With the bonus battle reaching new heights of frenzy, this piece in the WSJ from Professor Macey of Yale Law School jumped out. An excerpt:

"These paychecks are highly rational from the shareholders' perspective...[the] bonuses are big and they are unremittingly linked to performance.

What Mr. Obama and others apparently fail to understand is that the banks' own shareholders benefit from these huge performance bonuses. The bonuses are paid to those who make large profits for their employers—that is, they are linked to performance."

This is, of course, the linchpin of the we-have-to-pay-this-much-or-the-talent-will-walk argument. But what is this "performance" measure that anyone curious to ask about is hard pressed to find defined in mainstream media?

Academic literature is reasonably rich in plausible answers. A notable 2008 paper comes from Smith & Swan and describes increased equity and bonus awards to CEOs as the "road to riches" for shareholders. "Performance" is measured by Return on Assets for operations and by Tobin's Q for firm valuation.

Contrast this with the conclusions in a paper from last month by Michaud & Gai.

"Do CEO compensation schemes in large public companies relate to public company performance? Our empirical research shows that firm’s performance is not affected by CEO compensation.

Does a pay “incentivized” public CEO enhance firm performance? If so, to what degree does this occur? Our empirical research shows that the incentive components of CEO compensation packages including bonuses, stock options, and stock awards do not affect firm performance.

If CEO compensation does not influence firm performance, then how do we account for the relatively high levels of CEO compensation? What factors drive CEO compensation? Our empirical research indicates that that primary factor driving CEO compensation is firm size (measured in net sales). We note that is most likely due to CEO compensation benchmarking and the perception by compensation consultants, boards, and CEOs themselves, that there is a limited pool of talent that can manage large cap U.S. public companies."

Confused? Well, "performance" looks mighty different when considering - not unreasonably - if it means increasing shareholder wealth as defined by a measure (Economic Value Added) that is less artfully determined than Tobin's Q. Looks like Professor Macey may have assumed too much on the shareholder benefit front.

Lurking inside this argument of definitions is the directly related issue of handsome upside compensation versus no downside financial penalty. Try betting all-in at the poker table every hand and disaster awaits. Yet the feeling is that one would be an idiot not to do exactly that when in the world of investment banking compensation structures.

Watching bonuses being paid out this season thanks to the unique episode of massive global government intervention only reinforces this feeling; and efforts to bring symmetry to the problem (clawbacks, the cancellation of deferred share etc) look more like politically expediency than rueful recognition of good fortune and moral hazard.

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