Reining in financial firms’ compensation to reduce excessive risk-taking — and fend off a public backlash over bankers’ pay — is fast rising to the top of the regulatory reform agenda. But there are plenty of grounds for skepticism that any of the proposals on the table will lead to significant change.
President Barack Obama drew attention to the problem this spring on, of all places, the Tonight Show, when he told Jay Leno, “Who in their right mind, when your company is going bust, decides we’re going to be paying a whole bunch of bonuses to people?”
Then New York State Attorney General Andrew Cuomo began digging into Wall Street’s bonus culture. It emerged that Citigroup, which received $45 billion in federal government funds under the Troubled Asset Relief Program, paid out more than $5 billion in bonuses in 2008 — the same year it posted losses of $27 billion — and that one of the bank’s oil traders, Andrew Hall, was in line for a $100 million top-up.
The proposed regulatory fix, the Corporate and Financial Institution Compensation Fairness Act of 2009, was approved by the House at the end of July and is expected to go before the Senate this month. Dubbed “Say on Pay,” it calls for companies to set up advisory boards to oversee pay and to allow shareholders to express their views and cast a vote on compensation. That vote, however, is not binding. The legislation also contemplates requirements for a more independent compensation committee but does not spell them out.
The shareholder vote — a central provision of the act and the one insiders feel is most likely to get through the Senate — has no teeth, some compensation experts say, which makes one wonder: What’s the point?
“Any regulatory restriction on compensation can be and will be circumvented by any financial institution that wants to do so,” asserts Dirk Jenter, a finance professor and executive compensation expert at Stanford Graduate School of Business. “It’s an open question if the public mood will be appeased by subtle reforms like Say on Pay rather than more draconian limits on executive pay — but it is crucial to understand that financial engineering is what these institutions do for a living. If they want to pay an executive or a trader in a certain manner, they will find a way.”
Many observers say public outrage over executive pay will do as much to push reforms as the proposed legislation. “I think [the legislation] is a necessary first step,” notes Paul Hodgson, senior research associate at the Portland, Maine–based Corporate Library, a corporate governance research center. “In the most egregious cases, we will see shareholders objecting to pay proposals in much larger numbers and to more effect than they would have been able to in the past,” he says. Adds Joshua Bewlay, a consultant at Compensation Resources, an Upper Saddle River, New Jersey–based corporate compensation consulting firm, “Even though [a shareholder vote] is nonbinding, boards will ignore major investors’ wishes about compensation at their own peril.”
Just as the crisis itself crisscrossed the globe, a similar debate over executive compensation is raging in Europe. Last month the U.K.’s Financial Services Authority introduced a code that seeks to tie pay more closely to risk and ban guaranteed bonuses of more than one year. The agency abandoned proposals floated earlier this year to require banks to defer two thirds of bonus payments and link them to company performance, following industry complaints that those measures would hurt London’s competitiveness as a financial center. In France banks agreed last month to new rules tying bonuses to long-term performance and requiring that they be paid over three years. President Nicolas Sarkozy made clear that he intends to push for a global agreement on constraining bankers’ pay when leaders of the Group of 20 nations meet in Pittsburgh later this month.
Some banks aren’t waiting for Washington, or European capitals, to iron out the details. In December, Credit Suisse moved to lengthen the time horizons of bankers’ compensation and shift the lender’s most illiquid assets off its balance sheet by putting those assets into a bonus pool for senior executives. Known as the Partner Asset Facility, this pool, which rose 17 percent in value in the first half of this year, to about $5 billion, is made up of mortgage-backed debt and highly leveraged loans assembled during the recent credit crisis. Employees won’t be able to cash out for a minimum of five years.
“Our desire is to continually reduce risk for the firm and address compensation issues to align employees’ interests with shareholders’,” Paul Calello, CEO of Credit Suisse’s global investment bank, tells Institutional Investor. “This was a disciplined way to bring risks down and a fair way to compensate employees in what was a challenging year.”
What happens next in executive pay reform will also depend on whether proposals by the U.S. Securities and Exchange Commission — calling for enhanced corporate governance disclosure in proxy statements of how a firm’s pay policies could affect its risk management — are enacted.
New compensation czar Kenneth Feinberg, appointed by Obama on June 10, will also be weighing in (he declined to be interviewed for this piece). The president said Feinberg will “review for soundness and appropriateness and to limit risk relating to compensation packages for those companies that are either receiving extraordinary assistance or might in the future.” He is expected to give directives that will be adopted by all banks, not just those that tapped TARP cash. “Many will use them as guidance for what is acceptable,” says Bewlay.
In the end, some experts believe, if rules governing executive pay are not formally tightened, history is likely to repeat itself. “In the past people haven’t necessarily been willing to revisit their pay programs without a government nudge,” notes Morrison & Foerster attorney David Lynn, former chief counsel of the SEC’s division of corporation finance.
