Relevant and even prescient commentary on news, politics and the economy.

Stealth CEO Compensation and Stock Options

Via Dean Baker comes Eric Dash of the New York Times writing about one aspect of the compensation package for Denny’s CEO:

For leading the turnaround of the Denny’s restaurant chain, Nelson J. Marchioli was all but given an extra $500,000 last year, slightly more than his reported bonus for 2005. For leading the turnaround of the Denny’s restaurant chain, Nelson J. Marchioli was all but given an extra $500,000 last year, slightly more than his reported bonus for 2005. But Denny’s shareholders would be hard pressed to discover that added part of their chief executive’s pay. Instead of writing Mr. Marchioli a check, Denny’s board handed him about 333,000 stock options that came with a built-in paper gain. The amount was not mentioned in Denny’s compensation committee report. It was not counted in the company’s summary compensation chart. Only by carefully studying a table, deep in the proxy statement from the year before, would an ordinary investor realize that Denny’s awarded those options last December with a “buy” price of $2.42 when Denny’s shares were selling for $3.91, a 38 percent discount.

The $1.49 per option “discount” represents only the intrinsic value with the value of this compensation likely to be around $1 million. Nicholas G. Apostolou and D. Larry Crumbley had a nice explanation of the accounting for employee stock options:

Instead of replacing APB 25’s intrinsic value based method of accounting for stock-based employee compensation plans, SFAS 123 allows a choice between the intrinsic value method and the fair value method. The intrinsic value method, however, triggers footnote disclosure of the effect on earnings, whereas the fair value method does not. Since the great majority of publicly traded companies continue to use the intrinsic value method, the grant of options does not dilute reported earnings. Thus, stock options continue to be “stealth compensation,” deductible for tax purposes without diluting financial earnings. Warren Buffet, CEO of Berkshire-Hathaway, criticized the current rules for accounting for options in his company’s 1998 annual report: “If options aren’t a form of compensation, what are they? If compensation isn’t an expense, what is it? And, if expenses shouldn’t go into the calculation of earnings, where in the world should they go?” The authors surveyed the 1998 annual reports of 30 companies that used the fair value method rather than the intrinsic value method. In certain situations, the difference in earnings is so great that financial statement users’ decision making could be affected.
For years, stock options have been “stealth compensation”: expenses that are not charged against financial statement income but are deductible for tax purposes. Nevertheless, stock options dilute earnings, meaning that they are not free to shareholders. In 1995, FASB adopted SFAS 123, which established financial accounting and reporting standards for stock-based employee compensation plans.

In order to provide some estimate of the value of these options, let’s turn to Denny’s latest 10-K where we see they use the Black-Scholes option pricing model the following weighted average assumptions: (a) expected volatility = 90%; (b) expected life = 6 years; (c) interest rate = 4%; and (d) dividend yield. The Economic Research Institute provides us with a Black-Scholes calculator, which returns a value equal to $3.194 per option under these assumptions. Our attempt to model the value of the options received by Mr. Marchioli suggests that they were worth around $1 million – not $500,000.

In the late 1990’s, Apostolou and Crumbley as well as others were less worried that investors would not realize that executives were receiving options as part of their compensation packages and more worried that the true value of these options were larger than the APB 25 accounting would suggest, which is why Warren Buffet and others were arguing that we should make SFAS 123 valuations mandatory.

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Strong Economic Growth for 2006QI

The Advance Estimate for the first quarter of 2006 is out reporting 4.8% real GDP growth on an annualized basis, which basically makes up for the weak 1.7% figure for the last quarter of 2005. Investment growth remains strong and consumption grew relative to GDP. Andrew Samwick is worried that private savings remains low.

Rubinomics types like myself might take some delight in the fact that overall government purchases have not been growing that rapidly over the past 6 months – even if Federal purchases did grow by more than 10% on an annualized basis during the first quarter of 2006. I guess fiscal responsibility is a local affair – but not one we should expect our of Washington, D.C. Brad DeLong writes:

If households are myopic and are saving too little, the government should offset this and save for them – i.e., we should raise taxes to fund big budget surpluses.

Brad is right – but I’m not holding my breath expecting President Bush to listen to such good economic reasoning.

Update: Brian Riedl asks “Is spending restraint really gaining steam?” His NRO op-ed has a lot of praise for Senator Tom Coburn who does sound serious about spending restraint – but consider the “facts” as Mr. Riedl notes:

Since 2001, the federal government has expanded by 45 percent, as Congress enacted the most expensive agriculture, education, Medicare, and highway bills in American history. Additionally, the number of pork projects more than doubled as the “Bridge to Nowhere” came to symbolize Congress’s isplaced priorities.

OK, that’s misplaced not isplaced (not as funny as Jonah Goldberg calling himself a “hetersexual male of the species with a job“) but sort of on the right track – even if Federal spending in 2006QI was only 40 higher than it was in 2000QIV if one is looking at line 19 of BEA NIPA table 3.2. If Riedl meant to say Federal purchases rose a lot – they did rise by 59% at least in nominal terms. In real terms, this increase was only 32%. So I’m not sure what his 45% means.

But let’s take a look at Federal expenditure as a share of GDP and Federal purchases as a share of GDP. In either case, I see no evidence of fiscal restraint. It would seem that the White House is not really listening to Senator Coburn on spending or to Brad DeLong on taxes. Ahem!

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Exxon’s Profit Report

Kevin Drum watches the stock price of Exxon decline even though they reported $8 billion in quarterly profits. CNN’s American Morning was on the story explaining the decline in the stock price by noting that analysts had expected $9.2 billion (not trillion). At one point – Andy Serwer hinted that the difference between reported earnings and what the analysts were expecting might be due to some accounting gimmicks:

SERWER: Or just a dollar. Just enough.

First of all, Soledad, I want to report on Exxon’s profits. We’ve been mentioning that this morning. Just crossing the tape – $8.4 billion in the first quarter. And what’s interesting to me is that Wall Street was expecting $9.2 billion. They reported a lot less. And you wonder, you know, what have…

S. O’BRIEN: Where is the other…

SERWER: Yes. I mean was some stuff…

S. O’BRIEN: … .8?

SERWER: … sort of put aside? They’re not supposed to do that. It’s very illegal.

M. O’BRIEN: Yes.

SERWER: Of course, Exxon wouldn’t do that. But it’s funny that there was that much of a difference.

Given all the political fuss over oil profits – oh, never mind! Andy stopped sort of making such an accusation, so I’ll do the same.

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PlameGate Update: Karl “Not a Target” Rove

Jim VandeHei reports:

White House Deputy Chief of Staff Karl Rove sought to convince a federal grand jury yesterday that he did not provide false statements in the CIA leak case, testifying for more than three hours before leaving a federal courthouse unsure whether he would be indicted, according to a source close to the presidential aide. In his fifth appearance before the grand jury, Rove spent considerable time arguing that it would have been foolish for him to knowingly mislead investigators about his role in the disclosure of the identity of undercover CIA officer Valerie Plame to the media, the source said.

So it seems even Rove rejects that not a target canard. While Rove’s latest spin is that it would have been foolish to lie, Digby suggests Rove was preturnaturally confident to believe he could lie. Some legal beagle help us out – is being foolish a defense against a charge of perjury and obstruction of justice?

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Higher Gasoline Prices: Shift Along Versus Shift of the Demand Curve

Jonah Goldberg poses an Upward Mystery after reading one of his emails:

Gas prices go up, driving stays the same. Interest rates go up, the economy keeps on chugging along … If things are so bad, how come they’re so good?

This post came after he linked to an interesting article from Nick Schulz:

But what’s more interesting about these stories is what they don’t tell you. For example, the Associated Press reports that “surveys indicate drivers won’t be easing off on their mileage, using even more gas than a year ago.” Now why is that? If prices are rising, one would expect consumers would use less. The answer might be in some of the long-term trends that the short-term media lens is too cramped to see. Energy prices may be rising, but energy itself is much less important to consumers and to the overall economy than it once was … American consumer spending on energy as a fraction of total personal consumption has declined considerably since 1980. Whereas 25 years ago, one in every ten consumer dollars was spent on energy, today it’s one in every 16.

Simply put – while the price elasticity of demand for energy may indeed be negative, its income elasticity is positive. Which means – the rise in the price of gasoline represents an outward shift of the demand curve. So did Jonah even bother to read Schulz’s article?

Perhaps he should have also read what Bill Kucewicz wrote about world aggregate demand and commodity prices in general:

Confirmaton that the ongoing rise in commodity prices is of economic origin and not a worrisome monetary phenomenon comes from a Kudlow & Co. survey of 51 of the world’s larger economies, representing approximately 94 percent of global GDP. The data reveal a strong tandem relationship between the commodity price swings of recent years and the contraction and expansion of the global marketplace.
Growth in world aggregate demand would be expected to increase the relative price of certain commodities. But I do have one quibble with Kucewicz’s use of nominal GDP especially since the word inflation is in the title. How much of this nominal GDP growth represents inflation as opposed to real growth. Kucewicz gives us a clue:
In the absence of any resurgence in inflation …

In other words, inflation remains low even as commodity prices rise. I hope the National Review gold bugs that include Lawrence Kudlow pay attention to this point.

Let’s also turn to the NRO’s resident Keynesian Michael Darda:

High oil prices don’t necessarily slow growth … In other words, theoretically, high energy prices reduce the amount of spending on the part of consumers, which restrains demand and places a lid on inflationary pressures. This is what economists mean when they say “high oil prices are tightening for the Fed.” This theory sounds logical, but it’s as wrong as rain … The end result is that the sum of industrial and crisis demands have outstripped increases in new supply, pushing prices higher. But a shift in demand at every price is consistent with more output, not less. This also is why crude oil prices actually have borne a positive relationship with economic growth during the last five years.

In other words, an outward shift of the demand curve. Jonah – pay attention!

Darda could also be dusting off the old adage attributed to Keynes:

For one man’s expenditure is another man’s income.

In other words – as consumers pay more for energy, energy suppliers receive more income. But let’s review the entire paragraph from the 1932 The World’s Economic Outlook:

We have here an extreme example of the disharmony of general and particular interest. Each nation, in an effort to improve its relative position, takes measures injurious to the absolute prosperity of its neighbors; and, since its example is not confined to itself, it suffers more from similar action by its neighbors than it gains by such action itself. Practically all the remedies popularly advocated to-day are of this internecine character. Competitive wage reductions, competitive tariffs, competitive liquidation of foreign assets, competitive currency deflations, competitive economy campaigns – all are of this beggar-my-neighbor description. For one man’s expenditure is another man’s income. Thus, while we undoubtedly increase our own margin, we diminish that of someone else; and if the practice is universally followed everyone will be worse off. An individual may be forced by his private circumstances to curtail his normal expenditure, and no one can blame him. But let no one suppose that he is performing a public duty in behaving in such a way. The modern capitalist is a fair-weather sailor. As soon as a storm rises, he abandons the duties of navigation and even sinks the boats which might carry him to safety by his haste to push his neighbor off and himself in.

Keynes’s concern at the time was that various nations would be tempted in engage in beggar my neighbor or expenditure switching policies. The rise in oil prices generally favors the residents of the oil exporting nations and disfavors the residents of oil importing nations such as the U.S.

Brad Setser writes:

But for all the attention paid to China, the biggest pool of spare savings is found not in Asia, but in countries sitting on large underground resevoirs of black gold. The combined current account surplus of the world’s oil exporters is immense.

Brad goes on to quote Saleh Nsouli:

What are oil exporters doing with the extra oil revenue? Given the large government share in the oil sector in most oil-exporting countries, and thus in oil revenue, the deployment of the additional oil income is mainly the decision of governments. In many cases, in particular in the Middle East and Africa, these have adopted conservative assumptions on the path of oil prices in their budgets, much below market prices, and little of the excess revenue from oil exports is estimated to have been spent.

In other words – while world aggregate demand growth has been relatively strong as Darda argues – the shift in income away from nations such as the U.S. with our high marginal propensity to consume towards nations that appear to have lower marginal propensities to consume may dampen the growth in world aggregate demand growth.

Update: Mark Thoma passes along the Dean Baker analysis of the President’s ANWR claim and more. Also check out the comment from bakho who provides this link on refinery capacity over time. While we have fewer refineries, capacity per refinery has increased over time. In 1981, capacity utilization was less than 70%, while it was almost 93% in 2004.

Update II: Al “Not Glenn” Hubbard gives a briefing on Bush’s energy proposals and cannot answer a particular question:

Q Just to follow up, though, on one element of that point. The President made the point that had ANWR been approved ten years ago, you’d get about a million barrels a day. Had the Iraq production resumed to the level that had been projected before the war, how much would that contribute today?
DIRECTOR HUBBARD: I actually don’t know the precise answer to that. What’s really most important, though, is that we’ve become less reliable on overseas sources of crude oil and other sources of energy, and more reliant on energy from within our 50 states [sic].
Q You have no estimate, though, about what Iraqi production could be?
DIRECTOR HUBBARD: I do not have it.
MR. HENNESSEY: We can get back to you.
DIRECTOR HUBBARD: Yes, we can get back to you with that, or —
Q That would be useful. I mean, just – obviously, since the President has chosen one interesting example in ANWR, the Iraq one would be an interesting one to compare it to, whether that would be more or less than a billion — a million a day.
DIRECTOR HUBBARD: Yes, we will have to get back to you on that.
Q I appreciate that, thanks.

I wonder if the person asking the question had read Dean Baker’s discussion and already knew what Mr. Hubbard could not answer!

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Tony Snow’s Criticism of George W. Bush

Think Progress, Christy Hardin Smith, and the DSCC congratulate Tony Snow on his being appointed as President Bush’s chief excuse maker with a few quotes from the past. Byron York provides us with one of his reader’s views on all of this:

Of course, these (Center for American Progress) are among the same people who most loudly whine about Fox being the mouthpiece for the administration. Do you suppose they realize their clever selection of Snow quotes defeats their other argument? Mr. York, at least it can’t be said then that Bush only surrounds himself with “yes men” in his “bubble.” We can knock these lefty critcisms right out.

One example of how Mr. Snow has criticized Bush dates back to August 25, 2000:

On one side stands Gore, who envisions an America where every day is Halloween and every tree conceals an ogre from Big Something … The Gore Democrats believe every faction deserves some dough. Gore dutifully proposed an unprecedented spending spree – as much as $2 trillion in new stuff over the next decade. He has programs for virtually everything. But nobody in his entourage seems to have asked the pertinent question: Has any federal program ever solved a problem and then closed its doors? … On the policy side, he [Bush] has become a classical dime-store Democrat. He gladly will shovel money into programs that enjoy undeserved prestige, such as Head Start. He seems to consider it mean-spirited to shut down programs that rip-off taxpayers and mislead supposed beneficiaries.

Our argument is that Snow and the rest of the Fox News crowd is nothing more than a propaganda machine for the Republican Party. Last I checked, the Republican Party pretends it is for a smaller government. OK, they don’t back their rhetoric with action. But how is attacking Al Gore as allegedly being a big spender, while suggesting Head Start is a boondoggle in any way contradicting our argument?

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Sean Hannity Explains the Rise in Gasoline Prices – Liberals!

NewHounds watch Fox so we don’t have to:

Hannity’s face was in the bullyboy squint and he jabbed his finger as he spoke to “Democratic strategist” Bob Beckel. “I want YOU to know, Bob Beckel, I give blame for high gas prices. 30 years of the Democrats beholden to the extreme environmental movement, we haven’t built a refinery. We’re not allowed to drill in the 48 states or off the coast of Florida or California. We can’t drill in ANWR. We can’t do anything… Government taxes are 62 cents a gallon in New York for gasoline. The gas companies only get 9 cents a gallon. I blame you liberals for this.”

The gas companies get only $0.09 a gallon but the there are too few refineries? Somehow – there is a contradiction in Hannity’s logic unless he thinks the “gas companies” only perform the distributor function. The Gasoline and Fuel Update is out for March – but we’ll have to wait for the April data. In March, we paid about $2.43 per gallon on average. Since distribution and marketing made up about $0.11 of this, Hannity is close if we rephrase his rant. But taxes were only $0.46 and have not even kept pace with the rise in the general price index. Refinery margins have fluctuated over time but as we noted here do not show any evidence of the claim that the lack of refineries is the cause of high gasoline prices.

Update: Many thanks to AB reader Jim A. for this list of state taxes on a gallon of gasoline. If the Federal tax is $.0184 per gallon and the overall average tax is $0.46 per gallon – it would follow that on average, state taxes are around $0.27 per gallon. In my state – California – this chart says we pay $0.18 per gallon but then the chart also says “other taxes include a 6% state sales tax and 1.25% county, plus additional local sales taxes and 1.2 cents per gallon state UST fee”. OK, state taxes vary across the nation, which is one reason but the only reason why gasoline taxes vary across the nation. As far as changes in gasoline prices over time, I would not attribute much (if any) of the recent increases in the price at the pump to increases in taxes. Also, AB reader (and resident rightwinger) Jerry says it’s not fair for conservatives to blame liberals or for liberals to blame conservatives. When Nancy Pelosi claimed there was a cause and effect with respect to the President and Vice President being oil men and the rise in gasoline prices, I would agree with Jerry that such statements are nonsense. But consider what Dean Baker said about the “producing another million barrels of oil a day” via ANWR nonsense from President Bush including:

Iraq’s average oil output is approximately 1 million barrels a day less than it was before the war. In other words, the Iraq war has reduced world oil supplies by approximately the same amount that drilling in the refuge might have increased it.

Let’s turn this statement around as it might suggest that Dick Cheney has incredible foresight. After all – in the early 1990’s, he wanted us to march on Baghdad. So maybe Cheney realized that overturning Saddam Hussein would not increase world oil suppliers as some rightwingers were predicting 3 years ago – but would reduce oil supplies by a million barrels a day. Maybe this was the reason why conservatives starting pushing this ANWR idea back in 1993 – to make up for the lost oil supplies that would be lost from the march on Baghdad that would be the inevitable consequence of letting Dick Cheney into the White House. OK, this is all speculation and like gives Mr. Cheney way too much credit.

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Did Rand Beers Leak to Dana Priest?

High comedy from NRO’s The Corner as JPod accuses Rand Beers of leaking:

So Newsweek is reporting that Mary McCarthy denies being the leaker. This despite stories in the press saying that she failed a polygraph and admitted to it. McCarthy’s not the the one who told Newsweek. Do you know who did? Her “close friend” Rand Beers. Who’s Rand Beers? The National Security Council staffer who quit in 2003 and went to work as John Kerry’s senior national security campaign adviser. You know who else is Rand Beers’s old friend from the National Security Council staff? Joseph C. Wilson IV. Just saying.

Not a shred of evidence for this allegation exists – but when did that stop the Cornerites of attacking anyone associated with Senator Kerry in any way? Just saying.

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Our Fiscal Future – as Portrayed by the OMB

AB reader ilsm points us to a set of White House graphs on employment, GDP growth, and the budget. More on this after thanking Brad DeLong for commenting on a comment from Greg Mankiw on our fiscal future. Greg reminds us that we have to choose between reducing entitlement growth versus imposing taxes even higher than what we saw during the 1990’s. Brad is stunned that President Bush is still calling for tax cuts.

But let’s turn to those graphs. The first one shows the GDP growth rates since 2000 (more volatile than high) and projections that GDP growth will taper down to around 3.1% per year. And I thought these tax cuts will lead to rapid future growth according to the free lunch supply-side crowd! The next graph documents how weak employment growth has been since 2001. Well, that’s what the data shows but the titles of both charts talk about strong growth. As Brad might say – HUH?

The next chart shows projected growth in nominal tax revenues, which of course, is a misleading diagram (in real terms, relative to GDP, etc.). The fourth graph makes that infamous claim that Bush will lower the deficit in his second term comparing this bogus projection to one of those weird averages that the Bush crowd is known for.

But ilsm wants us to look at the last graph, which I have to admit is truly fascinating. Its title is “Current Trends Are Not Sustainable”, which is consistent with what Greg said. It also provides taxes as share of GDP from 1970 to today and projections through 2070. Note the rise in the share of taxes relative to GDP during the Clinton years and the dip after 2000. The chart does not say – but I suspect its projections are based on the assumption that we ignore President Bush’s calls for permanent tax cuts. Finally, the chart breaks out Federal spending among interest payments (ilsm wants us to notice how they grow over time), mandatory spending, and discretionary spending. Am I reading this graph correctly? The projected increase in spending as a share of GDP is not from a projected increase in discretionary spending but from a projected increase in mandatory spending. So why are so many rightwingers concerned about controlling discretionary spending?

To be fair, I have never paid a lot of attention to this arbitrary distinction between discretionary v. mandatory. Part of what is going on in this graph is that the Social Security surpluses over the next decade are masking the General Fund deficits. These Social Security surpluses, however, are only pre-funding the retirement benefits for the baby boom generation. The other part of what is going on here represents the rise in government funded prescription drug benefits that President Bush brags about one day as he brags about giving us a tax cut the next. Credit to Greg Mankiw for calling out the dishonesty of this fiscal pandering.

Update: Looking at the actual GDP growth figures for 2001 through 2005 as well as the OMB projections for the rest of the decade, it seems that our average annual growth rate over the past 5 years was only 2.55% and will be only 2.9% for the decade if actual growth follows these projections. Think about it. From 1947 to 1980, average annual growth was 3.5% and for the 8 years that Clinton was President, average annual growth was 3.7%. During the Reagan-Bush41 years, average annual growth was only 3.0% and according to the OMB, average annual growth for this decade will be less than that. So much for that supply-side mythology that President Bush keeps muttering as if it were the gospel.

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