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Alan Cring Productions in association with Emergent Light Studio presents the Illinois State Collegiate Compendium, academic lectures in business and economics.

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This is business finance, FIL 341 for Autumn Semester 2024.

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Today, corporate governance. This is a topic and I have a special PowerPoint presentation that is a major part of this lecture.

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And I will upload that. It's called, the PowerPoint is called Agency.

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And it will be in your file, in Canvas, your files, PowerPoints.

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And it will be there along with the chapter PowerPoints, but it's not one of them.

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It's one of my own. I've produced it, I produced the original years ago.

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And I have augmented it and added to it and modified it over the years.

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But it is definitely a must read set of PowerPoints.

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And it helps you with some of the terminology because in this lecture I will go kind of just push past words and terms.

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I'll say this is this, this is this.

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So the PowerPoint will help you if you don't get everything written down that I say.

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It's a large subject and it's become very hot.

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The whole thing about corporate governance has become so hot that professors, especially in finance, who are specialists in corporate governance, are now being kind of a thing.

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We just hired a professor two years ago, I think it was, or last year.

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She is, her specialty is corporate governance.

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That gives you an idea. We're paying for this kind of knowledge base in academia.

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And their companies are really serious about this, very serious in fact.

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But we'll get into that in just a little bit here.

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First we have a look at the numbers.

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And as you can see, there's nothing important going on.

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It is a dead as a doornailed kind of day here on Wall Street land.

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Now interestingly enough, just going through, obviously these numbers that you're seeing, the Dow is down about a quarter of a percent.

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The S&P 500 is up a quarter of a percent.

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The NASDAQ is the only one who's really showing much life, and that's not much life, at three-quarters of a percent.

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So there's not a lot of movement.

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Now here's something interesting about, let me hit crude oil here.

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For those of you who want to get into a life of commodities trading and all of that.

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Now crude was pushing upward.

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Generally that would be considered a war premium.

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Not a high probability of war, but the price had broken back into the 72 and above range.

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And so that was more prospect of a war, especially between Israel and Iran.

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Well interestingly enough, well, last week, late last week, Israel bombed the whoopee doo out of Iran.

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Just bombed the hell out of its war-making facilities and a lot of other things.

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And at first that caused the price of oil to surge.

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Because Iran's obviously going to turn around and escalate the war back.

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But then as I began to get the picture from some of the traders that I know, at first it surged it.

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But then the price of oil, as you can see, well, hell's bells and pigeon poop.

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Then the price of oil began to fall.

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And now it's fallen clear down to about under $68 a barrel.

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Well what the hell is that about?

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Commodity traders said, look, Israel has crippled Iran's ability to wage war.

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That means we now have a lower probability of a war.

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So the war premium is shrinking on this attack that Israel did on Iran.

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And it makes sense.

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But then another thing happened.

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Did you see this spike this morning in oil?

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That was because a news story came out that the White House was ordering the strategic reserve,

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our oil reserve of millions of barrels of oil to be replaced.

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Because it had been drained to get gas prices down a couple of years ago.

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So it was going low.

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And so this announcement that the government was going to refill it, that was the expectation.

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Demand would go up for oil because the government was stepping in to buy a ton of it.

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And then that would drive the price up.

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So you see that spike this morning.

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That was that expectation.

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And then the commodity traders came in and said, first of all,

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that's a very small amount of oil that is in the strategic reserve compared to how much there is out there.

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Second of all, they're not going to buy it all.

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Once they're not stupid, they're going to do it incrementally.

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So that it does not impact the overall demand very much.

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And it does not adversely affect the overall supply very much.

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So calm down all you crazies.

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And then as you see, once it began to be clear, as that information began to get processed more deeply,

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well, the price of oil, the barrel price of oil began to sag back down.

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So there's a lot of dynamics that go on here.

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That's one of the reasons that commodity traders love what they do,

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because you're dealing in a world of physicality of these things that you're trading.

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But also you're in geopolitics.

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You're in classic economic theory, supply and demand dynamics.

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So you've got everything you could possibly want if you are a geek, a trading geek.

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So that's not to say that I promote that,

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but I do have some former students who have gone to work as commodity traders,

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primarily at ADM, Arthur Daniels Midland.

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I mean, the pressure of the job is just sky high.

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And they are paid more than they're paid almost as much as God is paid.

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They make a lot of money just right off the bat.

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They make money.

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And the only downside is that ADM is located in Decatur.

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And so that means that you would have to, if you want to work for ADM, you'd have to live in Decatur,

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which is basically saying you have to live in hell.

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If you don't know what Decatur is, that's good.

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You don't know what Decatur is.

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But if you do know what Decatur is, you know you don't want to live there.

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Well, I do.

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You know, I've got a trailer and I can find a couple of three-legged dogs and all that.

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But anyway, it is a lifestyle of some finance majors.

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They get into it.

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They like it.

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Others say FTS and they get away from it.

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But it is something that you can do.

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Oil, wheat, hog bellies, gold, treasury bills, anything in the world.

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Not treasury bills.

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Well, yeah, actually they do for some hedging, I guess.

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But I don't know that for a fact.

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But anyway, that's enough of that promoting another one of our odder fields most people don't think about.

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Now, if we go over here, you see the 10-year bond.

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It's doing the kangaroo right now.

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It's bouncing up and down and up and down.

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Here's something that I finally found out.

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Okay.

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You've got all these days when the price of bonds is going down.

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That means because the yield is going up.

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Okay.

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If the price of bonds is going down, that means the bond investors are selling their bonds.

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So that drives the price down and that drives the yields up as we're seeing here.

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Okay.

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So what the mystery is, okay, they're getting funds by selling the bonds.

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So that should flow over into equities because you've got money to spare.

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You buy some stocks.

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But yet we don't see any major surges in the equities prices.

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S&P 500, Dow, Nasdaq, they're just as likely to go down as they are up on a given day.

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Plus the other uncomfortable part about this is these unholy, light trading volumes we see.

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Look at this today.

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We are well our way to the end of trading today.

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Only a couple of hours left on it.

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And yet we have the average over the past year has been 3.8 billion shares of S&P 500 stocks.

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Today we're right now clocking in at a blistering 1.4 billion south of 1.4 billion.

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We probably won't make it to 2 billion by the end of the day.

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Where the hell is the trading?

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Why?

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Because if there's funds flowing out of bonds driving bond prices down, bond yields up.

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And yet you don't see active trading in the heavies.

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The number of shares is just very thin trading.

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So where the hell are the funds going?

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Well, my reaction was, well, they're just putting it into money markets,

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holding it there until they see clear direction.

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You've heard me say that.

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Well, I found out something that I did not know.

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I was today years old when I found out where the money is going.

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It's going into CDs, certificates of deposits, one to three year.

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That's where it's going.

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You look at the volume of CDs, and I'm not talking about the CDs.

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Well, I put $500 into a one-year CD, substantial interest penalty for early withdrawal,

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but boy, I put my money.

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No, that's not the CDs I'm talking about.

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I'm talking about certificates of deposit, the big ones, $50 million, $100 million, $500 million.

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Those are the CDs that are being invested in.

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This money is not going into money markets where you get high liquidity.

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This is going into CDs, which are somewhat longer hauled.

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In other words, this money is not going to come out of there tomorrow when the sun shines.

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It's packed away in crates that do not open for one to three years.

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So there is not going to be a major flood of liquidity flowing back into the equities anytime soon.

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It's going to stay like this.

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And what's going on here?

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The general consensus is that there's going to be a period we don't know what the F is going to happen

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for the next year to three years because we've got so many situations happening globally,

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and we've got political instability in the United States as well as the rise of extreme right-wing factions

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to parliamentary and leadership positions in Europe, Orban in Hungary.

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The neo-Nazis took a number of parliamentary seats in Austria.

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They've been trying for years, and now here they are.

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In Germany, they're coming on strong.

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So you've got political instability like we haven't had since the 1930s.

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You also have the Middle East situation.

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You have Russia and Ukraine bombing the hell out of each other.

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They're putting their money away for a slightly longer time until all of this shakes itself out.

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That's what I'm hearing.

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And this is after a period of time, one thing that I do encourage.

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You're going to be in finance.

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Wire yourself.

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Get to know people.

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Find those you can connect with.

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They might know something you don't.

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You might know something that they don't.

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You begin to be an information animal because that's all we live on in finance.

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We don't live on these commodities.

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We don't live on those stocks.

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We live on the information that drives our prices.

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So keep that in mind.

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Get to know some people.

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Or become a professor like I am, and you get to create the people so that you get to know them better then when they go out there.

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Forty-four years has to have been good for something here.

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Let me show you the rest of this here.

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Seriously, okay.

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Let me go.

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For God's sake, all your ads are just tedious.

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No one looks at them.

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Okay.

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Now, the Nikkei actually had another one of those days where it spikes up and then it just floats.

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You see this over and over again.

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Sometimes it spikes up at the opening bell.

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In this case, it ramped up.

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It actually spent maybe an hour ramping up.

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But then once it had finished this ramp up, it just sat there and lived in the dream for the rest of the trading day over in Tokyo.

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As you can see, it finished up three-quarters of a percent both sides.

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Well, that's wonderful.

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But all of that happened in the first hour, hour and a half of trading.

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The rest of it was just nothing else to look at probably because Tokyo is on its market,

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it's running when the rest of the world is asleep in Europe and the United States.

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So I don't know. That's part of it.

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London tried to start a bull rally, but it just slid off into the oblivion on the FTSE 100.

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London is just most of these European markets are in something of where we are.

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There is a deepened level of just basic uncertainty.

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I mean, the funny thing is that you are coming of age in a world that's quite different from what would have happened

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if you had been coming of age in like the 80s or especially the 90s where everything was cruising upward, everything looked good.

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And then it began to get its turbulence at the beginning of the 21st century.

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And we really never have had that certainty of the future like we did back in the 90s.

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But now it's even more toxic. Looking very quickly here at the VIX, it's probably slow right now.

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Look at this. It's red because for the day it's been down.

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But do you see how there was volatility building and it spiked and then it just dropped off the face of the earth about midday?

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No, no, no. That would have been early this morning is when it dropped off.

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VIX is a futures market. Futures markets don't have the same clock as stock markets do.

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So the VIX has its own and at about just, well, that's kind of interesting because it was a little,

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looks like it was a little before the opening bell on the stock market.

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Suddenly the volatility in the market just went away.

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Very much like the weather. As a matter of fact, the dynamics, the physical dynamics, they are very similar.

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The equations are. And here we go. It just dropped off the face of the earth like a storm building.

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And then there was the thunder and then it just went away. And that's what you see here.

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You're going to get that feel that this is very much just a physical dynamic system.

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This is fluid dynamics in action. So you're almost partly meteorologist, I guess, in here.

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So in other words, the uncertainty is off. But that doesn't change the underlying edginess of the markets themselves.

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Any certainty that these traders are going to have, these investors I should say,

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is going to come from knowing that their money is now in a safe, comfy little house called CDs.

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That's where their comfort will come. That's where their greater level of certainty, their decrease in uncertainty will come.

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We're stashing our money away. It's safe now. We're okay. And that doesn't mean much for the stock markets though.

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But now another thing I should point out is that earnings are just pouring out right now.

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So that's just going to be one of those things over the next few weeks as we get to the end of October, the beginning of November.

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You're going to see stocks jumping up, dropping off the face of the earth as the announcements of the earnings

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are compared by the traders to what the estimates were that the companies had made for them.

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So for example, and I showed you this one last week, Intel, it is INTC.

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It is forecasting that we'll have a slight earnings loss for the quarter three.

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And we can see what the market thinks about that. They're thinking that that estimate is too optimistic.

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They're thinking, if you look down here, they're thinking that their estimate is down here at a slightly negative.

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They are thinking that it probably will be a little worse than that.

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And that's why the rumors are driving the price down.

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But you can see, well, we'll see what happens as we get closer to the earnings date.

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This will become a little bit more dramatic and we'll just have to see if Intel comes in.

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Even if it comes in right at the earnings that are projected, that will bring the stock price back up a little bit

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because the sentiment now is that they're going to get earnings that are worse than their forecast.

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So if Intel comes in at, it hits its earnings estimate, that will cause a pop, even though it would be negative earnings.

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If Intel comes in with anything positive as far as earnings go, that will really cause an upward jump in the stock price.

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That will be against the market expectations.

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If you go over here to a few other ones, another one that's a really small cap, Rivian.

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Why does this suck?

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Did I unplug something?

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Huh.

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R? Well, why does my keyboard suck right now?

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Oh, it's probably because I unplugged it, yeah.

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As a matter of fact, I got it caught in the stupid wheel.

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Oh, this is going to be fun.

241
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Ow, that hurt.

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What did I do that I'm going to have to blame one of you for what I did?

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Okay, I've got it.

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There. Now.

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Don't bully me.

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Okay.

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Oh, okay, good. Apologies for that.

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Rivian, R-I-V-N.

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It's taking a bath.

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Its earnings come out on November the 7th, and it is projecting that it's going to have a real jump in its earnings.

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The market's saying, bullshit, you're going to have bad earnings.

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And so the market is adjusting for an earnings, the actual earnings being considerably less than what Rivian is estimating they will be.

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Now, again, if Rivian comes in near or at its target, that's going to cause Rivian stock price to surge up.

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This is the kind of thinking that we do. Probability.

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Okay, the market, you don't fight the market.

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But right now, the investors are thinking that Rivian is going to have really sucky earnings.

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Maybe you have a better analysis and you think that they're going to come in on target or at least close to target,

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in which case you would do a swing, just grab the stock a couple of days before the earnings report and see if they actually pull it off,

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unless you really think that the investing community is right about them, which it probably is.

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But this is the kind of thinking that we do in this.

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Now, again, you could go in, see who's calling earnings in the next week or so.

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That's where the action is going to be.

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That's where you could actually make some money if you want to run contrary to what the market sentiment is,

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or you could lose some money doing the same thing, fighting the consensus.

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So there you go.

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Okay, let me take this off the board.

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This is corporate governance.

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Now, corporate governance is more or less the set of laws, rules, and policies that influence a company's actions, both financial and operations.

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Now, corporate governance covers both sides of it, operations side of it and the financial side of it.

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Corporate governance begins at the very top, and this is where the action has been happening,

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recently.

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There are challenges, let me put it this way, challenges to the old ways of corporate governance.

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There's always been corporate governance, but those old ways of corporate governance are, to some extent,

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they are inconsistent with the 20th, 21st century.

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And you have, finance, we are conservative, not necessarily politically.

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We can be liberals politically, but in terms of corporate governance, we have a conservative part to us.

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As I, my old Kentucky relatives, when they saw something new, they, they, I literally, they'd sit back and say,

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might be right for some, but it ain't for us, God-fearing folk.

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That's almost the idea that you have in corporate America.

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And we have been burned when we try to quickly move policies, governance policies, even marketing campaigns.

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When we move too quickly just because of a fad, you're probably, we see these spectacular examples of that

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really turning sour, and that makes us run back to our conservative positions.

283
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Well, we don't, we're not going to change anything after that.

284
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FTS, we're not going to do any more changes.

285
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And obviously Budweiser was a good example of that.

286
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Target even got, ended up being a good example of that.

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We've seen that there's been a pullback from DEI, a rather hard pullback from it.

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The question is, where is the balance between maintaining the old ways that have worked so far

289
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and still being progressive enough to embrace a new century and all of the things about that new century that are new?

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Our workforce is much more diverse than it was a long time ago.

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It really is.

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And our workforce is also very much different in terms of its educational level,

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in terms of its social awareness level, and all of those things.

294
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So we can't just reel back to 1950 when we had things much more stable.

295
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It's we're moving forward too fast now.

296
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We're plowing into the future.

297
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How do we do that in corporate governance?

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The first thing that we have to appreciate is that in this world, it's going to start at the top, at the board of directors level.

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That is where everything flows.

300
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And we have to recognize that changes must be made.

301
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We can pretend that we don't have to change, but the world is going to tell us differently.

302
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A good example of that is companies that move to multinational status.

303
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In Europe, the governance of the corporation at the board level is shockingly, in some ways,

304
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quite different from what it is here in the United States.

305
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There are laws that impose strict requirements on the board of directors.

306
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One of those laws is that it must have a significant representation of outside directors.

307
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In other words, directors that are not connected with the company.

308
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They give a more objective look at it.

309
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And in Europe, you have to do it that way.

310
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Another thing that would be shocking here in the United States is that you must have a government representative on the board, a board member.

311
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You have to have one.

312
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And that makes for a rather interesting situation if your board is going to do naughty things,

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and you've got the government right there watching them, well, you're probably not going to do naughty things.

314
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You're not even going to think naughty thoughts.

315
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You're not even going to watch My Little Pony with evil motives.

316
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My Little Pony isn't wrong, man.

317
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But look, this is something we would say, oh, you're restricting our freedom.

318
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And that's something that we have to deal with on a larger level.

319
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There's a big thing now about freedom of speech, freedom of speech, and all the Constitution and shrines that we can say whatever we want, that is false.

320
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The Constitutional law is very clear that no, you can't say whatever you want.

321
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And it makes a very clear distinction between speech that is protected and speech that constitutes behavior.

322
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And so we are still in corporate America in this thought that we're allowed to do anything we want.

323
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And recent Supreme Court rulings have reinforced that, but it won't last for long,

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especially in a global environment where our big competitors have very different ideas of how boards of directors work

325
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and what constitutes freedom of action in a free enterprise environment, in a market environment.

326
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So let me get on from there and give you a couple of pointers.

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First thing first, where is corporate governance changing right now?

328
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Well, the idea of outside directors is beginning to get really, get into the stream.

329
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You don't want some idiot coming in from the outside and being a board of directors, a board member.

330
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You do want people who are intelligent, well-educated, connected, and all of that.

331
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So it's a balancing act, but we do see that that is corporate governance is changing in that way.

332
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And there's kind of a question.

333
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If a corporation does not want that significant presence of outside directors, what the hell are they trying to hide?

334
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You're afraid to have people who aren't connected to this company?

335
00:29:59,000 --> 00:30:02,000
Are you afraid that you won't have a good old boys' network?

336
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Okay. Another part that has changed to some extent, and this is taken out of the, I'm taking this away from DEI.

337
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In the corporate governance world, diversity is actually happening in boards of directors.

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It's beginning to stir in.

339
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People of color, women, people of different types of belief systems are beginning to kind of, are showing up on boards of directors.

340
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We really have to.

341
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If you're running a corporation that most of your sales are to people in the United States, well, guess what?

342
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Our population distribution is changing in terms of age, color, and faith, and all of that.

343
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Well, we better have a corporation that reflects this.

344
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So there's a driving motivation behind this.

345
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Another thing that is interesting, too, and this is something the book brings up,

346
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and it's almost like, well, this has been the law for more than a century, well, for almost a century, interlocking directorates.

347
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In other words, it is actually illegal to have two companies in the same industry that are supposedly competitors

348
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that have directors from one on the board of the other.

349
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That's enshrined in law, and yet it happens all the time.

350
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And that's something that we have got to shake out.

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For one thing, the power of competition cannot be understated.

352
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Everyone has this, there's this bad mentality.

353
00:31:46,000 --> 00:31:54,000
Well, the founder of modern economics, Adam Smith, said free markets are the best.

354
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He said no such thing.

355
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He said competitive markets are the best, where you are fighting for every dollar that you get.

356
00:32:04,000 --> 00:32:06,000
You need efficiency.

357
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You need to use resources at the lowest level possible.

358
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You need static efficiency, and all through time you are constantly engaged in dynamic efficiency.

359
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Remember from the first lecture I talked about those?

360
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Well, here we are.

361
00:32:21,000 --> 00:32:28,000
You see, competitive markets, you don't need directors from two competitors on each other's boards

362
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because you don't have competition anymore, and that's something that we've got to shake back out.

363
00:32:33,000 --> 00:32:41,000
And unfortunately, that may require a few major high-profile lawsuits against ginormous corporations

364
00:32:41,000 --> 00:32:45,000
where basically you're breaking the law.

365
00:32:45,000 --> 00:32:50,000
Yeah, go out there and cry crocodile tears about, oh, the government is trying to control us,

366
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and we don't want to be controlled, you don't want to be controlled, we don't want to.

367
00:32:53,000 --> 00:32:54,000
Bullshit.

368
00:32:54,000 --> 00:32:57,000
It's law, and it's a good idea.

369
00:32:57,000 --> 00:33:01,000
And so some companies are actually beginning to shake out that interlocking.

370
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They're beginning to take it out.

371
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And especially corporations that, you've got to ask yourself,

372
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okay, this corporation over here is our competitor, and we've got his director on our board.

373
00:33:13,000 --> 00:33:16,000
What the hell are we getting out of that?

374
00:33:16,000 --> 00:33:18,000
We're not getting anything out of that.

375
00:33:18,000 --> 00:33:20,000
They're getting something out of that.

376
00:33:20,000 --> 00:33:25,000
And if we have a major advancement in our technological know-how,

377
00:33:25,000 --> 00:33:30,000
why are we going to have a board meeting where that son of a bitch hears about it?

378
00:33:30,000 --> 00:33:34,000
Where our board member over there is hearing about the same old same old,

379
00:33:34,000 --> 00:33:40,000
their director over here is hearing about all these new cool things that we're doing.

380
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So companies are beginning to think, this isn't such a good idea after all.

381
00:33:46,000 --> 00:33:47,000
Okay?

382
00:33:47,000 --> 00:33:54,000
Now, another thing that is, well, I'd love to say that it's something that's happening,

383
00:33:54,000 --> 00:33:56,000
but it isn't happening nearly enough.

384
00:33:56,000 --> 00:34:02,000
CEOs, CEOs who are board members.

385
00:34:02,000 --> 00:34:05,000
In other words, the board is supposed to be the boss.

386
00:34:05,000 --> 00:34:09,000
The shareholders are the boss of the board.

387
00:34:09,000 --> 00:34:16,000
The board is supposed to be the boss of, excuse me, the boss of the C-suite.

388
00:34:16,000 --> 00:34:23,000
If you've got the CEO is his own boss because he's on the board of directors,

389
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that's not an accountable system that lacks that power of accountability.

390
00:34:29,000 --> 00:34:31,000
So there you are.

391
00:34:31,000 --> 00:34:35,000
We've got that problem there that is something that we have to shake out.

392
00:34:35,000 --> 00:34:42,000
You see the corporations, they have some name, chief executive officer and president, CEO and president.

393
00:34:42,000 --> 00:34:48,000
Well, that means he's the top of the C-suite and he is the top of the board of directors.

394
00:34:48,000 --> 00:34:52,000
How do you have accountability in a situation like that?

395
00:34:52,000 --> 00:34:55,000
What is he going to do, spank himself?

396
00:34:55,000 --> 00:35:09,000
I mean, I don't know.

397
00:35:09,000 --> 00:35:10,000
Okay.

398
00:35:10,000 --> 00:35:19,000
Now, the board has important duties.

399
00:35:19,000 --> 00:35:25,000
Governance policies are going to determine the board of directors.

400
00:35:25,000 --> 00:35:35,000
Now, here are a couple of other ones that I should bring up before I lose myself in what's coming next.

401
00:35:35,000 --> 00:35:39,000
The board is elected by the shareholders, obviously.

402
00:35:39,000 --> 00:35:43,000
Let's say I have four board members and you have a sheriff's dog.

403
00:35:43,000 --> 00:35:46,000
You get one vote for each of them.

404
00:35:46,000 --> 00:35:53,000
Well, you see, that's actually not the ideal way to do it.

405
00:35:53,000 --> 00:35:57,000
Now, some companies are already, their charters already specify this.

406
00:35:57,000 --> 00:36:01,000
It would be better if you have four votes.

407
00:36:01,000 --> 00:36:06,000
You could actually concentrate them on one of the positions.

408
00:36:06,000 --> 00:36:11,000
Instead of scattered across four, you could let the other three go.

409
00:36:11,000 --> 00:36:14,000
You don't have a vote for them and you vote my ass out.

410
00:36:14,000 --> 00:36:20,000
You see, that would have a much greater impact on incompetent board members

411
00:36:20,000 --> 00:36:30,000
because then you could focus a lot of direction onto one position that was dodgy, that we didn't like.

412
00:36:30,000 --> 00:36:38,000
That would be actually, that is one of those things that we're encouraging corporations to go to,

413
00:36:38,000 --> 00:36:43,000
essentially what is a cumulative voting rights of the stockholders.

414
00:36:43,000 --> 00:36:51,000
That would be good because then everyone's watered down if you have only one vote per position.

415
00:36:51,000 --> 00:36:58,000
But if a lot of people are pissed off at, let's say, the treasurer of the board of directors,

416
00:36:58,000 --> 00:37:03,000
well, they could aim at him and get him off and let the other ones off the hook.

417
00:37:03,000 --> 00:37:07,000
And it would also send a signal to the other board members,

418
00:37:07,000 --> 00:37:15,000
don't be like this guy who just got nailed because everyone focused their votes on that one position.

419
00:37:15,000 --> 00:37:20,000
It makes them a little more accountable.

420
00:37:20,000 --> 00:37:24,000
That's something that is in some corporations already

421
00:37:24,000 --> 00:37:34,000
and we're encouraging other corporations to move toward this voting pattern model.

422
00:37:34,000 --> 00:37:41,000
This is getting into something, this will probably definitely spill over to Thursday,

423
00:37:41,000 --> 00:37:54,000
but at the level of the board of directors, I've met board members on corporations.

424
00:37:54,000 --> 00:37:59,000
A lot of them are very knowledgeable people.

425
00:37:59,000 --> 00:38:06,000
Unfortunately, some of them are some of the stupidest people I have ever met in my life.

426
00:38:06,000 --> 00:38:14,000
They got board positions because of who they knew or how much money they had.

427
00:38:14,000 --> 00:38:18,000
Literally, I've met them on both sides.

428
00:38:18,000 --> 00:38:20,000
I talked to one board member.

429
00:38:20,000 --> 00:38:24,000
The guy was just incredible in his knowledge of the industry, of the company.

430
00:38:24,000 --> 00:38:27,000
As a matter of fact, there was a joke someone else asked him.

431
00:38:27,000 --> 00:38:31,000
He said, I don't want to work for a living.

432
00:38:31,000 --> 00:38:36,000
I just sit here on the board making broad policy decisions.

433
00:38:36,000 --> 00:38:41,000
But the other side of it is that you do have some board members who are boxes of rocks.

434
00:38:41,000 --> 00:38:44,000
It's just the way it is. It's going to be both ways.

435
00:38:44,000 --> 00:38:53,000
The problem is that at the board level, big financial decisions have to be made there.

436
00:38:53,000 --> 00:39:00,000
Otherwise, you're putting the CEO or the CFO or the CIO, whatever, COO,

437
00:39:00,000 --> 00:39:08,000
you're putting them in a situation where they might not see the largest picture.

438
00:39:08,000 --> 00:39:10,000
That is where the board of directors.

439
00:39:10,000 --> 00:39:11,000
Let me give you an example.

440
00:39:11,000 --> 00:39:14,000
Just as quickly, it would be capital structure.

441
00:39:14,000 --> 00:39:20,000
Remember, the capital structure is the combination of debt and equity that comprises total assets.

442
00:39:20,000 --> 00:39:23,000
That should be a board decision.

443
00:39:23,000 --> 00:39:29,000
It should be informed by the C-suite jockeys.

444
00:39:29,000 --> 00:39:34,000
But at the final end of the day, the board should make that decision.

445
00:39:34,000 --> 00:39:41,000
That means that the board can't be populated with boxes of rocks sitting in nice chairs.

446
00:39:41,000 --> 00:39:49,000
It has to be where the board understands what capital structure means,

447
00:39:49,000 --> 00:39:52,000
just a basic definition of it for God's sake.

448
00:39:52,000 --> 00:40:00,000
Then from there, they have to understand what the implications of the chosen capital structure are.

449
00:40:00,000 --> 00:40:06,000
If I want a capital structure that is leaning more toward debt,

450
00:40:06,000 --> 00:40:10,000
I understand that that could very well increase ROE,

451
00:40:10,000 --> 00:40:19,000
but at the same time, it could also cause some real problems with the risk of the company.

452
00:40:19,000 --> 00:40:21,000
You're moving toward more leverage.

453
00:40:21,000 --> 00:40:27,000
Well, that's going to increase your cost of debt because that's going to scare the hell out of the investment bankers

454
00:40:27,000 --> 00:40:31,000
who are going to take care of your issues of bonds.

455
00:40:31,000 --> 00:40:34,000
But at the same time, well, let's back off that.

456
00:40:34,000 --> 00:40:38,000
Let's get back down here to 10% debt, 90% equity.

457
00:40:38,000 --> 00:40:46,000
Okay, good for you, but that means that you are not realizing hardly any gains to leverage

458
00:40:46,000 --> 00:40:49,000
that would benefit your shareholders.

459
00:40:49,000 --> 00:40:55,000
And the job of the corporation, the one and only one job of the corporation

460
00:40:55,000 --> 00:41:00,000
is to maximize the wealth of those shareholders, period.

461
00:41:00,000 --> 00:41:06,000
So if you are scared of debt, neither a borrower nor a lender be,

462
00:41:06,000 --> 00:41:16,000
well, you are probably not in a position where you should be fulfilling the wealth maximization requirement.

463
00:41:16,000 --> 00:41:18,000
You've got to find a balance in there.

464
00:41:18,000 --> 00:41:31,000
Do your board members understand that difficulty in finding the balance between debt and equity?

465
00:41:31,000 --> 00:41:36,000
Other things that the board does, and I could list you a lot,

466
00:41:36,000 --> 00:41:44,000
and yes, some boards do just sit back and lull their way and let the C-suite make these decisions.

467
00:41:44,000 --> 00:41:45,000
They shouldn't.

468
00:41:45,000 --> 00:41:52,000
Other things also, internal auditing, accounting and auditing controls.

469
00:41:52,000 --> 00:42:02,000
We are all in a world of Sarbanes-Oxley where we have to have hellacious internal controls.

470
00:42:02,000 --> 00:42:06,000
Are we fulfilling that Sarbanes-Oxley requirement?

471
00:42:06,000 --> 00:42:09,000
How do we know we are?

472
00:42:09,000 --> 00:42:16,000
The worst hack in the world is the one that you don't know happens.

473
00:42:16,000 --> 00:42:20,000
That's a geek's philosophy.

474
00:42:20,000 --> 00:42:24,000
And so do you know that you have internal controls?

475
00:42:24,000 --> 00:42:33,000
The worst embezzlement in the world is the embezzlement that you can't find, you can't catch.

476
00:42:33,000 --> 00:42:43,000
These are critical, and this is the board's responsibility to ensure that the best of the best is going to happen.

477
00:42:43,000 --> 00:42:53,000
Now, let's move a little bit forward from just the internal controls to the whole world that we are in in the 21st century.

478
00:42:53,000 --> 00:43:00,000
First things first, we have to have a CIO, a Chief Information Officer,

479
00:43:00,000 --> 00:43:10,000
and that means that the board has to understand the absolute criticality of our information systems.

480
00:43:10,000 --> 00:43:17,000
I'm building a course. You may be able to take it next year.

481
00:43:17,000 --> 00:43:20,000
It is in emerging technologies.

482
00:43:20,000 --> 00:43:28,000
And when I drop you into that world, you're going to be amazed at how deep and complex it is.

483
00:43:28,000 --> 00:43:39,000
I'm required, because of my certifications, I'm required to watch these continuing education videos done by IBM and all these others.

484
00:43:39,000 --> 00:43:43,000
And I swear, sometimes I just start seeing the wheels on the bus go round and round.

485
00:43:43,000 --> 00:43:45,000
I'm out. I'm gone. I'm dead.

486
00:43:45,000 --> 00:43:52,000
But we have to keep plowing and knowing and understanding what in the hell is going on here.

487
00:43:52,000 --> 00:43:57,000
And it's wild. Even in, you hear the term cloud computing?

488
00:43:57,000 --> 00:44:01,000
I mean, that is a whole world of its own.

489
00:44:01,000 --> 00:44:05,000
Do you choose SAAS, software as a service?

490
00:44:05,000 --> 00:44:13,000
Do you choose PAAAS, platform as a service? Or do you choose IAAAS, infrastructure as a service?

491
00:44:13,000 --> 00:44:19,000
And once you have made that choice, what are your responsibilities within that cloud computing environment?

492
00:44:19,000 --> 00:44:26,000
This has to be, at least at the top level, understood how critical all of this is.

493
00:44:26,000 --> 00:44:33,000
Cybersecurity is a nightmare right now. It is an absolute freaking nightmare.

494
00:44:33,000 --> 00:44:38,000
Also, the 20th century is a nightmare for us now, too.

495
00:44:38,000 --> 00:44:44,000
I just went through the hell of learning about something called identity fabric.

496
00:44:44,000 --> 00:44:46,000
And I thought, what the hell?

497
00:44:46,000 --> 00:44:55,000
And after about four hours of videos and quizzes, I thought, oh, God, I never even thought of that.

498
00:44:55,000 --> 00:45:00,000
This is a haunting. This is a zombie from the 20th century.

499
00:45:00,000 --> 00:45:09,000
Where you have employees, customers, suppliers, and they all have their own identities, their own passwords,

500
00:45:09,000 --> 00:45:17,000
their own access points, their own ways that they can get into the system and how deep they can get into the system.

501
00:45:17,000 --> 00:45:24,000
This is the identity fabric. Each individual could have as many as five passwords in a company.

502
00:45:24,000 --> 00:45:32,000
A supplier might have two, but that supplier really needs to have three identity levels of depth

503
00:45:32,000 --> 00:45:35,000
to get the information out of your system, to get it over there.

504
00:45:35,000 --> 00:45:41,000
What are the protections you have on the security? Is it end-to-end encryption or is it something in the middle?

505
00:45:41,000 --> 00:45:46,000
I don't want to get into this. I promised myself I wouldn't say this much, and I'll stop right there.

506
00:45:46,000 --> 00:45:50,000
But the 20th century is a problem for us in the 21st century.

507
00:45:50,000 --> 00:45:57,000
That's just something that the board of directors has to understand.

508
00:45:57,000 --> 00:46:10,000
We've got this setup here that I'm trying to convince you that the governance starts at the top of the organization.

509
00:46:10,000 --> 00:46:15,000
At the top, you must have a new breed of board members.

510
00:46:15,000 --> 00:46:22,000
They have to have, for lack of a better way to put it, they have to have the knowledge of old people,

511
00:46:22,000 --> 00:46:31,000
the wisdom of old people, and the dynamic understanding of the world, of you people, young people.

512
00:46:31,000 --> 00:46:38,000
How do we do that? Well, that's your problem, not mine. I just teach in a great school.

513
00:46:38,000 --> 00:46:45,000
But do understand, this is all part of governance, and it is nothing like...

514
00:46:45,000 --> 00:46:52,000
Okay, I should say this one more time. We see spikes off corporate governance.

515
00:46:52,000 --> 00:47:03,000
Spikes like DEI, and those are laudable goals, but they are goals that we are going to have to do carefully,

516
00:47:03,000 --> 00:47:10,000
because those are the ones that the exterior world can find out about and then bitch.

517
00:47:10,000 --> 00:47:17,000
Even though they don't know anything about what they're talking about, they're going to cause us problems.

518
00:47:17,000 --> 00:47:22,000
So we do those slowly. The internal stuff, we can do more quickly.

519
00:47:22,000 --> 00:47:30,000
We can't just charge in, but we have to have a balance, but always, always making sure that we understand

520
00:47:30,000 --> 00:47:37,000
that ultimately the future is going to belong to another generation, other generations,

521
00:47:37,000 --> 00:47:41,000
and we have to appreciate that we can go back to the past.

522
00:47:41,000 --> 00:47:48,000
When it was easy to be a racist, a sexist, or whatever else, we have to move forward to a more inclusive environment.

523
00:47:48,000 --> 00:47:52,000
And that's not a liberal position. I'm generally kind of a conservative,

524
00:47:52,000 --> 00:47:57,000
but you also have to appreciate what the world's going to be, and that's where corporate governance comes in.

525
00:47:57,000 --> 00:48:05,000
Now, I'm going to start this, and I'm going to stop a little early here, because if I get in and dig in too deep,

526
00:48:05,000 --> 00:48:11,000
I'm going to be...I'll leave you in a place where I don't want to leave you with lecture today.

527
00:48:11,000 --> 00:48:22,000
But let's do this. I'm trying to look at someone who fits this story.

528
00:48:22,000 --> 00:48:30,000
You. You are driving your car out here on the big American prairie.

529
00:48:30,000 --> 00:48:38,000
Straight road, beautiful sunshine day, and there's this nice, long, beautiful road, smooth,

530
00:48:38,000 --> 00:48:45,000
and you see a speed limit sign, 55 miles per hour.

531
00:48:45,000 --> 00:48:53,000
Now, out here, I found out that you see that as...what you say when you see that as challenge accepted.

532
00:48:53,000 --> 00:48:59,000
So you hear this little voice in your head that says, warp six.

533
00:48:59,000 --> 00:49:07,000
So you start grinding that pedal, and you get it up to a speed where you see the stars streaming by you,

534
00:49:07,000 --> 00:49:14,000
like they do in the Star Trek movies and all that kind of stuff, and everything's fine.

535
00:49:14,000 --> 00:49:22,000
But then way up the road, it's corn fields, but one of those spurs that go into a field, a drive that goes into a field,

536
00:49:22,000 --> 00:49:31,000
you see a car there. There's a farmer. And you get closer and go, oh my God, that's a sheriff's deputy's car.

537
00:49:31,000 --> 00:49:39,000
Well, what are you going to do? Have you ever been on a highway and all the cars in front of you,

538
00:49:39,000 --> 00:49:47,000
their brake lights come on all at once? Well, that's because they found Jesus, and his name was a highway patrol officer up the road.

539
00:49:47,000 --> 00:49:59,000
You're driving and you're going to slow down because you are being monitored. So that's the first thing.

540
00:49:59,000 --> 00:50:11,000
Now the second thing that happens, you get closer and you see that the sheriff's deputy is standing, or at least you see his finger,

541
00:50:11,000 --> 00:50:19,000
outside of the car. Oh God, he's got a radar gun. And he bleep, bleep, bleep. Yeah, slow down more.

542
00:50:19,000 --> 00:50:29,000
But then as you get really close, you see that he is actually stooped over and he's changing the tire on his car.

543
00:50:29,000 --> 00:50:37,000
You want to stay slowed down? Well, I'll just pick up my speed again. Hi, officer, how are you doing there?

544
00:50:37,000 --> 00:51:01,000
So in other words, enforcement. Both of these are critical to the next thing I'm going to bring up, contracts.

545
00:51:01,000 --> 00:51:10,000
You see, no contract is better than the monitoring of it, of its provisions, and the enforcement of those provisions.

546
00:51:10,000 --> 00:51:22,000
If you got a contract, and that contract has all kinds of monitoring involved in it, but there's nothing about what to do if someone violates the contract,

547
00:51:22,000 --> 00:51:32,000
you got no contract whatsoever. On the other hand, if you have iron fist, thou shalt not, we shall twack you in the ass if you do that,

548
00:51:32,000 --> 00:51:46,000
but no one's watching, well, you have no contract there either. By 240 classes, I have more than a small amount of cheating that goes on.

549
00:51:46,000 --> 00:51:57,000
Of course, obviously, if they are found guilty of cheating, they're kicked out of the university, and I'm not afraid to do that.

550
00:51:57,000 --> 00:52:09,000
But if I can't watch them, a 200-room caterpillar auditorium, how do I monitor it? So in other words, the enforcement doesn't matter.

551
00:52:09,000 --> 00:52:18,000
The policy says that I can see to it that that student is dismissed from the university, suspension for one year or whatever.

552
00:52:18,000 --> 00:52:27,000
Well, if I can't watch, see them doing it, well, nothing. On the other hand, if I can get monitoring up to watch them,

553
00:52:27,000 --> 00:52:36,000
but I have no ability to enforce no cheating rules, there is no meaning to those. People will continue to cheat.

554
00:52:36,000 --> 00:52:44,000
That's the thing about any contract. Now, contract is important here because we're about to get to something called the agency dilemma.

555
00:52:44,000 --> 00:52:54,000
And this directly impacts corporate governance. It is actually the heart of corporate governance.

556
00:52:54,000 --> 00:53:09,000
It is the contract between an agent and a principal.

557
00:53:09,000 --> 00:53:38,000
The first, the principal, and that's with P-A-L, principal. This is a person whose welfare is to be maximized.

558
00:53:38,000 --> 00:53:47,000
Now, before I go any further, you must understand what the word person means.

559
00:53:47,000 --> 00:53:55,000
That could be an individual, but I'm talking about person as it is defined under the law.

560
00:53:55,000 --> 00:54:05,000
A person could be an individual. It could be a couple. It could be an institution, a corporation, a company.

561
00:54:05,000 --> 00:54:16,000
A person is an entity that is recognized by law as acting as a unit to some purpose.

562
00:54:16,000 --> 00:54:25,000
So when I use the word principal and it's a person, that could be an individual, but it could also be a board of directors.

563
00:54:25,000 --> 00:54:35,000
A person could be a couple, a marriage. A person could be a partner to domestic partners recognized by that state's laws.

564
00:54:35,000 --> 00:54:42,000
A person could be a lot of different things, a professional organization, a partnership.

565
00:54:42,000 --> 00:54:49,000
These are all persons under the law. So understand that I am using this in a way that is not common.

566
00:54:49,000 --> 00:55:02,000
There is a problem with this. It was, I think, 14 years ago.

567
00:55:02,000 --> 00:55:20,000
We have been moving, we had been moving since the 1970s toward a broader interpretation of person beyond just plain business and legal contracts.

568
00:55:20,000 --> 00:55:35,000
Courts, including the Supreme Court, had been beginning to recognize that in the Constitution, the person could be something other than an individual citizen.

569
00:55:35,000 --> 00:55:47,000
Now at first this was pretty tame stuff. Courts found that, for example, a company could tell white lies about its products.

570
00:55:47,000 --> 00:56:02,000
That's called puffing. You're lying about your product, but it's okay because a person can do that, whether it's an individual person or a corporation could do that puffing.

571
00:56:02,000 --> 00:56:10,000
So you've seen that your whole lives. I mean, it was a little surprising when I began to see it when I was in the 1970s.

572
00:56:10,000 --> 00:56:19,000
Now it was always considered, you can't lie to us about a product. Well, companies would do it and then the FTC would kick their asses.

573
00:56:19,000 --> 00:56:29,000
But then beginning in the 70s we began to see little white lies. Everything, just nothing major. Cleaner than clean, whiter than white.

574
00:56:29,000 --> 00:56:38,000
What does whiter than white even mean? I mean, you pull your laundry out, oh God, I'm blind, it's too white. No, but it's allowed.

575
00:56:38,000 --> 00:56:52,000
Puffing. So in other words, the courts began to recognize that just like individuals can lie, companies can lie as long as it's not a material lie and everyone, supposedly everyone knows.

576
00:56:52,000 --> 00:57:06,000
But the problem was that this began a slippery slope where courts began to recognize more and more constitutional rights and privileges as belonging to persons instead of to individual citizens.

577
00:57:06,000 --> 00:57:22,000
It came to a really nasty head in, I believe it was 2010 when the Supreme Court ruled that corporations could contribute as much as they wanted to political candidates.

578
00:57:22,000 --> 00:57:36,000
Because people, individuals can, they're people and corporations are people so we can't keep corporations from putting whatever money they want to into campaigns.

579
00:57:36,000 --> 00:57:48,000
And they do it through political action committees, through astroturf things. So it's gotten unfortunately out of hand.

580
00:57:48,000 --> 00:58:06,000
We're restricting this only to the concept of the contract in that context. We're not putting anything about anything outside of law and business here.

581
00:58:06,000 --> 00:58:32,000
Now, the other one that I will define here is called the agent. The agent is a person who is charged with maximizing

582
00:58:32,000 --> 00:58:56,000
the welfare of a principle.

583
00:58:56,000 --> 00:59:18,000
Okay, let's try it. We'll do a couple of different examples here. A doctor, I'm your doctor, you're my patient. Who is the agent and who is the principle?

584
00:59:18,000 --> 00:59:30,000
Yes, and I am the agent because I am charged with maximizing your health. That's clear. That one's easy. Same would be with a lawyer and a client.

585
00:59:30,000 --> 00:59:43,000
The lawyer is the agent, the client is the principle. The lawyer has knowledge and ability to maximize the freedom of the client.

586
00:59:43,000 --> 00:59:57,000
Let's try another one. A parent and a child. Who is the agent and who is the principle?

587
00:59:57,000 --> 01:00:19,000
The child is the principle. The child is the principle because the parent is charged under law, in fact and in law, with maximizing the welfare of the child.

588
01:00:19,000 --> 01:00:33,000
So the child is the principle in that relationship. Now let's try another one.

589
01:00:33,000 --> 01:00:56,000
Who is the principle and who is the agent in a marriage? I caution you. Be careful. You know what you want to say. Let's try it.

590
01:00:56,000 --> 01:01:06,000
Tell me this. Who is the agent and who is the principle in a marriage? The guy's the agent and the girl's the agent.

591
01:01:06,000 --> 01:01:18,000
Good answer. You will live. Man card issued. No, actually, the marriage is the principle. The man and the woman, or the husband and wife, are the agents.

592
01:01:18,000 --> 01:01:30,000
They are charged as a couple, as a person, with maximizing the welfare of the marriage. Neither of them is a principle.

593
01:01:30,000 --> 01:01:40,000
They are both the agents of the marriage and it is their duty under the contract of marriage to maximize the health of that marriage.

594
01:01:40,000 --> 01:01:49,000
That is a very strange one. This is the beginning of realizing that the principle doesn't even have to be a living thing.

595
01:01:49,000 --> 01:01:57,000
It can be a contract. It can be represented on a piece of paper.

596
01:01:57,000 --> 01:02:09,000
So that's why, as a soldier, you swear an oath to defend the Constitution of the United States against all enemies, foreign or domestic.

597
01:02:09,000 --> 01:02:21,000
In other words, that Constitution is the principle and I, as a soldier, was and am the agent.

598
01:02:21,000 --> 01:02:30,000
Famously, some people say it happened and others say it didn't. George W. Bush, many years ago, President Bush,

599
01:02:30,000 --> 01:02:42,000
someone told him that something he was doing was violating the Constitution and he supposedly said the Constitution is just a goddamn piece of paper.

600
01:02:42,000 --> 01:02:57,000
And there was just a shock. Oh my God, wow, he's right. The only thing that gives it life is those who defend it, who are charged with and carry out their agency duty to defend it.

601
01:02:57,000 --> 01:03:13,000
That's just the reality of it. No person who is a principle will survive if the agents do not carry out their duties under the contract between the agent and the principle.

602
01:03:13,000 --> 01:03:22,000
Now, let's shift that to the corporate environment. Guess what? The board of directors is the agent of the shareholders.

603
01:03:22,000 --> 01:03:37,000
Not as individuals, but as a body, the body of shareholders, as an aggregate mass that is the principle, a singular entity with respect to the contract.

604
01:03:37,000 --> 01:03:45,000
So the board of directors is the agent of the principles who are the principle.

605
01:03:45,000 --> 01:03:55,000
Now the C-suite, to whom do they answer? They answer to the board, which answers to the body of shareholders.

606
01:03:55,000 --> 01:04:03,000
So there is a chain that happens there and that's where corporate governance begins to put its teeth into this,

607
01:04:03,000 --> 01:04:17,000
is that the corporate governance is how we carry out the contract, whereby the board of directors maximizes the wealth of the shareholders as a body.

608
01:04:17,000 --> 01:04:29,000
And that's why this is critically important when we get to this level of finance, is where you will go out there and you will be the agent of some principle.

609
01:04:29,000 --> 01:04:37,000
You will also be the principle in some, possibly in some situations, in some regards.

610
01:04:37,000 --> 01:04:45,000
But this is where it all begins and we'll finish this on Thursday. Remember, we're starting at 1 o'clock on Thursday.

611
01:04:45,000 --> 01:04:59,000
That's all I have for you. I thank you.