Bank Executive Compensation and the Bailout

Executive compensation is a difficult issue.  Although we grant that the challenge in designing a reasonable system that works in all seasons is daunting, in the net we come down on the side that the compensation is too often too great.

We believe that the incentives are not adequately designed by objective third-parties  — highly compensated directors who like their pay and serve at the pleasure of the CEO are not objective third parties.

Now with the moral hazard element associated with government rescue of financial institutions, the possibility of truly unjust enrichment of banking executives looms large.

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.

Some lost their jobs as a result of massive losses of shareholder equity, while being shoved out the door with huge sums of severance pay.

Now we face the issue of executive stock options issued recently during this period of deeply depressed bank stock prices.  Will they balloon into great riches for executives who happen to be at the helm when the Fed, the Treasury, the Congress and ultimately the tax payers bail-out the banking system?

To look at the situation more closely, we used The Corporate Library database, which tracks corporate actions, including executive compensation, and ranks public companies on several dimensions of corporate governance.

We found The Corporate Library database to be an excellent resource on all manner of questions about corporate actions, ranging from proxy issues, to board composition and cross linkages, to executive compensation and other matters.  They roll it all up into a net corporate governance rating.

While this article is in an activist mode, the database seems to be well balanced — as Jack Web used to say on the old “Dragnet” TV detective show when interviewing witnesses to a crime; “Just the facts ma’am.”

In fact, the database would probably be useful for those who want to increase executive compensation at a company by studying the compensation of competitors.

However, if you do have an agenda, as we do in this article, the database makes corporate governance more transparent than might otherwise be the case.

We think if there was more transparency and communication of the facts on a regular basis, shareholders would do more to moderate the egregious executive compensation situations that pop up in the news when it is entirely too late to do anything about it. We just stare at the news like deer caught in headlights, or we get angry and talk tough, then go back to our routines until the next mind boggling compensation revelation.

We think there is a situation potentially brewing (unintended and unforeseen by the directors who approved the current compensation plans), but we think directors should do something now to prevent free money being handed out to executives as a result of a taxpayer bailout of the financial industry.

The table below contains data on CEO compensation for the 24 banks that are constituents of the Keefe Bruyette & Woods large bank index (KBE).

You can see from the data that CEOs of large banks make substantial incomes, and that a large portion of the total compensation comes in the form of incentive compensation.

Whether that incentive income comes from operational performance or stock performance, that performance will be boosted dramatically by current government action.  Government action is a euphemism for you and me paying for the solution out of our tax pockets.

That government action will have more to do with the performance in the incentive compensation formulas than the skill, judgment and execution of the CEOs who will reap many millions in rewards for being at the helm when the corporate welfare was distributed from the Fed and Treasury.

We need a better system of executive compensation that is less self-serving, and directors who are less in-bred and more focused on their theoretical jobs of representing shareholders than on perpetuating their appointments by enriching the CEOs.

Call this a pre-emptive “I told you so” about the wealth that will be generated for the few by the many via the current financial sector bail-out.

Comments

[john s. gordon:]

thought provoking article, thank you. COF certanly stands out (i do not hold COF).
> jack

2008 Jul 20 08:15 AM

[YMCA:]

Since the huge bonus paid in the past years were paid on wrong profits or wrong stock performances, now that the real profits and stock performances are known, these executives should be asked to return the extra bonuses received in excess of the real figures.

Regulatory authorities should not hesitate to ask for reimbursements, mainly in the financial sector. After all the wrong figures were obtained after they forgot the basics of credit or lending. Any new college or university graduate in business administration would have done a better job than those "GENIOUS". Anyone with a reasonable banking experience would have predicted the financial disaster that we got and that is not over yet.

All those in executive positions closed their eyes on what was happening because of the nice bonus attached to a higher level of activity or profits. What is the difference between what happened in the financial sector and the Enron, Nortel, etc..who saw some of their executives ending in prison and having assets seized.

2008 Jul 20 08:58 AM

[tipalia:]

well YMCA to answer to your question, there is no difference except that in the financial sector they have the blessing of the government the biggest legalise mafia of this planet.By the way who votes for our supposedly representatives (the biggest farce of the human kind) ?
Not me! but all the upset readers, or most of them, will vote again at the next election.What does it take for those people to understand ? that they come to your houses and evict you in order to save our financial institutions and by the same time to enrich their FAT executives?

2008 Jul 20 09:32 AM

[GregY:]

User 138602 - not that I disagree with you, but what, if anything, do suggest as a constructive plan of action? Executive compensations are unrealistic, unconscionable, and promote wrong behavior for all participants of corporate and civic process. I do understand the motivations of the boards to keep the status quo, but I totally do not understand behavior of institutional investment managers who are showing decimal results for their efforts. Is it a conspiracy of incompetent?

2008 Jul 20 11:27 AM

[Oltjbarn:]

My old fashion idea that when I would hire somebody to run my company or to be in charge of a section of that company etc.I would judge that person to be qualified and experienced to do a good job for the firm and I would hire him at a mutually agreed salary, period. I did not expect to bonus him for doing that good job, or make him part owner of my business or eligible for rewards for doing his job. Wrong psychology. If I chose to reward him additionally in any manner it was because the job he had done was. far and away successful and profitable for the firm. Today we throw money at incompetance, rewarding executives for showing up, and pay exorbitant sums for failure to do the job for which an executive was hired. If the system is flawed for those who do their jobs well, the results questionable, it is time to change the hiring system at the top.

2008 Jul 20 03:11 PM

[quetzalcoatl:]

This is not a diffucult matter. Hire someone at an agreed upon salary. If he performs well, give him a raise. If he does not, replace him. Where did this onerous system of bonuses and stock options come from? It is the fault of the stockholders. Why is there no outrage? Why are the boards of directors not replaced with people who are responsible? We need activist boards of directors who are responsive to the shareholders and look out for their interests. It seems like the large institutions who hold vast blocks of stock are those best positioned to effect change. In order to force them to do so, we must replace their boards of directors. Of course, now we are back to the large institution that holds vast numbers of shares. I get it: Everyone is screwed.

2008 Jul 20 04:01 PM

[Albert Meyer:]

The Norwegian government considers stock options a criminal activity. The German government wants to clamp down on stock options. Avoid companies that use options to transfer wealth from shareholders to insiders. Pity Countrywide is not on the list - stock option abuse at its very worst. Respected mutual funds owned loads of Countrywide. American workers, trying to provide for their retirement, entrusted their hard-earned wages to these managers, who in turn thought they were investing in Countrywide. In fact, they were bailing out management, who were offloading their stock, took the money and ran, right under the eyes of the SEC and our lawmakers.

2008 Jul 21 11:08 AM

[Oltjbarn:]

Quetzalcoatl you are on target. Let's all get together an get unscrewed.

2008 Jul 21 02:38 PM

[morgan77:]

Saw that the housing sector was the big winner last week and did a little more research on it. This article (www.greenfaucet.com/fa...) argues that housing may finally have reached a bottom. Check it out if you're interested in buying.

2008 Jul 22 11:56 AM

[kfreed:]

Nevermind the fact that this entire fiasco was orchestrated by the very people who will profit. They created it ( with fill knowledge of the consequences I might add), managed it, made bundles of cash, and then skipped out leaving the poor slobs with pensions and foreclosures holding the bag (as has become the norm for corporate America). Let's also not forget that our ever-faithful President changed the bankruptcy laws just in time to prevent anyone from weaseling out from under their bad loans. And by 'bad' I do mean rotten to the core... I happen to have been one of the drones helping to crank out the loan documents and became sufficiently disgusted to resign long ago. I said it would happen and it did, but you'd have thought I was crazy to hear me relay this to my colleagues back in '04. They certainly thought so.

2008 Aug 18 01:07 PM