Business Law Prof Blog

Intrade: Alito is the Next Supreme Court Nominee

  At 4:00 today on the Intrade futures markets (explained) Judge Samuel Alito went from 11 cents on the dollar to over 50 cents on the dollar in a few minutes.  The bid price settled at around 35 an hour later with a substantial spread to the ask price at 43.  Strong ask price support in the 40s remains.  Alito jumped over all the other potential nominees with the price increase.  The previous high contract had been McConnell at 17 cents on the dollar; he has fallen to 6.  Luttig is trading at 16; he is the apparent fallback pick.  All other candidates are trading at insignificant prices.

The insider money may have joined the betting and Alito looks to be the front runner as the next nominee.

Disney/Ovitz Case Still in the News

Posted by Bill Sjostrom

First, this past Monday Disney shareholders filed an appeal of Chancellor Chandler's decision in favor of Disney's board of directors in the shareholder suit arising out of the Ovitz $140 million severance payment.  Story. I'm not sure how this squares with earlier reports that Disney settled the case to avoid an appeal.

Second, Reuters reports that in a recent speech to a directors group Chancellor Chandler called on directors to rein in soaring executive pay:

The entire matter of executive compensation, which seems in some cases to have come spectacularly unhinged from the market for corporate talent, will either be regulated by you the fiduciaries, or by the politicians . . . . If neither the courts nor the markets are able to restrain executive compensation, and if you the decision-makers fail . . . the result will be imposition of regulatory controls.

These are interesting comments considering Chancellor Chandler's ruling in the Ovitz case. They indicate to me that he would have liked to sock it to the Disney board thereby delivering a message to all boards, but, as should be the case, he was constrained by the rule of law, in particular the broad protection afforded boards by the business judgment rule.

Libby Indicted: Does Fitzgerald Have a Conflict of Interest??

Special Counsel Patrick Fitzgerald indicted Lewis Libby for perjury and obstruction of justice in Fitzgerald's investigation into a leak of the identity of an undercover CIA agent.  Asked how he could indict no-one for the leak and yet indict Libby for perjury, Fitzgerald used a baseball analogy. Story  The pitcher hits a batter and the umpire is trying to figure out whether it was intentional, but the umpire (prosecutor) is impeded by the pitcher "throwing sand in his face."  The sand throwing is itself serious and a crime says Fitzgerald.  Yes, but the victim of the sand throwing is the umpire, who is angered a bit by the impediment and yet it is the umpire who now prosecutes the sand thrower.  The victim as prosecutor (or prosecutor as victim) in these cases has always struck me as a conflict-of- interest.  Prosecutors do not like it when they believe they have been intentionally lied to; they get angry, like all victims get angry.  And Fitzgerald did not like it when he thought his investigation had been impeded. 

I have always believed in such cases that the angered prosecutor in such cases should turn the case over to a new, independent prosecutor for the decision to pursue an indictment before a grand jury.  [Oesterle]

Takeover Plays by Hedge Funds: Should We Care?

  In the Mylan takeover of King, Carl Ichan was long in Mylan and short in King.  He thought Mylan was paying too much and wanted to stop the deal.  If he was successful stopping the deal, he believed Mylan shares would go up and King shares would go down.  To get a play on both sides he sold King shares short while voting his Mylan shares against the deal (in a contested proxy contest).  A hedge fund could also take the opposite side, selling Mylan short and going long in King shares, hoping the deal would close.  In most deals, on the announcement the target shares appreciate in valve and the bidder shares depreciate (or are neutral).   The difference between the bid and the target share price after announcement but before closing is a discount reflecting the liklihood that the deal may not close;  the difference between the lower bidder share price after announcement and before closing and the even lower bidder share price on close is similarly a discount on the liklihood the deal may not close.

Should we care about such hedges?

No.  I have heard the argument that the latter hedge, long in the target and short in the bidder, encourages the holder of the hedge to vote (or otherwise encourage) the target to close no matter what, even if it could negotiate successfully a higher price from the bidder or a third party, new bidder.  The hedge fund would not be neutral to any changes in price between the two parties;  a higher price would produce gains in both positions, the long in the target and the short in the bidder.  Similiarly a lower price would decrease both positions.  A new bidder with a higher price would, however, increase the gain in the long position in the target but generate losses in the short position in the bidder;  the gain may not be large enough to maximize the position given the loss.  So a hedge fund may have a stake in closing the deal and acting to block new bidders.  The problem with the argument is that the two events are interrelated.  A new bidder might cause the existing bidder to raise its price in response;  if the existig bidder prevails the hedge fund maximizes gains.  In sum, there is no pure, fixed incentive to stop outside bidders and we should not create legal rules to stop the practice...

If a hedge fund is long on both sides, the bidder and the target, to lock in an arbitrage gain from different disounts on whether the deal will close (the bidder's stock reflects a higher probablity of closing that the target's), then the hedge fund has a stake in the deal closing, but a new bidder at a higher price maximizes gains.  Only when a fund is shorting both sides (the target stock is reflect a much higher probablity of the deal closing than the bidder's stock) will the fund encourage a broken deal with no higher bids from new bidders..  Both positions are very hard to calculate, however, (the bidder's discount is tough to figure out accurately) and the latter, short/short position is too risky.             

Hedge Funds: Successes and Failures

Jenny Anderson's Insider column in today's NYT chronicles a hedge fund raid on BKF, a publicly-traded asset management company.  Several hedge funds, led by Steel Partners and Cannell Capital, bought shares in BKF, waged a successful proxy fight and elected three new board members (forcing out, among others, Burton G. Malkiel a noted Princeton professor of economics), eliminated the firm's poison-pill plan, and pushed out the firm's CEO.  The funds sought to increase share value by increasing BKF operating margins, which were below industry averages.  For their efforts the funds lost big; stock has fallen 39 percent since last December and BKF continues to hemorrhage clients. 

The raid illustrates how and why hedge funds are so active.  Because hedge funds hunt in wolf packs (one announces a position and others follow), they do not trigger anti-takeover defenses.  Most poison-pill plans and other defenses are triggered by an unwanted stock acquisition of 10 percent or higher.  No one fund has ten percent and the funds are not collectively a single group because they act alone, not in organized explicit concert.  The five percent trigger of 13(d) is not a problem, indeed it can be an advantage, as one hedge fund goes over five percent and announces in a 13(d) filing what its plans are so as to encourage other hedge funds to join in. 

Once the funds take over 30 percent of the public float in the stock they have (or threaten) effective control over board elections.  Most managers capitulate and do what their new largest group of shareholders wants;  those that do not lose in BKF style proxy contests.  The key is the hedge funds' ability to circumvent a firm's anti-takeover defenses by flying under the stock accumulation triggers.

Why do firm's not declare that the hedge funds have triggered the defenses by acting as a group?  Because once triggered a poison-pill defense wrecks the financial structure of the firm for everyone, not just the unwanted bidder, by creating, among other things, situations of severe, uneven stock dilution or a severe captial drain.  The poison-pill plan trigger stops firms from using other defenses that do not wreck the firm (business combination freeze-out triggers, for example) because a declaration that they are triggered will also trigger a poison-pill plan.  The poison-pill plan becomes a firm liabiltiy!

It really is a game of chicken and the hedge funds have called firms' bluffs and forced them to swerve.  If the funds' prescriptions for corrections are correct, the funds profit on a stock price increase.  If incorrect, they lose big.

Fat Profits of Oil Companies Get the Hill’s Attention

The New York Times reports today that following third quarter announcements of fat profits by Exxon Mobil, Royal Dutch Shell and BP, the "windfall" profits tax debate is heating up on the Hill.  The discussion in congress reminds some people of similar measures in the 1970s, and some of the voices in the tax debate may surprise you. 

Senator Bill Frist, the Republican leader, said yesterday that executives of major oil companies will be summoned to Capitol Hill to testify about high energy prices . . . "If there are those who abuse the free enterprise system to advantage themselves and their businesses at the expense of all Americans," he said, "they ought to be exposed, and they ought to be ashamed." 

Frist has suggested that Congress should pass a federal anti-price gouging bill.  Gouging Post

The sharp rise in profits for these oil giants was largely attributed to the disruptions caused by Katrina and Rita.  For more coverage click here.

Hedge Fund Paranoia: Fretting Over the Mylan/King Deal Hedge

  The Mylan Laboratories covered short by Perry Corporation, a hedge fund, has captured the attention the the anti-hedge fund crowd. See David Skeel.  Here is the background.  Mylan made a bid for King Pharmaceuticals of $16.00, King shares traded after the bid at about $12.00 because several Mylan shareholders (Carl Icahn, no shrinking violet, was one of them) thought the price was too high and wanted to block the closing of the deal.  Perry bought the target shares, King shares, at $12 and hoped the deal would close at $16 so he could make $26 M or so.  Nothing novel about this. 

What infuriated Icahn, got the attention of the SEC and is the subject of comment by the anti-hedge fund crowd was what Perry did next.  He bought 9% of the outstanding shares in Mylan, the bidder, and shorted 9% of the shares at the same time; he entered into a covered short.  In other words, he bought 9% of the shares in the markets, borrowed another 9% of the shares (for 30 days or so), and sold the borrowed 9% of the shares back to the markets.  In the end, Perry holds 9% long and owes 9% to the share lenders in 30 days, the short. [The details were not revealed.]  In a covered short, the owner takes no risk on the price of the stock -- price increases, the gain on the long position offsets the loss on the short -- price decreases the short gain offsets the loss on the long position.  The only cost is the transaction cost of buying and clearing the two positions.  Why do the covered short?  Perry could vote the shares held long in the bidder in favor of the deal to make money on the close in the target.  It looked like Perry was vote buying in the bidder to make a gain in the target.  In voting to close the deal he would be voting against the best interests of the bidder without suffering the economic consequences, a drop in the price of the bidder's stock due to its overpaying in the deal.

This strategy is not as dangerous as Skeel and others make it out to be.  Perry could vote the 9% he held long in Mylan to vote in favor of the deal, but someone else votes the 9% he sold short against the deal if indeed the deal was a bad one for Mylan.  The votes wash but now there is a 9% yes vote on the deal that did not exist before the covered short.  The yes votes do not come free.  Perry will pay for it in the costs of borrowing the stock from a knowledgeable lender, who knows about the covered position and will discount the risk of losing share value in the rental fee (especially before a vote). 

It is as if Perry borrows the stock, votes it and returns to the lender after the vote (also a common hedge fund ploy).  The lender will charge in the rental fee for potential damage to the stock value generated by the unfettered voting, particularly if the stock is borrowed before a vote.  [One arrangement would charge Perry a fee plus hold the lender harmless for any loss in the stock during the period of the lease.] Perry's cost of a vote to against the company's interest would be close to what he would lose if he owned the 9% block of shares outright. 

If Perry buys a straight 9% of Mylan to vote against Mylan's best interest, he has a right to, but is not likely do so; he understands that he is unlikely to influence the outcome if the deal is truly bad for Mylan  -- he will be outvoted. [If he owns enough to be a controlling shareholder of Mylan, a traditional duty of loyalty case law applies to remedy, if need be, his conflict of interest;  nothing novel.] It is more likely that he has assessed that the deal is good (or at least neutral) for Mylan and he wants to help it close over what he believes to be ill-considered objections (Icahn's).

Suppose Perry did the minimum and just bought the right to vote 9% of the shares (probably an illegal arrangement under existing law).  A knowledgeable seller would make Perry pay full value for the potential damage to the underlying stock when the seller sells the votes (perhaps more to account for the unknown risk of what Perry could do); Perry's costs will be the same value (or more) as if he owned the shares outright.  Again a sensible fee would include a hold harmless payment against loss in the value of the stock around the time of the vote.

Note that in the Mylan deal, Icahn, the complainer, was shorting the shares of King while he was trying to block Mylan deal.  He also was on both sides of the deal!  I would argue, however, that he similarly did not pose a threat -- this is another post, however.

Why these deals panic smart people is beyond me.  Hedge funds look sinister to these folks somehow, yet they operate within the rules and take financial risks.  When they are wrong the lose money and when right they make money.  Moreover, they provide a real service -- they move prices faster to reflect available information and they are an outside influence on the operation of companies, many of which should restructure but are slow to because of manager's vested interests.  See Wendy's post.  [Oesterle]       

Trading in Delphi Shares

As is typical, Delphi’s shares were delisted from the NYSE following its bankruptcy filing.  Delphi’s shares now trade on the Pink Sheets under the symbol DPHIQ (they’re currently at $0.39, click here for an updated quote).  The Financial Times reports today that Delphi has obtained an interim court order prohibiting anyone owning 2.5% or more of Delphi shares from trading in the shares without permission from Delphi or the bankruptcy court.  According to the article, “[c]ompnaies typically try to restrict trading after bankruptcy filings to protect tax losses, which can be lost if there is a change in control.”  Bankruptcy courts grant these restrictions because the availability of tax losses increases the value of the bankruptcy estate.  Appaloosa Partners, a hedge fund that has bought 9.3% of Delphi’s shares following Delphi’s bankruptcy filing, is challenging the Delphi prohibition. 

Miers' Withdrawal

Posted by Bill Sjostrom

Well that was certainly anticlimactic.  Now what are we supposed to do with our free time?  The Plame affair?  More blogging about municipal bond flipping?

In a somewhat perverse kind of way, I was looking forward to the Miers hearings.  Unlike Larry Ribstein, I do occasionally watch reality shows (Survivor in particular).  With the withdrawal, we've lost out on daily CSPAN episodes of “Harriet Miers' final tribal council."  Atleast it's still football season.  Go Irish!  Go Bengals!

Lawyers to Investment Banks: Hersch Leaves Firm Goes to JPM

Elizabeth Moyer at Forbes.com is reporting that the head of M&A at Davis, Polk & Wardwell, Dennis Hersch has decided to leave Davis Polk and head for JP Morgan.  According to the article, which can be found here, JP Morgan's COO, James "Jamie" Dimon has convinced Hersch to join JP Morgan in January as chairman of the firm's mergers and acquisition advisory group.  This move by JP Morgan is nothing new, Citigroup has hired Lewis Kadan, also from Davis Polk, as chief administrative officer, and Morgan Stanley hired David Heleniak, a senior partner and mergers expert from Shearman & Sterling.

Time to Add a Lap Dance Clause?

Posted by Bill Sjostrom

Following up on this post, if the Savvis board does decide to fire the "Lap Dunce" as he's been dubbed by the press, will it be a "for cause" termination under his employment agreement?  Obviously, this depends on what his employment agreement says, but I suspect there would be a strong argument that it was not for cause if what McCormick did was not illegal or did not violate company policy.  This post discussed the expanded definition of cause Disney included in Iger's recent agreement which may have been motivated by the Ovitz situation.  Will Savvis now include a "lap dance" clause in its future employment agreements?  Celebrity endorsement contracts often provide that the contract can be terminated if the celebrity does anything that "embarrasses the sponsor or in any way causes damage or harm to the reputation or goodwill of the sponsor."  I think having it publicized that you spent maybe as much as $240,000 in one night at a strip club would fall within this language.  It certainly makes sense from the company's perspective to have a broad out like this in an executive employment contract, but given the shortage of quality CEO canidates, companies may not have the bargaining power to get it in.

Chipotle Files for IPO

Posted by Bill Sjostrom

Last night Chipotle Mexican Grill, Inc., a majority owned subsidiary of McDonalds, filed with the SEC for a $100 million IPO of Class A Common Stock.  Click here for the registration statement.  Chipotle's capitalization also includes Class B Common Stock with super voting rights, most or all of which will be owned by McDonalds.  Hence, McDonalds will maintain voting control, notwithstanding the IPO.  Chipotle will be another example of what this post referred to as a public totalitarian regime, i.e., a public company controlled by one or a few shareholders.

Incidentally, I recently looked into how many calories are in a Chipotle steak burrito and was stunned to learn that there are a whopping 1,200+.  That's more than two Big Macs and about 60% of the recommended daily intake of calories.  Click here to check the number of calories in your favorite Chipotle burrito (note that this is not the Chipotle site as Chipotle does not itself provide nutritional information).  Chipotle includes the following in the Risk Factor section of its IPO prospectus:

In recent years, there has been an increased legislative, regulatory and consumer focus on nutrition and advertising practices in the food industry. Restaurants operating in the quick-service and fast-casual segments have been a particular focus. As a result, we may in the future become subject to initiatives in the area of nutrition disclosure or advertising, such as requirements to provide information about the nutritional content of our food, that could increase our expenses.

On an ironic note, McDonalds announced yesterday  that it will be including nutritional information on its packaging.  Cick here for an article.  And recall that the House just passed the Cheeseburger Bill.

Your CEO Bills $241,000 at a Strip Club; What Does a Board Do?

  The board of directors of Savvis Inc., a St. Louis based company, faced an unusual public relations problem.  The CEO, Mr. McCormick, refused to pay a $241,000 bill from American Express for charges incurred over one night at a Manhattan strip club, Scores.  Mr. McCormick claims he owes only $20,000.  Apparently he enjoyed the benefits of the "President's Room."  Mr. McCormick did not submit any part of the bill to the company for reimbursement.  Apparently, strip clubs are gaining popularity, behind golf courses, ski slopes and ball games, as entertainment venues for negotiating business deals and entertaining business clients.  What did the board do?  Suspended the CEO without pay pending an investigation.  What are they investigating?  Whether any illegal payments were involved?  If none were and the payments were all for drinks and dances, then what?  If for a business deal should the board fire the CEO for poor business judgment?  If not for a business deal (it was entirely personal) should the board fire the CEO for boorishness?  [In Quebec, the revelation would make you a front runner for the Parti Quebecois. leadership. here]  Stay tuned.

We will no doubt soon see the case in a Harvard Business School case study in ethics. 

Flipping Municipal Bonds

posted by Bill Sjostrom

According to a recent academic study, institutional investors are routinely flipping municipal bonds.  Click here for a Bloomberg article describing the study. 

Flipping is common in the stock IPO market.  It involves buying shares at the IPO price and then reselling or “flipping” them once trading has begun.  Assuming the stock enjoys a first day pop, as many IPOs do, it’s a relatively low risk strategy for making a quick profit.  An IPO pop, however, indicates that money was left on the table by the issuer, i.e., the issuer could have sold the stock at a higher IPO price.  At the same time, a little money was left on the table by the underwriters of the deal as their compensation is tied to the gross proceeds of the deal (the number of shares to be sold is typically fixed, so a lower per share price results in lower gross proceeds).

Flipping of municipal bonds is slightly different:

Let's say a bond with a 5 percent coupon due in 20 years is priced at 100, to yield 5 percent.

A big mutual fund manager gets a block of these bonds at 100. He sells them a week later at a price of 102, which has the effect of lowering the yield on those bonds to 4.84 percent.

This indicates that essentially taxpayer money was left on the table by the municipality selling the bonds:

A municipality that borrows $1 million at 5 percent pays back $2 million: $1 million in principal, and $1 million in interest. A municipality that borrows the same amount at 4.84 percent pays back $1 million in principal, and $968,000 in interest.

The underwriters, however, did not leave any money on the table here because like with an IPO their compensation is tied to the gross proceeds of the deal which are not impacted by the interest rate.

I’m not familiar enough with municipal bond underwriting to know whether there are sound reasons to under price municipal bonds at issuance, but on its face it appears questionable.  There is much less guess work involved in pricing bonds than IPOs--for bonds, the market readily dictates the appropriate interest rate.  It reminds me of the mutual fund trading scandal where hedge funds were allowed to engage in late trading and market timing to generate low risk profits at the expense of everyday mutual fund investors. 

Note that most provisions of the Securities Act of 1933 do not apply to municipal bonds because section 3(a)(2) of the act exempts these types of securites from coverage.  Section 17 (anti-fraud) does, however, apply as well as the anti-fraud provisions of the 1934 Act (rule 10b-5).

Reflections on the Cendant Breakup

  The decision of Cendant to break up into four companies to release shareholder value,. Post, comes of the heels of several other shareholder-induced large spin-offs.  Voluntary, out of bankruptcy, break ups are becoming commonplace.  This is a major development.  In the not to distant past, managers of large publicly-traded companies, who prized size over shareholder value, would resist such break ups until forced into bankruptcy or they lose a takeover battle.  But takeovers by leveraged buy-out funds have been restrained by state statutes.  The new development is seemingly a change in philosophy by incumbent mangers; they now seem to be more open to releasing shareholder value even if it means breaking up a solvent company.  The appearance of sharp hedge funds as shareholders and executive's compensation packages that include options sensitive to jumps in stock price may have come together to produce the long overdue practice.   

Bernanke to Replace Greenspan

  The President has nominated Ben Bernanke to replace Alan Greenspan on Jan. 31, 2006 as Chairman of the Federal Reserve System (the Fed), subject to confirmation by the Senate.  He is extremely accomplished and Senate confirmation should not be difficult.  Some are worried that his "inflation-target" philosophy will constrain his willingness to "create jobs."  The worries are misplaced.  Indeed, his inflation-target theory, if he stays with it, will be a positive development in the leadership of the Fed.  ...

At present the market hangs on every word of the Greenspan, attempting to anticipate his interest rate decisions.  For traders know that with each interest rate decision comes a stock and bond market reaction.  Guess right and you can make some money.  Simply put, there is too much discretionary authority in one man to affect significantly the trading markets.   Bernanke is on record touting the benefits of a more predictable Fed rate decision procedure.  Predictability and market stability would come from a set inflation target, known in advance by all.  Rate decisions would be automatic in response to whether inflation was inside our outside the target.  If inflation is within a target there would be no rate change;  if outside the target the rates would change to bring it back inside the target. 

Critics of such an approach want the Chair of the Fed to be a Mr. Fix-it for a declining job market;  they want he to "create jobs."   This asks the Fed to do to much.  The Fed does not create jobs, business does.  Moreover, asking the Chairman of the Fed to use short term interest rate stimuli, regardless of its effect on inflation, to spur business growth whenever political winds blow in that direction is a recipe for long-run economic instability.  The resulting price instability in the markets will have long-term substantial costs.  It is eating the hen that lays the eggs.   

No Congressional Sarbanes-Oxley Relief for Small Companies

BNA reports that at a recent panel discussion Rep. Oxley acknowledged the legitimate criticism of the impact of Sarbox on small public companies.  He believes, however, that it is unlikely Congress will address the problem.  “If somebody is hoping Congress will ride to the rescue, you can put that thought aside.”  Instead, he states that it is up to the SEC and PCAOB to address the problem.  This makes sense given the expertise of these regulators, provided there is enough flexibility under Sarbox to allow regulatory fixes (I believe there is).  But it assumes that they will act.  To date, the SEC has only provided short-term relief by postponing the Section 404 compliance date for businesses with capitalizations up to $75 million from 2005 to 2006.

Speaking about Sarbox generally, Oxley stated:  “Given the checks that we've got in it, given the transparency of the process, the increased penalties and the increased oversight, there's far less chance that you're going to see" high-level corporate frauad.  Presumably, he doesn’t count Refco because, as Larry Ribstein points out here, the full breadth of Sarbox didn’t yet apply to it (and even if it had, it probably wouldn't have prevented the fraud).  [Bill Sjostrom]

Breaking Up To Release Shareholder Value

Today, Cendant Corporation (NYSE: CD) announced that it would be breaking itself up into four separate publicly traded companies. (AP Report can be found here).  Cendant, which owns Orbitz.com and Ramada and Howard Johnson hotels, will create 3 new companies each focusing on a separate area.  The four proposed companies will be broken up into a hospitality business (including Ramada and Howard Johnson), a real estate business (Century 21 and Coldwell Banker), a travel booking business (Orbitz.com), and a car rental business (Avis and Budget Rent A Car).

In its news release, Chairman and CEO Henry R. Silverman stated "We and our advisers believe the sum of the parts has a value in excess of our current share price."

This move by Cendant is has become popular as of late.  Viacom (NYSE: VIA.B) has already announced that it would be breaking up into two separate companies, one focusing on broadcast television, such as CBS, and the other on cable networks, such as MTV. (Prof. Oesterle discussed this in his post, Viacom Files S-4 for Split into Two Companies).

Also, rumors on the street have also discussed a possible break up of Altria Corp. (NYSE: MO) into Kraft Foods, Phillip Morris, among other companies.  Wendy's (NYSE: WEN) is planning on spinning off Tim Horton's, which Prof. Oesterle discussed in his post, An Example of The New Strategy of Hedge Funds: Wendy's.  McDonald's (NYSE: MCD) has also announce that it plans to spin off a minority stake in its Chipotle restaurants to increase shareholder value, which Prof. Oesterle discussed in his post, Will Ronald McDonald Put on His Smiley Face for the Hedge Funds.

After the announcement, Cendant is trading up $1.06 to 21.15, a gain of 5.28% in pre-market trading.

[Jason Job]

Are Investors Rational??

While doing some research for a recent investment, I ran a Google search on rational investing in S&P 500 funds.  I was looking for some information on whether it would be more rational to invest in an ETF or a standard S&P 500 tracking mutual fund.  I never did find anything which answered my question for my personal situation, but I did run across a very interesting article by Edwin J. Elton, Martin J. Gruber, and Jeffrey A. Busse.  The article is entitled Are Investors Rational? Choices Among Index Funds, and a copy can be found here in MSWord format.

First, I must note that the article has used a few formulas and statistical regressions, so it might not be an easy read.  However, the authors do an excellent job describing their results.

Next, I found some startling facts regarding the performance of S&P 500 mutual funds.  For example, among the 52 open-end S&P 500 index funds used in the survey, from January 1996 to December 2001, the difference in annual return between the best performing and worst performing S&P index fund was 2.09 percent per year.

Additionally, the authors do show that cash flows and performance are statistically significant, but they find that it is much weaker than they expected, based on rational behavior.

Finally, the authors find that, even though they expect mutual fund investors to be "rational" and allocate their money to maximize their economic payoff, the article shows that this was not the case.

I found it an extremely good read and strongly recommend it.

[Jason Job]

Executive Compensation Revealed

Gretchen Morgenson, whose Sunday NYT column should be required reading for all business law students, reports on a video of Ed S. Woolard, the ex-CEO of Du Pont, that reveals how CEOs work around compensation committees of independent directors to get sky high salaries.  In 2004 the average pay package for a CEO was $10 million, up a whopping 13 percent from 2003.

The compensation committee hires an outside consultant who asks the Human Resources Director of a company what the CEO wants.  The CEO sets the figure and the outside consultant writes a report justifying the figure on comparables.  The comparables are from other companies in which the CEO can also control his or her own salary.  The report goes to the compensation committee and the committee sets the salary in the "top half" of the comparables, otherwise it would be a vote of "no confidence."   The new salary of one CEO is then used for comparables of others, who also want "top half" compensation.  The salaries thus ratchet each other up.  Relying on compensation committees of independent directors is thus a demonstrable failure.

Woolard recommends that consultants be prohibited from asking the H.R v.p., or anyone else inside the firm for that matter, what the CEO wants.   These internal communication bars never work, however.  Enforement is impossible and back channel leaks are inevitable.

The situation is so bad that the requirement of a supermajority shareholder vote of approval (e.g.,majority of outstanding independent shares or sixty percent of shares voting) for any raise may be the only method of breaking this culture.