The stimulus has ended; what does that mean for the economy?

The stimulus has ended; what does that mean for the economy?

The stimulus from the CARES Act has ended, and so far, Congress cannot find a way to replace it. Democrats in the House have passed a bill, but Senate Republicans, lacking a unified approach, have waited until the end of the summer to propose a plan. Currently, Secretary Steven Mnuchin is negotiating with House Speaker Nancy Pelosi to find a compromise. So, what?

Well, without the stimulus, unemployment is expected to rise. Last week’s Bureau of Labor’s jobs report showed that the job gains from April slowed dramatically, adding just 661,000 jobs. The unemployment rate now stands at 7.9%, down from 14.7% in April. Currently, approximately 25 million people rely on jobless benefits to get by, and the outlook is worse. Last week, the Walt Disney Co. said it would lay off 28,000 people, and American Airlines Group Inc. and United Airlines Holdings Inc. announced 32,000 job cuts. These are just the massive layoffs; however, lots of smaller companies are laying off workers.

So far, most of the damage has been to low-income workers, but the pain is moving up the wage scale. A recent Wall Street Journal article pointed to a couple in New York who earned about $175,000, enough to cover the mortgage, two car leases, student loans, credit cards, and assorted costs of raising two daughters in the New York City suburbs. However, since COVID hit shutting down the courts, one of them, a lawyer, is unable to work, and the family is running low on savings. They can’t keep up with $9,000 in monthly debt payments, including mortgage installments.

In the U.S., consumer spending accounts for about two-thirds of gross domestic product, and as more people are unemployed, many will deplete their saving and stop spending. A fall in consumer spending affects everyone as we are all linked in this economy. If consumer spending falls, B2C companies suffer and lay off more people and stop buying from B2B companies, so the cycle continues. No one is immune.

While many have pointed to fall credit card debt levels during COVID, more worrying is the number of people behind on their mortgages, rent, and utilities. As we head into winter, with many facing evictions, no heat or water, the prospects are even worse. As some might recall from their economics class, the marginal propensity to consume is greater for those in lower-income brackets. Therefore, to boost the economy, middle- and lower-income Americans need to be able to consume. While the wealthy will spend some of the benefits they receive, they will spend far less, so the positive impact on the economy is limited.

Many fiscal conservatives have said that they are now concerned about the deficit and deterring people from working. It is nice to see they have finally found some courage; however, it seems more that they object to anyone they believe doesn’t deserve a benefit getting one. There was a deafening silence from this crowd with the passage of The Tax Cuts and Jobs Act (TCJA) in December 2017, which provided benefits to companies and the wealthy. Many in the Administration and other conservatives claimed that the TCJA would pay for itself. Unfortunately, not! The deficit increased since its passing, and Bloomberg’s analysis showed that most corporate tax cuts went for buy back shares. In my opinion, this spending on buyback is the leading cause of the stock market’s continued rise.

While some will claim that increases income for everyone, only about 10% of the population owns shares outside of a retirement plan. So, the impact of the rising market does little for overall consumption and the economy.

During the Great Recession, Congress failed to provide enough stimulus for a full recovery. It is in danger of doing the same again, and this time I fear the consequences will be far worse. I would advise all CEOs to what cash levels and liquidity, but at the same time, we need people spending to grow out of this hole.

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The Public Health Crisis Needs to be Solved Before the Economic Crisis

The Public Health Crisis Needs to be Solved Before the Economic Crisis

The accelerating increase in new Covid-19 cases is slowing the pace of the U.S. economy’s recovery from the pandemic. According to Bloomberg economist, Eliza Winger, “Most high-frequency indicators have shown signs of moderation. Consumers’ income and spending benefited from fiscal support and reopening efforts, both under renewed strains. The uncertainty was likely behind the latest deterioration in consumer sentiment, a key to the economic outlook.”

So, where do we stand?

  • Recent data shows that credit card spending has stalled.
  • OpenTable is showing a slowdown in restaurant reservations.
  • Initial jobless claims declined by the most in a month to 1.31 million in the week ended July 4, but they’re still double the highest level registered during the last recession. Furthermore, as states walk back their openings, these numbers are expected to increase.
  • A surge of layoffs are coming as company announce large layoffs to deal with COVID, e.g. American Airlines – 25,000; United Airlines – 36,000; Walgreens – 4,000;  Macy’s – 3,900; AT&T – 3,500; Hilton Hotels – 2,200; Chevron – 5,000; Boeing – 7,000; Uber – 3,700; Virgin Atlantic – 3,100; Wells Fargo – haven’t said but I am sure will exceed 20,000. This short list accounts for over 110,000, so the numbers will be large.
  • While many mortgage holders are refinancing to take advantage of the low rates, one in 10 households with a mortgage failed to make their last payment, and 16% of respondents in a U.S. Census survey said they fear they can’t cover the next one.
  • Federal Reserve Bank of Dallas President Robert Kaplan said that rising hospitalizations and death rates are having a “chilling effect on economic growth.”
  • With the eviction moratorium ending, the eviction of 20MM renters this month is possible. However, this has several ramifications, where will these people live and who will replace them as so many people would rent can’t make payments. Thus landlords will experience pain.
  • The $600 additional unemployment payments are ending.
  • The PPP program is about to end and those that took PPP funds have mostly spent them.
  • M&A volume is falling.

Thus, my take is that this is far from over. While I would argue that we are not in a second wave of the virus as we never exited the first, we are in an inverse square root recovery, but we could quickly move into a “W” recovery.

The key will be what will Congress do. The parties are wide apart at the moment, and to add to the problems, the Administration is pushing for a payroll tax cut (dubious effect), refusal to fund state COVID testing and tracking, and blocking billions of dollars that would go toward bolstering the Centers for Disease Control and Prevention, the Pentagon and the State Department to combat the pandemic. Somehow they haven’t yet accepted that this is a public health crisis and until that is solved, the economic crisis cannot be dealt with.

So, keep cash on hand and watch receivables and all leading indicators. It is going to be a rough second half, folks!

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Public Company CEO Pay, Is the Day of Reckoning Here?

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Income inequality in the U.S. is a recurrent theme in the U.S. today, and CEO pay is an item that gets attention. [Forbes has noted that]between 1978 and 2018, U.S. workers have seen their incomes rise by 12%, while CEOs have seen their incomes increase by 1008%. As of 2018, the CEO-to-worker pay ratio hit an all-time high of 278-to-1 up from 58-to-1 in 1989 and 20-to-1 in 1965.

One must keep in mind that the CEO’s compensation typically comprises salary, bonuses, share options or grants, and other valuable perks. So what drives compensation, and are they paid for performance?

 

What Drives Compensation

The Compensation Committee
The company’s Board of Directors, their Compensation Committees, and compensation consultants determine the CEO’s compensation. As Warren Buffett perfectly described the process, “The human relations director comes in and recommends a consultant to the Board’s comp committee. The human relations director is an employee of the CEO, his or her salary gets determined by the CEO, so what kind of a recommendation do you make to the comp committee? I don’t think comp committees should have consultants.  If you don’t know enough about the game to work out a fair compensation arrangement, get off the committee and put somebody on there who does know … they just don’t want somebody who knows something about comp on the comp committee.” The failures of compensation committees are legendary; however, nothing seems to change, primarily because of the CEO’s control of the Board, and in many cases, the CEOs sit on each other’s boards. 

The Ratchet Effect
Compensation consultants usually present the Board the pay of other CEO’s of other firms in their industry in terms of averages and rankings by quartiles. Similarly to our beliefs that our children, like those of Lake Wobegon, are all above average, boards believe their CEO is above average because:

  • the CEO usually picks the Board and so they tend to like the CEO and believe the CEO is excellent; and
  • if the CEO were below average, the Board would have failed in its job to choose a good CEO, and no one will admit they failed in their selection.

Thus, if the CEO is above average, then they must be compensated above average. However, if every CEO is above average, they must all be paid above average, the ratchet effect kicks in, and as Warren Buffett has this as, “Ratchet, Ratchet, Bingo!” Of course, if the CEO is thrilled with the consulting firm’s work and recommends them to other CEOs they know and so the ratchet effects continue unabated.

Say-on-Pay
Many point to “Say-on-Pay” as a mechanism whereby shareholders can express their view on executive compensation and can prevent excessive CEO pay. However, this say-on-pay is just an excellent way of appearing to provide some form of checks and balance while not changing the flaws in the system. The major of people assume that a say-on-pay vote is a vote to approve the executives’ compensation for the current year. To quote an old friend, “Let me disabuse you of this notion.” 

Say-on-pay votes ask shareholders to opine retrospectively on the compensation of named executives, rather than on the company’s compensation program going forward. Say-on-pay does not dictate actual executives’ pay.

Furthermore, in the U.S., say-on-pay votes are non-binding advisory votes by shareholders. Since it is an advisory vote, even if a say-on-pay proposal failed to receive majority support, this would not prevent a company from implementing its pay practices. 

While say-on-pay allows shareholders to engage with companies to encourage good governance practices and alignment with company performance, the most significant influence on executive compensation is the compensation consultants and proxy advisors. Ultimately the decision on executive compensation is that of the Board.

Pay for Performance
Lastly, we get to the main reason for the high level of pay, Pay for Performance. For years, CEOs and their supporters, e.g., compensation committees, compensation advisors, have staunchly defended the level of compensation to CEOs because of “Pay for Performance,” the idea to align CEO compensation to the company success, and the CEO’s performance provides value to the organization.

So, do these compensation plans drive performance? 

For about 25 years, I have said the job I want is “F##k up CEO,” or to put it politely, “Pre turn around CEO.” You get paid a lot of money to join the company, while as the CEO, you get paid an excellent salary to destroy the company, and then you get paid a whole bunch more money to leave. These jobs are out there, and I have seen many people get them, and here is a list just to name a few:

  • Carly Fiorina, CEO of HP. Fiorina was a great self-promoter, busy pontificating on the lecture circuit and posing for magazine covers. During her tenure at HP, the company’s value fell 65%. Fiorina made over $100MM at HP, including a $65MM signing bonus, and termination package of\\ $21 million in cash, plus stock and pension benefits worth another $19 million.
  • Bob Nardelli is a multiple offender. Nardelli was CEO of both Home Depot and Chrysler. His tenure at Home Depot was marked by losing market share, alienating executives, downplaying customer service, and no growth in shareholder value. While at Home Depot, he made over $65MM in cash salary, plus cash bonuses, and his exit package was $210MM. He was then hired by Cerberus to run its struggling Chrysler unit. There, the company took billions in government aid, went into liquidation, and merged with FIAT SpA. His compensation was not detailed.
  • Gerald Levin, CEO of Time Warner. During his tenure, he oversaw the acquisition of Turner Broadcasting System and the company’s merger with AOL. Within three years, AOL had lost $200BN in equity value, written down $99BN in equity value. Levin was salary, and bonuses rose from over a $4MM to $11MM year. Besides, he received annual grants of stock options which, when he exercised them in 2000, were worth over $150MM.
  • Richard Smith, CEO of Equifax. During his time at Equifax, Smith oversaw tremendous growth; the hack in 2017 brought his tenure to an end. During his time as CEO, Smith earned about $16MM in salary, $24.3MM was in non-stock compensation and $70MM in stock options. The infamous hack in 2017 reduced Equifax’s share value by 20%, and Smith left with $90MM.

There are so many others, including Dick Fuld at Lehman Brothers, Angelo Mozilo at Countrywide Financial, Ken Lay at Enron, but time is limited.

Therefore we there many stories of CEO enriching themselves while the organization fails to perform. However, while stories may be anecdotal, academic research has shown that incentive-based CEO compensation appears to have only a small or negligible impact on firm-level performance, and particularly when firms have weak corporate governance.

A study in the Journal of Management Research in 2018 analyzed the earnings of more than 4,000 CEOs throughout their tenures against several performance metrics. They found virtually no overlap between the top 1% of CEOs in terms of performance and the top 1% of highest earners. Among the top 10% of performers, only a fifth were in the top 10% in terms of pay.

In 2017, only two out of the 20 highest-paid CEOs, who didn’t leave their jobs before the end of the year, landed in the top 20 for shareholder return. According to many compensation consultants, many firms condition a significant share of pay on three-year performance metrics that are only partially affected by a single bad year.

  • In 2017, CBS Corp. paid Leslie Moonves, $69.3 million, while total shareholder return was negative 6.2%. In 2016 Moonves was paid $69.6 million when CBS achieved a one-year performance of 37%. 
  • Comcast Corp’s CEO Brian Roberts’s annual pay has hovered around $33 million from 2015 to 2017, while shareholder returns ranged from 25% to negative 1.1%.
  • Allergan PLC’s Brent Saunders received a 700% raise in 2017 to $32.8 million, despite the total shareholder return of negative 21%.
  • TransDigm Group Inc’s shares realized returned just shy of 5% for the fiscal year that ended September 30, 2017, including the reinvestment of dividends, while its CEO Mr. Howley earned $61 million, more than triple the $18.9 million he made in 2016.

 

The Curtain is being Pulled Back

As a result of COVID, many companies are filing for bankruptcy protection. However, according to Reuters, nearly a third of more than 40 large companies seeking U.S. bankruptcy protection have awarded bonuses to executives within a month of filing their case. Also, many of these companies are simultaneously furloughing or terminating employees. Some examples:
  • J.C. Penney approved nearly $10 million in payouts just before its May 15 filing and paid its chief executive, Jill Soltau, $4.5 million. J.C. Penny furloughed 78,000 employees.
  • Neiman Marcus Group paid $4 million in bonuses to Chairman and Chief Executive Geoffroy van Raemdonck in February and more than $4 million to other executives in the weeks before its May 7 bankruptcy filing. Nieman Marcus furloughed 11,000 employees.
  • Whiting Petroleum Corp paid $14.6 million in extra compensation to executives days before its April 1 bankruptcy. 
  • Chesapeake Energy Corp awarded $25 million to executives and lower-level employees in May, about eight weeks before filing bankruptcy.
  • Hertz paid senior executives bonuses of $1.5 million days before its May 22 bankruptcy. Hertz terminated more than 14,000 workers.

Firms paying pre-bankruptcy bonuses know they will face scrutiny in court on compensation proposed after their filings. Still, the trustees have no power to halt bonuses paid even days before a company’s bankruptcy filing, said Clifford J. White III, director of the U.S. Trustee Program, at the Justice Department. Thus, the firms “escape the transparency and court review.” Also, unsecured creditors and employee pension funds bear the pain in such activities. Concerning employee pension plans, the Pension Benefit Guaranty Corporation usually takes them over, meaning we all pay for the hubris through our taxes.

The spotlight on CEO “Pay-regardless-of-Performance” may lead to a day of reckoning and boards doing their job. There is increased pressure from some large asset managers like BlackRock, but not the majority as I write this.

Thus, while I hope CEOs may truly be paid for performance as this behavior reinforces the inequality of the system, reinforcing the view, “Accountability means lower-level people get financially penalized if they make a mistake, but the CEO never does.” I wouldn’t hold my breath.

Further, if CEOs were paid for performance, the concept might then migrate to Private Equity and Hedge Funds requiring not only pay for positive performance. Given the traditional 2 and 20, forget the 2% of AUM, but tied the 20% to exceeding some external metric, i.e. the S&P 500 for a Private Equity Group. That would really put the cat among the pigeons.

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Your Team Needs to go Upstream

Your Team Needs to go Upstream

There’s a well-known public health parable about upstream thinking that goes like this: you and a friend are by a river when you see a child drowning. You both dive in and save the child. But then another struggling child comes along, and another. You and your friend can hardly keep up with the crisis, but suddenly your friend swims back to the river’s bank. You indignantly ask where she’s going. Your friend says, “I’m going upstream to tackle the guy throwing these kids in the water.”

In life, we spend most of our time downstream pulling kids out of the water, but few up us go upstream to tackle the source of the issue. According to Dan Heath in his book, “Upstream: The Quest to Solve Problems Before They Happen,” we live in a downstream world, and we have a bias for downstream action. While the concept of upstream thinking has been around in the public health arena for years, Heath wants to bring to a broader audience.

Heath believes that “we should shift more of our energies upstream: personally, organizationally, nationally, and globally. We can—and we should—stop dealing with the symptoms of problems, again and again, and start fixing them.” While that appears obvious, we don’t and find ourselves time after time reacting again.

As we scramble through our busy day tackling fires, how often do we stop to address the source of the issue? First, we have to ask are what we are dealing with just symptoms, or is it the route of the problem? While a simple question, it is difficult to focus on that while dealing with a crisis. Even it is a symptom; it is hard to leave the mess to tackle the route cause because to do so; someone else has “to pull the kids out of the water.”

Those that tackle downstream problems get more attention because we notice them valiantly tackling issues all the time and solving them, basically pulling kids out of the water. Thus, they get recognition; however, those that go upstream seem to get less attention and credit, because while they solve a problem, no one realizes how many issues they have prevented because of the problem they have resolved.

As we struggle with COVID, many, including myself, are frustrated with the administration’s response which, if handled better, would have resulted in few lives lost. However, if the administration has shut down the U.S. like Taiwan or South Korea and severely limited the caseload, there would be many complaints about the cost of the “medicine” when there were so few cases. Thus, when dealing effectively upstream, many don’t appreciate how bad the alternative would be if it were not solved upstream.

Heath has identified three barriers to upstream thinking:

  1. Problem Blindness. Problem blindness assumes that the problem is natural or inevitable, and so there’s nothing you can do about it. So we accept it and conclude, “That’s just the way it is.” We don’t try to solve it, because, “When we don’t see a problem, we can’t solve it. And that blindness can create passivity even in the face of enormous harm.”
  2. A Lack of Ownership. Complacency. If we move upstream, it requires that we take ownership of the issues personally. “I choose to fix this problem, not because it’s my responsibility, but because I can, and because it’s worth fixing.”
  3. Tunneling. Tunneling is a condition where you find that “when people are juggling a lot of problems, they give up trying to solve them all. They adopt tunnel vision. There’s no long-term planning; there’s no strategic prioritization of issues.” When we are in a scarcity mindset, we become “less insightful, less forward-thinking, less controlled.”

I would add a fourth Budget. Several years ago, a company asked me to develop a risk model for some of its hotel management contracts. The company had entered into many ten-year management contracts that had guaranteed owners a minimum income; however, no one had considered the prospect that there might be a recession during the contract period, which would trigger the performance clauses. At the time I was asked to help the company, they were currently paying out over $50MM in performance clauses, causing the company severe financial heartache. I gave the company a proposal that would have cost about $30k. They rejected it because of two factors, (i) it wasn’t in the finance department’s budget and if they spent the money would miss their financial targets and lose their bonuses; and (ii) lack of ownership. The latter arose because those involved considered that by the time the next recession occurred, none of them would be in a position to bear the responsibility if big payouts were required. Hence, they weren’t willing to fight for the budget to get the modeling done.

Their focus on the short term reflects the failure to think upstream. Thinking upstream is critical because it results in making smarter decisions based on long-term thinking.

Heath has identified seven questions that upstream leaders must answer.

  1. How will you unite the right people?
  2. How will you change the system?
  3. Where can you find a point of leverage?
  4. How will you get an early warning of the problem?
  5. How will you know you are succeeding?
  6. How will you avoid doing harm?
  7. Who will pay for what does not happen?

In clarifying these questions, Heath reveals some of the significant issues that keep us from moving upstream. 

To succeed in moving upstream, he recommends that we need to consider:

  • Be impatient for action but patient for outcomes. We need to get moving, but often the change we seek takes time.
  • The macro starts with micro. Break the action down.
  • Favor scoreboards over pills. Kaizen mindset. Think in terms of continuous improvement and use data for learning, rather than data for inspection. Test and learn and test again.

While upstream is a direction, it is not a destination. Any movement upstream is a step in the right direction. Going upstream, you either get a little ahead of the problem, or you can go further upstream and look for the more systemic issues.

So as you look at your team and the most effective problem solvers, ask if the problems they are solving are downstream or upstream. If the former, get them to move upstream.

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