Posted by Marc Hodak on October 29, 2009 under Executive compensation | 
Every now and then, and outsider can see something that the insiders overlooked. Kenneth Feinberg, Treasury’s “pay czar” replaced cash salaries with something he’s calling “stock salaries,” which is shares of the company that vest immediately, but is paid out over three years. This is a kind of restricted stock where the restrictions are on the payout rather than the vesting. There are two nominal benefits to trading cash salary for this kind of “stock salary”: to give the manager an incentive to get the stock price going up, and to stick around to make sure their efforts result in sustainable improvements.
I give kudos to Feinberg for equating stock and cash from the perspective of a salary equivalent. Salary is referred to as “fixed pay” since it represent the guaranteed, time-based portion of managerial income. Most people in the compensation industry view stock as “variable” compensation because its value varies over time. I believe it’s more realistic to view stock as somewhere in between. It’s “fixed” insofar as there is a guaranteed value on the date it is granted, and it’s “variable” insofar as it does, indeed, vary in a manner that is arguably, somewhat influenced by managerial effort.
My view is that stock is more salary-like than bonus-like, even with the restrictions. The problem with “stock salary” is that the restrictions simply make the stock grant less valuable. The easy remedy is to replace stock for cash with a higher value of stock than is surrendered in cash, and Feinberg appears to have done something like this for many of the managers. He was able to get his headline that he “cut salary by 90%,” while giving managers a risk-adjusted salary-equivalent to try to keep the good ones around.
I think, however, that it’s a mistake to think that stock has any incentive effect on managers, besides the incentive to pray it goes up. Most managers simply cannot relate their day-to-day decisions and activities to the overall company stock price. It’s kind of like expecting them to use a globe to navigate between nearby towns.
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Posted by Marc Hodak on October 28, 2009 under Executive compensation, Reporting on pay |
The headline reads that pay czar Kenneth Feinberg increased base pay while cutting total compensation in half. As the reporter puts it:
The move reflects the complexity of regulating something that mixes politics and economics.
Actually, this move reflects the need to include politics in what is otherwise an economic trade-off between the three governance objectives of compensation:
– Attraction and retention of management talent
– Incentives that align managements’ interests with the owners’
– Control of total compensation costs
This trade-off is universal. It applies equally to any business one is charged with overseeing: auto companies, banks, drug companies, drug stores, and drug dealers.
Here is how this story characterizes Mr. Feinberg’s trade-offs for the Sorry Seven:
The Treasury Department assigned him the job of tying more compensation at the companies to long-term performance and cutting pay deemed “excessive.”
Government officials say Mr. Feinberg met that objective. All 136 employees and executives working at the seven companies under his review will earn much less this year than in 2008, even after accounting for the rise in regular salaries, also known as base salaries.
So, Treasury says he did fine, and this story does nothing to question that. Let’s see how he did against the universal governance objectives for compensation:
– Attraction and retention of management: Well, management talent is running for the exits at the Sorry Seven. The best have fled, leaving their belongings behind. Citibank sold off one of their most profitable units simply to avoid having to record that they paid that unit’s chief $100 million. Those that remain are doing best they can, I’m sure.
– Alignment incentives: Well, when you substitute bonuses for salary, dramatically reducing the overall level of pay, you take away a lot of incentives to perform. I’m not saying that people need 80 percent of their total compensation to be variable in order to get their attention, but it doesn’t hurt. Of course, how that variable portion of total compensation varies is hugely important, and devilishly tricky to get right, but I’m sure the Pay Czar or the Fed will make sure the companies do that right.
– Cost control: check!
Looks good to Treasury.
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Posted by Marc Hodak on October 26, 2009 under Self-promotion |
I was interviewed by the BBC last week on a story about Wall Street pay. Matt Frei conducted the interview and, I think, did a great job. You can hear the whole thing here.
My contribution comes in at around the nine minute mark, after the part where Matt Taibi calls our entire financial system a zero-sum game, and just before Katrina vanden Heuvel defends a culture of envy by renaming it a “system of shared prosperity.” Enjoy.
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 October 20, 2009 under Collectivist instinct, Patterns without intention |
Elizabeth Warren is discouraged. Not with regards to her job of overseeing TARP spending, on which the Harvard professor has done a decent job. Instead, she is “speechless” at the prospects that certain bankers may get record bonuses this year.
“I do not understand how financial institutions could think they could take taxpayer money and turn around and act like it’s business as usual,” Warren says. “I don’t understand how they can’t see that the world has changed in a fundamental way – it’s not business as usual. All I can say right now is they seem to be winning this argument.”
It’s not an argument, Liz; it’s a business model. The financial services business model is actually quite simple: employees get 50 percent of net revenues. The stable portion of this net revenue is paid out in “salaries” and the uncertain, variable portion of this net revenue is paid out in “bonuses.” The “bonus” portion gets split in rough proportion to who brought in the revenues. All this goes on regardless of how “the world has changed.” Last year, net revenue was lower, and bankers on average got much less. This year, net revenues are higher, and bankers (the ones who survived the carnage, anyway) get more. What’s not to understand?
Warren’s block is not the arithmetic. Warren’s block is that she hates bankers. Her real problem is that the world has not changed the way she wishes it would have changed, where the money that a bank makes flows to someone other than the bankers.
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Posted by Marc Hodak on October 12, 2009 under History |
President Obama has spoken eloquently, more or less, on the perils of pay without performance. I wonder what he would say about this:
For this:
Imagine a CEO receiving a $1.4 million bonus (among his other compensation) for promising to implement a grand strategy before it has even had the chance to fail.
Posted by Marc Hodak on October 6, 2009 under Invisible trade-offs, Reporting on pay |
This morning’s headline in the Wall Street Journal made me wipe my eyes and blink a couple of times to make sure I didn’t wake up in some sort of Kafkaesque twilight zone.:
Pay Czar Targets Salary Cuts
That appeared right above a headline about how the government wants to restrict gifts to bloggers. Nice.
Relative to the title of this post, Pravda, of course, would have reported on the glorious plan of a commissar instead of a czar, but that is a fine distinction for our purposes. The more relevant distinction is that the pay czar story is really two stories. The nominal story is about a government official who has ideas about how individuals in private firms ought to be paid, when most everyone agrees that the way they had been paid is defective. It’s stated as a matter of fact problem-solution story. The second, more subtle story, is about a government official harnessing state power to implement his ideas. This is about the unstated premise that it’s a good idea for government officials to implement their good ideas about how people should be rewarded in companies representing a significant chunk of the economy. Those who read the nominal story in its narrow sense will say, “Hey, these measures only apply to firms with significant government investment.” True enough, but that ignores the trend in government intervention in pay practices over the past couple of decades under Republican as well as Democratic administrations. The intent about this pay czar’s reach is clear:
However, the Obama administration is hopeful that Mr. Feinberg’s pay structure will be viewed as something of a “best practice” and that other firms may voluntarily seek to use similar methods in determining compensation.
And what if firms don’t seek to do so voluntarily, and generally shrug off these suggestions as they have every other government suggestion for how to structure the pay of the most sought-after talent on the planet? The trend is not good.
Kenneth Feinberg is a bright guy. He claims to have the best interest of taxpayer-as-reluctant-owners at heart:
At a speech before the Chicago Bar Association last week, Mr. Feinberg said he will not have done his job if companies react to his decisions by saying “that’s great, we’re going to lose all our people and we’re not going to be competitive.”
But the commissars who drew up the Soviet five-year plans wanted their companies to succeed, too. They wanted their economies to thrive. They considered it their patriotic duty to insure that success. For many of them, success was literally and personally a matter of life and death. But the commissars failed, and turned Soviet Russia into an economic basket case. Ken Feinberg has never designed a corporate incentive plan. He has never had his compensation ideas market-tested. But this morning’s headline reports his intent as if none of these things matter. All that matters is what was stated in the lead, that Mr. Feinberg is “clamp(ing) down on compensation at firms receiving large sums of government aid.” Because the people could not tolerate paying their proxy functionaries so much.
Posted by Marc Hodak on October 5, 2009 under Uncategorized |
Two stories popped up today in an employment blog I follow:
EEOC Accuses Pro-family Group of Pregnancy Discrimination and EEOC Sues Vanguard for Racial Discrimination.
Every knows the costs of job discrimination. The people discriminated against have their hopes and dreams thwarted by arbitrary and unfair judgments. The owners or agents rendering these judgments remove their firms from pools of talent that might otherwise enhance their competitiveness. It’s a system fraught with pain and economic inefficiency.
The government has attempted to eliminate such discrimination using the tools that governments have–moralizing and punishment. Most governments are in no position to moralize, but that has never stopped politicians. Unfortunately, democratic governments tend to reflect, rather than confront, the prejudices of their people, so moralizing is rarely anywhere near as effective in ending economically inefficient practices as market processes themselves in punishing the firms that most irrationally discriminate.
Government penalties, however, are downright counterproductive. Once someone is placed in a legally “protected class,” whereby it becomes more difficult to fire them once hired, or where one must pay them regardless of their economic contribution, then the government makes these people more costly to hire. This is clearly true for pregnant women and minorities. In other words, the most enlightened businessman eager to hire the best, or even to bend over backward to hire someone from a disadvantaged background, is now penalized economically for doing so. They risk having to be stuck with redundant employees in a downturn where letting go of someone from a protected class creates an almost automatic liability. That may be one reason why minority unemployment is persistently higher than for whites, despite the overwhelming legal benefits to accepting and promoting qualified minorities.
Posted by Marc Hodak on September 24, 2009 under Invisible trade-offs |
I really liked this exchange from EconLog:
Troy Camplin writes:
If Baucus’ bill passes, I would get a fine if I didn’t buy insurance (I currently am uninsured). Now, if I didn’t have the money to either buy insurance or pay the fine — or if I justly refused to pay the fine — then what? Defenders of his plan have to agree that the government can then come and arrest and threaten to kill me in my own home, in front of my wife and children, because I don’t want to buy insurance — or because I can’t. To support something like that is evil. Pure and simple.
I think this points to something we should all consider when we say that the government should do this or that: is it worth killing someone over? Because, in the end, that’s what we’re talking about. That is what we’re always talking about when we say the government should or should not do something. If you don’t comply, you die. As George Washington said, government is not reason, it is force.
Another way of thinking about it: what actions can another take that you can legitimately kill them over? If someone tries to murder, rape, or steal from you, you can kill them, and you will find few who think you can’t. But should you be able to kill me if I refuse to help you help someone else? Yet, we agree to let out governments act that way.
burk writes:
Mr. Camplin, you may not understand the concepts of insurance and democracy. Democracy is not doing whatever you like, but being part of a larger community that creates certain duties as well as rights. Should you be forced to pay taxes? Should they be voluntary as well, so that you could opt out of being defended by the military and our diplomatic corps? Should Social security be optional, so that, were financial disaster to befall you in old age, you would be left at the roadside, sleeping under park benches?
And for health care, should insurance there be optional as well, so that, were you to choose to opt out and get a dire disease or injury, you would again be left in a ditch, bankrupted by the medical system and then discarded? Right now you rely on emergency room care that is open to all. However wealthy you may now be, that may change in a heartbeat, and then where would you turn? Just what kind of society do you want to live in?
Troy Camplin writes:
Wow, Burk, you live in a pretty hateful society, where the only people you can count on to help are the police and bureaucrats. In the society I live in, there are all sort of generous people and organizations, ranging from my own family to churches. What country do you live in where all the elderly were lying in ditches before the government created social security, and the uninsured sick (as were everyone before insurance was created) were also lying in ditches, unhelped by anyone before, thankfully, such marvelous people as Congressmen and Senators, bureaucrats and policemen came along, lifted those poor, sad people up out of those ditches (must have taken them a long time!), washed them, put them on their feet, fed them, clothed them, and gave them the medical care they needed which nobody before them had ever done for them (nor had they done it for themselves). That must be a pretty awful society, full of people not even people in their awesome helplessness. I would invite you to come visit my society, where private individuals are able to work and feed themselves, provide for themselves and their loved ones, and give to each other. There is so much love and generosity over here, something I fear you must be unfamiliar with wherever you live, where the best you can hope for is that a bureaucrat will call your serial number after you’ve waited in the doctor’s office for 12 hours after your 18 month wait to even get an appointment — and if you do try to get better care by paying for it, you find yourself shot in the head after you resist arrest for having tried to better your life (which is, after all, illegal).
Democracy is not community. They two are utterly different. And a just democracy is not a majority forcing its will on everyone else, no matter what. That is mob rule. Nor is it a minority of government officials trying to force people to do what those officials think is “best” for them — that is tyranny.
burk offered no response. I wonder what could he say?
