AIG -- Defending the Undefendable

The outrage of AIG's (the insurance giant that is now 80% owned by taxpayers) recent $165 million bonus payout is quite understandable. First, the people receiving the bonuses included executives and traders from the derivatives division--the one that led to the company needing a government bailout. John Q. Public doesn't mind when people are rewarded for getting results, but see unfairness when they get rewarded for messing up the livelihoods of others. Second, the government, who now mostly owns the company let it happen--and did so even as they were negotiating a second $30 million bailout just a few weeks ago.

The PR blunder of the bonuses is immense and no less than Peter Drucker predicted such reactions years ago. In writing about the professional manager, who acts as an agent for the firm, Drucker claims their first edict of responsibility was to not knowingly do harm. He then said that there are some issues that are very harmful even if they are done unwittingly. First among these sins is executive compensation. Drucker reasons that excessive compensation schemes (e.g., large bonuses) does harm because of the perception of inequality it creates. This perception is exaggerated, but it puts the company on the defensive, just as the AIG CEO is now explaining to Congress how this $165 million fiasco happened. It sounds like it went badly for Mr. Liddy.

So how can we defend the undefendable (i.e., AIG executives)? Well my colleague, Turner White asked his students a very good question: "Why would AIG pay the bonuses?" The pile on answer is arrogance and/or greed. But there is another answer that makes sense: fulfillment of contracts. Even if Mr. Liddy (and his board who in this case was the President and Congress) hated the idea of the bonuses they felt some compunction based on meeting contractual law. In fact business fundamentally one of an infinite number of transactions and these are governed not only by the honest dealings of the parties involved but by the rule of the law. While bad decision were made all around on this deal, it is as likely the actual commission of the bonus bonanza was a case of feeling compelled to follow the law.