Archive for November, 2008

Thoughts on working through N-PXs

I spent some time today processing N-PXes (the annual filings in which mutual funds disclose their proxy votes) to build up our vote database. My process involves a lot of automation followed by a check step in which the idiosyncrasies of the different filings really come out. Some of these things are purely formatting things that are annoying to me and anyone else who tries to process this data. One of today’s annoyances of this type was the number of repeat meetings in some of the Franklin Templeton N-PXes: cases where they reported their votes for the same meeting twice. How does this even happen?

Another thing that came out was how often T Rowe Price Growth Stock Fund (PRGFX) lists “Did not vote” in its filing. In our database this gets recorded as “Did not vote” but coded the same way as an abstain. The coding choice makes sense because ultimately the vote does not get counted (unlike with individuals), but I wondered how often “Did not vote” was a choice and how often an administrative oversight. I don’t measure this in any way currently, and I don’t know if anyone would find it interesting.


November 26, 2008 at 5:50 pm Leave a comment

Tweaks: Now showing management positions on upcoming meeting

If you look at an upcoming meeting (here is the current list) you’ll notice that we are now indicating management’s position on each proposal. (For most meetings – in some cases our sources don’t include that information.) It was one of those small technical changes that leads to a bunch of other small improvements that I won’t get into.

Expect some more news on progress soon — we have some new data on the way, and we’re working on a new voting service and I look forward to telling you about it.

November 25, 2008 at 11:37 am Leave a comment

Barclays meeting in the news

The New York Times describes shareholders at today’s Barclays meeting (here is the page on PD) as “angry and outraged.” Barclays had foregone government assistance last month because the government would have placed restrictions on its dividend policy and investment decisions, and it called a special meeting to get shareholder approval to sell equity on favorable terms, primarily to Middle Eastern investors. Not surprisingly, Barclays shareholders are unhappy about the dilution, especially given the 70% drop in the company’s share price this year. But apparently they see no better option and the plan will go through.

I would expect to see a lot of angry meetings in the coming year. Let’s hope that we get productive reform, and not just bluster and accusations, out of the anger.

November 24, 2008 at 11:37 am Leave a comment

Michael Lewis on “Wall Street Boom and Bust”

Mark Latham of (here‘s his finance blog) passed along a link to this outstanding article written by Michael Lewis about the financial crisis. Lewis (author of Liar’s Poker and The New New Thing, among other books) sees the recent bust as the logical conclusion of a long accumulation of problematic practices on Wall Street. Lewis says that when he wrote Liar’s Poker in the 1980’s he thought he was writing about a culture and a set of business practices that must be on the brink of flameout. Instead the pathologies got more extreme over the next twenty years. It took a long time to blow up, but blow up it has.

Much of the article focuses on a hedge fund manager, Steve Eisman, who saw a lot of this coming and set up his fund to profit from the destruction. Based in part on what he heard from his cleaning ladies, Eisman knew that big banks were giving out home loans to people who were very unlikely to be able to repay them. He looked into the numbers and started shorting companies heavily involved in subprime lending. Then he started shorting the bonds that were derived from these mortgages (i.e. he was buying credit default swaps), essentially betting that people like his cleaning lady would not be able to pay their mortgages and the bonds based on her payments would default. The moment he realized things were colossally screwed up came after he started asking why the investment banks that were selling him the credit default swaps were so willing to bet on the cleaning lady’s side: the CDS’s he bought were the basis for a whole new set of financial products (called synthetic CDOs, although Lewis doesn’t identify them as such), which brought in more fees and kept everybody buzzing. Eisman (according to Lewis) started to see this part of the financial world as a “machine” that kept everybody happy by generating fees to go along with increasingly dubious financial products. Again and again, Eisman ran up against financial practices that he could not believe were legal, or, as he reportedly said on encountering an odious CDO product, “I cannot fucking believe this is allowed—I must have said that a thousand times in the past two years.”

The article closes with an interesting confrontation between Lewis and John Gutfreund, who was the CEO at Salomon Brothers when Lewis was there in the 1980s. (Gutfreund says to Lewis’s face that Liar’s Poker destroyed Gutfreund’s career and made Lewis’s.) Under Gutfreund, Salomon became a public company in the 1980’s, and Lewis’s claim here is that this was the beginning of the end for Wall Street. “The Wall Street firm became a black box,” Lewis argues.

The shareholders who financed the risks had no real understanding of what the risk takers were doing, and as the risk-taking grew ever more complex, their understanding diminished. The moment Salomon Brothers demonstrated the potential gains to be had by the investment bank as public corporation, the psychological foundations of Wall Street shifted from trust to blind faith. . . . No investment bank owned by its employees would have levered itself 35 to 1 or bought and held $50 billion in mezzanine C.D.O.’s. I doubt any partnership would have sought to game the rating agencies or leap into bed with loan sharks or even allow mezzanine C.D.O.’s to be sold to its customers. The hoped-for short-term gain would not have justified the long-term hit.

It’s an attractive point, but I don’t think it’s true. I don’t know what careful research would say, but observation suggests that private firms were just as likely to be highly leveraged, deeply involved in exotic and risky derivatives, and gaming rating agencies. Certainly there are plenty of big hedge funds organized as partnerships that have made colossal risk management mistakes in derivatives markets. (LTCM is the highest-profile example, but certainly there are lots in this crisis as well.)

The question ultimately is how incentives would have been different if these firms had been partnerships rather than public companies. I would argue that incentives would not have been different enough to change behavior substantially. One possibility is that key decision-makers would have been focused on increasing the firm’s long-term value (as opposed to generating fees on dubious products) if the firm had been private. Yet in these public companies there was plenty of stock ownership at the top of the firm, where the partners would sit. (I don’t know how far down meaningful stock incentives went.) These executives have taken a serious financial hit as a result of the bets their firms made. It seems likely that they simply did not understand what the risks were, and that increasing their ownership of the firm (as might happen if it were a partnership) is unlikely to have been enough to motivate them to understand those risks.

One possibility is that stock incentives were not the right way to get executives to think about the long-term value of the firm. Certainly compensating based on stock options rather than grants encourages risk-taking, since there is lots of upside and limited downside. But even if we’re talking about stock ownership, it is likely that the stock market in the last several years was not in fact rewarding long-term value generation, but rather was rewarding firms that took the casino approach to high finance. Partners in a private firm, the argument goes, would not have tried to satisfy the demands of this myopic market, but would rather have focused on long-term firm value and ultimately avoided the fate Wall Street has seen. Such an argument comports with what Rajan has been saying about delinking executive compensation from the stock markets and tying it more closely to accounting profit, as I blogged about a few days ago.

I don’t know if there is good evidence on how the risk profile of a private firm would have been different (it’s hard when there aren’t any private firms that big still around), but again I suspect it would not be that different. I believe the best way to make a lot of money in 2005 and 2006 was probably to be deep in exotic derivatives, and I think most executives would chase after those opportunities whether they were trying to increase their stock price or increase their accounting profits.

I have a lot left to learn here, and I welcome any comments on what I’ve said. I highly recommend reading this article for understanding some of the pathologies of Wall Street, but clearly I think Lewis’s concluding point about the critical role of public ownership is a lot murkier than he makes it seem.

November 17, 2008 at 4:03 pm Leave a comment

Eliot Spitzer reemerges; suggests corporate governance reforms

Eliot Spitzer has written an opinion piece in the Washington Post providing his assessment of the crisis and some suggestions for reform. (Is this his first foray in public life since the scandal earlier this year?) Corporate governance is one of the three areas where he sees the need for big changes. (His other points are that we need to rethink deregulation as a cure-all and overhaul the labyrinthine structure of federal financial regulation.) I find his suggestions on corporate governance frustratingly vague, tending toward moral suasion rather than structural reform. Here’s what he says:

Our corporate governance system has failed. We need to reexamine each of the links in its chain. Boards of directors, compensation and audit committees, the trio of facilitators (lawyers, investment bankers and auditors) whose job it is to create the impression of legal compliance, and shareholders themselves — all abdicated their responsibilities.

Institutional shareholders, in particular mutual funds, pension funds and endowments, must reengage in corporate governance. Over the past decade, arguably the sole challenge to corporate mismanagement and poor corporate strategies has come from private-equity firms or activist hedge funds. These firms were among the few shareholders or pools of capital willing to purchase and revamp encrusted corporate machines. So it shouldn’t be surprising that the corporate world has taken a skeptical view of them — especially short-selling hedge funds, which have often been a rare voice raising the alarm.

Boards of directors were also missing in action over the past decade; not only did they not provide answers, they all too often failed even to ask the appropriate questions. And the roles of compensation committees, of course, must be totally rethought. No longer can Garrison Keillor’s brilliant observation about our kids — that they are all above average — apply to CEOs and propel failed leaders’ paychecks through the roof. Today’s momentary public oversight and outrage over executive compensation, while long overdue, is no substitute over the long term for firm standards set by compensation committees and boards of directors.

I think he’s right that shareholders have failed to engage in corporate governance, and that directors often fail to apply the proper oversight to the companies they serve. But I tend to think in terms of incentives rather than “responsibility” (this is the social scientist in me), and I wish Spitzer would be clearer about how he proposes to change the incentives that got us here. Simply developing a culture of diligent oversight among directors and investors is one way to create those incentives, and maybe that’s what he has in mind. Or maybe the Enforcer wants to see stronger enforcement of directors’ legal duties to shareholders and institutional investors’ responsibilities to their beneficiaries. If he were still AG in New York what kind of lawsuits would Spitzer be plotting now?

November 15, 2008 at 8:58 pm 1 comment

Rajan: “We need to make people a little more worried about the future”

Andrew Ross Sorkin’s article in NYT Deal Book highlights Raghuram Rajan’s suggestions for improving executive compensation. Rajan, finance professor at the University of Chicago and former chief economist at the IMF (whom I met when I was at Brookings and Rajan was promoting his book with Zingales), has some interesting ideas on how incentive contracts could be drawn up to make executives “a little more worried about the future,” and how the government can encourage firms to take these steps.

First, how to encourage long-termism through executive pay: Rajan suggests that bonuses should be paid out over a longer period and subject to “clawbacks” so that they can be revoked if the results don’t stand up. These are moves that shareholder activists have been pushing for a while. More striking to me is Rajan’s suggestion that pay should be tied more tightly to accounting results, and less tightly to stock price. It’s a widespread view by now that stock options, which have large upside but little downside risk, encourage unproductive gambling with corporate assets; it’s a less widely-held view that stock grants also induce the wrong kind of behavior. I think the argument is that stock prices depend too much on phenomena that are beyond the executive’s control and thus provide a poor measure of how well the executive is performing.

It’s tempting to think that we can encourage executives to focus on things we care about (controlling costs, generating revenue, creating long-term sustainability etc) by rewarding accounting results, but I wonder — how do you set up a contract based on accounting results that encourages something hard to measure, like judicious investment in R&D? The alluring thing about stock compensation is that, in theory, the executive gets paid well if the analysts (and the market more broadly) think that the company’s investments will produce a nice stream of profits in the future. If the market is efficient and understands the firm’s actions and accurately prices future cash flows, this can create exactly the right incentives to undertake productive investments. The market does not of course do this perfectly, which makes stock grants imperfect incentive tools, but the question remains whether we can do better with bonus packages derived from accounting results.

Leaving aside these concerns, how do we get companies to adopt enlightened compensation packages? Rajan is skeptical that boards will do so of their own accord (again suspicious of the market), so he wants the government to reward firms that institute reforms. (In short, he wants the government to create incentives for firms to implement good incentives.) In the case of the financial sector, banks that choose to adopt reforms in executive pay would face lower capital adequacy requirements, since their governance makes them less risky than similarly leveraged banks that have not instituted pay reforms. (Rajan’s argument appears to be based on looking at banks in the context of the bailout, but for other kinds of firms other levers of influence such as tax policy could of course be used.)

Writing this up as policy would be a hard thing to do, because it requires agreeing on what good executive compensation looks like. (See above.) I would guess it’s unlikely that a comprehensive government solution like this will emerge. But I remain confident enough in the equity markets to believe that firms will innovate on executive compensation as a way of attracting investment. I would look for reforms coming both from shareholder activists and from boards themselves.

November 5, 2008 at 10:34 pm Leave a comment


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