Congress Should Not Cap CEO Pay, But Look at the Deeper Problems of Corporate Governance

It needs to be said: The Congress of the United States has no business setting the terms of executive compensation. That is not how capitalism is supposed to work.

But then again, the US Government has no business giving tens of billions of dollars to corporations, and getting nothing in return but a hope and a prayer. That is not how capitalism is supposed to work, either.

Take Citi. This Thursday, the market value of Citigroup--the icon of the American banking establishment--was $18.3 billion. That is to say, at least according to the old school rules, that for $18.3 billion, you could purchase all of the common stock of the company. For something less than that, you could purchase enough shares to control the Board of Directors.

Yet, over the past few months, the US Government has invested $50 billion in Citi. In the parlance of the venture capital world, we invested $50 billion in a company, and the "post-money" value is $18.3 billion. Suffice it to say that the "pre-money" value--the value of the company before the infusion of new capital--was a big negative number.

By any normal measure, Citi was insolvent. The common equity was worthless, but for the infusion of public money. So, all of the arguments of nationalization are somewhat academic. The federal government did not wipe out the common equity holders, the market did. If there is market value remaining, it exists only at the sufferance of the US taxpayers. The only question is what how the government should be asserting its rights and privileges.

In a normal world, an investor who bails out an insolvent company takes control of the board of directors--by one means or another. And any appropriate controls on executive compensation--on bonuses and the like--are subject to the control of the board, as they are in any corporation. But what seems to be broken in all that has transpired over the past few years, is that the fundamental concept of board control and corporate governance.

The notion is simple. A corporation is a company owned by stockholders. The stockholders elect a board of directors to serve their interests in the governance of the company. The board hires and fires the chief executive and the management team, sets compensation, and establishes corporate policy and the like.

But little has been spoken about the boards of the great American financial institutions that have brought the world economy to its knees. Sure, Robert Rubin has been silenced for his complicity as a member of the board of directors of Citigroup. But little has been said about the more fundamental issues, conflicts and failure of corporate governance that have occurred on our long march toward the abyss.

Richard Fuld, the CEO of Lehman Brothers, who demonstrated an astonishing lack of imagination as he sat before Congress and suggested that, even in the wake of the financial collapse, he could not think of a single thing that he would have done differently if he could do it all over again. Fuld served as both Chairman and CEO of Lehman Brothers, a not uncommon situation in corporate America where a CEO effectively reports to him or her self, evaluates his or her own performance and sets his or her own compensation.

If Lehman had been a partnership--as it was for most of its corporate existence--perhaps this conflict would be acceptable. But for a publicly traded company, this relationship violates one of the central tenets of corporate governance: That the CEO is accountable to the board of directors, and that the directors represent the interests of the stockholders.

AIG further illustrates the problem of the failure of board oversight. The collapse of AIG was directly a result of the company's failure to understand the risks related to its burgeoning credit default swap business. The profits of the global insurance giant became increasingly tied to its credit derivatives business, run by Joseph Cassano, the head of AIG Financial Products. Yet even as Cassano represented that there was no risk of AIG losing "a single dollar" on any of its credit default swap transactions, no one on the board managed to ask the simple question of why sophisticated financial institutions--the counterparties on the other side of those transactions--would willingly pay AIG billions of dollars annually, if there was no risk of loss. Presuming that all of those sophisticated counterparties were not fools, a board member might have asked, how can that be?

Looking back over years of financial crisis and collapse, and one common thread has been the failure of board governance of public companies. The savings and loan debacle. The collapse of Drexel Burnham Lambert. Enron. Each was characterized by boards who had lost site of their central purpose: To hire and fire the CEO, set corporate policy, and serve the shareholder interests.

Congress should take no action to set the terms of executive compensation. The problem that needs to be fixed is more fundamental: The failure of the fundamental governance structure of public companies. In the investment banking world--in the world of risk--perhaps it is time to return to partnerships and assure that when capital is at risk, people are too. But the days of the cozy insider boards needs to end. The cost--to the shareholders and the public alike--is too high.

Whether or not the Treasury controls the boards of directors in companies where the common equity has been functionally wiped out is not the salient question, though certainly there is not a true capitalist in the country who would debate whether after a $50 billion investment into a $18.3 billion company, anyone but the US Treasury is entitled to control. The question is how board accountability and responsibility should be reestablished--both for the recipients of TARP funds and across the corporate landscape.

Comments

[plumnelly]

when they began outsourcing American jobs and using H1B Visas to drive down the American worker's wages they lost the argument to not have their wages capped. Remember when one of these big banks brought in foreign workers to replace American workers. No, these financial wizards don't deserve $1, let alone to continue to be paid exorbant salaries not related to changing economic times. Hell,no!

[exhale09]

I have read through all the comments here and I am encouraged and impressed by so many of them.
In my opinion they are intelligent, logical, rational, valid...and many are very informed.

What I want to know is why we do not here any of these kind of comments from our Representitives?

[joebaggadonuts]

I agree that the caps are mostly window dressing, but disagree that they should not be imposed. Sometimes you have to advertise for effect, even if you have to give away the free samples you promised.

The resentment politics to which the R's have played so well for the past 30 years will not simply evaporate. Might as well use it to get real reform, with the window dressing they insist upon.... keeping the execs who control things in line with salary caps.

Why not?

[ThePeacemakers]

This form of Capitalism the US has practiced, has been propped up by government intervention since the days of slavery.
There has never, ever been a "free market system"...
Everytime the big corporations need something they run to the government. What else do you think all those lobbyists are for? They want the government (of the people, by the people and for the people) to be (of the corportations, by the corporations and for the corporations).
It's always been privatize profits and socialize losses way before this crises. There is a place for business, but it's time business learned it's place.

[unhipcat]

Maybe Congress does not have the right to tell companies how much to pay their executives, but they certainly have the right to determine how tax dollars are spent. If these clowns don't want the government to interfere, they should run a company without bankrupting it and then begging for federal money -- which they then want to use for their own bonuses and tents at the Super Bowl and retreats at seaside resorts..

[magen]

The American People have EVERY RIGHT to demand to know where our hard-earned tax dollars are going if these A-hole CEO's are gonna take them.

But if you wanna really change the system you have to change the "quarterly profit" game.

This is the root cause of the philosophy of --"it's all good as long as the bottom line is in the black, no matter who gets effed."

Make money fast and get out before everything blows up is not a sustainable economic policy.

[nthelurch]

Prior to 1980 (Reagan Revolution) there was a different kind of salary cap. It was called a marginal tax rate of 70% on income earned in excess of $214,500. By the end of the Reagan era, we were enmeshed in the era of greed which caused this problem and the top marginal tax rate was 28%.

Suddenly it wasn't a waste to pay huge CEO salaries and here we are today.

[stanjz]

Inferior products and businesses fail in Capitalism. We don't have that. Look at Microsoft Vista and Explorer. Look at the performance of these banks. We have corporatism/fascism in the United States.
Our media is corporately controlled. Do they talk about how almost the entire deficit is from Republican Presidents? Do they mention that 4 out of 5 of the top earmark per capita states are Republican states?

[paixa3]

Disagree. Both investigation and capping are needed. Not one or the other.

[mercury613]

The Congress of the United States most certainly DOES have business setting the terms of executive compensation when said executives receive bailout money as a result of their corporations' irresponsible actions.

What a crock.

[Rule Of Law]

"That is not how capitalism is supposed to work."

Hmmm....you have the Ivy league credentials, David, so tell us how Capitalism is supposed to work? By giving billions without any strings attached to the same great minds that created the mess in the first place? If you were writing your Phd thesis, how do you think that idea would fly with your advisors?

[paixa3]

The advisors would pass him with flying colors. Your educational system ranks 21 out of 22 of industrial nations in quality and FIRST in cost.

The problem is that you have an educational system that lacks actual expertise. I know too many professors who have NEVER had a real job, IN THEIR FIELD OF EXPERTISE.

A few real LOSING examples, Condi Rice and Phil Gram. This IS reality of the USA educational system.

[Rule Of Law]

And to ensure that is remains that way, one of the first things they stripped--and the Dems allowed--from the Stimulus, was money for education. Why are we not surprised?

[BadgersBite]

CEO's have proven time and agin that they cannot regulate themselves when it comes to their own pay. I for one don't want the money they are borrowing from the taxpayers to pay for some greedy CEO's 30 millon dollar bonus. When they've paid back all the money they've borrowed then they can do whatever they want with their pay and bonuses, until then everybody knows they cannot be trusted to use the money wisely.

[Euroflycars]

Why cap only the CEOs' salaries? Ins't greed motivated by total personal wealth rather than mere annual income? Hence the total assets a single person may accumulate should be limited to, say, $50 million -- or could anyone pretend not to be quite happy with that much? And a still better idea might be to also limit the total assets a company or corporation may own...

Capitalism's unlimited greed versus communism's zero property tolerance -- the right choice may lay somewhere in between.

The excellence of cross-bred dogs, cats, and motorcars is well known -- and so is the excellence of cross-bred people (e.g. Barack Obama)... the English language itself, a hybrid resulting mainly from French and German, shows to be superior to either of its constituents.

The key to hybrid excellence is indeed the combination of the mutual advantages without the respective shortcomings.

Hence combining the strengths of capitalism with those of communism without their respective weaknesses may be the only way out of the crisis -- so when do we start calculating 5-year-plans instead of continuing with bad governance based merely on wishful thinking and ruthless power?

[ratail]

There is a sharp distinction in the United States between firms that can sells equity directly to the public (public firms) and those that cannot (private firms). In order to have the privilege to sell equity on public markets here, firms must obey tons of rules promulgated by the SEC and others. Firms have a choice -- do not sell equity on the public markets, if they want to avoid SEC rules and regs.

Try this:

1. Flat out default cap all individual compensation at $5M in total compensation, and index this cap to the S&P 500. Firms can play with the cash and equity pay mix as they compete for talent.

2. Take away the automatic broker/dealer vote on directors, and open up all public company shareholders lists to public scrutiny, so that different parties can compete for votes during directors elections (right now, even the companies do not know who most of their shareholders are, thanks to NOBO/OBO rules that protect only broker/dealers.

3. Give public firms the right to pay up to a $25M cap, indexed to SP 500, with at least a portion at risk for performance, if they get a shareholder vote to exceed the cap every year.

4. Tax all stock transactions a tiny amount, give the money to this SEC / PBAOC, and have PBOAC pick and pay for the audits of all public firms, including detailed reports on compensation compliance.

[overd0g1]

In fact, the government doesn't have the right to do it. On the other hand, the government, as an investor, has a right to put conditions on the acceptance of it's "investment". As long as the company has the right of refusal, there isn't an issue. The money and the terms are a package (at least going forward). The pay condition wasn't part of the original deal, so now it's too late to revisit the original allocations.

[AnnfromCA]

I agree. Frankly, most of us should not participate in Wall St. at all, given the repeated willingness of boards to completely steal from shareholders and reward risks that work against them.

Better to invest elsewhere.