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A systemic fix for Wall Street’s crazy compensation practices

Saturday, November 1st, 2008

A systemic fix for Wall Street’s crazy compensation practices

Posted on October 31, 2008 at 9:50 AM
Filed under: Best Practices | Crisis On Wall Street | Deal International
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TeachingClassGuidanceLeadershipBig.pngWith good reason, a political storm is gathering over the prospect that financial firms now being rescued by taxpayers at immense expense will pay out billions in bonuses to employees this year.

New York State Attorney General Andrew Cuomo is pressuring some firms, as The New York Times reports. So is Congress. Friday’s Wall Street Journal reports that the executives running several firms may show some leadership and take pay cuts.

But this isn’t a one-year issue. The practice of giving outsize rewards to big-time risk-takers based mainly on their results in a given year is one of the main reasons we have a financial sector that’s too big and too self-serving. As financial firms become more and more focused on maximizing compensation for employees, they get more and more distracted from their basic reason for existing: managing society’s wealth and directing it to productive purposes. On these points, check out the thinking of Paul Woolley of the London School of Economics.

Regulating financial sector compensation practices is sure to be a big topic at the G-20 financial summit in Washington on Nov. 15 and at subsequent meetings. The challenge is doing it in a way that preserves rewards for people making real contributions and also doesn’t just drive talent to unregulated areas en masse. It’s not something you can accomplish by fiat.

What to do? Morris Goldstein of the Peterson Institute for International Economics has an interesting proposal, part of a comprehensive, 10-plank plan for financial reform. It’s based on several of the planks he identifies (most of which are under discussion in some form by various bodies) and would work this way:

1. Any institution big enough to pose systemic risk — banks for sure, but also hedge funds, etc. — gets regulated and is subject to minimum capital requirements, which by the way need to be raised from current levels.

2. Financial firms develop best practices in tying comp to long-term results. Some of these are already in the works, apparently.

3. Financial firms that embrace those practices get a break on capital requirements, enabling them to employ somewhat higher leverage and enjoy higher profits.

That assumes a lot of change, but then we need a lot of change. Perhaps it would even work. Are there other, more draconian fixes out there? We’ll find out, probably soon. - Kenneth Klee

http://www.thedeal.com/corporatedealmaker/2008/10/a_systemic_fix_for_wall_street.php

http://www.iie.com/

DOWNLOAD THE PDF:

Peterson Institute - Goldstein - Financial Services Regulatory Reform

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Payout May Spur `Say-on-Pay’ Bill

Friday, November 2nd, 2007

http://www.bloomberg.com/apps/news?pid=20601087&ref

er=worldwide&sid=asN_bC4V.H0k

 O’Neal’s $161 Million Merrill Payout May Spur `Say-on-Pay’ Bill
By Alison Vekshin and Ian Katz

Nov. 2 (Bloomberg) — Senate Banking Committee Chairman Christopher Dodd says Merrill Lynch & Co.’s $161.5 million exit package for former Chairman and Chief Executive Officer Stan O’Neal may revive efforts in Congress to give shareholders more power to curb CEO salaries.

O’Neal shouldn’t be rewarded for poor performance, Dodd said in an interview in Washington, adding that his committee may proceed with legislation aimed at capping excessive executive pay.

“There’s a lot of controversy, mostly on the other side,” said Dodd, a Connecticut Democrat, referring to Republicans. “We’ll try to get unanimity where we can. But there’s a possibility we’ll move on it.”

A bill to give investors a non-binding vote to protest excessive compensation was approved by the House of Representatives in April, almost four months after Home Depot Inc.’s ex-CEO Robert Nardelli got a severance package valued at $210 million. O’Neal left Merrill earlier this week with $161.5 million in securities and retirement funds. Merrill’s board refused to give him a severance package following a record $8.4 billion writedown of subprime mortgages.

The U.S. Securities and Exchange Commission, responding to complaints from investors, adopted rules in July 2006 to make executive compensation more transparent to shareholders. In the Senate, Dodd will need to pick up some Republican votes to get the so-called say-on-pay bill moving again.

Obama Legislation

“I don’t think it should be Congress’s prerogative to get involved in the internal affairs of corporations,” said Colorado Republican Wayne Allard, who’s a member of the Senate Banking Committee, in an Oct. 30 interview. “The boards have a definite responsibility. I don’t feel like the federal government ought to be stepping in.”

Dodd hasn’t yet called for a hearing on the legislation, introduced in April by Senator Barack Obama, Dodd’s rival in the race for the Democratic presidential nomination. Obama offered a bill mirroring the legislation that Representative Barney Frank pushed through the House.

Dodd is studying initiatives “that would improve shareholder rights and input in the executive compensation process,” his spokesman, Marvin Fast, said in a statement. Ideas include giving the SEC more authority to compel disclosure about pay packages and improving shareholders’ access to corporate ballots.

Merrill announced O’Neal’s retirement Oct. 30, less than a week after he lost the board’s confidence by posting a $2.24 billion third-quarter loss. Much of O’Neal’s pay was negotiated when he became CEO in 2002.

Exit Packages

“Why do you give someone a contract that winds up paying him so handsomely when he fails?” said Frank, a Massachusetts Democrat who is chairman of the House Financial Services Committee, in an Oct. 30 interview. “It shows this problem hasn’t gone away.”

O’Neal’s exit pay package will be among the 10 largest ever, said Paul Hodgson, a compensation analyst at the Corporate Library, a Portland, Maine-based research firm. Exxon Mobil Corp. paid CEO Lee Raymond $357 million when he retired last year and former Pfizer Inc. CEO Hank McKinnell received $200 million.

The Senate legislation “would improve things considerably,” by giving shareholders a stronger voice in executive compensation, Hodgson said.

To contact the reporters on this story: Alison Vekshin in Washington at avekshin@bloomberg.net ; Ian Katz in Washington at ikatz2@bloomberg.net .

Last Updated: November 2, 2007 00:15 EDT

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