Understanding Big Bonuses & The Coming Options Scandals

People can argue all they want about bonuses being a requirement to keep good employees.  It’s a lie.  Good employees with big cash bonuses due, stay at least until they are paid. Once they get paid, they see themselves as free agents, pure and simple.

Retaining GOOD employees has absolutely nothing to do with the bonus they have already earned.  Keeping good employees has everything to do with their next deal.

Here is what good employees want.

They want the  ability to be good at their job.- Are there any stellar revenue producers worth a damn that are going to stay at AIG ?  Hell no. Can you imagine the opening line of an employee from any of the AIG insurance lines… “Hi, Im from AIG and I’m here to help”. Yeah, that will help close a deal.  Every salesperson worth a damn over there knows they don’t have the capital to take risks, which is what they need to do deals and make money.  They also know that all the easy money has already been made and if you work at AIG you are going to be under a microscope with everything you do.

Of course, AIG competitors know this as well. You can bet every AIG employee is playing out the bonus season. The good employees are gone once the bonus issue is resolved. They are off to a company that has capital to cover the insurance and other products they get paid to sell.

And this doesn’t only apply to AIG. Any financial company without  capital to backstop financial products is going to lose their best people.

Good employees also want to be in demand.  They want to be loved and they know the only way to get the love is to test the free agent market

The ultimate arbiters of efficient markets are free agent salespeople. They are going to follow the money. They will do more homework than you and make sure they have every opportunity to get paid. Not only will they follow the money, they will play off the desperation of companies that feel they are going to lose their people as leverage for their next job.

In negotiating their new deals, these free agents are going to know the following:

a. There is a very good chance that stock prices will go up.

b. They are going to get paid very generous stock option packages because stock prices are depressed

c. If they can get huge numbers of options at current prices, any decent increase in the market over the term of their vesting periods can make them 10s, if not 100s of MILLIONS of Dollars.

The only possible way for  Citi, AIG and the banks that are struggling are going to get and retain employees is to overpay with stock options.. They know they can’t offer them a great deal making environment in order to be great at their jobs. So instead, they have to overcompensate them in options. Their pitch will be simple. We are giving you 1mm, 2mm, 10mm options at 50c, or $1.50, or $4, whatever. Remember when our stock was 50 last year ? Well if we only get back to 10, you are rich.

That my friends is a story any free agent will listen to. For that much money, like in pro sports, they will play for a losing team. That is what retention for many struggling financial companies will look like.

The good banks like Goldman will offer them the chance to be great at their jobs, and make some money if the stock goes up to prior levels. These employees will be able to make real money from the deals they close. The bad banks will offer stock packages that will seem like lottery tickets.

I can’t say that I know about any specific packages being offered. I don’t.  What I do know is this. If and when, next year or even 2 or 3 years from now, a few of the banks that are currently struggling  start paying back their tarp money, the headlines are going to be outrageous.

The fact that they can pay back the bailout money will probably mean they are in good shape.  Which probably will mean that the shares are selling for far more than they are now.

Which all in all translates as follows, the banks that needed the Tarp money the most and survive,  will end up having execs that make the biggest hauls from stock compensation.

The headlines will read ” Bank Execs make 100 million in just 3 years from stock options as taxpayers wait for their profits ”

Rather than arguing about how execs are getting paid for yesterday, our politicians should discuss the best way to pay them for this coming and future years. Thats when the real money will be made and everyone who is any good in the financial industry already knows it. Its just the politicians that dont

32 thoughts on “Understanding Big Bonuses & The Coming Options Scandals

  1. Way to go creating “a link between risk and the reward” Mark, if you keep compensating people with stock options they will NEVER EVER think twice about taking more financial risks. Let the executives and other lower level employees go out and spend their own money in the open market to buy stocks. Then, we will know how much risk they are willing to take.

    Comment by Gencer -

  2. Very true, and good comments on what employees want, wish my employer would follow this. I want to work for you!

    Comment by norcal_jeff -

  3. Hey Mark, Im not a business wiz or anything close but as far as the government getting involved and running any of these financial institutions. Before someone takes over a business, its fair to see how much debt they owe, no? Ok now here we go. Anyone that needs a finacial update on how well we run our money in the government check this site. http://www.brillig.com/debt_clock/ Nuf said. Thanks for the thoughts

    Comment by Frankie from Lawnside -

  4. I think there are nothing wrong with big bonuses. It encourages hard work and productivity. The governemnt shouldnt be screwing with peoples salaries.

    Sportsbook Review

    Comment by Kristain -

  5. Very ingenious thinking here Mark. I like how you blend principles with a specific problem and forecast it into the future. The real problem here is, though you as I both know, government intervention. The House just approved 90% tax on bonuses. The principle here is the ugliest of the ugly. The principle is, a government can own a corporation, and then excessively tax its income, or the money it feeds that corporation to stay alive. This is essentially know different than Putin nationalizing companies, and then living off them along with the government. The lines of capitalism and socialism are becoming so blurred, along with morality, that trillions of dollars are going into hands that no one knows of. And people are not as upset as they could be because they don’t understand the situation in terms of morality and individual rights. Every individual right is being violated today, the blank check has been signed, and the people driving this country into the ground do not have any recollection of principles other than they are crossing their fingers for serfdom and an international federal reserve. It’s absurd, the system cannot work. I must say, you are probably one of the smartest and accurate players on the field. This is rule by force, and the destruction of production. Who is Obama to say what my kids want to be when they grow up?

    Comment by Clayton -

  6. Mark,
    I have taken the unpopular stance of disagreeing with the outrage public officials are fueling for these bonuses. Everyone at AIG is getting lumped in with the small group who actually knew about the toxic garbage. Bailout companies like AIG and CITI after this week are probably assured failure now. Congress will ratchet up compensation restrictions going forward. No “best” and few of the “good” skilled workers will join these companies. They’ll struggle for a while, probably receiving more bailout money and fail – I predict by end of this year (or get 10s of billions more of taxpayer money to be propped up). Like you suggest, once the bonus dust settles there’ll be a massive exodus of people from that company. Maybe after these banks fail, taxpayers will finally direct their outrage to the real villians – Congress.

    Comment by Jim -

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  10. Mark,
    I understand what your saying but I strongly disagree. People (even sales people) stay at a company for more than 1 reason. A good manager will be able to keep his people for a long time if he keeps them happy. Money doesnt = happiness for everyone. I’m not saying money isnt a factor.. but its just that.. a factor. not the entire decision. You are right, when you are in a sinking ship.. its hard to keep and attract people, there are a lot of sinking ships out there right now (not just financial sector). and since you relate your discussion with sports.. lets do just that. We have certainly seen players (in all sports) take less money to stay somewhere where that player felt more ‘comfortable’ could be comfort level with the owner/coach/ whatever. Money isnt always the deciding factor. Company or “team” performance isnt always the deciding factor. It just depends on the individual.

    Comment by savednoteguy -

  11. Finally! The voice of reason!

    Comment by Stinger -

  12. Mark:
    You are spot on about the big bonuses and also about the upcoming ‘options scandal’. Since the ‘dot com bomb’, employees have been shying away from options but at these prices, it pays to roll the dice and a lot of money will be made by quite a few of them. Then the politicians will get smart and blame it on whoever is standing in the wrong place at the wrong time.

    Comment by Small Business Marketing -

  13. Good People these aig people lose everyone’s money. All there good at is conning people into their garbage hedge funds. There just oilsnake salesman.
    The government should of let all these banks go belly up. I am sick of the corruption. I am mad as hell.

    Comment by Mark -

  14. The Fed has no business regulating bonuses pure and simple. The government’s focus should be on setting the framework under which investment companies seek and exploit opportunities that allow them to concentrate capital power and make large returns in the 2nd, 3rd, and 4th quartiles.

    Government should fight against nescience, against inadvertence, against the supposition that leads to the financial crisis that the markets are experiencing now. Sadly, this is a global playiing field so its not only up to the U.S.

    Mark, you should go run Kraft. They are in need of a CEO. Maybe as your first act you could buy General Mills and tighten inventory.

    I’m sure Warren Buffett would back you since his purchase prices were between $32.24 and $34.4, with an estimated average price of $33.1 for his 132,393,800 shares. What has his money investment gotten him? A stock price of $22.16.

    We can dream can’t we; your to busy running HDNet and all your other companies.

    Comment by Darren -

  15. The options need to be priced above the current market value of the stock. That means that the employer owes no income tax until the option is exercise.

    It will be more “politically acceptable” if they do that, because you’re saying “we’re rewarding you for success.” Part of the AIG foo-foo-rah is that it looks like people are being rewarded for failure, or even that they are being rewarded for torpedoing the company.

    People aren’t dumb. If every other division of General Motors was losing money by the bucketful, but Saturn (to pick a highly unlikely prospect) was raking in billions, the public would be smart enough to see the people running Saturn rewarded nicely, even though the corporation as a whole was losing a lot. The problem with AIG is that it appears that the people getting the bonuses are from the division most responsible for their losses.

    If AIG could step forward and list the recipients and say, Mr. Smith generated $17 million in profit for us, and he’s getting $170,000 in bonus for that, or even $1.7 million in bonus for that, it also would defuse the whole thing, but the secrecy involved makes it look like the bonuses are not connected to performance. And I suspect that’s the case.

    I’d imagine anybody that was a star performer at AIG was gone by the end of September. Other companies would have fought to get them. What’s left are the losers.

    So we’re left with a company too big to fail, and when a company is too big to fail, they don’t follow the law, they *dictate* the law. We need to break up AIG into itty-bitty companies, perhaps 50 companies, one for each state, so that individual companies *can* be allowed to fail. And we need to inform all the other TARP recipients that if they don’t split themselves into companies small enough to be allowed to fail, we’ll step in and do it for them within the next couple of years.

    Pay for performance is a *good* idea. Allowing multinationals to hold us hostage is not.

    Comment by Harl Delos -

  16. mark, you are truly one of the few guys who gets it and tells is like it is. i am glad that there is someone out there who is able to be open and honest unlike so many other “investment pundits”, “pros”, journalists, etc, etc. i have read and re-read your blogs about the stock market many times (starting from back in 2004 when you wrote the intro to The Number) and it has forever changed my view of the market. many people are still believers of long term investing and continue to fall prey to the mutual fund marketing machine but the analogy you make to the market being as close to a ponzi scheme as you can get is dead on. thanks for all the great insight and advice.

    Comment by jimmy -

  17. Under this scenario, they are guaranteed to be rich no matter what happens to the share price post-grant. What they can do is to sell LEAPS (long expiry) options against the options grants they just got. Just a bit out of the money, and properly collateralized, these financials are so volatile right now that the premiums on the options are enormous. I just moved in and out of AIG today for a nice profit.

    I’m posting on this tonight to demonstrate how all employees that are granted options can do the same thing.

    Comment by Darwin's Finance -

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    Comment by GARY VADNAIS -

  19. But Obama & Pelosi will just make it illegal to make career choices based on the opportunity for personal gain.

    Comment by Jim -

  20. Pingback: The Investor Rebellion » Mark Cuban on the AIG Bonuses

  21. I’m really disappointed in the (so called) leaders of our country dating all the way back to (at least) F.D.R.
    the things that have been passed that have resulted in crime, corruption of officials, and the loss in human life and the enslavement of our people, and the theft of their property, by the banks through the use of manipulatory inflation of our currency by the BANKERS OF THE F.E.D. who end up with real estate for funny money (the root cause of inflation IS NOT BACKING OUR PAPER CURRENCY
    WITH PRECIOUS METALS. AND THEN PRINTING UP MORE PAPER CURRENCY EVERY TIME THEY FEEL LIKE IT! DIDN’T THEY USED TO CALL THAT COUNTERFEITING?
    THE LEADERS OF THESE CORPORATIONS SHOULD NOT BE BAILED OUT AND GIVEN BOUNSES, THEY SHOULD BE PUT IN PRISON FOR A VERY LONG TIME.
    AND THE POLITICIANS THAT ENDORSE THINGS IN GOVERNMENT THAT ARE UNCONSTITUTIONAL (LIKE THE F.E.D. AND THE I.R.S. WHICH IS MOSTLY THE COLLECTION AGENCY FOR THE PRIVATE BANKING CORPORATION CALLED THE F.E.D.) SHOULD BE SITTING IN THE JAIL CELL RIGHT NEXT TO THEM!
    TOM

    Comment by Recording Studios - TOM -

  22. What is the best way to compensate employees in order to retain them and align them with the long term goals of companies? I would imagine it’s quite a bit different between public and private companies as well.

    Comment by Geoff -

  23. Mark,

    While I wholeheartedly agree with the premise and conclusion of your article, one statement I have to disagree with. AIG’s state regulated subsidiaries, i.e. National Union and American Home are still extremely strong and well capitalized. If you look at the regulatory filings, National Union has 12 billion in surplus which is limited on how much can be dividended up to the parent by state regulatory agencies.

    In their traditional property casualty business they are still the 800 pound gorilla, with double the surplus of their next biggest competitor. This is where they should be concentrating their retention efforts, the healthy core of the company. Compared to Life Insurance, Mortgage Insurance and Financial Guarantee, P/C is still strong and AIG underwriters populate the P/C business. As an insurance buyer, it finally puts you in a position to dictate stronger terms to retain that business but to say they do not have the capital to compete is just not right.

    Financial products, you are right, no one will do business with those guys. The optics are just not right. But P/C is still strong and what they originally made their name in.

    Comment by Chris -

  24. Hmm, surprised by this, I don’t think this portrays how comp packages work for these fin services companies. Won’t involve options. This is actually a great time to get a new comp package because the markets are potentially near bottom and comp can be built on investment profits which are there to be had. You are right people don’t generally want to work for a loser like AIG but since all fin services companies are basically losers right now seems like they can compete by just being a little more aggressive. Smart people on wall street right now are re-negotiating comp plans and they are going to make a killing in the next few years. What really changed w/ what just happened is that it’s going to get much harder to make a killing when the market is near it’s top since we will see a reduction in new complex and risky instruments that wall streeters create when there aren’t other easier profits to be had … but that’s not a problem right now.

    Comment by alex -

  25. Meh. What with all the advantages “investment houses” (gamblers, not banks) like Citi, AIG, GS, etc bought for themselves in the form of corporate welfare (tax breaks, etc), and they still need bailouts. Capitalism per se says they should fail through backruptcy, not continually be wards of the state on the dole.

    This has been a complete waste of money. For something not needed. It’s like all the sports entertainment owners, WWE, NBA, NFL, MLB, NHL, etc. It’s a Field of Schemes.

    Let me know when you win the first NBA championship, ok.

    Comment by Dex -

  26. Couldn’t agree more

    Comment by halim -

  27. I think another outcome of all this will be a large shift of talent (“good employees”) towards private rather than public companies. Would you rather work at a large, heavily regulated bank, or a boutique firm? The hedge funds and proprietary trading shops that weathered the storm (or even made money) in 2008 are attracting some of the best employees from the likes of Goldman, Citi, etc. I think the government is aware of this and we may see stricter regulation in this area across the board such that any restrictions on institutions receiving TARP funds does not create a vacuum.

    Comment by George -

  28. Couldn’t agree more

    Comment by Brent R -

  29. I took a different point away from your essay. It sounds like AIG will have an impossible time retaining good people as long as the government ‘owns’ 80% of the company. By taking ownership, the government is ensuring failure, but delaying it and making sure tax payers pay for it.

    Comment by Carl Coryell-Martin -

  30. Edward Liddy testified yesterday that retention bonuses were paid to individuals to remain with the company until they unwound their ” … outstanding trades and balance[ed] … outstanding risk with hedges.” The intention was not to use retention bonuses to keep them around for ever but just “long enough.”

    Comment by Speed -

  31. They ought to rebrand the company first.

    Comment by Dan -

  32. Yes! That’s what I’ve been telling everyone. We think we the people/govt have to manage someone’s salary. These companies will counter with stock options. And like you say, 3 years from now, these people will have made out like bandits…again! If you don’t like that, then don’t use these company’s products. Or better yet, don’t bail them out!

    Comment by The Interest -

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