Academic

Only rarely does history supply a direct answer to current questions but it furnishes many perspectives through which to view the present. I'm grateful to the organizers of The Conglomerate for inviting me to blog, on this occasion about executive compensation. My current thoughts reflect two books I read over the holidays, both well-written but each a window into its own era. Toward the end of The Big Short (2010), Michael Lewis observes that "What are the odds that people will make smart decisions about money if they can get rich making dumb decisions?" Put differently, what worries Lewis is the risk that the incentives that channel greed aren't necessarily calibrated to encourage smart decisions. And, in the book's saga of derivatives transactions and traders, although abundant rewards came to those who perceived the wisdom of finding a way to short subprime mortgage bonds, those on the wrong side of the transactions did not walk away poor even when their firms collapsed. 

Pressing a bit further, decisions that are dumb may have negative effects for particular firms and their constituents, including shareholders. But, as we know, the adverse consequences of some dumb decisions extend more broadly. Some reforms to executive compensation practices - say-on-pay, more disclosure, greater focus on the composition and independence of boards' compensation committees - may help but also seem at best indirect responses to managerial decisions that create major systemic risks.

Much more of my vacation reading time was occupied by TJ Stiles's biography of Cornelius (a/k/a "Commodore") Vanderbilt, The First Tycoon (2009). When the Commodore died in 1877, the $100 million value of his estate's assets if then liquidated for cash would have taken out of circulation one out of every twenty dollars then in circulation (including demand deposits) in the United States. The Commodore's wealth stemmed from a long career of dominance of leading modes of transportation - first steamboats, then railroads. To his biographer, the Commodore is a sympathetic but ruthless figure who built his wealth as an owner and manager of the business firms he controlled. The Commodore's compensation came through dividends on stock; he managed his businesses as his own property. Stiles contrasts the Commodore with his competitors, top executives of the Pennsylvania Railroad, who were professional executives who rose through the compay, owned little stock in it, and demanded kickbacks from outside contractors who did business with the railroad. 

The Commodore's business adventures did not all succeed - the failed Atlantic-Pacific transit route through Nicaragua, for example- but perhaps most interestingly for our times, he emerged unscathed through the Panic of 1837. The Panic followed an asset bubble - much debt incurred on the basis of high expectations for cotton prices, all to collapse when the Bank of England restricted credit. Although many of the Commodore's debtors defaulted, he never lent on the security of cotton consignments, instead demanding prime real estate as collateral. The market value of shares he held declined, but he invested to secure operational control or longer-term gains, and he held plenty of cash. "Cold, hard cash" according to Stiles - silver shillings and gold coins paid for fares. And the steamboat business remained in demand.

To be sure, the Commodore's saga also amply illustrates anticompetitive and manipulative business tactics later to be prohibited or regulated. The larger picture is of incentives that encourage making smart decisions.