Fool Blog: Why Do We Pay Big Money to Executives Who Failed?

One news item that may be getting lost in the din of the Black Sunday developments is that Fannie Mae (NYSE: FNM  ) and Freddie Mac's (NYSE: FRE  ) outgoing CEOs aren't going to receive the millions of dollars in severance that had previously been expected. That might be a bright spot in a gut-wrenching time, when many of us feel like we're footing horrific bills for other people's massive mistakes.

The Federal Housing Finance Agency said it will block the severance payments for Fannie's Daniel Mudd and Freddie's Richard Syron, which together had been estimated at up to $23 million.

I have to say I'm down with that. When I begged Uncle Sam to please let something fail recently, I brought up the idea that when companies require bailouts, maybe top brass should be required to jump with no golden parachute whatsoever. Why do we give top executives a cushy landing when they're let go? Doesn't that sound suspiciously like an incentive to screw up, or at least give a message that screwing up wouldn't be that bad for them?

Take the Big Three's recent hope for government loans in the $25 billion to $50 billion range. How short are the memories of those who forget that Chrysler is headed up by Bob Nardelli, who left Home Depot (NYSE: HD  ) in shame -- OK, maybe not that much shame, seeing as how he got a $210 million goodbye present on the way out. Somehow it seems ironic that his company is among the ones asking for government help. Perhaps some of these rich dudes could kick in some cash when their companies are floundering? Call me crazy.

Shareholders should pressure their companies for say-on-pay policies and reasonable salaries. It's not unheard of. Costco (Nasdaq: COST  ) and Whole Foods Market (Nasdaq: WFMI  ) jump to mind as two companies that have been ahead of the curve when it comes to reasonable pay for CEOs, and some of the most brilliant minds in business and investing, like Peter Drucker and Berkshire Hathaway's (NYSE: BRK-A  ) (NYSE: BRK-B  ) Warren Buffett, have taken stands against excesses in CEO pay.

I think golden parachutes in particular should be viewed as symbols of decadence and thievery, not to mention the antithesis of true free-market dealings. Failure should not pay. In the case of bailouts and government assistance, then both shareholders and the public at large are the ones who get their pockets picked for a whole lot of nothing. I don't see why this stuff has gotten by so easily for as long as it has -- it's low on both ethics and logic. So many of these guys have been paid millions year-in and year-out anyway, sometimes making terrible decisions that don't come out in the wash until years later (like now).

Surely we can strive for better than this. Now is a good time to be furious -- and start rethinking the policies of a decadent phase that encouraged greed, ego, and self-absorption over ethics, prudence, and the pride of corporate excellence. It's a time we must put behind us.

Whole Foods Market, Costco, and Berkshire Hathaway are Motley Fool Stock Advisor picks. Home Depot and Berkshire Hathaway are Motley Fool Inside Value picks. The Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletters today, free for 30 days.

Alyce Lomax owns shares of Whole Foods Market. The Fool has a disclosure policy.


Read/Post Comments (19) | Recommend This Article (27)

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  • Report this Comment On September 15, 2008, at 5:13 PM, foundmoneycom wrote:

    Great Article, you hit it on the nail. We are basically reinforcing positive results for negative behavior. This has to stop. Could you imagine if only part of the handouts/bailouts went into health care. We would be in pretty good shape. www.foundmoney.com

  • Report this Comment On September 15, 2008, at 5:24 PM, chadplusplus wrote:

    An old economics book I read once put forth the following argument:

    Because shareholders are protected by the diversification of a well managed portfolio, shareholders want individual companies to take risks that may increase returns. That risk is balanced by the diversification across the shareholder's portfolio. However, an executive may be unwilling to take those necessary risks if his job is on the line with no safety net. So, shareholders are willing to provide a "golden parachute" to encourage executives to take these desirable risks.

    Take away those incentives and interfere with otherwise enforceable contracts and the government will do nothing but further stifle the American corporate environment.

  • Report this Comment On September 15, 2008, at 6:05 PM, TMFKaren wrote:

    Alyce,

    Great article. I agree completely. The idea of footing the bill for government bailout as a result of poor executive performance makes it imperative to know upfront what's the deal with the CEO for the companies I invest in.

    Something more to keep in the research workbook before clicking the 'buy' button.

    Karen

  • Report this Comment On September 15, 2008, at 6:23 PM, maddig wrote:

    chadplusplus...spoken like a future CEO. It's that old 'scare tactic' that the rich and piggish have been using for years. We're mad as heck and WE'RE NOT GOING TO TAKE IT ANYMORE!!!

  • Report this Comment On September 15, 2008, at 6:47 PM, vt1991 wrote:

    maddig, I agree with your comments about chadplusplus. I can bet that chadplusplus would be Republican. It is the mindless ideology of greedy capiltalists and the people who drink their cool aid.

  • Report this Comment On September 15, 2008, at 6:55 PM, vt1991 wrote:

    chadplusplus's comments are just so juicy for ridicule. Maybe the employees of such companies where their CEO is taking such undue risks should be offered severance packages too, how about a special reckless / greedy CEO insurance.

  • Report this Comment On September 15, 2008, at 8:18 PM, thku4grace wrote:

    CEO pay is determined by the board of directors. The board of directors are usually installed by the biggest shareholders whether individuals or institutions. They realize not every CEO will perform as expected. Sometimes its the fault of the CEO, sometimes poor performance is due to a challenging environment outside of their control. If a CEO is contracted to receive a certain package upon termination, fighting the CEO over the package will do more harm to the reputation of the company and board of directors than its worth in savings. Even if a CEO doesn't have a predetermined exit package, it is often unwise to be less than reasonably generous for a number of reasons. If the company is terminating a CEO for performance, they will need to hire someone else. How much are you limiting your options if it becomes clear to other potential candidates that you're tight with your exit packages? Is it worth the savings? If they do hire someone who is successful, will he now hold the power to influence the firing of the board of directors and installing his own board? Now we're also talking about the board's own desire to preserve their own positions. Ultimately, they will weigh that with the fact that they aren't spending their own money but shareholder equity.

  • Report this Comment On September 15, 2008, at 8:20 PM, Bullethole357 wrote:

    Had my pocket picked twice by outgoing CEO's moving on after bankruptcy leaving me with zilch. I am a capitalist by nature but it appears that the CEO, good ole' boy club is in cahoots with the so called compensation consultants who advise these nominded boards what they have to do to attract talent. I said I was a capitalist, but I must be a different breed. I seems that most of the public companies and their boards only have their eye on one thing. Financial Performance. Having said that, I think the first concern should be their CUSTOMERS. If you pay attention to who really pays your salary you might more successful. I worked for a man for thirty years who reminded everyone whom he employed that not one dime of his personal money showed up in our paychecks. It all came from the customers. It takes a different breed of cat with no ethics, morals, or concience to take millions and walk away from a failure. Hopefully their is a special place in Hell for people like that.

    The other problem is that the always seem to pop up somewhere else looking the same deal. Fool me once.................!

  • Report this Comment On September 15, 2008, at 10:33 PM, cwh89 wrote:

    I agree 100% with the article. Reward people for failure??? That will only lead to more reckless management in the future.

    CEOs should be payed for performance. If they turn out to be the best CEO money can buy and the company outperforms its competitors, the CEO should be handsomely rewarded. If they are average, their compensatin should be average. And if the company loses money, they should get nothing. You need to ensure that the executive's goals are in-line with the long term success of the company - NOT the executives compensation.

    Who is losing in this financial crisis? Is it the multimillionaire executive who has already stripped all of the money out of the company? NO. It is the stockholder who did not have any say in the ridiculous decisions that were made that led to this crisis, and whom did not have time to sell their shares before they were essentially worthless.

  • Report this Comment On September 15, 2008, at 11:34 PM, jmt587 wrote:

    I'm no Republican, far from it, so please don't accuse me of being such, but I thought chadplusplus brought up a good point in a reasonable manner. There is a good reason for golden parachutes. Not to say that they can't be overdone and excessive beyond their utility.

    Cut an opposing viewpoint some slack, and try to consider it with an open mind.

  • Report this Comment On September 16, 2008, at 9:05 AM, tharbold wrote:

    jmt587,

    Point taken on considering chadplusplus's opposing view point with an open mind. Here's my gut reaction when I first read chadplusplus's quote from his old economics text ... it seems that we don't really need golden parachutes for CxOs - at least not at the moment and certainly not in the financial industry. Many executives have already thrown caution to the wind in favor of taking on inordinate amounts of risk.

    So that 'good reason' for golden parachutes seems at the moment to be a bit hard to swallow.

    The other thought I've had is this - there seems to be a general belief out there that there are very few people on the market who are capable of being good CEO's. Following the law of supply and demand, this incents excessive compensation and employment terms for those supposedly few acceptable CEO candidates.

    I however disagree with the notion that when a company goes out to eat at the CEO restaurant, that they must always order the kobe beef to make sure they get 'the best meal/CEO available'. Perhaps the skirt steak or a pot roase would provide a better value, a satisfying and filling meal without the excessive cost. I myself just don't believe that having (or alternately lacking) a superstar CEO makes or breaks most companies. I expect that most if not all companies (at least those with solid business models) would do equally as well with a 'solid' CEO under more reasonable employment terms rather than throwing out an excessive compensation package - including an assurance that you walk away rich even if you run the ship aground - to hire the latest big name (especially if that name is Nardelli or some other sort!).

    Just my two cents to throw into the conversation!

  • Report this Comment On September 16, 2008, at 12:29 PM, SteveTheInvestor wrote:

    My feeling is that golden parachutes should not exist.... period. If an executive leaves a company because of poor performance (fired for cause or destroying the company ), they should just clean out their desk and leave. You know, like EVERY other employee of company does when they leave their job.

    Nobody, and I mean nobody should be treated like some kind of deity, which is exactly what happens with these idiotic severance packages. You basically are saying that the executive is above everyone else because only they get to live like kings, whether they do a good job or not. The other 99.9% of employees at the company have to figure out how they can put groceries on the table if they lose their job.

    If I work and do a good job for many years and build a reputation, I may get recruited by someone else at a higher salary. But if suddenly I become viewed as a screw-up, am I given a lot of money and shown the door? Yeah..... I wish.

    I am not opposed to a healthy salary with perhaps some tasty (yet reasonable) bonuses for outstanding performance. But there should be absolutely no severance package unless every other employee gets the same package. CEO's are not royalty and we need to quit treating them like they are.

  • Report this Comment On September 16, 2008, at 1:55 PM, bahrej wrote:

    Steve, I agree that a lot of the parachutes are excessive but I think you follow that line of reasoning too far when you argue for no severance packages.

    If the person you want (for CEO or any senior position) is already employed and successful and stable, you need to be able to offer them some incentive to "take a chance" with you. You could offer them silly money and incentives (which it sounds like you are against as well) or you can offer them responsible money AND a guarantee that even if it doesn't work out it's worth taking the chance.

    I think this is especially true in cases where you may want fresh out of industry thinking.

    Again, I'm NOT saying that $23 million for the FNM and FRE guys is reasonable. I support canceling those, but I think using that to argue against severence packages in general is excessive.

  • Report this Comment On September 16, 2008, at 3:00 PM, youkaykat wrote:

    CEO's should have limit placed on parachutes,not to be exceeded by set amount. If their options are redeemed, it should be redeemed 5 years after they leave the company or at the lowest price reached during their tenure as CEO, or if bankrupt, then let them bear the consequences also. Also a 5 year vacation with free room and board at the cross-bar hotel might not be bad idea either.

  • Report this Comment On September 16, 2008, at 5:00 PM, vt1991 wrote:

    I agree with tharbold, although the food analogy was a bit overdone (pun intended).

    To bahrej's point, about getting an executive to leave an existing position, it still does not justify the obscene severance packages. A modest sign-on bonus works for the rest of us and should work for the executive too.

    Outrageous severance packages only encourages the executive to gamble away the company's fortunes.

    thanku4grace, by not giving exorbitant severance packages, it may be beneficial that the company can get a more sincere person for the job and not just a greedy con who is likely to cash out. It would certainly have been worth the savings in the case of Fannie, Freddie, Bear Stearns and Lehman.

  • Report this Comment On September 17, 2008, at 3:35 PM, busyquizzing wrote:

    Agree with middig's comments on chadplusplus. These hot shot CEO's are speculating with our money. Superglue their speculating to their money!

  • Report this Comment On September 18, 2008, at 12:15 PM, TMFLomax wrote:

    Thanks for all the comments and discussion! I enjoyed reading this thread!

    Alyce

  • Report this Comment On September 26, 2008, at 2:30 PM, Docdearth2 wrote:

    Thank you for the article. I agree 150%. There has been a total lapse of morality in this country as particularly evidenced by many, if not most, of these Wall Street CEO "fat cats." This is clearly evidenced by those CEOs that totally ruin company's or run them inefficiently and then get rewarded "big time" for doing so. This is all done at the shareholder's and now the taxpayer's expense. It is just an outrage and insulting to anyone who thinks about it. Once more this is just another example of the death of common sense in America. Unfortunately, most of Wall Street has for too long been governed by unbridled greed and "funny money" bottom lines. Most CEOs are grossly overpaid for what they do, anyway. However, the more morally corrupt CEOs that get huge "golden (really platinum) parachutes" for running companies into the ground deserve to be put behind bars along with their boards of directors instead of being rewarded. They are all thieves and scoundrels in my book. Yet, they continually succeed in ripping off the shareholders and now the taxpaying public. It really needs to stop.

  • Report this Comment On September 27, 2008, at 3:07 PM, eightzeroes wrote:

    Great article. Love SteveTheInvestor's comment among others of the same ilk.

    What about the latest golden parachute - $20 million to Alan H. Fishman for 17 days on the job at WAMU. Would someone care to explain or justify that?

    We need to listen to McCain who in last night's speech was trying to tell us about how corrupt Washington (D.C.) is - once we clean up the government and start dishing out consequences the good-old-boy network will start to fall.

    Whether you vote for him or not is not the point - the point is that he hit the nail on the head and we need to seek reform.

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