The thing about useful stuff is: US Caps on Compensation

US Caps on Compensation Wednesday, February 04, 2009

Today it was reported that President Obama and the US Government was expected to impose caps on "executive" pay at organisations that accepted Government bailout funds. It was suggested that these conditions are not expected to be retrospective on those firms that have already received bailout monies [which will be a great relief to those firms!]. However the cap is on cash compensation - it is specifically proposed that any compensation over $500,000 would have to be paid in company shares which could not vest until all bailout monies had been refunded to the Government.

The reports do seem to focus on the banking sector, albeit it would seem reasonable that such provisions apply to any firm that required Government money.

Salary caps are always highly contentious with arguments usually polarising into accusations of greedy bosses versus the importance of paying the "market rate" to attract the best talent. However the debate has strongly swung in favour of caps because the recent downfall/demise of many large institutions are being directly attributed to incumbent executives who are seen to be the cause or at some fault. Consequently, there is no public support for "rewarding" failure especially with taxpayer money, especially when the compensation sums involved are colossal in contrast to average earnings. Throw in envy, plus people losing their jobs through no fault of their own but as a consequence of an economic slump accompanied by a contraction in available bank credit, and you have an populist and moral tidal wave to sweep away counter-arguments.

Defenders of unconstrained pay, myself included, will now get to prove or lose their arguments which mainly revolve around the belief that locations/industries with caps will be disadvantaged as the best talent will be drawn to locations without such caps [assuming jobs still exist there].

An example often quoted to support this contention is football, highlighting that the English Premiership regularly wins out in the battle for global talent because of the rewards on offer to players, with the consequence that the teams in the league regularly compete at the top of European/World football.

However, is it probable that the World's biggest firms will fail to lure the best talent, since landing a senior role at these firms is still a considerable "prize"? Even in football, recent failed transfer events at Manchester City showed money doesn't always work in prising away talent from a "big club". Moreover executives still need jobs and there are far fewer firms around that can offer "big" jobs or who are willing to pay "over-the-top" compensation in a recessionary environment. Hence, supply may be growing whilst demand is reversing, thereby automatically pushing down pay, especially when those hiring are increasingly sceptical about anyone claiming superhuman management powers, given the rapid fall from grace of so many former business stars.

The worst outcome of introducing the caps would be that they deters executives from seeking the very help that may be right for their companies. Whilst board members have a duty to their companies and shareholders, they are clearly conflicted given the personal ramifications for their own wealth. Of course, they could choose to move on and perhaps should in circumstances that their company needs a bailout. Yet career choices like that are rarely made dispassionately.

Depending upon how "executive" is defined e.g. main board directors only, some executives may follow Bob Diamond's example, who for years refused a seat on the main board at Barclays to avoid having to disclose his earnings, or so it is widely believed. It was undeniable that he had a major role in running a core part of the Bank despite not being a main board member, but who was in effect a shadow director. Some companies may well look at such devices to circumvent rules, especially if main board directors find themselves underpaid relative to considerable numbers of their employees, as would probably be the case in a number of banks.

Of course, if "executive" is widened to any senior manager or employee, then things could really be shaken up, especially since those firms who took money early would be free of any such constraints and thus able to poach talent with offers of higher pay from those who arrived at the trough later. And yes, that would definitely happen.

Pay aside, executives are clearly deterred by the prospect of Government oversight and intervention in running the companies if they accept bailout funds. Barclays demonstrated that the executives were much happier paying a higher price for capital instead of accepting UK Government money. Yet, increasing numbers of companies who are struggling to refinance their operations are jumping on the emotional blackmail bandwagon and demanding Government aid. Perhaps imposing caps will restore some balance by inflicting some personal pain on the wealth of the executives making the demands.

However, perhaps the most interesting thing is that the proposal stops short of capping all forms of compensation and allows executives to be paid in shares. Given that bank shares are in the doldrums, a $500,000 bonus in shares buys you considerably more shares than it did up until recently. Assuming a bailout does ensure a company's survival, then the executives forced to forgo cash may get to make even bigger sums if their shares manage to recover even some of their lost glories, which won't make for pretty news headlines e.g Lloyds is trading at 95p today from a low of 44p only a couple of weeks ago which would have double an executives money, but several fold returns are not inconceivable. Of course, you could contend that executives who nurse a company back to health are deserving of this, but against a backdrop of Government funded survival and the possibility of an economic tide lifting all companies in due course, the public may well feel aggrieved with such an outcome.