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February 18, 2009
Are Executive Pay Caps the Solution?
Debate continues over whether compensation limits will keep executives in check or will force out the best and the brightest just when we need them most.
The economic crisis has led to widespread cost-cutting efforts, and the concept of strict salary caps for top-paid management and employees has sparked intense debate. President Barack Obama recently instituted compensation limits at companies benefiting from government bailout funding, and the measure has gained in popular support. However, some see an undercurrent of retribution in the new initiative, claiming it punishes executives for earlier excesses at a time when companies should be focused on increasing their competitiveness.
Imposing compensation limits signals a push for greater corporate accountability and prudence. These restrictions are intended to improve executive responsibility by curbing undeserved rewards. Yet some analysts warn that salary caps might drive talented, high-performing managers and executives to seek more lucrative opportunities, effectively undercutting a company's attempts to rebound from financial collapse.
Establishing corporate salary caps is not a new idea. Rather, it is one rooted in a history of government regulation closely tied to the current situation.
The Compensation Crunch
The economic downturn has affected worldwide compensation rates dramatically, with many companies making across-the-board reductions in planned salary increases in addition to layoffs, pay and hiring freezes and bonus reductions.
According to a recent report from Hewitt Associates, U.S. workers are expected to see the lowest annual pay raises in three decades, with an average salary increase of 3 percent. While the majority of European companies are focusing on layoffs, roughly 50 percent of U.S. firms are planning to reduce variable pay budgets as an alternative to major downsizing.
Notably, though, only 1 percent of American companies are planning cutbacks on executive salaries, compared to 9 percent of companies in Europe and Latin America and 4 percent in Asia. This seems to indicate that U.S. firms are reluctant to accept compensation limits, especially if they involve scaling back management salaries. Approximately 18 percent of U.S. companies are offering their top performers retention bonuses in order to hold on to existing talent.
Government Intercession
While retention efforts are beginning to become a concern, the U.S. government has introduced strict compensation limits into the national debate.
The economic stimulus package signed by President Obama yesterday includes a provision that restricts bonuses for top earners at firms receiving federal cash — "including those that already received it," according to the Wall Street Journal — more severely than the Obama administration's previous pay limits.
"[I]t has become clear that [...] these measures will lead to some of the most drastic changes in CEO compensation in the financial industry," USA Today notes.
An amendment in the stimulus bill, introduced amid public uproar over Wall Street's hefty payouts, goes beyond the $500,000 executive pay cap restriction announced earlier this month by the White House for companies that receive government money.
The amendment not only caps bonuses and bans rewards for departing executives, it also seeks a review of past compensation to "negotiate for reimbursements if those payments were contrary to the public interest."
The new limits build on earlier executive-pay rules by the Obama administration that moved to put a shorter leash on companies getting government help, including capping the annual pay of top executives of some institutions at $500,000, limiting "golden parachutes" and requiring corporate boards to adopt policies on luxury expenditures such as lavish parties.
The strictest pay restriction bars any company receiving federal funds from paying top earners bonuses equal to more than one-third of their total annual compensation. "Any bonus would have to be in the form of long-term incentives, like restricted stock, which could not be cashed out until the Troubled Asset Relief Program (TARP) money was repaid in full," the New York Times reports.
"These rules would set a $500,000 cap on executive pay at firms that accept 'extraordinary assistance,'" the Wall Street Journal says. "So far, no firm has fallen under this limit. The Obama rules have looser salary caps for firms that get more-general aid."
And while the new rules don't mention salary caps and concentrate instead on incentive-based pay, the guiding notion is to prevent organizations from rewarding failure.
As noted by the New York Times, there is strong popular support for reining in corporate excess and compensation. But some experts are concerned that salary caps will make ailing firms less likely to seek government assistance or to recruit talented employees.
Supporters of the regulation claim that retention and new hiring won't be a problem. The Wall Street Journal's Lucian Bebchuk argues that "salaries commonly represent a small fraction of total executive pay, and firms will be free to increase performance-based compensation to make up for any salary reduction."
Likewise, it is natural for the government to restrict sales of equity-based compensation because, as a massive investor, "the government is warranted in restricting their [executives'] freedom to unload their restricted shares quickly, before the government is repaid."
However, other critics say the pay-limit language in the stimulus bill is too vague and open to interpretation to be truly effective. Of the provision earlier this month, banks were expected to find loopholes, and the cap may drive "talented" executives away from companies that need them the most.
Some compensation experts warn that because of the rules, firms might lose their best managers to foreign banks or hedge funds.
Others question the validity of targeting senior executives in the first place, claiming that the non-senior personnel involved in financial manipulation should also face restrictions. According to Jason Zweig at the Wall Street Journal, "[l]eaving the compensation of these hot shots intact, while reducing the pay of the people who are supposed to boss them around, isn't going to make the investing world any safer."
The Salary Cap System
In theory, compensation limits are intended to impose a host of positive reforms onto a sometimes-reckless business environment. But the current initiative is far from revolutionary, as it reflects more than 20 years of attempted salary regulations, most of which have had mixed results.
The Minneapolis Star Tribune recently provided an overview of salary cap legislation from previous years, including:
- 1984: Congress created a 20 percent excise tax on corporate "golden parachutes;"
- 1993: Congress limited the amount of tax deductible salary to $1 million;
- 2002: Enron-inspired legislation applied "claw-back" provisions to reduce bonuses and incentives for executives who provided misleading financial statements;
- 2004: Section 409A was added to the tax code to regulate certain types of deferred compensation; and
- 2005: A bankruptcy and consumer protection act restricted severance and retention bonuses within companies facing bankruptcy.
These regulations were introduced to improve corporate responsibility and apply fair business practices, but were often circumvented due to loopholes or manipulation of the financial system.
As TIME magazine notes, the 1984 excise tax on "golden parachutes" applied to packages that exceeded three times base salary, so executives began receiving rewards 2.99 times their salary. Likewise, the $1 million cap on tax-deductible salary from 1993 caused companies to pay their senior executives with stock options and massive deferred bonuses in lieu of standard salaries.
This track record suggests that the current round of compensation capping may prove inadequate for curbing big, undeserved payouts. As a general rule, however, shareholders tend to be the most effective source of restraint on compensation and corporate incentives. Now that American taxpayers have become a vast bloc of shareholders, the responsibility for keeping salaries within reasonable limits may be in the public's hands.
Resources
Hewitt Reveals Most Companies Around the World Cutting 2009 Salary Budgets to Help Reduce Costs
Hewitt Associates, Feb. 4, 2009
Obama Lays Out Limits on Executive Pay
by Jonathan Weisman and Joann S. Lublin
The Wall Street Journal, Feb. 5, 2009
Boo Hoo in the Boardroom
by Timothy Egan
The New York Times, Feb. 4, 2009
Pay Cap Debate: They Don't Go Far Enough...
by Lucian Bebchuk
The Wall Street Journal, Feb. 6, 2009
Bankers Face Strict New Pay Cap
by Deborah Solomon and Mark Maremont
The Wall Street Journal, Feb. 16, 2009
Stimulus Plan Places New Limits on Wall St. Bonuses
by Edmund L. Andrews and Eric Dash
The New York Times, Feb. 13, 2009
Stimulus Bill's CEO Salary Caps Affect Small Banks, Too
by Pallavi Gogoi
USA Today, Feb. 16, 2009
Wall Street Finds Ways Around Executive Pay Caps
by Jim Puzzanghera, Christi Parsons and Walter Hamilton
The Los Angeles Times, Feb. 5, 2009
Executive Pay Cap Could Have Unintended Consequences
by Adam Shell
USA Today, Feb. 6, 2009
Obama Signs $787bn Stimulus Package
by Gretchen Peters
The National, Feb. 17, 2009
Goldman, JPMorgan Won't Feel Effects of Executive-Salary Caps
by Matthew Benjamin and Christine Harper
Bloomberg News, Feb. 5, 2009
Pay Collars Won't Hold Back Wall Street's Big Dogs
by Jason Zweig
The Wall Street Journal, Feb. 7, 2009
Restricting Executive Pay Like Fighting Tide
by V. John Ella
The (Minneapolis) Star Tribune, Feb. 8, 2009
Do Caps on Executive Compensation Really Work?
by Barbara Kiviat
TIME, Sept. 25, 2008
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Comment
8 CommentsFirst, top of the line managers aren't that special! When the average worker is making less than the national poverty level, these CEO's, etc., should not be making obscene amounts of $$$. How about no more than 3 times the pay of the average worker in their industry. If every company in the US was required to hold that line, these "bright, capable managers would adapt. No private jets, special expense accounts, bonuses, or other places for managers to acquire cash from the companies they work for. Want more money? Develop your own company and be an owner and take the risk. No bonus from tax dollars!!!
February 18, 2009 1:13 PMI have no problem with these execs and their pay. Good for them! They caught a break, produced a huge deal, brought in tons of business, made drastic changes, worked the corporate ladder, increased shareholder value, etc. But what's next? Any corporation receving a government contract must restrict exec pay? Any corporation receiving tax credits must increase their lower pay scales? This is a dangerous precedent that can only snowball. There is no other word for this other than S-O-C-I-A-L-I-S-M!
February 18, 2009 2:20 PMYes I think pay, benefits and stock caps should be imposed across the board. Where have we come up with the idea that CEOs and upper management are that much more important than the people producing? It is nothing but pure greed and this is partly what has put us in this situation we are facing now.
The caps should be much more stringent than what is proposed and they should be for all businesses in the USA and for the companies that import into the USA. If companies want to import goods into the USA then if the CEOs do not follow USA guidelines for salaries their imports should be taxed appropriately and the tax revenues used to pay our national debt. But we cannot stop there as we need to make sure the foreign importers are paying salaries equal to the average pay for workers in the USA for that class of material imported.
The biggest step the USA needs to do is put in place federal laws against lobbyists and our federal officials accepting money. We need to make accepting money, gifts or favors by senators, representatives, military or civil servant punishable by death or life in prison without parole. The same punishment needs to be imposed on the lobbyist and the CEO of the company they represent.
We need a country that is for the people, not beg corporations.
February 18, 2009 2:30 PMI entered a comment but you folks were too chicken to post it?
February 18, 2009 2:33 PMHas anyone ever done a study of CEO compensation vs company performance in the following years? Everyone assumes that the guys making the big bucks are the best - show me some stats that prove they are worth it. IMHO a company's yearly performance isn't due to what it's CEO did that year, it's due to what was done in the 5-10 years prior.
CEO's will not start to focus on 5-10 years down the road until their compensation & more importantly Wall Street expectations reward them for it. Change the definition of 'long term holding' for tax purposes to 5 years, keep the long term capital gains tax low & raise the less than long term capital gains tax rate to ordinary income rates & watch Wall Street & CEO's focus change. Not allowing incentive compensation to vest for 5 years would help too.
February 18, 2009 6:19 PMExecutive compensation is a long-term bubble.
I agree with Rich above that directly regulating this is an unwelcome intrusion by the government.
The right way to solve this is to give shareholders more power to limit these excessive remuneration packages.
The problem is systemic: what government should do is fix the system not artificially try to set the "right" compensation.
I have read plenty of annual proxy meeting notices, but have stopped reading so closely for my sanity. Essentially what happens is that the board of trustees, who supposedly represent the shareholder, is a big club of buddies amenable to raising pay for their friends, the top management of any given company. Even mediocre performance "merits" a bonus. My view of this for a long time now has been: an overly high remuneration for the executives of the company is equivalent to stealing from the shareholders. If they want to further participate in the good fortunes of the company, the executives ought to by stock in the company with the same conditions to which the rest of the employees are subject -- at the same discounts, in the same quantities, etc..
In brief, there is very little real accountability in remuneration of executives at publicly held companies as can be evidenced by the high "bonuses" paid to companies that have performed miserably or gone bankrupt in recent history.
Warren Buffett agrees that compensation is overinflated.
For some reason, it seems the brightest and best appear to be the greediest with the least morals.
Maybe they should limit pay commensurate to those that are not so bright, and just plain "good".
If these executives actually "produced", as they expect their employees to do, we would have more jobs, lower priced products, and an expanding economy. Bottom-line doesn't mean anything. Enron and Madoff proved that. Pat McGinnis started it back in the 50's when he sold off the assets of the Boston & Maine for a bottom line. Any average intellect can do that so why pay a premium. Tie the bonuses to steadily increasing sales and profits without off-shoring. That's "REAL" talent.
February 22, 2009 11:34 PM
