shareholdersunite.com

Opportunities in smallcaps

shareholdersunite.com header image 2

Some good may come out of all this

October 2nd, 2008 · No Comments

Excesses have led to a big mess. When the dust settles, at least a little bit, some good might come out of all this. Capitalism’s main strength is that it learns from mistakes, and in a decentralized way. It’s a bit trial and error, but it’s better than any other solution out there.

In a famous paper (we think it’s one of the top three of the past century) by Friedrich von Hayek describes in 1945 that knowledge is distributed in society, his main argument against socialism. Today, this is ever more so, with increasing complexity and specialization.

That’s why capitalism is able to innovate so much, as it has the ability to come up with many solutions for a problem and a mechanism (the market) to decide which is the best. Since power is decentralized, there is no one central entity stifling competing solutions, a crucial advantage.

Alas, this doesn’t always work as it is supposed to, and the political field often messes the process up, as it dances to a different tune. However, even for them the chance to improve the long-term health of capitalism has arrived.

So, here is a few things that they might improve:

  1. The realization that markets, if they are to function as they’re supposed to, need tailor made regulation. If regulation is bad, or insufficient, this is what happens.
  2. The realization that this holds especially true for financial markets, which are plagued by information asymmetries and irrational waves of exuberance and pessimism, driven by herd behaviour.
  3. The realization that the so called ‘Washington-consensus’ model of capitalism with its prime role for inherently unstable financial markets is not necessarily the best form of capitalism out there.
  4. The cosy old-boys network in finance, leading to tremendous excesses in pay is a poor proxy for market forces.
  5. The smartest mind might actually move to engineering again, concentrating on making stuff, rather than the exotic financial engineering that got us into the mess in the first place
  6. The realization that the US cannot live forever on (foreign) credit and deep, financially engineered leverage.

It would be a start..

Putting some regulation in place to curb the exorbitant remuneration of CEO’s and top management is actually not unlikely (see article below), as main-street’s disgust at having to bail many of these out could still cost us the rescue package.

These pay packages make no sense. In times when CEO’s could direct most of their employees, there would have been some justification, but now, top management depends as much on the knowledge and insights of their employees as the other way around, and the escalating pay differences are threatening the social fabric of companies and even societies, especially there where they enter an alien culture via the back door of financial globalisation.

Even right-wingers like Nicolas D Kristoff seem to be in favour (notwithstanding the title of the article):

  • A starting point would be to remove tax subsidies on executive pay and allow courts to restructure mortgages as they do other kinds of debt. The Institute for Policy Studies in Washington estimates that U.S. taxpayers every year provide more than $20 billion in tax subsidies for executive pay.
  • Among the strongest critics of inflated executive pay have been Warren Buffett and the late management guru, Peter Drucker, who argued that C.E.O. salaries should peak at no more than 20 or 25 times those of the average worker. (Last year, C.E.O.’s got an average of 344 times the wages of the typical worker.)
  • The truth is that with the complicity of boards of directors, C.E.O.’s hijack shareholder wealth in ways that are unconscionable. As The Wall Street Journal reported in June, if Eugene Isenberg, the 78-year-old C.E.O. of Nabors Industries, were to drop dead one of these days, his estate would be entitled to a “severance payment” of at least $263 million — more than the firm’s first-quarter net earnings.

Bank bailout may lead to broader pay curb

Wall Street pay not only exec comp caught in crosshairs By Mark Bruno
September 28, 2008 12:01 AM ET

  • As lawmakers angle for ways to take the air out of Wall Street executives’ pay by tacking compensation-specific provisions on to the Treasury Department’s $700 billion bailout plan, their actions could have considerable implications for companies outside of the financial services industry.
  • At the moment, the compensation clauses in the bailout bill are tentative and fairly vague, but they’re exclusively aimed at curbing the pay of executives who choose to offload their companies’ distressed assets to the federal government. It appears, however, that any provisions included in the rescue plan could be used as the groundwork for broader changes that lawmakers would like to make in the way all executives—regardless of their industry—are paid.
  • “It really seems as though there are two pieces to all of this,” said Richard Ferlauto, director of corporate governance and pension investment for the American Federation of State, County and Municipal Employees. “There’s the quid pro quo with the bailout now, but then there’s the potential for broader compensation reforms that I’d expect to take place early next year—regardless of who is elected president.”
  • Members of Congress, who were thrust to center stage last week as they reviewed the bailout proposal, used the forum to highlight many of the hottest topics in the world of executive compensation: say on pay, using clawback provisions that allow companies to recoup executive pay, modifying or eliminating excessive severance awards, and capping pay so that executives are not incentivized to take inappropriate levels of risk.
  • In a brief television interview last week, House Financial Service Committee chairman Barney Frank acknowledged that Congress will continue to focus on these issues as they affect executives well beyond Wall Street once the bailout is buttoned up. “We do want those, in a binding way, to be applied to any company that benefits in any way from this program,” said Rep. Frank, a Democrat from Massachusetts, of the compensation provisions he proposed for the bailout bill. “We will then be looking at broadening those next year to all public corporations.”
  • Whether that takes the form of a comprehensive executive compensation reform act or comes as part of a broader overhaul of financial regulations or tax law is, of course, still uncertain. Calls to Mr. Frank’s Washington office were not immediately returned.
  • But it’s clear that lawmakers are set to strike while the iron is still scalding, and executive compensation has never been a hotter topic than it is right now. Whether it surfaced in President Bush’s address to the nation last Thursday, in stories on the covers of countless newspapers or on late-night talk shows, the outrage over executives receiving behemoth bonuses while the economy spoils seemed ubiquitous.
  • Severe economic dislocations are the catalysts for change,” said George Paulin, chairman and chief executive at Frederic Cook & Co., a compensation consultant to large corporations. “And compensation is clearly a target for change right now.”
  • One dramatic move would be to tweak the tax rule that limits to $1 million the amount of compensation a company may deduct for each of its top-paid officers. At one point last week, a Senate proposal for the rescue plan sought to limit the deductibility of compensation above $400,000, although it did not contain a thorough definition of total compensation.
  • The $1 million limit, outlined in section 162(m) of the Internal Revenue Code, doesn’t apply to the portion of an executive’s compensation that is based on performance, however, allowing companies to use stock options and other incentives to award executives larger payouts.
  • “[Lawmakers] may choose to take a look at the definition of ‘performance-based’ compensation and limit some of the exceptions,” said John O’Neill Jr., a partner in the government affairs group at law firm Venable, and a former policy director in the office of the Senate Republican Whip under Trent Lott. “If they included something like deferred compensation, it could generate significant revenues for the federal government.”
  • At the same time, most observers expect lawmakers to make say on pay—which gives shareholders a vote on executive pay packages—the first compensation priority in Congress next year.
  • Mr. Frank pushed say-on-pay legislation through the House last year, and Democratic presidential candidate Sen. Barack Obama introduced it to the Senate. The measure currently sits in a Senate committee, but if Mr. Obama is elected, “you can expect to see that pushed through in his first 100 hours,” said Steve Balsam, a compensation expert and professor at the Fox School of Business at Temple University. If Republican candidate Sen. John McCain is elected, Mr. Balsam added, the measure will still likely be a priority. “It’s a way to curb executive pay without imposing too many specific regulations and limitations on compensation.”
  • Along these same lines, lawmakers may choose to focus on legislation that expands the use of clawbacks, policies that let companies go after a portion of an executive’s pay if the financials on which an incentive payment was based are restated because of some misconduct.
  • New legislation could include language that would enhance a company’s ability to recoup bonuses or severance in other situations—if an executive misled shareholders or took too many risks, for instance.
  • “It’s a good idea in theory, and it’s certainly better than placing a cap on compensation,” said Charles Elson, a professor at the University of Delaware and a director at HealthSouth and AutoZone. “But it would be a challenge to draft any language that would really empower a company to recover compensation in these cases.”
  • “If there’s an instance of fraud, it’s not as difficult to enforce clawbacks,” Mr. Elson said. “But when a business is mismanaged, that’s a much more difficult thing to prove.” FW

Tags: The Markets