The impotence of governments and derailing of shareholder culture | FT Alphaville

The impotence of governments and derailing of shareholder culture

HOW MUCH POWER DOES A MAJORITY SHAREHOLDER HAVE IN AN ORGANISATION? The majority shareholder has great power for that person has the majority in passing the rules of the corporation. In business the stockholders vote by how many stocks they hold. The more stocks you have the bigger your vote. As the majority stockholder you would have the most votes and as in most cases majority wins. The person owning the majority stocks or at least authorized to control it (his/her personal stocks plus those he/she controls by permission of other holders) is usually known as the Chairman of the Board and makes the very large impacting decisions while the president/CEO makes the day to day decisions (most boards meet quarterly and the stockholders annually so the CEO has to be there consistently. The vote by the stockholders are the very big ones like sell the corporation, expand it, election of officers, etc.

Ho hum. On both sides of the Atlantic, we have heard political leaders thunder on about the “outrageous” bonuses that recalcitrant companies dependent on government largesse insist on paying their staff  – those very same people, as we know, who are largely responsible for the mess these companies got themselves into.

What’s more, we’ve heard these leaders’ self-righteous remarks about abuse of tax-payers’ funds and threats to use every legal means to halt the pay-outs. We had Gordon Brown in February threatening to wrest a sizeable chunk of former RBS chief executive  Sir Fred Goodwin’s cushy pension from him. Before that, Brown and his Treasury officials made all kinds of noises about trying to stop banks they’d just bailed out – Lloyds Banking Group and RBS – from paying hundreds of millions of pounds in bonuses to staff. (“Trying” being the key word.)
And now, Barack Obama has suggested that AIG’s bonus contracts should be torn up, telling his Treasury secretary Tim Geithner to use every legal means to recoup taxpayers’ money. Before that, Obama’s key economic adviser, Larry Summers, also ranted about AIG’s bonus culture, using the term “outrageous” even as he explained that the administration’s ability to force the company to cut the bonuses was “limited”.

“Limited”? Hold on, there seems to be a very serious disconnect – at the highest government levels – in the basic concept of shareholder culture here. When an investor buys a majority stake in a company, as defined above, the investor generally gets a big say in the company’s major decisions. In the case of both the US and UK governments, they now own between a third and nearly three-quarters of some of the biggest banks and institutions.

Yet, we are told, these governments are absolutely powerless to prevent their (or rather, the taxpayer’s) bail-out funds from going into cushy bonuses and pensions. In fact, judging by the latest news, the bigger the stakes they own in these institutions, the bigger and faster the pay-outs seem to be going.

All very convenient for the politicians, and a fine bit of high theatre, then, to see the likes of Messrs Brown and Obama citing their “inability” to curb the largess and supposedly siding with the beleaguered taxpayer against such payouts – while making apparently utterly impotent threats to stop the profligate nonsense. What happened to shareholder power?
AIG for example has received a staggering $173bn in US government aid, and now says it will proceed with plans to pay $450m in bonuses to staff at the very financial products division that caused a lot of the group’s problems. It has also earmarked $1bn in retention pay for about 4,600 of the company’s 116,000 employees – incredibly, just so they won’t leave. The UK government meanwhile now owns about 70 per cent of RBS, which is cheerfully doling out pay-offs to staff while Sir Fred sits tightly on his lavish pension pot.

So it’s hardly the time, then, to come out in defence of AIG’s bonus bonanza. But some brave, foolhardy – or provocative – souls have done just that.

DealBook’s Andrew Ross Sorkin uses the legal argument, saying in a Tuesday column that maybe, “we have to swallow hard and pay up, partly for our own good”.

He quotes Barack Obama saying: “This isn’t just a matter of dollars and cents… It’s about our fundamental values.”  On that, notes Sorkin, “lawyers, Wall Street types and compensation consultants agree with the president. But from their point of view, the “fundamental value” in question here is the sanctity of contracts”:

That may strike many people as a bit of convenient legalese, but maybe there is something to it. If you think this economy is a mess now, imagine what it would look like if the business community started to worry that the government would start abrogating contracts left and right.

As much as we might want to void those AIG pay contracts, Pearl Meyer, a compensation consultant at Steven Hall & Partners, says it would put American business on a worse slippery slope than it already is. Business agreements of other companies that have taken taxpayer money might fall into question. Even companies that have not turned to Washington might seize the opportunity to break inconvenient contracts.

If government officials were to break the contracts, they would be “breaking a bond,” Ms Meyer says. “They are raising a whole new question about the trust and commitment organizations have to their employees.” (The auto industry unions are facing a similar issue — but the big difference is that there is a negotiation; no one is unilaterally tearing up contracts.)

As for the US government’s commitment to the taxpayer, Sorkin moves to slightly more slippery ground to argue AIG “built this bomb, and it may be the only outfit that really knows how to defuse it”:

AIG employees concocted complex derivatives that then wormed their way through the global financial system. If they leave — the buzz on Wall Street is that some have, and more are ready to — they might simply turn around and trade against AIG’s book. Why not? They know how bad it is. They built it.

So as unpalatable as it seems, taxpayers need to keep some of these brainiacs in their seats, if only to prevent them from turning against the company. In the end, we may actually be better off if they can figure out how to unwind these tricky investments.

Another unexpectedly sympathetic view of the AIG bonus bonanza comes from DealJournal’s Evan Newmark, who ventures onto some odd territory with this Tuesday post on MeanStreet entitled “Hate AIG, hate thyself”:

Let’s face it. If we look in the mirror, we will see those AIG bonuses staring right back at us.

Here’s an exercise. Put yourself in the shoes of an AIG Financial Products executive circa February 2008. You have been at AIG only a few years, but you are up and coming–and the CDS market is white hot. Then in early 2008, things go wobbly. Soon the big guns that hired you are heading out the door.

So you are worried. The headhunters are calling you everyday with offers. And your lawyer says you are crazy to stay at a troubled AIG without an employment contract.

What would you do to protect your career and family? Wouldn’t you negotiate a guaranteed contract for as much as you could get? And wouldn’t you, as AIG is effectively nationalized six months later, threaten to leave unless you are compensated to stay?

Of course, you would. And that’s exactly how US taxpayers end up paying $450 million in bonuses to wind down AIG Financial Products.

The public anger over the AIG bonus affair is due to the lack of accountability,  he concludes.

“It’s outrageous,” says the President’s chief economic adviser. The Treasury Secretary is “distressed” and the Fed is “deeply troubled.” But what can they do? The search for enemies of the people at AIG is probably a futile one.

It was Washington that left the CDS market unregulated, Wall Street that securitized trillions of dollars of worthless mortgages, and Main Street that bought homes it never could afford.

Greed? It’s the American way.

As for the legal arguments raised by Sorkin, Felix Salmon has this to say in Tuesday’s MarketMovers about AIG’s protestations that it’s contractually obliged to pay out $165m in bonuses to members of the loss-making financial products group:

Is there a legal way to stop these payments being made? I don’t know. Cuomo’s attempt to paint the bonuses as “fraudulent conveyance” seems like a bit of a stretch, while a legislation trying to retroactively claw the bonuses back would easily pass Congress, only to face certain appeal on the grounds of being unconstitutional.

But right now, even Cuomo hasn’t seen the contracts which AIG is convinced are so ironclad. And it might just be the case that AIG’s contractual obligation to make the bonus payments is a bit like an underwater homeowner’s contractual obligation to make his mortgage payments. If AIG simply didn’t pay the bonuses, would the employees of the financial products arm really fancy their chances in court were they to sue to receive them?

Salmon ventures – and many would agree – that in the end, most of the affected employees would not sue AIG, and that the bonus payments would therefore be saved. “It’s hardball”, he says, but it might well work.

Don’t hold your breath, Felix.

Related links:
The case for paying AIG bonuses – DealBook
Mean Street? Hate AIG? Hate thyself – DealJournal
Obama vows to fight AIG bonuses – FT
Shock and awe over AIG bonuses – DealJournal
How not to pay AIG bonuses – Felix Salmon