December 18, 2014

In Capitalism, Executives Do Not Get Rewarded for Failure

Fed Chair Ben BernankeThe public’s outrage over the AIG bonuses is so strong, you can almost taste it. 

As the facts unfolded this past week and a half, one thing became increasingly obvious:  AIG executives and the American public have such differing perceptions of AIG’s situation — it’s as if we are are living in parallel universes with separate realities. 

AIG appears to feel it’s business as usual, with barely a few pesky little restrictions.  The American taxpayers, on the other hand, have a totally different view.  They think AIG is a failed company that is undergoing a kind of specialized takeover in which they should have some say — and with good reason. 

According to Fed Chairman Ben Bernanke, AIG operated as a giant hedge fund.  It engaged in risky activities on a scale so massive, it’s in a class by itself.  It’s still in business only due to the largess of the American taxpayer ponying up $85 Billion (correction – the amount is now $170 Billion).  We couldn’t afford to let it officially go under, or it would have taken down the entire financial system like a stack of dominos. 

Still, AIG is a failed business.

Executives in failed companies don’t get rewarded.  The employees at Enron, Worldcom and other failed companies didn’t.

Let’s be very clear on what the public’s outrage is about — and not about.  The American public is not outraged with the majority of hard-working employees at AIG.  No, this outrage is directed toward a relative handful of people.  The outrage stems from the take-your-breath-away size of the bonuses — and because so much money is being divvied up in the hands of a few.

It feels like these bonuses are a replay of the same old story of greed that got us into this economic mess in the first place.  A small number of people are lured by the desire for big money into taking big risks — putting everyone around them at risk.  Others in the organization, from the Board of Directors on down, enable this risky behavior.   When will these people ever learn?

Instead, the Board should have exercised independent judgment.  It should have asked “is this the right compensation structure for a failed company that nearly brought down the world economy single-handedly?”

Also, as someone who’s written numerous compensation plans over the years, I’ve never heard of retention plans that paid so handsomely.  Maybe you offer an extra 20-25% of regular compensation to stick around — not millions.  Nor ones where the people get paid early.  These sound more like the typical year-end Wall Street bonus  plans — you know, “business as usual.”

Barack Obama, the President of the United States and Leader of the Free World, makes $400,000 annually.  And look at the responsibility heaped on his shoulders.  And yet we’re to believe that someone with narrower responsibilities deserves $6.4 Million of taxpayer money?  Something is wrong with that picture.

So what do we do about these bonuses? 

I am not in favor of taxing these bonuses at 90%, like the measure the House of Representatives passed last week. 

On the other hand, I also do not buy into dire predictions that clipping AIG’s wings somehow spells doom to capitalism.  

We may well be inching closer and closer to socialism — but it’s not because of the AIG bonuses or because we’re being forced to do the job the AIG Board of Directors and the U.S. Treasury Secretary should have done in the first place.  AIG’s bonuses are just a bad situation all the way around, with no good solutions. 

But unwind them — seek the money back — is what we should do.

In the end, unwinding the AIG bonuses would be a proper exercise in capitalism.  In capitalism, executives should not get rewarded for their company’s failure.

30 Comments ▼

Anita Campbell - CEO


Anita Campbell Anita Campbell is the Founder and Publisher of Small Business Trends and has been following trends in small businesses since 2003. She is the owner of BizSugar, a social media site for small businesses, and also serves as CEO of TweakYourBiz.com.

30 Reactions

  1. Barack Obama, the President of the United States and Leader of the Free World, makes $400,000 annually. And look at the responsibility heaped on his shoulders. And yet we’re to believe that someone with narrower responsibilities deserves $6.4 Million of taxpayer money? Something is wrong with that picture. –> This is exactly the point Anita! I couldn’t agree more.

  2. Well said Anita. The groundswell of outrage over executive compensation has been growing over the last few years. This whole AIG bonus deal was just frosting on the cake. It’s more proliferation of of the gap between the front line employee and the executive in the top office in terms of compensation. While the “little” guys work to justify getting their single percent raises each year based on performance, the people in the top offices get heaps of money for just staying on day-to-day. Shameful.

  3. Anita:

    Your money quote: “In the end, unwinding the AIG bonuses would be a proper exercise in capitalism. In capitalism, executives should not get rewarded for their company’s failure.”

    I remember reading American Steel by Richard Preston and how he describes the bonus system at Nucor:

    http://koceiw.notlong.com

    “To achieve that high level of labor productivity Iverson decided to employ a compensation system that relied heavily on performance bonuses. But, unlike older bonus plans, Iverson’s system would be administered in a manner that promoted teamwork and a feeling of long term loyalty to the company. In addition to production workers, all levels of management were included in the bonus payment system, including Iverson.” – American National Business Hall of Fame.

    We have had an intensive debate in Sweden on the bonus system at failing banks and insurance companies. It is not a pretty picture. “‘No bonuses at state-owned companies'” http://yiuch.notlong.com

  4. Really great article Anita. I think you nailed it. As for the ‘retention’ bonuses, come on – there’s no place for those people to go! And who would want them anyway? They destroyed a company, and damaged the lives of those who worked for them.

    I think the massive greed is disgusting. I do not believe the government should be legislating a solution because they are equally culpable (in my humble opinion). I do think, however, that the shareholders should be screaming for change. Do they realize that they do not receive as much return on their investment when that money goes to the top staff?

    Something has to change. I would like to see the capitalist system create the change – not the government. It will be interesting to see where this goes.

    The lack of leadership is frightening.

  5. Diane Helbig,

    I agree with you that the lack of leadership is appalling. I think that many individuals should read the book, The Blackwell Handbook of Principles of Organizational Behavior.

    I don’t agree with your statement on greed. The philosophical base for greed is a good thing. You will understand what I am trying to say after you listen to my upcoming podcast interview with Jonathan Hoening of CapitalistPig LLC and author of the book, Greed Is Good: The Capitalist Guide to Investing.

  6. I couldn’t agree more. You said everything I’ve already been thinking myself.

  7. Hi Anita,

    That is very true, however when there is a profit in it they are the ones that benefit the most. The ones that suffer the most are the employees. Specially, when a company owns monopoly in the market.

    Cheers,
    Eddie Gear

  8. Eddie Gear,

    A company is not able to have a monopoly position on a free market. You will always have the opportunity to start a competing firm that will acquire market shares. If you have a mixed economy with state owned companies, then it could exist oligopoly and monopoly situations.

    I recommend you to read Brian P. Simpson’s book, Markets Don’t Fail! Click on “Martin Lindeskog” Says if you are interested to learn more about the book.

  9. There are two problems here:

    First, the bonuses referred to are for the Financial Products division which was not responsible for the financially risky decisions of that led to AIG’s downfall. In fact, if we are to believe one of the executives in that branch who resigned over this outrage, their activities actually served to offset some of the impact of failures elsewhere in the company.

    http://www.nytimes.com/2009/03/25/opinion/25desantis.html

    Second, the individuals who were given these bonuses were contractually entitled to those bonuses. If we do not DEMAND that these contracts be honored, then we are conceding that our property rights are subject to the howling of the mob.

    So, I would argue there is nothing bad about this particular bonus situation. As such, the outrage at these particular bonuses seems wildly misdirected.

    I also don’t think it’s really any of your business what companies pay their employees — then again, we wouldn’t even be discussing this if AIG had been allowed to fail as it would have under a truly capitalistic system.

  10. Trey,

    If the whole company is failed, as AIG is, then everybody goes down. It doesn’t matter which division you are in or whether your division was innocent. Lots of Enron employees were innocent, too.

    Second, it is very much my business what a failed company pays employees, when the U.S. taxpayer gives that company $85 Billion. I absolutely would agree that if the company were doing fine and didn’t need a bailout, it’s the company’s business. But when a company fails and you get $85 Billion in public money, then it’s EVERY taxpayer’s business.

  11. You are right, I have seen few things in recent years that have sparked public outrage that is palpable like this.

    And someone should be taking responsibility for those actions, but we all have to be sure we are taking responsibility for ourselves as well. Otherwise, these wounds will never heal.

  12. Useful summary that reflects my thinking, too. I can’t think of anything original to ask (or scream) — most everyone else here already said it or echoed it. How did we get here and how was this allowed? To the comment made by Trey, I have to agree that it’s their business…but only when they don’t get bailed out.

    There are many ways to rescue a person or company — in Lifesaving 101 you learn to never let the person you are saving pull you under… Perhaps with a little more thought (arguable, i know) maybe we could have achieved the same effect of rescuing the economy, but only after AIG was just a bit underwater and perhaps aware that they are and were being rescued, by the taxpayers.

    Has any university think tank studied the effect of greed on the brain’s ability to decide logically?

    All contracts are off, by the way, when your revenue does not cover them.

  13. Oh, and I couldn’t help but notice the cool (new?) feature that points out:

    Possibly Related Posts. I clicked over to these two right away, even though they were not exactly related to the post. They caught my interest:

    Advisory Boards are Not Boards of Directors
    http://smallbiztrends.com/2007/08/advisory-boards-are-not-boards-of-directors.html

    The Trend Toward Life-Work Balance
    http://smallbiztrends.com/2006/01/the-trend-toward-life-work-balance.html

    Cool.

  14. TJ,

    I recommend you to read the blog post, Don’t cap CEO pay, cap government coercion by Don Watkins. http://eefiqu.notlong.com

    Regarding a university think tank, check out Clemson Institute for the Study of Capitalism.

  15. TJ: Do you know how the “Possibly Related Posts” are generated? “Automagically” ;) or handpicked?

  16. Exactly Diane. Who would want this people when they are the ‘rust’ to the company and to the economy.

  17. Do you really think that anybody will get the reward for the failure. I do not think so.

    They are in corporate world and using the money of general public, if they have made any kind of mistakes than they should be liable to tell general public.

  18. Anita,
    Here is what I find even more bizarre about some of the bonuses;

    Some of these bonuses were “retention bonuses.”

    But, the folks left. So how did THEY get paid, if they were supposed to stay on?

    Just another scam. The wealthy always stick together, and help each other stay wealthy.

    The Franchise King
    Joel Libava

  19. I am not against anyone making a lot of money. I hope everybody in this country makes heaps of dough and gets really really rich, through legitimate hard work. I admire people who get rich through being successful.

    But dammit, as a taxpayer I don’t want money taken from me in the form of higher taxes, and redistributed to a company that has failed — so they can continue making incompetent management decisions like these so-called “retention” bonuses while the rest of us foot the bill.

    You see, redistributing wealth in that way would be the height of socialism.

  20. Anita: “You see, redistributing wealth in that way would be the height of socialism.”

    Amen to that! I am just now watching Ayn Rand’s television speech, Capitalism vs. Communism, to the American Management Association in 1961. http://ohpheic.notlong.com

    Ayn Rand’s novel, Atlas Shrugged, is now #1 on Amazon’s Bestseller List.

  21. Executives DO get rewarded for failure…when the government steps in to bail them out. The public can be outraged, but the executives would have suffered their just consequences had capitalism been allowed to work. Instead, the government fear machine convinced the public and Congress that AIG was too big to fail and threw billions at the problem. Why change your bonus packages if Washington will be there to save you? The root of the problem in an enabling government.

  22. Good article, Anita. It seems to me that many people are confusing abuses of the free market / capitalism with a failure of the system of capitalism. Capitalism has been a very successful system for the US – as evidenced by our very strong GDP growth over the past 50 years, increases in household wealth, and the amount of important innovations that have made our lives better. That’s not to say that there haven’t been problems or abuses – i.e. many of the problems that have lead to our current economic trouble – non-existent mortgage underwriting, excessive use of financial instruments to shift risk, bad corporate governance evidenced by excessive executive compensation at under-performing companies, and inept regulators – for example the SEC’s failure to seriously investigate Madoff despite Harry Markopolos repeatedly bringing evidence of the fraud to their attention.

    Yet, despite these abuses of our system, it doesn’t mean we should be throwing out the baby (capitalism) with the bath water. I’m concerned that many of the policies that the government is adopting are going to unwittingly hurt the country. I believe that one of the biggest philosophical problems we have in the country right now is our unwillingness to let businesses and people fail who have made bad decisions. Part of what makes a capitalist system work is that just as there are rewards for success, there should ultimately be punishments or consequences for bad decisions. When there is interference with this – and the government or anyone else decides to try to prevent the negative consequences the system won’t work correctly. Sure, allowing failure causes pain and hardship for some, but it also provides more accurate information to the market. When the government interferes by trying to protect businesses and individuals from negative consequence there are often unintended consequences that are unfair for others. Also, sometimes one person’s loss is another person’s gain (i.e. the person whose house is foreclosed on may be acquired by another buyer who benefits from a more attractive price).

  23. Hi Matt, Eric,

    As I read your thoughts and those of others here and all across the Web, it does seem that the core problem is that AIG is in a no-man’s land of quasi-nationalized status.

    It’s not being liquidated/reorganized under bankruptcy law. Yet the government intervened in a poorly-defined manner, in effect becoming owner of 80% of the company, leading to this gray area we are in.

    This article describes the no-man’s land AIG is in.

  24. For the record, I just want to clarify that I’m talking in this article ONLY about AIG and not about other organizations.

    From what I know of AIG’s role as guaranteeing obligations, and the wild risks they took, they are a unique case. Other institutions relied on AIG. AIG was like the keystone holding up the arch.

  25. Unfortunately, the public doesn’t care so much about the legal obligation to pay the bonuses. Rightly so. But if they’re not paid, the employees would have the right to sue (and I understand they could ‘win’ double the amount). Ouch. The reality is that the government should have known/recognized this liability as part of the bail out and found a way to mitigate the payouts, the perceptions and the reactions. It is taxpayer funded and the government is responsible for managing the AIG deal.

  26. Kris,

    “The reality is that the government should have known/recognized this liability as part of the bail out and found a way to mitigate the payouts, the perceptions and the reactions. It is taxpayer funded and the government is responsible for managing the AIG deal.”

    You are so right on this point.

  27. First of all, the vast majority of the “retention bonuses” went to ‘hard-working employees at AIG’ who were paid a “bonus” to work themselves out of a job. That isn’t being reported- the employees who received a bonus were given the responsibility of unwinding AIG’s bad business relationships. Most of the individuals who must undo these deals didn’t have anything to do with them in the first place.

    The AIG FP (Financial Products) division basically doesn’t exist anymore. These are folks from other parts of AIG who are cleaning up their co-workers messes. The guy who was in charge of AIG FP (the architect of the house of cards) is hiding out in a condo in London, where the office was located! Why isn’t Great Britain doing something?!

    I’m not saying that no one at AIG is to blame- far from it! But we need to make sure that the anger is not directed at those trying to fix the situation. The retention bonuses weren’t paid for bankrupting the company- they were paid for mitigating the damage. Keep in mind, these AIG employees worked for $1.00 and received the bonus when they cleaned up someone else’s mess.

    By the way, they are taxpayers too.

  28. concernedcitizen

    oh, gimme a break you weenies supporting these whiny executives who but for the taxpayer wouldn’t have a job at all. i have just one thing to say…read this reader comment in the New york Times in response to the big headed executive who wah-wahed like a baby over his bonus:

    Dear Mr. DeSantis,

    As a taxpayer, and a defacto part owner of your failed employer, I would like to take this opportunity to gladly accept your resignation.

    You, and those like you, apparently are oblivious to the fact that your employer is crumbling, and is presently only propped up by the U.S. Government. Had the Government permitted AIG to become insolvent, you would have certainly been facing a substantial likelihood of having the bonus contract nullified by a bankruptcy judge. And, you likely would have been looking elsewhere for employment anyway while the failing company reorganized.

    In other words, you only had the opportunity to continue in your present position because of the American taxpayers–the same ones that you so roundly criticize in your resignation letter.

    While you claim to have some sympathy for those in need, you clearly don’t understand them. If you did, you would grasp why your receipt of a nearly $750,000 “bonus” from what has essentially become a ward of the federal government is so offensive to taxpayers in a country where the median family income is approximately $48,000. If “guilt” is an insufficient motivator to return the grossly unwarranted bonus, perhaps you should give shame a try.

    Like you, I was raised by a schoolteacher and a blue collar worker. Like you, I worked hard and got through schools on scholarships. Like you, I have put in more than my share of 10/12/14 hour (and more) work days. Unlike you, I would never dream of taking an almost $750,000 bonus from taxpayer dollars, when that money could be used to help the unemployed, the homeless, or the hungry. Finally, unlike you, I would never be so pretentious to claim to be betrayed or victimized by the legitimate public outrage over this situation.

    Please clean out your desk. Security will take your key, and will show you to the door.

    Sincerely,

    The Management.

  29. Alright, alright people — calm down.

    Anyway, it looks like much of this brouhaha is being solved. The public uproar has brought about some changes:

    (1) many of the people involved have voluntarily given their bonuses back

    (2) the Board is being sued, and probably has a few more lawsuits to look forward to — that will go a long toward preventing future abuses like this from companies receiving public funds

    (3) some companies receiving public monies are already changing their compensation systems from these “sleight of hand” plans with $1-salary-hiding-jackpot-bonuses designed to hide their real pay, to a much more transparent system of regular salary. That way regulators will know up front what executives are really making.

    (4) the government had a fire lit under it to get more proactive and better at setting up-front conditions for companies getting public money, and doing their jobs at oversight.

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