The AP’s Cathy Bussewitz has done a very good job on a topic that I warned needed more attention. (AP Investigation: Calif. pension bonuses examined, 10/21/2010)
CalPERS’ plunging value came as stock values tumbled around the world, the state’s economy suffered its worst decline in decades and basic state services faced severe budget cuts.
Virtually all of CalPERS’ investment managers were awarded bonuses of more than $10,000 each, with several earning bonuses of more than $100,000 during the 2008-09 fiscal year. The cash awards were distributed as the fund lost $59 billion.
This makes CalPERS seem very bad. However, as the article goes on to point out, CalPERS was following normal practices at public pension plans. They’ve improved since then but could probably still use some additional reform. Maybe the AP article will result in a further reexamination of bonuses as CalPERS, other pension funds, and corporations.
CalPERS’ bonus structure suffers, to some degree, from characteristics frequently criticized in the corporate sector. Like options grants to corporate executives, CalPERS bonuses are structured with no downside risk, only upside gain. Additionally, adjustments or “clawback” provisions are needed to recoup unearned bonuses…
Additionally, it is my understanding that CalPERS annual bonuses are weighted (1 year performance counts 10%, 3 year 40%, and 5 year 50%) and that adjustments to fund valuation aren’t applied retroactively. If there is no mark-to- market accounting, staff might be getting performance bonuses based on a bubble. While the 1, 3, and 5-year bases give greater weight to long-term performance, since negative points aren’t considered, there is really no penalty for artificially spiking performance.
CalPERS should award negative points for under-performance and should subtract these from positive basis points. Payments should also be delayed to ensure performance reflects market, rather than book, value. This is especially important for real estate, alternative investment and other managers where value isn’t measured minute by minute, as it is with most equities.
Think about paying on a one or two year delay. Spread payout even more or scale it back if CalPERS is in a down cycle or the employee quits. In fact, if they quit, perhaps they should forgo their final year of performance pay. These reforms would not only better align pay with performance, they would decrease staff turnover and guard against a possible public relations nightmare.
CalPERS Board has made some changes to the compensation program to increase accountability. The new features include: the Board can defer, cut or eliminate performance awards if the fund’s fiscal year absolute return is less than zero percent, or for any other reason.
- Awards only given to staff employed by CalPERS at the time the award is to be paid, except in the case of involuntary separation without cause.
- Eligible employees must be in compliance with all regulatory requirements and ethics and conflict-of-interest policies.
- CalPERS can also require repayment of a performance award, with interest, if within three years of the payment it is discovered the employee was not entitled to the award because of a policy violation.
While these are improvements, in my opinion they still should:
- Award negative points for under-performance and subtract those from positive basis points.
- Delay payments by two years.
- Claw back based on accounting adjustments, not just policy violations.
- Substantially reduce bonuses in the case of employees who are terminated or quit.
Update: Apparently the AP article was written without taking into account new changes to bonuses at CalPERS. You can see draft documents here. They may have changed somewhat before being adopted by the Board. I only took a few brief moments to scan but still believe my recommendations are appropriate.