President Obama's new restrictions on the pay of bailed-out finance executives is likely to ripple across the broader U.S. economy, experts say. But if the history of executive pay is any guide, it's more likely to influence how the money is doled out, not how much of it makes its way into the pockets of top brass.
Obama's cutbacks will certainly reduce executive pay at the largest firms directly affected in the short term. According to Equilar, which tracks executive compensation, companies with $10 billion or more in assets that took taxpayer money from the Troubled Asset Relief Program (TARP) paid their CEO an average of $11 million last year, including an average cash bonus of $2.5 million. By contrast, Obama is capping pay at $500,000, with no short-term bonus.
Long term, though, bank executives could still make out quite well. Pearl Meyer, senior managing director at pay consultants Steven Hall & Partners, notes that the plan does allow for long-term grants of unrestricted stock. Considering the low stock prices these banks currently trade for, that could represent a lot of upside.
Nix on Lavish Perks
Like many pay observers, Meyer thinks even non-TARP companies will embrace certain restrictions in order to seem in step with the new frugality the public is demanding. Severance packages should come down, and luxury perks such as company cars and lavish office redos are certain to be out, she says. Companies are already reducing merit pay because of poor business performance. Meyer's clients typically are cutting merit pay for all staffers from 3% or 4% of pay to 2%.
That's being applied to the top brass as well as the rank and file, something that didn't always happen in the past. And two-thirds of the largest U.S. companies have already put in place the kind of "claw-back" provisions that Obama advocates, where companies reclaim bonuses that were paid out for performance that later turns out to be illusory.
But the potential for long-term payouts on stock grants provided for in Obama's plan )—even though they won't come through until taxpayers are paid back—provides a significant escape hatch for executives. That's why Meyers doubts the rules set forth by Obama on Feb. 4 will drop pay over the long haul.
Indeed, if anything, past government attempts at reining in pay have generally had the opposite effect. After Richard Nixon put in caps on raises for everyone, not just executives, during the inflationary 1970s, compensation went up across the board. One reason: A loophole let you get a raise if you were promoted, which led to a rise in promotions. Also, people demanded the maximum government-allowed raise, even if they would have settled for less without it.
Rules that Boomerang
A congressional $1 million cap on CEO salary tax deductibility in 1993 led to the current popularity of enormous stock option grants, mega- pension awards, huge severance payments, and perks galore. Special life-insurance arrangements arose that guaranteed executives substantially more income in future years, often subject to little or no taxes. Executive health-care benefits have grown richer as well, at times not only covering more services with less cost to the executives, but also extending for years—or even a lifetime—after departure. They were extended in many cases to cover spouses and children as well.
"Every single endeavor by the government through legislation or regulation to limit executive or employee compensation has had the exact opposite effect," says Meyer. "It has boomeranged."
Even if a pay cap works, not everyone thinks Obama's deal is fair. Alan Johnson, an executive pay consultant to the financial-services industry, believes the restrictions on the TARP companies are onerous.
"In a perverse way, the companies most on the edge of going under are the most hard-hit," he says. And if other companies don't embrace similar restrictions, managers at TARP companies will have incentives to move to their more healthy rival banks, or out to hedge funds or private equity where government restrictions are not an issue. Or, they may just stop working so hard.
More to Come?
Johnson says he's worried this is not the end of pay restrictions, either. "Mr. Obama has got to balance the political theater with not killing these firms," says Johnson. "This is a pound of flesh for political consumption. And if you're an executive, you can't be sure this is it."
David Wise, a pay consultant at Hay Group, who works with many boards, also thinks Obama's plan is flawed. "Salary caps are going to result in some of the top people on Wall Street finding other things to do," says Wise. "A good compensation program is all about balancing short- and long-term performance. The old banking model relied very heavily on annual performance. The President's puts too much reliance on long-term compensation. The right answer is somewhere in the middle."
But for companies that want more government aid, pay concessions were just the price of admission, says Representative Barney Frank (D-Mass.), chair of the House Financial Services Committee. Frank argues that without a show of pay contrition, and a better explanation of how they're spending the money already given, there's little chance that big financial institutions would be able to tap further into TARP funds. Otherwise "the chances of talking the American people out of this kind of anger is zero," Frank said at a Feb. 3 press conference,
Others point out that Wall Street’s huge bonuses reflect a risk culture that contributed to the current crisis. Thus, a reordering of incentives might be welcome. In a hearing before the Senate Banking Committee, former Federal Reserve Chairman Paul Volcker said: "When you mix together those enormous compensation practices [and] enormous gains possible with obscure financial engineering, you had a recipe…that came back to haunt us." As for the creative talent that fueled the complexity, he said: "I wish more of it would go to building bridges instead of financial markets."
Penalty for Failure of Leadership
Investor activists, meanwhile, have little sympathy for the plight of the newly clipped. "This is the inevitable consequence of their failure of leadership," says Nell Minow, co-founder of The Corporate Library. "It would have been really smart for the business community to clean up their own act instead of waiting for this to happen." Minow sees the government's move not as one a regulator made, but as something any capitalist-minded investor would demand.
Better than most, Minow knows the frustration of watching compensation grow despite efforts to curb it. Her group has for years been fighting for corporate governance reform. She agrees with Obama's support for "Say on Pay" provisions that would allow shareholders to vote on executive pay, but says even more important is fixing board compensation committees, which ultimately design and dole out pay.
"The focus should not be on the symptom, excessive compensation, but on the disease, which is bad boards of directors," Minow says. She advocates giving shareholders the right to vote off board members who are not doing a good job, especially those sitting on the compensation committee.
"They deserve to be under the microscope," says Minow.