ProfessorBainbridge.com

Crime and Punishment Mitigated at $82 per Day

NY Times:

Anyone convicted of a crime knows a debt to society often must be paid in jail. But a slice of Californians willing to supplement that debt with cash (no personal checks, please) are finding that the time can be almost bearable.  For offenders whose crimes are usually relatively minor (carjackers should not bother) and whose bank accounts remain lofty, a dozen or so city jails across the state offer pay-to-stay upgrades. Theirs are a clean, quiet, if not exactly recherché alternative to the standard county jails, where the walls are bars, the fellow inmates are hardened and privileges are few. ... “I am aware that this is considered to be a five-star Hilton,” said Nicole Brockett, 22, who was recently booked into one of the jails, here in Orange County about 30 miles southeast of Los Angeles, and paid $82 a day to complete a 21-day sentence for a drunken driving conviction.

Talkleft's Jeralyn says:

The counties defend the jails on grounds that they increase revenue for other programs. It seems unfair and elitist to me. ... The counties at least ought to use the fees generated to improve conditions at the non-pay jails.

I certainly agree that conditions in many US jails and prisons desperately need to be improved. But, on the other hand, is there really all that big a difference between self-pay prisons and Al Gore's use of carbon offsets to justify his extravagent use of electricity? Or the toll roads wealthy Orange County residents use to avoid traffic congestion? Or a wealthy murderer buying the best legal team money can buy (not that I'm thinking of OJ here or anything)?

I think these cases raise a very interesting and difficult moral issue. Back in the early days of the Civil War, a wealthy individual who was drafted could pay a substitute to go in his place. Indeed, sufficiently wealthy individuals could buy their way out of the draft by paying a $300 commutation fee. An analysis of the 1863 draft in Wisconsin found that "Of the 14,955 men drafted state-wide, 628 actually served, 252 hired substitutes, 6,285 were discharged for physical reasons, 5,081 paid the $300 commutation fee, and 2,689 never reported." In other words, over a third of those drafted bought their way out of service.

Was the availability of substitutes and commutation fees unfair and elitist? If so, what differentiates it from toll roads reserved for those who can afford to pay or the use of carbon offsets by energy profligate environmentalists? Is there an objective metric or are we all simply aping Potter Stewart's famous crack about obscenity; i.e., we know it when we see it?

Steel on SOX

At yesterday's Manhattan Institute conference, Treasury Undersecretary Robert Steel commented on Sarbanes-Oxley:

In one area -- the application of Sarbanes-Oxley corporate governance rules -- the Treasury official said he's optimistic about changes that will reduce the burden of audit requirements. The Securities and Exchange Commission proposed recommendations in December that instruct managers to focus on items most likely to cause financial misstatements.

I don't share Steel's optimism. At the Manhattan Institute conference, I criticized the SEC's December guidance. In brief, I rehearsed the arguments made in my Washington Examiner op-ed Much ado about little on Sarbanes-Oxley Act:

Guidance does not create safeharbors by which compliant firms are insulated from liability. To the contrary, guidance is inevitably vague and ambiguous, leaving plenty of room for interpretation and disagreement. Conversely, determination of whether a particular firm has complied with its SOX obligations is highly fact-specific and contextual, such that mere guidance is unlikely to be determinative of whether the firm properly complied.

Mere guidance will not change the incentives of corporate officers and directors. The Sarbanes-Oxley Act created significant new civil and even criminal liabilities for officers and directors whose firms have inadequate internal controls or improper financial disclosures.

The best way for directors and officers to avoid these liability risks is to pump a lot of corporate resources into ensuring compliance with Section 404 and the rest of SOX. Because it is a corporation’s directors and officers who control the purse strings, they get to decide just how much resources the corporation spends on SOX compliance. Because the money spent on compliance programs comes out of the corporation’s bottom-line, however, the money comes out of the stockholders’ pockets.

To put the directors and officer’s incentives in everyday terms, suppose you’re playing Monopoly and can buy a get out of jail card using somebody else’s money. Wouldn’t you do it every time?

Nothing the SEC has done or plans to do will change the existing incentive structure for officers and directors. The firm’s top management will still have plenty of incentives to spend shareholder money on protecting themselves from SOX liability.

American business is hemorrhaging and the SEC’s solution is to slap a Band-Aid on the problem.

Ribstein on Steel on Hedge Funds

Larry has a nice summary of Treasury Undersecretary Robert Steel's comments on hedge fund regulation at the Manhattan Institute program we attended yesterday. He quotes a Bloomberg report:

Robert Steel, the U.S. Treasury's top finance official, said he opposes stricter regulation of hedge funds because it would increase risks by suggesting the government has given their investments an "all-clear.'' Steel, the Treasury undersecretary for domestic finance, also said it would be costly and impossible to train enough people to keep tabs on some 8,000 hedge funds. "I don't like the moral hazard of communicating a government all-clear,'' Steel said at a conference hosted by the Manhattan Institute in New York today. The risk is that regulation "communicates confidence in a product that is riskier than normal investors should get involved in,'' he said.

As Larry observes, that "sounds right." Indeed, as John Carney quips, "Both points are the sort of thing that are so obvious—once they’re raised. You instantly feel like you’ve known them all along." Steel also commented on Sarbanes-Oxley.

Analysis of HR 1257 - The Say on Pay Bill

My memorandum criticizing HR 1257, Congressman Barney Frank's Say on Pay bill, is now up on the Washington Legal Foundation's website.

Should Gore Take the Pledge? Do Carbon Off-sets Work?

Washington Times:

A leading skeptic of global-warming science is challenging celebrity activists such as Al Gore and Sheryl Crow to lower their "carbon footprint" to the same level as the average American by Earth Day in April 2008. "I simply believe that former Vice President Al Gore and his Hollywood friends who demand we change the way we live to avert this over-hyped 'crisis' not only talk the talk, but walk the walk," said Sen. James M. Inhofe, Oklahoma Republican. "How hard is it for these elitists to become as frugal in their energy consumption as the average American? I think the American public has a right to know they are being had."

A so-called "Gore Pledge" was introduced last month when the former vice president appeared before a Senate committee to discuss his views on climate change. Mr. Inhofe asked Mr. Gore to sign the pledge to reduce his use of products that produce greenhouse gases, but he declined, instead citing alternative carbon trade-offs. Mr. Gore says he pays a self-imposed "carbon tax" to offset the environmental impact of his large home and global travels.

Do these so-called carbon off-sets really work? Over at SSRN, I found a paper that uses formal models to conclude that:

Carbon offsets can be purchased by consumers who wish to mitigate their emissions. In a model where the demand for such offsets is driven by consumers who feel guilt about their emissions, it is show that the introduction of offsets are complements to existing "dirty‟ consumption and can cause such consumption to increase. Net emissions are shown to decline, however, regardless of whether prices are regulated, chosen strategically or offset prices are endogenous.

The paper concludes that "voluntary purchases of offsets would likely reduce environmental harm." As the purchasers of off-sets feel less guilt, they increase their consumption (explaining Al Gore's huge electric bills and Laurie David's private jets?), but that effect is more than offset by a decrease in net emissions.

I have to admit that the math in the paper is way over my head; the narrative analysis, however, seems very plausible. So maybe the answer is not to demand that Hollywood elites cut their consumption, but simply to insist that they document their purchase of carbon off-sets before hectoring the rest of us?

Disclosure and Pay

Michael Kinsley wrote the following on campaign finance disclosure:

The ability to raise money has become an independent test of a candidate's prospects, completely apart from money's traditional role as a way to buy things. Candidates raise money not to purchase TV time and hire political consultants. They raise money to prove that they can raise money. All the major candidates have rejected federal subsidies in order to avoid the contribution limits that go with them. This includes McCain, whose name is on McCain-Feingold, the most recent failed attempt to curb money's role in politics. When the press started reporting that his campaign was in trouble, McCain hired a major corporate lobbyist as his finance chairman. The press approved. This showed that he was serious.

All of this parallels a development in the larger economy. For most people, the point of money is that you can buy things with it. But at the top, where people already can buy whatever they want, the purpose of money is keeping score: making sure that you don't slip down in the Forbes 400 list.

This prompted Time business and economist columnist Justin Fox to think about executive compensation:

The solution here is so simple: We just have to keep campaign finance data secret. Then candidates would worry far less about how much money they'd raised, and would spend far less time trying to raise it. Hushing up executive pay data would have a similar effect. If nobody outside the board of directors and the head of HR knew how much the CEO was making, there'd be far less keep-up-with-the-Home-Depots upward pressure on pay.

I'm kidding about this, I think. Although when you think about the impact that increased disclosure has had on both campaign spending and executive pay over the past couple of decades, you've got to wonder.

Indeed, there is a widely shared view that executive compensation disclosure has had the unintended consequence of pushing up compensation. Former DuPont CEO Edward S. Woolard, Jr., for example, reportedly stated that: "The main reason (CEO) compensation increases every year is that most boards want their CEO to be in the top half of the CEO peer group, because they think it makes the company look strong. So when Tom, Dick, and Harry receive compensation increases in 2002, I get one too, even if I had a bad year....(This leads to an) upward spiral." This phenomenon is known as the Lake Wobegon effect or the "keeping up with the Jones" problem. Jay Lorsch explains:

... compensation committees rely on surveys by compensation consultants about CEO pay in similar companies but without regard to company performance. These surveys report compensation by quartiles, and no compensation committee wants to admit that its CEO is below the median. In fact, most want to place their CEO in the upper quartile. As a result, CEOs are like the children of Lake Wobegon—all are above average.

The supposed effect is a favorite of financial populists like Gretchen Morgenson, who routinely invokes it in her screeds against CEO pay. (E.g., here and here). It's also a favorite of shareholder activists who claim that pay levels reflect managerial power rather than efficient market contracts.

Curiously, however, the Lake Wobegon effect seems to be more a matter of lore than hard evidence. An interesting analysis of the issue was conducted by economists Peter Swan and Xianming Zhou. They noted that Ontario in 1993 enacted the first Canadian rules requiring disclosure of individual executive compensation. They examined pay practices before and after the regulation went into effect. They found:

By examining CEO compensation of 461 listed Canadian companies over three fiscal years pre-disclosure (1991-1993) and five years postdisclosure (1994-1998) we document that the link between CEO wealth and shareholder value substantially increased after the disclosure regulation was enacted. This observation is reinforced when we use comparable U.S. firms as a control group. In a comparison in which Canadian firms are matched one-to-one with U.S. firms according to size and industry, we obtain two findings: (i) before disclosure, the pay-performance sensitivity for Canadian CEOs was only a small fraction of that for U.S. CEOs, and (ii) the sensitivity increased dramatically for Canadian CEOs after the disclosure requirement in Canada. Our findings are statistically significant and economically strong, as well as robust to model specification. They support the belief of the SEC and legislators that, by removing information asymmetry in executive compensation schemes, disclosure helps make executives more effective agents of shareholders. ...

Our results show that after disclosure, the total compensation to Canadian CEOs increased relative to U.S. CEOs. However, the increase resulted from higher incentive pay due to a stronger pay-performance relation. Thus, our results do not support the view that public disclosure helps either increase or reduce their compensation levels as such, but disclosure improves pay-performance sensitivity....

... after controlling for firm size and performance, we find no meaningful differences in the fixed, i.e., base pay, component of pay between Canadian CEOs and U.S. CEOs, either before or after the disclosure requirement in Canada. This observation does not support the compensation consultant’s view that pay levels are determined by the “keeping up with the Jones” effect, nor the shareholder activists’ view that, due to a lack of shareholder scrutiny, managers were excessively paid and that public disclosure of executive pay helps reduce compensation levels.

Of course, there are valid arguments against the current plethora of executive compensation disclosure requirements (e.g., overloading investors or inherent ineffectuality), but the Lake Wobegon effect isn't one of them. Instead, it seems to be mainly a myth.

Update: In an update to his post, Justin Fox implies that the effect may be limited to Canada. Maybe. What the researchers did was to identify a real world laboratory to test the Lake Wobegon effect. They found a jurisdiction where the law had changed to require significantly greater pay transparency. What effect did that regulatory change have? It increased pay but only because pay became more sensitive to performance. Hence, this is not mere economic modelling; it's real world experimental data. In addition, the paper cites a number of reasons to think the results would hold true in the US.

Rove versus Crow and David

So Sheryl (one piece of TP per potty trip) Crow and Laurie David had a dust-up with Karl Rove in re global warming. I gather they arrived in DC via a biodiesel-powered bus. It must be tough for Laurie David to be roughing it. After all, this is the activist of whom Gregg Easterbrook has written:

In the new Atlantic Monthly, Eric Alterman notes that Laurie David, wife of Larry David--among Hollywood's wealth elite owing to "Seinfeld" royalties--has become an influential environmental crusader, but herself travels in chartered Gulfstream jets. Laurie David has organized numerous celebrity save-the-environment events and "reviles the owners of SUVs as terrorist enablers, yet gives herself a pass when it comes to chartering one of the most wasteful uses of fossil-based fuels imaginable," a private jet, Alterman writes. I did a few quick calculations. The mid-sized Gulfstream G200 model can carry about 2,100 gallons of jet fuel, which is made from petroleum, and would burn around 1,200 to 1,500 gallons flying from New York to Los Angeles, depending on wind speed and how many passengers were aboard. A Hummer driven 15,000 miles, the average put on a car per year, would burn around 1,250 gallons of gasoline. So for Laurie David to take one cross-country flight in a Gulfstream is the same, in terms of Persian-Gulf dependence and greenhouse-gas emissions, as if she drove a Hummer for an entire year. But then, conservation is what other people should do.

Of course, Sheryl's roughing it too. I wonder, for example, whether she gets her bottle of Marker's Mark every Monday? (Check out Smoking Gun's list of Crow's backstage requirements)

Glenn Reynolds has more:

MORE CELEBRITY GREENHOUSE HYPOCRISY:

Laurie David, the producer of "An Inconvenient Truth" and global warming activist, told Texas A&M students to change their "individual behavior" in order to consume fewer resources and to help battle global warming. As an employee of Easterwood Airport, I would like to point out that Mrs. David flew to our campus in a luxurious private jet, which could be seen from 10 miles away due to the thick plume of smog it left in its wake. I am neither denying nor confirming the epidemic of global warming, I am simply pointing out that hypocrites such as Mrs. David don't care about the environment, only their own political agendas. This is proven time and again by these celebrities' and lobbyist's "do as I say, not as I do" attitude.

We need a database of private-jet-flying celebrities. Can that be created from publicly available information?

But wait, there's more:

Even worse is David's chic but hypocritical environmentalism at her summer home in Martha's Vineyard. She was issued a "notice of apparent violations" for building a 26-foot-long barbecue station, stone-and-concrete bonfire pit, and outdoor theater on an environmentally sensitive patch of their 14-acre North Road property without the proper permits. They were also cited for tearing up protected vegetation to make way for a lush, sodded lawn, among other crimes against nature.

The commission has since ordered her to remove the offending structures and restore the area to its previous state. All these violations were allegedly done to prepare for a political fundraiser hosted by Robert F. Kennedy, Jr. (another faux Green). Alas, there's no such thing as cheap environmentalism on the Vineyard.

Laurie David has been labeled a "Gulfstream liberal" by Eric Alterman, himself a proud member of the Left and a regular columnist for the Nation. He recognizes that Ms. David's brand of environmentalism is nothing more than a facade, a distraction from the financially secure yet intellectually boring life of the fabulously wealthy. But this hobby has dire consequences for the rest of us.

Well, some of them are dire. The rest provide a good, hearty laugh.

Ribstein on the Absurdity of Say on Pay

Lar ry Ribstein on HR 1257, the so-called Say on Pay law:

Remember the quaint idea that the states were supposed to decide corporate governance, and the federal securities laws were supposed to be just about disclosure? Obviously this is a significant decision about the allocation of power between shareholders and managers that's being made by the U.S. Congress. Wasn't that supposed to be a matter for state law?

Efficient compensation must be crafted on an individual- by-individual and firm-specific basis to provide the right incentives and attract the best people. It's like designing a product. Can anybody seriously believe that shareholders en masse can make a meaningful, intelligent, up-or-down decision on executive compensation?

Larry picks on Obama:

Now it's on to the Senate, with Barack Obama using this gimmick to demonstrate his astuteness on business issues.

Ouch. Precisely right. If this is Obama's idea of good regulation, God help the economy if he gets elected. But still, ouch. Larry also observes:

As I said a few months ago about the SEC's compensation disclosure rule that underpins this new initiative:

Unions already have secured an extensive executive compensation disclosure rule to whip up populist resentment about executive pay. The next step is to create a mechanism to bring that resentment to bear in corporate elections. It should be obvious to anybody who cares to look past the rhetoric that the unions are seeking bargaining leverage on behalf of their members, and to ensure their own survival. They are not seeking to represent the interests of investors generally. Their ideal is the sclerotic European firm, with its labor representatives on the board.

Let's think about some other likely specific effects of the proposal beside shoring up the flagging power of labor unions:

• Providing a potential basis for litigating the outcomes of board elections.
• More benchmarking of compensation.
• Increasing firms' incentives to manipulate compensation. Backdating was an early version of this technology, which will likely evolve into more sophisticated techniques.
• Spurring further brain drain of talent from publicly held firms. This, of course, increases the net costs of public ownership and the wealth and power of private equity (where managers' pay dwarfs that in public firms).

Even if one agrees with the concept of "say on pay," this law isn't necessary.  Many companies already are voting on, and some have adopted, similar shareholder proposals.  But the unions won't win all of these votes, so the idea seems to be to get Congress to force the idea down the throats of firms whose shareholders have rejected the union initiatives.

Smith on Why Say on Pay in Unnecessary

Gordon Smith offers a reason to think the Say on Pay legislation working its way through Congress is unnecessary:

Shareholders already have the option of offering advice to the board of directors through shareholder proposals. Such proposals cannot be excluded from the company proxy statement under Rule 14a-8. In a 1992 no-action letter, the staff of the SEC wrote, "proposals relating to senior executive compensation no longer can be considered matters relating to a registrant's ordinary business."

Gordon then opines:

I have serious reservations about the wisdom of Say on Pay -- my guess is that the votes will be pretty "noisy," not resulting in much useful information to the board of directors but imposing additional costs and providing another forum for protest -- especially if this reform is to be implemented via another one-size-fits-all "solution" from Congress.

Scholars: Cite Yourself

From Marginal Revolution by Tyler Cowen:

Does self-citation pay? In a word, yes:

Self-citations – those where authors cite their own works – account for a significant portion of all citations. These self-references may result from the cumulative nature of individual research, the need for personal gratification, or the value of self-citation as a rhetorical and tactical tool in the struggle for visibility and scientific authority. In this article we examine the incentives that underlie self-citation by studying how authors’ references to their own works affect the citations they receive from others. We report the results of a macro study of more than half a million citations to articles by Norwegian scientists that appeared in the Science Citation Index. We show that the more one cites oneself the more one is cited by other scholars. Controlling for numerous sources of variation in cumulative citations from others, our models suggest that each additional self-citation increases the number of citations from others by about one after one year, and by about three after five years. Moreover, there is no significant penalty for the most frequent self-citers—the effect of self-citation remains positive even for very high rates of self-citation. These results carry important policy implications for the use of citations to evaluate performance and distribute resources in science and they represent new information on the role and impact of self-citations in scientific communication.

Well, that explains some observations. Here is the paper, indirectly the pointer is from Aleks.

Pelosi Blog on Say on Pay

Speaker of the House Nancy Pelosi's blog celebrates the passage of the Say on Pay bill, with video of principal sponsor Barney Frank's floor speech in support of the legislation. It also criticizes GOP procedural efforts to derail the legislation. Meanwhile, the class warfare troops at Working for US criticize President Bush for opposing the legislation. Scroll down for earlier coverage.

Say on Pay passes House

News reports:

The U.S. House of Representatives voted Friday to give shareholders at public corporations a voice in executive pay packages that typically equal 500 times the salaries of workers at those companies. ...

Democratic Sen Barack Obama introduced a similar bill in the Senate Friday.

Well, I guess I won't be voting for Obama. (Not, of course, that it was very likely in the first place.) Anyway, keep watching this space. I've got an op-ed opposing HR 1257 (the bill in question) coming out in the Washington Examiner, which is based on a more detailed legal memorandum to be published by the Washington Legal Foundation on April 27th. In the meanwhile, scroll down for more commentary.

Rick Garnett on the "Chill wind from Rome ...."

Rick writes:

[A Chill wind from Rome] is what a number of bloggers and commentators perceive in the partial-birth-abortion decision.  I suppose I should not be surprised by this line, but -- I admit -- I'm disappointed.  And then there's this, from the Philadelphia Inquirer (which characterizes as "activist" a decision that declines to invalidate a measure which has always enjoyed broad and bipartisan support or to read broadly a precedent which invalidated an earlier law which also enjoyed broad and bipartisan support).

My point here is not to vent about the "last acceptable prejudice" .  What's irritating, to me, as a lawyer, about the cartoon is the claim that it is as Catholics -- i.e., because they are Catholics, and not because they think, as intelligent and engaged lawyers, that the Constitution does not disable legislatures entirely from regulating what most people (not just Catholics, fideists, and sexists) regard as a particularly gruesome abortion procedure  -- that the five Justices who voted to uphold the ban.

Bebchuk's Agenda

Fortune offers an interesting profile of Harvard law professor and "corporate governance gadfly" Lucian Bebchuk:

He insists he isn't an activist. Plenty of America's CEOs must hope he means it. "I'm mainly a kind of ivory tower academic," says professor Lucian Bebchuk of Harvard Law School, and that he surely is - the only person I know of with four graduate degrees from Harvard (master's and doctoral degrees in law and economics).

But as director of the school's Program on Corporate Governance he has also become America's most influential critic of CEO pay - to the deep annoyance of many CEOs, who say privately they wish he'd just be quiet. So now that he's behaving like a shareholder activist as well for the second proxy season in a row, the mere suspicion that it could be a new career cannot be comforting. ...

I like and respect Bebchuk. I also believe Bebchuk really believes corporations would be better off if shareholders had more power. I just don't understand why.

The core principle of corproate law is the separation of control from ownership of the residual claim (see, e.g., my The Case for Limited Shareholder Voting Rights). Given that activist investors tend to exhibit private rent-seeking behavior, collective action problems, rational apathy, and the like, there's no reason to think empowering shareholders will improve corproate governance; indeed, to the conrary, there is every reason to think empowering shareholders would have pernicious effects (see my Shareholder Activism and Institutional Investors).

Even if you believe some shareholder empowerment relative to the present situation under Delaware corporation would be appropriate (my condolences on being so fundamentally misguided, BTW), how much is enough? Even a shareholder advocate like Fortune's Geoff Colvin says he "isn't sure about" Bebchuk's latest pet project (the Say on Pay bill, discussed below). At what point does shareholder empowerment morph into shareholder micromanagement? And while the advocates of shareholder empowerment stop before reaching that line? Personally, my guess is that they'll blow past it sort of the way I blow past speed limit signs.

White House opposes HR 1257: The Say on Pay Bill

AP News:

The Bush administration is opposing a bill before the House, pushed by Democrats, to give shareholders at public companies a formal say in executives' compensation packages. The legislation, written by Rep. Barney Frank (news, bio, voting record), D-Mass., chairman of the House Financial Services Committee, comes at a time of growing public and shareholder anger over lavish compensation for executives unrelated to their performance. It would give shareholders a chance to cast an advisory vote on executive pay plans, allowing them to show their approval or disapproval of them.

The bill is HR 1257. The House Report (110-88) is here. The hearing record is here. I've got a couple of short pieces in the pipeline specifically addressing HR 1257. (Watch this space.) More generally, my paper Executive Compensation--Who Decides? argues against empowering shareholders in this area.

Update: The NYT has more:

Shareholders would have the right to a nonbinding vote on the pay packages of senior executives of public companies under a bill that the House began debating Wednesday. ...

The measure ... faces significant political obstacles. There is no comparable measure in the Senate. And this week, the White House issued a statement opposing the legislation, saying it “does not believe that Congress should mandate the process by which executive compensation is approved.”

The Times also reports that GOP opponents argue the bill "would provide a new weapon to groups including environmentalists and labor unions that would use these votes to promote narrow agendas." Precisely. See my article Shareholder Activism and Institutional Investors, which argues that activist investors tend to exhibit private rent-seeking behavior.

The White House statement opposing HR 1257 is here. It notes (sensibly) that " as a result of the Securities and Exchange Commission’s revised disclosure rules on executive compensation, which recently became effective, shareholders are receiving comprehensive information on executive compensation. Before additional corporate governance requirements are legislated, the Administration believes that recent enhancements should be given time to take effect," which is precisely one of the arguments I made in Executive Compensation--Who Decides?