But an interesting question is, how much does a CEO really add to a company’s business? When you get right down to it, I don’t believe it’s that much. Steve Jobs, sure. But others, I’m not so sure. I think culture and where the firm and industry are in their life-cycle can also be very important.

By my judgment isn’t what counts, it’s the market’s and Oracle’s market value has increased by $8 billion today. Henry Blodget notes that that’s about half of the $14 billion that HPQ lost when they fired Hurd.

Elfenbein makes a good point about the market value impact of Hurd’s departure and arrival.  Not so much about his personal sentiment that CEOs are not worth “that much,” although he expresses a widely held sentiment.

Those market value changes he cites–$14 billion drop at HP and $8 billion gain at Oracle–imply that Hurd is worth about one percent per year in return on capital to those respective organizations (Oracle happens to be about 8/14ths the size of HP).  Is it possible that a CEO besides Steve Jobs can make a one percent difference in a company’s return on capital.  Anyone who really doubts this (once they have the numbers in front of them) is pretty clueless about business and management.

In a rational world, knowing the reality of how much the best versus the next-best CEO can be worth should eliminate the deep concern of couch-bound critics about whether or not the board should have “given away” that last few million to keep the boss.

HT:  John McCormack

New York Times reader

A NYT editorial today commented on the new disclosure requirement emanating from the Frank-Dodd pile that firms need to calculate and disclose the ratio between the pay of their CEO and that of their average worker.

How does the pay gap between the boss and the workers figure into performance? Are companies efficiently providing goods and services or are they being run for the enrichment of the few? Disclosure of the gap could help provide answers and in the process, help investors, policy makers and the public understand the forces that are shaping business and the economy.

That’s called an assertion without any basis in logic or fact.  As someone who studies all kinds of ratios for all kinds of companies, I can assure you that no single ratio can help a serious analyst deduce a single, meaningful thing about that company’s performance, let alone the forces shaping business and the economy.  What does the fact that WalMart has always had a lower profit margin than K-Mart tell you?  What does it tell you that the best performing railroad in the 1990s had the worst operating ratio (a common measure in that industry)?

In all the discussions about this ratio, not one person has articulated what shareholders would get out of it.  Remember the shareholders–the purported beneficiaries of these disclosures that their companies must bear the cost to prepare?

The big lie in this editorial is not that this disclosure won’t help neither investors, policy makers or the public; it is the gross omission of the real reason for this disclosure:  that it’s intended use, and the sole reason it was inserted into the law, is to give the unions and their media supporters, like the NYT, another crowbar with which to beat management.  Such an omission is a serious lack of disclosure.

Corporate opponents of the law insist that pay-gap disclosures would be misleading. A company that outsources its low-wage work, for example, could have a smaller gap than a company that employs low-wage workers, even though the outsourcer is not necessarily a better-run company. That misses the point. The point is to calculate, disclose and explain the gaps as they exist for the way a company does business.

I always love it when someone who is horribly missing the point says “that misses the point.”

The U.S. Education Department this summer proposed regulations that would tie access to federal aid programs to graduates’ success in paying off loans.

“They aimed at the bad actors and they wound up scoring a direct hit on schools that service low-income students,” Mr. Graham said in an interview. “That cannot be what the Obama administration wants.”

Is it possible that the Obama administration doesn’t understand all the consequences of its proposals?

“Every single day, I’m pushing this economy forward, repairing the damage that’s been done to the middle class over the past decade and promoting the growth we need to get out people back to work,” Obama said.

No statement better reflects the fatal conceit.

Contrast with this, from one of Hayek’s discliples:

There were two great triumphs, two things that I’m proudest of.  One is the economic recovery, in which the people of America created — and filled — 19 million new jobs.

Good god, what a difference.

Experimental result: Not

[Professor] Barankay [of Wharton] randomly divided workers into two groups — a control group receiving no ranking and a treatment group receiving feedback with a ranking. He then sent an e-mail to all of the workers inviting them to return to do more assignments. The content of all the e-mails was the same, except that individuals in the treatment group found out how they ranked in terms of their answers’ accuracy. The aim was to determine whether giving people feedback affected their desire to do more work, as well as the quantity and quality of their work. Of the workers in the control group, 66% came back for more work, compared with 42% in the treatment group. The members of the treatment group who returned were also 22% less productive than the control group.

Prof. Barankay also offered workers either a job where they would be ranked or one where they wouldn’t be.

[T]he job without the feedback attracted more workers — 254, compared with 76 for the job with feedback.

“This was a surprising outcome, but it speaks to the paradigm of revealed preferences,” he notes. “Economists are usually very skeptical about what people say they will do. We focus on what people actually choose to do. Their choices convey information about what they care about. In this case, it seems that people would rather not know how they rank compared to others, even though when we surveyed these workers after the experiment, 74% said they wanted feedback about their rank.”

So, people generally don’t like to be ranked against their peers, even though they say they do, and rankings appear to encourage the high performers to slack off and the poor performers to give up.  Contrary to theory, it also encourages high performers to leave and poor performers to stay.  High performers are given the confidence to go out and find new challenges, while poor performers appear to get demoralized, and may have fewer options besides.

This research stands in contrast to research on tournaments, which appear to motivate more productive behavior.  Thus, the research indicates that it depends on how the feedback and reward mechanisms interact.  Competition can breed excellence, and competition includes comparisons and consequences.  But comparison alone can breed complacency or demoralization.

This is how I would expect a NYT columnist to see the central question, i.e., as a distinction that experts must make about when a financial instrument or transaction goes from being merely too hard for someone understand to being deceptive.  While many pundits and readers no doubt share this view of “the central question,” I think it distracts us from far more interesting questions:

- Does there actually exist a line of demarcation between a complex versus a deceptive financial instrument?  A seven year balloon mortgage might be perfectly sensible for someone planning to live someplace for only four or five years.  It might be silly or dangerous for someone without any plan other than to refinance when their home value goes up.  You can’t judge a financial instrument–like a balloon mortgage–apart from the way it is being used, any more than you can judge a knife apart from how it’s being used, i.e., by a capable cook or by a someone who shouldn’t be around sharp objects.  But the CPFC is not about improving financial literacy among our most vulnerable–it’s about regulating every financial services provider regardless of their capabilities or track record of providing value for their customers.

- If the problem is not the instrument or transaction but the financial sophistication of the persons involved, how effective can one be regulating the instruments or transactions themselves?  Leonhardt spouts the party line:  “More often than not, [the CPFC] will allow banks to continue a given practice — but force them to explain, in clear terms, what it means for consumers.”  As if getting lawyers more involved in a transaction will help clarify its terms for the layman.  How many times has that happened in history?

- Assuming the best intentions among the regulators, how will they balance the need for financial innovation with the need to protect vulnerable consumers?  With most of the electorate believing that “financial geniuses” were responsible for the meltdown, there is nothing in the political calculus weighing in favor of Wall Street cooking up anything good under any circumstances.  The penalties of allowing someone who got rooked in some deal from wailing on the pages of the NYT will far outweigh the largely invisible benefits of innovations that didn’t happen.  By an organizational necessity we have seen many times before, this regulatory agency will develop a bias against approving new financial products, a bias that can only be outweighed by vigorous lobbying.

- So, let’s not pretend that the CPFC will be insulated from politics.  Although the CPFC is largely intended to be a disclosure regime, it has nevertheless been given the power to review, approve, and potentially ban financial instruments or transactions.  How will it ultimately decide which to ban?  In theory, it would do so based on their danger to the least financially literate consumer.  But that’s a useless distinction that could apply as much to common equity as to exotic derivatives.  Granting them the power to ban products for what are necessarily arbitrary reasons is a recipe for politicized decision-making.  Those who invest most in dealing with the agency have the best chance of eventually getting their products approved.  The regulators and their patrons in Congress will basically be in the position of asking the banks “how much is in your wallet,” and all banks will be lobbying like Fannie and Freddie in the new regime.  That’s how fine distinctions are made in Washington.

- Does it even matter that a balance get struck between complexity versus deceptiveness, or between innovation versus danger?  Probably not.  With the average NYT reader so easily sold on the premise that financial service providers are indifferent to, or actively working to ruin their customers, and that a small army of bureaucrats can effectively prevent bad things from happening to dumb people, the regulators will certainly be encouraged to a zealous start.  If history is any guide, we will have to depend on a courageous few bureaucrats who see the crushing effects of their rules, using their common sense to begin to strike such a balance.  These courageous bureaucrats will be vilified by progressives as “captured” by those they are supposed to regulate.

What is missing from this analysis–the key to a much better “central question”–is that every rule the bureaucrats come up with has four consequences:

1)  It will make communications between the service provider and customer more complicated, putting the least financially literate consumer at a disadvantage.  I mean, count the number of times that getting lawyers involved in communications has helped clear things up.  That is why the comment “Done right, the new bureau can begin to…require banks to speak in the language of customers, not internal bureaucracy” is such a lunatic expectation.

2)  It will raise the costs to the service provider and, by necessity, to the customer.  Those lawyers and their accompanying army of compliance experts don’t come cheap.

3)  It will slow useful innovation that must now get over the hurdle of arbitrary rules.  Imagine how a computer industry would develop with a regulator making sure that hardware and software are always compatible, or that the software never causes the computer to crash, etc.  Can’t imagine such a computer industry?  Just picture the computer world of 1990 being our world today.  The miracle of Windows 3.0 (without the bugs)!!  A (non-crashing) GUI interface on every desk!!  The irony is that we wouldn’t miss a thing.

4)  It will speed up useless innovation in an effort to get around the rules.  The day after Glass-Steagall was passed separating investment banks from commercial banks, investment banks began inventing derivative instruments to re-create the debt exposures that were nominally forbidden to them, and commercial banks began inventing derivatives to re-create the equity exposures that were nominally forbidden to them.  Nearly all of the complexity that evolved in our financial system over the last seven decades was this useless kind done simply to get around rules that banks in Canada, Europe, or Asia didn’t have to deal with.

History is quite clear on the progress of increasingly regulated industries:  the more regulated they become, more inwardly focused they are with regards to compliance and regulatory concerns, and the less time, money, and attention they have to deal with customer concerns.  As the fixed costs of compliance go up, so do barriers to entry in that industry, thwarting the kind of competition that would spur useful innovation, quality improvements, and better customer focus.  The customers that fare best in this ecosystem are the most sophisticated, the most able to decipher and arbitrage the regulatory regime to their advantage.    This is what happened to increasingly regulated railroads, utilities, telephone services, trucks, airlines, you name it.

Having lived through railroad deregulation, it was like a huge weight lifted off our chests.  Suddenly, we could charge our customers whatever we wanted (oh my!) and guess what?  Our prices began to fall.  They fell because we no longer had an army of tariff clerks and lawyers to go through when setting a price for a route.  This allowed us to experiment with prices in order to attract more business, including reducing prices, even to our captive shippers (the people who needed to be protected from the big, bad railroad) without fear that whatever breaks we gave them in order to make them more competitive would get enshrined into law.  And we were free to get rid of unprofitable routes (oh my!).  That encouraged us, and a slew of new entrants, to establish new services without an army of lawyers, and without fear that any new service would become an entitlement for some industry.

We are facing the reverse of this process in financial services.  While Leonhardt is asking about malfeasance versus frailty, I think a much better central question is:  how much should regulators get between the providers of financial services and their customers in the name of protecting the latter while raising costs, complexity, and barriers to entry for everyone?  Wouldn’t we have been much better off (all of us outside the government, anyway) by taking the budget for the CPFC and dedicating it to raising or our general financial literacy.

Progressives accuse financial services providers of preying on the financially illiterate.  I would argue that progressives prey on financial illiteracy in order to secure more money and more power for the government they wish to control.  Unfortunately, government has the ultimate barrier to entry–a monopoly on violence that effectively prevents any challenge to its authority.  So, unlike a failed business model that can get wiped away by the market, the government’s policy failures become an enduring part of the nations landscape, until evidence of its failure becomes obvious to even the most economically illiterate voter.  By then, we have lost a entire generation of useful innovation.

New, higher disclosure standards for executives

Imagine that one of your large customers, say you’re a supplier to Target or Whole Foods, wants you to disclose how much you and your senior officers make?  You’re a private company, you may not even tell your kids or siblings how much you make, but these strangers want to know, and they want to place that information on the Internet.  How would you feel about that?

Well, that is exactly what the Federal government is requiring of its contractors and sub-contractors via rules in the Federal Acquisition Regulation (FAR).

Mark Hurd’s sudden, surprise resignation at HP offers a rare hint to the answer; in after-hours trading shortly after the announcement of his dismissal, HP’s stock declined by over 8 percent.

Ladies and gentlemen, that’s over $9 billion dollars in market cap.

So, while various pundits might claim that every CEO is replaceable, the question remains:  at what cost?  The answer isn’t found in the much vaunted proxy disclosures on executive compensation.

That $9 billion figure is a discounted future cash flow assessment of Mr. Hurd’s value.  In other words, in the apolitical judgment of equity investors, the only people with the incentive to make this collective judgment correctly, the company would have been better off paying about $2 billion a year for the next five or six years to keep Mr. Hurd than to lose him.

In fairness to the board, the Mr. Hurd they let go, the man who broke the HP ethics code he had done so much to champion, was not quite the Mr. Hurd the investors thought they had before the Friday announcement.  There was a legitimate concern that the expense-fudging Mr. Hurd could no longer govern with the same authority he had before this unfortunate news came out.  But that’s not the point here.

The point is that the buttoned-down guy atop his Silicon Valley perch that HP’s investors thought they had was worth far more than the mere tens of millions that the media (check out the comments) and good governance types have regularly derided.

Update:  Stephen Bainbridge weighs in.  Larry Ribstein offers his take.

The right number:  $12.2 million

That is the amount he is entitled to under the company’s pre-negotiated “Severance Plan for Executive Officers of Hewlett-Packard Company.”  All the rest is money he has already earned, and doesn’t deserve to be called “severance.”  Severance is what a company pays someone to shut up and go away.  It’s not what someone has already earned but not yet taken out of the company, generally for tax reasons.  The media gets this wrong all the time.

What they really want to know is if this arrangement could lead to a conflict of interest.  “How much” doesn’t answer that, but “How” could.  Is he being paid a flat salary, regardless of how claims are handled?  Is he getting a percentage, like a typical tort lawyer (which he is)?  Is there any reward for limiting the payout in any way (I doubt it, but worth asking).

Feinberg, being the stand-up, politically astute guy he is will reveal all, he says.