When Is a CEO's Bonus Well Earned?

Dear Reader,

Vedran here again, filling in for David Galland. With the presidential debate this last Wednesday, it would be impossible to ignore the elephant in the room and write this issue without mentioning it. However, I don't want to start another debate on what a Romney administration or another Obama administration might resemble. Such conversations involve much speculation and often get us nowhere. Obama's second term could be far different from his first in terms of government expansion and regulation. And Romney... well, does anyone really know what he stands for? And even if you think you know, what his presidency would really be like is another question altogether.

What I'd rather discuss is the problems that aren't going to disappear regardless of the winner. If you believe that four more years of Obama or Romney are going to solve all of the world's problems, you're just kidding yourself. Unfortunately, the world's problems are bigger than ever. Believe it or not, the US presidential election is not the most important event on the planet right now. Let's get started with a list of issues which aren't going away.

1. The Federal Reserve Will Keep Printing Money. Have you noticed one thing that didn't change from Bush to Obama? If you guessed Ben Bernanke, you'd be correct. But this isn't the first time it's happened. Greenspan was around from Reagan to Bush to Clinton and then Bush Junior. And Volcker before him started with Jimmy Carter and ended his career toward the end of Reagan's last term. What the Federal Reserve does is out of the hands of Congress and the president. Regardless of who wins the election, the Fed will stick with near-zero rates until mid-2015. Even another Fed Chairman likely wouldn't reverse course at this point. When you've promised the markets zero rates for years, they'll freak out if someone starts pushing them upward.

1. Europe's Problems Aren't Going Away. In the US, we have a tendency to believe that the world spins around us. At certain points in history that was certainly true, and it might be true again, but at the moment, the integrity of world markets is dependent on a few usually insignificant countries. In some ways, the politics of Spain is more important for the next few months than our own. On a larger scale, the politics and deal-making within the European Union is really the stuff worth paying attention to, rather than Romney and Obama.
   
   While Obamacare might be a central issue for the US, guess what? Nobody else in the world really cares about our system of health care. While this election deals with many domestic problems, it does almost nothing to solve international problems. Imagine this scenario. The US gets the perfect healthcare plan and everyone celebrates. Then, a year later, a few key European countries default and we rapidly fall into an even deeper recession. This is a very real possibility - except for the part about there being a "perfect" healthcare plan. On a global scale, our election doesn't really matter that much right now.

1. The Middle East Continues to Boil. Some people say that Obama has improved our relations with the Middle East. However, looking at the recent embassy protests, that's becoming a harder case to make. Even if there has been some improvement in foreign relations, it hasn't been much. At this point, we've been there too long and pissed off too many people. Our problems in the Middle East aren't going away any time soon. Even if the next four years of foreign policy takes a complete 180-degree turn, we'll still likely to be dealing with the repercussions of past poor policy for years. Now, maybe we'll be lucky and nothing too bad will happen in the Middle East in the next four years. It's quite possible. However, the risk of a new war isn't going away with the election of either candidate.
   
   To sum up this point, no jihadist is going to wake up the morning after election day and say, "Whew, Obama (or Romney) won. Now I'm going cancel my plans to blow up that checkpoint in Kabul."

1. China Worries Continue. If the US recovers, of course China will do a little better. But nonetheless, there are concerns for the country's long-term course. Is the slowing in Asia the result of the recession, or is there something deeper? With government spending driving much growth in China, the slowing could be the ultimate result of the government stimulus programs. All stimulus programs come to an end, and when they do, the economy feels it. Even if China picks up speed again, there are other problems to worry about: inflation; a housing bubble; and a troublesome managed currency.
   
   I won't go into all the details here, but the point should be simple: China faces major challenges which can spill over into the global marketplace. Those problems aren't going away with either an Obama or Romney administration.

In the past few decades, the US has been the center of the world. However, with the emergence of China and other markets and the organization of the European Union, other political decisions are often just as important as our own. Does this mean that we're completely helpless to international winds of fortune? Of course not; in this recession, some countries are clearly doing better than others. We could implement better policies, which would alleviate much of the suffering. Nonetheless, even the countries with lower unemployment rates and better growth are still sluggish. While things might be better elsewhere, they certainly aren't great either.

With this election season, we need to be realistic. Regardless of what happens with our candidates, there are still plenty of troubles worldwide to worry about. And those problems are big enough to drag us down with them. Even if my favorite candidate - Ron Paul - were somehow miraculously elected by write-ins, he wouldn't be able to solve all the world's problems. Unfortunately, the dangers in the economy extend far beyond our shores.

When Is That CEO's Bonus Wrong?

By Vedran Vuk

The press despises CEOs getting raises on top of bonuses on top of stock options, while the rest of us are barely keeping up with inflation. However, there's a special level of anger reserved for those CEOs whose bonuses go up when their profits and stock prices go down. We should be angry, right? Aren't losses matched with bonuses a clear sign of poor corporate governance? Actually, this isn't always the case.

Certainly, if the CEO has performed poorly, he doesn't deserve a bonus. However, how does one define performance? Despite what most people think, profits and the stock price aren't always the best metrics. No, I haven't gone crazy. Think about this from a non-corporate perspective.

When a crew member on a sinking ship saves the lives of dozens, there's only one word to describe him or her - hero. All sorts of adoration and sometimes even awards are bestowed on such individuals. However, what if we treated this hero like the media treats a CEO facing losses? "Hey, this crew member might have been responsible for sinking the ship. Perhaps he's no hero at all. Forget about the lives he saved; he and rest of the crew are responsible for the sinking."

Before throwing the CEO or your poorly performing stock overboard, there's a few questions to ask yourself about management with the ship example in mind. First and foremost, did the CEO sink the ship? It's one thing if the CEO was navigating through a hurricane and he hit the shore. It's a whole different matter if he sank the ship thanks to his bad decisions.

Second, once the ship started sinking, how did he react? Did he save almost everyone onboard, or were his evacuation plans even worse than his navigation? If he sank the ship but saved the crew, it's a gray area. You probably still want to throw him overboard. However, if the ship ran into a major hurricane and the CEO's decisions saved the whole crew, then he might be rightfully a hero.

The same goes with managing a company. If the company lost $500 million, we might immediately consider the CEO to be a failure. But what if the CEO's decisions saved the company from losses of $750 million? Without his decision-making, things would have been worse. Now, I'm saying this from a personal perspective, but if someone saved me $250 million, I wouldn't feel so bad for giving him a $5 million bonus for a job well done.

Whether a CEO deserves his bonus or not isn't always black and white - or should I say "in the black or in the red?" Sometimes one can give an excellent performance in bad times.

There's also a flip side to this issue. There are times when companies are making record profits, and the CEO doesn't deserve his bonus. This is particularly important in commodity-driven industries, such as mining and the oil industry. If the price of gold or oil shoots through the roof, the profits of most mining and oil companies are going to go up as well. In turn, the CEOs may get special rewards for meeting certain levels of profitability or share price, or they get a huge payoff from their options finally being in the money.

However, they didn't do jack to earn those profits. They just happened to be the lucky schmuck sitting in the CEO chair when the gold price jumped 30%. In some cases, higher gold prices might actually be hiding incompetence. While total revenue is up, production might be down, but the CEO gets rewarded anyway. While the money is good, lots of people will shrug off otherwise poor performance. But consider that someone who is underperforming in good times is probably going to be a disaster in bad times.

Firms with a proprietary trading division - mostly banks as well as companies with commodity derivatives trading departments - often face the same situation. The trading group will make a huge profit, and as a result of the success, the CEO will get a bonus as well for a good year. However, we can't attribute the success of the traders to the CEO. If the CEO had the idea to expand a new division into Asia and the division did very well, then he deserves a reward. But in the case of the trades, it's hard to argue that the CEO's plans contributed to their success. If you tell your shareholders and analysts that part of your plan is the traders getting lucky next quarter, things will not go over well.

When you're looking at the management of a company, it's not simply about being in the plus or the minus. Instead, it's about having a CEO whose decisions are cutting losses in the bad times and whose decisions are outperforming the competition in good times. That might be hard for the media to sort out, but as an investor, you can get ahead by putting aside that bias and judging performance objectively.

Cheers

West Coast Guy