On the Unfairness of the Bonus System on Wall Street

Craig A. Dubow, Gannett’s former chief executive, had a short six-year tenure that was, by most accounts according to The New York Times, “a disaster.” David Carr reports: “Gannett’s stock price declined to about $10 a share from a high of $75 the day after [Dubow] took over; the number of employees at Gannett plummeted to 32,000 from about 52,000, resulting in a remarkable diminution in journalistic boots on the ground at the 82 newspapers the company owns. . . .  the company strip-mined its newspapers in search of earnings, leaving many communities with far less original, serious reporting. . . . Not only did Mr. Dubow retire under his own power because of health reasons, he got a mash note from Marjorie Magner, a member of Gannett’s board, who said without irony that ‘Craig championed our consumers and their ever-changing needs for news and information.’ But the board gave him far more than undeserved plaudits. Mr. Dubow walked out the door with just under $37.1 million in retirement, health and disability benefits. That comes on top of a combined $16 million in salary and bonuses in the last two years.”

Besides the inherent unfairness in an incompetent manager getting millions of dollars in compensation (for championing incompetence?), it is morally problematic when, as Carr puts it, “the consequences of bad decisions land on everyone except those who made them.” As already pointed out above, in the midst of Dubow’s “championing” (this word is so broad it has scarce any real meaning), “the number of employees at Gannett plummeted to 32,000 from about 52,000.” One could just as easily point to Bank of America’s downsizing of its labor force in the wake of Ken Lewis’ shopping spree at Countrywide and Merrill Lynch. Lewis really did exemplify the “walmart” mentality applied to banking: an almost-complete indifference to quality in a desire to be everything to everyone. The “exporting” of bad consequences while exuberant rewards are retained indicates that the corporate executive compensation system in the United States is fundamentally broken. The fixation on aligning an executive’s incentives with the financial enrichment of the stockholders has not functioned as anticipated.

For one thing, the vesting of stock, which is meant to orient an executive to the longer term financial interest of the stockholders, is typically bypassed as an executive gets the equivalent in cash (or stock) from his or her new employer. An executive can thus discount having to look out for the eventual downside in his or her decisions.

Moreover, the sheer amount of the compensation cannot be justified on the basis of a competitive upper echelons labor market (which functions more like an oligarchy). Indeed, the degree of fixation on the bonus system alone has resulted in larger payouts (as executives make decisions primarily from the standpoint of the impact on their bonus). David Carr points to the excess as mentioned in a USA Today editorial: “The bonus system has gone beyond a means of rewarding talent and is now Wall Street’s primary business. Institutions take huge gambles because the short-term returns are a rationale for their rich payouts. But even when the consequences of their risky behavior come back to haunt them, they still pay huge bonuses.” Carr’s overall point is that this hypertrophy allies to corporate America—not just Wall Street, though certainly it is salient there too.

When John Thain of Merrill Lynch gave lip-service to serving the stockholders, even his own subordinates knew he was more concerned with having to play second fiddle to Ken Lewis at Bank of America than with keeping Merrill’s stockholders from losing everything (as Lehman Brothers’ stockholders did). Even as Fleming got $29 per share as a buyout price from Lewis, Thain preferred a line of credit of billions from Goldman Sachs in exchange for a 10% ownership that would keep Thain on top. That was Thain’s driving motivation: to remain CEO. Meanwhile, the general public assumed that CEOs, including Thain, were motivated to act in their stockholder interests—that boards of directors insisted on this agency. However, where a CEO is focused on his or her bonus (Thain insisted on $40 million cash bonus even as Merrill was losing billions) and position (and thus future bonuses) and the CEO controls “his or her” board, the stockholders are in actuality left unknowingly fluttering in the wind—relying on a system of executive compensation that supposedly aligns the executives’ motivation with the financial interests of the stockholders. Much too much is being assumed here, yet assumptions, like habits, are difficult to break.

Source:

 David Carr, “Why Not Occupy Newsrooms?” The New York Times, October 24, 2011. http://www.nytimes.com/2011/10/24/business/media/why-not-occupy-newsrooms.html

Tyco’s Kozlowski: Isolation or Work-Release?

L. Dennis Kozlowski, a former CEO of Tyco, was denied parole “due to concern for the public safety and welfare,” according to the New York Department of Corrections.[1] A parole board ruled that releasing him in 2012 would have the effect of minimizing his corporate crimes and affect public safety. The board concluded that early release would “not be compatible with the welfare of society at large, and would tend to deprecate the seriousness” of his offenses.[2] He was convicted in 2005 of looting nearly $600 million in bonuses and other payments from Tyco in the 1990s.

As much of a sentence of 8 to 25 years in prison may seem to befit such a case of greed and abuse of corporate position, that Kozlowski was transferred three months before the denial of parole to a minimum-security facility in Manhattan and approved in a work-release program suggests that the seriousness of his crimes did not translate into the punishment after all.

Although white-collar convicts should not be conflated with murderers and rapists, prison should not be conflated with a dorm for the corporate criminals. Put another way, the punishment ought to fit the crime (rather than another, or none). If the sentence includes prison, then prison it should be.

It is worth asking, however, whether prison is suitable for white-collar crime. Put another way, would the public safety really have been compromised had Kozlowski been released early? Does stealing $600 from a corporation without any threat of violence put anyone’s safety at risk? If not, then only enough security to keep the criminals in the prison facility should be necessary, as they are not dangerous. This does not mean an open door policy or giving the inmates permission to go out of the facility to work.

Having to confront oneself for hours without distraction in a cell for a sustained period of time—as if a kid sent to his or her room for hours as a punishment—may well be fitting to the white-collar crime. Furthermore, taking the criminal’s wealth and property and requiring work to repay any losses to others also seems fitting. These two elements ought to be applied successively rather than concurrently so each can have its full effect.

1. Chris Dolmetsch, “Former Tyco Chief Kozlowski Is Denied Parole in New York,” Bloomberg, April 5, 2012; Kevin McCoy, “Former Tyco Chief Told No on Parole,” USA Today, April 6, 2012.

2. Ibid.