Posts filed under “Wages & Income”
I stumbled across a fascinating pierce of research (via a reader) regarding misaligned pay incentives Bear Stearns and Lehman Brothers:
“The standard narrative of the meltdown of Bear Stearns and Lehman Brothers assumes that the wealth of the top executives of these firms was largely wiped out along with their firms. In the ongoing debate about regulatory responses to the financial crisis, commentators have used this assumed fact as a basis for dismissing both the role of compensation structures in inducing risk-taking and the potential value of reforming such structures. This paper provides a case study of compensation at Bear Stearns and Lehman during 2000-2008 and concludes that this assumed fact is incorrect.
We find that the top-five executive teams of these firms cashed out large amounts of
performance-based compensation during the 2000-2008 period. During this period, they were able to cash out large amounts of bonus compensation that was not clawed back when the firms collapsed, as well as to pocket large amounts from selling shares. Overall, we estimate that the top executive teams of Bear Stearns and Lehman Brothers derived cash flows of about $1.4 billion and $1 billion respectively from cash bonuses and equity sales during 2000-2008. These cash flows substantially exceeded the value of the executives’ initial holdings in the beginning of the period, and the executives’ net payoffs for the period were thus decidedly positive.
The divergence between how the top executives and their shareholders fared implies that it is not possible to rule out, as standard narratives suggest, that the executives’ pay arrangements provided them with excessive risk-taking incentives. We discuss the implications of our analysis for understanding the possible role that pay arrangements have played in the run-up to the financial crisis and how they should be reformed going forward.”
And to drive the point home, the authors include this lovely matching table and chart set:
Total Cash Flows from Bonuses and Equity Sales 2000-2008
It wasn’t just BSC & LEH, it was most of the publicly traded financial firms.
I always found it an amazing coincidence that none of the private partnerships got into any trouble. Coincidence? Perhaps not — from page 136, Bailout Nation:
More importantly, banks started adopting the “eat what you kill” compensation systems. The bonus structure, replete with short-term financial incentives, began to dominate banks. Throw in monthly performance fees and annual stock option incentives, and you end up with a skewed business model suddenly embracing quicker trading profits.
“This had an enormous impact upon the ways investment banks approached business generation and risk management. Like many public companies, they became increasingly short-term focused. “Making the quarter,” in Street parlance, meant pulling out all the stops to hit your quarterly profit figures, by any means necessary. Incentives became misaligned with shareholders’ interests, as risky short-term performance was rewarded with huge bonuses. Not surprisingly, this worked to the detriment of long-term sustainability.
But short-termism was only part of the equation. Of greater concern was how these firms’ internal risk management changed. Unlike in public corporations, partners are personally liable for the acts of any of the members of the partnership. If any one of a firm’s partners or employees loses a trillion dollars, every last partner is on the hook for that money.
As you would imagine, this creates enormous incentives to make sure that risk is managed very, very carefully. Nothing focuses the mind like the real possibility that any partner could bankrupt all the rest. It’s no coincidence that partnerships like Lazard Freres and Kohlberg Kravis Roberts did not suffer the same kind of risk management failures as Bear Stearns and Lehman Brothers, among others. (Lazard went public in 2005, but too late in the credit cycle for it to get into much trouble.)”
The entire Yale Journal on Regulation is worth a browse . . .
Cashing in Before the Music Stopped
Lucian Bebchuk, Alma Cohen, and Holger Spamann, Harvard Law School on Monday Harvard Law School Program on Corporate Governance, December 7, 2009
Bankers had cashed in before the music stopped
Lucian Bebchuk, Alma Cohen and Holger Spamann
FT, December 6 2009
The Wages of Failure: Executive Compensation at Bear Stearns and Lehman 2000-2008
Yale Journal on Regulation, Forthcoming
Lucian A. Bebchuk, Harvard University – Harvard Law School; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)
Alma Cohen, Tel Aviv University – Eitan Berglas School of Economics; Harvard Law School; National Bureau of Economic Research (NBER)
Holger Spamann, Harvard University – Harvard Law School
Today’s NYT magazine has a long, well done interesting piece on Kenneth Feinberg, the government’s special master for executive compensation, titled What’s a Bailed-Out Banker Really Worth?. Anytime I read a discussion on compensation, bonuses, and bailouts, I am astonished as to how much of the general discontent over these issues traces back to the…Read More
Distinguished law scholar Elizabeth Warren teaches contract law, bankruptcy, and commercial law at Harvard Law School. She is an outspoken critic of America’s credit economy, which she has linked to the continuing rise in bankruptcy among the middle-class.
Mike Santoli has an interesting perspective on the furious reactions to Goldie’s bonuses in this week’s Barron’s: “Absent in the rage against people earning impressive pay after their firms got public help is the key question: Do we want the firms that received aid to continue operating as autonomous, profit-seeking businesses, or as quasi-utilities operating…Read More
Its time for the quarterly hand-wringing amongst the populace regarding the over-sized bonuses at Goldman Sachs. This Q, its a mere $23B.
The focus on the bonuses of top performing traders and investment bankers is misplaced. There are many, many things to be upset about regarding the financial sector — but bonuses are not one of them. [BR: Or, at least not the most important thing to be enraged over]
We live in a capitalist system, where there are going to be winners and losers. Its not fair, but it is how it is. You can complain about it, but it is all but pointless. Feel free to pursue a millionaire’s tax of 1% (or 10%) on everyone who earns more than $1m — a super top tier — to pay for health care reform or whatever you want. (Best of luck with that!)
Every few years, we lament overpaid athletes, musicians, movie stars. Bruce Springsteen is going to make $100 million+ this year on tour. While you can complain about it, ask yourself how many people can fill 50,000 seat arenas 200 night a year at $100 a pop. Lebron James, Peyton Manning, and others justify their salaries by generating massive revenue and profits for their employers.
So too it is with Goldman Sachs and others.
The traders who throw off the most profits, the bankers that generate the most lucrative deals are worth tens of millions to their “team owners.” That is how it is, and it is unlikely to ever change.
What should you be upset about?
• Paying people in year one for risks that last years or decades;
• The “privatized gains, socialized losses” of the current system;
• Dramatically reduced competition in the Banking sector;
• The idea that “Too Big To Fail” is now an official policy of the United States;
• The “gifting” of $100s of billions of dollars to mismanaged banks that should have been allowed to fail in a controlled fashion;
• Bank lobbyists preventing any sort of credible regulation from passing;
• Goldman Sachs wresting $19 billion from AIG;
• The absurd and poorly thought out $750 billion TARP plan;
• The suspension of mark-to-market allowing banks to hide losses and not accurately disclose their bad assets;
• The outsized influence Banks have on Congress and Goldman Sachs has within the Executive branch.
There are plenty of things to be upset about these days. Top performers earning huge paydays at the biggest firms is not one of them . . .
Looking at Wall Street Pay (August 1st, 2009)
Why Financial Reform Died: “Banks Run Congress” (October 12th, 2009)
What’s Wrong With Billionaire Fund Managers? (April 16th, 2008)
I love the smell of napalm in the morning. You know, one time we had a hill bombed, for 12 hours. When it was all over, I walked up. We didn’t find one of ‘em, not one stinkin’ dink body. The smell, you know that gasoline smell, the whole hill. Smelled like [sniffing, pondering] victory….Read More
Are stocks cheap or expensive? Are wages up or down? The answer to the above question is obviously a a function of both hourly wages and S&P prices. Note that in the early 1980s, you could by the SPX with under 20 hours of labor — Stocks were cheap then. In the late 1990s, it…Read More
Improved savings rate? Not exactly. Mark Warywoda of Addenda-Capital.com up in Canada offers up some thoughts on why we should not read too much into the recent improvement in Savings Rates: “So far, all we have had is a two-quarter bump up in personal savings rates — that is trivial related to the outstanding debt…Read More
Two interesting front page articles this morning expand on several of our favorite themes. The first, the NYT’s A Reluctance to Spend May Be a Legacy of the Recession, treads over some well worn ground with anecdotes and data. The anecdotal stuff is the usual mix of sad tales, and psychology, some signs of improvement…Read More