More Unintended Compensation Consequences

There is no surer way to create unintended economic consequences than to regulate compensation plans.   Connecticut’s Senator Dodd made a last minute contribution to the stimulus bill that places severe restrictions on executive pay for TARP recipients.    As reported in the NY Times Dealbook Blog, one compensation consultant noted, “Any smart executive will (a) pay back TARP money ASAP or (b) get another job.”   These new pay rules may well be the single worst part of the flawed stimulus package.

I spoke to an executive, a personal friend, at one bank that had been considering TARP funding.  This is a well-managed bank that didn’t need the funds, but thought that it would be prudent to shore up their balance sheet in case the recession lasted longer than they anticipated.  This additional capital would give them more flexibility and comfort in lending — indeed, they have been one of the banks in the forefront of making credit available in their area.  My source said that at least in part because of the executive pay restrictions, they will now forgo TARP. 

Senator Dodd’s restrictions will result in more firms avoiding  TARP capital or repaying the TARP sooner than they would have otherwise.  At the end of the day, this will mean less lending.  More challenging will be the situation for  firms which have no choice but to stay with TARP capital.  These firms will be forced to either increase their executives’ salaries or provide compensation that falls well below market levels.  The former seems politically unfeasible.  If the latter, a “brain drain” is likely to result — a terrible outcome considering the taxpayers’ investment in these firms.  

What’s the real risk of the flight of executives from these TARP recipients?  The common counter-argument has been, “Who will hire these people?  They ruined their firms.”    This is simplistic and wrong.  While CEOs and Risk Management chiefs certainly should bear consequences of their failures, many high-paid executives successfully ran business lines which had no connection to the disastrous choices of their colleagues.  A quick perusal of the most highly compensated executives at Bank of America, for example, suggests that perhaps half had absolutely nothing to do with the balance sheet impairment that the corporation acquired courtesy of the purchase of Merrill Lynch.  This isn’t to say that their pay shouldn’t be affected by their company’s fortunes.  However, the company should certainly be able to have the tools to retain people like, for example, the head of IT, who surely is marketable to any number of corporations.

I’ve argued in a piece on Forbes’ website, that earlier regulations governing executive pay fostered Wall Street’s disastrous bonus culture.   Corporate governance expert, Lucian Bebchuk, writes of the risks in the way Dodd’s amendments restrict variable compensation to stock awards.  A list of similar examples of problems would go on and on.  The bottom line is that companies need flexibility in setting compensation.  Federal regulation of compensation is a pathway littered with unintended consequences, and has there ever been a “good” unintended consequence?

Disclosure: some of our clients hold positions in BAC, other financial companies and TARP recipients.

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5 Responses to “More Unintended Compensation Consequences”

  1. rjsgso Says:

    It is often argued that a minimum wage set by the government is anti-business and will cause businesses to fail. Now the argument being put forth is that being unable to pay someone MORE than the eqivalent of 34 minimun wage earners will cause them to go out of business.

    Perhaps the loss will not be so much brain power–there is plenty of underpaid brain power in the country–but rather the loss of influence(political) power that many executives bring with them.

  2. Phil Says:

    The government should not intervene. Let the banks which are insolvent fail. Not only will the money hungry executives lose their jobs but also their pensions, etc.

  3. Bubba Says:

    “Perhaps the loss will not be so much brain power–there is plenty of underpaid brain power in the country–but rather the loss of influence(political) power that many executives bring with them.”

    And that would be a good thing because…

  4. Alan Says:

    TARP came into existence because Paulson panicked last autumn. Phil is right in saying that the government should not have intervened. We make bad decisions and we suffer the consequences of those decisions. There are hundreds of healthy banks that are willing and able to take over their businesses. Instead, we are stuck with zombie banks that are going to be a drag on the economy.

  5. Compensation complications continue « (in)efficient frontiers Says:

    […] By Jeff Korzenik Two recent pieces in the Wall Street Journal add credence to the dangers of government interference with compensation arrangements.  In today’s edition, there’s an article highlighting the departure of key investment […]

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