Saturday, July 22, 2006

Bush’s Love Affair with Incentive Compensation Produces Prostitutes, Might Bush Be One?

One signature Bush belief is “incentive pay improves performance”. It is the basis for “No Child Left Behind” and part of Bush’s Medicare/Medicaid modernization. While early returns show schools and administrators taking untoward actions to improve test scores, the better place to look for information on incentive compensation is private industry.

The United States is a full 10-15 years into CEO incentive compensation. The track record is murky at best.

A key component of top management incentive pay is stock options. These programs issue an option to purchase the company’s stock at a discounted price thus incentivizing the CEO to grow profitability and correspondingly the stock price.

A recent SEC investigation revealed numerous companies committed fraud by backdating their stock option issue dates to a period of historically low stock prices. This enables option grantees to turn their options for massive profits with very little personal risk.

For stockholders, a similar experience is being conned in a street corner shell game. The company of which the stockholder owns a share, grants the option to the executive from a pool of company owned stock. Top management plays the con by picking the date by which option grantees get the best return. This is done in hindsight with perfect knowledge. The CEO and company flip the options, exercising their purchase at the deeply discounted price and then selling them at a guaranteed and usually huge profit.

Who pays for this? The company pays, thus the shareholders do. Currently the SEC is investigating over 80 companies for violation of stock option regulations.

Other tricks to maximize CEO pay (by maximizing profits) include cutting worker salaries, shifting production to China, dropping health insurance benefits and shifting the company pension plan from defined benefit to defined contribution. The Bush administration recently nixed a petition to investigate Chinese labor practices. The move of production to low wage China likely fueled many a CEO’s performance bonus the last 5 years.

The SEC is concerned about another area of profit speculation, hedge funds. These are large unregulated investments funded mainly by the rich. The funds buy and sell virtually any kind of investment, frequently purchasing whole companies before spinning them off again for huge profits.

The push from Wall Street is to keep the hedge funds unregulated. The push from just down Pennsylvania Avenue is likewise. The Carlyle Group functions in such a manner. The famously politically connected investment house has deep ties to Bush I and Bush II.

What makes the whole sordid money grubbing affair more interesting is the current SEC investigation into John Mack, CEO of Morgan Stanley. The focus is on Mr. Mack’s behavior as head of a hedge fund before taking the top seat at Morgan. The SEC wants to know if John had and used insider information about an upcoming merger as a fund manager to make millions.

A SEC attorney investigating this question said he lost his job after attempting to subpoena Mr. Mack. As John raised major campaign funds for President Bush, the question of improper political influence arises. Mr. Mack achieved Ranger status in Bush’s 2004 campaign. This means he personally mobilized over $200,000 for the Bush/Cheney ticket’s re-election.

Bush speaks openly about the benefits of being a “Pioneer” or the more elite “Ranger”. Does that include, pulling off SEC investigators breathing down a Bush Ranger’s neck for improper financial dealings? Hopefully, we will find out, but the track record of Bush led investigations is exceedingly poor.

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