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Fannie Mae Case Study Essay

In 2005, President Daniel Mudd received a base salary of $990,000, an annual incentive plan bonus of $3,000,000 and a long-term incentive award of $9,000,000, averaging a total of $12,990,000.  2005’s total was a decrease from 2004, which figured in at $15,000,000, a 20.2% decrease between a year’s compensation.  2005’s drop in overall pay is mostly due in part to the firing of CEO Raines and CFO Howards, and the transition of adjustments from the past four years, 2000-2003.

In 2006, President Daniel Mudd received a base salary of $990,000, an annual incentive plan bonus of $2,500,000 and a long-term incentive award of $9,000,000, averaging a total of $12,490,000.  2006’s total saw a decrease from 2004, which figured in at $14,750,000, a 17.6% decrease between a year’s compensation.  2006’s drop in overall pay is mostly due in part to the continued regulatory observation of Fannie Mae’s board since the expulsion of CEO Raines, and the appointed of Daniel Mudd as the new CEO in 2005.

In 2007, President Daniel Mudd received a base salary of $990,000, an annual incentive plan bonus of $2,227,500, and a long-term incentive award of $9,000,000, averaging a total of $12,217,500.  2007’s total was a decrease from 2006, which figured in at $14,449,947, a 15.4% decrease between a year’s compensation.  2007’s drop in overall pay is mostly due in part to poor financial performance.

1.      Summarize the third and fourth sections of the case, parts III and IV, and also the conclusion.

Part III surmises that, back in the 1990s, Congress passed a law to regulate the annual salary cap for an executive at $1 million in section 162 of the Internal Revenue Service (IRS).  Unfortunately, a legal loophole was created in regards to how the law was written.  The regulatory law only addressed the annual salary of an executive, but failed to state anything in regards to retirement.  Fannie Mae and several other companies have, in the past, exploited this oversight to their advantage by bolstering executive retirement plans and compensations.

Part IV deducts that camouflaging is a method that most companies practice in order to keep the actual value of an executive’s annual salary and, in the case of retirement, severance and retirement compensations, hidden from the knowledge of both the general public and mutually-vested stockholders.

Camouflaging allows a company to use stockholders’ money in ways that were never intended and as an incentive for better performance from its employees.  Such is the case with Fannie Mae, which was using stockholders’ money to smooth out its selling market, and make it appear, to the general public and stockholders, alike, that the company was not only meeting, but exceeding, sales quotas, presenting everyone with the façade that stock values were on the rise in the process, when, in all actuality, very little profitable gain had been made.

Camouflaging is not illegal; however, the practice of using one’s money for purposes other than those that the owner agreed on, or has knowledge of, is both unethical and immoral.  It would be in the best interest of every stockholder affected by the Fannie Mae case, and any person who may be mutually-vested with a company, to press Congress for an amendment to section 162 of the Internal Revenue Service, specifically in regards to the maximum capacity on an executive’s retirement plan and compensations.

The Conclusion points out that Fannie Mae, a private and government-funded company, is not alone in their actions, but that some public companies are guilty of having practiced, and continuing to practice the same methods.  This is something that stockholders definitely need to take a close look at.  If anything can be learned from the Fannie Mae case, it is to research and know the company and policies of the company that money will be invested in.  From the outside, a company may look like a well-oiled machine, but upon closer inspection and research, one may find out just what exactly they are doing with stockholders’ money.

2.      Do you believe the board and any responsible sub-committees such as the compensation and audit committees failed in their due diligence?  Why might this be so?  Should the board and compensation committee have required Raines to return the compensation that was based on the mis-reported financials?

Yes, the board and the compensation and audit sub-committees are all three to blame.  The board members, as “unaware” as they were to the activities within the company, should have maintained a more regulatory presence over its respected committees and sub-committees, fully aware of the activities of each group.

The compensation and audit sub-committees are both to blame for not reporting an unusual increase in sales and stock profits to the board.  As a result of the dishonest and underhanded policies over the four year time span, at least $5 million dollars of stockholders’ money was awarded to CEO Raines and CFO Howards, both of whom did absolutely nothing to deserve such a gratuitous bonus.

Yes, both Raines and Howards should have been required to return the compensation that was based on the mis-reported financials.  In truth, Raines and Howards stole shareholders’ money, money that neither of them earned, or deserved, and was acquired by a very shady tactic by Fannie Mae.

How should CEO Raines’ compensation structure have been linked to performance?  What sort of performance indicators should have been used to ensure shareholders’ interests were protected and CEO Raines was rewarded for “true” economic performance?

All of this could have been avoided had Fannie Mae not given CEO Raines such an incentive for a short-term period.  Any person would have been tempted; however, Raines’ response, natural as it may be, was still reprehensible, as well as ethically and morally wrong.  Yes, there is a performance-based structure that could have been implemented.

The board simply could have held an annual evaluation of Raines’ performance.  If he met or exceeded the company’s goals from the previous year, then he would be ensured a certain amount of money that both parties, the board and Raines, had agreed upon.  However, this predetermined bonus would only be awarded upon him retiring, not at the end of the year.  Raines’ incentive for working hard should have been based on him knowing that he was helping low-income and middle-income families buy homes, not on what he could gain.

References

Fannie Mae – Annual Reports and Proxy Statements.  (2007, April).

2007 SEC filings 10-K.  Retrieved January 23, 2009,

from http://www.fanniemae.com/ir/pdf/annualreport/2007/proxy.pdf


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