Wealth as a Societal Value in the E.U. and U.S.: The Case of Financial Reform

The E.U. and U.S differ markedly in the degree to which the interests of big business are etched in the respective societies and polities. That is to say, the difference goes beyond the question of the relative influences of the lobbyists. I contend that the relative proclivity societally in favor of business in the U.S. tilts the political playing-field excessively in the direction of the financial interests at the expense of the public good, which I take to be well represented generally by a full, equally-weighted spectrum of views. I further contend that influence is easier for financial-sector lobbyists in the United States than in the European  Union because the societal values in the former lean more in their favor. By analogy,  it is easier to run downhill than even on a flat surface.
These points can be discerned from the respective financial reforms in the E.U. and U.S. in the wake of the financial crisis of 2008. Because the financial sector was viewed as culpable in both societies, the ensuing respective financial reforms would be expected to be at the expense of the banks rather than conducive to their interests.

On March 10, 2010, the E.U. Parliament adopted a Resolution (536 votes in favour to 80 against) calling for the financial sector to contribute fairly towards economic recovery since the costs of the crisis are being borne by taxpayers. On 25 March, Members of Parliament’s special “Financial, Economic and Social Crisis Committee” debated the rationale behind a possible financial transaction tax. Stephan Schulmeister of the Austrian Institute for Economic Research in Vienna said short-term financial transactions can make short-term prices of currencies and other financial products such as derivatives and shares vary wildly. Schulmeister claimed that a tax on financial transactions of just 0.05% would eliminate these short-term transactions, bring greater stability and bring €300 billion of additional revenues to the E.U. While the tax would undoubtedly bring in revenue, it is not clear to me that short-term transactions would be eliminated, as they can be worthwhile even with such a tax. Moreover, the financial crisis of 2008 shows us that the volitility can come from the market mechanism itself (in so far as it magnifies irrational exuberance). At any rate, even as there was division on the matter of such a tax in the parliament, that the proposal had been made distiguishes the legislative body of the E.U. from the Congress in the U.S., where such a proposal would undoubted have been blocked. Indeed, the E.U. Parliament went ever further.

On July 7, 2010, the EU Parliament approved some of the strictest rules in the world on bankers’ bonuses. In the legislation, caps were imposed on upfront cash bonuses and at least half of any bonus had  to be paid in contingent capital and shares. The legislative chamber also toughened rules on the capital reserves that banks had to hold to guard against any risks from their trading activities and from their exposure to highly complex securities. “Two years on from the global financial crisis, these tough new rules on bonuses will transform the bonus culture and end incentives for excessive risk-taking. A high-risk and short-term bonus culture wrought havoc with the global economy and taxpayers paid the price. Since banks have failed to reform we are now doing the job for them,” said MEP Arlene McCarthy. Upfront cash bonuses were capped at 30% of the total bonus and to 20% for particularly large bonuses. Between 40% and 60% of any bonus had to be deferred for at least three years and could be recovered if investments did not perform as expected. Moreover at least 50% of the total bonus had to be paid as “contingent capital” (funds to be called upon first in case of bank difficulties) and shares. Bonuses also had to be capped as a proportion of salary. Each bank had to establish limits on bonuses related to salaries, on the basis of E.U.-wide guidelines, to help bring down the overall, disproportionate, role played by bonuses in the financial sector. Finally, bonus-like pensions were also covered. Exceptional pension payments had to be held back in instruments such as contingent capital that link their final value to the overall strength of the bank. This was to avoid situations similar to those experienced in the wake of the financial crisis of 2008 in which some bankers retired with substantial pensions unaffected by the crisis their bank was facing. The rules applied to foreign banks operating in the E.U.and to subsidiaries of E.U. banks operating abroad. The law gave state regulators binding powers to take action against banks that failed to comply with the new rules. In contrast, the U.S. went after Arizona for trying to enforce US immigration law.

Clearly, the U.S. financial reform did not go nearly as far; it did not put nearly as much crimp in the American banks. This is no accident. The feeling among big bankers in the US was that they dodged a bullet concerning what could have been in the American bill. No “too big to fail” limit was put on a bank’s capital or size , or on the bankers’ compensation. The American media and President Obama were strangely silent on why. In the case of the health reform, the President silently removed his objection to an insurance mandate and dropped his desire for a public option after the lobbyist for the American health insurance companies told him that her support was contingent on these changes. 
My point is simply this: Were not American society leaning in a pro-business direction (e.g., economic liberty being salient in how liberty itself is viewed), the President might not have felt the need, or pressure without a sufficient countervailing wind, to bend in the banking lobbyists' direction. That is to say, the lobbyist would not have had so much leverage. Wall Street no doubt had massive influence in the crafting of the financial reform as it was making its way through Congress (even though the banks were culpable in the financial crisis—which is itself telling). I submit that the reasons go beyond the sheer power of money to unquestioned societal values.

Sources:
http://www.europarl.europa.eu/news/public/story_page/044-71441-088-03-14-907-20100329STO71433-2010-29-03-2010/default_en.htm

http://www.europarl.europa.eu/news/public/focus_page/008-76988-176-06-26-901-20100625FCS76850-25-06-2010-2010/default_p001c011_en.

The Increasing Decadence in American Business (and Society): The Case of On-Screen Distractions during Television Programs

While watching Lord of the Rings on TBS in 2010, I noticed that the network was posting not only its logo on the bottom right of the screen, but also advertising for its programming on the bottom left. Also, “more movie, less commercials” was written to accompany the logo. What really got to me during the movie was when pictures advertising a television show were shown. They took up almost an eighth of the screen and thus could not but distract the viewer from watching the movie. I decided I would not watch movies on networks that compromise or prostitute their own programing in order to sell themselves while "in progress." It is like sitting down at a restaurant and having the waitor sell me on other dishes while I am trying to enjoy the one that I'm eating. “I just want to enjoy this fine meal, thank you,” any discerning customer would be wont to say. Once at Starbucks, the customer in front of me at the register was paying $25 for a variety of products.  As I was thinking that the store had made a good sale, the clerk tried to sell the customer on a certain food item for the next visit--as if the present sale was not enough.  The same propensity wherein nothing is ever enough is evinced by the television networks that can't seem to restrain themselves from adding more and more self-promotions onto the screen during their own programming.  These networks are playing off the mitigated nature of the additions being incremental, and thus not objectionable to the average viewer. 

It is simply bad business to interfere with a customer’s enjoyment of a product by trying to promote the business or another product. The over-reaching has the bad smell of self-indulgence knowingly at others’ expense. It is impossible to enjoy a movie while animated characters run around the bottom of the screen to get the viewers' attention. The perpetrators ought to be regarded as children wherein if we give them an inch, they will indeed take a mile. Sadly, too many of us allow ourselves to be strung along the slippery slope--perhaps some viewers don't even notice the incremental intrusions. The smell of the network managers' over-reaching ought to be emetic, but perhaps the stench is so ubiquitous that we as a soceity are innoculated against even smelling it.  One can hope that one day, we shall wake up to the decadence and "smell the coffee." Perhaps only the loss of a significant viewership would mean that the sordid managers will be out of their jobs–unable to earn their high salaries for trying to manipulate us in new subterfuges. That, ladies and gentlemen, would be justice and a more salubrious society.  In the meantime, American television will increasingly come to reflect the lowest common denominator in the viewership because that is where the numbers are. In fact, perhaps it could be said that this nature of television reflects the values that are taking hold in American society.

Do we as a society value mutual respect and self-restraint, or are we too tolerant of selfishness and manipulatory behavior? Do we not value strength, but instead enable weakness? Are the stars of reality shows famous for fifteen minutes because they evince our society's actual values?  In other words, have we become a self-absorbed, petty people without realizing it?  If so, the television networks may simply be us taking advantage because it is condoned.

Decoupling Responsibility from Power: The Case of Transocean in the BP Disaster

With much power comes implicit responsibility. Hence, on February 21, 2011, the world recoiled when Gaddafi violently turned on his own people--using his power sans responsibility in a selfish attempt to stay in power. So too, the world had been shocked in April, 2010 when BP's Deepwater Horizon oil rig exploded in the Gulf of Mexico and that the Gulf itself was at risk. That a company could ruin something as big as the Gulf of Mexico came as a surprise to many. That a company, or three in this case, could have minimized such a risk by, for example, sending the U.S. Government contingency plans on Gulf clean up that included rescuing sea animals that actually live in the Arctic, shocked the public just as much. How could people holding such power treat its use with such carelessness concerning any downside?  The defense of having followed company policy or having excuted business procedures pales in comparison with the societal demand that power, whether public or private, be handled responsibly.  In other words, people take it for granted that power is given to adults rather than to children.  I think we would be surprised how often this has not been the case.  The case of Transocean demonstrates this thesis.

Transocean, which owned the Deep Water Horizon oil rig that exploded in April of 2010,  was the subject of a criminal investigation into possible tax fraud in Norway. The company indicated in S.E.C. filings that Norwegian officials could assess it about $840 million in taxes and penalties. The filings also contended that a final ruling against Transocean could have a “material impact” on the company. The company was also the target of tax inquiries in the United States and Brazil. Furthermore, drilling equipment from Transocean was shipped by a forwarder through Iran and until 2009 the company had held a stake in a company that did business in Syria. The State Department claimed at the time that Syria and Iran sponsor terrorism.

In reaction to these charges,  a Transocean statement simply claimed that the managers at the company had always acted appropriately and that they would prevail in any investigations. This is interesting, for “always” is quite an accomplishment.  Once I took a self-inventory and one question was “I always tell the truth.”  Of course, no one always tells the truth, so the question was geared to assessing how truthful one is in taking the test.  Had I answered yes, I would have been lying. The transocean statement, taken by itself, indicates a proclivity to lie, for no human being always acts appropriately. Transocean's statement evinces a certain arrogance, as if to say, "We are above reproach."  Such an attitude is dangerous where there is sufficient power at one's disposal that one's actions can do real damage to the planet.

Transocean, which drilled in some 30 countries and employed more than 18,000 people, owned nearly half of the 50 or so deepwater platforms in the world in 2010. “These people are capable and considered the gold standard of deepwater drilling,” said Peter Vig, managing director at RoundRock Capital Management, an energy hedge fund in Dallas.  I contend that expertise in drilling does not sufficiently counter the kind of charges that were brought against the company. To focus only on expertise in operating machinery or in managing a company as though they were all that matters in business is to hold an extremely narrow perspective on what counts. Furthermore, to let blantantly false asseverations stand (such as of always acting appropriately) is to enable a pattern that can literally destroy a major marine ecosystem.

Source:

Barry Meier, "Owner of Exploded Rig Is Known for Testing Rules," The New York Times, July 7, 2010.

Related material is in Cases of Unethical Business, which is available at Amazon.

BP: Dividends to Stockholders Despite a Sordid Safety Record

As BP was wrestling with stopping the oil leak in the Gulf of Mexico and cleaning up the oil, a controversy broke out between the company’s stockholders and the  US Government on whether any dividends should be declared and paid before the company has taken care of the Gulf.  BP earned more than $16 billion in 2009. Based on higher oil prices, in the first quarter of 2010 the company’s profit more than doubled to $6.08 billion from $2.56 billion  in the first quarter of 2010.  BP’s dividend payment accounted for about £1 of every £8 handed out by British companies in 2009. Given the higher profit in the first quarter of 2010, stockholders were expecting more in dividends.

The question was how much the company’s costs in regard to the Gulf would or should cut into the dividends; the political question was whether any surplus wealth should be paid to investors before the company’s legal and moral obligations were taken care of in the Gulf region.  Although not suggesting that their company was not obligated to stop the rupsure and fund the clean up, BP officials claimed that their company had already paid in other ways.

Already by mid June, 2010, BP shares had fallen more than 40 percent since the fatal explosion at the Deepwater Horizon drilling rig in April, wiping more than £50 billion, or $73 billion, from the company’s market value. The drop came after lawmakers in Washington called on BP to suspend its dividend and advertising campaign to pay for the cleanup, and a senior official said the Justice Department was “planning to take action.” Most shareholders rejected concerns that the costs of a cleanup and possible damages could force BP into Chapter 11 bankruptcy protection, and said the drop in the share price is not justified by the value of BP’s assets.  BP officials indicated the company’s executives would decide in July whether to keep the quarterly dividend at 14 cents a share for the second quarter. In 2009, the company paid about $10.5 billion in dividends.

By June 10 2010, the company’s cost in regard to the oil spill had reached about $1.43 billion. A BP official said it was “too earlier to quantify other potential costs and liabilities associated with the incident.”  Earlier in June, BP officials told investors that the company had $5 billion cash on hand and that it was generating “significant additional cash flow” as the price of oil remained above $60 a barrel. BP had 18 billion barrels of proved reserves and 63 billion barrels of resources at the end of 2009 that it could draw on.

Iain Armstrong, an analyst at investment manager Brewin Dolphin in London agreed with BP that the company had enough money to pay for the cleanup efforts and also rejected any potential concern that the company might not be able to pay for its debt. “It’s gotten completely out of hand,” Mr. Armstrong said. “It’s a totally overpoliticized situation. There is a disconnect between reality and BP being totally lambasted… . Ironically, by being extremely strong financially, BP has become a target here,” he said. I contend, however, that BP became a target because of its atrocious safety record and its culpability at Deepwater Horizon.

BP falsified regulatory documents by indicating that there was zero percent risk of an off-shore rig accident creating a rupsure and that the company had the technology to stop and clean up such a problem.  Tony Hayward admitted after the explosion that BP lacked the “tools you would want in your tool kit” to close a blown deep-water well.  In other words, the earlier claim to have had the technology was a lie (which MMS never bothered to disconver, as the agency had been captured).  Lest it be said that no group of people is perfect, BP’s history attests to justifiable blame.

In 2005, a blowdown drum overfilled with liquid hydrocarbons at BP’s Texas City refinery killed 15 and wounded 170.  BP was cited for old equipment, overworked and unsupervised employees and contractors, and managerial inattention to safety. The US Chemical Safety Board put the cause as “organizational and safety deficiencies at all levels.”  Meanwhile, a shoddy ballast system was found at BP’s offshore platform Thunder Horse.  In 2006, a corroded pipeline in BP’s Purdhoe Bay field in Alaska leaked thousands of barrels. In the following year, Tony Hayward became the CEO. He promised to make safety his priority. Yet in 2009, the Occupational Safety and Health Administration fined BP a record $87.4 million for more than 700 safety violations at the Texas City refinery. Nonetheless, David Nicholas, a BP spokesman, wrote, “Safe, reliable operations have been and continue to be our number one priority.”  Not only has this not been the case, BP managers (and lawyers) have been more interested in minimizing liability than being responsible for the consequences of the lapses.

At Deepwater Horizon, when an employee discovered that one pod of the blow-out preventer was leaking, a manager simply shut it down and used the other pod (rather than fixing the leak). Another worker found such low hydrolic pressure in the device that he knew it was time to leave.  In Congressional testimony, Tony Hayward said BP regarded the equipment as the fail-safe mechanism, even as blow-out preventers in general have a 44% failure rate and the device at Deepwater Horizon was known to have a broken pod. Furthermore, after the well fire, the company low-balled the estimated volume of oil going into the Gulf in order to minimize its future liability.  During the first week after the explosion, the company’s estimate was 1000 barrels per day.  During the second week, the company estimated 5000.  Meanwhile, company documents show an estimate of 100,000 per day as a worse-case scenerio. That the wider society would not be sufficiently informed of the magnitude of the clean-up required did not seem to bother the managers at BP, whose concern was mainly to minimize the company’s liability (and thus maximize their stockholders dividends).  Selfishness among the culpable is telling. At the very least, responsibility can be defined as paying for the harm consequent to one’s mistake.  Satisfying such responsibility has priority over dividends, which are residual, after all. In making the protection of dividends (and the stock price) a priority, BP’s managers evinced a reversal of priorities that was ahistoric for the modern corporation.

It is for these reasons, not because BP is a giant corporation or is British, that BP was the target of such scathing rebuke by the American public and the American governments. Mr. Armstrong said that President Obama should not forget that 40 percent of BP shares are owned by United States shareholders. “So he’s not doing them any favors either,” he said. Again, I beg to differ. Acting in the public interest, Barak Obama is doing us all a favor.  Of course, the politics of this matter were no doubt different in Europe.

London’s mayor, Boris Johnson, said Thursday that the drop in BP’s shares was slowly becoming a political issue in Britain. “When you consider the huge exposure of British pension funds to BP and the BP share price and the vital importance of BP then I do think it starts to become a matter of national concern if a great British company is being continually beaten up on international airwaves,” he told BBC Radio on June 10th. However, Reuters quoted Prime Minister David Cameron as saying, “This is an environmental catastrophe. BP needs to do everything it can to deal with the situation, and the U.K. government stands ready to help. I completely understand the U.S. government’s frustration.”

In a general sense, the governments are relatively oriented to the public interest, whereas BP, as a private corporation, has a fiduciary obligation to its stockholders.  Robert Reich referred to this obligation as a company’s “corporate social responsibility” on the Countdown with Keith Obermann show on MSNBC on June 14, 2010.  “Social” can admittedly be in reference to stockholders’ social concerns (though “social concerns” is rather vague); however, the term can also refer to society, which is larger than any group of stockholders. To BP’s management, it makes perfect sense in terms of corporate governance to declare and pay dividends as long as the company has enough resources to cover its actual and contingent liabilities related to the gulf.  Considering the billions that the company has in oil reserves, it could satisfy both. In an economic sense, the dichotomy may not make sense.  However, politically, there is resistance to the declaration and payment of dividends, and this “irrational” element is ignored by BP to its economic peril.  Essentially, the political reaction is challenging the right of the company to continue to exist. At the very least, the objection is that the company should not be run as normal.  In other words, the political claim is ultimately that BP has broken the social contract that legitimates its right to conduct business within the US.

Lest we have become too ahistoric, it might be worth our while to study the history of the modern corporation.  Originally, the modern joint-holding company was delegated a function to do for the public by a government.  If the company had enough left over after performing the function, it could give the surplus to the stockholders.  Through the twentieth century, the interests of the stockholders became increasingly central, eclipsing even the “delegated public function” aspect of the charters.  Essentially, a society gives a group of people permission to do a function. This implies that doing the function, and taking care of any adverse consequences caused by the company, are primary.  The political demand of the American governments is that dividends not be declared or paid until BP has rectified the Gulf region as required by law, societal norms, and ethical standards. From the standpoint of BP having been granted permission to operate in the US (leaving aside the billions in contracts from the US Government), the demand is not so much the product of irrational exuberance.

In effect, BP’s managers ignored systemic risk.  In being the closest we have to anyone able to solve the problem, BP is too big to fail. Managers at the company lied about being able to handle a major rupture. The MMS regulatory agency went along, having been coopted by the industry it was to regulate.  This is a failure of business as well as government.  All the emphasis on BP taking orders from the US Government in the wake of the rupture can be interpreted as “reaction formation” given the powerlessness felt in government having been so dominated by private interests ahistorically oriented to their stock price.  If the Gulf of Mexico seemed broken, this condition could be read as a symptom of a political-economic rupture.  I suspect that big business has gotten too big—taking too big risks, capturing governments, and acting with impunity.  As if the financial crisis of 2008 was not enough of a warning call, the oil spill of 2010 depicts too big to fail in very concrete terms.  Whether governments have sufficient power to reassume the driver’s seat in delegating public functions to private commercial associations depends on whether legislators have enough backbone to limit the size and wealth of big business.

Sources: http://www.nytimes.com/2010/06/11/business/11bp.html?hp
Countdown with Keith Obermann, MSNBC TV, June 21, 2010; Byran Walsh, “The Spreading Stain,” Time (June 21, 2010), pp. 51-59.


Related material is in Cases of Unethical Business, which is available at Amazon.

Executive Compensation (Part II): Paying Failure

In late September 2011, Léo Apotheker was fired after 11 months as CEO at Hewlett-Packard. As a reward, he walked with $13.2 million in cash and stock, in addition to a sign-on package worth about $10 million, according to the New York Times. A month earlier, Robert P. Kelly received severance worth $17.2 in cash and stock when he was fired as CEO of Bank of New York Mellon. Even his clashing with board members and senior managers did not obstruct his nice severance package. A few days later, Carol Bartz was let go as CEO of Yahoo with nearly $10 million in spite of the company’s poor performance. Back in April 2011, John Chidsey, the CEO of Burger King, had departed with a severance package worth almost $20 million in the fact that McDonalds had been outcompeting Burger King. Baxter Phillips, the CEO of Massey Energy, got a package worth over $34 million in spite of “presiding over a company barraged with accusations of reckless conduct and with legal claims stemming from one of the deadliest mining disasters in memory,” according to the New York Times. Unfortunately, the list goes on and on. Is this a system of pay-for-failure? Moreover, do chief executives, who seem to outward appearances to be almost exclusively motivated by what they can get in additional compensation, have too much leverage over boards, and thus over even the owners as well? If so, is corporate governance itself severely broken? I answer in the affirmative.

“We repeatedly see companies’ assets go out the door to reward failure,” Scott Zdrazil, the director of corporate governance at a major bank’s investment fund that sought to tighten the restrictions on severance packages at three oil companies in 2010. He claims that investors are frustrated that boards of directors have not prevented such windfalls. Even the Dodd-Frank financial reform law has its mandated “say on pay” stockholder votes on a non-binding basis. It is as though stockholders have given up their property rights in favor of the “rights” having been taken or assumed by their agents—the directors and upper echelon managers. It is as though the business judgment rule trumps property rights even where the compensation of executives who typically control their boards is at issue. The conflict of interest here is extraordinary even as it is assumed to be obviated by the fiction of board independence from management. To be sure, a board of directors is supposed to hold management accountable.

Don’t look to public policy to shore up the property rights of stockholders any time soon. Eric Dash of the New York Times avers that the Obama administration “seemed to lose its bully pulpit for compensation reform after most of the nation’s biggest financial companies repaid their government loans.” Never mind that the administration allowed at least four of the mega-banks to repay early based on the bankers’ desire to avoid limitations on their own compensation.

The bottom line is that CEOs are not really all that interested in serving the owners of the companies; the top executives are primarily interested in their own gain, be it in terms of position/power or compensation. Structuring the latter in stock options with vesting periods and looking to outside directors for accountability are not sufficient checks on the single-minded pursuit of CEOs of their narrow self-interest. Even when a bank is in dire circumstances, such as Merrill Lynch was on September 15, 2008, a CEO can be obsessed with “letters”—statements on his or her compensation (as well as that of other top execs) being honored by the acquiring company.

As negotiations dragged on into the wee hours of Monday morning, Ken Lewis of Bank of America was utterly disgusted with John Thain’s fixation on what he and others at Merrill would get as bonuses (for a year of losses, by the way), even as Merrill and its stockholders held in the balance after midnight (when Lehman filed for bankruptcy). Lewis could only look over at Thain and think to himself, The only thing these Wall Street guys are concerned about is themselves. Even in the midst of a financial system collapse, Thain was focused on getting what he thought he deserved in spite of the huge losses. In fact, he had put off even talking to Lewis at Bank of America—repeatedly rebuffing his president’s (Fleming) lobbying—because the CEO did not like the idea of having to work for Lewis! Do you suppose the Merrill stockholders wanted to risk their entire investment in the bank because Thain didn’t want to end up working for someone else? The board of directors left the contingency plans up to him, so he didn’t have to worry about any pressure to start merger talks. Merrill’s stockholders were at best an afterthought to him, and yet the directors, who had been elected by the owners, had hired him. The eventual $29 per share price, by the way, was a result of Fleming’s negotiating for the stockholders; Thain was still looking for a line of credit from Goldman—risking an entire loss to stockholders so he could retain control of Merrill rather than turn it over to Lewis.

Even after Merrill Lynch had announced a $5.1 billion loss ($5.56 per diluted share) for the third quarter of 2008, Thain was insisting on a cash bonus of $40 million. Fleming and McCann were to get $25 million, while two other senior managers would get $15 million a piece. Thain subsequently admitted that a $20 million cash bonus for himself would be more "realistic." Given Merrill's losses in 2008 and the fact that the bank had to be sold, it is crazy that any cash bonuses would be paid for any senior manager. Thain's suggestion to the board's compensation committee that the bonuses be viewed as "success fees" for the top managers' efforts in putting together the sale of Merrill to Bank of America is nothing less than bizarre, if not comical. Failure as successs? What planet was Thain from? That a man like him ever got to be the CEO of a major bank (one too big to fail!) suggests that major flaws exist in how business practitioners view and value leadership and in how corporate governance is designed and operates.

When times were good, the finance crowd had lauded Thain as a “superman” for modernizing the NYSE. The business world tends to invent “superheroes”--even calling them rockstars!--while ignoring the more ignoble underbellies of its idols. In other words, leadership is worshipped without any clear grasp of the leaders' real contributions, while failure at the top is generally underplayed or ignored, at least financially speaking. This lack of proportion and balance is not by accident, as it is fully in the financial interests of the so-called "leaders." As for the followers and bystanders, these incredulous groupies--retarded court jesters wearing grizzled suits--happily allow themselves to get played as fools. They are dominated, not led, for the weak can dominate but not lead the herd animals.

Besides pointing to the utter bankruptcy and banality of business leadership, the case of Thain demonstrates that the system of corporate governance in the U.S. is broken even as it continues on as the status quo. Sadly, stockholders as a group are severely over-exposed to risk as a result. As long as top executives get what they believe they are worth, they will see to it, in a “by the way” fashion, that stockholders do not lose everything, but is this enough? Must stockholders (and society itself) settle for this? Are they even aware of the risk to their wealth as CEOs risk all to make sure they are taken care of? In academic terms, the system of corporate governance is incurring huge agency costs, yet I suspect we (and stockholders) are blind to their magnitude. As a society, Americans have a bad habit of taking the word of vested interests, who get away with making excuses or simply opining that there is no problem, after all. We assume that executive compensation is set by the invisible hand of the marketplace because it is in the executives’ financial interest that we take this bait and swim along with it in our gullible mouths. We are like fish that do not even realize that there are hooks in our mouths!

It does not occur to us, or to stockholders, that competent managers are out there who would gladly take top management positions for much, much less. Corporate executives have engineered a coup of sorts, having separated ownership from control at the expense of stockholders and even systemic risk in the financial system. The suits have even captured the government, such that stockholder votes on compensation are legally non-binding. This is not the invisible hand connecting demand and supply in the labor market; rather, it is a result of a rich velvet coup under the subterfuge of capitalism and democracy—with the electorate completely beguiled. Let’s not pretend this is the free market doing this, or that the governments in the U.S. are oriented to protecting the interests of stockholders and the public at the expense of the corporate managerial class.

See Essays on the Financial Crisis.

Sources:

Eric Dash, “The Lucrative Fall from Grace,” New York Times, September 30, 2011. 

Gred Farrell, Crash of the Titans (New York: Crown Business, 2010). On Thain's bonus, see chapter 16.

Executive Compensation (Part I): Systemic Risk

In the wake of the financial crisis, according to the Huffington Post, “a number of the nation's largest banks were excused from the government's rescue program before they had returned to a position of complete financial security -- in part because they wanted to avoid restrictions on how much their executives would get paid, according to a new report from the program's government overseer. Citigroup, Wells Fargo, PNC and Bank of America successfully lobbied to leave the federal bailout program early in 2009, even though the Federal Reserve Board and the Federal Deposit Insurance Corporation had recommended they take additional steps to shore up their assets, according to a new report from the Special Inspector General for the Troubled Relief Asset Program, a government watchdog office. Regulators, including the Treasury and the Federal Reserve Board, eventually ‘relaxed’ their criteria for letting the banks out of the program, the report says, leaving questions about whether the banks had strengthened their holdings enough to be able to withstand another systemic crisis.”[1]

The Huffington Post reports that according to SIGTARP, in 2009, the “four banks repeatedly tried to leave the bailout program, also known as TARP, ahead of schedule, claiming that the stigma attached to the bailout would damage investor confidence in their stability. Bank of America was especially persistent, submitting 11 separate exit proposals to the Federal Reserve Board in less than a month. The banks, particularly Citigroup and Bank of America, also expressed concern that if they stayed in TARP, they would be subject to the program's restrictions on executive compensation.

"Ultimately, the federal banking regulators ended up bowing to pressure" to let the banks leave early, said Christy Romero, Acting Special Inspector General for TARP and the author of the report. Romero added that in the event of another shock, many banks could be left with too little capital to endure, raising the possibility that "it could potentially trigger an avalanche of severe consequences to the broader economy." As a result of the regulators’ lenience, Romero told The Huffington Post, the financial system is still carrying considerable systemic risk from huge, interconnected banks, well after the meltdown of 2008. "The institutions that were 'too big to fail' ... are bigger than they were before," said Romero. "It's very critical that regulators remain vigilant to banks' demands to relax capital requirements."[2]

In short, the U.S. Government and its central bank, the Federal Reserve, acquiesced on bank executive’s desire for more (i.e., greed) at the expense of reducing systemic risk. That the bankers presumed themselves as being in a position to lobby—especially to obviate compensation restrictions —given the roles played by the banks in the mortgage securities crisis, is astounding, as is the obsequious reaction of the regulators. The dynamic itself evinces the U.S. as a plutocracy rather than as representative democracies. Furthermore, the motive of the bankers demonstrates a continued fixation on gain at the expense not only of the system (i.e., systemic risk), but also of stockholders. 

See Essays on the Financial Crisis.

1. Alexander Eichler, “BofA, Wells Fargo, Citigroup Left TARP Early to Avoid Restrictions on Executive Pay,” The Huffington Post, September 30, 2011.

2, Ibid.

CEO Pay: American and European Values

To what extent do inequalities in wealth accrue based on structural elements, such as tax deductions that only wealthy people can use, as distinct from factors pertaining to individuals, such as talent, sacrifice, and effort? The two clusters can build on each other, as people who have become rich primarily by exercising a talent and working hard use some of their accrued power to “reform” the system to their advantage at the expense of the poor and middle class. Such structural reforms in turn can make it easier for wealthy people to become even richer. In the context of a society in progress, structural and idiosyncratic factors doubtlessly interact—the trend being of an increasing chasm between the rich and poor. 

 

 

For example, as the graph above indicates, CEO compensation in the U.S. increased at a higher percentage rate than did corporate profits and factory worker pay every year from 1990 to 2005. In 2010, CEO compensation increased 27% while workers saw their compensation increase just 2.1 percent. Meanwhile, the poverty rate increased from 12% to 14%. CEOs in the E.U. were making comparably less. Foreign Policy in Focus reports that in 2006, for example, “the 20 highest-paid European managers made an average of $12.5 million, only one third as much as the 20 highest-earning U.S. executives. The Europeans earned less, despite leading larger firms.” I suspect that societal values have a lot to do with the difference, though changes in the make-up of American executive compensation should not be ignored.

Specifically, the ratio of pay between an American CEO and factory worker has been increasing in part to the growing proportion of executive compensation in the form of stock options. However, it is also true that Americans are relatively accepting of very high incomes (and inequality). A European is more likely to say, Enough is enough once a CEO has made far more than he or she could ever use. Politically, this is reflected in the fact that the Green Party and the Party of the Left are more powerful (and represented) in Europe than in America. Although the American two-party system acts to cut off the “extremes,” I suspect that the proportion of Americans who would agree with a European far-left party is less than in the E.U.

According to Foreign Policy in Focus, “In the United States, only 32 percent of the public [in 2007 supported] an outright pay cap on executive earnings. But average Americans [appeared] to be every bit as outraged over CEO pay excess as average Europeans. Indeed, 77 percent of Americans [said that] corporate executives "earn too much.” This disconnect, which I submit does not exist in Europe, reflects the American value on economic freedom and the association of freedom with putting up with someone else’s objectionable views or conduct.

In Europe, during and after the recession of 2008, “the idea of raising taxes on high-income earners” gained currency. New E.U. and state taxes were proposed, including a tax on financial transactions (E.U.) and a one-time levy on high-income individuals. In the state of Britain, the tax rate on the highest segment was increased from 40% to 50%, and in the state of Italy the government was considering in 2011 an additional 5% tax on annual incomes above 90,000 euros and a 10% on incomes over 150,000 euros. Considering the increasing fiscal demands being put on the E.U. Government and the pressing debt situations in many states, the recessionary risk of increasing tax on the rich may well be worthwhile. Indeed, Liliane Bettencourt and fifteen other billionaires made an open plea for a special tax on the European rich. Recognizing that they had benefitted financially from the European “structure,” they wanted to help preserve it.

As valuable as closing budget-gaps by revenue and spending reforms at the state and E.U. levels is, the matter of addressing a cycle of increasing economic inequality remains unanswered. If a given societal structure acts as a multiplier effect on a given inequality—exacerbating it, in effect—then something more than a new tax may be needed. In other words, any bias in the system that increases the inequality can be neutralized by the addition of a countervailing structure. For example, placing a strict limit, such as $1 million, on what an individual can inherit—with the rest going back to society via the state—would act to counter the “snowball effect” of “old wealth.” At least as of 2011, a person can live comfortably on $1 million; the surplus, being essentially surfeit with respect to what  person is apt to consume, would be better used as a corrective of the tendency of wealth to further accumulate among the rich. In other words, just as banks with assets over $1 trillion are too big to fail, a billionaire getting richer may not be worth the “cost” to society in terms of the increased inequality—to say nothing of the probable compromise to a republic form of government (which can often be too easily bought).

In short, income and even accumulated wealth can reasonably be considered as applying generally to one’s life (and those of one’s kids and grandchildren) and more particularly to being used (i.e., spent). If one’s wealth vastly exceeds what can be spent on things one can consume, this might be an indication that the concentration has gotten out of hand, at the expense of society itself. In other words, if you have a bank account with a balance of $15 billion, do you really need $5 billion more?  Will you ever use it? There is an opportunity cost—part of which being contributing back to society and reducing the economic inequality. Even so, this way of thinking reflects a value on solidarity that is much more European than American, at least in terms of being valued. In other words, the typical American would be more likely to object to any limitation on economic freedom, even if the playing field is tilted in the direction of the wealthy being able to take disproportionate advantage of that freedom, irrespective of whether the additional wealth is usable.  

Sources:

David Gauthier-Villars, “Wealthy French Push for Extra Tax,” Wall Street Journal, August 24, 2011. 

Matt Krantz and Barbara Hansen, “CEO Pay Sours While Workers’ Pay Stalls,” USA Today, April 4, 2011. 

Sarah Anderson, “Executive Pay Debate Raging in Europe and the United States,” Foreign Policy in Focus, August 28, 2007.