Perverse Incentives Are Endemic (TM)
Posted by Marc Hodak on April 28, 2010 under Executive compensation, Self-promotion | 
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My newest article, published in Directorship, online version here. The comment they chose to highlight in their printed version:
The explosive growth in CEO pay over the last 20 years coincides with a huge shift of power from management to boards.
Which, I believe, pretty much guts the managerial power thesis of rising CEO pay.
Posted by Marc Hodak on April 26, 2010 under Economics, History | Be the First to Comment
Reading about governance in the first villages of New England, I come across lessons that keep getting repeated, down to our time. In 1641 the English Civil War triggered an economic crisis across the ocean. It threatened to disrupt relationships and supplies from the mother country upon which the colony depended, causing a number of the colonists to either sail back to England or move south where they could create a better subsistence for themselves.
The resulting turmoil caused a sharp drop in the price of land and commodities. At the same time, with labor getting scarce, workmen were able to ask for much higher wages. Relatively larger landholders found themselves in an economic vise. So, the town fathers, made up principally of these larger landholders, decided to pass wage regulations, limiting how much workmen could charge for their labor. Here’s a sample of those rules:
Every cart, with four oxen, and a man, for a day’s work 5s.
All carpenters, bricklayers, thatchers 21d./day
All common laborers 18d./day
All sawyers, for sawing up boards 3s./4d. per 100
All sawyers for slit work 4s./8d. per 100
The grandees who argued in favor of this price list no doubt justified it by arguing (a) it was for the public good, (b) no worker should profit from economic turmoil, (c) no one was worth 10 s. per day, (d) it’s good to spread the pain, and (e) given that these limits would be imposed on relatively poor people living at the edge of civilization between an inhospitable wilderness and a gaping ocean, “where else could they go?”
For you economics majors out there, what was the predictable outcome of these wage controls?
Posted by Marc Hodak on April 25, 2010 under Politics | Be the First to Comment
The WSJ reports:
Hugo Boss reversed a decision to shut down a factory in Ohio, succumbing to an aggressive union-led campaign against the German fashion house and its private-equity owners.
Of course, unions have every right to resist the loss of jobs. They also have the right, recently enhanced, of lobbying the legislature to affect union-friendly rules, even if said rules constrain the freedom of employers, consumers, and non-union workers.
But what kind of politician would threaten whole, productive sectors of the economy in order to protect a few hundred jobs? A politician beholden to union support:
Top Democratic political officials in Ohio including U.S. Senator Sherrod Brown and Governor Ted Strickland voiced their support for the union. Mr. Brown announced hearings that had been scheduled for next week on the role of private-equity firms and the U.S. economy.
Senator Brown of Ohio, of course, could look up the “role of private equity firms and the U.S. economy” in a textbook on economics. What the reporter really meant is that Senator Brown of Ohio is looking for a way to intimidate PE firms into sacrificing their investors’ interests in order to serve his parochial, political interests.
Posted by Marc Hodak on April 21, 2010 under Collectivist instinct, Economics, History, Movie reviews, Politics, Reporting on pay, Stupid laws | Read the First Comment
The IMF is pushing for a bank tax:
[T]o pay for the costs of winding down troubled financial institutions, the IMF proposed what it called a Financial Stability Contribution”—a tax on balance sheets, including “possibly” off-balance sheet items, but excluding capital and insured liabilities. That tax would seek to raise between about 2% to 4% of GDP over time—roughly $1 trillion to $2 trillion if all G-20 countries adopted the tax.
On top of that, the IMF proposed that nations to adopt what it called a Financial Activities Tax, levied on the sum of profits and compensation of financial institutions. That would be paid to a nation’s treasury to help finance the broader costs of a financial crisis…
The IMF said that a nation didn’t need to put in place a specific resolution authority. Instead, the tax money could go to general revenues and used in case of financial crisis. But the IMF warned that the money would be spent by the time a problem arose.
OK, so let’s see how this would work. Congress levies massive new taxes on every major bank. Congress would then spend that money on…stuff. A financial crisis hits, and certain TBTF banks get into trouble. Congress bails them out, having to borrow gobs of money to do so because the tax revenues that were nominally for “Financial Stability” were in fact spent on…stuff.
So, how is this different from what happened last time? Hard to see. Does it do anything to reduce the systemic risks that regulators insist were at the root of the last crisis? No. Does it strengthen the banks to make them better able to weather such a crisis? Not likely when so much money of their capital–enough to raise between 2% to 4% of GDP–is being sucked out of their coffers. At least if the money were being held in a trust fund instead of dumped into general revenues, it would be there for frenzied politicians to disburse based on the rational workings of the government. But, of course, the money will not be there. It will have been spent not to support the financial system, but to support the reelection of incumbent politicians–the most short-term actors on the planet.
Oh. Yeah. THAT would be the difference.
So the lesson from all this appears to be: When it comes to a justify raising taxes, any excuse will do.
Posted by Marc Hodak on under Politics, Scandal | Be the First to Comment
Few mechanisms have a greater impact on democratic governance than gerrymandering. Having incumbent politicians redraw districts entrenches them to the point that their reelection rate exceeds 95 percent. To paraphrase Yakov Smirnoff, in gerrymandered districts the voters don’t choose their representatives; the representatives choose the voters.
Gerrymandering enhances the power of political parties since all of the action is in the primaries, and the general election is a forgone conclusion. Many districts throughout the country have not changed party hands in decades. Thus, any challenges to gerrymandering have been briskly opposed by the parties even more than by the incumbents. In fact, the more talented politicians, the ones who could win in competitive elections, would likely benefit from reform since it would bring them out from under the thumb of their party bosses.
It’s hard to imagine a circumstance where the parties that control the redistricting process would agree to reforms that would reduce their power. But such a circumstance appears to be taking shape in New York. New York’s legislature is arguably the most dysfunctional in the nation. It is legendary not only for its brazen corruption, but for the open institutionalization of this corruption. After a string of scandals, the door may now be open to a reform movement that is attacking this corruption at its root by proposing to eliminate gerrymandering.
A coalition of brand-name New York politicians and good-government groups are getting every gubernatorial candidate to promise, in writing, that they will only sign off on a redistricting plan drawn up by a non-partisan commission. Whether or not the elected governor will actually veto anything less than that remains to be seen. Whether the governor’s veto of anything less will stand in a gerrymandered legislature remains to be seen. One has reason to be hopeful on the first question. The leading candidate for governor is Andrew Cuomo, despite the fact that he hasn’t officially announced his candidacy. Andrew’s father, former governor Mario Cuomo, is one of the leaders of the reform campaign. After all, it’s no great honor to be lord of a cesspool.
Posted by Marc Hodak on April 16, 2010 under History, Unintended consequences | Be the First to Comment
The top marginal tax rate in post-war America on income over $400K was so high that anyone making large, but lumpy income would have a strong incentive to insure that the lumps were spread out across tax years:
The 1950s was the era of the 90 percent top marginal tax rate, and by the end of that decade live gate receipts for top championship fights were supplemented by the proceeds from closed circuit telecasts to movie theaters. A second fight in one tax year would yield very little additional income, hardly worth the risk of losing the title. And so, the three fights between Floyd Patterson and Ingemar Johansson stretched over three years (1959-1961); the two between Patterson and Sonny Liston over two years (1962-1963), as was also true for the two bouts between Liston and Cassius Clay (Muhammad Ali) (1964-1965). Then, the Tax Reform Act of 1964 cut the top marginal tax rate to 70 percent effective in 1965. The result: two heavyweight title fights in 1965, and five in 1966. You can look it up.
Of course, tax-driven behavior continues to create unintended consequences. In a lecture I gave today in Switzerland, I pointed out how the U.S. government’s elimination of tax deductibility of salaries over $1 million created a growing shift in the mix of executive pay from salary toward bonuses and equity. The mix went from about 70/30 (salary versus bonuses/equity) before the tax law to about 10/90. This change in the mix of pay contributed significantly to the huge growth in total CEO pay we saw in the ensuing ten years. And that is how American tax policy intended to reduce CEO pay actually led to its increase.
Something about other people’s high pay just drives congressmen a little nuts.
Hat tip: Marginal Revolution
Posted by Marc Hodak on April 13, 2010 under Executive compensation, Reporting on pay | Be the First to Comment
People intuitively understand “you get what you pay for.” People get that, for a given price, you can either get an extra thousand square feet of space or a view of Central Park, but not both. Or, if you’re dealing with Lee Iaccoca, you can get Corinthian leather but not power doors and windows. Persuasive negotiation only gets one so far.
But when it comes to CEO pay, people pretend that trade-offs don’t exist. They presume that CEO pay is arbitrarily high based on the feckless disposition of the board, and that the perks that rile the mob so much, and presumably have value to the executive, should therefore be arbitrarily banished without a second thought. So, they pretend to be surprised when the Abercrombie & Fitch CEO was denied personal use of the corporate jet and, instead, paid more in cash:
The high-priced teen retailer amended the employment agreement of Michael Jeffries, long-time chief executive, to limit his company-covered personal use of the corporate jet to $200,000 per year. The CEO would have to reimburse the company for any use over that amount.
Previously, Mr. Jeffries was entitled to unlimited personal use. From 2006 to 2008, he booked an average of about $850,000 a year worth of personal travel on the corporate jet. In 2008 alone, he tallied roughly $1.1 million worth of personal travel on the jet. In exchange for agreeing to the limitations, Mr. Jeffries will receive a lump-sum payment of $4 million. The agreement requires Mr. Jeffries to pay back a portion of that money should he choose to leave the company before Feb. 1, 2014.
So, why would A&F’s board do this? Because if you take something away from someone you need to keep, you need to replace that with something else, and cash is a useful substitute. Now, keep in mind that when the CEO chooses to fly Delta, the corporate jet is probably sitting idle, so that “$850,000 a year” cost is partly an accounting fiction. Or, if he continues to fly on the corporate jet at the same pace as before, he will simply be paying back about 75 percent of what the company paid him. The other 25 percent equals about half of the extra taxes the executive must pay to have the company funneling this perk through his personal bank account; the shareholders, who would get no deduction for that $4 million expense, would be out well over a million bucks on this deal.*
CEOs get paid to renegotiate their agreements all the time, but the quid pro quo for that cash payment is rarely this obvious because they are normally renegotiating several terms at once. In this case, the CEO was paid to renegotiate one term, i.e., less jet usage.
Alas, this has nothing to do with the shareholders. It has to do with the “public backlash as corporate jets became a symbol of Wall Street greed,” notwithstanding the fact that A&F is not on Wall Street.
