Friday, November 13, 2009

Is it a good idea to slash executive pay when you take over a business? 

Even if the business was losing big money? And you are the government?

Pay czar backtracks

The pay czar job may be getting to Kenneth Feinberg.

The government's special master for executive compensation said yesterday that he is "very concerned" that plans to rein in Wall Street bonuses may, in fact, be backfiring.

Companies including American International Group and Citigroup, which are under government control, have complained that pay restrictions will cause them to lose talented bankers and dealmakers to rivals.

"I'm very cognizant of the concerns expressed by these companies," said Feinberg at an event hosted by Bloomberg LLC. "The law makes it clear that the determinations I render are designed, first and foremost, to make sure those companies thrive and that the taxpayers get their money back."

The issue of pay restrictions has been a hotly debated topic in Washington and on Wall Street .

.. those hot-button issues were on display as AIG's CEO Robert Benmosche butted heads with the government over pay caps for his top 100 earners ... reports indicated that he had threatened to resign over the matter... [NY Post]

Let's agree that at least in the case where the government effectively becomes the controlling shareholder of a business, such as AIG or Citibank, it has the right to set whatever pay levels and practices it wants for top executives.

(Let's also agree that as a matter of politics, after the financial bailouts the Obama administration had to engage in some visible "beating up" of the financial firms' top people, to appease its left-side political base and the populists.)

The question is: should you slash pay across-the-board?

One might ponder several issues (the effect on contract rights and such), but let's stick to the most simple of questions: Is it good business?

The answer is: No!

How often have you heard of, say, Warren Buffett doing such a thing after buying a business? Never.

The reason is clear. After taking over a business, you want to have the best people you can get running it for you, to make money for you.

That means you may well fire a lot of the existing management when you take over (especially if the business was failing, which was what enabled you to take it over) and replace them with a management team of your own choosing. There's no problem with that.

But as to the executives you keep -- because they know the business and are the best ones you can get to do the job -- slashing their pay is suicidal.

What's going to happen? Salaries are set in a competitive marketplace. If you unilaterally reduce your executives' salaries to below the market level, they are going to leave en masse for other jobs (such as with your competitors). Certainly your best executives are going to leave, and you will be left with only your worst.

The problem is much like the well-known one faced by businesses that need to lay off rank-and-file personnel, but which wish to protect morale in the work force by offering "voluntary buyouts" instead of imposing forced layoffs.

Who takes the buyouts? Obviously, the best employees who can pocket the money and step into another good job right away, keeping the buyout money as a profit. Who declines them? The worst employees who fear they cannot get other jobs. So the work force that remains after the round of buyouts is degraded.

Slashing the pay of top executives across-the-board is similar but worse. The best executives leave ... the worst executives who remain have their morale devastated with their slashed paychecks, making their performance even worse yet ... and these are the business's most important managers, the people most critical to the future profitability or failure of the business.

Slashing executive pay across-the-board is nothing but self-destructive populist politics, Chavez management.

"Pay Czar" Feinberg seems to have had a first encounter with reality on this issue. To the extent you are a taxpayer and thus an owner of AIG, Citibank and the rest, hope the lesson sinks in and sticks.