Bonuses at AIG – Who Wrote that Compensation Plan?

It’s like everyone was waiting for this. The collective anger of a nation is spewing out. The media, the government and the average citizens are outraged. AIG Financial Products (AIGFP) employees have been getting hate mail. Bloggers are talking about forcing them to forgo their bonuses by threatening to make their names public. At the root of it – $165 million in bonuses to employees at AIGFP which was chiefly responsible for bringing down AIG which was then bailed out by the federal government with a whopping $170 B.

The political heat around this is intense. The one thing I’d like to get my hands, but probably won’t, is the contract that requires AIG to pay these bonuses out.

The first question I have is what is the nature of these bonuses? Are they committed compensation, but just deferred to the end of the period? That doesn’t make sense. If they are committed why not pay them out as you go. OK, then are they discretionary? It appears not. Otherwise there wouldn’t be this hullabaloo. So it must be a formula-based bonus much like a sales commission plan. The law takes a fairly narrow view of a commission dispute between employee and employer. So I understand why AIG feels that it is legally required to pay out the bonuses.

However, what is inexplicable is the way this bonus plan was written. How can a bonus pool be funded when the unit, AIGFP, made a whopping loss? When the company just posted the biggest quarterly loss in the history of mankind? Right after the federal bailout, the first thing they should have thought of was fixing the compensation plan. And don’t tell me that they couldn’t have changed the bonus plan, prospectively, in the middle of the year.

There were enough reminders about how sticky the issue of Wall Street compensation had become. First Wall Street CEOs gave up their bonuses for 2007 – it was all over the papers. Then the auto CEOs were given a tongue lashing for their corporate jets. Then the Merrill Lynch bonus thing happened. All this while, the AIG management was reading the newspapers, I presume. Why didn’t they change their bonus plans?

It’s possible that the bonus payments pertain to 2008 (unfortunately, as in all such issues, it is difficult to extract facts out of all the noise). But I haven’t heard AIG saying that the bonus plans have been changed from such and such date onwards. It’s not much a defence but it’s something. I don’t really think that’s been done.

Poor compensation practices are at least partly responsible for the mess we are in. I have written about it before. The prevalent compensation practices on Wall Street incentivize the manager to expose the firm to long-term risks because his compensation is tied to short-term goals. In AIG’s case, not only did the managers pile on the risk, but as these bonuses indicate, they just plain raked it in at the expense of the shareholders.