How about a Cronyism Mitigation Index?

By Max Borders - August 2, 2012 | Tickers: DUK, GE, GM, GS, MRK | 0 Comments

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Crony capitalism or "cronyism" is finally becoming a household word. If you’ve never heard of it, cronyism is the practice of investing resources to secure favors from government officials -- rather than in creating more value for more customers. The effect of successful cronyism can be big corporate profits as measured by the balance sheet. But the costs of cronyism are almost always borne by customers, taxpayers or both.

Whether it’s a restaurant paying city leaders for protection from hot dog carts (competition), or a solar company securing half-billion dollar loan guarantees, it’s a truly destructive phenomenon when taken society wide. And it’s not always easy to spot.

Most of the time, investors make no distinction between crony companies and competitive companies. But as we move forward in an age where cozy relationships between business and government are increasingly commonplace, we should look at some creative ways to counter these wasteful, anti-competitive practices.

Bootleggers and Baptists

You’ve heard of “socially responsible investing” (or SRI), right? It’s a feel-good approach. You invest in companies that have gained laurels -- fairly or not -- under some vaguely defined idea like sustainability, consumer protection or diversity. Some of your ROI comes in a feeling of rectitude. Unfortunately, many who are into SRI are being duped into bankrolling one of the most insidious forms of crony capitalism -- the kind that’s done under a white hat.

Professor Bruce Yandle of Clemson University explains a counterintuitive idea:

Durable social regulation evolves when it is demanded by both of two distinctly different groups. “Baptists” point to the moral high ground and give vital and vocal endorsement of laudable public benefits promised by a desired regulation. Baptists flourish when their moral message forms a visible foundation for political action. “Bootleggers” are much less visible but no less vital. Bootleggers, who expect to profit from the very regulatory restrictions desired by Baptists, grease the political machinery with some of their expected proceeds. They are simply in it for the money.

Of course, any decent PR lackey can drum up a feel-good narrative. And most of the time there is some group of moralists (Baptists) out there willing to stand in the picket line so that the profiteers (Bootleggers) can game the system -- or worse, lobby to remake the rules. Socially responsible investors are often unwitting backers of Bootleggers and Baptists coalitions. 

Cronyism Mitigation Index

So what do we do about it?

I hereby propose an CMI -- that is, a “Cronyism Mitigation Index." (There could also be an associated fund.) Dimensions of the CMI could include annual metrics on a number of dimensions, such as:

• Cronyism Hits - Number of accurate media references to rent-seeking activities including (though not limited to) actions taken for subsidies, targeted tax breaks, corporate handouts (“incentives") or membership on various governmental advisory committees.
• Lobbying Dollars - Capital spent on non-defensive lobbying activities, such as introducing regulations or going after subsidies.
• Lobbyists - Number of lobbyists or lobbying firms in the company’s employ relative to market cap.
• Revolving Door - Number of former employees working for the government and/or the number of former government employees now working for said company.

Because the government extends into so many different sectors at such a great degree, it’s difficult to find any large, well-known companies that would fail to register on any CMI. But a CMI ranking would allow conscientious anti-cronyism investors to select companies that have a low ranking on the CMI relative to other countries.

Top Cronies

This is, of course, purely conceptual at this point. But if we were to imagine which companies might appear in such an index, one can’t help but think about:

1. GE (NYSE: GE) - From Jeff Emmelt’s appearance on President Obama’s advisory boards to securing big government contracts, General Electric must surely be considered one of the bigger cronies. As reporter Tim Carney writes: “By far, the top recipient of GE money last election was Barack Obama. Obama received far more from GE last cycle -- $458,730 -- than any candidate in history. The company was in the top 15 of Obama’s fundraising sources. He raised nearly five times as much as McCain from GE, and more than the top 25 Republicans, combined.” Carney adds: “No company spends as much on lobbying the federal government as does General Electric.”

2. Chrysler-GM (NYSE: GM)-UAW - James Sherk and Todd Zywicki report in the Wall Street Journal that “President Obama gave over $26 billion to the UAW—more money than the U.S spent on foreign aid last year and 50% more than NASA's budget. None of that money kept factories running. Instead it sustained the above-average compensation of members of an influential union, sparing them from most of the sacrifices typically made in bankruptcy.”

3. Goldman Sachs (NYSE: GS) - While they were not the largest recipients of bailout funds due to the financial crisis of 2008-09, they certainly score high on the revolving door dimension. According to Marcus Baram at the Huffington Post, “It seems that every few weeks, another Goldman Sachs executive goes to work for a government agency, with bankers landing in positions of power at the Treasury Department, the Federal Reserve, and pulling the levers of the massive trillion-dollar federal bailout.”

4. Merck (NYSE: MRK) - Merck is famous for its effort to lobby governor Rick Perry to mandate its Gardasil product among young women in Texas. But Merck also provides largesse to a mega-lobby called PhRma, which contributed over $150 million to lobby for the passage of Obamacare. If Obamacare is one big all-you-can-consume healthcare buffet, Merck could benefit to the tune of billions.

5. Duke Energy (NYSE: DUK) - This huge energy concern is what you might call a Bootlegger and a Baptist in one. CEO Jim Rogers has been interviewed in Rolling Stone talking about the dangers of climate change and the need for a carbon tax. Of course, Rogers would benefit from a carbon tax because Duke has a big nuclear portfolio. Apparently, he learned this tack from the best. Rogers “left Enron in 1988 for the electricity industry...,” writes industry expert Robert Bradley. “He became the leading political entrepreneur of the electricity business. Over the years, he sold his industry on cap-and-trade as a global warming policy strategy.”

There are some companies with integrity out there. I’d love to read examples of publicly traded companies that refuse to play “economic incentives” games at the state level, don’t lobby for regulations that will give them a competitive advantage, and don’t beg for subsidies or other forms of corporate welfare.

Then again, as Ice-T once said: “Don’t hate the player, hate the game.”

Max Borders is author of the forthcoming Superwealth: Why we should stop worrying about the gap between rich and poor (Fall 2012). Contact him here if you’d like to receive a notice when the book is out.

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