Posted by Marc Hodak on January 27, 2009 under Executive compensation, Politics | 
The drama over John Thain and Ken Lewis, Merrill Lynch and BofA, and the government’s loan to Wall Street, gets juicier.
Chapter One: Merrill hires Thain to salvage what he can of the troubled hulk. Thain sells off toxic loans to a hedge fund, and then the dolled up Merrill to BofA, for many billions, all just before the fan is hit by a stinking mound.
Having just preserved a boatload of value for his shareholders, Thain wants to make sure his team is rewarded for it. He knows that BofA’s management won’t be sympathetic to getting taken for a ride once they figure it out, and would probably stiff the Merrill team when given the chance, so he pays out bonuses to his guys in advance of the sale.
Chapter Two: BofA’s stiffs Thain. Then they fire him, and unleash a barrage of bad press about him. The media laps it up.
Chapter Three: Enter Andrew Cuomo. Never content to leave criticism of high profile executive compensation to others, Andy subpoenas Thain over the Merrill bonuses. Ahh, the mystery deepens. What is Cuomo alleging? Under what law is he acting? What public interest is he seeking to protect? (Silence.) Oh yeah. Nevermind.
So, while New York state waddles toward its own spectacular bankruptcy due to the epic profligacy and rampant corruption of its legislators, Andy is chasing headlines about the pay of certain executives of a then-completely-non-state-owned company who had just pushed their grateful shareholders out of the way of a hollow-point bullet.
Why doesn’t Cuomo follow the path of his famous predecessor, and go after easier targets?
Posted by Marc Hodak on January 12, 2009 under Executive compensation |
The rumblings have been clear for a while now. This year will be big for activism on executive compensation.
The biggest complaint is “managers who walked away from the financial crisis with tens of millions of dollars despite big shareholder losses.” While some of this reaction references managers who were paid last year for performance that turned out to be unsustained, much of the reaction is to managers who left with huge “severances.”
The fact is that most of those severances were not really severances in the traditional sense of being paid to leave; they were deferred compensation that was earned in prior years and left in the company, and accumulated pension and other benefits after years or decades of service.
The main proponents of the compensation proposals are, naturally, the unions. The United Brotherhood of Carpenters and Joiners has submitted 23 resolutions to financial services firms. American Federation of State, County and Municipal Employees has submitted 36 proposals, 32 of which address pay practices. The proposals include ideas like having stock options indexed to peer performance, forcing managers to hold onto their equity until two years after retirement, and “bonus banking,” in which a portion of executives’ annual bonuses would be withheld for several years, and adjusted based on updated corporate results.
This last suggestion is actually a particularly powerful way to eliminate the short-termism that permeates much of corporate America. We advocate a version of bonus banking for most of our clients, and have implemented it at a number of them.
None of these suggestions are bad ideas for a board to consider. As specific shareholder resolutions, however, they attempt to force the hand of directors. We wouldn’t dream of giving shareholders a voice in any other kind of strategy; why do they merit one when it comes to compensation strategy?
Boards, in order to be effective, must be free to consider all trade-offs in making compensation decisions. For example, bonus banking can be a good idea, but it is expensive. Consider telling the union, “we’re going to take half of your pay, and keep it banked for three years, then pay it out later, if you’re still with us.” Right. Then add, “by the way, that amount is at risk. We’ll only pay it if we can afford to.” Riiiiiight.
Unions aren’t the only people who negotiate risk averse contracts. Whenever we’ve successfully implemented a bonus bank, we’ve had to offer higher target compensation in return for the extra deferral and risk. If we didn’t, we would have been taking on additional risk of losing the manager because, unlike union employees who could not possibly find other jobs at the rates they are being paid, managers can. That’s because of the most uncomfortable fact that union workers are paid way above market while managers are not, contrary to the impression given by the media.
But it’s easy to see whose side the media is on in all these stories about executive pay. In the WSJ article cited here, they spent eight paragraphs on the complaints before they got to the thee paragraphs defending what is going on. The WSJ is supposedly a business newspaper.
Posted by Marc Hodak on January 5, 2009 under Executive compensation |
Robert Frank, to whom I have been less than gracious on this page, today pays me the highest compliment. In an article about CEO pay, he notes that:
In large companies, even small differences in managerial talent can make an enormous difference. Consider a company with $10 billion in annual earnings that has narrowed its C.E.O. search to two finalists. If one would make just a handful of better decisions each year than the other, the company’s annual earnings might easily be 3 percent — or $30 million — higher under the better candidate’s leadership… That’s why companies where executive decisions have the greatest impact tend to outbid others in hiring the ablest managers.
Sound familiar? Here is what his NYU colleague said last May:
Consider that the average S&P 500 company has a market value on the order of $10 billion. If one had to choose among CEO candidates, and the board believed that one candidate’s leadership was likely to yield a return on capital just one percentage point better than the next best candidate’s, that difference would be worth $100 million per year to investors. A conscientious board with the shareholder’s interests at heart could hardly risk letting the best candidate go elsewhere over even a few tens of millions of dollars.
Thanks Bob. I feel bad now about the other thing.
Posted by Marc Hodak on December 19, 2008 under Executive compensation |
Jamie Dimon of JP Morgan Chase has joined the growing list of highly visible banking CEOs giving up their bonus for 2008. JP Morgan has outperformed its sector by over ten percentage points, arguably preserving about $16 billion in market value that, on a comparable percentage basis, was lost by its peers. Most observers, inside and outside of the company, would give Dimon a good deal of credit for that performance, at least $10 million, which is about what I would estimate he has surrendered.
Dimon doesn’t play the heads-I-win-tails-you-lose compensation game. He was among the lowest paid Wall Street CEOs when times were good for JPM. Given his firm’s relative performance this year, he deserves to be among the highest paid for 2008, but that’s not happening, either. I would think the shareholders would not begrudge him an extra $10 million if that’s what it took to keep him from even the least bit of indifference to bottom line results or his employment at their firm. What would Citi pay to get Dimon back? If they thought they could get him for an extra $10 million, how many milliseconds would it take for them to throw the cash at him? This is, in fact, a case of shareholders exploiting their CEO, based on his work ethic, and his demonstrated willingness to go all out for the firm regardless of his personal opportunity cost.
Alas, the shareholders are not in control, right now; the mob is. The mob controls things partly because the government forced JPM to accept a $25 billion investment that they didn’t need. (The New York Times version is that “Dimon, agreed to take a $25 billion capital injection courtesy of the United States government,” but the New York Times has long since proved that it can’t distinguish courtesy from coercion.) This investment gave the press and the politicians a license to opine on what they think executives should be making. In other words, Barney Frank, Henry Waxman, et. al used taxpayer money to buy a $25 billion ticket to a heckling session.
The cynical among us will say, “so, what’s $10 million to a guy like that?” True enough. But I have yet to see a single congressman who contributed to this debacle giving up anything, not a dime, even as they call everyone else on the carpet.
Posted by Marc Hodak on December 18, 2008 under Executive compensation |
Credit Suisse is going to use its toxic debt to pay executive bonuses. This is brilliant on a couple of levels.
First, it has a “let the chef eat his own cooking” appeal. True, very few of the managing directors eligible for this program were directly involved in creating these putrid instruments, but to the extent that this is a harbinger of a policy that threatens to use the most mis-priced assets as a basis for bonuses in the future, there will develop at least some peer pressure not to create such things again. Frankly, a lot of the problem in investment banks has been the willingness of one group of managers to laugh away boneheaded behavior on the part of their peers, instead of saying, “Hey, are you sure that lead structure will float?” Uncaring behavior happens where bonuses were based largely on the short-term profits of one’s own division.
The other clever thing about this plan is that it transfers these assets into something called a “Partner Asset Facility” at the current value. From here, any mark-to-market changes in these assets will be exactly offset by changes in their liability to the managers. In other words, this vehicle effectively removes from their balance sheet the very assets that were gumming it up.
The bank won’t begin making payments from this facility for five years, and who knows what those payments will look like, so the retention value of this plan is a bit dubious, like awarding you managers gobs of underwater options. But for those who believe that these illiquid assets are way undervalued, this could be exciting to the risk-takers in the firm who could possibly end up laughing all the way to and from the bank.
Credit Suisse will also be instituting a claw back mechanism. We did think of that one.
Posted by Marc Hodak on December 9, 2008 under Executive compensation |
It’s difficult for me to criticize Jonathan Macey given that I generally agree with his prescriptions. However, his diagnosis doesn’t make sense to me, at least the part with which I happen to have a personal familiarity.
In a recent WSJ editorial, Macey says:
The average pay for chief executives of large public companies in the United States is now well over $10 million a year. Top corporate executives in the United States get about three times more than their counterparts in Japan and more than twice as much as their counterparts in Western Europe… I argue that executive compensation is too high in the U.S. because the process by which executive compensation is determined has been corrupted by acquiescent, pandering and otherwise “captured” boards of directors.
It has become fashionable to argue that CEO pay is “too high,” and most critics blame it on “board capture.” Unfortunately, the “board capture” theory, for all its intuitive appeal, happens to run counter to facts and logic.
Consider Macey’s use of the term “has been corrupted.” That implies a period when boards were less corrupted, more pure. When did the corruption happen? Presumably in the 1990s, when CEO pay made its greatest gains. Unfortunately, nearly every corporate critic would say, and I’m sure Macey would agree, that the ’90s saw boards steadily and significantly gain power at the expense of the CEO, not the other way around. That’s not to say that boards don’t still get captured by their CEOs–it certainly happens. I’ve seen it. But as a trend to explain a general increase in CEO pay, this is a non-starter.
Then there’s Macey’s evidence of high pay–the fact that Japanese executives make a third as much as their American counterparts. This runs counter to his claim that weak boards are the problem. When was the last time a Japanese CEO got fired for poor performance? American CEOs have long experienced forced turnover at rates that Japanese companies would find inconceivable. I haven’t worked with Japanese boards nearly as much as American ones, but my sense is that few boards in the world are as independent and challenging as the typical American board, and few boards as collegial and unlikely to upset the apple cart as a Japanese one.
The fact is that CEO pay has gone up exactly as the relative power of the board has increased. While I haven’t heard a decent rejoinder to that inverse relationship, there is a plausible theory as to why increased board power may lead to increased CEO pay. The thinking is that as boards become more demanding and less forgiving, the CEO’s job becomes tougher and riskier–good reasons to command higher pay. Also, in this more competitive and demanding environment, boards increasingly recognize that they get what they pay for, and know that a little extra talent can mean billions of dollars in incremental returns. In that context, the last few million doesn’t really cost that much.
In the end, I agree with Macey’s prescriptions for a more vigorous market for corporate control.
Hedge funds and activist investors like Carl Icahn are the solution, not the problem. The market for corporate control should be deregulated and the SEC’s restrictions on all sorts of equity trading should be lifted at once.
Note that Mr. Icahn doesn’t operate in Japan or in Europe. Icahn counterparts, in fact, are rather hard to find anywhere outside the U.S. And yet we have higher CEO pay. Could it be that the critics have the theory about what is driving high pay exactly backwards?
Posted by Marc Hodak on November 24, 2008 under Executive compensation |
Citigroup has made a deal with the government. The way it’s reported, it sounds like the bank will get over $320 billion in capital and guarantees if they agree to curb senior executive pay to the tune of about $0.03 billion.
OK, so this version of the bailout deal is kind of a warped narrative, but no more warped than the prominence that this aspect of this transaction is getting in the popular press. I believe that all this attention illustrates as clearly as anything how the debate about executive compensation is really two debates. One debate is about dollars; the other is about process.
The more interesting debate by far–the one about dollars–draws most of the unnamed “critics” into the public light, those merchants of outrage cited in the breathless reports in the media. These critics’ attitudes are well summarized as such:
The public wants “strict limits on executive pay,” said Sarah Anderson, a pay expert at the Institute for Policy Studies, which has pressed for executive pay curbs.
IPS is one of those progressive think tanks that provide a ready stable of pay critics (or, in this strange rendering “pay experts”) whenever the subject of compensation comes up. Their critique is simple: the people want limits on pay.
I’m not sure what percentage of the public on whose behalf they speak would describe themselves as progressive (or it’s close cousin, socialist), but a hallmark of any collectivist ideology is that it presumes to speak for “the people.”
In any event, the progressive case presumes that the economy is kind of a zero-sum game, where wealth creation just happens, and wealth distribution is the result of arbitrary decisions by those in power. Such a view naturally leads to the conclusion that higher paid people get theirs at the expense of other, presumably lower paid, people. If you buy these premises, then the solution to “excessive executive compensation” is to define whatever the higher paid group makes as excessive, i.e., in need of “strict limits,” then give “the people” (read: the government) the power to decide how this excess should be distributed.
The idea that certain individuals might have some hand in creating the revenue from which their pay is derived does not enter into the equation. If a salesman’s commission revenue has dropped 50 percent, “the people” may think he deserves nothing, regardless of the commission structure that top executives, the board, or the owners may think is reasonable. Let’s put it up to a vote.
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Posted by Marc Hodak on November 17, 2008 under Executive compensation |
Remember the preemptive “greed baiting” over the last several weeks, those breathless reports about how much financial services executives were going to get in bonuses this miserable year? So called compensation experts have “gone through the numbers” supposedly showing that bonuses would be every bit as high as last year. These tinfoil speculations sent the likes of Andrew Cuomo and Henry Waxman into fits of outrage. My prediction to any reporter who asked (you’re welcome, Liz) was a bonus drop of 30-50% (among the survivors).
Well, in the case of Goldman Sachs, I was off by, oh, 100 percent. The firm is announcing today that their top seven executives will forgo ALL of their bonuses for 2008.
The top guys at Goldman are all mensch, and they have big kahunas risking the loss of talent to less politically savvy Wall Street sharks. But they know what’s good for the franchise, and are now putting tremendous pressure on their weaker peers (and they’re all weaker) by putting this out there right now.
Whaddya say, Mack? Are you willing to go another year without a bonus? Are you still tapping away to see how much Harry, Dick, and Jane should get (or Colm, Michael, Fabrizio…)? Save yourself the trouble. They aren’t going anywhere in 2009.
Collectively, Goldman’s munificent seven have sacrificed about $200 million on the altar of envy. I’m sure the politicians will take credit for the sacrifice, then take credit for the Spring rain that follows, when all they did was build the altar.
All I have to look forward to next Spring is a much simpler proxy statement.
Posted by Marc Hodak on November 10, 2008 under Executive compensation |
When got back to my office, I got a message about an invitation from the Drum Major Institute to attend a panel discussion they’re having on “Say on Pay.” Here is the blurb from their web site:
As compensation for top corporate managers has skyrocketed, even executives who mismanage their companies or demonstrate mediocre performance often receive lavish pay. Blockbuster Inc., led by CEO James Keyes, is at the forefront of efforts to provide greater accountability to shareholders. In March 2008, Blockbuster’s Board of Directors voted to grant shareholders an annual non-binding vote on executive compensation. Beginning in 2009, shareholders will directly advise the board on whether they approve of the pay levels of the company’s top executives. A majority of Blockbuster shareholders, headed by the New York City Employees Retirement System, first called for a ‘say on pay’ in 2007. In Britain, laws requiring say on pay have been credited with reining in exorbitant CEO retirement packages. A small number of other U.S. companies, including AFLAC and Verizon, have also adopted the reform.
Well, I think it’s clear that this narrative presupposes that CEO pay is too high (my read of “lavish”) because of a lack of accountability at the board level, and that “Say of Pay” can provide that missing accountability. In medicine, prescribing a cure without regard to the validity of the diagnosis would be called “quackery.” In politics, it is often called “good governance.”
I was struck by a couple of sentences in particular:
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Posted by Marc Hodak on November 2, 2008 under Executive compensation |
There is a growing outrage about the possibility that Wall Street employees might get paid anything this year. This outrage is translating into a demand to rob bankers of their legitimate savings, and the elimination of pay-for-performance in the banking sector.
To begin with, critics are complaining that banks “owe billions to their executives.” But the vast majority of those billions represent past compensation that executives have chosen to save inside the company. And those critics are further outraged that these savings are accruing interest. Imagine that? And they are further clucking about the fact that these deferrals are mainly for the purpose of deferring taxes. Can you believe that anyone would actually try to structure their affairs to delay paying taxes? Goodness, how greedy can one get? How…unpatriotic?
So, imagine for a moment that one of those bad, bad people decides to defer some of their compensation, essentially saving it within the firm. Under what conception of fairness or justice would one accept the company, reacting to government pressure, confiscating those savings? That is precisely what the ‘companies-owe-executives-billions’ crowd is implicitly advocating. Why else would this particular form of savings register as a front page headline?
Next, the scolds are complaining about new bonuses that many of bankers are set to get for 2008–upwards of $20 billion. New bonuses in a year like this? How dare they?
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