Daily Archives: January 29, 2005

More clear thinking on reforming corporate governance

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Following on a thread that involved earlier posts here and here, Professor Ribstein expands in this post on his proposal for reforming corporate governance:

My solution to the problems of corporate governance is to put pressure on managers to distribute excess cash by increasing owner distribution and liquidation rights. Ironically, it is the corporate form’s elimination of these partnership-type rights that Margaret Blair argues made modern business possible. I dispute that proposition here. In that article I also argue that thick sophisticated markets have made the giant corporation no longer as important as it once was.
You might well ask, if this is such a good idea, why haven?t we seen more of it ? e.g., partnership type provisions in corporate charters that mandate distributions? Why not more publicly traded LLCs?
My explanation is that the corporate tax and the ?double? tax imposed on corporate distributions reduce owners’ incentives to insist on distributions even if requiring distributions would efficiently reduce managerial agency costs, and therefore be value-increasing in the absence of this tax. So I propose eliminating the bias favoring retained earnings inherent in the our current tax system. Firms would then be freer to move toward more efficient governance forms.

Professor Ribstein’s focus on the detrimental effects of the double taxation of corporate profits raises an interesting incongruity of the related political issue.
The anti-business crowd rails against removal of the double taxation of corporate profits as an unfair concession to the rich capitalist roaders. However, the retention of corporate profits contributes to corporate blunders (such as HP’s acquisition of Compaq) and Enron-type scandals, which the anti-business forces attempt to remedy through bigger government — that is, shareholder lawsuits in the civil justice system, criminalization of questionable corporate actions in the criminal justice system, and greater governmental control in the regulatory system (i.e., Sarbox).
Thus, the anti-business crowd’s opposition to removal of the double taxation on corporate profits has the unintended consequence of promoting bigger businesses and bigger business blunders that, in turn, require bigger government to control. I’m not sure where the anti-business forces want to go with all of this, but my sense is that “bigger in everything” is not the destination that they have in mind.
Also, check out Professor Bainbridge’s additional cogent thoughts in this post on corporate governance issues, and also Professor Ribstein’s follow up post. Likewise, Professor Bainbridge passes along this site where you can download the papers presented at a conference over the weekend that addressed these and other corporate governance issues. These are great resources.

Is it time for Drayton to sell the Stros?

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Drayton McLane has done a pretty darn good job of running the Stros. During his tenure, the club has been in the top tier of performance among Major League teams and a consistent playoff participant or contender. Under his tutelage, the club developed a fine minor league system that has produced a number of solid Major League players. Drayton also did a good job of coordinating the approval and construction of a downtown ballpark that has generated attendance records. Although Drayton has made his share of mistakes, he is unquestionably the best owner that the Stros have had in their 40 year existence.
However, as I noted in previous posts here and here, I have suspected for awhile that Drayton is preparing to sell the Stros. Given that Drayton is the best owner in Stros’ history, I have not heretofore considered rumors of him thinking about selling the club to be particularly good news. But based on developments over this past off-season, I am beginning to think that it may be time for Drayton to sell the club.
As noted in this earlier post, this off-season began with the resignation of Stros’ general manager Gerry Hunsicker. Although I was more measured than some others about Drayton’s failure to retain Hunsicker, it’s certainly not a feather in one’s cap that the best general manager in the club’s history decided to move on after the best decade in the club’s history.
Then came the ill-fated negotiations with free agent Carlos Beltran. With Hunsicker gone and new GM Tim Purpura just gaining his bearings, Drayton allowed Beltran agent Scott Boras to play him like a fiddle during the negotiations rather than making his best offer up front and then placing a relatively short deadline on Boras to consummate a rich deal or risk losing it. Consequently, when Drayton’s initial low-ball offers for Beltran quickly went by the wayside, negotiations dragged on, preventing the Stros from taking care of other business, such as signing cornerstone stars Lance Berkman and Roy Oswalt to long term deals. When Boras gave Drayton only a couple of hours to respond to the Mets’ final offer, Drayton was unprepared to play by Boras’ rules and Beltran was gone. As noted here and here, the Stros are probably better off without Beltran at the price they would have had to pay for him, but that does not excuse Drayton from mishandling the negotiations in a manner that was detrimental to the club overall.
The first fallout from the mishandling of the Beltran negotiations was felt this week as Berkman and the Stros agreed to a one-year deal to settle Berkman’s arbitration case. The failure to lock him up to a long term contract now places the Stros at risk of losing Berkman, who will be a free agent at the end of the upcoming season absent the signing of a new deal. Losing Berkman — who has been one of the best hitters in the Major League Baseball over the past four seasons — would be devastating to the Stros, who now will probably have to pay Berkman far more than they would have had to pay him had they not neglected to sign him to a long term deal earlier.
Just to give you an idea of the market for a player of Berkman’s caliber, take a look at J.D. Drew, who is a player of roughly Berkman’s age and experience, but who is not as durable as Berkman and is not quite as good a hitter as Berkman. Drew recently signed with the Dodgers for $11 million a year over five years. Given that, there is little reason for Berkman to settle for less than $60-$65 million over the same period because, if the Stros aren’t willing to pay it, the Rangers almost certainly will. Chronicle sports columnist Richard Justice speculates that the Stros could have locked Berkman up for $30 million over three years as late as last season.
Meanwhile, the Stros remain at impasse with their best pitcher (Oswalt), whose arbitration demand of $7.8 million appears to be a clear winner over the Stros’ $6 million offer. Absent the signing of a long term deal with the Stros, Oswalt can become a free agent at the end of the 2006 season.
So, after the best season in the club’s history, the Stros now find themselves in turbulent waters. The club’s best two players in history — Bidg and Bags — are closing in on retirement. The club lost out on its attempt to retain Beltran, who would have been one of the building blocks for the future. Meanwhile, the club’s best two young players — Berkman and Oswalt — are at risk of being lost in the near future to the free agent market. Although potentially formidable, the club’s pitching rotation for this upcoming season will nevertheless rely heavily on a 43 year old superstar (the Rocket), another veteran (Andy Pettitte) who is coming off of elbow surgery, and a converted outfielder (Brandon Backe) who has not yet proved that he can pitch effectively over the course of an entire season.
Thus, Drayton has his work cut out for him in steering the Stros through these turbulent waters. Given his handling of the Hunsicker, Beltran, Berkman and Oswalt situations, my sense is that he may be losing his enthusiasm for doing so. If that is the case, then here’s hoping that Drayton sells the club before it is too late for a new owner to solve these quickly accumulating, and increasingly serious, problems.

Now, how did that happen again?

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In what can only be described as the result of an embarrassing lack of oversight, a grand jury in Williamson County indicted six people yesterday for allegedly being involved in a strikingly simple scam of the state’s electricity grid operator, the Electric Reliability Council of Texas (“ERCOT”).
The five former top managers and one contractor at ERCOT billed the organization $2 million for work by shell security and computer-contracting companies that the individuals controlled, even though much of the work was not performed. The activities were first detailed last summer in a series of articles by The Dallas Morning News, which prompted questions around the state about whether anyone involved with ERCOT had ever heard of the concept of “financial controls.”
All of the indicted individuals joined ERCOT as it grew rapidly in response to the introduction of electric competition in Texas in 2002. ERCOT’s mission is to maintain the reliability of the Texas electricity grid and coordinate key pieces of the state’s $20 billion deregulated electricity market. The nonprofit organization’s $127 million annual budget is generated through mandatory fees paid by electricity customers or their power providers.
A state district judge appointed Texas Attorney General Greg Abbott in November, 2004 as special counsel in the case after the findings of an internal ERCOT investigation were disclosed to the Williamson County district attorney. At the same time, the judge impaneled the special grand jury in Williamson County, where ERCOT has its primary control center. ERCOT’s headquarters are in Austin.
In announcing the indictments yesterday, Mr. Abbott said that the case is “far from over” and that additional indictments may be coming down the pike. Indictments make for good publicity, but I’m more interested in the identities of the people in ERCOT management, on the ERCOT Board, and at the Texas Public Utility Commission (ERCOT’s regulator) who were asleep at the switch and missed such a simple scam. Funny how those names tend to get lost in the shuffle of indictments.