Executive Compensation: Death by a Thousand Cuts
Today's NYT (online) business section features an article exclaiming the lack of empirical evidence of excessive compensation encouraging excessive risk-taking:
http://www.nytimes.com/2009/09/27/business/27stra.html?_r=1&ref=business
In so far as anyone can generate empirical evidence of what's going on inside a person's head, I mean.
Harvard Prof Lucian Bebchuk (no bastion of liberal progressivism, I assure you), on the other hand, points to the obvious: stock options reward successful risk taking, but do nothing in the event of failure.
Granted, fixing executive compensation laws won't likely solve the problem -- in this the NYT is correct -- and certainly there are other alternatives. For example: letting only long-term shareholders vote, thus making boards beholden to only those with long term interests; or, as my last blog post points out, putting a government official on the board.
Nevertheless, I suspect this "empirical evidence" bs is the enemy's foot in the door.
The "we can't win by claiming execs deserve all this money...but if we say it doesn't *hurt*...."
http://www.nytimes.com/2009/09/27/business/27stra.html?_r=1&ref=business
In so far as anyone can generate empirical evidence of what's going on inside a person's head, I mean.
Harvard Prof Lucian Bebchuk (no bastion of liberal progressivism, I assure you), on the other hand, points to the obvious: stock options reward successful risk taking, but do nothing in the event of failure.
Granted, fixing executive compensation laws won't likely solve the problem -- in this the NYT is correct -- and certainly there are other alternatives. For example: letting only long-term shareholders vote, thus making boards beholden to only those with long term interests; or, as my last blog post points out, putting a government official on the board.
Nevertheless, I suspect this "empirical evidence" bs is the enemy's foot in the door.
The "we can't win by claiming execs deserve all this money...but if we say it doesn't *hurt*...."
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Do they deserve it? That's a different issue. Frankly I think most finance executive are overpaid but that's between them and their shareholders.
I think the real question the article is trying to determine is whether excessive compensation caused excessive risk.
The fact is that the banks that did a good job of managing risk also overpaid their employees. So what does that say about the role of compensation in the crisis?
For one thing, bank CEO's held many multiples of company stock versus what they were paid in any particular year. Fuld's Lehman stock was worth close to $1 billion. Why would he increase risk taking just so he could make an extra 50-75mm bonus one year but put the $1bn at risk?
Another ironic thing about what happened is that the banks who got burned the most are the ones who thought they were buying AAA rated securities and they turned out to be worth much less. If those banks really wanted to increase risk, they would have bought BBB rated investments rather than AAA, but they didn't.
The rules under Basel were such that banks got much better capital treatment if they bought AAA rated mortgage backed securities rather than holding traditional mortgages or commercial loans.
The system could benefit from banks compensation systems that are more heavily weighted in company stock and other long-term options, rather than just cash. Some banks like JPMorgan and Goldman have already been doing that, and it's no coincidence that those firms fared better than Lehman and Merrill.
Now of course the G-20 wants to blame the crisis on excessive compensation, rather than its own Basel rules.
September 27, 2009 1:54 PM | Reply | Permalink
With the CEOs, they're not gambling with their own money. What result if they lose? Go through the revolving door to another bank? Meanwhile, if you or I double down and lose in vegas, we're on the hook down to the last cufflink, if you will. So even if he could "lose" a billion, just for a measly $40-70 million, he's not losing his own money.
I agree with you that excessive compensation is, to a certain extent, a facile scapegoat. It's reaallll easy to hate those rich bastards. Who surely aren't making as productive a use of their riches as the rest of us might. I also have an inkling that they begin to think they deserve all that money. whereas you and I don't, losers that we are. But that's the "deserve" part, isn't it?
As far as your point re: risk taking and investing in AAA: bit of a conflict of interest there. The whole thing reminds me of hiring a lawyer to paper the trail of accounting fraud, and let you point to a scapegoat.
So Maybe it was a case of believing in what they wanted to be true instead of what was actually true -- or maybe they rigged the game apurpose. Either way, if they didn't know, they SHOULD have known, that the securities weren't safe. And for whatever reason, they hadn't the motivation to figure it out.
Thanks for you comments!
September 27, 2009 2:26 PM | Reply | Permalink
How do you say that they aren't gambling with their own money? Fuld owns $1 billion worth of Lehman stock. Why would he take huge wagers and see his $1 billion go to zero? I don't understand your comment that he is "not losing his own money."
If they wanted to really ramp up risk, why weren't they buying BBB rated investments instead of AAA?
And if excess pay is what caused the crisis, then why is it that JPMorgan and Goldman didn't get as involved in the toxic real-estate assets as Lehman, Bear and Merrill did? Dimon and Blankfein certainly paid themselves handsomely.
September 27, 2009 3:11 PM | Reply | Permalink
Stock losses are a "paper loss" - from Fuld's perspective, that was never spendable anyhow. The tens (hundreds?) of millions of dollars that Fuld actually put in his bank as a result of gambling with Lehman's paper were not affected in the least, they continued to grow as a result of his taking risks. When the company was in left in rubble the cash he extracted was still in his bank account.
To say Goldman wasn't involved in the same risky toxic real-estate assets as the others is demonstratively false. We bought out their liabilities at 100% on the dollar - both directly and in the form of counterparty payments through AIG. In that respect, the question is why did the government make Goldman (who was actually in a position to absorb the losses without going under) and JPMorgan whole while putting their competitors out of business.
September 27, 2009 6:10 PM | Reply | Permalink
How do you know how much of his $1 billion in Lehman stock wasn't spendable immediately? And even if some of it hadn't vested yet, do you think he'd be more focused on this year's annual bonus (which again would be mostly non-cash)? Even if a portion of it wasn't spendable, it's not accurate to say that it's "never" spendable, right?
On Goldman, do you know how much of Goldman's AIG exposure was hedged? How much of the government "bailout" did they just pass through because they offloaded their AIG risk?
I don't quite understand your Goldman point. Yes, they bought credit protection from AIG. And they probably hedged their credit exposure to AIG in the case AIG couldn't make good on the payments. That's much different than owning sub-prime and synthetic CDOs. That's much different from selling too much credit protection than you should have, as in the case of AIG.
I did due diligence on Lehman's mortgage portfolio during 2008 for a potential buyer. The commercial and subprime residential exposure that they had was staggering. I don't work for Goldman but I would be surprised if they took similar risk.
I think it's fair to say that those who got drunk on real-estate related assets (Bear, Lehman, Merrill, Wachovia, etc) paid the price for it. The survivors weren't as much up to their neck in the toxic crap.
September 27, 2009 8:05 PM | Reply | Permalink
I think it's it is not entirely accurate to focus specifically on the amount of compensation when it comes to motivating risk. To me, that's more a symptom than the real problem itself. Excessive risk seems to be more a function of tying compensation to growth/performance.
Think about the motivations inherent when you tell a guy: you get $1 million; but if you can increase profits by $20 million this year, you get 10% of everything beyond that amount.
Compare that to the motivations of telling someone: you get $10 million; as long as the board agrees you have done an excellent job, you will continue to be employed.
IMO, that is the real problem with executive compensation in an over-simplified nutshell.
September 27, 2009 6:01 PM | Reply | Permalink
But that's not how it works at all places. At the successful firms, anywhere from 30-50% of your compensation is in stock that doesn't vest for 3-5 years. Over time the stock that you own is worth much more than the extra bonus you might get in any particular year because you beat budget. It does make you think like owners and for the long term. At least, that's how it works at many of the successful firms. But unfortunately it doesn't work that way at all firms.
September 27, 2009 8:10 PM | Reply | Permalink