ProfessorBainbridge.com

Strine Bashes SOX

Brilliant and influential Delaware Vice Chancellor Leo Strine bashed Sarbanes-Oxley in a London speech. Specifically, he reportedly:

... warned federal legislators to "stay in [their] lane" and leave corporation law to individual states. ...

Judge Strine said in a speech to the European Policy Forum, a think- tank, that following the Enron and WorldCom scandals "the sour scent of hypocrisy wafted from some important congressional chambers" as federal legislators who had previously helped to block efforts began to support rapid action. He described the Sarbanes- Oxley legislation as a "strange stew" that coupled sensible ideas with "narrow provisions of dubious value".

Well put. In my article, The Creeping Federalization of Corporate Governance, I likewise warned that the federal regulators were going too far in intruding into an area traditionally - and properly - left to state regulation:

Taken individually, each of Sarbanes-Oxley's provisions constitutes a significant preemption of state corporate law. Taken together, they constitute the most dramatic expansion of federal regulatory power over corporate governance since the New Deal.

... I advance both economic and non-economic arguments against federal preemption of state corporation law. Competitive federalism promotes liberty as well as shareholder wealth. When firms may freely select among multiple competing regulators, oppressive regulation becomes impractical. If one regulator overreaches, firms will exit its jurisdiction and move to one that is more laissez-faire. In contrast, when there is but a single regulator, exit is no longer an option and an essential check on excessive regulation is lost.

Strine also reportedly warned:

"The emerging model is a board comprised of one insider - the CEO - who knows everything about the corporation and who has a keen interest in its future, and 10 independent directors selected precisely because they have no affiliation with or, interest in, the business or its fate," he said.

"That is an odd group to help develop a business strategy and seems likely to function largely as a monitor, with strategy being left to the CEO and subordinates outside the board's presence."

I agree with Strine that SOX and concommitant stock exchange listing standards have gone overboard with mandating independence for boards of directors. As I explained in my article, A Critique of the NYSE's Director Independence Listing Standards:

... are not supported by the evidence on director performance and, moreover, adopt an undesirable one size fits all approach. Firms have unique needs and should be free -- as state law now allows -- to develop unique accountability mechanisms carefully tailored for the firm's special needs.

I also agree with Strine that the so-called "monitoring model" of the board of directors, a concept popularized by Boalt Hall law professor Melvin Eisenberg, among others, which has been effectively incorporated into SOX and the stock exchange listing standards, is too narrow an understanding of the role of the board. As I explain in my article, boards actually serve a number of functions:

First, while boards rarely are involved in day-to-day operational decisionmaking, most boards have at least some managerial functions. Broad policymaking is commonly a board prerogative, for example. Even more commonly, however, individual board members provide advice and guidance to top managers with respect to operational and/or policy decisions. In addition, the board provides access to a network of contacts that may be useful in gathering resources and/or obtaining business. Secondly, the board monitors and disciplines top management.

The analysis set out in my article strongly suggests that boards comprised almost entirely of independent directors often struggle to fulfill the first set of tasks and, perhaps somewhat surprisingly, even have problems with the monitoring function.

At least he hasn't prejudged the issue

Or maybe he has. Drudge reports:

Senate Judiciary Committee member Chuck Schumer got busy plotting away on the cellphone aboard a Washington, DC-New York Amtrak -- plotting Democrat strategy for the upcoming Supreme Court battle.

Schumer promised a fight over whoever the President?s nominee was: ?It's not about an individual judge? It's about how it affects the overall makeup of the court.? ... Schumer proudly declared: ?We are contemplating how we are going to go to war over this.?

It seems increasingly unlikely that the majority of Senate Democrats will give any SCOTUS nominee a fair hearing.

Brilliant and influential Delaware Vice Chancellor Leo Strine bashed Sarbanes-Oxley in a London speech. Specifically, he reportedly:

... warned federal legislators to "stay in [their] lane" and leave corporation law to individual states. ...

Judge Strine said in a speech to the European Policy Forum, a think-tank, that following the Enron and WorldCom scandals "the sour scent of hypocrisy wafted from some important congressional chambers" as federal legislators who had previously helped to block efforts began to support rapid action. He described the Sarbanes-Oxley legislation as a "strange stew" that coupled sensible ideas with "narrow provisions of dubious value".

Well put. In my article, The Creeping Federalization of Corporate Governance, I likewise warned that the federal regulators were going too far in intruding into an area traditionally - and properly - left to state regulation:

Taken individually, each of Sarbanes-Oxley's provisions constitutes a significant preemption of state corporate law. Taken together, they constitute the most dramatic expansion of federal regulatory power over corporate governance since the New Deal.

... I advance both economic and non-economic arguments against federal preemption of state corporation law. Competitive federalism promotes liberty as well as shareholder wealth. When firms may freely select among multiple competing regulators, oppressive regulation becomes impractical. If one regulator overreaches, firms will exit its jurisdiction and move to one that is more laissez-faire. In contrast, when there is but a single regulator, exit is no longer an option and an essential check on excessive regulation is lost.

Strine also reportedly warned:

"The emerging model is a board comprised of one insider - the CEO - who knows everything about the corporation and who has a keen interest in its future, and 10 independent directors selected precisely because they have no affiliation with or, interest in, the business or its fate," he said.

"That is an odd group to help develop a business strategy and seems likely to function largely as a monitor, with strategy being left to the CEO and subordinates outside the board's presence."

I agree with Strine that SOX and concommitant stock exchange listing standards have gone overboard with mandating independence for boards of directors. As I explained in my article, A Critique of the NYSE's Director Independence Listing Standards:

... are not supported by the evidence on director performance and, moreover, adopt an undesirable one size fits all approach. Firms have unique needs and should be free -- as state law now allows -- to develop unique accountability mechanisms carefully tailored for the firm's special needs.

I also agree with Strine that the so-called "monitoring model" of the board of directors, a concept popularized by Boalt Hall law professor Melvin Eisenberg, among others, which has been effectively incorporated into SOX and the stock exchange listing standards, is too narrow an understanding of the role of the board. As I explain in my article, boards actually serve a number of functions:

First, while boards rarely are involved in day-to-day operational decisionmaking, most boards have at least some managerial functions. Broad policymaking is commonly a board prerogative, for example. Even more commonly, however, individual board members provide advice and guidance to top managers with respect to operational and/or policy decisions. In addition, the board provides access to a network of contacts that may be useful in gathering resources and/or obtaining business. Secondly, the board monitors and disciplines top management.

The analysis set out in my article strongly suggests that boards comprised almost entirely of independent directors often struggle to fulfill the first set of tasks and, perhaps somewhat surprisingly, even have problems with the monitoring function.

Customer Service

As I struggle along trying to deal with Dell's lousy customer service - long call wait times, sending out the wrong part, automated customer service phone menus from hell, phone menus that just loop back on themselves, run arounds galore, and so on - I can't help but wonder what long-term costs a company like Dell incurs when it cuts corners on customer service. Here's an interesting take on the problem:

In the good old days, the customer service people were the company?s front lines. They not only were there to help a customer fix a problem, but to learn from customers? experiences and to bring that learning back into the company to develop new or better products. We are amazed, over and over, as we have navigated the print marketplace for many years, as to the versatility of customers in both their ingenuity and in their use of our products in ways that we never dreamed they could/would be used. While customers may have a hard time defining next generations of equipment, what they are able to accomplish without our help, and what they wish to accomplish with our help, typically drives the next generations of company products.

We are concerned that with the reduce-costs-any- way-you-can barrier between customers/users and their customer service helpers, that this age old learning opportunity will no longer be available to the designers of a company?s products. If this is the case, then we will have lost a vital connection to our customer bases in the name of reduced cost.

The article's also got some good points about the long- term costs associated with outsourcing and off-shoring customer service.

Customer Service

As I struggle along trying to deal with Dell's lousy customer service - long call wait times, sending out the wrong part, automated customer service phone menus from hell, phone menus that just loop back on themselves, run arounds galore, and so on - I can't help but wonder what long-term costs a company like Dell incurs when it cuts corners on customer service. Here's an interesting take on the problem:

In the good old days, the customer service people were the company’s front lines. They not only were there to help a customer fix a problem, but to learn from customers’ experiences and to bring that learning back into the company to develop new or better products. We are amazed, over and over, as we have navigated the print marketplace for many years, as to the versatility of customers in both their ingenuity and in their use of our products in ways that we never dreamed they could/would be used. While customers may have a hard time defining next generations of equipment, what they are able to accomplish without our help, and what they wish to accomplish with our help, typically drives the next generations of company products.

We are concerned that with the reduce-costs-any-way-you-can barrier between customers/users and their customer service helpers, that this age old learning opportunity will no longer be available to the designers of a company’s products. If this is the case, then we will have lost a vital connection to our customer bases in the name of reduced cost.

The article's also got some good points about the long-term costs associated with outsourcing and off-shoring customer service.

A Very Good Book

I have been reading with great pleasure Mike Weiss' book A Very Good Year. As the subtitle explains, it traces "The Journey of a California Wine from Vine to Table."

The well-regarded Ferrari-Carano winery allowed Weiss to track the making of its 2002 Fume Blanc from the vineyard to its unveiling at the Four Seasons in New York. (I reviewed Ferrari-Carano's 2003 Fume Blanc here.) Weiss' book skillfully blends a number of different styles and approaches. On the one hand, it's a people story, with lots of insights about the people who make the wine. On the other hand, it's also a business case study, with lots of detail on how Ferrari-Carano markets its wines and maintains its brand.

The access Weiss received from the team at Ferrari-Carano is remarkable. He describes (at 96), for example, visiting one of the migrant Mexican vineyard workers at the latter's home in Mexico. Twenty odd pages later he describes touring Don Carano's palatial mansion. So he clearly got the full spectrum.

As an amateur wine reviewer, I was particularly interested in the discussion at the end of the book, which relates the mixed emotions with which the Ferrari-Carano team awaited the Wine Spectator's rating of the wine and their disappointment when it came out with a grade of 85. Weiss' critique of the Spectator's grading system struck me as basically sound. The gist of it is that the Spectator's purported 100 point scale is effectively a 20 point scale, since there few wines are given a score below 80, and only certain wine varieties have a shot at scores in the high 90s. In my own grading system, I have tried to avoid grade inflation, giving Cs and even Ds when appropriate. I've also tried to be impartial as between wines I bought and those given me for review (indeed, a low score of one media sample elicited a very angry email from the winemaker). But, like the Spectator, I also tend to reserve the top scores for certain wine varieties. In my book, to get an A rating, the wine has to have a lot of aging potential. Because few California Sauvignon Blancs meet that criteria, they tend not to break into the A grade range very often. In any event, for whatever it's worth, my experience with Ferrari-Carano is that their wines generally merit grades in the range from B to A--.

Weiss writes well, with both panache and insight. If you wanted to get a closer look at how one California winery made one wine than offered by Weiss, you'd have to work for a winery. Hence, I highly recommend it both to oenophiles and general business readers.

A Very Good Year

I have been reading with great pleasure Mike Weiss' book A Very Good Year. As the subtitle explains, it traces "The Journey of a California Wine from Vine to Table."

The well-regarded Ferrari-Carano winery allowed Weiss to track the making of its 2002 Fume Blanc from the vineyard to its unveiling at the Four Seasons in New York. (I reviewed Ferrari-Carano's 2003 Fume Blanc here.) Weiss' book skillfully blends a number of different styles and approaches. On the one hand, it's a people story, with lots of insights about the people who make the wine. On the other hand, it's also a business case study, with lots of detail on how Ferrari-Carano markets its wines and maintains its brand.

The access Weiss received from the team at Ferrari-Carano is remarkable. He describes (at 96), for example, visiting one of the migrant Mexican vineyard workers at the latter's home in Mexico. Twenty odd pages later he describes touring Don Carano's palatial mansion. So he clearly got the full spectrum.

As an amateur wine reviewer, I was particularly interested in the discussion at the end of the book, which relates the mixed emotions with which the Ferrari-Carano team awaited the Wine Spectator's rating of the wine and their disappointment when it came out with a grade of 85. Weiss' critique of the Spectator's grading system struck me as basically sound. The gist of it is that the Spectator's purported 100 point scale is effectively a 20 point scale, since there few wines are given a score below 80, and only certain wine varieties have a shot at scores in the high 90s. In my own grading system, I have tried to avoid grade inflation, giving Cs and even Ds when appropriate. I've also tried to be impartial as between wines I bought and those given me for review (indeed, a low score of one media sample elicited a very angry email from the winemaker). But, like the Spectator, I also tend to reserve the top scores for certain wine varieties. In my book, to get an A rating, the wine has to have a lot of aging potential. Because few California Sauvignon Blancs meet that criteria, they tend not to break into the A grade range very often. In any event, for whatever it's worth, my experience with Ferrari-Carano is that their wines generally merit grades in the range from B to A--.

Weiss writes well, with both panache and insight. If you wanted to get a closer look at how one California winery made one wine than offered by Weiss, you'd have to work for a winery. Hence, I highly recommend it both to oenophiles and general business readers.

Inside Information and Prediction Markets

The idle speculation that TradeSports' betting contracts on the SCOTUS vacancy might have been affected by insider information got me to thinking about the role of insider information in prediction markets generally.

On the one hand, just as Henry Manne justified insider trading in stock markets by arguing that it improved the accuracy of stock market prices, bets by knowledgeable insiders will significantly enhance the predictive power of markets like the TradeSports contracts. Indeed, given the limits on the power of insiders to affect prices in the stock market, the effect is likely to be much stronger in prediction markets, where the ratio of activity by informed traders to that of uninformed ones is likely to be much higher than in stock markets. (See my review of the policy issues associated with insider trading in stocks.) In noncommercial prediction markets, you therefore presumably want to encourage trading by informed insiders. (See, e..g., this analysis of Policy Analysis Markets.)

On the other hand, in commercial prediction markets like TradeSports contracts, the proprietor of the market presumably has an incentive to eliminate informed insider trading. If there's a fairly high probability that you'd be betting against somebody with inside information, who thus can't lose, would you bet? Me neither. At a Vegas craps table, gamblers expect to be protected from the house using loaded dice, but insider trading amounts to the use of loaded dice by the insider because of his informational advantage. Assuming a commercial prediction market makes money by taking a rake out of every wager, it is in that market's interest to maximize the number of bets placed.

... amateurs serve a purpose in the ruthless ecosystem of the market. They are the sheep who attract the wolves. The amateurs' money entices serious investors to spend time scouring cardinals' past statements and other sources. The sheep's money also offers a temptation for those with inside knowledge to cash in .... ( Link)

At first blush, it would seem that these considerations should induce commercial prediction markets to ban trading by knowledgeable insiders. Indeed, given that tracing such traders may require law enforcement tools, just as is often the case with insider trading in corporate stocks, the prediction markets likely would seek laws against trading by insiders. Curiously, however, I have been unable to find a ban on insider trading by TradeSports on their rules website.

An alternative strategy is suggested by this paper's analysis of the role of uninformed traders. The authors recognize that trading by uninformed investors is essential to the success of a prediction market, but also appear to believe that achieving adequate levels of such trading requires irrationality on the part of uninformed investors:

Prediction markets are too small for meaningful hedging, and are likely to remain so for some time, so the primary motivations for uninformed order flow are likely to be entertainment and overconfidence. (P.7)

Other aspects of their analysis, however, suggest to me that it may be possible for a commercial prediction market to offer enough inducements, in terms of high interest contracts (e.g., Presidential elections), low transaction costs, etc...., for uninformed bettors to be willing to gamble even in the presence of trading by informed traders. Obviously, this strategy works best when the contracts are those as to which inside information provides merely strong probabilities rather than certainties. Compare, for example, the case in which a campaign staffer trades on the basis of internal polling suggesting that her candidate is going down the tubes with that of a White House staffer who has been told by the President that he intends to nominate Alberto Gonzales to the Supreme Court. The insider's advantage is significant in the former case, but only in the latter does the insider's informational advantage make the wager a certainty. If the latter class of contracts are rare, trading by informed investors may provide significant enhancements in the predictive power of the market, while reducing the risk of scaring off uninformed traders.

SCOTUS Quiz

Which of the following statements about the Supreme Court confirmation process was made by a Republican Senator and which was made by a Democrat Senator?

1. "All questions are legitimate," ______, said in an interview. "What is your view on Roe v. Wade? What is your view on gay marriage? They are going to try to get away with the idea that we're not going to know their views. But that's not going to work this time."
2. ?You not only have a right to choose what you will answer and not answer, but in my view you should not answer a question of what your view will be on an issue that clearly is going to come before the court in 50 forms probably, over your tenure on the court.?

It's a trick question. Both the statements were made by Democrats.

1. Chueck Schumer in 2004
2. Joe Biden in 1993 speaking to Clinton nominee Ruth Bader Ginsburg

Flip flop city.

Prediction Market Predicting Gonzales

Mark at Decision 08 reports:

The Alberto Gonzales contract at TradeSports just went through the roof...this would be the same TradeSports that has done so well in picking political outcomes, including the 2004 election. Very interesting...

In any event, the price of the Gonzales contract has essentially doubled on heavy volume...when the choice is between random talking heads and people who are putting money where their mouth is, always follow the money...

Wouldn't it be interesting if we could check West Wing computer records to see if anybody had been placing bets at Tradesports?

Which got me thinking about the role of insider information in prediction markets generally.

On the one hand, just as Henry Manne justified insider trading in stock markets by arguing that it improved the accuracy of stock market prices, bets by knowledgeable insiders will significantly enhance the predictive power of markets like the TradeSports contracts. Indeed, given the limits on the power of insiders to affect prices in the stock market, the effect is likely to be much stronger in prediction markets, where the ratio of activity by informed traders to that of uninformed ones is likely to be much higher than in stock markets. (See my review of the policy issues associated with insider trading in stocks.) In noncommercial prediction markets, you therefore presumably want to encourage trading by informed insiders. (See, e..g., this analysis of Policy Analysis Markets.)

On the other hand, in commercial prediction markets like TradeSports contracts, the proprietor of the market presumably has an incentive to eliminate informed insider trading. If there's a fairly high probability that you'd be betting against somebody with inside information, who thus can't lose, would you bet? Me neither. At a Vegas craps table, gamblers expect to be protected from the house using loaded dice, but insider trading amounts to the use of loaded dice by the insider because of his informational advantage. Assuming a commercial prediction market makes money by taking a rake out of every wager, it is in that market's interest to maximize the number of bets placed.

... amateurs serve a purpose in the ruthless ecosystem of the market. They are the sheep who attract the wolves. The amateurs' money entices serious investors to spend time scouring cardinals' past statements and other sources. The sheep's money also offers a temptation for those with inside knowledge to cash in .... (Link)

At first blush, it would seem that these considerations should induce commercial prediction markets to ban trading by knowledgeable insiders. Indeed, given that tracing such traders may require law enforcement tools, just as is often the case with insider trading in corporate stocks, the prediction markets likely would seek laws against trading by insiders. Curiously, however, I have been unable to find a ban on insider trading by TradeSports on their rules website.

An alternative strategy is suggested by this paper's analysis of the role of uninformed traders. The authors recognize that trading by uninformed investors is essential to the success of a prediction market, but also appear to believe that achieving adequate levels of such trading requires irrationality on the part of uninformed investors:

Prediction markets are too small for meaningful hedging, and are likely to remain so for some time, so the primary motivations for uninformed order flow are likely to be entertainment and overconfidence. (P.7)

Other aspects of their analysis, however, suggest to me that it may be possible for a commercial prediction market to offer enough inducements, in terms of high interest contracts (e.g., Presidential elections), low transaction costs, etc...., for uninformed bettors to be willing to gamble even in the presence of trading by informed traders. Obviously, this strategy works best when the contracts are those as to which inside information provides merely strong probabilities rather than certainties. Compare, for example, the case in which a campaign staffer trades on the basis of internal polling suggesting that her candidate is going down the tubes with that of a White House staffer who has been told by the President that he intends to nominate Alberto Gonzales to the Supreme Court. The insider's advantage is significant in the former case, but only in the latter does the insider's informational advantage make the wager a certainty. If the latter class of contracts are rare, trading by informed investors may provide significant enhancements in the predictive power of the market, while reducing the risk of scaring off uninformed traders.

Kennedy's the Problem

Orin Kerr predicts in today's LAT that Sandra O'Connor's retirement won't change things very much in terms of the partisan alignment of the court. I'm not so sure, since I'm pretty confident Bush will select a reliable conservative to replace Swinging Sandy. But Kerr does make a very important point:

... assume that O'Connor is replaced by a strong conservative, such as Judge J. Michael Luttig of the 4th Circuit Court of Appeals. The balance on the court would change, but only somewhat. Kennedy (for whom I clerked) would remain as a key swing vote.

Kennedy often votes with the more liberal justices to form a liberal majority in major cases. He has voted to uphold Roe vs. Wade, and he wrote the opinions that struck down sodomy laws and invalidated the death penalty for juveniles. All these decisions would remain intact.

Indeed. Justice Anthony Kennedy's apparent response to the Greenhouse Effect has been to move from more-or-less reliable conservative through squish and now, perhaps, towards Eastern elite liberal. As Todd Zywicki has suggested, Kennedy's core judicial philosophy now appears to be keeping the NY Times editorial board happy.

Business Gears Up

A couple of days ago, the WSJ reported that the business community was gearing up to play a possible role supporting President Bush's Supreme Court nominee(s). Today's LAT is reporting the same thing (the Times is always late):

"If the nominee is controversial, then we can make a judgment that we want to activate our vast grass-roots network, engage our lobbying power and there could be paid media as well," said Stan Anderson, executive vice president of the Chamber of Commerce. ...

Business lobbyists said it was likely that business and social conservatives would find themselves on the same side of a nomination battle but noted they are not always allies. Justices who are heroes to social conservatives, such as Antonin Scalia and Clarence Thomas, also have taken stands opposed by business, as in a 2003 case on punitive damages in which the two dissented from a court majority in favor of limiting awards.

"The point is that 'conservative' doesn't necessarily mean 'pro-business,' " Anderson said. Despite some decisions that rile business, Norquist is urging executives and owners to recognize that socially conservative judges are likely to be pro-business overall. "We are trying to make sure that every part of the center-right coalition is correctly focused on why this [judicial confirmation battle] is important," he said. "The same judge who will make Pastor Jones happy will make the Chamber of Commerce happy."

My guess is that Bush will either do something really stupid, like splitting his base by nominating Alberto Gonzales, or something really smart, like uniting his base by nominating a pro-business social conservative like Mike McConnell or Edith Jones. I've always admitted that Bush isn't the sharpest knife in the drawer, but I don't think he's dumb enough to do the former, so I'm reasonably certain the nominee will be somebody both business and social conservatives can live with.

Is Google's Management Dumb?

Google management arguably mishandled their IPO (although I await the final version of my colleague Vic Fleischer's article on that IPO before reaching a final conclusion). Now they've angered a lot of content providers by digitizing TV programs without the consent of the copyright owners. All of which makes me wonder whether Google management is as smart as people say. On the other hand, V ic seems to think this is all part of a careful branding strategy:

Google's company mantra is Don't Be Evil.  And this is why they were wise to do an Auction IPO last summer, even if they may have left some money on the table.  Their brand image, not their search engine technology, will soon become their most important asset.

Cruise's Cracked

An interviewer asked Tom Cruise what he thought of science fiction and got this "answer":

I just dig going to science fiction movies, always have. You look at science fiction and the role that science fiction has actually played in our culture because they were dreaming and pushing for the space race. It was the science fiction writers during that pulp fiction era that were writing about space, and then creating that trying to get them to not think about blowing each other up. Let's get the race going. I find it fascinating when we were preparing Minority Report, the research that Steven had done. Now, the scrubbing the image, actually Steven came up with that idea. I don't know if you've noticed but now, they're doing that. They've created that. (Link< /a>)

Huh? Is it just me, or is that raving, incoherent babling? Anyway, he forgot to mention that a science fiction writer invented< /a> Tom's own religion, in whose belief system an alien named Xenu figures prominently. Which may go a long way towards explaining both Tom's interest in science fiction and his inability to express that interest coherently.

Edith Jones?

Larry Ribstein floats a replacement for Sandra Day O'Connor whose name I'm surprised not to be seeing elsewhere:

Her replacement has to be Edith Jones.  As I have said, she's the best pick, period.  Given the gender issue, she's the hands-down logical choice for an O'Connor vacancy.

The overall improvement on the Court would be immense.  Among other things, a Justice Jones would provide real business expertise on a Court sadly lacking in that area.

She'd be a great choice, although I still think I prefer Michael McConnell.