My beef with Tom

In my "Work and the Labor Process" class we read some parts of Braverman's Labor and Monopoly Capital and discussed the phenomenon of deskilling work. Then we read some other stuff that rejected that phenomenon and said work was in fact still skilled, it was just a different kind of skill.

For example - Tom did a study on these furniture makers in a factory. He was arguing although the work appeared unskilled it was actually skilled once you took into account their knowledge of the job.  They even made little jigs to help make their job easier or to fix recurring defections.

We had several disagreements about this in class because I could not accept this as "skill".  I think the workers have experience (aka they've been on the job long enough to know from eyeballing if there is a mistake or have even created a jig to make their job easier on themselves) but I don't want to call that skill. You know what you are doing on the job because you've been there and any "inventions" you make to make your life easier perhaps isn't "taking pride in your craft" but a necessity you must do so you don't get sacked at yelled at.

I guess I could be okay with the argument what i'm calling "experience" is accrued "on the job skill" but this is the larger point:

I think Tom was dead set on convincing me it IS skill because IF it is skill then we can say the workers should be remunerated for it accordingly.  But I think if you fall into that argument you end up having to explain how every single job is skilled work and deserves fair pay.  We should just argue that any job regardless of skill deserves a living wage.  Then discussions of what is skilled work and what is not can be separated from whether workers deserve subhuman wages or not.

Puerto Rico - Initial Thoughts

What the fuck!

Hedge funds and other investors reap the rewards of the riskiness of the bonds - with yields on Puerto Rican bonds surpassing those of Greece. but actually don't want anything to do with the risk and will pull teeth (Puerto Rican citizen's teeth) to get paid in full what they paid pennies on the dollar for. Assholes.

Some lender should lend money to puerto rico to buy back a chunk of its debt at these depressed prices and then lend some more for development projects.  Who can do this without imposing some type of structural adjustment, "you must austerity" bull? Not at all within purview of Fed but maybe tie it in with calls for the fed to buy up muni bonds??? According to an off the record source, the fed can legally do this.

National Infrastructure Bank

All of today I've been trying to wrap my head around why a national infrastructure bank would be a good idea. 

After hours of googling, reading, and talking to myself - it just seems like it has a lot of potential to be good for the people but the proposals that are out there are not headed in that direction.

The whole point of a NIB is to increase infrastructure investment.  Though there are many proposals they all have this sort of structure:

A NIB is originally capitalized by federal fund appropriation - the government says its okay to start a bank and gives it $x amount of dollars- lets say $60 billion- to start with.

They can use that initial starting money to "leverage private investment" which I think means use some sort of mechanism to make the $60 billion into $120 billion (maybe through a bond offering or something). But they don't have to do this, they can just stay unleveraged and stick with the $60 billion.

They take applications for infrastructure projects that state/local governments or private firms would like to do and pick the best ones and give them low-interest loans.  The projects usually have to have some sort of monetary benefit so the loans can be repaid- like taxes or tolls. 

Upon repayment, the NIB can make more loans. 

The increased infrastructure investment comes from the fact that these borrowers probably wouldn't have made these investments without the low-cost loans. 

This seems to make sense.  However I have questions:

First- is it actually the case that state/local governments and private firms are credit constrained? Maybe they actually have access to loans that aren't high interest but they just don't want to make those investments. 

Second- how is this sustainable? Banks offer low-interest loans to finance these projects and owe interest to bondholders - is the spread really that big?

Third- the only thing that the NIB seems to be incentivizing is projects that have future revenue streams like tolls and taxes. This is what makes them want to offer the loan in the first place.  However, does this mean the only infrastructure that is being increased is infrastructure that will further tax people.  Aren't the federal funds used for initial capitalization our tax money already? We are being taxed to fund further taxation.

Fourth- the projects that have the most social benefits are exactly the ones that can't be charged per user.  It is easy to imagine Amtrak wanting a low-cost loan from NIB to expand their services but why the hell would anyone want to take out a loan to improve a public good?

To be fair I did read something about California's I-bank doing some good stuff - like making sure communities benefit from these infrastructure projects and that any wages paid via their loans are good wages.  This type of leveraging I'm down with.  

The NIB will probably increase infrastructure spending but also

enrich bondholders
not be sustainable
tax on tax on tax
give companies low cost loans to charge more fees

Wouldn't it be easier to just tell the government own up to the responsibility for our infrastructure?

Walk the Walk

That moment when most academic economists admit there is no such thing as a free market system and the market depends on government intervention to facilitate its functioning and then you read article after article saying that stock prices incorporate all available information and are the best guess about future performance...walk the walk guys.  You can't pose as a respectable, sane person on the one hand and on the other say financial markets are perfect. #behavioraleconomics  #emoinvestors #emoswooptrades #pumpanddumprevolution

Banks and business

Why would firms like McDonalds lobby against things like Dodd-Frank and financial firms not reciprocate by lobbying for things that would benefit firms like McDonalds?

Jim Crotty suggests that if there is some "solidarity" (my word, not his) between firms and banks, it would be easier to make the environment better for both.  

In my view, banks are the ones taking in the profits these days with low regulation, leverage, and excess reserves.  They fund democrats and republicans and have been shown love from both sides.  Banks run the show and there isn't any reason for them to waste resources lobbying for things that do not directly benefit them.  

Then why would firms like McDonalds lobby against things like Dodd-Frank without reciprocation? I'm not sure, perhaps Jim is right and they are trying to secure the most unregulated world for all business.  Or perhaps banks have some power over firms.  Perhaps via access to repo markets or their access to funds.

Stiglitz's Credit Rationing Model: Some Thoughts

Although I think the point of the Stiglitz model is to explain the movement and dynamics of interest rates and the effect of monetary policy, it offers some insights into how bank's behavior can deviate from the "normal way" banks behave.

"Equity markets are imperfect so that firms cannot fully divest themselves from the risks they face so they borrow.  There is a probability that they may not be able to meet their debt obligation- that they may go bankrupt. Because the costs of bankruptcy are high, firms will act in a risk-averse manner. How risk adversely they behave depends on their net worth"

How does this fit into what was actually happening during and after the most recent financial crisis?

Investment bank's net worth was strong on the books, but they must have known that they were actually buying crap and selling crap since they bet against it.  Perhaps the model shouldn't depend on "net worth" but perceived net worth, or the net worth of all other banks, or the net worth that everyone agrees upon.  Sort of like Keynes' beauty contest.

The heart of the credit rationing model, in my view, is that banks will loan when it is profitable to loan.  This makes some sense.  Even at higher interest rates, banks may not make loans because their expected profit is not maximized because of adverse selection - the people most willing to pay a high interest rate are the ones most likely to default. However, juxtaposing this with the fact banks were pushing out subprime loans to anyone who could sign a paper doesn't agree with this type of risk argument. The difference was that there was "no skin in the game" for all parties. Originators, packagers, sellers, raters, and buyers (thought they were great investments).

Black Wealth: Game Theory's Contributions

For a long time I've wanted to investigate the extent of US slavery's implications on black wealth. Seeing that Azealia Banks recently called for reparations, it seems a good a time as any to start.

Black PEOPLE were white people's wealth.

This makes me think of Marx's primitive accumulation, where he outlines how and through what means capitalists originated their initial wealth. Instead of stolen land, wealth was enslaved by coercion and force.

Furthermore, the value of slaves accounted for an estimated 100% of productive output,

"In 1860, slaves as an asset were worth more than all of America’s manufacturing, all of the railroads, all of the productive capacity of the United States put together,” the Yale historian David W. Blight has noted. “Slaves were the single largest, by far, financial asset of property in the entire American economy.” The sale of these slaves—“in whose bodies that money congealed,” writes Walter Johnson, a Harvard historian— generated even more ancillary wealth." (Coates, 2013).


Black people are systematically denied wealth.

It is well documented during Jim Crow there were systemic laws and rules that prevented black wealth from accumulating, see here and here.

Black wealth was often stolen or destroyed.

In the New Jim Crow, Michelle Alexander argues this same systemic form of social control still exists today in the form of mass incarceration.  "Criminals" are LEGALLY discriminated against and barred from wealth building (home ownership loans) among other things such as voting, employment, and serving on juries.


Black Wealth vs. White Wealth Today

Implications of a lack of wealth

Black people were people's wealth then were (and still are) systematically denied wealth, and currently the wealth gap is at a staggering 13x.  But so what? What does lacking wealth even translate into? Luckily we have a team of mostly white men to shed some light on the issue: Jared Bernstein and Ben Spielburg have aggregated studies dealing with this issue in their set of inequality slides while Sam Bowles has utilized the tools of game theory to analyze wealth effects on social efficiency.

Lack of wealth constrains economic mobility, contractual opportunities, overall economic efficiency and democracy

Economic Mobility

Even if the way black wealth has been treated throughout history doesn’t bother you, wealth inequality should be alarming because it kills the soul of America- the American Dream. The idea that anyone can “make it” is not represented in the data. Bradbury and Triest find  the more unequal a locality, the more likely it has lower levels of economic mobility.  A Pew Research study on economic mobility finds that there is "stickiness" at the ends of the mobility latter, indicating 66% of those at the bottom, will stay at the near the bottom. The study also finds upward mobility in terms of wealth is more likely among whites than blacks.  Furthermore, the study finds that “people who grow up in an affluent household and don’t graduate college are 2.5 times more likely to earn a top 20 percent income than people who grow up in a low-income household and do graduate" (Bernstein and Spielburg, 2014).

Opportunities

Embedded in the rags to riches story is that America is that this is the land of “opportunity”. No matter how wealth is distributed, all face the same opportunities.  Sam Bowles argues this claim is rooted in the Walrasian paradigm and it is not an accurate representation of how the world works.

The Walrasian paradigm is a world based on certain assumptions that simplify complex problems and to try and gain some insights into them.  One of these assumptions is that exchanges are completely contractible, meaning if a lender were to lend to a borrower, there would be a way for the lender to enforce the contract and surely be paid back. 

However, the real world does not work this way.  Even though many times lenders do find ways to somehow through coercion or other methods get their money back, there is not yet an enforceable way to get repayment. The lender-borrower relationship is an incomplete contract.

This seemingly small change in assumption yields major changes in insights.

*For an in depth presentation of the mathematical model as another way to draw the following conclusions see Bowles, Microeconomics, chapter 9.

Incomplete contracts are ubiquitous.  They are characterized by the fact that not all aspects of an exchange can be specified. For example, how much effort a worker should exert or how careful an insured person should be. If an individual can invest their own wealth in a project it rectifies two issues of incomplete contracts: adverse selection and moral hazard.  Adverse selection is the problem of not knowing the quality of a project that is bought or invested in.  In the lender-borrower problem, the lender doesn’t know the quality of the project the borrower will engage in.  The moral hazard problem concerns the action the borrower (agent) takes.  If the borrower already has the money, they might take risks that would be harmful to the lender (principle). 

An investor with enough wealth to fund a project on their own is the residual claimant of that project.  The investor has the incentive to have a quality project and to act in ways that would benefit the project.

When investors lack wealth and have to borrow to invest, the adverse selection and moral hazard problems return. Sometimes borrower’s wealth is so low that the incomplete contract problems are too risky to overcome; meaning the amount of wealth the borrower can invest in the project is not enough to convince the lender that the project is of good quality and/or that the borrow will not engage in risky behavior so the lender would rather invest money in alternatives. In other words, the opportunity cost for the lender would be too large. The people who cannot borrow are credit market excluded.

For similar reasons, the wealthier can borrow larger amounts, have lower quality projects, or a lower interest rate. The wealthier can borrow more (same quality and interest rate) because their extra wealth convinces the lender their interests align and the borrower will not have a bad project or act in harmful ways.  If a person with some wealth and a person with more wealth borrow the same amount at the same interest rate, the quality of the wealthier can be of lower quality.  The reasoning for this is the same as why the wealthier can borrow a higher amount, their wealth helps clear up the incomplete nature of a lender-borrower relationship. 

Clearly in the world of incomplete contracts, unequal wealth distributions do not offer the same opportunities for everyone. People with less wealth cannot borrow as much as they’d like or are charged a higher interest rate.  Some low-wealth borrowers are barred borrowing at all.

Social Efficiency

The equal opportunity sentiment reflects a belief commonly found in economics, namely who owns the wealth is not important. The Second Fundamental Theorem and the Coase Theorem state whatever the distribution of the initial wealth, (with complete contracts or incomplete respectively) a Pareto optimum will occur (Pareto optimum allocation meaning no one can be made better off without making someone worse off). In other words, the distribution of wealth in society doesn’t matter for efficiency in the society.

But Bowles argues wealth does matter for allocative efficiency by determining the set of opportunities facing a citizen, “Thus wealth differences have qualitative effects, excluding some and empowering others…Wealth difference may persist across generations due to the more limited opportunities to borrow and less lucrative investment opportunities of those who do not inherit wealth from their parents” (Bowles, 2006).

A lack of wealth impeding economic mobility and social efficiency is not anything new. It can be seen in the crop liens of the post bellum South.  Most farmers did not have enough wealth to post collateral for loans, so instead of collateral, lenders staked a claim on the planted crops.  Since cotton was a more secure crop to sell, relative to corn, farmers were forced to produce cotton, leaving individuals and the community worse off. 

Renting is a more current phenomenon with the same results.  A home owner is a residual claimant, meaning they own the house so they have a stake in what happens to it, so they take care of it.  If everyone in the neighborhood was a homeowner, the individual and the community would be better off, however, as of 1995 about a third of the population rented (Bowles, 2006). 

As from the lender-borrower relationship characterized above, borrowers with little or no wealth may have better equality projects than wealthy borrowers, but will not be lent to.  Social efficiency suffers from some low wealth borrowers being shut out of the credit market all together. A number of studies have shown people who received inheritances are more likely to be self employed or start their own business (Bowles, 2006).

Wealth determines contract options, contract options determine power level, those with more wealth exercise power. It is only a small step to see how wealth not only constrains mobility, opportunity, social efficiency but also democracy itself.

Lack of wealth undermines democracy 

Gilens and Page found that the US represents an oligarchy more so than democracy. In one of the researcher's own words, "ordinary citizens have virtually no influence over what their government does in the United States. And economic elites and interest groups, especially those representing business, have a substantial degree of influence." (Kapur, 2014).

The historical and current denial of black wealth in itself is unjust.  Furthermore, it destroys everything America is supposed to be a symbol of: economic mobility, opportunity, democracy and freedom.

________________________________________________________________________________

Bernstein, J. & Spielburg, B. (2014). Increasing Inequality: It's happening, it matters, and there's something we can do about it. Center on Budget and Policy Priorities. 

Bowles, S. (2006). Microeconomics: Behavior, Institutions, and Evolution. Princeton University Press. 

Coates, T. (2014). The Case for Reparations. The Atlantic.

Kapur, S. (2014). Scholar Behind Viral Oligarcy Study Tells You What it Means. TPM

Dependence on Businesses for Survival

                 “open their eyes in a country where they must be employees or nothing…”

How it happened

Marx, Marglin - the stages of capitalism, the separation of workers from the production process, productive knowledge, and productive means.

The extent of wage work

In the US, about 93% of employed persons are wage or salary workers (which includes incorporated self-employed persons)

HOUSEHOLD DATA ANNUAL AVERAGES 12. Employed persons by sex, occupation, class of worker, full- or part-time status, and race [In thousands]	2012	2013
Total Employed Persons	142,469	143,929
Wage and Salary Workers	132829	134421
Percentage of Wage and Salary Workers	93.23%	93.39%

Source: BLS http://www.bls.gov/cps/cpsaat12.htm

If we take incorporated self-employed people into account, the self-employment rate goes up to about 10%.

Source: BLS
http://www.bls.gov/webapps/legacy/cpsatab9.htm


Looking at similar countries, the world bank has estimated wage and salary  workers make up high 80% to low 90% of employed persons for developed countries (World Bank, http://data.worldbank.org/indicator/SL.EMP.WORK.ZS)

In developing countries, land used to sustain subsistance farming and families that depend on it, is not valued and therefore being sold for companies to build (Waring).

Interestingly, a BLS report indicates self-employed people are likely to be either White or Asian men (Hipple, 2010).


Firm Power

Realizing survival is based off of the ability to get and hold a job makes me feel like a crazy person. It isn't the survival of the fittest anymore, it is survival of who can conform and take orders the best.

Firms have an incredible amount of power.  They get to decide how many jobs to offer and how much to pay each employee. The only check on them, in terms of wages and number of jobs to offer, is the minimum wage.  The theory is that firms have knowledge the government couldn't possibly have and are supposed to be the optimizers of these choices.  Of course, many believe the firm really isn't making these choices - it is the market forcing them to certain choices, whether through supply and demand or competition.

I think firms, especially small ones, do work with constraints and are limited in what types of wages they can offer.  I think firms want their firm to continue and try to make decisions that will sustain their company.  However, I think beyond those constraints, there is menu of options most firms have (more or less jobs, better or worse wages) and use them as leverage to advocate for policies that benefit them.

With firms always holding jobs over everyone's head and a job being the only option for survival, how is any progress supposed to be made?

Alternatives

It seems ideal reforms like the great era of the 50's marginal tax rates of 90%, a maximum wage tied to a ratio of the minimum wage, increases in capital gains and estate taxes, enacting the Volcker rule, etc. don't rid capitalism of the disease of inequality of power, but effectively deal with the symptoms. But once the power starts accumulating, the accumulators leverage it to make sure they don't lose it and can accumulate more.

Alternatives that change the structure of capitalism into something different seem to me, the best sustainable alternative.

Strengthening worker's power by nullifying the job/survival threat would mean finding jobs elsewhere.

Alternative forms of ownership is one way- I frequently allude to Gar Alperovitz's America Beyond Capitalism.

I read something recently about a "employer" of last resort, by Randy Wray.  He was speaking of the government, but I think the government has proven to be tainted by this imbalance of power and not the best potential candidate of employer of last resort.  Perhaps community employer of last resort.  Pooling funds to do community work, getting away from corporate chains, developing jobs that have a stake in the community.

Hipple, S. (2010). Self Employment in the United States. Bureau of Labor Statistics.

http://www.bls.gov/opub/mlr/2010/09/art2full.pdf

Draft of Book Review American Beyond Capitalism

America Beyond Capitalism – 10 year review

“open their eyes in a country where they must be employees or nothing…”

“if income, wealth, and economic position are also political resources, and if they are distributed unequally, then how can citizens be political equals?” (50)

Summary:

In America Beyond Capitalism, Gar Alperovitz highlights shortcomings of our current economic system and outlines an alternative model for the US economy. He  provides extensive research on existing alternative institutions that already have demonstrated success as well as government reforms that could redistribute wealth.  Throughout the book, Alperovitz develops the “Pluralist Commonwealth Model” which is based on equality, freedom, and democracy.  Although the three concepts are interconnected, he argues liberty and democracy rest on equality. The key to greater equality lies in the distribution of wealth.  Low and middle-income people need access to wealth; owning assets such as stocks and bonds will (hopefully) produce continued income payments for the future. How can people accumulate wealth? Alperovitz explores a variety of ways people can accumulate wealth: worker owned firms (ESOPs), worker cooperatives, community development corporations (CDCs), municipal ownership, individual development accounts (IDAs), among others.  Once wealth is accumulated,  through these types of organizations or through government redistributed reform, people’s income will be more secure and they will possess more freedom to do what they will with their time and money – leading to better democracy and meaningful liberty.

Commentary:

Alperovitz documents citizens’ discontent with the government’s ability to take care of their needs and their dissatisfaction with corporation’s influence with politics.  Ten years after his claims, Pew Research polls indicate citizen’s trust of the government is currently at historical low of 19%[1] and that nearly 80% of those who have heard of the Citizens’ United ruling believe it has had negative effects[2]. He notes that even though the people are unhappy with current arrangements, they cannot imagine another economic system than the one that currently exists (3).

As an economic historian, Alperovitz observes it is very unlikely US history will end with the current economic arrangements (4).  By placing the current economic regime within historical context, it is easy for him to imagine a new regime emerging – as has happened multiple times throughout history.  In fact, he goes further than imagining a different economy by identifying and commenting on existing institutions that may well be transforming our economic system at this very moment. 

Alperovitz’s presentation of alternative wealth building institutions may be more optimistic than warranted – although he does qualify most of his data.  For example, he cites there are over 11,000 ESOPs in existence, but not all of the ESOPs are 100% or even majority owned. Furthermore, a more robust picture of these institutions would not only include the most successful and the success rates, but also the initial sample sizes.  For instance, he states there are over 4,000 CDCs in existence, but how many CDCs were started and then failed.  These additional data may prove to be less encouraging, but they would allow space for investigation and progress towards sustainable alternatives.

Some of Alperovitz’s ideas suggest various institutions invest individual’s or public  money in stocks and bonds via mutual funds, etc.  Expanding the financial sector even with the intention of increasing wealth for low-income earners demands hesitation and thought. The growth of the financial sector and its dangerous implications has been well-documented by Epstein[3] and others.

On the other hand, the idea of local finance is attractive.  Cities and municipalities could control their investments- making sure any company requesting a loan has a social benefit, will hire local people, say in the community, and not exploit the workers.  Business profits will benefit the community members and the community, now a residual claimant, has a vested interest in monitoring company’s behavior and actions (24).

In addition to developing and promoting new institutions to create wealth, Alperovitz proposes inequality reduction via redistribution by government reform.  His proposals to tax the 1% on net worth or estate (180) were echoed by Occupy Wall St. Even more recently, Thomas Piketty has suggested a tax on global wealth tax to battle income inequality.

The final piece of Gar’s outline for a new economy – regionalism – has been surprisingly relevant.  He argues the US is too diverse and large of a state to manage and decentralization would help restore democracy. He observes state legislation has been more prominent perhaps due to the gridlock nature of federal action (154).

Evidence of the need for regionalism can be seen in the literal areas of progress in the US.  Little reform has been passed by Congress and national legislation, but local governments have highly active in passing legislation on policies like minimum wage increases and paid sick days. 

---

[1] http://www.people-press.org/2013/10/18/trust-in-government-nears-record-low-but-most-federal-agencies-are-viewed-favorably/

[2] http://www.people-press.org/2012/01/17/super-pacs-having-negative-impact-say-voters-aware-of-citizens-united-ruling/

[3] Epstein, G. (2006). Finance and the World Economy. Edward Edgar Publishing.

Income and Wealth Inequality

Causes of Inequality

In my view, the root cause of income/wealth inequality boils down to power.  At times when workers have power (unions are strong, employment is high) workers can claim more for themselves, for example better wages, which leads to the ability for them to start accumulating wealth.

Increasing inequality in the US coincided with the rise of the neoliberal regime, which consisted of crushing labor, deregulation, liberalization, and privatization. 

• Average wages no longer growing with worker productivity

        Source: EPI

• Unions attacked (think Reagan crushing air traffic controllers strike)

• The Glass-Steagall Act, which separated commercial banking from investment banking, was repealed and the finance sector began to grow. 

•  CEO compensation became increasingly tied to stocks, giving them huge compensation packages.

• Citizens United ruling allows money to influence politics

Of course income inequality is tied to wealth inequality; the more income you have, the more likely you are to be able to save some of it. 

 Source: Saez and Zucman

Once power has been accumulated in the form of income/wealth it becomes increasingly difficult to change policies to stop the wealthy from accumulating more.

Reponses to Inequality

Increase Workers’ Power 

• Increase the minimum wage
• Support policies that promote full employment
• Increase support for unions

Source: Bernstein 

Redistribute

• Increase estate taxes (taxes on inheritances)
• Increase capital gains tax (taxes on income from owning assets)

Financial Reform

• Dodd-Frank Act (tried to restrict speculation and increase                            transparency – not working well)
• Financial Transaction Tax (a small percentage tax on financial trades)
• Rein in CEO pay (there’s really no proposed policy here, except discussion of a maximum wage bill: http://www.vox.com/2014/8/6/5964369/maximum-wage)

I think most people and economists would agree income inequality is inherent to capitalism and the “free” market.  I think the disagreement stems from whether the inequality is an issue or not.  Whether the people at the top are entitled to their income/wealth and if the amount they hold is harmful to the rest of us.

More Radical Alternative Solutions

American Beyond Capitalism by Gar Alperovitz discusses policies that address and attempt to correct the wealth disparities in the US.

•            Basic Income Grants: there are different proposals for implementation, but the idea is to give each new child either a lump amount or an amount that is invested and matures until the child is 18.
•             Worker Cooperatives: Worker owned and operated businesses would reduce income and wealth inequality since workers income would be more equitable and they would have ownership of a portion of their company.
•       Community Development Corporations: communities loan money to new businesses in exchange for a stake in the new business, yielding a stream of income to loan to future business start ups in the community.

Participatory Economics by Michael Albert, Robin Hanel Economic Justice and Democracy both discuss brand new economic systems that would greatly reduce inequality.

In terms of the most helpful policies to combat inequality, there is evidence the non-radical policies help (see below the Bernstein link to PowerPoint slides), but in my opinion, changing the economy towards something less capitalistic is the more meaningful change.  However, it is hard to empirically measure how much a hypothetical income grant would change inequality or how the existence of worker co-ops help.  

Other helpful resources on the topic:

Robert Reich’s Inequality for All DVD: http://inequalityforall.com/

Jared Bernstein’s Slides:http://jaredbernsteinblog.com/a-comprehensive-look-at-the-inequality-story-to-go/

Interesting YouTube video based on peer-reviewed studies https://www.youtube.com/watch?v=QPKKQnijnsM

Notes on Tom Juravich "Strategic Corporate Research"

Summary

Juravich began by claiming no discipline looks specifically at the firm for a level of analysis.  I think that is incorrect.  Within economic theory, economists have looked at firm level analysis - perhaps most famously in Coase's "Nature of the Firm".  Applied work has looked at firm level data, for example, Pay without Performance by Bebchuk and Fried explicitly discuss the make up of specific firms with actual data on them.

Juravich then discussed why labor is taking this new approach of action.  The post war labor accord which consisted of strong unions and perhaps not so toxic relationships between business and labor, was over.  Globalization, increased technology, and financialization have made the old strategies of resistance obsolte.  Striking at the plant when the owners of the plant are halfway around the world is not as effective as if ownership were in the US.

Juravich suggests using the wealth of information on corporations to find "pressure points" that could be leverage to make concrete gains for workers.

Implications, Questions, and Thoughts

I think first any gains from this strategy will be a band-aid for a systemic problem but that doesn't mean it shouldn't be done- there will be concrete gains for people.

Second, how reliable are the databases? Bebchuk and Fried go to great lengths in their book Pay without Performance to demonstrate how executives and boards distort actual compensation levels and earnings reports.  Do these databases address those issues?

Third, even if the databases are reliable (even if they aren't, it is all we have), how effective is the strategy of leveraging these pressure points?  If we do a lot of research, we could find things that outrage people or that we could use to put pressure on a certain group.  What if people don't care, or don't care enough to act and if the certain groups involved are too big to be affected by union pressure?

Fourth, Juravich discussed labor as employing these new strategies, but union membership has declined since the labor accord.  Will this new strategy strengthen union membership somehow? If social organizations take this work on in lieu of labor, will it decrease union membership?

Wages and Power

Considering the stagnation in general wages and worker's historically low union power, why have a number of states passed legislation to increase the minimum wage? Where is this pressure coming from?

Secular Stagnation Notes

1. All this buzz about secular stagnation implies the economy was running just fine and now post financial crisis and resulting recession, it is stagnate.

Rob Brenner and others have a different perspective - the capitalist model actually has never worked and stagnation has just been interrupted by weird periods of growth.

2. The Harrod-Domar growth model also sheds light on why there is this stagnation or 'excess capacity' and equally interesting how such a state can persist.

The model assumes for any change in the rate of investment, a change will occur on the demand side and on the supply side. On the demand side the increase in the rate of investment filters through the multiplier and increases the rate of income. On the supply side the increase in the rate of investment causes a change in the rate of potential output. Equilibrium is defined not only as y = potential output but when their rates of change are also equal.

Solving the model we find r must be equal to the given capital ratio times the marginal propensity to save. But if actual growth r is greater than p*s then demand will be greater than capacity and a shortage will ensue causing firms to act in the opposite way of an equilibrating action; they invest more even though they should invest less.

Imposing secular stagnation onto these results we can understand why this stagnation could persist- if the actual rate is smaller than the required rate to utilize all capacity then there will be a capacity surplus and firms will decrease investment when they should invest.

The model demonstrates something we already had intuition about- some investment is needed to correct the deficiency in investment.

Rise of Rentiers and Capital's Never Ending Quest

(Notes and Thoughts from David Deming's talk on Value of Post-Secondary Education)

The situation

The cost of  a college degree has been increasing steadily while state funding of post-secondary education has stayed the same since the 90's and more recently decreased (Deming et. al, 2014). This means students have had to foot more of the bill - which would explain the increase in student debt. The federal government's Title IV financial aid program is supposed to help fill this gap.

However, a good chuck of Title IV money is flowing to for-profit online colleges. For-profit online degree granting institutions have exploded in growth, many relying on Title IV as revenue (Deming et al., 2014).  Not only that, the largest of these institutions are owned publicly traded companies.

Deming and his co-authors investigate the value of a for-profit online degree given their explosive growth and their allocation of government funds. They find that, "applicants with bachelor’s degrees in business from large online for-profit institutions are about 22 percent (2 percentage points) less likely to receive a callback than applicants with similar degrees from non-selective public schools, when the job vacancy requires a bachelor’s degree" (Deming et al., 2014). This finding, coupled with the fact for-profit degrees are more expensive than public and community colleges, suggests investing in a public university or community college degree is the better investment compared to a for-profit online degree.

Implications and Questions

-Why is the cost of a college degree increasing?

- Title IV flowing to online schools which are more expensive and LESS valued in labor market has implications on student debt.  Debt might be higher and would definitely be harder to pay off, thus sucking more consumption out of the future and possibly leading to higher default rates.

-It seems as if financiers have ingeniously found a way to make the government absorb the risk of bad loans while they take in the profits.  The government lends the money to the student, which then gets transferred to the for-profit online college.  The college gets the money regardless of if the student graduates, graduates and finds a bad job, or graduates and finds a good job.  The risk of the student not being able to pay back the loan (which according to Deming's study is higher than a public degree holding student) is shifted to the government.  I might be missing something, but this seems like a great set up if I own stock in a publicly traded corp that has its hand in the for-profit degree business.

Deming et al. Paper

Deming, D.J., Yuchtman, N., Abulafi, A., Goldin, C., & Katz, L. (2014). THE VALUE OF POSTSECONDARY CREDENTIALS IN THE LABOR MARKET:
AN EXPERIMENTAL STUDY. NBER.Working Paper 20528
http://www.nber.org/papers/w20528

Game theory and the walrasian paradigm, game theory and the marxist paradigm

What is the relationship between game theory and the Walrasian paradigm? Between game theory and the Marxian paradigm?

The Walrasian paradigm in some ways can be seen as a subset of game theory.  The Walrasian paradigm works under complete contracts, exogenous preferences, and self-interested actors.  Game theory includes some of these assumptions in its more robust understanding of social interactions. 

Cooperative contracts are complete contracts, contracts that can be enforced by law. Things like having to pay a wage to a worker stipulated in the contract.  Noncooperative contracts are non-binding contracts, things that cannot be enforced by law.  Things like the amount of effort a worker must put in to earn the agreed upon wage.  Game theory captures the Walrasian assumption of complete contracts but also allows space for more than just complete contracts.

Similarily, people can be selfish in their behavior in game theory, but need not be.  Altrustic behavior is also a potential behavior for an individual. 

Game theory's relationship to the Marxian paradigm is the dialectic nature of games and institutions.  Games can be used to model institutions.  For example, you can set rules for a game by based on functions of an institution.  On the other hand, you can model the outcomes of games as institutions.  For example, equal distribution of a firm's final product might be the outcome of a game played.  This back and forth causality can be perceived as dialectic and emphasizes the endogenity of institutions and games.  Institutions cause game outcomes and game outcomes cause institutions. 

It's the questions, boy, it's the questions

Why do we assign businesses the important task of keeping people alive?

Why do businesses invest?

Do we care why they invest if we know their investment is prone to uncertainty?

Are they investing now?

Is the profit rate falling?

What is the role of a business?

Why do we assign businesses the important task of keeping people alive?  

Wages

From "Unlevel Playing Fields" by Randy Albelda, Robert Drago, and Steven Shulman

"if it takes me three hours to make a vest using the current level of techology, and I have what is considered to be the average skill in the industry, then I should be able to trade that vest for a chair that takes the same amount of time to make...Instead, workers offer their time... and in exchange they recieve a wage...Labor time must be worth the amount of time that it takes to "produce" a worker given the current context (i.e. the amount of time needed to support a worker and his or her family as the customary standard of living). The amount of time required to produce a worker is then a social and cultural relation, a matter of conflict over the coustomary standard of living.  If the customary standard of living requires a DVD player and a car, then the wage bill will reflect that."

Macroprudential Policy and Monetary Policy

Jared Bernstein sends us to Stanley Fischer's speech about financial regulation. Unsurprisingly, I agree with Jared's ideas about human behavior in finance.  As Robert Shiller and others have long argued, humans behave weirdly sometimes - falling into traps of euphoria and panic.  A little more broadly, even Keynes noted that some things are just fundamentally uncertain and thus "animal spirits" guide many actions in the economy.

What I am struggling with now is not human behavior in finance but the contradiction between expansive monetary policy and prudential macro policy. Recent expansionary monetary policy leading up to the housing bubble demonstrates how pumping money into the economy can not only cause misallocation of funds, but also increase the fragility of the overall system.

Macroprudential policy could improve the strength of the financial system and help allocate funds to non-bubbles, however when you try to guide a river into specific channels, it might lose some oomph. Likewise, monetary policy will be less stimulative due to restraints such as capital and liquidity requirements.

To me, fiscal stimulus is an obvious answer but in the present political arena, I'm not sure we can count on it. Therefore, we need to think of how monetary policy interacts with prudential regulation.

Pay without Performance: Long, Long Summary

At the heart of the corporate governance structure lies an agency problem.  Shareholders (owners) cannot constantly supervise the managers  (controllers).  Some mechanism to force managers to keep shareholder interests in mind has to be in place, otherwise executives would always act in their own best interest.  Enter the board of directors.  The board of directors was created to champion shareholder interests and vested with the power to run the company.  This trifecta of managers, directors, and shareholders allegedly operates under the arm’s length bargaining model which states the executive “comes seeking the best possible deal for themselves  and board comes seeking the best possible deal for the shareholders” (2).  

However the authors argue arm’s length bargaining has hardly been the case. After thoroughly inspecting executive compensation Bebchuk and Fried find that directors stand to gain much by supporting executives and suffer little cost of neglecting shareholders. Furthermore, the “checks” of shareholder action and the market do not provide the constraints financial economists believe.

It is assumed directors have shareholders interests in mind because they are mandated to do so, but upon further examination the authors find strong incentives for directors to please executives and weak incentives to look out for shareholders. 

Incentives to favor executives, small costs to ignoring shareholders, lack of market or shareholder limitations

Being a director comes with good pay, perks from the company, networking, low workloads, and extra business.  A seat on a company board is no doubt desirable.  Keeping the board seat is also attractive. A director obtains a seat by first being nominated by the current board’s nominating committee.  Nominating committees historically have not been independent .  In the past, having CEOs on nominating committees was not uncommon.  Recently, under new requirements, nominating committees have had to include more independent directors.  However, CEOs still maintain influence over nominations through independent directors desire to maintain good terms with the CEO. The work to get on good terms with the CEO and thus the slate for nomination is validated because once on the slate, being reelected to the board is almost a given.  For example a study looking at the years 1996-2002 found that “electoral challenges to board’s slate was practically nonexistent” (25). 

Once on the board, the financial and nonfinancial incentives to remain in good standing with the executive strengthen.  Financially, high CEO pay has been linked to higher board pay (30).  CEOs have power to give directors business, engage in pet projects, or contribute to director-favored charities (28).  This type of “back scratching” is inherent throughout board-executive relations and is exemplified by “interlocking” in which one executive sits on a director’s board and vice versa.  Non-financially, social and psychological factors also influence directors to favor executives over shareholders.  Besides becoming friends with executives and the desire to avoid conflict, some directors may experience cognitive dissonance where directors were previously or are currently executives and thus a lot higher CEO pay.  The magnitude of cognitive dissonance is by no means a small percentage. For example, in 2002, “41% of the directors on compensation committee were active executives” (33).  

Directors hold infinitesimal amounts of shares (34), allowing them to make choices that could decrease shareholder value yet benefit an executive. 

Assuming directors do have shareholder interests in mind, they are still constrained by time and lack of information, a study completed in 2001 finds that directors only worked about 100 hours a year (37). Thus the widespread use of compensation consultants should come to no surprise.  Compensation consultants are justified as impartial, a resource with an objective perspective that has access to other private company information, which many courts defer to in litigation.  However, compensation consultants also have strong incentives to please managers and no incentives for shareholder loyalty. Consultants seek future business and give the executive the news they want to hear.  Compensation consultants can boost CEO pay regardless of performance, “when a firm did well, consultants pushed for high compensation…when a firm did poorly, the consultant looked not to performance but rather to peer group pay norms” (39). 

Proponents of arm’s length bargaining claim shareholder action and market constraints will limit any deviations from the arm’s length model.  Bebchuk and Fried demonstrate the multiple barriers shareholders face in challenging the board.  A major obstacle facing shareholders that wish to challenge the board via litigation is the history of court action; courts don’t have the competency to judge compensation packages and thus have almost never overturned board decisions (46).  Courts defer to board decisions if minimum requirements are met (independence of comp committee), throw out cases due to formalities like the demand requirement (bringing a demand to the board before entering any legal cases), and the last route options like “waste” have been described as rare as the Lock Ness monster (46). In other words, the “check” of shareholder action on executive compensation has no teeth.

Because CEOs and other executives are at the top of the corporate latter, normal market forces don’t constrain their compensation.  They can’t move up, are unlikely to be picked up by different firm, and rare cases of dismissal is most certainly not due to compensation requests.  

Directors recognize pleasing executives can yield substantial benefits and the cost directors incur for neglecting shareholders is negligible.  Furthermore, constraints provided via shareholder action and the market are ineffectual.  

Managerial power existence and how it is used to extract rents and decouple pay from performance

It is clear the arm’s length bargaining model is not equipped to explain current executive compensation agreements; incentives influence the board to favor executives and not shareholders while there are no effective constraints to combat this effect. The authors develop and offer a managerial power approach that better explains executive compensation and the relationships between the board, managers, and shareholders. 

Under this approach, managers can extract rents  by camouflaging compensation under the outrage constraint.  The outrage constraint reflects the fact executives cannot receive infinite amounts of compensation without protest by shareholders and other community members. An example of the outrage constraint is CalPERS strategy of publicly shaming companies/CEOs that were performing poorly which lead to increased CEO turnover (69).  Managers also use their power to decouple their pay from their performance.  Executives are compensated for activities that do not reflect increased shareholder value. By camouflaging their pay, managers can extract rent, receive pay not related to their performance, and provoke little outrage. For example, compensation consultants can assist in camouflage by expanding and/or changing definitions to boost CEO pay (71).

The ratcheting effect of managers all wanting to be above average – leading to higher and higher pay reflects managerial power. For instance, instead of having to substitute cash compensation for equity based pay, executives received equity payments on top of already existing cash components. As seen later, the shift to equity payments could have been performance based but managers choose to pursue and maintain equity arrangements that were not strongly linked to performance.  

Certain environments can confer more power onto managers: larger boards, no large outside shareholders, no institutional shareholders, and protection from takeovers. Executives can utilize this power to garner not only more pay but pay that is less predicated on performance. 

CEO pay tends to be higher and less performance sensitive when the board is larger, directors serve on more than one board, and when directors are “attached” to CEOs either through interlocking or being appointed by CEO.  Psychological factors allow directors to be more generous when they can’t be the only one blamed or when they know the executive personally.

Both large outside shareholders and the presence of institutional investors place downward pressure on executive pay. A 2002 study found “a shareholder with a stake larger than the CEO’s ownership interest reduces CEO compensation by 5%” (82). Furthermore, studies show CEOs of companies with large external shareholders  are less likely to be rewarded for luck (83).

Under the arm’s length approach, shareholders should not have any obligations to outgoing executives, so it is puzzling why they receive so much compensation.  Using a managerial power lens, it is clear executives leverage their power to secure excess compensation on the way out.  Gratuitous payments are payments not stipulated in the CEOs contract.  CEOs that warrant firing should not receive compensation upon leaving, however Bebchuk and Fried describe several examples of fired executives receiving millions of dollars of gratuitous compensation (88).  An explanation for the excess payments to CEOs points to repaying old favors than with performance (93). 

Acquired companies executives also receive bonus payments from their boards. Since acquired companies usually benefit in some way, this bonus might not reflect managerial manipulation.  On the other hand, executives also get bonuses from the acquiring firm board, which can lead to lower acquisition premiums for shareholders (92). In this case, CEOs benefit at the expense of shareholders.

Gratuitous payments and bonuses from acquiring firms have little to nothing to do with performance and exemplify extracting rent. Retirement benefits demonstrate how managerial power influences firms to camouflage executive pay to lower outrage costs and how these benefits do not increase shareholder value. 

The then recent corporate scandals such as Enron prompted legislation such as the Sarbanes-Oxley act and tighter disclosure requirements.  Retirement benefits offer various ways to circumvent disclosure requirements and again separate compensation from performance.  Additionally, retirement benefits extended to executives do not contain favorable tax treatments for the firm and thus can only be the result of managerial power.

Regular or “qualified” pensions are considered efficient because they offer tax subsidies to the firm. Because these qualified plans can only pay out $100,000 annually (97), CEOs usually are covered by supplemental executive retirement plans or SERPs. SERPs, unlike regular pensions, “shift some of the executive’s tax burden to the firm” (97). SERPs also shift the risk of bad investment yields to the firm from the manager.  Since regular pensions are defined contribution, firms put in a defined amount but the benefit amount depends on investment yields.  SERPs alternatively are defined benefit meaning even if the investments have poor yields, the firm has to make up the difference.  Furthermore, SERP payments “are usually based on years of service and preretirement cash” (99) meaning performance is not linked to pay. It allows firms to hide build up of executive payments and past executive payouts. Why are executives different then regular employees?  The authors point out that executives more than regular employees would be better equipped to handle the risk of bad investment yields. The fact that in 2002 70% of firms supplied SERPs to their executives (98) may be an effect of managerial power.

Like qualified pensions, regular employees have 401(k)s but executives are allowed to defer compensation. And like SERPs, under deferred compensation managers receive substantial gains at the expense of the firm and shareholders.  The deferred compensation “builds according to a formula devised by the firm” (102).  Interestingly enough, usually the yield from this formula is above market returns.  If executives invested money themselves they would be subject to a 15% capital gains tax. Deferred compensation is subject to 35 percent corporate tax, thus it is again puzzling that “over 90 percent of firms offer deferred compensation” (105).

Retirement perks including “access to apartments, planes, cars, home-security devices, and financial planning” (107) highlight the desire to hide compensation. It would yield more utility if the executives received cash equivalent compensation and could decide for themselves what they’d like to do with the money.  However, perks camouflage the true value of extra compensation given to managers. Consulting contracts further exemplify camouflage and the decoupling of pay from performance. For example one executive received 1 million dollars for being available 5 days a month for one year (109).

Golden goodbyes and retirement perks do not make sense under an arm’s length bargaining model but can be understood via the  managerial power approach.  Executives utilize their power to not only extract excess compensation but to decouple their pay from their performance.  The next section examines CEO compensation and continues to document examples of this process.

Historically non-equity pay has not been correlated with performance and thus regulators instituted a rule that says firms cannot deduct more than 1 million dollars of CEO compensation unless that compensation is performance based.  However, CEOs have received salary and bonus beyond 1 million (122). In other words executives receive cash compensation at a disadvantage to firms and shareholders. Even further, CEO cash compensation is highly correlated to events not necessarily related to executive decisions like market-wide or sector-wide stock price increases. Allowing CEOs to reap benefits of results they did not help produce.

Unlike salary, bonuses have to meet objective and subjective criteria to be awarded. Objective criteria appear impartial and perhaps reasonable guidelines to allocate bonuses.  Upon closer inspection, it seems most objective requirements have little or nothing to do with increasing shareholder value.  Examples of such objectives include meeting a budget or having current profits exceed the previous year. Meeting a budget does not display any improvement to shareholder value while aiming at higher profits than the previous year can distort incentives for long-term success. A company could rank at the bottom of peer firms yet have higher numbers than last year. Moreover, the objective creates an incentive to make earnings look higher than they really are, “For example, companies have based bonuses on accounting earnings that include the appreciation of pension fund investments, which generally depend on stock market performance and not on the efforts of the companies’ executives” (125).  According to the authors, in 2001 Verizon awarded bonuses based on the net income for the year, which included about 2 billion dollars of pension appreciation income from investments (125). If the company did not include the appreciation, net income would have been negative. 

Executives also receive bonuses for making acquisitions that do not necessarily increase shareholder value, “A 2002 BusinessWeek study examining large acquisitions made in the spring of 1998 concluded that 61% of the buyers ‘destroyed their own shareholders’ wealth’ in the process by overpaying for their targets” (128).  Executives have monetary and non-monetary incentives to acquire firms, via bonuses or empire building respectively. Yet, there are no incentives to downsize.  Acquisitions therefore appear to be just another reason to hand out cash to CEOs.

Golden hellos such as signing bonuses represent pay that relates in no way to performance. Golden goodbyes even in the face of terrible tenure represent pay decoupled from performance, “Currently, most compensation contracts ensure that executives receive generous treatment even in cases of spectacular failure” (133). For example, Jill Barad received 50 million after overseeing a two-year stock decline of 50% (134).

Again, cash compensation has been historically weakly correlated with performance.  As fact became more apparent to shareholders they began to demand some type of performance-based pay.  Reflecting common feelings, the federal tax code in 1994 stipulated publicly traded companies cannot deduct pay in excess of 1 million annually per executive unless pay was based on performance or pay was granted via options.

  

Interestingly, the shareholder pressure led to an increase in option based plans while performance based plans were largely ignored.  Perhaps due to managerial power, when shareholders and institutional investors won their campaign for option plans, they were ADDED ON TOP of current cash compensation and not substituted out.  Inflated CEO pay produced little outrage largely because of the booming market of the 90’s.

Options (call) are promises that one can buy a company’s stock for a specific price, called the exercise or strike price.  The idea behind options based compensation packages is that the more stock an executive has, the more aligned the interests of the executive and shareholders will be.  

To test whether option plans really carried out their intended effect, shareholders use the share price to determine executive performance.  Share price seems like a good gauge of performance since increasing the share price is good for all shareholders, including the CEO, but without significant adjustments it isn’t. Many things can lift a share price without any intervention by a manager- for example,  a study found “only 30% of share price movement reflects corporate performance, the remaining 70% is driven by general market conditions” (139). Additionally, falling interest rates and the general upward trend of the stock market can produce windfalls for executives.

The most popular way to reduce windfall options is to index the exercise price to market average or average of a basket of peer firms.  This way, any market or sectoral swings won’t reward the executive; only good performance would reward managers. Another way to reduce windfalls for managers is to tie vesting to performance.  In other words, CEOs could not exercise their options unless certain goals were met.  

Some defend conventional options by stating reduced windfall options would change the accounting treatment regular options can garner.  If the exercise price is fixed, the firm does not have to take a charge against earnings.  Meaning under conventional options, earnings are inflated. Higher earnings could mean higher shareholder value. (148).  Taking a charge against earnings is known as expensing and it is the main reason firms put forward for avoiding reduced windfall options. However, as the authors note, expensing all options will most likely be required after 2004 by all firms, leaving no excuse to move towards reduced windfall options. The non-existent presence of reduced windfall plans even in the face of calls from institutional investors (Institutional Shareholder Services, Council of Institutional Investors) reflect managerial power “In 2002 only 8.5 percent of large public firms issuing options to executives conditioned even a portion of the grant on performance” (143).

Three more activities represent managerial power and how it has been used to decouple pay from performance: at-the-money options, backdoor repricing, reload options.

In-the-money options are not considered performance based because they have a strike price below the current market price.  The executive could buy at a low price and sell at a high price and the difference the executive made would have nothing to do with their performance.  At-the-money options have a strike price equal to the current market price.  This seems fair.  However, recalling the market’s general trend upward, at-the-money options soon become in-the-money and again can have nothing to do with performance.  Out-of-the money options have a strike price higher than the current market price, so for options to be profitable, the share price would have to be higher than the current market price.  This option out of the three has the most incentive for executive to raise the share price, even though the share price could rise on its own.  Under the managerial power model, it is not surprising then that less than 5% of companies use out-of-the-money options (160).

In 1992 95% of options were at-the-money (160).  This represents executives maximizing their gains under the outrage constraint. Of course managers would like in-the-money options but those cause outrage because there is no shareholder benefit.  Managers strongly oppose out-of-the money so the “compromise” is at-the-money. Even then managers “camouflage in-the-money as at-the-money” (164). Siebel systems “issued 600k options at-the-money with a share price of $33. The next day the company disclosed large increase in profits, driving the stock up to $46 per share. This increased executive options by 8 million” (163) and immediately turning at-the-money options into in-the-money. If Siebel had waited to grant the options at the time of the news release, no extra value would have been conferred to the options. 

Related is an activity known as repricing or backdoor repricing. This allows the exercise price in option plans that have gone out-of-the money to be lowered, in effect rewarding the manager for a decreased share price.  Repricing exemplifies managerial power, and their objective of structurally decomposing pay and performance.

A better way to organize option plans is to allow “the strike price to increase over time at predetermined rate” (161).  Since the stock market tends to rise over time, managers couldn’t be rewarded for something they had no influence over. Conventional options reward general market increases, but when the general market happens to decrease the options are repriced. This environment produces “heads I win, tails I don’t lose” (167) odds.  

Reloads are a particular mind-boggling type of compensation considering the purpose of options based pay.  Options allow executives to become shareholders, hopefully aligning their interests.  However, once options vest, CEOs own the options and most likely can exercise them the same day.  While it is not required CEOs sell the shares, evidence shows most do, “For every 1000 new options awarded, an executive sells 684 shares of stock” (174). Reload options allow executives who have sold stock to be “reloaded” with more options in order to replace the incentive to have shareholder interests in mind. 

A type of in-the-money option although not called it by name is restricted stock.  Restricted stock has a strike price well below the grant-date price – zero.  The justification for restricted stock is that it will provide some sort of long term-value, however restricted stock appears to behave identically to conventional options.  The selling of restricted stock is even worse than conventional options; in 1997 a study found for every 1000 new restricted stock awarded, an executive sells 940 shares of stock (174).

This pattern of “unwinding” erases the incentive options create. If executives can exercise options as soon as they vest and sell them, shareholders will either have less incentive for CEO to act in their interest or the same incentive at the price of granting more options.  

Not only are there no meaningful restrictions on unwinding but also managers stand to make additional gains by timing the selling of shares (179). There are countless examples of executives selling shares before bankruptcy or share price declines (181).  One striking example documents “Qwest insiders sold 2 billion while they were overstating revenues.  Shortly after, Qwest stock feel more than 95%” (182). For this reason, it is recommended that executives disclose in advance their desire to sell shares.  

The solution of equity based compensation shareholders fought so hard for has not been effective.  Instead of aligning shareholder and executive interest as previously thought, executives have been able to use their power to extract pay that is unrelated to their performance.  Much of this pay has been obscured and camouflaged to lower outrage and secure the maximum amount of managerial compensation under those constraints.  

The solutions the authors suggest are two-fold: treating the symptoms of the underlying problem and to treat the underlying problem.  Inflated executive compensation is largely a result of corporate governance malfunction.  To improve executive compensation, firms can link pay to performance, improve transparency, and require shareholder approval.

As discussed both non-equity pay and equity compensation are weakly linked to CEO performance.  To strengthen this link, companies can embrace policies like reduced windfall options – options that do not reward general market or sector-specific rises.  Revise the ways in which managers receive bonuses by deleting discretionary criteria and rewards for acquiring other businesses.  Restrict the sale of shares and require sales to be announced in advance.  Do not reward executives for failures.  Inspect the size and scope of retirement perks.

Transparency can be improved by expensing options.  This would not only reflect more accurate earnings numbers but also remove a key barrier to utilizing reduced windfall options. Firms can reduce camouflage by providing accurate monetary values on all forms of CEO compensation. 

Requiring shareholder approval could give teeth to intervention opportunities shareholders already have.  Voting on specific compensation components could give shareholders the chance to reject executive actions like unwinding incentives, excessive severance benefits, conventional options, and repricing.

To treat the cause of excess executive pay, corporate governance must be addressed.  More specifically, boards must be made more dependent on shareholders for reelection. Currently, several barriers exist for shareholders to remove a board member and replacing them with shareholder approved candidates. Significant time and money must be contributed as well as meeting a list of criteria such as ownership requirements.  

Placing new shareholder candidates shouldn’t require a vote or a year long wait.  In addition “short slates” should be replaced with “long slates” in order to have the majority of the board shareholder approved.  Providing challengers with some financial resources would remove advantages existing board members have. 

Removing these barriers would greatly improve the legitimacy of board decisions.  Most importantly, it would produce strong incentives for the board to make decisions with the shareholders best interests in mind.