April 13, 2009
'Say on Pay' and Other Bad Ideas—A Commentary by Jonathan Macey ’82
The following commentary was published in the Wall Street Journal on April 13, 2009.
'Say on Pay' and Other Bad Ideas: A ban on golden parachutes will entrench management
By Jonathan Macey ’82
To socialize the American economy, it is not necessary to nationalize every business in the United States. All it requires is to put the corporations that control the finances of all of the companies in the economy under government control. And that is what is happening now.
Recall that very early in the bailout process, Treasury Secretary Henry Paulson and then New York Federal Reserve President Timothy Geithner gathered CEOs of the nation's largest banks into a room at the New York Fed and insisted that they take massive sums of public money by selling preferred stock to the government. Some of these firms, most notably well-managed Wells Fargo, resisted. But they were coerced into taking the money by the farcical argument that if they turned down the money, then the companies that needed a bailout (i.e., Citigroup) would be stigmatized.
But how much worse could Citigroup's stigma be? Nobody really believes that the bank is anything but a zombie as it is.
The initial forceful injection of capital into hundreds of financial institutions, however, is another story. It is the first step in an ongoing process to socialize American finance. When this process is complete, every company in the U.S. that needs capital will first have to curry favor with some federal agency or politician. Solid business plans and prospects for growth and profitability will be far less important than diversity plans and political connections.
Apparently, members of Congress liked the special treatment that Connecticut Sen. Chris Dodd received in getting his mortgage through Countrywide. We're going to see even more of that kind of thing -- and outright corruption on a much bigger scale -- when the government is in direct control of the financial institutions and making the credit decisions that businesses large and small depend on to survive.
One example of the coming political circus is a regulation now being imposed by the Treasury Department that compels banks getting "exceptional assistance" from the federal government to "fully" disclose their executive compensation and obtain a nonbinding shareholder vote on this compensation. AIG, Bank of America and Citigroup all received such "exceptional assistance," because they've negotiated bank-specific deals with the government. But the government's regulations are a thinly veiled effort to enact "say-on-pay" proposals mandating shareholder votes on executive compensation that Rep. Barney Frank (D., Mass.) and then Sen. Barack Obama failed to get through Congress in recent years.
The fact that these proposals failed to make it through the legislature is in no way discouraging to the unelected Treasury Department officials who seek to impose them. Treasury is pushing to force companies receiving government assistance to cut senior executive pay to $500,000 a year, and to require compensation above that threshold to come in the form of "restricted stock that vests when the government has been repaid" with interest, according to a press release from the Treasury Department.
These regulations, according to the White House press release that accompanied their issuance, are part of President Obama's broad strategy "to examine both the degree that executive compensation structures at financial institutions contributed to our current financial crisis and how corporate governance and compensation rules can be reformed to better promote long-term value and growth for shareholders, companies, workers and the economy at large and to prevent such financial crises from occurring again." The Obama administration is just getting warmed up.
We're at the start of an unprecedented foray by the federal government into the governance of private-sector companies. The guidelines accompanying the new regulations make it clear that the administration favors requiring top executives to hold stock for several years before being able to redeem it for cash. The guidelines also favor requiring all U.S. financial institutions to hold shareholder votes, not just on total executive pay, but on the structure of executive compensation plans. The guidelines note that Mr. Geithner will soon host a conference aimed at pushing additional executive pay regulations for financial firms -- the new regs are, in other words, just the tip of a very large iceberg.
The regulations imposed on recipients of "exceptional assistance" initially banned "golden parachutes" (large severance payouts) for the top five senior executives at an institution receiving substantial federal assistance. That ban now has been expanded to include the top 10 senior executives. The new regulations also prohibit the next 25 executives from receiving golden parachute payments greater than one year's compensation.
The problem here is that in order to reform Wall Street, many top executives need to be pushed out. Severance payments are a small price to pay to dislodge an underperforming, entrenched executive. Golden-parachute restrictions will lead to the kind of managerial entrenchment that has crippled the economy. Demonizing executive pay will also drive the best managers out of private companies and into hedge funds and other boutique investment firms. Public companies will end up the domain of bureaucrats.
The new federal regulations on compensation attempt to obtain by bureaucratic fiat results that the markets and ordinary democratic processes rejected. The campaign for say-on-pay has been going on now for almost five years. Only a handful of companies' shareholders have approved the measures. There is no reason for the government to force public companies to enact say-on-pay proposals that shareholders have rejected in the past. After all, U.S. public companies are owned by their common shareholders -- or at least they used to be.
Mr. Macey is a law professor at Yale, and author of "Corporate Governance: Promises Paid, Promises Broken" (Princeton University Press, 2008).