Posts filed under ‘Corporate Governance’
Masters of Finance
| Peter Klein |
The American Finance Association has assembled a terrific set of video interviews and lectures with eminent financial economists including Markowitz, Sharpe, Samuelson, Merton, Scholes, Arrow, Fama, and Myers. (HT: Fama/French.)
Bankrupt Bankruptcy
| Glenn MacDonald |
The US bankruptcy process is designed to be an orderly way to preserve any value that is left in the bankrupt business, and treat the creditors fairly and consistent with their contractual rights. This process has been honed through use and generally functions highly effectively. The point of preserving value is obvious enough. Fair treatment of creditors is not about fairness per se, but rather about investor investor protection generally, i.e., in the US, to promote efficient credit markets, investors are generally well protected, including in bankruptcies. The recent GM bankruptcy is an interesting case of how this process can be made to fail, mainly through rushing the process and dictating its outcome rather than by letting the process do what it was designed to do.
Specifically, much value was wasted. For example, among car aficionados, there are few brands more revered than the Pontiac GTO; this persists despite the weak offering brought out in 2004. Where is the GTO? On the scrap heap with the rest of Pontiac. A more deliberate bankruptcy would have preserved this value, e.g., by folding parts of Pontiac into Chevrolet. Second, GM’s creditors rightly claimed they were wronged by allowing the sale of all good GM assets to the new GM, owned mostly by the government and the UAW, and denying them the rights to argue their case to the bankrupcy court. They correctly argue they were robbed.
Who are the main beneficiaries of this mess? To the extent that despite the poor reorganization, GM is actually worth something, obviously the Federal government and the UAW benefit from the treatment of creditors. But more importantly, this is terrific for GM’s competitors, who have much to gain from GM’s remaining value being wasted through a weak product line, politically driven lack of cost reduction as inefficient facilities are retained, etc.
Preaching from the Choir
| Dick Langlois |
It’s hard to top Bruce Kogut on the Daily Show. But by sheer coincidence I happened upon a video that offers a quite different perspective on corporate social responsibility.
Scandals and Financial Panics in Historical Perspective
| Peter Klein |
The Spring 2009 issue of Business History Review focuses on scandals and panics. Here’s the TOC. Follow the link for abstracts and ordering information.
A SPECIAL ISSUE ON SCANDALS AND PANICS
With an introduction by guest-editor Per H. HansenNaomi R. Lamoreaux: “Scylla or Charybdis? Historical Reflections on Two Basic Problems of Corporate Governance”
Thomas Max Safley: “Business Failure and Civil Scandal in Early Modern Europe”
Richard Sylla, Robert E. Wright, and David J. Cowen: “Alexander Hamilton, Central Banker: Crisis Management during the U.S. Financial Panic of 1792”
Eric Hilt: “Rogue Finance: The Life and Fire Insurance Company and the Panic of 1826”
Edward J. Balleisen: “Private Cops on the Fraud Beat: The Limits of American Business Self-Regulation, 1895-1932”
Events @CBS
| Peter Klein |
I’ve just arrived in Copenhagen, where I’m spending a month as a visiting professor at the SMG. Copenhagen Business School has become one of the most intellectually exciting places in Europe. This week alone the school is hosting the DRUID summer conference which features people like Anita McGahan, Sid Winter, Will Mitchell, Russ Coff, Mike Ryall, and many others, along with a workshop on corporate governance with keynotes by Mark Roe, Randall Morck, Annette Poulsen, and Florencio Lopez-de-Silanes Molina. Of course these are only appetizers for the next week’s main course, the PhD seminar on The Theory of the Firm and Its Applications in Management Research conducted by Professors F. and K. Truly an embarrassment of riches!
Peter L. Bernstein (1919-2009)
| Peter Klein |
I was saddened to learn (from Kenneth Anderson) that Peter L. Bernstein, author of Against the Gods: The Remarkable Story of Risk and other popular works, died June 5. Bernstein was a terrific writer and a clear and provocative thinker with a gift for making difficult concepts accessible. I was greatly influenced by an earlier book, Capital Ideas: The Improbable Origins of Modern Wall Street, which I came across in graduate school while searching for a dissertation topic. Bertstein’s characterization of the brokerage industry in the 1960s and early 1970s, before the deregulation of brokerage fees — an Old Boys Club, lacking competition and innovation — inspired me to examine the role of corporate internal capital markets in replicating the resource-allocation function normally performed by external capital markets, and how the growth and development of financial markets following liberalization contributed to the end of the conglomerate period.
Here are obituaries in the WSJ and NYT and here is Bernstein’s wiki.
The Ethics of Bankruptcy
| Peter Klein |
I like this 2003 HBR piece from Joe Bower and Stuart Gilson on bankruptcy. Substitute “Chrysler” and “foreign auto makers” for “WorldCom” and “competing telecom firms” and you’ll get the idea:
WorldCom’s bankruptcy, however, highlights an important, potentially very large social cost of the U.S. bankruptcy system. Competing telecom firms, which have played by the accounting rules and have used more prudent financing, now find themselves — once again — at a competitive disadvantage relative to the company. Unlike WorldCom, these firms had to stay current on their debt and service their lease obligations. They did not get to write down their assets and debt, nor have they been able to reduce taxes by claiming that their profits never existed.
Is this fair? Do the benefits of the system outweigh its costs? The system works well to protect assets and employees, to be sure. But are WorldCom’s assets and employees really the ones that should be protected? What about those of more efficient firms? In capital-intensive industries like petrochemicals, steel, telecoms, and airlines, doesn’t bankruptcy law make it harder for efficient companies to drive inefficient assets out of business? In the majority of bankruptcy cases in these industries, the top managers are gone, but old capacity returns to the market with an improved balance sheet. This can easily prolong a period of industrywide overcapacity as well as unfairly disadvantage competitors.
Their focus is bankruptcy resulting from corporate fraud, but the question applies equally well, in my view, to bankruptcy resulting from managerial incompetence.
BTW, for a primer on bankruptcy, Michelle White’s 1989 Journal of Economic Perspectives paper, “The Corporate Bankruptcy Decision,” is a good place to start.
Knights, Raiders, and Targets
| Peter Klein |
When doing my dissertation research long, long ago I was influenced by an edited volume called Knights, Raiders, and Targets: The Impact of the Hostile Takeover (Oxford University Press, 1988). It collected the proceedings of a 1985 Columbia Law School conference that must have been terrific. The authors include Robert Shiller, John Coffee, Mel Eisenberg, Oliver Williamson, David Ravenscraft and F. M. Scherer (previewing results of their important 1987 book), Richard Roll, Michael Bradley, and Gregg Jarrell, among others, with several contributions appearing in a comments-and-replies format. I just learned that one of the editors, Louis Lowenstein of Columbia Law, passed away this month. I’m not familiar with his best-known book, What’s Wrong With Wall Street: Short-Term Gain and the Individual Shareholder (1988). Apparently it proposes a tax on short-term trading profits to reward buy-and-hold investors, which doesn’t sound great to me.
SecondMarket
| Peter Klein |
Props to Molly Burress for pointing me to this article in today’s NYT on SecondMarket, a website that acts as a market-maker for illiquid assets. According to the Times SecondMarket is developing secondary markets for restricted public equities, bankruptcy claims, mortgage-backed securities, collateralized debt obligations, and other non-marketed financial claims. As the Times points out, the weak IPO market of the last few years has made VCs reluctant to invest in early-stage ventures; by giving VCs an additional exit option, SecondMarket may increase the flow of venture funding.
Not addressed in the article: If SecondMarket succeeds, and grows, and begins to impose disclosure requirements on the companies whose (now-liquid) assets are traded, will private equity lose its purported advantrages over public equity, in the Jensen (1989) sense?
GM vs. TCE: Another “Block Upon Block”?
| Mike Sykuta |
Ronald Coase has spent the past two decades or more lamenting the lack of progress in economic theory. He bemoans the fact that economics, unlike its physical-science counterparts, fails to dispose of (or pursue new versions of) theories when facts show that prevailing theories are inaccurate or incomplete.
Among his many arguments, Coase has pointed to Williamson’s Transaction Cost Economics (TCE) as one that seems impervious to the facts. Part of Coase’s discontent with the TCE story rests on his observation that many firms sustain relationships characterized by high degrees of asset specificity using contractual means. While Ben Klein and others pointed to General Motors-Fisher Body as evidence to support the TCE story, Coase pointed to relations with auto frame manufacturer A.O. Smith at the same time that were not subsumed by vertical integration. This eventually led to the infamous GM-Fisher Body debate that seems for want of a real conclusion (see some of Peter’s previous comments on this here, here and here).
Well once again, General Motors seemingly plays the foil against TCE. Several weeks ago, GM announced plans to purchase Delphi Group’s global steering manufacturing operations. Delphi operated the steering unit solely for GM’s use. Delphi, in bankruptcy since October 2005, has been able to use GM’s dependence on Delphi’s operations to secure roughly $450 million in liquidity capital from GM to maintain its operations. Sounds like the classic hold-up problem, doesn’t it? But wait! (more…)
Value Creation in Middle-Market Buyouts
| Peter Klein |
Here’s a paper by John Chapman and me, “Value Creation in Middle-Market Buyouts: A Transaction-Level Analysis,” forthcoming in Douglas J. Cumming, ed., Companion to Private Equity (New York: Wiley, 2009). Get your copy today, while they’re hot. Abstract:
Is private equity an effective governance structure, or simply a means of transferring wealth from “Main Street” to “Wall Street”? How do buyouts affect target-company organization and strategy? How do deal characteristics such as size, industry, transaction complexity, buyer characteristics, holding period, and the like affect the performance of private-equity transactions? Are revenue improvements driven primarily by changes in employment and capital expenditures, or by changes in organization and strategy? Despite a healthy literature on buyouts, little is known about the details of private equity transactions, as most studies rely on publicly available data or confidential data from a single buyout firm. This paper uses a unique sample of 288 exited transactions over a 20-year period across 19 industries from 13 buyout firm firms, based on confidential data from detailed interviews with the general partners of several leading private-equity partnerships. While prior studies have focused on whole-company, going-private buyouts, our sample includes transactions with minority stakes, syndicate deals, and consolidating roll-up or add-on strategies, and we have detailed information on internal rates of return, leverage, equity stakes, and other deal characteristics. We find that the pursuit of ancillary consolidating acquisitions is the biggest driver of post-buyout revenue and profit growth, that solo deals and deals with controlling stakes outperform syndicated or “club” deals, that rates of return have declined over time as buyout markets have become more competitive, that mitigation of agency costs is critical for deal success, and more generally, that private equity can improve the performance even of sound businesses by providing access to resources, industry-specific expertise, capital for recombining assets (most often, consolidation in a fragmented industry), or recapitalization and ownership transition. Finally, our findings suggest the potential for further research of private equity at the transaction level.
Literature Review Bleg
| Dick Langlois |
One of my graduate students has been working on an idea to formalize Henry Hansmann’s approach to the ownership of enterprise. Hansmann thinks about the ownership margin — which set of “patrons” in the nexus of contracts should own the residual rights of control and of income? The idea of this work would be to think simultaneously about the Coasean margin, the boundaries of the firm, which should be determined endogenously along with ownership. That means that firms would have different levels of vertical integration depending on which patrons own them. One interesting question: what happens to the level of vertical integration of banks if the government comes to own them?
We need to locate this idea in the literature and to find out if anyone else has done anything along these lines. So, if you know of anything remotely related, please send it along.
Thoughts on AIG
| Peter Klein |
Nothing has annoyed me more in the last 24 hours than the constant parade of angry, self-righteous, and ill-informed denunciations of AIG coming from Capitol Hill and the mainstream media. No one, of course, likes the thought of a failing, taxpayer-supported firm paying large bonuses to executives. But let’s talk some common sense here.
- The main lesson is that AIG should never, ever have been bailed out with taxpayer dollars. I said that at the beginning, and I stand by it even more today. AIG should have declared bankruptcy. Under bankruptcy there are well-established, orderly procedures for winding down a firm, distributing the remaining assets among the various legal claimants, and so on. Injecting taxpayer money without any serious thought about the implications of government subsidy and/or ownership for management and governance is just plain dumb. Naturally, that’s what Congress and the last President — people who know exactly zilch about what companies do and how they are run — did.
- Performance-based pay is a complicated subject. There are dozens, if not hundreds, of theoretical and empirical studies on the effects of performance-based pay on company performance, the benefits and costs of various compensation formulas, and the like. As Jensen and Murphy wrote back in 1990, “It’s Not How Much You Pay, But How.” Of course, the people screaming the loudest right now haven’t a clue about any of this. (more…)
Accounting Rules and Spontaneous Order
| Peter Klein |
David Albrecht thinks the US should not replace its accounting rules (GAAP) with the new, international standard (IFRS).
A language evolves to fit its culture. Language is not static. Moreover, there is no one best way for a language to be. . . .
If Americans wish to speak to a person from Peking, they can get their communication translated. The translation comes at a cost. The benefit from avoiding this cost by switching [to Chinese] would be much less than the huge opportunity costs of educating everyone in the U.S. to speak another language. If we continued using English, the translation to Chinese would (and is) a trivial expense, and a minor inconvenience.
Similarly, there is no good reason for anyone to have the U.S. discontinue using its accounting language (GAAP) and switch over to IFRS. Having multiple accounting languages in the world is a minor inconvenience and translation expenses are, in the grand scheme of things, trivial. Moreover, GAAP seems to fit our culture, economy and system of financial markets. . . .
Who would benefit if the U.S. switched to IFRS? Certainly not investors, for the same reason that they would not benefit if the country moved immediately to Chinese. The beneficiaries would be the accounting firms that would teach us the new IFRS, and company executives. (more…)
Speaking of Executive Compensation. . . .
| Peter Klein |
Chris Manion has a dream:
Obama Cuts Salaries for Presidents of Universities that Receive Federal Money
$100,000 annual cap enrages literati, “Violates academic freedom,” one president declares, from his limousine’s satellite phone.
Obama Limits Baseball Salaries to $100,000 per Player per Year
Administration points to baseball’s antitrust exemption as authority; “This could force our players to gamble on the side and maybe throw the world series even” says players union president.
Obama Limits Salaries of Former Government Employees
$100,000 a year ceiling enrages lobbyists, retired generals, and Trent Lott.
Obama Caps Federal Retirement Pensions
“These benefits should be no higher than those of the private sector taxpayers who pay the taxes to support them,” President says. Government Employee Union president threatens a general strike, scratches his head for a moment, and then retracts statement “pending further discussions.”
And then I woke up.
In my dream the President announces a cap on compensation for TV and movie stars, recording artists, writers, Hollywood directors and producers, celebrity speakers, and investors. “In this time of economic hardship, for Tom Cruise to earn millions for Valkyrie, even though Lions for Lambs was a total flop, for President Clinton to pick up $500,000 for recycling the same boring speech, and for George Soros to rack up interest and dividends even though he completely missed calling the financial crisis, is the height of irresponsibility. It is shameful. And I will not tolerate it as President.”
Business 101
| Peter Klein |
In announcing his caps on executive compensation this morning the President noted his outrage that Wall Street executives have “paid themselves customary lavish bonuses.” Apparently he is unaware that executive pay in large companies is set by a compensation committee, and typically by a formula determined well before performance results are realized. I guess he thinks executives just decide how much to pay themselves, based on whatever they feel like. He’s also upset about “executives being rewarded for failure,” suggesting he doesn’t know the difference between absolute and relative performance evaluation. Don’t they teach Business Organizations at Harvard Law?
The Recipe for Recovery Is Revealed
| Mike Sykuta |
The Obama administration has apparently revealed its recipe for economic recovery. Based on the rhetoric and policy proposals fronted thus far, the recipe appears as follows:
- Do everything possible to discourage potential high-value executives from working in troubled industries by capping executive pay in struggling industries.
- Eliminate high-powered market-based incentives for mid-level employees to perform their jobs well.
- Encourage distressed companies to renege on long-term contracts that populist politicians find offensive (or consider easy to target so as to appear they are being responsible with taxpayers’ money).
- Dole out a trillion dollars of taxpayer funds to pet projects and interest groups in the name of “economic stimulus” (enabled by the perception of “responsibility” created by their railing against the targets of #1-3).
- Ignore the economic consequences of the incentives created (or destroyed) in #1-3 as well as the fact that someone at some point will have to pay that trillion dollar bill.
- Half-bake under the heat of political pressure and serve to the masses who are starved for quick-fix solutions that only impose costs on “that other guy” or “the rich fat-cats of corporate America.”
I don’t know about you, but I think it will be interesting to see how quickly the soufflé crashes . . . though I’m not looking forward to it being force-fed.
Attacking Incentive Pay is the “Height of Irresponsibility”
| Peter Klein |
Imagine you’re a salesperson at a company. In order to create an incentive for you to bust your tail, the company negotiates with you a leveraged compensation plan under which you receive a relatively small base salary plus fairly generous commissions on the sales you close. Suppose you do a bang up job one year, but the company as a whole suffers a loss because of some poor decisions beyond your control (or because of developments in the macroeconomy, such as the bursting of an asset bubble facilitated by government-sponsored entities). Now imagine that the government perceives your company to be strategically important and therefore decides to subsidize it by, say, buying its preferred stock or extending it a loan. Would it be “the height of irresponsibility” for your employer to honor your legitimate compensation expectations and pay you the wages that you effectively earned under your implicit deal with the firm? And what would happen if your employer didn’t pay you what you legitimately expected? Wouldn’t you and the other successful salespeople at your company immediately bolt, leaving the company with a much less effective sales force?
I have little to add to Thom’s excellent post on Obama’s populist attack on bonuses except to note that the compensation system is just one element of a firm’s organizational architecture (along with the allocation of decision rights, systems of performance evaluation, and so on). The firm, as Holmström and Milgrom put it, is an incentive system, and the elements of this system interact in complex and nuanced ways. The idea that regulators can simply march in and dictate changes to one element or another, based on popular prejudice, without affecting the performance of the system, is typical of the hubris of the intellectual.
Spulber’s Separation Theory of the Firm
| Peter Klein |
Dan Spulber’s new paper, “Discovering the Role of the Firm: The Separation Criterion and Corporate Law,” defines the firm “as a transaction institution [in which] the consumption objectives of the institution’s owners can be separated from the objectives of the institution itself.”
The separation criterion provides a bright line distinction between firms and other types of transaction institutions. Firms under this criterion include profit-maximizing sole proprietorships, corporations, and limited-liability partnerships. Institutions that are not classified as firms include contracts, clubs, workers’ cooperatives, buyers’ cooperatives, merchants associations, basic partnerships, government enterprises, and government sponsored enterprises. The separation theory of the firm yields insights into corporate law that extend and complement the standard contractarian approach. The separation theory of the firm places emphasis on shareholder property rights and corporate governance.
The separation approach, Spulber argues, suggests that the corporate governance literature may pay too much attention to agency costs while downplaying the benefits of delegation. The paper builds on Spulber’s earlier work on intermediation and develops themes in his forthcoming book on the firm. Worth a look.
Government and the Corporation
| Peter Klein |
What is the net effect of government intervention on firm size, scope, complexity, and ownership? Roderick Long thinks government intervention makes firms larger and more hierarchical than they would otherwise be, and that a pure market economy would be dominated by small firms like worker-owned cooperatives. I think the net effect of government intervention on firm characteristics is ambiguous, because there are so many interventions affecting different types of firms. Here’s some back-and-forth between Roderick and me: his original essay on Cato Unbound, my comment on Mises.org, his reply, and my rejoinder.
Update: See also Caplan.
Organizations and Markets 
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