Yesterday's announcement by the Obama administration that they "will order the firms that received the most aid to slash compensation to their highest-paid employees" has drawn much criticism and discussion across the blogosphere, including right here on this blog.
The plan, for the 25 top earners at seven companies that received exceptional help, will on average cut total compensation this year by about 50 percent. The companies are Citigroup, Bank of America, American International Group, General Motors, Chrysler and the financing arms of the two automakers.
I've spent a decent chunk of time today watching CNBC (I love Fall Break) and following the arguments being put forward by the guests on the afternoon shows as well as CNBC's highly opinionated news anchors.
There are two main arguments being leveled at the proposed slashes in executive compensation at these seven TARP-funded firms: 1) The government should not get involved in decisions regarding executive compensation and 2) Capping compensation for these executives will incentivize them to leave these companies and make it easier for competitors to lure these executives away with higher compensation. The combination of those two factors, it is argued, will drastically hurt these troubled companies at a time when they need these executives to steer them back to profitability.
I'm going to spend very little time with the first argument and most of this post on the second. There were many banks/financial companies that took TARP funds last fall, some that needed the funding in order to survive and other that didn't need the funding but were asked/required to take it anyway. Those that took it and didn't need it have, for the most part, already returned the funds. The seven aforementioned companies that took TARP funds were struggling and would have collapsed had the government not invested boat loads of taxpayer money in them. The government is now a major shareholder (for some the largest, for others the sole owner) in these firms and with that investment comes the right to change management and production practices and that includes compensation levels. I see absolutely no valid legal or moral argument against the government intervening to change pay rules or business practices.
Now whether government mandated pay cuts for executives are a good thing for productivity or company performance is a different question altogether. Many claim that if the government slashes salaries (by as much as 90% in the immediate short run and 50% as a whole once deferred stock options are included) for those 25 executives at those seven firms, those executives will simply leave the firm and this flight will damage firm performance at the time that their leadership is needed most.
Most of the articles written and discussed, including the one that Will linked to earlier, have reported that
At Bank of America, for instance, only 14 of the 25 highly paid executives remained by the time Feinberg announced his decision. Under his plan, compensation for the most highly paid employees at the bank would be a maximum of $9.9 million. The bank had sought permission to pay as much as $21 million, according to Treasury Department documents. At American International Group, only 13 people of the top 25 were still on hand for Feinberg's decision.
These articles are presuming that these executives all left to take higher paying jobs at competitors, they left because they believed that the government would impose pay restrictions and that their departure will hurt the firm that they left.
I have a handful of questions because I really don't buy into the logic above. Where in the hell are these executives moving to? What financial companies, in the midst of the worst recession since the BIG ONE, are hiring executives at $30+ million a pop? Every company that I know of has been slashing jobs across the board. Where is this robust market for high ranking executives coming from? These claims are flying around with no hard evidence as to where these executives are going and who is luring them away with these large sums of money.
Also, I'm curious as to how many of these 27 (out of 50) executives from AIG and BoA that left over the past year were in their positions before the financial crisis? Are any of them responsible for some of the bad management and financial decisions that put these two companies in the horrible position that they currently face? If so, I don't see how them leaving would hurt their respective companies anymore than their decisions have already done. How many of these were retirements and how many were fired? You can't just look at 27 out of 50 executives leaving and assume that they all left because they were anticipating future government mandated pay cuts.
Next up is the claim that AIG, BoA and the other five firms aren't going to promote from within because their rising stars will be able to earn more remaining in their positions than being promoted to one of these few positions where pay has been capped. They claim that if they were to promote these people to high ranking positions, other companies will simply offer them more money and hire them away. In my very limited experience with Wall Street banks and other financial firms, I know that everyone at the top of these companies know each other and I'm really surprised that people are taking this claim at face value. These companies know exactly who the big whigs and top performers at each of the other firms are. You don't have to be promoted to CEO of AIG or BoA for people to know that you're big time. I go back to my previous point: where are all these $30+ million jobs? How are they going to hire all of these executives away? Look, these positions are going to be filled and these companies will put (hopefully) highly competent and smart people in charge. There are many qualified people who will agree to a $10 million dollar compensation package and the challenge of turning one of these companies around. There is no shortage of top level talent on Wall Street. Money means a lot to people, but it isn't everything. You don't simply pack up and leave because one company is going to pay you more.
To the last question: Will turnover in upper management positions at these seven firms really damage firm performance moving forward? Doubtful. As we all know, most of the day to day decisions are not made by the CEO, CFO or COO. These executives spend most of their time dealing with members of the board of directors, dealing with public relations and marketing issues, wooing potential investors and signing off on decisions made by their underlings. These executives aren't involved in daily trading decisions or most of what actually matters when earnings season comes around. Sure there will be some adjustment to new management but the claim that the departure of an executive will damage company performance is a bunch of bull.
Maybe the incentives for those traders who aspire to be members of upper management in the future will deter them from putting in all of their effort today because of slashes in compensation for high ranking executives. I don't know how much a cut in pay from $30 million to $10 million will undercut ambition but I'd venture to say that for someone making $100,000 to $1 million as a trader today, the ambition to make $10 million and be named CFO of a major company will still be there. I'm pretty confident in that.
To sum this long post up, I think all of this discussion of pay cuts for executives has been blown out of proportion. I don't think the feds coming in and mandating pay cuts for 25 executives hurts company performance, incentives for mid-level managers/traders or will promote some sort of intra-industry brain-drain.
UPDATE (11:26pm): The
NYTimes has a "Room for Debate" blog where six experts provided commentary on the cuts on executive pay at the TARP firms. The experts are
Tyler Cowen, Yves Smith, Nicole Gelinas, John Coffee, and Lynn Stout. I don't think Cowen actually addresses the issue. He claims that
These earners did not cause the crisis and they are working hard to bring their companies back from the brink. Cutting their pay is the last thing we should be doing because the best of them can simply move elsewhere, thereby undercutting the profitability of the firms we are trying to restore.
The odds of top traders sticking around at A.I.G. for $200,000 a year are small. There is a grain of a good idea in the recent proposal, namely that we should discourage firms from getting into a position where they need a taxpayer-financed bailout. But the new policy goes about this the wrong way.
No one is talking about capping a trader's pay at $200,000. The cap is on the top 25 high ranking executives making millions of dollars (I have no idea why he claims that $200,000 earners will be capped. Top traders make substantially more than that). The earners that the pay cap would affect may very well be those that were responsible for running these companies into the ground. My post above refutes his other points. I don't get to say this very often, but Tyler is wrong.