The NYT discusses the interesting recent case of Merrill Lynch. To quote their former CEO E. Stanley O'Neal in March 2008:
“As a result of the extraordinary growth at Merrill during my tenure as C.E.O., the board saw fit to increase my compensation each year.”When he left Merrill, O'Neal was awarded an exit package of US$161 million.
Moreover, benefits of huge magnitudes were made further down the line. For one employee in 2006, on a salary of US$350,000, total compensation was 100 times that at US$35 million. A 20-something analyst with a base salary of $130,000 collected a bonus of $250,000. And a 30-something trader with a $180,000 salary got $5 million. Many of these bonuses were in cash not equity so employees had little reason to take a longer-term view.
These huge payouts were intended to reflect huge earnings but they did not. Quoting the NYT:
'...Merrill’s record earnings in 2006 — $7.5 billion — turned out to be a mirage. The company has since lost three times that amount, largely because the mortgage investments that supposedly had powered some of those profits plunged in value.The losses Merrill made exceeded all the profits they had made for 20 years.
Unlike the earnings, however, the bonuses have not been reversed'.
Furthermore banks like Merrill will dole out bonuses even after they have had to be propped up with billions of dollars of taxpayers’ money.
These bonuses should never have been so big because they were based on 'ephemeral earnings'. They encourage employees to act like gamblers at a casino who can collect their winnings while the roulette wheel was still spinning. Employees contiunued to pursue risky deals even as the housing and mortgage markets weakened because what happened to their investments was of no interest to them - they have already been paid.
Sir Henry Casingbroke's amusing - though pointed - account of the US auto bailout provides further observations on crazy US incentive contracts. I assuime the business school gurus will publish a whole rash of learned papers pointing out that refining the way incentive contracts are designed can perfect their operation. But something more fundamental seems lacking - corporate morality for one thing.