Roger Ehrenberg has a good post on the comp plans at the top of bailed-out banks. He takes Lehman's Fuld as an example:

For instance, consider a guy like Dick Fuld. In my scheme Dick would
have been holding a portfolio of these 10 year maturity/5 year
cliff-vesting options, meaning that he has 5 years of stock
compensation cumulatively tied up in the company at all times. Now
consider if this total compensation was weighted, say, 80-90% in these
options, such that he got enough cash to live very, very well, but that
almost all of his net worth was tied up in the stock. Tied up for 5
years. All the time. It is very hard to keep a fraud going for 5 years,
to fool the market for 5 years. So Dick, in my example, would have lost
almost everything when Lehman went down. Which is as it should be.
Highly compensated traders should be paid the same way, specifically to
avoid the kind of "swing for the fences" attitudes that permeated Wall
Street and amplified risk to reckless levels. All in the name of
current year compensation. This has been and will continue to be a
recipe for disaster unless a wholesale revamping of executive and
highly-compensated employee compensation is undertaken.

I agree with Roger for the most part.  However, at the end of the day, this is a supply and demand driven negotiation, where outsiders trying to regulate (i.e. mandate that banks structure pay packages a certain way) would be a disaster.  Typically, you have a board trying to hire the right CEO who will try maximize shareholder value.

Now imagine you're on the board of a bank with a $5b market cap.  You have two candidates you're considering for the CEO job and you feel one is a better fit.  You have to determine what it will take to bring on the two candidates and make a cost/potential benefit decision.  The total package cost you end up negotiating with both end up at similar ranges, but the candidate that seems like the better fit will not accept your fully-aligned comp plan (such as the one Roger proposes).  What do you do?

Given the potential impact of the right person on the market cap of the company (in this case, a 10% difference in performance would result in PV $500m of shareholder value), I think it would be short-sighted to force the fully-aligned package.  I would imagine many people had frowned on Jack Welch's package when he took the helm at GE, and there would have been plenty of similarly qualified managers who would have taken the role at a lower cost, but at the en d of the day Welch's enormous package looks like a rounding error in the shareholder value created at GE over his tenure.

I don't mean I am happy with the money made by the management at failed banks.  It's just that compensation is a complicated issue and free markets are a bitch. 🙂

4 thoughts on “Compensation

  1. Good post, but you might have missed Roger’s point. The executive compensation restrictions are happening regardless, he’s just suggesting a sensible approach that banks should employ before the government comes in with hard limits. The real point isn’t just executive pay, but firm wide bonuses, they type where a secretary gets a $50K bonus, a lowly programmer $150K, etc. In aggregate, that eclipses the executive compensation impact by an order of magnitude. Will American taxpayers stand by idly to support this entitled lifestyle to keep these companies afloat? Doubtful, and the transparency during the bailout means we are a mere 3 months away from a PR nuclear assault on Wall Street compensation during bonus time.
    Where is Turkey in all this mess? Please tell me it’s not another Iceland. (I guess I should click around your blog a bit more…haha!)


  2. Thanks, Greg. I largely agree with Roger, but am troubled by the well-meaning intervention we seem to be headed to. In tho long run, it will, once again, be overrun by greed.
    In Turkey the TRY’s lost 40% of its value agains the USD over the last couple of weeks. The credit outflow has frozen. We’ll have a while until a complete thaw but nothing close to Iceland. We had that in 2001 which is partially shielding us now.


  3. You don’t have to mandate or regulate to achieve more aligned plans. You could structure it from a tax perspective, just like capital gains from stock trades, that are taxed at a much higher rate if they are gains from a short-term (held under 1 year) trade. You could extend this to cover compensation from stock options, and make the term longer (5 years, as in your example). If you think that would be “a disaster” to regulate it like that, you’d have to concede that the current tax structure is also a disaster, no?


  4. Gene, I am less concerned about short term gains. I am not sure I agree that you should be incentivized to take long term positions. Rather, the capital investor and the asset manager’s timing needs to be aligned. A HF does not distribute its capital back to investors every year but the HF manager takes his carry off that year’s gains. I propose a better aligned model, similar to PE compensation. If I understand your position correctly, the tax issue only encourages longer term positions.


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