Essay by J. Richard Finlay
The blind eye which shareholders and analysts too long cast upon the abuse of excessive CEO pay is now being turned to the recent trend of monetizing ethical abuse. Who knows when the tipping point might come in the ever-widening wealth gap where capitalism is finally seen to cross the river of moral conscience and moves from being trumpeted as a source of social progress and individual incentive to one of middle class tyranny and public opprobrium.
Continuing from Part I
One of the defining features of today’s world of big business is that, too often, shareholders have been willing to turn a blind eye to any amount of pay to a CEO, no matter how disproportionate, as long as they were getting impressive returns each quarter. Never mind how many times poorly crafted compensation devices gave incentives to CEOs to artificially push up the stock when such growth could never be sustained in the long run. As I suggested to the U.S. Senate Banking Committee long before the financial meltdown that traced its roots in part to unsound compensation schemes:
The most corrosive force in modern business today is excessive CEO compensation. Such lofty sums tempt CEOs to take actions that artificially push up the price of the stock in ways that cannot be sustained, and to cash out before the inevitable fall.
Our comments on these pages and elsewhere over the years have also attempted to rebut the most common justifications frequently advanced by boards as to why CEO pay needs to be at the level to which it has skyrocketed.
But the inescapable lesson of history appears to be that no boardroom scandal or financial meltdown is so great, no gap in wealth or income is so wide, that it will deter CEO pay from its self-appointed destiny of creating the wealthiest professional class in the history of the world.
Now a view is emerging in many boardrooms and on Wall Street that appears to regard ethical and legal transgressions, even the kind that result in multi-billion dollar fines, penalties and settlements, as mere transactions. This is the case with JPMorgan Chase, whose profitability is so vast its shareholders are prepared to accept a record settlement with the U.S. justice department for $13 billion (among other penalties) as just another cost of doing business. The stock has risen 28 percent in the past 12 months. Other examples abound, including Bank of America’s $9.5 billion to settle government actions involving federally insured mortgages, $1.2 billion paid out by Toyota and $7 billion in penalties by drug makers GlaxoSmithKline, Pfizer and Abbot.
It is not as if the ethical and legal dimension of business has suddenly dropped onto the corporate landscape unexpectedly. There are more compliance officers and university think tanks on ethics than at any time in the history of business. Every publicly traded corporation has a code of ethical conduct. Company websites all make reference to being committed to the highest standards of ethics and honesty. Most CEOs will give an annual keynote speech somewhere showcasing the social responsibilities of their business. I’ve written many of them over the years myself. Enron had a stellar reputation for commitment to high ethical standards. Its CEO, Ken Lay, liked to be known as “Mr. Business Ethics.” But between the words and the actions of too many companies there falls an ethical shadow. It is much easier to simply assume a standard of ethical performance than it is to subject it to the scrutiny and testing it actually requires.
History is littered with the bleached remains of fallen giants, even of the corporate species. Nortel and BlackBerry not long ago led their industries. Today, one has vanished and the other is quickly disappearing. Some years ago another Canadian institution, Royal Trust, collapsed under the slumbering eyes of inattentive directors and stunned regulators. Livent was North America’s largest publicly traded theatrical entertainment company. But its most artistic accomplishment came in the form of the highly creative, but decidedly unlawful, accounting engaged in by its Toronto-based founders Garth Drabinsky and Myron Gottlieb, who both swapped the company’s swank Manhattan condo for sentences in a Canadian prison.
General Motors had a hammerlock on the North American auto market that was thought to be unbreakable, until it limped pathetically to the wicket of government assistance and declared bankruptcy. The “new” GM is today being rocked by the lingering effects of a culture that dismissed the risk of customer deaths from defective ignition switches as an acceptable business cost. Microsoft, once the dominant force in consumer software to the point where it actually fixed prices, has been reduced to selling software for competing Apple iPads on the rival iTunes store as consumers abandon its signature Windows software in droves. And to the pantheon of vanished business icons, Bear Stearns and Lehman Brothers are now fully inducted, as are their former leaders, Jimmy Cayne and Dick Fuld.
Like many other companies, they were lost to the all-too-common, but entirely avoidable, affliction of hyper-ego and deficient common sense. Before the crisis that claimed them, we often asked here if some of these companies actually had a real board of directors, since it seemed there was little evidence of them when they were most needed.
In situations like these, and in many others, when disaster strikes the board of directors typically professes surprise and claims to have no idea what could have caused it. Memo to board secretaries everywhere: Have a full-length mirror installed in the boardroom.
The idea that there are few outcomes that are not insurmountable when a company skates over ethical and legal boundaries, that a board can throw money at any type of egregious conduct to get past it, is fundamentally subversive to the well-being of both capitalism and society. It feeds the delusion, commonly held by many who enjoy great wealth and power, that certain companies are endowed with a financial shield so impenetrable it makes them invincible to the consequences of their actions. This same view creates a culture of moral hazard where the scale of the transgressions, and the costs necessary to remedy them, inevitably keep getting bigger and bigger until the unthinkable calamity occurs. As the lessons of the great financial crisis of recent years demonstrate, when the unthinkable does happen, the CEOs whose misjudgments caused it have long fled with their trove of stock options profitably cashed out, while ordinary shareholders, and occasionally taxpayers, are left to pick up the pieces.
Far more important than the loss of any one giant, however, is the integrity of the system of capitalism itself. Capitalism cannot survive if its leaders, guardians and gatekeepers remain willing to tolerate such costly misbehavior. Nor will society, whose support it requires, endlessly abide a system that does not convincingly demonstrate that it recognizes a sacred obligation to the public for upholding a standard of ethical conduct that goes well beyond what has been evidenced by many firms in recent years. Lest there be any doubt, twice in the past 100 years, capitalism has effectively turned to government for its very survival in what amounted to a public bailout from the epidemic of excess and misjudgments that led to massive job losses and social dislocation.
It would be the height of folly for the titans of Wall Street and elsewhere to conclude, as a result of these recent multi-billion dollar settlements, that they can simply write a cheque and continue on with business as usual whenever moral impediments stand in the way of increased profitability and outsized compensation.
Business has misjudged the reaction of society to a number of major issues over the years, from the dangers to food safety and the exploitation of child labor to threats to the environment and the need for safer cars. The results were not particularly welcomed by business nor were they predicted by it. And the business world did not exactly distinguish itself by the silence of its leaders in the early phases of the subprime meltdown or for presiding over an inadequately governed system that let America down to the point where corporate welfare through the generosity of government became capitalism’s only hope. When high profile tycoons like former GE CEO Jack Welsh and Home Depot’s billionaire co-founder Ken Langone bemoan the expressions of antipathy toward Wall Street and big business, voicing puzzlement over its cause, as they regularly do on CNBC, for instance, they betray a larger disengagement from the forces that shape the social and political dimensions of modern capitalism.
Who knows when the tipping point might come in the ever-widening wealth gap where capitalism is finally seen to cross the river of moral conscience and moves from being trumpeted as a source of social progress and individual incentive to one of middle class tyranny and public opprobrium. A firestorm of outrage may be in the waiting.
In that context, it is not unreasonable, and certainly not imprudent, to suggest that if a more fair and honest culture consistent with the core values with which America has always approached its concentrations of power, is not soon embraced, if the idea that ethical abuse can be monetized is not quickly dispelled starting with capitalism’s most valued icons, the costs to investors and to society will be measured in more than the Sagan-like billions and billions tallied thus far.
An Essay by J. Richard Finlay
on corporate integrity in the post-bailout era
Recent multi-billion dollar settlements involving Bank of America and JPMorgan Chase show the staggering costs of ethical folly and the culture of moral hazard that places too many companies, and capitalism itself, at risk.
It is the curse of giants to believe in their own invincibility. It is also the curse of their acolytes, as the White Star Line discovered with its “unsinkable” Titanic and the Philistines learned with the defeat of their champion Goliath at the hands of a young shepherd boy. Yet these lessons, and countless others, over millennia have not dispelled such illusions in the world of business, where size is seen as an insulator against all manner of misadventures and the too-big-to-fail mentality shows few signs of abating. Indeed, the extent to which America’s major banks and Wall Street icons were on the wrong track when it came to compliance with the law and standards of ethics during the great financial meltdown and even afterwards is becoming even more striking. Recent reports involving Bank of America, Citigroup and JPMorgan Chase vividly make the point.
On these pages in the years and months leading up to the worst financial crisis since the Great Depression, and in numerous op-ed columns before that, I wrote about the dangers of relying on the myths of giants. Until they were categorized as being too big to fail, corporate monoliths like Bank of America, Citigroup and JPMorgan Chase were viewed as being too smart to fail. Trophy directors and fantastically compensated CEOs, with the assistance of huge PR departments that never seemed to sleep, worked overtime to present an image where success was virtually guaranteed. The reality, however, was that too many boards were recklessly disengaged from what was happening around them. Seeds of folly were being sewn by undersupervised employees more interested in creating clever short-term financial devices than sustainable building blocks of long-term business. And too many investors and journalists had become prisoners of what I call cheerleader capture. First cousin to the condition of regulatory capture, this refers to the state where it is virtually impossible for any dissenting voices to penetrate the thundering chorus of cheers by insiders and their loud choir of supporters.
There were warning signs of the unwise effects of that mindset, to be sure. Scandals involving security analysts, for instance, for which Henry Blodget became the poster-boy, revealed the dangers of a culture of cheerleader capture. In too many cases, the analysts who were supposed to be delivering objective assessments of the financial health of companies enjoyed personal and career incentives that caused them to paint a more glowing picture than justified by the facts. Citigroup was touched in several ways by that scandal.
There were the accounting frauds at Nortel, Enron and Worldcom that were so stunning they resulted in landmark legislation known as the Sarbanes-Oxley Act being passed. The collapse of Hollinger and Livent provided an interesting coda to those scandals. If these events of just a few years earlier had been taken seriously, they would have produced a higher standard of boardroom oversight that might have prevented the blunders and financial chicanery that brought the world to the brink of the financial abyss in the first decade of the 21st century.
But even before the gales of that crisis rose to full force, this space questioned the governance practices of companies like JPMorgan Chase, Citigroup, Bank of America, as well as Countrywide and Merrill Lynch, two institutions which BofA bought. We took frequent issue with the sweetheart boardroom deals that propelled their CEOs into the super-compensation stratosphere. We felt that the excessive deference accorded many CEOs reflected a perilous level of disengagement on the part of boards which in turn were failing to exercise the independent judgment needed to fully protect investors and the public franchise of capitalism itself.
Many of the decisions these companies made were fraught with ethical failures, violations of the law and just bad business thinking. Their consequences are coming home to roost even years later. Bank of America recently agreed to pay $9.5 billion in fines to settle civil lawsuits with U.S. federal housing authorities. Ken Lewis, the company’s former CEO, settled with regulators by paying $10 million personally. All told, it has cost BofA some $50 billion to resolve a variety of claims stemming from the subprime era, including the fraudulent actions of Countrywide Financial and misleading statements made in connection with the bank’s purchase of Merrill Lynch.
Improprieties at JPMorgan Chase resulted in an astonishing $20 billion being handed over to various regulatory authorities. The amount barely caused a ripple on Wall Street, where reaction to the announcement registered nothing untoward in respect of JPMorgan’s stock or the reputation of its CEO, Jamie Dimon.
Citigroup, which has also paid out huge amounts to settle regulatory claims, recently failed the Fed’s financial stress test — for the second time in two years. Its stock languishes at the unconsolidated 1-for-10 equivalent of the same $5 range it was at during the bailout crisis. Were its recent history of losses, bailouts and scandals not sufficient, there are new regulatory and legal issues arising from a potential fraud involving Banamex, a Mexican subsidiary. In one day early this April, Citigroup’s shareholders were hit with a double whammy. The company said that it was unlikely to meet a key profit expectation it had set and then announced it was paying $1.12 billion to certain investors to settle claims stemming from mortgage securities sold before the financial crisis.
Yet the level of shareholder outrage one might think would be directed at Citigroup’s board for this Job-like litany of woes has, for the most part, failed to surface, just as tolerance of years of poor boardroom practices and bad decisions earlier led to a cascade of scandals and financial losses culminating in the bank’s liquidity crisis that prompted the U.S. government bailout in 2008.
In no case has any banking or Wall Street executive faced jail time as a result of the misdeeds that resulted in these record massive payouts or those of other companies. By contrast, in any given day on Main Street, courts routinely hand out jail sentences to elderly seniors convicted of shoplifting and single mothers who pass bad cheques for even small amounts.
Like the notion of billions and billions of stars in the cosmos often attributed to the late Carl Sagan (with the help of Johnny Carson), it is hard to get the mind around the scale of these fines, payouts and penalties. And in the case of Bank of America and JPMorgan Chase, and numerous other companies from drug makers to car manufacturers along the way, it seems nobody is even trying.
What seems to be happening instead is that the wrong-headed mindset that gave birth to excessive CEO pay has infected other fields of business responsibility and decision-making. We explore this further in Part II.
Never in the history of modern business leadership have CEOs been paid so much to achieve so little at such cost to so many.
At the opening hearing of the Financial Crisis Inquiry Commission held in Washington this week, key players in the worst financial meltdown since the Great Depression admitted they did not see it coming. The chairmen and CEOs of JPMorgan Chase and Goldman Sachs, Jamie Dimon and Lloyd Blankfein, and the chairman of Morgan Stanley, John Mack (who used to be its CEO as well) all testified that they were surprised at what happened. They now agree they were overly leveraged and did not handle risk with the respect it deserved. Mr. Dimon apparently never contemplated the possibility that housing prices would stop rising, much less decline.
It seems that Messrs. Dimon, Blankfein and Mack had as much vision in anticipating the downturn, and the folly of some of their assumptions about growth, as over- extended buyers of subprime mortgages had. Except that Dimon, Blankfein and Mack were not struggling low-income homebuyers who took on one too many bedrooms. They were among the highest paid executives on the planet whose word commanded deference and awe among much of the investing public, the media and an ever-admiring circle of policymaker-groupies.
Over the five years leading up to the subprime debacle in 2008, these three men were collectively paid more than $310 million. For the year 2006 alone, when so many of the seeds of disaster were being sewn on Wall Street and among its top banks, Mr. Dimon was paid $57 million and Mr. Blankfein $38 million. When Mr. Mack rejoined Morgan Stanley in June 2005, he was awarded stock worth $26 million on day-one, and a further $13 million in compensation and benefits for his first five months of work. In December of 2006, Mr. Mack was awarded a bonus of $40 million on top of his $1.4 million salary.
As they were being paid these sums, much of the world was increasingly convinced that these were proper incentives to ensure alignment with shareholder interests. They earned every penny million, it was thought. The prevailing view, especially among the wishful thinking and the non-thinking alike, was that such men were really superheroes whose ability was so unique and so far beyond those of ordinary mortals, the fact that their feet touched the ground when they walked was seen merely as one of their many generous concessions to convention.
They were not alone, of course. There have been hundreds of CEOs who have happily participated in the greatest transfer of wealth of its kind –a transfer that, for all the soaring salaries, bonuses and stock options, has ultimately seen the worst economic crisis since the 1930s, the highest job losses in generations and a stock market performance over the past ten years that has produced virtually zero gains, except for the titans and bankers who managed to cash out before the fall.
The 21st century began with a series of corporate scandals involving companies like Enron, WorldCom, Tyco and Hollinger. It ended its first decade in the throws of the worst financial failure in modern time. One thing stands out to mark the beginning of this period and its end: the folly of executive compensation. In 2002, we warned Congressional committees: “The most corrosive force in modern business today is excessive CEO compensation. Such lofty sums tempt CEOs to take actions that artificially push up the price of the stock in ways that cannot be sustained, and to cash out before the inevitable fall.” The extent of that corrosion and fall is apparent today. The consequences in taxpayer dollars soar into the trillions. The costs in human terms remain beyond calculation, as does the loss of confidence in corporate leadership.
More than just Lehman Brothers, a few banks and a couple of Detroit automakers went bankrupt in this period. The trust of workers, the middle class and pensioners in corporate management and governance has also collapsed. There may be a seismic ruin of jobs, dreams and foreclosed homes on Main Street. But on Wall Street, where people like Mr. Dimon, Mr. Blankfein and Mr. Mack still command adulation for their leadership and vision, the Fed-supported, taxpayer-rescued towers of finance give hope and comfort to those still requiring generous bonuses to get through their Tiffany-challenged day. The magnitude of their gains this year, less than 18 months from a once- in-a-lifetime experience looking into the abyss, promises also to set new records, which, like housing prices, is something Mr. Dimon thinks should go only one way, too. Recently, he announced that he was sick and tired of the criticism being leveled against Wall Street on the compensation front.
These are forceful accelerants to the rise of Turbo Populism, the term we coined on these pages and will be speaking more about in the future.
Had the world the benefit of a modern Churchill capable of battling the monstrosity of betrayal and failure these titans of excess have wrought, he would surely have given voice to a mood that is thundering across the land from kitchen tables and church pews to swelling unemployment lines and Twitter postings: Never in the history of modern business leadership have CEOs been paid so much to achieve so little at such cost to so many.
This is a reality that escaped the CEOs who appeared before the Congressional committee this week. They do not escape our sense of outrage.
One of the dangers of excessive pay is that it tempts CEOs to think that maybe they really are god-like superheroes. But few have actually boasted about the role like Goldman Sachs’ s Lloyd Blankfein.
It has been a consistent view of these pages, and one much longer voiced by its author over some two decades, that executive compensation poses a number of systemic risks to companies, to the institution of capitalism and to society generally. One of those risks, the effects of which is being experienced in the economic slowdown today, is that stratospheric compensation tends to distort how CEOs view the world and tempts them to venture into unwise and perilous territory (see, for instance, 40-to-1 debt leverage; unbooked credit default swaps and subprime mortgages). Some are inclined to believe that they truly are the god-like superheroes they would have to be in order to justify pay levels that swell into the high tens of millions on a regular basis. Now, we have additional proof for our theory.
Earlier this week, the Times of London reported Goldman Sachs CEO Lloyd Blankfein, whose compensation in 2007 amounted to more than $70 million, as saying that he was doing “God’s work.” Goldman has always been filled with heavy-hitters who go on to exercise considerable sway in government (see Henry M. Paulson Jr.). It seems the influence has taken on a decidedly out-of-the-beltway, even out-of-this earth, tone.
It is difficult enough for Goldman to justify the compensation it regularly doles out. To add to that PR nightmare by taking on the role of an emissary from God may prove to be more than even this fabled company can pull off. Such talk only serves to divide Wall Street from Main Street further at the very time when public confidence in America’s financial institutions, and respect for its captains, still remains fragile.
Paying millions to a CEO like Mr. Blankfein, or any number of his contemporaries, can get you, well, a very highly paid CEO. But can it get you a leader who personifies both common sense and good judgment and is able to avoid making stupid statements that cause him and his company to be the laughing stock of late-night comedians and op-ed page commentators? That is the question, rather less for heaven than for earth, where the generous American taxpayer, and not Divine providence, is most responsible for placing Goldman Sachs, and the Wall Street economy it depends upon for its success, back on track.
AIG’s bonuses have become more than just a tipping point for a long simmering resentment over executive compensation. They have become an entire gravitational force field of umbrage at the greed, arrogance and now horrifically costly stupidity on the part of these Wall Street masters of the universe, as they preferred to be called in times of a calmer CBOE volatility index.
(Wall Street tycoon)
We are shocked, shocked, to find government trying to interfere with free market capitalism.
Here is your share of the TARP bailout, sir.
(Wall Street tycoon)
Thank you very much.
Recent events make it easy to imagine such a remake of Captain Renault’s iconic lines from the classic film, Casablanca. But even the highly creative Epstein brothers, who wrote the original screenplay, would have trouble accepting that the hypocrisy uttered on Wall Street today would make for credible dialogue. Believe it. (more…)
When bank CEOs tried to fall into line before an outraged Congressional committee, they were a little disingenuous about the true extent of the sacrifice they are bearing.
It is widely held that in the worst economic crisis since the Great Depression, an absence of meaningful transparency has been a major culprit. Too much in the financial sector was done in a less than open and clear fashion, and today uncertainty in respect of the true state of these institutions remains a chief cause of uneasiness in the market. This is a time when candor in the banking industry is needed as never before.
One might have thought that the CEOs of these institutions would have realized that and been prepared to demonstrate such a commitment, especially when their every word and action was being scrutinized by the world press and some of America’s top lawmakers. But when the CEOs of Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street, and Wells Fargo testified before the House Financial Services Committee this week, they were less than forthcoming on an issue that has become a flashpoint in the current crisis: CEO compensation.
True, all the CEOs who appeared before the committee boasted that they have not received, or will not accept, a bonus for 2008.They know that the public is expecting some level of sacrifice, given the dire state so many families are in today.But when the CEOs tried to fall into line, they were a little disingenuous about the true extent of the sacrifice they are bearing.
Here is what some of them told the committee last week about their 2008 compensation. Below, you will find what they were paid for the previous two years (according to Forbes), when the missteps in the subprime and related investment creations were being made.
Ronald E. Logue, CEO, State Street
2008 salary: $1.0 Million
2008 bonus: 0
Total compensation for previous 2 years: $39.33 Million
John J. Mack, CEO Morgan Stanley
2008 salary: $800,000
2008 bonus: 0
Total compensation for previous 2 years: $80 Million
Lloyd C. Blankfein, CEO, Goldman Sachs
2008 salary: $600,000
2008 bonus: 0
Total compensation for previous 2 years: $110.77 Million
Kenneth D. Lewis, CEO, Bank of America
2008 salary: $1.5 Million
2008 bonus: 0
Total compensation for previous 2 years: $124.64 Million
Vikram Pandit, CEO, Citigroup
2008 salary: $1.0 M
2008 bonus: 0
His share from the hedge fund bought by Citigroup in 2007, as part of the deal where he became CEO of the bank: $165.2 M.
(After flat performance and hefty write-downs, the underperforming fund was dissolved some six months later, leaving many to wonder if it was a foreshadowing of Pandit’s future at Citigroup as well.)
These CEOs are not unlike their counterparts in dozens of other banks and financial institutions which have received significant injections of U.S. taxpayer funds.They benefited handsomely from the overheated, overleveraged, risk-blind spree of recent years.The ones who appeared before the American public earlier this week should have done more than agree to coast on the princely sums they have stashed away.The public was not entirely oblivious to what these titans pulled out of the market at a time when they, and the PR machinery they employed, constantly assured the world that outsized CEO pay was a just reward for past success and a necessary incentive for future performance.
The heads of these banks were less than candid about the picture of restraint and sacrifice they were attempting to portray at a time when exactly the opposite is needed to restore confidence in Wall Street’s leadership and that of its major banks. They are our choice for the Outrage of the Week.