Treasury, Fed unveil broad effort to limit executive pay
Friday, October 23, 2009
WASHINGTON -- The government zeroed in on corporate excess and recklessness Thursday with unprecedented cuts in executive compensation at companies living on taxpayer money and a move to wield veto power over pay policy at thousands of banks to limit risk-taking.
The Treasury Department ordered seven big companies that haven't repaid their government bailout money to cut their top executives' average total compensation -- salary and bonuses -- in half, starting in November. Under the plan, cash salaries for the top 25 highest-paid executives will be limited in most cases to $500,000 and, in most cases, perks will be capped at $25,000.
The Federal Reserve came at the issue from another direction. It proposed to monitor pay packages at thousands of banks -- even those that never received bailout money -- to ensure they don't encourage reckless gambles.
The Fed proposal doesn't set specific limits on executive compensation, so it's unclear how it would actually affect pay. And the Treasury plan covers only 175 people, with the pay limits lasting only until the companies repay what they received from the $700 billion bailout fund.
For the already struggling companies, it also introduces a new concern: brain drain. The executives targeted by "pay czar" Kenneth Feinberg are among the most talented and productive at their companies.
"These people are considered the brains of the machine," said Steven Hall, who runs an executive compensation firm bearing his name. "They are who can pull you through the tough times. This will give them reason to leave."
The Treasury plan is limited to the seven bailed-out companies -- Bank of America Corp., American International Group Inc., Citigroup Inc., General Motors, GMAC, Chrysler and Chrysler Financial. The Fed's proposal is much broader in scope, covering nearly 6,000 banks and a wider range of employees.
Rather than set pay levels at specific banks, the Fed would review -- and could veto -- pay policies.
The plan is subject to a 30-day public comment period.
David Yermack, a finance professor at the Stern School of Business at New York University, called Treasury's pay curbs a "symbolic" act.
"I think the government is trying to make examples of some banks and hoping others will follow," Yermack said. "I think that's naive. Wall Street bankers and traders are motivated by money, and they're going to work for whoever pays them the most."
He predicted the seven firms would find ways to bypass the curbs through implicit promises that aren't written in contracts.
"They could say to someone, 'I'll give you a really big bonus three or four years from now. Just be patient,"' Yermack said. "There's an understanding that if you play the game, you'll be taken care of. That's been going on as long as there have been businesses, and Feinberg isn't going to be able to stop that."
Feinberg restructured the pay packages for top executives to provide a base salary and a portion described as "stock salary." The employees must hold the stock for two years. They can then sell only one-third of the stock payment each year for three years.
Feinberg said his goal was to tie compensation more closely to the long-term performance of the company.
In one pay plan, the three highest earners at Citigroup will receive a base salary of $475,000. Each executive also will be paid between $5.6 million and $5.8 million in company stock to be redeemed beginning in 2011. The third category of long-term restricted stock will equal $3 million for each executive.
The Feinberg plan provides an escape clause that might let some executives avoid the restrictions: It says the rules allow for "exceptions where necessary to retain talent and protect taxpayer interests."
According to Feinberg, base salaries above $1 million were approved for the new CEO of AIG, and for two employees of Chrysler Financial.
Under a package approved by Feinberg over the summer, AIG CEO Robert Benmosche will get a pay package of about $10.5 million.
Feinberg became pay czar earlier this year as Congress was responding to outrage about huge bonuses being paid to AIG. Lawmakers amended the bailout law to require that executive compensation at companies getting exceptional assistance be curbed. Feinberg has been reviewing compensation packages since August.
President Barack Obama welcomed Treasury's decision and urged Congress to pass legislation to give shareholders a voice in executive pay packages.
"It does offend our values when executives of big financial firms that are struggling pay themselves huge bonuses even as they rely on extraordinary assistance to stay afloat," Obama said.
In an interview with CNBC, Feinberg was asked if he thought the restrictions would influence pay at other Wall Street firms outside his authority.
"I hope so, but that would be voluntary," he said. "It's not the government's business."
Some observers said the changes could have a broader influence on pay beyond the seven companies.
"It's going to put them in a position of having to be more aggressive in defending their arrangements now that you've got an alternative out there that's been blessed by the government," said Mark Borges, a principal with Compensia, a Northern California compensation consulting firm.
It's also possible the restrictions could help govern pay at the thousands of banks that would be affected by the Fed's plan, said Charles Elson, director of the University of Delaware's Weinberg Center for Corporate Governance.
"It's highly probable that the Fed could use this as a model in their own guidelines, and yes, I think that would have a significant impact on pay," he said.
Some analysts saw the potential for restrictions to backfire. Yermack said linking pay to long-term incentives like deferred stock can encourage more excessive risk-taking, not less.
"If you want people to take more risks, pay them more in stock," he said. "It holds out the possibility of very big gains in a way that fixed contracts do not."
Others said the restrictions reinforced what many financial observers see as a banking system divided between the haves and have-nots. They wondered whether pay caps could jeopardize taxpayer money by making it harder for bailed-out firms to retain and hire top talent.
"You have got the companies that are unencumbered and can offer anyone anything they want, and you've got the other companies that are stuck with what they have," said David Schmidt, a senior consultant on executive pay at James F. Reda & Associates. "It creates a bit of a dilemma in banks' efforts to repay taxpayers."
A Bank of America spokesman complained that the restrictions would hurt its competitiveness.
"Competitors not subject to the pay restrictions already are exploiting this situation by identifying our top performers and using pay concerns to recruit them away for fair market compensation," spokesman Scott Silvestri said.
GM said it will adopt the compensation changes outlined by Feinberg by shifting its pay packages toward non-cash compensation tied to company performance.
CEO Fritz Henderson's base salary was cut 30 percent to about $1.3 million earlier this year when GM accepted government loans. Henderson received compensation valued at about $8.7 million in 2008, but much of that included stock and options that now are nearly worthless due to GM's bankruptcy filing.
Chrysler Group LLC CEO Sergio Marchionne and other Fiat executives who work for both Chrysler and Fiat were exempted from the pay cuts as part of the agreement with the U.S. government to take over management control of Chrysler.
Executives who work solely for Chrysler could be affected, but many of the top earners under Chrysler's former owner have left the company.
Under the Fed proposal, the 28 biggest banks would develop their own plans to make sure compensation doesn't spur undue risk-taking. If the Fed approves, the plan would be adopted and bank supervisors would monitor compliance.
At smaller banks -- where compensation is typically less -- Fed supervisors will conduct reviews. Those banks don't have to submit plans.
The Fed refused to identify the 28 banks that will have to submit plans. But Citigroup, Bank of America and Wells Fargo & Co. are usually included on such lists. Nearly 6,000 banks regulated by the Fed would be covered.