Will execs' salary cap pay off?

By BusinessWeek

President Barack Obama's new restrictions on the pay of bailed-out finance executives is likely to ripple across the broader U.S. economy, experts say. But if the history of executive pay is any guide, it's more likely to influence how the money is doled out, not how much of it makes its way into the pockets of top brass.

Obama's cutbacks will certainly reduce executive pay at the largest firms directly affected in the short term. According to Equilar, which tracks executive compensation, companies with $10 billion or more in assets that took taxpayer money from the Troubled Asset Relief Program, or TARP, paid their CEOs an average of $11 million last year, including an average cash bonus of $2.5 million. By contrast, Obama is capping pay at $500,000, with no short-term bonus.

Long term, though, bank executives could still make out quite well. Pearl Meyer, the senior managing director at pay consultants Steven Hall & Partners, notes that the plan does allow for long-term grants of unrestricted stock. Considering the low stock prices these banks currently trade for, that could represent a lot of upside.

Cutting back on the perks

Like many pay observers, Meyer thinks even non-TARP companies will embrace certain restrictions in order to seem in step with the new frugality the public is demanding. Severance packages should come down, and luxury perks such as company cars and lavish office redos are certain to be out, she says. Companies are already reducing merit pay because of poor business performance. Meyer's clients typically are cutting merit pay for all staffers from 3% or 4% of pay to 2%.

That's being applied to the top brass as well as the rank and file, something that didn't always happen in the past. And two-thirds of the largest U.S. companies have already put in place the kind of "claw-back" provisions that Obama advocates, where companies reclaim bonuses that were paid out for performance that later turns out to be illusory.

But the potential for long-term payouts on stock grants provided for in Obama's plan -- even though they won't come through until taxpayers are paid back -- provides a significant escape hatch for executives. That's why Meyer doubts the rules set forth by Obama on Feb. 4 will drop pay over the long haul.

Indeed, if anything, past government attempts at reining in pay have generally had the opposite effect. After Richard Nixon put caps on raises for everyone, not just executives, during the inflationary 1970s, compensation went up across the board. One reason: A loophole let you get a raise if you were promoted, which led to a rise in promotions. Also, people demanded the maximum government-allowed raise, even if they would have settled for less without it.

The boomerang effect

A congressional $1 million cap on CEO salary tax deductibility in 1993 led to the current popularity of enormous stock option grants, mega-pension awards, huge severance payments and perks galore. Special life insurance arrangements arose that guaranteed executives substantially more income in future years, often subject to little or nothing in taxes. Executive health care benefits have grown richer as well, at times not only covering more services with less cost to the executives, but also extending for years -- or even a lifetime -- after departure. They have been extended in many cases to cover spouses and children as well. "Every single endeavor by the government through legislation or regulation to limit executive or employee compensation has had the exact opposite effect," says Meyer. "It has boomeranged."

Even if a pay cap works, not everyone thinks Obama's deal is fair. Alan Johnson, an executive-pay consultant to the financial-services industry, believes the restrictions on the TARP companies are onerous.

"In a perverse way, the companies most on the edge of going under are the most hard hit," he says. And if other companies don't embrace similar restrictions, managers at TARP companies will have incentives to move to more-healthy rival banks, or out to hedge funds or private equity where government restrictions are not an issue. Or they may just stop working so hard.

Continued: More where this came from?

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