ProfessorBainbridge.com

Another Obama "green" company in trouble

President Obama's "green" industrial policy took a huge hit when Soyldra went down the tubes amidst charges of crony capitalism and so on. Now another beneficiary of centralized "green" planning is in trouble. Autoweek reports that:

Work on the Fisker Nina family sedan has temporarily halted at the Fisker Automotive plant in Wilmington, Del., while the carmaker and the federal government hash out details of the company's $529 million Department of Energy loan. The interruption has resulted in the layoff of 26 people at its Delaware plant and a number of contract engineers at Fisker's Anaheim, Calif., headquarters.

And the WSJ reports that:

Fisker spokesman Roger Ormisher said ... his company wasn't in peril. "We are still continuing to raise equity. We raised $260 million in the last three or four months," he said. The company said in a statement that it had raised $850 million in equity from private sources. But the future of the Nina and the 2,500 jobs in Delaware will depend on whether Fisker can revive the federal loans, or replace them, Mr. Ormisher said.

"There comes a point where you say, 'We can't keep putting money into that project,' " he said.

At the very least, it's another bump in the road for industrial policy.

Empirical studies of private equity

Steven Davidoff gives a fast review of the key studies.

Firing people

I'm no Mitt Romney fan, but I think he's being unfairly pilloried for seven words taken out of context. Here's ABC news:

Mitt Romney, already under intense scrutiny for his leadership at venture capital group Bain, inadvertently gave his rivals new material today when he said that he likes “being able to fire people.”

The remarks came during a speech to the Nashua Chamber of Commerce this morning in which he was trying to explain that he would like people to have the option to pick and choose their medical insurance and get rid of plans that don’t meet their needs.

“I want individuals to have their own insurance,” he said. “That means the insurance company will have an incentive to keep you healthy. It also means if you don’t like what they do, you can fire them. I like being able to fire people who provide services to me.

“You know, if someone doesn’t give me a good service that I need, I want to say I’m going to go get someone else to provide that service to me.”

...

Romney’s opponents have already pounced on him for today’s “firing comment,” former Utah Gov. Jon Huntsman remarking, “It’s clear is he likes firing people, I like creating jobs.”

President Obama’s campaign press secretary, Ben LaBolt, simply re-tweeted the comments with his own addition, “!!!”

Even a partisan liberal propagandist like Steven Benen admits critics are taking the "I like being able to fire people" line out of context:

In fairness, the context makes an enormous difference. Laura Conaway reports this morning that Romney was talking about health insurance when he said, “I want individuals to have their own insurance. That means the insurance company will have an incentive to keep you healthy. It also means if you don’t like what they do, you can fire them. I like being able to fire people who provide services to me. You know if someone doesn’t give me a good service that I need, I want to say I’m going to go get someone else to provide that service to me.”

But let's take it in the context critics like Huntsman hope the average uninformed voter will take the soundbite: Let's assume that back when Mitt Romney was working at Bain Capital, that he liked firing people. Personally, I wouldn't like being fired any better than the next guy, but as an investor I want the people running the companies in which invest to like firing people.

Why?

There are a number of inherent tendencies within any hierarchical organization, including nominally profit-maximizing corporations, driving them towards unnecessary creation of excessive layers of bureaucracy. Managers have well-known incentives to prefer empire-building to profit-maximization. In part, this phenomenon is driven by the psychological rewards of empire-building, but in many organizations the compensation regime reinforces these tendencies by adding pecuniary rewards for those who build large sub-enterprises around themselves. Because this tendency is only partially constrained by the familiar arsenal of legal and market forces directed at all forms of shirking, firm expansion is difficult to reverse.

Layers of bureaucracy therefore tend to grow over time in a process only weakly constrained by external forces. Peter Drucker offered up the impressive anecdotal example of a self-evaluation by one large defense manufacturer revealing that as many as 6 out of 14 management layers had no useful purpose.

The wide-spread corporate down-sizing and restructuring during the 1980s and 1990s thus is best explained as a reaction to the excess growth of corporate bureaucracies during the preceding decades. Whether down-sizing was undertaken by incumbent managers in order to stave off a hostile tender offer or by a buyer (like Bain) after a successful takeover, eliminating unnecessary bureaucracy was a major corporate goal in the 1980s. In a corporate restructuring, the hierarchy, especially the central office, was typically targeted for major pruning.

You see the same phenomena at work on the shop floor, producing bloated blue collar work forces.

A major reason corporate bloat persisted (and at many firms still does) is that managers find it psychologically easier to hire new employees than to discharge those workers who have become part of the firm’s “family and culture.”

In many cases, restoring a business to efficiency and profitability thus requires the kind of shakeup occasioned by a corporate takeover, such as the sort of LBOs in which Romney specialized, which brings in new managers who are willing to fire people. 

LBO specialists who like to fire people thus played -- and still play -- a critical role in ensuring that US corporations are sufficiently lean to compete effectively in a pitiless global economy.

I just hope that if Romney gets elected he puts his fondness for firing people to work at trimming the federal bureaucracy.

Costs and benefits of family ownership

One area in which I have a growing interest is the law and economics of family-owned firms. As some of you will know, there is an active debate over the relative corporate governance costs and benefits of having a controlling block shareholder in general and a family-controlled block in particular. I just read an interesting new paper, which sheds light on at least one aspect of the debate:

We use the global financial crisis following the failure of Lehman Brothers in September 2008 as a natural experiment to analyze the relation between controlling blockholders and firm value in a sample of more than 8,600 firms from 40 countries. Since the crisis shocks a firm out of its equilibrium, it allows us to explicitly observe adjustments made in the valuation of firms that have different types of controlling blockholders. We find that around the world family control is associated with lower firm valuation following a financial shock. We interpret this finding as evidence that family incentives shift from beneficial investing to diverting resources. Consistent with this hypothesis, we find that the underperformance of family controlled firms obtains only for financially unconstrained firms. We also find that non-family and multiple blockholders are on net beneficial during a shock, particularly in firms that are financially constrained, indicating that a non-family blockholder may help alleviate constraints during a financial shock.

Citation: Lins, Karl V., Volpin, Paolo F. and Wagner, Hannes F., The Value of Controlling Blockholders During the Global Financial Crisis (November 25, 2011). Available at SSRN: http://ssrn.com/abstract=1964764

Risk Management

Carlo V. di Florio, who is the Director of the SEC's Office of Compliance Inspections and Examination, offers up an essay on "two related topics that are growing in importance: the heightened role of ethics in an effective regulatory compliance program, and the role of both ethics and compliance in enterprise risk management," with three major take-home points:

1. Ethics is fundamental to the securities laws, and I believe ethical culture objectives should be central to an effective regulatory compliance program.

2. Leading standards have recognized the centrality of ethics and have explicitly integrated ethics into the elements of effective compliance and enterprise risk management.

3. Organizations are making meaningful changes to embraced this trend and implement leading practices to make their regulatory compliance and risk management programs more effective.

Does Gender Diversity Improve Corporate Performance?

The latest study I've seen in this highly contested field says that diversity doesn't improve corporate performance or profitability:

This article examines the debate within corporate governance about the appointment of female non‐executive directors (NEDs). The first part tracks the diversity story that corporate governance tells about itself from the Cadbury Report (1992) to the Davies Report (2011). The second sets out the evidence used to support the argument that female appointments enhance profits and corporate profile. The third part presents the authors' empirical analysis of FTSE 100 companies and female nonexecutive board membership, and concludes that there is little evidence that companies with female board membership display different characteristics from those without. Industry sector emerges as a significant factor in female appointments. The idea that women should be appointed to boards to increase corporate profitability and profile is not strongly supported by this analysis. A social justice argument based upon the right of woman to equal economic participation opportunities provides a much superior articulation of the need for boardroom diversity.

The trouble with those "social justice" arguments, of course, is that they bump up against the justice-based arguments against preferences and quotas.

Corporate Governance After the Financial Crisis gets a cover

My forthcoming book Corporate Governance after the Financial Crisis is rapidly approaching publication. The final proofs have been approved and the cover has been chosen.

As Oxford University Press' website explains,

The first decade of the new millennium was bookended by two major economic crises. The bursting of the dotcom bubble and the extended bear market of 2000 to 2002 prompted Congress to pass the Sarbanes-Oxley Act, which was directed at core aspects of corporate governance. At the end of the decade came the bursting of the housing bubble, followed by a severe credit crunch, and the worst economic downturn in decades. In response, Congress passed the Dodd-Frank Act, which changed vast swathes of financial regulation. Among these changes were a number of significant corporate governance reforms. 

Corporate Governance after the Financial Crisis asks two questions about these changes. First, are they a good idea that will improve corporate governance? Second, what do they tell us about the relative merits of the federal government and the states as sources of corporate governance regulation? Traditionally, corporate law was the province of the states. Today, however, the federal government is increasingly engaged in corporate governance regulation. The changes examined in this work provide a series of case studies in which to explore the question of whether federalization will lead to better outcomes. The author analyzes these changes in the context of corporate governance, executive compensation, corporate fraud and disclosure, shareholder activism, corporate democracy, and declining US capital market competitiveness.

You can order it here

MF Global: It wasn't Greece's fault

Kevin Lacroix has a typically thoughtful and interesting post on the collapse of MF Global. One point that particularly caught my eye dealt with the issuers of the debt that got MF Global into trouble:

... MF Global was not exposed to Greek debt. MF Global held the debt of other European countries. Its assets include $6.3 billion of Italian, Spanish, Belgian Portuguese and Irish debt. More than half of the total was Italian. It was the company’s exposure to these debts that led to regulatory scrutiny, downgrades, and margin calls that threatened the company’s liquidity.

It's hard not to to draw adverse conclusions about the prospects for resolving the debt crisis if the eighth largest bankruptcy in US history can be occasioned despite the absence of Greek debt from MF Global's portfolio. It certainly suggests a lack of market confidence in the prospects for countries like Italy.

Mob Governance

Alex Tabarrok:

The Mexican Mafia is a fairly small prison gang (perhaps 150-300 made members) and it has significant operational control only within prisons in Southern California yet the Mexican Mafia is extremely powerful. In fact, the MM taxes hundreds of often larger Southern California street gangs at rates of 10-30% of revenues. How can a prison gang tax street gangs? In Governance and Prison Gangs (also here), a new paper in the APSR, David Skarbek explains the structure, conduct and performance of the Mexican Mafia.

The key to the MM’s power is that most drug dealers will sooner or later, usually sooner, end up in prison. Thus, the MM can credibly threaten drug dealers outside of prison with punishment once they are inside prison. Moreover, prison is the only place where members of many different gangs congregate. Thus, by maintaining control of the prison bottleneck, the MM can tax hundreds of gangs.

One of the most interesting aspects of Skarbek’s analysis is that he shows–consistent with Mancur Olson’s stationary bandit theory–that as the MM grew in power it started to provide public goods, i.e. it became a kind of government. Thus, the MM protects taxpayers both in prison and on the street, it produces property rights by enforcing gang claims to territory and it adjudicates disputes, all to the extent that such actions increase tax revenue of course. The MM is so powerful that it often doesn’t even have to use its own enforcers; instead, the MM can issue what amounts to a letter of marque and reprisal, a signal that a non-taxpaying gang is no longer under its protection, and privateers will do the rest.

The MM even internalizes externalities:

In addition, the Mexican Mafia regulates drive-by shootings…because any particular street gang only suffers a portion of the increased attention of law enforcement from drive-by shootings, each street gang has an incentive to do too-many (Buchanan 1973). In 1992, Mexican Mafia members sent notes throughout the prison system and Sureño neighborhoods that any gang member participating in an unauthorized drive-by shooting would be killed. Shortly after the Mexican Mafia announced this rule, drive by shootings declined.

The Mexican Mafia has much to teach us about crime and governance.

As do pirates.

Apple and Occupy Wall Street

NY Post:

Even as desperate Pander-crats, including the president, continue to baby-talk the Wall Street hooligans, some of whom have violently attacked police, Mayor Bloomberg gets the point and tone just right.

“What they’re trying to do is take the jobs away from people working in this city,” the mayor told radio man John Gambling Friday. “And some of the labor unions, the municipal unions that are participating, their salaries come from the taxes paid by the people they are trying to vilify.” ....

Reader Harold Theurer sees another angle. Noting the passing of Steve Jobs, he wonders how many protesters carrying Apple products understand how those gadgets came to exist.

“What started out as two men in a garage with ideas and passion would have been nothing more than two guys in a garage with ideas and passion had it not been for an IPO on Dec. 12, 1980, when Apple went public at $22 per share,” he writes.

“Big Bad Wall Street raised $101 million for Mr. Jobs to expand his ideas, create jobs and change the landscape of technology. The next time any of the Wall Street occupiers makes an iTune purchase, it can be traced back to some Big Bad Banker’s belief in Mr. Jobs and his company.”

Saint Warren's halo gets a little more tarnish

In between opining on how to fix the US tax system, Warren Buffett still runs Berkshire Hathaway. as James McRitchie points out, however, Saint Warren's corporate governance practices leave something to be desired:

Francine McKenna isn’t afraid to take on the big four auditing firms or the rich and powerful. Look for her column, Accounting Watchdog at Forbes.com. The following is an extended excerpt from a recent post, The Berkshire Hathaway Corporate Governance Performance. “Buffett judges the investments he makes ruthlessly, but allows his operating companies to run on autopilot.” That decentralized structure allows plausible deniability when anything goes wrong.

I encourage reading the entire article and getting familiar with McKenna’s work. It is good to see such an expert willing to speak truth to power. As a Berkshire Hathaway shareowner, her analysis certainly makes me nervous and it is hard to imagine shareowners taking on such an iconic figure through governance initiatives successfully.

In particular, she identifies how Berkshire satisfies the "eight characteristics of decentralized companies that promote lack of accountability and, potentially, the existence of financial fraud." Go read the whole thing.

The declining attractiveness of being public

I'm going to be on a panel on "Rethinking Shareholder Value and the Purpose of the Firm" here at UCLA on Thursday:

​Join UCLA School of Law, The Aspen Institute and top thinkers in business and law to explore what priorities are legally demanded of corporations, rethink what is meant by "creating shareholder value," and ask "What really is the purpose of the firm?"

Panelists include Professor Stephen Bainbridge, UCLA School of Law; Professor Henry Hansmann, Yale Law; and Roger Martin, Dean, Rotman School of Business, University of Toronto. The panel will be moderated by Professor Lynn Stout, UCLA School of Law.

The organizer sent around several questions to stimulate our thinking, including the following:

The number of publicly-listed US firms has declined from nearly 9,000 in 1997 to only about 5,000 today.  What’s more, many of the firms  that do go public (LinkedIn, Google, Zynga) have dual-class shares.  Do these two data points suggest that the public corporation is a less attractive way to do business?  If so, why?

Here's what I came up with in reply:

I addressed the first prong of this question at some length in my paper, Corporate Governance and U.S. Capital Market Competitiveness (October 22, 2010), which is available at SSRN: http://ssrn.com/abstract=1696303.

During the first half of the last decade, evidence accumulated that the U.S. capital markets were becoming less competitive relative to their major competitors. The evidence reviewed herein confirms that it was not corporate governance as such that was the problem, but rather corporate governance regulation. In particular, attention focused on such issues as the massive growth in corporate and securities litigation risk and the increasing complexity and cost of the U.S. regulatory scheme.

Tentative efforts towards deregulation largely fell by the wayside in the wake of the financial crisis of 2007-2008. Instead, massive new regulations came into being, especially in the Dodd Frank Act. The competitive position of U.S. capital markets, however, continues to decline.

My essay argues that litigation and regulatory reform remain essential if U.S. capital markets are to retain their leadership position. Unfortunately, the article concludes that federal corporate governance regulation follows a ratchet effect, in which the regulatory scheme becomes more complex with each financial crisis. If so, significant reform may be difficult to achieve.

There are three major reasons why federal intervention in corporate governance tends to be ill conceived. First, federal bubble laws tend to be enacted in a climate of political pressure that does not facilitate careful analysis of costs and benefits.  Second, federal bubble laws tend to be driven by populist anti-corporate emotions.  Finally, the content of federal bubble laws is often derived from prepackaged proposals advocated by policy entrepreneurs skeptical of corporations and markets.

In her critique of SOX, Roberta Romano proposed that these problems could be addressed in several ways: "The straightforward policy implication of this chasm between Congress’s action and the learning bearing on it is that the mandates should be rescinded. The easiest mechanism for operationalizing such a policy change would be to make the SOX mandates optional, i.e., statutory default rules that firms could choose whether to adopt. An alternative and more far-reaching approach, which has the advantage of a greater likelihood of producing the default rules preferred by a majority of investors and issuers, would be to remove corporate governance provisions completely from federal law and remit those matters to the states. Finally, a more general implication concerns emergency legislation. It would be prudent for Congress, when legislating in crisis situations, to include statutory safeguards that would facilitate the correction of mismatched proposals by requiring, as in a sunset provision, revisiting the issue when more considered deliberation would be possible."

In adopting Dodd-Frank, Congress ignored that advice. As a result, Dodd-Frank suffers from the same three flaws as its predecessors.

The federal role in corporate governance thus appears to be a case of what Robert Higgs identified as the ratchet effect. Higgs demonstrated that wars and other major crises typically trigger a dramatic growth in the size of government, accompanied by higher taxes, greater regulation, and loss of civil liberties. Once the crisis ends, government may shrink somewhat in size and power, but rarely back to pre-crisis levels. Just as a ratchet wrench works only in one direction, the size and scope of government tends to move in only one direction—upwards—because the interest groups that favored the changes now have an incentive to preserve the new status quo, as do the bureaucrats who gained new powers and prestige. Hence, each crisis has the effect of ratcheting up the long-term size and scope of government.

We now observe the same pattern in corporate governance. As we have seen, the federal government rarely intrudes in this sphere except when there is a crisis. At that point, policy entrepreneurs favoring federalization of corporate governance spring into action, hijacking the legislative response to the crisis to advance their agenda. Although there may be some subsequent retreat, such as Dodd-Frank’s § 404 relief for small reporting companies, the overall trend has been for each major financial crisis of the last century to result in an expansion of the federal role. The unfortunate conclusion thus seems to be that there is no cure insight for the corporate governance aspects of the American Illness.

If the trial lawyers hate Rick Perry, maybe I should reconsider him

As a highly disgruntled GOP-aligned voter, I must confess to viewing the current slate of GOP POTUS candidates with emotions running from despair to disdain.

You've got serial flip-flopper and dog abuser Mitt Romney, who with his usual brilliant sense of timing has decided that a period of serious economic concern and persistent financial populism among the public is the right time to quadruple the size of his multimillion dollar home in La Jolla.

You've got people like Michelle Bachmann and Rick Perry who seem more interested in running for President of the Southern Baptist Convention than POTUS.

You've got Sarah Palin lurking in the shadows, a prospect that gives me the willies.

And then you've got seven or so dwarves.

I sort of like Huntsman, but I figure he's got about as much chance as the proverbial snowball in that proverbial Hell that Perry and Bachmann seem to think 90% of us are going to.

Today, however, a news report gave me cause to rethink Rick Perry:

America’s trial lawyers are getting ready to make the case against one of their biggest targets in years: Texas Gov. Rick Perry.

Among litigators, there is no presidential candidate who inspires the same level of hatred — and fear — as Perry, an avowed opponent of the plaintiffs’ bar who has presided over several rounds of tort reform as governor.

And if Perry ends up as the Republican nominee for president, deep-pocketed trial lawyers intend to play a central role in the campaign to defeat him. ... The governor has pushed through a string of tort reform laws, including a 2003 measure putting a monetary cap on non-economic damage awards. He passed another law in the most recent Texas legislative session, making it easier to dismiss some lawsuits and putting plaintiffs on the hook for legal costs in certain cases that are defeated or dismissed.

The campaign for tort reform in Texas began in the 1990s, well before Perry was governor, but the Republican can legitimately claim some credit for the results. It’s a story Perry proudly tells on the stump, casting himself as the man who mastered a legal system run amok and made Texas friendlier for business.

I realize that I'm flirting with a false dichotomy--i.e., the enemy of my enemy is my friend--but anybody who's been a successful tort reformer deserves a close look in my book.

I refer the interested reader to Trial Lawyers Inc., perhaps the best web site in the world on tort reform.

As Jim Copland explained in their first report, tort litigation is a huge drag on our economy:

Total tort costs today exceed $200 billion annually, or more than 2% of America’s gross domestic product—a significantly higher percentage than in any other developed nation.[1] Moreover, even as the economy has stagnated and the stock market has plunged, the lawsuit industry’s revenues have continued to skyrocket: in 2001, the last year for which data are available, U.S. tort costs grew by 14.3%.[2] Over the last 30 years, tort costs grew at a compound annual rate of 9.1%; by comparison, the U.S. population grew 1.1% annually, the consumer price index grew 5.0% annually, and the gross domestic product grew 7.6% annually during the same period.[3]

If Rick Perry runs on a platform of doing something about that problem, I may have to hold my nose and vote for him.

Saint Warren's halo tarnished when it comes to taxes

Ted Frank explains:

Warren Buffett's New York Times op-ed is getting some attention, with praise for his selflessness in calling for higher taxes on himself. It should be noted that Buffett's motivations can't be called entirely selfless: Berkshire Hathaway's business model often involves purchasing private family-owned companies that are hit hardest by the estate tax. The absence of the estate tax takes away this source of profit.

How many boards is too many?

One hears complaints quite regularly about directors who allegedly are spread too thin because they serve on numerous corporate boards. Supposedly, busy directors are bad directors. An interesting recent paper challenges the conventional wisdom, arguing that busy directors can be beneficial:

Overboarded directors have been widely criticized as being ineffective. Yet, we argue that such directors offer unique advantages for younger firms, who place different demands on their boards than seasoned firms. Because management of newly public firms has little experience navigating public markets, they are likely to rely more heavily on directors for their experience and network of contacts. We posit that busy directors rank highly on both of these dimensions. Empirical results support this prediction, and contrary to prior research, we find no evidence that busy boards destroy firm value. Moreover, among firms where the hypothesized advantages of busyness are greatest, we document a positive relation between busy boards and firm value. Our findings challenge the conventional wisdom that multiple directorships are detrimental to all firms.

Lowry, Michelle B., Field, Laura Casares and Mkrtchyan, Anahit, Are Busy Boards Detrimental? (July 25, 2011). Available at SSRN: http://ssrn.com/abstract=1894776