Tuesday, February 10, 2009

Limiting Executive Pay

President Obama recently announced the imposition of a $500K cap on the base pay for executives at financial institutions receiving substantial US taxpayer funds. Additional compensation in the form of stock options continues to be allowed, but with longer time restrictions before such stock can be cashed in. Regulations regarding large bonus payments in companies with a net operating loss are probably also forthcoming.

As expected, a cry of protest went up from different quarters about the unfairness or supposed ineffectiveness of the new regulation, though perhaps more muted than I might have expected. Conversely, the decision was greeted enthusiastically by the general public, still reeling from a strong belief that they are underwriting the business failures of rich CEOs. My guess is that not too many CEOs have wanted to appear in public to argue for their current compensation levels, opting instead for backdoor grousing.

Most of the stated objections centered around:
- the federal government should not be micromanaging businesses;
- these failed companies and CEOs are simply victims of the overall meltdown of the economy, and should be given an opportunity to bring their companies around;
- this announcement was just a public relations bone tossed to the public by the President, without substantive impact;
- $500K is not competitive pay, and will not keep or attract the quality of executives needed by these companies.
Each of these arguments is pretty easily refuted, though they miss the larger point we should be focusing on.

Yes, the federal government should normally not be dictating executive compensation pay scales. At least for successful businesses. But these are not successful businesses. These are companies that would be bankrupt today if not for the infusion of US tax dollars to prop them up. And when you are bankrupt, one of the many things you give up is the ability to control your own destiny; your creditors are now in the driver’s seat. The rule is, if you want to operate on your own, earn a profit. If you want a bailout, the bailers are understandably going to dictate the terms. And for better or worse, the federal government is now the bailer.

Victims? No. Banks and financial institutions got into their mess (and now our mess) by not minding the store. They chose to ignore long-standing rules of risk management, quality credit expectations in loan-making, and oversight of the financial products being created and the line people making these products. All using other people’s money. Their attention was on the quantity of sale numbers, not the quality of those numbers. The result is no different than irresponsible Chinese milk product manufacturers or peanut producers in Georgia. No pleas of victimhood allowed. (Note: they executed the milk producers in China.)

A good public relations move by the President? Absolutely. It was easy to do because it was right to do. And the American people know it is right. Given that virtually NO CEO has stepped forward and acknowledged, “I blew it” and taken responsibility for his/her mismanagement, then someone has to try to force that acknowledgement onto the desks of executives. That there is responsibility to be taken for your actions, and consequences for the failure of that responsibility. It is a message seemingly lost on a significant number of executives and Boards of major corporations. American common sense knows better.

Is $500K an appropriate salary for an executive of a $50B+ corporation? No, assuming that company is making a profit from that $50B! But there are two larger issues that this limitation really brings forth:

1) Executive pay has been and should be the province of the company’s Board of directors. But this principle has been effectively undermined because Boards’ pay decisions and their ultimate financial impact are typically hidden from the public and the stockholders. And many Board members all come from the same pool, members of the same big club who all think the same and look out for each other. I support you here if you support me there. Where are all the stockholders in all this voting who might rightly say that $5-10 million is a pretty adequate style of living; salary above that is eating into my stock dividend, thank you. Any greater compensation should be based on long-term company success, not short-term accounting games played while the CEO is in charge.

2) That $500K hopefully will in fact drive out a bunch of people who did not do their jobs, who did not perform to expectations. Apparently too many Boards do not seem capable of exercising this most basic responsibility: holding leaders accountable for performance.

Not all CEOs are created equal. There are different CEO skills needed for different companies at different points in a company’s existence. The startup CEO is a very different animal and skill set from the “steady state” CEO from the visionary “next plateau” CEO. What is needed now in these companies is a turnaround CEO. One who knows how to take a company that is on a downward spiral and reverse and reprioritize itself strategically, focus its efforts on prime activities, and shift its connections to a new sustaining market. This is a specialized skill. $500K and a significant bonus for success will fine with this brand of CEO because it will be the challenge that will be the prime appeal, not the dollars. These people are around. But these are clearly not the people currently running the automobile and financial companies. We need to get this old guard out, those whose time has come and gone, and get the right people in the right job at the right moment.

If a $500K salary cap helps to make that happen, then I am all for it. These are the new guys who will truly deserve the big bucks if they are successful.

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