Thursday, November 29, 2012

The Perils of Winding Down

I drove home listening to a left-wing talk radio show that focused on the $1.8MM in bonuses that Hostess Brands is using to retain 19 executives during its wind down. They thought this was pure evil and unfair.  Hostess has hundreds of millions of dollars in assets, so this is at most 0.5% of the value of the firm. For a top guy to get an extra $100k to do this correctly seems cheap.

It reminds me of a case where after a blow up in the convertible bonds space around 2006, the firm decided to wind the fund down. They told employees there would be no bonuses, just wind down, and leave. So one guy sold his portfolio at bargain basement prices to his favorite brokers. He then had lots of credit in the favor bank, and was able to land a great job at a new firm, which since then has done very well. 

Another fun story is when Niederhoffer blew up in 1997. As the fund was being liquidated, the agent for the liquidation with no skin in the game went to the pit to close out a large amount of eurodollar positions. Everyone knew he was going one way, and when he asked a price, they all stopped and looked at each other, silent. Eventually he sold his positions at such a low price, it was the best day ever for at least one firm there. The liquidator did not act in the investor's best interest, but he was not incented to.

 When someone is in charge of a lot money, if you take away direct incentives, they will game the system indirectly. It's foolish to think people in charge liquidating hundreds of millions of dollars will do this without simply giving away stuff to people that can (and will!) be helpful to them later. Navigating the favor bank is part of life, and people act in the self interest.


Dan said...

So, what would stop an executive to get the million $ bonus and also sell the assets to his favorite broker?

Anonymous said...

What about honor? is that just totally shit now?

Anonymous said...

So you're basically implying that without "incentives" ie: bribes, the people representing the company aren't going to do their jobs?

Somehow I get the feeling that the problem here isn't that a liberal radio host attacked incentives, it's that corporate employees above a certain level _require_ bonus incentives before they'll do their job.

Anonymous said...

And further perhaps there should be criminal punishment for people who manage large amounts of money and don't do their jobs properly without large bribes.

Anonymous said...

So, what would stop an executive to get the million $ bonus and also sell the assets to his favorite broker?

Condition the bonus on selling the assets for a good price.

Anonymous said...

Not that I disagree with your assessment of what happens without the bonuses, but think for a minute of how this looks to anyone other than a C-level executive type:

"These guys are psychopaths who will sell your grandmother into slavery unless you pay them several millions dollars in bribes"

Mercury said...

You guys who are *shocked!* to learn that incentives matter and that the default setting of human agency is self-interest may want to pause and consider why/how is it that top tier public "servants" manage to get so rich despite relatively modest official compensations.

One small example: If Hostess were a healthcare company that sold pills instead of cakes each bit of not-yet-public information related to government approvals, trials, contracts, investigations etc. would be sold by government employees (perfectly legally) to consultancy outfits like this one
founded by Ted Kennedy's son - who then turn around and sell it to hedge funds and other money managers.

And no this kind of thing was explicitly not covered by the recent insider trading prohibition that Washington slapped itself on the back for.

Anonymous said...


No one denies that top tier public servants are psychopaths, or at least supreme narcissists, who would sell your grandmother into slavery unless they are appropriately bribed.

On the other hand, there is no theorem in economics which says high level executives automatically get millions of dollars in compensation. There are lots of important, dangerous, high stress jobs that require long hours and only pay $40k/year. Under the right circumstances in a free market, being a C-level executive might only pay that much as well.

But however much or little they do get paid, it's expected they will act in good faith in the performance of their duties. For those making millions, there is the additional expectation that they are phenomenally good at their jobs.

The type of people Eric mentioned, on the other hand, are basically saying “we took massive compensation and screwed everything up, but unless you bribe us with additional millions we’ll screw you over even more”

Anonymous said...


You're dodging the fact that incentives are important no matter what level you're at. That vague 40k a year job you mentioned that has long hours and a dangerous work environment is currently being filled by an employee who chose to be there and has determined that the incentives (40k salary) is enough for her to do that job. Also from what you explained I bet that position we're talking about requires the skill set and expertise of a large percentage of the population. I'm betting the percentage of people who are best for efficiently winding down a complex corporation like Hostess is far smaller.

Entsophy said...

Most people don’t need any incentive to perform their job in good faith and they need relatively little incentive to perform it well. They start out assuming they’ll do that much and then try to be as well compensated for it as possible.

These knuckleheads start out with the assumption that they’ll be well compensated and maybe if they feel like it they’ll act in good faith and occasionally they’ll do a good job.

I’ll defend anyone’s right to be extremely well paid for delivering extreme value, but the idea that these wretches haven’t been incentivized enough to be honest and competent is insane.

Entsophy said...

Also since the subject of the post was about aligning incentives to job at hand, its worth mentioning that not all incentives are monetary. If these kinds of mercenaries took a substantial hit to their reputation (especially if strong enough to hurt future employment) for this kind of behavior, that would also provide incentive for them to do the right thing.

But for that to work, people have to be scandalized by that kind of behavior. Simply excusing it with the notion “what do you expect? We’re all just stimuli-response animals” reduces the total incentives involved. If society or the company involved can create non-monetary incentives which drive the executives to do the right thing then who exactly is hurt by that other than the executives?

It seems to me like society and shareholders both would benefit from more of those non-monetary incentives. Let the outrage begin!

Aaron Davies said...

The original “Two Things”: “One: Incentives matter. Two: There’s no such thing as a free lunch.”

Anonymous said...

Two more things:

One: some incentives don't involve money
Two: lunch is never free, but the bill doesn't always have to go on your tab.

Anonymous said...

Paying 1.8MM to 19 executives (just under 100k per employee) is a pittance to ensure that you get the best prices for the assets being liquidated. Would you prefer these executives simply threw the keys into the bushes and walked away? I get the sense that those posting that this is "unfair" would not feel this way if the 1.8MM was paid to the government to assure a proper liquidation.

Anonymous said...

"Would you prefer these executives simply threw the keys into the bushes and walked away?"

What I would prefer is for them to have done their job so that there was no liquidation in the first place.

Short of that I'd prefer they get the best deals possible in the liquidation and do so for no more than their current high salaries. Then the 1.8MM would go to creditors and stockholders.

If they can't be trusted to do that then fire them and pay someone else 1.8MM to liquidate.

Anonymous said...

"I get the sense that those posting that this is "unfair" would not feel this way if the 1.8MM was paid to the government to assure a proper liquidation."

No one here was saying it was unfair or even implying that. And absolutely no one is here is interested in the government getting involved in any way.

The issue is whether stockholders are getting ripped off by their high level execs. If the corporate finance books are right the company should be run primarily for the benefit of the stockholders. The company should take care of their employees and executives only in as much as it benefits the stockholders.

Executives had no problem making this very same argument to the workers when they asked for their initial cut in pay and benefits a few years ago. But when the exact same argument is made against them it's all of a sudden communism.

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Entsophy said...

The pro-bonus crowd seems to base their position on the assumption that 100k represents the free market price of those services. If you'd ever seen high level Execs interact with their board however, you'd know that the 100k bonus is not even close to being determined by market forces.

$10 is pittance. $100k is board members padding the pockets of their failed executive brothers at the expense of absolutely everyone else involved. There is no law of Man, God, or Capitalism which says this has to happen or is good when it does happen.

Steve said...

I don't think it's incentive to act in good faith - most people are going to act in good faith anyway and frankly a bonus does not enforce good faith.

The biggest problem is keeping these people around until the job is done. They know they need to find a new job so they might as well start looking right away and when they find one they will leave immediately, even if they are in the critical path for a hundred million dollar asset sale. Being the last rats on the ship is no fun anyway.

These people know the assets, know how to sell them, and are impossible to replace in the time available. Their regular salary is incentive enough to do a good and honest job. The bonus is to compensate them for beginning their job search *after* the job is done which will presumably leave them without income for a period of time.

Steve said...

Another thing the talk shows don't understand is that the $1.8MM isn't coming from the pockets of workers, it's coming from the pockets of creditors. The creditors have zero interest in giving away free money (which is why the baker gets no bonus). But the creditors (or their representative) have made the judgement that the $1.8MM payments are going to help protect the value of the billions they are owed.

Tel said...

It is hard not to ask the simple question that if executives were doing an excellent job of managing the company, then why is it facing bankruptcy?

If the executives really aren't much chop, then why not at least hire someone else for the liquidation and just march those guys out the door on the spot? I don't think you can build a working Capitalist system around the principle of rewarding failure.

They told employees there would be no bonuses, just wind down, and leave. So one guy sold his portfolio at bargain basement prices to his favorite brokers.

I for one would be just a little bit sheepish about asking for "incentive" money in return for not stealing your car. It would sound a bit like a shakedown or something.

Anyhow, it takes no genius to put tags on stuff and take it out to auction. You may not get the best price, but at least you get something close to market value and presuming the auction was well advertised and well attended it would sound a lot less like theft when you have to explain it to a judge later.

Then again, mixing up four or five ingredients to a well established recipe and sticking some cupcakes in the oven, then shipping it to customers who already know the product and are virtually addicted to it, errr, doesn't sound like much of an intellectual management challenge either. You know pretty quick if you are making money in that kind of business because every month's account statement has the same stuff on it.

Why a company like that even needed to run itself so deeply into debt is beyond me, I have a feeling it has been insolvent for years and the execs were milking the last few drops.

Finally, if the shareholders were asleep at the wheel, then it's their money so pay attention next time.