The GMI Blog

OWS Protesters Target Big Bank CEOs, Security Perks Put to Use

By Greg Ruel, Research Associate

JPMorgan Chase & Co. CEO James Dimon received $17k in security costs in 2010. The security figure represented a diminutive portion of his nearly $600k in perks for the year, though he could be looking to beef up security soon after being approached by Occupy Seattle protesters Wednesday afternoon. According to this article from the Los Angeles Times, Mr. Dimon was booked a year ago as the keynote speaker for a dinner at the University of Washington’s Foster School of Business. Protesters marched with arms locked down the street toward the hotel where Mr. Dimon was speaking and attempted to block entrances to the building. Several injuries were reportedly sustained by police officers. The next day, the “Occupy Jamie Dimon” movement sprang up in Portland, Oregon, as the CEO arrived for a Business Alliance lunch. Finally, we are seeing a tangible reason for all these CEO security costs, though we’d still argue the CEO can afford to pay them on his own. Big banks are now generally free of TARP restrictions and the cash began to roll in again during the 2010 compensation year.

Mr. Dimon, for instance, made $42 million in realized compensation in 2010. He received two bonuses for the year, including a discretionary cash bonus of $5 million awarded “with respect to his performance and contribution to the Firm in 2010 and in recognition of his leadership over the past several years.”  His equity grants of restricted stock units and stock appreciation rights were awarded for the same reasons, absent performance restrictions or metrics, and totaled $17 million in 2010. Mr. Dimon exercised more than 2.7 million options in 2010 and his profit on stock and options was more than $35 million for the year. He is also receiving a $500,000 salary raise for 2011, bringing it up to $1.5 million.

Goldman Sachs and CEO Lloyd C. Blankfein have faced similar attention from the occupy movement, including a “March on Goldman Sachs” Thursday afternoon. In 2009, Mr. Blankfein received uncharacteristically modest compensation of $1.1 million, including a $600,000 base salary and no bonus, in a second consecutive restrained year for big bank executive compensation under TARP. In 2010, not only did Mr. Blankfein receive a $5.4 million discretionary bonus, but so did the CFO, President, and two Vice Chairmen named in the proxy statement. No methodology for the bonuses is explained. Mr. Blankfein received $464,067 in perks for 2010, including $128,676 in security costs, and finished with $21.8 million in realized compensation. Included among compensation changes for 2011 is a base salary hike for CEO Blankfein from $600,000 to $2 million.

Last month, BlackRock CEO and co-founder Laurence D. Fink said he understood the protests against financial firms, as reported by Pensions & Investments:

“The protesting is a statement the future is very clouded for a lot of people,” Mr. Fink said earlier this week during an event in Toronto. “These are not lazy people sitting around looking for something to do. We have people losing hope and they’re going into the street, whether it’s justified or not. People are afraid of the future,” Mr. Fink said. “We have some structural issues we have to fix.”

For his part, Mr. Fink made about $40 million in 2010, and there are certainly “structural issues” in Blackrock’s compensation policy. According to Blackrock, “significant discretion is used to determine individual compensation…[and]…no set formulas are established and no fixed benchmarks are used in determining annual incentive awards.” The “structure” of Blackrock’s board is classified and includes designees from PNC, Bank of Americall/Merrill Lynch (BAC), and Barclays, which would seemingly make it hard for independent directors to provide a true impact. In addition to a bonus of $10 million, Mr. Fink also profited nearly $29 million on exercised options and vested stock in 2010, yet still received about $13 million in fresh equity grants.

Big bank CEO pay has rebounded in 2010 and protesters have undoubtedly taken notice. It's difficult to justify all the pay mentioned here when so much of it is discretionary. Pay that is awarded at the discretion of the compensation committee. The 2010 proxy statements for these banks make a point of noting how much compensation had been reduced in the prior two years, you know, when they needed government bailouts and were looking for remedies to catastrophic financial failures. But TARP is largely a thing of the past and big bank CEO pay is back on the rise, seemingly regardless of what is going on in the rest of the country.

GMI will be releasing its annual CEO Pay Survey soon with details on the 2010 compensation year as well as changes in CEO Pay since last year. The report will feature a top 10 list of highest earners, with the top two top spots occupied by CEO's in the Health Care Providers & Services industry who combined to make more than $243 million in 2010. Also, changes in perks in the S&P 500 and fluctuations in equity granting practices over the last two years.

Interview: J.C. Chandor of "Margin Call"

Even the movies seem to be supporting Occupy Wall Street this fall. The dystopian sci-fi film, "In Time" has a pair of heroes who are part Bonnie and Clyde and part Robin Hood and Maid Marian as they rob from the rich to give to the poor.  And writer-director J.C. Chandor, whose father worked at Merrill, Lynch, is behind the timely new film, "Margin Call," about one night at a big Wall Street financial firm, where the top executives must decide before the market opens who will bear the staggering costs of their poor risk management, they or their clients.  

The movie stars Jeremy Irons, Keven Spacey, co-producer Zachary Quinto, Stanley Tucci, and Demi Moore.  

It is specific enough to make some very pointed commentary on the financial meltdown but universal enough that its themes of betrayal and externalized costs could be set in any industry or indeed in any organization.  It has been in the works since 2007 but is in theaters at what Piaget would call "a teachable moment."

I spoke to Chandor about the film.

How did you come to write about the financial meltdown?

I had written several different things in several different capacities but had never done anything even sort of remotely topical let alone completely topical.  This was being written for myself to direct so it was from a very personal place, not a Hollywood script to go out and sell.  A lot of what has become the strength of the project and drew people to it came from an odd place, from production restraints I placed on myself to keep the budget realistic.

I’m a total real estate junkie and took time off to set up a partnership to renovate an old building and it happened to be on the other side of the real estate bubble.  The godfather of one of my  partners was a very prominent investment banker, a ground-breaker, an intellectual, invented the concept of a real estate hedge fund, a whole new model.  He intervened in his godson’s life and about halfway through our project came to him and said, “Those offers you’ve been getting to buy the project half-completed — take them.  I’ve been leaving millions of dollars in deposits on the table because it is time to get out.”  We took his advice, mostly because we were having trouble with one of the other partners but also because we had the feeling things were not going well in the markets.  We just broke even and felt like a defeat at the time but a year and a half later I felt I had a new lease on life.

As things really started bubbling to the surface I thought back to that man and what it was like to be walking around — you never know for sure, but he felt pretty strongly things were bad enough that he had to take a financial hit to avoid a worse one and warn us.  I thought it was an interesting issue to look at it from the inside, and do a small character-driven story about investment bankers as they see what they thought their lives were about changing in a deep way and what their responsibility was, all those things that were a little bit unsaid in the film but that the actors and I knew were all there.  I have only so much time, so much energy, this skill set, and this is what I’ve used it for.

It has the setting of a drama but it feels like a thriller.

To be there on that day was an interesting limited view into a wide problem.  It’s a ticking time bomb structure, which is a thriller by its very nature.  The one total deviation is that 45 minutes into the movie you know the bomb can’t be defused.  The drama is who will they hand the bomb to?

Do you see them as villains?

What most people would choose to do in this scenario is what these characters do — to look out for themselves.  To look at it in the macro viewpoint, they made the decision when they walked into the door coming out of Harvard or wherever they were to use their time and skills and very intense intelligence and education and have the big majority of those people get siphoned off into this world.   People who have already made that choice when they walk in the door it is unrealistic to expect them five, ten, fifteen years later to make a different choice about who to take care of.

Your father worked on Wall Street, at Merrill Lynch.  Did he guide you at all on the script?

For superstitious reasons I didn’t show the script to anyone in my family.  I’ve had a lot of false starts if you know what I mean!  I didn’t really tell my family I was doing this until we were really at the point of no return.  But what I learned from my father and from friends over the years is the toll that it takes on the people who stay behind and keep their jobs when others are let go.  It’s one of the only businesses that even in their best years still culls 5-10 percent of the workforce every year purely for motivation.  The people who last are the ones who play the game correctly.  For certain characters like Spacey’s it’s not about greed; it’s about survival.  For others like Simon Baker’s and Demi Moore’s it is about ego and the way you define yourself.

I originally wrote the scene when it wasn’t the big dramatic day, yet.  It was supposed to be more run of the mill, but as things developed in real life by the time we shot it, it became too subtle.

The way it was revised though, gets Stanley Tucci’s character out of the building, and that is important for the plot.

The fun thing about Stanley’s character, Eric Dale, is that I have a hard time naming characters and I usually use names from people in my life.  Eric Dale just worked and it is amusing for him because every character says the name through the film as he becomes the symbol of the paranoia that the information will get out.

I won’t give it away, but I wanted to tell you how much I liked your ending — you took something of a risk and it paid off.

The ending and the music are the things most people feel comfortable having an opinion about.  For me, the movie started with the ending and then you figure out how you get there.  Kevin Spacey would say something different but for me the most important thing is what’s behind him, the house.  It became very important to understand that in his mind, he did need the money.  No matter what you make, the way people rationalize their connection with money is almost identical.  As Paul Bettany says in the film, “You learn to spend what’s in your pocket.”

 

Interview: Alfred Rappaport of Saving Capitalism from Short-Termism

Alfred Rappaport's important new book, Saving Capitalism From Short-Termism: How to Build Long-Term Value and Take Back Our Financial Future, has a penetrating diagnosis of the disruptive forces in our markets and powerful prescriptions for addressing them.  He generously took time to answer my questions.

How does the current structure of incentive compensation at the CEO level affect the obsession with short-term performance? How can it be changed? 

Ideally, incentive compensation should motivate executives to maximize long-term shareholder value while avoiding either excessively risky behavior or excessively risk-averse behavior.

Most companies offer CEOs and other senior executives annual incentive plans featuring earnings, revenue, cash flow, and return on investment performance targets. None of these short-term financial measures is reliably linked to long-term value creation. On the contrary, these incentives can encourage reckless risk taking leading to massive value destruction because the long-term consequences of today’s operating and investment decisions are ignored. Executives of major financial institutions demonstrated precisely this type of behavior, with its disastrous consequences, during the housing-price bubble.

At other companies, executives may choose to delay or forgo value-creating investments in order to achieve their bonus targets. These vital investments include research, new product development, brand building, and product and market extensions. By refusing to take reasonable risks, executives boost the company’s short-term results at the expense of its long-term value-creation potential. The bottom line is that annual bonuses fail to achieve any of the three essential objectives of incentive compensation. They do not provide executives with an incentive to maximize long-term value, they can encourage excessively risky behavior, and they can encourage excessively risk-averse behavior.

Multiyear plans employ many of the same performance measures as annual bonuses. Extending the period over which unsuitable targets are measured from one year to three years doesn’t do the job. A company can report three or more years of earnings growth or improving capital-efficiency ratios without creating any value.

Standard stock option plans have limited ability to motivate superior long-term value creation because performance targets are too low (any increase in grant-date stock price) and holding periods are typically too short (3-4 years).   One potential solution is an indexed option plan that requires executives to retain a meaningful fraction of the equity they obtain well after the vesting date. Unlike standard options, which have a fixed exercise price, indexed options have an exercise price that rises or falls with an index of the company’s competitors. 

For companies that are unable to develop a reasonable peer index, there is an attractive alternative which I call an equity-premium option plan (EPOP). EPOPs require a higher level of threshold performance than standard fixed-price options, but, unlike indexed options, they do not require the construction of an index. Specifically, the exercise price of the option rises by the yield to maturity on the 10-year U.S. Treasury note plus an equity-risk premium minus the dividends that the company pays.  Suppose a company’s shares are trading at $50 at the option grant date, the yield on the Treasury note is 2%, and the equity risk premium is estimated at 4%. The exercise price would rise by 6% over the next year to $53.  Assuming a dividend of $1 per share the exercise price would be adjusted to $52. 

The post-Enron backlash against options encouraged many companies over the past decade to move from stock options to restricted stock.  Restricted stock grants vest after an executive has remained with the company for a specified length of time. At the end of the vesting period, executives own the stock and are free to do whatever they want with it. Restricted stock grants are equivalent to options with an exercise price of zero. They are largely guaranteed pay, have no commensurate performance requirement, and are aptly referred to as “pay for pulse.” Stock grants encourage risk-averse executives to play it safe, protect the current share price, and avoid getting fired.

In an effort to blunt the criticism that restricted stock plans are a giveaway, some companies offer performance shares that require executives not only to remain on the payroll, but also to meet performance targets for metrics such as earnings per share, revenue, and return on capital employed. Executives may pursue these short-term targets, which are typically set at undemanding levels, at the expense of the company’s longer-term value-creation potential. Unlike restricted stock grants, performance share plans do demand some performance. Unfortunately, it’s not the right performance.

 

Dodd-Frank v. The 10 Commandments

By Paul Hodgson – Chief Communications Officer

In an article in this week’s Agenda about the anniversary of Dodd-Frank, Josh Martin quotes some of what we discussed here:

These rules won’t prevent a future economic meltdown, says Paul Hodgson, chief communications officer at Governance Metrics International. “Fifty years from now, people won’t remember what Dodd-Frank is,” he declares. “The effectiveness of legislation is very short-term, even with the best of intentions.”

This comment was in response to Josh’s question about the legacy of Dodd-Frank. And I indicated that not only was the effectiveness of legislation short-term, so were the memories of many of those for whom it may hold interest right now. Fundamentally, what I was trying to say was it took only nine years for Sarbanes-Oxley’s checks on corporate nefariousness to become ineffective, and I didn’t hold out much more long-term hope for Dodd-Frank. It offers potential solutions – or it will when it is actually implemented – for the problems identified in the recent financial crisis. The next financial crisis will happen because of a whole set of different malpractices so it cannot hope to hold out a solution to those.

Josh also asked me which bits of Dodd-Frank should get a thumbs up and which bits a thumbs down. I answered that all the pieces that had been implemented should get a thumbs up and all the pieces that hadn’t should get a thumbs down. The delay in implementation is a huge frustration for the corporate governance community. Whether the delay is because of frivolous lawsuits or through lack of funding is irrelevant, the Act needs to be put in place. It’s like Moses coming down from Mount Sinai with the 10 commandments and saying we’ve only got time to implement the first five; so we can't take the name of the Lord in vain, but we can still get away murder, adultery, theft, lying, and covetousness.

Phil Angelides Refutes Attempt to Rewrite History

Phil Angelides, who chaired the bi-partisan Financial Crisis Inquiry Commission, has an excellent op-ed in today's Washington Post about "Wall Street's Fact-Free Revisionism" on the financial meltdown.  Like the Sarah Palin fans who tried to revise the Wikipedia entry on Paul Revere to conform to her muddled summary and revisionists through history who try to whitewash the tragic mistakes of the past, the people with a vested interest in the status quo are doing their best to "turn a blind eye to the sad history of widespread lending abuses that savaged communities across the country."  In this very important piece, Angelides documents the shameful attempts to divert attention from the documented causes of the meltdown to "refuse to acknowledge what went wrong and then try to stop efforts to make it right." 

The FCIC was explicitly charged to report on what happened in the tradition of the post-Crash Pecora Commission, whose fine work led to the reforms that made our financial markets the most credible and powerful in the history.  Angelides and his group did a fine job.  In this piece, he makes it clear that failing to assign blame to the many, many places where it is deserved creates an insurmountable obstacle to preventing re-occurance.

Does historical accuracy matter? You bet it does.  

Traveling down a road unfettered by facts will take us far from where we need to be: prosecuting financial wrongdoing to deter future malfeasance; vigorously enforcing financial reforms to rein in excessive risk; and rooting out Wall Street’s conflicts of interests, abysmal governance and badly flawed compensation incentives.

Worst of all, it will divert us from the urgent task of putting people back to work and creating real wealth for America’s future. Over the past decade, we squandered trillions of dollars on rampant speculation rather than on making investments — in technology, infrastructure, clean energy and education — that increase our productivity and economic strength. The financial sector’s share of corporate profits climbed from 15 percent in 1980 to 33 percent by the early 2000s, while financial-sector debt soared from $3 trillion in 1978 to $36 trillion by 2007. With tens of millions still unemployed, isn’t it time to shift from an economy based on money making money to an economy based on money creating jobs and genuine prosperity?

Oscar winner lashes out at Wall Street

In among the constant references to performance union workforces, Charles Ferguson, the director of the Oscar-winning documentary The Inside Job sure knew how to seize an opportunity. As he clasped his little statuette, he bent down to the microphone (like, everyone had to do this at the Oscars last night, were there just a lot of really tall winners or don’t they know they can adjust those stands?) and unleashed this magnificent quotation:

Forgive me, I must start by pointing out that three years after a horrific financial crisis caused by fraud, not a single financial executive has gone to jail — and that’s wrong.

You have to admire moral certainty like that, and you certainly can’t argue with his conclusions.

And apart from a couple of weak question and answer sessions with Congressional committees and the Financial Crisis Inquiry Commission at which the only executives who were called just raised their hands and said they were sorry, and if they’d’ve know they’d’ve done something about it, but they didn’t, really, honest, it was as big a surprise to them as it was to the rest of us… there’s been nothing.

But someone must have been to blame so why aren’t they being prosecuted? Why aren’t they even being sued?

Yo, shareholders! Isn’t this where you come in? You were the ones lost the money.

Paul Hodgson - Senior Research Associate

The Most Important Sentence in the FCIC Report

Within the 662 pages of the report released last week by the Financial Crisis Inquiry Commission, based on information from more than 700 witnesses and millions of pages of documents, and including two separate dissents from the Republican members, there is one sentence that encompasses all of the majority’s conclusions and refutes all of the dissenters’ objections. Here it is:

Compensation systems—designed in an environment of cheap money, intense competition, and light regulation—too often rewarded the quick deal, the short-term gain—without proper consideration of long-term consequences.

On Bnet, I explain why that sentence is not only at the heart of the report, but it also refutes every argument made in the minority dissents.

Charles Ferguson on his Documentary About the Financial Meltdown

The scariest -- and most infuriating -- movie of the year is "Inside Job," the documentary about the financial meltdown from Charles Ferguson, the director of "No End in Sight." With just two films, Ferguson, a PhD in political science who made a fortune in software, has become an extraordinarily accomplished director and journalist and an important participant in the conversation about definitional issues of policy. His films are exceptionally well-crafted. He has a true story-teller's understanding of the material and, as his interviews of the friendly and not-so-friendly subjects of this film demonstrate, a fearless intellect and a gift for getting to the point -- all of which made interviewing him a rare treat.

I have done a great deal of research myself on the subprime portion of the financial meltdown and I believe a core problem was that everyone at every stage of the Wall Street conveyor belt, had incentive compensation that was all upside and no downside -- they all got paid for success with no risk of loss for failure. Is that what you discovered as well?

These people were rewarded enormously for doing the dangerous things they did and even on a net basis, despite the losses they suffered when their firms collapsed, they made more money then they would have if they behaved ethically. Harvard Law School professor Lucien Bebchuk's study on executive compensation at Bear Stearns showed that it created incentives for excess risk.

I think it's unquestionably correct at several different stages and several different levels in the system, beginning with the yield-spread premiums that lenders paid to mortgage brokers which incented mortgage brokers to put people in more expensive and more dangerous loans than they should have going all the way up to the structure of trader and sales and CEO compensation in investment banking, which are all exceptionally dangerous and give people huge incentives to take risks and/or commit fraud, both of which occurred on a gigantic scale. Even the nature of director compensation and corporate governance -- the directors are essentially paid to be passive and to not challenge entrenched management.

How would you describe what went wrong?

Large-scale fraud became a core part of the financial system -- a combination of deregulation and lack of enforcement of the law.

One of the big differences between the financial crises of the Enron/WorldCom era and the more recent one is that no one seems to be going to jail. Why is that?

The reason that they're not going to jail is not that they didn't commit crimes. It's because there's been no effort to enforce the law, an even more disturbing phenomenon.

 

 

What's the solution?

The American people have to get angry enough and organized enough to force our political leaders to change. At the moment it doesn't seem at all likely that it's going to come from the current administration. It's been a great disappointment that it's turned out to be more of the same. And so far the American people have been remarkably quiescent in the face of this, given what's occurred. I hope that that's changing. There are good guys but they're not organized. There's no Chamber of Commerce for the good guys. That's what we need, whether it's a political party or some non-profit/lobbying organization that coordinates -- there are a number of organizations but they are very scattered and divided.

How can Washington stand up to Wall Street, given the amount of money they spend on lobbying and campaign contributions?

Wall Street has certainly become very powerful. It's depressingly the case that politicians are inexpensive to purchase. Three things are critical -- changing the role that money plays in elections, paying regulators very well, which some countries do, like Singapore, which gives them no financial incentive to move to or give favors to the private sector, and third is law enforcement. One of the least well covered in media terms developments related to this is the politicization of law enforcement for white collar crimes.

As they say, if you rob a bank with a gun, you go to jail; if you rob a bank with a pen, you get to keep your job and your bonus.

And that's a change. After the S&L crisis, many people went to jail. Now no one goes to jail.

Who should have gone to jail?

All of the major investment banks artificially concealed their liabilities, most of them inflated the value of their assets for quite a long period of time. We also know all the major investment banks were heavily involved in selling securities they knew to be defective and in many cases designing them to fail so they could bet against them or allow their clients to bet against them. In principle it's possible to do those things without violating the law but as a practical matter it's hard to sell hundreds of billions of dollars of those securities without committing fraud. If you're honest and you don't lie and you don't commit fraud, it's a tough sell. We know that Goldman Sachs executives were referring to these as "s***y deals" at the same time that they were selling them as very safe securities. I suspect that a very high fraction of the senior sales forces, the senior people on the mortgage tests, the senior mortgage traders, the senior management of the investment banking industry should be prosecuted.

What is the hardest part of explaining all of this to frustrated and angry Americans, where so many people feel that the system is unfair but whose eyes glaze over when they hear "credit default swaps?" How do you reach the people you want to get angry?

Keeping the jargon out and getting to the essence of things, not letting the jargon overwhelm you. We wanted to make the film interesting and accessible for the average person. We used good cinematography, cool images, great music, pacing, to make it appeal to the audience. I hope that many, many people will see this film.

You were a serious film fan before you became a film-maker. What are some of your favorites?

There are serious ones and silly ones. I love film noir, "The Maltese Falcon," "The Big Sleep," the newer incarnations like "LA Confidential." I love heist movies. "Inside Man" I thought was great. And serious things, too: "Kagimusha," "Ran." My friend Jason Kohn's movie "Manda Bala" about corruption in Brazil is beautiful, amazing. It's about crime and corruption in Brazil and it's gorgeous, really extraordinary. It's so unusual in the way that it is visually gorgeous. It was made in anamorphic Super 16, 2.7 to 1 so a standard DVD will not do it justice. It's really breathtaking.

Are documentaries the agent for social change the way Dickens was in the late 19th century and journalists like Upton Sinclair and Rachel Carson were in the 20th century?

It's not the only place investigative journalism gets done these days but journalism is shrinking, and under a lot of pressure. Documentary film is taking up some of that slack and I hope it will become increasingly prominent.

Nell Minow - Editor

The Mafia Running the Police Force

I just read in Mother Jones that among the 14 securities industry insiders currently working for the Obama administration to help regulate Wall St (including the likes of Neal Wolin) is one Herbert Allison.

Herbert Allison?

Responsible for overseeing TARP?

Isn’t that like asking the Mafia to run the police force? We know there’ll be lots of arrests, but what’s going to happen back in the cells? Or to reach further back into metaphorical history, isn’t that like getting the fox to guard the chickens?

I mean, I know he ran TIAA-CREF for a little while, but before that he was CFO and COO of Merrill Lynch, and on the board there. He was there 28 years. He was a director of the NYSE when Dick Grasso was walking away with barrow loads of cash. And then he worked at Fannie Mae just overseeing its total implosion.

There wasn’t anybody else without any skeletons in the conflict of interest closet that this administration is supposed to be doing something about?

Thank you, Mother Jones. She’s it for the best investigative reporting into this crisis and its aftermath.

Paul Hodgson - Senior Research Associate

The New Fundamentals - Nell Minow in the Financial Times

Don't miss today's Financial Times op-ed, "Impresarios on the board are a bad sign," written by The Corporate Library's Editor and Co-Founder, Nell Minow.

Opponents of post-meltdown reforms to corporate governance are trying to hold back change by focusing on Washington. ... They are missing the point. No matter what happens in Washington, the market is forcing through significant and pervasive reforms. The companies that first understand that will benefit from a lower cost of capital and more committed long-term investors. As we understand better the mistakes of the past and the challenges ahead, fund managers and analysts will look at "new fundamentals", four elements that will become as important as cash flow and return on investment.

Read the piece to learn more about the new fundamentals Nell Minow proposes.