Towards the end of 2009, it looked like Goldman would continue to pay amounts that, in a time of 10% unemployment, looked excessive.  The investment banking firm was on a path to set a record.  Push back from shareholders and a generally pillorying in the press apparently had some impact.  The firm announced that it would not pay a record amount of compensation, setting it at a percentage in the 30's, well below the typical percentage (between 45% and 50%) over the last ten years. 

The other shoe was the bonus paid to top management.  The CEO (and chairman), as well as four additional officers, received a bonus of $9 million on top of the $600,000 in salary.  The bonus was also in stock and couldn't be sold for 5 years.  The pay was even less than the amounts authorized by the Pay Czar with the companies subject to his oversight.  He allowed a couple of compensation packages to weigh in at $10 million plus. 

The approach used by Goldman was responsible and, as a result, the public criticism was muted.  There is no room to complain.  It was highly responsible and, on this one, the board and CEO did the right thing.  It was an impressive display of proper corporate governance.

The problem is that it is likely to have been a one time event.  Already the firm's Chief Financial Officer, David Viniar, is warning investors and the public not to read too much into the action.  As the WSJ reports, Viniar had this to say about compensation:

• "People ask me if this is the new normal," Mr. Viniar said at a Credit Suisse conference in Miami. "There is no formula. We tried to strike the balance right, and we'll try to strike the balance right this year."

In other words, the days of $65 million plus bonuses may not be over.  Moreover, its even possible that Goldman will pay interim bonuses and increase compensation during 2010 to attempt to compensate for some of the shortfall. 

In the end, the process of determining executive compensation lacks integrity.  For more on this, take a look at Returning Fairness to Executive Compensation.  It remains broken and, despite this act of professionalism by Goldman, it is still not fixed.  Directors need to be truly independent so that they can say no to proposed compensation packages that are unreasonable.  While the debate has calmed a bit because of Goldman's actions, the problem remains unaddressed. 

• the members of Goldman’s Board of Directors (the “Board”) abdicated their responsibility to administer the Company’s compensation plans in the best interests of the Company and its shareholders, and instead have blindly “rewarded” executives for corporate performance that has absolutely nothing to do with the skill of the Company’s employees. Over the last decade, Goldman’s directors have reserved and issued as compensation to employees an amount approaching 50% of the Company’s annual net revenues. Because the majority of the Company’s revenues depend on the reported values of the firm’s investments, however, these revenues are impacted by market forces and not necessarily the productivity of Goldman Sachs employees. Nevertheless, year after year, Defendants have caused the Company to pay billions of dollars in incentive based compensation, regardless of whether the Company’s performance could be attributed to the skill of the employees Defendants determined to so generously compensate.

The complaint does note that Goldman has been remarkably consistent in the amount paid in compensation over the years.  Id. at 19 ("From 1999-2008 that percentage [of monies used to pay employee compensation] has not varied from the range of 44-49% of the revenues."). 

As for 2009, the complaint contains an additional charge.  The Company's success "has not been the product of the skill and business acumen of the Company’s employees, but is attributable directly to the multi-trillion dollar infusion of capital by the American taxpayers to bail out the entire financial services industry."  

Whatever the merits of the case, they are, in the first instance, irrelevant.  The case will turn not on whether a fiduciary violation may have occurred but whether the plaintiffs have met the standard for demand excusal.  That in turn depends upon whether a majority of the board of directors are independent.  Plaintiffs allege that the board lacked a majority of independent directors because most of them sat on the compensation committee (the committee that approved "compensation decisions that were wholly divorced from the performance of the Company") and the audit committee (which "allowed or permitted the above failure to occur in the Company's internal controls"). 

Ordinarily, this case would be slated for dismissal.  Goldman is incorporated under Delaware law.  The Delaware courts do not generally permit a loss of independence solely because of membership on a committee.  See Wood v. Baum, 953 A.2d 136 (Del. 2008)("Plaintiff also asserts that membership on the Audit Committee is a sufficient basis to infer the requisite scienter.  That assertion is contrary to well-settled Delaware law.").  

The suit, however, was filed in New York.  Under the internal affairs doctrine, the courts must still apply Delaware law.  New York courts have sometimes evidenced a more liberal approach towards the definition of independent and, as a result, a New York court may be slower to dismiss the case at the demand excusal stage. 

The Complaint is posted on the DU Corporate Governance web site.

The review (and book) criticized the board for oversight lite and high pay.  Specifically, the piece noted that directors "attend 8 to 12 meetings annually" and "receive as much as $640,000 a year."  Of course, as we have pointed out, directors actually meet less often than that (although maybe during the financial crisis the number of meetings have been aberrationally higher) and can make well over $700,000. 

Surely, the number of meetings is not the sole measure of effectiveness.  Nonetheless, there is plenty of evidence that suggests boards exercise little meaningful oversight of the CEO's behavior.  As the piece noted:  

• The authors note that Rick Wagoner, the former General Motors chairman [and CEO], declared in 2008 that: “I get good support from the board. We say, ‘Here’s what we’re going to do and here’s the time frame,’ and they say, ‘Let us know how it comes out.’ ” (Memo to the board: your shareholders lost $52 billion in equity during Mr. Wagoner’s watch.)

The book called for "public directors" appointed by a nonprofit organization and the separation of chairman and CEO.  We have called for the latter and while the former raises any number of issues and questions, certainly providing shareholders with access to the company's proxy statement would facilitate the election of non-management directors. 

Even this, according to the authors of Money for Nothing, would not be enough.

• But no amount or manner of structural change can ensure that directors will step up and take responsibility for their fiduciary duties to shareholders, the authors assert. Boards overwhelmed by the power and glory of corporate chieftains tend to commit sins of omission, like not asking probing questions and not challenging management presentations of “fact,” rather than sins of commission like active participation in securities fraud.

This suggests extraordinary deference to the CEO.  Yet the deference comes from the legal standards.  Under Delaware law, directors are governed by the ostrich approach to information.  What they don't know in general can't result in liability.  As a result, they have an incentive not to ask, not to probe.  The way to change this ostrich approach?  Create legal standards that require questioning and probing, with liability on those who do not.  But as long as Delaware controls these standards, the ostrich approach will be the controlling standard.    

Much of the commentary is palaver, with a great deal of umbrage but no real solution.  One of the more interesting comments came from the Pay Czar, Ken Feinberg.  Feinberg has done a good job given the limitations of his authority.  Its possible, as we have noted on this Blog, that the role of the Pay Czar may ultimately prove harmful to the financial system.  The harm, though, is structural.  The Pay Czar could only control the compensation practices at a small number of companies and financial institutions, leaving the others to pay excessive compensation.

Over the weekend, Feinberg took note of this.  In the interview with Judy Woodruff, he decried his lack of authority.

• “The biggest disappointment, I think, is that under the statute my jurisdiction is so narrow, and so circumscribed, that I have no real direct mandatory power over other Wall Street or other national companies,” Feinberg said today in an interview with Bloomberg special contributor Judy Woodruff. 

In other words, the problem is systematic and requires a broader cure.  Yet Feinberg said exactly the opposite to Congress back in October.  In testifying before the House Committee on Oversight and Government Reform on October 28, 2009, he had this to day:

• Finally, I do not recommend that my responsibilities related to compensation determinations for senior executives, as currently defined by Treasury regulations, be expanded beyond the current seven companies receiving exceptional TARP financial assistance.

I criticized the comment when he made it, pointing out that this was not the time to view the compensation problem in narrow terms.

Only when the problem is viewed as industry wide willl a cure be possible.  While fixing the board of directors is one approach, the best is to federalize the regulation of executive compensation.  As noted in Returning Fairness to Executive Compensation, the excesses associated with executive compensation are best explained through the lack of meaningful standards imposed under state law.

The solution?  In Senator Dodd's bill on financial reform, he would allow bank regulators to adopt rules that prohibit excessive compensation.  As I have said elsewhere, there is nothing wrong with that. 

“In 2008, Federal Appeals Court Judge Richard Posner stated that, “executive pay is out of control and the marketplace cannot be trusted to rein it in. ” Legislative attempts to address executive compensation include the Excessive Pay Shareholder Approval Act, which mandates that no employee’s compensation may exceed 100 times the average compensation paid to all employees of a given company unless at least 60% of shareholders vote to approve such compensation.”

 The Nathan Cummings foundation does not believe the language is inaccurate.  Laura Shaffer, Director of Shareholder Activities confirmed via email on January 13 that:

“[the Foundation does] not consider the proposal to contain ‘factual errors,’only a quotation that was improperly attributed to Posner himself rather than a NY Times columnist who was summarizing one of Posner’s dissents.  We did not mischaracterize Posner’s views.  We view the challenge as an attempt by Goldman to divert attention from the substantive issues about compensation raised in the proposal.”

One has to wonder why Goldman needs to seek help from the SEC. Instead of asking permission to block the proposal, management might instead just agree to make the corrections – it would be a simple editing change or, Goldman management could just submit the proposal on its own behalf.

Goldman’s rejection of the Shareholder resolution and decision to seek SEC protection seems at odds with a recent, decidedly pro-shareholder move. Back in December, Goldman management made a surprising announcement. The firm voluntarily agreed to permit at the May 2010 annual meeting “an advisory vote on the firm’s compensation principles and the compensation of its named executive officers.”   Goldman was required to include a “say on pay” vote for the 2009 meeting because it was a TARP recipient. However, because Goldman paid back the TARP funds, this vote was not required. Somehow comfortable with giving the shareholders a “say on pay,” it is curious why Goldman management is not so keen on explaining executive pay in a broader social context.

With Goldman expected to announce record bonuses the financial institution has attempted to blunt the anticipated criticism by shifting bonuses from cash to stock and by considering requiring certain employees to make mandatory charitable contributions.  But whatever the steps, providing a straightforward explanation of the compensation practices will not be one of them.

"RESOLVED: shareholders request the Board’s Compensation Committee initiate a review of our company’s executive compensation policies and make available, upon request, a summary report of that review by October 1, 2010 (omitting confidential information and processed at a reasonable cost). We request that the report include –

1. A comparison of the total compensation package of senior executives and our employees’ median wage in the United States in July 2000, July 2004 & July 2009.

2. An analysis of changes in the relative size of the gap and an analysis and rationale justifying this trend.

3. An evaluation of whether our senior executive compensation packages (including, but not limited to, options, benefits, perks, loans and retirement agreements) are “excessive” and should be modified to be kept within reasonable boundaries.

4. An explanation of whether sizable layoffs or the level of pay of our lowest paid workers should result in an adjustment of senior executive pay to 'more reasonable and justifiable levels' and whether Goldman Sachs should monitor this comparison going forward."

The Shareholders asked that the resolution be mailed to shareholders in advance of the May 2010 annual meeting.  This would allow all Goldman shareholders to vote “by proxy” without the need to attend the annual meeting in person.  As a matter of law, publicly-held corporations, like Goldman, are required to include shareholder resolutions in these mailings and to allow shareholders to vote on them subject to a small list of exceptions.  According to a January 11th Reuters story, last Friday, January 8^th, Goldman informed the Nathan Cummings Foundation that it was seeking SEC permission to exclude the proposal from the proxy mailing. In requesting a “no action” letter from the SEC, Goldman is asking the government to promise not to take legal action against the firm for violating the federal securities laws in its refusal to put the resolution to vote. 

The article posited that Goldman was in a tough spot.  As the NYT noted:

• Goldman, like its peers, is caught between conflicting constituencies. The bank cut worker pay somewhat last year, and some employees may leave for hedge funds or private equity firms if they are not paid handsomely for their contributions to the firm’s profits. Some shareholders, however, want the bank to divert more of its money to them as dividends, though others think it should pay to keep workers happy.

It is likely that there are some financial institutions that would suffer a competitive disadvantage if unable to pay competitive salaries.  Some of the limits imposed by the Pay Czar on companies such as AIG and Citigroup may have caused some talent to go elsewhere. 

But having said that, its absurd to suggest that Goldman is in that position. 

First, the argument presupposes that the "underpaid" employees will be paid more at hedge funds and private equity firms.  In fact, hedge funds are likely to see a reduction in compensation.  Congress seems focused on taxing hedge fund compensation at ordinary income rather than capital gains rates.  So, working for a hedge fund is likely to become less lucrative soon.

Second, the argument defies practical logic.  Hedge funds are shutting their doors.  Are there really enough positions to absorb all of the "underpaid" officials at Goldman?  Moreover, with hedge funds capable of going under at a downturn in the economy, one has to wonder whether the "underpaid" employees at Goldman would give up the relative security of the most profitable financial institution for the relative insecurity of a hedge fund.

Third, and more to the point, even with some reduction in compensation, Goldman will still pay lavish amounts in comparison to others in the same industry.  In 2008, a tough year, Goldman paid 953 employees over $1 million.  Compensation in 2009 will be higher, with Goldman creating even more millionaires.  While this is only guesswork, it seems unlikely that had Goldman opted to pay amounts in 2009 comparable to those paid in 2008, there would have been a serious outpouring of talent.   

Finally, by taking the position that employees should donate some percentage of their compensation to charities, Goldman is all but admitting that it is paying more in compensation than it needs to retain key employees.  

Any argument that Goldman needs to pay the lavish amounts of compensation to keep its employees seems to an outsider looking in to be a very weak justification. 

The financial institutions could pay less in bonuses but they won't.  They are nonetheless aware that the amounts will generate enormous outcry and criticism.  Some financial institutions don't care and will try to ride out the criticism.  Others are worried and are seeking to mitigate the effects.  Goldman Sachs fits into this latter category.

Goldman has little choice.  In 2008, 953 employees were paid more than $1 million.  Amounts in 2009 are likely to be even higher.  It has been and will continue to be the poster child for excessive compensation.  The fact that Goldman received bailout funds (since repaid) doesn't help.

Goldman has already taken some steps.  In late 2009, officials visited with shareholders to discuss compensation practices and apparently got an earful.  The financial institution reacted by agreeing to convert the bonuses paid to the members of its executive committee (30 officials) from cash to stock.  The change was designed to provide a compensation package that provided long term rather than short term incentives.  It was a small but noticeable change.  I discussed these changes on MSNBC.  But the shift in the type of compensation didn't alter the huge amounts scheduled to be paid.

The latest effort by Goldman to ameliorate the criticism is apparently to require top officers and managers to donate a certain percentage of their compensation to charity.  As the NYT noted:

• The bank bonus season, that annual rite of big money and bigger egos, begins in earnest this week, and it looks as if it will be one of the largest and most controversial blowouts the industry has ever seen.

Moreover, these payments are not being made without awareness of the reaction that they will draw from the public. 

• Industry executives acknowledge that the numbers being tossed around — six-, seven- and even eight-figure sums for some chief executives and top producers — will probably stun the many Americans still hurting from the financial collapse and ensuing Great Recession.

What is going on here? 

There are several observations.  First, the paychecks approved by the government with respect to Fannie Mae and Freddie Mac (somewhere in the vicinity of $6 million) and those approved by the Pay Czar (at Citigroup, he approved pay packages worth $5 million or more for 6 employees) signal to the market that high pay is acceptable, even in these tough economic periods.

Second, individual financial institutions will in fact find themselves at a competitive disadvantage if everyone else pays high bonuses but they do not.  In other words, if the new report that BofA or Morgan Stanley paid low bonuses, they would deserve not accolades but criticism from shareholders once the outpouring of talent started. 

Third, this demonstrates the need for reform that is comprehensive.  So far, the only reforms to have been put in place are those that apply to financial institutions taking TARP money.  Once the funds are repaid, the limits disappear.  Thus, Goldman and BofA are free to pay whatever bonuses they want.  There are supposed to be legal limits on compensation but those limits are imposed under state (read Delaware) law.  The limits have been eviscerated, with the result that there are no effective legal limits on excutive compensation.  (This is discussed in greater detail in Returning Fairness to Executive Compensation).  

These high bonuses are predictable.  They show that the problems of excessive compensation cannot be solved by individual financial institutions.  Instead, there needs to be a comprehensive legal solution.  Right now, though, there is no meaningful solution on the horizon. 

Citigroup has fallen on hard times.  Over the weekend, The New York Times published a story about Sandy Weill, the architect of Citigroup.  The story has a number of themes, including Weill's "responsibility" for current crisis at the Bank (“'One of the major mistakes that I made was my recommending Chuck Prince,' he says of his handpicked successor, who ran the company from 2003 to 2007."), and his irrelevancy to any solution (when approaching the Citigroup board in 2007 to become involved, "No one responded to his offers."). 

We don't have an opinion on Weill's leadership although he did grow Citibank into the world's largest financial institution.  Likewise, whatever his mistakes, the article points out that he has taken a considerable portion of his wealth and donated it to assorted charitable causes, not something that everyone with a comparable net worth can say.

Mostly, though, we found insightful some of Weill's approach to compensation.  The piece noted that, after retiring, Weill was "horrified" at having been "cast as a greedy, out-of-touch Wall Streeter taking advantage of taxpayers"  The basis?  

• One news item, in particular, was crushing: Last winter, The New York Post ran a picture of Mr. Weill on its front page with the headline, “Pigs Fly: Citi Jets Ex-C.E.O. to Cabo.” He had taken the corporate plane to vacation in Mexico, weeks after Citi had accepted a $45 billion taxpayer bailout. The flight provoked a public outcry and media frenzy.

Weill responded honorably by issuing a press release and promising "to never again use the Citi jet."  He likewise terminated his consulting contract in which he got the "jet, as well as office space, cars and security."

But the fact that he had the benefits at all was the more interesting note and reminiscent of a time when imperial CEOs could receive from subservient boards compensation packages that continued the corporate largess even into retirement and even though the retiring CEOs had the net worth and income to pay any such expenses directly.   

It was the era of Jack Welch at GE, who received post-retirement benefits that included, among other things, court side tickets and unlimited use of the corporate jet.  Both Welch and Weiss became rich heading their respective companies.  Yet despite the wealth, they accepted post-retirement packages that provided them with services and assets that their great wealth could easily afford. Somehow using corporate assets provided greater satisfaction than using their own.

With public attention, both CEOs ultimately decided to give back or reduce significantly these post-retirement benefits.  But for every CEO that acted this way, there were no doubt plenty of others that merrily continued to use the corporate jet and take advantage of other similar benefits.  In other words, morality and principled behavior is not an adequate check on this type of largess.  It instead takes an active, strong board of directors.  Unfortunately this was not typically the case then and is not typically the case today.

The types of benefits given to Weiss-Welch are probably not as common today. More rigorous disclosure requirements have made it harder to keep these types of post-retirement packages out of the public eye.  Yet the problem of subservient boards that pay excessive compensation remains unchanged.  It remains the great unfixed problem of the current financial crisis and, from all indications, will remain unfixed once the crisis ends. 

Nonetheless, the Pay Czar has not reduced these officers to penury.  He has allowed compensation packages that total $10.5 million.  With respect to Citigroup, the Pay Czar approved six packages with a reported value of over $8 million.  Most of the compensation has been in the form of stock or stock related units.  In short, the Pay Czar has continued to allow lucrative amounts but required that most of it be in the form of long term forms of compensation.

Yet this is too much for the seven companies.  BofA has indicated that it will repay the TARP money, freeing it from the oversight of the Pay Czar.  Others are seeking to do the same thing.  While there may be other benefits that come from repaying the TARP funds, unlimited amounts of compensation is one of them.

We shall watch as each of the seven companies depart from the oversight of the Pay Czar.  Without systematic change, the permanent impact of the Pay Czar will be negative.  It will probably have resulted in some outflow of talent to other institutions, with no permanent benefit to the companies effected.  The logic of requiring "reasonable" compensation that encourages long term goals only for seven companies has never been entirely clear.  It becomes less clear as each one departs.  

Sometimes reports indicate that the Pay Czar has cut compensation when in fact he's allowed for an increase in compensation but only cut the salary component.  Thus, published reports indicated that BofA had trimmed the pay of the CFO, Joe Price, to $500,000 because of pressure from the Pay Czar.   Its true that Price had been paid $800,000 in salary the year before.  But his "total compensation" package in 2008 was $4,021,168 (based on the total compensation line for the 2008 proxy statement).  His total compensation for 2009?  Cash of $500,000 (beginning on Nov. 1, 2009) and stock related awards of $5,250,000.  Moreover, as the BofA noted, "Salary Stock Units are paid in cash" and some payments are accelerated if the Company repays its TARP funds.   

Then there was the much discussed effort by the Pay Czar to cut compensation back in October.  Note that the stories emphasized the cut of somewhere around 50% in the compensation of top officials.  Yet one analysis by the WSJ showed that 14 officials at Citigroup still could receive over $5 million (in salary and stock) and six could receive more than $8 million in salary and stock.

In short, the Pay Czar has sometimes lowered compensation amounts, although still allowing for large pay packages.  He has forced the seven companies subject to his oversight to shift large portions of compensation from cash to stock and options.  Yet even this modest approach has been too much for at least some of the seven companies.  They are seeking to get out from underneath the Pay Czar's oversight by paying back TARP funds. Once the funds are repaid, even these modest limits will no longer be required. 

And that, in the end, raises questions about the value of the Pay Czar.  He unquestionably showed the weakness in current system of determining compensation.  Even in an era of financial crisis and government bailouts, he still had to lower the compensation approved by the boards of the companies subject to his oversight.

Yet his oversight ultimately was likely negative.  It likely accelerated the payback of government funds, something that may not be beneficial to the financial system.  Moreover, the short term limits probably caused some talented employees to go elsewhere, weakening these financial institutions.  

These costs cannot be balanced against any concomitant benefits because there are none.  The compensation process remains broken.  The Pay Czar has provided no long term fix.  Moreover, as the Goldman example seems to show, once free of government restrictions, compensation amounts escalate upward.  Once the Pay Czar fades from the scene, the harm will still be there but the benefits will not.

Say on pay already exists in Britain.  Shareholders almost never vote down the compensation package.  There are a number of reasons for this, but one of them is that boards regularly talk to, and consult with, their shareholders.  To the extent there is serious criticism or concern, the shareholders can let management know and practices can be fixed before the vote.  Thus, compensation is essentially pre-screened.  Indeed, in Britain, where the practice is to separate the chairman and CEO, the chairman has the responsibility of regularly consulting with shareholders.  In other words, say on pay doesn’t increase hostility; it increases communications. 

The review process probably exercises downward pressure on compensation.  On the other hand, it cuts down on criticism and bad publicity.  In short, management most likely benefits from the advisory vote and the concomitant improvement in communications with shareholders. 

The same thing could easily happen in the US, as Goldman recently demonstrated.  Goldman was potentially on track to pay record amounts of compensation.  The bank visited with large shareholders over the planned amounts and, from public reports, appears to have gotten an earful. 

After the consultation, Goldman announced that it would change the compensation package.  The members of the management executive committee would receive bonuses in stock.  The Company would implement say on pay. 

Had Goldman consulted with shareholders in advance of all the publicity, it might have made exactly the same decisions, but avoided the outrage and bad publicity.  In the future, Goldman will presumably consult first, anticipating the shareholder vote.  In other words, communications with large shareholders on compensation issues will likely become a regular component of Goldman’s practices.  In short, Goldman, which opposed say on pay, has become a convert because it can see the benefits that result from the practice.