It seemed oddly out of place
the other day when I read that many investment banking executives
have decided not to take bonuses this year, sending letters to the
board of directors requesting their usual bonuses not be
offered. What seemed so wrong about this story is the notion of
Executives making a request. Over the years, Goldman Sachs
has posted some of the highest profits on Wall Street, and as a
reward their top executives have seen healthy bonuses for leading
this highly profitable company. Last year Lloyd Blankfein, CEO of
Goldman, received a salary and bonus worth
$68.5 million, almost all in bonuses (his salary was
approximately
$600,000). This very lucrative compensation is
supposedly awarded by the board of directors, representing happy
stock holders and showing their power over the company’s
leadership. The fact that the executives requested bonuses be
withheld tells a much different story. An effective board would
insist that the CEO who lost billions of dollars in stock
value and nearly bankrupt the company would not receive a bonus. This
effective board would never honor a request from executives to forego
a bonus because it is not their decision to make. The Goldman executive
request shows the board does not really have the power of
the purse, or any real control -- it is all held with the corporate
executive. This is a problem because the two groups represent
different time horizons. The executive view is short term: how can
they make profits as high as possible year over year to justify a
huge bonus at year end. In contrast, the board is supposed to
represent a longer-term view, ensuring company sustainability so that
the
company they own rises in value indefinitely. When the balance shifts
completely to the executive view, because there is a powerless board,
it results in short-sighted, quick profit decisions. In this case, it
meant diving head first into high-risk sub-prime mortgages to get a
$70 million pay day. The consequences are then left to the long-term
stock holders when the bets go wrong and the company is brought to
its knees.
In yesterday’s Wall Street Journal, buried way back on page C5, was an article by Dan Fitzpatrick telling a story of the compensation received by executives in the wake of the Wachovia collapse. As a refresher, Wachovia was one of the victims of the crisis, nearly collapsing under its exposure to sub-prime debt. It was acquired eventually Wells Fargo (Fargo won a fight for the company with Citi). In its wake was a devastated stock price, moving from about $50/share pre-crisis to today's value of about $5/share, and the prediction that most employees would be laid off as part of the acquisition. Today's WSJ article reports that the top 10 executives that controlled the helm of this company through its demise will be receiving a combined $98.1 million in severance for their fine work. I think a $100 million severance is a bit too high of a reward for destroying a company. Besides the obvious discomfort that comes with the fact that an executive is rewarded for bad work is the reality that this represents a backward incentive structure. In this case the severance is only accessible if the executive is let go. Similar to the Goldman situation they are now empowered to determine their salary. Looking at the fall of his or her stock options at some point, a Wachovia executive would be better off letting the company fail and taking the severance rather than try to keep the company alive.
The stories of both companies point to an absurd incentive structure where executives may not be looking out for the best interest of their companies. By putting compensation decisions in the hands of those receiving compensation, what is best for the company no longer persists; it turns into how someone can squeeze as much value out in a short period of time. In the Goldman case the CEO made very risky short-term decisions to justify the enormous bonus he received, only to see the company approach collapse the next year. Then flexing his power, he deemed it not necessary to receive a bonus for his own abysmal work. In the case of Wachovia, one could assume at some point executives were inclined to cut and run from a failing company, a process that they put into motion. A publicly traded corporate structure means that at the end of the day shareholders have the ownership stake in a company, and therefore should be making the final decisions on the best path of a company. We toss around the phrase "a duty to the shareholder," but in these cases the phrase has little meaning. The above examples show real issues in the modern corporate structure because it does not hold Executives accountable over the long term. These are terrible market forces all working against long term sustainability and growth.
Because I am never one to point out a problem without offering a solution, I will offer a simple and easy fix for this incentive structure: stock options only with a restriction on sale for 15 years.
For Wachovia, a severance should only be offered as a certain
number of stock shares and a restriction of sale for 15 years after
the Executive leaves. This assumes a severance is really necessary
because of some belief that it is needed to attract talent. I really
believe the best structure in this industry is no severance at all.
Any highly paid executive has such a lucrative level of compensation
that a comparable severance creates indifference for good work. (Go
ahead and fire me I literally will make millions.) But if the market
does somehow deem it necessary, I think stock options instead of cash are a much better solution.
For the Goldman issue, the same solution. All executives of any company should only receive stock option bonuses, all with restrictions of sale of at least 15 years. By shifting from cash to stock with a long term outlook it would ensure decisions made in the short term are targeted at long-term growth. If decisions made today go wrong these long-term assets will be valueless.
This shift is not something that should be enforced by government but rather by shareholders through boards of directors. It is in the best interest of the stockholder to design a proper incentive structure; this change will do just that by making the executive reliant once again on the success of the company and the stockholder.