The Wages of Failure at Financial Companies

They say a picture is worth a thousand words. I stumbled across a list recently that is worth two thousand words, at least.

The list in question is the 25 highest-paid men from a Fortune study for the year 2006. I was struck by the fact that 10 of the 25 highest paid men were executives at financial firms that were either directly or indirectly bailed out by the government just two years later in 2008. Below are the 10 with their rank among the 25 richest men:

10 of the 25 Highest Paid Men in 2006

Source: "25 Highest-paid men" in 2006 from Fortune.

This list is a perfect illustration of "socialism for capitalists." These executives took excessive risks and their compensation soared as a result. When those risks put their companies in jeopardy, the taxpayer bailed them out. Meanwhile, the executives were allowed to hold on to their riches (although Angelo Mozilo would eventually have to pay a significant fine as a result of his company's activities). Who knew that failure paid so well?

Heads I win; tails you lose
Sadly, the mind-set on Wall Street hasn't changed all that much since 2008. In a recent interview for Money Magazine, bank analyst Mike Mayo points to research that shows that average CEO pay at financial companies rose from $5 million per year in 1998 to approximately $12 million per year in 2010. During that time, the share prices of those companies fell by a third on average.

In the interview, Mayo also highlights the unusual compensation of Vikram Pandit, CEO of Citigroup (NYSE: C), whose incentives seem to encourage extreme risk-taking. Mayo adds, "Citi was bailed out and then the board still allows these ill-conceived plans, as if they did not learn a thing."

The "heads we win; tails you lose" outlook remains alive and well on Wall Street, despite the fact that clawback provisions are being introduced and some bonuses appear to be down this year. As Mayo argues in his recent book Exile on Wall Street, compensation seems to have "little correlation with performance, and the crisis was little more than a blip in that escalation." This problem of out-of-control compensation and golden parachutes for poor performance is a huge issue both within and outside the financial sector. Investors need to be prepared to either sell or "make a lot of noise about compensation problems," as my colleague Alyce Lomax urged in a recent article. Otherwise, it's the investor who is left holding the bag.

Capitalism for capitalists
Mike Mayo believes that well-run businesses that generate high returns for investors should result in "whatever salary and bonus the market will support." If things go wrong, however, he adds, "You shouldn't get to walk away with the fat paycheck anyway." That just seems like common sense. Alas, as Mark Twain pointed out, "Common sense isn't all that common."

The board of directors is responsible for CEO pay, so we need to make sure they are providing effective oversight on this issue. In the MF Global collapse, we saw a perfect example of what happens when a board fails in its oversight function.

Investors need to be paying close attention as well. Paying executives obscene amounts of money for poor performance is a luxury most companies cannot afford. The list above makes that point vividly and succinctly.

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