Thursday, May 25, 2006

Talleyrand on Options Backdating

Talleyrand on Options Backdating: One of the more interesting stories in the financial pages these days is the news surrounding the options backdating probes. As the options backdating story has continued to unfold, some have questioned whether or not there is anything wrong with options backdating. For example, the law blog has a May 23, 2006 video post containing a debate between a business school prof and a CNBC reporter on the topic. Options backdating is obviously not harmless -- the revelation of options backdating has already proven damaging to at least some of the companies caught up in the probe as they have had to restate their past financials to reflect their true compensation costs. But even beyond the restatement threat, there is a particular reason why the options backdating story has gained momentum in a way that stories about excecutives' use of corporate aircraft or gold-plated pensions have not. The peculiar feature of the options backdating scandal is captured in the following epigramatic statement of Talleyrand:

If a gentleman commits follies, if he keeps mistresses, if he treats his wife badly, even if he is guilty of serious injustices toward his friends, he will be blamed, no doubt, but if he is rich, powerful and intelligent, society will still treat him with indulgence. But if that man cheats at cards he will be immediately banished from decent society and never forgiven.

The whole point of options-based compensation is to align executives' financial interests with those of investors. Options-based compensation should subject executives to the same investment risk as investors. But back-dating options to ensure that executives gain in a way that investors cannot not only breaks the alignment between executives' interests and those of investors, it unfairly stacks the deck in the executives' favor. It is, in Talleyrand's memorable phrase, cheating at cards, which no one will ever forgive. I believes the options backdating story has legs and has a long way to run.

Talleyrand made the statement above to Napoleon Bonaparte to upbraid Napoleon for his treachery in tricking King Charles IV and Queen Marie Luisa, the Bourbon monarchs of Spain, to abdicate their thrones in favor of Napoleon's brother Joseph. The incident not only led to a falling out between Napoleon and Talleyrand, but it was the prelude to Napoleon's disastrous Peninsular War that led to the first of Napoleon's military defeats at the hands of the Arthur Wellesley, later First Duke of Wellington.

Talleyrand himself may or may not have known about cheating at cards from first hand knowledge, but he certainly knew about trading in securities. At the time of his death, Talleyrand had accumulated an immense fortune, only a potion of which was attributable to bribes and gratuities from foreign governments. A substantial part of his fortune came from trading in shares of companies based on inside information he obtained from his position inside the Napoleonic government and the Bourbon restoration. For more about Talleyrand, I recommend Duff Cooper's classic 1932 biography of Talleyrand.

Monday, May 15, 2006

" I feel stupid and contagious..."

The advent of the Internet facilitates a number of important public services. For example, it is now possible to establish that the Nirvana song Smells Like Teen Spirit really does have lyrics. It is also possible to learn that the song was written in the key of F minor. (Oh, so that's what it was.) It is also possible to learn not only about the official conclusion that Kurt Cobain's 1994 death was caused by suicide, but to find out that there is an active campaign to establish that his death was actually a murder. After a while it can all be overwhelming, so we must seek what consolation we can in those immortal words:

With the lights out, it's less dangerous /Here we are now,
entertain us/ I feel stupid and contagious/ Here we are now, entertain us/ A mulatto, an albino/ A mosquito, my libido/ Yea!

Sunday, May 14, 2006

The World Will Little Note (Nor Long Remember?)

On May 21, 2006, Montenegro will be holding a referendum on whether or not to become independent from the Serbia-Montenegro federation. The federation within the Republic of Serbia is all that remains of what was once the six republics that formed Yugoslavia.

Whether or not Montenegro should be independent is a question that goes back at least 87 years. In 1918, as World War I wound down, the Serb-approved Montenegrin legislature voted to join Serbia. Montenegrins loyal to the deposed king Nicholas refused to recognize the union and led an armed struggle. Nicholas appealed to the Council of Four at the Paris Peace Conference (Woodrow Wilson, David Lloyd George, Georges Clemenceau and Vittorio Orlando), but other issues captured their attention and the conference ended with the Montenegrin question unanswered.

In Paris 1919, the eminently readable account of the Peace Conference, written in 2001 by Margaret MacMillan, there is a colorful description of the events during the conference involving Montenegro:

Much greater problems were waiting for the peacemakers, but there was something fascinating about Montenegro. The country, a spot on the map between Croatia and Albania so small that few people could find it, was absurd, remote and beautiful... They were perhaps the tallest people in Europe, handsome, proud, brave and indolent...Their rulers until the middle of the nineteenth
century, had been warrior bishops. The modern dynasty was established by the last bishop of the line in 1851, when he tired of being celibate...There was a whiff of the Middle Ages about Nicholas: his insistence on leading his own troops in battle, on dispensing justice from his seat under an ancient tree, even the magnificant medals he awarded himself and his friends so copiously...He had dreamed of Montenegro's absorbing Serbia; it was not meant to happpen the other way around. He still hoped, in 1919, he could regain the throne he had lost during the war...He did not get a response; there were after all more pressing issues than the fate of a country of 200,000 people. Fresh votes were taken, under Serbian supervision, which seemed to show that Montenegrins wanted to be part of Yugoslavia... Nicholas died, still in exile in the spring
of 1921... Montenegro remains, as it has done since 1918, an uneasy part of Yugoslavia.

If the 2006 referendum suceeds, then the 650,000 Montenegrin people will become separate from the 7 million people of Serbia. But the structure of the referendum carries the unfortunate possibility that it will be inconclusive. In order for the referendum to succeed, at least 50 percent of eligble voters must participate and at least 55 percent must vote in favor of independence. These vote requirements have left the possibility of an outcome in the "grey area" where the votes for independence fall short of either minimum but still representing a substantial part (or even a majority) of votes cast. If the vote falls within the grey area, Montenegro will remain, as it has done since 1918, an uneasy part of a partnership with its larger neighbors.

Update: On May 21, 2006, amid massive voter turnout that far exceeded the requirement that 50% of eligible voters participate, 55.4% of voters voted in favor of independence, exceeding the minimum required favorable vote by a slight but sufficient margin. Montenegro will now turn its attention to seeking EU membership. It is also hopeful of fielding a fielding a team for the 2010 World Cup. The issue for resolution is the question of what will become of Kosovo.