Where There’s a Will, There’s a…Scheme

Ethics

Are laws that limit executive compensation simply enough to turn financial institutions and other corporations away from the entrenched norms of exorbitant compensation and bonuses? Before I address this question, let’s consider a hypothetical scenario:

Assume a new law required $500,000 cash salary cap for the top 10% of executives of the company, and also limited the amount of stock options they could be offered in the future.  (Sound familiar?) Do you think that Enron’s executives would dutifully comply with this mandate if it were enacted while they were still in existence as a company?

Well, judging from what we know about the nature of the executives at Enron and their obsession with compensation through our exploration of The Smartest Guys in the Room, I think that we all could agree that the chances of Enron executives directly complying with this law are…less than the chances of Hell freezing over.  My guess is that they would treat this law much like they treated the accounting laws-simply as guidelines to be manipulated with rather than rules.  The Enron “entrepreneurial spirit” would be seen as threatened if they could not adequately reward the individuals (both executives and traders) who were responsible for making the company money and driving profits.  Therefore, Skilling would likely create another “profit center” (aka scheme) whose sole purpose would be to ensure that Enron’s executives would, in some way, be adequately compensated to ensure ever-increasing levels of personal wealth for the executives.  (That’s only to say if Lay’s lobbying efforts in Washington failed first.)

One may argue however, that the behaviors and tendencies of the executives at Enron were the exception rather than the norm.  But as was pointed out in our class discussion, it may not simply be the individuals who are in the position of executives in a given company, rather, it’s the nature of the overall beast: the combination human nature and the nature of capitalism.  Therefore, former Enron executives would likely not be the only culprits who would attempt to circumvent new compensation regulation.

Back to the first question.  In researching this notion, I came across a recent article in the WSJ that confirmed my belief that no, laws on their own restricting executive compensation will not be enough to substantially impact the decades, even centuries, old trend of handsomely rewarding executives.  Regarding Obama’s new legislation (officially signed today) to limit compensation of bank executives receiving taxpayer dollars to continue the existence of their companies, the article stated:

“Unfortunately, while this move rightfully punishes yesterday’s fools, it may inadvertently create tomorrow’s culprits. The Treasury Department stated that the pay cap is meant to “ensure that the compensation of top executives in the financial community is closely aligned not only with the interests of shareholders … but with the taxpayers providing assistance to those companies.”  If only it were so simple. “The search for ways to get around this,” says one expert on Wall Street compensation, “started within minutes of the announcement.”

The article then goes on to list three ways in which this regulation can already seemingly be circumvented.  Great.

As sad as this is, frankly, what else can be done? If we want to wrangle in and rectify the issue of executive compensation, shouldn’t the government have to start somewhere? Although this may be a solid and earnest step in the right direction, I believe the change in this behavior of organizations has to primarily come from within the industry, rather than from outside regulation.   Here is where the moral and ethical aspect of compensation enters-which I believe is a part of the solution for this issue.

Luckily, (great for my own peace of mind) I was able to come across a website called Corporate Eye that tracks and provides information about corporate best practices.  The article I found on this website provided examples of companies today who are leading the way in executive compensation that takes into account the ethical actions of the executive.  Although I was unable to find the specific metrics they used to determine the “ethical-ness” of the executive, I still think that these companies are at the forefront of making the compensation process more legitimate. What is important to note here, is that these companies did not implement these policies as a result of governmental regulations.  They evolved, instead, within the bounds of the organization itself (internally or through the influence of key stakeholders).  Namely, this spurs internal change on the part of businesses that have the potential to reshape the industry as a whole.

I don’t want to discredit the merit of performance-based compensation, however, because I believe there is much validity in it.  I just feel that other factors, such as ethical considerations, should be explored in order to change the method by which executive compensation is calculated and regulated.  What do you think? Are regulations alone sufficient? Or, should the practices evolve internally as we learn from previous mistakes?

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7 Responses

  1. Just to add a little mix to the pot:

    In my system design and analysis class, we read a list that come from a poll of project groups. The outcomes of this survey said that in this type of group monetary compensation can actually be a demotivator. If the individual receives a bonus, they expect it every time (think Clark Griswold in Christmas Vacation). If they do not get the bonuses that they expect for good work, then they will likely be less motivated to produce high quality work in the future.

    This group is more of a worker/manager group. My question is when did our executives get so greedy? A great example is Wal-Mart. While Wal-Mart’s executives swim in pools of Ben Franklins, the people who are the heart and soul of the company (those that provide us with the Wal-Mart customer service that we know and love) are struggling just to get by.

    I do agree with you on this part Leah: if there is a problem with your business, then you seriously need to re-evaluate your executive compensation structure. This is a huge business cost today, and many businesses would be much better off if they were able to cut down on executive compensation spending.

  2. I agree with you Leah…it makes me so upset that executives are being compensated and at the same time they are lay9ng off their workers…something is seriously wrong with this picture.

  3. Great questions.

    One question is whether merit-based compensation is flawed, or whether on Wall Street and in Enron, a good idea was corrupted in practice.

    What were the three ways to get around new limits?

  4. The main idea in your article, and that came up in class, about executive compensation has made me think a lot about my personal beliefs about corporate America. On one hand I do understand that executive salaries are out of hand and the disparity between executive and non-executive salaries (similar to the wealth gap) is tremendous. Yet, on the other hand I can’t help but reason that the executives are making the salaries they are making because of the degree of specialization in their work and the fact that corporate America (or the executive free market) has made it acceptable. As I wrestle with these differing theories, I do absolutely agree that it is horrible that the first response to the legislation is how can people get around it. This attitude is what leads to corporate crookedness and in order to change the culture of Wall Street, this attitude needs to be changed.

  5. When did good performance, and ethical performance no longer go hand in hand? Performance-based compensation is good in my eyes– but it should be implied that good performance includes ethical performance. There should be no reward for acting ethically, there should be fines for acting anything less than that. Could you imagine on an exam getting bonus points because you didn’t cheat?

  6. […] Best written… Leah’s “When There’s a Will, There’s a Scheme.” […]

  7. The three ways that the article already pointed out to circumvent the law are:
    1. The new compensation rules seem to only apply to senior executives. This means that other people making huge amounts of money, such as the traders and hedge-fund managers, may not see the impacts of the legislation.
    2. The firms could easily create a spin-off trading or underwriting firm, “as a new company and retaining an ownership stake in exchange for a share of the profits and losses” (WSJ). Therefore the executives would not face limits on this compensation, but the risk on their shares are even higher. This sounds way too suspiciously similar to LJM.
    3. The senior executives are still permitted to obtain a certain amount of long-term incentive pay in the form of restricted stock options, but there is still no law restricting the cashing in of these options.

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