Executive Compromise: The Contrarian View

There has been much populist celebration over President Obama’s recent freezing of bank executives’ salaries who receive federal money, and before that the freezing of his senior staff’s salaries. I’m not adamantly against this, but I don’t see how it accomplishes much of anything. So I’ll take the contrarian view – the usually more fun view. Firms already have every reason to avoid taking government money - because they’re not getting “bailed out” at all. They’re giving up huge stakes in their companies and the future profits that go with it, and assuming new debt to pay the government back. AIG gave up nearly 80% of its assets in the form of preferred stock and warrants. This means everyone who has parked money with them is now in the back of the line behind the federal government for dividends or shareholder privileges, experienced huge price dilution, and will likely see the government slowly and painfully liquidate their holdings. The shareholders don’t want that, the executives don’t want that, employees don’t want that, no one wants that – it’s a last resort. So the notion that they’re willing to basically give up the entire company so they can get their hands on public money just so they can get their holiday bonuses seems implausible. Also, Wall Street bonuses typically make up about a third of the NYC tax base in a given year. Without these bonuses, the city faces an even bigger budget gap, has to cut more services in a time where government purchases are needed to create demand, and ironically some of the very funds being loaned to banks in the first place.

And then there’s the whole issue of incentives. There are very few people who have the experience or capacity to run large financial institutions, let alone fix them when they are awash in problems, and it’s not like they have nothing better to do. The Jamie Dimons or Lloyd Blankfeins are not short on job opportunities. Cutting compensation 95%+ isn’t exactly the recipe for recruiting the best managers and thinkers in a time when they are most needed to sort through a menagerie of problems. The financial downturn was precipitated by a phenomenal disregard for basic due diligence. Most people put more effort into buying a used car than Citi did buying $100 billion of bonds, as Robert Rubin put it – “it was an afterthought.” Jamie Dimon largely protected JP Morgan in the summer of ’07 just by realizing he couldn’t really explain the slight uptick in defaults, and once they realized that they also realized they had no idea why the bonds were rated so high, so they divested. And diligence, as the word suggests, is not easy or particularly enjoyable. These firms will avoid further trouble only when they have executive committees that take their time and scrutinize their every step. If they’re not rewarded, if incentives are muted, it becomes less clear that they have a motivation to perform this diligence. Misaligned incentives (like in securities bundling or rumor-fueled short selling) got us into this situation; a system capable of preventing it will not emerge until these basic incentives are realigned. And last, the success or failure of these firms does not hinge on the value of their relatively meager salaries. President Obama has about 300 senior staff that earn about $180,000 a year and usually get a 5% annual pay increase. Assuming Obama keeps this freeze in place for 8 years this amounts to $24m in savings. The economic system is facing challenges on the order of millions of jobs and trillions of dollars. And during this time, good policy, and the hard-working men and women behind developing it, are more important than ever. Saving a few million bucks and cutting pay to the people you most rely on doesn’t seem to accomplish much.

What people really care about is “are they doing a good job”. People care about good decisions, good investments and good profits. If the firms were above water today, no one would raise a peep about their compensation. Targeting annual bonuses confuses the issue, which is ultimately one of bottom line performance, something that usually requires more compensation, not less.