Diane Francis on Business Issues

Friday, February 17, 2006

Fess Up Lads

National Post column Feb. 18:

NEW YORK CITY - The Securities & Exchange Commission is circulating for comment tougher rules to crack down on excessive executive compensation. Among reforms will be the requirement that companies disclose on one-page in plain English the complete tally sheet paid to their top brass.

"The rules are about wage clarity and not wage controls...and not to impose salary caps," SEC's new Chairman Christopher Cox told newspapers at the time of the announced new policies.

Reviews have been mixed but predictable. Wall Streeters, corporate law firms and Republicans have complained about the imposition of more red tape.

But investors, money managers and pension funds have been clamoring for years to arrest the greed that's gripped executive suites and that continues despite scandals.

But even defenders of the status quo had to be shocked by a recent "eye popping" study by Harvard Law School Professor Lucien Bebchuk. In 2003, he said the top five executives in all public companies received a collective compensation which was equivalent to 10% of their companies' combined profits.

That magnitude of profit skimming should worry free enterprisers as well as investors. It should also worry the Ontario Securities Commission which must adopt these draconian new rules.

The SEC is circulating its 370-page policy proposal for comments and plans to impose them in time for the 2007 proxy season.

Highlights include more true independence and more professionalism when making decisions on the part of corporate compensation committee members.

Cronies are often embedded in these committees and approve piecemeal perqs which, under these rules, will now have to be fully disclosed every year in total.

Disclosure will now extend from salary, bonuses and stock options profits to retirement bonuses, pension entitlements, other incentives, discharge package and other perquisites.

Hopefully, regulators will zero in on the two most egregious, hidden benefits:

-- Entertainment budgets. There's abuse here and the public would be shocked at the amounts involved.

-- Use of private jets. It's an open secret that executives give "free rides" to friends and family. This is justified, by executives, on the basis that the plane was flying from A to B anyway with empty seats. But that's unacceptable.

And even when compensation is paid, it's inadequate. They usually reimburse the company the equivalent of a first-class ticket. But a chartered round trip on a four-seat jet between Toronto and Miami would cost at least US$25,000. First-class tickets for four return would cost a fraction of that.

Which brings up another point. Securities regulators are not the only persons who should be weighing in on this. The Internal Revenue Service and Revenue Canada should require corporations to disclose entertainment and jet perqs because they are "taxable" benefits to executives that aren't being taxed.

Executives using jets for any personal use should pay the full cost or, at the very least, be taxed on the difference between what they defray and the true cost to the corporation.

One New York money manager, who asked to remain anonymous said in an interview jets determine his investing choices: "When a public company gets a corporate jet for the CEO I consider it a sell."

The call for a crackdown has increased along with the amount of greed.

A recent study showed that median executive pay among the Standard & Poor 500 increased from US$2 million in 1993 to US$6.6 million in 2003, according to accounting professors from Wharton and Vanderbilt Universities.

Watchdog organization, the Corporate Library in Portland Maine, said executive compensation increased 15% in 2003 and 30% in 2004 or "about 10 times' the inflation rate."

Besides full disclosure, the SEC is cracking down on the cronyism which is rampant in compensation committees. Some expect these committees will be shaken up as much as Sarbanes-Oxley has shaken up audit committees.

These links, between cronies on boards and compensation, is the root of the problem. In a 2005 study by Wharton Accounting Professors called "Back Door Links between Directors and Executive Compensation", the issue was quantified.
A total of 22,074 directors working at 3,114 companies were surveyed as to their business or social associations. Where associated, executives reaped an average of US$450,000 more per year from their boards.

"Directors who serve on multiple boards may look like outsiders, but they are not really outsiders and may indulge in mutual back scratching," said Scott Richardson, Wharton Accounting professor.

Canadian regulators should also crack down on cronyism and hidden compensation in step with the SEC's reforms in order to protect the market's integrity north of the border too.

Privacy Conference

CAMBRIDGE - A disproportionate number of Canadians were on hand at a conference held recently into the growing concern by Internet users about protecting their identities from fraud, government agencies and marketers.

"You know Canadians. We've always had a national identity crisis," joked Kim Cameron, a Canadian now based in Seattle with Microsoft as an architect specializing in this field. "There is a growing concern in the public because of an exponential growth of fraud. In five years, it will be incredible and in the technical world it takes five years to change anything. As people know more about computers they are less likely to do things on line. The negative effects are very profound."

Internet players like Microsoft and IBM attended the gathering in the interests of shoring up the integrity of the on-line world. A recent poll showed a sharp decline consumer confidence in shopping on-line.

There are three concerns: The use of personal information by commercial interests, by criminals and by governments.
Technology now exists to monitor everyone's movements, shopping habits and financial reputation. And this information may not be securely stored or used without permission.

A recent rash of burglaries in Quebec occurred when bikers tapped into a data base listing the addresses of purchasers of expensive electronic equipment.

"US businesses are starting to appreciate the extraordinary risk of selling information to thieves. It's risky to hold on to this stuff," said Marc Rotenberg, Executive Director of the Electronic Privacy Information Center in Washington DC.

The conference, held at the Berkman Center on Internet and Society, zeroed in on the issues and on the types of technologies needed to protect consumers.

For instance, Microsoft is coming out with an "info card" addition to their software that, among other features, will verify whether a website asking for personal information from a user is "real".

But crime is not the only concern. Privacy is becoming as big an issue in the United States as the public begins to realize that companies, search engines and websites collect massive amounts of credit card, search habit and shopping information about individuals. This is then used to target advertising or is sold to third parties as sales leads or for other unknown purposes.

"Big companies have been rotten about privacy over the past 100 years and we need holistic change in corporate approaches to privacy," Mr. Cameron told the high-level gathering of 60 software professionals. "In Canada, there has always been a different attitude towards privacy. In the 1970s, social insurance numbers stopped being used as identifiers."
By contrast in the U.S., shoppers must routinely, on-line and off-line, disclose their social security numbers and other personal information.

People also have no idea how valuable this type of personal information is to unknown intermediaries. In Canada, one company processes most credit card transactions then packages and resells shopping habit information. Another gives free software to pharmacies in return for consumer spending information which it sells to pharmaceutical companies.

Another issue raised at the conference is the "Big Brother" concern -- the fact that the installation of city-wide Internet access in Philadelphia, and soon in San Francisco, includes provisions allowing the service provider to keep and resell surveillance data.

Stefan Brands is a mathematician who devises algorithms to encrypt, or render anonymous, information. He is adjunct professor at McGill University and CEO of tech start-up Credentica Inc which has devised e-cash, a breakthrough technology for shopping. This "virtual currency" allows a consumer to click and buy, but also keeps him or her anonymous.

Phone giant Nokia has invested in his company in order to explore the possibility that a "virtual cash" feature could be added to its cellphones.

But banks are not interested, he said, "because this cannibalizes their business model".

He's also working on technology that would allow companies to "mine" data about individuals but without knowing their identities or personal information.

"Information like 80% of people in a certain locale over 18 years of age with two children buy twice as many of these products as others," he said. "This is important marketing research information and we are working on ways to find this out without seeing the individuals."

The conference was organized by Berkman Fellow John Clippinger who wrote the "Biology of Business" which exposed the information collection processes and its negative impact on individuals' market rights and civil liberties.

The other players in all of this are law enforcement officials and Homeland Security which need systems that invade privacy in order to do surveillance and investigations.

Mr. Clippinger summed all the angles deftly in his opening remarks.

"It's Benjamin Franklin's 300th birthday and he used 40 aliases during his lifetime to operate freely," he said. "And as Franklin said `they who would give up liberty for temporary security deserve neither liberty nor security'."

Saturday, February 11, 2006

caving into Chinese Censors

Diane Francis, Financial Post
Published: Saturday, February 11, 2006

CAMBRIDGE, Mass. - A Congressional hearing next week into the activities of three of the world's biggest public companies is of more than just passing interest to Harvard's Rebecca MacKinnon.

A former CNN bureau chief in Beijing and fluent in Mandarin Chinese, Ms. MacKinnon is hopping mad at Google Inc, Yahoo Inc. and Microsoft Corp. for all caving in to China's censors. She has been the most outspoken critic of these companies and has singlehandedly helped bring Congressional attention to the issue.

"The fact is that every time a multi-national corporation goes in and agrees to build censorship into their business model, as these [three] companies have done, it is easier for dictatorships to exist and easier to transfer censorship to other parts of the world," she said in an interview this week at the Berkman Center on Internet & Society at Harvard Law School.

The Congressional hearing, starting Wednesday, promises to be one of the biggest business stories this year. Republican Chris Smith of New Jersey, chair of the subcommittee on Human Rights, will ask corporate officials to testify to determine whether U.S. laws have been broken, bent or should be changed to avert future complicity.

The issue came to a head last month when Google agreed to curb Internet searches in China on pro-democracy issues. (At the same time, it is fighting Washington's request to help it curb child pornography on the Internet.) "There are three separate cases involved here," said Ms. MacKinnon, who co-founded "Global Voices," which publishes bloggers in oppressed countries.

The most extreme involves Yahoo and a Chinese journalist who was using the search engine's e-mail service to send material to a dissident Web site in the United States. Chinese police traced the content back to the journalist's e-mail address and approached Yahoo.

"They asked Yahoo to hand over his account information and the company did," she said. "The man is now in jail."
Yahoo said that because its computers, containing account information, were physically in China, they had no choice but to comply.

"This is irresponsible," Ms. MacKinnon said. "If some government goon scared their Chinese employees, they do not have to comply even under Chinese law. Such requests have to go through proper channels, the chain of command and the state has to sign off. It's not true that there was no recourse except to hand over the account information."

Microsoft also ran afoul of China last year. The government complained to the company about access to a pro-democracy blog it offered users. Microsoft agreed to erase the blog.

"Microsoft's servers [computer equipment] are not even in China; they are in the U.S. So exactly what American law did this blogger break? Besides that, his blog was erased worldwide not just in China," she said.

After a hue and cry about the incident, Microsoft announced that it had revamped its software so that, in future, if a Web site or blog is erased in China, it won't be erased everywhere else.

Ms. MacKinnon thinks this makes matters worse. "By creating a more sophisticated and more finely grained system of censorship, Microsoft will still be instituting a workable model, which can be applied to China, Zimbabwe, Tunisia, Iran or wherever a government is cracking down," she said. "And who says this can't be applied here or Canada or Australia? This is the thin edge of the wedge."

Google's case is different from the others. At the end of 2005, it agreed, at the request of the Chinese government, to restrict searches by Chinese users. Certain words, such as democracy or freedom, won't be searchable within China and certain Web sites or blogs will not be accessible. Ms. MacKinnon wants Google to be forced to publish its Chinese-approved list of "forbidden" words and sites.

Google says the agreement it reached with China is that Chinese users trying to access these words or sites will be told that they are unavailable by government request -- a form of disclosure and transparency that it maintains will indirectly advance democracy and information.

Clearly, the China issue is complex and has legs politically and financially. There is also plenty of investor grumbling, along with serious political fallout. Google, a stock market darling, has lost its lustre since news broke about its compliance with China and non-compliance with Washington. It's been doubly embarrassing for the company given its "do no evil" motto, say Ms. MacKinnon and other critics.

Microsoft's compliance has also embarrassed Microsoft's global philanthropist and do-gooder Bill Gates, who waxes often about the importance of spreading democracy and the rule of law in order to underpin free enterprise and planetary prosperity. Worst of all, however, is the negative publicity concerning Yahoo, which calls itself a media company but helped hunt down a democratic journalist, now rotting in a Chinese jail.

Corporate defenders say these companies had no choice. But that's hard to believe, given the economic leverage that the United States has together with China's overriding need to create 55,000 jobs a day just to keep employment level.

Whatever the excuses, these companies' actions certainly leave a bad taste.

© National Post 2006

Saturday, February 04, 2006

Rational Exuberance

NEW YORK CITY -- Runaway bestseller “Irrational Exuberance” documented how technology breakthroughs inevitably result in stock market bubbles and catastrophe.

Its author, Yale Professor Robert Shiller has written another, “The New Financial Order”, which discusses how globalization and sweeping change threatens the “real assets” of people such as their incomes and value of their homes.

His prescription is to create imaginative financial hedging products, or insurances. And this April, his consulting firm, the Chicago Mercantile Exchange and investment banking partners plan to launch their first unorthodox “product” which will be designed to protect homeowners from losing any value on their homes.

"We want to launch the first real estate risk instrument. Real estate is bigger than the stock market, where hedging takes place, but single family homeowners have no way to hedge," he said in a recent interview. "A number of attempts have been made to provide this and they haven't worked, but it's going to come."

Essentially, homeowners will be able to eliminate any downside in value. This will be done through the use of futures: Homeowners or others will bet price drops will occur on average in 10 U.S. cities, thus allowing them to profit from losses which would, in turn, fully or partially offset their own drop in value.

"Imagine a broker being able to offer a homeowner a product which meant his house would never go down in value?" he said. “It will be very popular if the price is right.”

His book also explored other financial products that don’t exist yet, but should, such as insurance which would allow a worker to insure his or her future income stream against layoffs, downsizings, rationalizations or competition.

Professor Shiller’s work combines behavioural economics and risk management.
In this case, he has come up with profound ways to help mankind.
Income insurance and property protection insurance would give people enormous peace of mind, stabilize economies and shore up consumer confidence. It would create an economic boon.

He believes that financial markets will find ways to price these products and offer them to the public in a “win-win” fashion.

“We should be able to find a market for everything and we are only at the beginning of risk management in the world," he said. "What's changed is information technology which has allowed these products to be created. For instance, on-line auctioning is providing a market for people to take millions of risks each day. We want to provide a hedge that will change the world."

The home value protection product will fluctuate based on a Home Price Index that Shiller’s company, Macro Securities Research, devised 15 years ago.

He and the Exchange anticipate a huge market, but there are a number of obstacles to be overcome before the product can be offered to small, retail clients.

The sellers are plentiful and appetite for risk by institutional financiers is enormous even for the unorthodox. For instance, Swiss Re sold nearly US$800 million worth of "Lethal Epidemic Funds" to pension funds which would "benefit" if an epidemic wiped out many of their pensioners.

The Shiller group’s challenge is to determine how to price these products for both buyer and seller. But the fact is that there's a huge amount of capital out there looking for returns better than are now available in stocks and bonds.

"It all boils down to price," he said.
At the right price, there's plenty of players even willing to insure, and reinsure, the top three catastrophic risks currently in the world: North Atlantic hurricanes; an earthquake in California or one in Tokyo, said insurance executives.

Shiller’s product represents true breakthrough for humanity, an even greater benefit for our economies and psyches than our ancestors enjoyed.

Imagine what life was like before fire insurance was invented? It was nasty, brutish and bankrupt. House fires before insurance used to wipe out families and even cities. It still does in the developing world.

Now imagine life with protection against lower real estate prices for your home? Or protection against the bubble in your local real estate bursting, leaving you owing on a mortgage that's higher than the value of the underlying property?

Or, eventually, a way to protect your income until retirement age, whether you lose your job or not.
"There have been many attempts at this and like every innovation it takes time," said the shy Professor. "But we've learned from the mistakes of others, just as the Wright Brothers did. Lots of planes crashed before one actually flew. These will eventually fly and change the world."