|Man Without Qualities|
Wednesday, July 31, 2002
Zvi Bodie, Robert S. Kaplan and Robert C. Merton enthusiastically endorse the expensing of employee options in the Wall Street Journal today. Mr. Bodie is a professor of finance at the Boston University School of Management. Messrs. Kaplan and Merton are professors of accounting and finance, respectively, at Harvard Business School. Mr. Merton won the Nobel Prize in 1997 for his work on option pricing.
This is so much intellectual firepower that one wishes one could say that they really add something new, some insight more than their impressive credentials. But they don't. Worse, at least some of their arguments are downright disingenuous. For example, they argue:
Finally, some opponents of expensing employee stock options make two arguments that actually conflict with each other. First, they claim that it is enough to disclose the information in the footnotes to corporate financial statements as is done now. And second, they claim that to require that options be expensed would hurt companies, particularly high-tech firms that rely heavily on options as a form of compensation. But if deducting the expenses of options that are already disclosed in footnotes would drive a company's stock price down, then we have proof that the disclosure alone was inadequate to capture the underlying economic reality.
Well, ok. But what about people who argue that it is enough to disclose the information in the footnotes to corporate financial statements as is done now and don't think that to require that options be expensed would hurt companies that rely heavily on options as a form of compensation? It really doesn't take a Nobel Prize in economics to see that these distinguished authors have not answered the main argument, but have resorted to a disturbing and transparent rhetorical device to avoid it. It is even odd that this argument is placed at the end of the piece, since it is among strongest arguments offered by opponents of expensing.
The other arguments the authors spend most of their time refuting are almost straw men: grants of stock options do not involve cash outlays, expensing of stock options would be double counting, and employee stock options are worth less than publicly traded options because employees do not gain full ownership of the shares (do they mean "options," not "shares" here?) during their vesting period. Nor do the authors present the positions they are supposedly refuting in the best ways.
The authors' logic is simple, indeed it is exactly the same logic nearly every proponent of expensing options uses:
(1) "When a company issues securities whose value can be reasonably determined, accounting principles require that this value be recorded in the company's financial statements."
(2) The value of employee stock options can be reasonably determined.
(3) Therefore, value of employee stock options should be recorded in the company's financial statements.
What is most striking about the authors’ approach is the absence of any suggestion that expensing options as they advocate would actually bring additional useful information to the securities markets. Indeed, the approach seems to assume that expensing options would neither increase or decrease the amount of information conveyed, so that the matter may be treated as an academic algebra exercise culminating in the silly end of their article: "If the following true-or-false question appeared on an accounting exam, the answer is quite clear: Employee stock options should be expensed on a firm's income statement. True.". That final rhetorical flourish seems to reveal quite a bit more about the authors' thought processes than they appear to have intended.
I will set aside for other people the question of whether accounting principles have really been applied the way the authors suggest in connection with, say, convertible debentures. But I note that the authors seem to imply that the convertibility feature is expensed completely at the time the debenture is issued.
To apply their sylogism. the authors need to explain and do not explain - other than by assertion - why one or the other options pricing techniques is "reasonable" for purposes of preparing the balance sheet of a public company. It is surely not enough to argue as these authors do that investment bankers value options all the time and make important decisions based on those valuations, such as big mergers. Of course they do.
But that alone doesn't mean such valuation techniques provide a "reasonable valuation" for balance sheet purposes. "Reasonableness" in this context should require a consideration of how such valuations will be read and used by ordinary and professional investors. If the first will likely be misled by the inclusion of the valuation and the second will certainly disregard the valuation, how likely is it that the valuation is reasonable?
Simply put, the authors need to explain why in determining whether a "reasonable" valuation technique exists for purposes of applying the accounting principles to which they cite, no consideration should be given to the relative abilities of professional analysts to do their own calculation or the likely confusion expensing options would create in ordinary, non-professional investors.
All in all, an odd effort, in my humble opinion.
The Wall Street Journal now says about the new accounting oversight board:
The big losers are the accountants, for whom it is very hard to have any sympathy. American capitalism will live to fight another day.
The accountants are going to have to endure a new layer of government oversight as well as new conflict-of-interest restrictions. This is the price they're paying for trying to live like investment bankers off the federal audit mandate and for refusing to go along with former Fed Chairman Paul Volcker's proposals to fix the industry on its own.
If SEC Chairman Harvey Pitt is smart -- hope springs eternal -- he'll play it straight and resist the urge to pack the board with his accounting allies. The best way for the board to work is the way the NASD does with securities broker/dealers, as a credible, independent enforcer.
Even for accountants, however, it could have been worse.
Well, the Journal gets the last part of all that right. And NASD is hardly a narrow, "independent," government regulator.
Perhaps one might focus on an aspect of "regulatory capture" not particularly associated with George Stigler - the "life cycle":
Marver Bernstein in Regulating Business by Independent Commission (1955) ... develops the idea of a regulatory life-cycle. Regulatory agencies, he argues, go through four stages:
Gestation in which regulatory agencies are created, usually as the reaction to some perceived problem or crisis
Youth in which the agency is full of zeal, but is outmaneuvered by the regulated industry which usually has more experience to draw upon in conflicts with the agency
Maturity As political attention fades, the agency becomes less crusading, and co-operative relationships between the agency and industry are established. The agency becomes more sensitive to the needs of industry.
Old Age Priority is given to the needs of the industry, whose interests the agency begins to identify with as its own.
Both the Journal and Professor Coffee focus on the "Gestation" and "Youth" of the oversight board - and those periods could be annoying for the accountants. No one thinks of Winter when the grass is green.
But the accountants can look forward to the far future of, say, six months from now, when the events of this summer have passed beyond living memory of most of the electorate and investing class. Those can be seen as the beginning of the board's comfortable golden years of "Maturity" and "Old Age."
And the best thing for the big accounting firms is that the SEC will probably still not even have even worked out the new rules by the time Maturity, at least, sets in. Those firms should be cheerful, for surely:
"Bliss was it in that dawn to be alive/ But to be young was very heaven!"
Democrats on a key Senate panel yesterday urged Federal Communications Commission Chairman Michael K. Powell "to take a more active role in steering the telecommunications industry out of the financial turmoil that has engulfed some of the sector's largest companies," as the New York Times gullibly put it.
The New York Times found space and time to report on the Torricelli rebuke yesterday. But there is no editorial or op-ed piece on it today.
Perhaps the Times editorial page is too busy ginning up things like the misleading screed they just ran savaging Western Republican Senators for doing what Senator Daschle did to be concerned about a bribe-taking, rebuked, lying, unethical Democratic Senator from the state next door - a Senator so defiant and shameless that he does not even acknowledge that what he did was wrong.
Details, details. There's always tomorrow for these marginal issues. In the mean time, what about those Arizona trees?
Senator Clinton says her husband's administration left the economy in great shape, and now the Republicans have messed it up:
"It's harder (sic) to imagine a faster, more heartbreaking turnaround than the one we've seen."
But according to the Commerce Department today: The revised figures for 2001 now show that instead of contracting for just the third quarter, the economy actually shrank — although modestly — for three straight quarters. The new figures show that the economy contracted by 0.6 percent in last year's first quarter, by 1.6 percent in the second quarter and by 0.3 percent in the third quarter.
Well, you've got to hand it to Hillary. With a recession starting the very day she and her husband left the White House, it is surely true that "It's hard to imagine a faster, more heartbreaking turnaround than the one we've seen." The "turnaround" just means the exact opposite of what Hillary suggests it means.
But, hey, who's counting those fiscal quarters? Certainly not the "mainstream media!"
The BBC says Boeing is looking into it. Why does it seem right that this "invention" is Russian?
Tuesday, July 30, 2002
Senator Lieberman, edging dangerously close to becoming a Republican National Committee shill, now says that he will call Robert Rubin as a witness in the Enron matter "if Mr. Rubin would add something."
Well, if the good Senator is going to put it THAT way, surely Mr. Rubin will now be demanding to be heard!
Surely it is a strange and wonderful thing that a fall in a supposed measure of consumer confidence can have an effect - or at least be thought to have an effect - on stock markets, even as many economic researchers are losing confidence in the very existence of "consumer confidence."
The Wall Street Journal reports on the new corporate governance bill just signed into law by the President:
Just how much change is triggered, and how effective it is, won't be known at least until the Securities and Exchange Commission works out rules implementing the law and appoints the newly created five-member oversight board with powers to investigate and punish. "Congress enacted some structural girders and then left it to the SEC to fill in all the remaining framework," says John Coffee, a law professor at Columbia University who worked with Senate staffers in drafting parts of the law. The biggest unresolved detail, he says: whether the oversight board appointees will be "people of stature and independence or flunkies and fellow travelers of the accounting industry."
Professor Coffee's comment is surprising, to say the least, since regardless of who the first oversight board appointees may be, the new "independent" nature of the oversight board greatly increases the chance of its eventual, simple regulatory capture by the accounting industry, especially the surviving "Big Four." In other words, regardless of who the first appointees are, in a little while the board is probably going to be dominated by "flunkies and fellow travelers of the accounting industry."
Why? Well, the new board is focused solely on accounting. It has a much narrower regulatory constituency than that of the Securities and Exchange Commission. The new board's "independence" should insulate it from the effects of the SEC's more general constituencies. Narrowing the board's regulatory constituency will likely, pursuant to the now-standard economic theory of "regulatory capture" developed in large part by George Stigler, over time make the "independent board" much more prone to such "capture" than is the SEC itself. One commentator described Stigler's theory this way:
In a well-known paper, 'The Economic Theory of Regulation', George Stigler shifted attention away from [the] 'public interest approach'. He looked at how the struggle over economic rents by interest groups would affect regulatory policy. The principal actors in his analysis, businesses and politicians are assumed to be self-interested income-maximisers and not at all concerned with the 'public interest'. Businesses use their resources to bargain with politicians to bring about policies that benefit them. They will favour regulation that reduces competition, and maximises economic rents.
...every industry or occupation that has enough political power to utilize the state will seek to control entry. In addition, the regulatory policy will often be so fashioned as to retard the rate of growth of new firms.
The kind of benefits that Stigler argues that the state can provide to industry include:
Barriers to entry to competitors, including tariff barriers
Aid to businesses producing complimentary outputs, and harm to businesses producing substitute products (think of bread as complimenting butter, and margarine as a butter substitute)
At the same time, there are a number of costs involved in acquiring legislation desirable to the industry. These include
The costs of securing agreement from, and co-ordinating a number of legislators sufficiently large to form a legislative majority/
The information and organisation costs to industry of becoming informed about, and acting upon measures that can potentially benefit them.
Individual consumers have relatively little to lose from anti-competitive measures (the costs are distributed throughout society so that the impact on a single individual is negligible). The benefits, on the other hand accrue to a relatively concentrated business group. Because of this, businesses have more incentive to meet the costs of making policies, and are therefore likely to get their preferred regulatory policies enacted. It is no accident that regulatory policies protect industry rather than consumers: they are designed that way.
By narrowing the constituency of the oversight board, the benefits will accrue to an even more concentrated business group.
Now, whatever else the accounting industry may lack, it does not lack for political activism and sophistication, and it has plenty of "political power to utilize the state." Indeed, with the obliging annihilation of Andersen by the Department of Justice, the accounting industry is now positioned as something approximating a good old fashioned oligopoly - complete with the new "independent oversight board" to serve as its monopolistic, rent seeking coordinator. Indeed, once the dust from the Andersen demolition job settles, it will be interesting to calculate the Herfindahl-Hirschman Index of the accounting market. Would the anti-trust division at the Department of Justice have allowed the big accounting firms to achieve by merger the same level of market concentration that the Department has itself imposed through prosecution of Andersen? A concentrated national oligopoly of a key industry with its own, private, independent regulator! How comfy cozy for the regulated.
Wasn't it nice of the Congress - and especially the Democrats in Congress - to do this for the big accounting firms, even as those firms pleaded with the Congress "please do not fling me in that briar patch."?
Brer Rabbit hollered out, "Born and bred in the briar patch. I was born and bred in the briar patch!" And with that he skipped out just as lively as a cricket in the embers of a fire.
Today the Senate Ethics Committee "severly admonished" Senator Robert Torricelli (Democratic - New Jersey) for accepting gifts from David Chang, a Torricelli friend, supporter, campaign contributor and businessman that the lawmaker aided. The committee said in a three-page letter to Torricelli:
"Your actions and failure to act led to violations of Senate rules – and related statutes – and created at least the appearance of impropriety." .... "[We are] troubled by incongruities, inconsistencies and conflicts, particularly concerning actions taken by you which were or could have been of potential benefit [to David Chang.]"
New Jersey voters decide in November whether Mr. Torricelli will continue to be their United States Senator.
If New Jersey voters can't figure this one out, that State deserves all the jokes the New Yorkers tell.
But will the New York Times editors be able to figure it out? That's not so clear.
The New York Times actually ran an editorial today asserting that:
"[T]here has been no stopping efforts by the timber industry and opportunistic politicians to exploit the fires for commercial and ideological gain. The latest and most cynical manifestation of this impulse is a proposal by several Republican senators from Western states to suspend basic environmental laws in order to permit logging on up to 24 million acres of national forest land. The senators describe this as necessary to prevent further fires."
This with no mention whatsoever that, as noted here in a prior post, the Washington Times had already reported:
"Senate Majority Leader Tom Daschle quietly slipped into a spending bill language exempting his home state of South Dakota from environmental regulations and lawsuits, in order to allow logging in an effort to prevent forest fires.The move discovered yesterday by fellow lawmakers angered Western legislators whose states were forced to obey those same rules as they battled catastrophic wildfires."
This kind of thing just has to raise questions about the New York Times. Is the intelligence of the editors going down, or is it just the editors' estimation of the intelligence of their readership that's going down? Either way, it's consistent with the Ellis Theory.
The Washington Post today has a new state-of-the-art article about the latter days of Enron. It describes some wonderful, dark, priceless scenes:
A few days later, the [prominent Houston law firm, Vinson & Elkins LLP] reported to [Kenneth] Lay that no further investigation was necessary.
The deals that troubled [Enron vice president Sherron] Watkins did have "bad cosmetics" and carried "a serious risk of adverse publicity and litigation," V&E would write in a private report to Enron.
Still, "The facts disclosed through our preliminary investigation do not, in our judgment, warrant a further widespread investigation by independent counsel and auditors."
Talk about a dry sense of humor! Who knew Texas lawyers could compete in that arena?
But, overall, what is perhaps most striking about the Washington Post effort is how little it adds to what was already known about these matters say, four months ago.
And now it is Robert Rubin's actions in connection with Enron that are being described by some of his defenders as having "bad cosmetics," which nevertheless "do not, in our judgment, warrant a further widespread investigation," this time, by Congress. As the Note puts it:
We wonder when someone (in the press? in the Republican-controlled House?) will ask Bob Rubin for more about what he knew and when he knew it when he called Treasury looking for help for Enron; and we wonder if those White House and O'Neill sharpies have this serious push-back stratagem on their radar.
The Wall Street Journal ed board takes up just the corner of the Rubin matter, praising Treasury Secretary O'Neill for his Sunday Singapore Sling Slap at Rubin, but then reverting to form and saying what O'Neill really should have done was use the opportunity to call for more tax cuts.
The Washington Times editorial page continues its campaign to get Senator Joe Lieberman to call Rubin to testify. LINK , but we ask: why don't they call on House Republicans to do the same thing?
Of course, one possible answer to this last question is that if Mr. Rubin is asked the tough questions by a Republican controlled House committee, the Senate Democrat-controlled committee might be let off the hook, while the Democrats and the liberal media go off on a distraction riff about how poor, sweet, classy Robert was grilled by those horrid Republicans and made to say terrible things. All the better not to have to pay attention to the answers or evasive non-answers. The Washington Times may not want to provoke that situation (and, no, it is not necessary to suggest that the Washington Times and the House committee are working together on this, in case you asked).
Besides, it is by no means clear that Mr. Rubin will ever have to answer the tough questions from Republicans or Democrats, for the same reason J. Edgar Hoover never had to answer tough questions from Republicans or Democrats. HE MAY KNOW TO MUCH.
Senators Edwards and Clinton are tying their wagons to the belief that they can talk about "fiscal responsibility" without saying they want to raise taxes or cut spending. And what do they do when people start pointing out all that money investors lost in the dotcom and telecom disasters she and her husband presided over, for example? Also, this negative approach will have to contend with an ending recession, assuming that continues. Maybe it will somehow work, but it all seems rather incoherent.
"Short sellers" sometimes attempt to "talk a stock down." That is, they spread negative information about the stock in the market to push its price down. They hope that the stock will remain low enough for them to cover the "short" positions they buy in the stock. But, "the shorts" often face a nasty problem: after initially responding to the flood of negative information, the stock's price often snaps back abruptly on the basis of its "fundamentals." That effect often puts "the shorts" in the position of figuratively and uncomfortably taking it in the shorts.
The recent snap back of the entire stock market appears similar in some key respects to the above sequence, but played out on an enormous scale. First, the significance of some important negative information (in this case, a few companies with falsified books) was wildly exaggerated. In fact, less than one percent of all corporate profits reported last year by American public companies were ever subject to suspicion. It is very hard to find a sense of true proportion in Democratic statements or much of the popular media coverage. The Democratic leadership, in particular, did much to exaggerate and inflame market-depressing information. Then they added the specter of new, oppressive and depressive regulation, which even they did not dare to implement. Probably the most significant aspect of the passage of the corporate governance bill just signed by the President is its indication that the Democrats won't have an opportunity to pass even more damaging laws in the near future. The media have been happy to play on the sensationalism. That whole period resembles the period in which "the shorts" attack a stock. In this case, the Democrats appear to want the anxiety-producing effects to continue to Election Day. And, as the statements of Senators Clinton and Edwards indicate, they are investing a lot in this approach. But the snap-back in the market over the past few days resembles the way a single stock reacts when the market finally figures out what the shorts have been up to.
The Democrats may find out just how uncomfortable it is to be a short seller once the market readjusts to fundamentals.
What about that new corporate bill? Will the Democrats be able to draw energy from that source? Well. that's not what Bill Lerach says. He's the San Diego lawyer who is lead attorney in an investor class-action lawsuit against Enron Corp., and he comes dismisses the bill as "the reenactment of the current law with a great deal of huffing and puffing. ... Not a single word will help a cheated investor get a penny back." Mr. Lerach is just part of a large chorus of people who just can't find major benefits in that bill. But a lot of people sure are finding plenty of costs.
Monday, July 29, 2002
The Democrats are said by the New York Times to be trying out campaign themes:
``In the span of a year, this administration has turned fiscal responsibility on its ear,'' [Senator] Kerry said, ``turning a budget surplus into a budget with endless deficits spurred on by an irresponsible and unfairly structured tax cut.''
Are the Democrats going to campaign to raise taxes or not? If not, how long do they think they can talk about "an irresponsible and unfairly structured tax cut" before they have to say what they plan to do about it (that is, raise taxes). And if they do think it's a good idea to campaign to raise taxes, then why don't they say they are going to raise taxes? Are they proposing to raise taxes with the New York Times running a front page article yesterday warning of the risk of a "double dip" recession? Nothing like raising taxes going into a possible recession.
Maybe this mess is why the Times says what the Democrats are really doing is trying out themes for 2004. While they're at it, maybe they should try out some themes for 2012 - it would mean as much as the work they're doing now for 2004.
And, by the way, Senator Lieberman keeps turning up in such articles. Has anyone stopped to consider that the good Senator was chosen, and was as an asset to Gore, in 2000 because he is personally a good man, in contrast to the widespread public perceptions of the man Gore had served with for the preceding eight years. But, presumably, Mr. Clinton's erotic activities and possible federal felonies will not be an issue in 2004. So what does Senator Lieberman bring to the table? Polls show he was drubbed by Cheney in their one debate.
There are reports that "smoking guns" have been found showing that the Internal Revenue Service was used in the Clinton Administrations to conduct politically motivated tax audits. This should be added to such events as the Livingston White House misappropriation of hundreds of FBI files, the "unauthorized leak" of Linda Tripp's records and the creation of a vast partisan databank with taxpayer money.
At this point, the new reports of IRS abuses should, coupled with prior evidence of the Clinton Administrations' willingness to exploit government files, further suggest that Harken-related mischief will not likely amount to anything significant. The Clintonites had eight years to exploit that set of facts, and plenty of opportunities and incentives. The new reports of IRS abuse are said to involve the Republican candidate for governor of California. But the Clinton-Gore administrations had Mr. Bush's two runs for governor of Texas and his run for Presidency as incentives to exploit whatever the Clinton Securities and Exchange Commission could come up with. The Democrats did use the Harken matter each time.
But even the Clinton SEC just couldn't bring itself to reactivate that investigation, nor could they find gold in the matter.
New revelations such as the current IRS nastiness suggest that failure wasn't because the Clintonites weren't willing to do what they thought they could get away with.
There is a very fine opinion piece by Robert Bartley in the Wall Street Journal regarding the pitfalls of "expensing" option a la Warren Buffet.
The bottom line of the Bartley argument is that "expensing options" would make the bottom line of corporate financials less reliable and more confusing, at least to "ordinary investors" who don't work with option pricing equations.
At the same time, the Journal runs a remarkably bad options piece by Susan Lee, which serves up arguments that have been made for months (decades, if one counts the pure academic discussions) in other quarters as if they were fresh. Sample quote: "Well, now comes Brian J. Hall, economics professor at the Harvard Business School, to explain. In a recent paper, Executive Compensation and Ownership Structure (www.people.hbs.edu/bhall/ec), Mr. Hall argues that options are leveraged instruments."
Options are leveraged instruments? My goodness, we certainly need a nabob from HBS to tell us that! All those options traders in Chicago who have been pricing options using those Black-Scholes buttons on their calculators for the last few decades will just be decked!
It seems that Professor Hall and Ms. Lee think that options should be expensed because that would make it easier for companies to give their executives and employees restricted stock. Of course, no analysis is provided of any of the incentive problems created by restricted stock grants. No mention is made of what might be done in structuring the option program to reduce problems with option grants - but a board of directors that seriously represents shareholder interests can do a lot with such structuring. And if one posits a board of directors that does not represent shareholder interests (the real underlying issue here), might there be a little issue or two with allowing that board to grant large blocks of the already accumulated value of the company to existing management? Nor is there a word on the number of shares that have to go out the door as restricted stock to get the intended incentive effect. And while a few word are offered about the obvious if delicate need for companies to reprice or refresh options that have been submerged in appropriate cases, no criticism of the currently fashionable demonization of such practices is offered. How about a mention of the partial economic similarity of (i) options with a strike price less than stock price in effect on the day of the grant, on the one hand, and (ii) restricted stock grants, on the other hand (could that mean that options are more flexible and could capture many of the benefits of stock grants without some of their disadvantages)? No. I guess there just wasn't room for those details. Worse, because the Hall paper makes a virtual Marti Gras out of confusing objective economic incentives considerations with corporate "behavioral" considerations (read, "what boards who may or may not represent shareholder interests do"), it entirely confuses the separate issues of (i) what economic incentives are created by options as opposed to stock grants and (ii) how are boards of directors dealing with those incentives. The artificial and ad hoc concept if "option fragility" is arbitrarilly elevated by the paper to a position of supreme significance without serious evaluation of the economic fundamentals involved. In short, the paper is a complete mess.
Further, we are apparently to believe that public companies have never before seriously considered or understood the relative merits of these two standard compensation structures. For example, Kirk Kirkorian, who owns a solid majority of MGM GRAND, chooses to have that company grant stock options to its executives (who happen to be exceptionally clever). Are we supposed to believe that Mr. Kirkorian is just incapable of grasping the profound differences between options and restricted stock grants that Mr. Hall sees so clearly now?
The Man Without Qualities believes executive compensation issues are tough and unsettled. The matter has been discussed with much greater acuity than Professor Hall brings to the table by both Jane Galt and More Than Zero. I cannot understand why the Wall Street Journal runs a silly puff piece about an HBS professor's paper that appears to add exactly nothing to existing understanding of the matters it discusses. The author, Professor Hall, is no doubt a gifted person, and I do not want to be read as disparaging him generally and I think it's fine that he takes advantage of his opportunities. But in this instance the most objective thing that can be said about his paper is that it - together with the Journal's plump - should be good for some rich speaker fees at a good number of corporate and political lunches, and maybe a consulting contract or two.
Saturday, July 27, 2002
Many Blogger bloggers are having trouble posting because of "Error 503: Unable to load template file: /home."
The following little algorithm has almost always worked for the Man Without Qualities to correct Error 503.
1. Try to publish, but notice appears: "Error 503: Unable to load template file: /home."
2. Click on "Template."
3.Make no changes in your Template.
4. Click on "Save Changes." After a few moments' delay, this should return the screen to the original split-screen "Posts" setup, and a little yellow "Publish" button should appear on the far right in the middle of the screen.
5. Click on the yellow "Publish" button. Wait a few moments. [If "Publish" button is not there, bring your post up onto the upper half of the screen and click on "Post and Publish"]
6. Bring your post back onto the "edit" (upper half) of screen by clicking on "Edit" at bottom of stored post in lower half of screen. Do pot edit your post.
7. Click on "Post and Publish."
8. Wait a few moment or until little flipping pages stop. The "Error 503" message may appear again - that doesn't matter.
9. Check blog screen (you will likely need to "Refresh" it.)
10. If this doesn't make the post appear, repeat the whole algorithm. Sometimes it takes two or three interations to correct Error 503.
Friday, July 26, 2002
FURTHER UPDATE: Mr. Frantz may use the language and his intelligence as he sees fit. But most thoughtful people would not consider evidence that (rather weakly) suggests Howard Kurtz may be somewhat conservative demonstrates, or is even particularly relevant, to pegging him as a Republican National Committee "shill." Nor does evidence suggesting that Mr. Kurtz has more conservatives than others on his shows support such a thesis. Of course, Messrs. Frantz and Atrios are free to use "RNC shill" to mean someone who generally agrees with the RNC, or is simply generally more conservative than Messrs. Frantz and Atrios - which seems to be about the way they are using this word.
A demonstration that the New York Times editorial page, or its op-ed page, more often sides with the Democratic National Committee would not show those pages to be DNC "shills." Other examples among the liberal media and academics are so abundant there is no need to cite them. Not that Mr. Frantz's efforts should be called a "demonstration," and it is not necessary to discuss his more general "methodology" here.
Nor is it necessary for Mr. Frantz to broker Mr. Kurtz's views. Mr. Kurtz's writings are there for the reader to review every day. An archive of them may also be reviewed. Indeed, Mr. Kurtz will communicate with the reader in real time. The Man Without Qualities does not believe Mr. Kurtz is a "shill" - I don't even think it's arguable by reasonable people. That I leave the reader to her own intelligence to decide whether she agrees with me is not "assuming" anything other than that the reader has considerable intelligence. This appears to be an approach Messrs. Frantz and Atrios find baffling.
But as the great ancient South Asian mathematicians would demonstrate what we now know as the Pythagorean Theorem: "BEHOLD!"
UPDATE: Well, Atrios confirms that he does, in fact, literally thinks that Howard Kurtz is a National Republican Committee shill. And all the little Atriettes in the comment box agree with him, too. Better that they do. Otherwise, Atrios would be labeling THEM RNC shills. Gotta keep the prols in line!
And, no, there appears to be no trace of irony in the Atrios remarks. Perhaps it's just that the Man Without Qualities couldn't locate the trace. Maybe other people with sensitive irony geiger counters could scan the Atrios post.
Howard Kurtz of the Washington Post, a noted National Republican Committee shill, writes:
Should [Robert] Rubin's conduct be carefully scrutinized? Sure. Enron had plenty of help with its shell-game accounting, and the companies that helped the Houston energy giant fool the public should be held accountable. The deals are incredibly complicated, but it's time to unravel them.
Watch out, Howard. Atrios and Counterspin may come gunning for you, you old party hack.
Link from InstaPundit.
And, if you adjust for tone and style, Mr. Kurtz in substance is beginning to sound a little like Andrew Sullivan on this point.
With a corporate reform bill that the President has pledged to sign having swept through Congress with majorities that would make even the cheek of Joe Stalin perhaps blush a bit, it is time for a preliminary examination of what the federal lawmakers have accomplished and, in a related move, to ask if anything constructive might have been done. This exercise may help one to contend with the awful sense of Vuja De, or the feeling one will be here later, another concept for which the French don't have a word.
Senator Mike Enzi, a Wyoming Republican who is a former accountant, described the legislation as "earthshaking," telling The Associated Press it had been approved with "tremendous speed." The Senate approved the package, 99 to 0, only hours after the House had approved it, 423 to 3, just a day after House and Senate negotiators bridged their differences on the legislation.
To begin with, the reader must be disabused of errant suggestions that this legislation, which purports to profoundly restructure all of American business and accounting practices, was rushed, ill-thought-out or excessive. Reports that the bill is based on a computer dump of some Google searches performed by one of Senator Leahy's aides given instructions to throw in every cockamamie securities, accounting and corporate restriction that's popped into anyone's head in the last fifty years are considerably overdone. The Man Without Qualities has in fact received assurances form knowledgeable sources on Capitol Hill that great care was taken to eliminate duplicate "hits."
And before any provision was inserted into the bill, it was carefully reviewed by conscientious Congressional aides each of whom was required to be at least 18 years old. Results were impressive. In one case, a provision which had been advanced by Senator Leahy's office to address a perceived failure of the SEC "Plain English Initiative" (which sought to clarify Commission filings by requiring them to be written in "plain English" instead of legalese) was deleted after a sharp-eyed aide brought to the Senator's attention that the provision's text, which read
(i) From this day on, the official language of the Securities and Exchange Commission will be Swedish.
(ii) In addition to that, all executive officers will be required to change their underwear every half hour.
(iii) Underwear will be worn on the outside so we can check.
was actually cribbed from an old Woody Allen movie. After some initial effort by Senator Leahy to retain the provision, he relented when reminded that Allen had been disgraced as a result of his quasi-incestuous affair with Soon-Yi Previn.
Now, it is true that certain doomy-gloomy types, such as economists Kevin Hassett of the American Enterprise Institute and Robert Shapiro, formerly of the Democratic Leadership Council, have found that the bill will "likely impose significant new costs on American firms with little likely benefit" while opening up companies and their managers to more litigation from trial lawyers. But in considering such conclusions the reader should also bear in mind that media coverage is also bereft of any report that a single reputable economist in the nation has actually gone on record as asserting that the legislation will do more good than harm. So it is safe to say that the matter is open to debate.
According to the New York Times:
[S]enior executives of ... J. P. Morgan Chase, who told investors and reporters on Wednesday that their employees had done nothing wrong in helping Enron set up complicated financing vehicles that kept large amounts of debt off the company's balance sheet. They also pledged to spend their own money on J. P. Morgan's depressed stock: five of them bought a total of 85,000 shares, according to Kristen Lemkau, a spokeswoman.
Considering the nature of the accusations against Morgan, how likely is it that the purchase of 85,000 shares of Morgan stock by highly placed insiders was NOT predicated on material information not available to the general public. The purchase could also be construed as a device deliberately intended to manipulate the price of Morgan stock. In fact, wasn't that the actual intent?
Where the heck are the lawyers in all this bank mess?
A Gedanken Experiment for readers of the Man Without Qualities!
The reader is to imagine that she or he is a member of the Enron/Andersen prosecution task force at the United States Department of Justice. You have picked up your New York Times, where you read:
In a memo sent to Citigroup employees, Weill said Citigroup's transactions with Enron were legal, met accounting standards and reflected industry practices. ``And our people, relying on the advice of independent legal and accounting experts, believe they were doing the right thing,'' Weill said. [J.P. Morgan Chase Chief] Harrison delivered a similar message to the investment community Wednesday, saying that the acted ``properly and with integrity'' in all of its dealings with Enron ....
Now, how do you feel? Do you feel more confident that if you just run out and charge Enron and Andersen operatives with accounting, securities and bank fraud that things are going to fall your way in a criminal trial in which Messrs. Weill and Harrison and every other bank officer involved state from the witness stand that their products and dealings with Enron "were legal, met accounting standards and reflected industry practices?"
Do you think that in the face of that testimony that a jury will find BEYOND A REASONABLE DOUBT that the Enron/Andersen defendants "knew" exactly the opposite when they prepared Enron's financial statements?
See, you CAN do something with philosophy!
But would it make a good video game?
Lloyd's lost $12.6 billion from 1988 to 1992, causing financial ruin for some investors ("Names") who had unlimited personal liability.
About 30 Names were reported to have killed themselves as a result of their losses.
In another example of how federal prosecutors usually proceed when they see what appears to them to be clear, serious and egregious fraud, prosecutors reportedly plan to criminally charge former officers of WorldCom Inc. sometime next week.
Of course, mere indictments aren't convictions.
But this is what federal prosecutors do when they feel they can win the case. The judge and jury often see things differently.
As Mr. Ebbers' lawyer points out, there is, in fact, a kind of "howling mob" out for these people. And that kind of thing can be a problem in securing justice.
But massive crimes normally produce howling mobs. That doen't mean the crimes weren't committed by the people charged.
Thursday, July 25, 2002
Some of the odder feedback to the comments that have appeared here regarding Robert Rubin has taken the form of assertions that it is "really" Vice President Cheney who has the potential False Statements Act problem.
Whether or not Mr. Rubin violated the False Statement Act will not be affected by whether or not Mr. Cheney violated that act. It's not as if there is some kind of political conservation principle at work here.
But, also, an investigation of the supposed Halliburton issues has begun, and Mr. Cheney has indicated he will cooperate with it. All that being noted, it does not look at this time as if the Halliburton matter is going to be very satisfying for Mr. Cheney's political critics. But time will tell. And the harsh interests of Mr. Cheney's critic's are no basis for not questioning or investigating.
What has been sought here at the Man Without Qualities is an investigation of Mr. Rubin's involvement in the very controversial Enron/Citigroup matter as revealed by the New York Times.
So it is remarkable that defenders of Mr. Rubin who are arguing so vigorously to forestall his questioning or investigation would be so foolish as to cite to Mr. Cheney's involvement with Halliburton.
Remarkable - and odd.
Paul Krugman has been reduced to saying people he doesn't agree with are funny animals - Rhinoceroses, actually. That's not too disturbing. Any three-year-old can do it - it would be hard to find one who didn't do it.
What is a little more disturbing is that Mr. Krugman suggests that these people, including independent and perceptive, even quirky, types like Mickey Kaus, have succumbed to "conformity and the authoritarian impluse (sic)," in Mr. Krugman's words, an impulse apparently thought by Mr. Krugman to be roaming the world, seeking the ruin of souls.
And why does he stop where he does? Why not complete his thought and assert that Mr. Kaus and such types just fell asleep at an inopportune time and succumbed to absorbtion by alien plant pods? If one feels the need to sweepingly degrade one's intellectual opponents the way Mr. Krugman does here, by suggesting they have mental processes reflective not of their own personalities but of "conformity and the authoritarian impluse (sic)," why stop at the perimeter of the animal kingdom? Bean them, Mr. Krugman!
Except for Brad and Josh, of course, since of the thousands and thousands of bloggers out there, only these two bear reading today.
Mr. Krugman also says:
"The most memorable scene is one in which the hero's friend (famously played by Zero Mostel) begins making excuses for his neighbors - maybe it's not so bad to be a rhinoceros, after all - and, as we watch, turns into a rhinoceros himself."
When he wrote this, Mr. Krugman surely was thinking about the many people who hae observed that Mr. Krugman began as a serious economist, but has now largely completed the conversion to empty polemicist.
It's interesting to watch certain of the more hysterical corners of the left come to the conclusion that they absolutely MUST stand up for investment banks and bankers.
When someone gets this hysterical trying to stop an inverstigation, even a questioning of Robert Rubin, where such steps are entirely consistent with New York Times revelations about Citigroup's transactions with Enron, it is likely that the hysteric feels deeply that his interests are threatened in a big way. In this case, the hysteric goes so far as to blast Slate reporter Timothy Noah for raising the obvious question "What About Bob Rubin?" and even links to Citigroup's own press release calling the New York Times story a big error. That neither of the New York Times nor Slate is generally considered to be partisan right wing rags seems to elude Counterspin, to whom they have become mere Republican hacks. Perhaps Counterspin will also want to update with an attack on Tony Adragna for writing right wing agitprop.
The Man Without Qualities has more than once stated that it is unlikely that the Citigroup or Morgan transactions constitute major wrongs. And I have also stated several times (here, here and here, for example) that it is premature to point acusations at Mr. Rubin. But that doesn't stop the hysteric behind the keypad at Counterspin from characterizing a clear need for an investigation as "accusation by innuendo, and implication," even though that very post says: "Mr. Rubin's statements should be carefully investigated and he should be charged or cleared as quickly as possible, as the evidence indicates." And in another post I wrote: "[T]he matter has not yet come to the point of identifying a particular supposedly false statement of Mr. Rubin to a particular government official. And I have not suggested the matter has come to that point. What I have suggested is that Mr. Rubin should be investigated. I have not accused Mr. Rubin of any crime."
Counterspin advances the most bizarre "defense' of Mr. Rubin's call to Peter Fisher that I have seen yet:
"Rubin ADMITS he called up Treasury and asked whether or not something could be worked out to avoid Moody's eventual downgrading Enron. The reason for this was obvious. Citigroup was orchestrating a merger between Enron and Dynegy, Inc."
It is unlikely that Mr. Rubin would make a call to the United States Treasury to advance a merger that Citigroup was orchestrating between Enron and Dynegy without first doing a thorough check on Enron and Citigroup's relationship with it. So Counterspin's argument would mean that at the time of the Fisher call Mr. Rubin had much greater knowledge of that relationship than Mr. Rubin's defenders have asserted. The more Mr. Rubin knew at the time of the call, the more vulnerable he may be under the False Statements Act for not revealing it.
It's fairly clear that Counterspin and like minded people oppose an investigation or questioning of Mr. Rubin, despite the ample basis for such steps, simply because of fears of what such an investigation or questioning might turn up.
Tony Adragna of QuasiPundit asks Is "The SEC Talking To Sandy Weill?" Mr. Adragna locates the ultimate likely source of Citigroup Enron culpability (if there is any) not with Robert Rubin, but with Sandy Weill. Of course, Mr. Weill almost certainly knew before hand of Mr. Rubin's attempt to shore up Enron and its credit rating. If Mr. Adragna's concerns (and at this point that is what they are, Mr. Adragna has not made any acusations) are born out, does that mean Mr. Weill failed to inform Mr. Rubin of all Mr. Weill knew before Mr. Rubin, for example, called the Treasury Department?
Are these two men still on speaking terms?
The full story of the Citigroup/Enron relationship is likely complex, and Mr. Adragna's concerns are not unreasonable.
What all this means is that there is a pressing need for a full-scale investigation of Citigroup and its higher management. Some of the loftiest heads in the nation may roll as a result of that investigation.
But at this point, the need is for investigations, not accusations and not speculation. Only hard facts can settle this increasing disturbance. And it is important to make it clear to Citigroup and everyone else that the investigation has started and has broad scope, or else there is a risk that people involved will destroy documents claiming that they did not know an investigation had begun - EXACTLY AS HAPPENED AT ENRON AND ANDERSEN.
So why is it that Senator Lieberman and the Senate Democrats are refusing to call Mr. Rubin to explain himself?
Mr. Lieberman says that he wants to go "right to the top" and talk to Citigroup's Chief Executive Officer. This is at the same time some of Mr. Rubin's defenders are arguing that because Mr. Rubin occupied such a high position at Citigroup he was unlikely to have any valuable knowledge of Enron-related operations.
So which is it: Is Mr. Rubin too high or too low in Citigroup management to be worth talking to?
Some of Mr. Rubin's supporters point out that he supposedly was not yet an officer at Citigroup when the most spectacular Citigroup/Enron deals were created. But that particular point in time is likely not the most relevant. After all, nobody is claiming that these deals were in themselves wrong. The problem comes up later, when choices have to be made as to how to account for and disclose the deals. Mr. Rubin was surely in place at Citigroup when the Enron financial reports incorporating the effects of the Citigroup transactions started to come in. And, if Citigroup didn't know how Enron was going to treat their product (highly unlikely, to say the least, for an "off balance sheet product"), Citigroup certainly found out when the first Enron financials were delivered.
And where the heck were the Citigroup lawyers while these squirrelly deals were being put together and, more importantly, maintained and administered? The Man Without Qualities does not know what law firm represented Citigroup in these transactions, but Shearman & Sterling is their long-time counsel. So assume for the purposes of this discussion that Shearman & Sterling (or some comparable firm) represented Citigroup in the Enron transactions. Many aspects of these transactions probably raised serious legal issues and risks that Shearman & Sterling had an obligation to point out to Citigroup. THAT MEANS THAT SHEARMAN & STERLING THEN WROTE MEMORANDA EITHER TO CITIGROUP OR TO ITS OWN FILES POINTING OUT THESE LEGAL RISKS AND/OR PROBLEMS. Those memoranda are supposed to still be in the corporate and law firm files.
Such memoranda are clearly subject to attorney-client privilege. As has been pointed out by the Man Without Qualities in the past, Citigroup's board of directors should have no problem waiving that privilege, given the current national unease. Those memoranda should provide a virtual roadmap either incriminating or exculpating Citigroup.
Reports are that the new "corporate governance" bill just passed by the Congress includes a provision requiring lawyers to report on wrongdoings by corporate clients. Asking Citigroup for its legal memoranda is something in the same spirit.
Wednesday, July 24, 2002
The House of Representative on Wednesday expelled Rep. James Traficant, D-Ohio, for taking bribes and kickbacks. It was only the second time since the Civil War that it has removed a sitting member for unethical conduct. The vote was 420-1, with only Rep. Gary Condit, D-Calif., who was defeated in a primary for re-election after he was romantically linked with Chandra Levy, a government intern who was murdered, voting against Traficant's expulsion.
Preliminary reports are that the margin for passage of a subsequent resolution, to tar and feather Mr. Traficant and have him run out of town on a rail, was somewhat narrower, with Barbara Lee, D-CA, and Cynthia McKinney, D-GA, joining Mr. Condit to oppose that measure.
J.P. Morgan and Citigroup both say that they did no major wrong in their relationships with Enron.
The Man Without Qualities believes that is probably objectively correct, for all of the reasons described in previous posts. But both banks will have to contend with the obvious facts that the standards are being changed on them ex post facto.
Also, just because the banks probably did no major wrong doesn't mean they didn't know all about what Enron was up to, or that they didn't grasp the significance of what Enron was up to. To that extent the banks' current positions - which assert that they, too, were bamboozled by Enron - may ultimately result in a great deal of trouble for the banks and their representatives, including under the False Statements Act.
No, these banks and their representatives almost certainly knew everything they needed to know about Enron's finances and accounting, especially as to how the banks' own products were being disclosed. The banks may even have had doubts about Enron's disclosure. But they also probably concluded that a reasonable person could conclude that what Enron was doing was within the envelope of reasonable business judgement and procedures - relying in part on Arthur Andersen to reach that level of comfort. All of that is consistent with similar processes leading, say, the Enron board of directors to similar deferential conclusions. It's the same infinitely receding hall of mirrors that characterizes most serious questions of corporate responsibility.
Perhaps the board and these banks should have looked harder and thought more for themselves. They may have been negligent. Perhaps seriously negligent. They may be held accountable for more than that.
But it is interesting that while the feds are apparently towing away members of the Rigas family and their entourage by the truckload in handcuffs today for alleged bank fraud and the like, nobody at Enron or Andersen - and now Morgan and Citibank - has yet to be indicted.
How long has it been now?
Some members of the Rigas family, which controled Adelphia, have been arrested for bank fraud, among other things.
Nobody seems to be saying it was an option-driven "pump-and-dump."
The Rigases are said to have become crooked the old fashioned way. They controlled the company and allegedly took its money and cooked its books to cover that up.
This is hilarious. Tom Daschle must almost literally have no shame.
With respect to the post below captioned "Robert Rubin and the Federal False Statement Act", Alex Frantz says "There is one trivial detail that's been omitted from this discussion of Mr Rubin's crimes: neither Musil nor Glenn provides a single example of a statement Rubin made that they believe to have been false."
That post is separated by several others from an earlier one captioned "Butter Won't Melt In His Mouth," which in turn links to eight other posts in which the Man Without Qualities has expressed reasons to be concerned about Mr. Rubin's role and truthfulness in the Enron/Citigroup matter. Unless Mr. Frantz has been reading this blog consistently recently, he might easily have missed the earlier collection of links.
Andrew Sullivan has his own suspicions, which should be investigated. But whether or not Mr. Rubin was at Citigroup when certain Enron deals were put together, he was certainly there when Enron crashed and he made his call to Mr. Fisher. There is no indication in the media that Mr. Rubin mentioned any of Citigroup's questionable involvement with Enron when he requested Mr. Fisher's aid in pressuring the rating agencies. If Mr. Rubin knew about Citigroup's involvement at the time he called Mr. Fisher, Mr. Rubin may have misled Mr. Fisher in violation of the False Statement Act. Mr. Rubin is also reported to have spoken to various federal officials since making that call. But there are no reports that Mr. Rubin detailed Citigroup's deeper involvement, or any of the troubling deals that have recently surfaced. But Mr. Rubin does have a deep and justified reputation for acquiring vast information before taking important actions such as his call to Mr. Fisher and subsequent interviews with government investigators, and he does not move carelessly. There is therefore very good reason to ask "What did Mr. Rubin know about Enron and Citigroup's relationship with Enron when he spoke to Mr. Fisher and other government officials, and did he mislead them?"
For example, media reports imply that when Mr. Rubin requested Mr.Fisher's intervention Mr. Rubin suggested that a delay in a downgrade of Enron's debt might permit the company to get back on its feet. But the Citigroup transactions and involvement that have come to light recently indicate that Citigroup may have known Enron was doomed and was cooking its books with Citigroup help. The details of the Rubin-Fisher call have not been fuly disclosed. But if Mr. Rubin knew Enron was doomed but said otherwise to Mr. Fisher in an attempt to manipulate the rating agencies, that would be a very serious matter, not just a technical violation of the False Statements Act. And at this point, it looks like that may be just what happened. But we don't know exactly what Mr. Rubin said or knew when he called Mr. Fisher. Similarly, we don't know most of what Mr. Rubin said or knew when he thereafter talked privately to federal investigators about his call Mr. Fisher and Enron, or how it squares with the recent disclosures of the Citigroup/Enron relationship. But we know that Mr. Rubin was in a position to know a lot, and that he has a reputation for making sure he is fully informed when he acts. But we have no reports from Mr. Rubin, Citigroup or anyone else that he revealed any key transactions to the federal agents to whom he has spoken.
Mr. Frantz is quite correct that the matter has not yet come to the point of identifying a particular supposedly false statement of Mr. Rubin to a particular government official. And I have not suggested the matter has come to that point. What I have suggested is that Mr. Rubin should be investigated. I have not accused Mr. Rubin of any crime, nor has Glenn, nor has Mr. Frantz said that either of us have.
Why does Warren Buffet keep making these same arguments about options , when they have been definitively answered?
Mr. Buffet continues to pretend that a sound and "honest" number can be chosen to represent the "expense" of employee options. But not even the FASB proposal which would require expensing options contemplates any such thing. Here's what the proposal says:
The fair value of a stock option or equivalent award would generally be estimated using an option-pricing model that considers the following factors:
* The current (grant date) price of the underlying stock;
* The expected volatility of the underlying stock (i.e., the expected variance of returns on the stock);
* The option or exercise price;
* The expected life of the option;
* Expected dividends on the stock; and
* The expected risk-free rate of return during the option life.
The proposed standard would not require use of a particular option- pricing model or approach, but does specifically identify Black-Scholes and binomial option pricing models as being appropriate. The method used to estimate fair value should explicitly incorporate each of the factors enumerated above. This is critical because the proposed accounting would require compensation expense and the value of the award be adjusted to reflect subsequent changes in the expected life of the option. To appropriately adjust for changes in this estimate, its role in the determination of fair value must be explicit. There are several relatively inexpensive software packages that value options based on user specification of these six input values. With the availability of these option-pricing packages, determining the appropriate assumptions to use as software inputs is expected to be the most difficult task in the valuation process.
So the FSAB proposal would allow companies to choose the pricing model. Which is fine, since most analysts would ignore whatever number was used anyway and substitute their own. For example, the comment above notes that the expected volatility of the underlying stock is key to determining the value of the option. Consider the behavior of the markets over the past few weeks. How comfortable does one feel that the "expected volatility of the underlying stock" could have been predicted - for any stock at all?
Mr. Buffet says: "I have a proposition: Berkshire Hathaway will sell you insurance, carpeting or any of our other products in exchange for options identical to those you grant yourselves."
That sounds nice. Suppose Mr. Buffet uses Black-Scholes to value the options in the trade. And suppose his counterparties choose another measure - a so-called "ex post measure." Well, one study has found that "based on a sample of 53 firms ... the Black-Scholes model overestimates compensation expense by approximately 39 percent relative to ex post measures." Mr. Buffet is a clear financial genius. And he will need every bit of that genius to close a 39 percent gap between asking and selling price for all that insurance, carpeting or other products.
And why in God's name does he keep saying things like "Chief executives frequently claim that options have no cost because their issuance is cashless?" If some CEO's are making the point in that crude, misleading language, Mr. Buffet should be campaigning for them to stop doing that and instead explain to their shareholders that options have dilutive effect that can be measured by different ways under different assumptions. But this is no excuse for Mr. Buffet to be urging his own misleading single-number, single-model misrepresentation as a replacement for another misrepresentation to which he objects.
Mr. Buffet has repeatedly and famously asked: "If options aren't a form of compensation, what are they? If compensation isn't an expense, what is it? And if expenses shouldn't go into the calculation of earnings, where in the world should they go?"
And the answers are pretty clear:
Options are a form of compensation that can be valued in different ways.
Compensation is an expense that can be given different dimensions depending on the model and assumptions chosen. And once those are chosen, " there are several relatively inexpensive software packages that value options based on user specification."
This kind of expense should go in a footnote to balance sheet earnings describing the alternative "pro forma" calculation of earnings using one or more options pricing models, together with an explanation that other models and assumptions can be used.
It is hard to understand why a mind as capacious and practical as Mr. Buffet's gets stuck on this odd little issue. It is not too hard to come up with various, unflattering and flattering possible motives for Mr. Buffet's position - but that would be speculation. The reader may speculate for hereself, if she wishes.
But whatever may be motivating Mr. Buffett, this issue sure isn't any part of what has the equities markets in a snit.
Tuesday, July 23, 2002
The False Statement Act applies to every matter within the jurisdiction of every executive, legislative and judicial agency of the U.S. government. Under the act, it is a crime for any person:
* To knowingly and willfully falsify, conceal or cover up by any trick, scheme or device any material fact.
* To make any materially false, fictitious, or fraudulent statement or representation.
* To make or use any false writing or document knowing the same to contain any materially false, fictitious or fraudulent statement or entry.
Punishment for a violation may include fines and imprisonment for up to five years.
The False Statements Act applies to every matter within the jurisdiction of every executive, legislative and judicial agency of the U.S. government.
So the False Statements Act probably applied to Robert Rubin's bizarre and notorious telephone call to Peter Fisher, in which Mr. Rubin reportedly asked Mr. Fisher to pressure the bond rating agencies to delay the then-expected downgrade of Enron debt. It applies to any statements Mr. Rubin has made regarding his knowledge of Enron to federal bank regulators or to the Securities and Exchange Commission or to Congress
Mr. Rubin should be carefully investigated for violation of the False Statements Act.
Right now, his more intellectually dishonest apologists are able to charicature the increasing disturbing circumstances surrounding Mr. Rubin's Citigroup dealings (such as Andrew Sullivan's suspicions) as "string[ing] together a bunch of Rube Goldberg assumptions and implications to make his argument, rather than facts."
That should not be allowed to continue. It is not fair to Mr. Rubin or to the public. Mr. Rubin should be called to Washington, placed under oath and made to provide clear explanations for all of his Enron/Citigroup dealings, including the telephone call to Mr. Fisher. If he chooses, he may exercise his Fifth Amendment rights. Files should be opened, if that has not yet been done, at the Department of Justice, the Securities and Exchange Commission and the Federal Reserve (which is the chief regulator of Citigroup as a bank holding company). Mr. Rubin's statements should be carefully investigated and he should be charged or cleared as quickly as possible, as the evidence indicates.
Mr. Rubin is entitled to all that.
And so is the nation.
As most people now know from the Andersen trial, if Mr. Rubin violated the False Statements Act, then his guilt can be imputed to Citigroup.
UPDATE: Glenn Reynolds says that if Mr. Rubin is at risk, "this is probably a testament to the excessive reach of the False Statements Act." I completely agree that the False Statements Act is too broad - and the recent certification rule imposed by the SEC is broader still with respect to SEC filings. Although a man who has violated that Act arguably shouldn't be occupying the position Mr. Rubin does at Citigroup, the main benefit of employing the False Statements Act here would be to obtain whatever additional information Mr. Rubin may have regarding the Enron/Citigroup connection, a connection which now appears to be every bit as substantial as the Man Without Qualities has suggested might be the case. Mr. Rubin's information (if it exists) might be damaging or exculpatory to Enron or Andersen or their operatives or to Citigroup - or to, say, their respective lawyers, including the two partners at Shearman & Sterling (Citigroup's long-time counsel) who granted Enron critical waivers while employed at the SEC. As noted here previously, Citigroup should have no difficulty waiving attorney-client privilege.
Mr. Rubin has made a career of possessing lots of information that he shares only when and to the extent he chooses. The False Statements Act might help to shift that choice to federal investigators. It might even help out the Enron task force at the Department of Justice, who seem stalled at the moment.
FURTHER UPDATE: The extent of the sweeping anti-business mindset now prevalent in the less responsible quarters of the American left can be seen in Atrios' assertion that the False Statements Act to him "sounds like an EXCELLENT basis for prosecuting just about everybody involved in the energy trading business who communicated with FERC during 2001."
It is certainly true that False Statements Act applies to communications with the FERC - and Justice Department prosecutors should consider enforcement actions under the Act in the energy sector if evidence supports such actions.
But Atrios' assertion that "just about everybody involved in the energy trading business" violated this federal statute if they spoke to FERC indicates just how sweepingly hostile towards business whatever part of the left it is that includes Atrios has now become. It is likely that the costs of such hostility on the national scale will be huge.
For example, Atrios' inclusion of just about the entire energy business among the criminal class certainly makes a mockery of the explanation of Erik Smith, Mr. Gephardt's spokesman, that the Minority leader's agenda has "drawn strong support from corporate officers".
Mr. Smith said: "What Mr. Gephardt and Democrats are saying is not anti-business, it is anticriminal behavior." But, refreshingly, Atrios' is having none of that Gephardtian double-speak. No "few bad actors" or "a small, corrupt minority" evasions for Atrios. He says "just about everybody involved" could be prosecuted for this federal crime. Atrios doesn't seem to think the distinction Mr. Smith is trying to draw means very much to Atrios, who - like many on the left - doesn't even understand, or at least admit, how generally and obviously hostile he is to business. Mr. Smith understands the need to cover the tracks Atrios brazenly leaves behind.
Antidisestablishmentarianism Comes for the Archbishop?
The new Archbishop of Canterbury, Rowan Williams (no, not Robin Williams), advocates "disestablishment" — ending the Church of England's position as England's legally established church led by the Queen. Bishop Williams was appointed by a House of Commons widely believed to be totally dominated by Tony Blair, who is an Anglican.
The situation would be even more remarkable if the Prime Minister were actually Mr. Blair's wife, Cheri, who is a serious Catholic, who sends their children to a serious Catholic school in London.
Prospects such as a non-Anglican appointing the Archbishop of Canterbury seem to highlight the significance of disestablishment, and it is interesting that an advocate of disestablishmentarianism has now been appointed the head of the C of E. Of course, one doesn't know if he will change his official position on that issue now that he has been appointed to that particular office.
But such a conversion of the new Archbishop to antidisestablishmentarianism would be disheartening, if only because it would end the opportunity for text-based media to use a word one was duped in one's childhood into believing was "the longest word in the English language," only to later discover it had been edged out by the name of some dreadfully complex molecule or other.
Monday, July 22, 2002
UPDATE: When Roger Altman, former deputy Treasury secretary in the Clinton administration, starts writing articles like this for the Wall street Journal, perhaps Mr. Gephardt and other anti-business jihadists may want to take the note and re-think their current strategy.
The New York Times apparently wants to reassure us that Democrats will be able to extract money from business, notwithstanding their current jihad against corporate America:
Mr. Gephardt, of Missouri ... has been working overtime on fund-raising... "Your resources will help us win races all over the country," he told a wine-sipping audience of 100 or so ... Guests included representatives of the airline, high-tech and automotive industries, and Washington lobbyists with many corporate clients. Mr. Gephardt's office declined to provide a list of people who attended ... Earlier this month, aides said, Robert W. Pittman, the AOL-Time Warner executive who resigned on Thursday, held a fund-raiser at his Manhattan apartment for Mr. Gephardt. Advisers to Mr. Gephardt reject any suggestion that his push for new business regulations should disqualify him from raising corporate donations. They say his agenda has drawn strong support from corporate officers. "What Mr. Gephardt and Democrats are saying is not anti-business, it is anticriminal behavior," said Erik Smith, his spokesman.
It is interesting that “[a]dvisers to Mr. Gephardt reject any suggestion that his push for new business regulations should disqualify him from raising corporate donations.” Who, exactly, has been making those suggestions? The Times doesn’t say. Don’t the reporters know?
And while the Times reporters interviewed various politicians, lobbyists and congressional aides, somehow the reporters weren't able to come up with a single, actual, live businessman to confirm that Mr. Gephardt's strident, nearly hysterical broadside attacks on business "have drawn strong support from corporate officers." Indeed, Gephardt's people wouldn't even give the Times a copy of the guest list from the fundraiser. Perhaps the Gephardtians were concerned about what one of the "guests" might say in that tender 24-hour interval after being fleeced under these circumstances.
And considering what AOL-Time Warner had in mind earlier this month for Mr. Pittman at the time he held that fundraiser for Mr. Gephardt, I'm not sure the Minority Leader should take that occurrence as an entirely positive gesture, especially since Mr. Pittman is being lined up to be assigned most of the blame for some possible AOL-Time Warner accounting irregularities.
But business can't just freeze Mr.Gephardt out completely. After all, regardless of his policies, the Party-Out-Of-Power (in this case, the Democrats) do tend to gain seats in mid-term elections. So there is a good chance Mr.Gephardt will be Speaker next year, just by the historical numbers.
Perhaps he lets those business leaders know that when he asks them to pay up.
Can the Robert Rubin who wrote this be the same person who is one of the highest executives in the company they're talking about here and here and here?
And now here and here?
And, of course, here and here and here and here and here, and here and here and here.
No. It just can't be. Nobody has THAT much cheek.
In the ongoing Congressional brouhaha over executive options, some public discussion has become rather confused, at least in the opinion of the Man Without Qualities. It is in my view worth noting that the following are quite different criticisms of such options:
1. Not expensing options on company balance sheets allows companies to overstate earnings, leading to overpriced stock.
2. Executives compensated and incentivised with stock options will tend to engage in fraud and deceptive practices in order to boost apparent earnings and therefore the price of the stock. The executives will exercise their options and dump the stock while the market is artificially hot.
3. Because option holders enjoy the up side of stock price fluctuations, but not the down side, executives compensated and incentivised with stock options will tend to take more risk than the shareholders would like. This is sometimes called the "non-alignment (or disalignment) of interests" argument because it is based on the non-alignment of shareholder and option holder interests.
While reasonable minds may disagree, each one of these arguments is unpersuasive.
The first criticism fails because, as many people have now pointed out, it is well-known fact that once options are disclosed, investment professionals will simply evaluate the effect of the options on the company's financial condition by using any number of many, many methods of valuing the options. It is not that some of these methods are right and others are wrong. Rather, some methods are more appropriate than others under different assumptions. More Than Zero has made a similar point. To take a simple example: If the options have an exercise price of $1.00 and one assumes stock price will trade around $0.90 indefinitely, the value of the option will be very different if one also assumes either:
(i) that the stock will be highly volatile (in which case it will often be above $1.00, and represent a real dilution prospect and therefore a cost, to the company), or
(ii) that the stock price will always range between $.88 and $.92, in which case the option is worth zero, and the company faces no real expense.
How a particular analyst views the likely volatility of the company's stock under whatever circumstances the analyst is interested in will be key. For example, if the analyst is looking at hostile take-over scenarios, high volatility is likely. If a tender is unlikely, volatility will be determined by other market factors. This example varies just one assumption but implicitly uses the same methodology. But methodologies can also be properly varied, especially between the long and short term.
Simply put: Whatever number is used to reflect the expense of the options in the company’s balance sheet - no matter what that number is - will be wrong. So why do it? One can, of course, make certain "reasonable' assumptions about the factors most often used to value options in common methodologies - which amounts to saying that one assumes the future will be like the past - and require companies use a particular methodology and plug in such standard reasonable assumptions. That would probably produce the most "misleading' set of financial statements of all. Similarly, it is not that hard to imagine analogous "overstatements" of corporate earnings of unlimited degree and extent that do not represent any deception of the market at all and which should not be corrected simply because it is better to describe them in other terms and let the analysts evaluate their significance for themselves.
Nor does the second criticism really hold up. As a preliminary matter, it is worth noting that this incentive will exist if the prosperity of an executive is effectively linked by any means to the value of the corporation’s stock in a way that allows the executive to sever connections with the company and take the accumulated value away. So unless an executive is to become an indentured servant, it is not possible to solve this problem and still have the executive care about share value. Moreover, contrary to recent media coverage, there does not seem to be a very strong correlation between executive options and the recent spate of documented accounting scandals. Consider this formulation of the problem, by the op-ed writer for the New York Times article linked above:
Options, which are not counted as an expense and thus inflate earnings, bring with them a powerful incentive to cheat. They hold out the promise of wealth beyond imagining. All it takes is a set of books good enough to send a stock price soaring, if only for a while. If real earnings are not there, they can be manufactured — for long enough, in any case, for executives to cash out. This, in essence, is what happened at Enron, WorldCom, Xerox — indeed, at quite a long list of companies.
Except that nobody is saying that the scandals at WorldCom or Xerox were in any way connected with executives of those companies fraudulently inflating their stock prices so the executives could dump their option stock. Nor has either of the Adelphia or Global Crossing disasters been tied to "option dumping." For example, in 2000, Mr. Winnick, or companies he controlled, owned 78.9 million shares of Global Crossing stock as well as 8.56 million options. So if there was an incentive to boost the stock price at Global Crossing, it is hard to say that options – rather than simple stock ownership – were the cause of it.
In fact, the problems at Adelphia and WorldCom appear tied to the ways their executives were buying company stock, not dumping it. The Merck pseudo-scandal has not been assigned that likely causation. Not even the Im Clone disaster has been tied to options. The SEC and the Justice Department are reportedly investigating whether Computer Associates wrongly booked more than $500 million in revenue in 1998 and 1999, a time when three senior executives were enriched via stock payouts from the company – not options - that were triggered by stock price milestones, but that stock has for the most part not been sold. At Tyco, Mr. Kozlowski and other individuals have lots of problems, and some analysts and investors wondered if Kozlowski had approved some of the same accounting tactics as those allegedly used by Enron – but the “wondering” has not matured into serious civil or criminal charges. Further, if there are problems at Tyco, they are probably tied up with Kozlowski's sale of about $300 Million in company stock to the company prior to 1999 - a potentially dangerous issue, but not the same as option dumping. Problems at Qwest may be option-related, and Mr. Nacchio engaged in some alleged option dumping (although he denies that). But even here one has to contend with the fact that Mr. Anschutz was in ultimately charge there and he owned a 301 million-share stake in Qwest, where he sold about 3.3% of this stake during the questionable period. That doesn't sound like an option-driven problem.
Of the now rather long list of large companies tainted by accounting scandals recently, few other than Enron are even allegedly the product principally of option dumping. Of course some of these companies employed executive stock options - but that has not been reported as a major cause of the alleged scandals. So it's not surprising that the Times op-ed piece just omits the actual names on that "quite ... long list of companies" that have succumbed to this particular temptation. But it is Enron that caused the initial uproar, which may be why this criticism has gained currency. It is just hard to find a real pattern of executive options being the major issue with these companies, even assuming for the sake of argument that their irregularities are as serious as their critics contend.
It is also worth noting that this New York Times article says that that the accounting "fraud" suggested in that article has been going on for TWENTY YEARS AND THROUGHOUT THE MARKET. The reader can evaluate that probability for herself.
What is correct is that during the dotcom run up, many holders of executive options became fabulously rich by dumping option stock in companies with no earnings The shareholders in those companies eventually more or less lost everything, and that rankles still. But that's not today's problem - and there have been surprisingly few claims that the dotcom companies actually defrauded their investors. After all, each one of those IPO prospectuses pointed out the dotcom then going public had no earnings and a highly speculative "business plan." But this was a point made widely during the run up itself.
One might also point out that the great majority of companies using executive options have not been accused of improprieties. So if the incentive is so strong, why were more companies not affected?
Until there is some clear, widespread evidence that executives compensated and incentivised with stock options will tend to engage in fraud and deceptive practices there seems to be no reason to jump to that conclusion. After all, there are a great many anti-fraud and anti-insider-trading laws already on the books. Why assume the balance between the two sets of incentives (that is, incentive to cheat from options meets incentive not to cheat for fear of getting caught and punished) has been upset to the point it needs drastic overhaul? True, there may be a need to reassure the markets. But there is also the serious risk of overkill and overregulation, which is probably an even bigger risk to the markets. And let’s not forget that really serious restrictions on options could be a dagger pointed at the heart of the venture capital industry – thereby risking serious damage to one of the American economy’s greatest assets.
The third criticism is more subtle and interesting - but also ultimately unpersuasive in this crude form. For one thing exactly the same argument can be made about stock with respect to debt. Consider a company financed partially with a loan for, say, $100 Million. Suppose the directors perfectly represent the shareholders' interests. Suppose the company has two possible business plans: Plan A, which will yield exactly $100 Million and has a 100% chance of succeeding (that is, it's low risk), and Plan B that has a 50% chance of making $200 Million and a 50% chance of making $0 (bankruptcy). It is obvious that the board will choose Plan B, since the value of this Plan to the shareholders is $50 Million (.5 chance of success X [$200 Million return - $100 Million loan]) , where the "low risk" Plan A is worth nothing. But the lender would clearly prefer Plan A, since that Plan has a 100% chance of repaying the loan.
Does anyone think that this kind of "non-alignment of interests" argument as between debt and equity means that companies should not have both debt and equity? Of course not. Lenders protect themselves in such cases by including covenants in the credit agreement and structuring the loan in clever ways. Similarly, the structure of the option plan will be determinative in the executive option case.
But, more importantly, why should this third criticism matter much in the debate over legislative action. Yes, executive options can disalign shareholder and executive interests in the same way equity and debt holders are somewhat disaligned, and the interests of founders are somewhat disaligned from those of later shareholders. But most people understand that the founders, shareholders and debt holders also have many interests in common. Such disalignment is a factor for the investors to consider - not the Congress.