It’s Time to Champion Real Free Market Capitalism

By Eric Jackson

November 10, 2009

Market commentators and the White House have been quick to blame last year’s economic meltdown on a free market run amok. And they’ve used that false assumption to justify their unprecedented response of government intervention and increased regulation.

But we’ve never really had free market capitalism in this country. The last 30 years of America’s market system is better described as “mixed crony capitalism” – one part capitalism, one part government intervention through various programs, and one part corporate cronyism where officers and directors of big businesses pay themselves more, lobby politicians on both sides of the aisle and gain more power through favorable governmental regulations including mergers.

In such a three-way shared system, it shouldn’t surprise anyone that true free market capitalism always appears to be outnumbered by the interests of the government and corporate cronies.

For example, despite the billions in taxpayer dollars that have helped prop up a slew of “too big to fail” banks, and unprecedented government ownership of them, the powerful bank lobby has somehow convinced the current administration that little needs to be changed about how those banks operate. It’s as if the bankers and politicians are saying “let’s just call last year a mulligan and move on.” Not surprisingly, most of the CEOs and directors the banks that drove their institutions over a cliff are still in place.

If Standard Oil or Ma Bell existed today, it’s hard to imagine there would be the political will to break them up. Instead, politicians and their corporate donors would argue that what’s good for Ma Bell, GM, Bank of America, Citibank, or any other company is good for America. Politicians would never support programs that curtail spending, because it would give them nothing to go back home and talk about to get them re-elected.

There are many critical thinkers arguing why even more government intervention is needed today than ever before. Unfortunately, there are no critical thinkers arguing why our system needs more emphasis on free markets with clear “rules of the game” and less state involvement in our economy and less protections for corporate cronies. This paucity of ideas is something that greatly troubles me and other investors I know.

Milton Friedman and Ayn Rand are no longer around to argue for their vision of free market capitalism. Instead, we only hear alarmist libertarian rantings of Ron Paul or populist sloganeering to “keep the government out of our business” providing no clear direction for what changes should take place.

We need a renewed focus on the ideas of individual choice championed by Friedman and Rand. Both argued for a free market system built by entrepreneurship and small business and against abuse of power by “robber baron” CEOs. Government’s role in their eyes should be limited to police, defense, and the legal system. The importance of a market system following enforced rules is critical. The ideal market system the US should be striving to attain here is not Russia but Hong Kong.

The economic problems are country face are great, but they won’t improve by further deteriorating our federal balance sheet by short-term spending and tax breaks. Instead, we need to:

· reduce excessive government spending and restore fiscal balance to the federal and state governments

· break up companies that are “too big to fail” including the big banks

· force over-leveraged banks to undergo debt-to-equity conversions that allow them to get credit out to real entrepreneurs sooner

· bring back Glass-Steagall that separates commercial and investment banks,

· prosecute insider trading and other white collar crimes when they occur,

· get the government out of the business of setting executive pay in favor of giving shareholders more direct powers to remove directors not doing this appropriately and

· eliminate special tax breaks for homeowners and cars which only prolong the pain of an inevitable correction until later.

The heroes of free market capitalism are the entrepreneurs who create real value and real businesses. Those people are the antithesis of “fat cat” capitalists who ensconce themselves in money, power, with government protection. We need more people championing well articulated pro-market, pro-entrepreneurship policies in Washington.

Eric Jackson is Founder and Managing Member of Ironfire Capital and the General Partner and Investment Manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd.

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How to End Decoupled Executive Pay-for-Performance & Extravagent Perks

Over the past 2 weeks, I’ve criticized Yahoo!’s Carol Bartz and HP’s Mark Hurd for excessive pay and perks, given their companies’ recent performance. It’s been interesting to read the many emails I’ve received on the articles – mostly from employees of both companies.

A few emails – maybe 5% -- take the CEO’s side and make the case that paying our leaders a lot of money is part of our capitalist system. Their advice to me: get over it already.

However, the majority think it’s crazy that these leaders (more so Hurd because Bartz has only been there since February) have pushed through job cuts and slashed pay for workers and then pay themselves and their lieutenants gobs of money.

One reader who asked “why do people equate corporatism to capitalism?... Corporatism (what people ignorantly call capitalism today) transfers ownership of assets from the individual to the corporation. In pure capitalism, ownership of assets is predominantly held, and kept by, the individual.”

One reader asked me, expressing shock and outrage at how HP’s execs could be flying around on private jets for personal trips on the shareholders’ dime when she knew several former employees now in food lines, “how can this happen that these executives get away with this?” There are many to blame here.

Not many journalists or retail shareholders go through a company’s proxy statement in detail, reading footnotes on each page outlining executive comp. When mainstream reporters cover an executive’s new pay package (like Bartz’ back in January), they typically vastly understate it. Why? Quite simply, it takes a long time to read through and digest all the variables to tabulate a true likely scenario of what someone’s going to be paid over the next year or few years. Most journalists want to pump out a story and move on to the next one – or frankly aren’t trained in how to read all the permutations of a comp table.

If journalists aren’t able to read through these comp tables, is it any wonder that most retail shareholders can’t or don’t?

And, although the SEC has tweaked the requirements for how companies need to report this information, you can’t say the agency has nailed it yet, if the goal was for shareholders to be able to understand the information and act on it when necessary.

There is one group smart enough to know what’s going on in the comp tables, and is in a position to call out CEOs for egregious pay: the analysts who cover the companies. Yet, they won’t, because it doesn’t do them or their employers any good. Even post-Henry Blodget, analysts don’t get bonused for antagonizing CEOs with comfy pay packages. So, they keep their heads down, pump out meaningless price targets, and ask innocuous questions of management during their quarterly calls like “I wanted to get a little more color on your day sales outstanding,,,” or “what assumptions should we make about your tax rate for next year” and – my personal favorite – the obsequious pat-on-the-back “great job, guys.”

The few activist investors left are only going to poke the few companies that they take positions in. They’re not going to call out large numbers of CEOs – especially if they don’t have skin-in-the-game.

Larger institutional shareholders like Barclays Global or Legg Mason or some of the larger pension funds could take this issue on – and sometimes will raise their voice. However, these investors typically have hundreds of holdings. Is it worth their time and effort to stop and publicly criticize Mark Hurd or Carol Bartz? They also tend to shy away from having their comments in the press. So they’ll discuss their views during private chats instead – unfortunately keeping the CEOs self-serving practices from the light of public scrutiny.

Who’s left? Employees, who definitely have a vested interest in seeing a company’s shares increase and calling out internal practices that are hurting a company’s long-term prospects. But these people will not speak up publicly – understandably so – for fear of their jobs.

Then there are labor groups like the AFL-CIO and AFSCME – or Michael Moore for that matter -- who bring up excessive executive pay. Entrenched and overpaid CEOs and their aiders and abeters have been successful in portraying these groups as extremist and thus marginalizing them.

So, how will this problem of enormous executive pay that’s delinked to performance change? After all, we’ve been talking about this problem since at least the early 1980s and it’s never, ever changed. In fact, it’s only become more delinked.

As someone who strongly supports a free market capitalist system – not crony capitalism or ‘corporatism’ as the reader called it – I think it’s the responsibility of shareholders to speak up and put a stop to this. The SEC can help by changing regulations to make it easier -- and closer to a free market ideal -- for shareholders to remove entrenched directors who are not representing their interests in overseeing CEOs and management (such as the proxy access initiative being considered at the moment, which is an improvement over the status quo, but certainly could go further). Yet, it must start at the individual level, with each shareholder -- large or small – speaking up and making their voices heard.

Shareholders who assume they can free-ride off of what Gordy Crawford of Capital Research does (or Carl Icahn or Eric Jackson or whomever) will be playing right into the hands of Hurd, Bartz, and other CEOs who want us all to look away from all the pay and perks they’re getting – whether or not they perform.

I don’t expect employees to be martyrs and sacrifice the financial futures of their families by speaking out. But, with the Web, it’s become easier than ever for people to anonymously – yet with credibility and impact – share their views on a particular topic.

Shareholders also need to learn that, when you gripe about some fat-cat CEO on a Yahoo! Finance message board or a disgruntled employee blog, nothing changes. You have spoken as 1 voice only, and it’s been lost as soon as the words have left your lips. However, when you pool your voices together and speak as a group, it becomes impossible to ignore.

I hope that HP and Yahoo! shareholders (whether employees, retail shareholder or large shareholders), as well as other shareholders being extorted by crony capitalist boards and CEOs, start to channel their voices and put sufficient pressure on them to change their ways. Decoupled pay-for-performance (and extravagant perks) won’t change until shareholders rise up and say “we’re mad as hell about this and not going to take it anymore.”

[Jackson’s fund owns no shares in the companies mentioned in this article at the time of publication.]

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How Can a Free Market Capitalist be Against Management?

In response to my recent criticisms of Carol Bartz, her management team, and board at Yahoo!, I've had some people ask me "How can you be against management? Don't you support business and capitalism?"

When did it became assumed that anyone pro-management was pro-capitalist and anyone pro-shareholder rights was pro-socialist?

When I respond that I'm a free market capitalist in the vein of Milton Friedman and Ayn Rand, they seem surprised. I suppose they think that any CEO or executive would be a supporter of Friedman's conservative views - not a pro-shareholder person. Typically, on SEC votes, Republicans line up on the side management and Democrats on the side of shareholders. Isn't that the way it works? No.

I think that any individual -- CEO or shareholder (or Republican/Democrat for that matter) -- is self-interested. That's the whole basis of Friedman's views on the power of individual choice. Yet I don't think of most CEOs/boards/execs in America today as true free market capitalists -- at least in how they govern themselves and hang on to power. I think of them as crony capitalists -- not unlike the robber-barrons.

I don't think any of these individuals are inherently good or bad people, but they operate in a system in which they have found how it can be exploited for their self-interest -- especially when it comes to compensation and keeping the system for nominating replacements to the board as closed as possible. Welcome to Club Crony.

Since the beginning of the corporation, the board of directors was to have supposed to represent the will of shareholders. Yet Berle & Means showed that this intent quickly got side-tracked by management self-interest over the interests of the shareholders. The board was always supposed to take the long-view for the interests of its shareholders -- not do the work of management or make executives decisions by frequent referenda of shareholders. If the board wasn't taking the interests of shareholders in mind, the intent was to allow replacing directors until they did properly represent shareholders' interests. Both Friedman and Rand both recognized this.

Yet, in practice, what's happened is that board members became selected by CEOs (who often revamped the board when they took the job in order to be governed by "their people"). If I put my friend on the board, then promote him to the Compensation Committee, he might qualify for whatever definition of "independent director" you like, but he's still going to be my buddy and probably more generous to me in my compensation than if he was some 3rd-party.

Besides picking my directors to govern me as CEO, I can influence the compensation they receive. Therefore, if I wish, I can ensure they get paid a lot. If they're happy with receiving a lot of comp, maybe they will keep paying me a lot. It becomes a mutual admiration and back-scratching society.

The slate of directors runs every year unopposed. Most shareholders (especially retail) are apathetic and don't vote anyway.

If a shareholder wants to run a proxy contest against us, they have to pick up the tab for doing so, while we can use our shareholders' money. If a shareholder wants to sue us, our D&O insurance protects us from any liability (paid for again by shareholders) and the shareholders will also pay our top drawer NY lawyer fees.

This wasn't how it was supposed to be. Management's insulation from being held accountable to shareholders promotes waste, not efficiency; mediocrity, not innovation; wealth-destruction, not wealth-creation.

The solution before the SEC on proxy access isn't perfect, but it will probably do more to bust up crony capitalism and promote truer free market capitalism than any other piece of regulation they've introduced in the last 30 years. Let's hope it passes as is.

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