The issue of bonuses is complex. In some societies, Christmas (or year end) bonuses are a traditional way of sharing the risk of how well a firm does each year between firms and their employees. In poor years, employees share the firm’s fate by taking home less (no bonus or a smaller bonus). The signing bonus in sports increases a star athlete’s salary above and often millions of dollars above his or her fellow athletes. In the case of sports we all recognize that the club owners pay such big bucks out of the desire to maximize the income of the club for their own benefit. Generally we cheered the lucky athletes for their great skills and for getting some of that money for themselves (earlier rules in base ball, for example, imposed monopoly like restrictions on recruiting that kept more of the clubs’ incomes for the owners and less for the players).
Companies have also increasingly fashioned stock options and other bonus incentives (partially influence by tax laws) as a tool for rewarding above average performance and increasing the firm’s profits. For senior management (and financial market traders) performance bonuses were some time VERY large. Many shareholders (and society at large) are increasingly questioning whether bonuses as structure today do in fact increase shareholder value. The practice needs and will get a serious review by shareholders.
Weaknesses in corporate governance may make it difficult for shareholders to properly monitory or control the salaries and bonuses senior management give themselves. If performance bonuses are a reward for improving the firm’s profits, something has gone wrong if bonuses were paid in 2008 when many firms made losses. The structure of bonuses in many firms, especially financial firms, reward very short term profits (making loans) without sufficient regard for the longer run impact(loan repayment) of investments made today. Thus long run profits were sometime sacrificed for very short run gains. It is fair to say that in many instances the bonus system is broken and needs to be fixed.
The outcry over AIG $165 million in bonuses paid this week, on the other hands, seems largely misplaced. First of all they are not performance bonuses. They are retention bonuses—bonuses paid to keep valuable knowledge employees from leaving a sinking ship. Chief Executive Edward Liddy, appointed by the government in September 2008 as part of the government’s infusion of $173 billion, “said he knew about the bonuses since October but determined that they could not be legally altered. He also said he believed the retention bonuses at the financial products unit were necessary, so that competition would not take AIG’s best minds away…. I am trying desperately to prevent an uncontrolled collapse of that business,” he said. “This is the only way to improve AIG’s ability to pay taxpayers back quickly and completely and the only way to avoid a systemic shock to the economy that the U.S. government help was meant to relieve.” Losing the staff with the inside knowledge to unwind AIG’s credit default swaps and other complex instruments could cost the tax payers a lot more than the bonuses for keeping them.
From here the story gets totally bazaar and ugly. The fact that the government had put tax payer money into AIG gave the government a responsibility to ensure that those funds were used as intended in the public interest. But Congress’s reaction to the bonuses demonstrated some of my worst fears of the likely consequence of government involvement in “private’ enterprises. Congressional rantings befitted a ship of fools. No one can deny that many businesses (and investors) have made foolish and costly mistakes. At least in the beginning they thought they were doing so with their own money, which sharpens the mind. AIG’s bonuses may or may not have been good business decisions (saving the taxpayers money), but it is laughable to think that Congress can make wiser ones. What are we to think of Congressman Barney Frank’s complaint that: "These are not the people you want to retain — you need to get people who understand the mistakes and undo them,"
The Federal Reserve (which provided the initial $80 billion bailout money last September) approved the bonuses last fall. Pointing figures at who knew what, when only undermines the credibility of Congress and the Administration and is irrelevant. Fannie Mae, which is now fully owned by the government, is paying four top executives retention bonuses of over one million dollars each. In this instance, at least, the government (FHFA) considers the bonuses a sound business decision. One of the most ludicrous rants from Congress, and there are many to choice from, came from Congressman Paul Kanjorski, D-Pa "Why wasn’t this committee informed? And do you realize that the actions that you take at AIG and took in this precise case not only impacts AIG … but it may have jeopardized our ability to get a majority of this Congress to support further legislation to provide funds to prevent a recession, depression or meltdown?" It is hard to believe that these are the words of an adult.
Congress’s and the Administration’s demands that the AIG bonuses be stopped, and then after they had been paid that they be returned, ran into the constraint that these are valid contracts made with people who had other options and that we still believe (most of us anyway) in the rule of law. Such contracts can be abrogated or renegotiated in the contact of bankruptcy but AIG is not operating under bankruptcy rules. Congress’s rantings can be dismissed as the political posturing that it is. After all few of us are happy about out of control bonuses that don’t really always seem to be serving the interests of (long run) shareholder value. But the efforts today to pass tax legislation to tax back most of AIG’s bonuses reveals a big brother mentality that is truly scary. Sadly President Obama has joined in the demagoguery. The government has already increasingly intruded into the internal affairs of a growing list of company. “Late last week, Kovacevich gave a talk at Stanford University, complaining about how unfair it is that the government forced his bank to take $25 billion in bailout money last year when it could have easily raised private capital — and then compounded that outrage by changing the terms of the deal and forcing Wells to cut its dividend.”
In my opinion the financial sector crisis is being resolved and is about over as a result of actions taken by the Federal Reserve. The sight of a hysterical and vindictive government willing and able to bully the financial industry and potentially any other area of the economy is dangerous and threatens to derail or at least delay the market’s return to health. Investors will be more reluctant to restart investing and lending under these conditions and the economy cannot recover until they do. I hope that President Obama comes to his senses soon.
 Zachary A. Goldfarb, "Fannie Plans Retention Bonuses as outlined by the Government", The Washington Post, March 19, 2009, Page D01.