ProfessorBainbridge.com

Do Obama's Executive Comp Limits Help Shareholders of TARP Recipients?

At the start of the month, President Obama was proudly proclaiming an expansion on the existing rules restricting executive compensation for TARP firms:

President Obama is having his say on soaring executive pay. New rules unveiled Wednesday morning will cap annual cash compensation for executives at firms receiving future government aid at $500,000.

The guidelines prohibit payments above the $500,000 threshold in anything but company shares that must be held until the government's investment has been repaid.

The rules will apply foremost to companies that receive so-called exceptional aid from the government in the future. ...

Current rules bar such companies from taking a tax deduction for compensation above half a million dollars, but don't restrict how much executives can receive in salary and bonuses. In addition, the new rules will increase the bans on so-called golden parachute severance packages available for executives.

Good for the taxpayer? Maybe. Good for shareholders of TARP firms? Not according to a recent study by a Drexel finance professor:

Using 256 TARP recipients as a sample, I find that markets are mostly negatively reacting for the news on limiting the executive compensations. Although investors react quite positively for the initial announcement on the TARP on October 14, 2008, other announcements regarding compensation regulation including strict $500,000 salary cap are perceived as bad news in the market. The results is more supportive for the managerial talent hypothesis, which implies that investors concern for losing their talented executives due to the upper limit of the salary. Splitting the sample by various possible determinants for the CARs, I also find that firm size as well as financial performance is an important factor to decide the level of abnormal returns. In conclusion, shareholders for larger and better performed firms concern more for imposing the salary cap for the TARP firms, which is also the evidence of managerial talent hypothesis.

In other words, investors are worried that the pay caps are going to chase the best executives off to places like hedge funds where they can earn way more than $500K.

What, Me Worry? Credit Default Swaps on US Treasuries

Credit default swaps (CDS) are a form of insurance. Let's say you borrow money from me. I'm worried that you might default. So I hedge that risk by purchasing a CDS. If you end up unable to pay me back, the seller of the CDS will cover my losses. (The insurance analogy admittedly is not exact, but it suffices for present purposes.)

Like any form of insurance, as the probability of the event occurring rises, the cost of the CDS rises.

So what are we to make of the fact that the price of credit default swaps on US Treasuries has been rising lately?

A poster at Dealbreaker.com opines that:

Unless you can collect the protection in Swiss Franc, we find it difficult to get our head around credit default swaps on U.S. Treasuries. Surely, if you find yourself actually needing the protection, the last thing you want is U.S. Dollars. And in addition, if you find yourself in a position to expect payment from your counterparty, how likely are you to get paid? And finally, why in the world would the U.S. choose to default, rather than just turn on the printing presses?

Likewise, The Economist's Buttonwood column opines that:

Investors should also ask whether it makes sense to insure against a default on Treasury bonds. If the American government defaults, which bank will still be good for the insurance claim?

Points all well taken. Although sovereign defaults are hardly unknown, things would have to get incredibly bad for the US to default on Treasuries. And if they got that bad, you'd probably have been better off investing in a survivalist camp than CDSs. 

Having said all that, however, the rise in the cost of insuring against a US default is worrisome. It's a highly negative signal from the market. People are willing to bet that the USA can't get its financial house in order. Peggy Noonan is hardly a great economist, but I think her WSJ column today captures at least some of what's happening in the sovereign CDS market:

People are freshly aware and concerned about the real-world implications of a $1.6 trillion dollar deficit, of a $14 trillion debt. It will rob America of its economic power, and eventually even of its ability to defend itself. Militaries cost money. And if other countries own our debt, don't they in some new way own us? If China holds enough of your paper, does it also own some of your foreign policy? Do we want to find out? And there are the moral implications of the debt, which have so roused the tea party movement: The old vote themselves benefits that their children will have to pay for. What kind of a people do that?

The CDS market is sending us a signal. Do we have the will to listen?

Reconciliation

Press reports indicate that the Democrats are going back to the possibility of using reconciliation to ram health care (possibly even including the "public option") through the Senate with just 51 votes. If they do that, however, what's to prevent a future GOP-dominated Congress and White House from using reconciliation to repeal the damned thing? So if the Democrats do resort to reconciliation, people like CPAC ought to insist that the Republicans commit to repealing Obamacare via reconciliation at the earliest opportunity.

Live by the sword, die by the sword.

Questions about Poison Pills under Delaware Law

Gibson Dunn partner Eduardo Gallardo posts an interesting essay on Delaware law governing poison pills at the Harvard corporate law blog. He points out that:

Delaware law in this area, particularly as it relates to a board’s decision not to redeem a rights plan in the face of a financially attractive all-cash bid, has seen no major case law or statutory development in a number of years. With the recent levels of hostile M&A activity and the concurrent expansion of shareholder activism, the time may be ripe for the Delaware Chancery Court to resolve some of the perceived tensions in this important area.

He goes on to posit several questions Delaware law needs to answer, including:

... who ultimately controls a company? Is it the board, which manages the affairs of the company, or shareholders, who own the company? When faced with an all cash, structurally non-coercive tender offer, can the target board enact a plain-vanilla shareholder rights plan if it deems the offer price to be inadequate and essentially “just say no” to the offer? Or must the board give shareholders the opportunity to tender their shares? These questions remain to some extent unresolved under Delaware law.

He then reviews the relevant case law.

I addressed most of these questions in my article Unocal at 20: Director Primacy in Corporate Takeovers:

Bainbridge on the Breakdown of the Bailout

Yesterday I popped up to the UC Berkeley law school to give a talk on the financial bailout for the Federalist Society and the Berkeley Business Law Journal. You can view the program here.

Ken Starr News

Here at PB. com, we are big fans of Pepperdine Law Dean and former Whitewater Independent Counsel Ken Starr because of his outstanding work in favor of interstate wine shipping rights.

We thus are interested to note that Starr has been named the next President of Baylor University. According to the campus newspaper:

Nadine Strossen, Former President, American Civil Liberties Union and Professor at New York Law School hailed Starr for his integrity despite their disagreements on certain issues.

"From the students for whom he is impressively available, to the Death Row inmates whose legal appeals he has handled on a pro bono basis, he is unstintingly generous with his time, expertise, and wisdom," Strossen said. "Ken Starr is deeply committed to academic freedom and to the robust exchange of ideas, including ideas with which he personally disagrees.

In other Starr news, today's WSJ has a review of Ken Gormley's new book The Death of American Virtue: Clinton vs. Starr:

Kudos to Obama for Granting Nuke Loan

AP News:

The Obama administration's planned loan guarantee to build the first nuclear power plant in the U.S in almost three decades is part of a broad shift in energy strategy to lessen dependence on foreign oil and reduce the use of other fossil fuels blamed for global warming.

President Barack Obama called for "a new generation of safe, clean nuclear power plants" in his Jan. 27 State of the Union speech and followed that by proposing to triple loan guarantees for new nuclear plants. He wants to use nuclear power and other alternative sources of energy in his effort to shift energy policy.

Obama in the coming week will announce the loan guarantee to build the nuclear power plant, an administration official said Friday. The two new Southern Co. reactors to be built in Burke, Ga., are part of a White House energy plan that administration officials hope will draw Republican support.

Loan guarantees for other sites are expected to be announced in the coming months, the official said, who would speak only on condition of anonymity ahead of Obama's announcement. The federal guarantees are seen as essential for construction of any new reactor because of the expense involved.

If the GOP really is something more than the nihilistic party of no that our friends Bruce Bartlett and Andrew Sullivan so vigorously accuse it of having become, this is something the GOP ought to back. Nuclear power has proven successful in many countries (see, e.g., France) and, of course, in our own Navy.

Speaking of our Navy, my one complaint is that Obama has opted to go the traditional route of loan subsidies. There's a better route. The federal government ought to be building pebble bed reactors on government land (such as military bases):

The pebble bed reactor (PBR) is a graphite-moderated, gas-cooled, nuclear reactor. It is a type of Very high temperature reactor (VHTR) [formally known as the high temperature gas reactor (HTGR)], one of the six classes of nuclear reactors in the Generation IV initiative. Like other VHTR designs, the PBR uses TRISO fuel particles, which allows for high outlet temperatures and passive safety.

The base of the PBR's unique design is the spherical fuel elements called "pebbles". These tennis ball-sized pebbles are made of pyrolytic graphite (which acts as the moderator), and they contain thousands of micro fuel particles called TRISO particles. These TRISO fuel particles consist of a fissile material (such as U235) surrounded by a coated ceramic layer of SiC for structural integrity and fission product containment. In the PBR, 360,000 pebbles are amassed to create a reactor core, and are cooled by an inert or semi-inert gas such as helium, nitrogen or carbon dioxide.

This type of reactor is also unique because its passive safety removes the need for redundant, active safety systems. Because the reactor is designed to handle high temperatures, it can cool by natural circulation and still remain intact in accident scenarios, which may raise the temperature of the reactor to 1600°C. Because of its design, its high temperatures allow higher thermal efficiencies than possible in traditional nuclear power plants (up to 50%) and has the additional advantage that the gases do not dissolve contaminants or absorb neutrons as water does, so the core has less in the way of radioactive fluids.

A number of prototypes have been built. Active development is ongoing in South Africa as the PBMR design, and in China whose HTR-10 is the only prototype currently operating.

And, as I have proposed before, we should create a Naval Corps of Nuclear Engineering to run them:

Two by Scalzi

Over the long weekend, I finished two new books from John Scalzi.

Judge Sn Goes Golfing is really a short story, although his publisher Subterranean Press calls it a "chapbook." In the old days, it might have been a lead single issue short for Analog or Asimov, but Scalzi and Subterranean decided to make it available as a limited edition softcover. The story takes a minor character from Scalzi's novel The Android's Dream, puts him on a golf course, salts the text with a slew of Carlin's seven words, and churns out a witty and entertaining story. It's reminiscent of P.G. Wodehouse's The Golf Omnibus, in that you don't need to be a golfer to enjoy the comedic stylings of a great storyteller.

Judge Sn served as an amuse bouche for Scalzi's much more serious new novella The God Engines. It's a major departure for Scalzi. It's a fantasy noir--albeit with hints of an untold science fiction backstory--that gets darker as it progresses.

Modern fantasy basically sucks. It consists either of endless vampire supernatural romance erotica or bloated series of doorstoppers whose authors have or will drop dead before they finish them.

Scalzi has carved out something very refreshing: A concise, exciting, and highly original story. As Robert Thompson explains:

In “The God Engines”, John Scalzi introduces readers to a dark and chilling world where gods not only exist, but can also be tortured, enslaved, or even killed. A world where science has been replaced by faith, where Defiled gods are used as ‘engines’ to power spaceships, where followers may be blessed with Talents—“a thing gods give followers to channel their grace, so the followers may use that grace to their own ends”—and where faith is a tangible power. A world of rooks, Bishop’s Men, and commentaries. A world that is highly imaginative, mostly original (parts of the novella reminded me of James Clemens’ Godslayer Chronicles), immersive despite having only 136 pages to bring the concept to life, and utterly captivating.

In this grim, yet fascinating world, readers will meet a small and well-drawn cast of characters—Captain Ean Tephe of the ship Righteous, Priest Andso, Commander Neal Forn, rook Shalle, the Defiled of the Righteous—who play a pivotal role in the events recorded in “The God Engines”. Events that are straightforward for the most part, but culminate in an explosive and mind-blowing finish full of dark twists and shocking revelations…

And then there's Paul Stott's take on it:

The God Engines is unlike anything he’s done before, shockingly different, both new and completely unexpected. It’s the book Scalzi needed to write in order to mature as a writer and to take his considerable talents to the next level. It’s the book that shows he’s more than just a writer of humorous space operas; he’s also one of the best science fiction writers currently working.

A vastly rich tale set in a theocratic universe, The God Engines is a modern sci-fi classic, an intriguing examination of faith and worship and godhood. Intelligent and provocative, the narrative reminds me of a classic Twilight Zone episode, well-written, multi-leveled and rich with ideas. The God Engines is the best thing yet from John Scalzi and worthy of award consideration.

As you might expect from my opening comments, I disagree somewhat with Stott's take that The God Engines is science fiction. It's a hybrid of fantasy and science fiction, with the latter elements peeking through from time to time from a largely concealed backstory. It establishes Scalzi as someone capable of writing successfully in both genres.

In sum, highly recommended.

Sarah Palin is no Ronald Reagan

In the comments to the previous post, a reader replied to my observation that Sarah Palin's educational career did not suggest great intellect, by claiming that the same could be said of Ronald Reagan: "Fits Reagan to a T" 

I'll let Steven Taylor channel David Boaz on this point:

1. Reagan serves 2 terms as governor of a large state; Palin quit halfway through first first terms as governor of one of our smallest (population-wise) states. 

2. Reagan actually had a political philosophy that was worked out over time and in a public way (SAG president, radio commentaries, speeches, etc.). Palin hardly has that kind of track record.

3. Hard to summarize his third point in a bullet, but to quote Boaz “Read Reagan in His Own Hand, read the commentaries he wrote on yellow pads while being driven from Los Angeles to Santa Barbara, and ask yourself: Could Sarah Palin do that?”

My Belief-O-Matic results

I took Beliefnet's Belief-O-Matic quiz as honestly as possible, with this resulting list of religions most closely matching my own beliefs:

1.	Eastern Orthodox (100%)
2.	Roman Catholic (100%)
3.	Orthodox Quaker (97%)
4.	Seventh Day Adventist (93%)
5.	Mainline to Conservative Christian/Protestant (88%)

It's interesting (at least to me) that I moved from 5 to 2 as an adult. Never really considered # 1.

(HT: 100% Neo-pagan Kathleen Bergin)

Will there be Financial Regulation legislation?

Democratic SEC Commissioner Luis Aguilar thinks not:

“While there was much activity this past year, very little has actually been accomplished,” Securities and Exchange Commissioner Luis Aguilar said Feb. 5, expressing doubt that comprehensive financial services reform will become a reality. ...

Aguilar said that while some progress has been made, he remains concerned about how effective such legislation will be. For example, he noted, the 2009 Wall Street Reform and Consumer Protection Act, cleared by the House late last year, contains provisions to rein in predatory mortgage lending, enhance SEC enforcement powers, and boost federal oversight of the derivatives markets, private fund advisers, and credit ratings agencies. However, Aguilar stated, the bill also contains a number of loopholes—including a provision that would exempt half of all U.S. public companies from having an outside audit of their internal controls. He also expressed doubt that ongoing reform efforts in the Senate “will lead to actual legislation. In short, though there has been activity, we do not—yet—have accomplishment.”

The highlighted passage refers to the one clearly desirable aspect of the bill (at least IMHO); namely, the proposed exemption for nonaccelerated filers from the requirement in Sarbanes-Oxley § 404(b) that an issuer's external auditor provide an annual assessment of the issuer's internal controls. As I document in my book The Complete Guide to Sarbanes-Oxley: Understanding How Sarbanes-Oxley Affects Your Business:

Judicial Nominations: What Goes Around, Comes Around

Catholic University law professor Victor Williams blogs at HuffPo:

Last week, Harry Reid stated that recess appointments are needed to fill the growing number of federal government vacancies. On the Senate floor, Majority Leader Reid referenced his past resistance to recess commissions before asking: "But what alternative do we have? What alternative do we have?"

On Tuesday, February 9, 2010, President Barack Obama announced he was considering making the first recess appointments of his presidency.

Williams urges that Obama "should go to the White House's Roosevelt Room and under T.R.'s famed portrait, Obama should sign recess commissions by the score."

Fair enough. Indeed, when I go to PB.com's archives, I find this post:

Making Money by Sending Congress Home

Wasn't it former Senator Howard Baker who said that the invention of air conditioning was the worst thing that ever happened to Washington, because it made year round government possible?

Of course, Congress isn't really in Washington year round. They go home a lot on recess. And apparently it's possible to profit from that tendency:

The [recent snow storm that paralyzed Washington] spelled opportunity for the Congressional Effect Fund, a mutual fund that invests in the S&P 500 only when Congress is out of session, and in Treasurys and the money market anytime else. "When we found out at 4:30 p.m. yesterday that they were going to declare a snow day, we went into the market," said Eric Singer, who manages the portfolio.

The rationale for the fund: "Over the past 40 years, 99% of the price gains in the market cumulatively occur when Congress is on vacation," Mr. Singer said.

Makes sense to me. When they're not in town, they can't do anything that gums up the works of business.

Why Don't Entrepreneurs Use Uncorporations

In his excellent book, The Rise of the Uncorporation, Larry Ribstein points out that venture capital firms typically use limited partnerships to raise funds that are then invested in a portfolio of start-ups and early stage firms (226). In contrast, the VC's portfolio firms "typically are organized as corporations" (227). Ribstein argues that an uncorporation form (LLC) would be preferable in several respects and ascribes the continued use of the corporate form in this context "at least partly" to tax considerations (228).

A new paper by Florida State economists David Cooper and Krista Jabs Siral suggests an alternative behavioral explanation:

Limiting Risk Taking via Pay

President Barack Obama's core policy on financial regulation is imposing constraints on risk taking at financial institutions that are "too big to fail":

... limits on the risks major financial firms can take are central to the reforms that I have proposed. They are central to the legislation that has passed the House, under the leadership of Chairman Barney Frank, and that we're working to pass in the Senate, under the leadership of Chairman Chris Dodd.

Fred Tung has just posted a paper in which he proposes getting at the problem via executive pay constraints:

Excessive risk taking by firm managers did not originate with the Financial Crisis of 2007-08. Though bankers had special incentives to take big risks in the period before the Crisis, the incentive effects of equity-based compensation have been understood for some time. Among other things, equity compensation tends to induce greater risk taking by aligning managers’ risk preferences with those of equity holders. Bankers’ equity-based pay structure at the time of the Crisis was a natural outgrowth of the pay-for-performance movement that began in the 1990s and now informs all of corporate executive pay. Longstanding government guaranties of bank liabilities additionally served to intensify bankers’ risk taking incentives.

I propose to ameliorate this gamblers’ incentive with a new approach to compensation at the largest banks, one that explicitly accounts for the possibility of excessive risk taking and incentivizes bankers against it. I propose that bankers be paid in part with their banks’ public subordinated debt securities. Market pricing of this debt will be particularly sensitive to downside risk at the bank. Including it in bankers’ pay arrangements and personal portfolios will therefore give bankers direct personal incentives to avoid excessive risk.