In a week when failed CEOs at Merrill Lynch (NYSE: MER ) and Citigroup (NYSE: C ) got to leave with their eight- and nine-digit severance packages intact, there was a single, much smaller payday that astounded me with its audacity. Stanley O'Neal left Merrill after essentially trying to hide billions in losses generated under his watch by going rogue and trying to negotiate a merger between Merrill and Wachovia (NYSE: WB ) without so much as whispering to the board. His severance? $160 million. Chuck Prince did such a good job eviscerating Citi's banking franchise, you'd think he'd done it on purpose. Citi's board paid him $25 million last year.
You may not have ever heard of Greg Metz. You may not care that he recently received a $50,000 bonus. But the difference between the two clowns above and Metz is that both Merrill and Citi are going to survive. Greg Metz is a top executive of a company that almost certainly will not, destroying a billion in market capitalization along the way.
I'll get to the details in a minute, but let's talk about concepts for a minute. Vanguard founder John Bogle wrote a book a few years ago called The Soul of Capitalism, in which he argued quite forcefully that American capitalism had lost its moral compass, that capitalism for the benefit of the capitalist has been replaced by capitalism for the benefit of the managers. The technical term is "agency conflict." I call it "revolting." Let's go to Bogle's own words:
Over the past century, a gradual move from owner's capitalism -- providing the lion's share of the rewards of the investment to those who put up the money and risk their own capital -- has culminated in an extreme version of managers' capitalism -- providing vastly disproportionate rewards to those whom we have trusted to manage our enterprises in the interest of their owners. Managers' capitalism is a betrayal of owners' capitalism, a system that worked, albeit imperfectly, with remarkable effectiveness for the better part of the past two centuries, beginning with the Industrial Revolution as the eighteenth century turned to the nineteenth.
I think Bogle's right. So much of what passes for capitalism is a game of heads-I-win, tails-I-win-more. Managers demand higher and higher rates of pay. Boards larded with cronies and/or other beneficiaries of "the game" have little incentive to push back. There is no such thing as a free market for chief executives. And many, but not all, take advantage of this fact to pay themselves enormously well. Watching what has happened in these situations -- as well as what happened with Bob Nardelli at Home Depot (NYSE: HD ) and Dennis Kozlowski at Tyco (NYSE: TYC ) -- reminds me of a great baseline standard that investors should hold near and dear: When looking to entrust your money with someone, try to make sure he's not a dirtbag.
So, here's the Metz story. Greg Metz is the CFO of a soon-to-be ex-company called NovaStar Mortgage (NYSE: NFI ) . It's a now-former mortgage REIT that made risky bets in the subprime mortgage market, took on huge amounts of leverage, and then hoped that the thing that happened this year wouldn't in fact happen. But it did. As a result, NovaStar's market cap has declined from $1 billion at the beginning of the year to $15 million now. It's shed more than 1400 employees in layoffs. It had to shed its REIT status rather than pay a statutory dividend with money it didn't have. It could not close a rights offering with Jeffries (NYSE: JEF ) and Mass Mutual to raise funds. This is a dying company. Its servicing rights were the most valuable piece it had left, since the company is not originating any more loans, and it was a desperate seller. Included in the filing for the sale of the servicing rights was this little nugget:
In addition, certain employees of NFI and its affiliates received cash bonuses as a result of the closing of the transaction, including a $50,000 bonus received by Greg Metz, the Chief Financial Officer of NFI.
So NovaStar's in a desperate cash position, and its management is paying itself bonuses to fire sale its only remaining valuable assets? That's scummy. It's also par for the course, if you cared to watch the signs.
NovaStar's management team somewhat famously had an open mike moment in 2005, when, following a conference call, Greg Metz praised their IR director for not letting "anybody get on we don't want to take questions from." This was immediately followed up by another executive who said "There was one [golf word]-head who was being pretty much of a [same golf word]." Not exactly respectful of their shareholders. But that's not even the biggest thing that should have tipped off shareholders that these managers were not playing for their benefit.
As a REIT, NovaStar paid out substantial dividends to shareholders. But it also granted its managers a bevy of stock options. Stock options are not shares, so they should not be eligible to receive dividend payments. And yet NovaStar's board gave its executives "dividend equivalent rights" for unexercised and unvested options. That's management capitalism. It's a structure that shows that management was willing to pay itself first, no matter what.
And now we know that the "what" includes the total collapse of the company. I'm not saying that you need to like every single thing management does -- you'd find yourself never buying anything. But I believe strongly that an individual investor would do well to pay attention to the details about how management pays itself in good times and bad.
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