What Do Terry Semel, Henry Ford, and AIG Have in Common?
Published: March 16, 2009
Author: David Rodnitzky
By 1916 Henry Ford was a rich man: his company was making $60,000,000 of profit a year (in 1916 dollars!) and he was the dominant shareholder. Rich beyond belief, he made a shocking announcement to Ford’s shareholders – rather than paying out the profit in the form of dividends, he wanted to invest it back in the company to “employ still more men; to spread the benefits of
this industrial system to the greatest possible number, to help them build up their lives and
Minority shareholders were enraged by Ford and sued – alleging that a corporation could not put philanthropy ahead of the interests of the shareholders. The court agreed, stating:
The difference between an incidental humanitarian expenditure of corporate funds for the benefit of the employees, like the building of a hospital for their use and the employment of agencies for the betterment of their condition, and a general purpose and plan to benefit mankind at the expense of others, is obvious. There should be no confusion (of which there is evidence) of the duties which Mr. Ford conceives that he and the stockholders owe to the general public and the duties which in law he and his codirectors owe to protesting, minority stockholders. A business corporation is organized and carried on primarily for the profit of the stockholders. (emphasis added)
Since this court decision, corporations have frequently invoked this argument as justification for activity that might not be entirely good for the world, but is good for the profit of the corporation. Indeed, we’ve become so accustomed to the notion that corporations put profit before public good that its impossible to conceive of a corporate CEO standing up today and telling his shareholders what Ford attempted to do 90 years ago.
And yet, look at what has happened in corporate America, and particularly amongst financial institutions. Corporate executives – and the corporate boards filled with corporate executives from other companies – have somehow convinced themselves that the betterment of executives is above the best interests of the corporations. In other words – the exact opposite scenario described in Ford v. Dodge – but still just as illegal.
The news over the weekend that AIG – despite horrible management and a $170 billion bailout from the US government – is paying out $160 million in bonuses to the very people that brought the company to its knees, is an example of such “in house philanthropy” trumping corporate interests.
AIG’s CEO has given – on its face – a legitimate argument for the bonus payments. CEO Liddy noted:
“AIG’S hands are tied,” Liddy replied. In a letter to Geithner yesterday, Liddy said he found the bonuses “distasteful” but he added, “These are legal, binding obligations” and “we must proceed with them.”
But then, in light of the ruling of Ford v. Dodge, wouldn’t bonus payments that are clearly not tied to the performance of the company and the company’s profits, be on their face invalid. Why is it that corporations can’t choose to donate hundreds of millions of dollars to philanthropy without regard to profit but can do the same when it comes to executive compensation?
Perhaps, however, the real tragedy of the AIG bonus payments has nothing to do with the fact that US taxpayers are paying for these disbursements, or the fact that it seems like a violation of corporate law. Perhaps the real tragedy is what this says about the state of US corporations, and their ability to compete in the global economy. As a friend of mine noted, “the fact that AIG agreed to contracts where they would have to pay out these kind of bonuses in a year the company lost $99 billion ($61.7 billion in Q4 alone) is absurd and highlights the ridiculousness of the typical executive contract structure.”
I noted this a few years ago when Terry Semel, then CEO of Yahoo, received $200 million in stock and salary for one year of work. Aside from the fact that $200 million could enable you to hire 2500 high quality, experienced Internet employees, or buy around 400 million clicks on Google, Terry Semel’s big payout came despite the fact that Yahoo was losing marketshare at a rapid rate to Google, losing top executives, and making poor decisions left and right.
In other words, just like the corporate bigwigs at AIG, Terry Semel’s contract was clearly structured in a “heads on win, tails you lose” way; If Yahoo did well, Terry got rewarded handsomely, but if Yahoo did poorly, he still walked away with millions. Whenever you have a system set up without any regard for performance, you are asking for situations like Yahoo, AIG, Enron, Bear Stearns and all the other countless examples I could list. Here’s a long quote from my original post:
So will CEO compensation growth ever end? Ultimately, I think it will. If you continue to have companies paying their top brass $230 million a year, eventually this will create an opportunity for leaner companies without such insane fixed costs to undercut the bloated bigger companies. As noted at the beginning of this post, $230 million buys a lot of clicks, employees, acquisitions, or pure profit. That’s a nice competitive advantage.
When historians examine the rise and fall of the Roman Empire, they suggest that during the rise, the Romans conquered foreign lands but always made sure to provide something in return to the local citizens (roads, aqueducts, engineering, protection). Over time, however, as Rome became bloated, the Romans neglected this golden rule. Instead, they began to heavily tax their provinces, using this money to pay for massive palaces and statues in Rome instead of roads in Jerusalem. The Senate and the Caesars lived lives of luxury, but their decadence resulted in the destruction of the entire system.
American companies can do what they want, but ultimately a system that gives decadent rewards to a select few without tying this compensation to performance is just a drag on the system. Smart companies will eventually figure this out.
So go ahead, AIG, continue those payouts. Note, however, to the US government – a company that is legally compelled to pay millions to people who have lost billions cannot be saved, no matter how big the bailout. Cut your losses!