Compensation Is the Symptom, Not the Problem
Over the past few days, the compensation issue of senior execs art big finance firms has been front page news. The Obama administration is even appointing a “Comp Tzar.”
I find it amazing that at this late stage of the bailouts, how so few people — still — see the full picture. A perfect example of that is the focus (even obsession) on compensation. This is focusing on the symptom of an unhealthy6 corporate system, and not the underlying disease.
The true problem underlying the comp issue is corporate governance, and the way the Boards of Directors fail to represent the interests of shareholders. The way they systemically engage in the worst form of crony capitalism, transferring wealth from shareholders they are charged with representing to the senior management they are cronies with.
Yet another excerpt from Bailout Nation:
“We’ve come a long way from the days when the man atop the organizational chart made 40 times what the person on the lowest rung earned. Over the past few decades, executive compensation
has exploded, with some CEOs taking 200, 300, even 400 times the base pay at the company.With so much of this compensation made via options-based incentives, the bosses had every reason to swing for the fences. The upside was all theirs, and the downside was the shareholders’—and taxpayers’.
But don’t for a moment think their terrible track record had a negative impact on their compensation. Despite their performance, these CEOs were paid as if they were enormous successes. The compensation figures that follow are enormous; that they were paid for such abject failure is a national embarrassment.
It is also an indictment of three major corporate governance issues that have not been discussed widely enough. The first is the crony capitalism that was rife in boardrooms across the United States. The cronyismof major corporate boards, especially those in the finance area, has become legendary. Rubber-stamp directors who rarely buck the chairman or challenge the CEO are unfortunately all too common. These boards did not serve either their companies or their shareholders well.
Also enabling this festival of greed are the large institutions that held the companies’ stock, most especially the bigmutual funds that have been AWOL when it comes to policing the senior management. They have the time, expertise, and incentives to do so; it is beyond the capability of individual shareholders. Besides, it makes no economic sense for someone who owns 100 or 1,000 shares of stock to act as overseer and scold to corporate boards. But it was squarely in the interest of owners of 10 million shares and up to do so. Why the mutual fund complexes failed to protect their shareholders is hard to fathom. Perhaps when it comes to the finance sector, they feared missing out on syndicate deals and hot IPOs if they asked too many questions.
Then there are the so-called compensation consultants. They did a horrific disservice to the shareholders as well as the companies. The role of these primarily ethicless weasels was to give cover for these ridiculous compensation packages. I would love to see a review of the packages as written back then. If the compensation experts were members of an actual profession with standards and ethics, they would be drummed out of that profession. Instead, these people were merely tools used by the C-level execs to transfer vast sums of wealth from the shareholders to themselves.
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June 11th, 2009 at 11:13 am
Thsi is just one more piece of evidence of a Nation In Decline. Americans are behond hope. Apathy reigns supreme. The ‘Nanny-State’ is the desired state. One in 6 people live off the government. There is no way to turn it back. We either learn to live with the ‘commies’ or we leave.
June 11th, 2009 at 11:16 am
“The way they systemically engage in the worst form of crony capitalism, transferring wealth from shareholders they are charged with representing to the senior management they are cronies with.”
_______________
Yet people are still throwing money at them.
June 11th, 2009 at 11:19 am
Actually, I should clarify that “One in 6 people live off the government”. That’s probably wrong. I read where 1 in 6 civilians are getting an average of $17,000 form the government. But there is a very large segment of the population that is employed by the government, at all levels. Maybe I should have said, “8 in 10 people live off the government”. Does anybody know the correct number?
June 11th, 2009 at 11:22 am
Mish claims that $1 out of every $6 is from the gov’t in some form or another.
June 11th, 2009 at 11:22 am
One irony I note in all of this is that the failure has been so egregious that the shareholders would seem to be on firm ground for bringing lawsuits against the directors for willful failure to protect the shareholders interests. This of course would place further burden on the insurance firms which wrote policy to protect the directors precisely against such failure. The irony is that shareholders would be slamming themselves when the insurance firms paid out against these very insurance policies, since the same financial firms which wrote the insurance have treated their shareholders the worst in this regard. Just where does one find satisfaction in all of this. It almost makes one want the code duello to return.
June 11th, 2009 at 11:24 am
Ned, link to Mish’s missive on above topic I mentioned…not sure if that is what you meant, but the 1 in 6 thing was my link to that
http://globaleconomicanalysis.blogspot.com/2009/06/benefit-spending-hits-2trillion-highest.html
June 11th, 2009 at 11:25 am
Ritholtz, as Mr Bushong states, we talk – often cynically – about “green shoots”, “support levels”, “asset reflation”, and “price-earnings ratios”, but fundamentally, your blog is about:
- Can we Americans do the right thing?
- Can we become honest with each other?
- Can we compete to justify our current perceived wealth and position in the world?
- Can we create real products that people need that will sustain a real economy?
- Can we adjust to the world outside our borders?
- Can we get through the changes and the reckoning peacefully, much less get through it with care and gentleness toward one another?
Clearly, Obama has to walk a fine line, but I think we talk around these issues as a nation too much. It seems as though we need both a political leader and a spiritual leader, and by spiritual leader, I ain’t talkin’ about Billy Graham. No Republican has a soul.
June 11th, 2009 at 11:26 am
Wouldn’t that “every $1 in $6″ include all of the expenditures for the DoD, highways, police, prison guards, much medical care — not to mention all of the payouts to coupon clippers for government debt. I bet that last item isn’t included in that “$1 in $6″ figure though, since those are deserving recipients of government largesse.
June 11th, 2009 at 11:26 am
Compensation consultants are like rating agencies and accountants (remember Enron). In today’s greedy, corrupt society, the moral hazard is too great to resist. The upside for the big dog with little downside risk drives what is a rational choice.
June 11th, 2009 at 11:27 am
ned Says-
“evidence of a Nation In Decline”
and becoming more evident everyday-
BR Says-
With so much of this compensation made via options-based incentives, the bosses had every reason to swing for the fences. The upside was all theirs, and the downside was the shareholders’—and taxpayers’.
But don’t for a moment think their terrible track record had a negative impact on their compensation. Despite their performance, these CEOs were paid as if they were enormous successes. ”
seppuku anyone? seems the noble thing to do- how these worthless fucks live with themselves I’ll never know
June 11th, 2009 at 11:29 am
Amen Barry. The arrogance is unbelievable. Its American exceptionalism shitting in its own nest.
June 11th, 2009 at 11:32 am
BR- this is OT, but is your editor on vacation? typos galore today! :^)
June 11th, 2009 at 11:33 am
ahab:
Nothing is unconscionable to those who have no conscience.
June 11th, 2009 at 11:42 am
Including Social Security in that “$1 in $6″ figure just displays Mish’s elitist attitude. Precisely how in Social Security any different than any other pension system, particularly since any recipient must contribute to it in order to qualify for it. One could make an argument that any government payment is in fact a hand-out, depending on how one views the particular program. Anyone who follows major DoD contracts knows that at least 50% of them are welfare, so why wasn’t that percentage included in Mish’s numbers. This is just another example of the oligarchs pissing on the hoi polloi yet again because the oligarchs are deserving and everyone else can go hang. We may be approaching another Place de La Concorde faster than we know.
June 11th, 2009 at 11:43 am
[...] Nation: How Greed and Easy Money Corrupted Wall Street and Shook the World Economy which he excerpts today on his blog, The Big Picture: “We’ve come a long way from the days when the man atop the [...]
June 11th, 2009 at 11:52 am
I would like to ask just how we can go about fixing the corporate governance question with the fragmented corporate registration system we have in the US. Each state has its own system, and we all know that some of the states compete by having very loose standards on corporate registration in general. The wing-nuts will oppose any sort of national system, as they always do hypocritically on anything which they don’t want to regulate. Yet, only a national system will fix the problem. Otherwise, State A will just try to undercut State B in loose corporate governance requirements and we’ll be facing yet another race to the bottom as we’ve seen in other arenas.
My own personal preference would be for getting rid of the concept of incorporation totally. Force the whole system into the partnership structure, which modern IT and communications systems would seem to have enabled. Make the owners totally responsible for their creation, including the oversight of their hunting pack in the executive suite. The concept of layer upon layer of corporate shield has totally perverted the corporate structure approach.
June 11th, 2009 at 11:55 am
…very nice interview of Harry Markopolos -
download to your I-pod, I-phone, I-man here –
http://www.kingworldnews.com/kingworldnews/Podcast/Entries/2009/5/29_Harry_Markopolos_files/ED%20Harry%20Markopolos.mp3
it is 30 mins long – listen while you are working out…
June 11th, 2009 at 11:56 am
PrahaPartizan – Another “Place de La Concorde” is IMPOSSIBLE in America. This country is too right of center. If Americans don’t want to be associated with the “Republican Party” today, they call themselves “Libertarians”. I personally LOVE being associated with the Republican Party, and hence call myself a “registered Republican”.
I would consider some semblance of Cormac McCarthy’s “The Road” to be a more likely scenario in America than “liberte, egalite, fraternite”.
June 11th, 2009 at 12:01 pm
Well maybe it is time for your 2nd installment of the ‘How to fix ….’ series.
How to fix
1. Financial Television – check
2. Corporate Governance
a. Compensation
b. BOD
3. Rating agencies
4. Regulatory apparatus
I could go on………
June 11th, 2009 at 12:14 pm
Barry – Really enjoy your blog. You’re a breath of fresh air for those of us who are trying to play by the rules and make money in the market. In the article about the corporate governance issue you stated: “Why the mutual fund complexes failed to protect their shareholders is hard to fathom. Perhaps when it comes to the finance sector, they feared missing out on syndicate deals and hot IPOs if they asked too many questions.” Actually, there is another, I think more plausible reason: The big fund complexes don’t vote against management as often as they should because they want their defined contribution businesses (401-K, 403-B etc.) It’s a major conflict of interest.
June 11th, 2009 at 12:15 pm
check ot the Barney Frank meltdown on CNBC with Mark Haynes this morning
June 11th, 2009 at 12:15 pm
The Comp Czar sounds like another round-about cope-out to let things continue in the same incompetent manner that they have been. Bottom-line….the same people benefiting from the rules are the ones making them. You don’t need any rationalization to figure out what it will lead to or how.
June 11th, 2009 at 12:52 pm
[...] “The true problem underlying the comp issue is corporate governance, and the way the Boards of Directors fail to represent the interests of shareholders.” (Big Picture) [...]
June 11th, 2009 at 1:15 pm
Reform is not likely in a country where the lawmakers are owned by the wealthy.
June 11th, 2009 at 1:49 pm
ZH just posted this CNBC clip, compensation related. This goes to Barry’s FinTV fix #1:
http://www.cnbc.com/id/15840232?video=1149068722&play=1
June 11th, 2009 at 2:13 pm
The problem seems to be that the leaderships of those mutual funds are the same group of cronies that shift in and out of leadership jobs in the companies the mutual funds invest in. So they personally have no reason (and even a disincentive) to stop the current outrage. Why have we not seen offering of mutual funds that use a “fair compensation” screen? Many of us with a dayjob who cannot take the time to invest in individual stocks, would love to have the option of not supporting these pigs and still be diversified into stock investments. We don’t even have an independent rating of compensation so we at least could know what companies have gone how far over the line in compensation.
June 11th, 2009 at 2:33 pm
And where are the funds that promise always to always vote for any shareholder proposal that will limit compensation. It seems like a lot of popular screens are not being offered at all because somebody doesn’t want the real owners of the companies to have control.
June 11th, 2009 at 2:52 pm
I agree that compensation is more a symptom than a cause but why can’t we tie the longevity and existence of a company to “retention” or “bonus” pay? If a company goes bankrupt I think the last 2 years of bonuses for executive should require repayment in full. Accountability is the key, there simply hasn’t been any.
June 11th, 2009 at 2:54 pm
Really? Blaming the Mutual funds? ???
June 11th, 2009 at 3:09 pm
CNBC_Sucks — I doubt as well that any sort of uprising against these weasels is even remotely likely in the US. Unfortunately, they are way too comfortable for anybody’s good. They know they’ve got the system gamed — for now. The longer is pressure is allowed to build, the worse the resulting release will be. Given the way that the modern media distorts reality, I would expect the end result to be closer to Jack London’s “The Iron Heel” or William Gibson’s “Neuromancer” series. What do you do when organized crime families run the world? In the old days they called it the Roman Empire, but what about today?
June 11th, 2009 at 3:59 pm
I don’t know about Neuromancer, but that Iron Heel looks pretty good, although its premise is based on the assumption that we don’t start up World War III on somebody, which then indubitably assumes 75 straight years of Democratic Presidents and Congresses. Being a Republican, I try to read as little as possible, think even less, and care none at all, but I will have to check out that Jack London thingy.
I still say Cormac McCarthy’s “The Road” is our future. Cormac’s scenario is more in keeping with the American traditions of “independence”, “self-reliance”, and “freedom”…keep consuming without care for other people or the world, even if you are eating barbecued human leg. With my luck, I will probably survive the “long shear of light”, so I better start practicing my stick fighting.
June 11th, 2009 at 4:16 pm
@CNBC
Read half that book last night. Sounds like a bomb shelter would not be too bad.
June 11th, 2009 at 4:20 pm
I guess you haven’t gotten to the bomb shelter part ;)
June 11th, 2009 at 5:03 pm
I really think the American corporation is totally broke. When did dividends get such a bad name? It’s just amazing the execs say that traditional pensions are “too expensive” on one hand but stuff there pockets with the other. On one hand they say there is no longer jobs for life for the rank and file and on the other hand they make enough money in one year to last a life time. They say you need to save for retirement in your 401k while at the same time they take the money and run.
Would making dividends tax free and raising the marginal tax bracket help? For many of us socialism is looking better and better (and I call myself a neo-con).
Pitchforks and torches…..
June 11th, 2009 at 5:21 pm
@CNBC:
I would chide you for being repetitive but I can’t because The Road is, hands down, one of the best works of literature I have ever read. I read it last summer on Cape Cod and it changed the way I looked at the ocean. And I wasn’t even doing mushrooms.
June 11th, 2009 at 5:57 pm
@CNBC:
The Road sounds pretty interesting, but I must confess that I’ve read too much during my life which sounds very much like it. I”m just thinking of a number of Andre Norton’s juvenile SF titles, which I read long, long ago, through Miller’s A Canticle for Leibowitz to watching Escape from New York. I could also recommend Level 7 by Mordecai Roshwald for a look back at how some folks considered life under MAD.
June 11th, 2009 at 7:09 pm
Oh, Cormac McCarthy’s “The Road” is a must read, PrahaPartizan. Imagine “Dawn of the Dead” as if written by William Faulkner. Then think of a “Papa” and a young son trying to make their way to a southern coast through a dead, apocalyptic world from a Blue State (probably Ohio) through all of these Southern Red States (Kentucky, Tennessee, South Carolina), with a quick break in a nicely stocked bomb shelter, probably in the newly Blue State North Carolina. Then, add a bunch of cannibalistic Republicans – Southerners with trucks, baseball caps, guns, catamites, barbecue pits, and slaves – all trying to kill the Blue Stater and eat the son. They are all pro-life so they don’t eat babies until after they are born. There is no more government or law or order or even the Fed, so the Libertarians have finally gotten their way. The only fresh meat left are former “independent voters” held captive naked in a basement wishing they had voted Democratic for the previous fifty years. Despite all that, the Dow is at 17,447.
Cormac McCarthy’s The Road: highly recommended
June 11th, 2009 at 7:58 pm
[...] Compensation Is the Symptom, Not the Problem [...]
June 11th, 2009 at 9:20 pm
BR: I agree with the excerpt from Bailout Nation that mutual fund companies are partially to blame for the rise in over-compensated executives at public companies. I think it’s sad that there isn’t more of a revolution among individual investors to “move their money” to more activist fund companies. Activist investing shouldn’t solely be the realm of hedge funds and private equity shops. Hopefully, your book may be the beginning of an impetus among fund investors to become more “engaged” with the companies they invest in.
June 11th, 2009 at 10:54 pm
SWMOD52-
great post- many of us have the same frustration
CNBC-
so when I read this book will I feel uplifted or will i fell depressed and give up on humanity?
June 11th, 2009 at 11:09 pm
Don’t know if anyone is still reading this thread, but just got to catch up. Anyone notice who the Comp. Czar is and who his firm’s clients are:
http://www.feinberggroup.com/ Click on the clients list. I bet he’ll be really tough. Why not just appoint John Thain? Oh, yeah, he’s not beholden to the banks.
June 12th, 2009 at 7:12 am
ahab – When you read The Road, you will see the very worst of humanity. However, Cormac’s scenario strips down human existence to its most basic, and in doing so, he reveals its greatest meaning and purpose. If the book touches you, you will realize that the life we have been given is very good, we should be thankful for our blessings, and we must try to be gentle and kind to others.
June 12th, 2009 at 8:20 am
[...] // Per yesterday’s discussion on crony capitalism and CEO compensation: [...]
June 12th, 2009 at 9:43 am
“Why the mutual fund complexes failed to protect their shareholders is hard to fathom.”
Barry, that is a decidedly unsatisfying…”explanation.” You can do way better than that.
Thanks,
Steve
~~~
BR: What’s your theory, Steve? I spent 332 pages explaining mine — how about more than a sentence?
June 12th, 2009 at 10:32 am
I see a lot of complaints about the US corporation and the US system, but is corporate governance in the rest of the West that much better? (I’m not talking about non-Western modalities as Chinese communo-capitalism, because I’m simply ignorant of them.) The US may be a bit more extreme in this matter–it usually is in anything related to capitalism–but I don’t have the feeling it’s all that different.
PrahaPartizan, I really don’t think you can terminate incorporation in US law. I can’t imagine the kind of chaos that would ensue if the government were to try, which I’m pretty sure it legally could not. And if you did manage it somehow, that leaves how many other countries where “legal persons” exist?
Btw, you sound like a good chap, if a bit populo-leftie at times. At least you’re not a goddamn libertarian. (Yeah, I know, they’re not all crazy and/or selfish bastards desperately trying to justify their selfishness. Knew a quite decent one.) I’m in Prague too, so feel free to drop me a line. It’s my name with a dot between first and surname at google.
Oh, wally, let me restate your point, “Reform is not likely in a country where the lawmakers are owned by the wealthy” more succinctly: Reform is not likely in any country. Yet it does happen occasionally. Almost as if “the wealthy” were actual human beings with a range of personal and political philosophies, and included members who understood the value of social cohesion, or might even possess some sense of justice or responsibility.
June 12th, 2009 at 10:36 am
PPartizan, apologies, my address is at gmail, not at google per se.
June 12th, 2009 at 11:30 am
[...] of all, I completely agree with Barry Ritholtz in that compensation is a symptom and not the problem. His brief post (including a passage from [...]
June 12th, 2009 at 5:13 pm
@JeffRubinoff…
I’m fully aware that politically it is impossible to eliminate incorporation and practically it is not truly desired. I believe that no impediment exists, however, to stopping the practice or becoming much more exclusive in its application. Over the last thirty years the requirements for incorporation have been loosened dramatically, so why can’t the requirements be made more stringent going forward? The last time I looked, nothing like a check-valve existed in political or legal systems, outside the Constitution itself regarding a few specific issues. The bottom line is that we really do need a way to reintroduce responsibility into the corporate system and the governance of corporation activities and management. Sometimes only threatening to take away the punch bowl completely seems to be the way to get any acknowledgment from the folks gaming the system.
Incidentally, it matters not what other countries might decide to do in this regard – granting anonymity to shareholders in an enterprise. Once any of those businesses tries to establish a US presence, they would need to do it under US law. It’s exactly the same as when a US firm opens an operation in a foreign country. If the law says that no foreign country can own more than 49% of an enterprise, then you won’t be finding any enterprises wholly owned by US firms, even if they were to contribute 100% of the investment. If some corporations want to reestablish their headquarters in ultra-free market locations and subject themselves to the whims of the rulers in those nations, I say they should just go ahead and do so. Just don’t ask me to send a carrier strike group to bail you out when your enterprise gets expropriated, as is likely to happen.
I must regret to inform you that I am not located in Prague. I assumed my blog name many years ago based on my ethnic background (yes, I am 100% Czech, which has both good and bad points) and an interest in medieval weapons. “Partizan” comes from the second definition for the word, not the first. In part it’s a bit of play on words involving Slavs of all kinds. You’d probably also be surprised to learn that I’ve even graduated with an MBA.
June 12th, 2009 at 8:03 pm
JeffRuninoff,
Canadian Banks.
The main characteristic of Canadian Banks that make them different form any other western banks is that their board of directors has an actively adversarial relationship to the CEO and Bank management.
The board sets up all sort of committees that grill the various officers of the bank multiple times per year. Whether it is the internal audit head or the risk officer head, they have to go in front of the board and get grilled. Incidentally, this system has also produce compensation for CEOs relatively lower than European and American Banks. So maybe this is a model. An yeah, this means the CEO never sits on the board of directors – inherent conflict of interest.
Canada also has another weird corporate structure which sometimes also produces better returns, but runaway CEO compensation is a problem. This is what I call the “family dictatorship” corporation where the corporation has a dual share structure, where the A shares have 10 to 1 voting rights over the B shares and are usually all held by the founding family. Now the weird thing is this often produces better governance as the majority owners from a vote point of view take a long term view, as they almost always want to pass the firm on to their kids. But not always. And sometimes executive looting takes place. Fred Stronach the head of Magna International has been criticized for his excessive pay. Anyway I think this type of corporate structure is illegal in the US.
But the bottom line is a lot of imagination could be applied to corporate structure in America. I think a bit of a checks and balances system is a minimum. The board should be whipping the management, not be its happy friend.
June 15th, 2009 at 9:40 am
[...] // heheh — I don’t know if Scott Adams reads The Big Picture, but he certainly is keeping up with some of our favorite themes: [...]