Mark Byron

The Mediocre Coach

I saw this story on the government looking to regulate executive pay (actually a crawler of the news on Fox as we were leaving lunch the other day) and felt like one of those movie heroes as the bomb is about to go off. Everything goes into sloooooow-moootion, and the hero hollers "Noooooooo!" in a deep voice, since everyone sounds like Barry White in slow-mo, as he either starts to run in vain towards the blast or dive out of the way just in the nick of time.

The one thing that could make sense in the proposal is to have stockholders vote on corporate pay raises; the non-binding votes that are in the proposal have very little teeth other than to possibly show up sloppy boards of directors.

What might make more sense would be to have binding votes on top executive's pay. Corporate boards have a tendency to become a bunch of yes-men (have the board meeting in Mexico and they become a Si Section;-) and rubber stamp pay raises; making shareholders approve them would be a step in the right direction. If you coupled that with Internet voting of shares rather than giving proxies to whatever faction (usually the board's) will be at the meeting that you support, that would make the corporate accountability even better.

Most shareholders don't care about the details of their company's board as long as the company seems to be doing well and the path of least resistance is to give management your proxy if they seem to be doing well. If pay raises required an active majority of shareholders to mail-in or click-in saying "Yes, that pay raise is fine by me.," we'd get more reasonable pay package.

However, trying to conjure up a government-mandated formula for how much CEOs make seems counter-productive. One of my general thoughts on government in the marketplace is that it is a good referee (judicial system), a mediocre coach (regulation, industrial policy) and a lousy player (government-owned businesses).

Good decision making is worth money. If billions are riding on a decision, it may well be worth tens of millions to have a good decision-maker. Yes, that means he'll make a gazillion times more than Joe Shoprat, but more is riding on the CEO's decision whether to launch a new product that Joe's decision to pull a defective item off the line. Both are important, but Joe's decision isn't going to make as big of a dent on the bottom line.

What often the problem is with executive pay is that mediocre decision making is getting overpaid. However, that's better left to stockholders than to Uncle Sam, and Uncle Sam is best left out of the loop, with the possible exception of making it a bit easier to keep mediocre CEOs accountable to their shareholders.

Not the Worst

One of the things that was running through my mind is the large number of the reality/contest shows that work on the format of getting rid of the least-popular or least-successful person each round, round by round, until the final two square off.

I think Survivor was the first of that modern breed, but almost all the multi-week contest shows work on that format, like American Idol and Dancing With the Stars, where one person gets visited by The Turk each week. Or, The Apprentice, where someone gets to hear The Donald say "You're fired" each week.

The Weakest Link does that in game-showdom, and it's a Food Network staple format, with competitions to get new hosts and a new Iron Chef running that ditch-the-weakest format. A new half-hour show Chopped gets four chefs presenting appetizers; the weakest app gets to go home, then the weakest of the three entrees gets the cleaver, and then the weakest of the two deserts gets their bags packed.

Do we blame Survivor for this? No, try Jack Welch; he makes Trump look like a softie.

Each year, Welch would fire the bottom 10% of his managers. He earned a reputation for brutal candor in his meetings with executives. He would push his managers to perform, but he would reward those in the top 20% with bonuses and stock options. He also expanded the broadness of the stock options program at GE from just top executives to nearly one third of all employees. Welch is also known for destroying the nine-layer management hierarchy and bringing a sense of informality to the company.

During the early 1980s he was dubbed "Neutron Jack" (in reference to the neutron bomb) for eliminating employees while leaving buildings intact.

What the contest shows do is to adopt the first half of the platform, ditching the bottom-rung employee.

In corporate America, many managers have a good cadre that they don't want to break up; if everyone is doing their job well, a boss shouldn't have to select one to offer up as sacrifice to the pink-slip god. One friends of ours left a job as a manager when his workplace had him implement the fire-the-bottom strategy when he really didn't have a bottom to fire; he had a bunch of good workers, none of which deserved to be fired. However, if you're playing the game of Corporate Survivor, someone has to get voted off the island each year.

What we might be seeing in places that have this strategy is a bit of risk-avoidance, both on a personal and business level. If the goal is to not be the weakest link, one should avoid standing out and be part of the pack. If you can aim to be in the 50% percentile, you won't get fired.

Aiming high can also make you stand out, which might put you in line for Welchian bonuses, but might also put you in the unemployment line if your efforts are not appreciated by your boss or your co-workers. You might be hustling and doing a great job, but you might be earning the enmity of the semi-slacking middle who you make look bad; they might make your life miserable and make you negatively stand out.

I even see a bit of this in Christian circles, where we tend to focus on a bottom 10% of capital-s Sinners who do all those things that Paul rails against; the rest of us can get into some spiritual Welchism and see us well above that 10% that will get us voted off Heaven Island. We all have our low-grade vices that are often well hidden, but we can get a false sense of security if we feel better than the real reprobates. That was what Jesus ripped the Pharasees for, seeing themselves better than the spiritual riff-raff.

Jesus was more about reaching the lost sheep, the 1% that weren't with the program. We need to be working at bringing people onto the island (a.k.a. the Kingdom of God) rather than voting them off.

Life in a Northern Company Town

Some tough news for my hometown of Midland; Dow Chemical is having to do some serious trimming-

The Dow Chemical Co. today said it plans to eliminate 5,000 jobs, close 20 facilities in high-cost locations, divest itself of several businesses, temporarily idle 180 plants and cut the global contracted work force by 6,000.

The job reductions within Dow are roughly 11 percent of the company’s work force. The measures will save $700 million in yearly operating costs by 2010.

It's a real small world; the co-author of that Midland Daily News piece, Cheryl Wade, is one of our circle of friends from Midland. I can recall seeing she and her guide dog (she's blind) at Midland Free Methodist when we went their in 2006-7 before moving to Lexington.

Dow has been trimming staff for years, but an 11% cut means 11% of Midland's primary employer. That would mean something on the order of 500 jobs in a town of 40,000 if Midland gets its share of the cuts. That's around 3% of the working population, even before you start looking at multiplier effects; the 3% getting laid off or early-retired will have less to spend at local establishments, possibly forcing marginal stores to close and lay off more people.

How much of a company town is it? The new minor-league baseball stadium is the Dow Diamond, the city library is the Grace A. Dow Library, the old high school in town is the Midland High Chemics and the newer school (circa 1970) is Dow High. The two largest employees are Dow Chemical and Dow Corning (a Dow-Corning Glass 50-50 corporate "partnership"); confuse the two at your own peril if you go to Midland.

I can remember past Dow staff trimming. One of my dad's good friends Don Cormier got early retired from Dow in the early 90s and spend what should have been a productive 50s selling appliances at Sears at our then-new mall; however, he had more free time to help out in prison ministry and helping out with the Open Door homeless shelter. He passed on last year.

Not everyone's going to be as productively semi-retired as Don was; my father-in-law got early-retired out of a comptroller's job and works as a gas station/convenience store manager to supplement his pension pay.

Pray for the people in Midland and elsewhere who are getting laid off (and their families, church-mates and loved ones). Also pray for the ones who aren't getting laid off, for they will have both survivor's regret and a heavier workload if Dow is trying to do more with less; Eileen got let go from a long-term temp position at Dow a few years back when they decided to staff her department with one less person.

GM 2.0?

Democrats do occasionally, nay, frequently, have common sense, including Madam Speaker

Democratic leaders in Congress sidetracked legislation to bail out the auto industry Thursday and demanded the Big Three develop a plan assuring the money would make them economically viable. "Until they show us the plan, we cannot show them the money," Speaker Nancy Pelosi, D-Calif., said at a hastily called news conference in the Capitol.

She and Senate Majority Leader Harry Reid, D-Nev., said Congress would return to work in early December to vote on legislation if General Motors Corp., Ford Motor Co. and Chrysler LLC produce an acceptable plan.

I'm still working though what might be a viable way forward. Here's my framework if I were getting the combat pay as treasury secretary.

(1) Sit down with the UAW and map out a wage and benefit package that will pass muster for the long haul. This may be easier for an Obama administration econ guy early next year, for he can play the bad cop: "If we don't do this right, we'll be looking at losing the House in 2010 and, God forbid, getting stuck with President Palin in 2012. So, we really, really need to do this right."

(2) GM will get cleaned out and started over. Currently, GM has $110 million in assets and $170 in liabilities on the books. I'd offer the creditors $100 billion for the lot and start a GM 2.0 with a new labor contract (see #1) and a revamped balance sheet. We might be able to do it even cheaper than that, since GM debt has been trading at 20 cents on the dollar as of late.

(3) Where do I get that $100 billion for GM2.0?

$20 billion in convertible preferred from Uncle Sam.

$30 billion in common equity from private investors. Toyota might be interested in a controlling stake; they already have major ties to GM and have enough cash on hand to fork over $10 billion or so of that. The remaining $20B can come from an IPO of GM2.0.

$50 billion in long-term debt. We might offer to have Uncle Sam co-sign the debt in return for stock options.

(4) Ford is only $2 billion in the hole and might only need a modest infusion. Chrysler style loan guarantees might be all Ford needs; remember that the US made money on the Chrysler deal of the late 70s.

(5) I'd have to see the Chrysler financials in order to see where they're at. Since they went private last year, we don't have access to their numbers. I'm reminded of this bit from our Sullivan U faculty advance SACS and the City skit, where "Old Nick" (he of the horns and tail) is tempting some lady instructors into improving their teaching methods-

Old Nick: Well helloooooo ladies…

Miranda: Who are you?

Old Nick: Call me a teacher. Call me a preacher
Where learnin’ is burnin’ I’m the feature creature.
Don’t be passive, learning is massive.
If you teach it right it’s radioactive.
Problem solve, activate, maybe you collaborate.
Introduce experiential, that’ll make ‘em salivate.

Carrie: Salivate? You’re going to teach us to slobber?

Old Nick: Like Pavlov’s dog.

Charlotte: Who's Pablo? What kind of dog? A Chihuahua?

Old Nick: Forget the Cerberus, err, I mean dog, I’m here to help you learn.

For the time being, we'll need to forget the Cerberus..... Capital until they give some up-to-date financials on Chrysler.

It will be interesting to see if this actually gets through a lame-duck session of Congress, or gets left for the next Congress and either the very last days of the Bush administration or the early Obama administration.

Canadian help seems forthcoming, as it was part of the Throne Speech (the Canadian equivalent of the State of the Union address) yesterday. However, the US will have to be doing most of the financial heavy lifting on this one. It might not be as heavy as it might seem if we do it right.

However, doing it wrong might take out a good hunk of our economy. We need to get an economic FEMA in for this creative destruction, lest we take the heart out of our manufacturing sector.

Another Case for Global Brand Management

Here's an interesting case in point about giving regional managers a very short leash; Papa Johns was part of a promotion in Washington dissing LeBron James, who had complained about being roughed up by hard Wizard fouls during their series; they had Crybaby 23 jerseys printed up for their Washington fans.

Minor problem. Papa Johns also does business in Cleveland. What happens in DC doesn't stay in DC-

Papa John's Pizza issued an apology to Cleveland and the Cavaliers for making T-shirts with LeBron James' number and the word "crybaby" under it.

To apologize, Papa John's will sell Cleveland residents a large, one-topping pizza for 23 cents on Thursday. The 23 is an homage to James' jersey number. The company also will donate $10,000 to the Cavaliers Youth Fund.

That reminded me quite a bit of the absolute mess that a certain vodka company created when they ran an ad in Mexico with a fantasy map giving the southwest back to Mexico. American boozers (and non-boozers) complained and vowed to change brands.

I don't think selling vodka for $0.23 would make sense; I remember what 10-cent-beer night did in Cleveland years ago. What might be fitting is to move the price of a 750ml bottle down from $21.90, (if this Vermont site is a fair indication) to $18.48 to commemorate when the US got the Southwest from Mexico.

However, hard booze is often regulated by state folks, who often set prices to keep booze from being too competitive and people using liquor as loss leaders. So, that promotion would get regulated out of existence.

Closing thought for a menu joke for a jingoistic non-Tex-Mex restaurant: Dinner for two for $18.48 for Cinco de Mayo.

Berluscromney

Two news items caught my eye at lunch just now. The first was the FCC OKing the purchase of Clear Channel, the big radio and TV station owner, "by private-equity companies Bain Capital and Thomas H. Lee Partners."

Bain Capital... Mitt Romney's Bain Capital? Yep. The deal had been announced back in November, but just got finalized today.

So, here you have a guy seriously in the hunt for the presidential nomination as a partner in buying the biggest network of radio stations in the country.

The other somewhat related news item was the fall of the current Italian government; PM Prodi lost a confidence vote in the Italian Senate. What does that have to do with Mitt Romney and Clear Channel? Well, the opposition leader, conservative former (and likely future) PM Silvio Berlusconi, is a media magnate. Here's a summary from his Wikipedia page-

Berlusconi is the founder and main shareholder of Fininvest, among the ten largest Italian privately-owned companies, operating in media and finance including three national TV channels. Together these account for nearly half the Italian TV market. He owns three (out of seven) national television channels as well as some of the country's most important newspapers. He is also well known for being, since 1986, the president of A.C. Milan, a prominent Italian football team.

The best analogy I can think of is to cross Ted Turner and Rudy Giuliani, giving him Turner's media holdings pre-sale-to-Time-Warner and Atlanta Braves teams with Rudy's politics, attitude and love life (he was having kids with the lady who would become wife #2 before divorcing wife #1). His party's name, Forza Italia, would loosely translate as "Let's Go, Italy;" it replaced the old Christian Democrats as the main party of the center-right.

He's been able to have political coverage slanted in Forza's direction, which gives the Italian left no little bit of consternation.

Would the Bain-held Clear Channel do that, slant their news coverage Romney's way? Probably not, but the question would be posed.

Any slanting might not be that blatant; it might be that the news-talk stations in their flock tend to keep the talkers in the Rush-Hannity universe that tends to stick to a conservative Republican line and away from various heterodox thoughts, be it various liberals or maverick conservatives.

That might make business sense as well as political since, since the primary motivation for the purchase is to make a buck. This isn't going to evolve into an Air America of the right, for the right doesn't need it; conservative talkers seem to do better in ratings than liberal talkers, and radio station's favorite color isn't red or blue, it's green.

I channel surfed into Rush on my way back from campus this afternoon, and he was pooh-poohing that other Sullivan's (other than my big bosses) piece stating that the race was McCain versus Rush. However, it seems to be boiling down to McCain versus the new owner of one of Rush's major patrons; quite a few Clear Channel stations carry El Rushbo.

Roger, Over and Out (of the Mortal Coil)

Michael Moore's first big documentary effort was Roger and Me, a look at a declining General Motors and a even more declining Flint. The Me part of the title is still with us, much to the consternation of many conservatives, but the other title character has pass on to his reward. Roger Smith, GM chairman and CEO in the 80s, died on Thursday.

The obit in the Detroit Free Press puts a good spin on Smith, who tried to automate GM, learning Japanese productivity tricks, and take GM in into a global marketplace. Marketing seemed to be his weak suit; GM tended to send out cookie-cutter cars that looked the same across the various GM brands, because they often were the same.

GM made some smart acquisitions, buying EDS, then selling it at a profit after having a running feud with EDS founder Ross Perot. Back when the Little General was running for president, his inability to work well with Smith was seen as a detriment; given how anemically GM was managed, not working well with Smith seemed to be a plus. They also bought Hughes Aircraft, which they sold at a nice profit.

However, the same smartness can't quite be attributed to their core business. Part of it may be due to a global marketplace, that the Big Three ain't as big as they used to be and can't be expected to have the market shares that they had in a more nationally compartmentalized car market.

Decisions, Decisions

Another day, another midterm to proctor. Beats working for a living.

It's my Supervision class' midterm that I'm supervising, and we had some interesting discussion on our chapter on decision-making that we covered pre-exam, ranging from restaurants and satisficing (getting good leads on two local mom-and-pops, Bella Notte [which brings back way too many Lady and the Tramp images] and Cozy Burger), brainstorming (would the Pet Rock gotten through a normal corporate meeting?) and groupthink.

Interestingly, the textbook ragged on satisficing, where you make a limited-choice decision which may not be the best decision but a good enough one. The book called it "bounded rationality" instead. That attitude makes sense if we're talking about a big decision, where you need to cast the net further than the usual suspects, but such boundedness might make perfect sense if you have a low-impact, one-off decision.

For instance, there are plenty of good restaurants in Lexington, but if you were buzzing by on I-75 going through Kentucky to points beyond, you'd likely just hit whatever name-brand restaurant was near an exit; unless you get a kick out of discovering restaurants, you're not going to do that much research on a one-time pit stop.

The other topic that brought some politics to mind was on groupthink. One can make a case that there was a bit of groupthink in the Bush administration over Iraq, that the critics were both afraid to get in the way of the neocons who were itching to get Saddam and accustomed to look down upon a cautious, critical, diplomatic approach to things as typical Foggy Bottom wimpiness.

That's not to say that it wasn't the right call, but that critics weren't getting as good a hearing as they should have in 20/20 hindsight. The critics might have been both afraid to go against the grain and also felt that the critics were wrong by definition; in politics, you automatically discount what the opposition is saying, lest you grant the possibility that they might actually be right on occasion.

The other aspect of groupthink comes in when you're in a homogeneous group where "everyone thinks the same way about [fill in the topic]." Big-city newsrooms and liberal cultural stands would be one example; regardless of gender or ethnicity, most everyone's underchurched and to the left on abortion, gay rights and other such issues. Since "everyone they know" is a good liberal, it makes conservative stands on those issues seem radical.

In fairness, there are some of my circles where the reverse is true; if you run in a conservative crowd and everyone has a certain viewpoint, it makes the liberal alternatives look radical.

One of the nice things about reading blogs is that it give you a diversity of opinion that you may not get in your circle of friends and colleagues. I've learned a lot about earnest and devout Catholic faith from Catholic bloggers, stuff you would not get from the cadre of ex-Catholics in my evangelical circles for whom Catholic-bashing is often a favorite parlor game. I also get from folks like Bene and the Connexions crew a center-left Christian take that often shows the weak points of a standard conservative take on things.

Diversity helps making better decisions. Even if you don't agree all the time with folks, they often can inform you and help you get a broader view of the world.

The Totally Depraved Worker, or Imago Dei?

I'm still digesting a comment that one of my Basic Supervision students had Friday night. I was talking about the financial theory concept of agency costs. One version of it looks at selfish workers looking out for their own best interest (e.g low-level workers goofing off or higher-level workers voting themselves nice perks) rather than the interest of the firm; things like profit-sharing, employee stock ownership plans and stock options are frequent remedies for agency costs.

One of my students commented that 80% of the workers where he worked at wouldn't be motivated much by such equity bennies, that the reward for hard work was their basic paycheck and that they weren't quite the self-centered beasts that I was portraying them as. When I dropped back five yards and paused for a moment, I started to agree with him.

Back when I was taking my management classes in the late 80s, one of the current constructs was Type X and Type Y management. Type X managers assumed that their workers were lazy and untrustworthy and thus needed micromanagement and a very short leash. Type Y managers assume that workers were generally smart and hard-working and give them much more authority, more independence, and less micromanagement.

The idea is that most of us would hate to have a Type X drill-sergeant manager and would respond better if given a longer leash. There are some folks who need tight supervision, but they tend to be in the minority. Management courses of the era were trying to lead folks away from that drill-sergeant mentality and to a more trusting management style.

However, the thing that hit me was that our religious rhetoric in evangelical circles might lead us to a Type X attitude. If we look at the huddled masses as a bunch of totally depraved fallen sinners who are worthless without God, we could assume that folks are up to no good unless they're tightly controlled. Financial and economic theory often falls in along that sinner paradigm, assuming self-centered greedy folks who only respond to economic stimuli.

A Biblical factoid that would argue for a more Type Y approach is that we're all God's children made in the image of God. While we are all sinners and need a Savior to be made right with God, we're not living like we're in a Mad Max movie in our day-to-day lives. People are cultured to function cooperatively in society and have a lot of the rawest selfishness trained out of us; a two-year-old will scream "Mine!" but an adult will generally act in a more civil manner. We may not like living in a cooperative manner all the time, but we know that it makes things go more smoothly in the long run.

We're far from perfect, but we're also far from being perfectly imperfect. We may be totally depraved as per salvation, but are something far short of level of depravity that in the context of being a citizen and worker.

Might we be better off if we start looking at our fellow men at the workplace and in the public square as good-but-flawed folks in need of a Savior? I think so. Far from perfect, but still reasonably good, by and large.

Bird Colonel Motors

This is going to leave a mark down in metro Detroit-General Motors has just been demoted, as Toyota just passed GM as the world's biggest car maker. Even in the US market, Toyota has buzzed passed Chrysler and is toe-to-toe with Ford for #2 in the domestic market.

The days of the "Big Three" are toast, and have been for a while. The line between domestic and foreign cars have become blurred, as Toyota and a lot of other "foreign" auto makers are building plants and R&D facilities in the US, while our "domestic" car companies try to think on a global scale. Even Baby Big Three Chrysler got bought out by the Mercedes folks years ago.

A tip of the hat to those wonderful folks who gave us Pearl Harbor; they took the quality control and inventory processes that American business profs were preaching to heart and proceeded to show the Americans how to build a better car. It's a good example of international economics, letting the folks who can do things the most efficiently get the business. That may be cold comfort if you're a UAW family sneering at the "rice burners"; even there, more and more of those are being built in the US with US workers.

Mad Dogs and Canadians

The story of Chrysler being on the auction block has been around for a few weeks, and rumors of a takeover lead by Canadian-based auto parts maker Magna seem to be taking shape; Magna may be taking on some private equity partners to make the deal possible-

U.S. media reports have pointed to private equity firms Cerberus Capital Management and a group consisting of Blackstone Group LP and Centerbridge Capital Partners LP as the leading bidders for Chrysler.

The name Cerberus rung a bell from my school days; it's the three-headed dog that guards the gate of Hades, ensuring "that all spirits could enter, but none could return." Or, to borrow from the last line from Hotel California, the dog is "programmed to receive; you can check out any time you like, but you can never leave."

Not exactly the kind of vision that a Chrysler shop rat wants to see. Canadian Auto Workers boss Buzz Hargrove didn't like that vision much-"That's a big concern to us, because their history is to cut a lot of jobs, close a lot of plants, get lean and mean in a hurry to sell and make a lot of money for executives and throw a lot of people out of work."

That Magna-Cerberus team would have some interesting connections on both sides of the border. Magna's chairman Frank Stronach daughter Belinda is a Liberal MP (and former Conservative Party leadership candidate before crossing the aisle), while Cerberus has quite a few Republican heavy hitters. Dan Quayle has been on the Cerberus payroll and former Treasury Secretary John Snow is the new chairman.

It would likely mean some rather ruthless job-cutting on the part of the new team; part of that hardball could spill over into politics. Hargrove is a major player in the NDP, and having a Liberal stalwart like Stronach (he's been a Liberal for a longer time than his daughter, having stood for Parliament as a Liberal candidate in 1988) be part of a harsh job-cutting regime at Magna-Chrysler might have some interesting political ramifications. The CAW is not afraid to strike, and tends to play hardball much more easily than their UAW counterparts on the other side of the Detroit River.

This will be one interesting story to watch.

Finance Musings

The US stock market took a hit today, responding to a big drop in the Chinese stock market earlier in the day. That would have been a bizzaro-world headline for someone time-warping in from the 70s or even the 80s; Red China has become enough of a financial player that its stock markets move the rest of the world.

I'm in the process of closing out an old 403(B) account from my Warner Southern days; I hope that the TIAA-CREF folks didn't pick today to finish the paperwork and sell my mutual fund holdings.

______

This was an interesting piece in today's Detroit News that has some intriguing political implications-

Canadian auto supplier Magna International Inc. may be a serious suitor for DaimlerChrysler AG's Chrysler Group.

Canadian Auto Workers President Buzz Hargrove said Monday that he met twice last week with Magna Chairman Frank Stronach about Chrysler. He declined to discuss details of the meetings.

That might not mean much to folks south of the 49th, but Stronach's daughter Belinda is a Liberal MP and former cabinet member; she started her political career as a moderate Conservative, but bolted to the Liberals after losing a bid for party leadership.

What would the impact of having a major Canadian political player owning Chrysler?

Economics ≠ Accounting

I need to call USA Today's (and Gannett boss) Al Neuhardt to task on today's editorial on Ken Lay.

Ken Lay deserves our traditional presumption of innocence. But his former chief financial officer, Andrew Fastow, has plea-bargained guilt. Any claim by Lay that he didn't know Fastow and other financial executives were falsifying the balance sheets won't fly because of Lay's own economics expertise with these degrees:

• Bachelor's in economics, University of Missouri, 1964 (with Phi Beta Kappa honors).

• Master's in economics, Missouri, 1965.

• Doctorate in Economics, University of Houston, 1970.

        ...       

Difference between Lay and me: He didn't have to rely on other financial experts. He was one of them, so they couldn't dupe him.

If Enron's books were cooked, the No. 1 bean counter must take the blame.

Let me rewind the tape of my life to the early 80s. I was working on a MA in Economics at Central Michigan University before a bout of depression shot that down. I had zero credits in Accounting at the time. I later went on to pick up a BBA in Accounting, but I could have gotten an MA and a PhD in Economics without ever darkening the door of an accounting classroom.

At many schools like CMU, economics is a social science and hangs out on the academic flow chart with the history and poli-sci folks; I was a double major in political science and economics. At other colleges, it's part of the business school; business students generally have to have two classes in accounting. Even in the schools that have economics in the liberal arts camp, you'll have a lot of business students taking econ, since the vast majority of b-schools require a two-semester sequence of micro- and macro-economics; most of my CMU econ classes were at the business school's Grawn Hall.

Some people take economics from the micro-side; Managerial Economics is designed to get people to understand supply and demand curves in real life and help firms price their products. However, a lot of economists are into the macro-side, coming at economics as an extension of public policy; that was where I was at as a young adult.

You can also have a truckload of economics without taking much if any finance. Many economics courses have an intersection with finance. Money and Banking and other monetary policy classes will look at the macroeconomic side of finance, but an econ person could well be rather illiterate about derivatives and other exotic investments, especially if he did his work back in the 60s before organized options and finance futures markets came of age in the 70s.

A lot of the sophisticated futures and swaps that Enron was in would be beyond the schooling of someone with just an economics background. Even someone with a accounting degree could get lost in some of the legitimate stuff Enron was up to, let along the shady stuff; I did my doctoral dissertation on international derivatives (Nikkei put warrants), and a lot of the Enron stuff stretches my mind.

Lay's degree isn't a bean-counter's degree. He may have had a few accounting and finance classes along the way, but probably not enough to follow the jiggery-pokery that his finance guys were conjuring up. That's not to say he didn't pick up that knowledge outside of college, but you can have a doctorate in Econ and be left in the dust with the sophisticated finance and accounting that Enron was up to.

I don't know whether Lay was in on the illegal jiggery-pokery or not; that's what the federal court in Houston's going to decide. However, he could well have a case that the accounting and finance were beyond him even with a PhD in Economics; at least enough of one to give jurors a reasonable doubt.

The Japan Post Post-Part I-The Finance Angle

MarcV left this bleg earlier today-

Could you comment on the Japanese Parliament going postal? Could they seriously screw up $3T and cause an economic disruption for the rest of the world's economy? It is interesting/scary that Japanese politicians could consider forming the biggest private bank in the world.

I'm having to play catchup on how big Japan Post is and I can see where this would not be easy. First of all, let's have a little background. This Jappundit post that I Googled into seems to be an excellent summary if you want to dig deep.

Back in 2003, the Japanese government set up Japan Post as an independent corporation owed by the government, not unlike how the US Postal Service is set up. However, Japan Post also serves as a national credit union and life insurance company.
What the current Japanese government is looking to do is to spin off the banking and insurance wings of Japan Post into two separate corporations, to be sold off to investors by 2017.

However, that bill died in the upper house of the Japanese parliament today and PM Koizumi has called new lower-house elections, viewing the defeat as a vote of no confidence.

Why does the Japanese government want to do this?

The East is Blue

Big Blue, that is. This one's been in the works for a few days, but IBM wound up selling its PC division to mainland Chinese computer giant Lenovo for $1.5B. That's one of the most bracing computer stories since AOL used its Internet bubble PE to buy Time-Warner.

It's interesting for three reasons. The first is that the company that mainstreamed the modern PC (Apple gets the big creative credit, but IBM put it on office desks) is out of the business. There was a time where "you never got fired for buying an IBM;" not anymore.

The second is that a "commie" computer company bought it, showing where Chinese capitalism is at today. One can only picture Mao's grave doing about 4000RPM and some high-fives coming from Deng's corner of Hades. The ruling Communists aren't leftist ideologues, there's merely oligarchs hanging on to power, and this should remind us of that fact.

The third is that the price tag was only $1.5B. Their two main contractors are worth more. Intel has a market cap of $4.36B, while Microsoft is worth $294.29B. Who would have predicted that in the early 80s?

Attention, Sears Holdings Shoppers

I don't think this Kmart-Sears merger will work; surprisingly, it's Kmart buying Sears, even though the combined company will be called Sears Holdings. You might get some economies of size between the two that might help Kmart hang with Wal-Mart, but both stores have old-school images that aren't helpful.

Sears has the advantage of having a good appliance and hardware image, as their Kenmore and Craftsman house brands have a certian amount of cache. Kmart has next-to-nothing going for it other than it's the largest discounter that isn't named Wal-Mart; Kmart's been slow to modernize, and their older stores looked almost old enough to be retro but not retro enough to be appealing. They had the bad luck of pinning a revival of fortune on a Martha Stewart tie-in.

Here's my brainstorm: junk the K-Mart lable and rechristen the stores Sears-Roebuck General Store, harkening back to the frontier roots of Sears. Bring in the Craftsmen tools for the hardware section and give the place a quaint, turn-of-the-century motif while having all the day-to-day stuff you normally go to a discount department store. Make the shelves wood-toned and dress the staff in turn-of-the-century garb.

Another possibility is to take the retro back to the 50s and revisit Kresge's, from which K-Mart morphed out of. Redo the old five-and-dime motif with a big lunch counter, staff in 50's get ups and advertising that will look like it was ripped out of Lileks' archives.

Crazy enough to work.

Software as a Mature Industry

The basic rule of thumb in corporate finance is that companies will prefer to plow profits back into the company, expanding the company either by internal projects or buying other related companies; given the double-taxation of dividends, it's easier on the stockholder's bottom line if stuff is reinvested, assuming there are good things to do with it. If there aren't, it's time to start paying dividends. It also signals that the company's gotten about as big as they're going to get.

Well, Microsoft is getting seriously into the dividend business. They're breaking the standard Wall Street MO of not giving special dividends (slow and steady-growing dividends is the rule) by paying out a $3/share dividend. Mr. Bill will get a $3.4 billion check ("Checking account, please. Could I get a few million back in tens and fives?") out of it. They're also doubling the normal dividend and planning a stock-buyback plan.

Given that anyone they buy out will bring the anti-trust folks sniffing, there isn't much Microsoft can do on the takeover front and they don't need a much bigger R&D department, so they pretty much have to dump their cash on their stockholders. This piece mentioned that Microsoft was making 7% on their cash, but stockholders should be able to make more than that on stock investments.

Microsoft is in the process of looking more like a utility or bank stock than a tech stock.

Demon Customers?

Interesting AP piece on "demon customers" who are unprofitable to the store, either by being obsessive returners, only buying the loss-leaders, or (I hadn't thought of this one) buying an item, sending in for the rebate, then returning the item.

I was one of those for a grocery-store chain in the Akron area that went under in the mid 90s. I don't recall the name (I think Carls, for I remember it had a guys' first name), but the one store I went to was in Talmage just west of the big traffic circle. They had a double-coupon offer for coupons under a dollar. I would go in with my $0.75 off coupons for cereal and buy my morning grub at $1.50 off. I wouldn't buy stuff I didn't have a coupon for, save possibly one or two items that they weren't overpriced on. I left with about an extra $5.00 in savings each trip; while the store gets money for the face value of the coupon, they eat the doubling amount.

I used to joke that the grocery store would be been better of to hand me a $2 bill at the door and tell me to shop elsewhere. The chain went under; I feel a little bit guilty about helping put it under, for they lost money on me.

A 160 P/E? What Do You Think This is, the 90s?

Via Crooked Timber, we get this piece on a pending Google IPO. If Google has net income of $125 million and is expected to have a market capitalization of $20 billion, the price-to-earnings (P/E) ratio would be $20,000m/$125m or 160.

To put that into perspective, the average stock these days has a P/E of about 25. Eventually, Google will stop growing faster than the economy and settle in as a normal company. At their current market capitalization, they'd have to raise their net income to $800 million to get to a P/E of 25. How will Google do that? Will they get six times the traffic? Three times the traffic but double the profit margin?

Even if they do start getting more traffic, will they be able to keep it? It wasn't that long ago that Alta Vista was my search engine of choice; Northern Light held the honor for a while. It wouldn't take too much for someone to build an alternative Google; they may not put Google out of business, but it might slow their growth enough to bring their P/E back down into double digits.

I could buy a P/E of 50 or 60, since there's still room for growth there; doubling net income could be very possible with the right brand extensions. I don't see a six-fold increase. Once the opening-day feeding frenzy hits, it might not be a bad idea to short Google.

No, I'm not dissing Google, it's still my search engine of choice. It's sorta like making Michigan a 60-point favorite over Northwestern; they'll win, yes, but I don't think the Maize and Blue would cover the spread. Google's good, but it's not going to cover that 160 P/E point spread.

Fundamentalists-Part I-Cuban Sandwich

I finally got over to Mark Cuban's blog. Most of the stuff is on basketball (he owns the Dallas Mavericks), but he had an interesting post on the stock market. He has some inside experience, having cashed out of Broadcast.com right in the middle of the Internet boom, allowing him the luxury of owning an NBA club. I'd recommend reading the whole thing. A lot of it parallels my Capitalizing an Idea post of two years ago on the tech boom and bust.

However, Cuban is overly cynical about the market.

If the value of a stock is what people will pay for it, then Broadcast.com was fairly valued. We were able to work with Morgan Stanley to create volume around the stock. Volume creates demand. Stocks don’t go up because companies do well or do poorly. Stocks go up and down depending on supply and demand. If a stock is marketed well enough to create more demand from buyers than there are sellers, the stock will go up. What about fundamentals? Fundamentals is a word invented by sellers to find buyers.

Price-earnings ratios, price-sales, the present value of future cash flows, pick one. Fundamentals are merely metrics created to help stockbrokers sell stocks, and to give buyers reassurance when buying stocks. Even how profits are calculated is manipulated to give confidence to buyers.

I think fundamental analysis is more than just crunching the financial data; you'll also need to look at the company's product, their competition and how they realisticly fit into the future. Some of the accouting data can be gamed, but GAAP is designed to minimize the gaming and to provide a reasonably transparent view of what a firm's up to.

I (and plenty of others) teach that, as financial managers, we're supposed to look to maximize the value of the firm, not this quarter's EPS; there are plenty of ways that you can trash a firm's long-term prospects while increasing this year's income (cutting advertising, quality control, R&D, etc.). However, the stock market can get real short-sighed; Cuban plugs for Alex Berenson's The Number as an exploration of how Wall Street winds up geting fixated on this quarter's earnings.

However, smart investors should strive to look past the sizzle and assess the steak. Cuban mentions buying Gandalf at $1/share then see it go up to $20 as he extolled its virtues. It was a good stock at $1 but a lousy buy at $20; Cuban proceeded to sell out and short Gandalf, making more money on the way down to the Canadian version of Chapter 11.

Ignorant investors will buy on sizzle, and even far too many of the fat cats buy on sizzle. That means that fundamental analysis done well is still worth something. If the big financial guys are doing their jobs, stocks will be priced properly and studying stocks won't be worth much for the little guy; just stick your money in an index fund and let it rip.

However, if the big financial guys are full of it, then there may be something to doing your own analysis. More in a bit.

We Warned You About Canadian Drug Imports

Another signpost on the road to Candian World Domination; Quebec's Coutu bought out most of Eckard Drugs off of Penney's, with the remainder going to CVS. In Florida, Eckard and Walgreens are in a seemingly endless battle for market share, playing a game of Me and My Shaddow around the Floridian sprawl; if one opens up a store, the other will set up shop as nearby as possible. Now, that will be Walgreens and CVS, for they aren't much of a player in Florida; they are big up in Michigan.

How about Employee Put Options?

I'm working up a fifteen minute mini-lecture on employee stock options, starting off with a discussion on agency costs, moving into a quick review of option pricing theory and closing with some of the politics of stock options. I missed this last week, but FASB, the people who make the rules of the road for financial accounting, have made a tentative proposal to have firms expense stock options when issued rather than when they are exercised. That's not a great idea for start-ups (as I wrote two years ago) but might make sense for mature companies.

Politics doth make strange bedfellows-

Tech lobbyists are lending their support to a bill called the Stock Option Accounting Reform Act, which would essentially prevent federal securities regulators from recognizing any FASB decision. It would, however, require the expensing of stock options granted to a company's CEO and four other top executives, if the company had annual revenue of at least $25 million.

Backing the measure are legislators representing Silicon Valley. The legislation has the support of prominent Republicans and House Minority Leader Nancy Pelosi, D-Calif.

That reminds me a lot of Democrats who are dovish as the day is long but wind up supporting a defense program with plants in their area.

I was typing up the introduction to this just now; here's the first five slides of the presentation

What's Italian for LBO?

Our visiting evangelist made an interesting statement when discussing the wealth and prosperity of America: Microsoft alone had the market capitalization of the entire Italian stock market.

Not quite true, but close. The Italian stock market had a total market cap of €485 billion at the end of 2003 while Microsoft has a market cap of $302 billion. With the Euro going for about $1.20 these days, Microsoft has about half the market cap of Italy, but they could get some mezzanine financing together and buy the country.

When it Positively has to get Copied Overnight

FedEx is buying up Kinkos in an effort to do some brand extention and vertical integration. Kinkos has been a big drop-off point for FedEx, as people make last-minute copies of stuff and stick them in the overnight bin. It'll will be interesting to see how they cross-promote things.

I've got a soft-spot for Kinkos, for I spent quite a bit of time there as I was printing off copies of various drafts of my dissertation and for the trips to get article packs back before magazines were cracking down on fair-use rules where profs would make copies of articles without compensation the sourse, citing academic fair use. There was a stretch when I was working on my MBA at MSU where you made two ritual pilgrimages at the beginning of the semester, to the bookstore for your textbooks and to Kinkos for your article packs.

Specialist Zero-Class

This will be interesting to see play out; The California state pension fund, Calpers, is going after NYSE specialists.

A quick finance lesson. The New York Stock Exchange, like most stock markets that have a physical location, have a brokerage firm serve as a "specialist" for a stock. When there are plenty of buyers and sellers, the buyers and sellers will work out the price between themselves. If there aren't any buyers, the specialist will buy (at a price a bit lower than the last trade) and if their aren't any sellers, they'll sell at a slightly higher price. The specialist also will have a list of unfilled stop and limit orders that are triggered if the price of a stock goes to a certain point.

This lawsuit detailed three types of improper trades allegedly conducted by the NYSE specialist firms, including "freezing" the display of prices on a given stock so a firm could trade for its own account before executing investor orders.

It also claimed "front-running," when a firm uses its knowledge of pending orders to trade ahead of their completion, and "inter-positioning," when a firm fails to match buy and sell orders in order to get a better price on a stock itself.

For instance, if there are a lot of stop orders to sell if the price hits 50, a specialist might try and sell extra shares before the stock hits 50, for once the price hits 50, the selling pressure will drive it well back. The specialist might prefer to play the buyer/seller of last resort; if a buy order is heading his way and he's about to sell shares to a lone buyer, he might opt to make that sale at a advantageous price, then buy from the other guy at a price to his advantage.

The NPR piece I heard on this seem to assume that since NASDAQ is computerized, that they are immune to this kind of fraud. Not quite true. On NASDAQ, one or more brokerages serve as "market-makers," posting buy-and-sell (bid and ask in finance-speak) quotes on the system; your broker will then hop on his computer and choose the lowest ask price if you're buying and the highest bid price if you're selling.

At least that's how it's supposed to work. There have been times where brokers have been caught using something other than the best price for their customer in return for kickbacks from the preferred market-maker. Even though NASDAQ is "computerized," it can still be illegally gamed.

Vivisecting the Mouse

It looks like there are quite a few upset folks up Disney way. Roy Disney, Walt's nephew, resigned as a director in protest over Michael Eisner's leadership, joined by fellow director Stanley Gold, citing

...operational deficiencies, imprudent capital allocations, the cannibalization of certain Company icons for short-term gain, the enormous loss of creative talent over the last years, the absence of succession planning and the lack of strategic focus.

Being a half hour south of "the attractions" (as they collectively call the Disney, Universal and Sea World complexes in the traffic reports) Disney news is local news; the news media here will treat Disney news like Detroit stations cover Ford and GM.

It seems that Disney might be better off split into two units. One would be the original Disney, with the theme parks, Disney film studio, Disney Channel and Disney Store outlets. That would bring the core of the business back to the family (albeit a secular one with a unhealthy focus on the occult that isn't as wholesome as advertised) entertainment business that was their bread and butter until two decades ago.

The second outfit, ABC-Touchstone, would have ABC, the ESPN channels, the non-Disney movie studios, ABC Family cable and Capital Cities broadcasting outlets; I think I have all the key components listed. I'm not sure if Disney is getting positive synergy from this bunch, as the Kill Bill feedback helps show. I think the company would fare better if there were two different entities; the Disney folks may figure that out in the near future.

Let Eisner run ABC-Touchstone, and let someone who's more in tune with Disney's mission run the Mouse.

The Spinoffers

Three weeks ago, when a proposed Time Warner Music-EMI merger was announced, I wrote

The one this seems to make the most sense for is Time Warner. They get a lot of backlash on their other properties when their music label puts out raunchy rap or other objectionable material. That kind of negative synergy seems to outweighs any positive synergies of promoting their music stars on their cable TV and AOL outlets.Don't be surprised to see TW spin off that unit if the merger falls through.

Well, guess what happened today; Time Warner opted to sell the music unit to Seagram's heir and former Universal Music owner Edgar Bronfman Jr.

...Time Warner's board concluded the Bronfman deal would have a better chance of winning approval from antitrust regulators, particularly in light of a merger agreement struck earlier this month between Sony Corp (SNE). and BMG, a unit of the German media conglomerate Bertelsmann, according to a music industry source who asked to remain anonymous.

Yep.

Capitalizing an Idea

Here's an interesting piece from Bob Hiler (plugged by Microcontent News brother John) comparing the Internet bubble to a pyramid scheme. There are elements of a pyramid scheme available in that early investors are paid by later investors; little if any real commerce gets done outside the digital media circle. However, I think that there was a fundamental misunderstanding of the revenue income potential of online media that was more to blame than malfeasance of the online companies.

People forgot that positive cash flow is the end goal, and that profits are needed somewhere in the future. People overestimated the salability of advertising and the rates at which people will click through on ads. In growth companies that have yet to show a profit but are expected to in the future, people will often look at revenues rather than net income to try to evaluate a company. "Lazy Susan" deals (the money just wheels back and forth between two parties) were often done to nominally increase revenues. If I pay $1,000,000 each to Kevin, Ben and Louder to place a series of ads on their sites (just try cashing those checks) and they pay $1,000,000 each to place a series of ads on my site, I can loudly proclaim to Wall Street, "Look! Revenues are up three million!" So are expenses, and there is no economic change other than reciprocal ads.

Most of you are familiar with the phrase "capitalizing on an idea" with capitalize being a synonym for "to take advantage of, to utilize." That is the essence of being an entrepreneur, getting an idea and profitably running with it. In the past, an entrepreneur would typically have to be making a profit and have a fairly well established company before going public with it.

However, many dot-bomb founders capitalized an idea. They didn't wait for the company to start turning a profit, they were able to go public with just a basic idea and a small staff, selling the profits that the idea could make in the future. In an investing environment looking for the next Netscape or the next Yahoo, people were ready to believe that the Internet could do no wrong. They forecasted that the Web would grow by leaps and bounds indefinitely and that ad revenues would grow with it. They underestimated Web growth and underestimated ad revenues, as advertisers grew wise to the fact that click-through rates were lousy and that they weren't worth as much as advertisers originally thought.

When the lack of positive cash flow finally hit home with investors, the plug was pulled on a lot of endeavors. It isn't the first time that an industry was the hot item, only to be brought down to earth by a reality different from the one originally envisioned. Many of those were honesty tries to use the Internet but didn't make it. It's hard to run a freestanding digital media enterprise without a broadcast or dead-tree enterprise to back it up. The old-media parent can supply staff and content to the on-line site while the site provided brand loyalty to the old-media products. There have been a few lucky souls like Yahoo, but it looks like online content will be provided either by old-media companies or by amateurs or the occasional mom-and-pop on-liner who's filling a niche.