In what used to be called polite society, what other people earned and your own salary were nobody's business. Those days are over for CEOs and other highly paid corporate executives at public companies. The populace not only knows, it doesn't like what it sees, and the federal government doesn't either. Goodbye, politesse; hello, new regulations.
While outrage over executive pay had been boiling for some time, it spilled over when American International Group's credit default swap unit in London collectively received $165 million in government-paid performance bonuses after taxpayers had spent $185 billion bailing out the sinking insurer. Since incentive-based compensation is geared to a company's financial performance, this did not make sense--if results go down, so should compensation. Infuriated shareholders vented their rage through organized bus tours of AIG executives' homes in Connecticut, while others took to stalking the London-based traders. Needless to say, executive compensation is the cri de coeur of the moment.
The question is, Should it be? Several recent surveys indicate that executive compensation has fallen on a relative par with the descent in company financial performance and share values. Barring the few examples of egregious bonuses at AIG and Merrill Lynch, the system seems to be working. Nevertheless, all this may be moot. "The government has found the scapegoat for the economic crisis and it is executive pay," says William E. Mayer, chairman of the compensation committees of newspaper group Lee Enterprises and two other companies, and chairman emeritus and former CEO of the Aspen Institute, an international nonprofit organization dedicated to fostering enlightened leadership and open-minded dialogue on contemporary issues.
The American Recovery and Reinvestment Act, signed by President Obama on February 17, mandates strict new rules on executive compensation for recipients of the federal Troubled Asset Relief Program. As the largest shareholder of TARP companies in many cases, calling the shots on executive compensation seems appropriate, but is it equally fair to apply these rules to all companies? "I don't know who has the answers," Mayer says. "The world has been turned upside down. I've never seen compensation under such an intense spotlight."
Mayer fully understands the harsh public and government rhetoric over executive pay, and cites disapprovingly automakers flying in company-owned jets to Washington to beg for federal largesse. Other pricey (and publicized) perquisites, from country club memberships to remodeled executive suites, make him cringe, yet he does not believe government regulations are the solution. "Congress often passes a compensation law that leads to unintended consequences," he says. "It's happened before and will happen again."
A case in point is Section 162(m) of the Internal Revenue Code of 1986. The Clinton-era rule was crafted to limit excessive salaries by disallowing tax deductions above $1 million in executive pay, with an exception made for performance-based compensation like stock options and annual bonuses. The unintended consequence of the regulation was a shift from high salaries to high stock options and bonuses. In theory this seemed prudent since performance-based incentive compensation presents a greater upside potential for earnings. The problem was the lack of a risk management methodology to separate real performance from illusory performance, as the AIG bonuses underscored.
Another unintended consequence was that many companies lifted CEO salary to $1 million to keep par with their peers. In the years since, overall executive pay levels increased--the opposite of the rule's intent. "It didn't take long for comp committees to set up a formula for CEO pay reaching the GNP of Africa," says Bruce R. Ellig, an advisor to corporate boards and author of The Complete Guide to Executive Compensation.
The Obama Administration is not about to gut S162(m). In fact, it is considering the Treasury Department's idea of lowering the threshold to $500,000 for all public companies. Several other compensation rules mandated for TARP recipients also are being seriously considered. If House Financial Services Committee Chair Barney Frank; Senate Banking, Housing and Urban Affairs Committee Chair Christopher Dodd; and U.S. Treasury Secretary Timothy Geithner have their way, each will become law in the months ahead. "The regulations are coming fast and furious, setting one's head spinning to figure out where a company stands and what it needs to do," says...