maryland smoking ban

let me begin by making it perfectly clear that i hate cigarettes only slightly less than the people who smoke them. they disgust me so much that i can almost see the logic in the maryland legislature’s proposed smoking ban. almost, but not quite.

the bill’s legislative backers will tell you they’re protecting the innocent from the dangers of second-hand smoke. now, i’m fairly certain they’d accept the praises of voters who want unabashed paternalism and are out to ban smoking in all its forms, but let’s take them at face value.

the problem with their argument is that non-smokers do have a choice. it’s a tough choice, but you can always just not hang out in bars. i’m actually selling it a bit short, because there are some bars that don’t allow smoking (even some nice ones like our local “red maple” on charles).

there are clearly benefits to the ban, but i seriously doubt they’d outweigh the costs of trying to legislate it. this law’s impact on overall smoking will most likely be negligible. smokers will smoke outside, at home, in their cars, and pretty much anywhere they want to besides public buildings, bars, and restaurants. at the same time, smokers will spend less money at bars and tip less, which will hurt those business owners. and though smokers will save a little money, they are denied one of their pleasures, making them less well-off.

but perhaps the biggest problem is that after all the sound and fury, things probably won’t change that much. there will inevitably be some exception to the rule, into which all bars and restaurants will crowd.

just look at what happened when virginia tried to shut down all its bars. their law excepted establishments who derived a certain percentage of revenue from food sales, so guess what happened? for every bar that shut down there was a restaurant that added a bar, and the bars that survived just added a restaurant. in fact, some of them run their food operations at a loss, just so that they can meet the revenue requirements and keep their bar running. obviously, the profit on alcohol (which is inflated due to regulation) more than makes up for that loss.

so, the best we can expect to get out of all this hoopla is that every bar will start selling discount tobacco products, and every tobacco shop will open a bar.

well, at least we know that our legislature's trying to nanny us to death, even if they fail at it. and maybe that's not so bad. after all, it's the thought that counts.

backdating: hype, not harm

the latest scandal du jour is options backdating. judging by the media coverage, you’d think it was enron take two, and leading the charge are the usual suspects: plaintiff’s lawyers, the s.e.c., and the i.r.s. unfortunately, only one of them has good reason to sue. doubly unfortunately, it’s the i.r.s.

plaintiffs’ lawyers and the s.e.c. both claim to represent shareholder interest, but a little help from our old friend economics shows us that shareholders aren’t the least bit affected by options backdating. in fact, they want backdating because it saves them tax money.

let’s start, as per usual, with the basics. companies like to grant options rather than giving stock outright because their value is tied more closely to the future than the past. an option only has value only if the stock value goes up, whereas granting stock outright would reward the employee even if the stock price goes down. backdating occurs when the company gives employees the right to purchase stock at a price from the past that is lower than the current market price. for example, an option grant that allows you to buy ten shares of stock for $10 when the shares are trading for $10 would be worth nothing. however, if we chose a past price, say $5, the options would immediately be worth $50, since the employee could buy them for $50 and instantly sell them for $100. such options are called “in the money,” for obvious reasons.

but we all know that money doesn’t grow on trees, so where does it come from? two out of three plaintiffs answer “shareholders,” but is this really true?

back to basics. a stock’s value comes from two parts, present and future assets and dividends, which are simply what the company owns and earns. when an in-the-money option issues, two economically relevant things happen.

first, the pool of assets and dividends gets split more ways. for example, let’s say there are 100 shares of that $10 stock outstanding, so that the company is worth $1,000. when the employee exercises his $5 options, the company gets $50, but there are now 10 more shares, so each one is worth $1,050 ÷ 110, which is about $9.55, for a loss of 45 cents. now, before you scream bloody murder, think about the fact that this is public information. shareholders knew full well that the company could hand out authorized shares at any time, and they fully expected it to do so in order to reward its employees. so, whatever price they paid for their stock included a tiny discount to reflect this possibility. so much for that supposed rip-off.

second, we have to “account” for the fact that the company is forgoing the full market price for its shares. again, though, you have to ask whether this really matters to shareholders. sure, the company could have gotten another $50 from its employee, which would have kept things even-stevens at $10 a share. but in reality, forgoing $50 is exactly the same as paying $50 in salary.

some people are all riled up over the fact that companies are restating earnings to reflect these options grants as salary expenses, but any savvy investor knows that those entries are just for bookkeeping purposes. without getting into the merits of options expensing, leave it to say that your money managers get paid to weed out those entries from what really matters.

once you cut through all the hype, options turn out to be an investor’s best friend, since they’re taxed as capital gains at 15%, rather than income at an undoubtedly higher price. this means that the company can save on payroll and create extra shareholder value.

so, in the end, the only one getting bilked here is the tax man. no wonder they’re getting persecuted.