It's not you, it's them that are wrong
Tell 'em to take out their tongues
And bring on the backlash!
Arctic Monkeys – Who The F***k Are The Arctic Monkeys
There was a piece in the New York Times recently (yes I do occasionally still read newspapers) that talked about the Obama administration's fear of a populist backlash against the bank bailouts. Their fear is correct and the backlash is upon us and it is real and it is ferocious.
The Gotham Gal penned her thoughts on the topic yesterday on her blog and suggested we all cancel our policies with AIG. I am with her on that one. We won't be AIG customers in short order. If you'd like to join us in our own populist revolt, please do.
There is no question that the word "bonus" will now be political poison. And that is unfortunate. Because I believe that bonuses, when properly constructed, can be an excellent way to compensate executives.
In the startup world, the primary way that founders and the management teams they hire are compensated is via equity. And that is the very best way to compensate people who run businesses. It aligns the interests of the shareholders and the managers.
But until we get some sort of liquid market for secondary shares, it is impossible to feed a family, send your kids to college, buy a home, and do all the things we all want to do for ourselves and our families with founder stock, options grants, and restricted stock.
So when our portfolio companies get to profitability and are growing and meeting all of their goals, but aren't yet ready or able to go public or exit, I am always in favor of a bonus plan for the management.
Let me start with what I am not in favor of:
1) guaranteed bonuses – This is, I believe, a big part of the AIG problem. Guaranteed bonuses are not in anyone's interest other than the person receiving them. I don't like them and will do my hardest to make sure they never are part of a compensation structure in any of our portfolio companies.
2) multi-million dollar bonuses – We want the majority (ideally the vast majority) of management's compensation to be in the form of equity so our interests are aligned. When management is generating millions (or tens of millions of dollars) of cash compensation via bonuses, the equity becomes immaterial to them and that is very dangerous. That is what went down on Wall Street as the Gotham Gal pointed out in her post.
3) contractual obligations – all bonuses should, at the end of the day, be subject to board and compensation committee approval (even if the goals that trigger the bonuses have been met). The board has a fiduciary responsibility to look after the stockholders first and foremost. If paying the bonuses (even if they have been earned) puts the company in trouble, then there needs to be a mechanism for the board to avoid paying them. Compensation committee and board approval does that.
4) Bonuses should not be paid in unprofitable companies. I have violated this in a few instances when we wanted to recruit a CEO who had a compensation need that we could not meet with base compensation. I feel that bonuses in unprofitable companies are really just a form of additional base compensation. But the nice thing about bonuses is you have the board approval "kill switch" and we have used that recently to deal with a need to reduce burn rates. Bottom line on this one, I am very uncomfortable with bonuses in unprofitable companies and getting more so.
Now that we've dealt with the "no nos", here is what I like to do with management bonuses.
I prefer bonuses that are based on ebitda. My thinking is that value creation in companies comes from earnings growth. The more ebitda you have, and the faster it is growing, the more value you are creating for stockholders. But I don't like the idea that management is incented to maximize ebitda in the short run to create bigger bonuses for themselves while starving the business of needed investment.
So I've become fond of an approach where the company pays management bonuses on "incremental year ove year ebitda." The way this works is you pick a base year and for the next year you pay management a bonus of x% of the incremental ebitda they generate. The best way to do this is a five year plan with a goal of obtaining a significant increase in ebitda so management has time to make the investments needed to get there.
Let's take a hypothetical example. Say a company has just had its first profitable year and made $1mm in ebtida. The plan is to get to $20mm of ebitda in five years. So the board approves a plan to pay out 10% of incremental year over year ebitda as management bonuses. Let's say that the next five years produce the following ebitda numbers:
Year 1 – $2.5mm
Year 2 – $5mm
Year 3 – $9mm
Year 4 – $14mm
Year 5 – $20mm
Then the management bonuses would be:
Year 1 – $150k
Year 2 – $250k
Year 3 – $400k
Year 4 – $500k
Year 5 – $600k
The management team could choose in any year to not grow ebitda at all (and not get any bonus) if they had an opportunity to make an investment in the business that would generate significant incremetal ebitda in the out years and they would get paid for doing that.
There are some issues with this approach. One is acquisitions which generally force a reformulation of the numbers in the plan. Another is that this plan does not allow for incentives for "qualitative goals" like building a high quality management team, creating a long term strategic plan, etc. You can pair those qualitative goals with a quantitative plan but it dilutes the laser like focus on long term ebitda growth and that is not always good.
There are plenty of other approaches I've seen over the years for management bonuses and as long as they meet the four rules that I laid out, I am generally in favor of most anything that helps management get some incremental cash compensation for generating shareholder value before they can get liquidity on their investment of time and energy in building the company.
In summary, the word bonus is going to be a loaded term going forward and it is going to be harder for boards of all kinds to put in place bonus plans for management. In many ways that is a good thing and hopefully we'll see less of the bad bonus activity that I laid out in my four "no nos." But a well structured modest bonus plan for management can be a very good thing for shareholders and I believe we should not walk away from the concept entirely.
Slightly OT, but related to the bonuses coming out of AIG. I think that this solution from macroman (UK finance guy) seems to be a great solution:All of this makes Macro Man appear to occupy a place of the political spectrum further to the left than his usual ideological residence. So to put things right, he has a compromise, market-based solution. Don’t seize the bonuses via a one-off excise tax. Instead, pay them in the amounts contractually-mandated, and use normal tax treatment. But pay them in stock, and allocate shares on the basis of the average AIG share price in 2008: $27.57.So someone receiving a million-dollar bonus will receive 36,269 shares of AIG. Current market value: $34,818. This should appease the baying masses and also introduce an incentive to these valuable employees to right the ship as quickly and successfully as possible. Oh, and at the same time, introduce these guys to another concept well-known to hedge fund types: the high water mark.Source: http://bit.ly/pna5Y
How is that market-based?Thought market based was where buyer met seller….which is what occurred…..at the time the contracts were agreed to….and at the time the government was bailing them out and SPECIFICALLY wrote in that those bonuses were not to be touched.This is populist rage bullshit. Notice we aren’t gathered around GM with pitchforks telling them to stop paying pensioners for work they did years ago……
Andy Angry! Andy Smash!I’m right there with you on GM, but you can’t have it both ways. If you can get GM to reneg contracts, AIG can do the same.If private equity cash came into AIG vs. gov’t money (fat chance) and they said that you need to remove bonuses as a contingent of the money– they would do so, if they needed the cash fast enough. The gov’t, as always, sucked as a negotiator and didn’t realize the BATNA advantage was on their side. And I think we’re targeting the AIG bonuses because it’s politically convenient. No one was worried about the stimulus checks or bailouts of stupid companies, but we’re going to nitpick over something that is less than 10% of the 2nd (or 3rd) bailout for AIG.And if we’re going to go into gov’t waste, how come there hasn’t been a fury about the billions that have gone missing in our foreign incursions (Iraq, specifically). And the stupid cost plus contracts we gave out where it became more profitable for a contractor to blow up a truck rather than fix a flat tire.It’s because politicians want to call out a mess, but not their mess.
Yes…this is extremely frustrating for those of us who oppose government intervention in our lives and marketplaces. To see the population finally get mad….but at the group Obama’s teleprompter tells them to instead of the actual culprits on capital hill, in the whitehouse and chillin down in texas? Ugh.
Maybe we should be andyBoards have fiduciary responsibilities to shareholders and they should putthe shareholders in front of the managementAll bonuses should have a board “kill switch”There should not be any guaranteesIt leads to problems like the the pension problem at GM
Agree that guarantees are insane. The key is bonuses for REALIZED contributions to bottom line.Everyone has missed the “realized” part for the last couple of decades.
I haven’t heard a compelling argument for why government bailouts were a better solution to AIG’s insolvency than to let them file Chapter 11. Bankruptcy served the economy well for hundreds of years. What changed in 2008?Lehman’s liquidation seemed a lot more efficient and less destructive to taxpayers than the handling of AIG. Bankruptcy seems like the best way to deal with bankrupt firms.
I am with you
Ooh, I love that ideaThe punishment fits the crime
What, specifically, was the crime? I guess I missed the trial. Or do we even need those anymore?
The crime was running the company into the ground
Though i completely disagree on the simple fact that the bonuses are still being paid on a lack of performance, I COMPLETELY LOVE the win-win and De Bono style thinking of your plan!
Do people even realize that these AIG bonuses are deferred compensation for work contracted and completed prior to 2008 and prior to any bailouts?Careful what you wish for when you say “Hey Government—- take away HIS money!!!!”Every company I ever run, now and into the future, will have a bonus structure. Much of it will be deferred compensation, and hopefully there will be multi-million dollar bonuses going out.The difference is, I won’t have a kneejerk, populist and anti-business administration as a shareholder.
You can do anything you want in your own companyBut once you take it public or even raise money from the likes of me, youwill be held to a different standardI would not invest in a company you ran that paid out million dollar bonusesfor exampleSizeable equity stakes, yes, but multi-million bonuses are not my thing
Even if the million dollar bonus went to the salesman that spent all year getting the 20 million account?The reason I’d love paying million $ bonuses is because bonuses would be tied to realized earnings for the company. Something AIG, and just about every financial firm in the world has apparently missed for the past couple of decades.The best companies in the world pay huge bonuses….public, private, funded or not. It’s all in the alignment of incentives and as usual, I doubt we disagree on this as much as it appears on the surface.
Sales commissions are not bonusesThey are commissions and I love to pay themAs much as I possibly canBut only upon payment in full for the purchased service
I think “bonus” is probably a more common term in “financial” industry than outside of it….symantics are getting in the way here.In summary, we agree. Would never pay myself a bonus on someone else’s dime. But employees that contribute realized, accountable profits….fatty checks headed your way!!
Andy you know that you and I would probably agree about 80% of everythingAnd the 20% where we differ just makes it all more fun
The moment you take the government’s money in lieu of bankruptcy, you lose any more compensation coming to you (aside from standard wages) until it’s paid back. That’s how the bailout should have been structured, anyways.
Right….like Reagan’s handling of the S&L crisis….where you bail outcounterparties AFTER the company fails, AFTER management is fired, and AFTERshareholders are a zero.but it wasn’t. In fact, Dodd and company specifically wrote in that thebonuses WOULD BE PAID.Vengeful taxation is violent and slippery.
There are many useful parallels with the S & L crisis which are simply being ignored. American taxpayers paid full tuition to learn many of these lessons but we apparently threw away the textbooks and notes. This is the price of inexperience.The concepts of allowing institutions to fail, using the powers of the Bankruptcy Court to enforce good behavior, consolidating failed institution “good” assets with healthy institutions, the aggregation and immediate disposition of toxic assets, forcing the market to value the toxic assets, the prohibition of further involvement by people who “caused” the problems and the use of private funding are all concepts which can be effectively deployed, in part, to fix this problem.It would require a different mindset which would suggest that while government action may be and is clearly necessary, government intervention is not the FIRST course of action and may not be the desirable course of action.
I’ll defer to you on the deferred pool for sure. You have a great handle onit and my reaction is almost purely to the bloodlust of the populace and theresulting outrage (did I say OUTRAGE!!!) of our “representatives”. Youpretty much HAVE to take the other side of that trade, regardless ofunderlying facts :)Now….on the S&L/BK side…..we agree. Look, we’ve become a nation thatexpects our government to take care of problems…..because, that’s whatwe’re being sold. It has softened our core to a point where I can’t reallystand it anymore. I guess the nanny-state utopias of New Orleans, NYC,California, Detroit and Chicago know better than the rest of us…..butdamn…..can we at least allow a few sharp elbows in the bunch?
The outrage is totally phoney because guys like Sen Dodd and then Sen Obama took so much campaign money from the AIG folks — over $100K each and they were #1 and #2 in contributions. They started the cycle.While the AIG guys are gassing up their luxury foreign cars, heading down to Florida or Colorado for Spring Break vacations, fueling up their yachts/jet skis/airplanes — they are blessing Barack Obama and Tiny Tim for the bailout which funded one more year of their largesse.What is preposterous about this is that Pres Obama promised to take care of the middle and lower classes and send the bill to the top 1%-ers.In reality, he has taken care of the top 1%-ers and sent the bill to the middle and lower classes.Is this the “change” we had “hoped” for? I think not.The Administration looks mighty silly and Pres Obama’s words ring hollow. The phoney outrage is an insult to one’s intelligence when you realize that Sen Dodd provided legislative cover for those bonuses and Pres Obama funded them.Maybe Pres Obama needs to spend less time partying and filling out March Madness brackets and start paying attention.The missing insight: “capitalism”, raw success v failure capitalism is starting to look pretty damn good right now. AIG should have been waltzed right over to bankruptcy court, all contracts revoked and the US Gov’t should have been a DIP lender with all the votes on the creditors committee.You’re damn right we need some elbows and maybe a thumb in the eye and an ice pick in the ear. It will be very interesting to see how this impacts the unions as they are up next.
hot damn, JLM droppin’ a truth bomb on all ya’ll!i know it hurts, the truth always does. but it’s necessary.
The truth never hurtsAnd you guys know how much I love JLM
You guys are cracking me up. I’m trying to figure out how to get my brackets around one of Andy’s fatty checks. Major fantasy b’ball around here.
Lets discuss government employee bonuses. Certainly they are not in a category with corporate bonuses but they are a well kept secret of upper level government managers. They like to let a few dollars trickle down to the peons through performance awards but they keep most of it for themselves. There is little difference between corporate and government bonuses.
Actually the bonuses being paid are from a pool titled “Retention Bonuses”. The Deferred Compensation Pool was agreed not to be tapped in an agreement made between AIG management and the NY State AG Cuomo. You can find the exact letter on the web. I read it and the letter is clear.This brings to mind two important points:1. Deferred comp, in a bankruptcy parlance, is a company asset subject to demand by creditors. In the AIG instance, I suspect that the deferred comp bonus pool is unfunded and meaningless as the company is insolvent.2. Politicians really don’t know what they are doing. The AIG sharpies simply took government funding and put it into a newly named account and thumbed their noses at the NYS AG. Pretty arrogant attitude.This all argues for insolvency issues being managed under the purview of the Bankruptcy Court in which a company can revoke any and all contracts and in which payments made within 6 months of insolvency can arguably be clawed back as “fraudulent conveyances”. More importantly a creditor committee can examine each and every payment (e.g. these disputed bonus payments) and appeal to the Judge for an equitable result.Clearly AIG is insolvent and the money being paid to it is going out the same day to pay off the counterparty obligations, so the business reputation risk issue is not very convincing.What is unsaid is that from a pure financial perspective it is very difficult to imagine a scenario in which a single dollar of the government funding is repaid even when AIG is fully liquidated. Their exposure is simply too great. The idea that the government and the taxpayer is getting a penny back from AIG is pure fiction. A simple liquidation analysis supports this observation completely.
My independent financial advisor is affiliated with Royall Alliance, an AIG company. I like my advisor, but don’t like the AIG affiliation — not one bit. I’m awaiting his position on all of this.
Fantastic post Fred. I think your proposed approach is dynamite. I’ve always been a believer in “pay out 10% of EBITDA as bonuses” (that’s what I got in my first company after it was acquired – we got to pay out 10% of any EBITDA we generated as bonuses – up to 50% to management; 50% to everyone else.The incremental EBITDA normalizes for a starting position when a company has been EBITDA+ for some time. Of course, EBITDA_base=0 is just 10% of EBITDA.Now – you do need to be careful not to let EBITDA get gamed. I’d focus on a threshold cash flow number also, or force all “below the line expenses” (stuff that really should be EBITDA but gets counted as restructuring, one time charges, acquisition expense or other such BS. If you have an honest management team and a disciplined financial accounting process, this is easy to deal with.Pre-EBITDA – it’s clear this is simply additional compensation. While I don’t mind the base + variable approach (where variable is tied to tangible results), it’s definitely gotten conflated and twisted around with all the points you make above (e.g. “guaranteed bonus” – I’ve never understood that one).
Great additional points BradThe key is always an honest team and a good financial process
Many a times you have companies that abuse the rewards of “bonuses.” There are companies that lasted a decade without making money and revenues were down, but management still took $1 Million and above for compensation. This one company went bankrupt last month, and guess what they took their $350-450 K compensation and the board approved it. That’s funny. You gotta wonder where their heads are.. 😉
Thoughtful post. Thanks for sharing.
Interesting discussion, but when is a contract to be kept? only when we want? Or can it be broken because we don’t want to meet its provisions?BTW – What of the Dodd Amendment & Sen Dodd being AIG’s largest single recipient of campaign donations in 2008 with $103,100? No one talks about the problem only the results!
Politicians are corrupt, that is a givenOn contracts, boards should never ever guarantee contracts with employeeswithout a fiduciary and MAC outTo do otherwise is just bad business practice
The company should clearly be put in to a chapter – Bye Bye contracts – but doing so would introduce this ‘systemic risk’ paradigm. To litigate these contracts is to metastasize a broken approach to business.
Contracts are sacred for executives. When contracts are for autoworkers, they need to be reworked to save a company.
The issue of guaranteed bonuses and lucrative contracts has always been a problem for Wall Street, which ironically prides itself on an “entrepreneurial” spirit. All the good reasons why guaranteed cash packages make no sense for startups, are the same reasons why these never really made sense for Wall Street. And some in addition:1) Not only is the fire in the belly factor diluted because the near-term downside is minimized, but also because the absolute dollar value of Wall St. packages can be quite huge and in many cases results in a financial safety-net forever.2) When revenues decline, the first overhead that gets cut is the non-guaranteed employees (i.e., the guys with the fire in the belly) because that’s the easiest thing, and this is counter to maximizing productivity.For a long time Wall Street has gotten away with this counterintuitive and illogical business model, because when times are good and the water level is high, nobody notices the junk at the bottom of the river. Like everything else these days, the drought is causing the river to dry up, and things start to get noticed. AIG may be just the beginning.
Your approach makes a huge amount of sense for companies such as those in your portfolio. The stock-upside should pretty much dominate all behavior. I think AIG and other large companies are in a different place and use bonuses differently.In the case of AIG, I’m finding it really hard to get details on what these bonuses are beyond the same soundbites all the blogs/on-line news sites have. This is not a defense of AIG, and I’m surprised they haven’t had much more of a management shakeup than we’ve heard about. However, what I understand so far about the bonuses is many of these were retention bonuses. Those typically have zero to do with performance but are “stay until X date, and we’ll give you $Y”. They are really more like deferred salary to give someone incentive to stick around. That does make a lot of sense if the gov’t is becoming your primary stake-holder as that may incent quite a few people to leave. In general, I think retention bonuses make sense as a management tool if the goal is short-term (much like your CEO situation described above) and there is a critical issue such as this or even persistent raiding by another firm. For the long term, stock is a better option.Again, let me underline none of this is a defense of AIG and if I had a policy with them, I’d be joining the “populist revolt”. Just pointing out different situations call for a different set of tools (but these days, don’t call it a bonus! )
I wish they’d just breakup AIG and sell off or spin out all the goodbusinessesThen they could give mgmt equity in those units and would not need staybonuses
The problem w/ liquidating AIG is going to be the sudden realization of the magnitude of the loss that the government and taxpayers are going to ultimately take. This will be political suicide and could spell the undoing of the Obama administration if confronted before the mid-term elections.Tiny Tim: “Wow, Mr. President, this stuff is really getting dicey. I can’t believe how many zeroes all the numbers have now. Wow!”Pres Obama: “Don’t worry, Tim, you wil receive full Federal employee retirement credit for the entire 90 days that you were the Secretary of the Treasury. But don’t worry, it will give you some time to really learn the subtleties of Turbo Tax.”Tiny Tim: “Sorry, Barack, I guess I really screwed up.”Pres Obama: “Timmy, Timmy, Timmy — sho you right, homes! We good? Not so much, T Tim! I was counting on you, homie, and you screwed ME!”I suspect that the saleable portions of AIG will only yield about $50B in gross proceeds (based solely upon readily available info in Bloomberg and other generally reliable sources) in an orderly liquidation. Everybody will be looking for a discount based upon the current events. This is a mortally wounded duckling and it is only going to get worse as the “book of business” dwindles.The “book of business” is dwindling very, very fast. I have an airplane insurance policy w/ AIG which expires in June — guess what, I will not be renewing it w/ AIG not because I have a hard on for AIG but because I am concerned about their claims paying capabilities. Simple market reaction. Who in the world renews a policy w/ “AIG” on the jacket?Net that against $170B in “new money” and there will be barricades in Lafayette Park when the public realizes the magnitude of the absolute loss — not a long term Irish Sweepstakes ticket kiss your sister on the cheek kind of loss — a West Texas barbed wire enema kind of LOSS!Worse, I suspect that the derivatives division wherein all the crap is concentrated will need another $100B to get the tar off their hands. Their total exposure is $400B plus operating expenses and they stopped writiing this stuff in 2005.BTW, can you imagine how much more of this stuff is really out there when you realize that AIG only wrote the top tranche of the biz?I predict that the monkeys will start jumping out of the wood work about the week after the NCAA championship. Hook ’em, Heels! LOLI ponder at quiet moments what we really don’t know — YET!
Well if that’s what it is, that’s what it is.No sense pretending its something else
Fred,Really enjoyed your perspective on this.I’m curious of people’s thoughts on AIG’s compensation structure in the free markets. Some will inevitably say that AIG is a perfect example of free markets and the “greed is good” philosophy failing. It seems that short term personal interest outweighed long term interests of a healthy and prosperous company and service (for many companies involved in this mess, as a matter of fact).So how have compensation structures like AIG’s wound up in our “free markets?” What is capitalist about a “guaranteed bonus?” Nothing.As you’ve mentioned, everybody’s really got to take a long, hard thought about the word “bonus” really means.
As somebody who has spent years helping out the Long Now Foundation, I believe that short-term thinking is a pervasive problem, and the markets are just where it’s most obvious right now.The problem with the AIG fiasco isn’t that companies blow up when they do stupid things. That’s what should happen. The problem is that AIG did it in such a way that the damage wasn’t contained to their shareholders and counterparties. The problem is that they were too big to be allowed to fail, so we had to step in to fix things.I think the right long-term solution is to keep companies from getting so big that they can hold the economy hostage. Focusing only on AIG is a dangerous mistake that will keep us from preventing the next AIG.
Bonus formulas are tough to create as they are mostly based on shareholders value creation, which comes with the search for the maximum leverage.In the medium term, a high leverage brings higher funding costs (at best) and destroys the very value it should have created…but way after bonus are being paid.I always compared bankers (banksters, as I was one of them) as soccer players in term of management and pay check. I would not be surprised that change in comp system will them spread to the sport industry.
Good post, but I think you are omitting individual contribution from the equation. imho the bonus should be calculated based on company’s performance first and foremost, but also on an individual’s performance where applicable, specifically in larger organizations.
AgreedThe way the bonuses are paid out should reflect thatMy math is about how the bonuses should be calculated
A “guaranteed bonus” is not a bonus, it’s salary. “Guaranteed” and “bonus” do not go together, a “bonus” is for work done well above and beyond expectations.As far as leaving AIG, I think it’s good, unfortunately in todays bailout and parasite environment, it will only mean that AIG has to get your money through a detour via the IRS and treasury.
Your comment about the bonus to the CEO with a compensation need was interesting to me, and I’m curious how you evaluate a candidate’s personal finances as part of the hiring decision.I’ve heard it said that the best salespeople to hire are ones with too much debt, as then they have a strong personal incentive to go after the quick money of commissions. By the same token, I’d be nervous to hire a CEO who had a big need for dough, as I’d worry that they’d favor short-term cash extraction over long-term value generation. Not coincidentally, that short-term bias seems to have been shared by a lot of people in the headlines.Does a potential exec’s personal finances affect your hiring decision either way?
This is a complicated issue and I don’t think I can do it justice in thecommentsBut I will say that I don’t like to dig into their personal financesBut I do care about incentives and try like hell to get them aligned andright sized
Bonuses, by definition should be performance based. Performance at both the corporate level and the indiclvidual level. I’ve worked for companies that had very fair bonus components based on corporate, business unit, and indivdual performance. I’d be okay with that. But AIG bonuses don’t seem to be performance based. That’s what bothers me. It’s as if AIG is giving the crew of the Titanic a bonus for the job they did.
I’m completely baffled as to why executives should get bonuses at all. Give them incentives in stock only. If the company does well, or they sell it they do very well. Otherwise salary only.Bonuses should be paid to positions which bring in money to the organization…though should a salesman/broker be hurt if management makes bad decisions?I’m not against companies giving bonuses, but not with tax payer money. If AIG or wants to give bonuses, do it prior to asking for money, or don’t do it. And bonuses should be given in cash & stock, thus it gives the employees the incentive for the company to do better.RANT: Since when do people need multimillion dollar salaries? Don’t tell me you can’t live on $1million per year. If so you’re living to high on the hog.
Here is the logic for bonuses (with all the caveats I put in my post)1. equity comp can’t be spent. You can’t feed a family or send a kid tocollege or buy a house with private company stock2. base comp should be kept as low as possible so the fixed cost structurestays as low as possible3. if mgmt has a great year and the company is profitable, a bonus is a goodway to put addt’l cash in mgmt’s pockets
1) don’t pay them peanuts. Pay them a good salary & don’t put a limit on when bonus stock can be sold.2) agreed3) but wouldn’t that cash be better spent, building up the company? Most executives already write off most of their entertainment & travel expenses anyhow. Plus if an executive is relying on a bonus, and the economy tanks or a competitor takes all your business, what’s to keep the executive from jumping ship?
Fred, your EBITDA suggestion would not have prevented the problems at AIG, and may have even exacerbated them. The problem is down to the difference between realized and unrealized gains.AIG wrote a whole load of new business guaranteeing their clients’ sub-prime positions and then under provisioned for the associated risk. If we assume for the sake of simplicity that an insurance P+L looks like an industrial one, then the ‘EBITDA’ on this business was basically the value of the premium, minus the acquisition cost, minus the risk provision.Given the volume of new business they wrote, AIG’s ‘EBITDA’ went through the roof and the managers, even under your scheme, would have been well in the money.Only when the brown stuff hit the rotating object did everyone realize that the provisions were way too low, but by then the bonuses had already been awarded/paid.
AgreedI was not suggesting my approach for the AIGs and Goldmans of the worldIt is a methodology for the venture backed universe
Fair enough, but I believe there will always be a conflict between the interests of the company owners, who want to create long-term sustainable value, and the managers who are frequently focused on the shorter term.In theory the distribution of equity to managers goes some way to bringing them in-line with owners, but as you rightly point out, you can’t pay your kids college fees with paper.For what it’s worth, I’ve been thinking a lot about these issues recently. My current thinking is to pay a regular (perhaps quarterly) completely discretionary cash bonus to key personnel. They would then have the option to either bank the bonus or use some or all of it to buy stock (not options) in the company at a discount to an indexed valuation of the company.By indexed I mean based on an external valuation which is then adjusted based on internal factors (eg company revenues) and external ones (eg NASDAQ level).
Hmmm- and how exactly do you classify your own compensation. Most VCs earn substantial management fees (guaranteed of course) and how about that carry. When you do the hard work to nurture and build an investment from guy in a garage with an idea to $1 billion public company, do you not deserve a multi million dollar bonus?I think all of this hair pulling over bonuses is ridiculous. Companies have an obligation to make money for their shareholders and they should do whatever they feel is necessary to maximize that value and if a quant can figure out a derivative that can make hundreds of millions of dollars for their company – I have no problem paying them multi million dollar bonuses. If it blows up, fire the hell out of him. Want to discuss making that longer term so that you emphasize a longer term outloook, sure.But, I don’t begrudge MGM paying Julia Robert’s $20 million for a picture because the feel it will solidify the opportunity to make money, why are we so hung up with Wall Street and not Hollywood? Where’s the populist rage there? And for the record – I thought the bail out was a bad idea in the beginning – but if you’re going to give hundreds of billions of dollars of MY money to the company, creating a compensation structure to retain talent is the least of my worries. And from what I can see the outrage is that bonuses are going to people who ran the company into the ground – do a little research. Those people are long gone.
You have a good point about management feesThey are too high for most VC funds and they should be based on budgets thatreflect the cost of doing business not fees under managementCarried interest is the equivalent of equity compensation which I am a bigfan ofJulia Roberts should be taking a rev share on the movie, not an upfrontpaymentSame with authors and advancesIf compensation systems had better alignment, we’d have a better economy
Difference is huge between entertainment and Wall St. In the former, Julia Roberts gets paid because she, individually, personally, has a demonstrated track record to increase box office receipts by a quantifiable amount. In the case of the latter, a trader or banker relies on a balance sheet of someone else’s money, and an infrastructure that took years if not decades to build, to make bets that either win or lose.
You could make the same argument about Julia – she’s relying on a balance sheet, and entire team of people behind her – she’s not in her living room acting. Not to mention many segments in banking rely very little on the balance sheet – M&A which despite the last couple of years, makes a huge amount of the revenue for many big banks, doesn’t. They get paid that much money as they have a demonstrated track record of generating revenue by a quantifiable amount.
Valid points. I still see a huge difference, however, in that moviegoers go specifically to see Julia (not me, but just saying), as opposed to MGM. Wall St. clients, on the other hand, use Goldman Sachs and Morgan Stanley. Once upon a time, M&A was a little bit like “Julia”, to your point, but much of this has changed. Whereas Rohatyn and Wasserstein and Greenhill and the like used to attract clients on their own personal franchise, in the past 10-15 years advisory assignments were more like tips handed out for balance sheet access. So, while it is true that Julia is not in her living room acting, she can literally take her act anywhere and the result is a film star, whereas Wall Streeters (with few exceptions) do need a firm with lots of capital and resources and brand name.
I wonder where M&A is headedGranted our deals are not complicated but we haven’t used a banker to sellany of our companies in almost a decadeWe just do it ourselves with lawyers who don’t charge a percentage of theproceeds and are very skilled and know their stuffTotal cost of the TACODA/AOL deal which was $275mm was less than $200k tothe TACODA side I thinkSeems like a lot of the fees paid to bankers are wasted to me
I think you are right.I think some companies, especially at the high end, pay the enormous fees because they need the institutional support… and there again, they hire the firm much more than the individual. (I’ve met so very many who lose sight of this, who actually believe they have personally been responsible for hundreds of millions in fee income.)I think that what happens to M&A is the same that happens to all industries: excess capacity leads to consolidation and supply adjusts to meet demand. Until now, it may not have made sense for M&A bankers to work on a $275 million transaction for a penny less than $2.75 million. I’m guessing that this will rapidly change, because the opportunity cost is vanishing.Maybe at some point the pricing model migrates to that of law or consulting (i.e., time based rather than volume based). Maybe at some point the economics change to a degree at which it will be more efficient for USV to outsource the work.
In some ways this is the continuing of the “Charles Schwab-ing” of business and the ability to use technology and exemplars to mimic legal, securities and deal making expertise.Schwab took a transaction which was traditionally priced based upon the total cost of the transaction and standardized it based upon the realization that the electrons did not have to work any harder for 100 sh @ $50 than they did for 100 shares @ $5. He stripped out the uncertainties of questionable advice and focused on direct order execution. He unbuckled the “hard to price and value” element from the “transaction” cost element.For years now I have collected copies of good asset purchase agreements, employment agreements, incentive comp plans, leases, term sheets, etc etc etc — all with an eye toward paying for stuff once. There are websites which catalog good legal forms which are accessible by laypersons. I have stored electronic documents for decades and used them as the basis to create exemplars of whatever we currently are using. Every few years, I have a shrewd lawyer look at the FORM not work on the deal.When I was in the real estate biz, I used to freely give all brokers, banks, competitors and tenants copies of my term sheet, letter of intent, lease, lease abstract, offer to purchase, purchase contract exemplars in electronic form and hard copies — I was in the biz BEFORE computers and word processing, mind you. The market was a mix of “gross” and “NNN” leases. All my forms were NNN. Within 3 years, the entire market was NNN.I swear by binding arbitration rather than litigation and I have not seen the inside of a courthouse nor been involved in arbitration as a result of one of my exemplars in a quarter of a century.The advent of the info age and the grist mill of the internet makes information readily available and the M & A courtship ritual is a lame excuse for computer dating these days. Deal structuring has been reduced to following Betty Crocker’s cookbook and the ability to model cash flow easily has made the variations easy to model and follow. We are truly living in a golden age of democratic deal making and the power of “firms” is almost completely gone with the exception of foreign firms making their first inroads into the US which they consider to be unbelievably complex given our 50 states (or 57 for some folks).In some ways, this is what went wrong with the bailouts — including AIG — nobody had a good form or exemplar and nobody had a list of the deal making principles and yet they were investing money — OPM — and those principles are very, very, very easy to pick up quickly.Golden Rule of Investing: “He who has the gold makes ALL the rules.”The days of the lawyer/IBer as high priced scrivener and deal coach are over.
The biggest problem with the Wall Street bonuses that I see is that people are being paid on an annual basis for longer-term positions. The bonuses that people earned at AIG in 2008 may very well have been legitimate at the time they were awarded, based on the notional value of the assets on each trader’s books. When everything fell apart was when these same positions fell apart and there was no mechanism for recovery from these people (think of a clawback provision in a VC/PE fund). I like the idea of the high water mark, but the problem with the HWM is that it is too easy to say “I am underwater with no hope of a bonus for the next couple of years – time to leave and go to the next shop”. Perhaps one way to deal with a clawback provision in this scenario would be similar to what some of the sports leagues have done with player salaries (I believe this is the case in the NHL with regards to salaries as a % of revenue) – keep some percentage of the money in escrow. At the end of the day, when contracts reach their expiration and the true value can be ascertained, then the bonus “true-up” can happen.
Rewarding behavior which makes the business more valuable in the short term but not the long term is the biggest problem with these bonuses. The climate has indeed shifted as a result of the 80% equity stake we’ve had to take in AIG and the billions we’ve sent to other banks.I like the idea of ending customer relationships with firms (such as AIG) if they do not have business practices that seem reasonable. Trying to do the opposite, of rewarding companies that make long term strategic investments in the business and their customer base, is something I try to do as well.I don’t know what kinds of macro policies encourage executives to re-think the balance between short term and long term economic value creation (and choosing activities to encourage on the latter), but I believe such a discussion of that is material to our nation’s recovery.
I think its important to make a distinction between bonuses (either executive, performance based, or retention) and commissions that are paid to salespeople, etc.It appears these AIG payments were retention bonuses rather then performance but many of the “bonuses” paid on Wall Street are in reality commission payments based on the amount of business/profit a salesperson or trader generates.
Agreed on sales commissionsI was not talking at all about them and they are critical to every business
But if you’re talking about “greed” on Wall Street you are. Sean is absolutely correct, the vast majority of “bonuses” are commission or revenue share and yes they can be very big numbers because of a perceived if not actual rarity of the individuals abilities and the very big revenue numbers the companies are realizing. I brought in $60 million of fees in one year when I did M&A – should I have made $100,000? If I had, the bank next door would have been more than happy to collect those fees and pay me a bit more. At AIG, there was a broken company. I would argue that when that happens you take the short term pain and move on as a country. BUT if you want to give hundreds of billions of tax payer money to that company. Do you really think taking the high performing employees who can walk down the street and make millions of dollars and say, we took tax payer money therefore we’re giving no bonuses this year is going to fix that company? You might as well just shut the doors.
The problem is that the business they brought in, and got paid for, was mis-valued. What seemed like a sure thing turned out to be predicated on very shaky assumptions.It may in fact be the outcome here that certain kinds of business are driven out of publicly-held companies for this reason — that you can’t incent the employees competitively and also meet your governance guidelines, which are relatively blunt instruments.
well then those should be called commissionsbonuses are something else in my mindand the public’s mind too, it seems
Finance prefers bonus because it lets them have some discretion over payouts at the end of the year. There are HUGE fights by management to avoid explicit formulae for payouts, “direct-drive bonuses”, since it can create huge payouts and create pressure for reduced discretion across the board – which would end up with more going to the lower echelon employees and less to political stars. Bonus is applied universally to obscure who is on a fixed compensation structure and who is at the whim of management, leading to more people being at the whim of the execs.Almost all of the work at finance firms is sales and has a direct, personal P&L. The overall performance of the firm means nothing, unless they go bust. A decision was made that AIG shouldn’t go bust, so you need to pay the sales people.AIG used to have an excellent equity program that acted as golden handcuffs for management. This was mostly destroyed by Spitzer’s Quixotic attack on Greenberg. Without that, guaranteed bonuses are the only way to keep people who are critical to the operation and highly vulnerable to poaching. There’s no liquidity event on the horizon that’s going to pay them tens or hundreds of millions of dollars, unlike a startup.You’re demonstrating a blinkered, parochial take on this, along with the typical miserliness of a VC. Compensation structures, like capital structures, have many appropriate forms depending on the specifics of a company. AIG’s comp looks to be basically appropriate. Properly structuring and balancing compensation time horizons is a universal problem that more than a few people are working on. Problem is that you get killed over it no matter what you do – media and congressional hits over payouts of multi-year deferred compensation and stock options are the stock in trade of the Corporate Library.
I get that. I was not suggesting that the typical bonus approach for venturebacked companies is appropriate for wall street.And I take the word “miserly” as the highest compliment!
Great post & followup discussion on incentives. AIG is an extreme example of what Wall Street figured out in the last 20 years: how to get paid now for assuming contingent balance-sheet risk that comes back home later, long after you’ve spent your bonus. In AIG’s case it was all those credit-default swaps on AAA bonds: premium income up front, casualty payout much later. The game was predicated on “independent” rating-agency assessment of those risks, something that boards are trained to look for and believe in, combined with actuarial models based on historic behaviors of those ratings. Of course, those ratings turned out to be wildly inflated, putting AIG in a situation analogous to a life insurer who has underwritten policies based on counterfeit death certificates (“wait, I thought smokers on average lived to 90!”)My question is: given how we got here, what can we change about corporate governance to prevent a recurrence? The EBITDA recommendation might not have prevented AIG-like abuse, because GAAP’s mark-to-market mechanism was duped into underestimating those contingent risks, along with everyone else. We could abandon the rating-agency system as being hopelessly compromised, but it’s not practical for each and every investor to do their own credit research on every transaction; you need someone (that you trust, and whose incentives are aligned with yours) to do that for you. It’s a simple question to formulate: “Will I get my money back?” that’s why the rating-agency business (if not the incumbents, or their model of value extraction) is so attractive.
This post mixed two separate concepts and that is always dangerousI talked about AIG and then went on to talk about bonuses in VC backedcompaniesThat was confusing as the concept I detailed is certainly not appropriatefor AIGI wouldn’t even know where to start with AIG
I think you’re just exercising the host’s privilege 🙂 to put forth a complex topic and see where it goes. And I don’t think they are two such terribly separate concepts anyway: it’s all about incentives and governance (corporate governance and investment governance). Even little companies can get blown up by what AIG did wrong — service-level agreements and outsource contracts and suchlike are just as much contingent claims as credit-default swaps. Nobody else has managed to flame out on AIG’s sheer scale, of course! but give it a couple years…
You may be right. But I really struggle to get my head around a business like AIG
Fred, you know I love the structure of paying on incremental EBITDA as a good long-term plan for senior executives (though the issues are real, as you note). But the notion that bonuses in unprofitable companies makes absolutely no sense to me. Incentive compensation is an important part of anyone’s comp, not just a recruited CEO. First, there are market comparables for all positions, not just CEOs, and most of them at most companies, have some form of cash incentive comp. But more than that, it’s a critical lever for management to hold people accountable internally for meeting goals and objectives and numbers. When did that turn into a bad idea?Most of your other points are spot-on, about the value of equity vs. cash comp, AIG, and comp committees.
Start-ups…bonuses…Now you’ve got me dreaming. Maybe our board will see this post??
The unsettling thing for me is the underlying theme that there just something wrong and irresponsible with making a lot of money. The populist world view that makes this politically expedient is pretty vile and destructive. The politicians are validating the worst impulses of people to gain power and no one in politics or the media has a guts to call them out.
Nobody is complaining about the money Gates or Job or Page or Brin has made.What people are pissed off about is these people made hundreds of millionspushing paper around and calling it profitsBut none of it was real
Funny, I just posted on bonuses on Monday: http://startupcfo.ca/2009/0…Like you and Gotham Gal, AIG was the catalyst for the topic.Two points for you:Paying bonuses before profit: Massive value can be created before a company becomes profitable. I am in favour of bonuses before.EBITDA as the measure: There can be and very often are very valid reasons to delay profitability for technology companies. Winner takes (almost) all, so the rush is to get to the winning position. This takes investment and delays profitability. I worry that your proposal creates a misalignment between management’s personal incentives + what is best for long run value creation.
Those are good counter argumentsBut I’d prefer to pay stock based bonuses pre profits
Harsh on the employees who aren’t already wealthy. Especially with the typical equity cramdown and expected “reasonableness” of founders/management on taking hits to their portion of the equity pool when getting additional financing.
The percentage of deals I’ve been invloved in over the 22 years I’ve been inthe VC business where there has been a cramdown is actually pretty small.It was quite common post bubble in 2001-2003, but if you take out thoseyears which were unusual in many ways, I bet that less than 10% hadcramdowns
Interesting and timely topic. The larger issue is simply the design of effective executive or key employee compensation plans which support and drive the business plan of the company. The ancillary elements are performance appraisal, retention of key employees and the culture of the company. And, yeah, building great relationships which are going to make folks want to work for you. For you!I personally find that most companies are notoriously lazy in the design of such programs and there is no excuse for that. Take a look at Bruce Ellig’s book — “Executive Compensation”. This has been the Bible for some time. Have you ever actually looked at it? There are some great ideas in there but most importantly it puts the entire menu of possibilities in front of you BEFORE you make a hire or decision to invest. Isn’t that really what happened with AIG? They sent the money and then they decided to think about bonuses? This lack of business acumen is unforgiveable. THE POLITICIANS OUTTRADED BY A BUNCH OF TRADERS! Go figure. LOLCompensation is composed of salary, benefits, short term incentives, long term incentives and perquisites. Each element of compensation has a different bag of tricks associated with that particular element. The design of compensation programs requires a thoughtful and custom arrangement of each of these elements into a program in which an executive says: “Damn, that’s one hell of a deal!” And the equity owners should be able say: “If YOU produce what WE want and we make a shitpot of money ourselves.”Everybody has to be on the same side of the trough at all times. It is the design of the program which ensures that this happens.What much of the discussion is about here today (and w/ AIG) is a mixing of the metaphors of the kinds of compensation being employed. Equity is clearly a “long term incentive” type of compensation while cash bonuses are an element of “short term incentive” compensation. Deferred compensation — which simply impacts the methodology and timing of payment — can bridge the divide between short term and long term incentives and vesting periods can provide the “golden handcuffs” element which is an element of retention.Having designed such programs for my executives and having been the beneficiary of such plans, i make the following suggestions, if you truly want to attract, motivate, incentivize and retain great teams:1. Engage w/ the employee in the design of the program. Find out what he is looking for. Get his fingerprints on the murder weapon. Make him own the plan. Put it in writing. Make the other party know that he is “special”. You will be amazed at how little they may really want.2. Create written, measurable, attainable, realistic objectives — as part of the plan — which can be objectively measured. At first, make them modest and then make them progressively tougher. If you want to create a culture of “winning” then you have to create some easy wins at first.2. Conduct regular performance appraisals using a format which was agreed to in the compensation plan. Make the executive perform his own performance appraisal. Be tough in the dialogue and never, ever miss a deadline to conduct a performance appraisal. Make any short term incentive or long term incentive payments contingent upon the conduct of the performance appraisal. End every appraisal with a frank statement as to whether the executive’s job is secure or in jeopardy. Don’t equivocate or bullshit.If you have a Board, make the comp committe do its work and force them to get involved BEFORE AIG type issues come up.3. Use deferred compensation, vesting periods and other time dependent payment mechanisms (not earning mechanisms, payment mechanisms) to retain key employees. This golden handcuffs approach is critical to ensure that the company does not lose key employees during a growth phase.4. Overpay. Averages are built of the best of the worst and the worst of the best — be at the top end of compensation always. I would always pay a guy $5000 more than the competition — why? Cause I would get a $1MM of reputation for $5000 in cash. Pretty damn good leverage. It doesn’t take much to overpay and it builds loyalty.5. Truly plan for success being over the horizon. You will work for 7 years to become an “overnight” success.6. Always, always keep you word. Never, ever, ever, ever, break your word. It takes 25 years to build a reputation and 10 seconds to lose one.7. If your plan is designed correctly — people lose financially when they get fired for failing to attain stated objectives or leave the company, no huge incentives (bonuses) accrue when they fail to perform, employees must stay to benefit from the company’s growth (deferred comp and equity based compensation) and compensation will be proprotional to the company’s real success.8. Don’t overlook the value of perquisites in designing these programs. Pay somebody’s club dues or car allowance or continuing education or give a longer vacation (hell, nobody really stops working anymore just because they are somewhere else).9. Offer the best benefits you can possibly afford (vacation, sick days, health/dental/glasses/life insurance, ESOP, ESPP, 401K, caf 125, cont ed, emergency loan fund).Your job is to ultimately make your critical employees millionaires while they make you into 100 millionaires. Get them focused, get them incentivized and get out of the way. Be tough, be fair and be steady. Keep score and don’t be afraid to be critical.
WowAnother great comment from JLMNot sure I need to read Ellig’s book now
At Redfin, executive bonuses are based on revenue and customer satisfaction as well as EBITDA, which I think has produced longer-term thinking. When it was just EBITDA and customer-satisfaction, we could often just reduce costs (through deferred hiring or less program spending) to make our numbers; changing the bonus criteria should not have shifted our mind-set toward growth as significantly as it did but we are all glad we did.Maybe it sounds namby-pamby or too fancy but I really think you can make a case for customer-satisfaction as a criterion for the bonus, at least if you’re in a retail business like ours where there is always an easy-way-out tradeoff between cost and customer satisfaction.And I have the same reservations about bonuses generally for unprofitable companies — it seems unseemly — but the other way to look at it is that variable pay in some ways is even more important for a company that has to perform its way out of losses, especially if it has raised enough capital that its losses don’t seem imminently life-threatening.
A company loses $5MM in 2007 and loses $1MM in 2008 — unprofitable company —do you pay some form of incentive compensation for performance? I would.A company makes $1MM in 2007 and makes $5MM in 2008 — profitable company — do you pay some form of incentive compensation for performance? I would.A company makes $5MM in 2007 and makes $1MM in 2008 — profitable company — do you pay some form of incentive compensation for performance? I would because 2008 was a very bad year for business.Generalities all suck. Context is very important in making incentive compensation decisions. That’s why you have to have a multi-tiered plan of salary, benefits, short term incentive, long term incentive and perquisites.What is cash or stock or restricted stock or options or phantom stock or deferred comp or is vested is the context which must be explored.In 2009, everybody is going to be thankful to just have a freakin’ job! LOL
Iteresting comments. I have more of an issue with the the ‘Kill Switch’ provision. You usually have no idea if you’re going to use it until it actually comes time for the payout. Usually when you negotiate compensation with an employee you say, “your base is $$ (really/relatively low) but you have a potential bonus of $$$-$$$$ provided you hit certain requirements (which you are all debating here).” Any rational employee is goign to ascribe a value to the bonus and a probability of payout based on the requirements. If you then say, “by the way, we reserve the right to not pay anything out, even if you hit the targets” then you’ve introduced uncertainty, and no rational agent is going to give any value to a bonus that’s left to the hands of a potentially angry/wiley/political/populist board. Therefore he/she will negotiate for a higher base salary, which creates other potential conflicts. So I don’t see how a “Kill Switch” is economically legitamate.
Every employee is ultimately either an “at will” employee or a “contract” employee. If you make a promise to an employee and it is in writing then arguably the employee is a “contract” employee and the contract is legally enforceable.If you are going to create a class of “contract” employees then you owe it to the yourself to have it professionally designed and to include salary, benefits, short term incentives (bonuses), long term incentives and perguisites as well as addressing deferral, vesting and performance appraisal.There are a world of great sample out there for this kind of thing. I favor the simplest such arrangements with a quick quarterly review, an informal (go to lunch) semi-annual review and a formal annual review.The idea that the executive goes to the pay window when the company goes to the pay window is not an alien concept.Changing the deal after the fact is a legal mine field which will create ill will and litigation. People just want to know “what’s the deal” and be treated fair.
Agreed. You can’t set targets and then welch on your side of the deal, but you can award a discretionary bonus. In all the company’s I’ve worked for my bonus was always at the discretion of my managers. Targets were never explicitly written down, but that didn’t stop me from working hard.The way I would mitigate the uncertainty related to discretionary bonuses is to award them more often (eg quarterly), based upon both effort and results.This is also sends a clear and timely message to underperformers to pull their socks up.
That’s why I like incremental ebitda, because if you are just cutting andcutting to make your numbers eventually you won’t make them
Fred — love this, but hate to admit, another of my favorite sagacity sources today had a ripote that was short, funny, and on-point:http://freakonomics.blogs.n…
That is classic
Like most problems, the AIG “Bonus” problem is one of semantics. What AIG paid were not *bonuses*. They were simply part of the executive’s compensation, in the guise of a bonus.A bonus is “something in addition to what is expected or strictly due”. A “guaranteed” bonus is not a bonus, it’s a payment. A “contractual” bonus is, again, not a bonus, it’s an obligated payment.All of this bonus B.S. stems from an industry that quite simply just wants to pay executives more than ordinary folks would ever find reasonable. So they take what would, in a “normal” job be an excessive salary, chop off the obscene part and call it a bonus. Is it any wonder people are miffed about that practice? Especially when we’re footing the bill?I like your take on “bonuses” with one exception: stop calling them bonuses. You aren’t talking about a *bonus* either–you’re talking about an incentive–“something that incites or has a tendency to incite to determination or action.” You want to use the additional payments to get executives to perform above and beyond. Dangling it in front of them before hand is an incentive. Not having any expectation of that extra payment, but deciding to reward an employee who went above and beyond of their own accord, that, is a bonus.
We may get your wish as the word bonus is now so loaded as to make ittotally unacceptable
Umair dropped a bomb on this subject yesterday:”Here we have one of the nation’s most eminent financial journalists [NYT’s Sorkin] advancing patently absurd arguments for AIG bankers and traders to keep their bonuses, [using] the fact that society’s contractually obligated to bankers.”Is it? Sounds like a curiously one-sided deal to me. The real problem is, of course, the reverse: that bankers were never contractually obligated to society – and that, in the bigger picture, no business is…”Disincentives might revolve around the idea of liability, for example. Doctors face a personal liability because of the human costs they might impose. Bankers could too, given the clear and clearly massive costs they’re imposing on the rest of us.”http://blogs.harvardbusines…
I’ve got to go read Umair on this topicThanks for the link
Whoa. Umair really did drop a bomb with that post.I reblogged my favorite line at fredwilson.vcThanks again Ethan.I can always count on you to bring Umair into the conversation even thoughhe doesn’t participate much himself
Yeah, I tweeted yesterday “one thing that geeks me about @umairh isthat i think i’m more concerned about his messages’ distribution thanhe is…”Honored to be his conversational surrogate in this forum 😉
Good discussion about bonuses for entrepreneurs in startups and top executives, but I’m not sure it applies to traders and risk managers in companies like AIG. It is so big that no one individual in a subsidiary can affect ebitda much if at all.Since many of the AIG bonuses apparently were retention bonuses designed to keep talent on board, the question becomes, who is indispensable? AIG obviously thought a bunch of people were or that top executives would have better things to do than recruit new talent. Recruiting and training are costly and often painful.Frankly, If I had been paid $6 million in retention bonuses and now saw a bunch of ignorant members of Congress going after my boss for giving me the bonus, I’d take the money and run. Why put up with the silliness when you can comfortably retire, assuming most of these million dollar babies probably are worth millions already?Don’t give me the integrity and duty to country and AIG nonsense. Not when the president of the U.S. is demanding that his Sec. of Treasury force AIG to break its contracts with its employes. There is no integrity in Washington, and I would never work in such an environment.Ed Liddy is trying to serve his government. But there comes a time when you tell Obama, Frank, Dodd and Schumer, “You guys helped create this mess. Good luck in fixing it.”By refusing to do business with AIG, you are punishing Liddy and taxpayers, not the guys and gals in government and in AIG who created the mess.
Just a clarification:I don’t think the backlash is against the paying of bonuses per se. It’s a backlash against paying bonuses using taxpayer money. It’s a backlash against paying bonuses to a company that probably did more than any other to ruin our financial system. And it’s a backlash against paying bonuses to a group of people employed in the very division that caused most of these problems.If a privately-owned company that has done nothing to harm the average American taxpayer wants to pay bonuses, I don’t think anybody will really care.
I don’t know if this had been touched on already, but I just wanted to make a comment regarding you and your wife’s decision to personally boycott AIG Insurance Services. I was thinking about this on my run today regarding a wide spread boycott of AIG that could come out of this.However, while I don’t want to dissuade people from doing that , I realized that it would undermine the strong side (plain old vanila) of the AIG business. That ultimately will lead to more bailout money when the damaging Insurance brand is completely damaged and bringing in less revenue. They need to spin out the Insurance group and get it under a completely new brand – otherwise it’s completely damaged goods.Basically, we – as a society – have put ourselves into the situation where these people have accumulated all of our money – not just personal wealth, but also municipal and state money. Douced it with gasoline and are now dangling a match over the whole pile, daring us to not to completely remove all of the downside.Goldman Sachs can complain about restrictions on TARP money, but they just back-doored in +$12B through the AIG counter-party bailouts, with no restrictions or equity compensation. +$12B no strings attached. Seems even more outrageous than the $160m bonuses. Where’s the outrage on that?!? At least I’m seeings some reporting about this: http://www.reuters.com/arti…Sociopaths – all of ’em. Makes me want to rent and watch American Psycho again – although the misogyny is pretty upsetting, but the characterization of a young Investment Banker is quiet entertaining. Best scene: early on when all of the VP’s are comparing business cards. Perfectly understated cinematic moment.
I agree with all of it. Blanfein (GS’ CEO) was in the room when the decisionto bail out AIG was made apparently.Anyway, what needs to be done is for the good assets inside of AIG must bespun out and/or sold and rebranded immediatelyAnd the rest of AIG needs to be liquidated
You’ll forgive me for not joining in the “bonuses can be good” love fest. As Alfie Kohn points out endlessly in his books on business and education, rewards are counter productive and notoriously difficult to apply fairly.My two cents: You want to encourage performance? then find an intrinsic motivator and drop the artificial stimulants.
I don’t see that canceling insurance business with AIG advances the game. First, as far as I can see AIG does not have a serious insurance business problem. Second, we are punishing ourselves since “we” own the majority of the AIG shares. Third, we are treating “good” and “bad” employees alike.So, first, deal with the recipients of bonuses in the disaster segments of AIG. READ THE CONTRACTS. It seems no one has asked what did AIG and the employees agree to. Is there any contract language that an employee’s actions must be “prudent” and consistent with the goals of the business or any other similar language? If yes sue to rescind and recover the entire bonus amount from the individual based on a breach of contract. Taking money from the company is not what it is about. Punish the miscreants. Recover, in the courts if ecessary, from them. For this year leave others alone. Reward the (relatively) good; punish the absolutely bad. And revise the new bonus plans in line with your suggestions. Consider adding a provision that 100% of the bonus will be paid 40% on the current year award date and 30% on each of the two succeeding award dates. BUT, RIGHT NOW, READ THE CONTRACTS. In fact, with names redacted, publish the contracts for the indirect shareholders (that’s us) to read.
All of that is true. But I don’t want to do business with that company anymore
The $164M in payments being made to AIG-FP employees are not bonuses, they are payments under an Employee Retention Program (ERP) that the Firm put in place early in 2008. The agreement was publicly released yesterday when Liddy testified to Congress:http://dealbook.blogs.nytim…Please refer to Steven Davidoff’s assessment of the contract and the questions he raises in this posting:http://dealbook.blogs.nytim…AIG-FP employees committed to their jobs and in some cases put their lives on hold and passed up career opportunities because their employer asked them to. They made those commitments under the terms of the ERP which is the agreement that they were operating under for the past 12-15 months. Given AIG’s situation, we are right to question the payments, but the more relevant and more important question to ask is why did AIG and AIG-FP executives feel that it was necessary to lock in AIG-FP employees under such generous terms that no one would likely leave their positions?
<<…suggested we all cancel our policies with AIG. I am with her on that one. We won’t be AIG customers in short order. If you’d like to join us in our own populist revolt, please do.>>GENIUS idea! That would be the PERFECT and ideal way to really screw the owners (the American taxpayers). Without customers, they’d be certain to lose every penny of their $170B investment!
Very good post. I agree with your view on bonuses and also AIG. It should be spun off and let the profitable components of the business survive. Here is one company that is being spun off from AIG – http://www.travelguard.com/As long as the government is mucking around with our economy, there won’t be a recovery. It will take the innovation of small business to drive it forward. Let’s see, where is that Reagan quote..oh yeah – ‘Government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it’- Ronald Reagan
There are two general points I wanted to make:1. The AIG retention bonuses.People are scratching their heads as to why they needed to pay this. Essentially, this is not really to keep the paper pushing managers around, but they were largely promised to the group of derivative traders that largely blew up the firm in the first place.The reason is a handful (approximately 5) traders who ran this 2.6 trillion dollar book of exotic contracts are, unfortunately, the only ones who know it well enough to unwind it and sell it off to reduce risk. After things blew up they were ready to leave the firm, so AIG said, stay around for a few months, do a sane job unwinding the positions, and we will pay you this amount. Unfortunately, they had no choice. If they had left, unwinding the positions stupidly would have cost taxpayers, tens of billions, easily. Again, this was a 2.6 trillion dollar book. It would have taken any outsider 6 months to a year to even figure out what was in it, let alone unwind it.So they made a terrible, but necessary choice. Pay 150 million to these guys to make sure billions were not wasted. Terrible? Yes, of course. But also entirely logical. Sometimes, an offensive, completely unfair and morally disturbing path can still be the most optimal solution. Remember, when wall street banks got together to take over LTCM in 1998, even they continued to pay salaries to the people who blew up LTCM in the first place. They were really angry about it, but they knew only they could effectively wind down LTCM’s positions.2. While I somewhat sympathize with this view that money from the AIG bailout immediately went to counterparties like GS, an important clarification needs to be made.As is the normal course of business, many investment banks will take out insurance on their counterparties. So GS had an agreement to receive money from AIG, but just in case they also simultaneously purchased insurance that if this agreement was not fulfilled, the insurance would make them whole. In this case, this insurance was CDS on AIG.So there were two possible cases:AIG gets bailed out: the bank receives the money as per the contract, but the insurance on AIG expires worthless as AIG did not default.AIG does not get bailed out, and defaults: Sure, the bank no longer receives the 12 billion per the contract, but the CDS insurance contracts on AIG get paid out so they are still made whole.So the incentive to see AIG bailed out is not as nefarious as everyone believes it is, the worry was less about the 12 billion (they would have largely gotten it either way) and more about the risk to the system as a whole. A more intelligent argument is that who really got bailed out was the CDS seller in this case, but that is not as anger and conspiracy theory inducing as this currently popular view that Goldman engineered the bailout for its personal gain.
This is important stuff JLM and if everyone knew it and understood it, we’dbe way better off
The decision to incentivize traders to unwind books is happening throughout the financial industry. When viewed in the context of when that decision was made – the AIG plan apparently was adopted in March 2008, before the worst of the market meltdown – I’m not sure how unreasonable a decision it was.And not unheard of in the VC world, either. Fred, as you know, boards of VC-backed companies have been known to adopt “stay bonuses” or “management carveouts” in certain circumstances. Typically, it’s when the board decides that it is time to sell the company and fears that if management leaves, there won’t be anything to sell. A shareholder in that company (particularly one who may have been crammed down several times by financing rounds) may have some of the same type of anger that we’re hearing today about the AIG bonuses. One could ask why management should be “bonused” (an appropriate word in this context) when arguably they have run the company into a position where their equity participation in the company doesn’t provide sufficient motivation for them to stick around. The answer, from the board’s perspective, is that they saw it as a rational way to try to maximize shareholder value.Why is the AIG situation different? A few reasons that don’t really have anything to do with whether some type of retention plan was appropriate at the time it was adopted. Obviously the optics of having bailout money go to people that are perceived as superwealthy (and who are all being portrayed by the demagogues as crooks and co-conspirators, when that is far from the reality) plays big, and there are lots of issues under discussion about who knew what and when. But much like I expect to see management carveouts and pools remain facts of life in VC-backed companies, AIG was hardly the first company to adopt a retention program, and it won’t be the last. And given the economic realities faced by the company back in March 2008, which are now being played out in trading floors all over the financial industry, it doesn’t seem like so much of an outlier.One can argue whether EBITDA-driven compensation plans and equity-based incentive plans are appropriate AS A GENERAL RULE. But no matter how idyllic they may be, boards face circumstances from time to time when they can reasonably determine that the general rules of thumb may not work.
Great points JayI really wasn’t trying to trash the AIG bonuses, I was just saying that theyhave unleashed a ferocious backlashI don’t know enough about the AIG bonuses to opine on their merit, but itseems like there were good reasons behind them (at least the stay bonuses)JLM’s comment in this thread is a good read on that topicThe point about boards in VC backed companies giving stay bonuses iscertainly accurate and I have been party to them on a number of occasions
With all the AIG crap i think this shirt is timely:http://www.recessionjunctio…
I feel this whole thing is a diversion from the real deal, what is your take fred ?http://www.bloomberg.com/ap…
I think “when government funds business, it messes everything up”http://www.avc.com/a_vc/200…
Is it worth considering that AIG’s bonuses are quite possibly hush money? The mistakes made at these banks crosses the line from gross negligence to what might be considered a massive ponzi scheme.If AIG’s bonus defy outward logic lets rethink what they might be hoping to accomplish.
Apologies if this is incoherent, I’m just doing a hit and run because it interested me.I’m actually a little surprised to see, in all this intelligent discussion, a lack of commentary on the psychology of bonuses themselves. Regardless of whether they were retention-focused, or outright greed, or simply part of how we reward people, I think we have to consider a) what the goal was and b) how effectively the payment accomplished the goal.Equity is a great example. Fred likes it because it aligns the interests of the company (by some metric of profitability) with the interests of the CEO. Make us more money and we’ll pay you more. But is that the right way to run a company? Imagine a situation in which I make a five year, year-over-year increase in EBITDA by taking a company’s reputation and brand name and driving it straight into the ground. After five years, you fire me or I quit (probably with nice severance), you get a sucky brand that some other CEO now has to try and rescue, and I get my juicy bonuses that occurred along the way. I could make Charles Schaub into the next Girls-Gone-Wild and probably increase profits, at least for awhile – certainly long enough to make a buck.Compare this with Barry Schwartz’s recent TED talk, where he essentially talks about the use of agency. We have a psychological affinity for doing the right thing, when we are shown that it is, in fact, the right thing and worth doing. This is the common Zappo’s point, and yes yes, I know it doesn’t make anyone a bazillion dollars overnight and any number of VC’s will throw rocks at me for pointing it out. But look at the great generals throughout history, who have commanded troops into battle. The lesson they constantly point out is that you can’t threaten people into being good soldiers, and you can’t buy them into it in any reasonable way: you have to actually inspire them.So how do you do that in a structured way?First, give people segregated gains. Low/no bonuses, decent/high salaries, and perks that actually count. I don’t mean golf games with other rich CEO’s, I mean perks like decent working hours and lowered pain points – more assistants and agents that make your life, as a CEO, better. If you’re a startup, most CEO’s would actually be more satisfied in life if they had someone to help them share the load and keep them healthy and on track than with a bonus. If you’re a larger company that already has an assistant, there are still pain points that can be removed. Think of the number of CEO’s that wish they just had someone around to sort out their technology or to optimize their life so they didn’t feel stressed and overworked 99% of the time?For non-CEO’s, give them the same. The amount of rubbish the average mid-upper management person has to do to fill out reimbursement forms is ridiculous: spend ten thousand bucks and get a system that makes it so painless that they don’t have to think about it (or pay someone to do it for them). Give them autonomy, a la Google’s 10% time, to actually pursue things that are interesting. And I don’t mean just “go and think about it” time, but honest to god resources, where they can have a side project that you’ll actually assign an engineer to actually build. If you said “do you want $10K of a personal bonus or this side project”, they’d almost always say the money for themselves. But if you actually did both, you’d find the side project would probably actually make them happier, more satisfied, and more productive.The money you spend on bonuses can give people a lot of chances to actually do good in the world – people have a psychological need to be productive and to feel like they are actually doing good things in the world. AIG money is hush money in some ways, in that it is compensation for feeling shite about what you do, because it doesn’t actually seem to have a positive impact on people. Give them a chance to do something good and make a difference – human interaction is more important than it looks.