for the departing chairman. The Southwest pilot's union even thanked Kelleher in a USA Today ad.
Given these displays of admiration from employees, particularly in the contentious airline industry, one might expect Kelleher to be a fan of Southwest employees. In fact, he gives them the credit for the success of the company:
Over the years, whenever reporters would ask him the secret to Southwest’s success, Mr. Kelleher had a stock response. “You have to treat your employees like customers,” he told Fortune in 2001. “When you treat them right, then they will treat your outside customers right. That has been a powerful competitive weapon for us.” As he stepped away from the company this week, his line didn’t change.
“We’ve never had layoffs,” he told me the day before the annual meeting, sitting on the couch of the single messiest executive office I’ve ever seen. “We could have made more money if we furloughed people. But we don’t do that. And we honor them constantly. Our people know that if they are sick, we will take care of them. If there are occasions or grief or joy, we will be there with them. They know that we value them as people, not just cogs in a machine.”
Can that really be the reason Southwest is still making money while its competitors are bleeding red ink? Can it really be that simple?
Of course, it's probably not that simple. Nocera notes other potential keys to Southwest's success: it got its start by operating out of Love Field in Dallas and operated as a new kind of carrier; it expanded during the great bull markets in the 1980s and 1990s; and it recently made savvy fuel hedges that save the company about 60% off its oil costs. Undergirding these successes, however, was a constant philosophy of the importance of employees.
Of course, critics of an employee-centric approach will point to United Airlines, which had much less success during a period of actual employee ownership. The United ESOP has a complicated story, but it must nevertheless be recognized as an instance of failed employee ownership. But that failure should be contrasted with successes like Southwest. Although Southwest has never been employee-owned, Nocera notes that during its growth years, "[m]uch of [the Southwest] stock was in the hands of employees, because Mr. Kelleher believed in handing out stock options liberally."
The notion that "employees are important" is one of those Successories-type sayings that seems to have little meaning. But Southwest shows that the saying can be operationalized into a business approach that provides a competitive advantage. "Employee primacy" has yet to be developed into a competing theory of corporate law. But perhaps Southwest will be a useful example in our efforts to better understand the dynamics and potential of the corporation.