Let’s take a bit of a breather from the news about John Thain and Merrill Lynch. (We’ll come back to that momentarily, no doubt.) In all the excitement, we almost overlooked an important column by the Wall Street Journal’s Holman Jenkins. In today’s Journal, Jenkins urges some sobriety in the face of losses at Wall Street firms, something that’s been sorely absent in recent weeks.
Indeed, at some point—after the executions of Stan O’Neal and Chuck Prince and while the mobs were turning their attention to Bear Stearns’ Jimmy Cayne—the urge to overthrow the heads of so many Wall Street firms began to take on tones that almost recalled the French Revolution. After losses at Bear Stearns were less than expected, Cayne now looks safe but it’s worth taking a step back and wondering if anger at chief executives over losses might have gone too far.
Certainly calls for jailing O’Neal or Prince—as we heard from Bill Lerach, a plaintiff’s laywer who is himself on the way to prison—went too far. Losing money is not a crime, at least not yet. But the more broadly felt outrage at the size of severance packages for O’Neal and Prince were only slightly more measured. As Holman points out,
“Misplaced moralizing over business losses also infects the discussion of exit packages. Notice how these discussions substitute the language of reward and punishment for what are really matters of contractual relations and strategic, before-the-fact incentives.”
To wit, Merrill Lynch CEO Stan O’Neal’s severance is not a bonbon from a loving board, but what the board feels legally obligated to pay him, based on commitments made before the results of his tenure were known. Nor was he without proper incentives, then or now. His chief performance pay was Merrill stock, and his holdings are worth millions less than they were before the subprime losses emerged.
That won’t satisfy Mr. Lerach, who thinks Mr. O’Neal should be imprisoned. But nobody in his right mind would take the job on such terms given the risks entailed in running a modern business, including the risk of civil or criminal litigation if things go sour. Indeed, what towering pay in the risk-taking professions really may be telling us is how utterly averse to risk-taking ordinary human nature is.
One fact that will surely drive the Lerach’s of the world up the wall is that the recent ousters on Wall Street are likely to result in even higher pay for management. The risks of running a bank or a brokerage are greater now than they have been at any time in the past—risks of prosecution, lawsuits, and ouster—and the top managers will demand to be compensated for those risks. Already the wires are carrying stories telling us that one of the surviving CEOs—Lloyd Blankfein of the House of Goldman—may receive as much at $75 million this year.
Losing Money Is a Crime [Wall Street Journal]
A new study by the Corporate Library lists the 12 worst examples of CEO “pay for failure,” meaning executives with the greatest discrepancy between personal salary and company performance. The criteria for eligibility was lower total shareholder returns and slumping performance relative to industry peers over a five year period.
The companies on the list are – Home Depot Inc., Pfizer Inc., Time Warner Inc., Verizon Communications Inc., Wal-Mart Stores Inc., Dell, Eli Lilly, Affiliated Computer Services Inc., Ford, Abbott Laboratories Inc., Qwest Communications International Inc. and Wyeth. The compensation committees of these companies authorized $1.26bn in pay packages to CEOs who presided over $330bn in losses to shareholder value.
The study does note the recent share price recoveries of Abbott, Qwest and Wyeth and the new employment agreement for Home Depot CEO Francis Blake.
You can get the report here (for $495)
Some CEOs get paid millions to fail – [CNN]
Study assails “pay for failure” at U.S. companies – [Reuters]
The House of Representatives approved Barney Frank’s “Say on Pay” bill this afternoon. The bill would give public-company shareholders annual non-binding votes on executive salaries.
The supporters of the bill make no bones about viewing it as a way to stem the rise in executive pay. Opponents point out that ordinary shareholders will often lack an incentive to vote on the measures, and will be unlikely to have the relevant information to decide on the appropriateness of executive pay. The executive compensation elections will most likely be controlled by self-interested special interests who do not necessarily share the interests or incentives of the broader shareholding public, opponents say. Studies into public ignorance have revealed to electorates are usually characterized by large groups of relatively ignorant and apathetic votes who wind up ceding control to smaller, doctrinaire and self-interests cliques. Some opponents raise the specter of union controlled pension funds using its voting power to win union concessions from management.
But those opponents aren’t opposing enough, perhaps because they aren’t listening closely enough to Barney Frank. Frank has made it very clear that this is an incremental step toward a measure that would make shareholder votes on executive compensation binding. Just this morning on Squawk Box, he told Carl Quintanilla that if corporate board’s don’t follow the results of these supposedly non-binding votes, then Congress might just have to make them binding.
“I don’t think boards of directors are going to ignore people,” Barney Frank said. “If we try this out and it turns out there is a widespread pattern of boards ignoring shareholder votes the we will probably change it.”
So the shareholder votes are non-binding unless boards don’t let the outcomes bind them. That’s some kind of non-binding provision.
On the positive side, Blackstone’s IPO is looking even more attractive.
House OKs Bill to Give Investors Say on Executive Pay [Bloomberg]
Shareholder Say on Pay [CNBC]
In other “say on pay” news, the sisters of St. Scholastica Monastery are back in the habit this proxy season. Sister Susan Mika is director of corporate responsibility of the St. Scholastica Monastery near San Antonio. Yes, monasteries have directors of corporate responsibility. The nuns are having an active proxy season this year (you read that correctly), taking on issues from executive compensation at Coca-Cola to the year’s most penitent legumes grown by Cargill. Sister Susan is pushing a “say on pay” shareholder resolution at Coke that would require a direct shareholder vote to approve executive compensation. The nuns own $25k worth of Coke stock, which gives them a 0.0000002% stake in the company, or at least enough to take issue with Neville Isdell’s $250k travel budget. This is $250k that can’t come from Isdell’s $26mm annual take-home pay.
The nuns have an active history of fighting for various corporate reforms, historically lobbying for everything from wage hikes at Alcoa to the elimination of genetically modified crops at DuPont. Other organizations are following suit, from BusinessWeek:
Coke isn’t the only company facing shareholder resolutions for “say on pay” provisions. This year, a total of 60 such shareholder measures have been filed at public companies—up from seven a year ago. The proposals have been pushed by an unusual group of activists, from the Benedictine Sisters to the American Federation of State, County & Municipal Employees (AFSCME) to Walden Asset Management, a socially responsible investing firm. This week, at least three other companies face “say on pay” votes: Citigroup (C), U.S. Bancorp (USB), and Wachovia (WB).
Sisters on a Mission at Coke – [BusinessWeek]
Sunday was a banner day for executive compensation. Make that a banner headline day. The business section of the Sunday New York Times was largely devoted to articles
decryingreporting on executive compensation, including reporter Eric Dash’s long, splashy article on executive exit compensation. Now they’ve assembled an online version of the special section with over two dozen pieces on executive comp.
So what’s inspired all this? Well, for that we turn to a Wall Street Journal editorial from a few weeks ago which explained that the SEC’s new disclosure rules for compensation have brought us far more information, inviting exactly this kind of media attention. Unfortunately, the rules produce information which is somewhat misleading, a fact that the New York Times notes, although it doesn’t let this get in the way of reporting the scandal that executives get paid a lot! The most important thing the Journal editorial notes is that the new disclosure rules are particularly bad at revealing whether executive’s are getting paid for performance.
Proxy season is under way, and as companies file their annual reports we can expect a spate of “analysis” stories purporting to tell us just how much America’s top executives are making. These stories will also purport to demonstrate that there is no pay for performance at the top of publicly traded companies by comparing stock appreciation with the pay as disclosed under a new SEC rule.
These stories will be wrong. This is so for the simple reason that the SEC’s new standard is not designed to measure pay-for-performance.
Caveats aside, the niftiest function of the special section tries to address the very question that the Journal warns us about: executive pay for performance. Interestingly, however, it seems to undermine the hypothesis that executive pay is a scandal. It’s an interactive graphic that allows readers to compare company performance to executive pay along a couple of different axes. What’s clear from the graph is that, for the most part, improvements in executive pay seem pretty well correlated with company performance. (But keep in mind that measuring CEO performance over just one year is not necessarily fair or reflective of shareholder interests). Go ahead and play yourself!
Executive Pay [New York Times Special Section]
Earlier today we mentioned Graef Crystal’s column speculating about why the pay packages of Wall Street’s chief executives were so similar despite notable differences in the size of the institutions they manage. Crystal’s question is fair, especially since CEO pay largely tracks that of the firms they manage. Why should this pattern break down on Wall Street?
Crystal posits a couple of image—the smoky backroom, the circled wagons—none of which are very flattering to our leading financial institutions. His idea is that there is safety in numbers—if they all pay around the same thing to the top guys, who’s going to complain?
That’s not such a bad answer, really. And may well explain some of the psychology of the compensation committees. But it is, of course, just speculation. And it’s not clear that this is the only explanation available, or the most obvious.
In fact, if you understand why CEO pay is positively correlated with firm size you can quickly grasp why this doesn’t work out so well on Wall Street. In the broader corporate America, CEOs of larger companies are paid more not because there is some metaphysical connection between the size of a company and the size of a paycheck but because the biggest companies are in fierce competition to attract the top talent. Whether or not CEOs really are what make or break companies, the boards of directors of American companies believe this is true and are willing to pay up for this belief.
Which brings us to Wall Street, where the competition is fierce to hire top CEOs across the range of firm sizes and faith in the leadership principle is stronger than ever. Bear Stearns might be playing catch-up with the larger Lehman Brothers but the two banks are still competitors. Just because Bear Stearns is smaller doesn’t mean it can afford to hire a second-rate CEO on the cheap. The size-comp relationship breaks down on Wall Street, in other words, because the little guys need to constantly worry that the big guys will poach their executives.
There are big fish on Wall Street, and there are bigger fish. But they’re all swimming in the same pond, and to catch them you’ve got to use the same bait. And around here we have a word for the special bait used: it’s called “money.”
What Are They Smoking? The Wall Street Executive Pay Problem [DealBreaker.com]
The pay packages for Wall Street’s highest executives is coming under a new sort of scrutiny. This time what seems to have attracted attention is not so much the huge amounts of money the chief executives received by chief executives of investments banks—but the strange similarity in the pay packages. We noticed this a couple of days ago when Bloomberg’s otherwise measured reporting on the compensation of Bear Stearns chief executive James Cayne—who was reportedly paid $40 million for last year—was interrupted by a not-so-subtle implication that there was something odd about the fact that so many of the guys running Wall Street’s banking firms took in similarly sized pay packages despite the variety in the size of the firms. Why does the head of Bear Stearns get paid as much as the head of, say, Lehman Brothers?
Today Bloomberg columnist Graef Crystal drops the “subtle” and “implication” part and comes right out and says that he thinks there is something fishy going on. “Is Goldman, Lehman Pay Set in Smoke-Filled Room?” his column asks.
So why, when there is so much disparity in sales and net Income, is there so little difference in pay?
Is it just coincidence? Possibly. Although total pay packages have become more and more similar, there is still some healthy variation in different forms of pay, such as base salaries and annual bonuses, as well as free stock and option awards.
I have an alternative theory that takes its page from the Old West: circle the wagons. If you’re going to pay more than any other industry and by a substantial margin, it helps if you can justify your compensation by holding up the numbers of your industry peers.
So is it a smoke-filled room? Circled wagons? Is the fix in? Or is there perhaps less than meets the eye? More on this later today. It’s way too early in the morning to start talking about wage curves and positive correlations.
Is Goldman, Lehman Pay Set in Smoke-Filled Room? [Bloomberg]
Even when it comes the chief executives.
From today’s Wall Street Journal editorial page:
Watson Wyatt Worldwide has been tracking trends in executive pay for years. What it has found is that a CEO’s pay tracks a company’s three-year performance pretty closely.
Thus, a company that offered its CEO a pay package in the middle of its peer group and had middling performance over the next three years ended up putting an average amount of money in its CEO’s pocket. Companies that outperformed over those three years ended up with richer CEOs than comparable companies that underperformed, regardless of whether the pay package at the outset was low, medium or high relative to its peers.
Some companies do overpay. And Watson Wyatt’s Ira Kay acknowledges that the Lake Wobegon Syndrome is present in some board rooms: Few directors want an “average” CEO, so they pay above the average for their group. While overpaying may not be optimal for shareholders, even “overpaid” CEOs, according to Watson Wyatt’s research, do better when their companies do better. Which we thought was the idea.
Unfortunately, the editorial page goes on to warn, you won’t see any of this in the upcoming disclosures under the new SEC rules for executive compensation. And so we should all get ready for the outrage of the business columnists, which will of course be backed by graphs, charts and human interest stories about folks who cannot retire because they invested their life savings in an underperforming company whose CEO smokes cigars wrapped in thousand dollar bills on the thighs of America’s Next Top Model.
CEOs and Their Millions [Wall Street Journal]
Is it too early to start talking about bonuses for 2007? Bear Stearns doesn’t think so. It has already set up a bonus pool for its top executives, according to a recent SEC filing.
A maximum bonus pool of $165 million has been established for a group of five senior executives that includes Bear Stearns Chief Executive James Cayne, the company said. Payout will be pegged to the company’s return on equity. No executive can get more than 30 percent of the total pool, which can be as little as zero.
Bear Stearns’ compensation committee also approved the performance goals for a second bonus pool for seven other top executives. The maximum amount will be $140 million, with awards based on pretax return on equity, departmental income and expense controls.
These numbers include cash and non-cash bonuses. So if you do the math, the maximum bonus for, say, James Cayne for 2007 will be $49.5 million, or about $3 million dollars less than the co-presidents of Goldman Sachs got for last year.
We can’t help thinking that this suggests a new recruiting slogan for Bear Stearns: “Bear Stearns: It’s like working for Goldman in 2005. Wall Street The Old Fashioned Way.”
Bear Stearns Companies Inc 8-K [SEC]
Bear Stearns sets up $305 mln executive bonus pool [Reuters]
That Wall Street Journal story we mentioned earlier opens with this tantalizing lede. Too bad it is so misleading.
On Jan. 4, 2002, the chief financial officer of Broadcom Corp. tapped out an email about stock options to his chief executive and others.
“I VERY strongly recommend that these options be priced as of December 24,” he wrote.
They were, and that was fortunate for recipients. Broadcom’s share price rose 23% between the two dates. The pretense that the options had been granted on the earlier date made them extra valuable.
It also violated the rationale of stock options. They give recipients a right to buy stock in the future at the price when the options are granted, so that recipients can profit only if the price of their company’s stock goes up. Setting a lower “exercise price” for the options gives recipients a head start on profiting.
That last paragraph bears re-reading because it is, at the very least, quite contentious for a front-page news story. Remember, this isn’t a Ben Stein rant or a Gretchen Morgenson screed. So it unfortunate that the reporters make the mistake of stating the pro-criminalization, anti-backdating case as a matter of fact.
Backdating does not necessarily “violate the rational of stock options.” This is a point we made a long, long time ago. First of all, even the reporters statement of “the rationale” is questionable. There are many rationales for granting stock options. In addition to tying employee compensation to stock performance, stock options also allow a company to provide compensation to valuable employees without diminishing their immediate cash position. What’s more, some employees prefer stock options to immediate cash payments because they want to participate in the potential upside growth of their companies. There are also powerful tax-incentives for accepting stock-options, since they are usually not taxed until a gain is realized.
More importantly, none of these rationales (save, perhaps, for the tax-deferment) is violated by granting backdated stock options. This should even be obvious for the rationale preferred by the Journal reporters. Holders of backdated stock options may have a “head start” on their options—the options are actually in the money when granted—but they still must usually hold the options for years before they can be cashed in, and their profits still increase with the rise of the share price. Their incentives are thus aligned exactly with those of other shareholders.
Backdating involved violations of some very complex accounting rules. And reporters, investigators and shareholders certainly have every right to expect companies not to play fast and loose with these rules. But it doesn’t help the public understanding of this mess to paint backdating as some sort of corporate looting or embezzling or to pretend that backdating stock options destroys the very rationales for granting them in the first place.
Probes of Backdating Move to Faster Track [$$] [Wall Street Journal]