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.