Friday, June 12, 2009

Executive Compensation Revisited

In a lead article in yesterday's Los Angeles Times Business section, "Plans to Rein in Exec Pay Announced," we read about President Obama's latest plans to clamp down on executive pay. As expected, they have generated support from most Democrats and vocal opposition from many leading Republicans. None of this is surprising. Why write about this and what's going to happen?

My regular readers may remember that I posted two blogs on this subject in past months. On 1/31/09 I commented that the strong and widespread criticism of substantial and inappropriate bonuses paid Wall Street executives were in most cases highly justified. My conclusion then was that meaningful actions to deal with this will most probably be taken by the Congress, the Obama Administration, the regulators, some boards of directors and many shareholder groups. On 8/29/08 my blog commented on the then recent historical trend of excessive compensation, defining what was excessive, who's responsible and what possible actions might be taken.

In my view it's still appropriate to write about executive compensation, because it has a bearing on what's going on in our poor though hopefully slowly improving economy, on a likely changing corporate culture, as well as the pluses and minuses of the federal government's growing influence and control over our overall economy and our vital business community. Executive compensation has had a very significant bearing on our economy because it has in too many cases, through its structuring, led to imprudent high risk taking, which in turn has led to corporate failures, needs for federal taxpayer funded rescues, massive layoffs, and huge adverse impacts on federal and state financial budgets affecting all of us. Furthermore, all of this has been instrumental in contributing greatly to the world-wide recession and clearly been a major factor in falling stock and bond markets, eroding the values of savings and retirement portfolios of tens of millions of American families.

One prominent and controversial part of the Administration's plan is to appoint a "pay czar" to approve compensation for the highest paid employees of major companies, like Bank of America, Citigroup and AIG, as well as others who have received bailout funds from the federal government. Another part involves support for legislation to give shareholders a larger voice in compensation issues. Treasury Secretary Geithner also laid out broad principles on executive compensation, such as tying incentives more to long-term performance to contain short-term risk-taking, particularly by bond, currency and commodities traders. The various restrictions would likely last until the companies repay their bailout moneys and other financial obligations. Geithner stressed that the government does not intend to cap how much executives would be paid.

Ideally, executive compensations should be decided by an effective, independent company board of directors or its compensation committee, guided by experienced compensation consultants, often supported by recommendations of the CEO for compensations for those who report to him or her. The problem has been that to many directors and CEO's didn't do their jobs well, and too many directors were not really independent. Another contributing, but less important weakness has been that company auditors and rating agencies have not generally commented critically on compensation practices.

I think an executive compensation bill will pass, but it will probably require some concessions on both sides. I'd expect it to include more power for shareholder groups to vote, perhaps non-binding, on compensation for the top 4-5 executives and also pressure from regulators and the SEC to enforce more independence of the board directors. I'd expect more companies to expedite repayment of bailout moneys to generate some more freedom in compensation matters. I'm also sure that most company directors in future will be more sensitive to imprudent compensation structures and act more responsibly. Finally, I'd hope the "pay czar" position would be eliminated as the economy gets solidly back on its feet and the several stakeholders have learned their lessons on how best to deal with this.

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