Archives For disclosure regulation

I’m delighted to report that the Liberty Fund has produced a three-volume collection of my dad’s oeuvre.  Fred McChesney edits, Jon Macey writes a new biography and Henry Butler, Steve Bainbridge and Jon Macey write introductions.  The collection can be ordered here.

Here’s the description:

As the founder of the Center for Law and Economics at George Mason University and dean emeritus of the George Mason School of Law, Henry G. Manne is one of the founding scholars of law and economics as a discipline. This three-volume collection includes articles, reviews, and books from more than four decades, featuring Wall Street in Transition, which redefined the commonly held view of the corporate firm.

Volume 1, The Economics of Corporations and Corporate Law, includes Manne’s seminal writings on corporate law and his landmark blend of economics and law that is today accepted as a standard discipline, showing how Manne developed a comprehensive theory of the modern corporation that has provided a framework for legal, economic, and financial analysis of the corporate firm.

Volume 2, Insider Trading, uses Manne’s ground-breaking Insider Trading and the Stock Market as a framework for many of Manne’s innovative contributions to the field, as well as a fresh context for understanding the complex world of corporate law and securities regulation.

Volume 3, Liberty and Freedom in the Economic Ordering of Society, includes selections exploring Manne’s thoughts on corporate social responsibility, on the regulation of capital markets and securities offerings, especially as examined in Wall Street in Transition, on the role of the modern university, and on the relationship among law, regulation, and the free market.

Manne’s most auspicious work in corporate law began with the two pieces from the Columbia Law Review that appear in volume 1, says general editor Fred S. McChesney. Editor Henry Butler adds: “Henry Manne was an innovator challenging the very foundations of the current learning.” “The ‘Higher Criticism’ of the Modern Corporation” was Manne’s first attempt at refuting the all too common notion that corporations were merely devices that allowed managers to plunder shareholders. Manne saw that such a view of corporations was inconsistent with the basic economic assumption that individuals either understand or soon will understand the costs and benefits of their own situations and that they respond according to rational self-interest.

My dad tells me the sample copies have arrived at his house, and I expect my review copy any day now.  But I can already tell you that the content is excellent.  Now-under-cited-but-essential-nonetheless corporate law classics like Some Theoretical Aspects of Share Voting and Our Two Corporation Systems: Law and Economics (two of his best, IMHO) should get some new life.  Among his non-corporations works, the classic and fun Parable of the Parking Lots (showing a humorous side of Henry that unfortunately rarely comes through in the innumerable joke emails he passes along to those of us lucky enough to be on “the list”) and the truly-excellent The Political Economy of Modern Universities (an updating of which forms a large part of a long-unfinished manuscript by my dad and me) are standouts.  And the content in the third volume from Wall Street in Transition has particular relevance today, and we would all do well to re-learn the lessons of those important contributions.

The full table of contents is below the fold.  Get it while it’s hot! Continue Reading…

Update on backdating

Geoffrey Manne —  20 December 2009

It’s been quite a while since we discussed backdating here at TOTM.  But back when it was all the rage, we were substantial contributors, formulating (we believe) some of the first fundamental explanations of the issues.  Some of the best posts from our backdating archive are here:

I look pretty young but I’m just backdated, yeah (Geoff Manne)

Option Backdating: The Next Big Corporate Scandal? (Bill Sjostrom)

Backdated options and incentives (Bill Sjostrom)

Jenkins channels Manne (Geoff Manne)

Explaining Backdating (and Jenkins Channels Manne Again) (Josh Wright)

No, Matt, executive compensation is not all about norms (Geoff Manne & Josh Wright)

Thoughts on Walker on Backdating (Josh Wright)

Along with Larry Ribstein (of course) we were early critics of the law, economics and reporting of the backdating “scandal.”  One of our posts, “No, Matt, executive compensation is not all about norms,” was made into a short law review essay.  Geoff’s “I look pretty young but I’m just backdated, yeah” post was one of the first substantial criticisms of the claims in the Wall Street Journal article that broke the story.

Although we basically gave up the backdating reporting as the story dragged on, we have been interested to watch the spectacle unfold.  And it has been quite a spectacle.

With the latest”mockery of justice” in the prosecution of these cases upon us, we thought it might be a good time to revive some of our old posts for readers who might have forgotten that there was once a substantive debate over the topic, rather than a series of prosecutorial embarrassments.

Frankly, as Larry notes, the embarrassments stem in part from the fact–as we have discussed in the posts linked above–that these cases never should have been brought in the first place.  Maybe a reminder is in order.

Omri Ben-Shahar is the Frank and Bernice J. Greenberg Professor of Law at the University of Chicago.

I will focus my blog post on one of the proposals for reducing interchange fees: the requirement that the fees be disclosed to consumers. I am not sure how seriously this option is taken by the GAO report. Indeed, the report concedes that mandated disclosures in this context are not very likely to be effective, because “consumers are likely to disregard this kind of information.” But I will not be surprised if, of all the regulatory options discussed in the report, in the end it will be the disclosure rule that is enacted.

I am sure that readers of this blog don’t need a long explanation why disclosures would be futile in this area. Numerous studies have documented the failure of mandated disclosures in other areas of consumer credit, ranging from TILA, through other financial accounts such as depository, savings, and mutual funds, and extending to disclosure by financial brokers, investment advisers, credit reporting agencies, and even pawnshops. These mandated disclosure rules fail to inform people, to improve their decisions, or to change the behavior of the financial institutions. The fail because ordinary people can read them, can’t understand them even in the most simple format, don’t know what to do with the information even it were understood, and face way too many such disclosures in their every day lives

I recently conducted a study looking at the entire body of mandated disclosure statutes that people encounter, reaching beyond financial transactions.  (You can view a talk based on the study here). Mandated disclosures are a routine regulatory device found in insurance law, health care, informed consent doctrine, Miranda warnings, IRBs, and hundreds of product- and service-specific enactments. My study concluded that none of these disclosures do anything to help people, and many of them backfire. One of the features that runs through all these scattered disclosure statutes is how easy it is politically to enact them. When lawmakers respond to a particular problem that requires intervention—much like the one we are now discussing, interchange fees—there is often debate what rules would work, how deep the intervention ought to be, and whose interests to prioritize. But there is very little debate or opposition to disclosure mandates. Everybody supports them. The perception is that more information is always better: it helps people improve their decisions, it “bolsters their autonomy” as some like to put it, and it perfects market competition. At worse, disclosure believers think, the information will not help much, but it surely will not do any harm, and disclosure regulation involves very little budgetary allocation.

Here is a case in point. Just last month, the Federal Reserve regulated overdraft fees.  After much thought and consultation, the Fed found a solution to the problem of high overdraft fees for ATM and debit card transactions. Recognizing that many consumers would prefer that money withdrawal would be declined rather than pay a sizeable overdraft fee, the rule enacted by the FED prohibits banks from charging overdraft fees unless consumers opt in to the overdraft fee option. Sounds sensible: give people choice, and set the default rule to induce information dissemination.

But here is the catch. How, according to the legislation, would consumers learn about the size of the overdraft fees and choose, if they care, to opt in? By establishing mandated disclosure requirements! That is, to make sure that the notice is “meaningful”, the Fed, with the support of consumer advocates, mandated a new form—which they call a “segregated disclosure”—a separate sheet consumers will receive from the bank providing them “a meaningful way to consent and thus to providing meaningful choice.” The ingenious advance here, which ensures “informed choice,” is to have a separate form, with a separate notice, and a separate signature. This, supposedly, will prevent “inadvertent” consent.

Like any other technical financial disclosure, this format is unlikely to help, especially the least sophisticated consumers—those most likely to carry overdrafts. Whether it is one form of separate forms, one notice or separate notices, one signature or separate signatures, this will not change the ineffectiveness of this disclosure paradigm. Consumers will get yet another pre-printed boilerplate page, with another dotted line at the bottom, which they will happily not read.

The point is that, when all is said and done, nothing much happened. There was a moment of significant public and media attention to the problem of overdraft fees, but in the end they were not regulated. Another meaningless disclosure was added to people’s lives, already swamped with hundreds and thousands of disclosures. Politically, the Fed finished its job and the problem is now “solved.” This is a familiar pattern: a disclosure rule provides an excuse to refrain from a real solution.

Now back to interchange fees. The GAO report lists several possible policy options, from direct regulation of the fees to restrictions on the terms imposed by issuers and how they are negotiated. These are controversial options that would likely lead to substantial political wrestling. There is also much uncertainty, even among the most sophisticated of academic experts, as to the effects of these measures. Perhaps other entries to this blog will shed more clarity as to the right regulatory direction. But as long as these difficulties remain, and as long as interest groups exert pressure on lawmakers, disclosure rules will once again surface as a safe, unopposed, but unfortunately useless regulatory device.

The Law and Economics of Interchange Fees and Credit Card Markets

3274955487_766014dab1Today marks the start of our two-day symposium on the law and economics of interchange fees and credit cards.  As I noted in my announcement, the scholarly and policy debates over interchange fees and credit card markets more generally are raging, with several bills pending in Congress and a recent report by the GAO on the topic.  Meanwhile, the financial crisis has brought increased scrutiny to financial institutions and credit markets, and consumer credit in particular is in the regulatory cross hairs.  Litigation continues in the Eastern District of New York, and outside the US other countries continue to scrutinize (and regulate) interchange fees.

As the GAO notes:

Proposals for reducing interchange fees in the United States or other countries have included (1) setting or limiting interchange fees, (2) requiring their disclosure to consumers, (3) prohibiting card networks from imposing rules on merchants that limit their ability to steer customers away from higher-cost cards, and (4) granting antitrust waivers to allow merchants and issuers to voluntarily negotiate rates. If these measures were adopted here, merchants would benefit from lower interchange fees. Consumers would also benefit if merchants reduced prices for goods and services, but identifying such savings would be difficult. Consumers also might face higher card use costs if issuers raised other fees or interest rates to compensate for lost interchange fee income. Each of these options also presents challenges for implementation, such as determining at which rate to set, providing more information to consumers, or addressing the interests of both large and small issuers and merchants in bargaining efforts.

Our symposium will bring together several of the world’s leading experts on interchange fees and the law and economics of credit card markets.  Our participants will discuss a range of issues surrounding the regulation of interchange and credit card markets.

The Symposium will proceed in the following order:

December 8:

  • Introductory Statements.  Posts from Richard Epstein and Ronald Mann
  • Framing the Discussion.  Posts from Bob Stillman, Allan Shampine, Tom Brown & Tim Muris, and Bob Chakravorti
  • The Consequences of Regulation and the View from Australia. Posts from Joshua Gans and Todd Zywicki
  • Looking at the Proposed US Legislation.  Posts from Omri Ben-Shahar and Joshua Wright

December 9:

  • Assessing Cross-Subsidies.  Posts from Tom Brown & Tim Muris and Todd Zywicki
  • Assessing the Network Rules.  Posts from Bob Chakravorti and Joshua Gans
  • Considering the Costs: Fraud.  Posts from Jim Van Dyke, Allan Shampine and Geoffrey Manne
  • Antitrust Issues.  Posts from Joshua Wright and Geoffrey Manne
  • Additional Responses and Closing Thoughts.  Posts from TBD

The posts will appear regularly throughout the day to allow time between posts for discussion: Check back for updates and comments.  Expect free-ranging discussion in the comments–most of these issues are inter-related and we will return to several themes throughout the symposium.

We look forward to an engaged discussion in the comments to the symposium posts, and we hope all of our readers will check in frequently during the symposium and will contribute to the debate.

Finally, I am delighted to announce that this symposium is being hosted by the International Center for Law and Economics.

iclelogo

The International Center for Law and Economics (ICLE) is a new entity—a global think tank aimed at building a strong, managed, international network of meaningful (and self-sustaining) institutions and academics devoted to methodologies and research agendas that will inject rigorous, evidence-based thinking into important policy debates. Pursuing the most successful and rigorous aspects of law and economics, dynamic competition analysis, New Institutional Economics and similar approaches to law, economics and policy, the ICLE aims to become an essential part of the policy landscape in the most important policy debates around the globe. The goals of the ICLE are both to create important scholarship as well as to ensure that it has policy relevance. The ICLE develops intellectual work itself as well as drawing on its global intellectual network.  The ultimate goal is the reinvigoration of a law and economics movement in the spirit of intellectual forebears like Armen Alchian, Ronald Coase, Harold Demsetz, Frank Easterbrook, Benjamin Klein, Henry Manne and Oliver Williamson.  The ICLE is founded in honor of Armen Alchian.

The center’s work is built around the following principles:

  • A commitment to the application of economic theory, particularly price theory and new institutional economics, to antitrust and regulatory problems
  • A commitment to empirical scholarship and applications of economic theory with real world relevance
  • The use of formal mathematical modeling exclusively as a means to furthering our knowledge about the world, rather than an ends in its own right
  • A dedication to understanding both the role of the law and institutions in facilitating competition as well as the consequences of legal rules
  • A commitment to promoting an international discourse on issues of antitrust and regulatory policy in the increasingly-global regulatory environment

And so without further ado . . .

(credit card photo credit: http://www.flickr.com/photos/andresrueda/ / CC BY 2.0)

Truth on the Market is pleased to announce its fourth blog symposium:

The Law and Economics of Interchange Fees and Credit Card Markets

For the uninitiated, the interchange fee is the fee charged (usually) by the credit card issuing bank (the cardholder’s bank) to the credit card acquiring bank (the merchant’s bank) to settle a credit card transaction between the cardholder and the merchant.  Interchange fees, as well as various rules set by credit card networks governing credit card transactions and the structure of the industry more generally have long been the subject of debate, litigation and regulation.  Credit cards have been among the most successful financial innovations ever, and credit card markets are fascinatingly complex–two features leading inexorably not only to commercial disputes but also to academic dispute and scholarly attention.

As regular readers may recall, we have had a few posts on the topic, including a spirited exchange when Steve Salop was visiting a few weeks ago.  I noted at the time that the topic of the regulation of interchange was interesting and timely–in fact, since then, while the then-pending bills are still pending in Congress, the GAO has issued its report on the effects of interchange fees on consumers and merchants.  The GAO report notes that interchange fees have been increasing, but questions whether this leads to any viable policy responses.  As the GAO notes:

Proposals for reducing interchange fees in the United States or other countries have included (1) setting or limiting interchange fees, (2) requiring their disclosure to consumers, (3) prohibiting card networks from imposing rules on merchants that limit their ability to steer customers away from higher-cost cards, and (4) granting antitrust waivers to allow merchants and issuers to voluntarily negotiate rates. If these measures were adopted here, merchants would benefit from lower interchange fees. Consumers would also benefit if merchants reduced prices for goods and services, but identifying such savings would be difficult. Consumers also might face higher card use costs if issuers raised other fees or interest rates to compensate for lost interchange fee income. Each of these options also presents challenges for implementation, such as determining at which rate to set, providing more information to consumers, or addressing the interests of both large and small issuers and merchants in bargaining efforts.

Our symposium will bring together several of the world’s leading experts on interchange fees and the law and economics of credit card markets.  Our participants will discuss a range of issues surrounding the regulation of interchange and credit card markets.

The symposium will take place on Tuesday and Wednesday, December 8 and 9.  We have not yet set the precise agenda for the symposium, but our participants include:

  • Omri Ben-Shahar (University of Chicago Law School)
  • Tom Brown (O’Melveney & Myers)
  • Bob Chakravorti (Federal Reserve Bank of Chicago)
  • Richard Epstein (University of Chicago and NYU Law Schools)
  • Joshua Gans (University of Melbourne Business School)
  • Ron Mann (Columbia University Law School)
  • Geoffrey Manne (International Center for Law & Economics and Lewis & Clark Law School)
  • Tim Muris (George Mason University School of Law and O’Melveney & Myers)
  • Allan Shampine (Compass/Lexecon)
  • Bob Stillman (CRA International)
  • Joshua Wright (George Mason University School of Law)
  • Todd Zywicki (George Mason University School of Law)

We look forward to an engaged discussion in the comments to the symposium posts, and we hope all of our readers will check in frequently during the symposium and will contribute to the debate.

We’ll announce the agenda and schedule no later than Monday, December 7.

[UPDATE:  In order to avoid linking glitches we removed the quotes from around the phrase, “all about norms” in the original title.  This post thus has a different url than the original but is otherwise the same.]

In a post titled, “Backdating: Yes, Virginia, Execs Do Want Inflated Pay,� over at PrawfsBlawg, Matt Bodie weighs in on the backdating “scandal.� As many of you know, the topic has been much-discussed of late here at TOTM and over at Larry Ribstein’s Ideoblog (who, it turns out, beat us to this punch), and you’re probably wondering when we’re ever going to stop. Well, we (Geoff and Josh) think Matt’s post is so misguided that it merits its own paragraph-by-paragraph rebuttal in this, TOTM’s first-ever co-authored blog post!

Matt begins by quoting both me and Josh (you mean, me and Geoff) on why backdating isn’t the worrisome bother the Wall Street Journal, Gretchen Morgenstern, and Matt Bodie make it out to be. Then he takes us to task:

I think Geoff and Josh are putting together two notions here: (1) the value of the grants is published at some point down the road, and (2) even if the accounting was a little unusual, it doesn’t really matter because executives could and would have paid themselves the same amount in any event. Although I’m doubtful about (1), it’s really (2) that I’d like to take issue with here. Yes, I do believe that in the absence of backdating, executive compensation would have been lower.

First, it is not our claim that “the value of the grants is published at some point down the road.� Our claim is that the value of the grants is known – as well as (or even better than) it can be for any options – the moment the grants are made (or, assuming minimal insider trading, the moment the grants are disclosed), just as it would be for non-backdated options. Not only is the value known, but it is incorporated into share price (the effects of expected dilution when the options are exercised).

This is key. Most critics of backdating seem to act as if the options were in fact granted on the backdated date and not disclosed until later. In reality, disclosure is made in due course; only the strike price is set with reference to an earlier day’s stock price. There is not, in fact, delayed disclosure.

Matt goes on:

As for (1), companies may have reported the value of the options down the road, and they may have reported the strike price. But as Jeff Lipshaw discussed here, accounting rules required different reporting for options issued at a price lower than the current market price for the stock. So backdated options were clearly a lie: they said they were issued on a date when they were not actually issued. In addition, it may have been a violation of the company’s stock option plan to issue options at a price other than the market price of the date in question. Backdated options would thus also violate the requirements of such plans.

As Lipshaw notes in that very post, the economic effect of options is independent of their accounting treatment. The fetishization of accounting is something Geoff has taken on elsewhere. But it bears repeating: Accounting is a convenient and imperfect means of quantifying behavior. It does not purport to — nor does it — represent true economic values. It’s a short cut; it’s a little like looking for your keys under the street light even though you lost them elsewhere. It certainly makes some calculations and some inter-firm comparisons easier. But accounting cannot do the impossible. There remain countless ways that, even under the same standards (hell, even under the same rules), accounting measures vary from firm to firm. If one firm expenses backdated options and another doesn’t, aside from the possible technical rule violation, the effect on inter-firm comparison, share price, market valuation, etc. is unlikely to be significantly impaired.

The point is that, even if the accounting treatment of backdated options is different than the treatment of options that are not backdated but nevertheless are granted “in the money” on the date of grant (the issue addressed in the Lipshaw post), you’d have to believe in a woefully imperfect an inefficient market to believe that the actual economic effect would pass unnoticed.  And, as Larry points out, even if it did, it takes a heroic and wholly-unsupported assumption to assert that the consequence of the oversight would be to line executives’ pockets.

As we have said here and elsewhere: THERE IS NO LIE. Here, in fact, is Geoff’s comment to the Lipshaw post referenced by Matt:

I’m not sure why anyone thinks options backdating is a lie (technical violation of a rule, maybe, but lie, no). There’s just no harm in the practice. It’s not like the options cruise along for a period of time out of the money (and priced by the market accordingly) and then are miraculously turned into at the money or in the money options the moment they are exercised. Rather, the day the options are issued, they are issued with a strike price AS IF they had been issued on an earlier date when the market price was lower. But there’s no lie here – it’s just a convenient way of providing more compensation (which I think is part of Jenkins’ point. Once again, he seems to be reading Truth on the Market (see my comments to this post). The same could be done, I assume, by arbitrarily picking a strike price lower than the market price on the day of issuance. Either way, as I note in the comment liked above, the moment the at the money options are issued they pull down share price. They are not free, nor is their effect somehow hidden from investors. So why should there be any moral outrage or any serious consequences here at all?

There is more (much more) below the fold.  Continue Reading…

Holman Jenkins reports that a group of economists led by Milton Friedman and Harry Markowitz are getting behind the idea of putting an end to the expensing of options. It is a great column. Jenkins goes on to discuss options backdating and makes the following points, which will sound unfamiliar to TOTM readers:

  • “In no generic sense can one say executives “inflated” their pay or “stole” from shareholders. Backdated packages were not more “lucrative” — it’s fallacious to assume that the alternative package consisted of an identical number of options at a less advantageous price.”
  • “Backdating did not provide “guaranteed” or “risk free” profits. It did not “undermine the incentive purpose” of options.”
  • “It seems likely that companies, after all, did correctly report the number of options and their price to shareholders. Let it be remembered, too, that millions of these options were cancelled or expired unexercised.”

Geoff made exactly these points in this space months ago (and also more recently, here). Personally, I am thrilled to see a column that focuses on the real questions surrounding backdating: (1) Why do firms backdate? (2) What are the consequences of backdating? and (3) What is the theory of harm, if any, upon which we are going to base civil and criminal prosecutions? It is remarkable, but not incredibly surprising, how little attention has been paid to these questions in favor of the Gretchen Morgenstern-style rants that Professor Ribstein enjoys dismantling weekly.

Geoff’s earlier post frames the backdating issue in terms of the important economic (and legal) questions involved. For example, Geoff makes the following basic (and sadly overlooked) points:

  1. Backdated options have incentive effects too.
  2. Regulatory quirks involving accounting rules may have provided firms the incentive to backdate.
  3. If we are to believe that some 2,000 companies engaged in some form of backdating, many did not appear to be hiding it.
  4. There may be no harm whatsoever resulting from backdating. To borrow from Geoff: “It’s not like the options cruise along for a period of time out of the money (and priced by the market accordingly) and then are miraculously turned into at the money or in the money options the moment they are exercised. Rather, the day the options are issued, they are issued with a strike price AS IF they had been issued on an earlier date when the market price was lower. But there’s no lie here – it’s just a convenient way of providing more compensation.”
  5. And finally, there are a number of instruments available to compensate executives with or without backdating. I’m not sure if anyone really believes that in the absence of backdating the actual level of compensation would decrease, despite the fact that this assumption seems necessary to the theory of harm most frequently discussed.

Assuming for the moment that backdating is as rampant as the Lie study, media reports, and sudden wellspring of law firm and litigation consultant “backdating” teams suggests, it might be prudent to ask: “why?” and something along the lines of “so what?” The only answers to the “so what” question have been assertions about shareholder exploitation and comparisons to Enron. As to “why backdating,” there seems to be little interest in figuring out what economic and institutional conditions led to the widespread adoption of option backdating and whether the practice is an efficient element of a compensation contract or something more sinister. Rather, we get mostly claims that backdating is a function of widespread fraud or compensation committee naiveity. As I explain below the fold, I don’t think either of these theories get us very far in terms of explaining backdating. Continue Reading…

ISS on Option Timing

Bill Sjostrom —  18 July 2006

Institutional Shareholder Services (ISS) has posted an eight-page white
paper entitled An Investor Guide to the Stock Option Timing Scandal. The paper provides a good overview of the recent option backdating and spring-loading revelations.

There has been a number of posts in the blawgosphere debating the legality of backdating and spring-loading. While these practices are not necessarily illegal, as the paper points out:

The option-timing scandal . . . calls into question the oversight provided by boards and compensation committee members at these companies. . . . [I]nvestors may fear that other accounting problems exist but have yet to come to light. The disclosure of backdating sends a ‘signal that management is willing to fudge numbers for their own benefit and they might be willing to play other accounting tricks.’

ISS recommends the following as best practices for option grants:

  • Adopt “blackout” periods to preclude stock grants when company executives have material, non-public information in hand.
  • Adopt fixed grant date schedules that provide for grants on a periodic basis (monthly, quarterly, or annually), along with rules for the establishment of option exercise prices on such grant dates.
  • Refrain from making grants on these fixed dates when executives have market-moving news.
  • Disclose the rationale for grants on a certain date, explaining why the compensation committee chose that date over other possible dates.
  • File Form 4 reports on option grants promptly with the SEC.

While these practices would certainly go a long way towards eliminating backdating and spring-loading, as Geoff pointed out essentially on day one of the scandal (see here), option timing can be an efficient form of compensation. SEC Commissioner Atkins recently expressed a similar view regarding spring-loading in a speech before the International Corporate Governance Network (see here). This view, however, has not been particularly well received (see, e.g., here), perhaps in part for the reasons Tom discusses here.

It will be interesting to see how many companies adopt the measures recommended by ISS. For companies embroiled in the scandal, the lost flexibility in designing a compensation package would likely be outweighed by the potential restoration of investor confidence. For companies outside the fray, perhaps the scandal will simply result in a couple of lines of added disclosure along the lines of “The compensation committee may, in the exercise of its business judgment, from time to time approve grants of options shortly before the public disclosure of favorable company developments.”

Today’s WSJ has a great article by Holman Jenkins on reporting on the backdating “scandal.”  Larry is, of course, on the case.  I would also — modestly — point out that much of what Jenkins says in his article today, I said in this space about four months ago, when the news was first breaking.  The key elements:

  1. The notion that backdating gives executives an incentive-defeating “paper profit right from the start” is asinine.
  2. “Backdating” may make perfect sense as a means of compensation, especially given certain regulatory quirks.
  3. If the practice amounts to corporate shenanigans, they sure didn’t bother to hide it very well.
  4. Non disclosure of the practice, if disclosure was required, may, of course, be illegal.
  5. To quote Larry, “second-guessing executive compensation is a tricky business, even when the problems seem clear.”

On the somewhat-related matter of spring-loaded options (the raising of which was not at all inappropriate, Elizabeth), I find myself in complete agreement with Larry.  Strange, I know.  But it ain’t misappropriation if the board knows what’s going on.  Once again, perhaps some disclosure is required, but it’s hard to see how non-disclosure of the compensation scheme could transform informed executive compensation into a section 10(b) violation.

In both cases, I’m pretty sure there’s no “there” there, but I’m equally sure we’ll be reading (and litigating) about them for quite some time to come.

Over at Professor Bainbridge’s place, Iman Anabtawi has some thoughts on the granting of “spring-loaded” options, an option granted at a market price that does not incorporate some favorable non-public information, and insider trading laws. The practice is analytically similar to granting a discount option (one with an exercise price below the market price) and is related to backdating (issued retroactively after the information is released). Check it out.

UPDATE: Ribstein responds.

Today’s W$J has an article about Zion Bancorp’s plan to register and sell to the public stock options that mimic the stock options it grants to its employees .  It seems like another good example of the unintended consequences of disclosure regulation that Geoff has blogged about before (see here, here and here).  Zion does not plan to issue the options to raise capital but instead, because employee stock options (“ESOs”) are now required to be expensed (see here and here), to establish a market value for ESO accounting purposes.  Apparently Zion is assuming that the market value will be lower than that generated by the option valuation method it currently uses for ESO accounting purposes.  It will then use this lower value when expensing its ESOs thereby reducing the hit to income from issuing ESOs.  Perversely, according to the W$J, “[t]he lower price would help to offset the company’s cost of issuing the options-linked securities.”  Huh?  Aren’t we just talking about different accounting treatment but no difference in economic substance?

See here for the story.