The financial pages are regularly riddled with news of big CEO payouts, but research from Watson Wyatt seeks to dispel some of the negativity. In their 2007/2008 report, Debunking Executive Compensation Myths, the financial services consulting company draws a correlation between the compensation of high-performing companies and their lower performing brethren, with CEOs of better performing organizations earning up to 75 percent more ($10.5 million compared to $6.0 million).
In addition to the higher total direct compensation, CEOs of high-performing companies saw their paychecks sweetened with another $5.2 million in realizable long-term incentives, while CEOs of companies that delivered lower total returns to shareholders garnered just an additional $1.7 million. The report says, “These results show the sensitivity between actual pay and performance inherent in the executive pay model and that CEOs who do not achieve strong performance do not earn their full opportunity.”
ExecuNet’s ongoing executive compensation analysis recognized the trend to link pay to performance in the last few years. According to ExecuNet surveys, corporate recruiters reported that 84 percent of executives were being offered performance bonuses in 2006, compared to just 50 percent in 2005. And search firm professionals were also negotiating performance reviews after six months for 44 percent of their executive placements, nearly doubling since 2005.
The Conference Board also recently weighed in on CEO compensation, finding that chief executives have common financial interests with their shareholders. CEOs who have “skin in the game,” according to The Conference Board, “have a link between their own wealth and the stock price performance of the company, providing financial incentives (beyond current compensation) to guide their company toward positive performance.”
The financial storm that blew up in America’s subprime mortgage market last year has become a hurricane. The ill wind from reckless property lending blasted first the market in asset-backed securities, then banks’ balance sheets and, most recently, stock markets. Across the globe, more than $5 trillion has disappeared from the value of public companies in the first three weeks of January. Many markets are 20% or more below their highs, the informal definition of a bear market. On January 21st share prices plunged from Brazil to Britain in the worst day of trading since September 11th 2001.
Although America’s exchanges were closed that day, its policymakers’ response was more than commensurate. Before Wall Street opened on January 22nd the Federal Reserve announced an unscheduled rate cut of three-quarters of a percentage point, to 3.5%, its fastest easing in a quarter of a century. A day later the New York insurance regulator and leading banks began work on a multi-billion-dollar plan to rescue the country’s teetering bond insurers. As the markets pitch and yaw the pressing question is whether central bankers and regulators have acted with swift prudence, or ill-judged panic.
There is no doubt that this is a frightening moment. But the narrow economic rationale for the Fed’s emergency rate-cut this week was thin. America’s weak economy means monetary policy can, and should, be loosened considerably. But the central bankers’ next scheduled meeting begins on January 29th. Since lower interest rates take several months to work through the economy, accelerating rate cuts by a few days will not much affect the outcome. Yes, share prices had been falling sharply across the globe, but the slide was orderly and the system had not seized up. The Fed seems to have been spooked, and wanted to stop the markets’ fall.
That is a dangerous path for a central bank to tread. Its success will now be identified with short-term movements on Wall Street. Indeed, as the stock market shrugged off the latest rate cut, the Fed’s authority already looked diminished. As if to prove the point, shares soared only when the insurance regulator appeared. Ben Bernanke, Fed chairman and guardian of America’s economy, moved Wall Street less than Eric Dinallo, whom nobody had heard of, saying he would rescue some insurers nobody understood.
Rather than chasing the market’s tail, the Fed ought to be asking what the markets’ fall really signals. The answer is: unsurprising judgments that should not have led it to panic.
The Bernanke put-upon
For much of last year, stock markets ignored the bad news from the credit markets, thanks to three assumptions. First, that policymakers, led by the Fed, would avert recession in the United States. Second, that even if America stumbled, the rest of the world economy was “decoupled” and would carry on growing healthily. And third, that the credit mess would be confined to areas related to subprime mortgages.
These assumptions were always over-optimistic. America’s economy has stalled as the building bust deepens and consumers cope with the triple whammy of falling house prices, tighter credit and dearer oil. The labour market is weakening at a pace that has in the past heralded recession. The rest of the world, meanwhile, is slowing. Europe’s outlook has darkened. Its banks are embroiled in the credit crisis; and one of them, Société Générale, has lost €4.9 billion ($7.1 billion) in a fraud. Japan is weak; even turbo-charged China may cool.
And the credit crisis has continued to spread. Corporate lending and parts of consumer credit, such as credit cards and car loans, are wobbly. The looming downgrades — and possible bankruptcies — of the “monoline” insurers of some $2.4 trillion of bonds boded worse until Mr Dinallo moved. They would have hurt states and municipalities that are their biggest customers; and banks that had bought insurance in credit-derivative trades would also have been hit. A further round of losses at the banks could have been catastrophic. With the system at risk, no wonder stock markets swooned.
Heavy weather
None of this is exactly cheerful, but it is not disastrous, either. Particular problems, like the monoline insurers, should be dealt with by particular remedies, not the warm bath of monetary policy. It is early days, but one choice for Mr Dinallo would be to corral their worst risks in a “bad bank”, leaving the rest intact—and more tightly regulated.
As to decoupling, although the rest of the world remains somewhat vulnerable to America’s troubles, most rich economies are in a slightly better shape than the United States, and most emerging ones are better able to withstand an American downturn than they were. Many have plenty of reserves and flexible exchange rates, making a rerun of the 1997-98 crises unlikely. Many are growing nicely on the back of rising domestic demand and regional trade links. And many have strong budget positions, leaving room for fiscal loosening to offset weakening exports.
American policymakers also have tools to cushion — if not forestall — the downturn. Lower interest rates may not stop house prices falling, nor will they prevent banks from tightening their lending standards. But monetary policy can still stimulate the economy, as lower rates boost banks’ profitability, bring down firms’ borrowing costs and improve indebted consumers’ cash flow. Equally, fiscal policy will be a prop. Of course, President Bush promised too much when he suggested that a stimulus package would keep the economy “healthy”. But Congress is rushing the $150 billion package through, and, even if it takes a while to reach firms and consumers, it will give the economy a boost.
Taken together, the signs from the world economy are troubling. The credit binge will not unwind quickly or gently. Asset prices will fall. But central bankers and regulators have the tools to stop a downturn from becoming a slump, so long as they use them sensibly. Reacting to market panic with panicky rate cuts is likely to make things worse rather than better. The Fed should always be the calm centre of a financial storm.
If at first you don’t succeed, try co-ordinated intervention. Leading central banks have each laboured on their own to clear the log jam in the money markets—and all have failed. The spread between the cost of borrowing for governments and that for banks has widened sharply in recent weeks. That suggests investors are warier than ever of lending to the banking system. The longer this goes on, the greater the fear that banks will drag the economy down by starving it of capital.
Christmas, when markets are closed and banks are tidying their year-end balance sheets, is always a time of sparse liquidity. This year confidence is especially fragile. The last thing the world needs is for some big bank to be scrabbling for cash on New Year’s Eve. Hence this week’s decision by five central banks to redirect some $100 billion of funding to the banking system—and to ensure that it can be had in dollars. Markets were torn between hope that money will at last get to those that need it and fear that the plan reveals how worried the central banks really are. They are right to be anxious: this is the authorities’ best shot—and it is far from certain to work.
The plan helps explain why the Federal Reserve decided to cut interest rates by a quarter of a percentage point rather than a half (as many had hoped) on December 11th. Cuts in the official rate have proved a blunt instrument in solving the money-market crisis. Despite three reductions in the Fed funds rate, banks were still paying more on December 11th to borrow money for three months than they had been in March. Worse still, in their anxiety to rescue the financial system, central banks were endangering their anti-inflationary credentials. Headline inflation rates have stayed stubbornly elevated. The Fed reasoned—rightly—that money-market intervention was a more targeted remedy than a big rate cut would have been.
Nobody should doubt how urgently needed that remedy is. Banks have no problem borrowing money overnight, but they would be mad to rely exclusively on that as a source of funding. They need access to funding over longer periods, particularly three months. Yet those markets have been jammed as the normal providers of finance, the money-market funds, have been made skittish by losses on mortgage-related products. Central banks are trying to step into the breach.
Sick stigma
The plan is designed to deal with the things that have stymied such efforts so far. For instance, applying for help from a central bank has been seen as a sign of weakness—the financial equivalent of casting yourself as the little boy with “kick me” pinned to his shirt tail. By presenting the new package in the form of an auction, central banks hope to remove that stigma. Another disincentive for borrowers has been the penalty rates of interest charged by central banks (in particular, by the Bank of England) and the demand for very high-quality bonds as collateral. The new plan modestly relaxes such conditions.
Will that be enough? The Fed and the Bank of England have made it clear they are not adding overall liquidity to the markets (to the extent that they add money, they will take it away elsewhere). So far, the plan focuses on how to get money into the system, not how much. Yet the European Central Bank, which has been the most flexible in handling the money-market crisis, has had little more success than anyone else at reducing banks’ borrowing costs. Above all, the package does not solve the fundamental reason why both investors and bankers are so reluctant to lend freely: the crippling lack of information about potential losses on subprime mortgages and related structured-debt products. Even the banks themselves will remain reluctant to lend until they know how much capital they will need to sort out the mortgage mess.
Yet the package is surely worth a try. It is worth paying a high price to stave off a liquidity crisis over new year: better that weak banks are able to borrow at the same rates as strong ones than that they are not able to borrow at all. The package will give everyone breathing space to reassess the banks’ balance sheets. The hope is that a peaceful Christmas will help sentiment improve in January. But don’t be fooled: it is only a hope. If it is disappointed, the clamour for central banks to start cutting interest rates will start to mount once again.
The financial storm that blew up in America’s subprime mortgage market last year has become a hurricane. The ill wind from reckless property lending blasted first the market in asset-backed securities, then banks’ balance sheets and, most recently, stock markets. Across the globe, more than $5 trillion has disappeared from the value of public companies in the first three weeks of January. Many markets are 20% or more below their highs, the informal definition of a bear market. On January 21st share prices plunged from Brazil to Britain in the worst day of trading since September 11th 2001.
If at first you don’t succeed, try co-ordinated intervention. Leading central banks have each laboured on their own to clear the log jam in the money markets—and all have failed. The spread between the cost of borrowing for governments and that for banks has widened sharply in recent weeks. That suggests investors are warier than ever of lending to the banking system. The longer this goes on, the greater the fear that banks will drag the economy down by starving it of capital. 
