OCTOBER 6, 2008
Bailout's Bid to Limit
Executive Pay Will Be Tough to Realize
The $700 billion financial-rescue
law attempts to curb executive pay by barring incentives for
"unnecessary and excessive risks," among other steps. That
will be easier said than done, say pay experts.
It's "a very noble thought, but administering it will be very
difficult," says Paul Hodgson, senior research associate at
governance tracker Corporate Library and a frequent critic of
Merrill Lynch chief Stan O'Neal made $150 million before
leaving in the wake of a write-down.
excessive-risk language applies to financial firms in which the government
takes a "meaningful" debt or equity stake under the terms of the bailout.
Other provisions limit corporate-tax deductions on executive compensation at
some firms, bar "golden parachutes" for some executives, and allow companies
to recover compensation based on inaccurate results. Congress approved the
bill last week, and President George W. Bush signed it into law Friday.
The excessive-risk provision is aimed at what
some consider a contributor to the Wall Street meltdown: pay plans that gave
executives outsize rewards for taking big risks. Those led to big paydays
for some executives, despite big losses at their firms. In five years as
Merrill Lynch & Co.'s chief executive officer, Stan O'Neal made $150
million in salary, bonuses and the value of equity at the time of grants,
according to data-tracker Equilar Inc., before leaving in October 2007 in
the wake of an $8.4 billion write-down.
Few dispute Wall Street firms took too much
risk, but there is little consensus on the role of pay packages in
encouraging that behavior -- or how to prevent it from happening again. Some
experts say that banks such as
Wells Fargo & Co. avoided the worst of the mortgage mess, even though
their compensation plans were similar to those at banks that suffered big
Pay experts say the vague language of the new
law will make it hard to implement. The provision doesn't specify how to
determine what "unnecessary and excessive" risk is, says Mr. Hodgson. That
could give Treasury Department officials a lot of leeway.
Still, pay experts say the provision is
sparking debates on the link between pay and risk, and how to tweak
incentives to limit risky bets. Some of those ideas run counter to long-held
tenets of good compensation plans, such as tying pay closely to financial
results or stock price.
"This provision establishes a beachhead and
starts a discussion on how you'd achieve these results," says Mark Borges, a
principal at pay consultancy Compensia Inc. Mr. Borges and others say they
are discussing a range of ideas with corporate directors, including
requiring executives to hold stock for longer periods and delaying the
payment of annual bonuses.
Alan Johnson, managing director of pay
consultancy Johnson Associates Inc., blames unrealistic performance targets
for much of the risky behavior. He says executives of some financial firms
he advised had to produce a return on equity of 20% to earn their full
annual bonuses. A more realistic goal might have been around 15%, he says.
Mr. Johnson thinks firms in which the
government takes a stake might weaken the ties between executives'
compensation and financial results -- the opposite of what most companies
Ira Kay, head of compensation consulting at
Watson Wyatt, contends that linking pay to performance, particularly through
granting stock, is still the best way to avoid excessive risk-taking. The
problem on Wall Street, he says, may have been overly large cash bonuses
that made the stock seem like "gravy."
Others suggest tying more pay to long-term
results. Richard Ferlauto, head of corporate governance and pension
investment at the American Federation of State, County and Municipal
Employees, suggests companies delay paying annual bonuses for a few years --
until they are sure that good results will last. Consultants say some
companies tried such deferred-bonus plans in the 1990s, but later abandoned
them because they were hard to administer.
Mr. Ferlauto also wants more companies to
require top executives to hold a significant amount of stock until they
leave, forcing them to think longer term.
That idea, too, has been tried, with mixed
Citigroup Inc. requires senior executives to hold until they leave 75%
of the shares they are awarded; but Citigroup engaged in much of the same
risk-taking behavior as rivals.
"I am not saying it's a cure-all," admits Mr.
Ferlauto. He's now asking companies to make top officers hold some stock
until at least two years after they depart.
Write to Phred Dvorak at
Joann S. Lublin at firstname.lastname@example.org
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