Economic Dilemmas

We are in the greatest economic crisis in almost 80 years and attempts at saving the economy, not only in the US, but throughout the world, are being turned into a circus.

First we had a big flap about earmarks, which while deplorable, represent minutia, and now we have what can only be describes as a lynch mob after the heads of the bonus recipients at A.I.G (.mp3).

The outrage is understandable, but the bonuses represent less than 1% of the money used to shore up A.I.G. If this becomes the basis for stopping further aid to the financial industry, then we would be cutting off our noses to spite our faces.

We have not and will not invest money in A.I.G. or anyone else to help them or their executives or their stockholders, but in order to save the liquidity of our economic system, and in the process revive our economy. Any distraction from that task is a disservice, particularly coming from politicians who have for years protected and defended the system they are now denouncing.

We have much to learn from history. During the Revolutionary War the Continental Congress issued I.O.U.s (since it had no taxing power) in order to pay its bills, including paying the men of the Continental Army. By the time the war ended it was generally assumed that these I.O.U. were worthless and speculators bought them up for pennies on the dollar. With Washington President, and Hamilton Secretary of the Treasury, the question arose whether the I.O.U.s should be paid at their face value. (Bulls, Bears, Boom, and Bust by John M. Dobson, p.64) The populist response was that to pay these speculators the benefits of their speculation was unfair and rewarded those who had done nothing for the war effort, while defrauding those who did. Hamilton argued, however that the issue was the “Full Faith and Credit” of the U.S. which would be endangered by a failure to honor its I.O.U.s. Hamilton prevailed and the “Full Faith and Credit” of the U.S. has never been in doubt since.
The point is that sometimes we must hold our noses and let those reap who have not sown, for the greater good of our nation.
But there is a lesson to be learned. We have arrived at this cross road because our vaunted capitalistic system has turned into crony capitalism. The outrageous bonuses paid the execs at A.I.G. are but the tip of the iceberg and we need to address the greater problem. This from the Wall Street Journal of April 28, 2008:

“According to the Congressional Research Service, the average pay for CEOs was more than 180 times average worker pay, up from a multiple of 90 in 1994. Total direct compensation for CEOs was a median $8.8 million, counting salaries, bonuses and other incentives, as well as the value of restricted stock, stock options and other long-term incentive awards at the time they were granted, according to a survey by the Hay Group of 200 major U.S. companies.”

But what is even more outrageous is the severance pay that top execs in our corporate culture receive. As long ago as December 25, 2005, the NY Times discussed this problem. “In 2000, for example, after three years as chief executive, M. Douglas Ivester left Coca-Cola with almost $120 million jangling in his pocket. Included were a six-year consulting agreement, office space, furniture, home security service and country club dues. Steven J. Heyer, a former Coca-Cola president, struggled under the weight of a severance package worth $24 million when he left the company in 2004. He held his position for only three years as well. And Douglas N. Daft, a former chief executive, pocketed more than $36 million when he left Coca-Cola in 2004.”

When executives leave after a successful stint in their jobs with such outrageous severance packages it is bad enough, but often it is after they have all but destroyed the company under their tutelage and leave pursuant to severance agreements that amazingly enough provide that they are entitled to such rewards if they are fired. In other words they do even better if they fail then if they succeed. Talk about reverse incentives!

Thus for example, the CEO of the company I used to work for, Richard J. Kogan, departed Schering-Plough after wrecking the company, received $13.2 million in severance and $26.4 million in retirement payments. This was after Kogan had gotten the company into a war with the one government agency no drug executive can afford to antagonize, the Food & Drug Administration, by reducing quality controls to unacceptable levels in an effort to cut costs, causing the companies share price to fall from $50 to about $36 in a short time, and after he was charged by the SEC of giving insider information to a group of select investors.

But this is but one of many outrages. Other examples are set forth on the Obama website referenced above.

These abuses occur not because competition of the market requires it, but because of a system where neither the public nor even shareholders have any say, and when execs destroy a company it is the shareholders and innocent employees who bear the burden. Unfortunately, it is not shareholders who decide on compensation. It is the Board of Directors! And who chooses the Board of Directors? Usually the CEOs. To be sure Shareholders get a chance to vote at shareholder meetings for the Board, and whatever issues are placed before them, but the only choices they really have is to vote yes or no on whatever the management chooses to let them vote on. And increasingly, shareholder meetings are held at out of the way places so as to discourage shareholders from attending. God forbid, they might ask embarrassing questions. They are asked to send in their proxies to confirm what has already been decided. The Chinese communist voting system is not much different.

We should not ever consider government compensation controls. But changing the governance of American corporations so as to give shareholders a real say in the companies they invest in, is way overdue.

We must not learn the wrong lessons from the banking and liquidity crisis!