Show Me the Money and I'll Show You The Risks

As we all read the postmortem of the recent collapse of major financial institutions, the single thread throughout all the dead bodies are the litany of personal incentives tied to short-term rather than long-term results.  These incentives start at the very top as evidenced by the pay packages of the CEOs who drove their companies straight into a brick wall.  I was reading the Atlanta Business Chronicle yesterday and here is what they had to report on excessive CEO pay.

• Lehman Brothers Chairman and CEO Richard Fuld Jr. made $34 million in 2007. Lehman (OTC:LEHMQ) filed for Chapter 11 Bankruptcy protection earlier this month.


• Goldman Sachs (NYSE:GS), which Sunday gained Federal Reserve Bank approval to become a bank holding company, paid its Chairman and CEO Lloyd Blankfein $70 million last year. Co-Chief Operating Officers Gary Cohn and Jon Winkereid were paid $72.5 million and $71 million, respectively.


• Morgan Stanley Chairman John Mack earned $1.6 million. Chief Financial Officer Colin Kelleher got a $21 million paycheck in 2007. Morgan Stanley (NYSE:MS) also received approval to become a banking holding company, a shift that allows Morgan and Goldman to bring in bank deposit assets which offer more solid financial footing.


• Merrill Lynch CEO John Thain was paid $17 million in salary, bonuses and stock options in 2007. Merrill (NYSE:MER) is being acquired by Bank of America (NYSE:BAC). BofA CEO Kenneth Davis earned $25 million in 2007.


• JP Morgan Chase & Co. Chairman and CEO James Dimon earned $28 million in 2007. Chase (NYSE:JPM) acquired troubled investment house Bear Stearns earlier this year with the federal government promising to take on as much as $30 billion in Bear assets to help get the deal done.


• Fannie Mae CEO Daniel Mudd received $11.6 million in 2007. His counterpart at Freddie Mac, Richard Syron, brought in $18 million. The federal government announced earlier this month it was taking over the mortgage backers with Herbert Allison to serve as Fannie CEO and David Moffett the new CEO at Freddie.


• Wachovia Corp. Chairman and CEO G. Kennedy Thompson received $21 million in 2007. He was succeeded by Robert Steel as CEO in July. Steel is slated to get a $1 million salary with an opportunity for a $12 million bonus, according to CEO Watch. Wachovia (NYSE:WB) is one of the banks that could be sold in the midst of the financial crisis.


• Seattle-based Washington Mutual (NYSE:WAMU) will pay its new CEO Alan Fishman a salary and incentive package worth more than $20 million through 2009 for taking the helm of the battered bank, according to the Puget Sound Business Journal.

While this is no huge surprise, I'm sure if you dig further into the incentive structures of each of these companies, you will find much more excessive pay driving excessive risk taking.  Everyone seems to be saying that the regulators did not provide the appropriate level of oversight.  While that may be the case, one of the Fed Governors hit the nail on the head with his speech in February of this year.  Governor Randall F. Kroszner noted the following in his speech to the Global Association of Risk Professionals on February 25, 2008 in New York.

"In trading and certain other activities, there is a tendency for business-line heads or individual employees to focus on their short-term compensation and not think about the long-term risks that their activities create for the firm. But it is the responsibility of senior management to provide the proper incentives and controls to counter the potential for individuals within financial firms to discount risks to the broader institution, and of course to ensure that nefarious activity is promptly uncovered and stopped."

However, those very senior managers that should have been providing the proper incentives and controls were the very same senior managers who were receiving the excessive pay packages based on short-term results.  The risks will always be linked to pay packages and the behaviors they drive.   What are your thoughts?  Do you agree?  Please feel free to comment by clicking on the link below.

*For more on Governor Kroszner's speech, click here.