Brad DeLong: Zombie Firms Need Silicon Valley-Style Compensation
I think Brad DeLong has hit upon the right answer of what we need to do about compensation at AIG and firms in need of TARP money:
The engineers of Silicon Valley startups are significantly smarter and work a lot harder than do the traders of Wall Street. Some of the engineers of Silicon Valley make fortunes: they are compensated with relatively low salaries and large restricted equity stakes in the startup businesses they work for, and so if the businesses do well they do very well indeed–in the long run, in the five to ten years it takes to assess whether the business is in fact going to be a viable and profitable going concern. And the engineers of Silicon Valley have every incentive to use all their brains and all their hours to make their firm viable and successful: they get their cash only at the end of the process. They don’t get big retention bonuses if they stick around until the end of a calendar year. They don’t get big payouts if they report huge profits on a mark-to-market basis.
The traders of Wall Street, by contrast, get their money largely up front. If the mark-to-market position is good, they get paid–even though it is almost surely the case that nobody has tried to actually sell the entire position to somebody else. If the strategy produces short-run profits, they get paid–even though not nearly enough time has passed for anybody to be able to assess what the risks involved in the strategy truly are. They get “traders’ options”–we claim that we have made you a lot of money, we claim that the positions and strategies we have left you, the stockholders, with are sound, we claim that we have correctly managed our risks–but we are not interested in putting our own personal money where our mouths are but instead we insist on getting our fortunes up front.
The failure of the major institutions of Wall Street to adopt Silicon Valley compensation schemes in the 1980s and 1990s was always a great worry to regulators and policymakers. The strong view was that the venture capitalists of Silicon Valley knew what they were doing and were acting as prudent and responsible agents of their investors when they insisted on SVCS for their startups. So why didn’t the shareholders of the major banks do the same with their traders, quants, and strategists? The decisive argument in regulatory and policymaker bull sessions about this issue was that this was the shareholders’ business–that if the shareholders of these companies thought that there was good reason to elect board members and CEOs who did not impose SVCSs, the government should be cautious about stepping in. And the argument that “maybe the shareholders know of some good reason not to adopt SVCSs” no longer applies: we are the shareholders, we know of no reason, and we see no reason not to align the interests of our employees at AIG and at TARP-receiving companies with the long-run interests of the U.S. Treasury.
Therefore: punitive taxes on excessive immediate cash payouts paid by TARP and other government financial commitments are, I believe, completely appropriate. But thou shalt not bind the mouths of the kine that tread the corn: traders and financial executives who are willing to work very hard for what are now government-owned enterprises should be offered the carrot of long-term restricted equity stakes: that if they do their jobs well and if the government makes a healthy return because of their skill, forethought, and diligence, they should make healthy returns as well.
Punitive taxes on compensation that takes the form of long-term restricted equity stakes is a dangerous and destructive move. If the compensation bill that emerges from the conference committee does not allow TARP-receiving companies to offer such SVCSs, then Obama should veto it.
And if the traders of Wall Street then quit en masse? If they say that they are going to “Go Galt” if they don’t get their traders’ options to take the money upfront after assuring us shareholders that they have made us a lot of money, that their positions and strategies are sound, and that they have prudently managed the risks? Well, then that tells us something about what they really think the true value of their work product has been.
The Senate can and should step in here and offer a bill of this sort. That would take the worthy impulse behind the House bill and temper it in a more workable, more constructive way.
27 Responses to “Brad DeLong: Zombie Firms Need Silicon Valley-Style Compensation”
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March 20th, 2009 at 3:46 pm
I’m starting to get concerned if it is true that AIGFP really can’t go bankrupt, can’t even lose their employees because we don’t pay them enough.
If the downfall of AIGFP can bring down the world economy, or even our economy, why don’t we protect ourselves. Instead of 400 people who know how to ruin or save the world, why not 1200, three groups spread around so they could not all suffer from going Galt, getting sick, or killed in an accident, or whatever.
These guys should either be highly protected and pampered, or sequestered until we figure out how to duplicate what they do. It is just too important. This is national security.
Or all the arguments are just a big lie.
March 20th, 2009 at 4:09 pm
For an industry that has specialized in creating all sorts of sophosticated financial products, it is strange that Big Finance has relied on such crude compensation schemes.
March 20th, 2009 at 4:11 pm
This is a good idea for many sorts of companies. I think something like this could be reworked even for teacher compensation (okay, very reworked, but still…)
March 20th, 2009 at 4:26 pm
I see no reason to trust Brad’s (nor Matt’s) brain farts when it comes to capitalism.
Neither of them have ever run anything larger than a household even into the ground.
J-F-C Obama has proven himself incapable of administering even the hands off payoff to his bribers. We should trust him or Congress to now handle the nuts and bolts?
Ha ha ha ha!
All of this is just a distraction anyway.
The Obama administration knew of and approved these bonus payments from the beginning. The Obama administration has lied about this consistently.
Just as the Obama has lied about his budget “honesty”.
And to top it off Obama gives us a tax scofflaw for Secretary of the Treasury who has suddenly gotten religion and now wants to preach morality to the rest of us?
Really?
Maybe Obama just needs to get his old buddy Rezco in to handle the payoffs from here on out.
March 20th, 2009 at 4:51 pm
So JT thinks that running a truly large organization into the ground is what earns you trust when it comes to capitalism? I think that’s the point in the midst of his insults, although it’s a little hard to extract from the garbage that surrounds it.
Interesting argument.
March 20th, 2009 at 4:52 pm
Waht exactly the law should be concerning TARP and stuff I’m not sure about, but…
Where did DeLong get the idea that Wall Street trader types who worked at stock issuing companies like Goldman and the like weren’t or aren’t compensated in largely though not exclusively, in stock must be some sort of interesting story, given that high up have been compensated in stock, generally not sellable while still employed, as standard operating procedure for about 10 to 15 years. Wall Street guys lost tons of money when the stocks of their companies tanked, as they should have. He’s getting them mixed up with hedge fund types. His analysis might be worth something if he’d gotten his facts straight.
Per the latest brouhaha with AIG and it’s boss having the temerity to apply the law Congress wrote as it was written, noone is to deal with the govt, not even if they’re being bailed out. I’m not sure if Geithner realizes this, but his TALF plan just died.
March 20th, 2009 at 4:52 pm
I love it. Honestly,that is beautiful. Traders don’t work as hard as silicon engineer. If that isn’t funny enough, can anyone remember the “bubble” that drove market valuations prior to the “real-estate bubble”?
It start with a T as well as within Silicon Valley.
March 20th, 2009 at 4:56 pm
Government is the problem not the solution. A bunch of Washington hacks telling a group of overpaid, failed CEO’s how to change their culture will never work. Now, if we allowed the market to accurately price these firms into chapter 11, we’d get new capital, new management and new ideas about how to compensate their people. If the current crop of traders can’t function in the new environment, I am certain there are many, many others willing to take their place. Change in the industry is long overdue but you will never get it with the top management still in place.
March 20th, 2009 at 4:57 pm
Brad and Matt here don’t feel right to me. It’s at once way too kind and not kind enough to business. And even more, it has a short memory. I’m not sure this was thought through.
On the way too kind side, it was a fad only a short time ago, and a widely villified one, to reward executives with stock options and, yes, even bonuses. The idea was to align their interest with the shareholders more than straight salaries. And sure enough, it just became a tool for manipulation, self-enrichment, and worst of all taking the kind of gambles that pay off in the short term. Post 1 is way too kind in identifying it with the Silicon Alley people who knew when to sell out. At least those people had to create something first.
On the other hand, it worked because it offered the potential for real money and because there was sometimes no other money to be had. We’re talking about startup businesses with little income and huge potential. Banks have recently been businesses with money poring out of their ears and no obvious way to grow short of speculation and mergers, both of which we would best now regulate and discourage.
March 20th, 2009 at 5:07 pm
I stopped reading at this:
“The engineers of Silicon Valley startups are significantly smarter and work a lot harder than do the traders of Wall Street.”
Clearly Mr. DeLong is too much of a dumbshit to have experience with either. Go screw yourself, Brad. What an idiotic thing to say, much less start your article with.
March 20th, 2009 at 5:11 pm
TomJ,
the AIGFP guys can’t be replaced because they say so. Nevermind there are hundreds of financial engineering specialists throughout Wall Street who do the same exact thing at competing firms. The best part of this entire argument is AIG’s defense. They say the people responsible for creating this problem are long gone. The people who are left to unwind their position have to be relatively new hires then. How can people who just joined the firm know so much about their positions that they’re now indespensible? It doesn’t make any sense at all.
March 20th, 2009 at 5:23 pm
TH,
There are smart people in both Silicon Valley and on Wall Street. That said, Silicon Valley is a meritocracy whereas Wall Street is not. I know some of you guys think it is but you’re wrong. Look around any trading desk and you will find a mix of talent. Some of them are there on the merits but some are there because their daddy runs another part of the bank or their uncle owns a hedge fund. Put it this way, there are hundreds of Ivy League MBA’s on Wall Street but what does that really say about one’s intelligence? GWB has an MBA from Harvard. Do you think if his name was George W Jones and his dad drove a delivery truck he would have ever got in to Harvard? No. Silicon Valley recruits from the top engineering schools. MIT and Carnegie Mellon are less driven by legacies. Most dumb kids from rich families don’t apply. They know they’ll never cut it and besides, they can easily get a degree from Yale or Harvard. Wall Street arrogance may not disappear overnight but the sooner the dumb and arrogance vacate the business, the sooner we’ll have a recovery.
March 20th, 2009 at 5:29 pm
AdmChestermiynutz says
I love it. Honestly,that is beautiful. Traders don’t work as hard as silicon engineer. If that isn’t funny enough, can anyone remember the “bubble” that drove market valuations prior to the “real-estate bubble”?
It start with a T as well as within Silicon Valley.”
Are seriously suggesting Wall Street played no part in the creation of that bubble?
March 20th, 2009 at 5:32 pm
The traders are only irreplaceable cause the institution in which they trade is fucked. The whole of the OTC system needs to be razed. In a real market, with real products that accrue value because, you know, they are actually publicly traded, there aren’t any indispensible people who know what, exactly, it is that is being traded. Nobody says, wow, that equities trader knows what is inside the Sears Robuck stock.
The same should be the case with derivatives. You can’t build a financial system on mysteries and enigmas. Nor substitute price information gained through trading with assessments by rating agencies. We can all see, that is stupid. It certainly isn’t capitalism of any description.
March 20th, 2009 at 6:06 pm
brilliant.
March 20th, 2009 at 6:20 pm
As someone recently laid off from a SiVl startup, I have mixed feelings about this compensation scheme. It hasn’t worked for me, and employers can still hire and fire at will. For all of my hard work, I was rewarded with pink slips. It was for these reasons that I originally negotiated for more salary and less equity at my latest co. I’m glad I was forward-thinking at least once in my life.
This scheme will certainly reward the remaining equity stake holders, like the executive staff, but many of the engineers who put time over money into the co hoping for a reward won’t be getting any. If the co is successful, we won’t be reaping any of the benefit from it.
March 20th, 2009 at 8:54 pm
The financial industry obviously needs increased government oversight. Of course, executive pay may or may not be an important part of all that. But even though the present state of the economy is scary, I hope the government is able to also focus on some kind of “framework for future oversight” so that this financial mess won’t happen again, a few decades from now.
March 20th, 2009 at 11:07 pm
I’m going to chime in with those who think DeLong’s take on the Valley (at least with regard to the boom days) is rose-tinted. Your great company is bought in dry times? You’ll get a fraction of what a mediocre company gets in high times, work out your time before vesting, and walk away.
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