Archives For executive compensation

A recent tweet by Lina Khan, discussing yesterday’s American Express decision, exemplifies an unfortunate trend in contemporary antitrust discourse.  Khan wrote:

The economists cited by the Second Circuit (whose opinion SCOTUS affirms) for the analysis of ‘two-sided’ [markets] all had financial links to the credit card sector, as we point out in FN 4 [link to amicus brief].

Her implicit point—made more explicitly in the linked brief, which referred to the economists’ studies as “industry-funded”—was that economic analysis should be discounted if the author has ever received compensation from a firm that might benefit from the proffered analysis.

There are two problems with this reasoning.  First, it’s fallacious.  An ad hominem argument, one addressed “to the person” rather than to the substance of the person’s claims, is a fallacy of irrelevance, sometimes known as a genetic fallacy.  Biased people may make truthful claims, just as unbiased people may get things wrong.  An idea’s “genetics” are irrelevant.  One should assess the substance of the actual idea, not the identity of its proponent.

Second, the reasoning ignores that virtually everyone is biased in some way.  In the antitrust world, those claiming that we should discount the findings and theories of industry-connected experts urging antitrust modesty often stand to gain from having a “bigger” antitrust.

In the common ownership debate about which Mike Sykuta and I have recently been blogging, proponents of common ownership restrictions have routinely written off contrary studies by suggesting bias on the part of the studies’ authors.  All the while, they have ignored their own biases:  If their proposed policies are implemented, their expertise becomes exceedingly valuable to plaintiff lawyers and to industry participants seeking to traverse a new legal minefield.

At the end of our recent paper, The Case for Doing Nothing About Institutional Investors’ Common Ownership of Small Stakes in Competing Firms, Mike and I wrote, “Such regulatory modesty will prove disappointing to those with a personal interest in having highly complex antitrust doctrines that are aggressively enforced.”  I had initially included a snarky footnote, but Mike, who is far nicer than I, convinced me to remove it.

I’ll reproduce it here in the hopes of reducing the incidence of antitrust ad hominem.

Professor Elhauge has repeatedly discounted criticisms of the common ownership studies by suggesting that critics are biased.  See, e.g., Elhauge, supra note 26, at 1 (observing that “objections to my analysis have been raised in various articles, some funded by institutional investors with large horizontal shareholdings”); id. at 3 (“My analysis of executive compensation has been critiqued in a paper by economic consultants O’Brien and Waehrer that was funded by the Investment Company Institute, which represents institutional investors and was headed for the last three years by the CEO of Vanguard.”); Elhauge, supra note 124, at 3 (observing that airline and banking studies “have been critiqued in other articles, some funded by the sort of institutional investors that have large horizontal shareholdings”); id. at 17 (“The Investment Company Institute, an association of institutional investors that for the preceding three years was headed by the CEO of Vanguard, has funded a couple of papers to critique the empirical study showing an adverse link between horizontal shareholding and airline prices.”); id. (observing that co-authors of critique “both have significant experience in the airline industry because they consulted either for the airlines or the DOJ on airline mergers that were approved notwithstanding high levels of horizontal shareholding”); id. at 19 (“The Investment Company Institute has responded by funding a second critique of the airline study.”); id. at 23-24 (“Even to the extent that such studies are not directly funded by industry, when an industry has been viewed as benign for a long time, confirmation bias is a powerful force that will incline many to interpret any data to find no adverse effects.”).  He fails, however, to acknowledge his own bias.  As a professor of antitrust law at one of the nation’s most prestigious law schools, he has an interest in having antitrust be as big and complicated as possible: The more complex the doctrine, and the broader its reach, the more valuable a preeminent antitrust professor’s expertise becomes.  This is not to suggest that one should discount the assertions of Professor Elhauge or other proponents of restrictions on common ownership.  It is simply to observe that bias is unavoidable and that the best approach is therefore to evaluate claims according to their substance, not according to who is asserting them.

As Thom previously posted, he and I have a new paper explaining The Case for Doing Nothing About Common Ownership of Small Stakes in Competing Firms. Our paper is a response to cries from the likes of Einer Elhauge and of Eric Posner, Fiona Scott Morton, and Glen Weyl, who have called for various types of antitrust action to reign in what they claim is an “economic blockbuster” and “the major new antitrust challenge of our time,” respectively. This is the first in a series of posts that will unpack some of the issues and arguments we raise in our paper.

At issue is the growth in the incidence of common-ownership across firms within various industries. In particular, institutional investors with broad portfolios frequently report owning small stakes in a number of firms within a given industry. Although small, these stakes may still represent large block holdings relative to other investors. This intra-industry diversification, critics claim, changes the managerial objectives of corporate executives from aggressively competing to increase their own firm’s profits to tacitly colluding to increase industry-level profits instead. The reason for this change is that competition by one firm comes at a cost of profits from other firms in the industry. If investors own shares across firms, then any competitive gains in one firm’s stock are offset by competitive losses in the stocks of other firms in the investor’s portfolio. If one assumes corporate executives aim to maximize total value for their largest shareholders, then managers would have incentive to soften competition against firms with which they share common ownership. Or so the story goes (more on that in a later post.)

Elhague and Posner, et al., draw their motivation for new antitrust offenses from a handful of papers that purport to establish an empirical link between the degree of common ownership among competing firms and various measures of softened competitive behavior, including airline prices, banking fees, executive compensation, and even corporate disclosure patterns. The paper of most note, by José Azar, Martin Schmalz, and Isabel Tecu and forthcoming in the Journal of Finance, claims to identify a causal link between the degree of common ownership among airlines competing on a given route and the fares charged for flights on that route.

Measuring common ownership with MHHI

Azar, et al.’s airline paper uses a metric of industry concentration called a Modified Herfindahl–Hirschman Index, or MHHI, to measure the degree of industry concentration taking into account the cross-ownership of investors’ stakes in competing firms. The original Herfindahl–Hirschman Index (HHI) has long been used as a measure of industry concentration, debuting in the Department of Justice’s Horizontal Merger Guidelines in 1982. The HHI is calculated by squaring the market share of each firm in the industry and summing the resulting numbers.

The MHHI is rather more complicated. MHHI is composed of two parts: the HHI measuring product market concentration and the MHHI_Delta measuring the additional concentration due to common ownership. We offer a step-by-step description of the calculations and their economic rationale in an appendix to our paper. For this post, I’ll try to distill that down. The MHHI_Delta essentially has three components, each of which is measured relative to every possible competitive pairing in the market as follows:

  1. A measure of the degree of common ownership between Company A and Company -A (Not A). This is calculated by multiplying the percentage of Company A shares owned by each Investor I with the percentage of shares Investor I owns in Company -A, then summing those values across all investors in Company A. As this value increases, MHHI_Delta goes up.
  2. A measure of the degree of ownership concentration in Company A, calculated by squaring the percentage of shares owned by each Investor I and summing those numbers across investors. As this value increases, MHHI_Delta goes down.
  3. A measure of the degree of product market power exerted by Company A and Company -A, calculated by multiplying the market shares of the two firms. As this value increases, MHHI_Delta goes up.

This process is repeated and aggregated first for every pairing of Company A and each competing Company -A, then repeated again for every other company in the market relative to its competitors (e.g., Companies B and -B, Companies C and -C, etc.). Mathematically, MHHI_Delta takes the form:

where the Ss represent the firm market shares of, and Betas represent ownership shares of Investor I in, the respective companies A and -A.

As the relative concentration of cross-owning investors to all investors in Company A increases (i.e., the ratio on the right increases), managers are assumed to be more likely to soften competition with that competitor. As those two firms control more of the market, managers’ ability to tacitly collude and increase joint profits is assumed to be higher. Consequently, the empirical research assumes that as MHHI_Delta increases, we should observe less competitive behavior.

And indeed that is the “blockbuster” evidence giving rise to Elhauge’s and Posner, et al.,’s arguments  For example, Azar, et. al., calculate HHI and MHHI_Delta for every US airline market–defined either as city-pairs or departure-destination pairs–for each quarter of the 14-year time period in their study. They then regress ticket prices for each route against the HHI and the MHHI_Delta for that route, controlling for a number of other potential factors. They find that airfare prices are 3% to 7% higher due to common ownership. Other papers using the same or similar measures of common ownership concentration have likewise identified positive correlations between MHHI_Delta and their respective measures of anti-competitive behavior.

Problems with the problem and with the measure

We argue that both the theoretical argument underlying the empirical research and the empirical research itself suffer from some serious flaws. On the theoretical side, we have two concerns. First, we argue that there is a tremendous leap of faith (if not logic) in the idea that corporate executives would forgo their own self-interest and the interests of the vast majority of shareholders and soften competition simply because a small number of small stakeholders are intra-industry diversified. Second, we argue that even if managers were so inclined, it clearly is not the case that softening competition would necessarily be desirable for institutional investors that are both intra- and inter-industry diversified, since supra-competitive pricing to increase profits in one industry would decrease profits in related industries that may also be in the investors’ portfolios.

On the empirical side, we have concerns both with the data used to calculate the MHHI_Deltas and with the nature of the MHHI_Delta itself. First, the data on institutional investors’ holdings are taken from Schedule 13 filings, which report aggregate holdings across all the institutional investor’s funds. Using these data masks the actual incentives of the institutional investors with respect to investments in any individual company or industry. Second, the construction of the MHHI_Delta suffers from serious endogeneity concerns, both in investors’ shareholdings and in market shares. Finally, the MHHI_Delta, while seemingly intuitive, is an empirical unknown. While HHI is theoretically bounded in a way that lends to interpretation of its calculated value, the same is not true for MHHI_Delta. This makes any inference or policy based on nominal values of MHHI_Delta completely arbitrary at best.

We’ll expand on each of these concerns in upcoming posts. We will then take on the problems with the policy proposals being offered in response to the common ownership ‘problem.’

 

 

 

 

 

 

The antitrust industry never sleeps – it is always hard at work seeking new business practices to scrutinize, eagerly latching on to any novel theory of anticompetitive harm that holds out the prospect of future investigations.  In so doing, antitrust entrepreneurs choose, of course, to ignore Nobel Laureate Ronald Coase’s warning that “[i]f an economist finds something . . . that he does not understand, he looks for a monopoly explanation.  And as in this field we are rather ignorant, the number of ununderstandable practices tends to be rather large, and the reliance on monopoly explanations frequent.”  Ambitious antitrusters also generally appear oblivious to the fact that since antitrust is an administrative system subject to substantial error and transaction costs in application (see here), decision theory counsels that enforcers should proceed with great caution before adopting novel untested theories of competitive harm.

The latest example of this regrettable phenomenon is the popular new theory that institutional investors’ common ownership of minority shares in competing firms may pose serious threats to vigorous market competition (see here, for example).  If such investors’ shareholdings are insufficient to control or substantially influence the strategies employed by the competing firms, what is the precise mechanism by which this occurs?  At the very least, this question should give enforcers pause (and cause them to carefully examine both the theoretical and empirical underpinnings of the common ownership story) before they charge ahead as knights errant seeking to vanquish new financial foes.  Yet it appears that at least some antitrust enforcers have been wasting no time in seeking to factor common ownership concerns into their modes of analysis.  (For example, The European Commission in at least one case presented a modified Herfindahl-Hirschman Index (MHHI) analysis to account for the effects of common shareholding by institutional investors, as part of a statement of objections to a proposed merger, see here.)

A recent draft paper by Bates White economists Daniel P. O’Brien and Keith Waehrer raises major questions about recent much heralded research (reported in three studies dealing with executive compensation, airlines, and banking) that has been cited to raise concerns about common minority shareholdings’ effects on competition.  The draft paper’s abstract argues that the theory underlying these concerns is insufficiently developed, and that there are serious statistical flaws in the empirical work that purports to show a relationship between price and common ownership:

“Recent empirical research purports to show that common ownership by institutional investors harms competition even when all financial holdings are minority interests. This research has received a great deal of attention, leading to both calls for and actual changes in antitrust policy. This paper examines the research on this subject to date and finds that its conclusions regarding the effects of minority shareholdings on competition are not well established. Without prejudging what more rigorous empirical work might show, we conclude that researchers and policy authorities are getting well ahead of themselves in drawing policy conclusions from the research to date. The theory of partial ownership does not yield a specific relationship between price and the MHHI. In addition, the key explanatory variable in the emerging research – the MHHI – is an endogenous measure of concentration that depends on both common ownership and market shares. Factors other than common ownership affect both price and the MHHI, so the relationship between price and the MHHI need not reflect the relationship between price and common ownership. Thus, regressions of price on the MHHI are likely to show a relationship even if common ownership has no actual causal effect on price. The instrumental variable approaches employed in this literature are not sufficient to remedy this issue. We explain these points with reference to the economic theory of partial ownership and suggest avenues for further research.”

In addition to pinpointing deficiencies in existing research, O’Brien and Waehrer also summarize serious negative implications for the financial sector that could stem from the aggressive antitrust pursuit of partial ownership for the financial sector – a new approach that would be at odds with longstanding antitrust practice (footnote citations deleted):

“While it is widely accepted that common ownership can have anticompetitive effects when the owners have control over at least one of the firms they own (a complete merger is a special case), antitrust authorities historically have taken limited interest in common ownership by minority shareholders whose control seems to be limited to voting rights. Thus, if the empirical findings and conclusions in the emerging research are correct and robust, they could have dramatic implications for the antitrust analysis of mergers and acquisitions. The findings could be interpreted to suggest that antitrust authorities should scrutinize not only situations in which a common owner of competing firms control at least one of the entities it owns, but also situations in which all of the common owner’s shareholdings are small minority positions. As [previously] noted, . . . such a policy shift is already occurring.

Institutional investors (e.g., mutual funds) frequently take positions in multiple firms in an industry in order to offer diversified portfolios to retail investors at low transaction costs. A change in antitrust or regulatory policy toward these investments could have significant negative implications for the types of investments currently available to retail investors. In particular, a recent proposal to step up antitrust enforcement in this area would seem to require significant changes to the size or composition of many investment funds that are currently offered.

Given the potential policy implications of this research and the less than obvious connections between small minority ownership interests and anticompetitive price effects, it is important to be particularly confident in the analysis and empirical findings before drawing strong policy conclusions. In our view, this requires a valid empirical test that permits causal inferences about the effects of common ownership on price. In addition, the empirical findings and their interpretation should be consistent with the observed behavior of firms and investors in the economic and legal environments in which they operate.

We find that the airline, banking, and compensation papers [that deal with minority shareholding] fall short of these criteria.”

In sum, at the very least, a substantial amount of further work is called for before significant enforcement resources are directed to common minority shareholder investigations, lest competitively non-problematic investment holdings be chilled.  More generally, the trendy antitrust pursuit of common minority shareholdings threatens to interfere inappropriately in investment decisions of institutional investors and thereby undermine efficiency.  Given the great significance of institutional investment for vibrant capital markets and a growing, dynamic economy, the negative economic welfare consequences of such unwarranted meddling would likely swamp any benefits that might accrue from an occasional meritorious prosecution.  One may hope that the Trump Administration will seriously weigh those potential consequences as it examines the minority shareholding issue, in deciding upon its antitrust policy priorities.

This coming Friday (Oct. 12), the Center for Business Law and Regulation at Case Western Law School will host what promises to be a terrific symposium on executive compensation.  Presenters include TOTM alumnus Todd Henderson (Chicago Law), Jill Fisch (Penn Law), Jesse Fried (Harvard Law), David Walker (Boston U Law), David Larcker (Stanford Business), Stephen L. Brown (TIAA-CREF), Paul Hodgson (GMI Ratings), William Mulligan (Primus Venture Partners).

Here’s a description of the symposium:

Executive compensation has become the most contentious issue in corporate governance. Many claim that poorly designed executive compensation helped cause the recent financial collapse, but critics disagree widely about what was wrong with those designs. Management and investors are wrestling over their roles in structuring executive compensation through say-on-pay and over the role of proxy advisory services. The symposium brings together prominent practicing attorneys, institutional investors, proxy advisors, and academics to discuss the current issues and where we are, or should be, headed.

If you’re in Cleveland and able to make it to the symposium (for which 4.5 hours of CLE is available), do it.  Otherwise, check out the webcast.

On November 3rd, the president of the United States spoke at the Hotel Lowry in St. Paul, Minnesota, in what was billed repeatedly as a bi-partisan address. The president ridiculed reactionaries in Congress who he claimed represented the wealthy and the powerful, and whose “theory seems to be that if these groups are prosperous, they will pass along some of their prosperity to the rest of us.” The president drew a direct line between prosperity and increased “fairness” in the distribution of wealth: “We know that the country will achieve economic stability and progress only if the benefits of our production are widely distributed among all its citizens.” The president then laid out an ambitious agenda focused on creating jobs, improving education, expanding health care, and ensuring equal rights for all.

Addressing his opponents in Congress, the president said “[t]here are people who contend that . . . programs for the general welfare will cost too much,” but argued “[t]he expenditures which we make today for the education, health, and security of our citizens are investments in the future of our country . . . .” Giving a specific, and favorite, example, the president argued that government investments in the areas of energy are “good investments in the future of this great country.” Building on the meme about great countries doing great national projects, he praised the Louisiana Purchase, which brought Minnesota into the Union, and compared congressional critics of his past and proposed spending to those who argued President Jefferson should not have been allowed to borrow to buy “Louisiana” from Napoleon.

The speech was given on November 3, 1949, and the president was Harry Truman. But it could just as easily have come from the mouth of our current president, despite the fact that President Obama’s December 2011 speech in Osawatomie, Kansas was allegedly invoking President Teddy Roosevelt. In fact, we could play a game – call it, “Harry or Barry?” (as the president was called for most of his life) – to see how little has changed since 1949:

Continue Reading…

Not, as economic theory would predict, because they need the money, according to Bhattacharya and Marshall, Do They Do it for the Money?  Here’s the abstract:

Using a sample of all top management who were indicted for illegal insider trading in the United States for trades during the period 1989-2002, we explore the economic rationality of this white-collar crime. If this crime is an economically rational activity in the sense of Becker (1968), where a crime is committed if its expected benefits exceed its expected costs, “poorer” top management should be doing the most illegal insider trading. This is because the “poor” have less to lose (present value of foregone future compensation if caught is lower for them.) We find in the data, however, that indictments are concentrated in the “richer” strata after we control for firm size, industry, firm growth opportunities, executive age, the opportunity to commit illegal insider trading, and the possibility that regulators target the “richer” strata. We thus rule out the economic motive for this white-collar crime, and leave open the possibility of other motives.

One hypothesis:  the need for more money is not necessarily perfectly correlated with how much you have.  Insider traders are rich because they really want to be rich (some would call this “greed”). The higher demand for money offsets the risks. This doesn’t mean you can “rule out the economic motive” for insider trading. 

There may be broader implications here for executive compensation, executive misconduct generally, and for reconciling this data with evidence of executives’ willingness to trade off insider trading and other compensation.

Say on say on pay?

Larry Ribstein —  6 November 2011

“Say on pay” seems like one of those “chicken soup” ideas — at best salutary and at worst unobjectionable.  Who could object to letting the shareholders vote on executive pay?

Minor Myers, for one, in The Perils of Shareholder Voting on Executive Compensation. He suggests that “the more involved shareholders are in a firm’s managerial decisions, the more difficult it is for directors to be held accountable for the outcome of those decisions.” The shareholder vote, he argues, will insulate directors’ compensation decisions from shareholder outrage, which might otherwise have served as an important discipline.  He “proposes amending the [say on pay] legislation to allow firms to opt-out of the say on pay regime by shareholder vote. This preserves the benefits of say on pay for those firms where shareholders wish to retain it and allows other firms to exit the regime at little cost.”

This proposal makes some sense. Myers cites evidence indicating that some firms gain and others lose from say on pay.  In other words, some firms find that they benefit more from holding directors solely responsible for managerial pay than by having the (mostly disengaged) shareholders take responsibility. Indeed, Myers’ theory suggests say on pay may be a boon to greedy managers.

Although Myers would amend say on pay to make it optional, one wonders why the rule would be necessary at all.  State corporation law already provides for something like an opt-in regime by authorizing charter amendments on this issue. Myers argues that opt-out is better than opt-in because the equilibrium under the opt-in alternative would be driven by managerial opportunism.  But given shareholder inertia, I’m not persuaded the equilibrium under opt out would be any better.

In any event, the rationale for federal interference in state corporate law is the need for federal minimum standards.  If say on pay is no longer a minimum standard — if, like other corporate governance provisions it is just another default rule, with costs and benefits that vary from firm to firm — then why should it be a federal rule?

Myers’ analysis suggests that say on pay is, at best, one possible decent default rule, suitable for some firms.  If that’s the best rationale we can come up with, then it’s hard to see why we shouldn’t have federal say on all other corporate governance — in other words, a full-fledged optional federal corporate law.  Such a law could include a say on pay opt-in.  Or we could have an opt-in federal corporate law with opt out say on pay.  We could call such a statute say on say on say on pay.

Or we could just forget the whole thing.

As I discussed last May, corporations are hoarding cash.  According to today’s WSJ, they’re still hoarding cash.

Mira Ganor writes, in Agency Costs in the Era of Economic Crisis, that it could be about CEO compensation. Here’s the abstract:

This Article reports results of an empirical study that suggests that the current economic crisis has changed managerial behavior in the US in a way that may impede economic recovery. The study finds a strong, statistically significant and economically meaningful, positive correlation between the CEO total annual compensation and corporate cash holdings during the economic crisis, in the years 2008-2010. This correlation did not exist in comparable magnitudes in prior years. The finding supports the criticism against current managerial compensation practices and suggests that high CEO compensation increases managerial risk aversion in times of crisis and contributes to the growing money hoarding practices that worsen an economic slowdown. One possible explanation for the empirical findings is that during the last economic crisis, managerial risk seeking transformed into risk aversion that stalls economic recovery. The study has implications for the discussion on managerial pay arrangements and the implementation of the Dodd-Frank Act concerning say-on-pay

Whatever the cause, as I wrote last May there is a possible solution for cash hoarding (and possibly a better way to deal with agency costs generally), at least for some types of firms:

As I’ve pointed out in numerous articles (e.g.) and in my Rise of the Uncorporation, the uncorporation replaces often-ineffective corporate-type disciplines like fiduciary duties and shareholder voting with financial discipline centered on debt and distributions, which restricts the amount of cash managers have to play with.

And the underuse of the uncorporate form itself comes down to another problem:  the corporate tax.

Yesterday at the Illinois Corporate Colloquium Steve Choi presented his paper (with Pritchard and Weichman), Scandal Enforcement at the SEC: Salience and the Arc of the Option Backdating Investigations.  Here’s the abstract:

We study the impact of scandal-driven media scrutiny on the SEC’s allocation of enforcement resources. We focus on the SEC’s investigations of option backdating in the wake of numerous media articles on the practice of backdating. We find that as the level of media scrutiny of option backdating increased, the SEC shifted its mix of investigations significantly toward backdating investigations and away from investigations involving other accounting issues. We test the hypothesis that SEC pursued more marginal investigations into backdating as the media frenzy surrounding the practice persisted at the expense of pursuing more egregious accounting issues that did not involve backdating. Our event study of stock market reactions to the initial disclosure of backdating investigations shows that those reactions declined over our sample period. We also find that later backdating investigations are less likely to target individuals and less likely to accompanied by a parallel criminal investigation. Looking at the consequences of the SEC’s backdating investigations, later investigations were more likely to be terminated or produce no monetary penalties. We find that the magnitude of the option backdating accounting errors diminished over time relative to other accounting errors that attracted SEC investigations.

As readers of this blog, and Ideoblog before it, will appreciate, this paper particularly resonated with me.  As I wrote in a large number of posts (e.g.) backdating was a molehill the media blew up into a mountain.  Now come Choi et al with evidence that while the SEC was spending its scarce resources on this overblown molehill it was ignoring real mountains (e.g., Madoff).

I found the paper overall quite persuasive.  I wasn’t entirely convinced by the evidence that the backdating cases were getting weaker.  In particular, stock price reactions may just indicate the market was learning about the which companies were involved before the investigations were brought, and was gradually figuring out that backdating was not such a big deal.  But I was convinced of the evidence of the opportunity costs of the SEC’s backdating obsession — the otherwise inexplicable decline in investigations of serious non-backdating accounting problems.

As we discussed in the Colloquium, the paper reveals that there are agency costs not just in the backdating companies that were investigated but also in the agency that was doing the investigating.  Although it’s not clear exactly what moved the SEC to follow the media, there is at least some doubt about whether the SEC’s resource allocation decisions were in the public interest.

This calls attention to another set of agents — the ones in the media.  Why did the media love backdating so much?  As discussed in my Public Face of Scholarship, there are “demand” and “supply” explanations:  the public demands stories about cheating executives and/or journalists like to supply these stories.  David Baron, Persistent Media Bias, presents a supply theory emphasizing journalists’ anti-market bias.

Whatever the cause of media bias, when the media is influential its bias can result in bad public policy. SEC enforcement isn’t the only example. As I discuss in my article (at 1210-11, footnotes omitted):

Where interest groups are closely divided, the outcome of political battles may depend on how much voter support each side can enlist. This may depend on how journalists have portrayed the issue to the public. For example, the press is an important influence on corporate governance. One factor in the rapid passage of the Sarbanes-Oxley Act, the strongest federal financial regulation in seventy years, may have been the overwhelmingly negative coverage of business in the first half of 2002: seventy-seven percent of the 613 major network evening news stories on business concerned corporate scandals.

It’s not clear what can be done to better align SEC enforcement policy with the public interest.  Incentive compensation for SEC investigators?  Perhaps the only thing we can do (as with corporate crime) is to try to keep in mind when creating regulation that even if corporate agents may sometimes do the wrong thing, people don’t stop being people when they go to work for the government.

Larcker & Tayan speculate, for example (footnotes omitted):

Researchers have long noted that the compensation of college football coaches has risen faster than the compensation of other university employees. According to one study, the compensation awarded to head coaches rose 500 percent between 1986 and 2007. By comparison, the compensation of university presidents rose 100 percent and the compensation of full professors only 30 percent over this period. Student athletes receive no compensation. As a result, the average head football coach of an NCAA Division I school earns three times the compensation of the average president, 17 times the salary of an assistant professor, and an infinite amount more than the average student athlete. The NCAA Act required that a university calculate and disclose these ratios for its own constituents.

They ask:

* If these requirements would not work in an athletic setting, should we expect them to work in business?
* Why are the governance provisions of Dodd-Frank legally required, rather than voluntarily adopted by individual companies?
* Why does Dodd-Frank place such emphasis on executive compensation and disclosure? Will its compensation requirements reduce governance failures?

Now that regulating banker pay has been studied exhaustively, here’s something else worth studying:  bank regulator pay.  Fred Tung and Todd Henderson are on the case, in Pay for Regulator Performance.  Here’s the abstract:

Few doubt that executive compensation arrangements encouraged the excessive risk taking by banks that led to the recent Financial Crisis. Accordingly, academics and lawmakers have called for the reform of banker pay practices. In this Article, we argue that regulator pay is to blame as well, and that fixing it may be easier and more effective than reforming banker pay. Regulatory failures during the Financial Crisis resulted at least in part from a lack of sufficient incentives for examiners to act aggressively to prevent excessive risk. Bank regulators are rarely paid for performance, and in atypical cases involving performance bonus programs, the bonuses have been allocated in highly inefficient ways. We propose that regulators, specifically bank examiners, be compensated with a debt-heavy mix of phantom bank equity and debt, as well as a separate bonus linked to the timing of the decision to shut down a bank. Our pay-for-performance approach for regulators would help reduce the incidence of future regulatory failures

This is an interesting and well-executed idea which inspired a few thoughts.

First, if private-sector-type compensation for regulators is worthwhile, why not just rely on private sector rather than government regulators?  It would seem that the difference between government and private industry is really all about incentives.  Indeed, if we only semi-privatize by injecting market incentives into government actors, this could create tension in incentives analogous to imposing “corporate social responsibility” on corporate agents.

Second, might this proposal work for other types of gatekeepers, such as auditors?  Of course accounting regulation has moved in the opposite direction, toward making them more “independent.”  The Tung-Henderson analysis suggests that carefully structured performance pay may be a better way to go.

Third, if bank regulators, what about other public servants, including prosecutors? As I’ve written in my recently published Agents Prosecuting Agents (SSRN draft), they are agents too. Would incentive compensation better align their interests with those of the public?  My article discusses some problems with this (footnotes omitted):

Designing incentive compensation for prosecutors presents significant challenges.  Even in private law firms in which lawyers produce a clear financial output in the form of fees, there is controversy over whether billable hours or lockstep seniority-based compensation provides the best overall incentives.  The compensation design challenge is greater for prosecutors because there is no measure of the value of prosecutorial efforts.  Obviously a simple metric such as number of prosecutions would skew incentives, in that it may induce prosecutors to ignore the social costs of misguided prosecutions.  One author has proposed compensation based on convictions of charged crimes with deductions for findings of prosecutorial misconduct.  However, this could skew incentives toward, for example, undercharging defendants and over-caution.  On the other hand, tests that try to take more factors into account would be very costly to apply.

Tung and Henderson show how to overcome these metrics problems with bank regulators.  I’m skeptical analogous devices would work for prosecutors, even regarding purely corporate crime.  You’d have to, among other things, measure the deterrence effects of particular prosecutions. Not sure event studies could manage this.

There’s a lot more in this thought-provoking piece. Read the whole thing.

Ten leading corporate and securities law professors have petitioned the SEC to develop rules to require companies to disclose their political spending.

This is the latest iteration of efforts to end-run Citizens United’s restrictions on regulating corporate campaign activities by calling it corporate governance regulation.  See my recent post on the Shareholder Protection Act.  I’ve written on these issues in my recently published The First Amendment and Corporate Governance.

The proposed regulation has a good chance of passing muster under the First Amendment because it would focus on disclosure rather than imposing substantive restrictions on corporate speech. Nevertheless, the First Amendment is still relevant.  I have already noted my view that the SEC’s proxy access rule (which is also basically a disclosure rule) avoided a confrontation with the First Amendment only because the DC Circuit could invalidate it on other grounds. At some point mandatory disclosure can sufficiently burden corporate speech to be unconstitutional.  To give just one example, requiring firms to pre-disclose all of their spending for the coming year, thereby preventing them to respond flexibly to changes in the political environment, could push the line.

Even if the SEC rules are constitutional, they would still not necessarily be good policy.  Notably, the law professors’ rulemaking petition, while spending some time discussing the supposed importance to investors of corporate political spending, said nothing about whether an SEC rule was necessary.  The petition highlighted the fact that many corporations already were voluntarily disclosing political spending, sometimes even without shareholder request. Why not continue the experimentation and evolution rather than locking down a one-size-fits-all rule?  Do the benefits of standardization outweigh the costs of experimentation?

The petition cites precedents such as executive compensation disclosure as evidence of the “evolving nature of disclosure requirements.”  But there’s nothing about this evolution that suggests it needs to proceed toward more disclosure about every political hot-button issue.

No doubt the SEC will proceed as the petition requests.  After all, it needs a juicy political issue to deflect attention from the recent questions about the SEC’s soundness and competence as a financial cop. But let’s at least hope that the Commission has learned something from its most recent run-in with the DC Circuit and tries to get some data on exactly who would be helped and hurt by regulation of political disclosures and how much. As with proxy access, would this be all about empowering certain activists at the expense of others, or passive diversified shareholders?  My article discusses some of these tradeoffs. The SEC’s analysis  might benefit from data on exactly what was accomplished by the Commission’s past disclosure enhancements the petitioners highlight.

The danger that the SEC will fall prey to the arbitrariness the DC Circuit criticized is especially intense given the petitioners’ argument that the “symbolic significance of corporate spending on politics suggests setting an appropriately low threshold” on when disclosure is required. I don’t even want to think about the consequences of inviting the SEC to weigh the benefit of “symbolism” against the direct and indirect costs of disclosure.

Anyway, get ready for a contentious debate which, while providing an enjoyable distraction, does nothing to protect investors from the fraud and market dangers that are supposed to be the SEC’s top priority.