The new pay cap for some of America’s top bankers is rooted in the short-term exigencies of a government bailout, but it also may signal a turning point that affects executive pay for years to come.
On Wednesday, President Obama put a $500,000 limit on annual pay of bank executives whose firms receive government assistance during the financial crisis.
But he also said the new guidelines are “only the beginning of a long-term effort” to realign the way business leaders are paid, beyond the banking industry and other firms getting bailouts.
The announcement comes at a time of public anger about the meltdown of a once-strong financial industry, and as the Obama administration is about to unveil additional bank-rescue plans that are likely to cost taxpayers more than the $700 billion already allocated by Congress.
It also comes as many investors and financial executives say that reformed pay practices need to be part of any long-term solution for the industry’s problems.
“There is a serious problem with compensation [in the financial sector],” says Charles Elson, director of the University of Delaware’s Center for Corporate Governance. Top bankers “convinced the world that they were the smartest human beings on the face of the earth…. It turns out they weren’t all that smart.”
The financial sector has moved to the forefront of the long-simmering national debate over executive compensation, largely because it is receiving the greatest government assistance. But what happens in that industry could set trends that will affect others.
The big question now may not be whether executive pay practices will change, but how.
Mr. Elson, echoing the view of many experts on corporate governance, says the best way forward is for corporate boards of directors to take the lead, rather than having the matter legislated by Washington.
“The quick populist fix sounds great, looks nice on television,” he says. But “the solution is better boards.”
Obama's pay rules focus on any firms that seek and receive future help from government, with a firm cap on those getting "exceptional" assistance. Citigroup and Bank of America among the few examples of firms so far that have received targeted support that would cross the threshold to be called "exceptional." But the new rules will not be applied retroactively. [Editor's note: The original version did not make clear that the pay caps only applied to future help.]
“This is America. We don’t disparage wealth. And we believe that success should be rewarded,” Obama said. “But what gets people upset – and rightfully so – are executives being rewarded for failure. Especially when those rewards are subsidized by US taxpayers.”
Finance-industry analysts say it's possible that, as the government rescue of the banking industry proceeds, the cap on compensation could mean sharp pay cuts for executives of some of the largest banks. [Editor's note: The original version implied that the cuts were retroactive.]
“If these executives receive any additional compensation, it will come in the form of stock that can’t be paid up until taxpayers are paid back for their assistance,” Obama said.
Recent news reports that the industry paid out large bonuses at the end of 2008 stirred a furor in Congress and among voters who aren’t happy about the initial $700 billion cost of the financial rescues.
In that sense, Obama’s move reflects “a tiny fraction … of the public outrage at the completely irresponsible behavior of Wall Street,” says Nell Minow of the Corporate Library, which tracks executive pay and corporate governance. The guidelines “have been forced on Obama by the business community…. They’ve left him no alternative,” she says.
She says the best way forward is for corporations to strengthen their own boards, including with rules that require directors to get a majority of all votes cast at annual meetings. But whether significant change comes through private-sector or government action, Ms. Minow predicts that it is coming.
Tighter pay standards could include greater use of “clawback” provisions that require compensation to be returned by executives if corporate performance deteriorates.
The changes could begin and go furthest in the financial sector, which has been a trendsetter in recent years as executive pay has soared.
That is not just because of the Obama guidelines, but also because the lawmakers and regulators will probably have an eye on compensation when they consider how to reform regulation of the industry.
Some finance experts say that pay practices helped to set the stage for the wave of risky lending that now burdens the US economy.
“The most powerful market force of all is compensation,” Eugene Ludwig, the CEO of Promontory Financial Group, told Congress last fall.
“I would urge that [bank] supervisors, as well as companies, align compensation with safe, sound, and compliant behaviors, with a particular emphasis on the long-term well-being of the financial concern, as opposed to short-term benefits to the individual,” he said.
In the near term, the pay cap may give Obama some political cover to seek more rescue funds – measures aimed at making sure credit keeps flowing even as banks face big losses on bad loans.
“They know that they need this politically, to go to Congress and ask for a trillion dollars,” or whatever the tally may be, says Desmond Lachman, a finance expert at the conservative American Enterprise Institute in Washington.
Tight regulation of pay often brings unintended consequences, however. In this case, Elson says, it could prompt some talented bankers to leave their posts just when their expertise is most needed.