In the Sunday NYT, Yale Professor Robert Shiller discusses one of the recommendations of the Squam Lake Report — holding back some executive compensation to align their risk with taxpayers (Help Prevent a Sequel. Delay Some Pay.)

Here is their recommendation:

“The Squam Lake group recommends that companies be encouraged to withhold a good part of the compensation of their top executives for a number of years, and that it should not take the form of stock options. That would give them incentives to consider some of the long-term consequences, and intrinsic value, of their decisions.

The holdback should be for a pre-announced dollar amount, and the contract should specify that it will be lost if the company goes bankrupt or gets a government bailout. That way, the economic cost of a bankruptcy or bailout is placed partly on the executives who make decisions.”

The thought process behind this is that risky corporate activities should also become a risk to the firm’s executives. The case the Squam Lake economists make is that by holding back some of the executives’ personal assets, risky behavior becomes their problem, not just the taxpayers’. The hope is that “this will transform executives’ thinking about risks — and may help prevent another disaster.”

I sincerely doubt it. Similar disincentives were already in place — and they failed miserably.

At each and every one of the companies that went bust due to their excessively risky speculations — from AIG to Bear to Citi to Fannie Mae to Lehman to WAMU — every executive had huge amounts of stock, stock options, and future salaries at risk. Lehman’s Dick Fuld reputedly lost over $500 million dollars in stock value, and a few of Bear Stearns execs lost close to a $ 1 billion dollars each in asset value.

The mere threat of future losses has already proven insufficient to moderate behavior. Holding back $100s of 1000s of dollars — or even millions of dollars — is a meaningless inconvenience to the people whose net worth is measured $100s of millions or billions of dollars.

There are better alternatives.

While researching Bailout Nation, I did discover one group of Wall Street firms whose senior management took a very measured approach to managing risk. They managed to engage in risk taking and speculation in a fashion that was responsible, and avoided trouble.

The group? Wall Street partnerships.

There is a simple explanation for this: Unlike corporations, Partners have “joint and several liability.” Every partner is fully liable, up to the full amount of the relevant obligation, for the actions of every other partner. This has the effect of focusing the minds of management on exactly what the worst case scenario of their behavior can wreak. Imagine if a partnership like Lazard Freres (since gone public) or Brown Brothers Harriman embraced risk the way their publicly traded brethren did. The liabilities form the losses falls first tot he partnership. Once those assets are exhausted, the creditors can proceed to recover losses from the personal assets of every partner.  Bank accounts, Houses, boats, vacation property, 401ks, cars, jewelery, watches, etc. are all fair game for creditors.

Not surprisingly, none of the Wall Street partnerships got into trouble, and I argue the full personal liability for losses are why. Execs at publicly traded Wall Street firms only risk was their future earnings and stocks. The actual losses fell to the shareholders, bondholders and eventually, the taxpayers.

Risking minor amounts of future earnings, relative to massive, trillion dollar losses, is vastly disproportionate. It did not alter behavior in this crisis, and it will not prevent the next crisis. The amounts of money lost, relative to their existing wealth, failed to moderate behavior. The losses amounted to little more than tears in the rain.

If we want to prevent senior management from acting recklessly, then we need to impose costs that are proportionate to the losses they caused.  Personal partnership liability for senior management would have prevented the past crisis, and it will prevent future crises.

The question isn’t if this will work — we know it already does. The only issue is whether we have the political will to impose this liability on our reckless, irresponsible executive class . . ..


Help Prevent a Sequel. Delay Some Pay.
NYT, June 18, 2010

Category: Bailout Nation, Bailouts, Corporate Management, Regulation, Wages & Income

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

28 Responses to “Delay Pay? Try Partnership Liability.”

  1. dead hobo says:

    Grow up. It’s the nature of people to take as much as they can and justify it using the circumstances of the moment. It’s also the nature of people to believe experts really exist, they always come from somewhere else, that people who claim to be experts are telling the truth, and that economics dictates they should therefore be paid at the highest rates. This kind of thinking is a part of the lizard brain mentality you used to write about.

    Personally, I think everyone should love puppies and be kind to old people (especially those who look like massively handsome bums). And those who refuse should be made to wear assless pants only. If you can impose a fantasy equity system on avaricious and megalomaniac executives, then I can expect to humiliate those who I disagree with.

    BTW, Invistus and CrispE: I added a response to the bubble piece. My power went out for 1 1/2 days due to stors and I couldn’t reply earlier. Basically, Crispe: learn some algebra then come back. Invictus: I hope things don’t get as bad as Japan and this state is considered the new normal to the point it becomes textbook normal. The US becoming like Japan even more would only happen in the most malignant and manipulated financial system ever conceived.

  2. Hey, if people want to risk their OWN money, I could not care any less.

    When they risk the shareholders and taxpayers money, that where I draw the line.

  3. philipat says:

    Yes, this is the Volcker rule and beyond, which makes total sense. The casino banks should be separate from the commercial/community banks. It would be best of such casinos were entirely privately owned such that the capital of the owners was at risk as you describe. However, I do believe that publicly listed casinos would still be acceptable assuming that everyone understood the name of the game such that only high risk, casino, capital would be committed to such Companies, not the savings of widows and orphans. It seems to me to be totally immoral that such a basic understanding is not implemented.

  4. philipat says:

    Who me? I couldn’t agree more!

  5. dead hobo says:

    1 more thing:

    The executive pay logic thing is circular. For most people except those who like to whine a lot: If someone is discovered to be a highly paid executive then, in the absence of evidence that can’t be ignored, it must be assumed that experts decided this person is really worth the excessive pay. Otherwise the board would not permit it. Then it is permitted to openly admire the success and expertise of said overpaid executives because they really are better than the rest of us.

    PR spin to preserve the job of a failed executive who got discovered is required. If it works, then others at every company who are also massively overpaid can sigh in relief. The system still works and they can still rake it in. However, the system also requires a failed PR rescue attempt be followed by public termination, less the system stop working for those who are still getting away with it. Charades and public sacrifice are important.

  6. dead hobo says:

    Barry Ritholtz Says:
    June 20th, 2010 at 8:51 am

    When they risk the shareholders and taxpayers money, that where I draw the line.

    Crayon or whine?

  7. doug86 says:

    Yes, and why not take this a step further and hold all Board of Directors and company execs criminally liable for environmental and employee crimes, instead of just going after a few for financial fraud. If BP didn’t follow its own safety procedures and that resulted in 11 deaths, lets put some of the bigwigs in jail – perhaps the next greedy execs will think twice before encouraging lax oversight on the part of their company…

  8. philipat says:

    The fact is that the system of Corporate Governance is, demobstably, irreparably broken. And it will be very difficult to fixd because the decline has taken place over generations. Corporate Boards and Shareholders need to take back control yet, as we have seen, it’s not so simple whem CEO’s have a free hand to appoint cronies to the Board and Fund Mangers are part of the same broken system.

  9. dead hobo says:

    philipat Says:
    June 20th, 2010 at 9:12 am

    The fact is that the system of Corporate Governance is, demobstably, irreparably broken. And it will be very difficult to fixd because the decline has taken place over generations. Corporate Boards and Shareholders need to take back control yet, as we have seen, it’s not so simple whem CEO’s have a free hand to appoint cronies to the Board and Fund Mangers are part of the same broken system.

    Fortunately, we can depend on an honest and untiring Congress to come to the rescue. They’ll fix it up. If there are further problems, we can count on a really nice speech from Obama.

  10. philipat says:


    Fortunately, we can depend on an honest and untiring Congress to come to the rescue. They’ll fix it up. If there are further problems, we can count on a really nice speech from Obama.

    In your dreams.Back to the Bowery/Brewery?!

  11. Tarkus says:

    Of course making people personally liable for their decisions would work – that’s called “responsibility” – which is why most companies would fight tooth and nail to keep it from ever happening. The CEO often isn’t paid huge sums because of his decision-prowess – he’s paid so the rest of the board can cower behind him if there needs to be a sacrificial lamb after getting caught in malfeasance. He is then compensated enough via his golden parachute to not care about taking the hit for the team. The Board then elects a new golden-monkey and the game continues.

  12. rktbrkr says:

    These rules wouldn’t be necessary if BOD members had some skin in the game, then they’d really represent the shareholders. This is why GM paid Ross Perot so handsomely to go away after they bought his company and he started asking questions at GM board meetings.

    It’s an incestuous relationship between BOD members and management at big companies, all they need to do is bribe congress to stop this element of regulation, that shouldn’t be a problem

  13. DM RTA says:

    The Elliott wave principle applies to this very idea. Specifically the character of specific waves manifest differently at different degrees of trend. The fundamental dynamics of a trend become unhinged in the late stages of a trend and also in some part of larger corrections of that previous trend. During all encompassing trends, like those of the late 90s and then the mid oh-oh’s, the fundamental issues characterizing the trending behavior extended to include issues like this being discussed. The reason for pointing it out is that the real question is “when?” not, “if?” will we have the wherewithal to impose regulation that is socially sensible. That we do not have the will now only suggests it must get worse before we perceive the need to make it better. It follows that successive generations tend to learn the same lessons in a repeating cycle like that suggested in the Fourth Turning (Howe & Strauss).

  14. constantnormal says:

    “Partnership Liability” only makes sense if the “partners” own the entity incurring the liabilities, and therefore own the liabilities as well. In an environment of pubicly-owned corporations, this is not really applicable, because there is no good way to draw the line between shareholders’ liabilities and “partners” liabilities. The “partners” would continually be pushing that line away from themselves and back towards the shareholders.

    But perhaps I have missed the point here, and BR is only proposing a model of responsibility that fits with the Reality of a tiny fraction of people (the “Partners”) owning pretty much everything in the nation. So long as they pay all of the taxes and I still get to vote, I’m good with that.

    But there are models that impose regulatory controls on how publicly-owned corporations are allowed to compensate their employees. Those would eventually result in a cessation of the looting of the public by the CEO robber barons, and promote a return to the executive-to-average employee compensation ratios that existed up until the 1970s, and began to explode as Reagan unleashed the business elites in the 1980s. A turning away from regressive tax policies would not hurt either — but with the thoughts of the Congress increasingly turning to VAT, that seems unlikely, as Congress would apparently prefer to discourage consumption rather than puncture the wallets of those who send them big campaign checks.

  15. b_thunder says:

    the alternative to what Barry suggested is what the Chenese did to the top execs of the tainted baby formula factory, and to the entire supply chain: a 9mm in the back of the head, after with less than 1 month wasted on appeals. Oh, and those execs’ families lost all their assets (not hidden offshore I suppose) to pay compensation to the families whose kids died from the poison.

  16. Next you’re going to be calling for banks to have the cash on hand in order to lend it out. What kind of world would that make?

  17. cognos says:

    The problem with “partnership” is that there are very SMALL.

    Todays I-bank broker dealers stand ready to REGULARLY buy/sell $1B on value in many structured illiquid markets. In some case a SINGLE TRADE will be as much as $10B. Brown Brothers or Lazard cannot really do trades 1/10th this size, so they sit in niche markets.

    So now, if you like to understand the workings of modern finance you can trace those trades through to “who does them?” “why they are done?” and “what does the modern financial trading and risk taking world look like?”. If you or people like Elizabeth Warren or P. Volker spent more time understanding modern trading and risk taking… you might come up more relevant solutions.

    Instead, you are looking back at the car wreck evidence… saying, “lets all go back to riding bicycles”.

  18. Marcus Aurelius says:

    Those responsible lost nothing, and gained far beyond the excess that they left on the table (and it’s not like anything they gained was ‘earned’” in the classic sense of the word, in the first place).

    The penalty for wrecking all or any part of our financial system should be treble the damages — not at all related to income or future compensation — and should fall squarely on anyone who knew, should have known, participated, or profited from the scheme that resulted in the losses.

  19. OkieLawyer says:

    I know that I have previously mentioned piercing the corporate veil as a remedy to corporate malfeasance. If you want to impose personal liability for fraud and other serious torts by the directors of a corporation, that is one sure-fire way to do it.

    The problem is that this legal theory is not utilized enough when serious wrongdoing is committed against people. The rule needs to expanded so that it will create an incentive to not harm individuals.

  20. ACS says:

    Cognos, could I ask you how many of these mega deals serve a valid social purpose, justified by the implicit need for taxpayer backup, rather than merely creating huge fees for the players?

  21. flipspiceland says:

    Large institutions, be they corporate, governmental, or even familial, are ungovernable with any semblance of efficiency. At best they are barely managed chaos.

    The audacity that one man as CEO or group of them is powerful enough to control a corporation the size of BP, Goldamn Sucks, GM, is laughable. That anyone thinks that the Bamster is the “Most Powerful man on the planet” is a ridiculous myth.

    At a certain point, the increasing size of an organism renders it uncontrollable by the so-calledexecutives. Anyone who has ever worked for a sizeable company an attest to the fact that if they are successful, it is usually a matter of luck . Most organizations are a mishmash of internecine conflict.

    The best (worst?) example is the Federal Government. Here you have a massive multimillion employee behemoth, that is supposedly run by elected officials when in reality its day to day operations are being run by career civil service employees who have been there forever due to an iron hand union. And yet nearly the entire population think it’s run by POTUS, and SCOTUS and Congress.

    It is impossible to gauge the damage done by organizations, already sizable, combining to form a larger single ‘organization’, such as comglomerates. Why is GE a $15.00 stock? Because asswipes like the vaunted, narcissist former chairman, Jack Welch, turned it into a bank intermarrying a hamster with a flamingo.

    Schiller is dead wrong that delaying pay is a way to help insure solidly grounded decision making. Even if that were the truth, the people who would need to vote to do that, rein in annual bonuses, wouldn’t do so because they don’t actually run the company.

    It is said that one day the insects will be the only surviving species. I predict it will not be the insects but the next lowest rung on the evolutionary ladder, the Bureucrats.

  22. [...] Delay Pay? Try Partnership Liability.   By Barry Ritholtz – June 20th, 2010, 7:45AM [...]

  23. The corporation, by it’s nature, is a risk-transferring institution, created by us because we determined that limiting certain risks makes sense for society as a whole. The core justification is that limiting the risk of passive investors (who provide capital) makes sense, because it tends to encourage investment in new enterprises that would not otherwise be made, and that transferring that risk to the rest of society, which is what effectively happens when creditors are left on the hook rather than owners, is worth it because society gains disproportionately from the investment and greater levels of commerce generated.

    Unfortunately, we’ve taken this risk transference to ridiculous levels. If protecting passive investors makes sense, we’ve been convinced, why not protect those actively involved? Why should boards of directors not get the same kinds of protection, even though they take — or should take — an active role in the company. Why not protect management, even though they are really just hired guns whose job is to do the best job possible for shareholders within the constraints of the law. Why not protect every employee or subcontractor? Why not make society take on everybody’s risk?

    We’ve taken a core beneficial idea to a ridiculous extreme. The only way I can see to fix it is to redefine what risks a corporation and the people who work for it are allowed to transfer to the rest of society. As things stand right now, even the most egregious conduct often doesn’t result in any personal liability by those who made the decisions to engage in that conduct.

    How you can cause that to happen in this political environment is beyond me. My fear is that we end up throwing the baby out with the bathwater. Populist movements have always ended up having corporations in their sights. The Tea Party types don’t seem to be there yet, but most likely they will be, and you can bet they won’t be looking for a sane and rational way of making executives more accountable.

  24. bondjel says:

    You’re certainly right about this but the chances of any such legislation to change this would be about as close to impossible as it can get; I can hear the SCREAMS of our “free” market squealers now. Back in the 1840s or 1850s our political decision-makers gave corporations limited liability. Perhaps back then one could make a case for wanting to encourage economic growth in a developing economy. I wonder if the whole idea of limited liability for all corporations still makes as much sense. Or perhaps there could be limited liability for small businesses but once a corporation reached the behemoth-size it would lose its right to limited liability. Of course, no change like this has a snowball’s chance in hell of passing either. It’s one thing to pass legislation enabling certain practices but by the time it seems well to correct some things and take them back those who have benefited from the original gifts have so much political power no change is possible.

  25. AHodge says:

    i attach some ppt pts i made to kotoks group
    When is 8 figure termination severance not a corrupt bargain?
    19th century Co’s were limited liability corporations– but leaving a company bankrupt while grossly enriching yourself usually resulted in jail time.
    Comp. granted as % long term earnings with clawbacks? Esp if accounting still shaky?
    Jack Bogles list of good corporate governance?
    Delaware corporate law? Try North Dakota?
    And our founding fathers actually thought about having a federal statute– a federal corporate chartering statute. I think we probably need one because if some of the states step up and say improve their governance provisions, corporations will move

    a quote from trolloppe the way we live now London 1875
    “Of course I have been short of money. I have had enemies whose business it has been for some time past to run down my credit, and, with my credit, has fallen the value of stocks…. known that I have been largely interested….. When the time came at which I should pay it, stocks were so depreciated that it was impossible to sell. Very hostile proceedings are threatened against me now. Accusations are made, false as hell,”—Mr Melmotte as he spoke raised his voice and looked round the room “but which at the present crisis may do me most cruel damage. ….if you will undertake to stop proceedings which have been commenced in the City, I will have fifty thousand pounds,—which is the amount due to these two gentlemen,—ready for payment on Friday at noon.”

    Augustus Melmotte explaining his situation to his creditors. The Way We Live Now

    you could subst. mortgage paper for stocks and have it read perfectuly well today

    the difference now is Melmotte finally committed suicide on threat of charges and social ostricization.
    With accounting in its current state jimmy cayne, Sullivan, Fuld etc show up in testimony and say its those crazy illiquid markets and short sellers, i had $10-20 billion of “capital” and get away with it.

  26. foxorrabbit says:

    BR: If I understand correctly, you’re essentially saying that the problem is Limited Liability (which a corporate structure provides, but some partnerships do not). If Limited Liability didn’t exist for corporations, then a company’s stock price would effectively be allowed to go negative, i.e. the stockholders would be personally on the hook for any libilities beyond which the company could pay.

    I don’t disagree with your idea, but it’s essentially a proposal to undo all of the legal precedents that have led to the corporation being a limited liability entity. Do you think Wall Street firms should be forced to be partnerships? And if you think Wall Street executives should not enjoy limited liability, what about other industries? BP? Enron? Do you really have the brass cojones to propose that limited liability should be stricken from corporate law?? I don’t disagree with you, but if that’s what you’re saying (signed in your own name!) then damn, you’ve got a massively large pair.

  27. AHodge says:

    fox rab
    you dont need to actually have a prtnership for comp like one
    what i laid out before

    “Comp. granted as % long term earnings with clawbacks?”

    actually looks like a partner, clawbacks being paying back loss shares. can comp for some period go below zero? yes

  28. [...] Last weekend, we discussed issues of Wall Street compensation and liability in placing a natural limit to excessive risk-taking: Delay Pay? Try Partnership Liability. [...]