Bank CEOs and the infinite pile of cash
By Roger Martin The views expressed are his own.
The three-week old, 60’s-style Occupy Wall Street protest raises once again the question that won’t go away: What on earth were those bankers doing in the period leading up to the 2008 financial meltdown? This street-level insurgency combines with last month’s smackdown-from-on-high administered by the U.S. Federal Housing Finance Authority’s (FHFA), which sued 17 leading global financial institutions for $196 billion, charging that they knowingly peddled shoddy mortgage-backed security products to unsuspecting customers. With the European financial system continuing to teeter on the brink due to the massive bank losses and bailouts, the U.S. economy stagnating and its equity markets close to free-fall, the answer of Chuck Prince, former Citigroup chair, that “we danced until the music stopped” has not mollified either Occupy Wall Street or the FHFA, or anybody else for that matter.
It is obvious that they did keep dancing. But it leaves unanswered the question: Why did it make sense to them to keep dancing? And also: When the music did finally stop, how did we manage to have asset-backed derivatives contracts outstanding with an estimated value of three times the size of global GDP?
The answer was that thanks to the structure of their compensation, major bank CEOs were obsessed with their stock price and trying to keep beating expectations until the music stopped. And the asset-based derivatives market was their clever device for beating expectations for much longer than could have happened before – because it was the world’s first market of infinite size. And it worked for them. When the music stopped and expectations came crashing down, they were by and large wildly rich.
Public companies, such as FHFA’s target list, operate in two markets. In the real market, they produce and sell real services – like mortgages and mutual funds – for real customers – like you or me or your company – who pay them real money, which, in a successful company, results in a real profit at the end of the year. They also play in an expectations market, where investors observe what is happening to the company in the real market and, on the basis of that, form expectations about what will happen in the future. It is the collective expectations of investors that determine the company’s stock price.
While most assume that stock-based compensation is an incentive to improve real performance, it isn’t. It is an incentive to increase expectations about future performance because an executive’s stock-based compensation will be worth a penny more than when it was awarded only if the executive can cause expectations to rise. So the primary incentive at all times for executives with heavy stock-based compensation is to increase expectations – even when expectations are so high they can never be met.
So how heavily stock-driven were the bank CEOs? There is very nice data in the study of the compensation and stock sales of the CEOs of the 14 leading American financial institutions by scholars Sanjai Bhagat and Brian Bolton. Seven of the American financial institutions accounting for 94% ($116B) of the FHFA suit totals for the American firms ($123B) are included in their study (Bank of America, Citigroup, Countrywide Financial, Goldman Sachs, JP Morgan Chase, Merrill Lynch and Morgan Stanley). It shows that over the 2000-2008 period, the CEOs of these seven companies were making small fortunes by exercising options and selling stock – an average of $139M per CEO. That is almost double what they made in cash compensation ($78M apiece). They lost, on average, $83M in the market crash, causing some to argue that they weren’t taking excess risks because they had so much skin in the game. But it is hardly a compelling argument for a group that was left with net proceeds of the 2000-2008 period of $133M each, plus remaining stock holdings of $76M each. Remaining personal wealth of $209 million is not bad given the massive destruction of value suffered by their shareholders and the American taxpayers.
from James Saft:
Learning from Ken Feinberg
Sometimes it's what doesn't happen that is most illuminating.
When Pay Czar Kenneth Feinberg first slashed executive compensation at U.S. firms that benefited most from a government bailout the cry was that this would hurt these weakened firms when they could least afford it, as the best and brightest would leave for better money elsewhere, where the free market still ruled.
Well, the door didn't hit them on their way out, but mostly because they stayed rooted to their desk chairs. Feinberg evaluated the compensation of 104 top executives at affected companies in 2009, reducing pay for most to levels far below financial industry norms and their own former earnings.
Yet here we are in 2010 and about 85 percent are still working for the same firms, still toiling for the kinds of wages that may well make them wish they'd gone into the law rather than finance. Remember all those articles in glossy magazines about how impossible it is to make it in New York City on $500,000 a year?
"The argument that we hear all the time; that if we don't pay more this key official will leave, he will go to a foreign competitor," Feinberg told CNBC television.
"I've always been dubious about that argument and I think the statistics bear out the fact that most officials stay at those companies."
Feinberg announced this week that he has told AIG, General Motors Co, GMAC Inc, Chrysler Group LLC and Chrysler Financial Corp to cut cash compensation for 119 top executives by a third in 2010 and total pay by 15 percent. Bank of America and Citigroup have repaid taxpayer funds and are now subject to diminished supervision by Feinberg, whose brief is to determine if pay at bailout firms is "in the public interest."
Prepare for changes in executive compensation practices
– Patrick R. Dailey is a human resources executive and specialist in executive compensation. The views expressed are his own. –
The Obama administration is moving aggressively to reform executive compensation practices and impose more stringent governance regulations. These policy and regulatory initiatives are a result of the administration’s publicly stated beliefs that the global financial crisis of 2008 was in large part a result of executive compensation programs that were too highly-leveraged and short term, thus providing incentive for operating executives to engage in excessive risk taking – the corporate version of always swinging for the fences.
Without question, all public corporations will soon implement more stringent regulations and practices governing executive compensation.
Significant change is emerging in five areas of executive compensation and its governance.
Compensation Committees will have more clout
The Treasury Department seeks to raise the level of confidence among shareholders regarding executive performance targets and fairness in plan design by “beefing up” authority of the Compensation Committee to act in the interests of long term shareholders. Changes may likely include:
- Strengthened independence requirements for Committee members. - Increased decision-making authority and accountability. - Committee duties and reporting requirements will be more specifically-defined by SEC regulations. Compensation plans must pass new tests for shareholder alignment and risk
Most of the issues involving Ex. compensation run parallel to the financial sector. How do others, more knowledgeable people then myself, believe they will react to articles such as this one.
from DealZone:
Should Ken Lewis get his payday?
Ken Lewis started at Bank of America 40 years ago, working his way up from junior credit analyst to the CEO suite. His employment contract at the nation's largest banks obviously predates the government's bailout of Bank of America. Yet pay czar Kenneth Feinberg may have a say on whether he cashes in on retirement benefits and accumulated compensation worth $125 million.
Some argue it is simply inappropriate for Feinberg to try to tackle Lewis' retirement package.
"A fair reading of the situation would be he is getting what he is entitled to and game over," said Alan Johnson, a Wall Street compensation consultant.
But to many, Lewis is a poster child for the crisis that struck Wall Street banks last year, nearly collapsing the financial sector and resulting in taxpayers spending hundreds of billions of dollars to bail out firms like Bank of America.
"The Obama administration has to use every tool at its disposal to fix the pay problem, particularly the golden parachute for failed executives," said Richard Ferlauto, director of corporate governance and pension investments for the American Federation of State, County and Municipal Employees, one of the largest U.S. labor unions.
Should Lewis get his retirement package in full? Leave your answer in the comments section.
He does not deserve the payout as he misled shareholders in acquisition of Merrill Lynch. If he was pressured into the deal, shareholder had every right to be informed before voting on the deal. This resulted in the sharholders making an uninformed decision leading to the destruction of the value of the company and the brand.
Leave pay to companies, shareholders
– James Pethokoukis is a Reuters columnist. The views expressed are his own –
For the populists who really, really want to make Wall Street pay by slashing their pay, Treasury Secretary Timothy Geithner certainly isn’t giving them what they want.
Yes, the top executives of the remaining TARP firms seem destined to be salary serfs to the “pay czar”, Kenneth Feinberg.
Of course, it’s hard for even the most die-hard free marketeer to feel sorry for financial firms that mismanaged their businesses terribly, took government bailout money and now find themselves under Uncle Sam’s thumb.
But as for everyone else? Well, here’s how Geithner put it: “We are not setting forth precise prescriptions for how companies should set compensation which can often be counterproductive. Instead, we will continue to work to develop standards that reward innovation and prudent risk-taking, without creating misaligned incentives.”
Even worse for those who wanted the Treasury secretary to bring down the hammer, he went on to highlight how the financial sector is already making changes on pay and how he looks forward to a “continuing conversation”. Yes, self regulation in action! Hardly what the torch-and-pitchfork crowd craved to hear.
That’s just too bad. To his credit, Geithner seemingly understands his goal isn’t to punish, but to play a constructive role in nudging financial industry compensation in a direction that better connects risk and reward.
The US needs to stop supporting a corporate aristocracy. The gross and outrageous compensations for some of these Top Managers is nothing more than the US paying to support these individuals in a lifestyle they have become accustom to. By no means are these individuals worth this much to the corporation. No one could be worth these kinds of compensations. Some are over 400 times the average compensation of their employees. No corporate board could begin to justify that one person is worth that kind of compensation. Yet, that kind of compensation exists today in publicly traded corporations. What else would you call it but the support for a corporate aristocracy?
Publicly traded companies fall under federal laws. The Government does not have to “own” a piece of them to set rules upon them in order to protect the public.
The compensation of top management should be tied to the compensation of the average employee. Let’s face it they all had a part of the success or failure of the business. Some countries have put limits on publicly traded company’s top management at 10 times the average employee compensation. Compensation would include salary, stock options, and bonuses. To compute this they take middle management, front line managers and their employees including all secretarial and office administrative staff and average their total compensation. No one in upper management can make more compensation than 10 times this amount. This value is recalculated each year to set limits on the next year. Within this limit salary, stock options and bonuses are paid. If upper management wants a raise, they need to raise the compensation of their employees.
This type of pay limitations provides incentive for profits and efficiency while ensuring the benefits of a job well done are given to those that do a good job. These benefits will flow up a year later. And I am all for upper management being given incentives to think in terms of the long haul by withholding some pay in the form of stock purchases.
I for one am against maintaining a corporate aristocracy. We need fiscal responsibility forced back upon the corporate industry.
@weing – Point me to some of these studies and I’ll check them out, but I’m betting that they’re confounded by payments execs receive AFTER being fired (a year’s severance, guaranteed bonus payouts, accelerated vesting of equity, etc.). In other words, failure equals high pay, rather than high pay equals failure. Both are bad, but it’s inaccurate to say that “science” provides proof of your belief.