Why Executive Compensation Matters
Some folks I know think the drive to limit executive compensation as a condition of getting access to any bailout funds is a kind of red herring designed to distract attention from other important issues. I disagree for the reasons Brian Beutler discusses. To roughly summarize, in order to bail out banks that would go under absent a bailout, we need to also provide access to bailout funds to banks that wouldn’t go under without a bailout. To only bail the very least responsible banks out would create a terrible perverse incentives problem. But on the other hand, to bail out banks that don’t need bailing out would be a horrible waste of money.
Hence the need for executive compensation provisions. If we limited executive pay for bailed out institutions — say by forcing executives to work on government pay scale — then firms’ managers would have a strong incentive to avoid taking taxpayer money unless it was genuinely necessary. Banks that would mere prefer to get bailed out because it would enhance their profits won’t do it if taking the bailout means a big cut in executive pay. But institutions that would actually collapse absent a bailout will take the deal because they have no choice. In my view, of the major proposed conditions on a bailout, namely
- Executive compensation controls.
- Equity stake for the taxpayer.
- Second stimulus.
- Forced mortgage renegotion
none are red herrings, all are essential. Recall that Paulson appears to have pulled the number $700 billion out of his ass. In practice, once we start handing out the cash, the total tab will be limited only by the limits of business’ desire to take the money. Under the circumstances, it’s absolutely vital to ensure that there are strong incentives to avoid taking the money when it’s not strictly necessary and to get off the dole as soon as possible.
46 Responses to “Why Executive Compensation Matters”
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September 23rd, 2008 at 5:15 pm
Why not cancel all executive stock options for firms that take the money?
That way they can’t benefit from their firm’s upswing in stock price after taking the fed money in the bailout.
September 23rd, 2008 at 5:18 pm
“To only bail the very least responsible banks out would create a terrible perverse incentives problem.”
I’m not quite seeing this, if we drive the hardest bargain possible on the equity side. Can’t we shake down the worst banks for massive equity stakes, shake the more responsible ones for smaller equity stakes, and (hopefully) laugh our way to the bank?
September 23rd, 2008 at 5:20 pm
Also, there should be a 10 year ban on Paulson and other top Treasury officials, as well as their successors in the next administration, working or consulting for, or serving on the Board of Directors of, any firm that takes a bailout.
September 23rd, 2008 at 5:25 pm
Obviously they are trying to corner the (easily
cornerable and dikless) Dems.
If the Dems don’t approve
the bailout as proposed, the Repubs will blame
the ensuing recession on the Dems.
If the Dems approve
the bailout as proposed, the Repubs will blame
the ensuing recession on them.
September 23rd, 2008 at 5:25 pm
I’m not quite seeing this, if we drive the hardest bargain possible on the equity side. Can’t we shake down the worst banks for massive equity stakes, shake the more responsible ones for smaller equity stakes, and (hopefully) laugh our way to the bank?
I think that is Matt’s point; his statement refers to a bailout without sufficient strings being attached.
September 23rd, 2008 at 5:26 pm
bailing out the least responsible banks is the “for the good of the overall economy” alternative to letting them fail. It creates perverse incentives to the extent that the alternative doesn’t feel like failure does. Unfortunately, to the extent that CEO and top dog executive skills are fungible, what’s to keep a compensation constrained CEO from jumping ship and hiring on elsewhere at the customary CEO wage? We may be able to recoup things with the federal equity plays, but punishing the CEOs by treating them like GS-15s may not work out perfectly. on the other hand, there’s tarring and feathering them…..
September 23rd, 2008 at 5:27 pm
The only executive compensation that should be awarded is NO JAIL TIME.
These greedy fucks should feel lucky they get to walk away with their balls.
ENOUGH. Say THANKS BUT NO THANKS to the bailout in total. There is NO CRISIS, but this is just a last ditch effort by the busies to kill the dollar once and for all, for the INEVITABLE RESULT of this ridiculously UNNECESSARY and GREEDY bailout will be to devalue the dollar.
IF YOU DONT WANT TO STAND IN LINE AT THE SUPERMARKET WITH A WHEELBARROW FULL OF CASH, STOP this madness NOW. Write, telegram, email, fax, smoke signal your reps TODAY NO BAILOUT AT ALL.
If the banks fail LET THEM FAIL. This is the inevitable result of DEREGULATION. As a consequence of destroying every safeguard that was put in place after ‘29, THIS RESULT OCCURS. CAUSE –>EFFECT.
To allow these criminals to rob American taxpayers TO SAVE THEIR ASSES from the INEVITABLE consequences of their own unspeakable greed will DESTROY ANY CHANCE that America can EVER get back on the right track.
Obama is ALREADY SAYING if the bailout happens NO UNIVERSAL HEALTHCARE, no REPAIR of INFRASTRUCTURE; NO entitlements NO assistance for the most needy and vulnerable among us.
WHY give 700 BILLION of our hard earned dollars to these filthy rich motherfuckers. I really don’t care if they have to give up their vacation homes and private jets.
MOREOVER as I mentioned on another post, IF the institution in question really needs a bailout AND the officers/directors REFUSE it over the issue of their compensation, then they are BREACHING THEIR FIDUCIARY DUTIES to their shareholders and can face severe CIVIL AND CRIMINAL LIABILITIES.
This entire “emergency” is as phony as the one that started the Iraq war and brought us FISA and the Patriot Act.
As far as I am concerned, any congressperson who votes for this or ANY bailout can update their fucking resumes.
It’s time for a total tax revolt if it happens. Everyone should change their W2 withholding to max dependents. The government isn’t entitled to your tax dollars until April 15 anyway. Let’s see if those genuiuses in Washington can work WITHOUT ANY MONEY COMING IN TILL APRIL. Bet not.
Fuck these people. SAY NO.
September 23rd, 2008 at 5:32 pm
This whole plan stinks worse the older it gets, like a dead fish. It is rapidly becoming clear to me that we are looking at Paulson’s “Save My Friends’ Private Jets Act of 2008.” I would infinitely prefer $700 billion to cover homeowner’s mortgage payments, even though that punishes me for living in a responsible 1300 square foot bungalow. But the Administration’s plan shaft’s taxpayers, mortgage holders–everyone except the bank presidents and fund managers. To hell with that noise.
September 23rd, 2008 at 5:33 pm
I’m afraid that if we arrange the terms so that only the most desperate institutions take part, we’ll end up setting too low a price on the assets we purchase. Then every bank and company that has some of these on their balance sheets will end up in a worse position then they would otherwise. The plan isn’t to buy up all of the bad assets, but to buy enough so that the market has a base price that they can use to value the remaining mortgages and restart the market.
September 23rd, 2008 at 5:34 pm
Matthew Yglesias writes:
Banks that would merely prefer to get bailed out because it would enhance their profits won’t do it if taking the bailout means a big cut in executive pay.
I wonder what the shareholders would think of this.
September 23rd, 2008 at 5:35 pm
Executive pay limits = fig leaves for Pelosi & Reid to hide behind while they sell us out.
What fraction of 1 percent of the $700 billion (or whatever) would this save? There are countless ways the Wall Street thieves can get around this and they know everyone of them.
September 23rd, 2008 at 5:41 pm
If we limited executive pay for bailed out institutions — say by forcing executives to work on government pay scale — then firms’ managers would have a strong incentive to avoid taking taxpayer money unless it was genuinely necessary. Banks that would mere prefer to get bailed out because it would enhance their profits won’t do it if taking the bailout means a big cut in executive pay.
You get the same exact effect from the equity requirement, no? No CEO of a financial institution is going to want his own 3.8 million shares watered down if he can avoid it. I think this is a more powerful incentive than executive pay, because many (likely the vast majority) of highest echelon F.I. executives have salted enough cash away to survive a year or two on starvation wages. But they’ll try to avoid a huge hit to their portfolios with every fiber of their beings. That said, I support executive pay restrictions simply because, if some big F.I. gets a $2 billion infusion of taxpayer money, some of the cash (money being fungible and all) is obviously going to find its way into the payroll account, and the possibilities for (yet more!) piggish corruption are strong.
September 23rd, 2008 at 5:53 pm
“I think that is Matt’s point; his statement refers to a bailout without sufficient strings being attached.”
Sure, but the question is just about what sorts of strings you need. Matt wants a kind of string that I’m not yet seeing the use of. Though I do see the use of all the other strings.
September 23rd, 2008 at 5:57 pm
To roughly summarize, in order to bail out banks that would go under absent a bailout, we need to also provide access to bailout funds to banks that wouldn’t go under without a bailout.
And I’m saying that having the strings attached is making the bailout more palatable when what we want to do is to not eat it in the first. Additionally, we want the other stuff to pass in a functional form, not a broken one.
So we need to fix the core approach and make it work; doing the executive compansation thing (particularly in the broken form I saw) won’t fix the bad approach involved.
In EITHER the Paulson form, or yesterday’s Dodd form, the bailout will not work in the way people understand the intent. (People don’t understand what the bailout is actually trying to do (bank nationalization by another name without harming the the upper-tier personnel of the bank) and that it also won’t work in the current form (not enough money, not the right price, seriously wrong approach, risks the credibility of T-bills).) So glamming it up just makes the wrong thing to do more acceptable. Also, executive compensation only applies to CEOs I think, so there’s another problem. It isn’t just the head guy that screwed up.
What we need is for this bill not to pass.
max
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September 23rd, 2008 at 6:30 pm
I don’t agree with Matt on much but I agree with him on this. We have to force personal responsibility on these bastards. They are grabbing money with two hands living like lords while the rest of us have to look out for ourselves. Hubris.
September 23rd, 2008 at 6:39 pm
I don’t agree with your rationale and here’s why — Management doesn’t HAVE to take the bail-out, and since senior executives have been operating in their own best interests and not the long-term health of their institutions for years, what is going to force them to take the bailout if they don’t think it benefits them personally, and in fact penalizes them? They might just as well continue to gamble their company’s health, keep their multi-million dollar salaries and bonuses as long as they can, and then walk away if their company implodes in six months or a year. I say take over the companies by force, seize management’s shares and options, and then fire the bastards without their golden parachutes.
September 23rd, 2008 at 6:43 pm
I don’t think you get it. The issue isn’t that some banks are bad and need to be bailed out, and other banks are good and don’t need it–the issue is that the ENTIRE FINANCIAL SYSTEM is in danger of seizing up because everybody has tons of mortgage-backed securities, and nobody knows what they’re worth. So, no financial actor has any confidence in any other actor’s capitalization, and so no one will transact with anyone else. The goal of the bailout is to create a market for mortgage-backed securities where none exists today, so that financial institutions will have a sense of what their and their counterparties’ MBS are actually worth, and thereby have confidence in the capitalization of their counterparties.
Sure, as part of this process, some firms will sell MBS to Treasury in exchange for cash, but the Treasury will buy far less MBS than actually exists. If you’re trying to restore confidence in the markets, though, a “good” security–one that’s liquid, has a market value that everyone pretty much agrees on, and has a narrow bid-ask spread–is just as good as cash on a bank’s balance sheet. The bailout is an attempt to jump-start a market in MBS, and make them into “good” securities.
So when Paulson and Bernanke say that there shouldn’t be penalties because they’ll create an incentive not to participate, what they mean is that any disincentives to participate will make it less likely that the bailout will create a big & robust enough market to effectuate that transformation. I think whether or not to take that risk in exchange for equity or other valuable provisions is a tough call. I tend to be on the side of taking some deferred equity along the lines of the Dodd plan, but I can see the argument against. What I really worry about, though, is whether the Treasury’s purchases will establish marks that the private market believes, and jump-start non-government trading in these assets at levels consistent with where the Treasury ends up transacting; if that doesn’t happen, then this bailout was useless (although even in that scenario, the government might still make a profit).
September 23rd, 2008 at 7:05 pm
Let me make this simple for ya: Corporate directors and officers owe their shareholders FIDUCIARY DUTIES. A fiduciary is obliged to place the interests of the shareholder ABOVE their own self-interest. Therefore, any corporate D or O who refused a NECESSARY BAILOUT because it doesn’t include their multi million dollar golden parachutes would be BREACHING their FIDUCIARY DUTY. A breach of fiduciary duty renders the D/O PERSONALLY LIABLE to shareholders for their greed. Moreover, some such breaches are so egregious they are punishable CRIMINALLY as well.
In short, these greedy fucks are BLUFFING. If their companies NEED bailouts and they don’t take them out of self-interest, they are SCREWED. If their companies DONT need a bailout then WHAT THE FUCK ARE WE TALKING ABOUT?
Americans need their infrastructure rebuilt, cities, towns, villages, statewide….they need universal health care; they need their government back WORKING FOR THEM instead of the rich assholes who are too lazy to go out and work for a living instead of stealing everyone blind through their nefarious schemes.
NOT A BRASS FUCKING FARTHING for any of em, I say.
September 23rd, 2008 at 7:17 pm
Of course it feels good to try to stick it to Wall Street by limiting compensation at banks that participate in the bailout, but if you could run an investment bank on a government pay scale, somebody would be doing it. You can get people with limited education to work for 40k as mailmen and you can get principled educated peopled to work for 40k at the Justice Department, but you can’t get educated people to work the hours that working in finance requires to do something that is at best morally neutral for 40k. And in NYC, you probably can’t get people that have experience in their field and are reasonably accomplished to do it for five times that amount.
If you limit compensation at banks to that of a government pay scale, you effectively eliminate their ability to retain and compete for talent. And if a bank is so dramatically limited in its ability to retain the talent it has and to attract new talent, it won’t survive very long, and the government should have saved its bailout money in the first place.
#17 got this exactly right. This isn’t about creating incentives or rewarding good behavior and punishing bad behavior – it’s about saving the financial markets. I can understand the impulse to make the bailout somehow seem more fair – the notion of giving this sum of money to Wall Street is appalling – but some of these measures that are suggested in service of fairness really compromise the purpose of the bailout in the first place. That isn’t to say that the Paulson plan is flawless, or even a good plan and it should be questioned and revised as appropriate, but the primary objective of those revisions should be to make the economics better. The financial world really did almost fall apart last week and it still could happen. Trust me – that wouldn’t be a good thing.
September 23rd, 2008 at 7:36 pm
I don’t think the banks that are begging to be rescued are demonstrating so clearly that their leadership has some sort of special degree of talent.
I think it demonstrates quite the opposite, so far. Maybe I’m wrong, but I think the safe empirical starting point would be to assume that they’re run by venal morons, not the heroes of children’s books on the wonders of capitalism.
September 23rd, 2008 at 9:14 pm
Nice try Matt. But you’re just being whimsical, and piling speculative hypothesis upon speculative hypothesis in your desperate attempt to hang with the angry populist cool kids. What we’re going to get here is not any kind of sensible and economically rational executive compensation policy, but some half-assed, poorly thought out, back of the napkin junk policy, based on some flimsy theory – such as the one you’re reaching for here – a policy which will probably backfire in several unanticipated directions at once, after it delivers its short-term rush of vindictive ecstasy.
I personally support a thoroughgoing US maximum wage law. But I accept that such a law would be a major and radical regulatory innovation, and would require a lot of thought and debate in order to be intelligently designed and implemented. This is not the sort of thing to be cooked up on the fly in a thoughtless way while we are scrambling at the same time to pass some sort of financial bailout in a timely fashion.
This is really no time to ram through some seat-of-the-pants salary cap regulation. Now I can understand that we might have to include something in the plan, because that is what the hysterical, witch-hunting, pitchfork wielding public seems to be demanding as the price for daring to prevent the collapse of US capitalism and saving their fucking jobs. But I wish you wouldn’t indulge this mass stupidity by pulling bullshit rationales out of your ass.
September 23rd, 2008 at 9:46 pm
#19 seems pretty speculative, but I worry #17 may have a point. Getting the incentives all nice so that only the bank who really need to take the bailout kind of assumes that they know what they’re holding, and they’ve been working very hard to suggest that they really don’t. Now of course, they would say that, but I honestly don’t feel remotely qualified to say whether they’re telling the truth, and my guess is that neither do Paulson, Bernanke, or indeed Dodd.
Which is why the deferred equity plan seems like a smartidea – if banks deliberately trying to leave the government holding the bag, then they’re going to get burnt.
September 23rd, 2008 at 9:56 pm
Like many above, this strikes me as a terrible argument. To me the two most important flaws are: (1) you haven’t shown that things like the contingent equity stake couldn’t serve the necessary filtering function; and (2) it seems likely that what a filter based on executive pay limits would actually do is sort companies with strong oversight of management from companies with weak oversight of management, as opposed to companies that need the bailout from companies that don’t.
And frankly, at this point I have heard enough bad arguments for these provisions that I am coming to the conclusion that maybe there aren’t any good ones. The bottomline is that complaining about executive pay may be emotionally satisfying and politically savvy, but as a general matter executive pay is really only a substantive issue for the relevant shareholders, and as such I just don’t see any real justification for including these provisions in a bailout plan.
September 23rd, 2008 at 10:02 pm
If these pricks are really going to be saved from their own excesses, why not try the Swedish solution?
http://www.nytimes.com/2008/09/23/business/worldbusiness/23krona.html
September 23rd, 2008 at 10:42 pm
I don’t think the banks that are begging to be rescued are demonstrating so clearly that their leadership has some sort of special degree of talent.
I think it demonstrates quite the opposite, so far. Maybe I’m wrong, but I think the safe empirical starting point would be to assume that they’re run by venal morons, not the heroes of children’s books on the wonders of capitalism.
Well, alright. So they’re run by morons. That doesn’t really address the question of how you attract non-morons to leadership roles in those companies if wages are capped well below industry standard.
September 23rd, 2008 at 10:57 pm
I should add, though, agree with the rest of the proposals, and in particular the mortgage renegotiation. I’m not sure why there’s so much resistance to it–I would think that increased certainty of cash flow is a good thing here, since fear of mass defaults is kinda what started this whole thing, no?
September 23rd, 2008 at 11:29 pm
Compared with an equity stake, executive compensation is irrelevant. It would make me feel better to stick it to all the people who so greatly deserve it being stuck to, but if the business survives, they’ll figure out ways to get compensated through alternative means, or simply in retrospect (is the compensation limit going to stick to that company and/or individual for ever?). Further, while stock prices will be/have been depleted by the criminal mismanagement, a huge bailout could increase share prices significantly and I don’t expect divestment to be a component of the compensation cap.
While compensation limits will provide some disincentive, granting an equity stake will provide a more serious disincentive (board members are stock holders). It will also provide a mechanism for taxpayers to recoup some of the 700B (hopefully less). It will also provide at least a partial mechanism for accurate pricing. The higher the price of the crap paper, the larger the percentage of the market cap of the company and thus the higher the percent the govt gets in exchange. If they want a lot of cash they give up a lot of their company.
September 23rd, 2008 at 11:58 pm
Perhaps now is a good time to recall that Ronald Reagan helped get himself elected by directly and via his party calling out the horrid injustice of urban welfare queens driving Cadillacs.
For a generation, my fellow Americans moaned about the awful welfare queen.
Did they do so based on some rational calculation of how much welfare queens were decreasing the budget pool?
No — they viewed it as a matter of fundamental justice, however mythological the argument was.
I think that’s the impact of the ‘executive compensation’ debate for firms which otherwise might be going into bankruptcy — the creation of a longstanding political issue with far greater weight than anyone seems to care to admit.
September 24th, 2008 at 1:13 am
“To only bail the very least responsible banks out would create a terrible perverse incentives problem.”
What kind of logic is that? Why restrict it to banks? Why not include any person or entity that lent money recently? MY wants to help irresponsible banks and responsible banks, but for some reason doesn’t want to include, say, small business owners that leant money or uncle Charlie. Why not?
September 24th, 2008 at 2:58 am
There is another compelling reason to limit executive pay. It reduces the moral hazard inevitably caused by bailouts. If the managers do just fine out of the bailout, they will not be more careful in the future.
If they have to suffer the financial cost and oohhh the humiliation of getting only $400,000 for a year, they will be more careful in the future.
We want them to be more careful in the future, so we will gain practical benefits in the future from punitive measures.
September 24th, 2008 at 7:00 am
I concur with your four essentials, Matt.
I’d add a fifth, though: let’s not borrow the $700B. Let’s raise taxes upfront by $700B over the next five years, to make it clear who will pay for it.
In other words, make sure that the rich, rather than Joe and Jane Sixpack, get stuck with the bill.
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