An offer they couldn’t refuse

Posted by Marc Hodak on October 13, 2008 under Executive compensation | Read the First Comment

My prior conclusion was that no major bank would wish to directly involve themselves in the TARP program because of the compensation restrictions that came with it. It didn’t even occur to me that the healthiest banks would accept direct investment because they were healthy. Well, they did accept it…in the sense that one accepts an offer one can’t refuse.

According to the bailout law, “acceptance” of this investment comes with the following constraints on pay:

– Prohibition of golden parachutes, while the government has its investment in the firm
– Elimination of incentives for “unnecessary and excessive” risk for executive officers
– Potential claw back of bonuses based on accounting results that turn out to be false

Of these items, the ‘golden parachute’ prohibition is apparently the most onerous. I say “apparently” for two reasons. First, these CEOs would have to agree to have their contracts renegotiated to eliminate their golden parachutes. It’s not clear how the government would compel this even when the investments were voluntary, but it’s even more mystifying given that they weren’t. Alas, I don’t think Jamie Dimon or Lloyd Blankfein will cause too much fuss over this. They know pretty well that JP Morgan Chase or Goldman Sachs are unlikely to risk their departures over a few extra million per year, and they can negotiate that accordingly. If they can’t get it on the back end via a golden parachute, they can get it in current or up-front pay, or somehow via the infinite devices that us compensation consultants can dream up while staying in technical compliance with the wording of this law. Folks, boards and shareholders are rarely the winners in a forced renegotiation with the CEOs they wish to keep. The ones they don’t wish to keep can leave of course…with their golden parachutes (before the investment has been made).

The second reason to use “apparently” is that the more troublesome constraint, I think, will be the elimination of ‘incentives for risk’. Incentives that create greater alignment between managers and shareholders are invariably incentives for risk. The government claims no voting rights with these preferred shares, but they will have to find some way to comply with the law. It will be interesting to see how they do it. Interesting, that is, for us non-shareholders in these semi-nationalized firms.