Submitting Merger Lawyers to the Market Test

Matt Levine shall supply the problem:

The way merger lawsuits work is that after a deal is signed, a bunch of plaintiffs’ lawyers race to sue, claiming that the merger was underpriced, the board breached its fiduciary duties, and the whole thing was corrupt. This might sometimes be true, but it can’t be true in every merger, and the lawyers sue in virtually every merger. But then they sign a settlement with the company in which the company agrees to make a few extra disclosures about the deal and pay the lawyers a six-figure fee. The advantage for the company and the board is that the settlement binds all shareholders, so they get a release from future litigation if someone figures out that the deal was actually corrupt. The advantage for the lawyers is that they get the fee. There is no advantage for shareholders.

We shall provide the solution:

Do not pay the lawyers a cash fee.

At a random time, while the market is open, announce the disclosures that will be provided.

Then, pay the lawyers a fee proportionate to the stock’s movement (relative to the overall market) over the next hour (or second, or day, or week).

If the disclosure they heroically provided to shareholders is valuable, they will be rewarded.

But, if the disclosure they provided was a disappointment to the market, they have to pay the company. (And the court).

This system is both fair and efficient. Fair, because the lawyers will be paid if they added value to the company, and punished if they subtracted value. Efficient, because this will encourage them to only pursue lawsuits they think will add value.

Now, the lawyers (and perhaps my readers) will object that news of these disclosures would be but one small thing effecting the price of the stock that day. There would be a lot of noise – how then can it be fair to use such an unreliable method to reward the noble public servants who forced the disclosures?

And other lawyers (and perhaps other readers) will object that this could be manipulated. The lawyers could short the stock in to the announcement, and then cover their shorts when the news broke, and buy a lot of stock instead, to try to temporarily support the stock.

Fortunately, both issues can be solved together. Because this is not a single game, it is a repeated game. Any one time the lawyers might get unlucky and have the stock move “the wrong way”. But if done often enough (and this is their profession) they will come out ahead… if the disclosures they achieve are valuable. And maybe they could manipulate the stock once. But if they try to do it systematically, hedge funds will learn off it and take the opportunity to buy the stock when it is inefficiently cheap before the announcement… and then short it when the lawyers temporarily drive it up. The lawyers would need to burn a huge amount of money to manipulate the stock in the face of hedgies after an easy trade… at which point the whole thing would no longer be net profitable for them.

Does this sound plausible to you? It should, if they are adding value. If they’re on the side of angels, they should leap at the chance to have their worth measured.

Of course, this is rather a stretch. I suspect that if this were implemented, lawyers would cease these lawsuits.

And that would be good.

Ashley Madison was an Effective Altruist Conspiracy

Much as been said about the Ashley Madison hacks. Needless to say, my husband and I agree that anyone committing or attempting to commit infidelity is an abhorrence, who should be shunned by society. But that is not the topic of this essay. The question is, was the creation of the website itself a bad thing? Here is a theory that suggests its creation was actually a grand stroke of Effective Altruism.

Here is my conspiracy theory. Like all conspiracy theories, it ex-post fits the facts well, but probably should not be given a very high credence.

1. Ashley Madison was set up by an activist who wanted to promote ethical behavior and punish the unjust.
2. Firstly, it took money from people who wanted to commit infidelity. Taking money from people makes them worse off.
3. Then, it didn’t provide any services. It never matched any cheaters up.
4. After having handed over credit card details but not received anything, the would-be cheaters realized it was a scam.
5. Then can’t take Ashley Madison to court, because that would be public record.
6. So they try to get out … but realize Ashley Madison has them in an incriminating position.
7. Ashley Madison extorts more money from them to delete their data.
8. Ashley Madison does not delete the data.
9. Ashley Madison discusses a possible IPO purely for the publicity. It knows it’s a fraud and could never stand up to auditing.
10. Ashley Madison then hacks itself. This explains why they were able to access the data so easily. They had previously hacked another competing service.
11. Ashley Madison then releases the data. This provides early downloaders with the opportunity to extort the would-be cheaters.
12. Eventually all the would-be cheaters are revealed, and face the wrath of their poor spouses.
13. No-one ever trusts an infidelity website again, making it harder to commit infidelity in future

So the net result is:

1. Would-be cheaters are effectively fined a significant amount of money.
2. And then exposed.
3. And no-one can ever create an infidelity website.

Ideally I would like to test this theory against the third dump of Noel Biderman’s emails. Unfortunately my torrent, like everyone else, seems to be stuck at 93.3%.

The War on Drugs as Make-Work

An argument for ending the War on Drugs is that it would undermine the drug gangs. At the moment we have a baptists and bootleggers situation, where the drug ban benefits illegal providers, because it raises the price of drugs a lot. If drugs were legal, supply would increase a lot, lowering prices. Criminal gangs don’t actually have a comparative advantage at running efficient supply chains – if they did they would be running WalMart instead – so they will be out-competed by new, legal entrants to the market. This would dramatically reduce their revenues, making joining them less attractive, and leave them with less money to spend on sinful things.

And all of this is probably true. But…

Here’s another way of looking at it. At the moment some argue the US has a zero-marginal-product-worker problem; there are people who aren’t worth hiring at any price, because you can’t trust them not to steal from you, or break things, or insult customers, or get you into legal trouble. But, like the army before them, criminal gangs can make use of such people – perhaps because criminal gangs can make use of extra-legal motivational techniques. Normally, this would be bad, if criminal gangs were hiring such people to do immoral things like theft. But at present many of them are usefully employed in the socially productive activity of consumer product distribution.

And another group of thugs, who lack skills beyond the ability to yell loudly and order people around, get make-work as DEA agents.

So actually the War on Drugs is job security for semi-criminal ZMP workers, providing them with employment and protecting them from competition. Maybe pretty rubbish protection – it leaves many of them dead or imprisoned – but other forms of ‘protection’ for low-skilled workers also have some pretty negative consequences.

2015/01/28 Shadow FOMC statement

The members of the Shadow FOMC would like to apologize for our extended absence; we were held under house arrest by the agents of Stanley Fisher.

Release Date: January 28, 2015

For immediate release

Information received since the Shadow Federal Open Market Committee met in September suggests that economic activity has been expanding at a pretty reasonable pace.  Labor market conditions have improved further, with strong job gains and a lower unemployment rate, and the employment to population ratio has improved, albeit off a low base. The end of extended unemployment insurance seems to have significantly boosted employment; we suggest that the federal government would benefit from privatizing and making optional the remaining unemployment insurance.  On balance, a range of labor market indicators suggests that underutilization of labor resources continues to diminish.  Household spending is rising moderately; recent declines in energy prices have boosted household purchasing power, though we worry they may have been caused by a fall in global aggregate demand.  Business fixed investment is advancing, though recent profitability among industrial companies has been disappointingly weak. The recovery in the housing sector remains slow. House prices remain well below the net present value of avoided future rent payments, probably due to regulation hindering the supply of mortgage financing, though recent data there has been encouraging.  Inflation has declined further below the Light Committee’s longer-run objective, as predicted by the Shadow FOMC, and they should not blame energy: while energy prices have fallen dramatically, inflation ex. shelter has been running below target for years, due to the unconsciously tight monetary policy the light committee has followed. Market-based measures of inflation expectations have declined substantially in recent months, and are now indicating that the Light Committee will miss its target for the next 10 years. We are highly disappointed that the Light Committee chose the Orwellian step of renaming them ‘inflation compensation’ instead of ‘inflation expectations’, ignoring the enormous predictive power the market gives us. Yes, survey-based measures of longer-term inflation expectations have remained stable, but who cares? These surveys have been awful forecasters in the past.

The recent rise in the value of the dollar against a trade-weighted basket of other currencies (or, indeed, virtually any other currency other than the Swiss Franc) shows the high level of global demand for the USD. Since this is a product that can be created at basically zero cost, the Shadow Committee would accommodate this demand and print some more USD.

Inconsistent with its statutory mandate, the Light FOMC is failing to foster maximum employment and price stability. Unemployment is low, so the Light Committee’s actions could be justified if it was targeting that… but it is ostensibly targeting employment instead. Employment is still pretty awful; both employment and inflation suggest the need for loser monetary policy. The Shadow Committee expects that, even with a lack of appropriate policy accommodation, economic activity will expand at a moderate pace, as free markets have a tendency to grow. As the economy is kind of like a martingale; risks to the outlook for economic activity and the labor market will always be nearly balanced.  Inflation is anticipated to decline further in the near term, and though the Committee expects inflation to rise gradually as energy is a one-time shock and the oil forward curve is very steep, we have no idea why the Lighties expect it to reach the target at any point in the foreseeable future.  The Shadow Committee continues to monitor inflation developments closely; evidently more closely than the Light FOMC!

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. However, we wish to remind people that this by no means represents a lower bound on interest rates; in the event the economy deteriorates further, we would be willing to lower interest rates further, or to deploy an array of other policy tools. In determining how long to maintain this target range, the Committee will assess progress–both realized and expected–toward its objective of a certain NPGDP level, which increases by 6% a year.  This assessment will take into account a wide range of information, including market indicators, what people say on facebook, and the behaviour of our cats.

We regret that the Light Committee completed the taper of its bond holdings, though we believe that resuming the program now could be destabilizing and reduce the credibility of the Bed. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction.  This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and NPGDP of 6 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Shadow Committee views as more consistent with the fundamental level of human time preference, which implies long-run real rates of around 3-4%. Over the longer term, the Shadow remains concerned about value drift resulting in a future devoid of moral significance.

Voting for the SFOMC monetary policy action were: everyone, because I rule with an Iron Fist.

What if Regulation was a Finite Resource?

Alternative Title: Conservation of Regulation

Think of the fuels that have provided the energy for human civilization so far – coal, oil, gas. They existed for thousands of years, largely inert. A small part of them (mainly coal) was used by humans for forges and the like. But then we discovered them during the industrial revolution. We put them to good use, but there’s only a limited supply.

What if regulation was the same? There’s only a finite amount available. For most of history, this existed in a largely inert fashion, regulating the atmosphere, evolution, and so on. A small part of it was used by humans to regulate their habits and bowl movements.

But then during the industrial revolution regulation was discovered by socialists and paternalists. They started using it on a massive scale, trying to regulate all of society.

Unfortunately, there’s only a finite amount of regulation available. We’ve been using so much over the last few hundred years that there’s not enough to regulate the climate – hence climate change. It caused a breakdown in virtue when people’s ability to regulate their habits was reduced. It also caused the obesity crisis because we can no longer regulate our bowl movements properly.

Now, leading scientists are warning about an even greater threat: we might be using up so much regulation that the earth’s orbit will cease to be regular. This will have dramatic consequences, ranging from disruptions to the seasons and day-and-night cycle, to the earth crashing into the sun.

Leading scientists say we need to rapidly reduce our regulation consumption if this is to be avoided. They recommend bring our regulation uses back down to 1990s levels by 2020, and 1900 levels by 2050, and 1700 levels by 2100. Unfortunately, it may already be too late to avoid changing the day-and-night cycle by 1-2 hours, in an effect scientists have dubbed ‘daylight savings time’.

Economists are divided on the best way to respond to the crisis. Some favor a regulation tax, where anyone who implemented or enforced a regulation would have to pay a tax equal to the negative externality they caused. Others suggest a cap-and-trade system, whereby rich countries would be able to buy regulation credits from poor countries. Some politicians prefer a command-and-control approach, where they would pass regulations limiting the use of regulations in industry.

Some progress has been made – most countries have signed up to the Hong Kong Protocol, promising to reduce their regulation levels. The US risks becoming an international pariah by refusing to sign; the Obama administration defended its intransigence:

Hong Kong is, in many ways, unrealistic. Many states do not want to meet their Hong Kong targets. The targets themselves were arbitrary and not based upon political science. For America, complying with those mandates would have a positive economic impact, with increased hiring by small businesses and price decreases for consumers. And when you evaluate all these flaws, most reasonable people will understand that it’s not sound public policy.

But you too can make a difference! There are many easy steps you can take. Maybe turn off your thermostat – doesn’t the earth need that regulation more than your central heating? Write to politicians expressing your concern. Join a local libertarian group.

Remember, preventing the world crashing into the sun is more important than regulating your heartbeat, so ask yourself: do I really need a pace-maker?

Accruing Gas Mileage

The other day I made the (probably unwise) decision to criticize someone for their driving. In my defense, they were spectacularly awful.

I pointed out two things:

1. They were being dangerous, both to us and to others
2. They were wasting gas by alternately flooring the accelerator and then breaking sharply in quick succession

Mentioning the latter was probably a mistake, as it allowed him to focus on this more minor sin and ignore the danger to life and property he was creating. But enough about my mistakes – what’s interesting was his.

He argued that being gas-inefficient didn’t matter, because he had a full tank.

Obviously this is nonsense – by using gas inefficiently now, he was hastening the need to re-fill the tank. A life-long strategy of doing so would substantially increase his lifelong gas expenditures, and as acausal decision theory teaches us, in choosing once we choose eternally.

But it also made me appreciate accruals accounting more.

Accruals Accounting involves recognizing costs and revenues when the economic activity to which they correspond occur – not when the cash is paid out. So if my company sells you a widget in 2014, but you only pay me in 2015, I record the revenue this year. Similarly, if I invest in some equipment this year but use it over the next few years, I will record the cost (as depreciation) over the next few years.

You might wonder about what would happen if sell you a widget but you never pay me. Surely I shouldn’t have recorded it as revenue if I never actually get the benefit? It shouldn’t count as profit if it’s driving me to bankruptcy! Excellent point – the answer is that at some point, when I realize you’ll never pay me, I have to ‘write it off’ – take a loss to cancel out the revenue I counted earlier.

Accruals Accounting has advantages and disadvantages. In particular, the company does need to produce cash at some point – Accruals Accounting can be abused if management make overly-optimistic assumptions about how likely they are to be paid.

But it’s a good way of analyzing cases like gasoline consumption. Assuming you will eventually use all the gasoline in the tank (you won’t have to write it off) the real time when you incur gasoline expense is not when you pump it, but when you use it. The time to save gasoline is when you’re driving – by coasting more, accelerating gently or perhaps even walking instead – not at the pump. Good driving technique represents a real savings, which accrual accounting recognizes – only filling up half way is a false economy.

2014 Shadow FOMC Statement

Firstly I would like to thank the FOMC for allowing the creation of the Shadow FOMC. In these times of controversial monetary policy, it seems only prudent to have a loyal opposition. And with the increased importance of the Shadow Banking System, whose ranks have been swelled by refugees fleeing the forces of Genghis Frank and Khan Dodd, it is vital that said loyal opposition should be a Shadow FOMC.

We intend to issue quarterly statements, coinciding with the releases of the Light FOMC .

Release Date: September 19, 2014.

For immediate release.

Information received since the Shadow Federal Open Market Committee last met, which was never, suggest that the early universe rapidly expanded due to cosmic inflation. However, the expansion was disjointed due to quantum fluctuations. The effects of these imbalances continue to have a major effect on the universe, as they are the cause of all variation, including galaxies, planets, and the fractional reserve banking system. More recently, fear of another kind of inflation lead to mistakenly tight monetary policy during 2008, a key cause of the recession, from which the economy has now partially recovered.  Private Sector GDP is running at a trend rate almost as high as during the Clinton and Bush II bull years, though many analysts miss this due to a mistaken focus on total NGDP, which includes government spending at cost. Industrial production rose. The S&P500, which appeared on the verge of mass bankruptcy, is now at record levels, seeing a 30% rise in 2013. Unemployment, painfully high for a very long time, has started to accelerate downwards. Employment figures, however, have been very disappointing; partly because of demographics, many of the unemployed have simply given up looking for a job. Only recently have we seen the employment/population ratio begin to rise.

More recently, since the Light FOMC met in July incremental data suggests that economic activity is expanding at a moderate pace. On balance, labor market conditions improved somewhat further; however, the employment rate has only improved slightly and wage inflation is muted, suggesting there remains significant underutilization of labor resources. The minimum wage continues to distort labor markets, suggesting a need for higher inflation to reduce its effects. Household spending appears to be rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow. Restrained fiscal policy is encouraging true economic growth, although it is confusing accountants who mistakenly assume government spending is by definition useful activity. 10-year breakevens have recently fallen back to 2%, and 5-year breakevens are below 1.7%, slightly below the Light Committee’s longer-run objective. The US government has not issued NGDP-linked bonds, so we lack market implied growth figures, but trailing Nominal Private Sector GDP (NPGDP) growth has been trending around 5%, almost at our 6% target – and substantially closer than the irrelevant NGDP, which is closer to 4%.

If it was acting consistently with its somewhat misguided statutory mandate, the Light FOMC would not have initiated tapering, as low employment and low inflation both suggest a need for lose monetary policy. The Shadow Committee agrees that, with current mediocre policy, economic activity will expand at a moderate pace. The Light Committee thinks that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year, which is very strange, given that breakevens have fallen since then. Maybe the Light Committee could not afford a Bloomberg terminal.

The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions, but that this does not excuse irresponsible monetary policy. In light of the hugely reduction in the employment/population ratio since 2006, but improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to maintain the pace of its asset purchases. In October, the Shadow Committee will continue to add to its holdings of agency mortgage-backed securities at a pace of $10 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $15 billion per month. Both Light and Shadow Committees are maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that NPGDP, over time, is at the rate most consistent with the Shadow Committee’s mandate.

The Committee will monitor incoming information on economic and financial developments in coming months as closely as it can be bothered, and will continue its purchases of Treasury and agency mortgage-backed securities, until the outlook for the labor market has improved substantially in a context of NPGDP growth. If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and the Committee’s optimistic hope of NPGDP moving back toward its longer-run objective, the Shadow Committee will end its current program of asset purchases at sometime in early 2015. However, asset purchases are not on a preset course, and the Shadow Committee’s decisions about their pace will remain contingent on the Shadow Committee’s outlook for the labor market and broader economy, as well as its assessment of the likely efficacy and costs of such purchases.

To support continued progress toward maximum employment and price stability, the Shadow Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate, and suggests that the Light Committee might like undertake one, rather than merely talking about it. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 6% NPGDP growth. This assessment will take into account a wide range of information, including market indicators, what witty people say in our twitter feed, and patterns we see in clouds. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected NPGDP growth continues to run below the Committee’s 6 percent longer-run goal, and provided that longer-term NPGDP expectations remain well anchored.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and NPGDP of 6 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Shadow Committee views as more consitant with the fundamental level of human time preference, which implies long-run real rates of around 3-4%. Over the longer term, the Shadow remains concerned not only about technological stagnation but also about the risks from Superintelligent Artificial Intelligence.

Voting for the FOMC monetary policy action were: everyone, because of the Aumann Agreement Theorem.

Castle Consolidation as a raison d’être for the EU

People have given many (usually quite poor) arguments in defense of the EU. Perhaps this is because the EU is actually a quite poor quality institution. However, there is one argument for it that I have never seen considered in the literature: the argument from Castle Consolidation.

Castles are an excellent example of an industry fallen on bad times. Huge amounts of investment were poured into them a long time ago, but demand for their services fell over the centuries, as they were rendered obsolete in their primary market by new market entrants, like gunpowder and compacted earth forts. Regulatory change (the decline of feudalism) also hurt their profits. It’s safe to say that castles are no longer a worthwhile investment. Returns on invested capital¹ are low, which is why few private equity funds are building new castles.

There are a great many castles in Europe, all in competition with each other for tourists and film production. What the industry needs to do is consolidate; if it could get down to a smaller number of firms, they could collude to raise prices. Import threat is limited, because although there are some nice ones in the Middle East like Krak des Chevaliers, shipping costs are prohibitively high. Returns are currently so low that they have room to rise substantially before new entrants are attracted to the market. There is little room for substitution because castles are awesome.

English Heritage has already successfully consolidate most of the castles in the UK; what remains is cross-boarder consolidation. That, presumably, is where the EU comes in: as a castle cartel.

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1. If you’d like to learn more, I recommend Damodaran. ↩