May 27, 2005
I admit it. I love the show Mad Money hosted by Jim Cramer. Cramer is high energy, takes definitive positions on stocks, is tough in interviews of CEOs, reveals his strategies and logic on stock picking with disarming candor, and admits to his winners and losers (although we do not get a total). He also is genuine in his efforts to "make you money."
Here's the rub. The show undoubtly will encourage the home stock pickers to become day traders and lose their shirts. Empricial research by Terrance Odean at the Haas Business School has shown what pros in the brokerage business all know -- individual traders are suckers. ("All that Glitters: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors") They inevitably lose money to the pros. The best play for home traders is holding some form of investment indexed to a major market index -- an indexed mutual fund or an exchange traded fund (ETF). They minimize trading costs and hold a diversified claim on the market itself.
So the pros will applaud the success of Mad Money hoping that it encourages the marks to trade. Recent callers to the show, tauting gains ("I made 140,000 on your call on Google") should raise red flags. The testimonials (I assume -- hope-- are not stage by the show itself) mimic classic huckerterism. Listen to Cramer and enjoy his show. Do not select a few trades (urged on by the callers that tout big gains) and lose your money. Invest 60 to 85 percent of your money (depending on your abiltiy to take risks) in an indexed fund and put the rest in US Treasuries.
May 26, 2005
An investment firm, Relational Investors LLC, run by Ralph Whitworth, is worth watching. Academics for years have argued, and recently documented, that firms with better corporate governance procedures perform better than those without. Mr. Whitworth is putting is money behind the principle. He purchases a block of stock in poorly run firms, demands changes, and threatens proxy fights if the changes are not implemented. His current target is Sovereign Bancorp. Mr. Whitworth, among other things, has attacked the compensation of the seven member board. He argues that the directors are overpaid. They each recieved $313,000 last year, more than any other directors in the banking industry. Moreover, their pay is tied to whether executive bonus targets are met, giving the directors to set the targets very low.
On the announcement of Mr. Whitworth's involvement, the price of Soverign shares rose eight cents on an otherwise down day in the markets.
Mr. Whitworth, with money on the line, will attempt to identify real value-adding governance changes, not just stuff that may look good but add little value (number of independent directors, for example). His success--and failures-- will give evidence on what governance changes may count and what may not. Worth a watch. For more information on Sovereign and Mr. Whitworth click here
Settlement Funds: Grand Intentions, Poor Results
In April of 2003 the Securities and Exchange Commission (SEC),state securities regulators, and ten Wall Street investment banks negotiated a huge $1.4 billion settlement agreement. In exchange for the cash, the regulators agreed to drop its prosecutions against the banks for issuing misleading stock research on high-tech stocks. $900 million was "fines" (to be split among the regulators), $450 million was set aside to create an "independent stock research," and $85 million was set aside for investor education. (For full SEC story on settlement- Click here) The SEC should have take it all in cash. The set asides, creating funds that have to be managed by someone, have been nothing but trouble.
The $85 million for investor education gave $55 million to the SEC and $35 million to the states. The SEC program has collapsed. Its top executives are resigning and its board members are soon to follow. Now the SEC wants to give its share to a foundation run by the National Association of Securities Dealers (NASD). The federal and state money has, of course, created a new industry of consulting firms and not-for-profit organizations that apply for investor education grants. The grant winners produce lame ad campaigns warning investors of scams. Some attempt to teach investors the basics of investing, which may falsely encourage them to pick stocks on their own. Most all individual investors should go with some form of indexed investing; research has shown that individuals trading stocks for their own accounts is a sucker play.
May 25, 2005
Mergers as Regulatory Arbitrage
Three big deals in the electric utility industry depend on Congress repealing a piece of new deal legislation, the Public Utility Holding Company Act of 1935 (PUHCA). MidAmerican Energy Holdings Co., a company dominated by Warren Buffett, has agreed to buy PacificCorp (full story- click here); Duke Energy Corp has agreed to purchase Cinergy Corp.(full story- click here); and Exelon Corp has agreed to puchase the Public Service Enterprise Group. (full story- click here) All three deals are questionable under a literal reading of PUHCA.
PUCHA, among other things, limits public utility companies to those that operated in a "single area or region." It also favors intrastate, local companies over large regional companies.
For years the SEC, responsible for enforcing the Act, has on very losely enforced the act. A hearing judge inside the SEC recently stunned everyone when he ruled that the SEC erred in approving a 2000 acquisiton of Central & South West Corp. by American Electric Power Co. The hearing judge said simply that the SEC had ignored PUHCA in approving the deal.
Congress is now moving to repeal PUHCA in an obscure provisions in a huge omnibus energy bill than has passed the House and is now in the Senate. (Senate Panel approves Repeal- full article) The three proposed utility mergers may depend on the success of the bill.
The repeal of PUHCA makes sense. The Act created structural limits on utilities that misbehaved in the 20s by defrauding investors through the use of stock pyramind schemes. In essence, the Act responded by limiting size. We now have more powerful legal protections in place against large companies and the size limitations have adversely affected the efficiency of the industry.
If Congress does repeal PUHCA we will see a tsunami wave of mergers in the utility industry. Congress will have opened the floodgates. They are many, many localized utility companies that will be takeover bait.
Friedman on CEO's
Thomas L. Friedman's column in today's New York Times, "CEO's M.I.A.", is a classic. He complains that United States CEOs are not stepping up to the plate and lobbying for political reforms necessary to keep the country competitive in the global markets. The result? We will be a third behind China and India in economic "power." Using a paper title by David Rothkopf we will no longer be "Running the World."
What political reforms should CEO's support? Some form of national health coverage; more federal money for science research; a "sane" energy policy; successful completion of Cafta and WTO agreements; and an end to "reckless deficits."
There is much to say in response. First, CEO's main responsibility is running their companies to make a profit, not running the country. The legal system is the primary responsibility of our elected politicians, who should consult with, among others, our CEOs when they legislate on financial matters.
Second, CEOs are not of one mind on the list of issues Friedman wants resolved. For example, national health coverage and a national energy policy are code words for a socialization of an otherwise private system. Many believe, as I do, that relying on a private system is preferable to a federalized system in either health or energy. Reckless deficits is a code word for the budget problems caused by the Iraq war. Some CEOs may support the our government's efforts there and understand that war related deficits are inevitable.
In other words, Friedman wants CEOs to lobby for Friedman's personal policital agenda. And if they do not, China will eat our lunch? How silly is this.
Our CEOs will best determine how we compete with China and India by doing a good job running their companies. The most we can expect from our CEOs is that they understand the importance of our government's legal regulations of American business and that they communicate their views, which will often clash, to our elected officials. It is our elected officials that can aid, at the margin only, the CEOs in running their businesses by creating a legal climate that facilitates and does not retard their efforts.
May 24, 2005
There is a wonderful article in today's Wall Street Journal of the rhetoric from CEOs on the announcement of a new large merger or acquisition. The reporters took some of the most disasterous mergers of the last ten years and revisited the announcement language, full of spin and puffing. The reporters made the point the that real reason for the mergers, such as a thorny CEO succession problem or a looming product disaster, are never revealed. One wonders how, in a securities regime based full disclosure of all "material" information, we tolerate legally this "speechifying."
A study by Charles E. Lucien, a consultant for Booz Allen Hamilton, on executive tenure showed some surpising results for United States companies. American excutives of underperforming companies have longer tenures than executives of underperforming companies in other parts of the developed world. The study comes on the heels of comparisions between American companies and European companies on shareholder voting, one share one vote sytsems are much more common in American corporations than European corporations. So with more minority shareholder voting power and litigation rights, American corporations still somehow protect the executives of underperforming companies.
Anti-Business Graduation Speakers
For years I have had to sit on stage in full regalia and listen to at least one of the graduation speakers, be it student, fellow faculty member or invited guest, exort the law graduates to not "given in to the siren of money" and just practice business law. This year was a pleasant interlude as I was the faculty speaker and the invited speaker, an intentional human rights lawyer, was critical of the Bush's administrations refusal to sign various international treaties and critical of American military prisons.
In any event, for the record, the practice of business law is socially useful when done ethically and great way to feed a family. For a clever book on the importance of the corporation to modern society see, Micklethwait and Wooldridge, The Company: A Short History of a Revolutionary Idea, New York: Modern Library Chronicles, 2003.
New Law School Will Focus on Business Law
Drexel has decided to enter an already overpopulated market, starting a new law school to produce law grads. The new school will focus on, among other things, business law, however, in an effort to create a market niche for itself. (Click here for full article) The strategy mirrors the successful strategy of several other schools (Columbia, Vanderbilt, George Mason, among others) that have increased their standings by beefing up their business faculty. The school will open in 2006.