Is it fair to pay a corporate chief executive officer (CEO) a bonus when the company is losing money?

Suppose a company is losing $3M year after year, and the company hires a new CEO to fix the problem. Suppose further that the new CEO manages to reduce the annual loss to only $1M. This would save the company $2M just as surely as if the CEO had taken the profits from $1M to $3M. This is why it's critical to understand where a venture was going in order to know what counts as success.

The really hard part is not seeing that the loss was lessened, but understanding whether that change is a success or a failure. The naive expectation is to say that if the company is not returned to profitability instantly, there has been a failure. And that's possible. But judging that is hard. For example, it might be that most well-qualified leaders in the same circumstance would have done less well, perhaps taking losses only from $3 million to $2 million. In that scenario, the CEO has beat reasonable expectations. Or it might be that most well-qualified leaders in the same circumstance would have fixed the problem, eliminating the loss. In that scenario, the CEO has fallen short of reasonable expectations. It's all in how you decide what you expect.

Bonuses have been paid to some people in some circumstances for doing good work. And some of these people perhaps have done good work. I keep hearing news reports about “paying bonuses to people when their companies are losing money.” Such reports are not helpful. What I want to know is whether they are paying bonuses to people for not having improved the situation according to a comparison of a reasonable expectation for what a competent person in that job should have been able to do, and how the outcome actually turned out.

(In fact, though, I also think that the problem with gigantic CEO bonuses is not this issue of how we make the decision of when to pay out, but rather just that single individuals get a disproportionate share of the spoils. This artificially inflates the importance of a bonus or other discretionary perk paid for the wrong reasons. If bonuses and other compensation were limited to a dozen times the compensation offered to the lowest paid employee of the company, a lot of these issues would probably never come up publicly—the problems of whether to pay would probably just resolve themselves.)

The usual justification for paying money to a CEO when the company he runs is losing money is that (a) the CEO was hired after the problem started and is not the cause of the problem, and (b) one needs in such circumstances to hire people who can put a company back on track even if that process takes time to achieve. No one would ever take on the responsibility of trying if they were told they would be automatically blamed for failing to fix a large problem instantly.

Curiously, even as we discuss this matter as it relates to individual companies, President Obama finds himself in a similar situation.

On the news tonight, various members of the Republican party were whining that Obama's budget is larger still than Bush's. Perhaps so, but not because, as they might want us to believe, he's a “tax and spend liberal.” If anything, the problem is that Obama follows a “tax and spend and obfuscate conservative.”

The new budget is honest in many ways that Bush's was not, and the economy under Bush was spiraling downward as it closed. It was not like if we hired someone of similar philosophy to Bush, we'd have been on track to be doing better. We were on track for disaster and it was clear from the relative inaction on the part of not just Bush, but a great many Republicans, that the cure was not obvious.

Bush spent the first few years of his Presidency whining about the Clinton recession even though there had been no serious sign of it before Clinton left office. And the problems Bush was up against, whether of Clinton's making or his own, were small and still took years to resolve, if they were resolved at all; there's every reason to suppose that Bush's team did more just to hide problems than to solve them, all the while padding the pockets of the already-rich in a shameless way, widening the divide between the “haves” and “have nots.”

The best thing about Obama's budget is not the specific choices it makes, it's the goal of transparency. Frankly, I expect him to get beaten up over a lot of stuff because the populace is not used to transparency and it will be easy for the highly efficient Republican Spin Machine to use the newly available data to claim that problems “happened” under Obama, when I suspect in many (perhaps most) cases, the problems will be exposed under Obama. The Republicans have not been good with budgets, but they have been true scientists when it comes to spin. So I would expect this war of words to be vicious, as they struggle to demonstrate through words, rather than through deeds, that they are the ones who really care.

We should expect Obama to be beaten up over things that get discovered during this process; he probably expects it. But we should laud him for it, too. Because what is going to fix the problem is not creating the right budget from the start, but creating the right budget process. And transparency is the right first step. It may mean he has to say “oops” a lot, but who cares? If he's willing to say “oops” and to backtrack and correct, that's what will probably assure things are on track.

We should expect to hear from the Republicans that any step in the negative direction is inappropriate. Yet those same people would understand a number of one-time extraordinary charges in a company struggling to regain its legs. Moreover, they would even, under some circumstances, tolerate several one-time charges. One doesn't set out to do that, but it happens, and everyone in business knows it. The same may be true of Obama's plan. We'll just have to see.

Republicans would be quick to defend the compensation package for a CEO hired to rescue an ailing bank. Obama, our nation's Chief Executive, drawing a more modest salary than many corporate chief executives (and no bonus at all, other than the reward of doing well by other people), has been given the herculean task of rescuing a truly huge financial system. He deserves at least the same benefit of the doubt as we would afford other, more mundane, chief executives.

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