Hodak Value

For those of us who study executive compensation, you'd think that the new disclosure rules would have been a boon. It's not. In fact, I am becoming convinced that the only beneficiaries of the the new disclosure rules are the story writers of our so-called business press.

As I predicted in my note to the SEC (pdf file), the new rules provide very little for the serious analyst that wasn't already provided under the old disclosure rules. I was particularly skeptical of the need to disclose specific perks down to $10,000 when the total value all perks was already required to be disclosed. At the time I wrote that:

greater detail in the disclosure of perks would serve little purpose beyond the voyeuristic interests of those opposed to executive “privileges” of any sort.

Yesterday's front page story in the WSJ, for example, notes that the CEO of Occidental Petroleum "received compensation last year valued at $416.3 million." It makes no mention about what the shareholders got for this pay (in other words, the business story). No, this front page story is about $0.06 million of that amount for his wife's flights on the corporate jet.

The critics ask, couldn't someone who makes $416.3 million pay for his wife's use of the jet? Of course he could. But that would mean taking the time to perform an actual administrative process that wouldn't normally be necessary when simply using an existing corporate asset, like paying to use the bathroom on your floor. Of course, administrative costs are borne by pulling together all this tedium for corporate disclosure. It's hard to see how the shareholders benefit from any of this, until one accepts that the shareholders were never intended to be the real beneficiaries of such disclosures.

I think a more interesting story is how Journal author JoAnn Lublin arrived at the $416.3 million she says the CEO got "last year." The new disclosure rules properly distinguish "granted" versus "realized" compensation. Equity granted in prior years would not be counted as "last year's" pay. Prior year grants that were realized last year would merely be a reflection of company performance under the CEO over the period from grant to realization. If that number is large, it's a reflection of the terrific job done under that CEO.

Someone like Lublin who has covered business and compensation issues over the years--she is, in fact, the Journal's main writer on compensation issues--would, one might think, avoid the error of counting realized income as "last year's" pay. And under no circumstances, one might think, would she count both realized (i.e., historical) and unvested (i.e., future) compensation as "last year's" pay--a double counting flaw intended to be corrected by the new compensation disclosure rules. Alas, one would be bitterly disappointed. Lublin counts all of it as "last year's" pay. Why? Because that makes the number as BIG as possible, which happens to serve the interests of story writers.

Fortunately, there are no disclosure rules for journalists.

Instead, I'm concerned.

The adversary is Towers Perrin, the embodiment of everything that is wrong with compensation governance. Towers' outmoded, feel-good HR model places too much emphasis on "competitive" pay and too little on aligning managers and owners. They're responsible for entire HR bureaucracies focused on rewarding strategies instead of results. They don't offer shareholder-friendly incentives.

The government suspects this failure is the result of the corrupting influence of managers who resist the accountability of such incentives, but I believe that suspicion is misplaced. No, Towers fails to offer useful incentives because their clients, including the most conscientious boards of directors in America, don't want them. Useful incentives require innovation, and boards are not in the mood. Instead, HR firm clients rely on their consultants' experience to give them an incentive plan just like everyone else's. No one will pay Towers, or Mercer, or Hewitt, or Watson Wyatt--what you might call Big HR--for any incentive plan that will differentiate their company, so Big HR doesn't develop them.

Consequently, Big HR is intellectually stunted with regards to leading edge, value-focused incentives. Their consultants are uninformed in modern financial economics--the main vein of research relating incentives to shareholder value. Their analysis is schlock, based on reticent hypotheses, yielding conclusions of questionable validity. To the extent they keep up with developments in incentive compensation at all, it's by stealing the ideas of people who bridge the gap between research and practice. Some of us have a foot in academia and a hand on the pulse of actual clients. Firms like Towers Perrin have both arms around their clients, and legs, furiously shaking to loosen up some more dollars to meet their shareholders' quarterly expectations.

So, I should be happy that Towers is feeling the heat of a congressional committee seeking all of their sensitive client information. But, I'm not. Perhaps it's my sense of history. Perhaps it's because, for all their faults, Towers Perrin doesn't scare me.

Check out this lede:

The government regulates real-world commerce and crime. But as virtual worlds become more complex, should the government regulate virtual life?

Did it come from The Onion or the MSM?

How many people know what the Declaration of Independence actually says? My son, who just got back from a course at FEE (he loved it) read it yesterday because he figured it was probably worth knowing first hand.

Much of what we know about the drafting of the Declaration comes from John Adams. Adams had agitated for a formal declaration. He pushed through the formation of a subcommittee to write it and the quiet, young Jefferson as a member of that subcommittee. Here is his famous recollection of the argument with Jefferson over who should draft it.

The subcommittee met. Jefferson proposed to me to make the draft.

I said, 'I will not,' 'You should do it.'

'Oh! no.' 'Why will you not? You ought to do it.'

'I will not.'

'Why?'

'Reasons enough.'

'What can be your reasons?'

'Reason first, you are a Virginian, and a Virginian ought to appear at the head of this business. Reason second, I am obnoxious, suspected, and unpopular. You are very much otherwise. Reason third, you can write ten times better than I can.'

'Well,' said Jefferson, 'if you are decided, I will do as well as I can.'

The Declaration ends with the famous pledge by the signers of "our Lives, our Fortunes, and our Sacred Honor," but few people understand how dangerous the Declaration really was for it's signers. Up until July of 1776, members of the Continental Congress could hold out some hope for a negotiated settlement with the Crown, whereby they might get the King to see the errors of his ministers in provoking the colonies, and perhaps be spared from hanging for treason. The colonies were in a state of rebellion for over a year by then. The Continental forces had lost every battle thus far, and was steadily approaching desperation.

Against this backdrop, the Declaration was drafted and passed, personally calling the King a "tyrant" and completely severing the bond to England. This was the point of no return. To every practical person alive that day, each signer of the Declaration had basically signed his death warrant. It wasn't until the following Christmas eve that there arose the first glimmer of hope among the colonists to be free of the Crown, and among the signers of living to an old age, when General Washington would win his first battle in his surprise attack on Trenton after crossing the Delaware.

The Declaration was originally passed on July 2nd when most delegates were in a rush to get out of Philadelphia. John Adams sent a letter to his wife the next morning predicting the celebrations that continue to this day, kind of:

The Second Day of July 1776 will be the most memorable Epocha, in the History of America. . . . It ought to be solemnized with Pomp and Parade, with Shews, Games, Sports, Guns, Bells, Bonfires, and Illuminations from one End of this Continent to the other from this Time forward forever more.

As it turns out, the Congress debated a few more changes in the final draft on July 3rd and 4th before finally approving the document. Thus history fixed the date joining Adams and Jefferson in history forever as the 4th of July. Adams and Jefferson both died on July, 4, 1826.

First Chanos, the short-seller made famous by his Enron call, and now ISS. Chanos is concerned that Macquarie might be creating a false impression of high and growing earnings which may not be sustainable. ISS's complaint is that Macquarie's executives don't have the right incentives to sustain those earnings. I can't evaluate Chano's concern, but I can shed some light on ISS's:

Should the gains prove fleeting, an executive would have little exposure to that future downside risk...

ISS also criticizes the company for giving executives 74.2% of their total pay as cash. ISS argues that corporate executives should receive a bigger chunk of [it] in company stock that can't be sold right away -- an incentive for them to keep earnings growth brisk.

Of the US$25.6 million that Macquarie Chief Executive Allan Moss was paid in the fiscal year that ended on March 31, 87% was in his bonus check and 4.2% in Macquarie stock. By contrast, of Citigroup Chief Executive Charles Prince's $25.98 million, nearly 44% was in Citigroup stock.

Macquarie's bonus plan stands in stark contrast to Citigroup's. Prince's bonuses are based on multiple financial and non-financial criteria, subjectively assessed by the board. The criteria and performance thresholds get reviewed each year and are subject to change. This is the type of unfocused, discretionary, shifting plan that the same research shows to be of least value to the shareholders. Furthermore, unlike Mr. Prince's bonus, a good portion of Macquarie's is deferred and forfeitable. Mr. Prince may elect to defer some of his cash, but he can't lose any of it, even if he leaves involuntarily.

Perhaps ISS's qualm is that Macquarie's executives should have more equity. So how much equity does a CEO need? Macquarie's chief has nearly one million shares and options. Is that enough? A five percent gain or loss in Macquarie's stock price would swing his personal wealth by about $4 million. Citibank's Prince has 2.6 million shares. So, how much difference does it make to his alignment that he got another 0.2 million last year?

By the way, most of Prince's equity grant was not performance-based. The board awarded it to "increase retention." I suppose that means they needed to give him that award to keep him at the helm versus, say, jumping over to JP Morgan, or retiring. As if. And, unlike Citibank, Macquarie's guidelines prohibit hedging of executive's shares.

So what exactly does ISS have against Macquarie's incentive compensation that they might want it to look more like Citigroup's?

New York, the bluest city in the among the bluest states, whose people love taxes, is phasing out taxes on apparel and footwear by next year.

Interestingly, just a couple months ago the NY Times had an article about how popular destinations like New York were socking it to their tourists in the form of out-of-control hotel and rental car charges, telling visitors in essence to, "suck it up, you don't vote here." But even New York got embarrassed by their 20 percent tax rate on hotel rooms when the joke among travel agents became, "stay for four days, pay for five." New York has since backed down to about a 14 percent rate, at the lower end of the range among major cities. Tax competition.

Now, politicians seem to be singing a very different tune:

The repeal of this tax will enhance the City’s attractiveness as a tourist destination, particularly to individuals from outside the United States who wish to take advantage of the current exchange rates. Eliminating the city’s portion of the sales tax will encourage consumer spending, which will help to stimulate economic activity and create and preserve jobs in New York.

Where will it end? I predict, in the distant future, a uniform rate on consumption and earnings--all in--somewhere between 10 and 15 percent. That's the rate that would justify a political entity's ability to secure the rights of those transacting and owning property within its territory, and ancillary services most efficiently produced by a polity rather than a market. Everything else will be competed away--the graft, the logrolling, the favors to special interests that come at everyone else's expense, the looting of those who can afford to pay. Tax competition. The very people who hate it will be disciplined by it, as surely as water runs downhill.

Isn't it ridiculous that homeland security funds are being taken away from New York and given to terror targets like Louisville, KY, or Omaha, NE? That's the understandable reaction of New York politicians.

"Why do they persist in giving money to places that need it a lot less than New York City?" said [New York Senator Charles] Schumer, a Democrat.

"They still just don't get it," said [New York Rep. Peter] King, the ranking Republican on the House Homeland Security Committee. "New York is by far the No. 1 terrorist target in the country, and no one else is even a close second."

As a New Yorker, here is what I don't get: Why should I expect people from Nebraska or Kentucky to pay for my security in New York any more than one should expect me in New York to pay for security in Nebraska or Kentucky? In other words, why should these tax dollars be funneled through Washington at all? It's not like New York is a poor state. It's not as if New Yorkers don't choose to live there, acutely conscious of the risks of terrorism. It's not like God said that New Yorkers and non-New Yorkers in middle America are bound to cross-subsidize each other on matters of local protection, even from foreign enemies. Politicians playing God have decreed that, but it doesn't mean it has to be that way.

Everyone knows that the only reason Kentucky or Nebraska is getting Homeland Security funds at all, which include taxes collected from Kentuckians and Nebraskans as well as New Yorkers, is that (1) every state has representation in Congress, (2) Congressional representatives are in the business of getting the most for their respective constituencies, and (3) by just saying the right thing like, "Hey, terrorists can strike ANYWHERE," congressmen can dip into that tax pool to spread the wealth around. Anyone who expects legislators to act like anything other than politicians must have been a hole for the last couple of centuries.

Now, I can see that if New York, or any state, were being attacked by a foreign army then, yea, we all chip in for the common defense. I'm sure President Bush and the fear-mongering hawks on both sides of the aisle will say, "Well, Hodak doesn't get it. This is a WAR! Anyone who wants to treat terrorism as a criminal matter is basically surrendering to the enemy."

Hmm, "war" or "criminal matter?" Politicians benefit from eliminating useful distinctions, like the possibility that the fight against terror could be viewed as both a war and a criminal matter. If they bought into that distinction, then they could allocate money to the military for the "war" aspect of this fight, i.e., hitting terrorist bases in Afghanistan or wherever, and allow the states to carry on the domestic, "criminal" aspects of the fight, like car bombs and shootings, ideally coordinating with the Feds rather than getting into pissing matches over turf.

In other word, they don't have to funnel all that homeland security money through Homeland Security in Washington. Congress could allow local politicians to raise what they need locally to defend their localities from acts that are indistinguishable from crimes. In other words, we don't have to impose a beggar-thy-neighbor system for what is plainly local spending. Congress doesn't have to bribe us with our own money to do what we need to in order to defend ourselves.

If you wanted to enhance the credibility of the teaching of good governance, wouldn't you go to an organization like the U.N.? Of course. That is why the U.N. has endorsed certain guidelines for business school education such as:

We will incorporate into our academic activities and curricula the values of global social responsibility as portrayed in international initiatives such as the United Nations Global Compact.

Gee, if I wasn't so busy preparing for my course on corporate scandals, I'm sure I could dig up lots of examples of U.N. initiatives to illustrate good governance.

The McKinsey Quarterly features an interesting article on organizational complexity, offering the following advice:

Executives should distinguish between two types of complexity—institutional and individual. The former concerns the number and nature of interactions within a company, the latter the way individual employees and managers experience and deal with complexity.

One of the things that markets do extremely well is simplify our lives. Complexity has a cost, and producers compete on minimizing costs to their customers. So, if a producer has a choice between complicating their own life versus that of their customer, the producer will tend to absorb the complexity. Only then will they seek ways to minimize complexity within their organization so it can function more efficiently. Disney World is a notoriously difficult place to work precisely because it's a seamless paradise for kids and families. All the complexity required to produce the "Disney Magic" is absorbed by the folks behind the scenes.

Contrast that with how well government "services" internalize complexity--or not.

My dad was the first to call this morning to wish me a happy birthday. I figured he was the first person to wish me that when I came into the world, but he reminded me that things were different then. The father typically paced the waiting room until a doctor came out to announce, "Congratulations, it's a boy." After a while, the dad would be taken to a window behind which were an array of newborns that all looked much less like him than his bald, crotchety Uncle Saul. My case was complicated, my dad told me, by the fact that the doctors found the umbilical cord around my neck, and had to cut my mom to get me out which, at that time, was still a serious operation.

In contrast, when my big guy was born on this same day 18 years ago, I was in the operating room to see him emerge. (Like me, a generation earlier, he decided he wouldn't leave his mother without a scar for her trouble.) So, like every year since, we wished each other a happy birthday.

Actually, it's birthday week. My best friend was also born this day, and my wife on Monday. I took her out then, and she's taking me out tonight. Neither of us is that into growing older, but I always remind her that it's better than the alternative.

Which reminds me of the lady who brought me into the world. She was a 22 year old girl when the doctors cut her. Year's afterward, she often showed me her scar to remind me of the day I started causing her trouble--probably the weakest attempt at Jewish mother guilt I've ever seen. No doubt, the biggest trouble I caused her--also no fault of mine--was my near death due to illness just a few months after I was born. The doctors plainly told my parents that my survival was a miracle. My dad, who was hunted by Nazis as a child in France, probably took it as just another bit of good luck in an outrageously lucky life, but event clearly traumatized my mom. I believe it contributed to her unadulterated sincerity every time she wished me happy birthday thereafter. I've missed her calls very much these last few years.

Only the worst managements do it. It's a recipe for unintended consequences, like pushing for higher sales, and ending up with crappy profits because you gave up too much secure the sales. Or pushing for higher profits and ending up with crappy returns on investment because you invested too much to gain those profits. I see it all the time.

Guess what? You do too, when watching those managing our country:

“The longer I’m here, the more I’m persuaded that Iraq cannot be analyzed by these kind of discrete benchmarks,” [Ryan C. Crocker, U.S. ambassador to Iraq] said.

After the Iraqi government drew up the first list of benchmarks last year, American officials used them as their yardstick, frequently faulting the Iraqis for failure to act on them...

Measured solely by the legislative benchmarks, he said, “you could not achieve any of them, and still have a situation where arguably the country is moving in the right direction. And conversely, I think you could achieve them all and still not be heading towards stability, security and overall success for Iraq.”

For those of you not into basketball history, Red Auerbach was a heck of a coach. His Celtics won eleven NBA titles in 13 years. Maybe you remember how dominant the Chicago Bulls with Michael Jordan and Phil Jackson were the '90s. Those Bulls would have had to win another five straight championships to match Auerbach's record.

So, Red didn't trust benchmarks, or "the stats" as he called them. Like all great coaches, Auerbach had a mental framework for what it took to win at his game: The person with the best shot should take the shot; the team should ensure that that person gets the ball; the team should prevent their opponents from getting good shots... Pretty straightforward. All that mattered to him was the score at the end of the game. He stayed away from the stats, especially as they applied to individual performers.

There's only one stat I was ever concerned about. When this guy's in the game, does the score go up in our favor or go against us? The Boston Celtics never had a league's top scorer. We won seven championships without ever placing one Celtic in the top ten.

No Celtic got rated according to how many points or rebounds or assists or anything else he might have compiled. Each man was assessed according to his contribution toward making us a better team. That's all I cared about. In our system, the guy who sets the good pick was just as important as the guy who made the shot.

Now, imagine his coaching task if, before every game, he went behind a curtain and could only manage his team by receiving stats and the play-by-play announcement? The inherent limitation of "managing by the numbers" becomes quite plain.

For most of our history, the U.S. penny was made mainly of bronze, which is 95 percent copper and 5 percent zinc and tin. As the penny's value deflated over time, it's constituent metals became worth more than one cent. In 1962, the tin content of pennies was removed to increase their melting point. By 1982, when the copper value of pennies became sufficiently worth more than a cent that pennies were again in danger of getting melted for their intrinsic value, the mint re-designed the penny to become a copper-coated zinc coin--97.5 percent zinc and 2.5% copper. Last year, even that mineral content was no longer cheap enough. The cost of minting a penny was about 1.23 cents, and once again an arbitrage opportunity for coins appeared.

Like all organizations involved in making things, government's have various tools at their disposal, such as mineralogy and production efficiencies, with which to react to the arbitrage opportunities they sometimes create. But when all else fails, governments have a tool that no other organizations possess--a monopoly on violence. So, last December, the U.S. government instituted fines and jail time for anyone melting coins for their mineral value.

How effective are such government interventions? I guess it depends on how you define "effective."

The pervasive collectivist instinct discussed in certain posts here may seem discouraging to some of you, but take heart. I believe that the future belongs to those who love freedom. The evidence, though all around us, is sometimes disguised as braying by government officials. To wit:

It's simply unconscionable from an ethics standpoint for this company to go in from this unfair bargaining position...It's just exploiting a desperate town.

Actually, Lenoir did once have those revenues, but they lost them in the competition to keep their previous local industry. Alas, this is not really news. Localities always have to compete, and not just in the U.S. This competition is simply getting more visible, all over the world. That's economics.

People who lose jobs to competition don't like the laws of economics any more than people who fall and hurt themselves appreciate the laws of physics. But there is no point pretending they're not real, or that the government can override them. Economic relationships and consequences are becoming increasingly transparent, to the point that anyone can see them. Eventually, taxation and regulations will be competed down to the lowest level needed to competitively provide essential services. Yes, troubled readers, we may very well be on the path toward libertarian Nirvana. All you have to do is live long enough to see it.

Most proponents of universal health care see the basic trade-off as health of the poor versus leisure of the well-off. Most economists, however, believe that the real trade-off is between access, cost control, and innovation. You can't have more of one without less of the others. They also observe that in the real world, those trade-offs tend to place cost control first and innovation last. Access, sandwiched in the middle, is invariably compromised by rationing due to cost control. Elected officials have the last word on these trade-offs, and no one facing election in the next two-to-four years will spend scarce political capital on investments that might pay off in the next decade.

So, while proponents of universal health coverage posit that one can't trade-off lives versus dollars, the laws of economics force those very trade-offs both today and into the future. The only difference between lack of universal coverage versus the lack of innovation is that those deprived of coverage can be filmed by Michael Moore today to get sympathy for universal coverage in this election cycle. Those deprived of innovation won't be victims for years or decades, and Moore, if he hasn't died from self-inflicted wounds by then, won't have any idea which of the people dying from incurable diseases might have been cured if there had been greater rewards and incentives to innovation. Eventually, entire generations may be spared if innovation could proceed quickly enough.

So, the degree to which innovation affects life expectancy is an interesting question. This question has been partially answered by Frank Lichtenberg, a researcher at Columbia University. In short, innovation dramatically affects life expectancy, much more than policy-makers might suppose (or wish to acknowledge). Lichtenberg finds that life expectancy has increased very unevenly across the United States. In the last 13 years, life expectancy has increased by three to four years in some states while it has gone up less than a year in other states. Lichtenberg shows that two-thirds of that variation is due to differences in the availability of newer drugs, based on different Medicare policies across states.

This study indicates that the development and use of new medical goods and services...have been responsible for many recent gains in the health and longevity of Americans.

Health policy advocates have long contended that the FDA's power to review medical treatments has lead to far more patient deaths than lives saved. The theory, supported by a growing body of evidence, is underpinned by a simple set of incentives. If an approved drug leads to someone's illness or death, it may get all over the news, and we know how the FDA's antsy, congressional patrons would react to that. If an unapproved drug might have prevented hundreds or thousands of deaths, there would be no media or congressional reaction, because no one would likely know about it. So, the FDA has an institutional bias against drug approval below the very highest margins of safety, a decidedly non-economic standard, one that costs countless lives.

The exception that proves the rule: AIDS drugs. Here, the FDA's cumbersome, time-consuming, costly review process was highlighted by a politicized, media-savvy group that acutely felt the lack of progress in the development of treatments.

Last year, the FDA's authority was successfully challenged in court by the Abigail Alliance. This group was founded on behalf of 20-year old Abigail Burroughs (pictured above) who was denied access to a drug in 2001 that had passed Phase I trials. The drug that was later approved by the FDA, after she died. Imagine an FDA bureaucrat patiently trying to explain to you why a particular drug might have only an 9.3 percent chance of working on your dying child, and thus preventing your doctors or the drug manufacturer from selling it or giving it to you until more tests are done on its efficacy.

So, for the non-politicized masses with rarer diseases or no press agents, how far will the FDA go to protect its authority to tell dying patients what potentially life-saving drugs they may or may not take? After the court's Abigail Alliance decision last year, the FDA filed a brief challenging the standing of Abigail Alliance members who have all died since their original briefs were filed in 2003. That's right. The FDA, which arguably hastened their deaths, is arguing that their death undermines their standing to challenge the FDA.

That might be a statement about the size of their agency's balls, or about the agency's desperate grasp at a remedy for a judgment that threatens their regulatory body.

Every now and then, I figure that maybe Europe is at a stage where it might begin keeping America honest. They may look over here at our freedoms, and decide they don't want to be collectivist also-rans anymore, that they're ready to step up to the challenge of being the place where the world wants to live, and reduce taxes, and reduce regulations, and spread those human rights like warm Nutella on a baguette.

Then they pull sh*t like this.

I was a paper boy in high school. I would get up at about 5 a.m., go to my drop point where a stack of papers would be waiting for me, and deliver them through the neighborhood in time for me to get back home and get ready for school. Once a month, I would go around door-to-door to collect money from the families on my route. It was generally the only time I saw them. They would tell me what a fine job I did, and often tip me a quarter or 50 cents. A couple of customers even tipped me a dollar. I always remembered who they were. Every now and then, someone might tell me that I wasn't always getting the paper to them early enough, or that they preferred to get the paper at their side door rather than their front door, and I would adjust my deliveries to accommodate them.

Collecting money was a pain. I might have to go to some houses two or three times before finding someone home. After I collected the money, I would count up what I owed the newspaper, based on the wholesale price of the subscriptions, and put it in an envelope to give to Mr. B., the man who dropped off the papers for me each morning. The difference between what I collected and the wholesale price is what I got to keep.

One day, Mr. B. drove by to pick up the money, and he asked me if I would be interested in giving up collections. He offered to send out invoices, collect the money by mail, and instead of picking up an envelope of cash from me once a month, he'd bring me a check. He said it would be more efficient all around. Win-win.

I thought about it. The prospect of saving several hours a week not having to collect money definitely appealed to me. On the other hand, if I didn't collect it myself, I would lose the tips, which were nice, and what little interaction I had with my customers, who were also generally nice, and who sometimes let me know when I needed to change something in my delivery. In the end, I decided that it was worth it to let Mr. B. handle collections.

The next month, instead of running around to collect money, I sat back in my room at home, finished some homework without having to rush, and generally enjoyed what seemed like a little time off. Then I got my check from Mr. B.

I looked at it, and quickly realized it was less than I expected. I asked him what happened to the rest. He smiled, shook his head, and explained that he subtracted the administrative costs associated with collections. I told him that he didn't tell me about these administrative costs when he offered to do this. I was willing to give up the tips, but not this administrative cost, too. I told him this no longer seemed like such a win-win to me, and that I would just as soon return to the old way of collecting. Mr. B. smiled, shook his head, and said that there was no going back. I felt rooked.

That was my first experience with hidden trade-offs. After that, I became more careful whenever someone offered me a "win-win" opportunity. When a salesman promises me some sort of deal, I insist on understanding where, exactly, the value will come from. Will I be giving up some level of service in exchange for reduced costs? If not, where do the productivity gains come from? Sometimes, I would get good answers, and take a chance on the deal. If I didn't get good enough answers, I would pass.

I love getting value for my time, energy, or money, but I always react to offers with a little skepticism. Certain people tend to gain my trust pretty easily. They tend to be deliberate, precise types who back up their claims with logical explanations and sound data. I'm glad to have the kind of training that enables me to understand their explanations and evaluate their data, otherwise my skepticism would have long ago degenerated into cynicism. Other kinds of people have very little credibility with me. They tend to smile and shake their heads when explaining why their last deal didn't work out as well as they had promised. I no longer pursue their promises, no matter how wonderful they sound. Politicians generally belong to that group.

I wish more people had my experience of feeling duped at a time when the cost was low but the impact was high. Such an experience might coax more people to better learn how to evaluate promises. Unfortunately, it seems that most of my fellow citizens tend to be either credulous or cynical. I think that many of the problems we face today arise from that imbalance.

Earning guidance is a controversial practice on Wall Street. Companies don't like it because they're concerned that investors place too much emphasis on one little number--current earnings--instead of focusing on the long string of future earnings that everyone knows should guide valuation. Managers are also a little concerned about the liability associated with "misleading" investors about earnings, i.e., falling short, even if for reasons beyond anyone's control. Wall Street has the same concerns as management, plus the sense that certain managers may be pushing the accounting envelope a little far, or making short-term decisions to manage their earnings. Governance mavens don't like the idea of one party trying to manage the other's expectations. They would rather that companies simply became more transparent without the games.

So, if everyone is wary about earnings guidance, why is it so common? Over a third of the S&P 500 and perhaps a larger percentage of investors play this game. This game becomes more easily understood if one sees Wall Street as an animal that needs a certain amount of variety in its diet. Information from companies is a type of nutrient for the capital markets, and we are seeing the effects of nutrient deficiency in the feeding frenzy that surrounds earnings announcements. Companies try to mitigate this frenzy by offering earnings guidance, even though they don't necessarily benefit from doing so.

Earnings guidance has been around in some form for a long time, but it really became a focal point for the investment community after the introduction of Reg FD. The intent of Reg FD was to create a "level playing field" for corporate disclosure. The main effect, however, has been to severely constrain the flow of information between companies and outsiders. Companies are justifiably afraid to disclose information in something other than the prescribed manner, and the market has suffered from the effects of reduced disclosure.

MySpace recently booted about 29,000 sexual predators from its site. Nobody asked them to do it. They just figured that it was good business to keep their young customers from getting, you know, raped. On the one hand, one could read that as a positive indicator that a private company has every incentive to police its space and keep it safe for its intended users. On the other hand, one can read that as the perfect excuse for government involvement in the Internet.

"The exploding epidemic of sex offender profiles on MySpace - 29,000 and counting - screams for action," said Connecticut Attorney General Richard Blumenthal.

In North Carolina, Attorney General Roy Cooper wants a state law that would require children to obtain parental permission before creating profiles on sites such as MySpace, and require the site to check parents' identity.

The Daily Dish picks up on a new study from Democracy Corps that purports to find a collapse of support for the GOP among young people.

Money quote:

Young people react with hostility to the Republicans on almost every measure and Republicans and younger voters disagree on almost every major issue of the day. The range of the issue disagreements range from the most prominent issues of the day (Iraq, immigration) to burning social issues (gay marriage, abortion) to fundamental ideological disagreements over the size and scope of government. This leaves both potential Democratic nominees with substantial leads over Rudy Giuliani, but importantly, both Democrats still have room to grow their support among younger voters. The current problems with the Republican brand are not fully reflected in young people’s preferences for President.

I'm sure this generation now coming of age will one day look back on the growth of government in the first couple of decades this century (especially if we get the kind of president that Democracy Corps wants), and wonder how their parents/grandparents who professed to care about them so much could have stiffed them so badly.

(HT: ProfessorBainbridge.com)

That was the headline of a WSJ article today. It begins with the story of Invitrogen Corp. having spent $2.5 million and 10,000 man hours on SOX requirements.

Officials at the Carlsbad, Calif., biotechnology company think the costs are excessive. But they say Sarbanes-Oxley helped to spur other changes that made Invitrogen a better-run business.

* The government requires all restaurant food to be tested for bacteria before being served to customers. "Incidences of Food Poisoning Reduced"
* The government lowers highway speed limits to 40 mph. "Fewer Deaths on Our Nation's Highways"**
* The government mandates blender blades be diamond-tipped. "Smoother Smoothies for Everyone!"

If positive, absolute benefits were the primary criteria by which laws should be passed, we'd end up with nominally more benefits, but with significantly less of the things that we could have had if our resources had been allocated elsewhere. (Sound familiar?) Unfortunately, newspapers can't write compelling stories about the things we don't have as a result of resources that were not devoted to them.

Congress, of course, counts on invisible opportunity costs staying that way. That's why they didn't simply mandate that companies put the proposed SOX rules up to a shareholder vote. They had neither the good will nor the good sense to do that. Letting people decide what to do, letting them weigh their interests for themselves, is not what lawmakers do.

** (HT: Larry Ribstein)