Wednesday, December 29, 2004

Fannie Mae exits scandalous

The generous packages offered to CEO Raines and CFO Howard are ridiculous. I think the biggest problem today in US corporate governance is the cozy relationship between directors and management. It is obvious that directors are not incentivized properly to look out for the best interests of the company, but rather to maintain good relationships with the chief executive. Not only has CEO compensation become decoupled from actual performance, but "caretaker" CEOs who inherit existing public companies with strong brands and product lines are being compensated like entrepreneurs who actually create value out of nothing (see Michael Eisner and Disney for a great example). I don't see why a CEO should make $100M for anything short of a heroic turnaround - let alone lackluster performance.

For previous posts on Fannie, see here and here. Look for congress and OFHEO to claw back some of the largesse heaped on Raines.

From today's WSJ editorial by J. Stewart: "After pledging before Congress to hold himself personally accountable for any accounting errors, news reports suggest he embarked on a strenuous campaign to save his own job, huge salary and perks. Even after the Securities and Exchange Commission faulted the accounting and said Fannie Mae had misstated $9 billion in profits, Mr. Raines's benefit included an astonishing $1.4 million-a-year pension for life, not to mention a multimillion-dollar array of other goodies. Mr. Raines already is immensely wealthy; he earned more than $17 million from Fannie Mae in 2002 alone. I'm sorry, but harvesting a massive payoff for $9 billion in accounting irregularities doesn't constitute accepting responsibility for the errors.

This is all beginning to smell like the Richard Grasso pay and severance scandal at the New York Stock Exchange, with the massive payouts and cozy relationships between management and directors. There, too, a quasipublic institution lavished unseemly benefits on its top officer and is still embroiled in litigation and reform efforts meant to regain public trust.

Like the NYSE, the Fannie Mae affair goes to the heart of a serious problem, which is that a quasipublic institution that enjoys protection from the usual risks of the market, in the name of public service, has insisted on treating its top officers like their most highly paid peers in the far-riskier private sector."

2 comments:

nick said...

I think the biggest problem today in US corporate governance is the cozy relationship between directors and management. It is obvious that directors are not incentivized properly to look out for the best interests of the company, but rather to maintain good relationships with the chief executive.Reminded me of this:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=519722

On the Proper Motives of Corporate Directors (Or, Why You Don't Want to Invite Homo Economicus to Join Your Board)

LYNN A. STOUT
University of California, Los Angeles - School of Law

Abstract:     
One of the most important questions in corporate governance is how directors of public corporations can be motivated to serve the interests of the firm. Directors frequently hold only small stakes in the companies they manage. Moreover, a variety of legal rules and contractual arrangements insulate them from liability for business failures. Why then should we expect them to do a good job?

Conventional corporate scholarship has great difficulty wrestling with this question, in large part because conventional scholarship usually adopts the economist's assumption that directors are rational actors motivated purely by self-interest. This homo economicus model of behavior may be fundamentally misleading when applied to corporate directors. The institution of the corporate board is premised on the expectation, and the experience, of director altruism, in the form of a sense of obligation to the firm and its shareholders. As a result, to properly understand the role and conduct of corporate directors, we must take into account the empirical phenomenon of altruism.

One potential starting point for such a project can be found in the extensive evidence that has been developed over the past four decades on altruism among strangers in experimental games. This evidence demonstrates that altruistic behavior is in fact quite common. More important, it is predictable. A variety of factors can reliably increase, or decrease, the incidence of altruism observed in experimental games. These results may offer a foundation for building a model of human behavior that is both more accurate and more useful than the homo economicus model. They also carry important implications for how we select, educate, regulate, and compensate corporate directors.

steve said...

It seems to me that most people who end up on corporate boards *are* examples of homo economicus - with the possible exception of a few oddball academics, etc.

Then you have a problem, because the future value of a good relationship with a powerful CEO (e.g., Carly Fiorina or Franklin Raines) far outweighs the negative consequences of being too soft in oversight.

There was a good article in the Times or WSJ outlining how Raines and Fannie had directed large donations to various charities associated with directors on Fannie's board. It is obvious that these people are directly connected to Raines far more than to shareholders. Also, I seriously doubt most of the board understand derivatives, except for one academic and a finance guy, IIRC.

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