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Politics : Stockman Scott's Political Debate Porch -- Ignore unavailable to you. Want to Upgrade?

To: Jim Willie CB who wrote (5114)	8/23/2002 6:37:35 PM
From: stockman_scott	Read Replies (1) \| Respond to of 89467

The Outrage Constraint By PAUL KRUGMAN Columnist The New York Times August 23, 2002 The high pay of America's C.E.O.'s reflects intense competition among companies for the best managerial talent. Stock options and other typical forms of executive compensation are designed to provide incentives for performance. These incentives align the personal interests of managers with those of shareholders. Nothing in the preceding paragraph is true. That's the message of an extraordinary research paper circulated by the National Bureau of Economic Research, an economics think tank. The paper is must reading for anyone trying to understand what's really going on in our economy. I first read this paper, "Executive compensation in America: Optimal contracting or extraction of rents?" by Lucian Bebchuk, Jesse Fried and David Walker (of Harvard, Berkeley and Boston University respectively), last December. It was largely due to their analysis that I concluded, early in the game, that Enron would be only the first of many scandals. What they show is that the official theory of the corporation, in which the C.E.O. serves at the pleasure of a board that represents shareholder interests, is thoroughly misleading. In practice, modern C.E.O.'s set their own compensation, limited only by the "outrage constraint" — outrage not on the part of the board, whose members depend on the C.E.O.'s good will for many of their perks, but on the part of outside groups that can make trouble. And the true purpose of many features of executive pay packages is not to provide incentives but to provide "camouflage" — to let C.E.O.'s reward themselves lavishly while minimizing the associated outrage. The most obvious case in point is stock options. There is a good argument for linking an executive's pay to his company's stock price, but a true incentive scheme would have features that one almost never sees in practice. For example, an executive's pay should depend on his company's stock price compared with a benchmark index composed of other, similar companies, so that what he gets reflects the job he is doing, not general market conditions. In fact, however, a C.E.O. almost always receives stock options at the current market price — end of story. If the stock price goes up, he cashes in. If it goes down, he receives new options at the lower price. There are, to be fair, quirks in the tax law that encourage this practice. But the main reason executives are paid this way is that it gives them an almost sure thing — unless the stock falls steadily, sooner or later an executive who keeps getting options at the current price makes a lot of money — yet does so in a way that camouflages the sweetness of the deal. The options grant often isn't even counted as a corporate expense, and the payoff, when it comes, can always be represented as a reward for achievement. Thanks to the growing skill of companies at camouflage, and also to a steady erosion of old inhibitions against apparent excess, the average pay of C.E.O.'s at major companies has skyrocketed. It was "only" 40 times that of an average worker a generation ago; it's 500 times as much today. That's a lot of money, but the direct expense is not the main problem. Instead, it's the fact that the tricks used to camouflage exorbitant pay give executives an enormous incentive to get the stock price up in time to cash in their options. We're only beginning to see the extent to which that incentive distorts corporate behavior. We now know that some companies engaged in grandiose programs of acquisition and expansion that ended in grief — but only after top executives had profited immensely. We also know that companies eager to meet or surpass analysts' expectations engaged in creative accounting on a grand scale: in each of the last few years of the bubble most big companies reported double-digit profit growth, yet national statistics show that true corporate profits were hardly growing at all. I'm not claiming that C.E.O.'s are conscious villains, twirling their mustaches and chortling over their evil doings. People are very good at rationalizing their actions — even Jeff Skilling reportedly regards himself as a victim — and the great majority of C.E.O.'s surely stayed within the letter of the law. But the fact is that we have a corporate system that gives huge incentives for bad behavior. And I would be very surprised if Wednesday's plea by Enron's Michael Kopper is the beginning of the end; at best, it's the end of the beginning. ________________________________________________ Paul Krugman joined The New York Times in 1999 as a columnist on the Op-Ed Page and continues as Professor of Economics and International Affairs at Princeton University. Krugman received his B.A. from Yale University in 1974 and his Ph.D. from MIT in 1977. He has taught at Yale, MIT and Stanford. At MIT he became the Ford International Professor of Economics. nytimes.com

To: Jim Willie CB who wrote (5114)	8/23/2002 6:57:44 PM
From: stockman_scott	Read Replies (1) \| Respond to of 89467

thoughts toward a deflation reversal mechanism by Dr. Tom Drake 18 August 2002 04:15 UTC From the Longwaves discussion board at: csf.colorado.edu I have discussed here several times over the past few years the mechanism whereby falling crude goods prices eventually reduce investment in production, storage, processing, transportation, and inventory levels to the point that small upticks in demand cause rapid price reversals. We saw this over the past few years in petroleum, gas, hogs, cocoa, gold, and possibly now in grains. Besides crude goods prices, the other large factor in Long Wave economic cycle trends is interest rates. I've been looking at mechanisms here too for a supply/demand reversal. It is becoming clearer that a falling interest rate is deflationary. It is common knowledge, but incorrect, that lower interest rates are necessarily good for whatever ails us economically. Even if one comprehends that fallacy, one tends to think that falling prices and falling rates are symptoms of disinflation/deflation, but that isn't necessarily true either. They may be causes of deflation under certain circumstances. Falling rates are good for the banks, up to a point, as they can borrow short for less and go out further to notes and bonds and make money on those treasuries. That's how the banks were bailed out in the early 90's and how they are remaining strong now. For a long while as rates are low and falling banks have no incentive to lend to businesses as they can make more with less risk by buying treasuries. The FED can talk and encourage the banks to lend, but they don't do it. The FED loan officer surveys show that officers have been tightening loan terms for two years as rates fell. However, as the actual spread between short and long term narrows, there is less net income and some greater market risk in holding the treasuries since they have been bid up by this very "FED carry" by banks and funds. So the tradeoff for banks is where is the greatest income spread on their borrowed funds, and where is the least risk at that time? Once that spread gets narrow enough and the market risk on bid- up treasuries gets high enough, a cessation in lowering rates or even early and modest rate increases can induce banks to lend once more. (In all this I am assuming that some old and some new people still have good business ideas and plans at all times, but they don't get funded when the banks can make money so easily on treauries.)What the economy "needs" is some business finance for new businesses with new ideas or products and leadership. With short term rates getting down near 1% and the rates on 2-10 year notes plummeting, it could be that even a cessation of rate lowering and the fear of a rate rise could stimulate lending to businesses. And the banks are flush with cash and notes and bonds. In this project I have going, I am looking at actual market mechanisms which can self reverse a market. Interest rates can be too low for anyone to make any money just as they can be too high for anyone to make any money. So if the spread between treasury notes and deposits or funds gets too narrow, banks have to find another way to make some money. They will have to begin to take on a little more risk in order to make more money, so they will begin to look at loans. This could happen just on its own as an equilibrium phenomenon, or a clever FED could raise rates which would squeeze the note/funds spread. Maybe even a "buyers strike" by CD investors and other "dead funds" could begin to accomplish the same thing, drying up cheap fund supply. I'm not saying when or if this will happen, but rates are getting low enough to squeeze the spread. Reducing rates does nothing but reliquify the banks and stimulate a bond and note market rally by bank buying. This sounds absurd at first glance, but let's get rid of this ugly hyperinflation in bonds which is destroying the economy. Antal Fekete got me onto this idea about ten years ago when he said that the treasury bond market rally in the 1930's prolonged the depression. I didn't fully understand the implications of the idea until recently. Now it makes a lot more sense. Dr. Tom Drake Tenorio Research/NBU csf.colorado.edu