Goldman CEO's Pay Cut: Is Shaming Working?

I've written in law journals here and here about shaming greedy CEOs arguing that social sanctions could be more efficient than legal regulation in constraining excessive pay. Legal regulation is costly and frequently imposes unintended externalities. I argued that the "greed is good" norm is not widely shared outside Wall Street and that if the relevant constituencies (shareholders, institutional investors, stock exchange regulators, directors, etc) were to impose social sanctions on greedy CEOs, they might internalise desirable norms and engage in more responsible behaviour.

Goldman Sachs's announcement on Friday that CEO Blankfein would only receive $9 million as bonus - all of it as deferred stock that cannot be sold for 5 years - might be a small indication that my shaming argument has some merit. Here's the NYT on the topic:

Goldman made a series of political and business calculations in tallying Mr. Blankfein’s rewards. The timing, too, seemed deft: hours earlier, JPMorgan Chase had announced that its chief executive, Jamie Dimon, would receive a $16.6 million bonus and $1 million in salary. For once, Goldman, known for its big paydays, had grabbed the high ground by paying its chief executive less money. At the top, John G. Stumpf, chief of Wells Fargo, was paid $18.4 million in cash and stock for 2009 though he runs a less complex company. Vikram S. Pandit of Citigroup vowed to accept only $1 in salary until the bank is profitable.

Lucas van Praag, a spokesman for Goldman, insisted that the timing and size of the award was unrelated to Mr. Dimon’s announcement, and he would not say how the directors had arrived at the bonus figure, other than to say: “It’s a reflection of the times. Notwithstanding that there has been some extremely ill-informed speculation and a great deal of unpleasantness, we have shown respect for the environment.”

A person close to the board, however, said that in their discussion the directors had agreed they needed to send a strong statement that the firm understood the mood of Washington and the public.
On top of the bonus, Mr. Blankfein will receive a $600,000 cash salary, the same as in previous years, and other perks like a company car and driver.

The current award must, however, be put in the context of his past compensation — in 2006 he received $53.4 million, and the firm said that since 2000 he has received $181.5 million in total salary and bonus, though he has cashed out only part of it.

This might be a fleeting nod to the prevailing public mood, and given how short public memory is, bankers could return to their old ways very soon. If this window of opportunity for legal reform is used well, it might be possible to design regulation to make such behaviour sticky by creating pathways for the relevant actors to direct disapproval at greedy CEOs in a way that matters.

High CEO Pay Hurts Shareholders

The WSJ has an article today based on two new studies about the relationship between CEO pay and shareholder returns. The first study, conducted by Prof. Lucian Bebchuk (Harvard Law School) - who has done some of the best work in this area - analyzed "more than 2,000 companies to see what share of the total compensation earned by the top five executives went to the CEO. The researchers call this number—which averages about 35%—the "CEO pay slice." It turns out that the bigger the CEO's slice of the pie, the lower the company's future profitability and market valuation. "These CEOs," says Prof. Bebchuk, "seem to be trying to grab more than they should.""
The second study, by Prof. Raghavendra Rau (Purdue University), analyzed "CEO pay and stock returns for roughly 1,500 companies per year from 1994 through 2006. They found that the 10% of firms with the highest-paid CEOs produce stock returns that lag their industry peers by more than 12 percentage points, cumulatively, over the next five years. Companies at the top of the pay pile, Prof. Rau concluded, award their CEOs an annual average of $23 million—but leave their shareholders poorer (relative to other companies in the same industry) by an average of $2.4 billion per year. Each dollar that goes into the CEO's pocket takes $100 out of shareholders' pockets.Studies like these will give further ammunition to legislators in the UK and Ireland in their attempts to hit CEOs hard. I look forward to reading the full papers as I work on completing my own paper for submission shortly.

CEO Pay: Central Bank Chief is a Realist

The Examiner quotes Patrick Honohan, the Governor of the Central Bank, as favoring a sensible approach to the politically sensitive issue of compensation at financial institutions: "when it comes to certain key individuals with hard-to-find experience, skills and reputation, we have to be realistic price-takers and acknowledge the opportunities these individuals have in a competitive world market which still rewards these attributes very well."

The only issue is whether those asking for big pay packets by pointing at their counterparts in the U.S. are actually of the same quality. In other words, would these people receive comparable job offers at higher salaries in another market? If yes, there is an argument to be made to pay competitive salaries. If these individuals are not of comparable quality, there is little justification to look at U.S. figures. After all, one doesn't pay as much for a Beaujolais as for a Pomerol?

Walker Review of Corporate Governance in UK Banks

The final recommendations of Sir David Walker's review of corporate governance in UK banks were published today. You can watch a video clip here. The media has reported a variety of responses, ranging from predictable criticism from unions to cautious welcome from industry.

Here are the key general bits:
1. Walker rightly notes that "any undue hampering of the ability of bank boards to be innovative and to
take risks would itself bring material costs. It would check the contribution of the banks to wider economic recovery and delay restoration of investor confidence in banking as a sector capable of generating reasonable returns for shareholders."

2. In an apparent snub to those demanding more regulation, Walker seems to be saying that more is not necessarily the solution: "Good corporate governance overall depends critically on the abilities and experience of individuals and the effectiveness of their collaboration in the enterprise. Despite the need for hard rules in some areas, this will not be assured by overly-specific prescription that generates box-ticking conformity."

3. Walker is also absolutely right in highlighting the cost of regulation: "The behavioural changes that may
be needed are unlikely to be fostered by regulatory fiat, which in any event risks provoking unintended consequences. Behavioural improvement is more likely to be achieved through clearer identification of best practice and more effective but, in most areas, non-statutory routes to implementation so that boards and their major owners feel “ownership” of good corporate governance."

The main recommendations include:
1. "The FSA’s ongoing supervisory process should give closer attention to the overall balance of the board in relation to the risk strategy of the business, taking into account the experience, behavioural and other qualities of individual directors and their access to fully adequate induction and development programmes."

2. "The chairman of a major bank should be expected to commit a substantial proportion of his or her time, probably around two-thirds, to the business of the entity, with clear understanding from the outset that, in the event of need, the bank chairmanship role would have priority over any other business time commitment."

3. "The chairman of a BOFI board should bring a combination of relevant financial industry experience and a track record of successful leadership capability in a significant board position."

4. "The chairman of a BOFI board should be proposed for election on an annual basis. The board should keep under review the possibility of transitioning to annual election of all board members."

5. "The board should undertake a formal and rigorous evaluation of its performance, and that of committees of the board, with external facilitation of the process every second or third year. The evaluation statement should either be included as a dedicated section of the chairman’s statement or as a separate section of the annual report, signed by the chairman."

6. "The evaluation statement on board performance and governance should confirm that a rigorous evaluation process has been undertaken and describe the process for identifying the skills and experience required to address and challenge adequately key risks and decisions that confront, or may confront, the board. The statement should provide such meaningful, high-level information as the board considers necessary to assist shareholders’ understanding of the main features of the process, including an indication of the extent to which issues raised in the course of the evaluation have been addressed. It should also provide an indication of the nature and extent of communication with major shareholders and confirmation that the board were fully apprised of views indicated by shareholders in the course of such dialogue."

7. "The Code on the Responsibilities of Institutional Investors, prepared by the Institutional Shareholders’ Committee, should be ratified by the FRC and become the Stewardship Code."

8. "Fund managers and other institutions authorised by the FSA to undertake investment business should signify on their websites or in another accessible form whether they commit to the Stewardship Code."

 9. "Institutional investors and fund managers should actively seek opportunities for collective engagement where this has the potential to enhance their ownership influence in promoting sustainable improvement in the performance of their investee companies. Initiative should be taken by the FRC and major UK fund managers and institutional investors to invite potentially interested major foreign institutional investors, such as sovereign wealth funds, public sector pension funds and endowments, to commit to the Stewardship Code and its provisions on collective engagement."

10. "The board of a FTSE 100-listed bank or life insurance company should establish a board risk committee separately from the audit committee. The board risk committee should have responsibility for oversight and advice to the board on the current risk exposures of the entity and future risk strategy, including strategy for capital and liquidity management, and the embedding and maintenance throughout the entity of a supportive culture in relation to the management of risk alongside established prescriptive rules and procedures."

11. "In support of board-level risk governance, a BOFI board should be served by a CRO who should participate in the risk management and oversight process at the highest level on an enterprise-wide basis and have a status of total independence from individual business units. Alongside an internal reporting line to the CEO or CFO, the CRO should report to the board risk committee, with direct access to the chairman of the committee in the event of need. The tenure and independence of the CRO should be underpinned by a provision that removal from office would require the prior agreement of the board. The remuneration of the CRO should be subject to approval by the chairman or chairman of the board remuneration committee."

12. "The board risk committee (or board) risk report should be included as a separate report within the annual report and accounts."

13. "For FTSE 100-listed banks and comparable unlisted entities such as the largest building societies, the remuneration committee report for the 2010 year of account and thereafter should disclose in bands the number of “high end” employees, including executive board members, whose total expected remuneration in respect of the reported year is in a range of £1 million to £2.5 million, in a range of £2.5 million to £5 million and in £5 million bands thereafter and, within each band, the main elements of salary, cash bonus, deferred shares, performance-related long-term awards and pension contribution."

14. "Short-term bonus awards should be paid over a three-year period with not more than one-third in the first year. Clawback should be used as the means to reclaim amounts in circumstances of misstatement and misconduct."

15. "If the non-binding resolution on a remuneration committee report attracts less than 75 per cent of the total votes cast, the chairman of the committee should stand for re-election in the following year irrespective of his or her normal appointment term."

AIB Pay Mess - political grandstanding

Politicians got another opportunity to grandstand because of the poor way in which AIB handled the kerfuffle over how much to pay its new Managing Director, Mr. Colm Doherty. The Irish Times reported that the Department of Finance had "received a broad outline of the bank’s intention to retain Mr Doherty on his existing pay level as head of the capital markets unit ... [at an] annual salary of €633,000." Having received no response, it ought to have negotiated informally with the government rather than putting forth the proposal, which was ultimately rejected. Had the matter been handled with discretion, it could have prevented much embarrassment to Mr. Doherty and avoided negative media attention. Instead, politicians of all hues took shots at beleaguered bankers and sought to feed popular anger rather than focusing on the task of real reform.

Reducing Mr. Doherty's pay from EUR 633,000 to EUR 500,000 will not clean up the current mess. Government mandated pay caps are not the answer to the financial crisis. The only certain consequence of such caps is to drive away good talent. If, as is claimed, the government is acting on behalf of shareholders, this is the last thing that a rational shareholder would want. The need of the hour is to attract the best talent available and pay them what they deserve to drag AIB out of this morass.

A singular obsession with punishing bankers at the expense of addressing the more difficult systemic challenges only serves to appease popular opinion. While this is attractive in the short term, the real task of reform suffers.