There has been a lot of talk about Say on Pay, i.e., putting executive compensation packages up for shareholder vote. The U.S. government about to force every public company to submit to this policy. This is considered a corporate governance matter, i.e., something for the putative benefit of the shareholders. Unfortunately, debates over corporate governance policies rarely offer analysis of how the shareholders are actually likely to fare under a given policy.
Jie Cai and Ralph Walking of Drexel University recently published such an analysis for Say on Pay. The results will startle, well, no one.
Basically, they found that firms “with high abnormal CEO compensation and low pay for performance” benefit under a Say on Pay regime. If the CEO does not fall into the overpaid camp, Imposing Say on Pay will destroy value for the firm.
So, what is the net effect on shareholders if we impose Say on Pay on every public company, where the vast majority of them do not have overpaid CEOs? That’s right–shareholders as a class will suffer. But, hey, it’s a small price for the shareholders to pay so that our politicians can demogogue the issue for a few extra votes. And in the new definition that whatever is good for our politicians is “patriotic,” shareholders of well-governed firms should feel pretty darn proud.
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.
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.
One of my dear senators Chuck Schumer, has introduced a “Shareholder Bill of Rights” in his august body. After the reaming investors have gotten from recent government actions, it seems appropriate that the government offers them some relief. So what does this bill promise?
– Say on pay
– Proxy access
– A risk committee
– Separation of CEO and Chairmanship
– Annual election of all directors
If this sounds like an activist wish list without any identifiable link to the current financial problems, you’re right. I defy anyone to point to how any of these items, or all of them in tandem, would have prevented a single liars loan, or the artificial inflation of asset prices that drove so much behavior the wrong way, or would have stopped a single homeowner from taking on a mortgage they couldn’t afford. By insuring directors are elected each year? By providing access to the proxy statement to hedge funds and union chiefs? Aren’t the people arguing that a risk committee could have contained risks the same ones who argued that compensation committees could contain compensation?
“It has become apparent that one of the central causes of the financial and economic crises we face today is the widespread failure of corporate governance,” Schumer, a key member of the Senate Banking Committee, said in a letter to fellow lawmakers.
Like any good lawyer, Schumer selects his facts carefully. If any knowledgeable observer was to rank the central causes of the financial and economic crisis we face today, corporate governance would not possibly make the top ten. It would fall well behind such government induced causes as Fed loose money, federal guarantee of Fannie and Freddie bonds, CRA quotas, failure of regulators to identify fraud at SEC registered funds like Madoff’s…
Corporate governance has been far from perfect. But our current downturn may not have been preventable by any combination of public and private behaviors. Market downturns happen naturally; they create sparks and fires in various parts of economy. This downturn could, however, have been a far less damaging if the government had not thrown gasoline all over our economic structure.
Peter Orszag, White House OMB director, published an editorial about the importance of containing health care costs, and how to do it. The portion of our health care that is nationalized, i.e., Medicare and Medicaid, indeed threatens to bankrupt the country. From this, Mr. Orszag concludes that “we” are in big fiscal trouble and “we” need to do something about it, “we” being code for “the government.”
Mr. Orszag is optimistic about what “we” can do:
Representatives from some of the most important parts of the health-care sector — doctors, pharmaceutical companies, hospitals, insurers and medical-device manufacturers — confirmed that major efficiency improvements in health-care are possible. They met with the president and pledged to take aggressive steps to cut the currently projected growth rate of national health-care spending by an average of 1.5 percentage points in each of the next 10 years. By making this pledge, the providers and insurers made clear that they agreed the system could remove significant costs without harming quality.
A Bolshevik’s word is his bond. Bolsheviks are in the habit of fulfilling promises made by them. But what does the pledge to fulfil the control figures for 1931 mean? It means ensuring a total increase of industrial output by 45 per cent.
Like Stalin’s central planners, Orszag is using this faith in government-led change to make us all into guinea pigs of centrally planned reform. Orszag ignores the 800 lb. gorilla standing next to the guinea pig, i.e., the virtue of competition.
When one casually looks at the areas of our economy, they can judge the relative availability, variety, quality, and cost of different parts:
More competitive … More regulated/socialized
Private/Charter schools Public schools
UPS, FedEx Post Office
Private railroads Amtrak
Phone service post-1984 Phone service pre-1984
Anything pop out?
Imagine what restaurants would look like if their menus, prices, and policies were dictated by central planners.
Never mind what they would look like if they were actually owned and operated by the government.
Unfortunately, most people can’t visualize a free market in health care because they’ve been told, and appear to believe, that our current health care system is “free market.” To others of us, it appears as if the government is heavily involvedin nearly all areas of health care, especially insurance, and that the more it has gotten involved, the worse things have gotten.
President Obama, indicating that no aspect of corporate management is beyond the direct control of government, is now proposing to establish pay standards for the entire financial industry.
The administration is discussing issuing “best practices” to guide firms in structuring pay…
Government officials said their effort, which is just beginning, isn’t aimed at setting pay or establishing detailed rules. “This is not going to be about capping compensation or micro-management,” said an administration official. “It will be about understanding what is the best way to align compensation with sound risk management and long-term value creation.”
All this fuss about alignment is built on the clear evidence of Wall Street pay being clearly insensitive to performance. For goodness sake, don’t those greedy people know that we had a crash in 2008? Why do they continue to pay themselves as if nothing happened?
Boom and bust on Wall Street
Oh, well, I guess the real question is, why did they pay themselves any bonusesat all? Well, the reason doesn’t make any difference to this discussion. This is not really about alignment or risk management. If it were, the government would look to its own incentives, and their utter disregard for the incentives they have created–and continue to create–for making key players in the financial markets completely insensitive to the downsides of the risks they take. This is really about scoring more political points against a politically vulnerable target.
Options being considered by the administration and regulatory officials include using the Federal Reserve’s supervisory powers, the power of the Securities and Exchange Commission and moral suasion, the paper said, adding that officials are also looking at what could be done legislatively.
I love the part about moral suasion. The U.S. government has grabbed the moral high ground on financial management. That’s rich. But I’m looking around at my fellow citizens to see if they’re in on the joke.
Meanwhile, we in the compensation community are trying the best we can to help our clients not place themselves at risk of ending up like Dick Fuld or Jim Cayne (who, contrary to the implications of these proposed “options” really are not who Wall Street bankers aspire to emulate) while navigating the most treacherous set of incentives and constraints ever laid down by government.
Residents in Greenwood, Ind., planned to widen a road leading to I-69 in hopes of attracting businesses, Mayor Charles Henderson said. Instead, a regional authority gave the city $1.2 million in federal stimulus funds to build a pedestrian trail bridge over a road. “It does not stimulate long-term economic development, but we’re going to take that money,” he said.
Most people admitted that trying to quickly spend $780 billion just to spend it would yield some inefficiencies. One of the many things the bill writers didn’t consider is how the raw amount of money offered in different ways to states and cities would interact to place different hands in the same pocket.
Charlotte received far less than that — about $4 million from the stimulus funding for road refurbishing — only to learn that the state would take back nearly $4 million it had planned to provide to the city in highway funds…
In Rhode Island, Providence Mayor David N. Cicilline, a Democrat, said city schools were happy to get about $10.2 million in federal money. Then the state Legislature cut state school aid by the same amount. “It clearly undermines the intention” of the stimulus legislation, Mr. Cicilline said.
And how are state governments deciding where to give and take these funds?
Pat McCrory, Charlotte’s mayor, charges that states often hand out federal dollars “by politics and not by need.”
Perhaps Charlotte is not exactly Chicago, but c’mon. Mayor McCrory cannot be such a political neo-phyte that he is actually stating this in surprise.
Myth 1: Hedge funds attract the best and the brightest
Not more so than any other industry. In fact, it attracts its fair share of cranks and fools. Case in point: One can accuse a president of many things. Keeping his campaign promises isn’t one of them:
A top Obama fundraiser and hedge fund manager said: “I’m appalled at the anti-Wall Street rhetoric. It was OK on the campaign but now it’s the real world. I’m surprised that Obama is turning out to be so left-wing. He’s a real class warrior.
Which brings us to the second myth.
Myth 2: Hedge fund managers are a bastion of Republicanism
Most people mistakenly think of Wall Street in general as pretty Republican. Most people, as usual, are wrong.
"The report says that we might need to shore up those levees"
I have often noticed how business regulation is almost completely headline driven. If a photo of rats in a restaurant makes it on the front page of the local paper, city council members will stand up before the cameras and announce hearings the very next day. If a large business gets an offer from a foreign firm, and instead of portraying this as a vote of global confidence the press chooses to portray it as a foreign invasion, congressmen will step over each other to get to the microphones first to denounce it, even to the point of advocating law breaking. I see this phenomenon all the time with regards to compensation and governance. Serious issues get treated with populist sound bites. The intended effects of poorly conceived legislation invariably get perverted into consequences no one intended.
Given this pattern on visible issues, it should come as no surprise that we see the opposite–political neglect–on issues that could actually benefit from the attention of government, like water management.
Out of sight, water infrastructure remained largely out of mind for U.S. policymakers in the federal economic stimulus effort. The $787 billion program allotted less than $10 billion for drinking and wastewater projects.
State and local officials will not turn the cash away but they say much more is needed to fix and add capacity to the nation’s water systems.
“It’s something that concerns me, because we pay so much attention to things we see and this is something we don’t see — until it’s too late,” Maryland State Treasurer Nancy Kopp told Reuters in a recent interview.
“In Maryland and other eastern states there have been repeated episodes in which pipes carrying clean water or sewage have collapsed,” Kopp said. “Over the next 20 or 30 years, water systems are likely to hit obsolescence.”
I think that one of the reasons that Swiss government is so much more efficient in many ways is that their politicians are more anonymous than ours. They don’t have as much opportunity to jump in front of the spotlight because their society is not so politicized. (American society is relatively unpoliticized, too, compared to most of the rest of world, thank goodness, so far.)
Perhaps we should amend our Constitution to compel our legislators to remain anonymous or random, kind of like jurors, unable to discuss any issue they are working on with the press. I can’t help but think it would make the institution a little more serious. It might make the legislature less responsive to the crisis du jour, but it would prevent them from legislating about things that really deserve more than a day of contemplation. Removing the klieg lights might also encourage them to spend a little more time contemplating items that currently get less serious attention than they deserve.
Of course, nothing will get a politician to better allocate their time and attention better than value-based incentives.
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