Posted by Marc Hodak on May 30, 2007 under Collectivist instinct | 
Chicago, that is, where I’ll be the next couple days. I hate cigarette smoke. When I was growing up, I nagged my smoking dad so much about the smell that he finally quit (just as I was going to college). If I was driving with him and he wanted to light up, I would make him roll down the window an inch. Even if it was sleeting. (I figured out that one inch was all that was needed to neatly suction out the smoke of a cigarette close to the window of a moving car.) Even then, I’d complain about being to able to smell it. I was a total bastard about the smoke. I just seize up when I smell cigarettes. I literally can’t breath around it. I look for the closest exit so I can catch my breath. I think it has to do with my lung operation as an infant. I really hate cigarette smoke. In fact, there is probably only one thing I hate worse than cigarette smoke: sanctimonious, paternalistic, do-gooding legislators subjecting an entire major city to the same bratiness visited on my poor dad.
Posted by Marc Hodak on May 29, 2007 under Invisible trade-offs |
I’m putting together a presentation to a group of board members who requested that I start with some basics about the role of directors. So, I’m starting with the most basic question of all: why do companies exist? This is not a philosophy seminar, and we don’t have time for Coasian details, so I have to get right to the point:
– Shareholders create companies with their investment in exchange for a residual claim to the company’s profits
– Shareholders hire managers with the expectation that they will manage the company to legally maximize those profits
– The board’s job is to oversee management to insure that the shareholder’s interests are put first.
Managers, of course, have a zillion trade-offs to make–supplies, labor, new investment, etc.–in their quest to maximize shareholders’ profits. Even for insiders, overseeing the quality of these trade-offs is a very difficult task, but directors should understand in whose favor those trade-offs must ultimately be made.
For most outsiders, including critics, those trade-offs are invisible. But they still criticize. Business critics at least nominally hold the shareholders’ interests at heart when offering advice about new technology or grand strategy, which are sexy when they pay off, but often don’t. Kodak’s critics, for example, as well as their workers and communities, thought the company’s transformation from a chemical to a digital company was long overdue. Kodak’s shareholder’s blanched. They were content to milk the chemical company of whatever cash flow was left from chemical film rather than take that cash and plow it into something their managers had no clear competence in pursuing. Everybody loves a daredevil, as long as it’s not their baby on the ledge. Thus, “harvesting” is a highly underutilized strategy.
Social critics don’t even pretend to have the shareholder’s best interests at heart. And they hate “harvesting.” They would have us consider owners to be just one of many “stakeholders” for whose benefit the firm should be run. These people see the company not as the product of investment and risk-taking, but simply as a given, something to be milked for their own “good” ends based on some nebulous “social contract.” They advocate for “rights” of communities, workers, etc., competing with the rights of shareholders, supported by cash that would otherwise go to the shareholders. And where they have been most successful, they later complain about the decline of their communities and a lack of jobs.
My job is easier. I just have to help directors do their job.
Posted by Marc Hodak on May 26, 2007 under History |
After 15 years of Montessori, private and boarding school, about 100,000 hugs and endless other embarrassments suffered at the hands of his dad, Max graduates high school tomorrow! We’ll be partying all weekend with assorted family coming from all over.
Have a safe Memorial Day!
Posted by Marc Hodak on May 25, 2007 under Invisible trade-offs |
Adam Clayton Powell IV, assemblyman from East Harlem, has been accused of being the laziest legislator in Albany. As reported in the New York Sun:
Of the thousands of bills introduced this year, Mr. Powell can take credit for not a single one. If Mr. Powell doesn’t introduce a bill in the next month, he will have made it through three consecutive session years without acting as the prime sponsor of any piece of legislation.
I’m not sure how Powell slipped through. I guess being the son of a legendary politician gives you a big edge in the election game. But somehow, we now have a libertarian’s fantasy–a legislator who doesn’t believe in making new laws.
Most institutions create more rules than than they destroy. Their rules keep piling up. In the private market, a company will either have leaders regularly cleaning out the rules, like when Jack Welch took GE’s huge procedure manual and simply threw it in the trash, or the firm eventually collapses under the weight of its rules, left in the dust of its more nimble competitors.
The government, of course, can’t go out of business. So, if you believe that it’s possible to have too many laws, then one can’t view the current trend as a good one. In fact, your only prayer is someone like Adam Clayton Powell IV.
So, how does he get away with it? This is someone who mysteriously gets elected on something other than a promise to do something. This is a politician who apparently doesn’t stand up to be heard. Here is someone who apparently has little interest in telling other people what to do. This man, if mere mortal he be, somehow resists the lobbyists and activists, media crusaders and other assorted, professional busybodies who place incredible pressure on every one of our representatives, promising them funds and publicity and god-knows-what, so they can get state power behind some pet initiative that would clearly fail to get the voluntary support of their fellow citizens or pass any kind of market test.
Adam Clayton Powell IV, as long as your streak lasts, you are my hero.
Posted by Marc Hodak on under Collectivist instinct |
The WSJ presents a great example of this:
Sen. Hillary Clinton took the first step toward outlining her health-care agenda, suggesting a range of cost-cutting moves that she says would wring $120 billion of savings from insurance companies, drug makers and the rest of the health-care system.
She will draw from those savings when she details a much-anticipated plan for providing health coverage for the uninsured later this year.
Translation: Hillary is inventing savings now that she can spend later.
The “savings,” of course, are the product of an infantile imagination, the kind of things that kids dream up who have never actually struggled with the reality of turning managerial initiative into market-tested products or services when they say things like, “I’ll invent a laser that gets rid of cancer” or “I’ll invent shoes that never go out of style.” You don’t want to discourage the tykes, but you’re not about to give them a hundred billion dollars to test their cute theories. But Dr. Hillary will no doubt convince millions of voters that she should be given that access to our tax dollars because she has the cure to what ails them.
The spending–that will be very real. Hillary actually has a track record on that one.
Posted by Marc Hodak on May 23, 2007 under Invisible trade-offs |
In this article:
The House, eager to do something about record high gasoline prices in advance of the Memorial Day weekend, voted narrowly Wednesday to approve stiff penalties for those found guilty of gasoline price gouging.
The bill directs the Federal Trade Commission and Justice Department to go after oil companies, traders or retail operators if they take “unfair advantage” or charge “unconscionably excessive” prices for gasoline and other fuels.
Rep. Bart Stupak, D-Mich., its chief sponsor, in urging his colleagues to support the bill said the issue was whether “to side with Big Oil (or) … side with consumers who are being ripped off at the gas pump.”
The bill calls for criminal penalties of up to $150 million for corporations and up to $2 million and a jail sentence of up to 10 years for individuals found to be engaged in price gouging.
…the bill’s supporters argued that states can’t combat energy price gouging, leaving motorists at the whim of arbitrary oil company pricing.
So, the remedy to “arbitrary pricing,” approved by two-thirds of our Congress, is arbitrary prosecution. Even Rep. Stupak (I’m resisting the obvious play on his name) has no idea what “unfair advantage” or “unconscionably excessive” mean. I will let the lawyers tell me if there is such a thing as unconstitutionally vague laws, and if this would qualify.
What concerns me is that most of the people who voted for this bill are really not that stupid (damn, there I go). Congress has commissioned numerous studies on price gouging over the years, under Democratic and Republican administrations, and they all come back with the same verdict. It’s the voters who go in for the conspiracy theory behind such laws. The clearest evidence of the irrationality of that position is the utter lack of explanation about what leads to occasional gas price decreases. (It’s a one-way conspiracy? Big Oil was less greedy last month?) The point of this law is that the answer to why prices sometimes go down is clearly not current price gouging laws.
So what would be the predictable consequences of such a law? Well, rational business persons, when faced with possible $2 million fines and 10 year jail penalties for raising prices will:
(a) avoid situations where they might need to raise prices on a volatile commodity by always keeping them high,
(b) stop selling altogether in times of emergency, when the actual or opportunity cost of the commodity exceeds the “normal” price.
What businesses won’t do is try to make a decent return on a volatile commodity by allowing the price to come down when supplies are easy and not raise them when supplies are tight. And businesses certainly won’t take a chance on finding a market-clearing price for gas in the very times of emergency when gas, in fact, becomes most valuable to the public. So, then everyone will have theoretical access to gas at the “conscionable” price, but people who would have gladly paid more than the $1.50 or $2 (equivalent to $6-$8 per gallon) it might have cost them to drive five miles they desperately wanted to travel will instead stay put for fear of running out of their “reasonably priced” gas.
Posted by Marc Hodak on under Invisible trade-offs |
I found this comment on The Borgas Blog. It echos the sentiments of many people who have been citizens since birth:
I’m an immigrant who took the citizenship oath last December. I’ve been through the system. From my experience, the immigration system works if you decide to follow the rules. Before I immigrated, I never overstayed my student or tourist visas. When I decided to immigrate, I paid the fees, had a physical, was re-immunized against all those childhood diseases (including the oral polio medication), had a criminal record check in my country of birth, an interview in the US Embassy, and paid the required fee. I also had to prove that I had sufficient funds to support myself for a period of 5 years, and promise that I would not be a burden on the US people by agreeing not to apply for welfare (yes, this is true!) After fulfilling the residency period, I applied for citizenship, paid the fee, was finger printed (for the 4th time), had an FBI background check, passed the English language test (required even though my first language is English), passed the US history test, and interviewed for suitability by the INS/BCIS. I gladly did this. I followed he rules and everything worked well during the entire process. In my experience, if you follow the rules, the immigration system works well.
This commenter went on to express his rather extreme antipathy for letting off those who chose not to go the legit route.
On the one hand, it’s hard to argue with the rule of law and its adherents, and immigration law, which seems so messed up to so many people, has clearly evolved to account for many little things that the less informed continue to rant about, like checks for background, ability to provide for oneself, etc.
The key phrase for me, though, was “when I decided to immigrate…” I’m not sure that reflects the typical path, suggesting that this comment may reflect little more than the fact that the winners of the lottery are fine with the lottery. I also won the lottery by being born (abroad) to a U.S. serviceman. Both of my parents are immigrants, but they came over in a window of time when European refugees and Holocaust survivors weren’t subject to as stringent visa caps.
On the other hand, I went to business school with someone who married and had kids in the U.S., but was suddenly barred from returning from a visit with family abroad until she gave up her job at Price Waterhouse and promised never to work again in the U.S. (yes, this is true!).
Back to the commenter above:
Our Congress’s capitulation to illegal residents over the views of US citizens devalues US citizenship. Most legal immigrants I know share these views. Now that I am a registered voter, I’ll be making my views known.
Translation: The hell with her. Now that I’m in, I don’t mind if we slam the door shut. Or, if I can get a piece of it, let’s charge an arm and a leg for entrance. Who are these people tyring to take my jerb?
Ah, it’s so easy to be the lucky one!
Posted by Marc Hodak on May 21, 2007 under Executive compensation |
I guess it makes sense for a retailer to be the first to experiment with a bargain CEO. Sharper Image took a step advocated by many governance mavens to improve their bargaining position in negotiating for an outside CEO. They avoided identifying a single “gotta have” person, then trying to negotiate pay from a position of potentially failing to get him or her. As Pearl Meyer noted, this creates a situation where if “they find the person they think will make a difference, the cost is immaterial.” Instead, Sharper Image decided to take the pressure off themselves by identifying back-up candidates in case their first choice got too demanding. Fine so far, but then they looked at the sticker and got all Jack Benny.
Their compensation consultant conducted a peer analysis to determine that the board needed to be prepared to pay a target salary plus bonus of $1.5 million plus 150,000 options per year to attract current or past CEOs identified by the board’s search firm. Even though this was not much less than the current CEO was making, all things considered:
The potential price tag dismayed board members. “Everybody raised their eyebrows,” remembers Morton E. David, chairman of the nominating committee and former CEO of Franklin Electronic Publishers Inc. “Nobody was happy with the numbers” amid Sharper Image’s declining revenue, he explains. “Money was an issue. For some people, it was the prime issue.”
Directors decided to seek alternative candidates who had not run public concerns, and likely would cost less. Mr. David says they gave Mr. Levin [the interim CEO] authority to offer such a candidate “materially less” than a seasoned public-company chief would have demanded.
So, the board decided that brand-name was too expensive, and decided to take a chance on discount–someone less “seasoned.”
Now, I’m not one to automatically exclude the less obvious candidates for any position, but to do so for the CEO position based on price? To save $700,000 per year? Sharper Image has a $170 million enterprise value. A CEO that could bring their return on capital up to the industry median, where they were just a few years ago, would generate over $50 million per year in extra EBITDA, easily tripling the company’s market value. A merely “very good” CEO, one able to return the company to profitability, might generate a 50 or 100 percent return–not bad, but not 200 percent. In other words, the potential difference between the best and next best CEO could easily be hundreds of millions of dollars. And they’re concerned about $0.7 million per year?
Admittedly, no one can predict which candidate in the field would turn out to be the best. There is no guarantee that the guy who costs the most would actually be the best. There are many qualitative characteristics a board should consider before paying top dollar for someone who might not be a good fit, regardless of their track record. But to eliminate contender because of a cost that could easily be a fraction of value added does not seem like good governance to me.
No one can predict how this will all turn out, of course, but for what it’s worth, Sharper Image’s stock dropped 1.5 percent upon the release of this story (the market was flat), shedding about $2.5 million in market value. That would be net of the cost savings on the CEO.
Posted by Marc Hodak on under Patterns without intention |
The WSJ is trying its damnedest to disprove my theory that education makes a difference. In this story, tautologically headlined “In a Volatile Market, the Winning Analysts Had Their Timing Down,” they compile a list of Wall Street analysts based on the performance of shares they recommended. This is their 15th annual ranking of analysts, which means that this intellectual embarrassment was inaugurated when 20 years worth of papers had already accumulated providing empirical evidence that stock picking prowess was a largely illusory phenomenon. Yet the Journal still writes stuff like this:
Although there are many ways to rank analysts, this survey is strictly quantitative and based solely on stock picking skill.
Here is a funny definition of skill: luck.
One of the attributes of skill, the reason you know that Tiger Woods is skillful instead of lucky, is that skill results in performance persistence. A top athlete will consistently beat a mediocre athlete over any period of time. Wall Street pros, at least those with public records, don’t display this persistence. Neither analysts nor fund managers tend to stay on top from one year to the next with any greater frequency than a group that had good results picking stocks by throwing darts. Here is how the Journal interprets this phenomenon:
Several firms that performed well in previous years were tripped up by last year’s volatile market. A.G. Edwards & Sons, a unit of A.G. Edwards Inc., the No. 1 firm with nine awards a year ago, fell to No. 31 on this year’s list, with just three winning analysts. Citigroup Inc., which ranked second a year ago, sank to 49th place. Credit Suisse, a unit of Credit Suisse Group; Standard & Poor’s Corp., a division of McGraw-Hill Cos.; and J.P. Morgan Chase & Co., which rounded out the top five a year ago, all failed to place in the top 20 in this year’s survey.
Sigh.
Posted by Marc Hodak on May 20, 2007 under Collectivist instinct |
Today’s lesson is that China represents “A Shining Model of Wealth Without Liberty.” Here is author James Mann’s breathless warning:
This all adds up to a startling new challenge to the future of liberal democracy. And the result is ominous for the cause of freedom around the world. China’s single-party state offers continuing hope not only to such largely isolated dictatorships as Burma, Zimbabwe, Syria and North Korea but also to some key U.S. friends who themselves resist calls for democracy (say, Egypt or Pakistan) and to our neighbors in Cuba and Venezuela.
That’s his story–a snapshot comparison between nations that pretty cleanly ignores any trends, such as the growing difference between China and the other dictatorships cited by the author, or the increasing similarities between China and the Western countries it is catching up with. All Mann sees is the politics. Sure, he notes that, “The ruling party allows urban elites the freedom to wear and buy what they want, to see the world, to have affairs, to invest and to profit mightily.” But he sees this freedom merely as a sop by the party to bribe the elites into complacency, rather than a possible source of their growing national wealth.
Here is another view.
“Everyone said the fall of the Berlin Wall would herald the spread of democracy around the world. I think the experts and pundits got it wrong. Democracy has made inroads, to be sure. But what really took off was the spread of capitalism. It was the opening of markets that has made the most difference to the most people, lifting millions out of poverty.”
That was Stanley O’Neal, CEO of that petty bourgeois institution, Merrill Lynch.
Which view do you think holds more merit?
