Last week Barack Obama announced pay caps to executive compensation for any firm receiving money from the TARP. This was in response to public outrage over executives and high-level managers receiving billions of dollars in bonuses last year despite the fact that their firms were losing billions of dollars.
However, this plan is, like almost all government plans, going to be completely ineffective. The very minute that it was announced, I assure you there were people at every company that might be affected looking of loopholes. The plan calls for the top five executives at any company needing "exceptional" assistance to be limited to $500,000 in pay. There is no limit to the amount of stock compensation an executive can get. However, the stock cannot vest until the money from the TARP is paid back. Do you see all the problems with the plan? Let me just point a few of them out.
It only applies to those needing "exceptional" assistance - Further, it is not retroactive, so it only applies to companies needing new aid. This can only be a handful of companies. I would be surprised if this applies to more than a dozen or so.
It only applies to the top 5 executives -This provision is bound to get manipulated in many many ways. People will take "demotions" so as not to be in the top five. Since there is no rules about paying external agencies, you could just spin off a separate company and use them as "consultants". This is much like what happened when there was an outrage over high salaries to those who ran Harvard's endowment. They simply outsourced the work to the same people who used to run it inhouse. What's worse, this might have some really awful unintended consequences. You want top talent fixing the toughest problems at the highest levels of an organization. If I am top talent and my firm wanted to give me a promotion that put me in the top five, you could see how someone would turn down the job.
Stock grants are unlimited - Remember the backdating scandals just a few years ago? Want to know what caused that? It was caused by the $1 million cap that was put in place in the mid 90's. What on earth makes you think something else like that will not happen again? What is worse, there are some serious tax consequences to the company to pay out this way. This ends up being really bad for shareholders which are some of the very people the government should be looking to protect.
Grants vest when the government is paid back - This one is a doozy and seemingly innocuous. But boy can it have some bad side-effects. Think about this one carefully. If I am an executive, and I do not get paid until I pay back my loan, what am I going to do? I am going to pay back that loan as fast as I can. Is that a good thing? Probably not! This is how we got into the mess in the first place. Executives traded off short term profits for long term financial stability. This does not align the executives with the interest of the public or the shareholders of the company.
Income, how do you define it? - This one will fail for some reason I cannot even conceive of. Why? Because someone is going to come up with a very creative way to pay without paying. That is because income is notoriously difficult to define and can come in so many creative ways. This is why I hate the income tax and believe it should be abolished. There are just way too many ways around it.
For all these reasons, the Obama Executive Pay plan is nothing more than some political theater. It sounds good, but it just really does not do very much.