Friday, March 20, 2009

Why Confiscating the Bonuses is Fair

The 90% tax on bonuses paid out by companies that are on life support due to government intervention is imminently fair.

But once again, special interest groups are trying to convince legislators that the tax is unfair, and sets a bad precedent, and everyone would understand why this is bad policy if only Congress really understood "the way business works."

Well, the way business should work is that businesspeople should figure out how to build sustainable businesses and should get rid of any incentive schemes that encourage people to work against the long-term best interests of the company.

Early in my career, I benefitted from stock options that were paid out over a multi-year period. The value of the stock was directly tied to how well the company was doing overall. It really dawned on me how effective this compensation system was when an employee sent email to his work friends boasting about how much he'd spent on a business dinner the previous evening. People were aghast, and the mail got forwarded around. A common theme was "How dare you boast about spending OUR money?" Everyone in the company who had stock options felt like they were owners of the company. That affected everything, including hiring decisions. After all, it's a lot different if you're hiring people with someone else's money; when it's your money, and you're going to be sharing it (the net effect of hiring people who also get stock options), you tend to be more thoughtful.

Since I frequently managed multi-million dollar budgets and hired agencies at that company, I was often "courted" with gifts - things like courtside seats to pro sports games. Only once did I take tickets - for a set of great seats to a Rolling Stones concert. That experience made me uncomfortable because, although I convinced myself I would never make a business decision based on such gifts, I could see how easy it would be to become seduced by such experiences. (The irony was that everyone around me with great seats to that concert looked like a corporate type - and though the Rolling Stones did a great job, the crowd experience felt completely sanitized and somehow unfulfilling.)

After that, I accepted only the occasional Christmas basket, which I always shared with everyone on the floor. Later, the company adopted an official policy, essentially banning gifts of any value.

The ban on gifts was put into place to keep employees from making decisions that worked against the best interests of the company. If you're hiring an ad agency or PR firm, you should be hiring them because they can do the best job for the company, not because you control the type of purse strings that tend to attact lavish gifts.

Later, when I joined my husband to build a startup, we decided upfront that we needed for everyone to feel like owners. So while the founding partners put up the upfront cash and took the earliest risks, employees who joined later earned a piece of the company. And when my husband and I later sold our interest, we sold a good chunk of it back to the company over a multi-year period, knowing that we were only going to get paid if the company continued to do well.

So when I hear about employees at AIG and Merrill Lynch getting huge bonuses just before or even after their companies are getting huge bailouts from the government, my blood boils. As a taxpayer, that's MY money. And I don't care what type of business you're in or whether your part of the business made money and did all the right things but your colleagues down the hall or in a completely separate part of the world made all the bad decisions, YOU WORKED FOR THE SAME COMPANY AND THE COMPANY FAILED. And the fact that you and your bosses can't seem to fathom that because the company failed, you shouldn't be paid ANY bonus is just beyond comprehension. When a company fails, no bonuses should be paid. And since you people can't seem to figure that out, Congress must step in.

I know how business works. I'm comfortable that I'm not missing key facts on how compensation should be structured. Members of Congress shouldn't be distracted or deluded by so-called experts who say that taxing these bonuses is somehow bad policy. It's atrocious policy, but because the underlying acts are even more atrocious, it needs to be done.

Monday, March 9, 2009

Pensions - Past Their Prime

One thing that should be a clear to everyone tracking the current financial crisis is the new pension reality: Pensions as currently structured are completely unworkable in a global economy that is powered by the private sector.

This applies both to government pensions and benefits and to private sector pensions.

The current debate about what to do with the UAW contracts with Ford and GM is one part of a much bigger problem that has to do with human nature and the way our economic system works.

Whenever possible, people will tend to make decisions that are beneficial over the short-term rather than face up to unpleasant long-term realities. Auto executives, their management teams, and investors (which fittingly enough includes lots of pension funds) basically gave an IOU on pensions and retiree health care benefits in order to get labor to sign contracts in the near-term that would be beneficial to the bottom line. No one was really thinking about the consequences years out. The UAW and the companies were equally complicit and the federal government turned a blind eye when it should have stepped in more aggressively with appropriate rules and regulations.

The truth is that there isn't a person smart enough on this planet to accurately forecast retirement obligations given the uncertainty that exists around future health care costs, future competition, long-term investment returns, and future regulatory requirements. People who pretend that they can are simply passing the IOU to future generations to figure out.

No one in a global economic system can be guaranteed a specific return. What companies, governments, employees and labor unions can do is work toward agreement on retirement benefits that will be funded while the obligation is being created and then work together cooperatively to see that those funds are managed well. For most workers, barring on-the-job death or disability, the obligation should be funded completely while the employee is actively employed and then managed conservatively with the goal of matching inflation. This applies both to all funds that will be disbursed during retirement - including social security, Medicare, and any other retirement funds.

In the case of the UAW and the car companies, contracts they signed years ago should have required full funding of all future obligations. If the funding was to be invested in the stock market, it should have been explicitly stated that it was subject to the vagaries of the stock market. If it were to be invested solely in "safe" securities, like US Treasuries, it should have been explicitly stated that it was subject to the vagaries of inflation. Instead, it was invested in the future success of the companies themselves - and the companies have failed. Now that they have, the UAW and the companies are looking to the government to bail them out, which goes beyond what we have expected of government to this point and which simply shifts the burden from one group (the autoworkers and retirees) to all of us (taxpayers).

To do other than fund obligations fully at the time they're incurred is to tax future generations in a way that is immoral and should be illegal. When someone is dead, we don't allow that person's creditors to go after the deceased's children. Yet we seem perfectly willing to let mass obligations pass on to future generations of workers, investors, and taxpayers.

We need a new system for funding and managing retirement obligations - one that recognizes that we all have a responsibility to plan for and fund retirement during our working years and that we should all be working together toward a financial system where investors who want low risk/low valatility returns over the long term have options that make sense.

What this means is that whether you work for a private company or for a government agency, your pay stub should reflect the full cost of whatever obligations are being incurred on your behalf. Understanding those full costs is the only hope companies, investors and governments - and the people who rely on them - have for making smart decisions that will bring long term benefit.