Archive for the ‘Sarbanes’ Category

Executive compensation: Robert Wenzel sees a "United States of Obama"; I see people too frazzled to give a screwdriver to a those who only have a hammer

June 11th, 2009 No comments

Robert Wenzel has a couple of posts up on his blog that rightly ring alarm bells about the plans of the Obama administration to seek legislative changes that would allow regulators to oversee executive compensation (1) in the financial sector (“The United States of Obama Has Arrived“) and (2) for all public companies generally (“It`s Worse Than I Thought:”). 

And make no mistake, Wenzel is VERY alarmed:

“Treasury Secretary Timothy Geithner’s statement on
executive compensation packages is a clear signal that a dictatorship
has arrived in America. Make no mistake, the compensation package
regulations that are about to be instituted will go way beyond
regulations on banks and other financial institutions that took TARP
money. It is about controlling the entire financial sector–which will
ultimately result in controlling the entire economy.”

“Now that the government is moving in to control the financial sector,
the rest of the economy will be a lay up. Money controls the economy
and Barack Obama is about to take over the money infrastructure. Money
is going to end up going to some very funny places. Mostly to people
who control lots of votes in the next presidential election, and to
those who finance such election campaigns. In other words, the
connected. In the first group, we are talking unions, in the second
group we are talking about Goldman Sachs, Carlyle Group and the like.

this is all over, the United States of Obama is not going to look
anything like the America we now know. Think Cuba, think North Korea,
that’s how all dictatorships end up.”

“The compensation oversight programs announced by Geithner will not be
limited to financial companies. The Treasury will propose legislation
giving the SEC the power to ensure that compensation committees are
more independent, for all publicly traded companies, according to Sperling.”

“What should be of major concern is that this is going to bring to the
compensation table all kinds of people with all kinds of agendas”.

“In short, there appears to be Herculean oversight of executive
compensation coming that is likely to turn into more regulation than
oversight. And there is enough wiggle room in these proposals, at this
point, that the Administration can drive the programs in any direction
they want, any time they want or need to. It sounds like a Paulson plan
all over again. Throw everything up against the wall, get legislation
passed and interpret all these broad generalizations any way you want,
down the road.

“Very scary.”

But in his rush to tell us that the doctor is about to enslave the patient, Wenzel neglects
to offer an opinion on whether the patient is sick, if so, why, and what treatment might be more apt.  Such analysis must be offered if one wants to persuade – either the patient that the doctor is a quack (and to run), or those with the lobotomizing tools to put them down (in favor of a more appropriate diagnosis and treatment). 

Have faulty incentive structures in the financial sector and within public firms not contributed to the financial crisis?  If indeed they have – as seems to be universally acknowledged –  how did those incentive structures arise, and what are the best ways to remedy them? 

While the discussion can become quite nuanced, it seems to me fairly clear that root causes lie in financial regulation and in the regulation of “public” companies, both of which have served to loosen shareholder/investor control over management. 

This loosening of control, of course, has an even deeper root, namely, the grant of limited liability to shareholders for the torts committed by company executives and employees.  This grant incentivized lighter oversight by shareholders (as gains from risky activities could be captured, with losses in excess of  assets being shifted to the public), and in turn has led to a continuing cycle of federal regulation intended to rein in risks – particularly on environmental, health and safety areas, and regulation of stock markets and “public” companies – with resistance from and rampant rent-seeking and gamesmanship by larger risk-generating firms.  Sometimes forgotten by advocates of “free markets” is how larger firms utilize their political influence to co-opt regulators and regulations, both to raise barriers to entry to keep smaller and nimbler competitors at  bay and to ensure that they can continue in business without facing the full external costs of their business activites.

This dynamic – and the way free market advocates miss it – can be seen in Wensel`s most recent post, where he notes:

“The Treasury will propose legislation
giving the SEC the power to ensure that compensation committees are
more independent, for all publicly traded companies, according to Sperling.

championed this as putting standards into effect for compensation
similar to those put in place for audit committees as part of the
Sarbanes-Oxley Act.

“I know of no one, including most legislators
, who don’t think that Sarbanes-Oxely was a big mistake, that it costs
companies millions of dollars annually in compliance costs, with zero
benefit. Setting up such a nightmare for all publicly traded companies
will make it even more difficult, if not impossible for small companies
to raise money and go public, and will force others to leave the public
markets and go private (or overseas).”

Sarbanes-Oxley vastly extended the reach of federal securities regulation, and raised costs for public firms.  But while Wenzel can see this, why has he failed to note that such regulation also greatly raised the costs of access to the public capital markets, thus benefitting public companies by insulating them from potential competitors?

The whole system of public company regulation is rotten.  We need less regulaton, and greater self-policing by investors and market counterparties of the risks they face.  The alternative of lightly-regulated private companies (especially unlimited liability structures like partnerships) ought to be more vigorously explored.

I quote  a summary of my views on this subject from another recent post:

“I share Ariely’s concern that we are likely to be distracted by a
focus on big “bad apples” that may satisfy our needs to string someone
up, but that will ignore the rot at the core – the systemic
cheating that, in the American system, is very much related to the
institution of state-granted “limited liability” to corporate
.  This grant (1) frees investors from the
downsides of losses suffered and borne by third parties as a result of
corporate actions, (2) limits investor incentives – and abilities – to
monitor and control risks faced by and generated by executives,
managers and other employees, (3) thus incentivizing risky behavior and
providing greater freedom of action to executives and managers –
including freedom of action to seek favors from government , (4)
leaving executives and managers freer to loot their companies by taking
large bonuses, which shifting downside risks to shareholders and
taxpayers, and (5) fuelling pressures by consumers and others adversely
affected by corporations to seek to use legislative, regulatory and
judicial mechanisms to check corporate behavior.  In sum, limited investor liability has proven to lie at the core of the moral
hazards which have produced the Great American Ponzi scheme that our
fearless leaders are now struggling mightily to patch together and
profit from

“Did I leave anything out?  (Ah, maybe how various firms, investors and their political handlers profit while socializing climate change risks?)

“Anyone game for exploring ways to reduce the destructive gaming and rampant cheating in the American system?”