The underlying causes of this last 2008 massive global recession was and remains a lack of effective regulation and oversight by the government and its agencies. During the Great Depression many of the very same problems were identified and addressed. But slowly, during the ascendency of monetary and social philosophies which aggrandized greed, and political parties which “poo-pooed” government regulation as too repressive, and corporations which insisted that they “regulate themselves” based on ineluctible “truths" and "market forces”, these sensible and needed government safety-nets were slowly closeted, closed down, or weakened. The results were economic chaos, bank failures, financial hardship, massive monetary loss and bankruptcy.
Besides lack of governemnt regulation from outside the corporation offices, lax regualations within the boardrooms also had their effects, resulting in excessive chief-executive-officer (CEO) compensation, which encouraged unwise corporate risk-taking leading to bank and corporate failures which ultimately became a major factor in the 2008 global economic collapse. Acccording to Seekingalpha.com, "Many bank executives received large salaries and large bonuses for the growth and illusory short-term profits associated with mortgage lending and mortgage securitization that landed us in the current mess." See: http://seekingalpha.com/article/85806-bank-executive-compensation-and-the-bailout
Why couldn’t we have well-learned our history and economic lessons and kept in place those post-Great Depression government regulations? Our behavior would have been termed by the ancient Greeks as prideful or hubristic and they would have predicted that such actions must call down on us our nemesis--economic chaos. And it did! Concerning hubris, Herodotus states (in part): “Seest thou how God with his lightning smites down” (the tallest animals first, and )….”his bolts fall ever on the highest houses and the tallest trees? So plainly does He love to bring down everything that exalts itself….” And how the Wall Street moguls did exalt themselves…with great big stock options, cash, perks, and massive bonuses.
If excessive CEO compensation was a factor in this recent economic crisis, what are we talking about? What is excessive ?
Recently Goldman-Sachs’ CEO, Mr Lloyd Blankfein joined the chorus of people lashing out at excessive executive bonuses..asserting that “compensation continues to generate controversy and anger. There is little justification for the payment of outsized discretionary compensation when a financial institution lost money for the year,” stated Blankfein, (reported by Bloomberg and at bloggingstocks: http://www.bloggingstocks.com/2009/09/09/goldman-sachs-ceo-blasts-excessive-compensation) who is the same person who, in 2007, awarded himself $68.5 million in annual compensation as valid compensation for his company’s participation in what would later turn out to be a giant bubble economy, and who (yes the same Lloyd Blankfein) recently directed Goldman-Sachs to set aside a record $1.4 billion (yes with a “b”) for executive compensation in 2009—yes this did occur during a global recession.
Is this the classic case of a Greek hubris, or simple conservative hypocrisy of the “Kάνω όπως εγώ λέω, όχι όπως εγώ κάνω” or “Do what I say, but don’t do what I do” sort?. Or perhaps it is simply greed. The "take it if you can and damn the hindmost" concept.
In 2007, the latest year that figures are available, the largest corporate participants in the Obama Administration’s bailout program paid their chief executives an average annual compensation of $11 million dollars (each), including salary, bonus and benefits. Of that amount, according to a review by Equilar, an executive compensation firm, only about $844,000 was cash salary. While about $2.5 million was in a cash bonus, with the bulk — $7.4 million — in stock awards, and the remainder in benefits and perks. See http://www.nytimes.com/2009/02/05/us/politics/05pay.html. But see below how stock awards can be manipulated by “back dating” so that the actual amount of compensation is difficult to ascertain.
These figures may be put into perspective by examining executive compensation as compared to salaried workers in the same companies. While in Japan--not a country where executive talent is so common (and cheap) that you can find a talented executive in every Tokyo sushi joint—executives are paid an average of three (3X) times greater than non-management employees. Their companies and executives seem to do quite well…in view of their large share of our domestic auto-market. The Nipponese compensation package does not come close to the excesses found in the US workplace. For example, in the US even as far back as the 1980s, the ratio of total executive compensation (including bonuses and deferred compensation, pensions and perks) to the comparable figure earned by non-management employees was 50 (i.e. executive compensation was 50 times greater than non-management employees). About two decades later, by around 2003, this ratio had blossomed by a factor of six to over 300 times greater than non-management salaries for the approximately 400 largest corporations in the US. While in the fewer very large corporations, it rose to as much as 500 times greater! Thus, in a large corporation in which the average non-management employee made $65,000 dollars per year…the executive class were earning $2.6 million dollars, and in the very large entities, an executive might be taking home more than $3.2 million dollars annually. http://economix.blogs.nytimes.com/2009/02/06/supply-demand-and-executive-pay/
Recall that the most powerful head of state, the premiere executive, and perhaps the one with the most demanding job in the world, is the President of the US--who earns only $400,000 in cash and no stock options. He does get good health care, a plane and a nice house to live in and some other perks that go along with that. But the whole package could not reach the annual level described for Mr Blankfein a Goldman-Sachs’ executive…of a corporation which had to be bailed out and lost money for its investors.
Even corporate board members themselves, view executive compensation as too “rich”. In an inquiry into excessive CEO compensation by the Center for Effective Organizations at the University of Southern California board members of the corporations studied acknowledge that CEO compensation is “frequently too high” . The authors conclude that 75% of board members questioned, agree that compensation (other than their own corporations) is too “rich”, and of that group, some 25% consider compensation to be “generally too high” in some high-profile cases. But in regard to their own corporation, their opinions are more sanguine regarding the level of compensation. http://www.businessweek.com/managing/content/feb2009/ca2009025_072667.htm?chan=careers_managing+index+page_top+stories.
In an precient article entitled: “The solution to the bonus culture”, Davendra Kodwani (http://www.guardian.co.uk, March 26, 2009) states: that “the corporate entity with limited liability, where the owners delegate the responsibility of managing a business to professionals, may have been the most powerful of social innovations of the last four centuries”…but, as a result of the “innate conflict of interest between the managers and shareholders –the conflict is also at the heart of the current banking failures and the chaos in the world economy. ” (http://www.guardian.co.uk/commentisfree/2009/mar/25/corporate-governance-bonus-incentives)
What went wrong? Kodwani explains that in the 1970s companies tried to align these opposing interests by designing “compensation deals” that would link manager’s and shareholder’s interests. But how did the deal backfire? Kodwani asks, why didn’t the link prevent managers from assuming astronomical risks? First, most academic research indicates that there is really little support for a link between a firm’s performance and the level of executive incentives. Second: when a firm’s executive incentives are based on “CEO compensation in stock options , it increases the chances of questionable (perhaps a better word is fraudulent?-- Remember Enron) financial reporting in following years.” Kodwani reminds us that “reward and risk should go hand in hand…particularly in the age-old business of lending and borrowing”.
But what about using stock options as a way to “link” shareholders and managers interests? In regard to the potential for fraud in using stock options: (See 9-12-2006 OMB Watch Senate Finance Committee Looks at Executive Compensation Excesses“ Stock options are automatically considered "performance-based" and have become a popular way of providing deductible executive compensation. Companies can "backdate," or choose the date from which the options would be issued, to change the value of the stock option. Stock “backdating” is not necessarily illegal, but it can make it easier for companies to hide the true extent of an executive's pay. “ (See: http://www.ombwatch.org/node/3051)
David Reilly, in “Bankers craving bonuses, fudge loan-loss reality” evaluates another problem with the "bonus culture". Reilly states that “Back in the early 1990s, postmortems of the savings and loan crisis found banks had too much leeway in determining potential losses. As a result of their fradulent or misleading book keeping, "this ended up leading to bigger losses and making it tougher for regulators to deal with weakened institutions. Fast forward to today’s crisis and investors and regulators are seeing this same problem. Bankers apply a "light touch" (rjk's quotes) to loan-loss reserves, allowing them to reap profits -- and bonuses --even though a day of reckoning may result. The failure last week of Colonial BancGroup Inc., the largest U.S. bank to collapse since Washington Mutual Inc. did last fall, is the most recent example. In acquiring most of Colonial’s assets and liabilities, BB&T Corp. marked down the value of Colonial’s loans by an average of 37 percent.
That exceeds the average markdown of 18 percent at recently failed banks, according to research from Goldman Sachs Group Inc. When it took over Washington Mutual, JPMorgan Chase & Co. wrote down that institution’s residential mortgages by about 16 percent and home-equity loans by about 20 percent.
This means that the collapsed banks hadn’t created adequate reserves for possible losses, leading their loans to be wildly overvalued. The Federal Deposit Insurance Corp. is left to clean up the mess. See( http://www.bloomberg.com/apps/news?pid=20601039&sid=a4LNv_COFnzY)
Why is executive compensation so often excessive? And why are companies unable to control the excesses? Most non-management employees agree to a level of compensation when they are hired and then live with it. But in the executive corporate world, it is the CEOs who head the board of directors and it is that body (the board) which sets their compensation package. Oh! how I would have liked that situation when I was an employee!
“ In the US, the CEO is usually the chair of an organization’s board but that person also selects the board members. In addition, continued tenure on the board is often dependent upon the willingness of the CEO to support reappointment of board members. As a result, the boardroom is the one place where pay is determined by the very people who are subservient to the person whose pay is being set.” I envison this as something like, permitting kindergartners to set their teacher’s salary, of course with her able assistance. In a board meeting managers can obviously set the agenda, control the figures presented to the board, and since they provide all the supporting information the board receives--they can manipulate that data to fit their own purposes. Anyone who has ever sat on a board knows how essentially powerless individual board members are relative to the manager. http://www.businessweek.com/managing/content/feb2009/ca2009025_072667.htm?chan=careers_managing+index+page_top+stories.
Understandably, companies are very reluctant to hand over to the “government” or some outside agency the power to control their executive compensation, but since it is now fully apparent that they cannot do it themselves, and recent history has indicated how dangerous to the economy at large the “bonus culture” of large corporations remains. Thus, if corporations are unable or unwilling to monitor and control themselves—and their actions are a threat to our economy, we must act to protect us from executive excess (greed) and the government must step in to act.
Thus, government must step in and help control the “bonus culture” in American board rooms, a culture which leads to inefficiency, fraudulent practices and ultimately to economic chaos.
To underscore the seriousness of the situation, I submit here an article posted by Stephen Castle (September 17, 2009) in the NY Times: entitled: “Banker Pay to Face Global Limits at G20 Session” (downloaded 9-18-09). In it, Castle states that “The Euopean Union leaders…on Thursday agreed to use the Group of 20 meeting next week in Pittsburg to press for binding global rules on banker’s pay and new controls on bonuses, but avoided any explicit call for a ceiling on remuneration.” It is an unprecedented action to take –where by an international body such as the G20—would be setting rules for corporations within a sovereign state. But a good solution—if they can arrive at some reasonable mechanism and put teeth into rules for non-compliance.
The Europeans who suffered dearly from a recession that originated right here in NY City and are now united behind a call for new global rules..”backed up by the threat of sanctions at a national level”. Castle claims that the leaders of both Germany and France were determined to take a strong message to the G20 meeting and "put pressure on President Obama" (who has been wavering on this issue). “The leaders of both countries blame excessive risk-taking by bankers, motivated by the prospect of” (massive and excessive) “bonuses, for part of the economic crisis.” Unfortunately, “a ceiling on bonuses was opposed by Washington and London, where it was seen as unworkable”. Probably because, as noted above, there are many ways that a devious and determined CEO could arrange for a variety of compensation arrangements through stocks, stock options, back dating, etc. that would be difficult to police.
One option endorsed by Gordon Brown of the UK was the principle of “extending payments over several years and clawing back” portions of the pay-out if the company does not prove to be making a profit." This proposal seems more complex and even more easily circumvented than a simple bonus and salary ceiling. Howver even Brown was determined and stated firmly, that “there was no going back to the bonus structure of the past.” http://www.nytimes.com/2009/09/18/business/global/18trade.html?_r=1&ref=global-home
Get the picture?
rjk
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