In case you think my headline is too harsh, consider the one at Bloomberg: “Obama to Work on Executive Pay Limits After Industry Complaints.” So in case you were laboring under the delusion that widespread managerial failure among the nations’ top banks, to the point of being dependent on taxpayer provided drip-feeds among the nation’s top banks, would lead most thinking people to show those officers the door. Remember, these companies have been looted, in a process described by George Akerlof and Paul Romer in a 1993 Brookings paper:
Our theoretical analysis shows that an economic underground can come to life if firms have an incentive to go broke for profit at society’s expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.
Bankruptcy for profit occurs most commonly when a government guarantees a firm’s debt obligations. The most obvious such guarantee is deposit insurance, but governments also implicitly or explicitly guarantee the policies of insurance companies, the pension obligations of private firms, virtually all the obligations of large or influential firms. These arrangements can create a web of companies that operate under soft budget constraints. To enforce discipline and to limit opportunism by shareholders, governments make continued access to the guarantees contingent on meeting specific targets for an accounting measure of net worth. However, because net worth is typically a small fraction of total assets for the insured institutions (this, after all, is why they demand and receive the government guarantees), bankruptcy for profit can easily become a more attractive strategy for the owners than maximizing true economic values…
Unfortunately, firms covered by government guarantees are not the only ones that face severely distorted incentives. Looting can spread symbiotically to other markets, bringing to life a whole economic underworld with perverse incentives. The looters in the sector covered by the government guarantees will make trades with unaffiliated firms outside this sector, causing them to produce in a way that helps maximize the looters’ current extractions with no regard for future losses….
So let us start with the obvious:
1. People in these firms (the large banks on life support) were overpaid by a considerable degree in the last few years. The earnings were bogus (they were hugely overlevered relative to the risks they were taking; in addition to holding more equity , they should also have made greater loss provisions). So recent pay is no guide for what their services are worth
2. The companies ought to be in turnaround mode. Normally, the board brings in a new CEO. the CEO sets a new direction and replaces people at the top either lacking in the right skills or unwilling to support the new program.
3. The managers and line staff were hired when these companies were drunk on growth and fat fees. They are by temperament and training the wrong type now. Look how badly the once well-regarded John Thain stumbled at Merrill
I see no particularly reason to be anxious to hang on to these individuals. The threat to quit is empty. Hedge funds and PE firms, favored havens for disgruntled “talent” are shedding staff and in some cases closing their doors.
And even if there are some legitimately valuable individuals, there is no excuse for an organization being held hostage to them. As DeGaulle remarked, “The graveyards are full of indispensable men.”
Now readers may think I am harping on a minor issue; indeed, I’ve labeled the pay issue “symbolic” because they usually involve too few people (recall that Merrill last year has over 700 staff members earning more than $1 million). But it serves to illustrate how the industry has completely bamboozled Team Obama. If you put the same argument made by the bankers, that they might lose their precious talent, in the mouths of auto industry executives, they’d be laughed out of the room. Yet the financial industry meltdown has done vastly more damage to the economy than the decline of the Big Three, which suggests their ability of their managers and staff to operate competently and responsibly is even more in doubt.
But Team Obama seems cowed by Wall Street psychopaths, so aptly described by The Epicurean Dealmaker. And if the Obama crowd lacks the nerve to take on the banks on issues that are largely window-dressing, it’s obvious they won’t even attempt to tangle with them on matters of substance.
From the Epicurean Dealmaker:
I will go further and say that I have yet to encounter a senior executive manager at a large investment bank who does not demonstrate a very substantial number of the commonly accepted markers for psychopathy.
Common characteristics of those with psychopathy are:
Grandiose sense of self-worth
Reckless disregard for the safety of self or others
Impulse control problems
Inability to tolerate boredom
Aggressive or violent tendencies, repeated physical fights or assaults on others
Lack of empathy
Lack of remorse, indifferent to or rationalizes having hurt or mistreated others
A sense of extreme entitlement
Lack of or diminished levels of anxiety/nervousness and other emotions
Promiscuous sexual behavior, sexually deviant lifestyle
Poor judgment, failure to learn from experience
Lack of personal insight
Failure to follow any life plan
Abuse of drugs including alcohol
Inability to distinguish right from wrong
Looking back over my career, I can recall encountering individuals who were clearly destined from a very tender age for greatness in investment banking. With the exception of the tendency toward physical aggression and violence—investment bankers, as a rule, are the wimpiest and most cowardly of creatures, when it comes to nonverbal violence—and sexual promiscuity and deviancy—for which one only has the self-reported “evidence” of these supposedly superhuman young Lotharios—I find it hard not to ascribe some measure of all these characteristics to those individuals I know who have risen to high management responsibility within an investment bank.
And lest any of you try to rationalize the value of these attributes in anything other than a sales context. consider the findings of Jim Collins in his classic Good to Great. Collins was looking to see what lead to sustained outperformance, and was not looking for leadership style; in fact, he resisted when his team insisted there was something different about how these companies were run.
Their CEOs were the opposite of the investment banking “type” depicted above. They were self-effacing, took blame for failure but shared credit for success, but were nevertheless tenacious and driven (but we’ve tended to stereotype that as being the province of chest-beating alpha males, and may be predisposed to ignore it in those whose priority is organization-building, not narrow self interest).
With that preamble, here’s the Bloomberg story:
The Obama administration said it would work with Congress on limiting executive pay at banks that get federal bailout money after critics said tough new restrictions in an economic stimulus plan would prompt talented managers to leave..
“The president shares a deep concern about excessive executive compensation” and “he looks forward to working with Congress to responsibly address this issue,” she [spokeswoman Jen Psaki] said.
Administration officials wanted to keep the executive compensation measures as part of the financial sector rescue package, according to a person familiar with the administration’s views. This person said the executive compensation provision in the stimulus bill was a contentious issue. The administration decided not to fight the provision because of the possibility that it would have to go back to Congress for more bailout funds, the person said….
Yves here. Did you catch that? The Admiinistration would have fought were it not for the need to keep Congress appeased. Back to the article:
Some of Congress’s provisions go beyond the $500,000 cap announced by Obama last month, by restricting bonuses for senior executives and the next 20 highest employees at companies that receive more than $500 million from the Treasury Department’s Troubled Asset Relief Program. It limits bonuses and other incentive pay at companies on a sliding scale according to how much federal aid they receive….
Yves here. Note that the 20 are ranked by pay, not managerially, so this does have more teeth than earlier formulas. Back to the story:
Asked about complaints the provisions would spur some talented managers to leave companies subject to the restrictions, [senator Christopher] Dodd said today in a statement: “Some very high earners will have to adjust compensation expectations and maintain a different sense of proportion than in the past. The current job market should deter employees from leaving, and if they do, there are many qualified replacements.”
Readers may recall I did some quick back-of-the-envelope math on how far pay fell for top producers at big firms in the dot-bomb era. There were not doubt a few here and there who managed to do better, but the number I heard back then for MDs who ran significant (as in formerly big earning) departments and were key rainmakers themselves was $300,000-$400,000. Compound that forward by 3% inflation and you get $500,000. The pay caps suggested, in other words, are in line with past bad market reward levels. Despite the howls, the bankers would not be underpaid by historic standards. And the other dirty secret is that without the TARP money, you’d likely see more firings at the mid and senior levels.