The proposed changes could have a sweeping impact over time on an issue that has stirred public outrage for years – and amplified during the recession. But the new pay plan appears to be guided more by economic pragmatism than by populist ire. President Obama has occasionally lashed out at Wall Street, but the pay proposals were announced with little fanfare in a statement issued Wednesday by Treasury Secretary Timothy Geithner.
The proposed steps include a blend of legislation, regulation, and friendly advice:
• Supporting efforts in Congress to pass "say on pay" legislation, which would give shareholders a much larger voice on compensation packages at individual firms.
• Proposing legislation enabling the Securities and Exchange Commission to ensure that corporate compensation committees are more independent of management.
• Working with bank regulators in new efforts to reduce the risk of booms and busts in the financial sector, partly by addressing pay incentives that encouraged high-risk activities.
• Laying out principles of sound compensation at banking firms and beyond – notably that pay should take account of risk as well as profit, and that performance should be measured over a long span of time.
Efforts by policymakers to influence corporate pay have often failed to work, but it's possible that the Obama administration framework will have more of an impact for two reasons. First, it comes as investors and corporations already feel financial pressure to change pay practices. Second, the administration's plan seeks to partner with the private sector more than dictate to it.
"The overall environment for executive pay is lending itself to increased conservatism – regardless of what industry you're in," says David Wise of Hay Group in New York, which provides compensation consulting services. "The administration is focused on arming shareholders with as many tools as possible to hold their companies accountable. That’s what the [Obama pay] principles signal to me."
'Say on pay' could take time
Even if the administration's effort is successful, it will probably take some years for the evidence to roll in.
Mr. Wise notes that "say on pay" is a privilege American shareholders aren't used to exercising. At the few companies where votes on pay have been taken, the typical outcome is for shareholders to give strong support for the packages put in place by the board's compensation committee.
But he says that over time, “say on pay” could have teeth. In Britain, shareholders have long voted on pay "and many people do believe that it has been responsible for slowing the rate of pay increases," Wise says.
The board committees that set compensation for executives – everything from bonuses to perks and stock options – operate in a zone between the shareholders who own companies and the managers who run them.
Critics of corporate governance say that in practice, the balance of power has been tilted to make boards more responsive to managers than to shareholders. Where "say on pay" would boost the clout of shareholders, another Obama proposal would reduce the clout of managers, by preventing making the pay committees more independent.
Link between pay and risky behavior
In releasing the pay proposals, Secretary Geithner framed the goal in pragmatic terms – to create a more stable economic climate.
"This financial crisis had many significant causes, but executive compensation practices were a contributing factor," he said in a statement. "Incentives for short-term gains overwhelmed the checks and balances meant to mitigate against the risk of excess leverage."
The issue goes beyond banks, but experts on compensation say the incentive problem has been particularly challenging in that industry. Subprime mortgage lending was fueled in part by investment banks where managers, traders, and dealmakers reaped big money from bonuses based on a single year's performance.
One example that received wide media attention: The troubled insurance company AIG paid $220 million in so-called “retention bonuses” to about 400 employees last year.
A top principle, Geithner said, should now be to set pay over longer horizons, "in ways that are tightly aligned with the long-term value and soundness of the firm." But he acknowledged that finding the right way to incentivize players at all levels of a firm is not a simple task.
In the financial industry, new pressure on pay could come from bank regulators, to the extent that they find pay practices to play a central role in ensuring the safety and soundness of the banking system.
The Treasury's plan on pay Wednesday was accompanied by the Obama administration's naming Kenneth Feinberg, a lawyer, to oversee pay practices at firms that receive exceptional government assistance. Those firms might include AIG and General Motors.
Critics of the administration say it isn't moving aggressively enough to set new limits on bankers – at a time when the financial crisis provides a political opening to do so.
Rep. Barney Frank (D) of Massachusetts, who chairs the House Financial Services Committee, applauded parts of the Obama plan, but he expressed concern that boards will remain closely tethered to the interests of corporate management. “Legislation should be adopted that instructs the Securities and Exchange Commission to set principles" to guide boards in setting compensation, he said in a statement.
Other experts, however, say that sharp new limits on banker pay could push America's top talent overseas. At firms getting government rescue money, oversight and pay curbs have already stirred concern about a drain of talent to other Wall Street firms.
It’s at these firms receiving government aid that high pay and bonuses have stirred most public outrage. The most prominent example is AIG, the insurance company that has cost taxpayers billions to rescue. In March, protesters took a "Lifestyles of the Rich and Infamous" bus tour past the Connecticut homes of AIG bonus recipients.