Posts Tagged ‘Pollock’

Pay Czar Targets Pay

Wednesday, October 7th, 2009

The Wall Street Journal reports that “the Obama administration’s pay czar is planning to clamp down on compensation at firms receiving large sums of government aid by cutting annual cash salaries for many of the top employees under his authority.”

However, according to Smeal’s Tim Pollock, it’s going to take a cultural shift, not a government edict, to really rein in exorbitant CEO salaries:

The problems with executive compensation can’t be solved with regulation, or by a pay czar, because they are deeply embedded in the culture of Wall Street, in the case of financial services, and in the culture and belief systems of the executive suite and boardroom, more generally.

CEOs and senior executives, while always well compensated, were not always as lavishly compensated as they are today. What we see now largely began in the 80s when stock options began to be used more widely as a consequence of proscriptions derived from the logic of agency theory, which argues that executives will act in a risk averse and self-interested manner unless provided with incentives to behave otherwise.

The problems with stock options are that, unlike actual stock, which can go down in value as well as up, stock options can’t go below zero in value. And until recently they received favored accounting treatments that essentially made them a “free good”. As a consequence of the former problem, executives really face no downside risk from stock options. Thus, rather than take reasonable risks, they are more likely to take excessive risks because they bear no real costs from failure; they just might not (in theory) make any gains. However, even this rarely comes to pass, because boards swoop in to reprice the options, or to give the executives new grants at lower exercise prices, in order to keep them sufficiently “motivated.”

This problem was exacerbated by the Clinton administration’s well-meaning but disastrous attempt to limit executive pay by limiting  its tax deductibility unless it was tied to firm performance, which meant more stock options. Further, the favored-accounting treatment options received made them a cheap form of compensation, so it was easy for boards to load CEOs up with huge option grants that turned into phenomenal amounts of compensation in the 1990s’ bull market, which, by the way, raised all boats, even those of marginal and incompetent CEOs. Because it was easier to ascertain the value of an executive’s compensation package due to the new reporting requirements implemented in 1993, CEO pay packages could be compared to each other, and the executive pay arms race was off and running.

Today, the use of stock options, and the phenomenal levels of pay that CEOs, investment bankers, and traders receive, have become taken-for-granted parts of the corporate landscape. Restricting or modifying the pay of a few executives and firms by the government will not lead to a sustained change in pay practices,  and could lead to the poaching of the competent individuals left at the troubled firms by firms not bound by these restrictions. We’ve already seen that it’s business as usual again at most Wall Street firms.

Until executives feel real pressure from shareholders, and each other, to rein in pay, not much is going to change, I’m afraid. This isn’t going to happen as long as the mantra of “maximize shareholder value” (And what does this even mean? Over what time frame? In what way? If firms compete successfully in delivering the best products and services, won’t this happen anyway?) continues to drive decision making.

Tags: Economic Crisis, Executive Compensation, Politics, Pollock
Posted in News | 1 Comment

Thought Leader Award

Tuesday, June 30th, 2009

The Academy of Management’s Entrepreneurship Division has selected a paper by Smeal’s Tim Pollock as the recipient of its 2009 IDEA Award in the Thought Leader category, which is representative of the best published papers in entrepreneurship in 2008. Pollock and his co-authors Violina Rindova of the University of Texas and Patrick Maggitti of Villanova University will accept the award in August at the 2009 meeting of the Academy of Management, the leading professional organization for scholars in the field of management and organization.

Their paper, “Market Watch: Information and Availability Cascades among the Media and Investors in the U.S. IPO Market,” is available online.

Tags: Announcements, Pollock
Posted in News | No Comments

Pay Czar Is Not the Answer

Tuesday, June 9th, 2009

“The Obama administration plans to require banks and corporations that have received two rounds of federal bailouts to submit any major executive pay changes for approval by a new federal official who will monitor compensation,” according to The New York Times. Kenneth Feinberg, supervisor over the payouts to the families of the victims of the September 11, 2001, terrorist attacks, will enforce these compensation restrictions as the government’s new pay czar.

Smeal’s Tim Pollock, who studies executive compensation, is skeptical of the plan, stating the new position will create more problems than solutions.

More from Pollock:

Executive pay is out of control and it can’t be fixed by government regulation. Whenever the government tries to regulate compensation, compensation consultants always find a way around the regulations. In the early ‘90s, the Clinton administration tried to rein in executive compensation by limiting the tax deductibility of executive compensation in excess of $1 million, unless it was tied to company performance. This led to the increased use of stock options and instead of limiting executive pay, their pay skyrocketed over the ensuing 15 years and led to some of the risk-taking we see today.

Another problem arises with the current regulations only applying to companies that have received funds from the Troubled Asset Relief Program (TARP). If they are limited in what they can pay and their competitors are not, it will create an uneven playing field, making it even more difficult for these firms to recover.

It is also important to keep in mind that when talking about the financial services industry, the compensation of the traders and other mid-level employees is just as great an issue. They are the ones making the trades and engaging in excessive risk-taking that hasn’t gotten the financial services industry into trouble.

Nothing is going to change as long as 1) traders and mid-level employees are rewarded for taking risks that pay off and don’t suffer any consequences for the risks that don’t, 2) their compensation and the compensation of executives are tied to short-term performance measures, 3) analysts, directors, and others continue to focus excessively on short-term performance metrics (quarterly earnings) and over react to hitting or missing their expected earnings, and 4) most of the players involved have little or no understanding of how the financial instruments they have created work.

There has to be a massive culture shift on Wall Street that takes a longer term perspective on rewarding performance and making the traders and decision-makers responsible for failures as well as successes. The well-being of the system as a whole must be taken into account and not just the narrow self-interest of the traders, executives, and their firms.

Tags: Economic Crisis, Executive Compensation, Pollock
Posted in News | No Comments