May 18, 2006
A new study by Gabaix & Landier, discussed in today's New York Times article by Tyler Cowen, comes to the shocking discovering the CEOs are paid more if their firms are larger. An increase in firm capitalization is correlated with an increase in CEO pay. Duh; this is the age old motivation for empire building. A larger firm pays more so make your firm larger (even if not justified by gains in efficiency). Moreover, it is not much of an economic justification for high pay. Salary of line workers does not depend on capitalization of the firm for which they work; it depends on replaceablility of the worker -- the market for labor. Are CEOs replaceable? If so, the labor market should be more competitive and salaries should reflect the competition. The study notes that replacing one CEO with another in the top 250 CEOs does not make much of a difference in firm value.
Ohio and Indiana Bidding For Honda Factory
On the heels of the Supreme Court case that refused to reach the merits of whether state tax incentives are unconstitutional, Ohio and Indiana are bidding against each other for a new Honda automobile factory. Both states, suffering from the loss of manufacturing jobs, will pull out all the stops in this bidding war. No tax incentive will go unoffered. The problem, of course, is the winner's curse; the winning state will bid away most all the economic gains from getting the factory. A state can justify granting tax incentives if the factory's location in the state will generate tax gains from other sources, individual income from workers and income from other businesses that locate in the state or grow as a result of the new factory (the multiplier effect) that exceed the tax losses from the incentives. At some point the tax incentives are too large; they do not generate a return that exceeds the tax losses. States will bid against each other to this point and the winning state will just break even. If the winning state miscalculates, it may even lose money on the tax incentives. The winner then may be the state that miscalculates.
SEC Declares on Section 404
The Securities and Exchange Commission has rejected the recommendations of its small business advisory panel and declared that it will not exempt any publicly traded businesses from Section 404 of the Sarbanes Oxley Act of 2002. The SEC will, however, issue new guidance on how companies can asses the adequacy of their internal control systems and the PCAOB will amend its rules on auditing such systems that will attempt to make the rules less costly and cumbersome. The SEC has put the ball squarely back in the Congress's court, which makes sense. Without solid Congressional backing the SEC cannot modify Section 404 on its own; it would be political suicide for the agency. Senator Jim DeMint (R-SC) followed through on his plans to introduce a bill in Congress exempting any company with a market value of less than $700 million or revenue of less than $125 or owners of record fewer than 1,500 from Section 404.
May 17, 2006
Stock Exchange Mergers
Do the stock exchanges' efforts to merge to "diversify" remind others of the failed conglomerate mergers of the 60s and 70s??
Arthur Levitt, the former chair of the SEC, has redone the board of directors of American International Group (AIG) to clean up the company's image after CEO Hank Greenberg was forced out for manipulating the company's books. Of interest is Levitt's focus on charitable gifts. He notes that such gifts are "an item of seduction for boards that is far greater than almost any other perquisite..." AIG's new board rules prohibit board members from soliciting charitable contributions from the company. Interesting observation. But the rule will not work. When a board member's alma mater shows up and asks for cash (without any participation by the member), the board member will leave the room and the other board members will do the deed.
Milberg Weiss Indictment?
Federal prosecutors are deciding whether to indict the country's highest-profile plaintiff securities class action law firm, Milberg Weiss Bershad & Schulman, for illegal payments to class action plaintiff/clients. Two of the named partners, Bershad and Schulman, who may be charged personally, have taken leaves of absence from the firm. There is no doubt great rejoicing in the board rooms of the many companies that have felt the sting of Milberg's lawsuits. It takes a well-funded, dedicated firm to mount large scale plaintiff securities litigation. One plaintiff's lawyer keeps many, many defense lawyer's busy. A defense firm can also do other kinds of business consulting and compliance work for companies -- a plaintiff's firm is a pariah to corporate legal counsel. Defense counsel can be part of a large corporate law firm; plaintiff class action counsel cannot. Defense lawyers are paid by the hour; plaintiffs lawyers by a portion of the result, often delayed well after expenses must be paid. In short the defense side is the comfort zone, the safe bet, for "excellence" and prestige in the corporate bar. The plaintiffs lawyers are the risk takers. There should be no surprise that plaintiffs lawyers push the boundaries of litigation and that corporations want to stifle them. I hope the prosecutors are doing the right thing here. In any event, with larger shareholders stepping into these suits under the 1995 legislation (favoring the choice of the largest complaining shareholder as class action plaintiff), the temptation of class action firms to find and compensate "front" individual shareholders to act as plaintiffs is diminishing with time.
May 16, 2006
Commerce Clause and State Tax Incentives
The Supreme Court decided Cuno v DaimlerChrysler on state tax incentives for businesses. It ducked the commerce clause issue with a ruling on taxpayer standing; taxpayers cannot bring such suits in federal court. An aggrieved business competitor of a tax-favored business or perhaps another state losing a business to a state offering incentives must bring the suit in federal court. Such suits are unlikely and so the issue will smolder. [Taxpayers could try a suit in state court perhaps.] If the Supreme Court had the case on the merits it would probably be 9-0 in favor of the state tax incentives as well. The state tax competition is bad policy but not unconstitutional. The states, to stop the practice, need an inter-state compact (a cartel) creating an agreement to stop the tax competition. In international trade, the WTO is facing a similar issue -- it has declared tax subsidies for firms that export to violate GATT. A federal congressional effort to stop the practice could run afoul of state's rights doctrines. Interestingly, several states have state constitutions that prohibit the practice but their state Supreme Courts (Ohio and Colorado are examples), under heavy political pressure, have abandoned the prohibitions with very technical constructions of the language.
May 14, 2006
KKR's new publicly traded private equity fund has the power to make hostile acquisitions. Will it? Not likely. Since the heavy handed regulation of hostile takeovers at the state level, LBO funds found that there best business was in acquiring divisions of public companies, friendly deals. The funds did not want to upset potential customers by mounting hostile deals with a small likelihood of success, so LBO funds became manager's best friends. Hedge funds stepped in but only to acquire minority stakes. The hostile takeover market remains unfunded and neglected. Had the Supreme Court followed up CTS v Dynamics (on a mild form of anti-takeover legislation) with an opinion limiting the more effective forms of state anti-takeover legislation (in the spirit of Edgar v Mite), the economic foundations of American investment would be remarkably different and much healthier. A pity.
The Quiet Period
The SEC's new rules on public offerings are a mess. The agency's preoccupation with "gun jumping" is continuing to stifle public information on new stock offerings. The new rules opened up some information flow in the pre-registration period, but only for our largest companies -- those with information already in the market, and did not fix the quiet period. The quiet period is after registration and before the effective date, the waiting period. In the quiet period only very privileged investors (those at road shows) get any information on a new offering. It is a travesty. The SEC's efforts to control information in the Internet age should be the subject of ridicule. The agency needs to focus on what is said (suing folks if they lie or otherwise mislead) and relax their censorship rules. censoring what can be said for fear of public misunderstanding. The SEC is following an obsolete and failing strategy.
The Breaking News column by Cox, Cyran, Wade & Ford, reports that the author of the "Magna Carta of Shareholders Rights", Mario Gabelli, who railed against supervoting shares has established a company, Gamco Investors, with, you guessed it, supervoting shares. The company went public in 1999 with two classes on common shares. Gabelli controls the company's Class B stock, each with 10 votes. The Class A shareholders hold 25 percent of the equity and have only 3 percent of the vote. The effect? Gabelli could pay himself $55 million last year when assets under management fell 7 percent, stock price slide 10 percent, and profits were flat.