The Myth of Dick Fuld

Wall Street critics often say that compensation should be in long-term restricted stock so that managers and employees do not have the incentive to take excessive risk, make big money in good years, deposit the cash in their bank account, and then escape to their private islands when their bets blow up the next year. Wall Street defenders like to point to Dick Fuld, who supposedly lost $1 billion by holding on to Lehman Brothers (LEHMQ) stock that eventually became worthless. You don’t get more of a long-term incentive than that, the argument goes.

Lucian Bebchuk, Alma Cohen, and Holger Spamann have exploded this myth in a Financial Times op-ed and a new paper. They look at the CEOs and the other top-five executives of Bear Stearns and Lehman Brothers. (All numbers are adjusted to January 2009 dollars.) From 2000 through 2008, these ten people received $491 million in cash bonuses (Table 1) and sold $1,966 million in stock (Table 2); on average, each person took out $246 million in cash. (Both Lehman and Bear had rules that prevented top executives from cashing out equity bonuses for five years from the award date–see p. 16 n. 33.)

At the beginning of the period (2000), these ten people had $1,398 million in stock and options (Table 5; option value calculated conservatively as the current difference between market price and exercise price). So on average, each one had $140 million in stock at in 2000; received $49 million in cash over the next eight years; sold $197 million in stock; and lost the rest in 2008 when their companies collapsed. Dick Fuld began with $301 million in stock, received $62 million in cash bonuses, and sold $471 million in stock before losing his supposed $1 billion.

Let’s put this in perspective (insofar as it’s possible to put these kinds of numbers in perspective) two different ways. First, let’s say you’re a bank CEO with a lot of wealth tied up in stock. Satan comes along and offers you the following deal: if you undertake a strategy with a lot of risk, every year you will get a cash bonus, every year your stock price will go up, every year you will be able to sell some (but not all) of your stock at this higher price, and every year you will get more restricted stock awards–until at some point everything collapses and the stock becomes bankrupt. Would you take that deal? Of course you would. Yes, it means that your losses in the final crash will be bigger than with a more conservative strategy. But it means that you would make a lot more money in the meantime.

Second, let’s say you’re a house flipper in a rising market. You buy a few houses with borrowed money, sell them at higher prices, buy more houses with more borrowed money, sell them at even higher prices, buy yet more houses, etc. Each time you sell you take out some of the money as cash and put the rest back into the housing market. At some point the market crashes and you lose the houses you were holding onto at the end. But in the meantime you stashed millions of dollars of winnings in your bank account. Did you do well by using leverage to maximize your risk in a rising market? Of course you did, even though you lost a lot in the crash.

Now, there are things in life besides money, and Dick Fuld has no doubt suffered tremendously in the past year. And at this point, maybe he would gladly give up that $533 million he took out to see a healthy Lehman Brothers. So yes, there are other reasons why CEOs do not want to see their banks blow up. But holding a lot of restricted stock is not necessarily one of them.

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