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Saturday, January 28, 2012

A Future of Regulators at Fault?

The typical case in the U.S. is that the industry being regulated resists being regulated, while the regulators insist on enforcing the regulations. To be sure, particularly strong firms in an industry may propose incremental regulations for strategic advantage—knowing that smaller or less profitable firms in the industry would have more trouble complying financially. The strategic use of regulation is an under-appreciated phenomenon in the de-regulation movement. Perhaps even more bizarre is the case of an industry complaining about lax enforcement of existing regulations and demanding even more. What industry might fit this bill? As a hint, look for a major scandal that did reputational harm to an industry.

In the industry, the firms’ calls for a crackdown must contend with a legacy of a light regulatory touch.” People in the industry question whether regulators have been “too gentle” on the firms. If a firm “runs afoul of the rules, regulators largely rely on the firms to report their own wrongdoing.” It sounds like Andy Taylor’s jail in Mayberry—the keys are hanging on the wall, help yourself Otis (he was the drunk). From 1996-2011, regulators penalized only ten firms, letting scores of others off the hook “because [the] regulators deemed their violations accidental.” The sounds like the work of Andy’s deputy, Barney—find the loot only to lose the criminal.

I am describing the futures industry, whose firms, “ordinarily loath to accept regulation,” decided in the wake of MF Global’s collapse and loss of $1.2 billion of customer money to spearhead efforts for “new oversight as they try to heal the black eye.” In its article, the New York Times describes the existing regulations as nearly non-existent. For example, “firms need not inform customers of the whereabouts of their money.” It is no wonder that prospective customers would be hesitant to enter that arena—hence the firms’ financial interest in additional regulations. The question is perhaps why the regulators had not recommended any to Congress.

Without the usual vested interests thwarting prospective regulations bearing on themselves while Congress stands by and takes the contributions, any additional regulations “spearheaded” by the industry can be expected to be enacted. The question, I suppose, is whether the regulators will feel like enforcing them. With no headwind from the industry, lax enforcement would be an interesting nut to crack. Could it be that regulators exist who don’t believe regulations are very important? Such a mentality would be the opposite of public service—something like agnosticism in religion, only as held by clerics. Such a thing simply is not expected, hence it is worth investigating.

The most likely explanation is that the regulatory agency was “captured” by its industry, and ultimately it was in the interest of the industry itself to come up with something stronger. If so, might it be that once the new regulations are up and running, particular firms or the industry as a whole might want to capture the agency again? Even in following the industry’s “spearheading,” the agency is essentially “captured.” Is it the case in the American system more generally, that agencies are captured by their regulatees whether in increasing or decreasing enforcement? In other words, might the business and financial sectors be too powerful over government for their own good—like children telling their parents when to discipline them and when to let them get away with something?  The sectors—and in particular their largest firms—may be too powerful for a viable republic: TBTG, meaning too big to govern. TBTF might not be the biggest elephant in the living room after all.

Ben Protess and Azam Ahmed, “Insiders Call For Oversight of Futures,” The New York Times, January 26, 2012. http://dealbook.nytimes.com/2012/01/25/futures-industry-sees-chance-to-shape-oversight/

Wednesday, January 25, 2012

Reining in Corporate Pay: Europe as a Model of Fairness for America

Corporate compensation—executive pay in particular—represents a “clear market failure,” so said Vince Cable, the business secretary in the E.U. state of Britain. While suspected, the sheer explicitness, or blatant manner, of this verdict is itself noteworthy. Moreover, it stands as an opportunity for the E.U. to surpass the U.S. on economic fairness, which is a type of justice (see John Rawls). That is to say, Europe had an opportunity at the time of Cable’s statement to set the E.U. on a trajectory that would make the unfairness in the American system more transparent.

The business secretary, a Liberal Democrat in a coalition government with the Conservative Party, told the British House of Commons in January 2012 that business and investors “recognize that there is a disconnect between top pay and company performance and that something must be done.” In New York at the time, the disconnect was generally taken as a fact of life, given the power of the managerial elite in corporate capitalism (as well as American legislatures). As if attempting to pop this stygian balloon filled with the noxious air of denial, Vince Cable continued, “We cannot continue to see chief executives’ pay rising at 13 percent a year while the performance of companies on the stock exchange languishes well behind . . . (a)nd we can’t accept top pay rising at five times the rate of average workers’ pay as it did [in 2010].” The unfairness, in other words, is at the expense of not just the corporation’s owners, but also the (other) employees—executives being employees too.

It could be argued that the 13% annual increases in executive pay are a function of an increasing proportion of company stock options in the compensation. If the profits are languishing, the theory goes, the value of the options should be zero (i.e., unexecuted). However, what if the next group of executives, or even the economy over all, “performs” such that the options held by the previous executives then become valuable? Moreover, what do options cost non-management stockholders in terms of dilution? I suspect that options are “an easy way out” relative to cash compensation. The question is thus whether the practice can be reined in.

Under Vincent Cable’s proposals, shareholder votes on executive pay would be binding. Seventy-five percent, rather than a mere majority, would be needed for approval. I have never understood why the American states limit such votes to “non-binding,” as if the business judgment rule trumps property rights on compensation. Given that CEOs typically control their boards, whose job it is to oversee the executives for the stockholders, treating the property owners of the corporate wealth as if they were a focus group or a meaningless straw poll in Iowa seems misguided at best—and supportive of an institutional conflict of interest centered on the executives. To be sure, the suggestion made by Chuka Umunna, Vincent Cable’s counterpart in the Labour Party, to have employees as part of executive compensation committees also incurs a conflict of interest—one centered on the employees who have an interest in wanting “payback” for the decades of unfair compensation. Conflicts of interest can work both ways—inflating and deflating deserved compensation.

My main point is the following: Were Europe to strengthen investors’ property rights—including disallowing proxies held by managements for such votes on account of the conflict of interest—the fault running through American political economies and civil societies would become more transparent (i.e., more obvious). “We have  been clear that executive pay must always be fair and transparent, and that high pay must be for outstanding, not mediocre, performance,” John Criby of the Confederation of British Industry—a business lobby group—said. “Millions [of pounds] for mediocrity does a disservice to the reputations of hard-working businesses.” Indeed, it does a disservice to the society as a whole—particularly in terms of what it stands for. Can you imagine the U.S. Chamber of Commerce coming up with such a statement? It is a pity, particularly in terms of systemic risk, that a lack of enlightened self-interest in the vested interests on such a “clear market failure” exists in America. For this reason, “Europe as a Model” is not such a bad thing, certain rhetoric (of the usual suspects) to the contrary.

In Vermont and Wisconsin at the time of Vincent Cable’s speech in Britain, movements were underway to amend the respective constitutions (as well as that of the U.S.) to make it clear that corporations are not “legal persons.” I believe it would follow that money is not speech, though the amendments ought to make this explicit, given the tendency of justices to invent legal doctrines and the sway of money in legislative halls. Polls at the time showed 71% of the people across the United States were opposed to the Citizens United (unlimited corporate political contributions) decision of the U.S. Supreme Court two years before (almost to the day). Lest those movements get cocky, their leaders should be aware that huge corporate “war chests” used to buy politicians, commentators, and air time may mean that even such a supermajority’s popular will may not be sufficient. If so, it is unlikely that anything like Vincent Cable’s proposals would see the light of day in America. Accordingly, I have pointed out here the value in merely having an alternative displayed in Europe, even if the benefit is limited to wakening Americans up to the grip of corporate capitalism in American societies.

Julia Werdigier, “British Government Works to Rein in Corporate Pay,” The New York Times, January 23, 2012. http://dealbook.nytimes.com/2012/01/23/british-government-looks-to-rein-in-executive-pay/

Sunday, January 22, 2012

Credit Downgrades in the E.U.: Blaming the Messenger?

On January 13, 2012, “S&P stripped France and Austria of their prized triple-A credit ratings and reduced the ratings of seven other [states in the euro-zone], including Italy, Spain and Portugal. Germany, Finland, the Netherlands and Luxembourg were spared, along with Belgium, Estonia and Ireland,” according to the Wall Street Journal. Italy was downgraded from single-A to triple-B-plus. "We think there are elements missing in their analysis … when it comes to the growth strategy … there is no space for maneuver for fiscal impetus but we believe that a growth strategy will have to rely mainly on structural reforms," Olivier Bailly, an E.U. Government spokesman, told reporters. The Journal also reports, “Bailly also called the timing of the S&P decisions ‘very odd’ citing fiscal policies adopted to weather the crisis in the downgraded countries as well as the two successful debt auctions in Spain and Italy last week. ‘We think that there is a strange timing in this announcement considering the signals from the markets,’ Mr. Bailly said.” The “very odd” and “strange timing” reference a tacit political motive behind S&P, which the European officials point out is an American company.

The full essay is at "Essays on the E.U. Political Economy," available at Amazon.