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.


Pay them their full bonus -- in AIG stock!

The issue of bonuses arises from one of the last times Congress got angry with Wall Street. Salaries above $1million are effectively prohibited, so bonuses with pathetically easy requirements became the substitute.

When Smith Barney went under and Lehman was rescued the financial opinion writers, financial experts, bloggers, and ordinary letter writers all advised Congress about the impending bonus problem. My letter recommendation was that any bailout come with terms like those of Smith Barney. Their bonus was based on profits, but payable in 20% chunks over the next five years. Each chunk was contingent on continued profits. When Smith Barney went under, several hundred million in pending bonus payments vanished.

Congress obviously heard, because the bailout authorization included a section prohibiting the Treasury from modifying any bonus terms. Barney Frank can bloviate all he wants. The clause is sitting there and was passed by Congress.

Another fairness aspect about AIG bonuses is to recall that half of the company is an insurance company. Someone who keeps their insurance operation running smoothly while the other half of their company has gone crazy actually does deserve their big bonus. The people doing the contract unwinding are doing some very demanding hard work, so they might deserve something.

A government bailout for a private business should never have happened. It isn't and has never been a government responsibility to decide which businesses will fail and which will succeed - that's for a free market to decide. Under those circumstances, an issue of who gets what bonus or portion of a failing company would have been for shareholders, new management, present management, or in the case of actual bankruptcy, a court to decide.

No government money whatever should be used to fund anything except the police, military, and a court system. Everything else should be left up to each individual. That's the heart of all business: private mutual agreements between individuals. If the agreements turn out to have been in poor judgement, let the individuals suffer and not tax payers who had nothing to do with it to begin with.

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