ProfessorBainbridge.com

The Grapes of Protectionist Wrath

My latest TCS column

U.S. oenophiles held their breath this week as the Supreme Court heard argument in cases challenging the constitutionality of New York and Michigan laws prohibiting their residents from importing wine from other states. According to Free The Grapes.org, New York, Michigan, and 22 other states prohibit consumers from purchasing wines directly from out-of-state wineries and having the wine shipped to their home or office.

The justifications advanced in defense of these laws are, put bluntly, ludicrous. The State of Michigan's brief to the Supreme Court argued that its law is necessary to prevent minors from getting access to alcohol and to ensure that Michigan collects alcohol taxes.

To be sure, when a Michigan consumer goes on line to order wine from a winery in California, which is then shipped directly to the consumer's home, it may be difficult for Michigan to collect taxes on that sale. Yet, it is no more difficult for Michigan to collect taxes on that transaction than it would be for Michigan to collect sales taxes on books one of its resident orders from Amazon. In other words, taxation of wine is not a unique problem; it is part of the broader question of taxing the on line economy.

As for protecting minors, does Michigan really believe that a 16 year-old is going to swipe his Dad's credit card and order a case of Opus One on line? In any event, it's critical to note that Michigan and New York both permit in-state wineries to ship directly to consumers. So their laws do nothing to prevent a minor from ordering wine from in-state producers. This distinction reveals the utter disingenuousness of Michigan's purported justification for its laws.

So what is going on here? New York and Michigan are happy to permit in-state wineries to sell wine on-line and ship it directly to their residents; they just don't want their residents to be able to buy from out-of-state wineries. This discrimination not only protects in-state wineries, it also protects the interests of alcohol wholesalers and distributors, who are insulated from competition from on-line merchants.

It's plain and simple protectionism. Michigan, New York, and 22 other states are discriminating against their own consumers so as to protect entrenched local interests. This discrimination has a definite impact on oenophiles: A study of Virginia's direct-to-consumer sales ban by Alan Wiseman and Jerry Ellig found that "Virginia's direct shipment ban reduces the varieties of wine available to consumers and prevents consumers from purchasing some premium wines at lower prices online."

Of course, the mere fact that these state laws are bad public policy doesn't mean that they're unconstitutional (or some one hopes). The legal issue here is the conflict between the 21st Amendment to the US Constitution, which repealed Prohibition and broadly authorized liquor regulation by states, and the dormant Commerce Clause, which forbids states from doing precisely what New York and Michigan are trying to do -- i.e., discriminate against out-of-state producers.

In a 1984 case, Bacchus Imports, Ltd., v. Dias, 468 U.S. 263 (1984), the Supreme Court made clear that the 21st does not "remove state regulation of alcoholic beverages from the ambit of the Commerce Clause." Discriminatory state laws thus can and should fall, despite the 21st Amendment.

Press reports on the oral argument suggest that at least a plurality of the Supreme Court "gets it." Justice Ginsburg, for example, reportedly quoted a passage from the Bacchus Imports case in which the Court held that "one thing is certain: the central purpose of the 21st Amendment was not to empower states to favor local liquor industries by erecting barriers to competition." Justice Kennedy, likewise, is reported to have said that the New York and Michigan laws go "to the core of the Commerce Clause." Justice Scalia reportedly opined that New York needs a "good reason" to justify these laws and apparently indicated that he didn't see one.

Oenophiles should not get too excited, however. Although it now appears likely that the Supreme Court will strike down the New York and Michigan laws, the Court likely will do so solely on the narrow grounds that their discriminatory effect violates the dormant Commerce Clause. If the states chose to change their laws so as to ban direct-to-consumer sales by both out-of-state and in-state wineries, those laws almost certainly would be upheld as within the states' powers under the 21st Amendment.

What should a thirsty New York or Michigan oenophile do? It might not hurt to invite your state legislator over for a nice glass of California wine.

More on the Wine Case

We are quoted in a MSNBC story on the Supreme Court case on the legality of state bans on interstate shipment of wine:

"It's the discrimination that's the critical problem with these statutes," said UCLA law professor Stephen Bainbridge.

Kevin Phillips on Joe Kennedy

Former conservative (and current populist crank) Kevin Phillips tells the Washington Post why he likes Joe Kennedy:

"An old buccaneer and bootlegger like Joe Kennedy became an SEC head for Roosevelt and cracked down on his own class."

Wrong. Kennedy never had an epiphany after which he became a class traitor (for one thing, the Kennedys hadn't yet become respectable, let alone royalty). Kennedy used his position at the SEC to settle old scores from his days on Wall Street, put potential future competitors out of business, and advance the political prospects of friends and family. But, heck, isn't that what the revolving door is for?

In any event, it ill-becomes even an odd duck like Phillips to say anything nice about Joe Kennedy, who was a perfectly awful man:

He was a notorious adulterer who carried on with a long list of women, including actress Gloria Swanson and even his own Hyannis Port secretary, and cruelly flaunted his infidelity in front of his wife and children. (Swanson and Joe's wife and children would dine together.) Joe arranged for his daughter, Rosemary Kennedy, to be given a lobotomy in the fall of 1941 without even consulting his wife, the child's mother, Rose Kennedy. The then highly controversial and experimental treatment left Rosemary, who had been suffering from what is now regarded as a case of clinical depression, a woman with the emotional development of a two-year-old child, one who could not wash or dress herself, not even put on her own pair of shoes. Joe paid off politicians and newspapermen, especially to endorse his son Jack for president and also cover up family dirt, like Jack's notorious infidelity and Teddy's expulsion from Harvard College for cheating. Joe openly did business with gangsters and bootleggers during Prohibition, whether his ventures were legal or not isn't really the issue. Notorious gang boss and murderer Frank Costello considered Joe his friend and business partner. ...

Much of Joe's reputation today as an investor is sullied by the company he kept as a business leader and a politician. He did business with gangsters in the liquor business during Prohibition, sleazy stock market operators during the 1920s, and slimy yes-men in Hollywood. But probably what left most of his reputation in tatters was his endorsement of anti-Semitic and pro-Nazi views during the 1930s, especially after his appointment by President Franklin D. Roosevelt in 1938 as Ambassador to Great Britain. ...

Harry Hopkins, Roosevelt's most trusted aide, [learned] that Joe had sold Czech securities and made $500,000 in profits while U.S. Ambassador. He apparently traded on top secret intelligence information that the Germans were going to invade Czechoslovakia and when they did the Czech stock market collapsed and Joe covered his shorts.

Curiously, however, it is the Bush family rather than the Kennedys that draws Phillips ire.

Wine in the Supreme Court

The Supreme Court heard argument today in the cases raising the constituionality of state restrictions on the interstate shipment of wine. According to CNN:

Several justices appeared troubled by the notion of unequal treatment, although they also seemed uncertain about whether overturning state laws that have been in place since Prohibition was the solution.

Actually, that is precisely the correct solution. As I argued in my TCS column Bacchus Bytes Back:

The Supreme Court should strike down these antiquated special interest laws. As I recall my civics lessons, preventing economic Balkanization was one of the principal reasons the Founders replaced the Articles of Confederation with our present Constitution. Discriminatory state bans on direct-to-consumer sales represent precisely the sort of economic Balkanization that would have offended the Founders. These laws advance no legitimate state interests, but rather are designed solely to protect entrenched special interests. It is time for them to go.

Update: We are quoted in a MSNBC story on the Supreme Court case on the legality of state bans on interstate shipment of wine:

"It's the discrimination that's the critical problem with these statutes," said UCLA law professor Stephen Bainbridge.

Justice Thomas

On Sunday's Meet the Press, Democrat Senate Minority Leader Harry Reid opined that Supreme Court Justice Clarence Thomas is  "an embarrassment":

Reid reserved his strongest remarks for the issue of the Supreme Court, which is expected to experience significant turnover during the coming term. He said he disagrees with many of the decisions made by Justice Antonin Scalia and remains troubled by recent "ethics problems" relating to Scalia's refusal to recuse himself from a case in which he appeared to have a conflict of interest. But Reid said he probably could support Scalia to be the next chief justice because, he said, "this is one smart guy."

But he offered no hope of support for a Thomas appointment. "I think that he has been an embarrassment to the Supreme Court," Reid said. "I think that his opinions are poorly written. I just don't think he's done a good job."

Today, the WSJ editorial page appropriately blasts Reid:

As it happens, this insult comes just when Justice Thomas has been enjoying better publicity for his work both on and off the High Court. The Washington Post published a series earlier this year that was remarkably flattering toward his contribution, and noting that he is very much his own man on the bench. A new book by Atlanta reporter Ken Foskett, "Judging Thomas," also attempts an objective appraisal and concludes he is making a mark on the Court. As a final point, imagine the reaction if, say, Trent Lott had ever dared to suggest that the late African-American Justice Thurgood Marshall wasn't really up to the work?

Speaking of Trent Lott, where are all the bloggers who led the charge against Trent Lott for his comments about Strom Thurmond on this one? Why aren't they blasting Reid for his comments about Thomas?

Update: Tigerhawk and Mike Collins both blogged it.

Spitzer. Sigh.

Well, we knew this was coming:

New York Attorney General Eliot Spitzer will announce Tuesday he will run for governor of the state in 2006, a spokeswoman said.

"He's announcing that he has decided to run for governor," Cindy Darrison said of the state's top prosecutor who has taken on Wall Street for fraudulent stock research, and mutual funds for overcharging customers.

Darrison said Spitzer, a Democrat long expected to enter the governor's race, would issue a statement on his Web site, www.spitzer2006.com, sometime after 11 a.m. ET but would not hold a news conference. (Source: CNN Money)

Longtime readers know I'm no fan of Eliot Spitzer. I shan't rehash the arguments here, but if you want more check out my TCS columns Spitzer v. Grasso and Spitzer Goes over the Line. If you really want to be inundated with anti-Spitzer editorializing, check out my archive of blog posts on NY's crusading AG.

Bebchuk and Fried on Executive Compensation

As previously reported, I am reading with great interest Lucian Bebchuk's and Jesse Fried's book Pay Without Performance, which is a damning critique of executive compensation. I find much of their argument plausible and even persuasive, but I also think they overstate the case a bit.

Their analysis is premised on what they call "managerial power," which claims that management controls the mechanism by which its own pay is set. Hence, they argue, executive compensation fails to align managerial interests with those of shareholders. Although this claim seems true with respect to some types of compensation at some companies some of the time, there is evidence to the contrary. For example, the latest issue of the Economist reports on an interesting study of executive perks:

Raghuram Rajan, the IMF's chief economist, and Julie Wulf, of the Wharton School, looked at how more than 300 big companies dished out perks to their executives in 1986-99. It turns out that neither cash-rich, low-growth firms nor firms with weak governance shower their executives with unusually generous perks. The authors did, however, find evidence to support two competing explanations.

First, firms in the sample with more hierarchical organisations lavished more perks on their executives than firms with flatter structures. Why? Perks are a cheap way to demonstrate status. Just as the armed forces ration medals, firms ration the distribution of conspicuous symbols of corporate status.

Second, perks are a cheap way to boost executive productivity. Firms based in places where it takes a long time to commute are more likely to give the boss a chauffeured limousine. Firms located far from large airports are likelier to lay on a corporate jet.

In other words, executive perks seem to be set with shareholder interests in mind, which tends to undercut the likelihood that managerial power is a unified field theory of executive compensation.

Ouch

J uan Non-Volokh catches left-liberal law professor Erwin Chemerinsky in an apparent reversal of position:

In yesterday's L.A. Times, law professors Erwin Chemerinsky (Duke) and Michael Gerhardt (William & Mary) argue against Republican proposals to eliminate the availability of filibusters for judicial nominations. This so-called "nuclear option," Chemerinsky and Gerhardt write, would be "a cynical exercise of raw power and not based on constitutional principle or precedent." Elimination of the filibuster "would transform the Senate into a rubber stamp."

That's what Chemerinsky says now. But in 1997 -- when there was a Democratic President who found some of his nominees slowed by a Republican Senate -- Chemerinsky sang a different tune. As Patrick Frey documents here, Chemerinsky co-authored a 1997 law review article taking a quite different stance.

The modern filibuster . . . has little to do with deliberation and even less to do with debate. The modern filibuster is simply a minority veto, and a powerful one at that. It is not part of a long Senate tradition and history alone cannot justify it.

Indeed, in 1997 Chemerinsky appeared to endorse the view that Senate Rule XXII, which purports to require a two-thirds vote to change the filibuster requirement, is unconstitutional.

Op-eds aren't subject to the same standards as academic work, but the onus now clearly is on Chemerinsky to explain why he's changed his position.

Tigerhawk Blasts Spitzer

Tigerhawk dug up a letter to the editor that raises some pretty troubling questions about NY AG Eliot Spitzer:

Mr. Spitzer has turned this industry on its head. There have been no court hearings, no testimony in front of appropriate agencies, yet market values of public brokers have plummeted, and thousands will likely lose their jobs. All due to the "appearance of impropriety."

Speaking of "appearances," how about Mr. Spitzer's tennis pal, campaign contributor and former boss securing a 19% sweeter, all-cash deal for his company from Marsh & McLennan Cos. Inc., after Mr. Spitzer hit Marsh with a tsunami of subpoenas. Then, Mr. Spitzer's tennis buddy ends up as CEO after Mr. Spitzer says he "can't deal" with the current Marsh CEO. Later, Mr. Spitzer says it's OK for his tennis pal, now Marsh's CEO, to pay any potential fines from their contingent commissions, which Mr. Spitzer earlier alleged were ill gotten. Isn't this like the DA indicting someone for burglary and saying they can use the proceeds to cover any fines? Yeah, "appearances" do matter, Eliot, and this does not look good. (Link)

Kudos to my tax law colleagues

Tax law prof blog writes:

The UCLA School of Law made one of the largest leaps in the latest US News survey of tax programs, moving from #25 in 2002 to #6 in 2004. In large part, this move was fueled by the unprecedented hiring of three tax professors in 2003, joining the four tax professors already on the faculty to form one of the strongest tax faculties in the country.

The resurgence of UCLA?s tax program is evident in its many activities planned for this year, including its Tax Policy and Public Finance Colloquium this Spring, the UCLA Law Review's Symposium on Rethinking Redistribution: Tax Policy in an Era of Rising Inequality in January, UCLA?s Institute on Tax Aspects of Mergers and Acquisitions in May, and the hosting of a Conference on Historical Perspectives on Tax Law & Policy in July. Moreover, because of the combination of an expanded tax faculty and substantial student interest, the UCLA Program in Business Law and Policy will offer a separate tax track in its business law concentration starting next year.

In a seven-part series, TaxProf Blog will spotlight the tax professors who make up the heart of UCLA?s tax program.

Calpers President Fired

Sean Harrigan was ousted from the board of the No. 1 U.S. pension fund on Wednesday after spearheading a controversial corporate reform drive that drew the fund into pitched political and boardroom battles. (Link)

About time. Calpers has always been something of a gadfly in corporate governance, but for a long time the big pension fund actually did some good. Under Harrigan's watch, however, Calpers' missteps have escalated, ranging from mere stupidity to outright abuses of the powers Calpers' vast portfolio conveys upon it. E.g.?'

1. In order to advance the political ambitions of Phil Angelides, California's state treasurer and a Calpers board member, Calpers last spring targeted directors for removal at 2700 corporations. As I pointed out at the time: "A campaign directed at 2700 companies cannot succeed."
2. Also last spring, Calpers announced that it would note vote to re-elect investor Warren Buffet to Coke's board. I said the decision was based on "a bad policy that will not serve investor interests in the long run."
3. Calpers intervened in the Southern California grocery store strike on the side of the unions. At that time, 11 of the 13 Calpers board members were either union members, union officials, or politicians who take union campaign contributions. In particular, Harrigan is also the executive director of the very union (the UFCW) that was on strike! I said: "Those who like classical references will want to ask "Quis cusotdiet ipsos custodes?" Those who lean towards Biblical references will invoke Matthew 7:3-5."

Harrigan took much of the blame for these and other missteps; and appropriately so:

[A] UK governance activist said on Wednesday: “Sean's heart is in the right place but he never understood that thumping the table is not the best way to get companies to change. He comes from a union background, where it's all about confrontation. His approach alienated many of us who previously followed Calpers' lead.”

That same theme was aired at a Calpers board meeting weeks later. The gathering heard from luminaries such as Arthur Levitt, former Securities and Exchange Commission chairman, who warned that the fund must avoid “going off on political tangents which do not directly impact investment performance”.

Richard Koppes, a former Calpers general counsel, said the fund had become “too political”. He added: “There is serious concern that you are causing damage to the corporate governance movement.” (Link)

The problem is bigger than just Harrigan, however. It has been apparent for quite a while that the members of Calpers board are making policy on the basis of their own personal and political preferences, not the good of their beneficiaries. Firing Harrigan must be just the first step. It is time for a thorough going reworking of Calpers governance system, which at present is dominated by political appointees rather than representatives of the beneficiaries. It is time to stop the board from using the retirement savings of countless California public servants as a soap box for ends unrelated to maximization of the return earned by the fund.

Executive Compensation

I have been reading Pay Without Performance: The Unfulfilled Promise of Executive Compensation by (Harvard law professor) Lucian Bebchuk and (Boalt law prof) Jesse Fried. Bebchuk and Fried take issue with the standard academic account of executive compensation, which goes something like this: Executive compensation is a classic agency cost problem.  Although CEOs and other executives are agents of the corporation and its shareholders, they have incentives to shirk. Indeed, they have incentives to behave opportunistically - i.e., to maximize their own wealth and perks at the expense of their shareholder principals.  Accordingly, executive compensation schemes must be designed in ways that constrain shirking and opportunism; in other words, executive compensation schemes should strive to align executives' interests with those of the shareholders.  In the literature, this usually leads to a recommendation of some sort of performance-based pay scheme, typically entailing the use of stock options.

Bebchuk and Fried do a good job of explaining why executive compensation schemes fail adequately to align managerial and shareholder interests. In brief, they make the very sensible point that managerial influence over the board of directors taints the process by which executive compensation is set. In other words, the system by which agency costs are to be checked is itself tainted by an agency cost problem.

I get off the boat, however, when it comes to the solution. Bebchuk and Fried want to displace the time-tested corporate governance system of director primacy with an untested new system based on shareholder primacy. As regular readers of my academic work know, this is anathema in my book. (See, e.g., Director v. Shareholder Primacy in the Convergence Debate. I'm writing a review of their book for the Texas Law Review, which will focus on this point, and which should be available on my scholarship web site in a month or two.)

Having said that, however, Bebchuk and Fried are to be praised for having written a book that makes highly technical doctrinal and economic analysis accessible to the educated lay reader, while not dumbing down some very sophisticated analysis. As a result, the book remains useful to the specialist as well. It is definitely a book that anyone interested in corporate governance and executive compensation ought to own.