Executive Compensation: Where Does the Money Come From?
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Related subjects: Economic Recovery, In the Loop, Mortgage & Credit Crisis, Obama administration, U.S. Economy, U.S. news, U.S. Politics Comments Off
When the CEO of a major bank takes home $150 million in compensation in just one year, that means the bank must find an equivalent amount in profits in order to pay the CEO’s salary. That’s 150 million transactions worth $1 each to the bank, or 150,000 transactions worth $1,000 to the bank. How many of those are there in a year, and how many executives are earning in the millions, or in the tens of millions?
Major banks can inflate their revenue base by selling stocks, which may increase dramatically in value over time, and by funneling higher interest payments from borrowers into their coffers. There are competing philosophies about how such revenue streams should be tallied and redirected, and some of the nation’s major banks have been accused of extracting “profits” prematurely from those aspects of their business, driving them to rely too heavily on subprime mortgages as a business strategy.
Ultimately, extracting enough revenues from interest repayments to justify extremely high-end reimbursement packages means charging more interest from all borrowers and higher fees for basic banking activities, like ATM use, checking and “maintenance”. Those fees, whether you favor them or not, are an adversarial approach to customer relations, and that means a less reliable customer base out into the future and possibly less sustainable repayment and investment conditions for existing customers.
As the G20 prepare to meet in Pittsburgh next week, one of the topics some European nations want addressed is an upper limit on salaries and compensation packages for the managers of multinational banks, whose instability or collapse could imperil the international economic outlook for months or years to come. There is support for this in Europe and among the American public, but the White House and most Washington politicians remain skeptical about so strictly limiting private firms’ compensation packages by legislation.
But as the push for comprehensive financial regulatory reform gets underway —and the Federal Reserve has announced plans to put regulators inside banks to review, and in some cases veto, the compensation schemes set up for top executives, under the “safety and soundness” regulatory authority the Fed already has—, questions are being raised about whether some banks’ pay schemes might be a threat to their solvency and to long-term economic soundness.
Outsize pay packages can very really threaten to undermine a bank’s ability to make the right investments at the right times, and contribute to a climate of reduced transparency, in which executives have an incentive to keep certain information about basic banking activities out of the public eye. This has raised the ire of shareholders who say they have a legal and contractual right to see every detail related to such schemes, and has further inflamed sentiment among the public and to some extent in Congress, that pay packages are becoming a threat to the solvency of the banking industry.
According to the Wall Street Journal:
The proposal [...] will “give [regulators] another opportunity to have someone come in and tell us how to run our business,” said Edward Wehmer, chief executive of Wintrust Financial Corp., a Lake Forest, Ill., company with about $11 billion in assets and 79 branches. “It’s opening Pandora’s box,” he said.
Others in the business applauded the Fed’s plan, saying it wouldn’t affect banks with prudent pay practices. “I like it,” said Steve Steinour, chief executive of Huntington Bancshares Inc., Columbus, Ohio. “Having disciplined pay practices is good for the country long term,” he said. “I do believe people should be paid with a view of how much risk they’re taking.”
Congressman Barney Frank (D-MA) famously asked banking CEOs point blank, earlier this year, why they needed to be “bribed in order to do their jobs”, why they needed multi-tens-of-millions-of-dollar bonuses on top of already lavish salaries, benefits and stock options, just to do the job they were contracted to do. The question was asked in response to then oft-repeated claims that without lavish bonuses, the best executives would just leave the companies where they worked.
Frank says legislation he drafted, which passed the House, still has to be signed into law in order to properly clarify how much authority the Fed has in implementing such a strategy of regulatory supervision of executive pay packages. Chris Nunn, of Security Bancorp of Tennessee, said “If institutions were not allowed to grow so large as to threaten the entire financial system, then federal intervention such as this would not be necessary”, in effect praising the Fed’s effort as a move toward de-incentivizing the unfettered consolidation that has dominated American banking over the last decade.
There have been efforts to try to trace whether specific questionable elements of the banking industry’s failed “innovations” over the last decade could be linked directly to the need to feed ever expanding executive reimbursement demands, but so far, no specific case has been found where a banking executive openly admitted casting his banks lot in with questionable dealings in order to inflate the revenue base and thereby extract higher pay. But many believe this is one of the points of contention that remain between regulators and the major banks, as reforms are being hashed out.
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