I think a more important factor is the fact that many actors in this mess were able to get a fee for their part in the action, regardless of how sound or toxic the investment was.

posted January 18, 2009

It possibly is more a case of mis-written compensation plans. There was a recent study of 270 public companies that redid there executive compensation plans to better align them with the business viability (after having various kinds of problems with executives attempting to manipulate things to enhance their compensation).

GAO has been doing database of restatements of public company financial reports (in spite of SOX). Basically the executives are fiddling the reports to enhance their compensation. Later the reports may be restated, but the compensation is not forfeited. One example, was in 2004, Freddie was fined $400m for $10b fiddling in their public financial statements and the CEO replace ... but the tens (hundred?) of millions wasn't forfeited.

Part of the issue is that there may be extreme downside to the
business operation ... but it appears that the executives still
believe that they can come out ahead.

The Fed's Too Easy on Wall Street
http://www.businessweek.com/investor/content/mar2008/pi20080318_697440.htm?chan=top+news_top+news+index_businessweek+exclusives

from above:

Here's a staggering figure to contemplate: New York City securities industry firms paid out a total of $137 billion in employee bonuses from 2002 to 2007, according to figures compiled by the New York State Office of the Comptroller. Let's break that down: Wall Street honchos earned a bonus of $9.8 billion in 2002, $15.8 billion in 2003, $18.6 billion in 2004, $25.7 billion in 2005, $33.9 billion in 2006, and $33.2 billion in 2007.

... snip ...

some part of the $700B wallstreet bailout possibly goes to replenish the $137B sucked out of the infrastructure (as reward for their part in creating the current situation).

... recent update

Bailed-Out Banks Dole Out Bonuses; Goldman Sachs, CitiGroup, Others Mum on How They Are Using TARP Cash
http://abcnews.go.com/WN/Business/story?id=6498680&page=1"

from above:

Goldman Sachs, which accepted $10 billion in government money, and lost $2.1 billion last quarter, announced Tuesday that it handed out $10.93 billion in benefits, bonuses, and compensation for the year.

... snip ...


How Wall Street Lied to Its Computers
http://bits.blogs.nytimes.com/2008/09/18/how-wall-streets-quants-lied-to-their-computers/
and
Subprime = Triple-A ratings? or 'How to Lie with Statistics'
http://www.bloggingstocks.com/2007/07/25/subprime-triple-a-ratings-or-how-to-lie-with-statistics/

other recent articles:

Computer Models and the Global Economic Crash
http://news.slashdot.org/article.pl?sid=08/12/16/2048235&tid=98
Axioms, downturns, and a global (computer?) crash
http://arstechnica.com/news.ars/post/20081215-axioms-downturns-and-a-global-computer-crash.html

Some number of the institutions buying triple-A rated toxic CDOs were playing long/short mismatch ... even tho that has been known for centuries to take down institutions. Comment was that Bear-Stearn and Lehman had marginal change surviving (playing long/short mismatch)
http://www.forbes.com/entrepreneursfinance/2007/11/13/citigroup-suntrust-siv-ent-fin-cx_bh_1113hamiltonmatch.html
decade old article from the fed
http://www.frbsf.org/econrsrch/wklyltr/2000/el2000-26.htm

The recent washington post series about CDS ... basically talked about CDS being sold on instruments that were totally unrelated to the original business case risk analysis.

Links:

• http://www.businessweek.com/investor/content/mar2008/pi20080318_697440.htm?...
• http://abcnews.go.com/WN/Business/story?id=6498680&page=1

posted January 18, 2009

Let's start with the term "Executive Compensation". This specifically refers to the people, "executives",, that run the company. These are the people <who should be> making the final decisions that drive a company's success or failure.

Executive Compensation does not refer to all of the other people at the company, some of which may be very highly paid. These other highly paid people are essential to a company's performance but nothing they do can occur without explicit or tacit approval from the executives. It's sort of like a star athlete on a team. The individual can choose to perform ot not, but they cannot directly decide strategy, other players, equipment, rules to the game etc.

So, does excessive executive compensation inspire reckless risks? Probably not to much.

These risks are more an effect of limited oversight, and accountability. They are also a product of the increasing complex financial structures and corporate regulations that define business today. Often the risks were not excessive, it was the foundation and platform to support them that was simply not strong enough. Most failures look avoidable once they have occurred, Fewer are predictable, without massive amounts of information and analysis, before they occur.

I do believe that pay, especially that of executives, should be more closely tied to performance. That will help limit the pay to people who fail slightly along the way while increasing the pay of those who do well along the way. No form of pay will ensure the avoidance of truly risky decisions, outright fraud or incompetence. That is what management, in the form of corporate boards, are supposed to handle.

Where the executive deceive their boards and shareholders fraud is the problem. Where they provided information but it was misunderstood or ignored, the problem is more complex and less on the heads of the executives.

Links:

• http://www.performensation.com

posted January 18, 2009

Subodh,

Interesting question. I think if you spend time with these CE0's you will find a lot, if not most, of them do not have the chip on their shoulder to "justify their compensations".

In business at that level, risk is inherent in everything they do. As with the professional athlete paid millions, they push themselves to the brink of performance because they are high performing and aggressive by nature.

All of them are human, so they all make mistakes and many push the boundaries of what is prudent, but the market corrects that via the personal and professional bankruptcy that befalls them as a result of their actions being under constant scrutiny. This current market downturn has exposed an handful (and that all it is when you consider the number of business in the us with high paid CEOs) that have gotten away with too much. Perhaps in the future a more commission based or highly bonus driven comp would be more appropriate so the cash they are earning works in everyone's favor, not just theirs.

Having said that, we should be careful to hate CEO pay or be bitter about it. If given the opportunity in the land of liberty to make that kind of money, nearly all of us would do it so we could provide for our families and leave a financial legacy to them. So, we should not begrudge people for making money. We should instead criticize their actions, as shareholders in their companies or if it affects us as the general public. Criticizing their pay doesn't ultimately fix anything.

posted January 19, 2009

Probably not.

I do not think executive compensation and the current economic meltdown are all that related. High executive compensation is probably the result of a mix of moral hazzard (executives setting their own compensation is a bad idea) and the added value executives create simply by being the executive of larger companies than in years past.

posted January 19, 2009

The answer is "No".

Thes guys were no different from the rest of the herd, you and me included who were very happy in the good times and didn't ask to many questions. We were all persuded that the experience of previous cycles could be forgotten and that we were on a continual growth path caused by innovation both finanical and otherwise. Those who did warn us like Robert Prechter and Nouriel Rubini was mocked and ridiculed. It has become so accepted that one must be positive - the power of positive thinking etc - that we all became brainwashed. And lets face it, it is safer to be one of the herd, isn't it.

It is not surprising that some of these guys got to believe their own hype - afterall the politicians took the credit for the apparently ever increasing properity claiming it was because of their good stewardshire. A certain Prime Minister still believes he can do a Canute job and turn back the tide of depression - he declared to the Legislature he had saved the world! - OK, slip of the tongue - he meant the world's banks. Let's get real.

So then there is the other current reaction we have collectively developed when ever things go wrong. We insist on finding out who was to blame. Hindsight clearly points us to the seemingly arrogant fatcats who shareholders were only to happy to reward richly for their seemingly good performance.

Scapegoats found - how can we punish them?

What a waste of effort and a misidentification of the true cause. fOf course it makes us feel less responsible if we can park the blame - after all what was our role in it? A significant number of us over borrowed on our properties believing prices would never stop rising, many borrowed heavily on their credit cards so that personal debt as a percent of disposable reached 134% in the US and 164% in the UK. How hollow this makes the UK politicians claim that it is a problem caused by the US.

So lets accept our responsibilities, stop claiming it is someone else's fault and get on with particpating in sorting it out. Yes, part of this must include redressing excesses and identifying those who in fact only performed well because there was such a strong following wind. Let shareholders play a stronger role. Edward de Bono's idea that any one who thinks they merit an increase in their salary should wear a yellow shirt might make it fun too! Not many takers maybe?

posted January 24, 2009