Posts Tagged: executive compensation

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9
Dec 11

This Dimon Doesn’t Have it Rough Enough

Jamie Dimon, CEO of JP Morgan Chase, is back in the news railing against those who bash the rich:

Dimon was responding Wednesday to a question at an investor conference about the hostile political environment towards banks.

“Acting like everyone who’s been successful is bad and that everyone who is rich is bad — I just don’t get it,” said Dimon at the conference, which was organized by Goldman Sachs Group Inc.

Dimon said he’s worked on Wall Street for much of his life and contributed his fair share.

“Most of us wage earners are paying 39.6 percent in taxes and add in another 12 percent in New York state and city taxes and we’re paying 50 percent of our income in taxes,” Dimon said in defense of his fellow Wall Street bankers. See Jamie Dimon Rails Against “Rich is Bad” Talk

Are We Bashing the Rich or the Well Connected?

America is a land of opportunity.  Children of poor immigrants can grow up to be President, entrepreneurs, brilliant scientists or even CEOs of Fortune 500 companies.  Thus, Americans venerate a Steve Jobs or a Bill Gates.  Not that these individuals are without detractors, but they are admired for starting from scratch, innovating, and filling a market need.  Often these individuals single-handedly create the market for their products and services. See All Millionaires are not Created Equal

Let’s examine why Jamie Dimon and other bankers are less admired and often vilified.  Note the deft sleight of hand in Mr. Dimon’s answer to the question: the question posed concerned the hostile environment toward banks.  Mr. Dimon’s response is that he does not understand why the public thinks that everyone who is successful is bad.  He in fact never answered the question of why everyone hates banks.

At the core of the hatred of banks (and perhaps Mr. Dimon himself) is crony capitalism.  Mr. Dimon’s “success” is owed largely to the unholy alliance between the Bush and Obama Administrations and the Too Big to Fail Banks.  Let’s examine the blessings the government has bestowed on Mr. Dimon:

  • Bear Stearns – JP Morgan Chase and Mr. Dimon merged with the “failing” Bear Stearns, paying $10 per share for a company that had recently traded at $93 per share.  The Federal Reserve then made a $29b non-recourse loan to JP Morgan secured only by the mortgage backed securities of Bear Stearns.  Thus, the Federal Reserve could not seize JP Morgan Chase assets, if the Bear Stearns collateral proved insufficient to repay the loan.  See Seeking Fast Deal, JP Morgan Quintuples Bear Stearns Bid, Wikipedia
  • Secret Loans from the Federal Reserve – From 2007-2009, the Federal Reserve made $7.7 trillion of secret loans to 190 financial institutions, resulting in profits of $13b.  These loans were at below market rates, virtually free, ensuring profit for the banks. Bloomberg, which made the Freedom of Information Act request, estimated that JP Morgan profited in the amount of almost $458m.  Mr. Dimon did not disclose these loans or the banks’ need to his shareholders:

JPMorgan Chase & Co. CEO Jamie Dimon told shareholders in a March 26, 2010, letter that his bank used the Fed’s Term Auction Facility “at the request of the Federal Reserve to help motivate others to use the system.” He didn’t say that the New York-based bank’s total TAF borrowings were almost twice its cash holdings or that its peak borrowing of $48 billion on Feb. 26, 2009, came more than a year after the program’s creation. See Secret Fed Loans Gave Banks $13 Billion Undisclosed to Congress

  • Zero Interest Rates – The zero interest rate policy of the Federal Reserve continues to permit banks to borrow at below market rates, thus enhancing bank profits at the expense of savers.
  • Compensation – While being rescued by the Federal Reserve, JP Morgan Chase’s board awarded Mr. Dimon a $17m bonus for 2009. In 2010, Mr. Dimon made $20.8m.  JP Morgan partisans will argue that this was modest compared to industry peers.  Should US taxpayers, those of us who ultimately stand behind these loans, reward executives with large compensation packages?  Unlike the situations of most of the rest of us, JP Morgan Chase makes available to its top executives tax advantageous programs such as the permitting tax deferral of compensation, 401k plans, a defined benefit pension plan and use of the company plane.  If terminated without cause, Mr. Dimon would receive cash and stock awards valued at $16.7m. See Are CEOs Paid too Much: Not All of Them; JP Morgan Chase CEO Gets $17 Million N0-Cash Bonus; Elements of Executive Compensation (JPM); JP Morgan Chase 2010 proxy

Being Rich Isn’t the Problem

Yes, there is income inequality and we have heard endlessly about the elite 1% profiting at the expense of the 99% of ordinary Americans.  But the real hostility goes deeper than just these income disparities.   There is a good reason why Mr. Dimon chose not to discuss the hostile environment toward banks.  He is well aware of why it exists:  the American public has been treated to the spectacle of secret loans to banks; CEOs have been permitted to keep their jobs after nearly destroying their own banks and the US economy; too generous executive compensation practices and perquisites continue which ignore the fact that taxpayers needed to bail out these institutions (and will probably have to do so again);  banks still fail to undertake serious loan modification programs for underwater homeowners; they hoard excess reserves at the Federal Reserve rather than make loans to stimulate the real economy; they attempt to impose fees on cash withdrawals from ATMs;  and finally and disgracefully,  these banks have not been  prosecuted.

Mr. Dimon, the focus is on you and other bankers, not necessarily “the rich.”   Perhaps we need more hard hitting articles like the Bloomberg piece on secret loans to banks, to focus the attention on the true issues, not bogus articles of class warfare.   Unfortunately, neither the press nor the Administration has been rough enough on Mr. Dimon.

 

 

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5
Aug 11

The Meal Was Great…Part II

Dinner with friends included lots of discussion points that resonated and reminded us of our corporate working lives.   While these points were clear to us as working persons, our perspectives from the outside render these points just as important.  The revealing fact that hits home so closely is:  Americans are being impacted by flawed policies and assumptions whether employed or not, or impoverished or not.

  • Financial Sector Dominance – Government policy encouraged the growth of the financial sector at the expense of the “real economy.”  Glass Stegall, which separated banking operations from trading operations, was repealed by Graham-Dodd.   Devilishly complex financial instruments became Wall Street fee generating devices at the expense of traditional lending.    These firms became employers of choice for talented university graduates.
  • The Short Cut Society – Instead of saving for a house, a vacation or a new appliance we were happy to use credit cards or second mortgage lines for instant gratification.   Instead of a boring career in manufacturing, better a Wall Street trader or hedge fund manager.  CEOs expected huge compensation packages regardless of performance quality.
  • Spin vs. Truth – Shading of the truth became a national obsession.  Instead of honest reporting of inflation statistics, hedonic adjustments lowered the consumer price index, depriving social security recipients and federal pensioners of earned cost of living adjustments.   CEOs spun disappointing earnings results taking write offs, obfuscating the accounting or lowering earnings guidance so that when earnings were finally announced “they beat expectations.”   Congress is no better, promising “smoke and mirrors” debt reduction plans with little, if any, real deficit reduction.
  • Lack of Political Leadership – The debt reduction exercise is one more example of the lack of leadership at the Chief Executive and Congressional levels.  Politicians are more concerned about preening before cameras than serious statesmanship. Bipartisanship seems like a quaint relic of a bygone era.
  • Congress for Sale – Given the enormous cost of congressional races, representatives are in a constant search for dollars from corporations and other large contributors.  Thus, we have Congress captured by special interests.  Congress has long forgotten the middle class voter.  The appearance is that Congress is totally beholden to the corporate sector and that corporations appear entitled to special relief any time they are in need.
  • Complexity – Complexity pervades every part of our political and economic system.  Complexity is used to muddy rather than clarify.  The tax code, Obamacare and financial reform are the latest examples of overly complex legislation and accompanying regulation.  Only an army of lawyers can navigate through these legal minefields.  Conveniently, citizens are kept in the dark and small businesses cannot afford to compete with larger enterprises.
  • Rise of the Nanny State – We recently had New York’s ridiculous attempt to regulate kickball, dodge ball, waffle ball and Red Rover as dangerous activities needing state oversight and a permit.   See Classic Kid Games Like Kickball Deemed Unsafe by State to Increase Summer Camp Regulation.  This is emblematic of a society which demands a legislative or regulatory solution to every problem.   Businesses must be protected against failing (GM, Chrysler, Citicorp, AIG),  employees must be permitted leaves for such mundane diseases as chronic sinus infections (Family and Medical Leave Act), and the public must be protected against carcinogens such as the sun and salt.    Every aggrieved person must have a day in court.  Spill hot coffee on oneself, bring a lawsuit against McDonalds.  Play football and suffer an injury, sue the helmet manufacturer.  Somebody is always to blame and our legislative bodies are all too willing to protect us against life’s vicissitudes.
  • Free Trade– Say it fast and free trade sounds like a great idea.   Cheap foreign goods enrich our lives.   Thus, Ross Perot was ridiculed for saying that NAFTA’s giant sucking sound was American jobs heading for Mexico.   Mr. Perot sold American ingenuity short: American jobs are heading for China, India, Vietnam and a host of other low wage countries. These countries have few, if any, labor, anti- discrimination, family and medical leave, unemployment, child labor, environmental or safety laws.  American workers are being asked to compete against workers who are paid subsistence wages and afforded no protections.   Our politicians are only too willing to serve corporate interests at the expense of the American worker.
  • Immigration – Immigration is probably the purest example of selective enforcement of our laws.  It is difficult for American workers to compete against Chinese or Indian workers.  The problem is even greater as regards undocumented residents in our country.  Further, the cost of medical, education and municipal services is underwritten by the American taxpayer.  In places like Texas, Arizona and California this puts enormous strains on state and local budgets when education and medical services must be extended to undocumented residents.
  • Structural Unemployment – Technology and job outsourcing has added to shockingly high unemployment rates.  It is not clear whether any of these jobs will ever return. As we pointed out, zero interest rates lead to use of more labor saving capital equipment at the expense of hiring workers.  See The New York Times Finally Discovers Structural Unemployment. Hence, our employment problems may not be temporary but a permanent feature of the economic landscape.

 

All of the factors are intertwined.  In fact, they are negatively synergistic.   For example, a Congress that supports failed banks condemns savers and pensioners to miniscule return on savings, further compromising any incipient economic recovery.  A below trend economic recovery only encourages the exile of more jobs overseas so that corporations can retain profitability.

Believe it or not, dinner was pleasant and more.  But our conversational substance and concern for what is happening with our country and what is wrong with America indeed cast a cloud over all our thinking.  Along with other “ways that we were,” optimistic was also one of them, and that is much diminished.

After all this postulating about what is wrong, clearly what should come next are some hypotheses about solutions that can work.  A discussion for another blog.

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22
Apr 11

Over Compensating

Executive compensation is a “hot button” issue.  Corporate executives argue the need for a free hand in setting compensation:  we must attract and retain high performing executives.  They further argue that correctly tailored compensation creates appropriate incentives to increase shareholder value.  According to this thinking, this aligns management and shareholder interests.

Shareholder activist groups strenuously disagree.  Management over compensates itself, and awards senior executives hundreds of times the average worker salary.  Equity compensation (options, restricted stock grants) richly rewards management at the expense of diluted shareholders.   Even more egregious are executive compensation increases even when the corporation has a bad year or underperforms its industry peers.  Boards of Directors, who should be guardians of shareholder interests, are often too aligned with ineffective management. True confession: executive compensation issues comprised much of my career.  Generally, I agree with keeping the government out of the executive compensation process.  In my view, management knows its own business and knows the market for top talent. With Board of Directors’ review, advice and consent, let management set compensation and let the chips fall where they may.  Internal safeguards and shareholder activist groups inevitably punish bad or greedy managements.

However, there is one industry where the government needs to take an active role in setting executive compensation.

Is Goldman Sachs Allowed To Fail?

Simon Johnson, former IMF chief economist, asks the question:  if another financial crisis appears would Goldman Sachs be permitted to fail and follow the Lehman Brothers bankruptcy route?  See Could Goldman Sachs Fail? Johnson polled leading experts who unambiguously stated that Goldman would be bailed out again.  Goldman’s balance sheet at $900b would be just too big to permit bankruptcy.  Dodd-Frank legislation which has resolution authority to handle a large bankruptcy would be ineffective because of the international scope of Goldman’s operations.

While Goldman is one case study, Mr. Johnson could ask the same question about JP Morgan, Citibank, Wells Fargo or a number of other large American financial institutions. I believe he would get the same answer: they are too big to fail. Thus, the experts agree that these institutions have a favored position in the market place: they borrow at below market costs, and benefit from the full faith and credit guarantee of the US government.

A Modest Proposal or a Proposal for Modesty

Mr. Johnson posits that the only solution is to “press hard for higher capital requirements for Goldman and all other big banks.”  More capital would permit absorption of more losses in the event of a financial crisis.  Allow me to propose an alternative.

Goldman and other large banks pay out nearly half their revenue in compensation:  amazing that this practice has not received more government scrutiny.   As we know from Untimely News That’s Unfit to Print, the government is afraid to prosecute these banks for their financial misdeeds.  How about severely limiting executive compensation?

I can hear the howls from Wall Street now.  How can we attract the best talent?  This is antithetical to the principles of the free market!  Our work would not be properly valued!

When a bank accepts bailouts from the government (TARP), when it enlists the government to make good on derivative bets (AIG and Goldman), when it is subsidized by American savers through a zero interest policy, and when it receives a full faith and credit guarantee of the US government,  that bank is no longer a free market enterprise.  That bank is a ward of the state.  As such, its compensation should look more like the federal civil service pay scale.

Controlling and changing bank top management pay scales in this way would be hugely beneficial:

  • Banks would be able to retain more earnings, and immediately improve their capital base.
  • Shareholders would benefit as more cash would be available for dividend payments.
  • The productive economy could successfully compete for the best university graduates.
  • Wall Street firms would shrink.
  • Systemic risk of too big to fail institutions would diminish as would rent seeking behavior.
  • The real economy would flourish.

Perhaps we should start a new campaign:  Government Service Levels (GS) for Goldman Sachs (GS). Put more simply:  GS for GS.

 

 

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22
Dec 10

Reward Points

No, this is not a blog about airline or credit card rewards programs.  It is about the incentive systems in our society and how we reward job performance.  Incentive systems have enormous implications beyond the organizations that craft them.  Most people’s eyes glaze over when thinking about incentives and compensation, but it is worth a further look.

Early Exposure to Incentives

One of my first cases involved a sales compensation dispute before the California Department of Labor.  My employer sold large telephone switches.  At the time, some of these switches were as large as a small office building.   Sales representatives received half their commission when they signed a deal and the balance when the switch was installed and paid for.  In my case the sales representative left between these two benchmarks.  He received only the first  payment,  and thereafter brought a complaint for failure to pay wages.   My company prevailed, arguing that the sales representative had not fulfilled the second half of his sales responsibility.  He had customer service requirements to ensure the switch was installed to the customer’s satisfaction and payment received, and that did not happen on his watch. The reality is that in many cases the sale is never consummated, or the customer does not pay.  Thus, the sales representative was only partially rewarded for signing the customer:  a partial payment for a partial job.

Misaligning Incentives and Rewards

We are now living through an age of misaligning incentives and rewards.  One could argue that this misalignment is the root cause of the current financial crisis.  A look at some of the misalignments:

  • Countrywide and Washington Mutual were poster children for misaligned compensation systems.   Regardless of ability to afford payments, mortgage brokers recklessly wrote subprime, 125% loan to value, no documented income, adjustable rate and other questionable mortgage products.  Compensation was earned on closing. There was no “claw back” of the compensation provision when the mortgage holder ultimately defaulted.
  • Wall Street financial engineers created inexplicably complex credit default swaps and other financial derivative products. These products were sold to cities, pension funds and college endowments.  Many of these weapons of  mass financial destruction caused shocking losses.  At AIG these derivatives blew up, sending insurance companies into government receivership.  Writing these bad toxic financial products had no adverse consequences for AIG executives.  In short, the head of AIG Financial Products collected $300m in compensation for creating fiendish products.  See We Were ‘Prudent’: AIG Man at Center of Crisis.  Again compensation was paid up front without a “claw back” when these products misfired.
  • Money center banks and Wall Street firms were given $700b in TARP funds. No restrictions were placed on compensation, and no requirements were imposed to lend to businesses.  A zero interest rate policy incented banks to borrow at near zero cost, buy longer dated treasure securities at virtually no risk and earn large profits.  All this resulted in near record financial firm bonuses in 2009 and 2010 and almost no lending to small businesses.  Even worse, many of these Wall Street bonuses were based on illusory profits.  Suspension of “mark to market accounting” overstated profits and the resultant bonuses.

In each of these instances rewards were based on the initial sale rather than outcomes.  No one owned the outcome and society suffered.

Other Misaligned Incentives

Outside the financial area we have misaligned incentives:

Politics – The expense of purchasing mass media to run a national campaign or a local campaign in an expensive broadcast market requires endless fundraising.  Given the Supreme Court removal of restrictions on corporate campaign contributions it is no surprise that we have a Congress and executive branch held hostage by corporate contributors.  The end result is earmarks for special interests, endless increases in defense spending and watered down financial and health care reform shaped by corporate sponsors. Congress is incented to reward special interests at the expense of the broader good.

Executive Compensation – Executive compensation for CEOs is open to endless possibilities for “gaming” the system.  If increased earnings per share is the target objective, a skillful CEO can effect share buy backs, delay recognition of expenses or cut the research and development budget.  If options are granted, the same techniques can be used to boost share price.  Need to meet cash flow targets?  Easy!   Just cut expenses through layoffs and reduced product development and research. Virtually any financial target can be manipulated in some way to the CEO‘s advantage.

We Have Learned Nothing

The financial crisis should have been a wakeup call that we cannot continue the same path of misaligned incentives.  Financial executives have paraded before Congress with the sorry excuse that they really did understand the derivative products that they were selling or the consequences of a worst case economic scenario.  This behavior should be unacceptable and is a failure of both senior corporate management and boards of directors.  Nevertheless, the banks and Wall Street firms continue to expand their derivative business. See Far More Derivative Exposure Today than Two Years Ago

Recently, the CEO of D.R. Horton, a major home builder was quoted in the Wall Street Journal:

“As I tell our salespeople as I travel around the country, if they are warm and they have a pulse, write them,” he said on an investor call for the company’s fourth-quarter earnings Friday. “Write them, and then we’ll figure out whether or not we can get them qualified.” Heard on the Street – Overheard: Still Dreaming

We are back to business as usual.  We continue to incent bad behavior at the peril of our economy.   There continues to be no ownership of outcomes.  We should not be surprised if the new year includes a rerun of 2008.

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2
Mar 10

Goldman and the Winner Take All Society

Finally, Goldman Sachs has gone too far.  In A Reputation as Good as Goldman?  Part I, we discussed Goldman’s selling of mortgage backed securities, and its role in the current Greek budget crisis.  These activities clearly contributed to its self-inflicted reputational damage.

Perhaps the hubris went further.   Does Goldman believe that its status as a favored Federal Reserve “too big to fail” firm will insulate it from government investigation? Last week Ben Bernanke put a dent in Goldman’s Teflon shield:

Ben S. Bernanke, the Federal Reserve chairman, told Congress Thursday that the Fed was ‘looking into a number of questions relating to Goldman Sachs and other companies and their derivatives arrangements with Greece.’

Mr. Bernanke said the Securities and Exchange Commission was also concerned about how derivatives — financial instruments that are largely unregulated and do not trade on public exchanges — have contributed to Greece’s problems. ‘Obviously, using these instruments in a way that intentionally destabilizes a company or a country is counterproductive,’ he said. See In Greece’s Crisis, Fed Studies Wall St.’s Activities.

In Is Goldman Finally About to Be Leashed and Collared? Yves Smith observes and analyzes Goldman’s corporate culture.  As a former employee, she reports on colleagues’ piggish and overly aggressive behavior. But in an otherwise excellent post, I believe she overlooks the role of current compensation systems.

Pay Practices and Reputation

In previously discussing the banking crisis, we pointed out a fundamental principal: you get what you incent.

Banks were interested in generating upfront fees. Incentives were predicated on “making the deal.”  The best way to make a deal was to ignore the creditworthiness of the borrower.  The banker who made the bad loan suffered no personal financial penalty.  There was no “skin in the game.” Why not write as many loans to poor credits as possible? See Hard Truths from the Banking Crisis.

The Goldman culture incents a “winner take all” mentality.  Since it is a public corporation rather than a partnership everyone is an employee.    A highly mobile employee rather than an owner is far less concerned about the firm’s long term reputation.  That employee wants to maximize current compensation; worrying about future consequences is for suckers.  Drawing on this paradigm, we are not shocked by headlines excoriating the firm for trading against its clients’ interests, shorting the municipal bonds it helped underwrite, skirting EU rules, or tanking the housing market.

Goldman operates in a larger Wall Street and indeed general culture that encourages greed at the expense of overall civic good:

  • Successful hedge funds report individual earnings in the hundreds of million dollars per employee.
  • Loyalty is dead.  Employees change firms. Highly paid athletes change teams without a second thought.
  • The media treats great wealth as reason for great celebrity.
  • Compensation validates individual worth.
  • Government backstops losses and allows gains to remain private.
  • The zeitgeist promotes: “I better grab as much as I can now before the economy implodes.”

Does It Have To Be This Way?

Any alert Board of Directors should be asking some difficult questions.  Why aren’t we concerned about the long-term firm reputation?  What do we want the corporate culture to be? Just because we can legally do a transaction should we be doing it?  How do we blend partnership-based personal accountability with a public corporation structure?   How do we get employees to care about the long-term view?  How do we meet the competitive threat of hedge funds and private equity without damaging corporate reputation? How does our compensation system comport with these concerns?

Yves Smith noted that it was as dangerous for anyone to get in the way of a Goldman employee and a profit making opportunity as it was to get between a predatory animal and its kill.  Goldman has managed to get itself between a very worried Obama Administration and a very angry public.  How ironic if the Goldman predatory lion becomes the Administration sacrificial lamb.

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19
Jan 10

Citigroup, Branch Rickey and the Theater of the Absurd

In 1951, Pittsburgh Pirate Ralph Kiner led the National League in home runs, but his team lost 112 games and finished last.  In response to Kiner’s request for more money, legendary general manager Branch Rickey said: “We finished last with you; we can finish last without you.”

Where is Branch Rickey when you need him?

Citigroup 2009 Earnings

This morning Citigroup announced that it lost $7.6b in the fourth quarter of 2009 and $1.6b for the full year. The Wall Street Journal pointed out the positives: better than last year’s fourth quarter; narrowing losses in the consumer credit area; greater efficiencies and financial stabilization.

The main stream media seems determined to make poor performance sound better than it is. I guess we don’t want to ruin the self esteem of executives, who are trying really really hard.

What the media fails to point out is that Citigroup has been given every financial advantage.  The government has given it TARP funds, participates in its capital structure with a 34% ownership stake, and has permitted the bank to mint money with a zero interest rate policy.

Citigroup Bonuses

Citigroup announced a bonus pool of $24b and the media again has obfuscated the real story.   The headline in the Times Online (London) is: “Citigroup Cuts Compensation by 20% as Losses Fall.”  Dig into the story a little further and there is virtually no reduction in compensation.  Because of layoffs the compensation pool of eligible executives has been reduced by 18%.  Thus, the compensation pool is virtually flat year over year.  The company has lost $1.6b this year and $29.2b over two years.

The CNBC corporate apologists attempted to justify the bonuses: there was improvement, Citicorp needs to retain executives to remain competitive, and the bonus will be paid in stock.  One commentator did point out that the stock was immediately vested, and therefore indistinguishable from a cash bonus.

There was a Different Time

I have written about disconnecting effort and reward. See What Went Wrong? Disconnecting Effort and Reward. Citigroup results have made me think that we have also disconnected results and rewards.

In a different time, I worked for a company that one year paid no bonuses.  That year we had poor financial results, but did not lose money.  Based on the poor results, the Chairman and CEO engaged in no handwringing, no excuses, no attenuated intellectual justifications nor elaborate proofs. He merely reached the conclusion that poor performance equaled no bonus – amazing in its simplicity.  As a result, very few executives voluntarily left the company, the world did not end, we all worked harder, and did better the next year.

Maybe Mr. Pandit, Citigroup CEO, should channel his inner Branch Rickey and eliminate all bonuses for 2009.  His reply to whining executives who threaten to quit: “we lost $29.2b with you; we probably could have lost $29.2b without you.”

Branch Rickey applied one other perfect aphorism to a non- producing, disruptive ballplayer:

“It was addition by subtraction.”

Too bad Mr. Rickey is not around to advise Citigroup.

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