Unembarrassed CEOs Have More Freedom

(Bloomberg) -- Oh Elon.

Why should public companies be run for the benefit of their shareholders, anyway? It’s not the law, not really. Corporate directors do normally have certain fiduciary duties to shareholders, and shareholders do normally have certain governance rights, but the idea that the sole purpose of a public company is to maximize the stock price for shareholders is mostly a myth. Like many myths, though, it works because it commands widespread belief. If the shareholders believe it, and the directors believe it, and the managers believe it, and the public believes it, then companies will maximize the stock price for their shareholders, and for practical purposes the myth will be true.

There are some enforcement mechanisms, though, to keep the people who don’t believe it in line. If a company’s management doesn’t act in the shareholders’ interests, an activist shareholder can launch a proxy fight and appoint her own directors and change the company’s direction. Or another company can mount a hostile takeover and extract value by running the company in a more shareholder-friendly way. These are blunt instruments, though. They are expensive, and legally complicated, and require way more of the activist’s or bidder’s time and attention and money than most regular shareholders can spare. And in many scenarios they can destroy as much value as they create. If you have a visionary founder-CEO who doesn’t care about shareholder value and who just pursues his own idiosyncratic interests, but whose idiosyncratic projects nonetheless sometimes create shareholder value, replacing him with a shareholder-focused bureaucrat might just make things worse. 

There are lesser enforcement mechanisms. Shareholders can write angry letters, or go on television to complain. They can introduce nonbinding shareholder proposals, or withhold their votes from the company’s directors. The key feature of all of these enforcement mechanisms is that they have no binding effect. If you don’t vote for a company’s directors, they keep being directors just as much as if you do—unless you mount an active proxy fight to nominate someone else.

The only effect of these things is to embarrass the directors and executives. This is not nothing! Indeed it seems to be the principal mechanism of corporate governance. The greatest disaster that can befall most public-company boards of directors, in the ordinary course of things, is that like 30 percent of shareholders might vote for a nonbinding proposal that the board doesn’t like. “Oh no, a large minority made a completely symbolic gesture,” say the directors, and they promptly change their ways. This makes sense. From a corporate perspective, symbolically disgruntled shareholders become somewhat more likely to support non-symbolic enforcement mechanisms, like proxy fights and takeovers, that would actually toss out the directors. And from a personal perspective, if you are a public-company director, your main objective might be to maximize your public-company directoring, and you are more likely to get on more and better boards if your service on your current board meets with enthusiastic shareholder approval.

But one of the great arbitrages in finance—in life—is being immune to embarrassment. If you are an unembarrassable chief executive officer, you can just do whatever you want. When your shareholders come to you and say “you should really maximize shareholder value instead,” you can reply “well where does it say that?” And then they can write angry letters and vote on nonbinding resolutions and you can gleefully ignore them. You are increasing your risk of a proxy fight or a hostile takeover, but in this scenario (1) you are probably enough of a risk-taker that that doesn’t bother you and (2) you have probably come by your immunity to embarrassment honestly—by actually creating shareholder value—so that the risk remains acceptable. 

Obviously Elon Musk is up to some things again. Well, and so are his shareholders:

An activist firm representing Tesla Inc. shareholders has excoriated the electric-car maker, claiming that it’s veered off the path to profit and urging a major overhaul of the Elon Musk-led board.

CtW Investment Group, working with union pension funds that are Tesla investors managing more than $250 billion, opposes the re-election of three board members who are up for votes during Tesla’s June 5 annual meeting. The firm calls for shareholders to cast ballots against Antonio Gracias, a private-equity investor and Tesla’s lead independent director; Kimbal Musk, Elon’s brother; and James Murdoch, CEO of Twenty-First Century Fox Inc.

Now, sure, if 30 percent of shareholders withhold their completely symbolic votes for a public-company director, that will be embarrassing. But when the director is the CEO’s brother, who cares, man, who cares? “’We would find it inexplicable if Tesla were anything like a well-run public company,’” CtW executive director Dieter “Waizenegger said of Kimbal Musk’s re-nomination,” but that sort of begs the question doesn’t it? Yes, if Tesla was a different kind of company, it wouldn’t stock its board with its CEO’s relatives, but it does, which tells you that it isn’t. 

Meanwhile here are real words:

Move over, candy and flamethrowers. Elon Musk tweeted out plans Monday for yet another side venture: alleviating the nation's housing crisis.

"The Boring Company will be using dirt from tunnel digging to create bricks for low-cost housing," he wrote in a tweet about his nascent tunneling enterprise.

A company spokesman confirmed the plans, saying the bricks will come from the "excavated muck," and that "there will be an insane amount of bricks.” Musk has also suggested he has plans to sell them, and the company said future Boring Co. offices will be constructed from the company’s own bricks. 

If Tesla was anything like a well-run company its CEO wouldn't also be running a whole other company that appears to consist entirely of a series of Twitter jokes. But here we are! I have often said that I would not want to be Elon Musk’s lawyer, but I kind of do want to be the corporate secretary or whoever will bring him the news that a substantial minority of Tesla shareholders have withheld their votes for his brother to be a director. “Hahahaha who could possibly care,” Musk will shout, while tossing bricks out of the candy-filled rocket that he is flying to Mars. 

Libor.

What will replace Libor? That is actually two subtly different questions. One question is: In new floating-rate loans and derivatives, what will people use as the floating reference rate now that the London Interbank Offered Rate has been discredited by manipulation scandals and a lack of actual market transactions? (That itself may be two or more questions, with different answers for derivatives and loans, or different answers for different regions.) In the U.S., people seem to like the Federal Reserve’s Secured Overnight Financing Rate, and if it builds up a term structure it may become the standard for interest-rate derivatives and floating-rate loans. So that’s the answer to that question, and that question tends to be the one that people ask, because it is forward-looking and substantive.

But the other question is: In old floating-rate loans and derivatives, which referenced Libor, what will happen? This is a less interesting question in theory, but a more interesting one for lawyers. If there’s a good new Libor replacement—SOFR, say—then people can negotiate to amend their contracts to reference SOFR instead if Libor. (If they coexist for a while and there are Libor/SOFR basis swaps, then you can get a spread between Libor and SOFR and use that to amend the contract: If 3-month Libor tends to be 60 basis points above SOFR, and your loan was at Libor + 300, you can change it to SOFR + 360, or whatever.) But that is a lot of negotiating, and you could imagine a lot of contracts just not being amended even as Libor goes away. Then what? 

Well, then the contract says what will happen, but you don’t want to know. Here is an analysis from Oliver Wyman and Davis Polk & Wardwell LLP of Libor fallback language in existing contracts:

Crucially, legacy fallback language was typically originally intended to address the temporary unavailability of LIBOR, such as a computer systems glitch affecting the designated screen page or a temporary market disruption. Until recently, such language was rarely written to address explicitly the possibility of the permanent discontinuance of LIBOR. As a result, legacy fallback language may result in unintended economic consequences.

Here’s a particularly silly one:

Securities issued in the capital markets that reference LIBOR typically provide that if LIBOR is not available for an interest determination date, the rate will be determined by reference to quotations by reference banks, and, if the reference banks are not quoting, LIBOR for the relevant interest determination date will remain LIBOR for the immediately preceding interest reset period. If there was no interest reset period, the rate of interest payable will be fixed at the initial interest rate. ...

The net effect will be that instruments that were intended to be floating rate securities become fixed rate securities, with the fixed rate based on LIBOR at a point in time during the term of the security, no longer fluctuating based on changes in interest rates. There will be winners and losers based on future interest rate movements. Consequently, we believe that there is likely to be regulatory scrutiny of the impact of this outcome on retail investors.

If your floating-rate Libor thing becomes a fixed-rate thing, and interest rates keep going up, you might feel aggrieved. Or thrilled, depending on which side of the thing you are on, but one assumes that if the banks are on the receive-floating side they are not going to let this sort of thing happen. And if they’re on the pay-floating side then regulators are going to hear about it.

My own dumb idea is that Libor should cross-reference itself out of existence: The organization responsible for Libor (currently ICE, which replaced the British Bankers’ Association after the scandal) should just say “overnight U.S.-dollar Libor is defined as SOFR + X basis points, and 3-month Libor is defined as the following formula applied to SOFR futures prices, and euro Libor is defined as” etc. etc. etc., and then it should report a thing called “Libor” that is actually just calculated from the new benchmark, and that should flow to the designated Bloomberg screens that contracts use to define Libor, and everything will be seamless. I mean, except that everyone will sue. But if you could get a consensus that “____ is the new Libor,” for some ____, and “new Libor” meant not only “rate that will be broadly used to replace Libor” but also “rate that is considered the economic equivalent of Libor,” then that would be the clean way to do it. A lot of contracts call the Libor function. You can amend the contracts to make each of them call a new function. But you could also just rewrite the Libor function to make it call the new function, which seems like a lot less work.

Bitcoin futures.

We talked yesterday about Bitcoin futures, and about the San Francisco Fed’s view that the introduction of futures at Cboe Global Markets Inc. and CME Group Inc. made it easier for investors to short Bitcoin and so brought down the price. This is contrary to my own earlier prediction that the introduction of futures would make it easier for investors to go long Bitcoin, and so would raise the price. The fact that the price of Bitcoin is about half what it was when futures were introduced is a pretty good argument for the San Francisco Fed’s view. But Donald Wilson of DRW Holdings disagrees; he emails:

If the launch of BTC futures was the catalyst for the decline in the price of BTC, we would have expected to have seen aggressive selling in BTC futures.  This would be reflected in the term structure of the spot and futures.  We generally need to consider cash-and-carry, and other arbitrage factors in thinking about a neutral curve shape.  Suppose storage costs of spot BTC are close to zero, and market participants are willing to use cash-and-carry as an alternative to risk-free investing, and there is no benefit to owning spot BTC (this is probably an incorrect assumption), then we would expect a very slightly upward sloping curve (contango), with the shape driven by the risk free rate.  Since in fact there is a benefit to being long spot and short futures (ability to capture forks, and ability to arbitrage between spot exchanges with the coins), we need to compare that benefit vs. the risk free rate.  There is fortunately a proxy for that benefit - namely the BTC borrow market.  Currently BTC borrow is about 10% per annum.  Therefore we would expect the curve to be backwardated to the tune of the difference between 10% and the risk free rate, or roughly 8%.  Now that we have an expected curve shape based on rough arbitrage boundaries, we can think about how dramatically one-sided order flow would impact this curve.  Clearly, if there were aggressive sellers of futures, we would expect an even more backwardated curve.

So what did we actually see?  We saw futures trade at a huge PREMIUM to the spot market. …  My conclusion is that the launch of the BTC futures was in fact not the catalyst for the decline in the market. It was not used by "smart money" to short BTC. Quite the contrary, the dominant futures market participants bought BTC futures when they were launched, with prices on the highs, and later sold at lower prices.

If people were flocking to sell futures, then futures would trade below the spot price of Bitcoin, and longer-dated futures would be even lower than near-term ones. In fact the opposite was true. Now, I have argued that in fact the the cost of storing “physical” Bitcoins is not zero, and that it would be rational for certain types of investors to prefer to hold Bitcoin in the form of futures rather than in the form of actual Bitcoins. But my argument and Wilson’s come to roughly the same place, which is that the introduction of Bitcoin futures seems to have been a catalyst for people to buy Bitcoins.

Of course the fact that prices plummeted shortly after futures were introduced is an embarrassment for our theories, but not a fatal one. Price changes are complicated! It’s entirely possible that the introduction of Bitcoin futures led to an increase increase in the price of Bitcoin that was more than offset by a drop in the price of Bitcoin for entirely unrelated reasons. I feel silly typing that but it is nonetheless true. 

Airline miles.

Oh look it’s another random company announcing a random pivot to blockchain:

The Cathay Pacific Group and its rewards programme, Asia Miles, are launching their first application of smart blockchain technology in a marketing campaign, in collaboration with Accenture. ...

The Mobile App has been designed by Cathay Pacific and Asia Miles. It has been delivered by Accenture, using a mixture of deep blockchain, loyalty and aviation industry technology expertise.

By harnessing blockchain technology, the Cathay Pacific Group and Asia Miles are providing Asia Miles partners a single data source when managing account activity. This allows Asia Miles, partners and members a near real-time ability to manage rewards.

You know it is good because it uses both smart blockchain technology and deep blockchain. Etc. etc. etc.; the obvious objection, here and everywhere, is that if Cathay Pacific is the trusted central administrator in charge of Asia Miles then it can just keep a list of who has how many miles. That list could be the “single data source,” and if Cathay just updates it quickly then it can give everyone “a near real-time ability to manage rewards.” You so rarely need to administer a single company’s customer database using a blockchain, or a smart blockchain, or even a deep blockchain.

Back when initial coin offerings were a novelty and people were struggling to understand them, airline miles were a commonly used metaphor to explain them. The idea of an ICO is—loosely speaking, and ignoring the key element of an unowned distributed infrastructure—that a company can raise money by pre-selling a token that will eventually be redeemable for its product. You know, like airline miles. Except on the blockchain. “My explanation is that they’re like if the Wright Brothers sold air miles to finance inventing the airplane,” I once tweeted. Now actual airline miles are moving to the blockchain. It is only a matter of time before Asia Miles become CathayCoins, and Cathay Pacific sells a bunch of them in an ICO.

Speaking of random pivots to the blockchain, Facebook Inc. has “a new internal team dedicated to exploring blockchain technology.” Facebook’s stock closed up 0.4 percent yesterday, which is a little disappointing; time was, an internet company could announce a pivot to the blockchain and shoot up 10, 20, 30, 100 percent. Of course Facebook is a half-trillion-dollar company. It would be funny if it could add $100 billion in market cap just by blockchaining a blockchain onto the blockchain. Anyway look forward to your centrally administered Facebook data now being on a centrally administered Facebook blockchain.

Congrats Penny Pennington.

Here’s some retail-brokerage people news:

Edward Jones has named Penny Pennington as its new head, the only woman to lead a major U.S. brokerage firm as the industry scrambles to attract more female advisers and assets.

That is an important milestone but I cannot resist adding that Penny Pennington is the greatest financial-industry double-barreled aptonym since Rich Ricci left Barclays. If you were launching a new roboadvisor or trading app and wanted to have an animated artificial-intelligence assistant to help your customers use the app, you’d be thrilled to come up with a name half as good as Penny Pennington. But this one is real!

Things happen.

Where are we with electronic bond trading? Will the 10-year come with a 3 percent coupon? Argentina Is in Talks to Get a $30 Billion Flexible Credit Line From the IMF. Deutsche Bank Weighs Cutting U.S. Staff by About 20%. The CFTC is “holding this place together with duct tape.” Valeant will change its name to Bausch Health. Is the “IPO tax” a thing? Xiaomi Cuts IPO Valuation Target to $70 Billion to $80 Billion. Switzerland’s ‘Vollgeld’ banking overhaul: how reform would work. Pension Funds Still Making Promises They Probably Can’t Keep. AT&T Hired Firm of Michael Cohen as It Sought Trump ‘Insights.’ Ray Dalio’s “Principles” is now a 30-minute online animated series for recent college graduates. Naturally Occurring Escape Rooms.

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