Dispatches from the Creation Wars

The Empty Executive Compensation Rules

A few weeks ago, the CEOs of Ford and GM offered to work for a salary of $1 a year if they had to take federal bailout funds and I immediately wondered if that included all compensation, like stock options and bonuses, or whether it was just salary. When Obama announced the new rules on executive compensation for companies receiving bailout funds, limiting it to $500,000 a year, I wondered the same thing. Here’s the answer: Apparently not.

The plan, announced Wednesday, includes a $500,000 cap on annual compensation for senior executives of companies that receive future “exceptional” government aid. Additional compensation would have to be paid in restricted stock or similar long-term incentive arrangements, which the executives could cash in only after the government is repaid, with interest.

Here are a few of the loopholes:

Many applauded the moves as a useful step to curb Wall Street compensation practices that may have led to excessive risk-taking. But some critics identified weaknesses, suggesting the restrictions be retroactively applied to companies that already have received federal bailout cash. They noted that the most stringent restrictions likely would affect only a few firms; others could avoid some of the curbs by putting extra pay to a shareholder vote.

Some said the plan doesn’t limit total compensation, because it allows companies to boost awards of restricted stock.

“I am fearful that companies will look at this as an opportunity to grant more restricted shares and stock options to executives who already have an abundant amount of equity,” said Jesse Brill, a securities and compensation lawyer who is chairman of CompensationStandards.com, an advisory Web site. He would prefer barring executives from cashing in stock until age 65 or two years past retirement to encourage long-term decision making.

Michael Kesner, head of compensation consulting at Deloitte Consulting LLP, worries the plan allows executives to claim restricted-stock awards once the company pays back the government, and doesn’t require companies to tie those awards to operating results or share-price gains, as many companies now do.

That last criticism strikes me as invalid. Do companies really tie stock award to operating results? A lot of them clearly don’t. Nor do they tie overall compensation to results very often. For example, last year Alan Mulally of Ford made $22 million in total compensation. Only $2 million of that was salary, the rest was bonuses, stock options and other forms of compensation. And that was while Ford was losing money like crazy. If a company ties executive compensation to performance now, I doubt they would stop doing that after these restrictions are put in place.

Other loopholes:

Others said the preliminary restrictions released by the Treasury Department are overly vague. For example, the $500,000 annual pay limit applies only to “senior executives.” James F. Reda, a New York compensation consultant, said companies could give certain executives lower titles or assign them to head subsidiaries.

“Now you’re going to have executives ask not to be called a senior executive,” said Steven Hall, a New York pay consultant…

There also isn’t a clear definition of what constitutes a luxury perk. Companies could grant executives benefits such as medical exams, tax gross-ups and personal tax advice, said Sarah Anderson, an executive-pay analyst at the Institute for Policy Studies, a liberal think tank in Washington. Gross-up payments from companies reimburse senior executives for taxes the executives owe on company-provided perks and other benefits…

David Yermack, a finance professor at New York University’s Stern School of Business, said the initial guidelines don’t address many aspects of executive pay, such as deferred compensation and pension arrangements.

Mr. Yermack also said it isn’t clear if companies would be allowed to boost executives’ pay by repricing existing stock options. Such a repricing could be worth millions of dollars in potential compensation.

Now the good news:

The Treasury official said the department plans to issue more detailed regulations, likely in a few weeks. He said each company’s perk guidelines will be vetted and posted publicly.

This will certainly be worth watching. It also provides opportunities for enterprising investigative reporters to look into the details of executive pay and any changes made at companies receiving federal funds over the next few months. These rules are certainly better than no rules at all, but I hope the implementation rules from Treasury have some teeth in them and have a real impact.

Hopefully these companies will be motivated by wanting to avoid the bad press and perhaps more draconian measures that might result if they try to game the system and those games are exposed, motivated enough to avoid doing so. Time will tell.

Update: After I wrote the above, much of this changed. The stimulus package included much stricter executive pay restrictions. But Obama was apparently opposed to those stricter limits:

President Barack Obama objects to some executive compensation limits in the $787 billion stimulus package he plans to sign Tuesday, but his chances of wiggling out of the rules Congress passed don’t look very good.

The White House opposed language authored by Sen. Chris Dodd (D-Conn.) requiring that the top earners in companies receiving federal bailout funds collect no more than one-third of their compensation in the form of bonuses. At firms taking a half-billion dollars or more in federal aid, the limits apply to the top 25 earners. Fewer employees are covered at smaller banks taking part in the so-called Troubled Asset Relief Program, or TARP.

White House officials have cited concerns that the new compensation limits, some of which are to be applied retroactively, could scare small banks out of participating in the program. And privately, officials said the limits could cause executives to leave troubled firms when they are most needed. The administration is also worried that the limits could encourage banks to pay back TARP funds when they should be using that money to make loans.

Two silly arguments. First, the banks aren’t loaning out that money anyway. Second, the notion that we should be worried about losing the very executives that drove their companies into the ground doesn’t strike me as terribly convincing.