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So Hank Paulson yesterday admitted that no Wall Street bailout plan will pass without some sort of deal to limit executive pay for those who work for companies that participate in the deal.

"The American people are angry about executive compensation, and rightly so," he said. "No one understands pay for failure."

So what could this possibly mean?  And how can this be structured so that it actually discourages bad behavior?  Follow after the jump...

First of all, let me explain that compensation is my career.  I work in compensation for a publicly-traded company, and am involved with setting pay levels for my firm's CEO.  I have been working on comp issues for nearly 15 years.  

Everyone now is talking about this in vague terms.  I have yet to find published a single proposal on what these limits could be, to whom they would apply, what compensation elements would be included, the time frame for any restrictions, etc.  We need to talk about this now, before anything gets passed, or else the CEOs who exec comp limits are most supposed to affect will be finding loopholes and exceptions left and right, and nothing will change.  And trust me, things need to change.

Let's be clear about one thing up front: Laws dealing specifically with limit executive pay have always backfired.  There have been many attempts by the IRS, SEC, FASB, and Congress to either limit executive pay, or make abuses so transparent that no outside corporate director in their right mind would allow them to continue.  These have all failed spectacularly, as any historical analysis of exec comp levels would show.  So I'm not optimistic about this latest round of scrutiny.

A few things almost certainly won't work.  Congress cannot pass a law that just puts a cap on salary, since the firms will then just increase bonuses or stock grants.  They can't just limit CEO pay, since it won't stop a company from giving millions to the COO, CFO, group heads, and whoever else they want.  Any laws passed have to be all-inclusive, applying at all levels of the organization and to all employee rewards.  And, they have to be in effect until the taxpayers are made whole as it relates to the cash infusion made into the companies that participate.  

So, given those guidelines, I have a few ideas of things that could work to make this a better plan for both the companies and the taxpayers.

1. Eliminate the performance-based pay exemption for IRS Section 162(m).  What's 162(m)?It's an IRS rule that says companies cannot deduct from their corporate income taxes any compensation paid to a CEO or other Corporate Officer over $1 million in a single year.  Generally a good idea, but there's a massive exception for anything that's considered "performance-based".  That includes bonuses, stock options, performance based stock grants, and a host of other things.  As a result, many companies pay their CEOs $1 million in salary and then provide many millions in bonuses and stock option grants.  Eliminate the exception, and the cost to companies of making these mega-bonuses and mega-stock grants just became 40% more expensive -- and allows taxpayers to recoup more of the cost.

2. Suspend non-qualified deferred compensation.  When you read about things like "fired CEO gets $50 million package", more often than not the package includes lots of deferred compensation - money the exec earned but didn't take, instead agreeing to accept the money at a later date.  The money then gets to earn interest at a tax-deferred rate.  This is great for the executive who doesn't need the cash at the time he earns it (deferring your compensation earns you on average 20% more in interest than if you didn't defer it), but it's bad for the companies because they end up paying the tax on it over the time period that the executive has deferred the money.  It's not in the best interest of the companies to continue this practice in a time of crisis, and it is in the taxpayers' best interest to ensure the companies survive.  The IRS rule for this is 409A - just say that 409A cannot be used by companies that participate.

3. Prohibit any employee or consultant from receiving compensation (bonus, merit salary increases, stock, promotions, anything) directly related to the price of the assets they sell to the government. As the NYT asks this morning, "What's all this stuff worth?" Nobody knows yet, and it's in the government's (and taxpayers') best interest to keep the price as low as possible.  Conversely, it's in the companies' best interest to keep the price as high as possible.  But the real goal is to determine a mutually fair price.  Executives that participate -- that is, those that run companies in such desperate straits that they need our money to survive -- should not be incented more if they fleece us.  This should apply to anyone, executive or non-executive, who is part of the negotiation process related to the sale of their bad securities.  (My best guess is that, in order to avoid any appearance of a conflict of interest, the companies would respond by outsourcing the negotiation with the government on the asset sales to an independent consultant for a fixed fee -- and that's a much better situation for taxpayers.  Congress could allow for a "safe harbor" provision such as this.)

4. All existing executive employment contracts must be voided before the firm can participate, and no severance can be offered to executives dismissed by the Board. Every single Officer at these firms should be working on an "employment at will" basis, and if they do a lousy job, they get fired with no golden parachute.  Period.  The problem with CEO employment contracts is that they don't allow Boards of Directors to fire a CEO "for cause" if they are just doing a lousy job.  And the difference is important -- dismissing a CEO "for cause" voids the golden parachute provisions they all have in their contracts, while dismissing them for any reason other than "cause" triggers the millions of dollars in pay-for-failure payments that annoy and befuddle the average citizen.  Just eliminate the contracts altogether and Boards can make decisions about who the right people are to run these firms without paying out millions to get rid of them.

5. Any prohibitions listed above carry over to companies that purchase firms involved in the bailout.  Let's say I'm the CEO of Goldman, and I accept a limit on my pay as a condition of getting taxpayer money.  Then JP Morgan Chase (just humor me for a moment), who does not participate in the bailout, buys Goldman.  Do the new pay rules on Goldman's CEO carry over to JPM?  It should, since a big part of the appeal of Goldman to JPM is the improved health of Goldman brought about by taxpayer money.  They should also apply to anyone who takes over the role of Goldman CEO should the first one be dismissed or quit.  The rules apply to the companies, not the individuals running them.

None of these measures put a cap on executive pay.  Pay limits are easy for taxpayers to understand and sound great politically, but they never work and will lead to more exceptions and more bad behavior.  (Pay caps could also lead to these companies moving offshore, which would be, well, terrible.)  But they're a reasonable set of steps that improve the deal for taxpayers and eliminate the loopholes that helped get us into this mess in the first place.

So my fellow HR and compensation people, have at it.  What other provisions would you include?

Originally posted to obie0000000 on Thu Sep 25, 2008 at 06:57 AM PDT.

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Comment Preferences

  •  could this be the poison pill for the bill? (0+ / 0-)

    I was wondering if the dems pushed for this to make it unable to work.

    Republicans are not a national party anymore. Read My Lips: One Spouse, One House.

    by jalapeno on Thu Sep 25, 2008 at 07:02:09 AM PDT

  •  No performance-based exemption = brilliant! (0+ / 0-)

    Frankly, I don't want hard caps on CEO pay for the reasons you give. It won't work, and they can backfire in all sorts of ways. The American government should be in the business of progressive taxation and corporate governance reform, but directly setting salaries in the private sector is a bridge too far.

    But I desperately want to see large tax increases on the super-wealthy. There's no real downside; they'll work just as hard to earn five million as they do to earn ten million, and the government needs the revenue desperately. I have been wishing that this could be on the table during the current debate. It's obviously a much, much better way to limit excess and raise much-needed revenue to help the people who need it, instead of just gumming up the plan with empty punitive measures. Not that these goons don't deserve punishment, but if there's no upside to the taxpayer or the economy it's not worth fighting for.

    You have suggested an EXTREMELY smart way to raise taxes on excessive incomes, while staying within the bounds of what's possible in this package. "Eliminate this stupid tax loophole" is something that can easily pass as part of the bill, and better yet, it will affect all businesses -- not just those who take advantage of the bailout. And such a change need not expire with the bailout program in two years, either.

    I hope this suggestion is repeated and amplified!

    We don't see things as they are, we see them as we are. - Anaïs Nin

    by Valentine on Thu Sep 25, 2008 at 07:24:57 AM PDT

  •  I don't think it makes sense (0+ / 0-)

    to try to undo existing contracts. That's a big mess, and, barring a very broad suspension of the rule of law, it would have to be dealt with contract-by-contract.

    What I think might be more workable is, (a) no bonuses of any sort (cash, equity, options, deferred comp, anything) until the government gets back every dime, plus a nice rate of return, that it provided to the firm; (b) slap a confiscatory tax rate on high incomes, like 90% above $1 million. Yes, the latter screws rich people who had nothing to do with the problem, but either this is a national crisis or it isn't; if this country has allowed you to do well enough that you make more than $1 million a year, I think it's reasonable to say that you have a responsibility to help keep the damn thing going.

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