October 19, 2008
We’ll Rescue You on Four
YOU may have been wondering
what it takes to get overpaid executives to rein in excessive compensation.
Well, now you know. It takes a historic financial market conflagration and
hundreds of billions of taxpayer dollars in bailouts.
It is only fitting, of
course, that restrictions on
executive pay be part of any deal in which beleaguered taxpayers rescue
companies that helped drive the country into a ditch. Here’s a data point:
The nine banks participating in the capital infusion program paid their
former and current chief executives a total of $231 million last year.
So it is gratifying to see
Henry M. Paulson Jr., the Treasury secretary, applying common sense to
executive pay at institutions being propped up with investments from the
Bank of You and Me.
There are four aspects to
the compensation rules in the so-called Capital Purchase Program:
Part 1: Combating the kinds
of incentives that encouraged outsized risk-taking by managers.
Part 2: Recovering
compensation given to senior executives who benefit from reported earnings
that turn out to be inaccurate, typically known as “clawback” provisions.
Part 3: Prohibiting golden
parachutes — which the
Internal Revenue Service defines as more than three times an executive’s
average pay prior to retirement.
Part 4: Making companies pay
taxes on any compensation an individual receives over $500,000. (Normally,
compensation up to $1 million per executive is tax deductible.)
SO, is all of this good, bad
or indifferent from the taxpayer’s standpoint? I asked Brian Foley, an
independent compensation consultant in White Plains, to analyze the pay
program as he would any public company’s plan.
Part 1, restricting pay
incentives that encourage risk, is so basic, Mr. Foley said, that it should
not even have to be specified. “It looks to me like the plan calls for a
self-administered process where the company’s compensation committee will
commit to get together periodically with its risk officers,” he said. “They
should have been doing that all along. And if they weren’t, they should be
doing it now anyway.”
When it comes to clawbacks,
Treasury’s plan takes a slightly tougher stance than a similar requirement
in the Sarbanes-Oxley law. For example, while Sarbanes-Oxley’s clawbacks
relate only to chief executives and chief financial officers, Treasury’s
provision covers the three most highly paid executives in addition to those
two officers. In the future, the Treasury plan also doesn’t limit the time
period to which the clawbacks can be applied.
provisions could not be more paramount. Consider the recent performance of
the nine banks participating in the Treasury infusion plan. Between early
2004 and mid-2007, these banks earned a total of $305 billion. Since then,
they have written down their assets to the tune of $323 billion.
“The notion that we have to
take a harder look at clawbacks is overdue,” Mr. Foley said. “That involves
not only having better provisions permitting the clawback, but if there is
no provision companies should go for them anyway. Let the executives go in
front of a jury and try to win that one.”
Mr. Foley added that the
Treasury’s recovery provision won’t necessarily cover employees who earn
more than the top five executives, like top-producing sales representatives
or heads of highly profitable subsidiaries.
For instance, Treasury’s
rule would not have applied to Joseph J. Cassano, the executive overseeing
the unit at the
American International Group that sent the insurance giant off the
rails. Mr. Cassano earned $280 million over the last eight years, according
to Congressional documents; his unit racked up $25 billion in losses.
As for the parachute limits,
Mr. Foley called them barely limiting. If an executive earned $10 million
annually in the previous five years, he or she would still be entitled to
$29.9 million in exit pay. That ain’t nothin’.
Moreover, two executives
earning the same amount and generating the same corporate performance could
receive wildly different treatment under the Treasury plan. Say two
executives both earn $10 million in total compensation annually. If one
exercised stock options worth a total of $30 million in the prior three
years, then his average annual pay would rise to $20 million, entitling him
to a parachute of $59.9 million.
If the other executive had
not exercised stock options, his exit package would be $29.9 million.
“This gets deep into the
vagaries of parachute calculations,” Mr. Foley said. “It is a limit that
will have uneven results.”
As for the $500,000 cap on
deductible pay, Mr. Foley said it is interesting that the limit appears to
apply to any executive, even after he or she retires, who was among the top
five targets — even if only for one year. “Once you are part of the top five
it appears that you are permanently targeted,” he said.
Optimists may hope that
restrictions on pay at financial institutions dining on the public dime will
force similar moves at other companies and boards. But Mr. Foley isn’t so
Because compensation tied to
stock prices is already falling, companies are less likely right now to
restrict their pay plans, he said. “You almost have to batten down the
hatches and take the best shot with the programs that are in place.”
AS for financial
institutions, bonus pools will be savaged regardless of the Treasury’s new
rules because, by any financial measure, those companies’ performance has
Gary Lutin, an investment
banker at Lutin & Company, convened a shareholder forum on executive pay for
investors and managers last July. With the taxpayer now on the hook for
executive pay, the topic has only grown in significance.
“If we want to save our
economy we need to establish a reward system that’s based on simple
fairness,” he said. “Everyone understands fairness and at least most of us
want it. But it is painfully obvious now that what we’ve been doing has not
A version of this article
appeared in print on October 19, 2008, on page BU1 of the New York edition.