:LPE:

Barry McKenna yesterday had an article that, though buried on B4, contained some good bits and peices for the corporate profits file. Link.

First, something we know already: current profit rates in corporate US are up, and those retained earnings are being retained, not spent. Various folks want their bit: pension top-ups, wage increases, dividends, share buy-backs, creditors and bondholders repaid. How to allocate that cash is the senior management’s job, although activist shareholders are making noises (hedge funds, private equity placements, pension funds).

McKenna cites a study by some US academics showing profit:asset ratio increasing between 1980 and 2006 (this study from September 2006). It looks like decent data. The authors think that the “climate of uncertainty” accounts for the hoarding. Maybe so, but that wouldn’t account for the whole of the trend 1980 to present. And there are potentially many other factors, including exactly what influences the decision-making of those allocating retained earnings. Here, there is still some really good work to be done on the effect of the “financialization” of corporate decision-making, which has literally made management much more risk-averse, it would seem. This is of course the opposite of the fundamental (and naive) view of the purpose of a corporation: to gather disparate savings together in a pool for collective risk-taking into new productive business ventures. Instead, we have the equivalent of bankers in charge, re-packaging balance sheets to offload risk, and hoarding cash. It’s a funny, perverse outcome. This exact problematic, the source, treatment and spending of retained earnings - is at the centre of law and economics, and the centre of what capital accumulation is all about, the centre of capitalism, to use the 20th century term. Time to finish that PhD thesis…

A new paper from the NBER in the U.S. providing a summary of behavioural law-and-economics. Not the place for a thorough review - yet - but note the last sentence of the abstract: ” ‘ debiasing’ through law - using existing or proposed legal structures in an attempt to reduce people’s departures from the traditional economic assumption of unbounded rationality”.

Now, that is one heck of a proposition. Make people’s behaviour fit the (heavily criticized and highly contested) model, not the other way around. One of the hard-won insights of the 1990s was just that - that rationality was ‘bounded’ and some fundamental building blocks of law-and-economics needed modification. There is something panglossian about these propositions, and something totalizing about the project that expects evidence to bend to the model, not the other way around. From the abstract:

Behavioral Law and Economics, Christine Jolls

NBER Working Paper No. 12879 Issued in January 2007 NBER Program(s): LE

Behavioral economics has been a growing force in many fields of applied economics, including public economics, labor economics, health economics, and law and economics. This paper describes and assesses the current state of behavioral law and economics. Law and economics had a critical (though underrecognized) early point of contact with behavioral economics through the foundational debate in both fields over the Coase theorem and the endowment effect. In law and economics today, both the endowment effect and other features of behavioral economics feature prominently and have been applied in many important legal domains. The paper concludes with reference to a new emphasis in behavioral law and economics on “debiasing through law” - using existing or proposed legal structures in an attempt to reduce people’s departures from the traditional economic assumption of unbounded rationality.

Recent posts have noted that the McKinsey/Bloomberg report, co-authored by another Senator whose name always escapes me, is stirring up visions of a barrage of securities litigation. I did a little poking around: securities filings were down 35% in 2006, 44% between 2005 and 2006 together. 2006 saw the lowest annual total of new filings since 1995 and the passage of the PSLRA, which itself was passed to curtail “excessive litigation”.

An appropriate time to recall the purpose and role of private enforcement of these rights: no question that it would be delightful if the SEC or OSC were staffed and funded to provide comprehensive securities regulation and enforcement. However, to some extent, both have adopted the private statutory cause of action as a complement to their regulatory efforts, to assist in enforcement. If the system is working, we should expect to see litigants holding issuers to account this way. Yes, there are debates about how effective this model is in deterring wrongful conduct (it doesn’t seem to slow down insider trading much), but it is the system the major issuers had a key role in designing.

Last weekend the NYT profiled a piece of research that argues that we are “over-saving” for retirement. Link.

Well, the NYT called it “oversaving”, and noted erroneously that even in the absence of Social Security (the U.S. public pension plan) people could be over-saving. Not true, actually, the report noted something very different.

The report (actually, it was a research paper by a couple of academics) argues that U.S. citizens are adequately saving for retirement, and that there was a relatively low chance that people would not have adequate retirement savings. That chance got larger as you went down the income scale, and was most likely for single non-white females in retirement. No surprise there. It also noted that at the lower end of the retirement savings scale, Social Security accounted for a good 40% of retirement income. This is consistent with Canadian studies, which tell us that CPP/QPP is 35-50% of income in retirement.

Here’s my only point: basic model of income replacement in retirement (and hence, savings needed to replace that income) assumes that people need about 70-80% of their pre-retirement income to maintain their life-style. That may be true, it might also be subject to a number of key variables not measured (e.g., home owning versus renting, etc.). But if you are in the middle or low income end of the scale, 70% of Too Little is still not a dignified retirement, let alone any unexpected costs like a new hip, or such things.

If there is a case for the over-saving argument, it would be good to know. Jim Stanford is always levelling his guns at the RRSP season ads, and he makes some good points that the individual account managers get paid a lot to throw darts, and the fees and churning in the mutual fund industry are something to be wary of encouraging. I’d like to see some more on the empirical case for “over-saving”, and a critique about the assumptions of income replacement models.

The WSJ today had an editorial (need to subscribe) that parroted the Bloomberg report produced by McKinsey stating that SarOx was the cause of a lot of problems in the US capital markets. SoX 404 (auditors statements) was once again singled out as a costly ‘burden’ on companies (yawn), and this time “several new causes of action” that would cause a sharp increase in securities litigation in the next market decline. The empahsis here was on the threat of new securities litigation, and the liklihood it would come in a great wave with any downturn in the prices for securities.

First, securities litigation cases in the U.S. have declined two years running (there have been fewer new cases). So, the available empirical evidence says, hey, it’s not a growing issue, its a shrinking issue. And that there are fewer cases is not necessarily a sign of health: maybe fewer frauds are being detected. We don’t know. At least we found out about the stock options scandal. Possible without SarOx? Not sure.

Second, what does the threat of increased securities lititgation - however unrelated to current trends — have to do with a ‘market decline’? At most this is associative, there is some kind of exposure during periods of volatility, or bad decisions (read, negligent or fraudulent decisions) get exposed by losses. That might be true as a matter of observation, but it is nothing to base regulatory policy on. If the market prices of securities fall in a secular trend, we might indict Paulson or Bernanke for their monetary policy, but not individual companies for suffering losses.

Unless - and this is crucial - *unless* the losses are legally related to wrongful conduct at the company. After the Dura case, it is even more necessary to prove direct losses as a result of, say, wrongful disclosure, false accounting, and so-forth. This is worth repeating: if there is no wrongful conduct, then a mere drop in price is only that, a drop in price.

This editorial response is a knee-jerk response, and it comes from issuers’ who are entirely focusing on strike suits. They think that any decline in a stock price will attract a (frivolous) lawsuit based solely on the fact that there was a loss. Maybe it will. The U.S. system is famous for its “first to file” rule that causes plaintiffs and perhaps more likely their lawyers to race to file a claim before all the facts are out and a more sober judgment can be made.

The way to fix that is to require a ‘best plaintiff’ to lead a case, or some other approach that does not throw out the baby with the bathwater.

This obsession with the lawsuit-following-the-loss is entirely to be expected in this system, given its primarily boosterish function. A majority of researchers and promoters missed the tech bubble and missed the housing bubble until they were already deflating. Short sellers are vilified as pessimists and anti-capitalist. The bias is consistently toward price increase, not price correction, whatever the fundamentals (don’t take my word for it: read a lawyer and former bond trader on this topic, Frank Partnoy). In that context, it is natural to look at a price decline - especially if it is one contrary to a rising market - and think oh, something must be amiss here.

Abitibi, in the red for some time now, has announced a “merger” with a U.S. based Bowater. Folks at Desjardins expect it’ll raise some “competition issues”. Link.

Note the U.S. company will own 52% of the voting stock of the merged company. Where’s Dominic D’Allessandro?

I noted the release of the report a week ago or so, and have now had a skim through it. Link.

It’s what you might expect - anxiety over “overregulation” of the US capital markets which could lead to loss of marketshare. Hardly a surprise then, that it recommends a series of steps that would in different ways, hinder regulatory efforts.

Number one: limit liability of listed companies not resident in the U.S. to damages sustained in U.S. markets (not losses on foreign markets). Does the wrongful conduct not cause damages outside the U.S.? Is this not incentive to mulitplying parallel suits with risk of contradictory findings?

Number two: cap auditor’s liability. Why again? Why incent auditors (who work in one of the big oligopolies of the planet) to take risks by limiting their losses? Why extend the limited liability principle to their businesses? They already have their own protections — LLCs and LLPs — and they can contract limits, or attempt to. Why provide this subsidy?

Number three: encourage arbitration not court proceedings. Fair enough - almost always a better system. However, I really wonder if you can shove one of these lawsuits through an abbreviated process like an arbitration, or if they would begin to resemble court proceedings in any case. If so, then there is a new cost added to the plaintiffs and defendants — the arbitrator or the panel — and the lingering risk of the judicial review of the decision.

Number four: permit appeals of procedural motions — here, they mean the initial motion to dismiss — to appeal courts immediately, not after trial. If I have my U.S. procedural law right — I need to check this — this is in effect handing more tools to the defence, permitting them initial rights of appeal before the prosecution has had access to the disclosure stage of the proceedings. The disclosure stage is the most important stage for a plaintiff, where the defence must open up some files and permit the plaintiffs to ask some hard questions. This is one reason why almost all defendants make a motion to dismiss (or to have part of the pleading struck and sent to another jurisdiction — see point one), in order to try and end the case or test the plaintiff before there is any disclosure relating to the alleged wrongdoing. Note that after the disclosure process, most settlement discussion begin in earnest. For the plaintiff, it is important to get to disclosure.

Let’s consider these recommendations, from the governor of New York and a Senator, as if they were applied to the fraud provisions of the penal code. So, we would let, say, counterfeiters (a) not be liable for any U.S. dollars they printed and sent to Mexico; (b) limited the liability for the fence used so they would not be as damaged by the work they do; (c) encouraged private, not public settlement of the prosecution according to relaxed rules of procedure; and (d) permitted the accused forger rights to appeal that the AG is not permitted, and makes it costlier and harder to prove their case.

There is more, but you can sum these items and this report up in a quick phrase: hindering access to justice. Yes, there are debates about how effective securities class actions are in improving transparency, or recovery for plaintiffs, and yes, nothing beats a fully-funded SEC or AG of New York going after the bad guys with vim and vigor. But this is the model we have for now, and these measures are not going help reduce fraud on the market when it occurs.

An odd spot for a Lord Black defence and a position paper on securities law and corporate governance, but Books in Canada has done one, authored by none other than its own publishers, the Steins. Link.

The crux of the essay is that Black is being hounded by the latter day equivalent of the Inquisition, and that their creed, “excessive regulation”, is going to destroy “economic man” by which they mean “entrepreneurialism” or something similar. Where to start, where to start with that thesis. With the Black case itself? We still don’t know, but the accusations are that he’s paid himself handsomely at the expense of his shareholders, and done some accounting tricks that would make the Enron folks blush. And for anyone who would judge him by his past practices - not necessarily a legally valid manoeuver, although the prosectution is attempting to establish a “pattern of conduct” through his spouse’s spending habits - remember how he made his fortune. He arguably gutted independent news reporting in Canada, he obtained Argus from a group of widowers, he attempted to clean out pension funds, and so-forth. He did start the National Post and donate some money to a hospital wing — wait: that money was not actually his money, it was Hollinger shareholder’s money, so by rights, perhaps it should be the Hollinger Wing. The courts will test the accusations, or more likely, there’ll be a settlement on the eve of trial to avoid the tabloids. His laywers, we might note, have already settled their account for $30 million. Of course, there was no admission of liability.

Or, how to view this corporate governance thesis: putting guys like Black out of business, or more broadly, energetic regulation of securities and corporations, threatens to destroy creative entrepreneurs, the core of the capitalist project. They weigh into a debate that stretches back to the 1800s, perhaps earlier, a struggle between those who provide the financing for the corporation, or happen to own its shares, and those who manage the business affairs of the corporation. Where those two groups are separate, there has always been a struggle over the property of the corporation. The Steins appear to think that the current swing toward “shareholder primacy” is the end of history, and will emasculate the rugged but under-financed manager who just needs a few bucks with which to begin the process of accumulating capital, for which the shareholders will be well-paid thank you. That’s a quick and dirty version of this debate, sometimes known as the debate of the Berle-Means corporation, or also the Berle-Dodd debate, after the famous 1932 analysis of large corporations that evolved from smaller more disparate firms, largely as a result of the consolidation permitted by regulatory changes in corporate law the early 1900s. The pendulum has swung back and forth for some time now, more and less regulation, more or less control by shareholders or directors, and theoretically, it got a little boring. Bright law students preferred the Charter or international humanitarian law. There has also been a small and not unpersuasive group of marxists and neo-marxists reminding us that neither position is all that radical, and miss the interesting bits about the role of shares or corporations in society.

I risk this history here, because in context, the Stein’s position can now be seen as a defence of mere managerialism as much as it is about rugged individualism, a form of economic policy that was articulated first in the mid-1800s as laissez faire capitalism, and again in the 1970s as market-based capitalism. What both eras produced, by and large, were a series of massive corporations, “small states” as Blackstone called them, that tended toward oligopoly or near-monopoly in their industries, and that rapidly became objects of social concern as the bad behaviour in their controlling parties was exposed, and the very large influence they had over social and economic affairs became politically untenable, some even saying anti-democratic.

Placed in context, the current Inquisition of regulatory enthusiasm, a.k.a., SarOx is about as mute and tepid a regulatory response as you could possibly get: for the Steins to characterize this as the end of economic man is nearly incoherent, and surely an exaggeration that erodes all possible credibility in the position they take. Berle saw the same thing and thought that large corporations should be considered “public property”. The 1930s saw the creation of entirely new areas of law - securities regulation - and in context, a whole New Deal. Surely history would have ended then, if it was going to? Galbraith - the man who ran the war economy and arguably set the foundation for the greatest expansion and distribution of wealth in world history - thought the S&P 500 ought to be nationalized, they were so dangerously unaccountable. The current Bush administration - the veritable champions of anti-interventionist economic policy, notwithstanding their military fervour - won’t permit U.S. firms to be sold to Chinese investors. What’s a corporate manager to do - not being permitted to buy and sell as she pleases?

“Economic man”, as the Steins’ characterize him, doesn’t exist. It is a red herring, a story told to cover up the dirty side of making money. Where did Black make his money? He inherited it. Then bought a newspaper, fired a bunch of folks, and pocketed the profits. He redistributed wages from those lower on the food chain, up to him. He applied the formula to half the newspapers in the country, and borrowed shareholder money to do it. He finegled Argus from those less financially sophisticated. These tactics are lauded by some and those are usually folks working on Bay St. or attending the Chicago school. It is surprising to see it come from Books in Canada. For a better and more credible source on just what economic man looks like in Canada, anything by Peter Newman or Linda McQuaig, early Diane Francis, and probably the best single book of reportage on the creation of wealth in Canada, Gustav Myers’ A History of Canadian Wealth. They don’t write them like that anymore. Note: he was a U.S. academic, third party objectivity and all that.

This is a review, and I must mention something I thought useful in the essay. I give credence to a version of the persecution theory: the US regulators do at times appear much happier to go after foreign companies and their managers than domestic ones - less upsetting to the Wall St. elite, I assume, to just take out the odd jumped up Canadian or Brit to keep the system’s “integrity”. U.S. markets are famously parochial that way. What cruel irony then, that Black spent so much of his political capital here explaining to us how backward and socialist our ways were, so much so that he had to seek the citizenship of another country in order to take a feudal title, that he has to come back to avoid facing the music overseas. We might note that the Ontario Securities Commission has not seen fit to prosecute just yet.

Blackstone, the private equity group, has offered the largest LBO in history if the deal goes down. Link.

Hard to know the details of the deal, but if it it truly is a leveraged offer, then that money is borrowed, and the target is commercial real estate properties. Two major risk factors: interest rates on the borrowed money remain stable (don’t ise), and returns on commerical real estate remain stable (don’t fall). This deal, in a real estate asset price bubble (admitedly, bubble concentrated in retail and large cities) and rising European interest rates, it’s interesting. I’m sure the wonks at Blackstone have worked it out to three decimal places, but…

Minister Sorbara has made the usual decision not to raise minimum wages (further than the 25 cents per hour they are being raised this spring, by legislation). He’s made the less usual decision to say why: because, he says, it would cost Ontario 60,000 jobs. Well, he did say “at risk”, which implies they are not already at risk.

An interesting number. “Most economists” said Sorbara, “say a large jump in the minimum wage would have a significant negative impact on employment.” How does he know this? Has he read “most economists”? It would be interesting to know. What’s a “significant increase”? His number suggests that 66k would lose their jobs, out of a total of 200k workers on minimum wage. Really? That sounds incredibly high - 33%, for $2 wage hike from $8 to $10. I don’t think so. One-third of low-wage workers? I seriously doubt it. If it was a bet, I’d take that bet.

Last I read, there as mixed economic evidence that non-trivial raises in the minimum wage caused any sigificant or measurable decline in employment, or if so, it is fairly modest, in the range of 1-5%. If 200k workers on minimum wage got a say 25% increase (from about $8 to $10) and this caused a 5% drop in minimum wage employment, from 200k to 190k, wouldn’t the gains outweigh the losses? If those jobs get eliminated, which I’m not convinced of.

Especially given the fact that a lot of low-income employment is temporary and there is a significant “churning” in the low-wage labour market, so that re-employment is usually the case. Some would argue this is an exogenous change, and as such, would permanently lower the employment rate. I’m not so sure. The demand for whatever these workers did would not decrease.

Really, what this would be would be a transfer of profits from employers to employees. This can be a good thing, economically, given that employees at the low end of the income scale have a higher propensity to spend their wages locally.

Sorbara’s own example is incoherent - he says employers will keep total wage expenses the same, and make up the increase in wages by eliminating jobs or cutting hours - that is, ask fewer workers to do the same job. In industries where minimum wage is the salary, including many service industry jobs, this is very unlikely to be the outcome. If a MacDonalds has 40 employees to cover their shifts, will they just close down one shift, or go with fewer workers? It does not seem likely. Instead, this will be absorbed by folks further up the food chain, as it were, or possibly even passed along in prices.