Cutting pay by raising salaries

Posted by Marc Hodak on October 28, 2009 under Executive compensation, Reporting on pay | Be the First to Comment

The headline reads that pay czar Kenneth Feinberg increased base pay while cutting total compensation in half.  As the reporter puts it:

The move reflects the complexity of regulating something that mixes politics and economics.

Actually, this move reflects the need to include politics in what is otherwise an economic trade-off between the three governance objectives of compensation:

– Attraction and retention of management talent

– Incentives that align managements’ interests with the owners’

– Control of total compensation costs

This trade-off is universal.  It applies equally to any business one is charged with overseeing:  auto companies, banks, drug companies, drug stores, and drug dealers.

Here is how this story characterizes Mr. Feinberg’s trade-offs for the Sorry Seven:

The Treasury Department assigned him the job of tying more compensation at the companies to long-term performance and cutting pay deemed “excessive.”

Government officials say Mr. Feinberg met that objective. All 136 employees and executives working at the seven companies under his review will earn much less this year than in 2008, even after accounting for the rise in regular salaries, also known as base salaries.

So, Treasury says he did fine, and this story does nothing to question that.  Let’s see how he did against the universal governance objectives for compensation:

– Attraction and retention of management:  Well, management talent is running for the exits at the Sorry Seven.  The best have fled, leaving their belongings behind.  Citibank sold off one of their most profitable units simply to avoid having to record that they paid that unit’s chief $100 million.  Those that remain are doing best they can, I’m sure.

– Alignment incentives:  Well, when you substitute bonuses for salary, dramatically reducing the overall level of pay, you take away a lot of incentives to perform.  I’m not saying that people need 80 percent of their total compensation to be variable in order to get their attention, but it doesn’t hurt.  Of course, how that variable portion of total compensation varies is hugely important, and devilishly tricky to get right, but I’m sure the Pay Czar or the Fed will make sure the companies do that right.

– Cost control: check!

Looks good to Treasury.

The increases, which weren’t discussed by the Treasury or Mr. Feinberg last week, offset the total cuts by only a small amount. But they reflect the economic reality of Mr. Feinberg’s task: He had to address public ire against large pay packages and political pressure to crack down on bailed-out firms without damaging these companies’ ability to pay and retain key employees — something Mr. Feinberg was explicitly charged with doing. They could also arouse the ire of Congress.

So, besides the three universal governance objectives, Feinberg had to add a fourth:

– Don’t raise Congress’s ire

Why these reporters refer to this as an “economic reality” is mysterious.  This is better characterized as Mr. Feinberg’s political reality in dealing with economic trade-offs.