How I learned to stop worrying, and love limits on executive pay

Posted by Marc Hodak on February 5, 2009 under Invisible trade-offs, Politics | 2 Comments to Read

I have gotten a number of inquiries about my thoughts on the new executive compensation rules laid out by President Obama.  So, here they are:

1)  The rules look like they’re about executive compensation, but they’re not.  They’re about getting congressional and public support for the fabulous spending orgy that has the president’s congressional colleagues in a state of priapic delirium.  Obama is using “$500K” to buy “$500B” (the spending portion of the “stimulus”).

2)  If you have any doubt about the political intent, check out the requirement of an “Adoption of Company Policy Relating to Approval of Luxury Expenditures.”  This the clearest example yet of of how the institutionalized greed of Wall Street is being replaced by the institutionalized envy of Washington.

3)  As little economic training as Obama has, he knows that real wage controls will not work in America (if anywhere), so he is promoting these reforms knowing their potential danger, and acceding to various loopholes in their implementation.  He may mistakenly believe that these dangers can be well contained (see #8 and #10 below).

4)  Yes, we compensation consultants will be able to use the proposal’s loopholes to work around the limits to a considerable extent.  Obviously, we have restricted stock, albeit with a few extra restrictions, that enable us to greatly improve the value of the plans to the executives.  Less obviously, we have a large variety of long-term incentive arrangements we can create well within the letter of the law.  All of these will be costlier to the shareholders than the arrangements they replace.

5) Ironically, these newer compensation structures will also be dramatically riskier for the shareholders in ways the government cannot contemplate, despite their mandate to limit risk.  We might be able to create equity compensation instruments that can limit these risks, but the SEC will inevitably drag their feet on them, and Congress will likely block them, so we will probably not even try.

6)  In the cases where we can’t get around the limits imposed by this plan, you should sell those companies short.  They will lose talent at an unconscionable clip.

7)  Outside of my professional capacity, I actually have no qualms about these firms losing their competitiveness and going under as a result of the plethora of unintended consequences of this proposal.  If these rules accelerate that process, all the better.  Replacing market discipline with political discipline will not help these companies, and they won’t get our economy back on track.

8)  The worst part of this proposal is not the nominal effect it will have on firms getting TARP money; it will be the precedent of Congress legislating pay.  As the shortcomings of these rules come into focus, and as the contortions necessitated by business imperatives become plainer, and spread to other parts of the economy via a misguided attempt to satisfy political constraints at the expense of shareholder value, Congress will inevitably feel the need to “fix” these rules, enlarging their scope and increasing their complexity.

9)  We’re one step closer to widespread adoption of “Say on Pay” if not outright legislation of it.  Anyone who has kept up with my writings on this knows that, while I don’t believe “Say on Pay” will be the end of civilization as we know it, I think it will significantly step up the politicization of executive compensation, pulling it further from the market-driven/shareholder-friendly ideal that many of its proponents nominally favor.

10)  Congressional involvement in executive pay will quickly spawn a cottage industry in compensation lobbying.  In fact, very few areas of congressional intervention will get the attention of executives faster than messing with their pay.  Congress is basically increasing the rift between the interests of managers and those of the shareholders.  It’s hard to think of anything adding greater agency costs than mandates along the line of, “well, you can choose this constraint on your pay, or that policy that will help your firm.”

11)  So, in a political fight over executive compensation between the concentrated interests of highly effective, type-A executives, and the dispersed interests of shareholders defended by ivory tower intellectuals and effete guardians of the “public interest,” guess who will win?

12)  That’s right:  private equity.  It’s fashionable to remark “where will these overpaid Wall Street stiffs go in this environment when we slash their pay?”  And it’s true, the private equity markets are as far down as anyone these days. But the market won’t stay down forever.  And when it comes back, the PE firms will only have economic hurdles to get over.  The political hurdles being set up will still be there for public companies.

Where the title comes from:  An excerpt of White House deliberations.