Friday, October 23, 2009

I don't think garden-variety caps on executive compensation are the way to go--but I don't care if there's a rush to the exits, either.

Joe Nocera's column in this morning's New York Times (here) once again gets it right: it's not about the caps, it's about the boards of directors deciding about compensation packages in the first place. If shareholders are unhappy with who's getting paid what, the fix is with getting rid of the folks believing the hype about who has to get paid the gargantuan bucks.

Look, I'm a firm believer in capitalism. I don't believe that the free market system works perfectly--obviously, we don't have anything near perfect information--but I have no problem with people making money, even scads of money. But boards of directors who let people get scads of money for failing abysmally, year after year, just aren't doing their jobs. Rewards aren't aligned with risks, and that's why so many boneheaded risks are being taken. It's all upside and no downside, because the risks are being paid for with other people's money.

Want the C-level officers to take more reasonable risks? Then create incentives for them to have more skin in the game? (Of course, that's what stock options were supposed to be about, but those options didn't quite work out the way we hoped.)

Boards are being told by compensation gurus that the best people won't work for less than huge salaries, all of which have to be earned up-front, or close to it, or these best folks will bolt for better jobs. Fine. Let them bolt. Heck, hold those doors open for them so that they won't bruise themselves during their dash for better, more lucrative work.

In a wonderful case, reported by WSJ Blog's Peg Brickley here, Bankruptcy Judge Jeff Bohm said "no mas" to ludicrous requests for compensation:
Oblivious to recent congressional and public criticism over executives of publicly-held corporations who are paid monumental salaries and bonuses despite running their companies into the ground, two investment banking firms now come into this Court requesting that they be employed under similarly outrageous terms. They do so because two committees in this Chapter 11 case have filed applications to employ these investment banking firms to perform valuation services even though two other independent firms have already performed similar valuations. These investment bankers, who wish to have their fees and expenses paid out of the debtor's estate, have sworn under oath that they will render services only if they immediately receive a nonrefundable fee aggregating $1.0 million. This Court declines the opportunity to endorse such arrogance. The purse is too perverse.
In observing that the two investment banking firms' proposed compensation was significantly higher than the compensation that an already-retained firm was charging in the same case, the bankruptcy judge also pointed out that
one other investment banking firm--i.e. Parkman Whaling--has already been retained to provide similar valuation services in the case at bar without demanding such a high premium; Parkman Whaling has received $75,000.00 per month, which is substantially lower than the fees demanded by Houlihan Lokey and Tudor Pickering. It is entirely legitimate to ask why Houlihan Lokey and Tudor Pickering are unwilling to work under the same or similar terms as Parkman Whaling. Neither Houlihan Lokey nor Tudor Pickering adduced sufficient testimony at the July 15, 2009 hearing to convince this Court that they should be treated so differently--indeed, so much more favorably--than Parkman Whaling. Stated differently, Parkman Whaling is as capable and competent an organization as Houlihan Lokey and Tudor Pickering, and to approve the far more exorbitant terms demanded by Houlihan Lokey and Tudor Pickering would suggest that these two firms somehow provide services that are superior in quality than those provided by Parkman Whaling. There is nothing in the record to suggest that this is true.
The court then highlighted its shock at the tone-deafness of some of the specific compensation requests:
Nevertheless, the Court feels compelled to discuss the initial provision in the proposed terms requiring a daily witness fee of $25,000.00 because the very fact that Tudor Pickering made such an audacious request underscores how oblivious the investment banking community--or, at least this one investment banking firm--is to the extremely hard economic times in which the country in general, and this Debtor in particular, find themselves. This Court believes that a discussion of the $25,000.00 daily witness fee request is appropriate to telegraph to the business bankruptcy bar and the investment banking community how unseemly this request really is.
One of the best parts of the case is the footnote immediately following this part of the court's opinion:

For example, the men and women of our nation's armed forces, who risk their lives to preserve and protect the abundant freedoms of this country, earn an annual salary that barely exceeds Tudor Pickering's proposed $25,000.00-per-day appearance fee. See United States Army Public Website, Benefits--Total Compensation, (listing the average annual salary for a military police sergeant as $26,967.00). Moreover, there are numerous other occupations whose members are in daily physical danger and who provide absolutely necessary services for our society but yet are paid an annual salary approximating the requested daily fee of the Tudor Pickering witness. For example, a nursing-aide at a public hospital, can expect to earn less annually than what Tudor Pickering is requesting for each day it appears for a hearing. See United States Department of Labor, Bureau of Labor Statistics Website, Occupational Employment and Wages, May 2008, Nursing Aides, Orderlies, and Attendants, http://www.bls. gov/oes/current/oes311012.htm (listing the average annual salary for a nursing-aid as $24,620.00). Finally, public school teachers who are educating future generations can expect to earn barely more in one year than Tudor Pickering seeks to be paid for each day that it appears for a hearing. The per annum salaries of the military personnel, nursing-aides, and public school teachers, compared with the requested daily fee of $25,000.00, speaks volumes about the level of hubris among some members of the investment banking community.

(Citation omitted.) In concluding its opinion, the court refused to fall for the adage that the requested compensation had to be paid or the case would lose the opportunity to get the best and brightest minds:

The exorbitant fees requested by Houlihan Lokey and Tudor Pickering are similar to the "appearance fees" which certain of the world's top athletes--for example, Tiger Woods--are able to command. However, unlike Tiger Woods, whose presence does guarantee a financial benefit at any event where he appears, neither of these two investment banking firms introduced any testimony or exhibits guaranteeing some benefit to the estate in this case. They expect to be paid an appearance fee for simply showing up--not only do they not guarantee success; they do not even guarantee they will work a minimum number of hours in order to try to achieve success. This Court will therefore not approve the payment of their requested "appearance fees." Tudor Pickering is not Tiger Woods. Nor is Houlihan Lokey.

In In re Mirant Corp., 354 B.R. 113 (Bankr. N.D. Tex. 2006), the Honorable D. Michael Lynn made some very telling comments about the integrity of the process with respect to financial advisors demanding guaranteed compensation under [sec] 328:

The court erred seriously in entering orders which left it so little discretion in assessing the work of the financial advisors. Though the court was given to understand Debtors and the Committees could not obtain competent financial advisors without assurance that there would be substantial "success" bonuses, whether or not each advisor could show it had earned such a fee, the court has since learned that some financial advisors, at least, will accept more conventional arrangements in terms of compensation. In the future, the court hopes and expects that parties in large chapter 11 cases in this and other districts will seek out financial advisors that are willing to have their work judged on a basis similar to the rules applied to other professionals.

In re Mirant, 354 B.R. at 128 (emphasis added). In effect, Judge Lynn has recommended that parties in large Chapter 11 cases should call the bluff of investment bankers who make Shermanesque statements that they will only provide services pursuant to a huge, guaranteed fee approved under [sec.] 328. Judge Lynn is urging parties to respond to these investment bankers by telling them that if they will not work under the more conventional arrangements pursuant to [sec.] 330, or at least pursuant to reasonable fee arrangements under [sec.] 328, then the parties will find one or more of their competitors who will. Implicit in Judge Lynn's remarks is that if the parties themselves give in to these investment bankers, then the bankruptcy courts themselves must call the bluff of these financial advisors and challenge them to accept reasonable fee arrangements.This Court shares Judge Lynn's concerns about the integrity of the process and also accepts his remarks and advice. Given the state of the record in this case, this Court will not approve the proposed enormous fees for Houlihan Lokey or Tudor Pickering, but rather chooses to call their bluff. Every other key professional in this case--including the investment banking firm of Parkman Whaling--has agreed to reasonable fee arrangements that are governed by, among other orders, the Procedure for Professionals Order, the Cash Collateral Order, and the Budget. Given the state of the record, there is no good reason why Houlihan Lokey and Tudor Pickering should be exempt from these same reasonable compensation arrangements. This Court does not want to make the error (about which Judge Lynn cautions in Mirant) of approving the Applications and later learning that some other financial advisors would have accepted much more reasonable compensation arrangements, which include agreeing to oversight by this Court. Indeed, given that Parkman Whaling, an investment banking firm every bit as competent and qualified as Houlihan Lokey and Tudor Pickering, was willing to work for a reasonable fee, this Court's approval of the compensation schemes proposed by Houlihan Lokey and Tudor Pickering would not only be an error; it would be a gross error.

(Footnotes and citations omitted). Judge Bohm added that "Judge Lynn's willingness to concede his mistake [in Mirant] in order to educate others and improve the bankruptcy system underscores his own high integrity and brilliance."

My point? A judge in Houston, Texas understands the difference between good compensation for good work and unreasonable compensation for very little work. And he's not the only judge with, well, judgment. I'd expect boards of directors to be able to distinguish gold from dross as well. If they can't, then let's vote them out and vote in others who can distinguish the two, and who have the courage to do so.

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