March 18, 2009
Paying Workers More to Fix
Their Own Mess
We cannot attract and retain the best and the
brightest talent to lead and staff the A.I.G. businesses — which are now
being operated principally on behalf of American taxpayers — if
employees believe their compensation is subject to continued and
arbitrary adjustment by the
Liddy, chief executive,
American International Group
Ah, retention pay. It has
been one of the great rationales for showering money on chief executives and
bankers regardless of how well they are doing their jobs. It’s just that the
specific rationale keeps changing.
In the booming 1990s,
companies supposedly had to pay retention bonuses because executives had so
many other job opportunities. There was a war raging — a war for talent,
said McKinsey & Company, the consulting firm.
Then came the aftermath of
Enron, when new scrutiny and regulations apparently made some chief
executives wonder if they still wanted their jobs. “I’m thinking of actually
getting out,” David D’Alessandro, the head of John Hancock Financial
reported hearing from one fellow chief executive. The antidote to such
doubts? Retention pay, obviously.
Now comes Mr. Liddy, the
government-appointed chief of A.I.G.,
multimillion-dollar bonus payments for the people who run the small division
that brought down the company. If the government doesn’t let them have their
money, they will walk away, Mr. Liddy says, and nobody else will know how to
clean up their mess.
We’ll get to the merits of
his argument in a moment, but it’s first worth considering the damage that
the current system of corporate pay has wrought. The potential windfalls
were so large that executives and bankers had an incentive to create rules
that would reward them no matter what. The country is now living with the
So any attempt to build a
new financial system, one that’s less susceptible to bubble, bust and
bailout, will have to include a new approach to pay. Yes, the issue is
thorny. Some past attempts to rein in pay have ended up being feckless or
even counterproductive. But that is no reason to give up.
Nothing highlights the
fiction of performance-based pay quite so well as retention bonuses. It
turns out that, at least for chief executives, retention bonuses are almost
A few years ago, when the
economy was still expanding, I looked into every large company that had
changed chief executives over the previous six months. Not a single boss at
any of them had left for another job. Such departures are so rare that Booz
& Company’s annual
of executive turnover doesn’t even include a category for them. The benefits
of the job — the pay, the perks, the gratification that comes from running a
company well — are too good to leave, even for a similar job.
The situation is a little
different for jobs below the top level, particularly on Wall Street. Surely,
if the employees of A.I.G.’s notorious financial products division were to
be denied their bonuses — a big chunk of their annual compensation — many
The nub of Mr. Liddy’s
argument is that these departures would be a terrible thing. But there are
several weaknesses with this argument.
The first is that the
original explanation for these bonuses was rather different. When they were
devised in early 2008, months before the first bailout, as Mr. Liddy’s
letter to the government on Saturday explained, “A.I.G. Financial
Products was expected to have a significant, ongoing role at A.I.G.” The
idea, he said, was to guarantee “a minimum level of pay for both 2008 and
2009.” So the rationale for A.I.G.’s retention bonuses is as malleable as
the rationale for chief executives’ bonuses.
Most amazingly, the A.I.G.
bonuses haven’t even accomplished their stated goal.
Andrew Cuomo, New York’s attorney general, said Tuesday that 52
employees who received bonuses had since left A.I.G.
The second problem with Mr.
Liddy’s argument has to do with Mr. Liddy himself. His defenders have noted
that the government brought him out of retirement to fix A.I.G. and that he
presumably puts a higher priority on doing a good job than pleasing A.I.G.’s
And he probably does. But he
is also a product of the current, broken
executive pay system. As the chairman of
Allstate from 1999 to 2007, when the company’s
stocks underperformed those of its rivals, he made $137 million. Almost
$14 million of that, according to the Corporate Library, came in the form of
stock that the company called a “a tool for retaining executive talent.”
Which means Mr. Liddy may not be entirely objective about retention bonuses.
Finally, there is the
question of how hard replacing those A.I.G. employees would be. Certainly,
some of them must have particular insight into unwinding the toxic portfolio
they built. But I doubt that anywhere near all 418 financial products
employees — who have received bonuses worth $395,000 on average — are
Simon Johnson, a former
chief economist at the
International Monetary Fund, has
pointed out that in financial crises, bankers often exaggerate the
difficulty of cleaning up their mess. They do so partly to justify their own
continued importance and also to fight off calls for a government takeover
of banks. In reality, Mr. Johnson says, the mechanics of cleaning up hobbled
banks turned out to be fairly straightforward during other recent crises,
like the Asian one in the ’90s.
understandable, then, that the Obama administration, the
Federal Reserve and Congress are looking for creative, legal ways to
claw back some of the bonuses. That bonus money is really taxpayer money:
absent a bailout, no A.I.G. would exist to pay bonuses.
The larger question is how
to change the rules on corporate pay to reduce the odds of future crises.
Throughout this crisis, policy makers, starting with President George Bush
Ben Bernanke and now including
President Obama, have been a bit too deferential to Wall Street. That
deference has fed populist anger, which threatens the political viability of
the necessary continuing bailout of the credit markets.
The bonus scandal offers Mr.
Obama and Mr. Bernanke a chance to get ahead of the curve — so long as they
come up with changes that extend well beyond A.I.G.
The starting point would be
a rigorous analysis of whether the government can take specific steps to
restrain pay. Some thoughtful management experts think any such efforts are
doomed to fail. Others are more optimistic. “There are ways to do it,” says
Lucian Bebchuk, a
Harvard Law professor.
Across-the-board caps on pay
don’t make sense. But perhaps the government can prevent companies from
claiming a corporate tax deduction on any pay above a certain threshold. The
current limit, which is $1 million, applies only to base salaries and thus
has little meaning. Or perhaps companies can be penalized if they pay
bonuses based on short-term profits, as A.I.G.,
Lehman Brothers and just about every other company recently has. The Fed
made a suggestion along these lines recently, but it didn’t do anything more
than ask nicely.
If no such ideas proved
workable, there is still one more option. Today’s tax code makes no
distinction between income above $373,000 and income above, say, $5 million.
Both are taxed at 35 percent.
That is a legacy of the tax
changes of the early 1990s, when far less of the nation’s income went to
millionaires. Today, you can make a good argument for a new, higher tax
bracket on the very largest incomes. In the past, the economist Thomas
Piketty says, higher marginal tax rates tended to hold down salaries and
bonuses, because executives had less incentive to angle for
Do these ideas stem in part
from anger and bitterness? Of course they do. How can you not be a little
angry and bitter about the role that huge, unjustified pay played in causing
the worst recession in a generation?
In fact, that’s sort of the
point. Given the damage that’s been caused by our decidedly unmeritocratic
system of paying executives, the most irrational course of all would be the
A version of this
article appeared in print on March 18, 2009, on page B1 of the New York