Posted by Marc Hodak on October 22, 2009 under Collectivist instinct, Executive compensation | 
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.
Posted by Marc Hodak on October 21, 2009 under Executive compensation, Invisible trade-offs, Politics |
Obama’s pay czar has just dropped more shoes, this time on 175 pairs of feet:
Kenneth Feinberg, the Treasury Department’s special master for compensation, will lower total compensation for 175 employees by an average of 50%, these people said. As expected, the biggest cut will be to salaries, which will drop 90% on average.
I’m sure that Mr. Feinberg, like any good fiduciary, carefully examined the value of each of these 175 executives, individually determined their cost relative to their value, evaluated competing alternatives for their talents, including more entrepreneurial venues (e.g., hedge funds) where they can make gobs of money away from public scrutiny, then evaluated the risk associated with losing each of these people, and the cost to the shareholders of doing so.
Or, more likely, Mr. Feinberg was told by the politicians who ran a different calculation that he had to cut those executives’ pay in half, regardless of the financial consequences, and he figured out how to deliver that result.
The political calculation went something like this: “If we slash the pay of these executives enough to grab headlines, and lose 35% of them, e.g., to competitors, early retirement, etc., then taxpayers-as-shareholders may lose about 25% on their investment relative to keeping that talent. But, of course, the taxpayers-as-shareholders will never know what they’ve lost because if they thought like prudent investors we government officials could never get away with the crap we pull on them all the time. On the other hand, headlines that say we really stuck it to the bankers can get us a 4-6 percent voting edge in competitive districts where we might otherwise be vulnerable to political challengers.
In short, the politicians have figured out yet another way to buy our votes with our dollars. And our largely innumerate media pretends like these decisions are made purely based on the public good.
Posted by Marc Hodak on September 20, 2009 under Executive compensation, Reporting on pay |
The current debate over how bankers should be paid is actually two conversations conflated into one.
The nominal conversation is about elevated concepts, such as corporate governance and systemic risk. The Fed proposal is about regulating “compensation policies deemed to pose a potential threat to a financial institution’s soundness.” In fact, the discussion of governance and risk is simply a front for the real conversation driving public policy—envy, i.e., a less elevated concern about how much other people make and who gets to decide.
Governance, as a distinct topic, is too boring for the media to write about. On the other hand, how much other people make is quite interesting. But raw dollars is too crude a topic for our media elite to claim as an explicit journalistic interest. So the MSM satisfies this interest implicitly by conflating the governance and envy conversations in a kind of bait and switch. The bait is code words like “millions” and “outrage” in the headline or lead. Then, for the next fourteen paragraphs, they will discuss governance and risk, as if those considerations were actually driving policy makers and government leaders to the point where compensation overwhelms the agenda of the upcoming G20 talks. Finally, in the fifteenth paragraph, they will return to the crux of what’s driving the debate:
In the U.S., the Fed’s plan will further inflame the debate between those who feel it bank pay too high [sic] and those who resent Washington’s reach into the private sector.
“Pay too high” is a concern about envy, not governance, but even here the narrative is used to disguise envy by obliquely citing ‘those who feel.’
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Posted by Marc Hodak on August 23, 2009 under Collectivist instinct, Executive compensation |
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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Posted by Marc Hodak on August 17, 2009 under Executive compensation, Reporting on pay, Stupid laws |
…in the war for global banking talent:
“Aggressive compensation systems – amongst many other factors – contributed to the financial crisis by creating false incentives,” BaFin said in a statement. “In future, short-term profitability must play no further role in the variable components of the compensation of managers and employees who can establish high risk positions.”
The commanding tone of this pronouncement makes one believe that they have a working definition of “aggressive compensation systems” and some proof that they contributed to the financial crisis. They don’t.
The most startling aspect of these new regulations is the claw back provision for bets that go bad:
“Variable components of compensation must also take into account negative future developments,” Lautenschlaeger said. “With this, risk takers are to share not just in the profits, but also in the possible losses.”
There is no distinction between whether the bets that led to those losses were good ones or bad ones at the time they were made, only whether or not they turned out bad. Consider the following scenario: A banker sees an opportunity to bet $100 on a project that has even odds of either doubling his money or losing half of it. He would be a moron banker to pass up this bet. The bank wants to encourage him to find these bets and make them. They have two choices on how to reward him. They can either reward him based on the expected value of the bets, i.e., $25 in this case, or they can reward him based on whether the bet actually succeeds of fails, i.e., plus $100 or negative $50. A reward based on the latter has a much higher cost to the bank since it must compensate the banker for the added uncertainty.
According to the new rules, the bank must adopt the latter, costlier scheme. They will have no ability to pay people bonuses for their expected value contributions if they must claw them back if good bets sour, as they often do in the business world. And that latter scheme has additional problems in the real world besides cost. In some cases it may be easier to estimate the quality of a particular bet than to know its actual result if the results of that bet get tied up into the results of other bets from the same book. In some cases, the results of particular bets, even if they can be tracked, may not be known for several years, possibly after the banker has moved onto another position. Delaying bonuses also significantly increases compensation costs since one must be compensated for deferring compensation. If you don’t defer the compensation, and you have to take it back later, then you have the logistical issue of recouping compensation already paid–in essence reaching into someone’s personal savings to get back the cash.
What did the regulator say to all these problems?
For the first time, Bafin has established provisions for clawing back money from individual employees if the deals they do turn sour. In so doing, Lautenschlaeger acknowledged that she had overridden concerns from the banks that such provisions are unworkable.
The English translation for Lautenschlaeger’s response begins with an “f” and ends in “you.”
Ironically, the banks’ reactions to these provision are almost certain to both increase the costs to the banks, and also reduce the alignment of their bankers. That’s what happens when you base prescriptions on the wrong diagnosis.
Depressingly, the reporting of this news has basically read like BaFin press releases.
Posted by Marc Hodak on under Executive compensation, Reporting on pay |
The speaker is “Pay Czar” Kenneth Feinberg. The law he is referring to are the compensation clauses under the TARP legislation passed last September and February.
What does “anything is possible under the law” mean? I thought laws were supposed to delineate what was not permissable. Feinberg clarifies what “Pay Czar” means:
“The statute provides these guideposts, but the statute ultimately says I have discretion to decide what it is that these people should make and that my determination will be final,” Feinberg said.
“The officials can’t run to the Secretary of Treasury. The officials can’t run to the court house or a local court. My decision is final on those individuals.”
Man. I wonder if this means that he can also fend off the green-eyed monster we call Congress?
Posted by Marc Hodak on under Executive compensation |
Board capture Exhibit A: Larry Ellison
Ellison routinely gets Wall Street sized bonuses for running a software firm of which he owns about 23%. He is awarded millions of stock options each year, including 7 million new options in each of the last two years. In 2007, that award alone was worth over $50 million. Last year, the award was worth $71 million. Now, a board with some say over compensation would ask two questions:
– If we didn’t give Larry 7 million options, would we be risking him leaving? We probably shouldn’t be too concerned about Larry being snatched up by Microsoft or Sun, but would he even offer the credible threat of retiring?
– If we didn’t give Larry these 7 million options, would the shareholders suffer in some way from lack of alignment of his interests with theirs? In other words, what alignment would 0.007 billion shares add to the other 1.173 billion shares that Larry already owns?
The most likely answer is that this board does not really have that much say over Larry Ellison’s compensation.
This would fit neatly into the widely accepted theory that boards in general are captured by their CEOs, willing to ignore shareholder concerns in favor of keeping the big guy (or gal, but usually guy) happy. This theory or managerial power behind the topsy of regulations being proposed this year.
But is Ellison the rule or the exception? Research suggests that he is the exception. So, if board capture is the exception, do we as shareholders benefit from the new rules? (Answer here.) But that is a tired question.
Today, I ask a different question. Would any of the new rules being proposed actually prevent the kind of agency costs/shareholder pilferage represented by exceptions like Ellison?
It is highly unlikely that the shares being showered on him serve any retention or alignment benefit. But how, exactly, would mandating nominally independent directors help? Oracle already has those. What would shareholders have to say about his pay, especially given that he owns nearly a quarter of those shares? Would they withhold votes for rest of the board if they ignored a non-binding vote against his pay? Would Ellison care?
In fact, all captured boards share certain characteristics. Their CEO has been around a long time–probably longer than any of them–so he benefits from multiple sources of authority. The main source of authority is raw success. You may not be surprised how hard it is to argue with extreme success, especially when measured in billions. The captured board’s CEO is probably a celebrity, and has the kind of PR machine that your average director could merely dream of. You don’t want to get in a public p*ss*ng match with this guy.
These characteristics of captured boards make it extremely difficult to contain their CEOs. Short of mandatory retirement or terms limits (and imagine enforcing that on an Ellison, or a McNealy, or Hank Greenberg, etc.), there is little one can legislatively do keep such people in check. Michael Eisner only became vulnerable when Disney’s performance lagged for about a decade, undermining that key source of his authority.
The average CEO who was appointed by the board within the last seven years. His or her track record ranges from OK to pretty good. People like this are already in pretty good check by their boards, and it’s a good bet that the market is driving their compensation. For those firms–representing the vast majority of companies–all the new rules simply add cost and risk to the firm, which I really don’t appreciate as a shareholder.
So, I’m waiting to see how the new rules may contain Larry Ellison and his board. I don’t doubt that Oracle’s shareholder suffer from overpaying their CEO, but they bought into this leaky bucket up front. Ellison didn’t just appear one day and take over. The costs of legislative and SEC attempts to keep his compensation in check may result in modest net savings for Oracle’s shareholders, but they are sure to add significant costs for the vast majority of the public company universe.
Posted by Marc Hodak on August 13, 2009 under Executive compensation, Politics, Reporting on pay |
The Screwed Seven must submit their pay plans to the horribly nicknamed Pay Czar by Friday. The reports about this have fairly captured his situation:
Many believe Feinberg will be squeezed between public fury over outsized bonuses on one side and what is best for companies trying to compete and retain talent in a marketplace that demands million-dollar salaries on the other.
If Feinberg rules that big compensation packages are mostly fair, lawmakers may assail him as the tool of corporate interests. If he tries to strike down salaries, boards and shareholders may blame him for chasing away the rainmakers.
The implication, here, is that our lawmakers consider corporate interests expendable. In the context of taxpayers’ interests in these particular corporations, this would make Congress a lousy fiduciary, but we already knew that.
Once again, this Congress has placed itself to the left of the administration:
“I don’t think the American people begrudge that people make big salaries, as long as they’re not jeopardizing the goodwill of the public in doing so,” White House spokesman Robert Gibbs said Wednesday.
Contrast that with this concern from Nancy Pelosi and Barney Frank:
[TARP recipients could] “enrich their executives while deferring repayment of the federal financial assistance that helped them avoid financial catastrophe.”
As if preventing their “enrichment” will help anyone avoid financial catastrophe.
The fact that Feinberg is doing this job for free is not reassuring. On the other hand, I know they could not have paid me enough to do it. I get rather claustrophobic in the crevices of shifting boulders.
Posted by Marc Hodak on August 8, 2009 under Collectivist instinct, Executive compensation |
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.
Posted by Marc Hodak on August 6, 2009 under Executive compensation, Reporting on pay, Unintended consequences |
Would you like to squeeze this?
Another bank, Wells Fargo, has decided that they, too, will not sacrifice competitiveness for the sake of making their politicians feel good; they are dramatically raising salaries of their top executives:
“We must pay our senior people fairly,” said Melissa Murray, a Wells Fargo spokeswoman. “We are using stock to increase their salaries to keep the pay of these leaders closely tied to the success of the shareholder.”
Wells Fargo’s move illustrates the tricky mix of politics and government oversight that TARP recipients must navigate in running their businesses. Banks maintain that they must continue to offer competitive pay packages to avoid losing key talent. To do so, some are skirting rules designed to limit such pay.
The intent of the rules was certainly to limit such pay. The companies are skirting the rules in the same way that an animal will skirt a trap designed to make it dinner. Unfortunately, most readers are likely to interpret “skirting rules” as one of those nefarious things that dishonest business people do rather than the logical, predictable response of a market to ill-conceived regulations.
How much of an increase in salary did these silly rules induce? Over a 600% increase, in this case:
The Wells Fargo board approved a new salary of $5.6 million for Mr. Stumpf, who was originally slated to earn $900,000 in base salary this year. Last year, Mr. Stumpf made more than $9 million, $7.9 million of which came in the form of stock options.
My favorite line of this article:
Elizabeth Warren, chairman of the Congressional Oversight Panel, which oversees TARP, declined to comment.
Indeed.
