Executive Compensation at Fannie Mae: A Case Study of Perverse Incentives, Nonperformance Pay, and Camouflage – Case Study – Lisa Wanderlust
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Executive Compensation at Fannie Mae: A Case Study of Perverse Incentives, Nonperformance Pay, and Camouflage
Executive Compensation at Fannie Mae: A Case Study of Perverse Incentives, Nonperformance Pay, and Camouflage Summary In the end of 2004, the CEO and the CFO of Fannie Mai were asked to resign by the board of directors after the U.S. Securities and Exchange Commission had determined that Fannie Mae had inflated its earnings. The senior executives had manipulated accounting to collect millions of dollars in undeserved bonuses and to deceive investors for several years. The summarized text is a case study of Fannie Mae’s executive compensation arrangements during the period from 2000-2004 and highlights their four major flaws. It is to assume that these “flaws” have motivated the executives to commit the fraud.1.Perverse IncentivesThe “summary compensation table” (for the years 2000-2003) presents the compensation for each of the five top executives has four subcategories: Salary, annual bonus, option/restricted stock grants and the long-term incentive plan (LTIP). It shows that more than 50% of CEO Raines reported pay came from the annual bonus as well as the LTIP program. The problem now is, that these yearly bonuses (in both, money and shares) were tied to the company’s financial performance (a particular “earnings goal”). Taken into consideration, that half of the executive’s salaries depended on declared earnings, one could see what could motivate them to inflate these. Additionally, the board plans didn’t include a clause that would have the executives return the bonuses in case the reported earnings were found to be mistaken. In the period right before the SEC announced the misstatement, CFO Howard was selling his shares, making around 6 million, that he likely wouldn’t have made, had the investors known that the earnings were misstated. According to Lucian A. Bebchuk and Jesse M. Fried, the problem lies in the executives being financially rewarded for short-term results rather than results that increase long-term shareholder value or stock price results as well as the above mentioned lack of a recovering mechanism in the case earnings were misstated. The Sarbanes-Oxley Act requires the return of compensations in the case of misleading financials only in special circumstances involving misconduct. Therefore the authors suggest, companies should add adjustment provisions to future executive compensation contracts
2.Soft LandingEven though the executives had to resign for being responsible for Fanny Mae’s “accounting problems” the retirement packages they received were no different than the ones they’d have received if they had performed flawlessly. They received high monthly pensions. Raines received around $25 million worth in  options to purchase shares of Fannie Mae as well as a monthly $114,000 pension. Howards monthly pension amounted to approximately $36,000.These “soft landings” for executives in case of failure are seen as problematic. If there is no “cause” for determination, even if the executives performance was poor, their employment contract doesn’t reduce their level of benefits.If it doesn’t matter if one manipulates his company’s statements to get higher boni or if he does a good job increasing the stockholders’ wealth, because in either case he’ll get away with a pension higher than what most people make in their entire life, his incentives to perform well are lower. People are greedy individuals after all.The case study shows how Raines’s and Howard’s employment contracts could only be terminated for “cause” which includes 1) being convicted of a felony 2) participation in an act of fraud as an executive, that discredited Fanny Mae irreparably, 3) continued for twenty days following written notice from Fannie Mae to (a) engage in activities that constituted a material conflict of interest with Fannie Mae, (b) fail substantially to perform material duties (other than as a result of incapacity or illness), or (c) fail to cure a material breach of his employment contract. “Soft landings” weaken the section 304, because it doesn’t include pension to be returned in case of misconduct, even if they are based on the inflated earnings. So even if a CEO or CFO has committed “misconduct” the board can make sure that he/she leaves the firm with a huge pensionThe issue lies in the executive’s employment contract as well as in the board member’s actions. Poor operating performance, fraud, or the manipulation of earnings that falls short of the legal definition of fraud are not grounds for a for cause termination. It is mentioned by he authors, that such narrow definition for “cause” is standard in executive employment contracts.  As in the Fanny Mae case, the termination of the CEO and CFO’s contracts did not fall into the above stated definition. It is explained however, that even in case of a termination they would still have received sizable retirement packages according to their contract. This is, because when the government began investigating Fannie Mae’s accounting problems, the board changed a number of components in Raines employment agreement, that basically protected him of penalties and made sure that even in case of a cause determination, he would receive large amounts of money, seeking benefit for Raines. All this is damaging for the shareholders and investors should press the boards to introduce and apply compensation packages that are reduced in case the executives perform poorly.
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(2017, 05). Executive Compensation at Fannie Mae: A Case Study of Perverse Incentives, Nonperformance Pay, and Camouflage. EssaysForStudent.com. Retrieved 05, 2017, from
“Executive Compensation at Fannie Mae: A Case Study of Perverse Incentives, Nonperformance Pay, and Camouflage” EssaysForStudent.com. 05 2017. 2017. 05 2017 < "Executive Compensation at Fannie Mae: A Case Study of Perverse Incentives, Nonperformance Pay, and Camouflage." EssaysForStudent.com. EssaysForStudent.com, 05 2017. Web. 05 2017. < "Executive Compensation at Fannie Mae: A Case Study of Perverse Incentives, Nonperformance Pay, and Camouflage." EssaysForStudent.com. 05, 2017. Accessed 05, 2017. Essay Preview By: Lisa Wanderlust Submitted: May 24, 2017 Essay Length: 2,034 Words / 9 Pages Paper type: Case Study Views: 382 Report this essay Tweet Related Essays Pepsi Blue Case Study - the Challenges Inherent in Executing a Global Re-Branding Campaign PEPSI BLUE CASE STUDY: THE CHALLENGES INHERENT IN EXECUTING A GLOBAL RE-BRANDING CAMPAIGN During the 1990s, PepsiCo launched new products and engineered a global re-branding 1,473 Words  |  6 Pages Fannie Mae Case Fannie Mae case. Federal regulators noted a growing string of high profile scandals at major U.S. corporations in recent years. The number of fraud cases 1,248 Words  |  5 Pages Faith Community Hospital Case Study - Executive Summary Faith Community Hospital Case Study Executive Summary The mission statement of Faith Community Hospital Mission states, With the foundation and commitment to our spiritual heritage 653 Words  |  3 Pages Critical Thinking Case Study: Let It Pour- My First Assignment as Executive Assistant Let It Pour: My First Assignment as Executive Assistant Hospitals are a necessary part of every individual's life. When one thinks of hospitals, help comes 2,200 Words  |  9 Pages Similar Topics Case Study Gerber Babyfoods Montclair Papermill Case Study Get Access to 89,000+ Essays and Term Papers Join 209,000+ Other Students High Quality Essays and Documents Sign up © 2008–2020 EssaysForStudent.comFree Essays, Book Reports, Term Papers and Research Papers Essays Sign up Sign in Contact us Site Map Privacy Policy Terms of Service Facebook Twitter