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Bailout Bill Hones Ax Over Exec Pay

October 22, 2008
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The big bank bailout doesn’t just take aim only at excessive severance packages for top executives of financial companies, as has been widely reported.

The limitations Congress has mandated apply to other elements of bailed-out financial institutions’ pay packages, and they could potentially apply to those of other publicly traded companies in the not-too-distant future.

The provision that may have the greatest impact on financial firms is a new $500,000 deductibility limit that will apply to all forms of compensation for top officers.

Steve Barth, partner at Foley & Lardner, said it’s a major change from current laws, which allow companies to deduct much more of their top officers’ pay for tax purposes.

Currently, he noted, companies can deduct up to $1 million of an executive officer’s non-peformance-based compensation, so this new cap clearly lowers that ceiling on financial institutions.

But now, all forms of performance-based pay—including stock options and deferred compensation—are also subject to the $500,000 cap, confirmed Treasury spokesman Andrew DeSouza.

The first companies that will be subject to this limitation are the nine financial institutions that are receiving a combined $125 billion in equity infusions from the Treasury Department.

These firms—which include Goldman Sachs, Bank of America and JPMorgan—paid their top officers a combined $1 billion in total compensation last year, according to a Financial Week analysis of their proxy filings. Roughly 98 percent of this pay was dished out in the form of incentive awards, such as stock options and deferred compensation, which would have been subject to the new deductibility limit.

“This $500,000 limit won’t prevent these companies from awarding larger compensation packages to their executives,” Barth says. “It just means that they’ll pay higher taxes, which many financials view as a pretty fair trade-off for the cheap equity injection they’re receiving.”

In announcing the $700 billion rescue package for banks, Treasury Secretary Henry Paulson asserted that in exchange for equity infusions, financial institutions will have to agree to such stringent restrictions and provisions governing compensation for their CEOs, CFOs and three other highly paid officers.

Besides the $500,000 limit on total compensation, these companies in the capital purchase program will be required to “claw back” bonuses or incentive payments if a company’s financials are proved to be “materially inaccurate” and recover any portion of the pay that’s based on misstated information.

Also, the Treasury Department’s rules will prohibit these companies from making golden parachute payments to any of their top executives.

Lastly, the rules state incentive compensation payments made to these executives should not “encourage unnecessary and excessive risks that threaten the value of the financial institution.”

All of these rules are sure to draw a significant amount of attention in the coming months, especially since lawmakers have said they’ll use the pay provisions in the rescue package as a template for broader executive compensation reforms they plan to introduce in Congress next year. These reforms would apply to all publicly traded companies, lawmakers have said.

Now, not only do lawmakers have a road map for these broader changes, but they can also use the financial institutions participating in the capital purchase program as a test group to measure just how effective these rules are at reining in massive payouts.

“There’s now some material for an actual analysis,” said Tim Bartl, vice president and general counsel at the Center on Executive Compensation in Washington.

The rules related to clawbacks and golden parachutes are rather innocuous, compensation consultants and attorneys note, because many companies already have policies on both in place.

The rule stating that financial institutions must discourage any incentive payments that are based on “unnecessary and excessive risks” is vague, but it could wind up having a major influence on the types of awards companies use to incentivize executives, such as stock options.

In spirit, the rule aims to get companies and their compensation committees focused on rewarding executives for “long-term and sustained value creation, not fleeting short-term factors that could compromise a financial institution’s health,” said compensation consultant Yale Tauber.

But it remains a question whether companies are supposed to adopt this as a “statement of principle,” Tauber said, or actually apply it to the types of incentive awards they give executives.

“If it’s the latter, maybe it means that these companies shouldn’t be granting stock options to their executives,” Tauber said. “Theoretically, don’t options put you in a position of being a short-term trader, as opposed to a long-term investor?”

Filed by Mark Bruno of Financial Week, a sister publication of Workforce Management. To comment, e-mail editors@workforce.com.

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