DeLong on Henderson III

Larry Ribstein —  7 October 2010

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.

Larry Ribstein

Posts

Professor of Law, University of Illinois College of Law

11 responses to DeLong on Henderson III

  1. 

    “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.”

    I think the last question is the best. I’ve learned in any corporate context that calls for someone else to be fired are (a) unfriendly, (b) seldom win an argument unless you are the person’s supervisor, and (c) often backfire, even if you have your own way initially. I know that academe isn’t like corporate America, and that academics can sometimes behave like prima donnas from the Golden Age of Opera, but I thought this was particularly uncalled for here. There are those of us who wouldn’t be sorry to see a whole raft of professors of some different political persuasion fired, but it is neither useful to say so nor does it strengthen one’s argument by one iota. Moreover, there is this thing called tenure . . .

  2. 
    Horace A. Winthrop 7 October 2010 at 4:17 pm

    Larry,

    Um, why do comments need to be moderated?

    Are you afraid of the market?

    • 

      Horace,

      Per blog policy, comments are moderated and will continue to be on the basis explained there. FWIW, its a property rights thing.

      Josh

      • 

        Josh,

        It’s not a property rights thing at all. You don’t allow comments that you don’t like, even if they comply with your stated policy.

        Or put more directly, you’re scared little puppies. A true free debate frightens you, or so it would appear.

        You attack Brad Delong, but then you don’t allow true rebuttal.

        Pathetic.

      • 

        Debate away James. I’ll do my best to manage my fear in the face of true rebuttal from you, Delong, etc. If you find the comments policy here too restrictive, there are many forums available for you elsewhere. In the meantime, your comments to this and other posts appear to still be here.

  3. 
    Horace A. Winthrop 7 October 2010 at 4:16 pm

    Larry, you the man!

  4. 

    To be clear:

    You think there is no difference between the statements “A finds that X is true” and “A’s findings are consistent (in line ) with X.”

    I see a great deal of difference there, and I think you have to be unreasonable not to be able to differentiate between the two claims (the simplest differentiator being that the truth values of the two statements are independent of one another)).

    • 

      Errr, nice try,

      Except for the fact that X includes the line “may serve” which weakens the force of both statements. So what kind of truth is evident in a conclusion that includes the term “may”. If you’re going to parse to this level, at least do it right.

  5. 

    Consider the present quote from Ribstein: “First, Verret did not say what DeLong attributes to him in his edited version of Verret’s initial post, as Verret himself noted later.”

    This is plainly incorrect. Compare the following two passages:

    [DeLong, in toto] 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…

    [Verret, in toto] In Insider Trading and CEO Pay, Prof. Henderson examines the effectiveness of insider trading as a compensation device using a study of 10b5-1 trading plans. His findings 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.

    These are virtually the same. The correct statement is that **Henderson** did not say what DeLong correctly attributes to **Verret**.

    How can you be so dismissive of an outsider’s criticism of a colleague’s work, when you don’t even understand it yourselves?

    • 

      GW —

      To say that what research finds is “in line with” a theory is to say they is consistent with the theory. That is not the same thing as saying that the research finds the theory to be true. DeLong’s truncation of Verret’s quote creates a stronger claim than either Verret or Henderson made and thus misrepresents the original text.

      JHA

Trackbacks and Pingbacks:

  1. DeLong pledge « Truth on the Market - October 7, 2010

    […] Comments GW on DeLong on Henderson IIIDeLong on Henderson III « Truth on the Market on DeLong and Insider TradingDeLong on […]