Friday, October 3, 2008 0 comments ++[ CLICK TO COMMENT ]++

How Come No One Is Blaming The Investors?

It has become quite fashionable to bash corporate executives these days. Especially those from financial institutions. Even if we ignore the misguided attacks emnating from those who are simply jealous--no, I am nowhere near an executive and am not even middle class :(--there are valid reasons for criticizing their strategies over the last decade. A large number of financial institutions have either gone bankrupt or are on the verge. This includes what one would have considered best-of-breed, strong moat, companies such as AIG, Citigroup, UBS, Fannie Mae & Freddie Mac, and even MBIA and Ambac (bond insurers never had strong moat though.)

But how come no one is assigning blame to investors? That's the question asked by Eric DeCloet in a Globe & Mail article.

Few, it seems, have bothered to point the fingers at the cat owners – the investors in financial companies who sat idly by while their top executives were given preposterous bonuses, absurd pensions, obscene benefits, ridiculous golden parachutes. The directors may have agreed to these things, but it's the shareholders who, by their complacency, made it all possible.

How complacent? Since it's the latest big U.S. bank to essentially fail, let's pick on Wachovia, most of which was sold to Citigroup for two bags of kibble [it looks like a new deal with Wells Fargo has been cut]. When its shareholders met this spring at the Marriott City Center hotel in Charlotte, N.C., they already had plenty of reason to be worried, if not fearful. Their shares had fallen 53 per cent in a year. Their dividends had been slashed. They knew of the horrors lurking inside the loan portfolio of Golden West Financial, which Wachovia had acquired in 2006, including the disastrous “pick-a-pay” mortgages.

Rebellion time, right? Nope. The shareholders re-elected Ken Thompson, the CEO who'd bought Golden West and who'd earned $45-million in cash, stock and other pay over the previous two years, by 95.8 per cent. They re-elected every other director, including those who'd given him that gaudy pay package, by at least 92 per cent. For good measure, they turned down a proposal that would have given shareholders a non-binding vote on executive pay. (Six weeks later, the board gave the boot to Mr. Thompson – too late to save the bank, it turned out.)

(note: a new deal between Wells Fargo and Wachovia seems to have been agreed upon)

There is going to be a huge backlash against free markets over the next decade. The movement to de-regulate everything is going to take a backseat given the mess we are in. I don't believe it is de-regulation alone that caused the problems, but the movement certainly facilitated the mess.

If there is one big change that will result from the current mess, I hope it is greater activism from shareholders. It's fine and dandy to pin the blame well after the fact but hopefully shareholders act well in advance. I hope there will be a revolution in human resources, with a shift away from instaneous compenstation and perks for executives and towards longer-term compensation. The joke with executive compensation for many financial institutions is not that they made so much money, but rather that they made it on fictitious profits.

I've bashing the accounting profession lately (can't get mark-to-market off my mind ;) ) but it's time to turn my rant towards the human resources profession. It's pathetic how the HR profession seems incapable of designing better compensation schemes. Once upon a time, it was all about money. But now these misguided schemes are casuing unintended side-effects, such as inducing executives to bet the company on a low-probability, high-risk, high-payoff events. Paying $1 million or $2 million excessively to an executive is less of an issue than when they bet the future of the firm on risky ventures.


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