Will Pay Caps in the Bailout Be A Deterrent?

Ever thought executive compensation in financial firms excessive?

And now, with those firms seeking a taxpayer-funded bailout, should there be limits on how much executives get paid?

The issue is a key flashpoint in the debate currently raging in Congress over the $700 billion financial bailout.

On the one side some, including Secretary of the Treasury Hank Paulson, think such limits could actually discourage deserving firms from seeking government help. Distressed companies could lose the talent necessary to fix them.

But others counter that a public bailout should require safeguards against corporate excess. They also wonder what opposition to pay caps says about our country’s executives. 

“I don’t think it is much of a discouragement in this kind of emergency situation,” says Paul Hodgson, a senior research associate for Corporate Library, a leading voice on compensation and governance. “Faced with the choice of dissolution and/or bankruptcy, and there being some sort of arbitrary limitations placed on potential compensation, I would think most executives would go for having the [Paulson] plan invest in their company and therefore submit themselves to the limits.”

See video with House Financial Service Committee Chairman Barney Frank’s comments on the negative implications of Paulson's argument on the character of American executives and that there will be no 'golden parachutes.'

“If the difference [on whether to participate or not] is the pay, then they probably don’t need the help or the board of directors needs to find new leaders, new executives,” argues Lawrence Mishel, an economist and president of the Economic Policy Institute.

No Exact Numbers ... Yet

Exactly what the limits on compensation would be for institutions participating in the program are still to be determined by Treasury.

The length of time on such limits is also unknown. Initially it was two years from the time firms enter the program, but some argue it should be in place as long as government retains equity stake in participating companies.

Current draft legislation says that firms “seeking to sell assets through the program will have to meet appropriate standards for executive compensation and corporate governance in order to eligible.”

The liberal Economic Policy Institute suggests a reasonable level would be no more than what the US president earns - $400,000 (plus $50,000 in expenses).

“Are you telling me that people can’t support themselves on over $400,000 a year until this is all resolved — that would be a hard thing for most Americans to hear,” says Mishel.

“Hey, when private equity firms take over there is a lot of conditions, and why should the government be any different — what’s good for the goose is good for the gander — nobody’s forcing anyone to take lower pay because nobody is forcing anybody to come to the government for help.”

Of course the financial industry sees it differently.

“What’s wrong with this is plan is you have the government dictating the pay packages for executives and those decisions are best left to compensation boards who can evaluate the executives’ skill set and match that up with companies' needs and not the government,” counters Scott Talbot, a spokesman for  Financial Services Roundtable, which represents large financial firms.

See video for CNBC's Steve Leisman's analysis of today's Congressional hearings.

Timothy Bartl, of the Center on Executive Compensation, argues that the draft provisions are overly broad and too vague and could have a range of unintended consequences, including triggering finance executives, especially those nearing retirement, to cash out while they can, leaving a “talent void."

It could also “unnecessarily undermine pay for performance at a time when both the industry and the nation needs it most,” he warns.

The proposed limits might be closing the proverbial barn door after the horses have bolted since Wall Street's meltdown resulted from decisions made throughout the industry – as well as among irresponsible borrowers – when unfettered incentives were in place.

“It’s very definite that the incentive programs operated by almost all of these companies have encouraged the kind of risk-taking activity that has led to this financial fall-out in the first place,” says Hodgson.

Everyone Wants Clawbacks

One area where there does seem to be emerging consensus is on the need for claw-back mechanisms, and a provision for that is included in the draft legislation. Clawbacks are fast becoming “best practice” in the industry already, notes Bartl, who says that 28 of Dow 30 companies have such mechanisms. Hodgson agrees it is being adopted rapidly in the last few years but in practice they have only been applied once - when Warnaco trimmed the packages for three top executives in 2007. “If Congress believes it must regulate executive compensation, then it should promote a carefully structured clawback provision that requires companies to recoup pay in the event of a financial restatement,” says Bartl.

Another provision in the 42-page financial bailout draft would ban incentives encouraging  executives to take “inappropriate or excessive” risks” – although these are not defined.

Even if Congress does include compensation limits the industry could easily circumvent them by offering cash compensation to attract incoming executives, says Bartl.

That would be necessary in order to “compensate for the inability to address the risk premium of joining a company in a troubled industry, which is normally accomplished through severance,” he argues.

Such salary workarounds – which others say may be prohibited – “would certainly increase the level of executive compensation and blunt the desired effect of the legislation,” Bartl warns.

Still, the industry seems resigned to accepting some limits. “Congress is looking for a way to respond to taxpayers that say, 'Hey you just gave out $700 billion to the industry, where’s ours',” says Talbott.

The question is how Congress responds to that populist argument. 

“Limits on executive compensation on a substantive basis are wrong but politically it will be easy for members of Congress to return home and say 'Yes, we gave them $700 billion but we also cut their pay.' I think that will resonant with taxpayers — so I think it is going to be difficult to keep all limits out," Talbott adds.

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