This week, I was a talking head on CCTV‘s The Heat with Anand Naidoo. I was brought in to comment on how poorly implemented corporate incentives could lead to the kind of scandals we have seen of late, e.g., Wells Fargo, Mylan, and VW. Being an expert on incentives and corporate scandal, it seemed like a good place for me to contribute. I believe that was also the impression of Richard Bistrong, who is an expert on corporate corruption and compliance.
Unfortunately, the interviewer instead peppered us panelists with questions about the corrupt relationship between business and politics. I was not entirely comfortable about that direction, not because I don’t have well-supported opinions on that topic, but because it just wasn’t what I was prepared to talk about. So, I kept trying to bring it back to corporate incentives, with modest success. (They cut my comment that, hey, I was a governance expert, not a political commentator.) I was ultimately able to make a few key points:
Perverse incentives were at the root of a number of the scandals
Those incentives are widespread in corporate America
It’s getting harder for public companies to monitor internal bad behavior by virtue of their increasing size
My one acknowledgment of the politics was to counter one of the comments by the far-left lobbyist they brought on as a third panelist. He suggested (several times) that Obama’s DOJ and SEC failed to do their job of wholesale jailing of bankers and executives because government prosecutors were involved in some sort of concerted effort to not prosecute criminals, what I called a reverse conspiracy theory.
Being relatively new to TV, I learned that my habit of looking up for a moment as I think about what to say may look a little shifty on camera. Need to keep my focus on the lens.
In the History of Scandal class that I taught in the mid-2000s, one of the lessons was that scandals have a life of their own, separate from the reality that they are nominally attached to, with the reality invariably being much less salacious than the stories that grew up around it. I have since seen the opposite phenomenon, as well–stories that could easily be made into huge scandals, but simply make the news one day to die the next.
In that context, I find myself asking, why isn’t New York’s attempt to outlaw Airbnb a scandal? The ban, and the now accompanying fines of thousands of dollars, is designed to restrict apartment owners from renting out their apartments to visitors. This has several obvious effects:
Restricting the number of rooms available to visitors from out of town
Making hotel rooms more expensive, so that the visitors that do come have less to spend on non-hotel items
Preventing generally less affluent apartment owners from adding to their income (rich people don’t need to rent out their apartments to make ends meet)
But it should not be surprising that the bill was not called the “NYC Visitor Cap Bill,” or “Only Rich Visitors Allowed Bill,” or the “Ordinary Apartment Owners Don’t Really Need Extra Income Bill,” or the most honest title, “Government Supports Hotel Owners and Unions Bill.”
I’m not sure if that is what this union officer meant by this:
“We fight for our pensions and paychecks the same way C.E.O.’s fight for theirs,” said Scott Diederich, a lifeguard and president of the Laguna Beach Municipal Employees’ Association.
That is, the head of a lifeguard union whose head lifeguard just retired at age 57 with a pension of $113,000 per year.
Anyway, there are a couple of interpretations of Mr. Diederich’s statement. The most innocent interpretation is: “Everyone has a right to negotiate hard for what they want.” True enough, and the reason I believe that “greed” is a peculiarly weak accusation against people who end up with more by dint of their preparation and hard work.
However, there is another interpretation. Most unions characterize the negotiation between CEOs and boards as a form of self-dealing. They believe that directors are generally cronies of the CEO, belonging to the same country club, sitting on each others boards, or, worse, that CEOs have the power to boot dissident directors who might not “play ball.” Leaving aside the gulf between that out-of-date stereotype and my experience in dealing with modern boards, the implications of Mr. Diederich’s statement is that he is condoning a form of, “Everybody does it.” Not as noble a sentiment.
It’s a subtle difference. On the one hand, someone is taking advantage of their leverage in a fair game–we’re not all born or made equal with regards to what is needed to win at a particular game. (Luck plays a role, too–my parents were obviously way wrong in denigrating my ambition to become a Cali lifeguard.) On the other hand, someone is taking advantage of their ability to alter the rules of the game to favor themselves. People have trouble with that.
When we complain about CEOs extracting money from pliant boards, the proper focus is on the system of governance that allows such a thing to happen. That focus has led to immense changes in corporate governance over the last 20 years. Now, attention is turning to the influence of public sector unions over the bosses they help elect, teeing up that system for changes. I expect unions to fight those changes every bit as much as the good ole’ boys resisted changes to our board culture. But when you give up the moral high ground with an “everyone else does it” explanation for a scandalous outcome, your power to prevent change measurably drops.
CEO pay is generally discussed and debated from the point of view of more typical kinds of employees, from minimum wage teens to well-salaried executives, who work for what seem like arbitrary sums offered by frugal or venal owners, or their sometimes clueless representatives on the board. At this level of the discussion, one loses a key distinction about pay in a market economy, i.e., that one should be paid about what they’re worth. So, a relevant question in this debate that is never asked: What is a CEO worth?
Mark Hurd’s sudden, surprise resignation at HP offers a rare hint to the answer; in after-hours trading shortly after the announcement of his dismissal, HP’s stock declined by over 8 percent.
Ladies and gentlemen, that’s over $9 billion dollars in market cap.
So, while various pundits might claim that every CEO is replaceable, the question remains: at what cost? The answer isn’t found in the much vaunted proxy disclosures on executive compensation.
That $9 billion figure is a discounted future cash flow assessment of Mr. Hurd’s value. In other words, in the apolitical judgment of equity investors, the only people with the incentive to make this collective judgment correctly, the company would have been better off paying about $2 billion a year for the next five or six years to keep Mr. Hurd than to lose him.
In fairness to the board, the Mr. Hurd they let go, the man who broke the HP ethics code he had done so much to champion, was not quite the Mr. Hurd the investors thought they had before the Friday announcement. There was a legitimate concern that the expense-fudging Mr. Hurd could no longer govern with the same authority he had before this unfortunate news came out. But that’s not the point here.
The point is that the buttoned-down guy atop his Silicon Valley perch that HP’s investors thought they had was worth far more than the mere tens of millions that the media (check out the comments) and good governance types have regularly derided.
Prof. Larry Ribstein on the Goldman ‘Abacus’ settlement. He predicts that the end result will be confusion about what big banks must disclose:
[W]hat lesson should Wall Street take away from this case? What, exactly, does a bank in Goldman’s position have to disclose to a customer? The identity of another customer on the other side, as the complaint suggests? Only when that customer is somebody like Paulson. What does that mean? Only if the customer has selected the portfolio? What does that mean? Many deals are put together with buyers in mind. Suppose ACA (the collateral manager) assembles the portfolio here with Paulson in mind, and then Paulson says, “that’s for me. Now I’ll invest.” Is this more “material” than having Paulson take the initiative? Suppose they collaborate in putting the portfolio together?
Get ready for even more fine print in our ever less readable disclosure regime.
On the other hand, why bother. If the government targets you, no amount of disclosure will save you.
No, I’m not referring to TARP. The bailout of America’s banks was counteracting what could credibly be considered a liquidity crisis. The Europeans are providing the same medicine for a very different ailment:
The European Union agreed on an audacious €750 billion ($955 billion) bailout plan in an effort to stanch a burgeoning sovereign debt crisis that began in Greece but now threatens the stability of financial markets world-wide…
Immediately after the announcement, the European Central Bank said it is ready to buy euro-zone government and private bonds “to ensure depth and liquidity” in markets.
A liquidity crisis is when private banks generally refuse to lend money to anyone regardless of credit because they’re afraid that they might get caught short on their own cash needs. When private banks refuse to give more money to a spendthrift borrower, that’s prudent lending practice. When a collection of sovereign nations backs the loans of a spendthrift nation (especially knowing that they are inviting other spendthrift nations to continue their indulgence), they are simply shifting risk from private banks onto taxpayers. In this context, the soaring stock market we’re seeing in response to this shift is entirely understandable. But it would be paralleled by a similar decline in the value of taxpaying households, if that were being tracked in any kind of transparent market, since that is where this value is unarguably coming from.
That’s bad enough. The real problem is with how the EU is proposing to execute this massive value shift:
The money would be available to rescue euro-zone economies that get into financial troubles. The plan would consist of €440 billion of loans from euro-zone governments, €60 billion from an EU emergency fund and €250 billion from the International Monetary Fund.
Those €440 billion of loans would be borrowed through a debt facility guaranteed by the euro states via a special purpose vehicle (SPV). That’s like a company borrowing enough money to bet the whole firm via an SPV backed by its own shares. Where have we seen this before? If you’ve taken my History of Scandal course, would have guessed it. It’s like having the house double-down on failure.
Few mechanisms have a greater impact on democratic governance than gerrymandering. Having incumbent politicians redraw districts entrenches them to the point that their reelection rate exceeds 95 percent. To paraphrase Yakov Smirnoff, in gerrymandered districts the voters don’t choose their representatives; the representatives choose the voters.
Gerrymandering enhances the power of political parties since all of the action is in the primaries, and the general election is a forgone conclusion. Many districts throughout the country have not changed party hands in decades. Thus, any challenges to gerrymandering have been briskly opposed by the parties even more than by the incumbents. In fact, the more talented politicians, the ones who could win in competitive elections, would likely benefit from reform since it would bring them out from under the thumb of their party bosses.
It’s hard to imagine a circumstance where the parties that control the redistricting process would agree to reforms that would reduce their power. But such a circumstance appears to be taking shape in New York. New York’s legislature is arguably the most dysfunctional in the nation. It is legendary not only for its brazen corruption, but for the open institutionalization of this corruption. After a string of scandals, the door may now be open to a reform movement that is attacking this corruption at its root by proposing to eliminate gerrymandering.
A coalition of brand-name New York politicians and good-government groups are getting every gubernatorial candidate to promise, in writing, that they will only sign off on a redistricting plan drawn up by a non-partisan commission. Whether or not the elected governor will actually veto anything less than that remains to be seen. Whether the governor’s veto of anything less will stand in a gerrymandered legislature remains to be seen. One has reason to be hopeful on the first question. The leading candidate for governor is Andrew Cuomo, despite the fact that he hasn’t officially announced his candidacy. Andrew’s father, former governor Mario Cuomo, is one of the leaders of the reform campaign. After all, it’s no great honor to be lord of a cesspool.
Last November, the Government Accountability Office released a report titled “PRIVATE PENSIONS: Sponsors of 10 Underfunded Plans Paid Executives Approximately $350 Million in Compensation Shortly Before Termination.” At the time, I was wondering: Gee, how did they pick those ten companies?
Not really. Anyone familiar with politics knows exactly what the criteria was–it was blazoned on the title of the report. The more interesting question is: What exactly is the link between unfunded pensions and executive pay that the government would consider it worth highlighting in a few hundred pounds of wasted paper?
It’s a weak link. Benefits consultant Michael Barry snaps it with some hard sense:
Obviously, out in the political atmosphere, these two things—PBGC liability and executive compensation—are connected somehow, but is there a logic to that connection?
Certainly, you’ve got to pay an executive something, and who is to say that in these circumstances this $350 million wasn’t the right amount? It’s clear that there are, anecdotally, instances that could only be called grotesque abuse. Also without doubt, there are companies out there (perhaps not these 10, which apparently all went bankrupt) with executives that are underpaid. In real life, if you want to win, you’re going to have to pay for talent.
Moreover, why exactly is executive compensation the PBGC’s problem? Couldn’t you make the same argument about corporate charitable giving? Every dollar of matching grants that these companies paid the United Way could have gone to fund the pension plan. Why pick on executives? Why not pick on the company day-care center?
Or, why not pick on regular employees? Surely there are some rank-and-file employees out there who are overpaid. According to The Wall Street Journal, the UAW jobs bank program cost U.S. automakers $1.5 billion in one year—2006. These were “employees” getting paid not to work.
Of course, there may be perfectly reasonable reasons for giving to the United Way, or providing a day-care center, or providing a jobs bank. There also may be perfectly reasonable reasons for paying executives managing companies through difficult times big salaries and bonuses. Or there may not. However, the government—is there any money being wasted on government employees I wonder?—is in no position to tell which is which.
That last point bears repeating. What standard does an outsider use to determine if a company is spending too much or too little on anything, especially something as difficult to value as senior talent?
Barry’s conclusion is not something we see in the mainstream media:
The point being—if it’s not obvious—that there is no necessary link between executive pay and unfunded benefits. The idea that there is, is simply an appeal to envy—which is, you know, a base instinct. (Some of us actually think it’s a sin.)
And some of us think envy is every bit as bad a sin as greed–much worse if it has state force behind it.
So, you offered your investment managers an extra 50 cents for every $1,000 they make you as an incentive to better performance, i.e., more money for you. Then you got the best performing investment management in the whole industry. They earned you an extra $6,000, for which they are entitled to a bonus of $3. So, now you:
A) Increase the incentive to 60 cents–maybe the extra incentive will motivate even better performance going forward;
B) Pat your managers on the back, and keep the existing incentive in place. No need to get greedy;
C) Ridicule your management for being paid a BONUS, calling it “unconscionable,” try to take away what they earned, and cancel the whole incentive program, and their cost-of-living increases to boot.
The title of this post is attributed to Gary Findlay, head of the investment management team that had performed so well, only to be berated for it by his ignorant, spineless bosses.
Addendum: My wife considered the last comment unusually harsh for a sober blog. I am willing to admit that I overstated my critique of Findlay’s bosses. He has at least one who is not ignorant or spineless.
“By any objective standard, MOSERS is the best fund in the country,” said Senator Jason Crowell, a Cape Girardeau Republican who cast the lone dissenting board vote, according to the AP. He said the board should not change its policy based on “newspaper articles and political speeches,” and said taxpayers could ultimately lose money if the system’s rate of return fell because talented staffers left.
Thanks, Sen. Crowell, for standing up for reason against the thankless mob.
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