Executive Compensation and the Financial Crisis: A Problem In Search of a Solution (Still) (Part 8)

What about bank regulators in the compensation process? 

Don't expect much.  The Fed will rely on "guidance."  Moreover, with respect to the largest financial firms, the Federal Reserve apparently plans to eschew consistent policies in favor of a case by case review.  See Fed Press Release, Oct. 22, 2009 (Fed plans to review for the 28 largest banking organization their "policies and practices to determine their consistency with the principles for risk-appropriate incentive compensation"). 

This will not likely have much long term impact.  First, it is not clear whether regulators really have the necessary expertise in this area.  Second, it requires considerable resources to do a firm specific analysis of compensation each time inspections occur.  Whatever energy goes into the process now will likely wane as other issues become paramount.  Third, policies will change over time, likely allowing practices to creep back to where they were before.    

The approach can be contrasted with the actions of regulators in Europe.  The Committee of European Banking Supervisors (CEBS) just issued guidelines on compensation for European financial institutions.  The guidelines require proportionality in the determination of compensation.  As the guidelines explained, the “principle aims to consistently match the remuneration policies and practices with the individual risk profile, risk appetite and the strategy of the institution, so that the objectives of the principles are more effectively achieved.” 

More than generalizations, the guidelines provide specific limits on pay practices.  They emphasize the need for the deferral of compensation and the payment of a healthy portion in stock.  Specifically, the guidelines require that 40-60% of bonuses have a minimum deferral period of three to five years and that 50% of the bonus should be paid in stock. 

Restrictions were placed on retention bonuses.

• Guaranteed variable remuneration can take several forms such as a "guaranteed bonus", "welcome bonus", "sign-on bonus", "minimum bonus", etc. and can be granted either in cash or in instruments.  These practices can only be allowed in so far as they remain within the remit of the provisions of the directive: they should be applicable only for the first year of employment and in the context of hiring new staff. Institutions will no longer be able to guarantee multi-year variable remuneration over, for example, two or three years.

Golden parachutes are deemed presumptively unsound from a prudential perspective.

• “Golden parachute” arrangements for staff members who are leaving the institution and which generate large payouts without any performance and risk adjustment are prudentially unsound. Such arrangements create a “heads I win, tails I still win” approach to risk, which encourages more risk-taking than would likely be preferred by the institution’s shareholders or creditors. Any such payments should be related to performance achieved over time and designed in a way that does not reward failure. This does not preclude termination payments in situations such as early termination of the contract due to changes in the strategy of the company, or in merger and/or takeover situations.

The approach will not be a complete fix.  It does not affect the amount of compensation.  Moreover, as happened in the US, there will likely be increased pressure to raise base salaries.  Nonetheless, the approach eschews the case by case approach (except within the ranges provided in the guidelines) and mandates long term performance metrics.   Perhaps in time the US will take a similar approach.