The Myth of Dick Fuld

Wall Street critics often say that compensation should be in long-term restricted stock so that managers and employees do not have the incentive to take excessive risk, make big money in good years, deposit the cash in their bank account, and then escape to their private islands when their bets blow up the next year. Wall Street defenders like to point to Dick Fuld, who supposedly lost $1 billion by holding on to Lehman Brothers stock that eventually became worthless. You don’t get more of a long-term incentive than that, the argument goes.

Lucian Bebchuk, Alma Cohen, and Holger Spamann have exploded this myth in a Financial Times op-ed and a new paper. They look at the CEOs and the other top-five executives of Bear Stearns and Lehman Brothers. (All numbers are adjusted to January 2009 dollars.) From 2000 through 2008, these ten people received $491 million in cash bonuses (Table 1) and sold $1,966 million in stock (Table 2); on average, each person took out $246 million in cash. (Both Lehman and Bear had rules that prevented top executives from cashing out equity bonuses for five years from the award date–see p. 16 n. 33.)

At the beginning of the period (2000), these ten people had $1,398 million in stock and options (Table 5; option value calculated conservatively as the current difference between market price and exercise price). So on average, each one had $140 million in stock at in 2000; received $49 million in cash over the next eight years; sold $197 million in stock; and lost the rest in 2008 when their companies collapsed. Dick Fuld began with $301 million in stock, received $62 million in cash bonuses, and sold $471 million in stock before losing his supposed $1 billion.

Let’s put this in perspective (insofar as it’s possible to put these kinds of numbers in perspective) two different ways. First, let’s say you’re a bank CEO with a lot of wealth tied up in stock. Satan comes along and offers you the following deal: if you undertake a strategy with a lot of risk, every year you will get a cash bonus, every year your stock price will go up, every year you will be able to sell some (but not all) of your stock at this higher price, and every year you will get more restricted stock awards–until at some point everything collapses and the stock becomes bankrupt. Would you take that deal? Of course you would. Yes, it means that your losses in the final crash will be bigger than with a more conservative strategy. But it means that you would make a lot more money in the meantime.

Second, let’s say you’re a house flipper in a rising market. You buy a few houses with borrowed money, sell them at higher prices, buy more houses with more borrowed money, sell them at even higher prices, buy yet more houses, etc. Each time you sell you take out some of the money as cash and put the rest back into the housing market. At some point the market crashes and you lose the houses you were holding onto at the end. But in the meantime you stashed millions of dollars of winnings in your bank account. Did you do well by using leverage to maximize your risk in a rising market? Of course you did, even though you lost a lot in the crash.

Now, there are things in life besides money, and Dick Fuld has no doubt suffered tremendously in the past year. And at this point, maybe he would gladly give up that $533 million he took out to see a healthy Lehman Brothers. So yes, there are other reasons why CEOs do not want to see their banks blow up. But holding a lot of restricted stock is not necessarily one of them.

By James Kwak

17 responses to “The Myth of Dick Fuld

  1. Huh. It almost sounds like the problem has something to do with the size of these numbers.

  2. Executive compensation is looting from start to finish. Having allowed financial (and industrial) companies to become gigantic aggregations of other peoples’ mmoney, we endorse the fiction that these aggregations are somehow ‘managed’ by a collection of recycled stooges drawn from the ranks of celebrity nearly all of whom make their only living serving as management enabling directors, whose only real job is rubber stamping the compensation demands of the chiefs who have selected them in the first place, and whose approbation is the only thing keeping their own little scams running.

    To make things even better, we tax the looters at middle class rates because to do otherwise would somehow reduce ‘investment’ and ‘growth’, which themselves are fantasies peddled by the corporate rich and academic charlatans to justify their personal grabs.

    The growth fantasy was swallowed hook, line and sinker by a middle class bribed with cheap mortgages, housing price appreciation and stock market gains which always looked great in the rear view mirror and ceded most of the benefits to the swindling class of pundits and asset managers getting theirs off the top.

    Meanwhile, the country became a herd of desperate people selling ‘services’ and things mostly made in China to one another, while elites capitalized on the only businesses any longer making serious profits: finance, war and oratory.

    Tinkering with this system is Nero fiddling while Rome burns. It will take a real crash and a depression to make people serious about economics and politics. We are now living through 1930. The stock market did pretty well that year too.

  3. The problem is simply the numbers. Once you have a couple hundred million dollars in the bank, you’re untouchable. Pay everyone $1 Million a year and make all bonuses vest at age 65 or in 10 years which ever is longer and the whole dynamic changes.

    What I still don’t understand is why stockholders allowed this to happen. Every dime in compensation is a dime not paid in dividends. While certainly you have to pay your employees (and the executives are the stock holders employees) but at these numbers the compensation packages spread out among stockholders becomes actual significant money, whole percentages of possible dividend returns. They also sat back while their holdings were devalued by massive stock awards. This is basically the Agency Problem case study from my CFP courses come to life far beyond even the wildest, hyposthetical dreams of the test designers.

  4. I followed planned methodologies of stock sales of big company shareholder’s for many years to check on my own ideas for the big shareholders of my firm. What we see here is competent financial planning. My job was to dovetail tax planning to create a smooth high after tax net cash flow for the shareholders of my firm. An awful lot smaller firm but the methodologies are the same. One may create hypothetical alternative uses of pretax income generated by stock holding activities reported to the SEC as a learning device.

    Of course, these same people may well have had massive losses of cash they invested elsewhere over the years in highly leveraged vehicles with substantial losses. A lot of these high earners invested in real tax shelters… the kind where you lose your money.

    These people live in their own little world with their own self destructive group mindsets. If they lose massively in their main area of personal profit generation the same flaws in understanding facts will translate to other things they do.

    Just think of the values of deferred comp arrangements these people have parked in their own operation. These arrangements are probably subordinated creditors to boot.

    I can see many being flat broke unless they turn things around for themselves.

  5. Like Angelo Mozilo used to say, they’ve all got big families. (His answer to the question about why he needed to make so much money — his, what, 1/2-3/4 Billion — was that he “had a big family.”)

    Isn’t the concept at work here “skim”? You generate numbers so huge that the fortune you suck out really doesn’t look all that big in comparison.

  6. This highlights how bogus Goldman’s stock bonus gambit is. But of course the MSM has been pushing the lie that that’s real progress. I sure hope the people aren’t falling for it, though I don’t recall seeing any poll numbers.

  7. To me, this demonstrates the folly of trying to stop credit bubbles through exec comp. Hundreds of thousands of subprime mortgages were made between 2000 and 2004 that were paid off in full.

    How in the world can one possibly parse ex ante between “toxic” mortgages that pay off in full and “good” mortgages that do? Even ex post it is a challenge.

    If someone originates a risky loan with a high interest rate, and it pays off in full with interest, how do you not compensate them for that? Isn’t that their job? What does long-term compensation mean if it doesn’t mean the outcome of the original loan? Why should I be punished because someone else wrote a bad loan to refi a perfectly good loan I wrote.

    So compensation isn’t the best way to address the problem.

    Instead, I’d stop basing capital requirements on ratings. We encouraged banks to make and hold AAA rated securities by allowing them 200X leverage on them. This is insane. I’ve written articles on this that I’d be happy to share with anyone who cares about actually stopping this problem from repeating itself.

  8. Yeah, so? Dick Fuld and his Wall Street cronies have played us by buying real estate on Capitol Hill and doing a leaseback deal to their toadies, where, if the toadies do what they want in legislative action and regulatory inaction, they get to stay, guaranteed. So that is the story and they’re not talking. We see what’s happening, but until we take the country back from the toadies, it will not belong to us, but to Wall Street. I really don’t care how much Dick and the rest make in general, but I do resent the fact that they make most of it on the backs of those who continue to elect the toadies to allow it to happen. If this is Laissez-Faire Capitalism at its best, God save us, because soon our lifestyles will resemble those of Obama’s family who still live in Kenya.

    I want my own scheme, or I’ll lie on the floor streaming and kicking my feet!!!!!!!!!!!

  9. What is the value added proposition that executive compensation at the above numbers might represent? Certainly not the technical mechanics of running a financial business that is a large corporation. What then? Perhaps we have to go back to the old school Sociology and read C. Wright Mills’ The Power Elite or other such books. Perhaps something does go on at the country club that only certain people can deliver to the firm.

  10. “What I still don’t understand is why stockholders allowed this to happen. Every dime in compensation is a dime not paid in dividends.”

    I doubt the people making volatile bets with the financial institutions they run are really rushing to the shareholders to announce that they’ve invested in a very nice looking illusion. When the only thing between a CEO and $533 million is convincing the investors that they’re well-balanced, make good decisions, and really need the crazy-high pay to keep the stock prices going up, I’m sure it’s not hard to do. Especially not when they know the game will have some definite end, either when they retire and take their winnings or when the whole scheme comes crashing down.

    Besides, when the price of the shares you own is going up, and the financial news is talking about share prices everywhere going up, I doubt many investors will start clamoring for the breaks to be put on.

  11. There is survivorship bias in the presentation. Sadly a CEO who didn’t pursue the reckless strategy while peers did may have been removed due to poor performance. The flawed reward scheme was equally balanced with a flawed risk scheme in place as well. This was a group (systemic) behaviour fail. http://nickgogerty.typepad.com/designing_better_futures/2008/08/you-call-that-a-bubble.html

  12. I read a bank director asking: How could I convince my fellow directors that we should stop what was providing us great profits because it was too risky while the credit rating agencies kept on rating it AAA?

    When you as a regulator tell the banks that in order to establish their capital requirements you will follow the opinions of the credit rating agencies you are in effect declaring the bank board incompetent and consequences will follow. This does not mean of course that some of the bank boards were extremely incompetent to begin with… but it was of course made worse by publicly declaring them incompetent ex-ante.

  13. I agree I believe the ratings agencies to be very dangerous as they become a proxy for critical thinking. I have written a couple posts about it.

  14. I think you are all missing the point about these narcissistic sociopath CEOs:

    They do not care anything at all about the company
    [or the employees, or the customers, or the real owners]. I used to work for a thriving tech company until the last recession and one of these Robber Barons destroyed it [completely out of existence!] while collecting several hundred $ millions in a few short years – as the stock plunged 80-90%. We were a service company and he did nothing except slash people every Qtr and skim shareholder equity [even got his wrist slapped by the Bush SEC]. He ruined a famous company and the lives and prosperity of tens of thousands of families while pulling stunts like cancelled health insurance on midnight the day you were laid off [after decades of working death march projects], or short-changing our long term customers’ on service and staffing.

    To be a corporate citizen in the 21st century is much like being an Egyptian in the Old Kingdom: ALL the wealth, and people, and other resources are funneled into a singular goal: erecting a monument to Pharaoh [CEO compensation]. Nothing else matters. Look at the quick paybacks of TARP funds. That had one point only.

    Several of these CEO bankers were offered deals that could have SAVED the company but apparently they were holding out, hoping to be made whole [very ENRON-like] while everyone ELSE went down the toilet!

    Even if we get meaningful reform, if people like that are placed at the head of any company they will deny and lie, claim that everything is FINE [to avoid takeover] while worrying ONLY about their own stake
    [I am thinking of a certain insurance conglomerate and not a bank in this particular example but it does not matter what business it is].