Private Market Compensation: AIG CEO vs. Kobe Bryant

“Anger”, more so than “fear”, is perhaps the most often expressed emotion by U.S. citizens, Congressmen, and media analysts when discussing the proposed $700B federal bailout of the U.S. financial system. “Anger” is the primary emotion because the $700B will be put at risk by the American taxpayer to bailout the very same financial institutions that have become increasingly reckless and greedy regarding their investing and borrowing practices.

In America, especially over the last two weeks, the discussion of a bailout to save our financial system and economy from ruin has become logically intertwined with a concurrent discussion of Chief Executive Officer (CEO) compensation packages. Many are outrgaged, especially in light of the horrendous financial results and excessive risk taking, when finding out about the lucrative CEO compensation packages consisting of base pay, bonuses, stock options, and termination (severence) pay.

Let’s analyze this topic by comparing the compensation packages of basketball superstar Kobe Bryant and recently fired AIG CEO Martin Sullivan.

In 2007, Kobe Bryant earned $20 million dollars playing basketball for the Los Angeles Lakers while Martin Sullivan earned $14 million dollars in 2007 running AIG, one of the largest insurance companies in the world.

In 2006, Bryant also earned $20 million for the year, whereas Sullivan earned $27 million as AIG’s financial performance was much stronger in 2006 versus 2007, causing Sullivan’s 2006 incentive-based compensation to be higher than 2007.

Now the big one: Sullivan’s 2008 termination or severence pay upon his firing as AIG CEO was $47 million dollars (two years pay)! Pretty nice “goodbye present” for Sullivan given the fact that AIG failed causing its owners (the stockholders) and potentially our country (taxpayers via bailout) to be crushed! Although Bryant has no termination or severence bonus built into his contract, his contract is guaranteed through 2011 which is somewhat similar to Sullivan’s “severence deal” in that Bryant is guaranteed payment should he be injured.

Thus, both compensation packages (Bryant and Sullivan) are somewhat similar in dollar amount, but beg the question: Is anyone worth that much money?

So the primary question of this blog is to discuss whether private market compensation, should be somewhat controlled or limited by governmental law, and if so, how.

Let’s start with Bryant.

If we passed a law taking the position that Bryant’s salary could not exceed $5 million per year, he would likely go play in Europe where European contracts are becoming more competitive and similar to U.S. contracts. Even if Bryant did stay with the Lakers, despite the new law, at $5 million per year, the $5 million savings (reduced salary) would go to the Lakers owner, Jerry Buss, so Buss would be making $5 million more at Bryant’s expense. In summary, we would have passed a compensation limiting law taking money from Bryant and giving it to the owner! Through the study of economics we ultimately understand that Bryant is, in essence, being paid by you and I whenever we see him at the arena (ticket prices) or watch him on TV (ad revenues). Ultimately, Bryant gets $20 million because we, not Buss, pay him $20 million! This is the private market at work, where voluntarily owners (Buss) pay their employees (Bryant) what they believe they are worth. Said one last way, Buss pays Bryant $20 Million per year because Buss thinks he can make more profit than if he doesn’t and loses Bryant to another team.

Let’s go to Sullivan now.

If we passed a law limiting executive salaries to some arbitrary number, say $5 million per year, the same thing would happen that happened to Bryant. The Harvard & Yale MBAs would not pursue American companies but would go to work at Canadian, European and Asian companies whose compensation would be “free market”. The U.S. would lose its best talent and our companies would become mediocre, fail at an increasing rate, and our standard of living would deteriorate as our leadership quality would deteriorate. It is the CEO that is at the helm of companies helping American businesses to produce an average 10.4% return for their owners (stockholders).

Now we get to the toughest question which is “should CEOs be paid a multi-million dollar severence payment after they have failed and been fired?” The obvious answer seems to be no! But sometimes, what appears to seem to be the obvious answer becomes less obvious in a free market. Any smart, Harvard or Yale MBA knows that they have a 50/50 chance of failing and being fired within their first 3 years as CEO. Statistics bear this out as CEOs are fired all the time as it is easier to fire the CEO than all of the employees. Large firms need the best talent and a talented CEO knows that sometimes their companies fail quickly often for reasons beyond their control no matter how talented they are. Thus, CEOs demand an “insurance payment” called severence pay to compensate them for their high risk and rate of failure. Once the CEO fails it becomes increasingly difficult to get that next CEO job as their reputation in the market place sours. Thus, a CEO looks at the entire compensation package (salary, incentives, and severence) when deciding where to work. If the risk is too high (dedicating their life to their business in lieu of their families) relative to the reward, they will take their talents elsewhere or to a new career.

What is my suggested government solution regarding trying to protect shareholders from excessive executive compensation? I suggest that our government only pass new law to increase ”disclosure requirements” on executive compensation to provide a better ”check and balance” on the Board of Directors who set the pay and severence amounts for the CEOs. The Government (SEC) should not get involved, in my opinion, with compensation limits or restrictions on severence pay, but they should pass a new law to provide greater visibility for the owners (stockholders) on their CEO’s (and other key management) compensation. For example, even though today all executive compensation is publicly accessible by the owners by examining publicly filed documents, the Government could pass new legislation making it mandatory for companies to send an annual letter directly to its owners (stockholders) outlining only their CEO’s and Board’s compensation.

But , please Government, be careful and don’t do anything stupid like setting maximums for CEO compensation.

Discussion Questions:

  1. In your opinion, should the Government limit CEO salaries to some maximum? What about their severence payments, should they be limited? If so, how would you set the maximum amount?
  2. Is it fair that Kobe Bryant makes more than a police offer? Why or why not?
  3. What specific action should the Government take, if any, regarding executive compensation?

Originally published at Welker’s Wikinomics on Oct 2, 2008 and reproduced here with the author’s permission.

3 Responses to "Private Market Compensation: AIG CEO vs. Kobe Bryant"

  1. Anonymous   October 3, 2008 at 1:32 am

    “Even if Bryant did stay with the Lakers, despite the new law, at $5 million per year, the $5 million savings (reduced salary) would go to the Lakers owner, Jerry Buss, so Buss would be making $5 million more at Bryant’s expense.”Picking this up as an analogy to Sullivan’s (CEO’s) situation, the savings in AIG’s (corporation’s) case would be passed on to the owners, that is, shareholders. We may not sympathize with Jerry Buss making more money at Kobe’s expense, but more profit for a corporation whose stock I own should trickle down to eps and a higher stock price over time.That said, sometimes you get what you pay for–and sometimes you don’t, such as Alex Rodriguez in the post-season. Regulation is probably not better than a free market system to determine value.So while I don’t agree with salary caps for pro ballplayers or CEOs, especially government mandated ones, I disagree with your assessment of lucrative severance packages. You say CEOs could fail and then have a hard time getting their next CEO job because of their soured reputation? Give me a minute while I dab my tears for all those poor fired CEOs; not.If they are aware of that dimension of their role then they should work hard not to fail (or let their company fail). Just like the rest of us whose performance leads to being judged a success or failure, despite the fact that we do not control every variable that contributes to that success/failure.I think the reason CEOs are paid so well is because the job is difficult (like playing professional sports at the MVP level), because the sacrifices (professional over personal) are significant and because there is a risk of failure and early termination.Failure should not be rewarded with exorbitant severance packages in my opinion. Practically speaking, there should be greater transparency (as you say) and perhaps shareholders should be given a vote on executive severance packages when they are over a multiple of 1X annual salary.

  2. metamorfus   February 5, 2009 at 7:14 am

    Issues are complex and people try to use complexity to destroy common sense.I am for the free market but the market is never completely free, it’s regulated, taxed, tariffed and/or has some type of treaty on it at all times.The NBA has salary restrictions (I am hoping the original writer understands and has knowledge of this); thus his analogy is not a good one as it provides the basis to put forth arguments for restrictions on the TARP infused recipients(Banks).These banks left the free market when they were socialized by accepting government/taxpayer aid. The NBA is not receiving a piece of the $700 billion dollar TARP fund. The Lakers’ are not a failing entity (business). Some NBA teams have relocated ( a form of adaptation/change) when they could not raise the revenue in their previous market location. Free market enterprise must adapt/change to survive.If we believe in the “free market” we would allow these businesses to fail or adapt/change. In a free market, talent will move to new thriving companies, better opportunities or sometimes will start their own companies if they are that unique, special or knowledgeable; but there is no evidence there is a shortage of individuals that could be successful in the given industry. There will always be people to fill the void, and often times you will get better performing and ethically inclined individuals.

  3. Guest   February 15, 2009 at 10:16 am

    We have a minimum pay scale for the poor people. Limit pay by % rather than $’s and do so for publicly held companies with stockholders. Corporate executives for publicly held companies should have a minimun salary with bonuses and other compensations tied to profitability and revenue growth. Feed back into the system by providing all employees with stock. When the company grows and profits, so do all of it’s employees and stockholders will see an increase in value based on profitiability and earnings per share. Since the employees and executives are also stock holders, they also see a second benefit in the stock price growth.To be allowed to layoff thousands and export jobs to other countries in order to see executives rewarded, it’s clearly greed driven. Currently, stockholders, employees, customers and the economy all suffer the selfish motives of the few executives driven by greed.