AIG Forgot About Customer Value

The furor over the bonuses paid to AIG executives reveals a fundamental problem, not only with AIG but with most Wall Street companies and probably many other corporations as well.

Before I get to that, let me mention a pet peeve that stems from my background as a journalist. I believe words should be used properly. If the bonuses on Wall Street are a major – and expected – part of an employee’s compensation, then don’t call them bonuses. Wall Street may have its own reasons for calling them bonuses, but if so, I take a different position.

However, that is a minor point. The major one is that huge bonuses distort what a business should be all about.

People work so they can make money to live and prosper. And the owners or shareholders of a business have making money (i.e., maximizing shareholder value) as their mission.

But that is different from the mission of the business itself – which should be, as lean advocates understand, to serve customers by providing them with value.

People are human, and they respond to incentives. When the incentives are huge – hundreds of thousands, or even millions, of dollars – that overrides everything else. Serving customers then takes second place to getting that big bonus.

The result is that everything becomes focused on making money, even to the detriment of customers. Wall Street firms eagerly throw money at mortgage lenders and brokers to buy the mortgages they’ve created because securitizing those mortgages produces huge profits. Never mind that the underlying sub-prime mortgages are junk that will eventually blow up in their faces. They justify their actions by deluding themselves into believing the value of real estate will always go up.

In the case of AIG, the company essentially assumed the risk of those assets on behalf of many other companies, eager to take the profits that came from doing so, foolishly assuming they would never have pay claims on the insurance they provided.

Ratings companies facilitated these deals, giving high ratings to products that never came close to deserving them – because it was so profitable.

Everyone involved probably claimed they were providing value for their customers. Everyone should have known better.

The best example I’ve heard recently of people who truly were concerned about serving customers was in a column written for The New York Times by Thomas Friedman.

I live in Montgomery Country, Md. The schoolteachers here, who make on average $67,000 a year, recently voted to voluntarily give up their 5 percent pay raise that was contractually agreed to for next year, saving our school system $89 million — so programs and teachers would not have to be terminated. If public schoolteachers can take one for schoolchildren and fellow teachers, A.I.G. brokers can take one for the country.

Executive compensation is a thorny issue, and I don’t have any easy answers on how it should be structured. I have no problem with people making lots of money, or even getting bonuses. I’m inclined to think bonuses should be tied to the rising and falling of the company’s performance, with stock options preferable to cash.

But whatever the structure, compensation should not get in the way of executives being dedicated primarily to providing value for customers.

AIG – and the rest of Wall Street – lost sight of that.