Trump’s tax: one budget buster and one revenue raiser [Financial Times]

Donald Trump’s campaign to become the next president of the U.S. has thrown up two far-reaching proposals to reform the taxation of corporate profits: reducing the tax rate on domestic profits to 15 per cent, and taxing foreign profits of U.S. corporations at 15 per cent each year.

The first proposal, a budget buster, is a poorly designed way to tax business; the second proposal, a revenue raiser, is a reasonable way to fix the current system for taxing foreign profits.

The current tax rate of 35 per cent is almost the highest in the world, so it should be lowered to make the U.S. a more competitive location for corporate facilities and jobs.

Read the rest at brookings.edu…

A Nobel Idea to Pay CEOs What They’re Actually Worth [Wall Street Journal]

Next month, Bengt Holmstrom, a professor at MIT, is slated to accept a Nobel Prize in Economics for his pathbreaking contributions to contract theory. Congressmen and corporate boards might want to take note: Mr. Holmstrom’s innovative proposal for indexed stock options, which aren’t yet widely used, could be one solution in the running political debate over whether CEOs are fairly paid for performance.

Almost all stock options today have a fixed exercise price: The holder buys the company’s stock at the market price on the day the options were granted. The idea is to align the interests of CEOs and their shareholders. If the stock rises, the executive buys at the old price and makes a profit. On the other hand, if the company’s stock is flat or down, the options become worthless.

Unfortunately, as Mr. Holmstrom pointed out in 1979, fixed-price options can easily reward poorly performing executives during times of rising markets. Suppose a drug company grants 50,000 options to its CEO with an exercise price of $100 a share. If in three years the stock rises by 30%—to $130 a share—the CEO exercising his options would make a profit of $1.5 million.

Sure, sometimes this profit might reflect the outstanding work of this CEO. But suppose the stock prices of comparable drug companies rose by 60% on average during the same three years. Suddenly the CEO’s options look like a windfall instead of a reward for his superior managerial skills.

Read the rest at brookings.edu…

Corporate Boards Need to Abolish Mandatory Retirement [Real Clear Markets]

The resignation under duress of the CEO of Wells Fargo, after being pummeled in a Congressional hearing, raises a fundamental question: how can corporate boards hold management accountable for performance problems? One trendy answer from several governance mavens — limit the terms of independent directors so they do not become unduly deferential to the CEO.

The most typical limit on independent directors is mandatory retirement at age 72. This is the tenure limit for the Wells Fargo board. It is a significant limit because most directors do not join large company boards until age 60.

The tenure limit for independent directors is even stricter in UK. After serving for 9 years, a director of a UK public company will not be considered independent unless the company makes a special disclosure justifying longer service for that director

However, I believe that these uniform limits on director tenure are counter-productive. By relying on these automatic rules, boards may get stuck with a relatively young director who is not making a significant contribution to managerial oversight. Meanwhile, these many directors with valuable expertise and real independence are forced to leave boards at age 72 or after 9 years.

Read the rest at realclearmarkets.com…

In defense of corporate quarterly reports

Executives, fund managers and even politicians have criticised publicly traded companies’ undue focus on generating profits in the next quarter instead of making investments with good five-year prospects.

To encourage these companies to take a longer-term perspective, several regulators have shifted corporate reporting requirements from quarterly to semi-annually.

Most prominently, in 2013 the European Commission amended its Transparency Directive to abolish the requirement for quarterly reports by publicly traded companies in favour of semi-annual reports.

After an impact assessment, the commission concluded that “quarterly financial information is not necessary for investor protection”.

But a recent study severely undermines the commission’s conclusions.

Read the rest at brookings.edu…

Is the Bond Market in a Bubble? [Wall Street Journal]

Bonds issued by governments and companies are priced high these days. In the seesaw relation of bond prices to their yields, prices are up, and yields are smacking hard against the ground, at record lows.

Investors, wary of stock valuations and looking desperately for yield, have poured money into bonds and bond funds.

There was a brief scare in September when bond prices suddenly fell over concerns that the Federal Reserve and other central banks might end their “easy money” policies.

But that pullback quickly vanished, with investors convinced that the Fed will move slowly in eventually raising rates. Bond prices recovered.

So, are we left with a valuation bubble that will burst, as tech-stock investors experienced more than 15 years ago? Or are the worries merely another false alarm, which bond investors have heard before for many years?

Robert C. Pozen, a senior lecturer at MIT Sloan School of Management and former mutual-fund executive, argues that the situation is verging on a bubble as yield-hungry investors are gravitating toward riskier bonds. Guy LeBas, chief fixed-income strategist at Janney Montgomery Scott in Philadelphia, says he doesn’t see the credit excesses that would qualify this market as a bubble.

Read the rest at wsj.com….

US money market funds: the gain isn’t worth the pain [Financial Times]

Next month the new rules of the Securities and Exchange Commission (SEC) will become effective for money market funds (MM funds).

Most importantly, MM funds with any assets from institutional shareholders – e.g., corporations, pension plans and insurance companies – will no longer maintain a constant net asset value per share of $1. Instead, the net asset value of institutional MM funds will fluctuate on a daily basis – for example, 99.8 cents per share on one day, and $1.01 per share on the next.

The new SEC rules apply to institutional MM funds investing in short-term debt of cities and states – called “municipal” MM funds. The new rules also apply to institutional MM funds investing primarily in short-term debt of banks and top-rated companies – called “prime” MM funds.

However, the new rules do not apply to institutional “government “ funds — investing almost all their assets in short-term debt issued by the US Treasury or federal agencies, loans backed by such debt or cash.

Read the rest at ft.com…

Negative interest rates are counterproductive [Brookings Institution]

Central bankers in several countries have entered the “neverland” of negative interest rates in an effort to promote economic growth and boost price inflation to 2 percent per year. These countries include Denmark, Switzerland, Sweden and Japan as well as the European Central Bank.

These central bankers apparently believe that negative interest rates will motivate consumers to save less and spend more. In turn, higher consumer spending will allegedly induce companies to invest in new products and facilities — thus, promoting economic growth and raising consumer prices.

However, negative interest rates have so far not produced the desired behavioral changes of consumers or companies. While there are many possible explanations for these non-results, I believe that many central bankers have underestimated the adverse psychological and political effects of their unusual monetary policies.

Read the rest at brookings.edu…

Retirement healthcare could bust the budgets of many US cities [Brookings Institution]

While the deficits of public pension plans have been widely discussed, much less attention has been given to the obligations of US local governments to supply healthcare for their retired employees.

The unfunded liabilities for retiree healthcare for the 30 largest US cities exceeds $100bn, according to the Pew Charitable Trusts, a Philadelphia-based non-profit organisation. The unfunded liabilities for the 50 US states exceeds $500bn, according to Standard & Poor’s, the rating agency.

Retiree healthcare plans are uniquely American. They exist because the US has never offered universal healthcare before Medicare, the national social insurance programme, at age 65.

Many employees of cities and states retire between 50 and 55, so local governments usually provide them with highly subsidised healthcare between retirement and Medicare, and sometimes beyond.

Yet retiree healthcare plans of local governments, on average, have less than 10 per cent of the funding they need to meet their future obligations. By contrast, if a public pension plan were less than 60 per cent advance funded, it would be considered to be in dire straits.

Read the rest at brookings.edu…