Posted by Marc Hodak on May 28, 2009 under Executive compensation | 
Finally, a sensible editorial on banking compensation. Alan Blinder waves away the misdirection associated with “how much” bankers have been paid to identify the critical element of “how” they’ve been paid. The answer, as my loyal readers know, is the infamous trader’s option and the trader’s supervisor’s option.
Darwinian selection ensures us that these folks are generally smart young people with more than the usual appetite for both money and risk-taking. Unfortunately, their compensation schemes exacerbate these natural tendencies by offering them the following sort of go-for-broke incentives when they place financial bets: Heads, you become richer than Croesus; tails, you get no bonus, receive instead about four times the national average salary, and may (or may not) have to look for a new job. These bright young people are no dummies. Faced with such skewed incentives, they place lots of big bets. If tails come up, OPM will absorb almost all of the losses anyway.
Blinder suggests what I would consider timid, but sensible reform directed at exactly the right place–the board of directors.
The thing we have working against us is incredible, but understandable conservatism on the part of shell-shocked boards that truly can’t distinguish bold, good mechanisms from bold, schlock mechanisms. I know where they’re coming from. I feel the same way about macroeconomists as I try to get a handle on what’s going on. The thing we have working in our favor is that, the top executives at even public companies actually have a lot of skin in the game, and it’s not just upside. Dick Fuld and Jimmy Cayne didn’t actually want to end up the way they did. If they had any idea of the risks they were actually enabling, they would have looked for a better way. Their surviving competitors are not dummies.
Extra credit for the compensation mavens reading this if they can identify the irony in the title, which was actually coined nearly 20 years ago.
Posted by Marc Hodak on May 27, 2009 under Executive compensation, Reporting on pay |
The new head of UBS is apparently faced with the same problems that were faced by the old head of UBS. One of the biggies is: how do you remain competitive (and solvent) as a bank without being competitive as an employer? Answer: you can’t. Another problem, then: how do you remain competitive as an employer without upsetting the public?
As in the U.S., the Swiss bank gave up its right to pay high bonuses when it got into trouble and accepted a bailout from their government, which basically capped the bonuses. The Swiss people, kindly and educated as they are, still suffer from the mob’s envy of the highly paid. UBS had a choice between being competitive or making the public happy, and they chose survival.
The “exceptional” salary increases “were necessary to safeguard our profitable business areas and to secure their success,” Gruebel said. “Following significant cuts in variable compensation, we had fallen well behind the market in certain areas, and that is unsustainable in the long run.”
Hmm. Companies being compelled to dramatically raise salaries when they were constrained from paying bonuses…who could have predicted that?
By the way, have you noticed that whenever Bloomberg (the same can be said for the WSJ) have multiple stories about a subject, they always start with the part about executive compensation?
Title reference here.
Posted by Marc Hodak on May 26, 2009 under Economics, History |
The world is far too complicated for me to figure out beyond my little niche in corporate governance. So, I’m always looking for high quality material to inform me on the larger issues. Gold, Money, and the U.S. Constitution by Eugene Holloway is such material.
It’s easy to bemoan the actions of private or political officials out of context, or to argue polemical abstractions. By weaving the history into the law, Holloway provides a richer understanding of why things evolved the way they have, and a sense (warning, really) of where things are likely to go from here. An excellent read.
Note: I have linked to the last of four parts, but additional links to the prior three parts are right on that page.
Posted by Marc Hodak on under Revealed preference, Stupid laws |
New York State, in an obvious attempt to see just how much it can piss off its taxpayers, has sent an extraordinary notice to all its citizens. It warns them that not only will their tax rates be raised in 2009, but they will have to recalculate their 2008 taxes now based on the new 2009 tax rates in order to comply with the new law. I know you think you just misread that last statement, so read it again, and rest assured that it is correct.
Here’s how it works. Most income taxes need to be paid each quarter on an estimated basis; the state doesn’t want to wait until the end of the tax year to collect its loot. The typical rule for estimated taxes is the lower of either (a) 90% of your actual tax bill that you’ll eventually have to pay or (b) 100% of your last year’s actual tax bill. For most filers whose incomes are flat or growing, the easiest thing to do is to look at your tax bill for last year and just pay that in equal installments over the current tax year. Simple enough.
This year, New York is saying that if you wish to use the second option to pay estimated taxes, i.e., 100% of last year’s taxes paid, you need to recalculate the amount you would have owed last year based on this year’s higher tax rates.
That’s right, the lovely time you recently spent calculating your New York taxes, you need to go through that again now using the new tax rates so that the state can squeeze that last $100 from you without having to wait until next April. We really are talking about chickensh*t sums, here. For the 60% of people who hire accountants to do their taxes, the vast majority of them would ending paying more for this recalculation than they would owe in additional estimated payments.
Why would the state do such a crazy thing? Because the state’s politicians are desperate for those incremental dollars, and they truly don’t care if what it costs you to pay them the lawful amount.
Most debates on tax policy center on the elasticity of supply, i.e., the degree to which an increase in taxes will reduce the willingness of the person being taxed to continue engaging in the taxed behavior. For example, if raising the sales tax causes people to buy less such that the actual tax raised is minimal, and businesses will otherwise suffer from the reduced sales, most policy makers would say that’s not an efficient tax. In New York State, we now have proof positive that if a business has to pay someone doing no productive work $10,000 in order to get the state an extra $8,000, the politicians feel they are ahead. Such abuse of New York State taxpayers is why we are seeing more of this.
Posted by Marc Hodak on May 25, 2009 under Executive compensation, Unintended consequences |
Damn those finance geeks. The government imposed restrictions on their bonuses, and they turned around and increased their salaries. Who could have predicted that?
It’s as if Wall Street has this mysterious knowledge about the ability of value to be transformed into different kinds of financial claims, and that these claims that can be traded across time…and stuff. Where does this mysterious knowledge come from?
Posted by Marc Hodak on May 23, 2009 under Executive compensation, Politics, Reporting on pay |
Congress cooking up new legislation (artist's depiction)
According to this story in Bloomberg:
Treasury Secretary Timothy Geithner called for an overhaul of compensation practices at financial companies and said the Obama administration’s plan to help realign pay with performance will be rolled out by mid-June.
“I don’t think we can go back to the way it was,” Geithner said in an interview on Bloomberg Television’s “Political Capital with Al Hunt,” to be aired tonight and over the weekend. “We’re going to need to see very, very substantial change.”
Geithner is not too clear what he means by “the way it was” in compensation practices that begs for “very, very substantial change,” so let me clarify.
1) Let’s say you work in a bank that has seven divisions. One particularly leveraged division, not the one you work in, totally screws up pushing the whole bank into a loss. Your division made money. In fact, it made enough to keep the whole bank from going under. In Geithner’s view, echoing the view of the rest of the government and the media, you should get no bonus.
2) Let’s say you work for a company that the government has more or less taken over. You have a contract with the company for your services, a contract the government in essence approved, dictating compensation to be paid later (bonus, retention payment, deferred comp, whatever). The media hates you and embarrasses the politicians. In Geithner’s view, you should get none of the promised payment.
In other words, given the mob’s inability to distinguish behavior and results within institutions, once those institutions become unpopular, the mob’s sensibilities of what other people should be paid should be made the law of the land. The mob is similarly blind to the difference among firms in an unpopular industry, as if there were no difference between Goldman and Lehman, or between JP Morgan Chase and Citi, in their need or willingness to take bailout money.
The hypocrisy doesn’t stop there:
[Geithner] said that Wall Street’s pay practices encouraged taking on short-term risk, and helped precipitate the financial crisis. What’s needed is a set of broad standards that federal regulators can use to make sure that doesn’t happen again, he said.
If we exchange “Wall Street’s pay practices” with “Congressional policies” we get a far more accurate sense about what precipitated the crisis.
Posted by Marc Hodak on May 20, 2009 under Invisible trade-offs, Politics |
One of the best encapsulations I have ever read on the subject. Sample:
Politicians need headlines. And this means they have a deep need to do something (“Sen. Snoot Moves on Widget Crisis!”), even when doing nothing would be the better option. Markets will always deal efficiently with gluts and shortages, but letting the market work doesn’t produce favorable headlines and, indeed, often produces the opposite (“Sen. Snoot Fails to Move on Widget Crisis!”).
Awesome stuff. This article should be required reading in every school purporting to teach introductory social science.
FD: I’ve done my part in introducing the author, John Steele Gordon, into a curriculum; he has guest lectured in my “History of Scandal” course at NYU.
Posted by Marc Hodak on May 19, 2009 under Executive compensation |
Shell Oil’s board has suffered one of the worst rebukes a board can bear–the slap down of their executive pay package in a “say on pay” vote.
I’m not a big fan of “say on pay,” but when a company sets up an incentive plan based on placing in the top three among a set of peers, then the company places fourth, you can’t expect to get away with:
“The difference between Shell and the third-ranking company, France’s Total SA, was marginal and Shell’s ranking didn’t fully reflect its relative performance.”
The Brits, especially, will not countenance a bonus for finishing behind the French. What was the board thinking, really?
Posted by Marc Hodak on May 18, 2009 under Executive compensation |
UBS is dealing with an outflow of its top talent by raising pay. Of course, since they’re constrained in paying bonuses, they will have to raise salaries, instead, increasing the risk of their business with higher fixed costs, and insuring that they pay more in a downturn than they otherwise would have.
Here is a scary comment on normally conservative Swiss sensibilities:
On Sunday, paper SonntagsZeitung reported the results of a poll that showed 75 percent of participants would vote in favor of government-imposed restrictions on management pay in Switzerland. Only 9 percent said they would vote against.
Don’t ask me why any country as attractive as Switzerland would want their only wealthy people to be foreigners.
Posted by Marc Hodak on May 17, 2009 under Invisible trade-offs |
Assistant Professor of Finance Linus Wilson has done a valuation of the warrants bought by Old National Bancorp from the U.S. Treasury to satisfy repayment of the Capital Purchase Program, the investment that healthy banks everywhere are dying to pay back. Prof. Wilson has estimated that Treasury accepted a discount of up to 80 percent. Tyler Durden comments:
While these days, when $9 trillion misplaced here or there by the Federal Reserve is taken as almost a given, the amounts in question are nominal, it merely underlines the continuing trend of short shrifting taxpayers at the cost of established banking interests. One can be sure that what is valid for ONB, is more than valid for Goldman Sachs, Citi and BofA.
Wilson summarizes it best:
U.S. taxpayers do not appear to be receiving fair market value for the risky securities that they purchased. Policy makers should be troubled because Wilson estimates that the CPP warrants could be worth between $5 billion and $24 billion based on May 1, 2009 closing prices. It could mean billions of dollars in lost revenue if the U.S. Treasury continually negotiates deals at the low-end of or below fair market value. Further, if the U.S. Treasury agress to sell the CPP warrants below fair market value, then the estimates of the subsidies involved in the CPP investments by the Congressional Budget Office (2009) and the Congressional Oversight Panel (2009) may be significantly underestimated.And here comes the kicker:
Many readers will not be surprised by this results. U.S. Treasury officials’ incentives are not as well aligned with the interests of taxpayers as bank managers’ incentives are aligned with the interests of their shareholders. For this reason, we should probably continue to expect the U.S. Treasury to negotiate a price that is below or on the low-end of the fair market value of the CPP warrants. Without a major change in the structure of compensation in the federal bureaucracy, which seems nearly impossible, the best hope for taxpayers is to sell the warrants to third party investors.
Of course, Treasury may have particular reasons for giving Old Bancorp a great deal on their warrants, besides simply not caring about a few measly millions. Taxpayers are oblivious to the amounts or the reasons. If the press gave them the information, which would require more financial literacy than possessed by their average readers, they would have no idea what to make of it. And, because this theft is invisible to the taxpayers, it means absolutely nothing to the bureaucrats managing their money.
But to hear it from our legislators, our country needs a massive dose of help in making its public corporations more accountable to their shareholders. Meanwhile, the largest accountability gap on earth continues unabated under the very noses of Congress, while their putative oversight focuses on pointy-headed academic dissertations about what Treasury ought to be doing.
HT: Zero Hedge
