February 7, 2007
Stock Option Valuation
Last week, the Securities and Exchange Commission approved securities proposed by Zions Bancorp (a Utah banking group) that are designed to value the company's executive stock options. Now that executive stock options must be expensed on the income statement, companies struggle to value them accurately. Most valuation numbers come from the application of complex and obtuse academic formula, originating with the Black-Scholes method, that most company managers believe overvalue the options. In an effort to secure a market-driven valuation, companies have made an effort to float securities tied to executive option payouts. What the market pays for the securities is what the options are worth. Companies believe market driven values will be significantly lower than the values produced by the formula. The securities are complex because the option payouts are delayed, the options vest in the future, and are contingent, the employee must stay on the job. Cisco has tried a proposal and the SEC rejected it; Zion's proposal has been accepted. The financial community will watch and if it works, many many more companies will do it. Of interest is the commentary on the securities. Everyone knows the risks -- the new securities will be thinly traded and this is of concern. The company worries that competitors (or critics) Will drive up the value of the securities by manipulated purchases; academics and competitors worry that the company with drive down the value of the securities by manipulated short positions. Each side knows what the other can do with a thin trading market and assumes that they will do it. The SEC will have to be on its toes to check for market manipulation efforts.
February 6, 2007
A student approached me yesterday with an opinion that the economy was in "terrible" shape. According to opinion polls, his view is not unusual. Only 40 percent of those surveyed in a NBC/Wall Street Journal poll approve of Bush's handling of the domestic economy. Yet the statistics show otherwise: The economy grew 3.5% in the fourth quarter of last year (beating expectations), inflation is at a low 2.1% annual rate, unemployment is at 4.6%, oil prices are coming down (from a high of $77 a barrel to around $55 a barrel), and stock market indexes are setting new all time highs. To put this in perspective, the unemployment rate last year, averaging 4.5 percent, has been at such low levels only once in the past fifty years (from 1965 to 1969). Why the pessimism, when there was optimism during the 90s when unemployment rates were significantly higher (over 6.4 percent)?
Bush on SOX
President Bush, in his speech on Wall Street, attacked excessive executive salaries but also praised the efforts of Treasury Secretary Henry Paulson to roll back Section 404 of Sarbanes-Oxley. Following the lead of several in Congress, Bush said we don't need to change the statute we need only to change how the law is "implemented" (i.e. the agency rules - both from the SEC and the PCAOB- that implement the statute).
Data on Income Inequality
The best description of the data on the degree of income inequality in the United States comes from the book by Alan Reynolds, Income an Wealth (Greenwood Press, 2006). He takes a careful look at the data and concludes that the percent of income claimed by the top 1% earners in the United States has not increased since 1988 but has decreased. His columns in the Wall Street Journal of February 6, 2007 and Dec. 16, 2006 explain why popular studies on which the press bases its claims on increasing income inequality are flawed. The core of his claim is that raw income tax data is misleading and once one adds in various other assumptions to make the data more usable, the assumptions are critical and often loony. The Congressional Budget Office study for example, added an assumed percentage of capital ownership to the top 1%, and the assumed percentage itself increases with time, leading, naturally to an increase in the income of the top 1%'s income. The CBO study also shows, for example, that raw disposable income of the top 1% did not increase from 1988 to 2003 (the 2004 data reflects a new lower tax on capital gains). Many simply want to believe that the rich are getting richer, it is a convenient political argument; but a careful dissection of the data shows, at minimum, that the position is contested.