How the executives of financial services firms that take part in any government bailout are paid is hardly the most important element of the legislation Congress is fast-tracking this week. But given the issue’s political clout, it’s looking almost certain that legislators will have to come to some resolution on compensation if the overall bill is to be passed.
So far, it’s the Democrats who are doing most of the shouting. Proposals floated so far have been all over the map, and some of them are quite extreme. For example, Senator Chris Dodd (D-Conn.) suggested disallowing incentive compensation for executives who took risks that the Treasury Department considered inappropriate. Meanwhile, Rep. Barney Frank (D-Mass.) is looking to bar severance packages for departing executives.
More modestly, Sen. Max Baucus (D-Mont.) wants to reduce the maximum tax deduction for an executive’s compensation expense from $1 million to $400,000, and to eliminate deductions for bonuses and performance-based pay.
In a House Financial Services Committee meeting today, Democrats would not let the issue drop. “Taxpayers’ interests must be most important, over corporate fat cats and cowboy capitalists,” said Rep. Paul Kanjorski (D.-Pa.). “Americans are tired of enabling corporate excess. We must prevent those who contributed to this crisis from profiting.”
The same sentiment was expressed by Rep. Ron Klein (D.-Fla.), who insisted that the bailout plan must include limits on executive compensation.
But it’s not just Democrats who feel that way. Republicans too are saying that before the bailout package can receive their blessing, it will have to address the compensation issue in some way, noted John O’Neill, a partner in the legislative and government affairs group at Washington law firm Venable LLP and a one-time aide to Republican minority Whip Trent Lott (R.-Miss.).
Members of Congress feel forced to respond to the political heat, according to O’Neill, a former tax and benefits counsel to the Senate Finance Committee who also served as the Senate’s legal point person on executive compensation issues. “From the standpoint of whether this package will advance, executive compensation is a critical component,” he told CFO.com. “It’s very unlikely that this bill is going to get all the way through the process without some provisions on that.”
That’s the case even though such provisions probably will have little impact on whether the legislation achieves its intended purpose, O’Neill said, with one exception: if the compensation restrictions are so stringent that some financial services firms decide not to participate in the program.
He said Dodd’s proposal, which would let Treasury decide ad hoc whether to compensate departing executives, is problematic for that reason. “When there’s sweeping language and nobody really knows what it means, it will put board members and others in fear of participating,” O’Neill said. “You may have that fear even when you know what the consequences will be, but when you don’t know how to structure your compensation to meet the requirements, that’s a significant problem.”
On the other hand, Baucus’s proposal to drop the tax-deductibility limit for executive comp to $400,000 would not, by itself, have enough teeth. O’Neill pointed out that IRS Section 162(M), which in 1993 established the current $1 million limit, clearly did not have the effect of limiting executive compensation, which has skyrocketed in recent years.
In fact, he noted, many believe it was that tax rule that pushed companies to pad their executives’ pay with noncash compensation — such as stock options, performance shares, restricted stock, and deferred compensation — which composes the bulk of their income today. (There currently is no deductibility limit on noncash compensation.)
O’Neill acknowledged that the heart of the issue is not necessarily how much money executives make, but rather whether there is an appropriate downside risk to poor performance. After all, Lehman Brothers CEO Richard Fuld, for example, made huge bonuses for 2007 based on the firm’s bottom-line performance, but did not lose any of that income when actions taken last year contributed to the firm’s demise this year.
“You want the interests of shareholders and senior management aligned, and ideally they are aligned in the short term, the intermediate term, and the long term,” he said. “Arguably there has been too much focus on the short term. In my opinion you don’t want to get rid of performance-based compensation altogether, but you want to make sure that what you put in place really judges performance over the long term as well.”
Issues that O’Neill said will probably need to be addressed to break any impasse over the legislation include:
• Will the new rules present a “roadmap” for more generally applicable executive compensation reforms in the next Congress?
• If there is a $400,000 deduction cap, will it include noncash forms of compensation? If so, what types of changes might companies make in their compensation practices?
• How will proposed changes in laws regarding golden parachute packages affect whether boards of directors approve the packages?