Posted by Marc Hodak on March 21, 2013 under Executive compensation, Governance, Reporting on pay | 
And that means a new flood of stories about CEO pay. In the past, the stories have almost uniformly been of the “can you believe…” variety. Can you believe that CEO whose company stock dropped 20 percent still earned $5 million? Can you believe that CEO who was canned got $20 million on the way out the door? So, I was surprised to finally see an example of intrepid journalism entitled “Pay for Performance’ No Longer a Punchline.” Apparently the relationship between pay and performance is improving.
The shift in how CEOs are paid highlights the growing role of investors in shaping executive compensation—and their push to align pay more closely with corporate results.
While a welcome the change in tone, I think that both the shift to improved alignment and the role of growing investor involvement are overstated. To see why, consider two items about CEO pay that are approximately true:
Read more of this article »
Posted by Marc Hodak on February 28, 2013 under Executive compensation, Unintended consequences |
That was the comment of a Green Party member of the EU Parliament regarding the sweeping compensation restrictions on banker’s pay in Europe. The measure would limit bonuses to the level of salary without explicit approval of a supermajority of shareholders, and up to two times salary with such approval. This is part of a package of reforms intended to reduce banking risk on the theory that highly leveraged pay structures encourage the kinds of risk that got the world into the financial mess of 2008-2009. This theory has no empirical support, but that’s never stopped the social engineers and the occasional filmmaker who know better.
The UK is in a fit about this since they understand that this measure threatens the competitiveness of European banks, and London is the center of European banking. “People will wonder why we stay in the EU if it persists in such transparently self-defeating policies,” said Boris Johnson, no stranger to populism but, alas, the Mayor of London.
Boris need not fret. Unlike the Greenies and socialists, London bankers understand exactly how liquid money can be, and will easily figure out a way to keep control of it. For example, say they have a star investment banker who has proven himself capable of bringing in $30 or $50 million worth of fees. The new law will nominally prohibit his bank employer from paying him $200,000 salary plus a bonus based on, say, 20 percent of the fees he brings in. The bank will, instead, raise his salary to $5 million, with the possibility of a $5 million bonus. This would keep the banker whole, more or less. But it can’t stop there.
Consider for a moment what an investment banker (or fixed income trader, or M&A adviser, etc.) must do to bring in $50 million in fees. They must plan and continually adapt an aggressive and creative strategy to thwart their global competitors in getting those fees first. They must then execute that strategy by waking up in a different city nearly every other day, working 60 to 90 hours a week, driving their teams crazy, then calming them again or hiring their replacements in order to maximize their productivity, and continually wondering if they might miss the next deal by days or hours because their competitors are chasing them that much faster, all the while leaving behind their families time and again because a real or potential client needs to see the analysis or the man the next day. And they must hope the global economy is good this year, or it’s all for naught. They work that hard because (a) every incremental hour on the job is potentially worth over $1,000 and (b) they won’t be young forever.
Now, if a banker had to work about 3,500 hours to earn their $10 million bonus under the old compensation program, they might get away with working much more normal hours, including watching their kids grow up, to make, say 35 to 40 percent of their new bonus opportunity. Under the new compensation structure, that would mean getting their $5 million in salary, and about $3 million in bonus. (Go ahead, check the math.) Experienced bankers know the 80-20 rule better than most, and if they can make 80 percent of their previous pay with about half the flights and half of the evenings and weekends sacrificed to the job, more than a few will try that, especially the older, more experienced ones with fewer years left before they call it quits and open their hedge fund out of the public eye.
Well, their banks can’t let that happen. Neither can they allow their fixed costs to jump that high, and they certainly can’t allow their top talent in New York or Hong Kong to go across the street to their competitors. So they will do something else. They will enact the kind of strict clawback regime that everyone has been waiting for. Eighty percent of the new, $5 million salary would be placed in escrow, and at risk of forfeiture. To the extent that the banker fails to achieve, say, $30 million in fees, his salary (in escrow) will be docked by twenty percent. If he brings in at least $50 million in fees, he will get his full $5 million salary plus $5 million bonus. That way, if the banker does pretty much what he does now, the bank can pay him pretty much the way they pay him now.
When the Greenies and other socialists in Brussels catch on to this, they will no doubt enact additional laws preventing this particular work-around. We compensation advisers will then develop others. To the extent that the Greenies and socialists tighten the screws to the point where workarounds become too difficult or costly, then the City of London will fade as a global banking center, while the diehard, remaining European banks see their fixed costs as a proportion to their revenues move sharply higher. The net effect of higher fixed costs, of course, is higher risk to the company. I know, I know; the whole purpose of this regulation was to reduce bank risk, but that’s what happens when financial illiterates make financial rules. It’s a bit like watching novice campers trying to cut down trees with blowtorches.
As with all pay rules, the people living under the evolving EU rules will have their choice of unintended consequences:
1) Encourage endless additional complexity by creating new rules to stop the workaround of the old rules;
2) Increase banking risk by forcing banks to accept a higher fixed-cost structure (more than offsetting any benefits of new capital requirements that are driving this whole process);
3) Push their banking centers to other nations, further lifting the property values of New York, Hong Kong, and Singapore.
One way or another, the Greenie who commented “I think it will really hit them” will prove correct. But like the hapless shooters that lawmakers often are, they will hit the wrong target.
Posted by Marc Hodak on June 20, 2012 under Executive compensation, Governance |
That is one of the main arguments being put forth in the continuing assault on corporations in the form of new proposals for binding Say on Pay.
The short answer is “No.” Shareholders are not “owners” like Ma and Pa who own their store and have decision rights with respect to its management. Shareholders have no legal say in the operations of their company unless one changes the law to give them that say. Shareholders can’t set prices for the products their companies sell. They can’t sign off on what the companies pay for supplies, including their supply of labor. Who would give them such power, unless they wanted to destroy the corporation as we know it? The question answers itself.
People making the argument that CEO pay is different from other kinds of costs invariably avoid the implication of that argument. What they mean is that CEO pay “seems” too high (against all kinds of irrelevant standards that no one would really argue in an honest debate about the best interests of shareholders). What they leave out is the possibility that paying a lesser amount can, at least in some situations, have an impact on the company far more costly than the reduction in pay they presumably desire. In other words, the decisions by boards of what to pay their executives are strategically significant, with a profound impact on shareholder value. The Say on Pay mob ignores the existence of that impact, and makes no allowance for even well-functioning boards doing a job that can’t possibly be done as well by outside “owners.” (Please spare us the idiotic response of CEOs not possibly being worth what they are paid by their “owners.” You try to buy a $5 million home for $1 million, and see the response you’d get from the owners.)
There is no doubt some fat in the pay of some executives. But once you change the law to give shareholders an axe to wield at that kind of corporate fat, you can’t take it back just because there is a lot of blood when they try to use it.
Posted by Marc Hodak on May 24, 2012 under Executive compensation, Reporting on pay |
From the Chronicle of Higher Education, an article on What Public-College Presidents Make. Their peculiar take:
Public outcry over presidential pay has intensified, but it appears to have done little to affect what presidents earn at public research institutions.
The underlying premise in this statement is that public outrage should have an effect on pay. This premise is, in turn, derived from the widely accepted managerial power narrative of executive pay, which asserts that the pay of corporate leaders, which could encompass university presidents, is set so arbitrarily that if you simply criticize it, the powers that be will be shamed into reducing it.
This assumption has been repeatedly frustrated by actual history. Still, the purveyors of this narrative stubbornly refused to accept the possibility that boards might be more reluctant to see their chosen president or CEO go away simply in order to make the bad press go away.
Posted by Marc Hodak on May 9, 2012 under Executive compensation, Reporting on pay |
It had to happen. At some point, the CEO pay critics second-guessing the board of directors would lead a CEO to say “Screw it,” and leave the shareholders to deal with the aftermath.
Yesterday, Aviva’s shareholders, saw the departure of Andrew Moss, their CEO, after his pay package was voted down. While it’s difficult to interpret any given Say on Pay vote, it’s a fair assumption that these votes respond to headline news about a company. In the case of Aviva, the headline appeared to be “Insurer performing badly; CEO pay goes up.” So, here is what the shareholders have wrought:
Read more of this article »
Posted by Marc Hodak on January 27, 2012 under Executive compensation, Reporting on pay |
In a warmup for the upcoming proxy season, we have the following lead in the WSJ:
On the way to bankruptcy court, Lear Corp., a car-parts supplier, closed 28 factories, cut more than 20,000 jobs and wiped out shareholders.
Still, Lear sought $20.6 million in bonuses for key executives and other employees, including an eventual payout of more than $5.4 million for then-Chief Executive Robert Rossiter.
The implication here is that the CEO was paid a bonus for slashing jobs and bankrupting the company. I suppose it would not have been as juicy a story if the lead were:
Lear Corp., an auto parts maker caught in the maelstrom that bankrupted a large swath of the auto industry, was forced to close 28 factories and shed 20,000 jobs in order to stay alive. The company survived, eventually adding back those 20,000 jobs and more, due to the difficult decisions made by its managers working through a trying time.
The employees collectively earned $20.6 million in bonuses for that effort, with the CEO earning $5.4 million of that.
The problem with the second version is that it does not support the narrative that paying a lot to turn around a company might make sense. The latter version also undermines another purpose of this article, which is to report on the allegedly widespread skirting of a law intended to prevent companies from paying “retention bonuses” to managers when the firm is in bankruptcy.
The 2005 measure—an amendment to broader bankruptcy legislation aimed mostly at changing rules for personal filings—severely restricted “retention” bonuses that reward executives for sticking with distressed companies. It was fueled by popular outrage over money paid to executives of Enron Corp. and other companies that imploded.
But in the past few years, some corporations have found perfectly legal ways to escape federal strictures on bonus pay during bankruptcy cases.
That’s because Congress can’t outlaw compensation for services. All compensation, whether it’s guaranteed (as in salaries) or at-risk (as in bonuses) have a retention element to them. So, instead of offering a “retention bonus,” those clever compensation consultants offered an “incentive bonus” with easy targets. Keep in mind, they did this with the full cooperation of the investors on whose behalf they were working. A rule that prevents people from doing what they think is right for them is always going to be tested.
So, to prop up an illogical law, the courts had to get into the business of deciding whether the incentive goals were rigorous enough to qualify the resulting pay as at-risk versus guaranteed. As the judges drew the line out, this policy began to force investors to dilute themselves even more. That’s because the more at-risk the pay actually is, the more compensation investors have to promise their managers they need to retain them. That’s because managers, like investors (or anyone else), must be rewarded for taking risks.
This rule, stemming from outrage over Enron, once again illustrates the old adage that tough cases make bad law. Of course, the people making bad laws get irritated when they feel they are being ignored.
Sen. Charles Grassley, the Iowa Republican who introduced bankruptcy-reform legislation in 2005 that later included the pay restrictions, said: “You can’t use subterfuge to get around the law. It surely needs further inquiry.”
Which is why I am quickly gravitating to the presumption that every law Congress passes is a bad law, and every attempt to improve it makes it worse.
Posted by Marc Hodak on October 15, 2011 under Executive compensation, Politics |
Depiction of Goldman Director (not based on any facts)
Last January, when I was still updating this blog regularly, I wrote about various unions bringing suit against Goldman Sachs for their compensation practices. In particular, they objected to the firm’s longstanding formula that employees would get about 45 percent of net revenues, with the bulk of their pay being determined after the company knew what those net revenues would be, i.e., as “bonuses.” The allegation was that this program (basically a profit-sharing system) created incentives toward excessively risky and short-term behavior against the interests of the shareholders. If the latter were true, and if the board approved of such a plan knowing that were true, it would arguably constitute a breach of their fiduciary duties. Of course, there are a couple of big “ifs” in that allegation, both of them needing some substantiation before a board’s culpability could even begin to be ascertained.
Last week, the Delaware Chancery Court decided that in the absence of any substantiation whatsoever, and insisting on these things called facts, that they had to dismiss the case.
I only wish that the fiduciaries who brought this fact-challenged suit could be held accountable for the far more provable waste of their investors’ resources for their personal profit, i.e., maintaining their union sinecures. Wouldn’t some enterprising plaintiffs lawyer love to find that e-mail from a top union official that says, “I know this case doesn’t have any merit, but hiring lawyers to publicly poke Goldman’s eye would help me get re-elected.” Or at least these enterprising lawyers could allege without any facts that this was the motivation. Alas, there is no private party willing to waste their own money to bring such a frivolous suit.
Posted by Marc Hodak on September 24, 2011 under Executive compensation, Reporting on pay |
The severance package of the fired CEO of Sara Lee’s North America division is in the news:
His package is worth about $11.3 million, based on Sara Lee’s share price of $17.10 as of 4 p.m. Eastern on Friday, according to a calculation for The Wall Street Journal by Mark Reilly, a partner at Compensation Consulting Consortium LLC in Chicago. The estimate reflects Friday’s value of his unvested equity and assumes he earns the pro-rated portion of his annual bonus. “It’s a competitve package,” Mr. Reilly said.
That last comment struck me: “It’s…competitive.” I know what the consultant was thinking when he said that. He looked at other severance packages for departing executives of similar responsibility and similarly sized firms, and saw that, on average, they were given severances with similar terms or of similar magnitude. That’s how comp consultants define “competitive.”
The authors of this article have been reporting on executive compensation long enough to learn the lingo of the comp consultants they rely on for the numbers they report. It appears that they simply bought into the notion that paying the same as everyone else is, by definition, “competitive.”
Apparently neither the writers nor the consultant (not to pick on this consultant–most comp consultants use the same lingo) thought about how the word “competitive” looks to the intelligent reader, who could very well view the departing executive’s $11.3 million pay day and ask, “who were they competing against to provide that award?” Was another company ready to offer $10 million for him to stay? Was someone calling in with an offer of $10.5 million or $11 million if he didn’t leave?
It is likely that his severance was, in fact, established by contract or policy at the time he agreed to commit to the CEO job. Severance is a reasonable component of an executive compensation package, especially to the extent that it consists largely of unvested stock or options in the context of a change in control. If an executive builds a company to the point where the shareholders can cash out in a sale or merger, they want their executives to work hard to make that situation as valuable as possible, without worrying that they are cutting themselves out of the payday through forfeiture of their now valuable, but still unvested equity. So, in a sense, the competition happened at the time the executive was hired, and the board is simply following through on a deal.
However, the average person doesn’t get millions of dollars for being fired. So when the average person doesn’t know about the deal, which is ancient history, and when fulfillment of the deal is simply referred to as “competitive,” the average person can easily be left with the feeling that the game is rigged. Then the average person ends up supporting Dodd-Frank and similar monstrosities.
Posted by Marc Hodak on May 10, 2011 under Executive compensation |
Larry Ribstein notes a questionable allocation of scarce SEC resources:
The SEC brought in Hu, a widely recognized expert on financial regulation, in response to its embarrassing Madoff failure. The Reuters article discusses some reservations about how much Hu accomplished, but I want to focus on another issue it covers: the price of Hu’s services.
The SEC let Hu call Austin home, then paid him to travel between DC and Austin and to stay in temporary housing in Chevy Chase.
The SEC allocated nearly a quarter of its entire travel budget to this one expert. Furthermore, the amount they paid his university in salary reimbursement and contributions to his benefits exceeded the cap on federal employee salaries for SEC division heads.
The point is not whether or not Hu was worth it. His SEC commissioners made that determination, and one ought to give them the benefit of the doubt. I’ve been involved in countless negotiations where getting the “right” guy or gal meant paying all sorts of travel-related expenses that the board considered worth it compared to the value of the services they were expecting to receive.
Ribstein makes the point that when the majority of SEC is looking at similar determinations by corporate boards, they feel that such decisions should be second-guessed by outside shareholders. He then suggests:
I suppose it’s too much to expect a national referendum on SEC pay. But shouldn’t we at least give Congress a say on SEC pay? If anything it’s more justified here, since investors can simply sell or decide not to invest in companies that pay too much, but what’s the taxpayers’ remedy for excesses by the SEC?
Of course, Congress does indirectly, but powerfully, have a say on SEC pay. I would suggest (and Larry would likely agree) that Congress is all too willing to focus on relatively inconsequential amounts, like the extra hundred thousand that the SEC may have used in their best judgment to attract Dr. Hu, while ignoring the hundred thousand dollars that the government spends every second that they tie themselves up in such deliberations. In adopting Say on Pay, Congress was merely spreading the fun of second-guessing the immaterial executive awards to institutional investors who are generally poorly equipped to make such distinctions, and should be much more concerned about what they are getting from their managers than what they are giving them.
But if they don’t like what’s going on with their CEO’s pay or policies, investors can cut loose their shares without having to permanently leave the country.
Posted by Marc Hodak on May 6, 2011 under Executive compensation, Governance |
Well, not a rabbi, really, but the CEO of a Jewish organization, along with the others “will be there to press Goldman Sachs Group Inc. to evaluate whether it’s paying executives too much.”
“When we see CEOs earning over 300 times more than the typical worker, it raises serious questions for shareholders on whether they are really (that) valuable,” says Sister Nash, who has been a nun for 50 years.
I personally have no doubt that Goldman’s executives are paid way too much. I have somehow found a way to be reasonably happy and secure with my relatively paltry income, so why do they need so much? I can only imagine how it must look to nuns, who have taken a vow of poverty.
But that, of course is my personal, not my professional, opinion. I can’t render a professional opinion on Goldman’s pay because I don’t know what information the board had about:
a) Agreements, explicit or implicit, that had been reached between these executives and their (quite independent) compensation committee
b) The likelihood of losing key executives to hedge funds, where they could each make multiples of what the top five made together
c) The impact on the company’s returns if one or more of these people left
The latter gets to the heart of how valuable these executives are relative to the “typical” worker.
Goldman has a market cap of about $82 billion. Its shareholders understand that the firm recently survived a financial tsunami, is now dealing with the radioactive Frank-Dodd aftermath in the midst of market and regulatory shifts that are transforming the global financial industry. The “typical worker” is not going to have much impact on how Goldman Sachs strategically and organizationally responds and adapts to these changes for the benefit of the shareholders. So, the relevant question is this: Is it possible that the difference in outcomes between what this management might achieve versus the next best management team that the board might lure could be something in the range of $69 million?
If the Sisters of Saint Francis asked God, “would losing your dear, unconverted son, Lloyd, in favor of his next best make a two hundredth of one percent difference in the GS stock price?” and the Lord replied, “Yea, my children, losing Lloyd would make 10 times, nay 15 times, that difference,” would they then go back to the board and insist that they increase management’s pay? Would they do that for the sake of the shareholders?
