On October 3 I wrote:
The DeLong point I want to focus on is his last: “I genuinely do not understand why Henderson has his job.” By which he means Todd’s law professor job.
DeLong’s sole reported basis for this is a post, not by Todd, but by my co-blogger Jay Verret, who refers to a recent Henderson paper, Insider Trading and CEO Pay. Jay says Todd’s findings in the paper “are in line with Henry Manne’s original thesis from nearly 40 years ago that insider trading didn’t diminish firm market value on net and may serve a useful purpose as an executive compensation device to motivate managers to maximize the value of the firm.”
DeLong responds that “[g]iving firm managers the freedom to use information they privately have as a result of their jobs to decide when to buy and sell shares of stock does not motivate managers to manage the firm in the interest of shareholders.” That’s because, according to DeLong, “the ability to engage in insider trading. . . gives managers an incentive to make the price of the stock vary–they don’t care which way.. . . Insider trading makes executives’ portfolios’ long not the company but long the volatility of the company. . . . This claim that freedom to engage in insider trading aligns executives’ interests with those of shareholders is so basically wrong, so obviously erroneous, so simply stupid that–well, words fail me.”
As Jay notes, there’s at least significant intelligent debate on these issues. Opponents of insider trading regulation don’t argue that insider trading is always good, but that firms should be allowed to contract for it. But the most remarkable thing about DeLong’s post is that it accuses Todd of being “stupid” and unfit for law teaching because of an argument Todd didn’t make!
If DeLong had bothered to look even at the abstract of Todd’s article, perhaps he would have noticed that the article’s not about alignment of incentives, but about whether boards bargain with insiders over their gains. Todd finds evidence consistent with the hypothesis that “boards pay executives in a way that reflects the profits they are expected to earn from informed trades.”
Todd doesn’t even argue based on this evidence that insider trading liability should be abolished. Rather, he says only that “the case for classic insider trading is made much weaker by this data.” He also notes in the abstract that “there still may be good reasons to prohibit some individuals from trading on material, non-public information.” One of these reasons might be DeLong’s point that firms would be better off if insiders weren’t paid with insider trading profits. Maybe that holds even if the insiders are willing to pay for the opportunity to trade. I don’t necessarily subscribe to DeLong’s arguments, but I’m not willing to call somebody “stupid” and unfit for teaching for making them. My only point here is that Todd doesn’t discuss this issue at all.
I will leave it to the reader to decide what we should make of a Professor of Economics at U.C Berkeley, Chair of Berkeley’s Political Economy major and former Deputy Assistant Secretary of the Treasury who is willing, in print, to accuse somebody of being “simply stupid” for a position he does not take expressed in a blog post he didn’t write
DeLong responds:
Ribstein, Adler, Volokh, etc.:
[T]he abstract of Todd [Henderson]’s article… [shows] that the article’s not about alignment of incentives, but about whether boards bargain with insiders over their gains. Todd finds evidence consistent with the hypothesis that “boards pay executives in a way that reflects the profits they are expected to earn from informed trades”…
J.W. Verret:
In “Insider Trading and CEO Pay,” Prof. Henderson examines the effectiveness of insider trading as a compensation device…. His findings are… that insider trading… may serve a useful purpose as an executive compensation device to motivate managers to maximize the value of the firm…
Todd Henderson, in said abstract:
Insider Trading and CEO Pay: This Paper presents evidence boards of directors “bargain” with executives about the profits they expect to make from trades in firm stock. The evidence suggests executives whose trading freedom is increased using Rule 10b5-1 trading plans experienced reductions in other forms of pay to offset the potential gains from trading. There are two benefits from trading—portfolio optimization and informed trading profits—and this Paper allows us to isolate them. The data show boards pay executives in a way that reflects the profits they are expected to earn from informed trades…. As a matter of policy, the data seriously undercut criticisms of the laissez-faire view of insider trading…. At least with respect to classic insider trading (that is, a manager of a firm trading on the basis of information about the firm where she works), if boards are taking potential trading profits into consideration when setting pay, it is difficult to locate potential victims of this trading. Current shareholders should be happy with a deal that pays managers in part out of the hide of future shareholders…
I call this one for Verret 6-0, 6-0, 6-0.
The reader will note two things. First, Verret did not say what DeLong attributes to him in his edited version of Verret’s initial post, as Verret himself noted later. Second, Todd’s abstract does not say what DeLong’s edited version of Verret says. Henderson says that the data shows that insider pay adjusts to reflect expected insider trading profits, not that “insider trading. . . may serve a useful purpose as an executive compensation device to motivate managers to maximize the value of the firm.”
I wonder whether (1) DeLong does not understand the difference between these two statements; or (2) by clever manipulation DeLong wants the reader to believe that Henderson said something he didn’t say, so that DeLong can then call it stupid (which, as I said earlier, it isn’t).
Whichever is the case, I also wonder why a person in DeLong’s position decided to embark on this character assassination in the first place.
Update: Jonathan Adler also responds, with more detail on the stuff DeLong cut out. That is all I plan to say about DeLong on Henderson (and probably about DeLong on anything). There is much more that can be said about whether insider trading should be regulated, and I will likely discuss it when the issue is raised by a new case, SEC rule or cogent commentary. In particular, I expect to have more to say later about Henderson’s very interesting paper which DeLong carelessly trashes. But I can now see that a discussion with the likes of Brad DeLong is not productive.
