A VC - Latest Comments in Bonuses

Re: Bonuses

matt @ Thrive — Tue, 24 Mar 2009 16:17:48 -0000

Apologies if this is incoherent, I'm just doing a hit and run because it interested me.

I'm actually a little surprised to see, in all this intelligent discussion, a lack of commentary on the psychology of bonuses themselves. Regardless of whether they were retention-focused, or outright greed, or simply part of how we reward people, I think we have to consider a) what the goal was and b) how effectively the payment accomplished the goal.

Equity is a great example. Fred likes it because it aligns the interests of the company (by some metric of profitability) with the interests of the CEO. Make us more money and we'll pay you more. But is that the right way to run a company? Imagine a situation in which I make a five year, year-over-year increase in EBITDA by taking a company's reputation and brand name and driving it straight into the ground. After five years, you fire me or I quit (probably with nice severance), you get a sucky brand that some other CEO now has to try and rescue, and I get my juicy bonuses that occurred along the way. I could make Charles Schaub into the next Girls-Gone-Wild and probably increase profits, at least for awhile - certainly long enough to make a buck.

Compare this with Barry Schwartz's recent TED talk, where he essentially talks about the use of agency. We have a psychological affinity for doing the right thing, when we are shown that it is, in fact, the right thing and worth doing. This is the common Zappo's point, and yes yes, I know it doesn't make anyone a bazillion dollars overnight and any number of VC's will throw rocks at me for pointing it out. But look at the great generals throughout history, who have commanded troops into battle. The lesson they constantly point out is that you can't threaten people into being good soldiers, and you can't buy them into it in any reasonable way: you have to actually inspire them.

So how do you do that in a structured way?

First, give people segregated gains. Low/no bonuses, decent/high salaries, and perks that actually count. I don't mean golf games with other rich CEO's, I mean perks like decent working hours and lowered pain points - more assistants and agents that make your life, as a CEO, better. If you're a startup, most CEO's would actually be more satisfied in life if they had someone to help them share the load and keep them healthy and on track than with a bonus. If you're a larger company that already has an assistant, there are still pain points that can be removed. Think of the number of CEO's that wish they just had someone around to sort out their technology or to optimize their life so they didn't feel stressed and overworked 99% of the time?

For non-CEO's, give them the same. The amount of rubbish the average mid-upper management person has to do to fill out reimbursement forms is ridiculous: spend ten thousand bucks and get a system that makes it so painless that they don't have to think about it (or pay someone to do it for them). Give them autonomy, a la Google's 10% time, to actually pursue things that are interesting. And I don't mean just "go and think about it" time, but honest to god resources, where they can have a side project that you'll actually assign an engineer to actually build. If you said "do you want $10K of a personal bonus or this side project", they'd almost always say the money for themselves. But if you actually did both, you'd find the side project would probably actually make them happier, more satisfied, and more productive.

The money you spend on bonuses can give people a lot of chances to actually do good in the world - people have a psychological need to be productive and to feel like they are actually doing good things in the world. AIG money is hush money in some ways, in that it is compensation for feeling shite about what you do, because it doesn't actually seem to have a positive impact on people. Give them a chance to do something good and make a difference - human interaction is more important than it looks.

Re: Bonuses

Anton — Mon, 23 Mar 2009 15:24:02 -0000

Is it worth considering that AIG's bonuses are quite possibly hush money? The mistakes made at these banks crosses the line from gross negligence to what might be considered a massive ponzi scheme.

If AIG's bonus defy outward logic lets rethink what they might be hoping to accomplish.

Re: Bonuses

fredwilson — Sun, 22 Mar 2009 10:42:37 -0000

Great points Jay

I really wasn't trying to trash the AIG bonuses, I was just saying that they
have unleashed a ferocious backlash

I don't know enough about the AIG bonuses to opine on their merit, but it
seems like there were good reasons behind them (at least the stay bonuses)

JLM's comment in this thread is a good read on that topic

The point about boards in VC backed companies giving stay bonuses is
certainly accurate and I have been party to them on a number of occasions

Re: Bonuses

JayR — Sat, 21 Mar 2009 16:17:42 -0000

The decision to incentivize traders to unwind books is happening throughout the financial industry. When viewed in the context of when that decision was made - the AIG plan apparently was adopted in March 2008, before the worst of the market meltdown - I'm not sure how unreasonable a decision it was.

And not unheard of in the VC world, either. Fred, as you know, boards of VC-backed companies have been known to adopt "stay bonuses" or "management carveouts" in certain circumstances. Typically, it's when the board decides that it is time to sell the company and fears that if management leaves, there won't be anything to sell. A shareholder in that company (particularly one who may have been crammed down several times by financing rounds) may have some of the same type of anger that we're hearing today about the AIG bonuses. One could ask why management should be "bonused" (an appropriate word in this context) when arguably they have run the company into a position where their equity participation in the company doesn't provide sufficient motivation for them to stick around. The answer, from the board's perspective, is that they saw it as a rational way to try to maximize shareholder value.

Why is the AIG situation different? A few reasons that don't really have anything to do with whether some type of retention plan was appropriate at the time it was adopted. Obviously the optics of having bailout money go to people that are perceived as superwealthy (and who are all being portrayed by the demagogues as crooks and co-conspirators, when that is far from the reality) plays big, and there are lots of issues under discussion about who knew what and when. But much like I expect to see management carveouts and pools remain facts of life in VC-backed companies, AIG was hardly the first company to adopt a retention program, and it won't be the last. And given the economic realities faced by the company back in March 2008, which are now being played out in trading floors all over the financial industry, it doesn't seem like so much of an outlier.

One can argue whether EBITDA-driven compensation plans and equity-based incentive plans are appropriate AS A GENERAL RULE. But no matter how idyllic they may be, boards face circumstances from time to time when they can reasonably determine that the general rules of thumb may not work.

Re: Bonuses

fredwilson — Sat, 21 Mar 2009 10:41:11 -0000

I think "when government funds business, it messes everything up"

http://www.avc.com/a_vc/200...

Re: Bonuses

nil — Sat, 21 Mar 2009 04:21:50 -0000

I feel this whole thing is a diversion from the real deal, what is your take fred ?

http://www.bloomberg.com/ap...

Re: Bonuses

fredwilson — Fri, 20 Mar 2009 18:02:20 -0000

Good one!

Re: Bonuses

KJCANTERBURY — Fri, 20 Mar 2009 15:04:37 -0000

Lets discuss government employee bonuses. Certainly they are not in a category with corporate bonuses but they are a well kept secret of upper level government managers. They like to let a few dollars trickle down to the peons through performance awards but they keep most of it for themselves. There is little difference between corporate and government bonuses.

Re: Bonuses

danl70 — Fri, 20 Mar 2009 12:07:52 -0000

With all the AIG crap i think this shirt is timely:
http://www.recessionjunctio...

Re: Bonuses

fredwilson — Fri, 20 Mar 2009 10:46:24 -0000

I am with you

Re: Bonuses

Eben Thurston — Fri, 20 Mar 2009 10:38:29 -0000

I haven't heard a compelling argument for why government bailouts were a better solution to AIG's insolvency than to let them file Chapter 11. Bankruptcy served the economy well for hundreds of years. What changed in 2008?

Lehman's liquidation seemed a lot more efficient and less destructive to taxpayers than the handling of AIG. Bankruptcy seems like the best way to deal with bankrupt firms.

Re: Bonuses

fredwilson — Fri, 20 Mar 2009 09:21:16 -0000

The percentage of deals I've been invloved in over the 22 years I've been in
the VC business where there has been a cramdown is actually pretty small.

It was quite common post bubble in 2001-2003, but if you take out those
years which were unusual in many ways, I bet that less than 10% had
cramdowns

Re: Bonuses

fredwilson — Fri, 20 Mar 2009 09:19:16 -0000

I get that. I was not suggesting that the typical bonus approach for venture
backed companies is appropriate for wall street.

And I take the word "miserly" as the highest compliment!

Re: Bonuses

karen_e — Thu, 19 Mar 2009 21:27:16 -0000

You guys are cracking me up. I'm trying to figure out how to get my brackets around one of Andy's fatty checks. Major fantasy b'ball around here.

Re: Bonuses

Bulging Bracket — Thu, 19 Mar 2009 18:18:02 -0000

Harsh on the employees who aren't already wealthy. Especially with the typical equity cramdown and expected "reasonableness" of founders/management on taking hits to their portion of the equity pool when getting additional financing.

Re: Bonuses

Bulging Bracket — Thu, 19 Mar 2009 18:12:20 -0000

Finance prefers bonus because it lets them have some discretion over payouts at the end of the year. There are HUGE fights by management to avoid explicit formulae for payouts, "direct-drive bonuses", since it can create huge payouts and create pressure for reduced discretion across the board - which would end up with more going to the lower echelon employees and less to political stars. Bonus is applied universally to obscure who is on a fixed compensation structure and who is at the whim of management, leading to more people being at the whim of the execs.

Almost all of the work at finance firms is sales and has a direct, personal P&L. The overall performance of the firm means nothing, unless they go bust. A decision was made that AIG shouldn't go bust, so you need to pay the sales people.

AIG used to have an excellent equity program that acted as golden handcuffs for management. This was mostly destroyed by Spitzer's Quixotic attack on Greenberg. Without that, guaranteed bonuses are the only way to keep people who are critical to the operation and highly vulnerable to poaching. There's no liquidity event on the horizon that's going to pay them tens or hundreds of millions of dollars, unlike a startup.

You're demonstrating a blinkered, parochial take on this, along with the typical miserliness of a VC. Compensation structures, like capital structures, have many appropriate forms depending on the specifics of a company. AIG's comp looks to be basically appropriate. Properly structuring and balancing compensation time horizons is a universal problem that more than a few people are working on. Problem is that you get killed over it no matter what you do - media and congressional hits over payouts of multi-year deferred compensation and stock options are the stock in trade of the Corporate Library.

Re: Bonuses

fredwilson — Thu, 19 Mar 2009 16:51:35 -0000

This is important stuff JLM and if everyone knew it and understood it, we'd
be way better off

Re: Bonuses

JD1 — Thu, 19 Mar 2009 16:20:59 -0000

There are two general points I wanted to make:

1. The AIG retention bonuses.

People are scratching their heads as to why they needed to pay this. Essentially, this is not really to keep the paper pushing managers around, but they were largely promised to the group of derivative traders that largely blew up the firm in the first place.

The reason is a handful (approximately 5) traders who ran this 2.6 trillion dollar book of exotic contracts are, unfortunately, the only ones who know it well enough to unwind it and sell it off to reduce risk. After things blew up they were ready to leave the firm, so AIG said, stay around for a few months, do a sane job unwinding the positions, and we will pay you this amount. Unfortunately, they had no choice. If they had left, unwinding the positions stupidly would have cost taxpayers, tens of billions, easily. Again, this was a 2.6 trillion dollar book. It would have taken any outsider 6 months to a year to even figure out what was in it, let alone unwind it.

So they made a terrible, but necessary choice. Pay 150 million to these guys to make sure billions were not wasted. Terrible? Yes, of course. But also entirely logical. Sometimes, an offensive, completely unfair and morally disturbing path can still be the most optimal solution. Remember, when wall street banks got together to take over LTCM in 1998, even they continued to pay salaries to the people who blew up LTCM in the first place. They were really angry about it, but they knew only they could effectively wind down LTCM's positions.

2. While I somewhat sympathize with this view that money from the AIG bailout immediately went to counterparties like GS, an important clarification needs to be made.

As is the normal course of business, many investment banks will take out insurance on their counterparties. So GS had an agreement to receive money from AIG, but just in case they also simultaneously purchased insurance that if this agreement was not fulfilled, the insurance would make them whole. In this case, this insurance was CDS on AIG.

So there were two possible cases:

AIG gets bailed out: the bank receives the money as per the contract, but the insurance on AIG expires worthless as AIG did not default.

AIG does not get bailed out, and defaults: Sure, the bank no longer receives the 12 billion per the contract, but the CDS insurance contracts on AIG get paid out so they are still made whole.

So the incentive to see AIG bailed out is not as nefarious as everyone believes it is, the worry was less about the 12 billion (they would have largely gotten it either way) and more about the risk to the system as a whole. A more intelligent argument is that who really got bailed out was the CDS seller in this case, but that is not as anger and conspiracy theory inducing as this currently popular view that Goldman engineered the bailout for its personal gain.

Re: Bonuses

anumberone — Thu, 19 Mar 2009 11:37:27 -0000

Very good post. I agree with your view on bonuses and also AIG. It should be spun off and let the profitable components of the business survive. Here is one company that is being spun off from AIG - http://www.travelguard.com/

As long as the government is mucking around with our economy, there won't be a recovery. It will take the innovation of small business to drive it forward. Let's see, where is that Reagan quote..oh yeah -
'Government's view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. And if it stops moving, subsidize it'- Ronald Reagan

Re: Bonuses

Robb — Thu, 19 Mar 2009 11:29:25 -0000

<<...suggested we all cancel our policies with AIG. I am with her on that
one. We won't be AIG customers in short order. If you'd like to join us in
our own populist revolt, please do.>>

GENIUS idea! That would be the PERFECT and ideal way to really screw the
owners (the American taxpayers). Without customers, they'd be certain to lose every penny of their $170B investment!

Re: Bonuses

unclaimed — Thu, 19 Mar 2009 09:07:54 -0000

The $164M in payments being made to AIG-FP employees are not bonuses, they are payments under an Employee Retention Program (ERP) that the Firm put in place early in 2008. The agreement was publicly released yesterday when Liddy testified to Congress:

http://dealbook.blogs.nytim...

Please refer to Steven Davidoff's assessment of the contract and the questions he raises in this posting:

http://dealbook.blogs.nytim...

AIG-FP employees committed to their jobs and in some cases put their lives on hold and passed up career opportunities because their employer asked them to. They made those commitments under the terms of the ERP which is the agreement that they were operating under for the past 12-15 months. Given AIG's situation, we are right to question the payments, but the more relevant and more important question to ask is why did AIG and AIG-FP executives feel that it was necessary to lock in AIG-FP employees under such generous terms that no one would likely leave their positions?

Re: Bonuses

fredwilson — Thu, 19 Mar 2009 08:57:22 -0000

All of that is true. But I don't want to do business with that company any
more

Re: Bonuses

fredwilson — Thu, 19 Mar 2009 08:33:17 -0000

Well if that's what it is, that's what it is.

No sense pretending its something else

Re: Bonuses

fredwilson — Thu, 19 Mar 2009 08:28:12 -0000

I agree with all of it. Blanfein (GS' CEO) was in the room when the decision
to bail out AIG was made apparently.

Anyway, what needs to be done is for the good assets inside of AIG must be
spun out and/or sold and rebranded immediately

And the rest of AIG needs to be liquidated

Re: Bonuses

Leon Liebman — Thu, 19 Mar 2009 07:03:34 -0000

I don't see that canceling insurance business with AIG advances the game. First, as far as I can see AIG does not have a serious insurance business problem. Second, we are punishing ourselves since "we" own the majority of the AIG shares. Third, we are treating "good" and "bad" employees alike.
So, first, deal with the recipients of bonuses in the disaster segments of AIG. READ THE CONTRACTS. It seems no one has asked what did AIG and the employees agree to. Is there any contract language that an employee's actions must be "prudent" and consistent with the goals of the business or any other similar language? If yes sue to rescind and recover the entire bonus amount from the individual based on a breach of contract.
Taking money from the company is not what it is about. Punish the miscreants. Recover, in the courts if ecessary, from them. For this year leave others alone. Reward the (relatively) good; punish the absolutely bad.
And revise the new bonus plans in line with your suggestions. Consider adding a provision that 100% of the bonus will be paid 40% on the current year award date and 30% on each of the two succeeding award dates.
BUT, RIGHT NOW, READ THE CONTRACTS. In fact, with names redacted, publish the contracts for the indirect shareholders (that's us) to read.