Saturday, September 20, 2008

Golden Parachutes

Last week in the financial sector was crazy. Stocks, of which I own several just for fun, were nuts.

Huge companies have failed, and the major investment banks have quickly shrunk in number. I have been struck, though, by the fact that CEOs of these failed companies are still walking away with wealth. Even if stockholders and the average employee are not, the leaders seem to be doing alright.

In an article called How the Masters of the Universe ran amok and cost us the earth, explaining the Lehman Brothers failure, The Scotsman details the walkaway pay many of these CEOs garnered:

Fuld [Lehman's CEO] joined the bulge bracket. He was paid $34.5 million in 2005, comprising a base salary of $750,000, a $13.8 million cash bonus, and stock and options worth $19.94 million.

So how does his demise compare with the other fallen idols who have now fled the crashing debris in Wall Street? They may have driven their banks – and their shareholders – into enormous losses. But the former Masters of the Universe will never know what it's like to live in a subprime home.

By the end, 62-year-old Fuld was Lehman's biggest individual stockholder. Despite the crash, he stands to leave with about $65 million, based on Lehman's Friday morning stock price of $3.73. This tally includes 8.6 million unrestricted shares worth some $32.1 million as of Friday morning – though they had been worth $582 million last November before the credit crunch hurricane struck.

Chuck ("I'm still dancing") Prince left Citigroup with a package said to be worth $40 million. He also received a pension of $1.74 million and another one million stock options – worthless at the time of his departure. Merrill Lynch's Stan O'Neal spent much of last summer perfecting his golf swing, confident that his trusty lieutenants at Merrill could avoid those subprime bunkers. It turned out to be a bad call.

HE WAS ousted last October as the first waves of the credit crunch struck, with a retirement package reckoned at more than $160 million.

Jimmy Cayne, 15 years at the top of Bear Stearns, was said to be on the golf course in June 2006 just as the bank dropped the first of many clangers, with a 10 per cent dive in profits. Worse followed, with the bank having to put up $3.2 billion to try to rescue its imploding hedge fund.

By mid-March last year, when the bank collapsed, Cayne, who would rush from Wall Street by chopper to the private Hollywood Golf Club in New Jersey to play 18 holes before dark, had already relinquished the reins, handing over the chief executive's role to Alan Schwartz.

When Schwartz went cap in hand to the New York Fed for a $30 billion bail-out, Cayne was said to be competing in the North American Bridge Championship in Detroit.

Cayne and his wife, Patricia, sold all their 5.6 million shares in Bear Stearns – worth as much as $1.2 billion in January 2007 – for $61.3 million at the end of March this year. The couple recently bought two adjacent apartments in New York's plush Plaza building for $28.2 million.

He left with a $30 million "golden goodbye" – enough to do up his Park Avenue property and a mock Tudor mansion in Greenwich, Connecticut. But it emerged that the mansion, set in 2.3 acres of land, was surplus to requirements. "It no longer meets his needs,'' said the local estate agent, trying to sell it for $6.15 million. He was forced to cut the asking price.

That's how tough it gets at the top in Wall Street.

Hmm, something about this doesn't seem right. So here we have a bunch of companies failing miserably. The person who was paid to make sure exactly that was not the case is still being rewarded handsomely. Sure, they've lost money, but they've still gained much. I think Mark Cuban nailed it when he said,

There is one major problem on Wall Street, that until solved, will result in meltown after meltdown in future years. I can’t say if the meltdown monkey will hit every 2,3, 5 or 10 years. But I can say with certainty that it will happen again. Why ?

Because Risk and Reward have been decoupled for CEOs on Wall Street.

If you are the CEO of a major public company, once you qualify for your golden parachute there is absolutely no reason not to throw the Hail Mary pass, and do high risk deals every chance you get.

The excuse for such high levels of pay is that these are jobs high in risk, and so there needs to be a high reward so people can accept the risk. But if the risk is still worth millions of dollars, I think it's fair to say that the risk is gone. And thus, the incentive not to fail is greatly removed.

I was glad to see Newseek this week analyze the levels of pay of more of these CEOs and give a fantastic rundown. They asked what the CEOs heavily involved in the events of the past week went away with financially.

So what can we do? Is this a problem? I personally would not be opposed to legislation requiring publicly traded companies to cap CEO pay at something like 100 times the average worker at their company's salary. Thoughts?


Greg said...

So what can we do? Is this a problem? I personally would not be opposed to legislation requiring publicly traded companies to cap CEO pay at something like 100 times the average worker at their company's salary. Thoughts?

For starters, this question is above my pay grade. But I'll give it a shot anyway.

Yes, I agree with your assessment of Cuban's statement. He makes a great point.

My personal thought is that transparency is the key. If we can figure out a way to minimize the chance of a company "cooking the books," then we can maximize the chance of investors making sound decisions based on the information they have.

Robby said...

I think a cap on what a CEO makes would be horrible for the economy. You're also ignoring the huge list of CEOs who have lost most of their net worth as a result of bad decisions. Also one of the reasons Mark Cuban has a point in that going for the Hail Mary is rewarded is that the government appears ready to bail out companies with problems.

I think the main issue which caused all of these problems is that the Fed made money available at unsustainably cheap prices for too long and we are now paying for it. We will continue to pay for it through inflation as a result of all these bailouts.

Robby said...

Another very important contributing factor to the financial crisis is our insane tax code. Taking on massive amounts of debt is rewarded all over the place from mortgage interest deduction to write-offs for losses and being able to write off all rental income, etc...

Greg said...

You know, we might think CEOs get off a little easy in our country, but gosh, it seems like the punishment is a bit harsh in India...

Chairman said...

2 things. First, to Robby's point, CEO salary isn't the cause of this, but it's sort of a little blip that's annoying to folks. With market caps in the billions, $50 million here or there really isn't an overwhelming number. That said, it's newsworthy and concerning to regular folks. Is it worth examining? Perhaps.

I'm not sure that regulation of salaries is the way to go, and certainly not at 100x the average worker's salary.

The factor that is closest to CEO pay is the makeup of corporate boards. When you have CEO's of other companies setting the pay of a CEO, then there's an inherent conflict of interest. The normal check and balance of having shareholders elect the board is more or less a sham, given the blocks of stock held by investment firms, who want information and business networks with these firms. The incentives are lined up for corruption, or at least a lack of oversight.

The underlying question from our prior discussion is still there - does a truly free market lend itself to a clean or a corrupt system?

Robby said...

My opinion is more that a truly free market is the only system that is in itself clean. All other systems are inherently corrupt as they immediately violate the idea that all interactions should be voluntary.

Chairman said...

Why should all interactions be voluntary?

Social systems require obligations, don't they?

jp said...

Some good suggestions and thoughts here.I echo Greg's on transparency, BUT there has to be the will to investigate and indict. Without that, all of the transparency in the world's for naught.

Robby talks of the Fed making cheap money available is indeed a cause, but the truth is there were MANY other factors, equally or in some cases more on point for causing EM08, the econ meltdown of '08. Phil Gramm and Bill Clinton were major players in setting the EM08 table with two pivotal laws; the Gramm-Leach-Bliley Act (decimates Glass Steagall) and the Commodities Futures Modernization Act which kept derivatives dark. In each, Gramm was the architect and Clinton signed them. Note, a Republican and a Democrat working as one.

Chairman makes one of the more salient points about boards. I fully concur, and refer you to Bill Gillespie's and David Zweig's excellent "Money for Nothing" - also, the conflict of interest in a corporate board is even closer than having cronies on them. For example, Jamie Dimon is the Chair AND CEO of JPMC - that in itself is a conflict of interest, since a board is there to check the CEO. Also, chairs will often appoint the head of the compensation committee. This explains why someone like Rick Wagoner, ex GM chair/ceo, could reap huge pay raises even when GM was melting down and needed welfare to survive.

Btw, GM lost more than $82 BILLION and 90% of its cap under Wagoner. The irony, of which there is a surfeit when it comes to EM08, is that Wagoner got his BA in econ from Duke, hardly chump change there, and an MBA from Harvard, even less chumpier.

These kinds of pedigreed white collars are "The best and the brightest" according to the likes of Al "Chainsaw" Dunlap. Good god, I'd hate to see the worst... Guess the study and "science" of econ has a way to go, eh?