The Great Debate

This is the heyday of institutional investor activism in proxy contests. Insurgents are running more slates and targeting larger companies. They are also enjoying a higher rate of success: 66 percent of proxy contests this year have been at least partially successful. The reason is probably the support that activists have received from the principal proxy advisors: Institutional Shareholder Services (ISS) and Glass Lewis & Co. According to a recent New York Times Dealbook survey, ISS has backed the insurgent slate in 73 percent of the cases so far in 2013.

All this may be well and good. Shareholders certainly have the right to throw the incumbents out at underperforming companies. But there may also be a dark side to this new activism.

This year, two activist investors, Elliott Management Corp. and Jana Partners, have run minority slates of directors for the boards of Hess Corp. and Agrium Inc., respectively, and each has offered to pay special bonuses to its nominees (and no one else). Elliott will pay bonuses to its five nominees measured by each 1 percent that Hess shares outperform the total rate of return over the next three years on a control group of large oil industry companies. A ceiling limits the maximum payment to a nominee director to $9 million. In the case of the Agrium proxy fight, which Jana narrowly just lost, Jana offered to pay its four nominees a percentage of any profits that the hedge fund itself earned within a three-year period on its Agrium shares.

Both Hess and Agrium have objected that these bonuses are intended to incentivize these nominees to sell the company or promote some other extraordinary transaction in the short run. The activists and their defenders respond that there is no conflict because all shareholders will benefit if the new directors cause each company to outperform its peers.

This claim that incentive compensation aligns the nominees’ interests with those of the shareholders ignores much. First, there are timing conflicts. Two years from today, a bidder might offer a 50 percent premium ($60 for a $40 stock). But for these bonuses, the directors might all believe it was better to decline this offer, because the company’s long-term value in two or three more years was expected to exceed the current premium. Second, there may be disagreements over risk: Leveraging the company up to its eyeballs may raise the short-term stock price, but also expose the company to failure in the next economic downturn. Finally, special bonuses may balkanize the board, creating suspicion and tension.

As President Barack Obama’s first term ends and second begins, it is an opportune time to reflect on the cost and sheer volume of new red tape his administration has created; analyze its impact on small businesses, and prepare for what’s next.

The Obama administration has pursued an active regulatory agenda. The overall regulatory burden is now $1.8 trillion annually, according to the Competitive Enterprise Institute, and this year alone new rules have added $215.4 billion in compliance costs. Small businesses are understandably concerned that the second Obama term will only add to this already heavy regulatory burden.

There has already been a wave of “economically significant” regulations ‑ those with an annual impact of $100 million or more ‑ that outpaced both the Clinton and Bush administrations. That pace slowed leading into the 2012 elections, but a second wave has been building.

The Dodd-Frank Act to re-regulate the big banks was intentionally tough. It was passed in the wake of the 2008-2009 financial crash to end cowboy banking; require far more capital  and much less leverage, and rein in the trading-desk geniuses who pumped up serial bubbles. Since Congress is a poor forum for crafting such a complex statute, the details were left to the expert regulatory agencies.

The big banks pay lip-service to the goals of Dodd-Frank — but they’re mounting bitter, rearguard actions in federal courts to block meaningful constraints and regulations on procedural and other grounds. This is an ominous turn of events, since these banks have the legal firepower to overwhelm budget-constrained U.S. regulatory agencies.

While Dodd-Frank is aimed at preventing another cycle of bubble-and-bust, shrinking the financial sector is crucial for other reasons. One is a mass of evidence demonstrating that hyper-financialized economies have lower growth. Another is the appalling ethical record of large financial companies. The chance of making huge paydays by risking other people’s money, it seems, can sometimes derange moral compasses.

Excerpted from the author’s new book, The Honest Truth About Dishonesty: How we lie to everyone – especially ourselves. (Harper 2012)

A few years ago, in one of my graduate classes, I lectured about some of my research related to conflicts of interest. After class, a student (I’ll call her Jennifer) told me that the discussion had struck a chord with her. It reminded her of an incident that had taken place a few years earlier, when she was working as a certified public accountant for a large accounting firm.

Jennifer told me that her job had been to produce the annual reports, proxy statements, and other documents that would inform shareholders of the state of their companies’ affairs. One day her boss asked her to have her team prepare a report for the annual shareholders’ meeting of one of their larger clients. The task involved going over all of the client’s financial statements and determining the company’s financial standing. She did her best to prepare the report as accurately as possible, without, for example, overclaiming the company’s profits or delaying reporting any losses to the next accounting year.

By John Kemp
The writer is a Reuters market analyst. The views expressed are his own.

LONDON – Should federal government agencies have to prove the benefits of new regulations outweigh the costs before introducing them?

It sounds like a simple question with an obvious answer. But the role of cost-benefit analysis in writing federal regulations (and even laws) is shaping up to be one of the biggest battles between the Obama administration and business groups in 2012.