‘Excessive’ executive pay. Flawed unfairness argument

Last Friday (07/03/2008) I was listening to BBC Five Live‘s Wake up to Money when they started commenting on William Cohan’s last book: The Last Tycoons: The Secret History of Lazard Freres & Co.

It seems executive pay and their severance packages are again on the spotlight. The US Congress set up a committee last Friday to investigate the matter further. Its chairman, Henry Waxman, was worried about they level of executive compensation:

[…] CEOs don’t get salaries any more, they get stock options, restrictive stock units, deferred compensation, executive pension plans, lucrative severance packages and a bast array of perks from corporate jets to tax and financial planning services and country club memberships. These compensation packages can be worth hundreds of millions of dollars […]

When Charles ‘Chuck’ Prince resigned from Citigroup ($42m) or Stan O’Neil retired from Merrill Lynch ($161.5m), or Angelo Mozilo left Countrywide Financial, the largest US mortgage lender, a populist popular uproar came about. We are back again talking about the top guys’ salaries but at a House Committee on Oversight and Government Reform level.

Why should they get this massive severance packages on a falling market? Short answer? because it was in their contracts.

We all agree that top managers getting paid 1,000,000-times more than their lowest paid staff member can be arguably dishonest. However, I don’t think that any government should get involved at all in the matter unless they were after the old trick of making examples out of a minority segment of the population that happens to abide the law.

Excuse me the obvious differences, but was the Jewish community in inter-war Germany trying to take advantage of their fellow German citizens? They were taken by the populist government as target for the nation’s anger created by the hyper-inflation generated by WWI reparations to neighbour countries.

Where do we stand now? Well, how professional these guys are or are not is not down to me, you or any government unless, of course, you are a shareholder of the companies that employ them. If, to draft the very best executive management you have to throw in corporate jets, river-view 400sqm offices, manicure and a getting rid of the noise neighbour, so be it. I guess that the company’s independent executive pay committee will have worked out if the proposed salary (normally low or non-existent), bonus (back or not backed-dated stock options and the like) and golden parachute (secretary and executive office for life et al) terms and worked out whether at the end of the day:

  • The increase in shareholder value and corporate profits will more than make up for the proposed executive package
  • Someone else out there could do the same job at a lower cost

If they think they have found the person, and s/he agrees with the challenge (I don’t think these Alfa-members of our societies are so much into money anyway) they are handed the baton.

If company ABC goes bust because of gross management incompetence (Northern Rock anybody?), to some extent employees at company B shouldn’t care much unless:

  • Company ABC is a supplier, client, debtor, creditor of Company XYZ (in which case, the livelihood of XYZ might be affected)
  • Company XYZ’s pension fund is heavily invested in ABC’s stock (Joe doesn’t even care to understand the works of his pension, so why should he bother about what happens to ABC?)

Other than that, generally speaking Joe, Jose, Giani, Kostas, Hans or Niels just want to go about their own thing, XYZ is where they work, not their life. However, I see where and why the government steps in. I believe in minimal regulation to cover market blanks and regulate against dominant actors in the markets. The banking and financial sector has a major proven influence in the economies of developed countries. Stability in the sector is vital for the health of the economy and therefore the country as a whole.

Basing employees’ bonuses in the short term performance of their investment decisions or new financial products not even their creators can understand (CDOs, SIVs, C3POs, and the like) is prone to bubble making.

Mainly bonus-based salary packages allows for flexibility for the employer. When the going gets tough, bonuses drop, hence pay costs drop accordingly. An increase in fix-salaries would turn into largest numbers of jobs lost in downturns. So bonuses seem like the least bad tool for the job.

However, as commented above, the problem with bonuses of the average Wall St/City trader and the ‘golden parachutes’ for senior executives is that they are short-term based.
Give the world to the CEO who is forced to resign because his time is up. But link his severance package to the future development and profitability of decisions taken under his wing.
Take well care of the trader when he sells ABC stock at £/$/€12 and buys it back at £/$/€6 a few days later, but link his bonus to the performance of the stock in the next 12/18/24 months (for good and for bad).

Apparently William Cohan’s The Last Tycoons: The Secret History of Lazard Freres & Co. digs into the matter. I just added the book to my Amazon shopping basket, I will keep an eye around local bookshops to have a browse and make my mind before buying it.

All this sounds very good as long as timing is adequate and the matter being dealt with is not about ludicrous (for some) amounts of money, but freedom of contract within a nation’s legal frame. A $100m severance pay plus an annual cost of $10m per former CEO per year doesn’t look like much for these brontosaurus companies.

I look forward to your commentaries, Hobbes.

Until tomorrow,

.Calvin

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