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Thursday, April 11, 2013

Public Accountants Betraying Clients: Insider-Trading on Client Information

There are two basic types of conflicts of interest: personal and institutional. In any conflict of interest, two roles conflict in such a way that one role can compromise the other. The role compromised is the more legitimate of the two. In this essay, I distinguish the two types and situate the public accountants involved in insider trading in the personal rather than institutional type. I discuss two specific cases, both of which resulted in the auditors being prosecuted, in order to distinguish that outcome from the failure of society to come to grips with some of the most important ongoing institutional conflicts of interest.


The full essay is at Institutional Conflicts of Interest, available in print and as an ebook at Amazon.

Tuesday, April 9, 2013

Johnson’s “Reinvention” of JC Penney: Too Much and Too Little

In April 2013, JC Penney’s board wished the CEO, Ron Johnson, “the best in his future endeavors.” His effort to “reinvent” the company had been “very close to a disaster,” according to the largest shareholder, William Ackman. During Johnson’s time at the company as its CEO, shares fell more than fifty percent. In February 2013, Johnson admitted to having made “big mistakes” in the turnaround. For one thing, he did not test market the changes in product-line and pricing points. The latter in particular drove away enough customers for the company’s sales to decline by 25 percent. Why did Johnson fail so miserably?
                                  Ron Johnson's short tenure as CEO of JC Penney was disastrous, according to Altman.   Source: Reuters

Some commentators on CNBC claimed that JC Penney’s board directors should have known better than hire someone from Apple to have so much responsibility right off the bat in a department store. However, Johnson had been V.P. for merchandising at Target before going over to Apple. Therefore, Penney’s board cannot be accused of ignoring the substantive differences between sectors. Even so, Target and Walmart are oriented to one market-segment, whereas JC Penney, Kohls and Macys are oriented to another. Perhaps had he taken the time to have market tests done at JC Penney, any error in applying what he had learned at Target could have been made transparent.

Although as the former CEO Ullman who would be replacing Johnson pointed out, customer tastes are always changing so you can’t go back to worked in the past, to “reinvent” a company goes too far. For one thing, it is risky for a retail company to shift from one market segment to another. Additionally, to “reinvent” something is to start from scratch to come up with something totally new. Even if that were possible for a retail chain, the “new front” would likely seem fake to existing customers. “They are trying to be something they are not,” such customers might say. Put another way, Ron Johnson might have gotten carried away with his notion of a turnaround.

In an interview just after Johnson’s hiring at JC Penney was announced in June 2011, he said, “In the U.S., the department store has a chance to regain its status as the leader in style, the leader in excitement. It will be a period of true innovation for this company.” A department store isexciting? Was he serious? Perhaps his excitement got the better of him in his zeal for change. But were the changes of “true innovation?” Adding Martha Stewart kitchen product-lines is hardly innovative—nor is getting rid of clearance sales and renovating store designs and the company logo. In fact, renovation is rather superficial, designed perhaps to give customers an impression of more change than s actually the case. Put another way, Ron Johnson may have had a tendency to exaggerate in the sense of gilding the lily as evinced by his appropriation of faddish jargon while coming up short in terms of substantive change. In an old company trying to be something it's not (i.e., going from a promotional to a specialty pricing strategy), there is too much superficial change and too little real change. Sometimes even upper-level managers can get carried away with their own jargon in trying to make their respective companies something they are not. It is like a person trying to be someone he or she is not. In "reinventing" JC Penney, Ron Johnson was trying to make an old woman come off as young by applying make-up and new clothes.

Sources:

Stephanie Clifford, “J.C. Penney Ousts Chief of 17 Months,” The New York Times, April 9, 2013.

Joann Lublin and Dana Mattioli, “Penney CEO Out, Old Boss Back In,” The Wall Street Journal, April 8, 2013.

Addressing Systemic Risk By Increasing Capital-Reserve Requirements

Although the Dodd-Frank Wall Street Reform Act includes significant reforms such as liquidity standards, stress tests, and resolution plans, the additional capital requirements (i.e., the SIFI surcharges) may not be sufficient should there be another financial crisis like the one in 2008. A study by the Federal Reserve Bank of Boston found that even the additional capital requirements in Dodd-Frank would not have been enough for eight of the 26 banks with the largest capital loss during that crisis. As overvalued assets, such as subprime mortgage-backed derivatives, plummet in value, banks can burn through their capital reserves very quickly. A frenzy of short-sellers can quicken the downward cycle even more. This raises the question of whether relying even in part on additional capital requirements as a bulwark is smart. It is not as though the financial crisis of 2008 was the crisis to end all financial crises.
With the $6.2 billion trading loss at JPMorgan Chase in the hindsight, Sen. Sherrod Brown (D-Ohio) and Sen. David Vitter (R-La) in the U.S. Senate proposed a bill that would require banks with more than $400 billion in assets to hold at least 15 percent of those assets in hard capital. The two senators meant this requirement to encourage the multi-trillion-dollar banks to split up into smaller banks. The Senate had recently voted 99-0 on a nonbinding resolution to end taxpayer subsidies to too-big-to-fail banks. Accordingly, the U.S. Senate had Wall Street’s attention. Considering that the U.S. House of Representatives was working on legislation to deregulate derivatives, the chances that the U.S. Government would stand up to Wall Street even to the too-big-to-fail systemic risk were slim to nil. Indeed, the U.S. Department of Justice’s criminal division had been going easy in prosecuting the big banks for fraud out of fear that a conviction would cause a bank collapse.
The senators’ strategy of going about breaking up the biggest banks indirectly can be critiqued on at least two grounds. First, should one or more of those banks decide to go with the 15% requirement rather than break up into smaller firms, even the additional capital might not be enough to protect a bank during a financial crisis. The study discussed above suggests as much. Second, even if the additional requirements would turn out to be sufficient in a crisis, the approach would obviate a decision by the government on whether systemic risk justifies a cap on how large banks can get. The question is similar to that concerning the Sherman Anti-Trust Act. Should systemic risk be added to monopoly as justifying government intervention in limiting private property? I contend that even the actual harm that the financial crisis of 2008 wrought on the U.S. economy justifies such intervention under the rubric of systemic risk.


Sources:

Eric Rosengren, “Bank Capital: Lessons from the U.S. Financial Crisis,” Federal Reserve Bank of Boston, February 25, 2013.

Zach Carter and Ryan Grim, “’Break Up the Banks’ Bill Gains Steam in Senate As Wall Street Lobbyists Cry Foul,” The Huffington Post, April 8, 2013.

Monday, April 8, 2013

Taoist Business Leadership

Leadership from the standpoint of Taoist teachings is paradoxical or even oxymoronic in nature. A leader intending to apply the teachings should therefore be willing to tolerate the co-existence as apparent opposites, or at the very least be willing to lead in ways not typically thought to be consistent with leadership. If this seems too taxing, one might consider the potential benefits. For one thing, leading in unanticipated and unusual ways may give one a sustainable competitive advantage both in terms of alternative leaders below and competitors leading other organizations. Put another way, going down the rarely trodden path opens one up to being able to use something of value unknown to other people. One could “corner the market” on that asset.

Material from this essay has been incorporated into The Essence of Leadership: A Cross-Cultural Foundation, which is available in print and as an ebook at Amazon. 

Sunday, April 7, 2013

North Carolina Weighs Making Christianity the State Religion

“Congress shall make no law respecting an establishment of religion, or preventing the free exercise thereof.” Congress. The writers of the First Amendment of the U.S. federal Constitution were obviously excluding the state governments. Even so, the U.S. Supreme Court has established that the amendment applies to the states as well as Congress. From Lemon v. Kurtzman (1971), the Court gave us what is known as the Lemon test. State funding for parochial schools (e.g., Catholic schools) must have a secular legislative purpose (e.g., education), neither advance nor inhibit religion in its consequences, and not foster “an excessive government entanglement with religion.” Yet the leap in claiming that the amendment bears on the states must deal with the explicit language of “Congress shall make no law.”
When the 13 original American states that formed the United States had been colonies, Calvinism was the “state religion” in all of the New England Confederation, which excluded Rhode Island on account of its freedom of religion. Pennsylvania was known as the Quaker experiment. Maryland was heavily Catholic. Virginia was Anglican. New Jersey split in two for a few decades in the late seventeenth century, with the Calvinists taking East New Jersey and the Quakers taking West New Jersey. Even by the time the U.S. Constitution was being considered, the notion of a state religion in a particular state would have been familiar to most Americans. The U.S. Supreme Court’s precedent seems artificial in comparison.
Even so, the North Carolina General Assembly would have gone too far had it passed the bill stating in part that the North Carolina General Assembly “does not recognize federal court rulings which prohibit and otherwise regulate the State of North Carolina, its public schools or any political subdivisions.” The bill also states that the U.S. Constitution does not prohibit states from making laws respecting an establishment of religion. While this assertion is probably correct in theory, the precedent set down by the U.S. Supreme Court makes the prohibition the law of the land. Refusing to recognize the U.S. Supreme Court as bearing on the states harkens back to the Nullification Crisis centered on South Carolina. President Jackson pointed out that the Union would not long last if the states could decide for themselves whether they would be bound by federal law.
Rep. Carl Ford of the NC Assembly. He proposed the bill that would have sidelined the U.S. Supreme Court and paved the way for Christianity as the state's official religion. 
The challenge is to get back to the wording, “Congress shall make no law,” without throwing out the U.S. Supreme Court. Proposing state laws, whether on religion or abortion, that are obviously unconstitutional under the Court’s rulings makes a state body look foolish. Rather than having selective amnesia, state representatives could seek to reverse the Court’s precedent either through the consent power of U.S. senators or by proposing a federal constitutional amendment. The first route may require state governments to have greater sway over the senators. Originally, they were to represent their respective states by representing the governments.
In terms of an official religion at the state level, Utah would obviously be Morman, but not every state has such a concentration of one particular denomination. Nor is religion itself equally strong in every state. Not every state would want to institute an official religion. All of this suggests that the United States would be a richer quilt to the extent that states can differ on religion as a phenomenon and with respect to the particular religions. Put another way, the U.S., being imperial in scale, is innately more diverse than can be seen by the extent of one-size-fits-all Congressional action. Allowing the states to fulfill their particularities more fully would make the U.S. itself a richer tapestry and thus a strong union.
If some of the American republics in the U.S. were to have established state religions, a person in the minority in one of those states might feel more like an outsider in one’s own town. Being a non-Mormon in Utah would be even harder were Mormonism the official state religion.  However, is it not already awkward for atheists in the small towns of several states, such as Alabama and Mississippi? Is there really so much difference between an overwhelmingly Christian population and making Christianity the official state religion? It would not be as though the heretics could legally be burned alive. To counter any unfairness more generally, equal protection under the law and due process could be used in a non-Christian’s defense.   
I would even say that it should not be the case that the typical American feels equally at home in every state, for that would mean that the one-size-fits-all approach of Congress has effectively homogenized an empire that is inherently diverse. In terms of historical political theory, an empire is “different in kind” (i.e., qualitatively) than the kingdom-level on the next scale down. It is not only that an empire is larger than a kingdom (i.e., quantitatively). Whereas a kingdom is only large enough that it may or may not be diverse within, an empire by definition consists of kingdom-level polities and is thus inherently diverse because kingdoms are different. From the beginning, the American colonies/states were mapped on the scale of the then-extant early-modern kingdoms in Europe. The European countries and American republics generally are comparable. France is a bit smaller than Texas, Germany is roughly the size of Montana, Spain matches Arizona and Italy is the size of California. Among the respective smaller states, Malta, Luxemburg, and Cyprus cluster with Rhode Island, Delaware, and New Jersey. Belgium and Maryland are both mid-sized states in their respective unions. To compare the U.S. and France or the E.U. and Texas thus evinces a category mistake. Flawed conclusions should be expected.
The United States altogether thus form an empire, which is composed of kingdom-level polities/cultures/territories. We should not be surprised to find that the culture in Texas differs from that of Massachusetts, for example. One of the benefits of living in the U.S. is that one can live in a republic that fits one’s ideology or lifestyle. For example, a gay person can move to a culture such as Massachusetts or California in which greater acceptance exists. People in the majority cultures in Oklahoma and Arkansas would not have to be pushed into changing their respective cultures into accepting homosexuality, though the marriages made in the other states would have to be recognized due to the full faith and credit clause of the U.S. Constitution.  A fuller happiness for both gays and traditionalists/Biblicalists would result if each can find a fitting environment than would be the case were Congress to pass an empire-wide one-size-fits-all “solution.”  Were it made under one giant compromise, U.S.-wide, it is likely that the result is not a fit for any American. Moreover, to suppose that every state should be virtually the same just because the U.S. is recognized as “a” country ignores the intrinsic diversity that exists within an empire-scale complex-polity. Even the poll finding that roughly a third of Americans want Christianity to be the official religion in their own state cannot be generalized using a broad brush across the United States. I suspect that a much higher percentage of Arkansans than New Yorkers or Californians want Christianity to be their official religion.
In short, the establishment of state religions in some of the states even as strong majorities in other states prefer their respective cultures (and governments) to remain primarily secular would provide a closer fit for not only the people involved, but also the diversity that exists anyway within an empire that is composed of kingdoms and/or republics. To treat an empire as though it were synonymous with one of its republics or kingdoms evinces a category mistake. The benefits of diversity that can be enjoyed within an empire are threatened when Congress makes the mistake by acting like a state legislature. Put another way, the United States would be stronger were the strictures relaxed such that they could more fully manifest their uniqueness. Seeing a strip-mall with a McDonalds restaurant in every town from coast to coast is appreciably more bland. “Sameness” multiplied across a continent is not only tiring; it fails to take advantage of the inherent diversity that springs from distance and more than one government. One need only look at the E.U. states to get a sense of how little distance is necessary for culture to differ. Even though the North Carolina’s General Assembly was pursuing a foolish strategy in proposing a bill that would have the government ignore the U.S. Supreme Court when convenient, the presumed article of separation between church and state at the state level can and should be re-considered.


Sources:

John Celock, “North Carolina House Speaker Kills Bill to Create State Religion,” The Huffington Post, April 4, 2013.

Emily Swanson, “Christianity As State Religion Supported By One-Third of Americans, Poll Finds,” The Huffington Post, April 6, 2013.