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Undoing bonuses after a failure

The news of the past few days has been full of anger that AIG is paying $165 million in bonuses out to managers who drove the company into insolvency, using federal bailout money to do it. The excuse — these bonuses were guaranteed in contracts.

This may be the case. I have always thought it strange when a contract includes a mandatory bonus and not sure what the point is. A normal bonus is contingent on some metrics of personal or corporate success. If this is the case here, did they just design their metrics so badly that the goals were met even in light of driving the company into the ground?

However, if you’ve been through a corporate buy-out or rescue, you know that contractual rewards like these get nullified fairly often. Usually it’s presented as a choice between getting your bonus from a bankrupt company (and thus being in line with other creditors to collect nothing, or a small fraction) or renegotiating your contract to help the rescued company get the deal. You can be a hold-out, of course, but only if it is your plan to resign, since the new management, and the people who did renegotiate, will have no interest in working with you.

Stockholders get this done to them all the time. They have various rights in the stockholder agreement, but the white knight says, “No deal unless we redo those agreements from scratch with new terms.” Stockholder agreements can be renegotiated for everybody with not everybody agreeing, however, unlike bonus agreements.

The buyout of AIG was of course different. First of all it was done in an emergency, to keep confidence in the economy. And it was done by the government, which had no choice but to do it. With no choice, the normal threat of “Fix the bonus contracts or we won’t do the rescue” was not an option for the government. And finally, the government is easy to embarrass politically. It has to be seen as benevolent, unlike a corporate raider or rescuer.

Still, I am surprised they could not make it clear that it’s “Take your contracted bonus and resign with a stink on your name, or lower/eliminate your bonus and keep your job.” Perhaps they did, but the bonuses are so sweet that the former is the easy choice. This case is famous enough that those who decided to take their bonus and leave would become well known, or at least their circumstances would be well known. A resume that says “Left AIG March 09” would be one that spoke of failure and greed.

It may just be a lesson that companies need to do better at writing bonus contracts, so they don’t pay off in the event of total company failure, or any failure connected to the employee of this scale. These would not be hard to negotiate. At the table, you can’t seriously stand up and demand you get your bonus even if you drive the company into the ground. You can’t make that a deal-breaker.

Update: A NYT Op-Ed on other ways to get out of bonus contracts.