Does the Administration Care About Executive Compensation?

They certainly want you to think they do. Yesterday was Executive Compensation Day in Washington. The Treasury Department appointed Kenneth Feinberg to oversee executive pay at seven companies that have received extensive government aid – AIG, Citigroup, Bank of America, and the car companies and their finance companies. The administration, which always seemed uneasy with the popular outrage over bonuses earlier this year, seems willing to throw the seven sinners to the wolves, while letting the bulk of the financial sector off the hook. Feinberg will only provide advice to other TARP beneficiaries, and banks that pay back TARP money will not even have to deal with that.

This, of course, solves precisely nothing. The problem with “executive compensation” – no, make that just “compensation” – in the financial sector was its structure. Huge end-of-year bonuses tied to short-term metrics, with no corresponding downside risk, motivated people to take on excessive risk in hopes of maximizing those bonuses. And the companies we need to worry about most are not the ones that are most beaten-down today, but the ones that are (relatively) the strongest and will be taking the biggest bets.

So the administration is also thinking about addressing these structural issues. Tim Geithner made a statement on compensation yesterday that lays out five reasonable-sounding principles (compensation should reward performance, compensation should be “aligned” with risk management, etc.). On closer examination, it’s remarkably short on verbs that aren’t prefaced by “should.” For example, “I met with SEC Chairwoman Mary Schapiro, Federal Reserve Governor Dan Tarullo, and top experts to examine . . .” Or, “in considering these reforms, we start with a set of broad-based principles . . .” Or, “by outlining these principles now, we begin the process of bringing compensation practices more tightly in line . . .” (Emphasis added, obviously.)

At its heart, there are only two proposals: first, “say on pay” legislation, which requires non-binding shareholder votes on executive compensation packages and, according to Geithner, “would encourage boards to ensure that compensation packages are closely aligned with the interest of shareholders;” and second, new standards for independence of board compensation committees.

If you’re wondering how a non-binding shareholder vote could possibly solve the problems with executive compensation, you’re not alone. I think “say on pay” is slightly better than nothing, because there is a chance that in some cases the additional attention will shame boards into more reasonable packages. But in general, shareholders’ ability to influence corporate governance is pretty weak. Outside shareholders, even major institutional investors, face many challenges: fragmentation of ownership, which makes it hard to build a big enough coalition; the control of information by management and the board; the usage of compensation consultants to insulate pay packages from criticism; and the tendency of small shareholders to either not vote or vote the way the board recommends. Even if dissident shareholders can muster a “no” vote, the likely outcome would be a cosmetically modified package that is simply harder to understand – or no change at all (non-binding, remember?).

Independent compensation committees are also a nice idea, but without many teeth, at least in the proposal floated yesterday. They key question is, what incentive do the compensation committee members have to really crack down on executive compensation? The proposal draws a parallel to Sarbanes-Oxley and audit committees. But audits turn out to be right or wrong, and if there is a restatement, that is deeply embarrassing to the people involved. Excessive compensation is a matter of judgment, and it’s hard to see compensation committee members ever being held personally liable for giving away too much money.

Over at The Hearing, Brett McDonnell is similarly underwhelmed, although he does suggest some additional ideas, such as allowing regulators to evaluate the effect of compensation on safety and soundness requirements.

This reluctant approach to regulating executive compensation should come as no surprise. In his press briefing the day he announced the Public-Private Investment Program, Geithner responded to a question about TARP executive compensation conditions by saying, “the comp conditions will not apply to the asset managers and investors in the program.” When the Washington Post reported on April 21 that that was not what the lawyers were saying, Treasury rushed out a new FAQ (see the April 21 FAQ) trying to assuage investors’ fears.

This looks to me like a strategic choice. The administration has decided that the economy depends on the banks, and therefore it needs to keep the existing bankers happy. Or it has decided that executive compensation is just not such an important issue, and it would rather focus on others. (What, though? The Wall Street Journal reported on Tuesday that the administration is backing off plans to consolidate regulatory agencies.) Or, more likely, both.

These are reasonable positions, even if I don’t agree with them. But they are more evidence that the financial sector of 2010 will look more like the financial sector of 2006 than anyone would have thought possible just six months ago.

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