Tag Archives: executive compensation

Clinton on Quarterly Capitalism

Clinton “We need an economy where companies plan for the long run and invest in their workers through increased wages and better training—leading to higher productivity, better service, and larger profits. Hillary will revamp the capital gains tax to reward farsighted investments that create jobs. She’ll address the rising influence of the kinds of so-called “activist” shareholders that focus on short-term profits at the expense of long-term growth, and she’ll reform executive compensation to better align the interests of executives with long-term value.” [Clinton]

I could happily live with this.  She had me at “… where companies plan for the long run.”  Let me start here, and then move forward into a familiar topic on this digital soap box.  I, too, have had enough of “quarterly capitalism,” and it is high time someone offered a cogent proposal to deal with the specter.

First, no one should try to argue that all short term equity and bond purchases are necessarily bad – there are some valid reasons for such trading. However, as in most other things in life it is possible to have too much “of a good thing.”  Let’s face it, high frequency traders aren’t investors – they’re traders, and shouldn’t be confused with those who are putting capital into the distribution system.    Too much short term investing (trading) in the mix and we’re asking for problems, three of which from the investment side are summarized by PragCap:

    1. A short-term view tends to result in account churning, higher fees, higher taxes and lower real, real returns.
    2. A short-term view often results in reacting to events AFTER the fact rather than knowing that  a well diversified portfolio is always going to experience some positions that perform poorly in the short-term.
    3. Short-term views are generally consistent with attempts to “beat the market” which is a goal that most people have no business trying to achieve when they allocate their savings.

If short term investing isn’t good on the investor’s side of the ledger, it’s not good on the corporate side either.  Generation Investment Management (UK) issued a report in 2012 on “Sustainable Capitalism,” [pdf] that emphasizes this point:

“The dominance of short-termism in the market, often facilitated and exacerbated by algorithmic trading, is correlated with stock price volatility, fosters general market instability as opposed to useful liquidity and undermines the efforts of executives seeking long-term value creation. Companies can take a proactive stance against this growing trend of short-termism by attracting long-term investors with patient capital through the issuance of loyalty-driven securities. Loyalty-driven securities offer investors financial rewards for holding a company’s shares for a certain number of years. This practice encourages long-term investment horizons among investors and facilitates stability in financial markets, therefore playing an important role in mainstreaming Sustainable Capitalism.”

Or, put more succinctly, short-term vision creates market volatility (big peaks and drops) which makes our stock markets more unstable, and undermines executives who are trying to create companies with staying power.  Instability and volatility improve the prospects for traders but not for investors, and not for the corporations and their management.

If we agree that “quarterly capitalism,” or “short-termism” isn’t a good foundational concept for our economy – from either the investors’ or the company’s perspective, then what tools are available to make long term investing more attractive, and to help corporations seeking “patient capital?”

rats rear end One tool in the box is the Capital Gains Tax. If only about 14% of Americans have individual investments in “The Market” [cnbc] why should anyone give one small rodent’s rear end about the Capital Gains Tax structure? 

Because:  The present capital gains tax structure  rewards investment transaction income more than on earned income. If we are going to allow this lop-sided approach, then there has to be some economic benefit in it for everyone?  The current system:  

“Capital gains and losses are classified as long term if the asset was held for more than one year, and short term if held for a year or less. Taxpayers in the 10 and 15 percent tax brackets pay no tax on long-term gains on most assets; taxpayers in the 25-, 28-, 33-, or 35- percent income tax brackets face a 15 percent rate on long-term capital gains. For those in the top 39.6 percent bracket for ordinary income, the rate is 20 percent.” [TPC]

Thus, if one’s income is “earned” by trading assets then the tax rate is 20% at the top of the income scale, but if the income is earned the old fashioned way – working for it – the rate could be 39.6%.  This is supposed to incentivize investment.  But note the definition of a “long term asset,” as one held for more than 12 months… that’s right: 12 months. 

Contrast that definition of a long term investment with the Clinton proposal:

Clinton Cap Gains Tax ChartNotice that in Secretary Clinton’s structure the combined rate on capital gains moves from 47.4% for those “short term” investments, down to 27.8% if the investor holds the assets for more than six years.  Five and six years fits my definition of “long term” much better than a “little over 12 months.”

Thus we have an incentive for longer term investments, which means less instability and less volatility.  This seems a much better plan to practice “Sustainable Capitalism.”

rats rear end

But, what of the executive compensation packages that are tied to short term stock prices?   Yes.  That’s a problem. [NYT] And yes, President Bill Clinton’s attempt to rein in executive pay back-fired. However, Secretary Clinton has proposed legislation to provide shareholders a vote on executive compensation, especially on benefit packages for executives when companies merge or are bought out. Her proposal would have created a three year “claw back” period during which the SEC could require CEOs and CFOs to repay bonuses, profits, or other compensation if they were found to have overseen – or been intentionally involved in misconduct or illicit activity.  Granted that doesn’t cover the entire landscape of corporate misadventure, but this could be combined with the following excellent suggestion for amending the tax code:

“Instead, Section 162(m) could be rewritten to allow a deduction for compensation paid to any employee in excess of $1 million only if the compensation is paid in cash, deferred for at least five years and unsecured (meaning that if the company goes bankrupt, the executive would not have a priority over other creditors). This approach would encourage corporate executives to act more like long-term bondholders and obsess less about short-term stock price movements.” [NYT]

Every bit of “encouragement” might help.  I’d be very happy to see CEOs thinking like long term bond holders (if long term means more than 13 months) and less like the traders/gamblers in the Wall Street Casino.

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Filed under Clinton, Economy, financial regulation, Hillary Clinton, Politics, Taxation

Income in America – The Hurrier We Go The Behinder We Get?

The average worker’s pay in the state of Nevada is $35,206 per year. The average CEO pay is $5,130,077.  That’s a ratio of 146-1 in favor of the CEO, a figure which rockets up to 299-1 if CEO compensation is compared to our minimum wage earners.   [Paywatch]  If we look to the 89101 Zip code specifically, the median annual compensation for a CEO is $736,318 or 21 times the earnings of the average worker.  The range in that area goes from $396,391 to $1.059,652. [SalWiz]  If we look north, the average CEO compensation in the 89501 Zip code is $732,846, with a range of $394,522 to $1,054,657. [SalWiz]  The problem isn’t that some individuals are paid more than others — the core issue is that there are economic pressures which continue to put a drag on our economic recovery, and some of these are the result of wage and tax policies which favor financialism over good old fashioned capitalism.

The first argument launched from the conservative side of the spectrum is that these numbers are necessarily flawed, and therefore of little utility in debate about wages, salaries, and compensation in general.  However many issues the Center on Executive Compensation , allied with the U.S. Chamber of Commerce, and the National Association of Corporate Directors, may have with the methodology, and with the proposed SEC rules on ratios, [Blmbrg]  the points remain — (1) Multinational and other large corporations really don’t want to disclose their CEO pay packages, and (2) They really don’t want the issue of executive compensation tied into the discussions of tax equity and fairness.

This is an interesting line because corporations generally have no problem reducing almost any issue by quantification, be it allocation of purchasing orders or labor costs and productivity.  One easily reached conclusion is that the quantification called for by the SEC under the terms of the Dodd Frank Act isn’t something the corporations want to do.

The second common assertion is that these are the “job creators,” and therefore should be immune from any additional taxation, and certainly from any increase in the taxation of capital gains.  We are continually told that any attempts to adjust the inequities via minimum wage increases or tax policy will have dire effects on small business.  Testing this contention requires looking more carefully at the old common ‘wisdom’ that small companies are the driving force in job creation.  There’s some evidence this may not necessarily be the case.

While it’s still true that businesses with 49 employees or less create the most jobs, the trend since 1990 indicates that large employers (over 500 employees) added 29% more workers between 1990 and 2011, while those with 50 or less added 10.9% more. [NYT BLS]  In short, what the large corporations do in terms of compensation of CEOs and employees is important, and become more so as additional jobs are the result of hiring decisions made by large firms.

Practical Matters

## As a practical matter, income inequality only becomes a problem when such a large portion of wealth is tied up in the hands of so few that the savings capacity of individual workers is reduced.  Obviously, at the theoretical level, the more workers save the more money becomes available for investment.  Practically, the more workers are able to save the less reliance there is on social safety net programs, and the more savings accounts of all varieties are available for (a) consumer spending — such as in retirement, and (b) investment by the banks and mutual funds which hold them.

One way to observe this in the real world is to look at what people are doing with their 401(k) accounts.  Now that housing isn’t the most apparent source of income, individuals and families are increasingly tapping their retirement accounts to meet necessary expenses.  In 2011, for example, Americans withdrew about $57 billion from their retirement accounts while home equity loans were down by 38%. [Blmbrg]*

At the consumer debt level, the Federal Reserve’s report on Household Debt Service and Financial Obligations ratios shows consumer debt which bottomed at 4.97 in the first quarter of 2012 is now back up to 5.14.  People who are borrowing aren’t saving, and if they aren’t saving then those funds are not available for investment.

Our debt levels are back up and our personal savings rates are headed back down.  The Federal Reserve chart shows an increase in personal savings during recessionary periods, a spike in December 2012, and then back down we went.

Personal Savings RateNothing says “squeezing the middle’ quite like watching (a) dipping into retirement accounts, (b) increasing consumer debt, and (c) declining personal savings.

## Income inequality becomes a problem when the funds which should be invested in the expansion or improvement of capital projects is diverted into ‘manufacturing’ financial products which add wealth to their holders and traders, but do not add assets, fixed or short term, to corporate enterprises.  Look at the following chart showing the trends in how banks earn their income:

US investment banking fee composition

(See Capital Markets Outlook – Deloitte Israel, Global Investment Banking Review – Thomson Reuters, both in pdf)

Trading in “equities” is earning a larger portion of banking revenues in recent days, from 17% to 48%, while loans have contracted since 2005.  And bonds, the old staple of the investment banking sector? Improving, but not as well as the equities column of the ledger.

If the tax on capital gains is only 15% then what incentive does an investor have to invest for the long term in manufacturing capacity?  For that matter, if funds are in the hands of institutional investors what incentive is there for long term investment instead of seeking short term gains?  In 1995 institutional investors held 140.8% of our GDP, in 2011 that number had increased to 211.2%.  In 1995 institutional investors held $11,223 billion in financial assets, by 2011 that figure stood at $24,220 billion. [OECD pdf]  And then there’s this chart — notice the increase in the column representing investment funds compared to that of pension funds:

Investment Institutions by typeIt isn’t a stretch to conclude that recent trends indicate there are more institutional investors and those investors are increasingly in the form of ‘investment funds.’  The small chart below shows the the increase in the number of hedge funds since 2000:

Hedge Funds






And, as we might guess, the smaller, newer funds are doing well, but they’re also more likely to ‘blow up.’ [FTAlphaville]  It’s necessary to remember that what’s good for the hedge funds and asset managers (short term gains) is not necessarily good for the rest of the economy (long term stable prosperity).   The focus of the money managers is, predictably, money. Money becomes the ultimate measure of wealth, not the fixed and other assets of other enterprises.

If we’re looking for the barriers to economic growth in the U.S. some attention needs to be paid to (1) the growing income inequality which puts pressure on individual and family saving capacity; (2) tax policy which rewards investment for the sake of ‘money’ rather than investment for the sake of long term corporate viability; (3) the role of institutional investors and their agendas in the financial markets; and (4) the declining role of retirement funds for their original purpose (retirement) and in the overall institutional investor landscape.

We’ll do better when we can return to the traditions of capitalism — in which wealth is measured not only by bank accounts, but by what those bank accounts can provide for the businesses and industries who build them.

* See also: Angry Bear Blog “Americans Raid 401(k)s” May 8, 2014; EPI, “The State of U.S. Retirement,” March 12, 2014; Naked Capitalism, “Even Harsh Frontline Program on Retirement Investments Understates How Bad They Are,” April 24, 2013.  CAP “What Can We Do About Retirement Fees Straining Middle Class,” April 15, 2014.


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H.R. 1135 and the Baize Door: Republicans Revisit CEO Pay Disclosure

Monopoly Character bankerWe can’t really say that the 113th is a Do Nothing Congress, they are doing something.  However, what the Congress is doing is not getting much press.  The Village Media, hot to inspect the implications of the latest Drudge headline, or to masticate endlessly over the ramifications of immigration reform or health insurance reform politics, is singularly inept at economic reporting.  The problem is that there’s nothing particularly sexy about the implementation of the 2002 Sarbanes Oxley Act or the Dodd-Frank Act, and this may be exacerbated by the evident lack of economic knowledge of some who carry the label journalist.

Our problem is that as everyday, ordinary, reasonably well educated Americans we are getting a heavy dose of information slanted toward the professional investors — “business news” designed by and delivered to professional investors.   Today’s post concerns a topic once rendered dramatic enough to attract the attention of the news networks — when a sufficient number of 99% Protestors raised a ruckus — but now has sunk back beneath the ocean’s  Mesopelagic Zone: Corporate CEO Pay.

There’s A Plan Here

The Dodd-Frank Act, section 953 (b) was never popular with corporate leadership.  The section dealing with the disclosure of CEO compensation was initially ignored, never really enforced, and now the Republican controlled House of Representatives would like to repeal it wholesale.  [NVRDC]

Corporations are currently required to follow the rules pertaining to section 953 (b) which are, in detail:

(1) IN GENERAL.—The Commission shall amend section 229.402 of title 17, Code of Federal Regulations, to require each issuer to disclose in any filing of the issuer described in section 229.10(a) of title 17, Code of Federal Regulations (or any successor thereto)—  (A) the median of the annual total compensation of all employees of the issuer, except the chief executive officer (or any equivalent position) of the issuer;  (B) the annual total compensation of the chief executive officer (or any equivalent position) of the issuer; and (C) the ratio of the amount described in subparagraph (A) to the amount described in subparagraph (B). (2) TOTAL COMPENSATION.—For purposes of this subsection, the total compensation of an employee of an issuer shall be determined in accordance with section 229.402(c)(2)(x) of title 17, Code of Federal Regulations, as in effect on the day before the date of enactment of this Act. [DoddFrank]

Translation:  Corporations are now required to report the ratio of pay between their CEO’s and their “median” or most typical workers.  The plan devised by the CEO’s and their Congressional allies is to avoid telling the investors and the public anything about CEO pay…ever.

The Bill to Implement the Plan

The bill introduced into Congress to put this simple plan into effect is H.R. 1135, Representative Bill Huizenga’s (MI-4) “Burdensome Data Collection Relief Act.”  It is summarized by the Congressional Research Service as follows:

“Burdensome Data Collection Relief Act – Amends the Dodd-Frank Wall Street Reform and Consumer Protection Act to repeal the requirement that the Securities and Exchange Commission (SEC) amend certain federal regulations about executive compensation to require each issuer of securities to disclose in any filing: (1) the median of the annual total compensation of all the issuer’s employees, except the chief executive officer; (2) the annual total compensation of the chief executive officer; and (3) the ratio of the first amount to the second.”

In short — corporations will no longer be “burdened” by having to disclose the total compensation of their chief executive officers, or to disclose the ratio of CEO pay to that of their median workers.  And, those of us in the general public will no longer be “burdened” by having such information available.   At this point, the CEO’s would be pleased to have information about their compensation packages drift and drop down into the Abyssopelagic Zone on its way to the Hadalpelagic…

One criticism of the requirements of section 953 (b) is that executive pay is a package of components consisting of base pay, bonuses, stock grants and other long term compensation, accumulated benefits in pension plans, and the value of accumulated benefits in more specific executive pension plans.   Some of the benefits are much higher than the base pay.  [BlmLaw]  In short the argument is that computing the CTAC (total annual compensation) is “difficult.”   It’s tempting to offer the rejoinder that perhaps someone would like to sell the corporation a computer for its actuaries and auditors to use in this calculation.   The computation is probably too much for the average abacus, and perhaps even for a nice old fashioned pocket calculator, but … I thought this was why we had computers?

Why the introduction of H.R 1135?

The essential question boils down to: Is it worth the effort to calculate and compile statistics on corporate CEO compensation?

Representative Huizenga says no.

“Huizenga told BNA that “Section 953(b) of Dodd-Frank creates an enormous burden for publicly traded companies while offering no corresponding benefit. By forcing publicly traded companies to report median total compensation, the federal government is requiring companies to provide data that is potentially misleading to investors due to the differing geographic locations of the business. A salary in Detroit is going to be different than a salary in San Francisco, which is going to be different than a salary in London.” [Huizenga]

With all due (lack of) respect, I think individuals can figure out that a company based in the U.S. with most of its employees in Bangladesh is going to have a slightly skewed ratio of CTAC to MTAC.  (median total annual compensation)  Likewise, its not hard to figure that the ratio will be different for companies with domestic manufacturing or service provision activities.   The point remains — whether the ultimate calculation can be slanted is assumed, it’s the out of control full on flash flood of executive compensation which remains unaddressed by corporate boards and problematic for their employees.

Think just for a moment or two about the great push to disclose the salaries and benefits of public employees; as if kindergarten teachers, local firefighters, DOT personnel, and retired police officers are a “Great Drain On The American Way of Free Enterprise” and we should all know exactly what they are collecting.  However, the base pay, benefits, general and specific pension plans, and bonuses of corporate executives is just “tooooo difficult to calculate,” and the great unwashed might be “ill informed” by the release of such data.  It appears as though requiring the corporation to reveal the compensation of top ranking employees is enough to drive them all so frantic as to require fainting couches trailered from their golf carts.

Now, where might Representative Huizenga have gotten the notion that section 953 (b) was the cause of so much pearl-clutching?  There’s a hint in a January 19, 2012 letter from the Financial Services Roundtable to SEC Commissioner Mary Shapiro. (pdf)  The letter is a summation of the common talking points. The section is “too difficult,” some of the results might be “misleading,” and their are problems for multinational corporations.

It shouldn’t surprise any one that the signatories to this epistle include such very special interests as the American Petroleum Institute, the American Insurance Association, the National Association of Manufacturers, the Financial Services Roundtable, the Securities Industry and Financial Markets Association, and the U.S. Chamber of Commerce.  (*full list provided below)  We’d probably not see another such  collection of pro-corporate/financial interests beyond the manicured greens of Augusta, Merion, Pebble Beach, and Oakmont.

Breaching the Green Baize Door

Once upon a time, in the days of Downton Abbey, when  the domains of the served and the servants were rigidly prescribed, the green baize door separated the two realms into precisely delineated classes.  To trespass into the the “other’s” territory was all but an assault on foreign territory.  Thus, the dis-inclination to divulge such information as CEO compensation to those below stairs.  The compensation packages are “too complex for the average person to understand,” and the recipients might be mislead by the statistical requisites necessary to calculate the ratios with any precision.

Further, the computations are an annoyance for the corporate management, confusing for the multi-national corporate structure, and of only moderate utility to the domestics.

What the Residents beyond the green baize door have decided, if we are to believe their January 2012 missive, is that the inconvenience to the Residents outweighs the value of the information to the Domestics.   Thus, on June 19, 2013 members of the House Financial Services Committee voted to protect the Residents on a 36-21 vote to repeal section 953 (b) and send H.R. 1135 to the floor of the house. [HFSC pdf]

If the Residents have their way, no more information about CEO compensation will flow down through the green baize door, and the amount of compensation received by the Executive Class will be consigned to the Hadalpelagic Zone as far beneath the waves as possible.  What could possibly go wrong?

*Signatories to the January 19, 2012 letter to Commissioner Shapiro: American Benefits Council, American Insurance Association, American Petroleum Institute, Business Roundtable, Center On Executive Compensation, Competitive Enterprise Institute, The Financial Services Roundtable, HR Policy Association, National Association of Manufacturers, National Association of Real Estate Investment Trusts,  National Association of Wholesaler-Distributors, National Investor Relations Institute, National Restaurant Association, National Retail Federation, Property Casualty Insurers Association of America, The ERISA Industry Committee,  The Real Estate Roundtable, Retail Industry Leaders Association Securities Industry and Financial Markets Association, Society of Corporate Secretaries & Governance Professionals, Society for Human Resource Management,  U.S. Chamber of Commerce,WorldatWork

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Filed under Economy, financial regulation, Politics

Lessons Not Learned: More Financial Follies

In case we’re inclined to listen to the likes of Senator Dean Heller (R-NV) and declare that “onerous regulations” are “burdening” our economy and slowing economic growth — here are some recent bits from the financial pages which should be a reminder that the Big Bankers haven’t mended their ways since the last time they blew up the economy:

Capital Adequacy:*   Seeking Alpha rates Morgan Stanley “cheap,” but includes a chart on capital adequacy that should give investors a moment of pause –  of HSBC, Wells Fargo, SunTrust, and USBancorp, none have a capital adequacy ratio above 11.5%.  BB&T, Northern Trust, Bank of America, JPMorgan, and Fifth Third are below a 12.5% capital adequacy ratio. [Seeking Alpha]

Risk Management:  There’s this from across The Pond – “The European Central Bank lacks an independent risk management authority and suffers from a disconnect between management and risk management authorities, at least as of 2010, according to an independent audit report released today. ” [Business Insider]

Meanwhile back at JP Morgan: “Little-noticed amid the furor over J.P. Morgan’s loss is a significant increase in the risk measurement of its commodities and fixed-income trading desks within the investment bank.” [WSJ]

“Past Lessons Missed in Failed JP Morgan Hedge..”  [Reuters] “Excessive leverage and complex credit derivatives were a big factor behind the 2008 financial crisis that led to the Dodd-Frank legislation being passed by Congress in an effort to reduce risks. Until JPMorgan’s losses became known in May, bank-led industry groups were gaining ground in trying to head off many key tenets of the derivatives reform regulation.”

Fall out from the Last Fiasco:  Shareholders filed suit contending that Ken Lewis, (Bank of America) bought Merrill Lynch and they were “not told about the looming losses, which would prompt a second taxpayer bailout of $20 billion, leaving them instead to rely on rosier projections from the bank that the deal would make money relatively soon after it was completed. ” [NYT]

Bankers are still lobbying to water down the Volcker Rule: “Under the proposed version, bankers would be permitted to do “risk-mitigating hedging activities” for “aggregate positions.” That means using derivatives or other products to reduce the risk of an entire pool of investments, as opposed to a single transaction or position. The JPMorgan loss has ignited a debate whether aggregate or portfolio hedging is appropriate at all and how to define and spot these trades.” [Bloomberg] As Rep. Frank put it, an aggregate hedging isn’t hedging — it’s a profit center. Hedges break even.

“Woman who couldn’t be intimidated by Citi wins $31M award.” Bloomberg. “she took her employer to court — and won. In August 2011, five months after the meeting with Polkinghorne, Hunt sued Citigroup in Manhattan federal court, accusing its home-loan division of systematically violating U.S. mortgage regulations. ”   And, the update to the case? “Citigroup behaving badly as late as 2012 shows how a big bank hasn’t yet absorbed the lessons of the credit crisis despite billions of dollars in bailouts, says Neil Barofsky, former special inspector general of the Troubled Asset Relief Program. ”   (emphasis added)

CEO Compensation:  Just as good as ever –thank you very much.

Catepillar is demanding concessions from workers after granting its CEO a 60% pay increase.  [ThinkProgress] Verizon is planning to lay off 1,700 employees after giving its CEO a $22 million compensation package last year. [ThinkProgress]

*”The Tier I capital ratio is a measure of the firm’s Tier I capital (consisting largely of shareholders’ equity and disclosed reserves) divided by the firm’s risk-weighted assets. We rank banking firms based on this measure to show which banks have the greatest capital strength after considering the riskiness of their underlying assets.”  [Seeking Alpha]

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Filed under banking, Economy, financial regulation

Coffee and the Papers

Breaking News: Yucca Mountain is still dead. [Las Vegas Sun] The Clark County, NV Republicans are still in disarray. [KTVN] [Las Vegas Sun] [WaPo] [KOLO] and [LVRJ]  The Ron Paul supporters are seeking “genuine conservatives.” [LVRJ]  And, do click over to NVProgressive for a description of what’s happening in NV-04.

Hearts and Flowers:  If you can read the President’s remarks at the graduation ceremony for Joplin High School graduates without tearing up just a bit, check your empathy chip and replace if necessary.

Breaking the News:  The typical CEO in the United States was paid $9.6 million in 2011, that’s up 6% from 2010.  Or, to put it another way, the CEO’s were paid what it would take the typical American worker 3,489 years to earn.  [RGJ]  Not to get all attacky on the capitalists or anything, but the worker’s earnings aren’t keeping up with worker’s productivity:

“Manufacturing sector productivity rose 5.9 percent in the first quarter of  2012, as output grew 10.8 percent and hours worked increased 4.6 percent.  The increases in productivity and output were the largest since the second  quarter of 2010. Over the last four quarters, manufacturing sector productivity increased 2.5 percent. Unit labor costs in manufacturing fell  4.2 percent in the first quarter of 2012 and decreased 1.3 percent from the same quarter a year ago.” [BLS]

Productivity is a nicer way to say “working harder and longer to make more stuff” and in this case for the same pay or less for doing so.  In this case “unit labor costs” (wages and benefits) declined while production numbers increased.  Declining “unit labor costs” usually mean declining spending power; declining spending power usually means decreasing demand.

Meanwhile in Xenophobia:  Noted citizen of Xenophobia, Representative Steve King (R-IA), drew criticism for equating immigrants to dogs during a recent town hall meeting. [Politico] This might help to explain why President Obama holds a 61% to 27% advantage with Hispanic/Latino heritage voters?  [The Hill]

The Romney Plan student loan plan “By The Bankers and For The Bankers:”  Here’s the former MA Governor: “Reverse President Obama’s nationalization of the student loan market and welcome private sector participation in providing information, financing, and the education itself.”  Here’s a critique.   And here’s a problem for the defenders of free market capitalism:

One of the nicer features of free market capitalism is the notion that he who takes the risk shall be he who gets the rewards.  That’s why some loans have higher interest rates than others.  The greater the risk taken the more interest should be earned to compensate for taking that risk.  However, the old Bush new Romney version stands that principle on its head.

Under the Bush/Romney plan the banks got a subsidy for making student loans, and then the federal government (using taxpayer funds) guaranteed the loans, so that the Banks earned the interest without actually taking any risk!  What the Obama Administration did was remove the Middlemen.  Since the taxpayers (government) were the ones taking the risks, the taxpayers (government) should be the ones earning the interest.  Interesting how the bankers are now bellowing about losing their “privatized earnings” on the “socialized risks?”  And by the way, there’s no “nationalizing” involved, private banks still make student loans and are perfectly free to do so — they just can’t expect taxpayers to subsidize them and guarantee their collection of interest earnings.

There’s more over at the Nevada Rural Democratic Caucus blog.

Dispatches from the War on Women:  “Five female Democratic senators pressed for legislation Wednesday aimed at closing the wage gap between men and women. The Paycheck Fairness Act would bring up to date the Equal Pay Act, which was signed into law by President Lyndon Johnson nearly 50 years ago.” [Politico] What you should know about the Paycheck Fairness Act here.   Senate Majority Leader Harry Reid (D-NV) will bring the measure up for a cloture vote (Yes, the Republicans are filibustering it) during the week of June 4, 2012.

Dispatches on the Despicable:  One so-called charity on behalf of American veterans has already been revealed as fraudulent. [HuffPo] Worse still, almost half of the 39 veterans charities received failing grades from the American Institute of Philanthropy. [HuffPo] The AIP has a web site Charity Watch which will assist donors who want to make certain their contributions are not misused or squandered. The organization advises donors to beware of organizations which use as much as 80% of their donations for more fundraising. [CW] Charity Navigator also has a ratings guide for organizations.

About that Federal Spending Mythology: Two handy charts —

Bloggy Mountain Breakdown:   H/T to The Sin City Siren for the link to this nifty graphic of the War On Women.   Have you been checking in on The Nevada View lately.  (highly recommended)   If you missed this piece on small businesses and the battle with the Big Box stores at Blue Lyon, click over there now.

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Filed under Economy, education, Immigration, Nevada politics, Obama, Veterans, Women's Issues, Womens' Rights, Yucca Mountain

The Fragile Notion of Shareholder Value

Once upon a time when Capitalism was in full bloom corporations cared about their investors, and deferred to their shareholders as the owners of the enterprises.  At least that is the way it is supposed to work.  Now, the best shareholders can manage is to catch a quick gleam from an executive’s eye, a wave of the hand, and some trite catch phrases about promoting “Shareholder Value.”   Unfortunately, what we’ve been looking at in this wondrous age of deregulation and dogma is a portrait of Capitalism under attack from the very people who purport to espouse it uxoriously.

If pleasing the shareholders were a prime consideration, then it would be self-evident that every dime that goes into executive compensation is ten cents out of the pockets of the people expecting dividend checks.  For example, some of this nation’s largest banks had a rough 2011, Goldman Sachs reported a decline of 67& in profits from 2010.  Morgan Stanley dropped 40%  But what happened while shareholders were getting bashed? The executives were merely getting bruised.

“Despite the difficult environment, New York firms paid roughly $20 billion in year-end cash compensation to their employees. The average bonus was $121,150, down just 13 percent from the year before as the head count shrank. In 2006, the year before the financial crisis, the average investment bank employee took home a bonus of $191,360.”  [NYT]

These figures don’t include non-cash compensation.   If a person is thinking that restricted stock options don’t affect shareholders — please, do think again.  There are at least two problems with stock option compensation.

The first problem is the dilution of shares.  WatsonWyatt defines this: “As options are exercised, the shares are issued and counted as outstanding. More shares at the same level of earnings mean lower earnings per share, thus the “dilution” effect.”   Lovely, just what I want to hear from my broker, my per share value is diluted by the guys and gals at the top.

A second issue encompasses the ramifications when a corporation decides to compensate executives at the expense of the shareholders instead of “the corporation.”  One primary concern is that the executives, hoping beyond hope that the price of shares will be vastly higher than when the options were awarded, will leverage (pile up debt) to the gunwales and when the ship starts to sink as happens often in business cycles, it’s the creditors, the ordinary investors, and the employees who take the biggest hits. [Tavakoli]

Another concern is predicated upon a very human weakness — i.e. Whatever Can Be Manipulated Will Be Manipulated.  With stock options came backdating.   The concept was simplicity itself: If the stock option was for a $20 per share price — why not back-date it to when the share price was $10? and — badda boom! — cash in.  This practice was usually perfectly legal, falling neatly into the Lawful But Awful category of human activities.  [NYT] What was NOT legal was failing to tell the shareholders how all of this pen-pushing was going to work when the investors approved compensation packages.  It wasn’t until FASB required stock options to be expensed that the practice and the surrounding furor died down.   Those Sarbanes-Oxley haters of “onerous regulatory burdens” should also note that back-dating is no longer an issue because under the terms of that statute all stock option issuances have to be reported within two days.

However, the manipulation of corporate assets and revenues is still an issue so long as such short-term executive compensation tricks of the trade, like stock option grants, are a significant part of executive management pay packages.  So, last month Goldman Sachs awarded $7 million in stock option grants to two top executives, [NYT] and last year several executives waltzed out of their corner offices with significant amounts of compensation.   Burger King’s profits might be down 13% but CEO John Chidsey left with $49.9 million for his services.  [WSJ] Carol Bartz, fired as CEO of Yahoo, parted with a tidy $23.1 million severance package. [NYT]

This is not to say that the whinging and whining about declining bonus pools has abated all that much, it hasn’t.  However, that is probably as it should be. If revenues are down, then the bonus pools should obviously decline.  Shareholders should watch for new gimmicks like the convertible bond.  Let’s say that an executive’s compensation is $1 million, with $500,000 in cash and instead of stock options the exec is given a bond paying about 8% to make up the remaining $500,000.  [DealBook video] Stock options, convertible bonds, whatever … this is still money that isn’t headed toward shareholder dividend checks or employees paychecks, or for that matter, being reinvested in the company.

Is asking about the level of executive compensation a matter of miserly shareholders, creditors, and employees not wishing to part with pennies, or is there a correlation between executive compensation and corporate performance? [HBR]

There is, but it’s not the one the executives want to hear.  A Purdue/Utah University study released in December 2009 reported (pdf):

“We find evidence that industry and size adjusted CEO pay is negatively related to future shareholder wealth changes for periods up to five years after sorting on pay. For example, firms that pay their CEOs in the top ten percent of pay earn negative abnormal returns over the next five years of approximately -13%. The effect is stronger for CEOs who receive higher incentive pay relative to their peers. Our results are consistent with high-pay induced CEO overconfidence and investor overreaction towards firms with high paid CEOs.”

Bloomberg News reported similar results:

Although there is no standard method for analyzing compensation, Crystal, 76, developed the formulas he uses over the course of 30 years advising companies such as CBS (CBS), Coca-Cola (KO), and American Express (AXP) on their pay practices. In an ideal world, Crystal and many investors agree, stock performance and CEO pay would be closely aligned. But no matter how he parsed the numbers, Crystal discovered no relationship between shareholder returns and CEO compensation. “

A quick observation about causation and correlation is required.  Some studies of specific industries, public utilities where executive compensation is usually lower, or a small study of local banks, do indicate a correlation between compensation and a corporations general performance. [Bentham] [Alabama] Nor should we overlook the short tenure of some executives, or the differences in the types of businesses in which they function.  What we can conclude with some certainty is that there doesn’t appear to be a direct correlation between executive compensation and share value over time, and there definitely isn’t an causal relationship that can be documented which would include all types of corporations in all manner of commercial pursuits.

Another factor which deserves more study is the relationship between investors and executives in terms of compensation. Are potential investors “turned off” by companies with lavish executive compensation packages?  Would there be more “buy orders” and hence higher share values if the compensation packages were not so extravagant?

There are resources for investors who want to evaluate the performance of CEOs in regard to share prices.  And, there is hope on the horizon that corporations will be more transparent on the subject:

“There have been many new laws passed to help satisfy investor concerns over executive compensation. Changes in SEC reporting requirements have forced companies to include an “Executive Compensation Discussion & Analysis” section to accompany all future pay documentation in all SEC forms. This section requires a “readable” explanation of how the compensation was determined and what it encompasses.” [Investopedia]

It isn’t all that comforting to find that many corporations weren’t fully reporting compensation to the SEC, or weren’t putting it in readable form.  However, there have been some improvements and for these we probably ought to be grateful if not exactly thrilled.

Executive compensation is one facet of the more general issue of shareholder control. Spokespersons representing the management side often argue that shareholders should not exercise control because  (1) they may be misinformed, (2) they may have “agendas,” or (3) they lack the technical expertise to make informed decisions.  An interesting, if highly technical study, published by economists from Northwestern University and the University of Chicago came to some intriguing conclusions: (pdf)

• “Shareholders should always control decisions about which they have no private information.
• Shareholders should not control some decisions about which they have private information.
• Misinformed shareholders should control some decisions.
• Shareholders with social/political/environmental agendas should control some decisions.”

While the bullet points may be confusing, what is clear is that the standard talking points from the executive offices do not mesh neatly with the realities of corporate management.

If publicly traded companies are fraught with issues of executive compensation, and more general questions about management/shareholder powers, are we better off with having private equity firms take over major companies?   Depends.  Should we simply invest in the hedge funds and let them buyout companies? Probably not.  A study from the University of Chicago (pdf) underwritten by conservative foundations ended by saying:

“Finally, what will happen to funds and transactions completed in the recent private equity boom of 2005 to mid-2007? It seems plausible that the ultimate returns to private equity funds raised during these years will prove disappointing because firms are unlikely to be able to exit the deals from this period at valuations as high as the private equity firms paid to buy the firms. It is also plausible that some of the transactions undertaken during the boom were less driven by the potential of operating and governance improvements, and more driven by the availability of debt financing, which also implies that the returns on these deals will be disappointing.”

One way to translate this would be to say — don’t get your hopes up because the deals may have been the result of market timing and cheap money.  Or even more simply — the hedge funds and private equity firms borrowed too much money to buy companies at prices that were too high.  A recipe for disappointing returns if there ever was one.

As more and more money from the 1%’ers flows into the accounts of private equity firms and hedge funds, what are we likely to see in terms of value for investors?  Again, there’s a mixed picture.  These are not for the faint of heart, as this description explains:

Determining whether this asset class is appropriate for clients begins with a clear understanding of these funds. The word “hedge” might invoke images of investors prudently covering their bets.  But hedge funds can be highly risky and super-volatile. In fact, dozens of hedge funds have suffered serious losses, shut down or filed for bankruptcy in recent years.  Being relatively unconstrained by SEC regulations that apply to mutual funds, hedge fund managers can and do use leverage, take short positions and invest in derivatives. Overall, hedge fund managers employ an estimated 15 to 20 different types of strategy, which Hedge Fund Research, the largest industry data tracker, groups into four broad categories, […]  For their vaunted expertise, hedge fund managers typically charge high fees, which industry critics cite as a value detractor.  The industry average is the so-called “two and 20,” 2% of AUM and 20% of the profits. In practice, management fees range from 1% to 3% and performance fees can be as high as 40% of the fund’s upside. [Securities America FA]

Right off the bat the investor should know that the “strategy” is proprietary information some of which may or may not be imparted, mostly may not.  So, for 2/20 or 3/40 the hedge fund management will take your money, invest it in something, with some mathematical (or not) formula for trading and portfolio management, using money you can’t get back for a specified period of time,  and then may or may not give you a satisfying result, or might give you what you could have gotten by putting the money in Treasury paper.  We can all hope that the investments by major players like pension funds with plenty of good old fashioned clout will make hedge fund managers more cooperative in terms of reduced fees and shorter “lock up” periods.

What would NOT be helpful for Capitalist America is to have more money flowing into more private hands with a paucity of transparency, less accountability, and practically no oversight. It is, indeed, an invitation to manufacture more  “creative” products cranked out for sale in the financial markets with esoteric alphabetic nomenclature and fizzling results.   We tried this — it didn’t work so well, as we found out to our horror in 2007-08.

Shareholders, the backbone of American Capitalism, have every right to expect to invest in a financial market that is as transparent as possible — after all isn’t the cornerstone of pricing the notion that both sides in a transaction have as much information as possible?  Investors also have the right to expect management to make decisions which improve the company’s revenue, promote growth, and insure that the company can pay off its debts — if a firm can’t do this it’s not worth the time it takes to put the prospectus in the shredder.  In order for these to be accomplished we need:
  • Laws and regulations which require full and complete corporate information regarding financing and operations, which is in readable and comprehensible form.
  • Enhanced shareholder control of corporate decisions.
  • Executive compensation which is adequately monitored and terms which include claw-back provisions to recoup losses resulting from poor management.
  • Increased oversight of private equity and hedge fund transactions to protect investors from outrageous fee structures and incompetent fund management.
  • Improved transparency from private equity and hedge firms when handling pension funds and other public investments.

Then we can talk about “shareholder value.”

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