Do The Right Thing, Even If You Don't Want To... And It Just Might Be Profitable, Too

It's depressing when someone has to be dragged kicking and screaming to do the right thing... and then turns around and makes a ginormous profit on the process.

This thought first occurred to me last month, during the uproar over basketball's L.A. Clippers owner Donald Sterling's racist remarks -- while the NBA promptly assessed a $2.5 million fine (relatively speaking, chump change to a billionaire), if the forced sale of his team goes through, he stands to profit to the tune of more than $1.5 billion. Which is real money by anybody's standards. (What will actually happen is anyone's guess, as the matter continues to be locked in the courts.)

And here's another example: today's New York Times reported -- as did most other major media outlets -- that the U.S. Patent and Trademark Office had stripped the Washington Redskins football team of six of its trademarks because the name is "disparaging" to Native Americans (full article, by Ken Belson and Edward Wyatt, here).

An attorney for the team was dismissive:  "We have seen this story before. And just like last time, today's ruling will have no effect at all on the team's ownership of and right to use the Redskins name and logo." (Full statement, as .pdf, here)

"Just like last time" refers to a 1999 trademark office decision cancelling the trademark registrations, which was reversed on appeal by a federal district court judge in 2003.

Even if the current Patent Office decision were to be upheld, it wouldn't stop the team from continuing to sell Redskins' glasses, T-shirts, blankets, and assorted other paraphernalia, although it would make it harder for them to rein in the counterfeiters.

Washington Redskins owner Dan Snyder has said that he would "never" change the name, and that "Redskins" was "never a label. It was, and continues to be, a badge of honor" (from a letter to the Washington Post, published 9 Oct 2013; available here).

The truth is that the world has changed since 1999. More of us understand the power of words, and especially of slurs. If it were my team, knowing that a great number of people who could be described as Redskins consider it a slur and not a "badge of honor", I'd have changed the name as soon as I was made aware of the problem. Snyder clearly needs some more convincing.

And if Snyder is smart -- and not just an insensitive racist -- he's busy meeting with marketing and branding folks right now, thinking up a new name and a new logo. Because all his team's biggest fans will be lining up to buy blankets, glasses, T-shirts, and all the other tchotchkes with the new name and logo, making a satisfying ka-ching sound in the football team's cash registers, and in Snyder's pockets. Sigh.

We All Knew It. And Now There Seems to be Proof.

There's a flurry of activity in the stock of Company X, for no apparent reason. And then, after the fact, after the acquisition (or merger) has been publicly announced, then it all makes sense: Insider trading, we think.

But the evidence is seemingly all anecdotal. So maybe it just looks bad, and that's why the Securities and Exchange Commission isn't prosecuting right and left.

Three professors (two from New York University and one from McGill) have done the math, however, and the evidence is overwhelming. In fact, they say, as many as a quarter of all deals involving public companies may also involve insider trading.

Their study, reported by Andrew Ross Sorkin in the DealBook section of today's New York Times (full article here; full 81-page report with some really dramatic charts, here), makes for depressing reading:

...[We] document pervasive directional options activity, consistent with strategies that would yield abnormal returns to investors with private information. This is demonstrated by positive abnormal trading volumes, excess implied volatility and higher bid-ask spreads, prior to M&A announcements.

Isn't it possible that this is simply coincidence? The authors, who studied deals between 1996 and 2012, scoff: the probability of similar actions occurring randomly is about "three in a trillion." Remind me to buy a Lotto ticket tonight.

As Sorkin writes,

The results are persuasive and disturbing, suggesting that law enforcement is woefully behind — or perhaps is so overwhelmed that it simply looks for the most egregious examples of insider trading, or for prominent targets who can attract headlines.

In other words, in the words of an income-tax professor of mine, "Be aggressive, but don't be stupid." (He would add that if you had to think about whether something was aggressive or stupid, "it's usually stupid.")  Just don't be so aggressive that the SEC has to notice, and you should be fine.

And by the way: while the SEC focuses largely on stock trading, the study suggests that much of the most questionable activity occurs around options. 

As you might expect, the study found that "the bigger the deal and the more trading volume in the stock of the target company, the more likely there will be insider trading." Not -- perhaps surprisingly -- because there were more bankers and lawyers involved with the deal (and therefore more people to leak information to the media and others). But simply because "the anticipated abnormal stock price performance upon announcement is larger" and because it's easier to hide the illicit trading in a bigger pool.

We all knew it was probably happening. Now we know for sure. Sigh.

How Much Harder Can We Make It to be Poor?

Once again, I find two unrelated articles resonating in my head: an opinion piece in Sunday's New York Times  Sunday Review section, "No Money, No Time, by Maria Konnikova (here) and a Jessica Silver-Greenberg and Michael Corkery article (here) in today's Times, "Bank Account Screening Tool is Scrutinized as Excessive".

The Silver-Greenberg / Corkery article begins with the account of a young woman who has been unbanked, because she "is one of more than a million Americans who have been effectively blacklisted from the mainstream financial system because they overdrew their accounts or bounced a check — mistakes that routinely bedevil young and low-income consumers, financial counselors say."

The young woman in question did pay back "the roughly $700 that she owed, [but] a record of her youthful transgressions remains in a vast private database, preventing her from opening a new account."

Such databases, used by Bank of America, JPMorgan Chase and other big banks, were intended to weed out serial fraudsters. Now, regulators say, banks are screening out potential customers and swelling the ranks of the so-called unbanked — the roughly 10 million households in the United States that lack even a basic bank account.

According to today's article, the New York attorney general's office is looking into the practice. A single error has significant consequences, as "negative marks typically stay in the databases for at least five years".

Without access to a checking account, many have no choice but to rely on costly alternatives for even the most basic transactions, like paying bills, withdrawing money and wiring funds. At first blush, the fees can seem relatively small: $15 to cash a check, for example, or $1 to place a money order. For people already living on shaky financial footing, however, the costs can quickly add up, eroding a chunk of their paychecks before they even have access to their cash.....

Such fees can make saving money, which is critical to building wealth and long-term financial stability, almost impossible, financial counselors say.

So here's another way we make it more difficult for the working poor to "bootstrap" themselves out of poverty. Thanks, banks.

And it's not just the additional cost (and the time required to get to the check-cashing storefront or the payday lender). There are other risks as well:

For low-income Americans who may already be living in crime-ridden neighborhoods, carrying around money from a check casher can be dangerous. When the Pew Charitable Trusts conducted a two-year study of 1,000 families in Los Angeles that lacked bank accounts, researchers found that one in five lost money — on average $729, or the equivalent of two weeks of household expenses.

All of these can trap the poor. But there's more to the story, I know, since I'd also read the Sunday Review piece on the relationship between money and time. Konnikova spoke with a Harvard economist, who explained that there are really three types of poverty:

..."There’s money poverty, there’s time poverty, and there’s bandwidth poverty." The first is the type we typically associate with the word. The second occurs when the time debt of the sort I incurred starts to pile up. [The reporter had mismanaged her deadlines, and therefore had to ask for an extension to complete this piece.]

And the third is the type of attention shortage that is fed by the other two: If I’m focused on the immediate deadline, I don’t have the cognitive resources to spend on mundane tasks or later deadlines. If I’m short on money, I can’t stop thinking about today’s expenses — never mind those in the future. In both cases, I end up making decisions that leave me worse off because I lack the ability to focus properly on anything other than what’s staring me in the face right now, at this exact moment.

In other words, being short of time is one thing when you're rich -- you can buy someone else's time to take the pressure of yourself (think a nanny to keep an eye on your kids, an event planner to organize your next social event, a landscaping service to mow your lawn). But if you're poor? No such luck. And the stress of that bandwidth poverty can lead you to making very bad decisions.

So the poor don't just make the same mistakes that we all make: they make worse ones. Konnikova continues with examples drawn from a research game run by the economist and two psychologists, with participants assigned to be "poor" or "rich":

...When the experimenters showed players a preview of the next round’s questions, the rich ones took advantage of the edge, performing better over all, while the poor acted as if they couldn’t see the previews at all. They were so focused on operating under scarcity that they couldn’t think their way through to a strategy — or, indeed, even realize that an opportunity to do so was available. 

We all have only a limited attention span. When all the pieces of your life are held together with duct tape, and that tape keeps threatening to split, that's where your attention goes. Not on what you could do two years from me if you husbanded your resources more carefully. I'm tired of hearing the poor called "shiftless" when we've allowed the game to be stacked against them.

Do You Really Want to Know What's Going On in Your Organization? Or Are You Just Pretending?

Three articles in the last four days in the New York Times provide a great explanation of why I'm so hung up on Trust and Transparency.

I have, of course, been following the story of GM's recall of more than a million vehicles for an ignition switch defect that has been responsible for at least thirteen deaths (earlier blogpost, here). And the story keeps unfolding.

On Friday, Bill Vlasic reported that GM's lawyers went so far as to hide product flaws from each other (full article, here):

Employees were discouraged from taking notes in meetings. Workers’ emails were examined once a year for sensitive information that might be used against the company. G.M. lawyers even kept their knowledge of fatal accidents related to a defective ignition switch from their own boss, the company’s general counsel, Michael P. Millikin.

As a result of GM's internal investigations, at least three senior company lawyers have been dismissed (but not the general counsel).

Sunday's paper carried a great column by Gretchen Morgenson on the internal investigation and CEO Mary Barra's report to her employees and to the world:

...In her remarks, Ms. Barra projected an earnest and urgent desire to reform the company’s culture, which she said was permeated by "bureaucratic processes that avoided accountability." That culture meant no one took responsibility for faulty ignition switches in Chevrolet Cobalts and other cars that were ultimately responsible for at least 13 deaths.

Ms. Barra told her audience that she wanted to make sure this sort of thing never happened again at G.M. I believe her. But the depth of the dysfunction at this company, as detailed in the report, makes it hard to see how she can keep that pledge.

The report ...says G.M. officials showed a “pattern of incompetence” that led to inaction on the defects, Ms. Barra said.

That’s the mild version. The report exposes a mind-set throughout the company that was so self-absorbed, so bent on self-preservation and self-protection that it routinely put its customers last.

The key to success at GM, apparently, was finding someone else to blame, known internally as the "GM Salute": "a crossing of the arms and pointing outwards toward others, indicating that the responsibility belongs to someone else, not me." (Relatedly, there's the "GM nod": "when everyone agrees to a plan of action after a meeting 'but then leaves the room with no intention to follow through'.")

And then there's an article, today, by Matthew Wald, exploring how the siloization of decision-making can help create perfect opportunities for management disasters like this one.

In the case of G.M., the crucial insight was that a faulty ignition switch could cause vehicles to lose power and deactivate the air bags. The link between the ignition and the air bags was not a secret; it was an intentional goal of the design, to protect people in parked cars from being injured by air bags that were deployed mistakenly.

The investigation commissioned by G.M. from Anton R. Valukas, a former United States attorney, turned up a memo from August 2001 written by an engineer named Jim Sewell, pointing out that if the ignition power was lost, the "S.D.M. would also drop," a reference to the sensing diagnostic module, which determines whether the air bags are deployed.

But the recalls didn't begin until this year, thirteen years after that memo. How is that possible?

Wald quotes a Columbia University sociology professor with a difference example of poor management response to product flaws that ended in disaster: "Both [NASA's] Challenger and Columbia [space shuttle disasters] had a long incubation period with early warning signs that something was seriously wrong but those signals were either missed, misinterpreted or ignored." If the culture encourages you to look away from potential problems and focus on your own self-preservation... well, how much more likely is a disaster?

The GM engineer who first identified the problem focused on a different, seemingly "non-safety" complaint (cars stalling out). (But I'm not sure how a car suddenly stalling out when under way can be considered a "non-safety" issue....) A little more transparency, a culture that encouraged sharing of and joint solution of problems, should have brought this issue to light much earlier. 

But the fact that GM lawyers kept secrets from each other leads one to conclude that there was much more than the "pattern of incompetence" that CEO Barra acknowledged: it sounds much more like a culture of "We don't want to know."

What Do Drug Companies Make?

It sounds like a trick question, doesn't it? And at one level, it is.

Andrew Ross Sorkin, in a DealBook column in today's New York Times, asks the question a little differently: Do drug companies make drugs, or money?

He begins with a passionate-sounding quote from the CEO of Valeant Pharmaceuticals:

I just want to emphasize that this is an industry where it is composed of really great people, working to do good things for patients, for doctors and actually for society, and when I look at our employees, there is sort of a noble purpose to working in the pharmaceutical industry.

Wow - I can almost hear the banners snapping in the breeze and a brass band playing something triumphal, can't you?

Alas, it's mostly an auditory illusion.

The reality, as Sorkin lays out, is that Valeant is "among the least innovative" of the drug companies. That's not to say it hasn't been profitable. Its CEO has achieved success "by sharply cutting research and development budgets, arbitraging tax domiciles — Valeant left the United States for Canada’s lower tax rates in 2010 by merging with Biovail — and buying rivals so he can cut their costs, too, while they take advantage of his lower tax rate."

Now Valeant has set its sight on Allergan, whose stock "is up 290 percent in the last five years."

Now what I hear is lip-smacking, because "Valeant, desperate for ways to increase its revenue, needs a cash cow to milk until it can find the next one."

Allergan invests five times as much of its revenue in research and development as does Valeant, and Valeant has already been quoted as planning to cut 20 percent of the combined companies' workforce.

There's no question that pharmaceutical companies have a right -- and an obligation -- to be profitable, just like any other company. The questions arise when profitability becomes an end in itself. How many "good things" are you still doing "for patients, for doctors and actually for society" at that point?

Parlez-vous "Trolley"?

Or maybe I should say, Sprechen Sie Trolley?

A fascinating article in last week's Economist suggests that we think about moral issues differently in our native language than we do in another language in which we are competent but not fluent.

For those of you unfamiliar with the philosophical game of "Trolleyology", here's the simple version: A runaway trolley is speeding down the track. From a bridge above, you can see that five people around the next bend, unsuspecting, will be struck and likely killed. You can run and pull the switch that will turn the trolley onto another track, where it will hit "only" one person. Do you pull the switch?

What if, instead of a switch, there were only one, very fat, man, standing next to you on the bridge. If you push him over, his mass would stop the trolley and save the five. Would you push the fat man?

Most people say, "Yes" to the first example, and "No" to the second. But why? In both cases, one person dies, involuntarily, so that five others may live (And there are endless variations to the problem).

The fascinating new study reported in the Economist is that "when people are asked the fat-man question in a foreign language, they are more likely to kill him for the others' sake." The study was conducted by Albert Costa of the Universitat Pompeu Fabra in Spain and his colleagues, and was published last month in the journal PLOS ONE.

When asked in their native language, only 20% of subjects said they would push the fat man. When asked in the foreign language, the proportion jumped to 33%.

 As the Economist reporter noted, "Morally speaking, this is a troubling result."

Why would the language used affect the decision made? Was the difference cultural (the problem was posed in English, Spanish, Korean, and French; half of the group were asked to consider the "fat man problem" in their native language, and half in the second language)? No, because the results were the same no matter what combination of languages was used. Note that those who considered the problem in a foreign language were competent in it, not fluent. And that's where the crucial difference seems to lie.

Several psychologists... think that the mind uses two separate cognitive systems -- one for quick, intuitive decisions and another that makes slower, more reasoned choices. These can conflict, which is what the trolley dilemma is designed to provoke: normal people have a moral aversion to killing (the intuitive system), but can nonetheless recognise that one death is, mathematically speaking, better than five (the reasoning system).

Since the subjects who considered the problem in a foreign language were not fully fluent, they had to think harder, more slowly, than did the native-speaker subjects. And were able therefore to achieve "psychological and emotional distance" -- which made it easier to sacrifice one for the good of the five.

The Economist is hopeful that, because more and more firms are making English their de facto language "even if it is not the native tongue of most of the workers", they may start making better, more rational decisions.

"More rational", of course, as long as you're not the fat man being tossed over the bridge.

How Much Is Too Much?

Or is there even such a thing, when you're talking about CEO pay?

There are certainly some people who will argue that there's no such thing as too much; that the big guys earn the big bucks because they're so smart and so capable. But maybe attitudes are changing, just a little bit.

This morning's New York Times carried a DealBook article by David Gelles on the remarkable pay package proposed for Chipotle Mexican Grill co-chief executives Steve Ells and Montgomery Moran. Chipotle is arguably one of the hottest chains out there today, and the company rewarded its chiefs last year with cash and stock in excess of $24 million. Each.

As Gelles noted,

Each man individually made more than the chief executives of larger companies like Ford, Boeing and AT&T. Together, they made more than all but the highest-paid chief executive among the country’s biggest 100 companies, Lawrence J. Ellison of Oracle.

I'm not going to say that running Chipotle is easy, but it strikes me as a lot less complex than running Boeing.

And last year was not an aberration: "Since 2011, Mr. Ells and Mr. Moran have each made more than $100 million on top of their salaries through a complex mix of stock awards."

Most troublesome is the huge gap between executive pay and front-line pay:

...[Although] general managers at Chipotle can earn upward of $100,000 a year, the average starting salary at one of the company’s 1,600 restaurants is about $21,000 annually. Earning that wage, a Chipotle employee would have to work for more than a thousand years to equal one year of the co-C.E.O.s’ pay.

Ells and Moran hit on a great concept and have rolled it out brilliantly. They deserve to be well-compensated. But the skills to be great entrepreneurs aren't necessarily the skills needed to be great managers. And if what they are now is managers, shouldn't they be paid as managers?

One investor, who was planning to oppose the pay proposal, said, "It's a reckless pay structure that does nothing to appropriately incentivize management to create long-term value.... Their pay is out of whack however you measure it."

At last year's shareholders meeting, "27 percent of shareholders... voted against the company's compensation package." Gelles surmised that the number might be higher this year.

And he was right. In a follow-up story posted online later today, Gelles reported that

More than 75 percent of investors voted against Chipotle’s say-on-pay measure, which asked investors to ratify a compensation plan that would continue such payments to Steve Ells, Chipotle’s founder, and his co-chief, Montgomery Moran, over the next few years. That was the highest vote against any say-on-pay measure among the country’s largest 3,000 companies this year.

The motion is of course non-binding, but "Chipotle said it was taking investor sentiment into consideration." We'll see....