Executive Compensation and the Financial Crisis: A Problem In Search of a Solution (Still) (Part 1)

Executive compensation was a hot topic during the financial crisis.  Concern existed on two fronts:  The absolute amount and the form of compensation.  The astronomical amounts contrasted sharply both with the high unemployment rate and sector's dependency on government bailout funds.  The form of compensation provided incentive to engage in short term profit making, irrespective of the long term consequences.

The approach to compensation demonstrated the failure of state law, the primary source of regulation for compensation, to impose any meaningful limits on compensation practices.  Even with compensation paid to the CEO, who invariably sat on the board of directors, Delaware courts allowed for the application of the business judgment rule rather than the more obviously applicable duty of loyalty.  As a result, compensation because a matter of process (and weak process at that), with the substantive terms (the amount, for example), largely becoming irrelevant to the compensation determination.  It resulted in compensation witout limits.  For more on this, see Returning Fairness to Executive Compensation. 

During the financial crisis, the government to some degree stepped in, at least with respect to companies taking bailout funds (which mostly involved banks and other financial institutions although some operating companies such as General Motors also received government funding).  With respect to the type of consideration, most of these companies were pressured or required to pay a higher portion of bonuses in the form of stock and to impose vesting schedules.  The theory was that this would remove much of the incentive to make short term profits and provide an incentive to manage in a manner that maximized the long term prospects of the company. 

With respect to limits on amounts, almost nothing was done.  For a time, limits were imposed on the size of bonuses relative to the base salary.  Nothing, however, prevented a company from raising base salaries.  Moreover, the limitation wholly exempted stock.  For the companies that received the largest dollops of government bailout money, their compensation scheme was subjected to review by the Pay Czar, Kenneth Feinberg.  He could not review past awards or contractual obligations and retained review authority only as long as TARP funds remained unpaid.  His oversight likely reduced compensation amounts but only on a short term, temporary basis.

The issue always was whether there would be any long term change in compensation practices. 

Comments

[czander]

Its impossible for government employee to regulate Wall Street tycoons who make at minimum 85 times the salary of the regulator. This is precisely the dilemma those who direct the Securities and Exchange Commission and the Federal Deposit Insurance Corporation face every day on the job. These two agencies, lack the experienced and committed staff they need to protect average Americans from financial industry recklessness and greed. The Bernie Madoff’s of the world go unchecked because those who are expected to check on them suffer from envy, low morale, and a desire to enter this world of the financial tycoons. They shun their responsibilities and in many cases look the other way in hope of obtaining a position in the world of high finance. According to Pizzagati (in Anderson, et. al. (2009) “The lure of lucrative private sector jobs doesn't just siphon off talent from public service," "It also breeds corrosive and ever-present conflicts of interest: Why 'get tough,' as a regulator, on a firm that could be your future employer?" To “get tough” requires that regulatory agencies create an opportunity structure where their employees get rewards, salary increases, promotions, etc. when they discovered wrong doing. A revolving door culture where government employees can join the regulated is a breeding ground for corruption. There is no better example of this relationship then Neil Kashkari the government’s bailout chief who went from Goldman Sachs to run the Troubled Asset Relief Program for banks (TARP) and then returned to finance at the Pacific Investment Management Company (PIMCO). Kashkari has been accused of doing this company’s work even when he was employed by the government as PIMCO benefited from various Treasury Department actions (Leonard, 2010).