ProfessorBainbridge.com

Out of town to damn SOX

I'm off to San Francisco to give a speech on Sarbanes-Oxley to a Hoover Institution function. Back Tuesday. A long version of my remarks will be posted to SS RN soon and an abbreviated version will be published in the Hoover Digest eventually. In the meanwhile, here's Bainbridge's greatest SOX hits:

• Peekaboo, the Constitution Doesn't See You
• Shedding Light on SOX
• SOXing It to Small Businesses
• Incentives and Business Ethics
• SOX Pox

The World's Greatest Rock and Roll Band's Greatest Concert

The Who Live at the Isle of Wight Festival 1970 on DVD. Are the songs finally in the right order? No. Are there still missing songs? Yes. Is the editing still choppy? Yes. But who cares? This is still a priceless look at the original line-up of my favorite rock band in their prime. Murray Lerner and Pete Townshend have collaborated to produce a concert that is visually and aurally superior to earlier releases, with the added bonus of a fascinating interview with Townshend in which he opens up on the band and its music to a remarkable degree.

One of my chief regrets is that I only saw the Who once with Keith Moon as drummer and, at that, near the end of his all too short life. This concert confirms that the band was never quite the same after his death. His playing is chaotic, to be sure, but the telepathic chemistry he had with Townshend is obvious. Their improvisations are nothing short of amazing. On a big TV and surround stereo, you get a sense of why Townshend thought these concerts were little short of a religious experience.

The greatness of this concert DVD is perhaps best summarized by my wife's comment that, after 20 years of living with a Who fan, she "finally gets it."

I was 11 when The Who played this concert. Anybody with an 11 year old who's addicted to Britney Spears, Jessica Simpson, or the latest boy band ought to set their kids down and make them watch this DVD to see what real music was - and could still be.

Behrens & Hitchcock Syrah (Mendocino) 1998

At age 8, this wine had plenty left. Still a deep purple despite having thrown a ton of very fine sediment (I ended up resorting to decanting it through unbleached coffee filters). If it lacks the intense forward fruit of young Aussie Shiraz, it more than makes up the difference with class and breeding. Licorice, grilled meat, black cherries, and soy sauce on the nose. The palate follows the bouquet, but adds some nutmeg and clove spice. Very fine. Grade: A--

Duck Cassoulet

• 1 ½ cup haricots blancs (substitute any dried white bean)
  
• 1 package D'Artagnan duck fat
  
• ¼ pound pancetta
  
• 4 cloves garlic, peeled and minced
  
• 1 cup dry white wine
  
• 1 medium yellow onion, peeled but left whole
  
• 5 whole cloves
  
• 2 medium carrots, cut into chunky dice
  
• 1 bouquet garni made by tying up 1 rosemary spring, 4 parsley sprigs, 2 thyme sprigs, 2 bay leaves, and 1 tablespoon whole black peppercorns in a cheesecloth bundle
  
• 7-10 cups organic chicken stock
  
• 1 14.5-ounce can of diced tomatoes
  
• 4 D?Artagnan duck legs confit
  
• 3 links D'Artagnan duck and armagnac sausage, cut into ½-inch rounds on a slight bias
  
• 1 shallot, diced
  
• 1 package D'Artagnan duck and veal demi-glace
  
• 1 cup panko bread crumbs
  
• 1 teaspoon dried Italian herbs
  
• salt and freshly ground black pepper

Pick over the beans to remove any debris then put into a colander or sieve to rinse under cold running water. Soak overnight in at least 2 quarts cold water. Drain and transfer to a large pot.

Melt one teaspoon duck fat over medium in a non-stick skillet. Saute pancetta until its fat renders and the bacon crisps. Add the garlic and saute 1 minute, not allowing the garlic to brown. Transfer to large pot.

Deglaze skillet with white wine. Bring wine to the boil for 1 minute. Transfer to large pot.

Stud the onion with the cloves. Add onion, carrots, and bouquet garni to large pot.

Add enough chicken stock to pot to cover ingredients. Bring to a boil, reduce to a low simmer. Cook 1 to 1-½ hours or until beans are tender but still intact. Skim any scum that forms. Add tomatoes (with their juices) and a pinch or two of salt and freshly ground black pepper about 30 minutes before cooking ends.

Put a colander or large sieve over a large bowl. Drain bean mixture, reserving cooking liquid. Remove and discard bouquet garni and onion. Taste beans and adjust seasoning with salt and pepper as needed.

Put 2/3 bean mixture into a large casserole dish.

Remove skin from duck legs, reserving. Remove meat from bones, discarding bones. Shred leg meat. Add to casserole dish.

Melt 1 teaspoon duck fat over medium-high heat. Saute sausage rounds until lightly browned. Add to casserole dish. Mix well.

Sweat shallot in fat left in skillet after cooking the sausage until translucent and tender. Mix with remaining beans. Add resulting mixture to the casserole dish. Pour duck demi-glace over casserole. Pour in enough of reserved cooking liquid so that the bean mixture is just covered. If you want a leaner and tastier version, make ahead to this point, then cool, cover, and refrigerate overnight. Most of the fat will collect on the top and harden for easy removal the next day.

Preheat oven to 350 degrees.

Mix bread crumbs and Italian herbs. Melt 1 tablespoon duck fat and drizzle over bread crumbs. Mix well. Use the mixture to top the casserole.

Cover casserole dish with aluminum foil and bake at 350 for 1 hour. Remove foil and bake an additional 30 minutes or until bread crumbs are a deep golden brown but not burnt.

Make duck cracklings by cutting reserved skin into small pieces and rendering them in in a non-stick skillet over medium-high heat until crispy.

Serve in deep bowls. Top with cracklings and finely chopped fresh Italian parsley just before serving. Offer a Syrah-based red wine. I chose Torbreck The Steading (Barossa Valley) 1999, whose sweet and jammy fruits complemented the rich flavors of the cassoulet, while retaining enough bright acidity to slice through the unctuous cassoulet.

Schramsberg Brut Rose (California) 2003

Year in and year out, this is one of my favorite California sparklers. It goes especially well with Cal-Asian cuisine, such as tonight's Seared Ahi Tuna in Cilantro-Lime-Soy Sauce. The 2003 is a lovely salmon color with very fine bubbles. At the moment, it's dominated by bread/yeast and nutty flavors and aromas, although there are some berries underneath. Grade: A--

Seared Ahi Tuna in Cilantro-Lime-Soy Sauce

The sauce:

• 1 cup fresh cilantro leaves
• 1/2 jalapeno chile, seeded
• 1 tablespoon grated fresh ginger
• 2 garlic cloves crushed
• Juice of 1 lime
• 3 tablespoons soy sauce
• 1 tablespoon extra virgin olive oil
• 1 teaspoon sesame oil
• 1 tablespoon rice wine vinegar
• dash hot sauce or chili oil
• 1/8 teaspoon sugar
• Salt and freshly ground black pepper

Combine all ingredients in a mini-food processor and puree on high until the solid ingredients are finely diced

2 8 ounce blocks (preferably 1 inch wide and high) sushi-quality ahi tuna

1 ripe avocado, halved, pitted, peeled and sliced

Heat a tablespoon of peanut oil over high heat in a 10 inch non- stick saute pan until almost smoking. Meanwhile, lightly season the tuna with salt and pepper. When the oil is hot, saute the tuna blocks 1 minute on each of the four sides. Remove to a cutting board and let rest briefly. Slice thinly crosswise. Plate the sauce, arranging the tuna and avocado slices on top.

I like to serve this with pre-made shrimp tempura.

Whatever happened to being the party of limited government?

CNN reports:

Every American taxpayer would get a $100 rebate check to offset the pain of higher pump prices for gasoline, under an amendment Senate Republicans hope to bring to a vote Thursday.

While they're at it why don't they just vote themselves free campaign ads? As the K Street Gang's popularity sags to perilously low levels, a transparent attempt at vote buying is the best the Senate GOP can come up with?

In the first place, this sort of pandering really is unnecessary. Yes, people are annoyed by gas prices, but as Nick Schulz points out, their annoyance isn't changing behavior - and for good reason:

Energy prices may be rising, but energy itself is much less important to consumers and to the overall economy than it once was.

According to the Bureau of Economic Affairs ( see chart here), American consumer spending on energy as a fraction of total personal consumption has declined considerably since 1980. Whereas 25 years ago, one in every ten consumer dollars was spent on energy, today it's one in every 16. In other words, what it takes to heat and cool our homes and drive to and from our jobs and vacation destinations is relatively less costly than it was then.  ...

Of course, no one likes to pay more at the pump. And with some analysts predicting oil per barrel going up to $75 or higher in the near future, we might see retail prices go up further still. But unlike a generation or two ago, these increases won't prompt the broader economic pain they once did.

In the second, whatever happened to being the party of limited government and economic sense? Instead, as John Hinderaker reports:

The Republican Senators' proposal does nothing, other than ANWR drilling, that acknowledges the rules of supply and demand that govern prices. The "Gas Price Relief and Rebate Act" is mostly crude pandering of the kind we used to expect from Democrats, not Republicans.

One is tempted to agree with Bill Quick's summation:

We have to wake up the Stupid Party, before it completely merges itself into the Republicrat Statist Party.

Corporations in Politics

It is inevitable that corporations will play politics. Critics contend that corporate political activity, most especially campaign contributions, corrupts the political process and enables corporations to obtain legislation granting them rents at societal expense. In response, defenders of corporate political involvement argue that the ever-increasing burden of regulation requires corporations to include lobbying regulators and legislators as part of their overall business strategy. hence, it is to be expected that corporations will seek to manage politics in much the same way as they manage other business ventures. Jill Fisch makes an important contribution to this literature with a case study "examining the political involvement of one company, FedEx, in a series of regulatory reforms over a forty year period."

Drawing upon the business context, the legislative record, campaign finance materials and interest group analysis, the Article demonstrates that political activity has been an integral component of FedEx's business growth and operations. FedEx has successfully used its political influence to shape legislation, and FedEx's political success has, in turn, shaped its overall business strategy. Moreover, in identifying the specific components of FedEx's political activity, the Article highlights the range of mechanisms that corporations use to engage in politics, revealing that the exercise of political influence is far more complex than the purchase of political favors in a spot market.

Regulation is becoming an increasingly important factor for United States businesses. As a result, corporations must integrate political activity into their overall business strategy and must develop and manage their political capital in the same way that they manage other business assets. The FedEx story demonstrates the importance of politics to business and explains the growing investment by corporations in political capital. It further explains how the business world has responded, and will continue to respond, to regulatory restrictions by developing alternative mechanisms for exerting political influence.

Criminalizing Agency Costs

My TCS column this week is Are We Criminalizing Agency Costs? Should You Care?

Few mainstream pundits have provided better insights on the Enron and other corporate governance prosecutions of recent years than have bloggers Tom Kirkendall (a Houston lawyer) and Larry Ribstein (a University of Illinois law professor). In particular, they've repeatedly drawn attention to the problem Ribstein calls "criminalizing agency costs."

They've been so successful at popularizing this concept within the admittedly narrow confines of the corporate governance blogosphere that WSJ law blogger Peter Lattman recently felt comfortable using the phrase to describe one Enron defendant Jeffrey "Skilling's main defenses"; i.e., "that the government has criminalized corporate agency costs."

Lattman explains: "Criminalizing corporate agency costs? That's just a fancy way of saying that the government has misused criminal laws in this case to punish questionable business transactions and bad business decisions." This is true, but some additional elaboration perhaps would be helpful.

"Agency costs" are a central concept of modern corporate governance and finance. These costs arise because public corporations are characterized by a separation of ownership and control: The firm's nominal owners, the shareholders, exercise virtually no control over either day to day operations or long-term policy. Instead, control is vested in the hands of professional managers, who typically own only a small portion of the firm's shares.

As Professors Berle and Means observed in their landmark book The Modern Corporation and Private Property: "The separation of ownership from control produces a condition where the interests of owner and of ultimate manager may, and often do, diverge . . . ."

Economists Michael Jensen and William Meckling coined the term "agency costs" to refer to the consequences of Berle and Means' divergences. Jensen and Meckling defined these costs as the sum of the monitoring and bonding costs, plus any residual loss, incurred to prevent shirking by agents. In turn, shirking is conventionally defined to include as any action by a member of a production team that diverges from the interests of the team as a whole. As such, shirking includes not only culpable cheating, but also negligence, oversight, incapacity, and even honest mistakes.

A sole proprietorship with no agents will internalize all costs of shirking, because the proprietor's optimal trade-off between labor and leisure is, by definition, the same as the firm's optimal trade-off. Agents of a firm, however, will not internalize all of the costs of shirking: the principal reaps part of the value of hard work by the agent, but the agent receives all of the value of shirking.

Economists Armen Alchian and Harold Demsetz offered the useful example of two workers who jointly lift heavy boxes into a truck. The marginal productivity of each worker is difficult to measure and their joint output cannot be separated easily into individual components. In such situations, obtaining information about a team member's productivity and appropriately rewarding each team member are very difficult and costly. In the absence of such information, however, the disutility of labor gives each team member an incentive to shirk because the individual's reward is unlikely to be closely related to conscientiousness.

Accordingly, an essential economic function of management is monitoring the various inputs into the team effort: management meters the marginal productivity of each team member and then takes steps to reduce shirking.

The process just described, of course, raises a new question: who will monitor the monitors? In any organization, one must have some ultimate monitor who has sufficient incentives to ensure firm productivity without himself having to be monitored. Otherwise, one ends up with a never ending series of monitors monitoring lower level monitors. Alchian and Demsetz solved this dilemma by consolidating the roles of ultimate monitor and residual claimant. According to Alchian and Demsetz, if the constituent entitled to the firm's residual income is given final monitoring authority, he is encouraged to detect and punish shirking by the firm's other inputs because his reward will vary exactly with his success as a monitor.

Unfortunately, this elegant theory breaks down precisely where it would be most useful. Because of the separation of ownership and control, it simply does not describe the modern publicly held corporation. As the corporation's residual claimants, the shareholders should act as the firm's ultimate monitors. But while the law provides shareholders with some enforcement and electoral rights, these are reserved for fairly extraordinary situations. In general, shareholders of public corporation have neither the legal right, the practical ability, nor the desire to exercise the kind of control necessary for meaningful monitoring of the corporation's agents.

How then do we deter agents of a public corporation from shirking? Economic theory tells us that actors are deterred when the expected punishment exceeds the expected benefits of committing the crime. In turn, the expected punishment is determined by multiplying the nominal sanction (the penalty imposed if convicted) times the probability of being caught.

An example might be helpful. I know from painful personal experience that the nominal penalty for speeding on Sunset Boulevard in West Hollywood is a $271 fine, plus the cost and opportunity costs associated with going to traffic school to keep the citation off my record. Because the odds of getting caught are very low, however, the expected sanction probably is just a few pennies. Being a rational actor, I therefore speed.

As I explained in an earlier TCS column, "Crime? And Punishment?", however, the criminalization of bad corporate governance has increased the expected sanctions faced by corporate executives. The probability of conviction has gone up because ambitious prosecutors can bring to bear the full panoply of coercive measures available only in criminal litigation, while the nominal sanction has gone up dramatically. All of which raises the question of whether we have cranked up the expected sanction to the point of over-deterrence.

The problem is that business decisions rarely involve black-and-white issues; instead, they typically involve prudential judgments among a number of plausible alternatives. Given the vagaries of business, moreover, even carefully made choices among such alternatives may turn out badly.

If prosecutors, judges, and juries are unable to distinguish between competent risk taking and criminal mismanagement, however, the threat of criminal sanctions may discourage managers from taking risks.

Yet, risk-taking is precisely what shareholders want managers to do. As the corporation's residual claimants, shareholders don't get paid until all other claims on the corporation are satisfied. Because risk and return are positively correlated, the high returns on corporate investment necessary to leave something for the shareholders require high risks.

The problem of criminalizing agency costs should now be apparent. Obviously, shareholders want managers who steal from the company or defraud investors to be punished. Yet, they also want managers to take risks. If prosecutors and juries can't tell the difference between the two, however, criminal sanctions may leave shareholders worse off by making managers more risk averse.

Stephen Bainbridge is a TCS columnist and teaches law at UCLA. Find more of his writing here.

Confirming Judges

From Hugh Hewitt:

These are votes which the Republican base will watch closely, and will demand fairness on and conformance to the "Gang of 14" agreement. If Senator Graham, for example, helps kill the Haynes nomination in the Judiciary Committee, that will be laid at Senator McCain's feet and rightly so.

And if any of these three are filibustered, the Constitutional Option will have to be dusted off and deployed, exactly a year after it ought to have been used in the first place.

I agree with Hugh that the 60-odd nominations in the pipeline need to be moved forward. I also agree that the Gang of 14 agreement needs to be enforced. For those of us on the right who have basically given up on Bush and the K Street Gang, solidly conservative judges are about the only thing left on offer by the Republicans. But why is Hugh still pushing to abolish the judicial filibuster. Abolition of the filibuster has always been a bad idea and, as the confirmation of Alito proved, was unnecessary. Just in PR terms, it'd be the GOP equivalent of FDR's court packing plan (or, if you prefer, Gingrich's government shut down). It might play well to a segment of the base, but the center-right majority in this country probably would be turned off by it.

The K Street Gang

The mail brings Matthew Continetti's new book The K Street Gang: The Rise and Fall of the Republican Machine. As a conservative critique of the GOP in Congress, it makes a nice match to Bruce Bartlett's critique of the Bush White House - Impostor. Continetti is a staff writer at the Weekly Standard, who has also been published in the New York Times, the Washington Post, and the Los Angeles Times. His conservative credentials are impeccable. And, like a lot of us, he has seen the conservative revolution of 1994 turn into a mess that serves only to demonstrate Lord Acton's aphorism about power corrupting. The K Street Gang blows the lid off the whole sordid history.

Response to Increasing Shareholder Power

My essay Director Primacy and Shareholder Disempowerment can now be downloaded in its "as published" form from the Harvard Law Review's website. From the introduction:

In his 2004 article, Lucian Bebchuk advances proposals designed to allow “shareholders to initiate and vote to adopt changes in the company’s basic corporate governance arrangements.” As Bebchuk explains, the housekeeping rules of corporation law effectively preclude shareholders from initiating corporate decisions. Indeed, the extent to which corporate law is stacked against shareholder “intervention power” goes beyond just the housekeeping rules; much of business law acts to limit shareholder involvement in corporate governance. Taken together, these rules form a regime I call “director primacy.”

Hence, I do not quibble with Bebchuk’s exposition of shareholder weakness; to the contrary, I welcome it as further evidence that my director primacy model accurately describes how corporations work. Instead, I intend to take issue with Bebchuk’s proposal to replace the existing, mostly permissive rules disempowering shareholders with a new set of mostly mandatory rules empowering them.

Part I of this Response argues that Bebchuk’s proposed default rules would be inefficient, asking: if shareholder empowerment is as value-enhancing as Bebchuk claims, why do we not already see it in the marketplace? After all, free markets typically produce only those goods people actually wish to purchase, and corporate governance terms are no exception. Part II invokes first principles to offer an alternative to Bebchuk’s account of the proper role of shareholder voting in corporate governance. It argues that the present regime of limited shareholder voting rights is the majoritarian default and therefore should be preserved as the statutory off-the-rack rule. Finally, Part III questions whether shareholders would make effective use of Bebchuk’s proposed regime.

"In the name of God, go"

The Economist's Lexington thinks Rumsfeld should go:

There is now widespread agreement on what he got wrong. His biggest mistake—the fons et origo of all the others—was to try to fight the war with too few troops. His second-biggest was to make no proper provision for restoring order afterwards. But there is no shortage of other mistakes. Mr Rumsfeld misread the intelligence in the build-up to the war, and much of it was simply wrong in any case. He failed to plan for the occupation. He ignored the growing insurgency. He disbanded the Iraqi army, scattering 300,000 armed and unemployed men into the population. The more interesting question is why he messed up so comprehensively.

The most obvious reason, of course, is arrogance. Mr Rumsfeld suffered from exactly the same problem as another whizz-kid CEO turned secretary of defence, Robert McNamara: iron self-confidence.

So does the LA Times editorial board:

The secretary should go not because he has been criticized by a group of retired generals but because he embodies the smugness and inability to acknowledge error that has characterized both the Iraq war and the wider war on terrorism. Rumsfeld has been the pinched public face of an administration that has cut legal and humanitarian corners in dealing with people — including U.S. citizens — suspected of involvement with terrorists.

This administration's arrogance, smugness, and inability to admit error surely have been critical factors in the unraveling of its public support and the erosion of confidence even among much of the base. As I wrote in the space almost a year ago:

George W. Bush has pissed away the conservative moment by pursuing a war of choice via policies that border on the criminally incompetent.

Yet, if I can invoke a baseball analogy, the owner of a struggling team rarely starts out by firing the players (Rumsfeld) but by firing the manager (Cheney). The LA Times editorial urges Cheney's replacement. The Times of London reports that Bush is getting the same advice from members of his own party:

REPUBLICANS are urging President George W Bush to dump Dick Cheney as vice-president and replace him with Condoleezza Rice if he is serious about presenting a new face to the jaded American public. ... Fred Barnes of the Weekly Standard magazine and author of Rebel in Chief, a sympathetic new biography of Bush, said: “There are going to have to be sweeping personnel changes if people are going to take a second look at the Bush presidency.” Barnes, who is close to the White House, said he believed Cheney would be willing to stand down in order to help Bush. “It’s unlike Bush to dump somebody whom he likes and respects,” he cautioned. “But the president needs to do something shocking and dramatic such as putting in Condoleezza Rice.”

As I contemplate Cheney and Rumsfeld, I am reminded of something once said by a man against whose iron will even Cheney and Rumsfeld's arrogant smugness would dash like waves on rocks:

You have sat too long for any good you have been doing. Depart, I say, and let us have done with you. In the name of God, go!

Il Circo Il Domatore di Leoni (Montepulciano) 2003

A Tuscan red imported by Bonny Doon. Kudos for using screwcaps. But this is still a generic red. Thin, acidic, and oddly sweet on the finish. Grade: C

Duckhorn Cabernet Sauvignon (Napa Valley) 1998

For a vintage condemned as Napa's worst of the 1990s, this is a remarkably fine wine that surprisingly is still going pretty strong. Big Cab Sauv nose - cedar, leather, black currants. On the palate, the currants and cedar are supported by cherry and espresso notes. The tannins are well-integrated and while the wine is definitely ready to drink it could have gone a few more years without strain. The principal criticism I would offer is that the finish is a tad thin and quite short for a wine of this caliber, which is perhaps where the mediocrity of the vintage finally shows itself. Grade: B+