Fiscal Relativity

CAMBRIDGE, MA When Einstein first remarked that “Everything is relative,” he didn’t have Stan O’Neal in mind. This week, Merrill Lynch’s top banker was paid $161.5 million to take an early retirement after suggesting, quite acceptably, that the bank ought to consider merging with another global titan of finance to buoy its sagging share price, restore investor confidence, and position the company for growth after the latest shake-up in the credit markets.

To be fair, the bank just announced that it was writing down $8.4 billion in holdings as a result of the recent mortgage meltdown, and Merrill’s stock has underperformed every one of its global banking peers in 2007. But this latest sacking adds yet another ugly data point to the growing debate around executive compensation at a time when even failure, it would seem, can be a sign of success.

Such criticism is common when jaw-dropping numbers are thrown around, perhaps because it toys with our sense of decency and equality, or perhaps because our minds still can’t grasp the scale of a nine-digit profits and losses. But like many of our feelings about relativity and proportionality — like guestimating Stan O’Neal’s compensation as a percentage of his performance — our instinct is typically wrong.

In fact, if you compare O’Neal’s golden handshake with the total increase in Merrill’s market value since April 2003 when he first took over as Chairman, his package represents a little over 1.2% ($161.5 million over roughly $13.1 billion). That’s less than most salesmen make on a relative basis in just about any other industry, from car dealerships to auctions on eBay. It just so happens that the scale and scope of the financial services industry make the final numbers seem so nefariously large.

Examined another way, these same twin promises of relativity and scale have been lauded as the next great hope in mobilizing capital for the developing world. Emerging markets, long starved of cash with no geopolitical strings attached, now offer enlightened investors and companies the opportunity to unleash the socio-economic potential of the “Bottom Billion,” logic that only works when the denominator is so mind-blowingly humongous. This may seem like self-serving capitalism at first glance, but it’s more like Capitalism 2.0. Profit with honour, etc., with the hoi polloi lining up at the trough.

The parallels here are important. In both cases, globalization has diminished our ability to estimate relativity. Stan O’Neal’s compensation is a drop in the hat for Merrill’s investors, representing roughly $0.19 for every common share outstanding compared to a $20/share appreciation over the course of his tenure as Chairman. Similarly, China’s total economic output swelled to nearly $3 trillion in 2006, placing it fourth in the world behind Germany, Japan and the US. But nominal GDP/capita still hovers around the $2000 mark, a hair behind the Republic of the Congo and a nose ahead of Samoa in global IMF rankings, thanks to the world’s largest demographic denominator.

What investors and staunch anti-capitalists ought to be focusing on instead of the hefty payout is the impact of O’Neal’s predictions on both the average American consumer and global export markets. A $161.5-million handshake may seem like a gross misallocation of private resources, but if Stan was right and the sky is falling in the broader credit markets, shareholders, consumers, activists, and corporations will have a lot more to worry about than a $0.19/share changing of the guard.