Posted by Marc Hodak on February 6, 2009 under History, Invisible trade-offs | 
…I offer this little commentary:
There are men regarded today as brilliant economists, who deprecate saving and recommend squandering on a national scale as the way of economic salvation; and when anyone points to what the consequences of these policies will be in the long run, they reply flippantly, as might the prodigal son of a warning father: “In the long run we are all dead.” And such shallow wisecracks pass as devastating epigrams and the ripest wisdom.
But the tragedy is that, on the contrary, we are already suffering the long-run consequences of the policies of the remote or recent past. Today is already the tomorrow which the bad economist yesterday urged us to ignore. The long-run consequences of some economic policies may become evident in a few months. Others may not become evident for several years. Still others may not become evident for decades. But in every case those long-run consequences are contained in the policy as surely as the hen was in the egg, the flower in the seed.
This wisdom was offered in 1946. Which reminds me of this wisdom.
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 31, 2009 under Futurama |
It think the biggest problem I have with the McCaskill proposal for paying senior executives like the president is that it gets it all backward. Most of what executives get is variable compensation. Say what you want about pay-for-performance, but when was the last time senior government officials saw their pay drop 44 percent for a bad year? It think the president and congress should get much higher pay, but most of it variable, based on performance.
Since I design this stuff for a living, let me propose something simple and definitive, something that points us in about the right direction. How about:
– A target bonus equal to current salaries, e.g., $400,000 for the President, and something similar for every senator and congressperson,
– A bonus pool for these 536 elected officials that adds $1 for every $1,000 in budget surpluses to those target bonuses, and reduces them by $1 for every $1,000 in deficits. (I’m talking cash surpluses and deficits; none of this “off-balance” sheet stuff that only the most Enron-friendly accountant would accept.)
So, a $230 billion surplus, like Clinton and the Republican congress produced in 2000, would create a bonus pool of $230 million, to be divided among our president and legislators in proportion to their respective salaries. That would average about $430,000 per pol, with a little more for the Prez and little less for a House member. Remember, this would be on top of their respective target bonuses.
On the other hand, if they bring home a Bush-sized $400 billion deficit, their bonus pool would be -$400 million, which would wipe out their target bonuses. Don’t even ask what a $2 trillion deficit would do.
Actually, let’s ask. That would create a negative bonus of over $2 million per pol. Should we institute clawbacks? Or perhaps do it like the hedge funds that we love to demonize, and have our new bonus babies earn back the negative amounts before they can get more bonuses in the future.
I know my libertarian friends will complain that this will encourage tax increases as much as spending decreases, but I wouldn’t fret too much about that. We like to joke about the financial literacy of our elected representatives, but I think they are actually smart people, and will quickly realize what most of us economists already know, which is that they don’t control the lever of overall tax revenue nearly as much as they control expenditures.
And I solemnly promise not to complain about their massive layoffs of government employees while getting paid large bonuses. Not one peep.
Posted by Marc Hodak on under Revealed preference |
Senator McCaskill has proposed a ceiling on the pay of anyone working at a company taking government money–i.e., the same as our highest paid public servant, the President. The cap of $400,000 per year would include salary, bonus and retirement contributions. As usual, the Senator failed to think this through.
First of all, the president will get a pension of $200,000 per year when he leaves office. Even assuming he’s a two-term guy, the value of that retirement, if we calculate that contribution according to proxy disclosure rules, is about $400,000 per year. So, out of the box, McCaskill is offering an apples-to-oranges standard. Salary, bonus, plus retirement contribution for the president is about $800,000 per year, and much more if he gets the boot after just four years (so much for pay-for-performance).
On the other hand, this bill doesn’t appear to mention a limit on perks and other benefits, where an executive mimicking the president can easily begin to make up some ground. To begin with, there is the much-maligned corporate jet. The president has one. Actually, he has two of them, and each is tricked out with far more comforts and gadgets than the most audacious jet available to the average GM or Citibank CEO. In addition, the CEO should be entitled to a fleet of helicopters, as well.
Then there’s a housing allowance. To get something equivalent to Obama’s crib, a mammoth, historic mansion with sprawling acreage in the heart of a major city, would test the generosity of even the most spineless board of toadies. But let’s throw in, say, the top floor of the newly renovated Fairmont Plaza. Plus unlimited use of their entire staff, dining, and ballroom spaces. If you’re an auto company CEO, I don’t think the entire city of Detroit would offer an equivalent value, not that they would take it.
And if you think the post-retirement benefits of office were extravigant for Jack Welch, they don’t compare to this guy’s.
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 under Executive compensation |
Actually, Carl Levin and other congressional democrats want to raise those taxes, and it looks like Geithner will go along.
What? You haven’t heard any proposals for a tax increase being bandied around by the Obama administration? Well, no, Obama is not agitating for higher corporate taxes. Neither is Geithner, per se. But Geithner did tell Levin that he would “consider extending at least some of the TARP provisions and features of the $500,000 cap to U.S. companies generally.”
That would be a $500,000 cap on the tax deductibility of all senior executive compensation. Without any exceptions. At every public company in America.
This policy is nominally intended to penalize firms for paying their top executives “too much,” the premise being that boards can pay their top people whatever they feel like, so if Congress penalizes them for paying over $500K, they’ll think twice about doing so. Nice theory.
But what if the pay of executives is actually largely set by the market? What if the market actually values their services at $1 million, or $5 million, $10 million? Sure, there are many people worth much less, some of whom pass our laws, who can’t conceive or accept that certain people can be worth that much. But what if that were possibly the case? Then corporate boards would simply have to pay it. They would have to, in accordance with their fiduciary duties to their shareholders to secure the valuable talent. And their shareholders would be left coughing up the tax money.
In other words, the greedy executives negotiating for their out-sized pay packages won’t be the ones penalized by this exercise in congressional outrage. The companies will, via a much higher marginal tax rate on compensation. This will not be the first time a congressional bullet aimed at top corporate executives ends up hitting the shareholders. When it comes to executive compensation, Congress is the gang that cannot shoot straight.
In a time when most sober economists agree that cutting corporate taxes would be the single most effective way to help our struggling economy, it’s ironic that our top economic agent in government, the Treasury Secretary, would basically be supporting higher taxes on corporations.
Posted by Marc Hodak on January 28, 2009 under Invisible trade-offs |
Forbes has been highlighting the Consumer Product Safety Improvement Act in a series of articles by Walter Olson and Paul Rubin. These articles provide an excellent example of regulatory overkill, and how doing “for the children” invariably ends up doing it to those children’s parents, with little noticeable benefit for the children themselves.
Meanwhile, the safety nannies are keeping the pressure on. In a typical “it’s for the kids” logic, consumer advocates continue to point out that (a) lead is bad, and (b) the bill passed by an overwhelming majority (“we’re all parents and grandparents”). They also helpfully point out that some congressmen, responding to howls of protest, have already offered some advice to the CPSC on how to keep the implementation costs down, advice it’s not clear the CPSC will be able to follow. And don’t you know, those business ingrates are still not happy.
What the consumer advocates ignore is that this law simply makes no sense. It is founded on the principle that people who sell things to kids are indifferent to any injury they might cause. Toy makers, who completely depend on the happiness of their little customers, happen to know lead is bad. That’s why Mattel reacted the way they did when they found out. What keeps them awake at night is not the possibility of offending the effete sensibilities of the safety nannies, it’s the possibility of losing their customers.
And, also, if the number of congressmen rushing to pass a bill in hysteria is the measure of a bill’s virtue, then my troubled, liberal friends should have no problem with this.
Posted by Marc Hodak on 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.
