Perverse Incentives Are Endemic (TM)
Posted by Marc Hodak on May 21, 2010 under Collectivist instinct | 
2 Comments to Read
According to Cass Sunstein:
for whom all my respect has now drained away.
This now puts Dr. Sunstein on the same plan as this intellectual giant:
except that Harry actually has the Constitution on his coercive side.
Posted by Marc Hodak on May 20, 2010 under Unintended consequences | Be the First to Comment
Travis Dove for The Wall Street Journal
There has been a lot of breathless speculation on both sides of the debate about what government-run health care would look like. On the one hand, there are those who contend that it will provide universal access, guaranteed minimum benefits, and at a reasonable cost to the taxpayers–heck it will even reduce our deficit! On the other hand, there are those who believe that the distribution of care will be politicized, that central planning will result in unfair and inefficient outcomes to both providers and patients, and that government rules will constrain rational trade-offs, making the system grossly uneconomical.
Well, Medicare is not a speculative program. It’s been around for decades, and has had every chance to realize those savings and work all the bugs out. Here’s the update:
Posted by Marc Hodak on May 19, 2010 under Executive compensation, Politics | Read the First Comment
I’ve been following the bonus drama in Missouri as the MOSERS Board of Trustees channeled the envy and ignorance of the mindless mob in denying their retirement plan managers their bonuses just because the fund went down in 2008. Never mind that the bonus plan approved by the Trustees was rewarding managers for several years of outperformance, including during the disastrous 2008. Once the newspapers mentioned the word BONUS, the reptilian part of their brains reacted with: bonus = bad, and the board stripped the bonuses from their managers, reneging on their deal.
The board subsequently commissioned a compensation study. The study told the board that even with the bonuses, the investment staff would only be getting 92 percent of median pay. That’s below-median pay for above-average performance if they had gotten their bonuses. Via PLANSPONSOR:
The retirement system’s board of trustees commissioned the study to help set new pay levels for next fiscal year, and a compensation committee has reviewed the options. Committee chairman Bob Patterson said members will vote by e-mail this week, and the recommendation will go to the full MOSERS board in June, according to the Post-Dispatch.
So, if they follow traditional form, Missouri will end up paying their fund managers a higher total compensation than they otherwise would have by leaving the bonus plan intact, with none of that compensation in a variable form that would advantage the fund and retirees by providing the proper incentives.
I spoke to Gary Findlay, MOSERS Executive Director, when the bonus spat first broke out. He then believed that one could make the state agency work as well as a private fund. I think Gary is an honorable fool. On the other hand, it’s not like Goldman or any other private sector outperformer has been spared bonus envy.
Posted by Marc Hodak on May 13, 2010 under Politics | 2 Comments to Read
At Wharton, I was taught that there was exactly one reason to invest in an asset: you would get more out of it than you put into it. That’s the definition of value creation. So, why would anyone invest in ShoreBank, a bank that has proven to be a massive money loser?
People familiar with the situation said Goldman initially declined to invest in ShoreBank. Within the past week, people familiar with the effort to save ShoreBank say Goldman agreed to commit about $20 million to the bank. That would make it one of the largest investors, according to people familiar with the talks. Goldman Sachs declined to comment on its involvement in the rescue effort.
Well, it would be difficult for Goldman to publicly acknowledge that it’s basically donating $20 million as a political sop to President Obama. But that’s what they’re doing. They aren’t the only one:
If Goldman invests, it will join a group that tentatively includes Bank of America Corp., Citigroup Inc. and J.P. Morgan Chase & Co., among others, people familiar with the discussions say. BofA, Citigroup and J.P. Morgan all declined to comment.
Because it would be really tough to say, “President Obama has let us know that he would really, really appreciate it if we helped out ShoreBank. He’s just concerned about them, you know. And he has our nuts in his grip.”
Another Illinois politician was slightly more direct.
Bill Brandt, chairman of the Illinois Finance Authority, said. “I know that Mr. Blankfein and his marvelous organization have been much in the news of late, and I can sympathize with their desire to change the narrative.
If Goldman could change the narrative for a mere $20 million, they’d do it in a second. But one can only change the narrative if one looks like they are doing this thing all on their own, and not because they are being shaken down by the feds and state.
A spokeswoman for Eugene Ludwig, a former U.S. comptroller of the currency who is working with ShoreBank to raise capital, said the White House and Chicago city officials haven’t been involved in encouraging the fund-raising effort among big banks, describing it as “totally a private-sector initiative.”
But of course. So, again, why is this particular bank of such interest to the rest of the private sector?
“There’s been a lot of very determined voices about doing it because it’s the right thing to do,” a person familiar with the effort to save the bank said. “It’s an important institution, an icon, and we don’t want to see this one fail.”
President Obama drew attention to the bank’s micro-lending efforts while traveling in Nairobi as a senator. ShoreBank co-founder and now president Mary Houghton offered guidance on small-business lending to Mr. Obama’s mother, who worked on similar issues in Asia. Officers and employees of ShoreBank gave Mr. Obama’s 2008 presidential campaign a total of $12,150, according to data from Center for Responsive Politics.
In January, the Illinois Finance Authority considered assisting ShoreBank. Mr. Brandt, the authority’s chairman, said he and George Surgeon, ShoreBank’s CEO, are childhood friends, and Mr. Brandt was sympathetic both to ShoreBank’s “historic” status and to its request for a state bond issue to finance a bailout.
So, private banks are making this investment because:
– It’s the right thing to do
– The bank’s leadership and the President go way back
– The state finance authority chairman and bank’s CEO are childhood friends
Nothing about NPV or ROI, except some mention that the bank has long since been ignoring those factors, which all adds up to my favorite explanation:
“Sometimes a bank like ShoreBank has to rely on karma, and the planets seem to have aligned to provide some karma with respect to this particular deal,” Mr. Brandt said.
Yeah, planets aimed at the bankers’ testicles. Welcome to the new world of political lending.
Posted by Marc Hodak on May 10, 2010 under Governance, Scandal | Read the First Comment
No, I’m not referring to TARP. The bailout of America’s banks was counteracting what could credibly be considered a liquidity crisis. The Europeans are providing the same medicine for a very different ailment:
The European Union agreed on an audacious €750 billion ($955 billion) bailout plan in an effort to stanch a burgeoning sovereign debt crisis that began in Greece but now threatens the stability of financial markets world-wide…
Immediately after the announcement, the European Central Bank said it is ready to buy euro-zone government and private bonds “to ensure depth and liquidity” in markets.
A liquidity crisis is when private banks generally refuse to lend money to anyone regardless of credit because they’re afraid that they might get caught short on their own cash needs. When private banks refuse to give more money to a spendthrift borrower, that’s prudent lending practice. When a collection of sovereign nations backs the loans of a spendthrift nation (especially knowing that they are inviting other spendthrift nations to continue their indulgence), they are simply shifting risk from private banks onto taxpayers. In this context, the soaring stock market we’re seeing in response to this shift is entirely understandable. But it would be paralleled by a similar decline in the value of taxpaying households, if that were being tracked in any kind of transparent market, since that is where this value is unarguably coming from.
That’s bad enough. The real problem is with how the EU is proposing to execute this massive value shift:
The money would be available to rescue euro-zone economies that get into financial troubles. The plan would consist of €440 billion of loans from euro-zone governments, €60 billion from an EU emergency fund and €250 billion from the International Monetary Fund.
Those €440 billion of loans would be borrowed through a debt facility guaranteed by the euro states via a special purpose vehicle (SPV). That’s like a company borrowing enough money to bet the whole firm via an SPV backed by its own shares. Where have we seen this before? If you’ve taken my History of Scandal course, would have guessed it. It’s like having the house double-down on failure.
Posted by Marc Hodak on under Executive compensation, Reporting on pay | Be the First to Comment
The press reports on the soaring value of executive equity. The lead:
America’s top CEOs are set for a once-in-a-lifetime pay bonanza. Most of them got their annual stock compensation early last year when the stock market was at a 12-year low. And companies doled out more stock and options than usual because grants from the previous year had fallen so much in value that many people thought they’d never be worth anything.
“The dirty secret of 2009 is that CEOs were sitting on more wealth by the end of the year than they had accumulated in a long time,” says David Wise, who advises boards on executive compensation for the Hay Group, a management consulting firm.
The first paragraph is a backhanded explanation of the “fixed-value” philosophy of equity grants so popular among public companies. The theory is that equity grants should make up a constant value of compensation over time. So, when share values drop from one year to the next, one should give more shares or options to the executive to remain “competitive.” Likewise, when share prices increase, we should lower the number of equity grants to keep the total value of the grants in check. Of course, this philosophy rewards management with more shares/option when the stock drops, and penalizes them when the stock price rises.
The really dirty secret, from the perspective of me and my colleagues, is that this fixed-value philosophy is favored by all the major compensation consulting firms, including, ahem, Hay Group. And their client boards say, “OK” because they don’t want to stick out on any compensation policy, however perverse its effect.
And then when we have a huge rebound, the AP writes a story about the windfall that CEOs are getting, and boards have to defend this windfall, and the major comp consulting firms we compete with shrug and say “hey, who could have predicted this?”
One can’t blame the reporters this time for making CEO pay look bad, only for not being able to identify the underlying causes. They didn’t call me because none of my clients are part of this story.
Posted by Marc Hodak on April 28, 2010 under Executive compensation, Self-promotion | Be the First to Comment
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.
