June 10, 2009
Statement by Treasury
Secretary Tim Geithner on Compensation
For the Say on Pay fact
sheet, visit link.
For the Providing
Compensation Committees New Independence fact sheet, visit
WASHINGTON – Our financial system is
built on trust and confidence. It requires rules and practices that
encourage sound risk management and align the benefits for market
participants with long-term growth and value creation – not only at
individual firms, but for our financial system and the economy as a whole.
This financial crisis had many significant
causes, but executive compensation practices were a contributing factor.
Incentives for short-term gains overwhelmed the checks and balances meant to
mitigate against the risk of excess leverage.
Today, I met with SEC Chairwoman Mary
Schapiro, Federal Reserve Governor Dan Tarullo, and top experts to examine
how we can better align compensation practices – particularly in the
financial sector – with sound risk management and long-term growth.
In considering these reforms, we start with a
set of broad-based principles that – with the help of experts like those we
assembled today – we expect to evolve over time. By outlining these
principles now, we begin the process of bringing compensation practices more
tightly in line with the interests of shareholders and reinforcing the
stability of firms and the financial system.
First, compensation plans should properly
measure and reward performance.
Compensation should be tied to performance in
order to link the incentives of executives and other employees with
long-term value creation. Incentive-based pay can be undermined by
compensation practices that set the performance bar too low, or that rely on
benchmarks that trigger bonuses even when a firm's performance is subpar
relative to its peers.
To align with long-term value creation,
performance based-pay should be conditioned on a wide range of internal and
external metrics, not just stock price. Various measurements can be used to
distinguish a firm's results relative to its peers, while taking into
account the performance of an individual, a particular business unit and the
firm at large.
Second, compensation should be structured
to account for the time horizon of risks.
Some of the decisions that contributed to
this crisis occurred when people were able to earn immediate gains without
their compensation reflecting the long-term risks they were taking for their
companies and their shareholders. Financial firms, in particular, developed
and sold complex financial instruments that yielded large gains in the
short-term, but still presented the risk of major losses.
Companies should seek to pay top executives
in ways that are tightly aligned with the long-term value and soundness of
the firm. Asking executives to hold stock for a longer period of time may be
the most effective means of doing this, but directors and experts should
have the flexibility to determine how best to align incentives in different
settings and industries. Compensation conditioned on longer-term performance
will automatically lose value if positive results one year are followed by
poor performance in another, obviating the need for explicit clawbacks. In
addition, firms should carefully consider how incentives that match the time
horizon of risks can extend beyond top executives to those involved at
different levels in designing, selling and packaging both simple and complex
Third, compensation practices should be
aligned with sound risk management.
At many firms, compensation design
unintentionally encouraged excessive risk-taking, providing incentives that
ultimately put the health of the company in danger. Meanwhile, risk managers
too often lacked the stature or the authority necessary to impose a check on
Compensation committees should conduct and
publish risk assessments of pay packages to ensure that they do not
encourage imprudent risk-taking. At the same time, firms should explore how
they can provide risk managers with the appropriate tools and authority to
improve their effectiveness at managing the complex relationship between
incentives and risk-taking.
Fourth, we should reexamine whether golden
parachutes and supplemental retirement packages align the interests of
executives and shareholders.
Golden parachutes were originally designed to
align executives' interests with those of shareholders when a company is the
potential target of an acquisition. Often, they have been expanded beyond
that purpose to provide severance packages that do not enhance the long-term
value of the firm. Likewise, supplemental executive retirement benefits can
make it more difficult for shareholders to readily ascertain the full amount
of pay due a top executive upon leaving the firm.
We should reexamine how well these golden
parachutes and supplemental retirement packages are aligned with
shareholders' interests, whether they truly incentivize performance, and
whether they reward top executives even if their shareholders lose value.
Finally, we should promote transparency
and accountability in the process of setting compensation.
Many of the compensation practices that
encouraged excessive risk-taking might have been more closely scrutinized if
compensation committees had greater independence and shareholders had more
clarity. In too many cases, compensation committees were not sufficiently
independent of management, while companies were not fully transparent in
explaining their compensation packages to shareholders. In addition,
existing disclosures typically failed to make clear in a single place the
total amount of "walkaway" pay due a top executive, including severance,
pensions, and deferred compensation.
We intend to work with Congress to pass
legislation in two specific areas. First of all, we will support efforts in
Congress to pass "say on pay" legislation, giving the SEC authority to
require companies to give shareholders a non-binding vote on executive
compensation packages. "Say on pay" – which has already become the norm for
several of our major trading partners, and which President Obama supported
while in the Senate – would encourage boards to ensure that compensation
packages are closely aligned with the interest of shareholders.
Secondly, we will propose legislation giving
the SEC the power to ensure that compensation committees are more
independent, adhering to standards similar to those in place for audit
committees as part of the Sarbanes-Oxley Act. At the same time, compensation
committees would be given the responsibility and the resources to hire their
own independent compensation consultants and outside counsel.
Beyond legislation, I also want to emphasize
the importance of the efforts being taken by Chairman Bernanke and the bank
supervisors to lay out broad standards on compensation that will be more
fully integrated into the supervisory process. These efforts recognize that
an important component of risk management is getting incentives right, and
we will support the Fed and the other regulators as they work to ensure
executive and employee compensation practices do not create unnecessary
Finally, I want to be clear on what we are
not doing. We are not capping pay. We are not setting forth precise
prescriptions for how companies should set compensation, which can often be
counterproductive. Instead, we will continue to work to develop standards
that reward innovation and prudent risk-taking, without creating misaligned
As we seek to strike this balance, the
President's Working Group on Financial Markets will provide an annual review
of compensation practices to monitor whether they are creating excessive
risks. And we will encourage experts in the field – academics, business
leaders and shareholders – to conduct their own reviews to identify best
practices, emerging positive and negative trends and call attention to risks
that might otherwise go unseen.
Many leaders in the financial sector have
acknowledged the problems posed by past compensation schemes, and have
already begun implementing reforms. But we have more to do to address this
challenge, and we look forward to continuing this conversation with a wide
range of stakeholders in the weeks and months ahead.