Government Intrusion into Executive Compensation: It's Not the Solution

The publicity swirling around the Pay Czar's apparent decision to drastically cut the compensation at seven companies receiving the most bailout money needs to be put into perspective.  First, it is the Pay Czar, not the board of directors, who is ensuring that the compensation is fair.  In other words, the need for a Pay Czar reflects an awareness that the system of relying on the board to determine compensation doesn't work, at least if setting compensation at a fair amount is the goal.

But this solution relies on one person, the Pay Czar, with his almost unlimited authority, to oversee a mere seven companies.  There are, however, over 10,000 public companies.  The pay issue cannot be so easily constrained.

Is there a permanent role for government review of executive compensation?  Proposals suggesting that the Federal Reserve Board was going to issue rules/guidelines to regulate some practices suggest that at least some think there is.  It looks like from published reports, that Fed guidelines on compensation will become part of the inspection process.  But if the experience at AIG is any indication, this won't be a particularly successful effort.

The Report issued on October 14 by the Office of the Special Inspector General for the TARP Program, SIGTARP-10-002, illustrates how confusing compensation has become and how woefully unprepared the government is to actually oversee it.  The study was essentially driven by the need to examine the role of the government (in this case the New York Fed and Treasury) in the decision, announced in March 2009, that AIG would pay out $168 million in retention bonuses.  The report concludes that the payments were legal and recommends a few mild policy changes, particularly the need to require advance notice to Treasury of these types of decisions.  

The more interesting aspect of the report is the daunting task confronted by the government in trying to oversee the compensation process.  The study describes the situation confronting the NY Fed (FRBNY) in the fall of 2009.  At that time, AIG had a:

• "staggeringly complex, decentralized system consisting of hundreds of separate compensation and bonus plans.  Over time, they identified 650 AIG bonus programs totalling approximately $455 million for 51,500 employees, 13 retetnion plans allocating about $1 billion to almost 5,200 personnel, and deferred compensation of approximately $311 million for about 5,400 employees."

The confusion wasn't limited to the government.  As the report also pointed out:  "Both [the NY Fed] and AIG corporate officials have struggled over time to fully understand and document the details of the varied compensation plans within AIG." 

The confused and staggering nature of the task didn't suffer from lack of resources.  As the report further notes: 

• "Within fifteen days of singing its September 22, 2008, credit agreement with AIG, a team of FRBNY officers, including Senior Vice Preidents, Vice Presidents, and supervision staff, moved on-site at AIG to assess the magnitude of the company's funding and liquidity needs, to understand its financial condition, and to assess borader risk managment issues at the company."

The FRBNY hired consultants, including Ernst & Young, which ultmately was used in connection with the examination of compensation issues.

It was an extraordinary commitment of resources.  Yet even with the examination, the report notes that while the FRBNY knew of the size of the retention bonuses, "it is unclear whether FRBNY officials knew that thousands of dollars in payments would go to non-essential AIGFPO support employees, such as kitchen and mailroom assistants."

With the 10,000 or so public companies, the government lacks the resources, the expertise or the incentive to become this involved in the compensation process.  Indeed, the report demonstrates why the focus should be on fixing the process inside the board of directors and avoiding government oversight as the solution.