The New Bull Market

So, now it’s the turn of corporate CEOs to feel the righteous petulance of the American people. In the 1990s the CEO was society’s glamorpuss, and politicians were the dawgs. Now people tell pollsters they have lost their faith in corporate officers, and the politicians joyously pile on, measuring their outrage in prison terms for future miscreants and bragging about whose is longer. John Walker Lindh got 20 years this week for joining a terrorist network at war with his country. Lucky for him he didn’t try something really bad, like capitalizing an expense item.

It took campaign-spending reform many years to go from an obsession of high-minded scolds and bores to a popular cause to a law of the land. Corporate reform is covering that ground in a few weeks. Republicans have put aside any concerns they might have mentioned once or twice in the past century and a half about overregulation of business, centralizing of power in Washington, and so on, to join the bidding war for new federal constraints on corporations. This issue, so dear to their hearts, is strangely not mentioned at all in the most recent (2000) Republican platform. That document’s only reference to “financial markets” is about what a splendid place they would be to put Social Security funds. The Democratic platform touches on some corporate reform issues, but just barely.

President Bush, who spent 56 years on this earth without revealing the slightest passion for corporate reform, now says life will be intolerable if he doesn’t have a bill to sign within a couple of weeks. And he has sent signals that he doesn’t give much of a hoot what is in it. Bush the born-again reformer even wants to outlaw one of the dubious ways he himself got rich (sweetheart loans from a corporation to buy its own stock).

The politicians are only trying to ride the wake of popular outrage. But this public outrage is also a bit stagey. It seems that average citizens are so emotionally invested in the conventions of financial documents that discovering the cost of stock option grants in a footnote, rather than in the profit-and-loss statement, itself is enough to destroy their faith in the economy. Who knew? And I can’t help suspecting—can you?—that the real betrayal people feel is not the dubious bookkeeping or the insider trading or even the outright fraud. It’s the downright un-American refusal of share prices to continue soaring. If the Dow were at 15,000, corporations could embroider their financial data all they wanted, turn the embroidery into pillows, and let Martha sell them at Kmart, for all anyone would care.

The abuses have been real, and the reforms are mostly sound, but the connection between the abuses and the reforms is weak. This is all less about solving an actual problem than about a sort of law of political thermodynamics, which holds that every public frenzy produces legislation purporting to address it. Take the proposal—pushed by superinvestor Warren Buffett, endorsed by Federal Reserve Chairman Alan Greenspan in congressional testimony on Tuesday, and adopted voluntarily this week by the Coca-Cola company—that stock options should be treated as an expense on corporate books. The argument is twofold. First, as a form of employee compensation, stock option grants are in fact a current expense, and allowing the cost to be hidden or postponed (only on the books, not in real life) makes corporate profits look higher than they really are. And second, this opportunity to mislead investors encourages companies to give their executives more stock options, which gives those executives an unhealthy interest in pushing up the company’s stock price.

The basic accounting complaint is legitimate, but odd. All major companies do disclose their stock option grants, even if they don’t factor them into their profit-and-loss calculations as they should. There may be two or three investors somewhere who examine the P&L with care and never glance at the fine print. Most folks never look at any of this stuff but rely on professionals who (we presume) read it all and are free to recalculate as necessary. It does not seem possible that enough people could be actively misled about options to affect a company’s share price.

Another problem with all this is that stock options are worthless unless the price of a share is going up. (A stock option is the right to buy a share of stock at a set price—usually the market price at the time it is issued.) If we are in a long-term bear market, stock options will be worthless or close to it and will not affect executive behavior for good or ill. In fact, as Greenspan pointed out, when the market is not rising, many fewer options are issued. Meanwhile, if the bull returns, investors are no longer going to complain.

For more than a decade until the past few weeks, the conventional wisdom was that stock options are a good thing because they align the interests of corporate executives with those of their shareholders. Is that no longer true? As shareholders, most investors still prefer to see a company’s share price going up, and it is not obvious why they should be enthusiastic for legislation to dim the enthusiasm of the people who run the company about that same goal. The argument must be that options cause executives to do things that hype share prices in the short run but hurt them in the long run, or that options tempt them to corrupt behavior that no decent shareholder would wish to profit from. But I cannot see how options give executives a greater incentive for short-term or corrupt behavior than shareholders would want them to have. If anything, the differences between options and normal shares—option vesting periods, holding requirements, and so on—encourage executives to think longer-term than the ordinary shareholder, who paid full price yesterday and can sell tomorrow, might wish.

In short the abuses these reforms address, if anything, drove stock prices up, but what really bothers people is that they came back down again. Politicians promising to solve that problem are making the same mistake they purport to correct: grabbing a short-term advantage that will cost them dearly in the longer run.