Judge's Refusal of BofA / Merrill Bonuses Could Unleash Reality on Financials

Includes: BAC, IYF, MER, MER.I
by: Wendy Fried

Oh, that Judge Rakoff is such a spoilsport, refusing to bless the SEC's settlement with Bank of America (NYSE:BAC) on the Merrill Lynch (MER) bonuses.

The Times said today that the judge (a nice man who once terrorized me in Contracts class) may hold a hearing to find out whether the bonuses - all $3.6 billion - were necessary. More specifically, he'd like to know if Merrill's management really tried to figure out "how many of the roughly 39,000 bonus recipients would have left had they not received their payouts."

In response, Bank of America's lawyer said the bank could prove "there were a number of companies that might have hired Merrill’s employees.” Which is nice, but doesn’t really address the judge’s concern.

Rakoff is asking about the process: Did the board ask management to prove these bonuses were essential, and did management meet that burden? To do so, I think, would have required them to muster empirical evidence on the following points:

- Exactly which employees were likely to stomp out the door if they got smaller bonuses, or no bonuses, and how management knew this in advance.

- Whether all hell would really break loose if some of these folks left.

- Whether or not the firm could recruit, on the streets of Lower Manhattan, some dazed but qualified victims of Wall Street’s bloodbath who'd be willing to work for less than $3.6 billion.

Did the board ask for such factual backup? I’m guessing no. The “science” of executive compensation is a strange kind of science, in that it’s pretty much devoid of both evidence and experimentation. Year after year, public companies assert in proxies that their compensation programs are exquisitely designed to retain each indispensable, irreplaceable employee. A less generous pay scale just wouldn’t do the trick, we’re told. But few firms tell us how they know this. Nor do they road-test different compensation schemes.

For empirical research on whether compensation methods actually work the way they're supposed to, we’ve got to resort to academics. Like these guys, who concluded a couple of years ago that stock options encourage foolhardy risk-taking. Hey, how about that.

How can you say your compensation structure is efficient and effective if you never experiment with a cheaper one, even when the world is coming apart at the seams and you have a perfect excuse for cutting pay?

Thanks to a crabby guy in robes, one company may soon have to answer that question.

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