Compensation Confidential


The salary of the chief executive of a large corporation is not
a market award for achievement. It is frequently in the nature of a warm personal gesture by the individual to himself.

John Kenneth Galbraith

What would Galbraith have said about the AIG bonuses?

When AIG CEO Edward Liddy said the bonus payouts helped retain “the best and the brightest,” he revived a theme that has been common throughout the modern era of executive compensation: an arithmetic correlation between money and talent. Lost on Mr. Liddy, and indeed on much of Wall Street, was the fact that the term was used by David Halberstam to characterize the intellectuals who led us to war and failure in Vietnam. Sweet irony.

I have been silent witness to the growth of executive compensation entitlement syndrome for the last ten years as a sometime ghostwriter for a prominent company in the field, which shall remain nameless (they pay infinitely more than, and may want to hire me again). This week seems the appropriate moment to share the lessons I learned about the behavioral underpinnings of today’s financial industry bonus crisis.

1) The seeds of each new scandal in executive pay are sown in the wake of the last one. Remember stock options? They came into vogue in the early 1990s when executives awarded themselves bonuses for laying off vast numbers of workers, rationalizing that they had raised profit margins and deserved a payoff. Congress decided that compensation in excess of $1 million would not be tax deductible to the corporation unless it was geared to performance. As we have learned over and over, performance can be cut to order conveniently when options or other incentives vest. This is what one economist called “the invisible hand of Alexander Portnoy, not that of Adam Smith.” When I began working in executive compensation, CEOs chose which options to cash based on which vintages from a multiyear portfolio were in the money at a particular time.

And if the resulting tax bill was too high? The stockholders would pick up the tab. Even Apple was caught backdating options for Steve Jobs. Regulators were — and are — perpetually one barn door behind the horses. Who knows what well-intended remedies will be born of the current crisis?

2) CEOs are as peer conscious as any high school clique, but better paid. Executive comp consultants refer to the Lake Woebegone Effect. To wit, if your pay isn’t above average, or well above average, the board is admitting to the world that you are sub-par…and we wouldn’t want that, would we? So comp committees and their consultants have to find schemes whereby CEO pay keeps rising, perks keep rising, and the water level in Lake Woebegone goes up accordingly until it overflows its banks. If a CEO at a competitor in your industry category is in the 75th percentile, you have to be in the 80th or 90th. World-class management, like a designer accessory, is a function of the price tag.

3) CEOs are risk averse. They want their money upfront, to justify the risk of taking the new job and the headaches that go with it. Once seated, management finds ways of locking in wealth. The turnover in these jobs is massive. Five years after the Mergers & Acquisitions boom of 1989-91, fewer than half of CEOs who had received sizable recruitment bonuses were still in place (figures courtesy of The Wiley Book of Business Quotations).

Earlier in this decade, I interviewed a dozen or so CEOs for a Wall Street publication, which deemed them exemplars for a new economic age. Two years later almost all of them were on a list of CEOs who had been indicted or were otherwise disgraced. Of course, the pay levels that justify the risk of failure look a lot like the rewards for success to the rest of us. The bigger scandal comes when the initial contract ink is dry, and they start to manage the company in a way that makes the shareholders feel like they deserve to earn their enormous compensation. That’s when they take risks, as AIG did when the bosses saw the company’s Triple-A credit rating sitting on a shelf and decided to put it on the street in the form of Structured Products.

What they failed to do was something the barbershop down the street from me, in its capacity as a “number hole”, always remembered to do. If the action was too heavy on a number, they’d lay it off on another bookie…er, banker. Who will hedge the hedgers now that AIG is circling the bowl?

4) CEOs hate their jobs, mostly. That’s why you have to pay them extra for doing the jobs they are already paid to do, only better. Look, I wouldn’t want to do it either. Corporate jobs are good when business is good and soul-destroying the rest of the time. That was true at my level and I’m sure it’s true at the top, too.

Come to think of it, even when things were apparently going well, I saw the body language; I heard the mental gymnastics, the ethical contradictions, and the hairsplitting. When you have what comp consultants call “line of sight” for the whole company, you see that it’s a rare event when everything is going well. You make your numbers by selling assets and hope that the problems stay out of the newspapers. But when things are rotten, and they have been rotten for a long time, it’s no wonder that CEOs take everything they can: apartments, jets, club dues, sports tickets, million-dollar furnishings, a piece of the M&A action, stock buybacks, and $440,000 spa weekends complete with manicures and hair styling. They’re like hookers going through a john’s wallet while he’s in the shower. And successful or not, they feel they’ve earned it.

To be sure, they buy back their humanity with good works, a form of plenary indulgence, as I learned first hand the last time my mother was sent to the emergency room. En route, on the car radio I had listened to the Senate Banking Committee questioning Lehman Brothers chairman Richard S. Fuld. When I arrived, I noticed a plaque on the wall of my mother’s ER cubicle. The space had been donated by Mr. and Mrs. Richard S. Fuld.

This is the curse of the managerial class, particularly the financial managerial class, and one of the sorry phenomena of our current situation is that everything is financial. Everything is worth what the financial chieftains say it’s worth for as long as they can get away with it. They don’t love the product, the process, or the people. They love the pay package, the perks, and the power. They love the action. When Bear Stearns was melting down, its CEO was incommunicado at a bridge tournament. Isn’t that a bit like a busman’s holiday? What happened to their brains? They hold their breath and search for the greater fool. The best and the brightest, indeed.

Henry Ehrlich is author of Writing Effective Speeches and The Wiley Book of Business Quotations. He is currently working primarily with companies that are trying to fix the health care mess. Piece of cake.

Photo by David Shankbone

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Compensation Confidential

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