February 03, 2009
Executive Compensation Gets Crushed
Posted by David Zaring

Now that the Obama administration, pursuant to the EESA, is capping executive compensation in bailout recipient firms at $500,000, it's time for a bit of we told you so.  The previous Treasury Secretary, Henry Paulson, asked for lots of flexibility in setting executive compensation standards once it became clear that Congress would insist on them as a condition of the bailout.  This flexibility was sought one month before an election that the government was extremely likely to lose, at least if you trust Ray Fair or Jack Balkin (this post by Balkin was written in February, 2008).  Are the standards that the Obama administration will adopt the ones that Paulson would have wanted?  Even a median term political strategist might have suggested that he negotiate for some hard targets on executive compensation (or, you know, a Trojan horse) in the bill rather than unfettered discretion.  Which suggests, as Steve Davidoff and I have written, that the government was thinking more about the next deal than the long, or even median, term.

Is the Obama compensation limitation legal?  Pending a close reading of the yet to be released provisions, I bet it will be.  Though the TARP exec comp provision contemplated asset purchases (which the government never did), it indicates that companies in which the government takes an equity position shall be subject to "appropriate" limitations, which grants a lot of discretion to Treasury:

Where the Secretary determines that the purposes of this Act are best met through direct purchases of troubled assets from an individual financial institution where no bidding process or market prices are available, and the Secretary receives a meaningful equity or debt position in the financial institution as a result of the transaction, the Secretary shall require that the financial institution meet appropriate standards for executive compensation and corporate governance. The standards required under this subsection shall be effective for the duration of the period that the Secretary holds an equity or debt position in the financial institution.

There's some detail for senior executive officers, and said officers might be able to argue that capping executive compensation at $500,000 does not prevent them from taking excessive risks - an argument I think is risible:

[requiring] limits on compensation that exclude incentives for senior executive officers of a financial institution to take unnecessary and excessive risks that threaten the value of the financial institution during the period that the Secretary holds an equity or debt position in the financial institution.

Moreover, since "senior executive officer" is defined a the top five best paid at the firm, it's not as if you can cut the CEO's pay, but fork over big bucks to the star traders, at least, not unless the Obama administration wants it that way.

It will certainly incentivize paying off the bailout money as fast as possible.

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