The Magazine

Pay Day

Why it makes sense to worry about executive compensation.

Aug 31, 2009, Vol. 14, No. 46 • By IRWIN M. STELZER
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Bliss is it in this dawn to be alive, but to be a banker is very heaven--with apologies to Wordsworth. The Federal Reserve Board's monetary policy gurus are making cash available to banks at almost no cost, it can be re-lent to desperate borrowers at mouthwatering margins, and if anything goes really wrong, the government stands ready to bail you out. Free cash, or almost; high and rising charges to borrowers and consumers; bailouts if assets become toxic--what more can a bank president and his board want in this best of all possible worlds?

Freedom to set compensation, that's what. But that is not to be: The government has decided that it shall be the final arbiter of just how much banks that depend on it for their existence can pay their 5 senior executive officers and 20 "most highly compensated employees" in bonuses, and the compensation of the "100 most highly paid employees that are not subject to the bonus restrictions." Exempted are employees whose total annual compensation is not more than $500,000, and to whom any additional compensation is paid in the form of stock that can be sold only in the "long term." In its broadest terms, compensation packages must be "performance-based." Indeed, even those firms that have paid back bailout loans might well find themselves caught in this new regulatory net, since Kenneth Feinberg, the designated "pay czar," has taken the position that he has the discretion to claw back any compensation received by employees not only in firms that still owe the government money, "but in any company that received federal assistance," even those that have paid all their loans in full. Once a debtor, always in debt.

Feinberg contends that his discretion is complete and not subject to review--by anyone. "The [bank] officials can't run to the secretary of the Treasury. The officials can't run to the courthouse or a local court. My decision is final."

The pay czar does not have the field of compensation-setting all to himself. The ever-active Barney Frank has persuaded his House colleagues to approve legislation that is designed to control executive compensation--sort of. But not directly. Instead, it seeks to introduce pay restraint by sprucing up corporate governance. Shareholders are to get the power to have a "say on pay" by casting advisory votes on proposed pay packages, and compensation committees are to be given somewhat greater power to do their job properly. Unless the very thought of Barney Frank trying to curb management's ability to set its own pay without regard to shareholders' interests offends you, nothing much here to worry about. After all, it is over 60 years since Adolf A. Berle and Gardiner Means, in their classic The Modern Corporation and Private Property, wrestled with the problem created by the inability of scattered shareholders to make certain that the managers of their businesses pursued the owners' interests, rather than those of the management group.

Since the current financial upheaval spread to the real economy, we probably have thought harder and learned more about the problem of compensation in the banking sector than at any time since Berle and Means put pen to paper. The first and easiest lesson is that when the government is a major shareholder, or the source of the financing that provides life-support for any company, it will want to have a say in how much of the dependency's revenues go into executive pockets. It's hard to quarrel with the modern version of the old British notion that he who takes the king's shilling is obliged to render service to the king. No self-respecting private equity guy would allow the executives of a company he has just rescued with a major investment to set their compensation without giving him something to say about it. Neither will, or even should, the government. So pay czar Feinberg is busily reviewing the detailed executive compensation plans plunked on his desk by the not-so-magnificent-seven companies still beholden to the government: AIG, Bank of America, Citigroup, Chrysler, Chrysler Financial, General Motors, and GMAC. Feinberg has 60 days from receipt of the plans (submitted to him on August 14) to decide whether to approve or demand modifications of plans to compensate the employees of the seven firms. The entire financial services industry, even those that never heard of TARP or accepted any government aid, knows that what Feinberg decides will affect it. J. Mark Poerio, co-chair of the executive compensation group at consultants Paul Hastings, advisers to hundreds of financial firms, tells the Washington Post, "What Feinberg eventually approves will essentially serve as an outer boundary for what the law allows."