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Balanced Fare: We Report, You Deride

Tuesday, August 13, 2002




Krugman-less in Crawford

President Bush's economic summit begins in Crawford, Texas, and Krugman has some thoughts. And who, you wonder, is Paul Krugman? Well, he is like Michael Bellesiles of Emory: both are professors, both have written for the popular market, and both attract a lot of flack from the right side of the blogosphere.

Oh my goodness, you HATE that comparison! Well, then, how do you feel about this one, from Krugman' latest?

"In short, people thought about Cisco the same way they thought about Enron.

That's not a strained comparison. Even when Cisco was riding high, an analysis in Barron's dubbed it the "New Economy Creative Accounting Exemplar." The company's specialty was using its own overvalued stock as currency — paying its employees with stock options, acquiring other companies by issuing more stock...."


Well, yes, Cisco doesn't expense stock options, and merger accounting has been a hall of mirrors for a bit longer than the past couple of years. But why pick on Cisco, when the telecom bust includes Worldcom, Global Crossing, Qwest, Lucent, AT&T, and many European telecoms? Cisco went over the falls in a big barrel, with lots of company.

Cisco is singled out because its Chairman, John Chambers, will be speaking at the summit. I suppose it is fair to say that Cisco has made some business decisions that were not ultimately vindicated (we call them "mistakes"), and I imagine that, if I researched the company's statements over the past few yers, they have admitted the same. Does this mean we should never take advice from them again? If so, then a lot of other people, including an economics professor who was wrong about Latin America, ought to pipe down.

Oh, enough. Like many Krugman columns, this one needs to viewed somewhat like a letter from the Unabomber: interesting ideas, but mind the explosive bits. Krugman wonders why there have been NO indictments of Enron officers, but correctly points out:

"Some cynics attribute the continuing absence of Enron indictments to the Bush family's loyalty code. But the alternative explanation is both innocent and chilling: Enron executives may have deluded and defrauded their shareholders without actually breaking the law. What Cisco did was definitely legal."

And he is right - it is a strange world we live in that Enron can point to a thicket of legal and accounting opinions, and thereby escape any criminal liability. I will join him in calling for carefullly thought-through reform. Better laws, but no bad laws! And definitely, no unintended consequences!

So, where does Krugman take us:

"The next step, surely, is dealing with stock options. It's not just that companies overstate their profits by failing to count options as an expense. Huge grants of options also give executives an incentive to do whatever it takes to produce a short-term bump in the stock price — if one year of illusory success can net you $157 million, who cares what happens later?"

I am satisfied that stock options have, in may cases, failed to align the interest of managers with the interest of shareholders. The immediate reform Krugman is backing is simply to require the expensing of stock options. The concern is not just that investors fail to grasp the "hidden expense" of stock option compensation; rather, the objective is to discourage the use of stock options, and reduce the incentives for managment malfeasance.

Well. It may be the case that a person who would cheat you for $50 million would still cheat you for $25 million. Lacking reliable data on the price elasticity of integrity at these levels, I can not judge just how effective this reform might be. Reducing the reward to cheating will surely reduce the amount of cheating, but by how much?

That said, my secret plan for Bill Gates is to support the expensing of stock options. [Disclosure: I own some MSFT, but it looks like my plan is no longer secret]. This plan runs the "rising tide lifts all ships" video backwards: expensing stock options might hurt Microsoft, but it could crush the competition, who would struggle to attract talent and capital. There is a word for economies that do not have bio-tech start-ups or tech start-ups. The word is "Europe", and if we are looking down a path towards their level of entrepeneurialism, well, I wonder whether that is a good thing. No more Enrons, and no more start-ups. If that is the choice, and I am identifying a possibility rather than making a prediction, then it is a bad choice.

Alternative vision: sophisticated investors peer right through the reported results, don't mind the option expense, and the use of stock options continues as usual. Bravo, efficient markets! But what was the result of our reform, intended to discourage the use of stock options? Well, not much. Sound-bite, but no fury.

The best is the enemy of the good. Critics of all reform will trot out arguments like mine above as arguments in favor of the status quo. However, having looked into my heart, I am convinced that we need to find a better way; I seriously doubt that the expensing of stock options is it. Constructive ideas? Still stewing, sorry.


UPDATE: A more impassioned defense of Cisco, and more on the progress of the Enron investigation, at Hoystory. Hoy's concluding paragraph begins: "Krugman does have some good points in his column ...", so it's not just me that is slowly being won over.

Hmmm. It seems that Stan "The Man Without Qualities" Musial is not being won over. Something is not right.


TAPPED cheerleads energetically for the Professor, and manages to leave the impression they have never heard of Cisco or John Chambers prior to this morning. Enjoy the coffee, chaps! Smell it again someday.


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