Sunday, May 24, 2009

Quick Hit (Yes, after a year!)

Here is a great piece with respect to the article that I've published last year. I've been tied up for the last "12 months", so here you go with an edition of a quick hit from the web's best b-ethics blog. Enjoy.

Here's a smart & balanced piece on executive compensation by Ray Fisman, writing for Slate: Comparison Shopping: The real reason CEO compensation got out of hand.
The popular (and populist) perception is that of America's CEOs greedily rubbing their hands together as they approve their own paychecks, and there certainly has been some of that. Others argue that in most cases CEOs are richly compensated because they're so good at what they do.

Several recent studies stake out a middle ground, assuming that CEOs are neither villains nor business masterminds. These studies argue that the seemingly innocuous practice of benchmarking pay against other companies' CEOs may be to blame...

I heartily recommend reading that entire article. It's enlightening. And it's enlightening on an issue about which many of us have strong opinions. And opinions without understanding are useless, perhaps dangerous.

I think there are 4 factors that go into explaining public outrage at executive compensation.

1) Corporations sometimes screw up, in which case any executive compensation, never mind 6-figure compensation, seems outrageous. (If you think "sometimes" is an understatement, you're falling prey to the same fallacy that leads people to believe, falsely, that plane crashes are common.)

2) Executives sometimes are paid too much — too much, that is, by any standard other than cronyism. That is, sometimes Executive Compensation Committees make bad decisions, in some cases because they're insufficiently independent of the CEO.

3) Many people hate the rich. And many (not all) corporate CEOs are rich. Hating them leads naturally enough to believing they don't deserve what they have. (This typically involves a philosophically controversial assumption that justice in the distribution of wealth is a matter of how much we each end up with, rather than how we each got what we have.)

4) Most of us don't understand enough basic economics. I include myself in that category. (So read this book.) One consequence of this is that many people don't know that there just is no other, well-worked out theory of the value of labour beyond "What The Market Will Bear." (The notion of benchmarking CEO salary based on what other relevantly-similar companies are paying is part of figuring out just how much the market will bear.) Even the notion of tying salary to performance leaves open the question of how much reward for how much performance of what kind. Also, this helps explain why reason #1 above can be a mistake: base salary is related to expected performance: it's a gamble, based on what the company expects the CEO to be able to do. Failure on the part of the CEO doesn't necessarily mean the salary was unjustified in the first place.

All that being said, the salary-ratcheting phenomenon discussed in Fisman's article strikes me as a genuine problem, because the feedback loop implies a kind of self-fulfilling prophesy regarding what, in fact, the market will bear. And if CEO compensation looks, to corporations, like it's rooted in a reliable methodology, it will tend to trump, and hence squeeze, other, less-readily quantifiable, corporate objectives.

Wednesday, April 02, 2008

Sovereign Wealth Funds and the Need for a (Better) Code

What did The Economist ask? (From “The World in 2008” print edition.) - December 2007
"The fastest-growing wealth funds are being built by Russia and China and some of the bigger ones are in the Middle East in countries like Abu Dhabi and Dubai, which might be friendly now but cannot be guaranteed to remain so for ever. What happens if those funds take stakes in defense companies or energy groups: will they be content to remain passive investors or over time might their controlling governments be tempted to wield their influence?"

What did (National security fan) President George W. Bush say? - March 2008
“It makes no sense to deny capital, including sovereign wealth funds, from access to the U.S. markets...” “It’s our money to begin with. It seems like we ought to let it back.”

Let me translate this for you: “We can't refuse that life-saving liquid capital, when our financial system is in a turmoil and trying to diverge from the point of collapse, even if it comes from a country that produces weapons of mass destruction.” He just can't say this of course... But he's right about a point. Those funds could create good force for overcoming the current liquidity/credit crisis.
But without strict scrutiny and solid corporate governance structures they are also large enough to start other financial or even political crises.
In this context, the IMF is working out to meet with the state-owned funds in April, so as to finish a draft for a “code of best practices” by August. A deal has already been agreed between the US Treasury, the Abu Dhabi Investment Authority and the Government of Singapore Investment Corporation on some set of general principles. Deals with others like Chinese, Qatari, Russian and Norwegian funds are to follow.
But to place China Investment Corporation, or the Stabilization Fund of the Russian Federation on the same footing with the Norwegian state pension fund or Singapore Investment Corporation is a serious classification problem. You will obviously have less headaches about the Norwegian fund than you would have about the Chinese's, with investments in your energy or defense companies. (Remember China National Offshore Oil Corporation's - withdrawn - bid for UNOCAL?) China and Russia are huge countries who have great economic resources and tremendous militaries to support their political and strategic objectives all around the world. When being compared to them, Norway, looks like Bambi, despite it's enormous pool of assets. (See the Chart.)

So, setting up rules for transactions in multilateral measures is not so easy as it seems. Interests and positions vary a lot and when you try to butcher up these rules into smaller parts, that's another problem. The starting point of this dilemma in our situation is evident: Those rules are not generated in favor of the investor funds. They look like that they are safeguards to protect only the invested countries' (U.S.) interests not the investors'.
We all (emerging countries specifically) have grown used to adherent and manipulated acts of American (energy-oil, defense-aerospace) companies who are selfishly guarding their own interests with little respect for standards of business ethics. So if you at least look from this perspective, what the authorities (IMF) should be looking for is a broader arrangement, which encloses everyone's benefit, based on the groundworks of international investment regulations. So, to start working on these (GENERALLY accepted international investment regulations) looks like a brighter idea.

Saturday, March 22, 2008

There Will Be Greed...

Greed is on the headlines again. Corporate brainiacs have given full weight to their firms' short term profits and their short term “wealth” instead of exercising the main cause behind the understanding of a “business” and here we are wrestling with another crisis. Used leverage, earned fees... Used leverage, earned fees... Nobody ever dared to question the consequences in the long-run because every single actor was busy with his/her “little” - individually little parts of a huge amount - short-run goals. They were rapaciously running a fund which even they don't know the value of or trying to buy a house which they couldn't really afford. But these were all right in front of them... Who could say no to an offer like this. Something you can't afford but you can buy, something you don't really own but it generates a huge return. Sweet deals...

It was the politics first with 9/11 and the interest rates and all, but then it has been personal integrity all over again. As usual there is the turmoil first and then comes the adjustments which has just started to eventuate by the bail-out of Bear Stearns last week. But I think, what really needs an adjustment are the conceptions of senior bankers / hedge fund quants about the meaning and purpose of a business. If that happens, the business world will be way better of with some “long-term greed” of those white-shoe elites at lower Manhattan. Everyone is greedy about something but the point is to take it under control in specific terms that it won't do any harm to other parties around.
Some might find this greed scenario too vague and argue that both the offender and the victim was the system itself with CDOs, MBSs and all those exotic securities. It might also be true yet a little bit incomplete, insufficient let's say. Without unorthodox practices and with some professional scrutiny they were nothing but innovative ways to “contribute to the development of a far more flexible, efficient, and hence resilient financial system than the one that existed just a quarter-century ago”, as Alan Greenspan stated in 2005.


I think it's nothing but that deadly sin worth a $300 billion loss for the financial giants, just a little bit over 2% of U.S. GDP. And for what? For a few more millions of fees and a better parking spot at the golf club maybe, who knows?

Wednesday, January 30, 2008

On Big Paychecks and The SEC

Last summer, The Securities and Exchange Commission sent letters to some hundreds of companies asking the way they described executive compensation. But now, The SEC doesn't seem so happy with the answers it has received so far. This is of course, due to the reason that some companies may not want to uncover some of their secrets related with individual (CEO) compensation so they switched to systems applying ratings to performance targets. But SEC, still, does not find those explanations reasonable and is asking for (more) “substantive analysis and insight” from many of those companies.

The thing SEC is trying to do is to give more information to shareholders and public about executive pay, after years full of scandals on excessive “high-profile pay packages”. But I have to say that this approach has the possibility to mislead many institutions in a way which also led a great number of dot.com companies to collapse.

Pushing companies to move towards indicators that only take turnover and stock price into account and away from individual performance indicators, may make the executives substitute short-term financial goals for long-term success and durability of their companies. It might, in the end, “corrupt” how companies are managed. (Have a look at this January 2007 post.)
Financials are of course a vital part of the indicators for a company's measure of success but they are not the only ones. There are many other important factors to be considered like, corporate governance and social responsibility. These actually, when successfully managed, could easily make a company sell.

When we look from the reason side, these huge compensation packages are actually crops of supply and demand resulted from the competition for the most talented managers in the market, which is mostly a consequence of the rise of private equity. The solution might be giving the shareholders a greater say in deciding the executive pay and letting them contribute to their own proxy statements.