Executive bonuses: heads you lose, tails I gain

February 25, 2009

Professor Tamar Frankel– Tamar Frankel, a professor at Boston University School of Law, is author of “Trust and Honesty, America’s Business Culture at a Crossroad.” The views expressed are her own. –

The debate over corporate executive bonus payments should be put in perspective.  Some say that the executives did not earn these bonuses and don’t deserve the millions in parting payments that they received.  But if parting payments were specified in the executives’ contracts they must be paid.  A binding contract is binding.

But what if the payments were made at the discretion of a board of directors, as bonuses usually are?  Can such bonus payments be retrieved from the executives?  Probably not.  Unless the executives failed to give the board accurate information, or illegally caused the payments, they are entitled to retain them.

But directors who approved bonus payments notwithstanding the corporations’ losses may not be as free of liability.  Unlike salaries, bonuses are usually paid at the discretion of the employers.  They are awarded not as a matter of right but as a recognition that the recipients have done a good job.  In the past, most were tied to the “performance” of the corporations, usually defined in terms of higher profits or higher share prices.

The lore was that “executive talent” must be rewarded with money or stars would migrate elsewhere. And without such talent the corporation — and America — would be lost.  But this wisdom has now extended to non-performance situations where talented executives received bonuses no matter what happened to their corporations. The current crisis might not have been their fault, the reasoning went.  They did their job.  They performed well.  They worked as hard as they did years before.  Why should they be punished because the economy is in recession?

There is one answer to these arguments.  When bonuses were linked to “performance” (short term rise in corporate profits and market share prices) executives collected incredible amounts.  That may have been how the corporations took so much risk — to earn so much that the bonuses could be huge.  But whatever the reason for the profits and share-prices rises, the bonuses were linked to these measures and the executives did not complain.  So they cannot complain now, and the directors cannot suddenly change the rationale for the payments.  What was good for many good years is good for bad years.

Historically, executives and their supporters pressed hard for payments reflecting the owners’ fortunes, even though executives are not the owners and never were, unless they owned the corporations’ shares.  Their payments were based on the theory that their incentives should be identified with those of the shareholders.  If this theory is valid, let them share the shareholders fortunes today just as they had in the boom time.

Executives cannot be sued to repay the bonuses they received when their corporations were sold in a “fire sale” or went bankrupt.  But the directors who were generous at the expense of their corporations (with which they had a legal obligation to honestly and diligently represent) can be sued.  And if the executives do not return their bonuses to the corporations, the directors should repay the corporations.

Generosity is fine at one’s own expense but it’s not fine at the expense of others whom one represents.  Directors and executives should settle the accounts among themselves.

24 comments

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Excellent article by Professor Frankel, devoid of the usual cynicism and envy that usually permeates most opinions about this subject. I agree totally with her sentiments regarding directors’ liabilities but would also point out that they have agreements too. They may well be indemnified from such suits and should action be taken, the onus could fall back on the corporation and hence, the shareholders. Since most extraordinary executive compensation consists of stock, there is a simple solution: no employee, executive, or director of a public company should be allowed to own or trade in their company’s stock. Call me crazy but these, in case you haven’t noticed, are crazy times.

Posted by profjack | Report as abusive

A very clever analysis of the psychology behind bonuses and a very appropriate conclusion that the board of directors can and should be held accountable in many cases. They had a fiduciary duty towards shareholders and they violated it by being generous at the wrong time and for the wrong reasons.

Thoughts:

1. A contract is a contract.

2. Directors are protected by the “business judgement rule”. You would need to show bad faith/self-dealing to hold them accountable.

3. Folks could consider new legislation going forward, but not backward-looking for things already closed. Consider (i) cdo/credit swap/derivatives/lending rules that were avoided over the last decade or so or (ii) allowing only equity bonuses with long term (even post employment) vesting rules.

4. Not anyone was complaining when stock and housing prices rose consistently, and without any basis in underlying value (stocks: actual earnings; housing: cost of ownership vs rental cost), but were simply happy to treat these assets as perpetual cash-and-goodies machines.

5. The only issue with lenders re-selling their loans is (i) it makes them toss credit-worthiness concerns out the window and (ii) we had credit rating agencies rubber-stamping all loans as AAA (wondering when there will be fraud claims on this point?).

6. If everyone who took out a home loan would pay it back, we would not be in this situation.

Posted by rbsjr | Report as abusive

Well done.

Posted by Bank Investor | Report as abusive