"Pay for Performance" In The Bailout Era

Here’s this past Sunday’s column, now we’re caught up. Hope you like the Robert Rubin-Robert Downey line; I thought that would get a rise out of the editor, but nothing. Of course, he’s also so short he can’t stand up, sir, and maybe it’ll get a bigger reaction for you guys. Newspaper version here.

DON’T CONFUSE INTELLIGENCE WITH LUCK
East Valley Tribune, Dec. 7, 2008

Business types (by exquisitely powerful social custom) detest lawyers, because we get paid for providing services but they claim to get paid only for results. But given the world-wide financial meltdown, wouldn’t your 401k be better off if you had gotten rid of all the bankers instead?

Even the most successful trial lawyer is far less destructive of wealth than the financiers whose work boiled down to following the herd making highly-leveraged bets on poorly-understood and opaque debt instruments.

Admittedly, a year when Robert Rubin’s reputation sinks below that of Robert Downey, Jr. is, by definition, unusual. I also used to worry that I didn’t fully understand these new securities, but unfortunately the financiers being paid millions to create, market, and value this stuff didn’t fully understand them, either.

What counts as innovative leadership in business -- staying just ahead of a trend -- is wonderful when the economy grows. But when the business cycle starts topping out, it’s not that great to leap ahead of your competitors if you’ve just moved closer to the front ahead of the crash.

But as bad as boom-then-bust seems now, it’s more popular than slow-and-steady. It seems lots of businesses (apart from boring, lawyerly fee-for-service stuff) is basically real estate development with different commodities. Entrepreneurs make money in a hot new area. Others join in. A crowd gathers and generates circular enthusiasm. Prices rise, demand rises faster. People make money, and confuse a rising market for their brilliance and business acumen. Then the market crashes, which absolutely nobody could have foreseen.

Some bubbles are too small to generate the requisite delusional mass. (Remember Beanie Babies?) And some worrywarts always complain that prices are way outside historical ratios, but others see plentiful reasons why today isn’t like the past. It’s not much fun being a contrarian when the trend you’re bucking is everybody else doing really, really well. And for all the talk of the “discipline of the market,” for most entrepreneurs the real market-oriented question is “What can I get funded?”

In just the past decade, we’ve lived through the dot-com and the real estate and finance bubbles, but having seen the one didn’t help us avoid the other. It’s hard to see a bubble from the inside, which requires a degree of objectivity far beyond most of us. It also requires convincing really rich and successful people that they’ve merely been lucky, not smart, which isn’t a very promising business model. And even if you do recognize that you’re in a bubble, what incentive do you have to get out early?

Think back to 2002, and whether it made sense to invest in Arizona real estate. In five years, the market will crash, but if you stay out, you’ll miss five wonderful years. It’s also not clear what alternative investments you’d make instead. And if you can use other people’s money, then why not place more bets? Maybe the crash comes a year later than originally predicted. Or maybe if you’re told enough times that you have some special talent for business, you start believing it -- and believing you’re underpaid, too.

So after years of worshipping (and paying) CEOs who got lots of credit on the way up, we now learn that they really didn’t understand the risks their companies took to generate those wonderful numbers. It’s “pay-for-performance,” but only the pay was real; the performance, not so much. And to where do richly-compensated, smarter-faster-more efficient market-based giants of business turn, when they didn’t do their jobs properly?

To the only group they like less than lawyers: Politicians. Our biggest banks, insurers, and automakers now rely much less on their CEOs than on Congress. So isn’t the pay scale still out of whack? Not that members of Congress should make what a CEO makes, but that bailed-out executives shouldn’t make more than a member of Congress.

The leadership needed to run huge companies into the ground shouldn’t be so expensive. Not with such a plentiful supply -- and when what we once thought was smarts was really luck.