The AIG bonus controversy and financial crisis response

¶ … economic crisis was precipitated by the collapsed of the subprime mortgage market. When the housing bubble burst, home values began to stagnate. Many subprime borrowers had not only taken out loans that they could not afford to service, but they had signed on for interest rate schemes that resulted in their rates stepping up dramatically after the first couple of years. The result was that these individuals could not make payments on the new rates and with the market collapsed they could not sell their homes either. The result was defaults on a massive scale.

Insurance firm AIG had sold credit-default swap contracts to protect investors against default in subprime mortgages. When that market collapsed, AIG was faced with mounting liabilities. The remainder of AIG's business was profitable, but the impact of the credit default swap losses was set to bring the company down. The federal government stepped in, paying $85 billion and taking control of the company (Karnitschnig et al., 2008).

As part of the takeover process, the government insisted that CEO Robert Willumstad resign, and they placed former Allstate CEO Edward Liddy at the head of AIG to oversee the restructuring process (Ibid). The company then received $153 billion in capital loans and financial injections. The underlying premise was that AIG was too big to be allowed to fail, as such a failure could set about a chain reaction that brought down the financial system. However, AIG's insurance businesses were insulated from the collapse of the holding company and would have carried on even without the bailout (The Economist, 2008).

It was later revealed that AIG paid year-end performance bonuses in the amount of $165 million to its employees. This news outraged taxpayers, who had to the point ponied up $170 billion to support the company. The government and CEO Edward Liddy were now faced with controversy. The issue, however, was complicated. The bonuses were part of employment contracts that had been signed prior to Liddy's takeover of the company. Additionally the bailout had been orchestrated by the Bush administration, so any failure to oversee the spending of bailout funds fell to a group no longer in power. Yet, the outrage was palpable, with 87% of Americans registering disapproval (Tuggle, 2009).

Opponents of the bonuses feel that the employees at AIG did not deserve bonuses, given that the firm was about to fail. Moreover, when taxpayer dollars are involved, the normal rules with respect to bonuses should not apply -- the firm is supposed to look after the interests of shareholders and those shareholders are now the people of the United States of America. The bonuses have become a flashpoint because they represent mismanagement, greed and arrogance in the financial community, and a lack of appreciation for the situation they are in and how they got there. The staff at AIG did not do their jobs well and thus should not be rewarded.

Proponents of the bonuses argue two things. One is that the bonuses were included in contracts that were written and signed in good faith. The other is that such bonuses are essential to retain top talent, who would otherwise seek work at firms not subject to these constraints. As a postscript, the federal government deducted the amount of the bonuses from the aid it has given AIG (Kuykendall & Murti, 2009), something of a token gesture to placate an outraged public.

Q2. There are two recommendations I would make to Liddy with respect to external communications. The first is I would recommend that he not focus on the fact that the current government and himself bear little responsibility. The public is not interested in that, and nor should they be given that the person in charge should be in charge, not pass the buck to former leaders. Liddy instead needs to focus the discussion away from the bonuses paid to how he and AIG can set things right.

The second recommendation I would make with respect to external communications is that Liddy adopt more stringent measures than the government has insisted upon with respect to spending controls. The government has set out some measures, but AIG should be tougher than that. This would demonstrate a sense of culpability on the part of the company for the fact that the situation it is in is of its own making. A major component of the public's offense is that it feels cheated in the deal. Taxpayers, many of whom are feeling the sting of economic hardship themselves, are insulted that they have been called upon to bailout a company that then pays six and seven-figure bonuses to its executives. Most of the people contributing tax dollars to those bonuses will never see money like that in their lives. Liddy has the luxurious advantage of not being directly responsible for the AIG mess. He needs to be fully sympathetic with the public on this issue -- they are the taxpayers for whom he works.

Q3. Internally, such contrition may not sit well. AIG employees may feel like the leader who was airlifted into the company by the government is now throwing them under the bus. Regardless of whether or not they deserve it, there is little doubt that morale will be affected. With respect to morale, Liddy should not be too concerned. His position is that of a hatchet man. His job -- as mandated by the government -- is to fix the problems at AIG. He actually has little responsibility to the employees at AIG beyond the role they will play in the firm's recovery. His role is thus simply to lay out the facts -- they are owned by the government and significant work will be undertaken in order to restore the company. The employees can either get behind that effort or they can bring the company to its knees.

Liddy need not worry about employees not performing in their jobs for a couple of reasons. One is that most employees are not significantly motivated by money anyway. Most employees are motivated by higher order needs. They are probably embarrassed by both the government takeover and the bonus scandal, as employees at MCI were similarly embarrassed by the WorldCom debacle. Thus, the average AIG employee is probably more motivated by the need to set things right and preserve their long-term future than by short-term bonus concerns.