Executive Compensation - Supplement

There's been a great deal of justified criticism in recent weeks about annual bonuses totaling a reported $18.4 billion paid or promised largely to investment bankers on Wall Street for their performance in 2008. This was at the same time as their employers are reporting huge financial losses, many of them have applied for and received substantial federal bailout moneys, tens of thousands of primarily lower paid and mid-level employees in their industry are receiving pink slips, and the country is in the worst economic recession since the Great Depression in the early 1930's.

Particularly newsworthy was the imprudent and inappropriate decision by former Merrill Lynch CEO John Thain and its board of directors to approve between $3-4 billion in bonuses to a large pool of their investment bankers at a board meeting on December 8th, when they knew, or should have known, that Merrill Lynch would be reporting a loss exceeding an incredible $15 billion for the 4th quarter alone! Furthermore, they decided to speed up the payments to later in December, rather than the customary January period, because, I think, they feared the possibility of Bank of America's CEO Ken Lewis and the bank's board downsizing the bonuses after their merger deal became official on December 31st. However, and it may have been another factor, Thain's reported rationale for the speeding up was that he wanted his senior executives to allocate the bonus pool to the respective beneficiaries before the merger and many of them left for other employers.

Additionally, the reported rationale from Mr. Thain and his supporters in paying the bonuses was the fear of losing many of their best performers, who no doubt would be quite unhappy if no bonus were paid. Critics, including myself, maintain that there couldn't have been that many top performers last year if the firm lost as much money as they did. And where would they go, since almost all the better firms in the industry are laying off people, not hiring?

On Thursday President Obama blasted Wall Street executives and board members for their actions in paying the bonuses, calling it the "height of irresponsibility" and "shameful." I think he was right to do so, even if the actions were legal. And I say that as a former investment banker who spent ten years in the industry. But to be fair to Mr. Thain, though originally apparently seeking a $10 million bonus for himself, I understand neither he nor the top four other executives at Merrill Lynch, were actually paid any bonus.

In my experience, bonuses to investment bankers are typically paid based on performance against pre-agreed personal objectives, especially involving revenue generation, and the level of individual contributions to the firm's financial results. However, limited bonuses were paid to anyone if the firm didn't achieve satisfactory overall financial results as measured against stated corporate objectives. By this standard, certainly, the bonuses, though much smaller than for performances in 2007, seem quite excessive and definitely inappropriate.

Given the public and media uproar on this subject, and understandings about limiting executive compensation for companies receiving federal bailout moneys, congressional investigators have called on the banks to justify their actions. In addition, New York Attorney General Andrew Cuomo has instituted his own investigation to determine if some of the executives have violated their fiduciary duties to shareholders, creditors and other employees. Apparently he has already subpoenaed Mr. Thain and Bank of America's Chief Administrative Officer J. Steele Alphin to testify. I'm fairly certain he will press hard for some meaningful convictions or similar outcomes, depending on the evidence he can come up with, particularly if this covers clear and unwarranted harm to shareholders, creditors or other employees.

What's going to be the end result? As I discussed in my post published last August, there will be even more pressure by the Congress, the media, the regulators, rating agencies and a great many shareholders for the boards of directors and CEO's of these firms to be more careful and a little more rigid and disciplined in how salary compensation levels are established and what policies will apply to incentive compensation, also often referred to as bonuses. I also would not be at all surprised if a number of additional CEO's and board members of these banking firms retire or are forced to resign.