Geithner's Plan to Overhaul Executive Pay

Geithner: The idea now is to ensure that pay doesn't encourage excessive risk Jim Bourg/Reuters

With the threat of a financial meltdown receding, Treasury Secretary Timothy Geithner has a new project: reining in the pay of bankers, traders, and other financial players.

Good luck with that.

Geithner's goal is understandable. Financial-services executives have had every incentive—through rich option plans, bonuses, and other compensation—to take maximum risk for maximum profit, whatever the long-term consequences. These practices contributed to the biggest Wall Street crisis in decades.

But past efforts by regulators to limit executive pay have never made much of a dent. The current push may not be more successful. Already pay at the big banks and brokerages is bouncing back to pre-crisis levels. "It's a fool's errand to try [to regulate pay]," says compensation consultant James Reda of James F. Reda Associates. "It just creates more work for lawyers and people like me."

One case of unintended consequences: the Clinton Administration's 1993 efforts to curb executive pay by limiting companies' tax deductions for salaries over $1 million. A loophole allowed unlimited, fully deductible pay in the form of options—and the Gilded Age of lush executive comp was ushered in.

Administration officials say the agency won't be outfoxed this time. Instead of absolute limits on pay, it will ensure that pay doesn't encourage excessive risk.

But the problem is far easier to recognize than it is to remedy. Companies that have collapsed, for example, have had limited success enforcing "clawbacks" designed to force managers to pay back salaries or bonuses based on what proved to be fictional or short-term profits.

To avoid such scenarios, closer government monitoring of pay practices is being considered. Another possibility: requiring bonuses to be paid out over three years or more so executives don't churn out low-quality loans that produce profits now but losses later. Or C-suite executives might have to hold on to stock awards till retirement, encouraging them to take the long view.

Corporate governance adviser Patrick S. McGurn of RiskMetrics Group (RMG) sees no easy solution. If government gets too prescriptive, he says, "that will just encourage lawyers to find workarounds." If regulators rely on a better review of risks, they "have a huge learning curve in understanding pay practices." Effective regulation of executive comp? Don't bet your paycheck on it.

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