Posted by Marc Hodak on February 5, 2009 under Invisible trade-offs, Politics | 
I have gotten a number of inquiries about my thoughts on the new executive compensation rules laid out by President Obama. So, here they are:
1) The rules look like they’re about executive compensation, but they’re not. They’re about getting congressional and public support for the fabulous spending orgy that has the president’s congressional colleagues in a state of priapic delirium. Obama is using “$500K” to buy “$500B” (the spending portion of the “stimulus”).
2) If you have any doubt about the political intent, check out the requirement of an “Adoption of Company Policy Relating to Approval of Luxury Expenditures.” This the clearest example yet of of how the institutionalized greed of Wall Street is being replaced by the institutionalized envy of Washington.
3) As little economic training as Obama has, he knows that real wage controls will not work in America (if anywhere), so he is promoting these reforms knowing their potential danger, and acceding to various loopholes in their implementation. He may mistakenly believe that these dangers can be well contained (see #8 and #10 below).
4) Yes, we compensation consultants will be able to use the proposal’s loopholes to work around the limits to a considerable extent. Obviously, we have restricted stock, albeit with a few extra restrictions, that enable us to greatly improve the value of the plans to the executives. Less obviously, we have a large variety of long-term incentive arrangements we can create well within the letter of the law. All of these will be costlier to the shareholders than the arrangements they replace.
5) Ironically, these newer compensation structures will also be dramatically riskier for the shareholders in ways the government cannot contemplate, despite their mandate to limit risk. We might be able to create equity compensation instruments that can limit these risks, but the SEC will inevitably drag their feet on them, and Congress will likely block them, so we will probably not even try.
6) In the cases where we can’t get around the limits imposed by this plan, you should sell those companies short. They will lose talent at an unconscionable clip.
7) Outside of my professional capacity, I actually have no qualms about these firms losing their competitiveness and going under as a result of the plethora of unintended consequences of this proposal. If these rules accelerate that process, all the better. Replacing market discipline with political discipline will not help these companies, and they won’t get our economy back on track.
8) The worst part of this proposal is not the nominal effect it will have on firms getting TARP money; it will be the precedent of Congress legislating pay. As the shortcomings of these rules come into focus, and as the contortions necessitated by business imperatives become plainer, and spread to other parts of the economy via a misguided attempt to satisfy political constraints at the expense of shareholder value, Congress will inevitably feel the need to “fix” these rules, enlarging their scope and increasing their complexity.
9) We’re one step closer to widespread adoption of “Say on Pay” if not outright legislation of it. Anyone who has kept up with my writings on this knows that, while I don’t believe “Say on Pay” will be the end of civilization as we know it, I think it will significantly step up the politicization of executive compensation, pulling it further from the market-driven/shareholder-friendly ideal that many of its proponents nominally favor.
10) Congressional involvement in executive pay will quickly spawn a cottage industry in compensation lobbying. In fact, very few areas of congressional intervention will get the attention of executives faster than messing with their pay. Congress is basically increasing the rift between the interests of managers and those of the shareholders. It’s hard to think of anything adding greater agency costs than mandates along the line of, “well, you can choose this constraint on your pay, or that policy that will help your firm.”
11) So, in a political fight over executive compensation between the concentrated interests of highly effective, type-A executives, and the dispersed interests of shareholders defended by ivory tower intellectuals and effete guardians of the “public interest,” guess who will win?
12) That’s right: private equity. It’s fashionable to remark “where will these overpaid Wall Street stiffs go in this environment when we slash their pay?” And it’s true, the private equity markets are as far down as anyone these days. But the market won’t stay down forever. And when it comes back, the PE firms will only have economic hurdles to get over. The political hurdles being set up will still be there for public companies.
Where the title comes from: An excerpt of White House deliberations.
Posted by Marc Hodak on February 4, 2009 under Executive compensation, Politics |
So, Obama is proposing a $500K cap on executive pay for firms taking bailout money. What does $500K buy?
In some parts of the country, it can get you a nice house, with a nice yard, in a nice neighborhood. But it can’t get you a $1 million house. It can’t get you a $1.5 million house. You know you can tell the difference. The location, the views, the acreage, the amenities…a $500,000 house is not the same as a $1.5 million house. Nobody who is looking at the comparison with eye toward buying can fail to see the difference. And no matter how well you bargain or cajole or pray, you can’t get a $1.5 million house for $500,000. You just can’t.
Yet, judging from the popularity of the political clampdown on executive pay, everyone seems to think that either there is no difference between a $500,000 executive and a $1.5 million executive, or we (as co-owners of an enterprise) can get $1.5 million executives for $500,000.
Or, they don’t really think anything at all; they’re running purely on emotion. “Nobody is worth that much!” “Nobody needs that much!” “I don’t want them to make that much using my money!”
A lot of this emotion was stirred up by the big numbers reported in the media, numbers like $20 million, or $60 million, or $20 billion. But we’re not talking about a $10 million cap in pay; we’re talking about a $500,000 cap. Lots of senior executives–corporate functional chiefs, division managers of major corporations, not to mention successful traders and asset managers (many of whose assets did not blow up)–make over $1.5 million per year. These people get paid that much because they are better than $500K managers. The people making the pay decisions can see it. The $1.5 million managers are more intelligent, more experienced, more decisive, or more politically savvy than the $500,000 managers. They get things done more effectively. They inspire more confidence. But most people who know they could never buy a $1.5 million house for $500,000 seem perfectly content to believe that a company can simply offer less without any noticeable penalty.
The central lie in this scenario is that Obama and Congress are doing this to protect the taxpayers-as-shareholders. Well, as a shareholder, I don’t want discount managers running my company. I don’t want the retention risk associated with grossly underpaying the very people I need to make the kinds of tough decisions these times demand.
Maybe that’s because I’m in the market for executives every day, just as a real estate broker is in the housing market every day. You see how it works. You see it’s contours, and imperfections, and messy negotiations. But in the end, you see it’s a market. Most people who have been in the market for a home know what I’m talking about when it comes to homes. Unfortunately, few people have negotiated big pay packages, either as the buyer or seller of executive services, like I have.
For those of you who don’t believe it, please let me take back my portion of this immense investment our government is about to make on my behalf, and let me reallocate it to companies not run by $500,000 managers.
Posted by Marc Hodak on January 30, 2009 under Executive compensation, Politics |
OK, Wall Street collectively earned $18 billion in bonuses.
After the NY Comptroller’s report yesterday, BDS has come into full swing. President Obama gave a wag of his finger. Many in our anti-business media are piling on with psychobabble dressed up as analysis. Now, the Davos clique, striving for relevance, is chiming in. And check out how hot “b” can sound when enunciated by the babe in the MSNBC video.
The comptroller’s report itself did not contain the outrage it provoked. In fact, it noted that the lack of these bonuses had a material impact on the ability of the state and city to finance public services, reinforcing the truth of what P. J. O’Rourke once said about the value of the undeserving rich:
The worst leech of a M&A lawyer making $500,000 (he wrote this in 1992) will, even if he cheats on his taxes, put $100,000 into the public coffers. That’s $100,000 worth of education, charity or U.S. Marines.
What is shameful, I think, is the PR problem Wall Street has created for itself by mislabeling what it pays its producers as “bonuses.” Wall Street, like any other enterprise, depends on its talent, such as it is. And, like any other enterprise, the famous 80/20 rule applies–about 20 percent of its talent generates about 80 percent of its revenue. Rather than pay all its talent equally, they give these people base salaries that would barely keep them in a small Manhattan apartment. These folks need to earn up to their competitive level of pay through “bonuses” based on their production. So, whereas most people in the country think of a bonus as something “extra” awarded for very good performance, on Wall Street most of these bonuses resemble commissions earned by a modestly salaried salesperson. The I-banks like to call them bonuses because it sounds better to the employees they wish to attract and retain.
Unfortunately, it sounds the same way to everyone else. The point is, no one familiar with how sales people get paid would seriously think that paying them zero commission in a bad year makes sense (except, perhaps, Barney Frank). Hey, the guy sold only half of what he sold last year, but he didn’t sell nothing. He deserves his commission, which will add up to less than he could have made in a less risky compensation structure of mostly salary.
But all this outrage leaves out the most important point of any discussion of bonuses: as long as someone has a their compensation at stake via a commission, bonus, whatever, they will perform better at the margin. Wall Street had a miserable year. Believe it or not, it could have been worse. How much worse we won’t know until we eliminate all remaining incentives to preserve, if not earn, as much revenue as possible. When you take someone off the incentive curve, however it’s labeled, they cease to care how many more billions go out the door and down the drain.
They become like congressmen.
Posted by Marc Hodak on January 29, 2009 under Politics, Scandal |
1,736,219 people trusted this guy
Gov. Blagojevich asked the Illinois Senate that is acting as jury in his impeachment trial, “How can you throw a governor out of office who is clamoring and begging and pleading with you to give him a chance to bring witnesses in to prove his innocence?”
The answer kind of lies in the question, I think.
Hey, I don’t know if Blago is guilty or not. My prejudice of politicians says, “Of course he tried to use his public office for private gain. What are you thinking?” My prejudice of prosecutors and the press is along the lines of “Sentence first–verdict afterwards.” I’ve been teaching about scandal long enough to know that scandal is a creature driven by raw emotion. Nevertheless, I can’t summon the outrage about his proceedings. He and his accusers are in the profession they have chosen.
The whole spectacle serves as a great civics lesson about the wisdom of the constitutional prohibition on bills of attainder.
Posted by Marc Hodak on January 28, 2009 under Economics, Executive compensation, Politics |
OK, Andy, you can stop hyperventilating now about how much certain other New Yorkers are making. The media and politicians have been fretting about how much Wall Street bonuses would be this year. The nominees were:
1) Up three percent (!)
2) It should be zero (Barney Frank)
3) Down about 25 percent (Alan Johnson, Wall Street comp specialist)
4) Down 30 to 50 percent (yours truly)
And the correct answer is (drumroll, please): down 36.7% per worker; 44% overall
I’d like to think that our AG’s obsession with how much these bankers make has contributed a little to this comeuppance. Alas, the market’s work is swift while the wheels of justice grind on at their deliberate pace. I’m sure Andy and Co. will press ahead, however, making it as difficult as possible to pay anything to those greedy bastards on Wall Street, tamping those bonus dollars down for as long as possible. Of course, Andy’s own job is secure. It’s up to his compatriots to figure out what to do with the $1 billion in state tax revenue and $275 million in city taxes that have evaporated with those bonuses.
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 22, 2009 under Politics |
Apparently, a small Internet bank from Boston wanted to get hold of some of those sweet TARP funds. They approached Massachusetts Congressman Barney Frank, and asked for his assistance. Congressman Frank happens to be Chairman of the House Financial Services Committee. When he was approached by the bank, he told them, “Hey, I wish I could help you, but there are lots of firms like you in Wisconson and California and, well, I really can’t use my position to play favorites. Besides, I am dealing with trying to oversee a few hundred b-b-billion in disbursements, and you really can’t expect me to spend any mind space pushing for a $12 million loan, right?”
Pause.
Hahahahahahahahahahahaahahahahahahahahahahahahahaahhaaahh.
Ha.
OK, now that we’ve got that out of our system, you can read the real story, here.
At least someone is writing the story, because I think the story that businessmen are greedy isn’t really any more interesting, at least to me, than the story that politicians are political. Businessmen at least have to convince the people providing them money to voluntarily part with it, even if they’re lying and scheming to do so. Politicians don’t have that particular funding problem–they simply “ask” the taxpayers. The fundraising problem for politicians is getting support for their elections so they can keep their power. And if you’re the head of the Financial Services Committee, guess where that support is likely to come from?
All this, by the way, is not meant to blame Congressman Frank. He’s being rational, too. And legal.
Posted by Marc Hodak on December 12, 2008 under Politics |
Richard Wagoner, the CEO of General Motors, played politics with his company and lost. For the last couple of months he has been going around telling the American public that if GM went into bankruptcy, no one would buy its cars. That’s tantamount to telling the public “If GM goes into bankruptcy, you shouldn’t buy our cars.”
One of the key roles of any CEO is chief sales officer. The CEO is supposed to believe in his company’s products 100 percent. If he doesn’t who else should? Even if it’s plausible that under certain conditions one’s products might not be as desirable, it’s not a CEO’s role to point that out. That’s the job of the competition and the critics. The CEO is supposed to be a cheerleader. When the home team is down 30-7, a cheerleader doesn’t turn to the fans and say, “If we don’t score on this next drive, we might as well all go home.”
So why has Wagoner gone around telling customers that if GM went into bankruptcy, they might as well buy a Toyota? Because that was his brinkmanship strategy to shake taxpayer dollars out of Congress. He was trying to scare them with an apocalyptic story that went, “if we go bankrupt, no one will buy our cars, which will lead to…economic depression!” What’s bad for GM is bad for America.
It’s important to note that Wagoner was making this cheer apart from his board. The board has responsibly maintained throughout that all options are on the table. They must know that their leader could have embraced the argument that a reorganized, stronger GM is exactly the kind of company car buyers could have confidence in.
But that was not the tack taken by Wagoner. Wagoner chose instead to put all their marbles on a bailout. He pitted GM against the taxpayer in a bold grab at the public treasure. What has that done for GM’s reputation with the 60 percent of the public that was against the bailout? He lost by playing his hand arrogantly and incompetently. Worse yet, he lost playing against the sensibilities of a board that must have known that if he lost, GM would be closer to liquidation than if he had not taken this tack. I don’t know why Wagoner played it the way he did. Maybe he knew his job would not survive bankruptcy, and so he personally had nothing to lose by aiming GM toward the cliff with his foot on the accelerator.
At this point, the board’s credibility is at stake. They need someone who can deftly drive GM through bankruptcy, packaged as best as possible, able to salvage whatever one can for bondholders, workers, and suppliers. They need someone who can reclaim from the customers the trust that Wagoner deliberately undermined.
Update: It appears that Bush is ready to throw the Big 3 losers a lifeline, and that the union seeing Bush standing on the deck with a lifeline in his hands emboldened them to balk at a Senate deal that would have forced them to be competitive. In other words, the Bush administration, which has never owed anything to the unions, is ready to cave in to them again, just as he did with the steel companies early in his administration, almost certainly with the same, dismal political and economic outcome. Or he’s dumb enough to believe the “sky is falling” rhetoric of his CEO buddies. Either way, I find myself counting down the days that Mr. Bush settles back into a nice Dallas retirement.
Posted by Marc Hodak on December 3, 2008 under Politics |
The “Big Three” auto companies can’t make a legitimate business case for getting funds from Congress, so they must appeal to their fear.
GM says:
The way I would explain it to your constituents is it’s going to prevent the United States from entering into an economic depression in my view.
Chrysler says:
If we have a catastrophic failure of one of these car companies, in this tender environment for the economy, it’s a huge blow. It could trigger a depression.
I particularly favor Rick Wagoner’s wording (the GM quote above). He’s not actually saying the failure of the auto companies would cause a depression. He’s just saying that’s what congressmen should tell their constituents in justifying a federal bailout.
In the unlikely case Congress asks my opinion, here is what I would have them tell their constituents:
GM and Chrysler have together about $200 billion in assets. In 2002, a particularly “tender environment” for our economy, the top three bankruptcies sent nearly $200 billion in assets into receivership. The federal government didn’t bail anyone out that year. The following five years were ones of significant economic expansion.
I would also note that it is highly unlikely that all three of the “Big Three” will go bankrupt if events run their course. In fact, if GM and Chrysler go into receivership, it’s likely that Ford’s odds of survival go up, not down, notwithstanding all the scare talk about an interdependent supplier network. The fundamental problem with our car companies is: they are making too many cars, and the markets consider the “Big Three” vehicles to be the most expendable. One or two fewer car makers, even if they simply reorganize around a shrunken asset base, will make it easier for the rest to survive.
If Congress feels it absolutely has to “do something” to help the auto companies, it should announce that it will pick just one of the three based on who is worthiest. It will probably pick the wrong one, but by promising to saving one, they can get some real action in terms of the turnaround plans it has requested. And by letting one or two of the others fail, it can then prolong the agony of the decrepit supply chain just long enough to allow the country to see that the Big Three, in fact, do not support the sky.
Posted by Marc Hodak on December 1, 2008 under Politics |
I was trying to imagine what the execs at GM were actually doing to prepare for the presentation in Congress later today. I’m sure the first draft prepared by some savvy junior executives included some consolidations of plants or brands, improved designs, supply chain re-engineering, cost concessions from the unions, etc.
CEO Rick Wagoner would have no doubt responded, “Are you nuts? Who the hell do you think is reviewing this plan? Institutional investors? Venture capitalists? Christ, boys, we’re talking to Congress. Do you think Henry Waxman knows what a supply chain looks like? Maxine Waters thinks P&L is a street corner in Chicago.
“Men, you’re forgetting the customer, again. We’re selling to Congress. They are in the drivers seat. They don’t know squat about ROI or lean production or anything about what makes a car company work. If they had the slightest interest in that, they would have taken a tour of Toyota’s Lexington plant. Men, they want green cars that no one will buy. They want protections for their union patrons. All we have to do is tell them that they can have those things and a turnaround. They’re looking for magic. Show me a plan where we’re delivering that.”
No one in that room would have the balls to point out that Congress also wants the CEO to accept $1 a year, so he’s not going to hear that until some snide reporter asks him on the way to the public airport.
In the end, we will be witness to the spectacle of businessmen acting like politicians (which is much less of a stretch than most would suppose), and politicians pretending to be businessmen (which is pure acting).
Consider that most taxpayers are forbidden by law from investing in private equity firms. Congress considers the average taxpayer as not sophisticated enough, and the typical P.E. partnership as too risky. Imagine, then, being asked to invest in a P.E. firm without a single principal who would qualify as a “financial expert” even by the government’s criteria. Consider, indeed, that the principals consisted almost entirely of economic illiterates. Imagine, further, that these P.E. principals did not earn their positions based on any track record of financial success, but exactly the opposite, based on their track record of squandering as much money as possible, earning negative returns that constantly require capital calls on the limited partners. Consider that this P.E. firm is not only able to solicit you as a limited partner, but compel you to invest. You would be forced to invest in some of the worst performing assets in all the land, and the capital calls that you will be subjected to, will bind your children and grandchildren for generations to come.
Welcome to Congress as your fund manager.
