Executive Compensation and the Stimulus Package: The Problem of Non-Comprehensive Solutions

The WSJ reports that the stimulus package includes some severe limitations on executive compensation for firms receiving federal money.  The most severe restriction is a cap on bonuses for top officials.  They cannot equal more than one-third of an officer's total salary (the bonus could, therefore, equal 50% of the non-bonus compensation, with the result that the bonus would be one-third of the total).  The number of people affected depends upon the amount of money accepted and the provisions are, apparently, retroactive.

Senator Dodd, who inserted the provision, had this to say:

• "the decisions of certain Wall Street executives to enrich themselves at the expense of taxpayers have seriously undermined public confidence in efforts to stabilize the economy.... With vigorous oversight by the Treasury Department and by Congress, these tough new rules will help ensure that taxpayer dollars no longer effectively subsidize lavish Wall Street bonuses."

The provision reflects the frustration of those in Congress and among the American public with problems associated with excessive compensation.  But it also demonstrates the problems with a piece meal solution.

First, the best way to avoid the caps on bonuses is to increase compensation.  This could, therefore, result in higher salaries for executives and no drop in total compensation.

Second, because the limits are tied to companies receiving federal funds, this will discourage some companies from participating in the bailout.  In fact, the restrictions ought to apply to all companies, not just those participating in a bailout.

Finally, capping bonuses still does nothing to guarantee that the board approves a compensation package that is commensurate with an executive's contribution to the company.  In other words, the approach leaves the Delaware model in place.  Ostensibly "independent" boards can approve any amount of compensation, subject only to the caps, which as noted, will be easy enough to circumvent.  The problem of executive compensation rests with the standards employed by directors in approving compensation (Take a look at this piece for a more complete discussion of this issue:  Returning Fairness to Executive Compensation).  Until the matter is systematically corrected at the board level, problems of excessive executive compensation will remain.