Friday, December 12, 2008

Revisiting Compensation: Lagging Incentive Comp To Match Long Term Performance

The Wall Street Journal's Scott Patterson wrote a piece in Wednesday's edition entitled "Securities Firms Claw Back at Failed Bets."

Mr. Patterson began his article by stating,

"As securities firms rein in risk-taking that ran amok when times were good, the use of clawback provisions is spreading, with Morgan Stanley and UBS AG rolling out rules that allow them to take back money paid to traders and other employees whose bets blow up later.

But the push to clean up an old problem on Wall Street may create some new ones. By giving themselves the power to reclaim bonuses and other compensation, firms might unintentionally make traders too skittish about taking even healthy risks, nudge some of the best talent out the door or encourage employees to conceal their losses, some observers warn.

"It would be hard for traders to hide losses for more than a year or two, but if we incentivize them to do so, they will find a way," said Frank Partnoy, a University of San Diego law professor who has written about corporate malfeasance.

The clawback "has far too long a memory and makes your most successful traders the most risk-averse," added Aaron Brown, a hedge-fund risk manager who used to work at Morgan Stanley."

I must admit, I have no concept of what Mr. Brown could mean. Isn't most of what has befallen traders, and the companies for which they work, in the last year or so too much focus on short term profits of trades, while disregarding the longer term ramifications?

In fact, in this year, of all years, it is ludicrous to be quoted publicly as saying that traders may not take enough risk in the future.

To me, the following comment in the article makes much more sense,

""We're making what we see as a good-faith effort to more closely tie employee compensation to longer-term performance," said Morgan Stanley spokesman Mark Lake.

I have argued for years, beginning with the application of my proprietary corporate performance research for consulting with CEOs, that incentive compensation needs to be vested some 3-5 years after the year in which it was earned. Shareholders benefit from consistently superior returns, not yo-yoing, inconsistent returns. Thus, Morgan Stanley finally seems to be on a credible, effective track for matching employee incentive compensation with shareholder interests.

Regarding other banks, Patterson continued,

UBS, which announced its clawback provision in November, will hold about two-thirds of eligible cash bonuses in an escrow account from which the Swiss bank will dole out payments based on employee performance and UBS's overall profitability."

"UBS acknowledged that its clawback rule could cut into short-term profits if employees become too risk-averse. Overall, though, the policy is expected to result in more consistent and less volatile long-term gains. Reginald Cash, head of U.S. investor relations at UBS, said the provision could create "some limit to chasing the last dollar on any given strategy." "

Again, this is precisely what shareholders should want. Long-tailed investment positions may be profitable trades in the initial year, but come back to haunt the company. Consider how many of the mortgage-backed securities or CDOs may have performed in their early years, versus their valuation changes in 2007 and -08.

Thus, anyone who argues that traders should not bear the risk of their positions in their compensation for the life of the positions is clearly not paying those traders with their own money. And doesn't care about shareholder interests, either.

This is an idea whose time is long, long overdue. In fact, even the name given the approach by financial services companies promotes incorrect thinking.

It's not 'clawing back' compensation from employees after the fact. It's releasing the incentive compensation in concert with each year's successful earning of the money by an employee, on a lagged basis.

Had this type of compensation approach been in place five years ago, there would have been much less damage from toxic structured financial instruments in the most recent cycle.

Thursday, December 11, 2008

10 Lies About Bailing Out GM, Ford, Chrsyler & the UAW

As I have heard and read, like you, countless articles and hours of Congressional testimony and news program interviews pursuant to the question of the American taxpayer bailing out GM, Ford and Chrysler, a list of lies told by Rick Wagoner, Alan Mulally, Bob Nardelli and Ron Gettelfinger has occurred to me.

I can't link each lie with one person, in every case. But this is a list of claims made by one or more of the four which are simply untrue.

1. Bankruptcy is not an option.

Of course it is! This is something basically uttered by all four of these guys.

Ask yourself why they bothered to go to Washington first, rather than Chapter 11? Because, in Chapter 11, an apolitical bankruptcy receiver would restructure the whole mess with abandon, to truly be capable of survival. It won't be pretty, and it will make the efforts of at least Wagoner and Gettelfinger look silly and half-assed by comparison.

2. Filing bankruptcy will bring down hundreds of suppliers and cripple the US economy in the midst of a recession.

No, it won't. This is a bald-faced scare tactic. GM, for example, only has something like a 25% market share. Chrysler is even smaller. The few cars that actually turn a profit could be bundled into one unit and either spun back out or sold to another car maker. The suppliers for these cars will still have demand.

For any share lost by GM, Ford and Chrysler, other US-based, foreign-owned brands will pick up the share, and, with it, demand that feeds back to the suppliers.

This argument is just baseless on the face of it. No matter how many times CNBC auto-blowhard Phil LeBeau contends this to be true, it simply is not.

3. Nobody will buy a car from a car maker in bankruptcy.

This hasn't been demonstrated, by research, to be true in the proper context. Plus, it's never clear that the question is asked with a proviso that a third-party warranty would be provided. If anything, many buyers, assuming they even want some of the junk peddled by GM, Ford and Chrysler, merely would expect to pay lower prices.

4. This is a loan, not a bailout.

Lie. If this were merely a loan that was truly expected to be repaid, the capital markets would be handling the transaction. It's precisely because nobody expects this money to ever come back that only the taxpayer, via Congress, would provide it.

5. Without GM, Ford and Chrysler, the US will lose an important manufacturing base and be hostage to other world powers, plus become less capable of self-defense.

Nice try, but, this, too, is a lie.

First, we have a dozen or so foreign-owned auto plants in the southern US which, together, manufacture- actually, more correctly, assemble- fully as many cars as GM currently manages to sell. Losing GM doesn't lose this capability, but, merely the worst-performing, least-efficient amount of capacity.

Second, car making is more about assembly nowadays, less about manufacture. So this argument is wrong and specious on this point, alone.

Third, real defense-related production comes from companies like Boeing, General Dynamics, Lockheed and other similar contractors. Not to mention their suppliers.

Last time I checked, Wagoner, Gettelfinger, the governor of Michigan,, were not Nobel-winning economists capable of credibly assuring US taxpayers that the precise capacity and capabilities of car assembly represented by Detroit-based auto assemblers is vital and necessary to a vital US economy in the future.

We've been moving to a service-based economy for over a decade. The real high-end, value-added manufacturing base is more efficient, requires fewer workers per dollar of value-added, and resides in other sectors than auto production.

6. There's light at the end of the tunnel for GM, Ford, Chrysler and the UAW with this 'loan.'

No, there isn't. Look closely at the CEO's promised dates of return to profitability. The earliest, I believe, is Ford, in 2009. Wagoner keeps babbling about 2010 and his cherished 'Volt' electric car. But his own EVP, Bob Lutz, let slip recently that green cars won't actually make money if priced so that consumers can afford them. Ooops!

Chrysler is a recurring disaster, profitable only during peak years of US economic cycles.

Republican Senator Tom Corker, among others, was correct when he noted, on CNBC, earlier this week, that none of these three companies have a plan to become truly viable and profitable in a reasonable timeframe.

No sane investor or lender would accept, today, from an existing large US industrial concern, a business plan which does not promise a profit for the next two years. It's just insane.

7. The current dire situation of GM, Ford, Chrysler and their common, primary union, the UAW, was caused by the US financial market crisis which began earlier this year.

One of the bigger lies propagated by everyone pushing for this bailout.

These three auto makers, and their greedy union, have mismanaged their situation for well over a decade. True, their situation worsened since September, when credit tightened/vanished. But that's part of running a large corporation- planning for many scenarios.

GM, in particular, has been headed for bankruptcy for nearly the entire term of Wagoner's ineffectual reign. The recent financial crisis merely offered an opportune occasion for these parties to raid the Federal Treasury and taxpayers' pockets.

8. Rick Wagoner is the best person to 'lead' GM.

Another big lie. Wagoner has misled GM for eight years. He's a major part of the problem, not any part of a solution, such as it may be.

A bankruptcy receiver would be far better and more objective for doing what needs to be done at GM to survive.

9. Bankruptcy of GM, Ford or Chrysler will be a disaster for the US economy because these companies will "go down."

Another lie, similar to lie #2.

Bankruptcy is not liquidation.

Putting GM into receivership, via Chapter 11 bankruptcy, does not mean it ceases operations. It means a trustee is in charge of reorganizing the firm to survive in the future.

Liquidation occurs when the operations, under bankruptcy, prove to be unable to be sustained, even with reorganization.

For example, the retailer Dave & Barry's went bankrupt this past summer. But it was not in liquidation until a few months later. Prior to that, the chain still operated, albeit under court protection.

See the difference?

That's why all this handwringing about GM filing Chapter 11 is a hoax. They won't stop production lines the day after the filing.

10. The UAW and the Detroit auto makers have already made a lot of concessions and done a lot of restructuring, so they deserve this Federal help.

Nice try, but the market doesn't reward efforts, only results.

Veteran auto-sector reporter and writer Paul Ingrassia, late of the Wall Street Journal, has written for months that the Detroit Three have been slow and ineffective in coming to grips with their troubles, and realistically fixing them. Bloated costs, too many brands, and too little effort spent attacking Congress' CAFE regulations have left them incapable of surviving in their current shape.

The UAW, for its part, points to concessions, but Gettelfinger badly needs to avoid his union's employers filing bankruptcy. If they do, he and his union are history.

Not because anyone is out to 'break' them. Rather, their own greed and shortsightedness has resulted in them crippling their employer.

In truth, a great deal of GM's, Ford's and Chrysler's troubles are co-owned by prior UAW rank file and leadership. Including Gettelfinger.

He, too, must go. Most likely with the decline into near-obscurity of his once-influential union.

Washington's Bailout Bill for Detroit

Take $20B, divide into 400,000 employees, and you have $50,000/person.

That's what you could do with a little more than the money currently being offered to Ford, GM and Chrysler, in exchange for something less than bankruptcy.

After all, not every employee of the three US-based auto makers will be out of work. Some will transfer with their successful, profitable product lines to other owners. So, between out-of-work auto employees, and some among their suppliers, you could assist a lot of non-management employees without 'bailing out' shareholders and management.

Let's help the non-management employees, and let management and shareholders pay the price for decades of lousy management.

Force Wagoner to file for Chapter 11, and probably Nardelli, too.

But under no circumstances should Congress give any of the three US auto makers money prior to a Chapter 11 filing.

Wednesday, December 10, 2008

Disbelief and Denial On "Wall Street"- Or What's Left of It

I read Dennis Berman's piece in yesterday's Wall Street Journal, entitled "On the Street, Disbelief and Resignation," with great interest, and more than a little surprise.

Berman wrote, in part,

"Inside what's left of Wall Street, investment bankers are doing all they can to cope with a business that is disappearing before their eyes. Yes, there are tens of thousands of people still with jobs. They just don't have much work. Debt and stock markets are virtually shut, merger volume is down by 28%, and whole lines of structured finance are closed for good.

This would appear a moment of natural self-reflection. Perhaps the time to consider a career move out of New York, or pursue an abandoned passion. Oddly, few of the senior bankers seemed to be able to accept the basic reality of their own profession: that an overleveraged world created an excess of bankers, too.

It is a testament to Wall Street's inherent optimism -- and exactly why the boom-and-bust cycles will continue -- that bankers remain so committed. As the Goldman banker summed it up: "People are busy. They're just not getting paid."

Here's what I don't get.

Ten, five, even a year ago, these whiz kids were supposed to be able to out-think corporate CEOs and CFOs, identify mergers, create novel financing approaches, and, generally so it was presumed, add value.

How can a group of largely kids, with a few adults riding herd on them, be so currently misguided, blind, and clueless, yet be in a position to 'assist' US companies with financial consulting and engineering?

We're dealing with global deleveraging. A serious pollution of the world's financial markets by toxic securitized waste. Credit is being retracted, or only extended in rollovers at very high rates of interest.

Underwriting is probably headed back to the stone age, since nothing glitzy will be trusted by most investors for maybe a decade. There is no 'Wall Street' anymore, simply corporate finance and M&A divisions of commercial banks.

I was around in the 1980s, when investment bankers and corporate raiders routinely merged companies, engineered leveraged buyouts, and purged hundreds, sometimes thousands of employees from the affected companies.

Guess whose turn it is now?

Thaaaat's riiiiiight! Investment bankers, M&A mavens, and traders, both buy and sell sides.

The underlying markets and demand for much of what these typically-younger, well-educated, highly-financially aspirational financial service workers are gone. Vanished. Vaporized.

Thus, so are the jobs serving those vanished markets and demands. And they likely will not ever return. Period. It is a new era. Publicly-held investment banks are gone, and will not return.

It's revealing to see how, when it is now apparent to all who understand these markets and sectors, that there has been a one-way sea change in employment opportunities and careers in investment banking and trading, these young worthies still cling to the hope that there will be a dawn following this night.

If this represents their considered business judgment, that's just another reason for the once-vibrant, overheated investment banking sector to have vanished as publicly-held companies.

Tuesday, December 09, 2008

Today's Auto Sector Woes Are A Rerun of The 1970s Steel Sector

As the current drama involving GM, Ford and Chrysler has taken center stage on business news for the past week and weekend, I've written quite a few posts about it, here, here and here.

In discussing the topic this weekend with my business partner, I was reminded of another US industrial sector which experienced the same pressures and difficulties in the 1970s and 80s.

I am referring, of course, to the once-significant US steel industry. In fact, while researching some history for this piece, I found, to my shock, this article, appearing recently in the Herald Tribune, a unit of the NY Times.

The opening of that piece observes,

"A few years ago, an industry whose history and mythology were indelible parts of the U.S. identity was dying. The great steel mills of Pennsylvania and the Midwest had literally built the United States, but the twin burdens of competition and self-inflicted wounds had brought them to the edge of extinction.

If they were allowed to go under, their partisans warned, the consequences would ripple through the economy at a cost too high to bear. The old saying, "As steel goes, so goes the nation," was as much a threat as a boast.

The Detroit automakers are using the same argument as they seek a $25 billion bailout from Congress. "What happens in the automotive industry affects each and every one of us," a General Motors Web site declares, warning that the consequences of a shutdown would be "devastating."

Yet steel's savior was not the government bailouts it ardently sought but exactly what it tried so long to avoid: bankruptcy. Only when the companies failed were they successfully slimmed down and retooled into smaller but profitable ventures. As debate continues over what, if anything, should be done for GM, Ford and Chrysler, the steel industry may offer a model."

I could not agree more.

Back when I was in graduate school, the old-line steel industry in this country was on the ropes. The situation was eerily similar to that of today's US-domiciled auto sector.

Just to refresh your memory, I am referring to: US Steel, Bethlehem Steel, Lukens, LTV, Republic, Armco, to name a few.

As the Herald Tribune article correctly notes, the steel industry- both companies and their union- claimed the same disastrous results if they were allowed to go bankrupt as GM, Ford, Chrysler and the UAW now do.

Back in the 1970s, it was mini-mills, cheaper foreign steel, and bloat USW contracts that led to Big Steel's demise.

And, make no mistake about it, they were left to file Chapter 11, consolidate, and, ultimately, emerge as a smaller, profitable sector.

The sky did not fall. Economic ruin did not visit America once these firms began to reorganize.

And it won't, now, either, when the auto makers are allowed to choose filing for bankruptcy.

The Herald Tribune piece notes, near the end,

"Over the decades, the companies had shed employees to stay afloat. Soon, retirees greatly outnumbered the actual workers. At Bethlehem, the ratio was six retirees for every worker. All these retirees had good pensions and good health care plans, which they thought were guaranteed. But these costs were a tremendous weight on the companies.

Bankruptcy changed the rules, allowing the steel makers to unload billions of dollars in pension obligations onto the government's Pension Benefit Guaranty and to cut more than 200,000 workers from their supposedly guaranteed medical care.

The failures also allowed for the renegotiation of labor contracts, something Wilbur Ross Jr., a specialist in distressed assets, realized when he began looking at the moribund industry. The only bidder for the bankrupt LTV Steel, he proceeded to buy Bethlehem and other old-line companies, putting them together as International Steel Group. He cut more employees and revamped work rules, taking Bethlehem, for example, from eight layers of management to three.

Steel's turnaround was dramatic. The 17 leading companies went from a combined loss of $1.1 billion in 2003 to an after-tax profit of $6.6 billion in 2004, according to an analysis done for an industry trade group. Ross sold International Steel to the Indian entrepreneur Lakshmi Mittal for $4.5 billion in 2005, earning a tremendous return.

Thanks to all of steel's tribulations and consolidations - and a world economy that was booming until recently - the industry is relatively healthy."

The article goes on to note some issues which could make an auto sector bankruptcy result in a different outcome than that of the US steel sector. For example,

"Not so fast, Ross said. He doesn't dispute that the auto companies are as bloated as the steel companies were, and certainly doesn't think they should get a blank check. But he thinks the consequences of what he calls free-fall bankruptcies - ones without any government role - could be disastrous.

GM would drag hundreds of suppliers down with it, and they would all have trouble getting back up again.

Furthermore, it is a tremendously problematic time. The final collapse of the steel industry came when the economy was relatively healthy and could absorb the blow. The current economy is the weakest in decades."

Well, a Federal DIP loan is solution in which the government will play a role. Just not one which puts a dead corpse on life support.

In my opinion, it's more than worthwhile to learn from the success of letting market forces work in the sector of 30 years ago, and do so, again, in the auto sector.

Monday, December 08, 2008

More On Detroit's Bailout

Paul Ingrassia, former Detroit bureau chief of the Wall Street Journal, and Pulitzer Prize-winning author, wrote another excellent editorial in Thursday's edition of the paper, entitled "The Latest Song of Detroit."

The core of Ingrassia's piece are these passages,

"Consider GM, which appears to be in the most immediate danger, and sits "at the epicenter of the auto industry's crisis," in the words of respected Deutsche Bank analyst Rod Lache. General Motors seeks a total of up to $18 billion (including the $4 billion mentioned above), which is a hefty $6 billion more than it had requested just weeks ago.

The company proposes in its "Restructuring Plan for Long-Term Viability" to reduce its distribution network from some 6,500 dealers today to 4,700 in 2012. It also pledges to put its Saab and Saturn brands through a "strategic review," which means a potential sale, in addition to Hummer, which already is under review. Ailing Pontiac would become a niche brand, leaving GM mainly with Chevrolet, Cadillac, GMC and Buick. Additional efficiencies could come through amending contracts with the United Auto Workers union. GM suggests a federal "Oversight Board" to monitor its progress in meeting its "restructuring benchmarks."

But here's the problem: GM, by its own admission, is out of time. The benchmarks, while moving in the right direction, remain too low and too slow. Making Pontiac a niche brand isn't new; that plan has existed for years. Putting the other ailing brands "under review" will mean little unless GM actually can discontinue the brands (and thus end the cost burden they create) if the company is unable to sell them. Negotiating contract changes with the UAW will be a protracted process, and negotiating with dealers to reduce their numbers will be slower still. Even if the company does get down to 4,700 dealers by 2012, it will still have an excess of at least 2,500 dealers -- as compared to the average annual sales volume of Toyota dealers.

That's why an "Oversight Board" isn't enough. What's needed, under the aegis of the board, is a federal restructuring trustee who can lead car companies through a bankruptcy-type process if they opt for federal loans -- which Ford, alone among the Detroit Three, says it might not have to do. A restructuring trustee would have the power to set appropriate compensation for terminated dealer-franchise contracts, which would be invalidated with no value if an auto maker files for Chapter 11 bankruptcy. And the trustee should help find a foreign buyer for Chrysler, which is that company's best hope now.

The trustee also would have the power to impose a new labor contract on the UAW. An excellent model for such a contract already exists at the GM-Toyota joint venture plant in Fremont, Calif. The UAW represents that plant too, but the contract there is shorter, simpler and more flexible in every respect than the union's master contract with the Detroit Three."

He pulls no punches. A Chapter 11 filing, or an equivalent status, must be required for GM in order to receive any more Federal help.

As I discussed this ongoing drama with my business partner yesterday, he noted the front page of a newspaper, probably the NY Times, listing five options for Detroit's auto makers. Bankruptcy wasn't even among the top three, and anything requiring outsider-led reorganization was down the list and assessed as being opposed by the UAW and company managements.

It's taken this to make the strangest bedfellows, UAW chief Gettelfinger and CEOs Wagoner, Mulally and Nardelli. And, this morning, GM executive Bob Lutz, who has worked for all three auto makers, at one time or another.

Lutz and Gettelfinger were each interviewed on CNBC this morning. It was pretty disgusting.

Lutz sang the praises of Wagoner, but, when asked how much the UAW had to give to make things work, he punted. Then he continued by claiming that firing Wagoner was like 'firing the mayor of a town just hit by an earthquake.' According to Lutz, i.e., the company line on this fiasco, all of Detroit's problems have been external. They didn't mismanage themselves, ever.

Nope. The financial crisis and current recession are entirely to blame.

Then Lutz corrected the interviewer, saying something like,

'I don't know why people call this a 'bailout.' It's not a bailout. It's an emergency loan that will be paid back.'

Yeah. Right. A company that can't forecast being profitable under the best case for two more years will pay back an $18B loan on time.

If this were such an attractive financing opportunity, GM would be going to the capital markets, not Congress.

A little later, Ron Gettelfinger, head of the UAW, was interviewed. What's surprising is that Gettelfinger is so craven and desperate that he's singing the same song. When asked about firing Wagoner, Gettelfinger virtually repeated Lutz' argument- that all the trouble GM is in is outside of its control.

When pressed for what the UAW would give to make a reorganization work, Gettelfinger, too, punted, saying everything was on the table, but nothing was sure until he 'saw what everyone else was giving, too.'

When corporate management and their union suddenly begin singing from the same hymnal they are holding together, you should worry.

And put your hand on your wallet. And hope your Congress has its hand on your Federal wallet, too.

It seems that these clowns really believe nobody has noticed how the managements of GM, Ford and Chrysler, together with the greedy UAW 'management' and its workers, have run this sector's US-based companies into the ground. Now, they want $34B of our money to 'tide them over,' as if we'll ever get it back.

Paul Ingrassia, who has followed this industry for decades, making his mark by studying it closely, is right on target. The only way these three companies should receive any more Federal help is in Chapter 11. Period.