Monday, July 30, 2007

Suing the lawyers

There's another big principal-agent problem in a large corporation: that of the in-house lawyer. Though hired to protect the interests of the company, the lawyers are told what to do by executives, agents of the company. Business Week quotes Stephen Gillers, a NYU law professor as saying with regard to in-house lawyers:"They have to be aware of the risk that their bosses are violating a duty to their clients, and it's a real challenge, because you don't want to accuse your boss of illegal activity."

The Business Week article discussed a Chicago jury's decision to convict the in-house attorney of Hollinger Intl., a company whose former chairman Conrad Black was also recently convicted of fraud.
Prosecutors alleged Black concocted a scheme to demand noncompete payments from buyers of Hollinger publications, and then he and others pocketed the money without telling the board. Kipnis' role in drafting the noncompetes was so extensive, says juror Tina Kadisak, that "we definitely came to the conclusion that he did know what was going on."

The article goes on to say that of 1,236 convictions obtained by a federal Corporate Fraud Task Force in the last five years, 23 were of corporate counsel.
I'm not sure that this can be construed as representing an increasing trend in going after in-house counsel. However, the high profile of this case is making that possibility more apparent. Consider the precedent set.

Thursday, July 26, 2007

Should I renew my subscription to the WSJ?

I'm waiting to find out what happens with the takeover.
And if the takeover succeeds, is Rupert going to mess with our beloved Journal ?

From the article:

"In the long run, the owner of the newspaper is going to wind up calling the shots," said newspaper industry analyst John Morton.

"There has been this history, whether (Murdoch) acknowledges it or not, that his publications have sometimes operated in furtherance of his business and political interests," Morton said. "Although he denies it, his publications and some of his broadcast operations have not vigorously investigated things that go on in China because he has business interests there."

Ben Bagdikian, a media critic and former dean of the Graduate School of Journalism at the University of California at Berkeley, said that because of Murdoch's history, "any promise, written or oral, not to change things toward his own ideology has to be taken with a grain of salt."

"The Wall Street Journal's editorials are already the most conservative in the country, so his changes, I think, will be in what news he prints and what he does not, what sources he uses and which ones he shuns," Bagdikian said.

The Dark Lord's taking over the world, all right.

An economy ground in finance won't work!

According to Business Week at least.

Fueled by headlines about top managers such as Home Depot (HD ) CEO Robert Nardelli, who received stratospheric pay even as his company's stock price stalled, shareholder activists this year took aim at executive compensation. Unfortunately, they should not expect much from those efforts, even if every corporation in the U.S. adopts "say on pay"measures that allow shareholders to vote on pay deals. That's because such proposals treat only a symptom, not a cause, of a more dangerous trend within American capitalism.
The real culprit is the growing preeminence of finance over operations. It causes stock market considerations to trump those that improve the actual workings of a business. And the quicker the stock payoff can be engineered, the better. Until that changes, don't expect CEOs to stop gaming the system.
The real culprit is the growing preeminence of finance over operations. It causes stock market considerations to trump those that improve the actual workings of a business. And the quicker the stock payoff can be engineered, the better. Until that changes, don't expect CEOs to stop gaming the system.

This reward bias toward finance has been with us since the creation of the giant public corporation in the late 19th century.
Today you see the consequence of this financial dominance. Ask the 400 CFOs who in a 2005 survey revealed a consensus opinion that they would mutilate their own companies to keep stock prices high. Ask the derivatives traders and hedge fund managers who control the direction of the market by trading in instruments that have nothing to do with financing the production of goods and services and everything to do with stock price movements. Ask the stock-trading public who in 2006 turned over share ownership on the New York Stock Exchange (NYX ) by 118% (almost 30% more than in 2000). Meanwhile, CEOs figure that if their job is to make shareholders as rich as possible as quickly as possible--as opposed to managing companies to generate long-term profits--they should be paid like the investment bankers, money managers, and hedge fund czars who do the same.

Read the full article here. Though the author doesn't explicitly say so, he adds his voice to the chorus against private equity since the key to their operations is really leverage and not, um, operations.

Thursday, July 12, 2007

Moody's criticism of Private Equity: Part 2 of 2

Arguments for and against taking companies private:

There are two related issues that are somewhat buried in the article. One is reporting pressure. I am usually a little leery of when companies want to do something that reduces their level of transparency to investors, citing the costs of reporting etc. (case in point: Sarbox.) My reasoning being that if they do not want to be open and upfront about their activities, they are probably doing something that will not withstand public scrutiny. On the other side of the issue, the need to report earnings quarterly (and meet or beat expectations) does put undue pressure on companies. (Case in point: The statistically abnormally large number of companies that beat expectations by one penny. Managers have a strong incentive to avoid negative earnings surprises.)

The second issue here is investing horizon. Generally, equity is seen as a longer-horizon investment than debt, simply because equity is long-lived. However the PE guys claim that the stock market induces short-termism because of quarterly reporting and scrutiny. Moody's disagrees with that.
On the other hand, (and this reminds me of my grandfather's joke: Economists have to have many hands because they keep saying "on the other hand.."!) academics have long posited, and tested the theory that debt is what induces short-termism. The reason is that the threat of bankruptcy associated with being unable to keep up payments leads firms to often pass up very profitable projects which are even slightly risky.
(This is called the debt overhang problem relating to companies - not countries - definition in the bottom paragraph).

To summarize, reporting pressure is a very real consequence of listing a company. However the argument that debt has a longer investing horizon, in my opinion, is bogus. Surely there are ways to manage the short-termism induced by reporting pressures by clearly indicating that long-term beneficial actions are being taken by the company!

Moody's criticism of Private Equity: Part 1 of 2

The FT recently reported on Moody's criticism of private equity:

Moody's takes issue with the argument that private ownership frees companies from the short-term pressures of equity markets, enabling them to invest and plan for the long term. Its report says: "The current environment does not suggest that private equity firms are investing over a longer-term horizon than do public companies despite not being driven by the pressure to publicly report quarterly earnings."

The agency says buy-out funds' tendency to increase a portfolio group's indebtedness to pay themselves large dividends runs counter to their claim of being long-term investors. It cites the dividend received by Thomas H Lee, Bain Capital and Providence Equity following their takeover of Warner Music in 2004 and the one paid to Blackstone after the purchase of Celanese.

It also takes aim at private equity's claim that improvements in companies' performance are driven by more focused management teams rather than financial engineering and higher debt.

The private equity industry rejected Moody's claims. "Corporate leaders who have experienced . . the positive effects of private equity ownership are quick to tell you that this structure can and does liberate management to focus on long-term growth," said Doug Lowenstein, president of the Private Equity Council. There was "compelling evidence" that private equity made companies "stronger".

(Part 2: My two cents.)

Qwest sentencing update: What's Nacchio's liability?

The Race to the Bottom blog has an excellent summary of the government's and the defendant's views on what Nacchio's sentence should be.

Addressing the “extraordinary family circumstances” issue, government cites States v. McClatchey , 316 F.3d 1122, 1130-31(10 Cir. 2005) for the rule that this downward adjustment applies only where the defendant is the only person that can take care of a family member. Since Nacchio’ wife “has the time and resources” to care for the children, the government asserts the exception does not apply and states the following:

“While Dr. Hammer certainly paints an unfortunate picture of David Nacchio’s prognosis, it simply does not justify absolving the defendant from his crimes and allowing him to avoid his just punishment.”

Addressing the issue of Nacchio’s charitable works, the government again cites case law that only extraordinary charitable works will support a more-lenient sentence and business executives do not meet this test since they ordinarily become leaders in community charities. The government labels Nacchio’s charitable works as not extraordinary, but ordinary and “entirely consistent” with Qwest’s business development goals.

Wednesday, July 11, 2007

Qwest sentencing: Did the crime, doing the time?

The WSJ Law Blog yesterday discussed the conviction of Joe Nacchio, the former chief executive at Qwest on multiple counts of insider trading. He is set to be sentenced on July 27 and prosecutors are calling for a 10-year sentence plus $71 million in fines and restitution.
In response:

Nacchio’s lawyers countered the government on Friday, arguing that Judge Edward Nottingham should consider the perilous health of two of Nacchio’s family members before agreeing to the 10-year sentence. The motion doesn’t identify the family members, and Nacchio’s lawyer wasn’t reached by the Post for comment..The government’s sentencing statement said a departure from guidelines is warranted only where the defendant is the only one able to provide assistance to a family member.

Aging relative or not, the comments to the blog debate the appropriateness of the 10-year sentence for a white-collar crime. Not to minimize the crime itself: The reality was brought home to me by posters who had lost 80% or more of their 401Ks thanks to the insider trading.

Others might argue that the ex-CEO is not a physical danger to society and that fines alone should be enough for proper restitution and to "make whole" the plaintiffs.
Not knowing enough about the law, I can't comment. But I, like others, will be following the developments in the case with interest.

Governance Metrics: predictor of corporate performance?

From an article in the WSJ: Governance Metrics claims that its ranking of corporate behavior is a good predictor of investment returns.
The graphic on the right indicates that companies with above-average scores appear to have significantly positive investment returns compared to companies with below-average or average scores.

The reasons why not everyone's convinced:

- Many of the governance-related studies are sponsored by governance consulting services and others with vested interests.
- The measures chosen are not systematic and vary depending on the study. As a result, top ranked companies by one measure may be poorly ranked by another. Case in point: Google.
"The company made the 2007 "World's Most Ethical Companies" list of governance-tracker Ethisphere, because of its strong code of conduct and positive customer views of its behavior. But Audit Integrity Inc., which scrutinizes accounting behavior and litigation risk, ranks Google poorly. One recent red flag: Viacom Inc.'s copyright lawsuit against Google and its newly acquired YouTube video-sharing site. "

- On my part, I do not have any indication whether the numbers on the left are statistically significant, adjusted for other predictors of returns etc. It is well known in the academic community that it is not easy to find corporate governance variables that are consistently and strongly related to corporate performance.

The rebuttal:

- Just like with any other predictor, once information about a company's governance practices is known, it is quickly priced into the stock.
- From the article: Audit Integrity Chairman and founder James Kaplan says the company tried -- and failed -- to find a connection between share performance and corporate governance alone. After including the accounting analysis, however, the firm's top-rated large companies posted better returns than the Standard & Poor's 500-stock index.
The link between accounting quality, litigation risk and corporate performance is harder to refute based on several academic studies on the topic.
- Some governance variables - such as the number of antitakeover provisions in the charter - may be more remotely related to corporate performance than others such as disclosure transparency. These studies help direct our attention to what matters.

Tuesday, July 03, 2007

SECs awards payouts to Columbia Fund investors

The SEC today awarded payouts to investors in Columbia Funds who were damaged by their market timing and fradulent practices between 1998 and 2003.

From this article:

More than 600,000 investors damaged as a result of fraudulent "market timing" in the Columbia Funds will be collecting a total of $140 million from a distribution fund set up by regulators, the Securities and Exchange Commission said Monday.
The first distribution will be in the amount of $37 million and go to more than 300,000 investors harmed due to market timing between 1998 and 2003, the SEC said.

At the time of the fraud, Columbia Funds was owned by FleetBoston, subsequently taken over by Bank of America.