The bureaucrat’s edge

Posted by Marc Hodak on October 22, 2009 under Collectivist instinct, Executive compensation | 3 Comments to Read

OK, incentives at banks have been deficient.  I’ve seen them all:  bonuses based on loan volume; banking fees based on a percentage of the debt issued; traders being richly rewarded for unsustainable performance shortly before getting fired.  So, granted that such incentives can motivate counterproductive behavior, how does it follow that having every major bank in the country submit their incentive plans to Fed review makes sense?

What is some Fed governor who, by law, can have no personal stake in the welfare of any particular bank going to see that the CEO or directors of those banks are going to miss?  Some 29-year old with a check list in the bowels of the federal government will be looking over incentive plans that took a CEO, Chief HR officer, and General Counsel many hours of review after several months of design and implementation, with all the lessons learned from the recent debacle, and that bureaucrat will send them an opinion saying, “I don’t think this plan is good for your firm or the economy.”  And these people, the ones who were good enough to survive the crash, with years of experience in their particular bank, and with a significant portion of their personal wealth tied up in their firm, these people are to expect to gain some insight from this GS-11 examiner, supervised by people who have never in their lives created and market-tested executive compensation plans?

Apparently, the people drafting these rules sincerely believe that Fed bureaucrats are going to give these major banks that edge.  And people apparently believe that the Fed will offer its opinions completely absent any political interference.

I’m not saying it couldn’t happen.  I’m just wondering who out there believes that it is worth having every major bank submit their incentive plans to prior judgment by federal officials.  Especially when there is zero evidence that incentive plans actually contributed to the financial crisis, and plenty of evidence that the Fed did contribute to it.

Elizabeth Warren doesn’t understand

Posted by Marc Hodak on October 20, 2009 under Collectivist instinct, Patterns without intention | Read the First Comment

Elizabeth Warren is discouraged.  Not with regards to her job of overseeing TARP spending, on which the Harvard professor has done a decent job.  Instead, she is “speechless” at the prospects that certain bankers may get record bonuses this year.

“I do not understand how financial institutions could think they could take taxpayer money and turn around and act like it’s business as usual,” Warren says. “I don’t understand how they can’t see that the world has changed in a fundamental way – it’s not business as usual.  All I can say right now is they seem to be winning this argument.”

It’s not an argument, Liz; it’s a business model.  The financial services business model is actually quite simple:  employees get 50 percent of net revenues.  The stable portion of this net revenue is paid out in “salaries” and the uncertain, variable portion of this net revenue is paid out in “bonuses.”  The “bonus” portion gets split in rough proportion to who brought in the revenues.  All this goes on regardless of how “the world has changed.”  Last year, net revenue was lower, and bankers on average got much less.  This year, net revenues are higher, and bankers (the ones who survived the carnage, anyway)  get more.  What’s not to understand?

Warren’s block is not the arithmetic.  Warren’s block is that she hates bankers.  Her real problem is that the world has not changed the way she wishes it would have changed, where the money that a bank makes flows to someone other than the bankers.

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Two conversations about compensation

Posted by Marc Hodak on September 8, 2009 under Collectivist instinct, History, Reporting on pay | Read the First Comment

People reading the news may be forgiven for thinking that we are having a kind of national conversation about executive compensation.  In fact, we are having two conversations.  One of them is about corporate governance.  The other is about wealth redistribution by non-market means.  Both of them sound like they’re about compensation because the word is used often in the story, but they are different.

Take this item headlined:  Warning: Pay Gap Between CEOs and Workers Will Keep Growing

This is nominally about compensation.  It has the words “CEO” and “pay” in it.  In fact, this is a story about a study released by the Institute of Policy Studies, which is a progressive organization dedicated to revamping society along socialistic lines.  They simply hate the idea that some people make a lot more than others.  Governance is simply a side show for them:

Governance problems do need to be resolved,” notes IPS Director John Cavanagh. “But unless we also address more fundamental questions – about the overall size of executive pay, about the gap between the rewards that executives and workers are receiving – the executive pay bubble will most likely continue to inflate.

But.  It’s about the size of pay.  A colleague of Cavanagh wrote:

Shareholders have no reason to begrudge executives like these their fortunes. But the rest of us do.

For IPS, it’s not about the shareholders.  It’s about social justice, which is code for democratizing pay.  I get to vote on how much you make, and you get to vote on how much I make, regardless of how we “vote” in our revealed preferences via the market place.

What annoys me about this is not the nominal aims of the progressives.  I too would prefer a world with less extreme distributions of income.  What annoys me is that this sentiment is not really about income–it’s about state power versus market power–it’s simply reported as if it’s about income.

Practical definition: Confiscatory taxation

Posted by Marc Hodak on August 24, 2009 under Collectivist instinct, History, Invisible trade-offs, Revealed preference | Read the First Comment

Confiscatory taxation:  What is going on in Great Britain.

Contrast this with

Socialism:  Using state power to penalize success and reward failure.

Using the threat of violence to take an extra $50,000 from someone making $1 million is not considered a crime if implemented by authorities elected by the people who are, for the most part, not being taxed at that level.  In fact, these people call their confiscation the patriotic or moral thing to do.  They will claim that most of the people being taxed are actually OK with it; but they don’t dare let the class of people paying it vote on whether they should all do so.  They will claim that those who do not wish to pay it lose their claim to their money by virtue of their selfish desire to keep it; but they don’t see the irony of their preferences forcibly imposed on others as a baser form of selfishness, abetted as it is by coercion.

But the victims of this self-justified view of theft-disguised-as-patriotism-or-morality won’t sit still for the grasping hypocrisy.  They will leave.  They take their money and, more important, their wealth-creating talents, to friendlier climes.

Ellison gives up the one part of his comp that almost made sense

Posted by Marc Hodak on August 23, 2009 under Collectivist instinct, Executive compensation | Read the First Comment

Previously, I was wondering out loud what possible retention or alignment benefit Oracle’s shareholders received from awarding their CEO another 0.007 billion shares on top of the 1.173 billion he already owns.  The cost, in the many tens of millions of dollars worth of dilution is impossible to justify.  The one part of this compensation I didn’t criticize was his $1 million salary, which amounted to about 1.2 percent of his total compensation.  So, guess which part of this compensation his toothless board chose to cut?

The compensation committee recognizes that Mr. Ellison has a significant equity interest in Oracle, but believes he should still receive annual compensation because Mr. Ellison plays an active and vital role in our operations, strategy and growth.  Nevertheless, during fiscal 2010, Mr. Ellison agreed to decrease his annual salary to $1.

At least the disclosure was honest about who was agreeing to what, here.

By the way, Jeffrey Berg, chairman of the compensation committee that once again awarded Mr. Ellison his 7 million options owns a talent agency whose actors have been used in Oracle advertisements.  Anyone who watches Entourage can imagine how arms-length that transaction had to be.  I wouldn’t impugn the integrity of the other two comp committee members, Hector Garcia-Molina and Naomi Seligman, but the former is a computer science professor and the latter runs networking organization for CIOs.  Not exactly the types who would stand up to Mr. Ellison for the little people who share ownership in his firm.

This composition belies the rebuttal offered by Oracle to the Say on Pay proposal in their current proxy:

Our Compensation Committee, which consists entirely of well-informed, experienced and independent directors, meets regularly to review and set executive compensation…The Committee also retains an outside compensation consulting firm and regularly seeks its advice and assistance as part of the Committee’s review and approval process.

And how did the compensation committee use its outside consultant?

The Compensation Committee selected and directly engaged Compensia, Inc. as its outside advisor for fiscal 2009 to provide the Compensation Committee with insights and market data on executive and director compensation matters, both generally and within our industry. Compensia also assisted the Compensation Committee with a peer company executive compensation comparison. Compensia did not determine or recommend any amounts or levels of our executive compensation for fiscal 2009. [Emphasis mine]

Translation:  They got peer data from their consultant, then asked Larry how much more he wanted than his peers.

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Executive compensation as a cause of the crash? The evidence

Posted by Marc Hodak on August 8, 2009 under Collectivist instinct, Executive compensation | Read the First Comment

It has been a mantra of corporate critics, and a major source of the justification for extensive pay regulations, that executive compensation was a contributing factor in the financial crisis.  In particular, we keep hearing three assertions underlying ever growing pay regulations:

– Lack of alignment of top executives and their shareholders contributed, if not precipitated, the financial crisis

– Stock options, in particular, provided an asymmetrical risk/reward structure for executives that induced greater risk-taking

– Senior executives were able to successfully insulate themselves from the losses they created for their shareholders.

So, I often find myself asking, how do these three assertions apply to, say, the poster children of the financial meltdown Jimmy Cayne or Dick Fuld?  Is it conceivable that they would have put up their personal fortunes on the bets made by their firms if they had really understood them?  Fuld and Cayne could be accused of a lot of things–arrogance, short-sightedness, poor leadership–but they cannot be called stupid, and they certainly couldn’t be called disinterested or poorly aligned with their shareholders.

Now Rudiger Fahlenbrach and Rene Stulz have gone beyond the anecdotal experience of these two CEOs to broadly study the impact of CEO and shareholder alignment upon bank performance through the financial crisis.  Here is what they concluded:

There is no evidence that banks with CEOs whose incentives were better aligned with the interests of their shareholders performed better during the crisis and some evidence that these banks actually performed worse both in terms of stock returns and in terms of accounting return on equity.  Further, options compensation did not have an adverse impact on bank performance during the crisis.  Bank CEOs did not reduce their holdings of shares in anticipation of the crisis or during the crisis; further, there is no evidence that they hedged their equity exposure.

That takes care of not one or two, but all three assertions.  I’m sure the regulators didn’t want to base anything on the anecdotal evidence of actual CEOs and firms when alternative hypotheses and conclusions were available.  Now that empirical evidence is available (which, based on our own preliminary research, I’m all but certain will not be refuted), I’m looking forward to seeing how it is incorporated into the deliberations on regulatory reform.

Bebchuk on pay

Posted by Marc Hodak on August 4, 2009 under Collectivist instinct, Executive compensation | 3 Comments to Read

Lucian Bebchuk is editorializing on compensation regulations again, proposing that bank compensation is too important to be left to the banks (or, more precisely, to their boards).  Like any good debater, he attempts to address the objections put forth by critics of his position.  I think he kind of stumbles on this one, though:

Furthermore, limiting structures that incentivise risk-taking is not more demanding in terms of information than regulators’ traditional intervention in investment, lending and capital decisions.

Not exactly a confidence booster, huh?  (I’m visualizing the smart guys in Basel grinning nervously, asking, “Hey, what could go wrong?”)

Look, Bebchuk offers perhaps the best defense of certain proposed compensation regulations around.  He is thorough, insightful, and moderate by the standards of current political discourse.  In this case, he is not relying on his mistaken managerial power thesis to defend what he describes as a problem of externalities.  But in the end, he makes the same error in assuming that developing optimal pay structures is something that anyone can do if they just think about it hard enough.

Developing good compensation mechanisms is not an exercise for amateurs.  Even the experts get it wrong when they are acting in good faith.  To expect a regulator, or any non-interested third-party to develop optimal compensation contracts for both the firm and society is like asking a committee of lawyers to develop a surgical strategy for treating leukemia; you know there’s a problem there, but it assumes the people you’re asking to solve it know what the right questions are, let alone the right answers.

I say, let the regulators show that they can regulate investment, lending and capital decisions–which at least have a basic theoretical ground of common understanding–before unleashing them on incentives, which can multiply the effects of unintended consequences.

Who doesn’t believe in incentives?

Posted by Marc Hodak on July 30, 2009 under Collectivist instinct, Executive compensation | 4 Comments to Read

Well, we have Barney Frank:

You get hired for this very prestigious job and you get a salary, and now we have to give you extra money for you to do your job right?

This puts Mr. Frank to the left of Albert Shanker, militant union leader of the United Federation of Teachers, and Nikita Khruschev, leader of the Soviet Communist Party.

His use of “we” might be viewed as a sense of financial services companies under TARP being an arm of the U.S. government.  But in the context of his proposing to expand compensation regulation to non-TARP firms, “we” can only be interpreted as evidence of his collectivist mindset, as if the bonuses paid to executives comes from the public at-large.

Sold down the river in Missouri

Posted by Marc Hodak on July 22, 2009 under Collectivist instinct, Executive compensation, Politics, Scandal | 5 Comments to Read

Missouris head of HR

Missouri state's HR department

The nice people at MOSERS, the Missouri state pension fund, had a bonus plan.  They beat their targets, earning their bonus.  The Governor and legislature denied them their bonus.

Governor Jay Nixon called $300,000 in bonus payments to the 14-member staff of the Missouri State Employees’ Retirement System (MOSERS) “unconscionable.”

Unconscionable?  What happened?

MOSERS’ incentives are based on a five-year cycle.  The bonus payments paid this year were based on fund performance from January 1, 2004, through December 31, 2008.  In that period, says [Executive Director Gary] Findlay, MOSERS had an overall return of 3.9% compared with its benchmark of 1.8%. (the benchmark is the performance of the asset allocation if it were invested passively).

The difference to MOSERS between a 3.9% rate of return and a 1.8% rate of return over that period, points out Findlay, is $600 million.  So, the MOSERS investment staff added $600 million in value to the fund’s assets for bonus payments of $300,000, which is 5/100 of 1%.

So, tell me again, why did the politicians hose the MOSERS fund managers?

[Chairman of the legislature’s pension committee, Senator Gary] Nodler argues that payment of bonuses makes no sense in any year in which the fund experiences no actual growth.  When the fund loses money, he says, then there is no money from which to pay the bonuses except to go into current assets.   And that, he says, is a misappropriation of funds and a breach of fiduciary responsibility.

Makes no sense, indeed.

I give Nodler points for creativity, however.  I have never heard a “breach of fiduciary responsibility” allegation used to cover up a breach of contract and a breach of good faith.  You have to have a highly cultivated sense of mendacity to make this stuff up while summoning outrage for the cameras.

If the politicians had a shred of integrity, they would have told their pension fund managers five years ago that they would under no circumstances get any bonuses when absolute returns were negative.  That way, the managers could have evaluated their compensation fairly versus their other opportunities, and decided whether they wished to stay or take their talents elsewhere.  Given that the pols agreed to a bonus plan, their ignorance of its terms, or difficulty in explaining to the public why they are making payouts, is not a reason to stiff their employees.  At best, if they decided after the fact that they wanted to pay for absolute performance rather than relative performance, then they should recalculate the bonuses earned in past years under this plan on an absolute basis, and pay them consistently.  As it stands, the Missouri politicians were content to pay bonuses based on relative performance when peer fund returns were positive, but for absolute returns when the funds are negative.

And that is why politically run systems can’t outperform private sector ones.

WSJ going down the tubes

Posted by Marc Hodak on July 21, 2009 under Collectivist instinct, Reporting on pay | Be the First to Comment

This was an amazing transition.  Here is the headline, sub, and lead:

Pay of Top Earners Erodes Social Security

Fund Expected to Be Exhausted in 2037

The nation’s wealth gap is widening amid an uproar about lofty pay packages in the financial world.

So, is this an article about Social Security?  Wealth distribution?  Or pay in the financial sector?

None of the above.  It appears to be a critique of tax policy.  I say “appears” because this article looks like a poorly edited complaint about how the affluent are not taxed enough in the opinion of the writer.  Here is the paragraph among this swampy muddle that comes closest to saying what she is really trying to say.

Social Security Administration actuaries estimate removing the earnings ceiling could eliminate the trust fund’s deficit altogether for the next 75 years, or nearly eliminate it if credit toward benefits was provided for the additional taxable earnings.

Translation:  If we take more money from the affluent, or reduce their benefits, we could eliminate the deficit in the social security trust fund.

No plausible actuarial basis is offered for these prescriptions, and no moral basis for why the government’s problem in managing SS becomes a justification for looting the income or wealth of the affluent.  Just a gentle suggestion that breaking a deal can help the side that wasn’t screwed.

Of course, the ultimate sleight of hand, here, is that the extra dollars brought in by raising or eliminating the earnings cap on taxes will actually help SS solvency.  Every dollar of those taxes will simply be spent on current projects, and future taxpayers will simply have a higher obligation to repay to the “Trust fund.”  Bernie Madoff must shake his head in amazement thinking, “What a piker I was.”

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