Regulators Need To Fix Dividend & Share Buyback Schemes

Possibly my most important posting this year.... This is not the crux of the problem we are facing but is part and parcel of navigating the "compensation culture" of Wall Street and high-falutin' CEOs. Excessive risk taking has been the center of what brought the credit markets to its knees. The compensation culture is one where the base salary is only a fraction of these people's compensation packages, even though for many of them the base salary is already more than $1m. In Wall street, the culture is even more evident in that analysts and bankers get between $100,000-300,000 as their base salaries but there is a tacit understanding that their overall compensation will be in multiples of their base salary - and not in number of months like the rest of us. Hence many of them argue that the compensation cap by Obama will not work. Its like saying "don't throw us in prison as there are too many of us"...

An article by David Reilly, Bloomberg news columnist, wrote recently that there need to be a revamp of the way companies pay dividends and do share buybacks. I totally agree. Dividends that are steady, predictable and "high-ish" will always attract the longer term funds as solid shareholders, thus propping up share prices. As the CEO, your destiny is tied to the share price, thanks to the finance literature over the last 20 years which says that the CEO and senior management's goals, objectives and compensation must be tied to the share price performance - which indirectly implies that shareholders interest are served. BUT ARE SHAREHOLDERS INTERESTS BEING SERVED PROPERLY?

The compensation maniac rise over the last 10 years and the current crisis basically reinforced to us that shareholders interests are not best served under current system of tying in share prices to compensation.

The current system will make almost all CEOs to aggressively pay out strong dividends or have a strong dividend policy, and worse still, engage in frequent and at times excessive share buybacks. Share buybacks in the US are usually then canceled (unlike in Malaysia, which defeats the purpose) and that will improve the EPS by a corresponding amount, which will then move share prices higher if forward PER ratings and valuations stay the same. That is because the bulk of the CEOs and Wall Street compensation rides on share options.

The danger with Obama's pay cap is that much of the additional compensation will be paid via shares, although they will only vest after TARP money has been fully repaid. Thus, I can already predict what the CEOs will be doing once they get profits rolling again:
a) pay down TARP
b) improve dividends
c) buyback shares
The only difference is that they will pay down TARP as a new priority. It does not change the compensation culture. Especially in times like this any free cash flow should be used to shore up balance sheet and increase your capital standing and sufficiency, not paid back via dividends or doing useless share buybacks.

I can soften the blow for dividends, its good and essential to encourage long term shareholders to hold onto good stocks for a long time. I do agree that if a company can, they should pay good dividends, above the company's capital requirements for normal growth strategy. It would be prudent to have a proper dividend policy (e.g. percentage of profits that goes into dividend pool; or targeting a dividend yield year in year out). But do not do haphazard dividend payments one year from the next, it is unprofessional and unpredictable, and will cause valuations to be marked down.

Here is where we need more bite from the board of directors, especially the independent ones. New guidelines by the SEC should be furnished to the directors to ensure that dividends and share buybacks are backed by a solid grasp of business fundamentals and industry trends.

Share buybacks are only OK if shares are subsequently canceled, otherwise the CEOs have no fucking idea what share buybacks are supposed to do. Trashing share buybacks was my very first article for this blog, so its ranks very high on my list of piss-me-off-silly issues. However, owing to the compensation culture in Wall Street and among CEOs in the US, the share price is like their religion. Thus they will engage in excessive and frequent share buybacks, EVEN when they are not necessary - this will lead to a depletion of capital, and hello... what are really troubling the banks nowadays.... They have pushing a lot of free cash flow into share buybacks, depleting capital, pushing up EPS... and yet leveraged up even more on their remaining lesser capital.

Now, oops, they need more capital... We need a regulatory body to oversee the amount of shares each company is buying back and reassess them as normal capital requirements for the companies in those industry. For example, between 2003 and 2007, Citigroup paid out $44bn in dividends and spent $22bn buying back stocks. If they had slashed their dividends by half and not do any share buybacks, they would have an additional "capital" of $44bn. But noooo... the compensation culture is such that every time these buggers see some money flowing into the coffers, they will think of ways to use them immediately, always running on the edge, skirting between raindrops... maximising every dollar. Capital is there for a reason, ... to fund growth , AND TO HELP THE COMPANY RIDE OUT BUSINESS CYCLES & MAYBE CATACLYSMIC RECESSIONS.

Is there anybody out there???

p/s photos: JJ

Goldman Sachs, The Hated Kid On Wall Street

Blankfein, presidents and co-chief operating officers Jon Winkelried and Gary Cohn, chief financial officer David Viniar, and three vice chairmen -- J. Michael Evans, Michael Sherwood and John Weinberg -- asked the board's compensation committee that they not receive a bonus, spokesman Lucas van Praag said. The compensation committee met and agreed, Praag said.

The executives will only be eligible for a base salary of US$600,000 (HK$4.68 million) each, the Wall Street Journal reported. Last year, Blankfein made US$68.5 million, Winkelried and Cohn got US$67.5 million, and Viniar got US$57.5 million.

Goldman Sachs, not being badly hit by the current financial turmoil, is now leading the way for the rest to follow. This will make everyone on Wall Street to hate them, especially the senior management at poorer performing firms such as Merrill Lynch and Citigroup - how are they going to be able to ask for a decent bonus now. Having said that the top guys at Goldman knows when to play their cards right. When you have over US$60 million last year, its quite pointless to fight for US$20 million. Might as well forgo all, win enormous credibility in the market place for leadership, making the tough decisions, gaining respect from other players. The only enemey they have is Vikram Pandit, who will be cursing them in hushed tones... how will he get his bonus approved now?

p/s photos: Ayumi Lee

Investment Banking Bonuses To Be Slashed

Bloomberg: U.S. taxpayers, who feel they own a stake in Wall Street after funding a $700 billion bailout for the industry, don't want executives' bonuses reduced. They want them eliminated. President-elect Obama cited the program at his first news conference on Nov. 7, saying it will be reviewed to make sure it's ``not unduly rewarding the management of financial firms receiving government assistance.''

While year-end rewards are likely to decline with a drop in revenue this year, industry veterans say that eliminating them risks driving away the firms' most productive workers.``There are instances where bonuses are justified, deserved, and in the best interests of the investment bank involved,'' said Dan Lufkin, a co-founder of Donaldson Lufkin & Jenrette Inc., the investment bank acquired by Credit Suisse Group AG in 2000. ``Your very best people are people you want to hold, and your very best people will have opportunities even in this environment to transfer allegiance.''

The companies, which set aside revenue throughout the year to pay bonuses, haven't commented on plans for year-end awards, typically decided this month or next. A study released last week said the firms are likely to cut bonuses for top executives by as much as 70 percent. Cuomo is expected to go through the bonus proposals from these investment banks, and is likely to cut the bonuses a lot further to appease the public's fury. I think Cuomo could further halve the actual bonuses.

``Even really sober people are saying this is the worst financial crisis since the Depression, and they're saying bonuses are just going to be reduced?'' said a 53-year-old retired merchant marine in Seattle. ``Oh my God, you read that and your jaw drops.''

Wall Street firms' pay has traditionally been tied closely to performance of the companies, which is why employees receive most of their compensation at the end of the year after final results are known. Depending on seniority and performance, bonuses for traders, bankers and executives can be a multiple of their salaries, which range from about $80,000 to $600,000.

The nine banks that was pressed to detail their bonus plans asked for more time to respond. They've been granted an additional two weeks. The original deadline was yesterday.

Goldman, the largest and most profitable U.S. securities firm in the world last year, paid Chief Executive Officer Lloyd Blankfein a record $67.9 million bonus for 2007 on top of his $600,000 salary. That was justified, he told shareholders at the company's annual meeting in April, because of Goldman's superior financial results. ``We're very much a performance-related firm,'' he said. ``If those results don't come in, I assure you at Goldman Sachs you won't see that compensation.''

Goldman's profit is down 47 percent so far this year and five analysts expect the company to report its first loss as a public company in the fourth quarter that ends this month. The stock price has dropped 67 percent this year and Goldman received $10 billion from the U.S. government in the bailout last month.

``The executives in companies that get bailout money should have their base salaries reduced by 10 percent for 2009 and they should pay back a substantial portion of their 2007 bonuses to the government for the financial devastation they oversaw, fostered and, in some cases, directly caused,'' said a 57-year-old lawyer in Baltimore. ``Their sense of entitlement is appalling.''

In addition to Goldman, Morgan Stanley and Citigroup, the companies that received the first round of money from the U.S. government's Troubled Asset Relief Program were Merrill Lynch, JPMorgan Chase & Co., Bank of America Corp, Wells Fargo & Co., State Street Corp and Bank of New York Mellon Corp.

Some needed the money more than others. Citigroup and Merrill haven't been profitable since early last year. Earnings at each of the other firms, except Boston-based State Street, have been dropping.

``Bonuses and severance packages will obsess the American public'' and become ``a humiliation and embarrassment,'' said Arthur Levitt, a senior adviser to the Carlyle Group, former chairman of the Securities and Exchange Commission, and a board member of Bloomberg LP, the parent company of Bloomberg News. ``Compensation committees, believe me, are paying close attention to this.''

Several of the companies -- including Citigroup and Wells Fargo -- have said they won't use federal funds to pay bonuses. That's disputed by some. ``The argument of saying we're not using the bailout money is just crap because money's fungible, money's money,'' said Crystal, who writes the newsletter graefcrystal.com. ``It exposes them to ridicule.''

The bailout is only part of the reason that people object to Wall Street bonuses this year. The financial industry worldwide has taken more than $690 billion in writedowns and credit losses this year and cut more than 150,000 jobs. A decline in lending has caused the wider economy to contract: the U.S. gross domestic product shrank at a 0.3 percent annual pace in the third quarter, consumer spending fell at its fastest pace since 1980 and unemployment jumped to 6.5 percent, the highest since 1994.

Attention is most focused on the top executives at the banks that are receiving federal money. They'll have to take the steepest pay cuts because their pay is disclosed in proxy filings, according to Alan Johnson, managing director of Johnson Associates, the compensation consulting firm that estimates bonuses will decline between 10 percent and 70 percent. ``I'd advise the CEO to say he can't take anything if it's one of these firms getting bailed out by the government,'' said Crystal. ``I think he's just going to have to go down to just his salary.''

That's probably not the case for employees whose pay isn't disclosed, even those who get bonuses that exceed $1 million. Top performers should receive bonuses this year or companies risk losing their best workers. Of about 600 people who responded to an online survey on the eFinancialCareers.com Web site, 46 percent said they would be unwilling to take any pay cut this year.

p/s photos: Fiona Xie