Governance and the Government's Purchase of Equity (Part 2)

Treasury has announced the compensation restrictions that will apply to companies selling equity interests to the government.  These include:

• The financial institution must meet certain standards, including: (1) ensuring that incentive compensation for senior executives does not encourage unnecessary and excessive risks that threaten the value of the financial institution; (2) required clawback of any bonus or incentive compensation paid to a senior executive based on statements of earnings, gains, or other criteria that are later proven to be materially inaccurate; (3) prohibition on the financial institution from making any golden parachute payment to a senior executive based on the Internal Revenue Code provision; and (4) agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each senior executive.

The most significant thing about the announcement is that apparently the restrictions apply to "[a]ny financial institution participating in the Capital Purchase Program."  In other words, there will be no effort to determine whether the interest acquired by the government is substantial but instead the restrictions will be applicable to all participating financial institutions.  The most immediate impact, of course, is that the nine largest financial institutions agreeing to participate (some under duress) will become subject to the restrictions.

Moreover, because many other banks will receive equity injections, the impact of the restrictions will be that they become applicable to the entire financial industry.  In other words, the government will be overriding the Delaware approach to compensation for an industry.  This will likely put pressure on other companies to enage in similar practices even if not legally required to do so.  While the restrictions are at best modest, they will demonstrate, once the experiment is over (they only last as long as the government retains its investment), that federal intervention is both necessary and prudent in limiting excessive compensation and preempting the Delaware approach.