Category: Book reviews

Weekend Book Review: Money for Nothing

The subtitle of Money for Nothing lets you know what’s coming: How the Failure of Corporate Boards Is Ruining American Business and Costing Us Trillions. If you’ve had your pitchfork and torch at the ready for a march on corporate malfeasance, then this is the book for you.

John Gillespie and David Zweig spend the first half of the book bashing on the easy targets: Countrywide, Lehman Brothers, Tyco, Fannie Mae, GM, Chesapeake, and AIG.

The role of the board of directors

The board of directors of a corporation is supposed to oversee senior management, approve key strategic decisions and nominate directors for appointment by shareholders. That part is the legal framework.

Strong governance would have the board members contribute their business knowledge and long-term vision for the company to help guide the executives in running the business operations. They should be a check on executive power and act as a watchdog for long-term shareholder value.

For some companies, the board is merely a tool to lend legitimacy to the fiction that shareholders’ interests are being taken into consideration.

Testing board governance

How do you measure or identify poor corporate boards? One measuring stick is executive compensation. It does make sense that an over-compensated CEOs should be an indication that the board is not willing to stand up to the CEO. That may also lead you to conclude they are not paying attention to succession, ethics or risk management. The authors don’t reference any studies or empirical evidence that their conclusion is correction.

Board failure

Clearly shareholders should want a board of directors that contribute to the leadership of the corporation. They should not want simple rubber stamps for approving the decisions made by the CEOs.

A director who speaks out risks being ignored or being thrown off the board in the next election cycle. After all, shareholders have little or no input on who gets nominated to be a director.

Chesapeake

One example in the book is Chesapeake Energy Corp. They cite the work of Michelle Leder of Footnoted in digging through the company’s filings to discover excessive executive compensation and naming the worst footnote of 2009. In addition to his excessive salary as the company was under-performing, the company purchased CEO Aubrey McClendon’s antique map collection for $12.1 million (that was $8 million over its valuation).

Separating CEO and Chairman

Is it the structure of the board? One change that makes a lot of sense is splitting the Chairman and CEO positions. The authors cited a study by Lucian Bebchuk and Jesse Friedin in Pay without Performance. Bebchuk and Friedin found that CEO pay is 20% to 40% higher if the CEO is also Chairman of the Board.

Let the CEO run the company with the board of directors as the CEO’s boss. Let the chairman run the board of directors. They are different tasks with different needs.

How does excessive CEO compensation happen?

Zweig and Gillespie mention one reason when they discuss a conversation they have with Dennis Kozlowski, the imprisoned former CEO of Tyco.  Kozlowski said he thought his compensation was justified in relation to what hedge fund managers were getting for creating considerably less value.

The second reason is one I like to call the Lake Wobegon Effect. It’s hard for a board to say that a CEO is below average without firing him. If you set the pay and compensation to be below average, then you are making a negative statement. As a result most CEO pay gets set at the average or above average. That has the effect of moving the average upward when next year’s round of compensation consultants look at average salaries.

An Economic Policy Institute study showed that CEO compensation has risen to become about 10% of all corporate profits. That’s nearly double the level it was in the min-1990s. (See The State of Working America)

How much does the board affect performance?

It’s easy to attack the failures of Lehman, Bear Stearns and Merrill Lynch. If you are going to blame some of the failure on their boards, shouldn’t there be some credit given to the boards of Goldman Sachs and Morgan Stanley?  Goldman and Morgan survived and the others didn’t. Perhaps the causation is not as strong at the authors think.

The authors criticize the board of Exxon-Mobil.  I agree with the criticism. On the other hand, the company has experience remarkable success as one of the world’s biggest companies.

(I do own stock in Exxon and Goldman.)

The gatekeepers

The authors don’t just stop at the board.  They have plenty of harsh words for the auditors, lawyers, compensation consultants and other professionals hired by boards.  These gatekeepers have a “vested interest in preventing the boat from rocking.”

They have a rant worthy of Francine McKenna on auditors:

“Accountants and auditors in America seem to have spent the last century dodging five major terrors: regulation, financial liability, legal liability, the imposition of uniform accounting practices, and offending current and future corporate customers by making audit rules and processes more rigorous and accurate.”

What to do?

For retail investors I think the answer is very easy. Sell the stock and buy stock in a different company. Its a bigger issue for institutional investors. Their ownership interest may be so large that selling their position would bring down the share price even further resulting in an even bigger loss.

After 200+ pages of pointing out board failures the authors turn to a chapter full of solutions and ways to fix boards. If you are a student of corporate governance you’re not going to find anything particularly new or innovative in the author’s proposed solutions.

The real question is how to get them implemented. As the authors tell throughout the book, it’s not in the short-term interests of the board or senior executives to implement these changes. It will be up to the exchanges, regulators and big investors.

Thanks

I want to thank the book publisher for providing a review copy of the book and Jerod Morris of Corporate Compliance Insights for directing it my way.

Weekend Book Review: The Big Short

Michael Lewis has put together a great book on subprime loans, home mortgage bonds and how their crash led to the Great Panic.

The Big Short starts with this quote:

The most difficult subjects can be explained to the most slow-witted man if he has not formed any idea of them already; but the simplest thing cannot be made clear to the most intelligent man if he is firmly persuaded that he knows already, without a shadow of doubt, what is laid before him. – Leo Tolstoy, 1897

That was the challenge in 2006. To not be considered insane when standing apart from the mass hysteria to say the financial news is wrong and “the most important financial people are either lying or deluded.” People were quitting their jobs to become real estate investors. House buyers, lenders and the purchaser of home mortgage bonds seemed to think that house prices in the United States would never decrease.

I really enjoyed The Blind Side: Evolution of a Game. (The book not the movie. The book was about the evolution of football, using the unusual background of Michael Oher as a lens. It was not the sappy family story that was in the movie.) That turned me into a Michael Lewis fan. (Even though Liar’s Poker and Moneyball have not yet risen to the top of my reading list.)

In The Big Short, Lewis uses two people who saw the problems to act as the lens for the story. Michael Burry is a one-eyed hedge fund manager with Asperger’s syndrome. Burry liked to remain isolated from public opinion and human contact. He focused on hard data and the incentives involved in the human behavior in the financial markets. Steve Eisman was another money manager. Eisman was convinced that the subprime mortgage market was full of corruption and exploitation.

Lewis points out how Wall Street was gaming the rating agencies. One example is that the agencies were looking at an average credit score of the borrower, not each individual borrower. So Wall Street would package a barbell of loans. Throw together a bunch of credit scores that are horrible and very likely to default. Then sprinkle in enough loans with high credit scores to get the average credit score just right.

The rating agencies has flawed formulas and Wall Street knew it. After all, Wall Street helped create the formulas. Lewis paints a very dim view of rating agencies.

The rating agencies gave bonds full of floating rate loans a higher rating than those with fixed interest rates. The flawed logic was that borrowers would be just as likely to make payments at 12% as they were at 8%. Obviously, the bigger problem was that borrowers couldn’t make the payments at 8% in the first place.

Eisman and Bury both saw the flaws in the system and made big bets against sub-prime mortgage bonds using credit default swaps. They saw lots of subprime loans being made with loan interest rate teasers that would reset in two years. The borrowers couldn’t afford the property at the teaser rate and would clearly default when the rate reset unless property values continued their astronomical increases.

Lewis did write a great article in Vanity Fair on Iceland’s Financial Metldown if you need a taste of his writing. That story paints a similar of tale of over-exuberance in the financial markets.

The Big Short does a great job of explaining how loans are packaged into commercial mortgage backed securities (CMBS), then sliced up into tranches and sold as bonds, repaid by the cash flow from underlying mortgages. The tranches that get paid first receive the highest rating of AAA, labeling them as nearly risk free as US Treasury bonds.

Then Lewis focuses squarely on collateral debt obligations (CDOs) that repackage the poorly rated tranches of CMBS into new mortgage bonds. As with the CMBS, the tranches that got repaid first received the AAA rating. That was the alchemy, turning garbage into gold.

Lewis does a good job of explaining how all of these mortgage bonds work. If you want more detail on the market for subprime mortgage-backed CDOs read the thesis from A.K. Barnett-Hart, a Harvard undergraduate: The Story of the CDO Market Meltdown: An Empirical Analysis. Lewis cites her thesis as being more interesting than any Wall Street research on the topic.

The Tolstoy quote points out that many on Wall Street did not understand how they worked and did not understand the risks involved.

I recommend that you add The Big Short to your reading list and move it to the top of the list.

Weekend Book Review: The Informant

I’ve had Kurt Eichenwald’s The Informant on my reading list for a long time. It dropped farther down the list after seeing the previews for the Steven Soderbergh movie. Why read the book when you can watch the movie?

What raised my interest was hearing a great radio segment from This American Life that tells some of the background of the price fixing conspiracy and FBI cooperating witness Mark Whitacre: The Fix is in.

I have to admit that while reading the book, I had the image of Matt Damon in my mind as the character of Mark Whitacre. The other image that stands out is the scene in the movie previews with Damon (playing Whitacre) as he is fiddling with the hidden tape recorder in his briefcase. As you can see from a video of the meeting, Whitacre really did open open up the hidden compartment and check out the tape recorder.

The true story in the book is a crazy tale. Whitacre came forward as a cooperating witness to the FBI, telling them that his company, Archer Daniels Midland (ADM), was engaged in price-fixing for the global market for lysine. The allegations quickly spread to other products and to kickbacks. Whitacre was a great witness, eagerly taping conversations of illicit activity and clearly willing to take down his colleagues and management of the company.

The story wanders a bit, periodically gets stagnant, then explodes as new secrets are revealed. The author, Kurt Eichenwald, tells the story from the perspective of the FBI. If the story were not true, it could have been streamlined and the characters could have been explored in more depth. But it’s a true story with real people. So you have to let the story evolve as the FBI uncovers more and more of the activity of ADM, and unfortunately more and more of the activity of Whitacre.

Whitacre had problems. These problems become apparent and worsen as the story progresses. The perfect witness ends up not being so perfect. Inconsistencies begin to appear and then grow worse.

Kurt Eichenwald covered the story for The New York Times and interviewed most of the participants in writing the book. He tells the story by methodically recording the six-year investigation and deconstructing the disturbed Whitacre.

Add the book to your reading list and move it towards the top.

Weekend Book Review: Shades of Grey by Jasper Fforde

shades of grey book cover (US edition)

Books about compliance, business ethics, law and financial markets can be well written, interesting and thought-provoking. But they’re not fun.

So I decided I needed change and found a whimsically absurd novel that touches upon compliance: Shades of Grey, by Jasper Fforde.

Chromatacia is a world where people have limited ability to see color and your standing in the community depends on the colors you can see and how well you can see them. At the top of the social order stand those who see purple. At the bottom are the greys who can’t see any colors. Society is dominated by color and you are what you can see.

The protagonist is Eddie Russert, a red-seeing youth who has been punished with a humility reassignment for a school prank. Eddie is sent out to a fringe city with a “Pointless Task” of conducting of a chair census.

The book is more about a totalitarian regime than compliance. But it’s the rules that run the regime and compliance with rules that keeps society in order.

“But they were the Rules – and presumably for some very good reason, although what that might be was not entirely obvious.” For instance it is forbidden to count sheep, make new spoons or use acronyms. There is also a ban on the numbers between 72 and 74.

“The Rule book tells us precisely what is right or wrong — that’s the point. the predictability of the Rules and the unquestioning compliance and application is the bedrock of —” Eddie is cut off by Jane, a grey in the village of East Carmine. It’s his interest in Jane that sends Eddie on his adventures in Shades of Grey.

Jasper Fforde is probably best known for his Thursday Next series of books where literature has a prominent place in everyday life. Thursday Next herself being in the Literary Detective Division of Special Operations at starts the series by looking into who has stole a manuscript and killed one of the characters in it, changing the story forever. If you enjoyed those books, you will also enjoy Shades of Grey.

Weekend Book Review: In Fed We Trust

It is only fitting that I am writing this book review on a Sunday. In Fed We Trust: Ben Bernanke’s War on the Great Panic starts off by telling about the importance of a few Sundays in 2008. In March, there was the Sunday when the Federal Reserve announced an unprecedented action to lend $30 billion to JPMorgan Chase to buy Bear Stearns. There was the Sunday in August when the Federal Reserve and the Treasury Department decided to seize Fannie Mae and Freddie Mac. Of course, there was the Sunday in September when they allowed Lehman Brothers to fail. There was the Sunday when Bank of America agreed to take over Merrill Lynch.

David Wessel tells a story about Ben Bernanke’s rule of the Federal Reserve deciding to do “whatever it takes” to protect the U.S. economy from the incredible economic threat of those Sundays. The story takes us through what it missed, what it did, what it didn’t do, what it got right and what it got wrong during the “Great Panic.”

During Alan Greenspan’s term as chairman of the Federal Reserve we mostly watched as he and the Board decided whether to raise interest rates or not. Most of the country thought that was the extent of what the Federal Reserve did. During Bernanke’s term we saw the incredible power of the Federal Reserve to create vast sums of money out of thin air.

One of the key takeaways from the book is that is very difficult “to get the politics, the policy and market reaction all right at the any one point in time.” That was a quote from former Secretary of the Treasury Henry Paulson shortly after leaving office.

The book is sometimes short on its depiction of events. The one that stuck out the most was the short description of the Merrill Lynch discussion by Bank of America’s Ken Lewis and Joe Price. The New York Attorney General tells a more interesting tale in his indictment of the Bank of America executives.

But of the book provides terrific insight into the events of the Great Panic. (That’s the term the Wessel uses.) During the full-court press of forcing the largest banks to take TARP money, it’s Merrill Lunch’s Thain that asks how taking the TARP money would affect government controls on executive compensation. As we later find out, Thain became one of the poster boys for the banks’ failures with executive compensation.

In the end, as we all know, mistakes were made. The Federal Reserve did not always get the politics, policy and market reaction right.

But what if Bernanke had not been a student of the Great Depression? What if he had not taken bold steps? I think the economy and the country would be much worse off.

Weekend Book Review: Sonic Boom by Gregg Easterbrook

You may know Gregg Easterbrook from his previous book The Progress Paradox (one of his six books) or his articles in The Atlantic. I know him mostly from his hobby: writing the Tuesday Morning Quarterback column on ESPN.com.

Sonic Boom tries to look beyond the current recession. Easterbrook looks ahead to what to expect after we make our way out. He sees the continued growth of globalization, interconnectedness and technology improvements. That should lead to greater prosperity, knowledge growth, instability and financial distress.

Easterbrook starts off Sonic Boom by using the Chinese city of Shenzhen, with its population of 9 million. But thirty years ago, the city did not exist. In 2007, it sent out 21 million containers, making it the fourth largest port in the world.

His next example grabbed me because it revolves around Waltham, Massachusetts, which is just down the street from me. He even calls my alma mater, Brandeis University “an outstanding institution”. Waltham is an example because it was the home of the first modern factory in the US. (I wrote about this is an article for Wired: GeekDad Visits the Charles River Museum of Industry & Innovation.) Waltham went through some tough times as it went from being a center of manufacturing to center for high tech and venture capital.

The book continues by focusing on a city and the how globalization has affected each. There is disruption, innovation, loss, growth, distress, and gain. Easterbrook then uses the example to launch into further discussion.

All of the turmoil in the job markets makes employer-sponsored health-care a bad fit. “It’s ridiculous that our cell phones work wherever we go but our health-care coverage does not.”

Yes, globalization is displacing manufacturing jobs from the United States. But you also need to look at the advances in efficiency and technology that reduce manufacturing jobs. The US made 106 million tons of steel in 2007 with 159,000 workers. That is more than the 91 million tons of steel made in 1977 with 531,000 workers.

Globalization is also bringing peace. A few decades ago the world’s two most important countries had horns locked trying to destroy each other. The US and USSR had nuclear missiles aimed and fingers on the button. We would not even send athletes to the other’s hosting of the Olympic Games. Now the two most important countries are the US and China. We are locked “cooperative competition” of trade and finance.

Sure, China has a long way to go towards democracy and human rights. But the country is much better than it was 30 years ago.

If you have read Tuesday Morning Quarterback, you will encounter some familiar stories. You will also find the writing familiar as he has weaved some of these tales of economics into his football column.

Is Easterbrook right? Do I agree with everything he writes? Well, even Kurt Warner throws a few incomplete passes.

If you like football, then you should also read his Tuesday Morning Quaterback column on ESPN.com. I enjoyed reading Sonic Boom and recommend that you read it. With only one meaningful football game left this season, you’ll need something to read in the off-season.

Disclosure: Most of the links above are Amazon affiliate links.

The Drunkard’s Walk, The Butterfly Effect and The Black Swan

drunkards walk

The “drunkard’s walk” refers to the Brownian motion, the seemingly random movement of particles suspended in a fluid. The original thought was that you might be able to calculate the movement by measuring and calculating the interaction. It proved impossible. There are too many factors and too many interactions.

Small changes in a system can dramatically affect the outcome. This is the butterfly effect. The origin cam from a meteorologist who was using a computer model to rerun a weather prediction and one of the numbers he used was shortened from six decimal points to three decimal points. The result was a completely different weather scenario. It’s not that a butterfly can cause the problem. It’s that a seemingly inconsequential random event can lead to a big change in an outcome.

Leonard Mlodinow addressed this topic in The Drunkard’s Walk: How Randomness Rules Our Lives. (I mentioned the book previously in Criticism and Praise.) There is much more randomness in our lives than we give credit.

We poorly understand the effect of randomness.

He explores his concepts using the backdrop of Pearl Harbor. In hindsight there were many signs pointing to the eventual attack. “In any complex string of events in which each event unfolds with some element of uncertainty, there is a fundamental asymmetry between past and future.” It’s nearly impossible to predict before the fact, but relatively easy to understand afterward. We have seen the same 20/20 hindsight with the 9/11 attacks.

That’s why it is easy to explain why the weather happened three days ago, but have trouble getting the weather forecast right three days into the future.

Mlodinow never mentions it, but for me the next step is the theory of the Black Swan. How do you end up with high-impact, hard-to-predict, and rare events that are beyond the realm of normal expectations?

Combining the Black Swan with the Drunkard’s Walk and the Butterfly Effect, you see that a combination of small events can lead to an over-sized outcome. We get used to being able to calculate and measure so many things. There will always be factors that we miss, or overweight or underweight.

Not to be depressing. The Drunkard’s Walk leaves you feeling in less control than when you started. But there is a factor you can control: the number of chances that you take. “Even a coin weighted toward failure will sometimes land on success.” Keep flipping the coin.

The Drunkard’s Walk is worth reading if you deal with risk.

SUPERfreakonomics and Compliance

superfreakonomics

Steven D. Levitt and Stephen J. Dubner are back putting the freak in economics. As they did in Freakonomics, SUPERfreakonomics uses economic analysis to give some insights into actual human behavior.

When the original Freakonomics came out it was very original. Since then other books have hit the mainstream trying to do the same thing, most notably Malcolm Gladwell. SuperFreakonomics is good but comes across as much less original than the original. There are many other reviews of the book by people more competent at book reviews than me. The authors’ take on global warming has stirred up lots of controversy.

SuperFreakonomics has plenty of stories that compliance professionals should find interesting. It’s certainly worth your time to read the book.

One item in the book that caught my interest was some research by Melissa Bateson in her department’s break room. Faculty members paid for coffee and beverages by dropping money into an “honesty can.” Each week professor Bateson posted a new price list. She didn’t change the prices, but she did post a different photograph on the list each week. She alternated between using a picture of flowers and using a picture of human eyes.

i'm watching you

When the eyes were watching, nearly three times as much money ended up in the honesty can. Cues of being watched enhance cooperation in a real-world setting (.pdf) by Melissa Bateson, Daniel Nettle and Gilbert Roberts, published in Biology Letters 2006.

“We believe that images of eyes motivate cooperative behaviour because they induce a perception in participants of being watched. Although participants were not actually observed in either of our experimental conditions, the human perceptual system contains neurons that respond selectively to stimuli involving faces and eyes, and it is therefore possible that the images exerted an automatic and unconscious effect on the participants’ perception that they were being watched.”

Maybe I will scrap using my corporate signature in email and use that last set of eyes.

What are your thoughts?
eyes im watching you

Are You Trying to be a Trust Agent?

Yes? Then you have probably already read at least part of Trust Agents: Using the Web to Build Influence, Improve Reputation, and Earn Trust, the new book from Chris Brogan and Julien Smith.

Most likely, you are wondering what a “Trust Agent” is supposed to be.

“Trust agents have established themselves as being non-sales-oriented, non-high pressure marketers. Instead, they are digital natives using the web to be genuine and to humanize their business.”

The main premise is that cultivating “trust” will enable you and your business to succeed. They talk about creating this trust using social networks and online media. Be a trust agent and people will gravitate towards you when they need something, and then trust you with their information and leads. The book combines some theory, with the author’s success stories, other relevant examples and actionable suggestions.

Unfortunately, I found big chunks of the book to miss the mark for my involvement on the web. My original jump into the web was to see how these tools would work as knowledge management tools inside an organization. I found these web 2.0 tools were well ahead of the enterprise tools. My approach in using the web is for personal knowledge management.

These tools (including this blog) are for me to find the information I need to succeed at my job and to organize that information for reuse. I use web tools for selfish reasons. They are really good at helping me collect information. That others can leverage my work is a by-product. That these tools allow me to stay connected with colleagues is a by-product.

Some of that stems from the nature of my job and my company. We don’t use the web to advance our corporate image. As the chief compliance officer I am not trying to sell anything, ever.

But I do like staying connected with my colleagues and peers. There are many more people outside your organization who do what you do or have the information you need to succeed, than there are inside your organization.

Trust Agents is about creating social capital. I think it could just as easily be called: “Don’t be a jerk online.” They go into a lot more detail than that and come up with six characteristics of Trust Agents.

1. Make your own game.

Try new ways of doing things. Stand out from the crowd. First movers have an advantage. They quote Warren Buffet on when to enter a market: “Be fearful when others are greedy, and be greedy when others are fearful.”

2. Be one of us.

Be part of the community. Don’t be the self-promotional jerk in the community who is continually handing out business cards and asking for business. Contribute to the community. You need to give first if you want to receive. The more you give, the better.

3. Use the Archimedes Effect

Archimedes propositioned that if he had a long enough lever and a fulcrum on which to place it, he could move the world. Leverage your message.

4. Try to be Agent Zero

Cultivate your personal networks and recognize their value. Connect with good people. Connect between different groups.

5. Become a human artist.

Learn how to work well with people and help empower people. You need to learn the etiquette and start off by listening to the community before you burst in with a full head of steam.

6. Build an army.

You can’t do it alone. You need to find people who are willing to collaborate with you.

If these concept resonate with you, then it is worth your time to read the book. If you are just starting out with web 2.0 tools you should heed the lessons in the book. Even if you are a wily veteran, you will find some useful information in this book.

Trust Agents is a bit uneven at times. In places it reads more like a collection of blog posts instead of a coherent narrative. Some of their ideas are better flushed out than others. Those six characteristics don’t have equal weight.

———————————————

This is the first book I’ve read in 2010. You can look back at the books I read in 2009.

Whales and Compliance

watching giants

I was surprised to be thinking about compliance while I was reading about whales. Sure, I eat, drink and sleep compliance. But there are some lessons that compliance professionals can learn from the study of whales.

This came up while I was reading Watching Giants: The Secret Lives of Whales by Elin Kelsey.

My original interest in the book was its intersection between parenthood and whales. During college I took a class at the New England Aquarium on marine mammals taught by world-renown experts. The class was fascinating on many levels. As a parent, well, I find parenting itself interesting.

Whales are incredible species, reliant on breathing air, but needing to dive the depths of the ocean for food. For example, as the book points out, a blue whale opening its mouth to take in a school of krill is the biggest biomechanical event to happen on the planet. The scale of a whale’s life is well beyond the scale of humans. If you read about the parenting life of whales, I think you will be hard-pressed to believe that we have hunted many of these species to the brink of extinction.

Getting back to the compliance side of things, whales are hard to study. Fraud, corruption and misdeeds are hard to study. Whales spend over 95% of their time outside the boundary of human observation. The deeds that compliance professionals are looking for are also, for the most part, outside of our perception.

The compliance lesson that resonated with me was that we should not assume that we can see is truly representative of what is actually happening beneath the surface. We need to understand our perspective. What we can see and what we cannot see. When you look beneath the surface, something unexpected may be happening.

If you are looking for a good book to read, try Watching Giants: The Secret Lives of Whales.