Treasury and the Regulation of Executive Compensation

There is simply not enough time to write about the corporate governance issues that seem to surface on a daily basis.  A few weeks back, Treasury issued an interim regulation dealing with executive compensation.  There are a few gems in the regulation that are interesting and extraordinary.

Most noticeably, Treasury went beyond the requirements of Section 111 of TARP and appointed a Pay Czar (less colloquially known as the Special Master for TARP Executive Compensation).  The Pay Czar essentially has a blank check to approve/not approve the compensation paid at seven companies: AIG, Citigroup, Bank of America, Chrysler, GM, GMAC and Chrysler Financial.  The Pay Czar (Kenneth Feinberg) must approve the compensation paid to the top 5 officers and the next 20 most highly compensated employees at each company.  It goes much further, however.  He also has the obligation to approve the compensation "structure" for senior executive officers and the 100 most highly paid employees.  And, the Pay Czar will also review compensation (including bonuses and retention awards) paid before February 17, 2009 by TARP recipients and, "where appropriate, negotiate appropriate reimbursements to the Federal Government."

As for the standards to be used in approving/disapproving compensation?  The compensation will not be allowed if found to be "inappropriate, unsound, or excessive."  Unsound apparently has some meaning, albeit not much.  Unsound means compensation that encourages "unsound risk taking."  Inappropriate (which apparently means something other than excessive) and excessive are undefined and largely allow the Pay Czar to do whatever he wants.  The regulations do contain some guidelines but these go to form rather than amount.  Thus, they include such platitudes as the need for TARP recipients to remain competitive (presumably allowing Citigroup to pay higher salaries to its energy trading group) and for appropriate allocations among salary, pay incentives, and retirement.  In addition, the compensation must avoide incentives that reward employees for "short-term or temporary increases in value," be performanced based, and comparable to similar entities.

With respect to the Stimulus Bill's requirement that TARP companies establish policies governing luxury expenditures, the Treasury regulations took it one significant step further.  The CEO and the CFO must certify that any expenditure requiring approval (either of the board or a senior executive officer) "was properly approved." The regulations also prohibited gross ups and required expanded disclosure of perks.  Rather than just disclose amounts, TARP companies were required to disclose perks for a wider group of officials and to provide a "narrative description of, and justification for, the benefit."  The narrative justifying the perk may place downward pressure on their use.  Moreover, it will open directors to challenge for approving their use.  

Finally, the regulations took some tentative and overdue steps in the direction of disclosure about compensation consultants.  An area that has been begging for additional disclosure requirements, TARP companies must "provide a narrative description of the services provided by any such consultant, including any non-compensation related services provided by the consultant or any of its affiliates, as well as a description of the use of any 'benchmarking' procedures in the consultant's analysis."

The rules in this area, particularly the need to appoint a Pay Czar, demonstrate the absolute failure of state law (read Delaware) to adequately regulate practices in this area.  The standards imposed on the Pay Czar (that compensation not be unsound, inappropriate or excessive) would seem to be standards that ought to already be in place.  Nonetheless, Treasury apparently felt that this wasn't true and, as a result, had to appoint an alternative guardian to ensure proper practices. 

The failure of state regulation is clear enough.  The only real question is what the Obama Administration plans to do once the crisis is over.  Will the Adminstration go for a permanent fix or allow Delaware to regain its preeminancy and compensation to continue to remain excessive?