Out of the courtroom and into the back room

I've been reading a little about Obama's Supreme Court pick, Sonia Sotomayor. She's not great, obviously, but she's probably not the worst result we could have gotten from Obama's "empathy" litmus test. Tom Bowden at ARI has a good blog post on why Sotomayor is unfit for the Court because of her opposition to objective judicial interpretation. (Does denial of its existence count as opposition?) Even so, a judge without principles is basically a broken clock, and ends up ruling well now and then due to sheer happenstance.

So, in reading about this woman, I came across a tidbit of information that troubled and saddened me. In the WSJ's article about Sotomayor's ruling history, this paragraph described one case of investor fraud:

In another pro-plaintiff ruling, Judge Sotomayor allowed a shareholder class-action suit against Merrill Lynch that alleged fraud. A unanimous Supreme Court in 2006 overruled Judge Sotomayor's Second Circuit opinion. The high court found that federal law assigned enforcement to the Securities and Exchange Commission, leaving no room for lawsuits under state fraud laws.

Ignoring the fact that legal philosophy has deteriorated in this country to the point that you're either pro-plaintiff or pro-defendent, I want to draw your attention to the Supreme Court's ruling in this case. As free-marketers, we always talk about how, without the SEC, investors could sue their management for fraud. This, and other vehicles of management's rational self-interest, make sure investors' interests are looked after. What we don't mention enough, I think, is that whent the government removes from the marketplace the competitive advantage that is integrity, investors are at the mercy of the SEC to protect their property rights, a charge the SEC also executes with broken-clock precision. For more on this type of issue, read Alan Greenspan's article in Capitalism: The Unknown Ideal called "The Assault on Integrity". (Greenspan's apostasy notwithstanding)

As in my previous post on regulation, in general, I stress that regulatory bodies like the SEC remove strategic advantages from firms, and drown all interested parties in a sea of mediocrity and subjective selection.

Successful Succession at Xerox

Xerox CEO Anne Mulcahy is stepping down in July, but will remain on as Chairman. Her hand-picked successor, Ursula Burns, Xerox's current president, will lead the company. Incidentally, she will become the first black woman to lead a Fortune 500 company.

Mulcahy was an excellent CEO by almost any standard. She took over the company when it was on the verge of bankruptcy and mired in an accounting scandal. She downsized, reducing the workforce by over 20,000 people. She led the firm in a new direction, making it more competitive in a world where copiers are becoming obsolete. The market capitalization of Xerox today is not far above what it was when she took the company over in 2001, however that can mostly be attributed to the market downturn. It is not far-fetched to suggets Xerox might not even have much of a market cap today if it were not for Mulcahy.

Mulcahy has been grooming Burns for this job, and the succession process looks to be almost seemless. It will be interesting to see how Burns leads the firm through its latest trials and tribulations. Here is an article on Mulcahy and Burns, and here is one on the "model" succession process.

More on CEO Pay

On ARI's blog, Voices for Reason, Don Watkins has a nice post about CEO pay, and how it is a challenging thing to get right, even in a free market. As he writes:

It requires a tremendous amount of thought and judgment. What should be the mix between base salary and incentive pay? What kinds of incentive should be offered–stock options, restricted stock options, stock appreciation rights? How should those incentives be structured–over what time frame and using which metrics? And what about a severance plan? What kind of plan will be necessary to attract the best candidate? And on and on. The mere fact some people make their living as executive-pay consultants illustrates how challenging the task is.

Now, it is sometimes difficult to determine what exists because of its competitive advantage, and what exists to comply with or avoid regulation. (Topic for a study, maybe?) Nevertheless, I think viewing CEO pay as a source of competitive advantage, rather than as merely an administrative, HR-ish issue, has interpretive benefits. It allows us to see that what the Obamanons, and the Bushies before them, are doing is waging all-out war on success. This goes way beyond the tax code. With regulation, you don't just take away the products of success, you force people to all do the same thing, thus ensuring that success in that area is impossible. This helps those firms who would never stay competitive on their own, and hurts those firms who innovate and create.

Put into CEO pay language, being able to appropriately pay an executive for his or her successful effort is a major strategic issue for companies (it better be, otherwise I'd need to switch majors). This is mainly because almost no one has any idea how to do it. Regulating CEO pay takes away any strategic elements, and "levels the playing field," so to speak.

"And the trees are all made equal
by hatchet, axe, and saw."

(Allow me one Rush reference every now and then.)

He's Real and He's Tall

Yesterday, I had the opportunity to bask in the golden glow of capitalist He-Man John Alison. He was speaking at the Chicago Club, in an event hosted by FreedomWorks (Dick Armey's organization) and The Heartland Institute, where I interned last summer. Alison was speaking on the causes of the financial crisis, and gave a presentation almost identical to the one I linked to on this blog that he did back in January in D.C. Still, it was fun to see him talk in person.

It is also worth mentioning that BB&T, the bank which Alison led for over twenty years, has applied to pay back its TARP money, money they were forced to take in the first place. They have to raise new capital to do so, unfortunately, and that requires raising new equity, as well as temporarily cutting their dividend. This was especially difficult for them, because they pride themselves on not having cut their dividend in thirty-some-odd years. Now-CEO Kelly King made an excellent justification in his letter to shareholders, though, in which he stated that even though they hate to do it, the interests of shareholders are better served by getting out from under His Majesty's TARP thumb than by keeping the dividend high this quarter.

It is far too rare in business that leaders embrace uncomfortable reality head-on, and do what's best for shareholders in the long-run. The leadership of BB&T deserves much praise and respect.

Published

It's official, I am now a published scholar. The Michigan Journal of Business, the only major undergraduate academic business journal to my knowledge, has published my paper on executive long-term compensation in its latest issue. Here's the link for the journal and for my paper. In my paper, I found that in a sample from the fifty largest U.S. banks, "long-term" compensation had no effect on either of two metrics of long-term thinking.

This is especially pertinent, if I do say so myself, because His Majesty has lately been talking about issuing new royal decrees governing compensation of all bank executives of the realm, TARP-receiving or not. Here's an article on the subject. A nice excerpt:

Few companies that would be affected by a federal crackdown on compensation would publicly discuss the options being considered by administration and regulatory officials, which include trying to more closely match pay with long-term performance. The wait-and-see response also reflects nervousness about openly challenging the Obama administration on an issue that has become a flashpoint for anger over Wall Street's culpability for the financial crisis and recession.

That's nice, Barack. What I love about this whole charade, other than the blatant violation of individual rights, of course, is that, as I show in my paper, that "long-term" compensation crap is bullshit. Throwing stock options at someone does not a long-term incentive make. This is just more of His Highness' Royal Circus.

So yeah, go me.

No More Drunk Driving at Anheuser-Busch

I don't drink Budweiser (because I'm an elitist snob who likes "craft" beer), but I have friends who do, and so I have a bit of an interest in the progress at Anheuser- Busch. Some of you may remember that several months ago Belgian brewer InBev approached A-B several times offering a merger, only to be turned away several times, and threatened with defensive tactics, such as buying dead-weight companies to scare InBev off (That would have been stellar strategy.) In the end, A-B's board couldn't say no to their European wooers, and caved, much to the chagrin of jingoistic Amer'can protectionists everywhere (mostly in St. Louis).

At the time, many wondered (myself included) how InBev could justify spending $52 billion on a giant, low-growth company. Well, now we know, and it looks like this deal might have been a stroke of genius.

In the business world, we always like to talk about synergies when discussing mergers. According to this WSJ piece on the merger's progression, there were no synergies with A-B. InBev intended to make them.

Since taking over the company, InBev has been attempting to change the culture at A-B from that of an extravagant, perk-pumping employment mill to that of a lean, mean, profit-generating machine. Consider just these changes:

After InBev swooped in last fall with a $52 billion takeover, it sacked about 1,400 employees in the U.S., equal to 6% of the U.S. work force before the merger, and 415 contractor positions. These followed 1,000 employee buyouts accepted at Anheuser-Busch just before the merger.

InBev has overhauled the U.S. division's compensation system for salaried employees, as part of what an internal memo called "an increased focus on meritocracy." In the future, the company will pay salaried workers 80% to 100% of the market rate for comparable jobs, "and any increases above that require special justification and approvals," said the memo. That changed a system in which "high performers...might have seen fewer rewards as dollars were spread more evenly."

Dollars do not spread well. The compensation system is just one change, but I think it is one of the most important, as it lines up incentives when done properly. This can remove the need for a lot of other expensive measures down the road. This little detail is great:

Anheuser-Busch InBev in November gave a total of 28 million stock options to about 40 executives companywide, as an incentive to combine InBev and Anheuser-Busch successfully and lower corporate debt. The executives will be able to cash in the options, potentially worth tens of millions of dollars to each recipient, if the company reduces its debt-to-income ratio by about half in five years.

Meanwhile, the company will halt contributions to its pension plan for salaried employees in 2012. And in January, it will stop providing retiree life insurance.

Stock options are really tricky things, and are usually done wrong, but this idea seems really interesting. Normally stock options are pretty worthless as an incentive because most employees have very little influence on stock price, and thus on whether their options will make money. This vesting criteria of halving debt/income, on the other hand, sets a clear objective that every employee can help affect, through both raising revenue and cutting costs/borrowing.

And providing retiree life insurance is just dumb. Good going InBev. However, your beer still sucks. Work on that.