Bill Black — CEO Compensation: “Cheaters Prosper”

Background from Wikipedia:

[Michael] Jensen's best-known work is the 1976 paper he co-authored with William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure,[3] one of the most widely cited economics papers of the last 30 years. Besides reigniting interest in the theory of the public corporation as an owner-less entity made up of only contractual relationships (a field pioneered by Ronald Coase), the paper laid the foundation for the widespread use of stock options as executive compensation tools.
It was a 1990 Harvard Business Review article CEO Incentives: It's Not How Much You Pay, But How[4] by Jensen and Kevin J. Murphy that prescribed executive stock options in order to maximize shareholder value. The justification they gave was that shareholders were the "residual claimants" of the corporation, meaning that they had the sole right to profits. This idea that shareholders are residual claimants was later rejected by legal scholars (e.g., Stout 2002).

After Jensen and Murphy (1990), Congress passed a law,[5] making it cost effective to pay executives in equity. As a result, executives focused their efforts on increasing stock price. In the short run, many executives manipulated accounting numbers (e.g., Enron, Global Crossing).NYT article 2005 In the long run, executives outsourced labor to reduce costs, then used the cost saving to repurchase stock; thus, increasing their own compensation. Over the last 20 years, stock buybacks total a few trillion.[6

Bill comments:

In some ways, however, it was remarkable that the intellectual father of modern executive compensation, Michael Jensen, has turned on his creation. Further, he turned on it vehemently – in 2001. Subsequently, scholars whostudy executive compensation have agreed that it has created perverse incentives.

New Economic Perspectives
CEO Compensation: “Cheaters Prosper”
William K. Black | Associate Professor of Economics and Law, UMKC

Barry Ritholtz gets it right, then gets it wrong.

Barry Ritholtz put up a nice blog post calling Bullshit on Andrew Ross Sorkin's video that claimed Lehman's failure caused the crisis.

In the post Ritholtz correctly reminds us that there was criminality associated with the period leading up to the crash and those crimes were ignored by both the Bush and Obama Administrations (and they continue to be ignored by the Obama Administration).

Furthermore, Ritholtz points out that many of the main actors who were involved in that criminality or, who's actions either brought on the demise of their firms or contributed to the crash itself, were highly compensated despite their denials. People like Dick Fuld of Lehman, Jimmy Cayne of Bear Stearns, Stanley Neil of Merrill and Angelo Mozilo of Countrywide, to name just a few.

But what killed it for me was when I went back to re-read Ritholtz's piece only to click through to his Washington Post column where he "educates" us as to what really caused the crisis only to hear him invoke the same, lame, worn out excuse of artificially low interest rates. (Cue Peter Schiff.)

It amazes me that a smart guy like Ritholtz is so clueless to the fact that interest rate adjustments are, at best, neutral, but more likely in the case of low interst rates, deflationary as opposed to being iinflationary.

What's so hard to get? For every debtor there is a creditor and for every saver there is someone who spends more than his or her income. That means, all that happens when rates are raised or lowered is that income gets redistributed around the economy. That's it. There is no "commodity boom" that pushes foodstuffs to record highs.

Did commodity prices rise from 2002 to 2008? Yes.

Was it due to low interest rates? No.

The crisis was caused by wild speculation and lack of regulatory oversight.

Had we regulated properly and prohibited "large passives" from owning scarce resources, just as was recommended to Congress by Mike Masters in a 2008 hearing, the runnup in foodstuffs and oil and everything else never would have happened.

Let's put an end to this "artificially low interest rate" meme once and for all. Please, we should be way beyond that by now.