CHAPTER 12 Recognizing Employee Contributions with Pay 573 MANAGIN The President fires a warning shot across execu- tives’ bow, but the history of government efforts to rein in CEO pay is not encouraging President ‘Obama's new restrictions on the pay of bailed-out finance executives is likely to ripple across the broader U.S. econ omy, experts say. But ifthe history of executive pay is any Buide, i's more likely to influence how the money is doled out, not how much of it makes its way into the pockets of top brass. Obama's cutbacks will certainly reduce executive pay at the largest firms directly affected in the short term. According to Equilar, which tracks executive compensa. tion, companies with $10 billion or more in assets that took taxpayer money from the Troubled Asset Relief Pro- gram (TARP) paid their CEO an average of $11 million last year, including an average cash bonus of $2.5 million By contrast, Obama is capping pay at $500,000, with no short-term bonus. Long term, though, bank executives could still make ‘out quite well. Pearl Meyer, senior managing director at pay consultants Steven Hall & Partners, notes that the plan does allow for long-term grants of unrestricted stock. Considering the low stock prices these banks currently trade for, that could represent a lot of upside. Nix on Lavish Perks Like many pay observers, Meyer thinks even non-TARP companies will embrace certain restrictions in order to seem in step with the new frugality the public is demand- ing. Severance packages should come down, and luxury perks such as company cars and lavish office redos are cer- tain to be out, she says. Companies are already reducing merit pay because of poor business performance. Meyer's clients typically are cutting merit pay for all staffers from 3% oF 4% of pay t0 2%. That's being applied to the top brass as well as the rank and file, something that didn't always happen in the past. And two-thirds of the largest U.S. companies have already put in place the kind of “claw-back” provisions that Obama advocates, where companies reclaim bonuses that were paid out for performance that later turns out to be illusory But che potential for long-term payouts on stock grants provided for in Obama's plan—even though they won't come through until taxpayers are paid back—provides a significant escape hatch for executives. That's why Meyers doubts the rules set forth by Obama on Feb 4 [2009] will drop pay over the long haul. Indeed, if anything, past government attempts at reining in pay have generally had the opposite effect. After Richard Executive Pay: Will the Big Bucks Stop Here? Nixon put in caps on raises for everyone, not just exeeu- tives, uring the inflationary 1970s, compensation went up across the board. One reason: A loophole let you get a raise if you were promoted, which led to a tise in promotions. ‘Aso, people demanded the maximum government-allowed raise, even if they would have settled for less without it. Rules that Boomerang A congressional $1 million cap on CEO salary tax deduct- ibility in 1993 led to the current popularity of enormous stock option grants, mega-pension awards, huge severance payments, and perks galore. Special life-insurance arrange- ments arose that guaranteed executives substantially more income in future years, often subject to little or no taxes. Executive health-care benefits have grown richer as well, at times not only covering more services with less cost to the executives, but also extending for years—or even a lifetime—after departure. They were extended in many ‘cases to cover spouses and children as well. “Every single endeavor by the government through leg- islation or regulation o limie executive or employee com- pensation has had the exact opposite effect,” says Meyer. “It has boomeranged.” Even if a pay cap works, not everyone thinks Obama's deal is fair. Alan Johnson, an executive pay consultant to the financial-services industry, believes the restrictions on. the TARP companies are onerous. “In a perverse way, the companies most on the edge of going under are the most hard-hit,” he says. And if other companies don't embrace similar restrictions, managers at TARP companies will have incentives to move to theit more healthy rival banks, or out co hedge funds or private equity where government restrictions are not an isu. Or, they may just seop working so hard. More to Come? Johnson says he's worried this is not the end of pay restric- tions, either. "Mr. Obama has got to balance the political theater with not killing these firms,” says Johnson. “This isa pound of flesh for political consumption. And if you're ‘an executive, you can't be sute this isi.” David Wise, a pay consultancat Hay Group, who works with many boards, also chinks Obama's plan is flawed. “Salary caps are going to result in some of the top people con Wall Strect finding other things to do,” says Wise. “A good compensation progeam is all about balancing short- and long-term performance. The old banking model relied very heavily on annual performance. The President's puts {oo much reliance on long-term compensation. The right ‘answer is somewhere in the middle.”574 PART 4 Compensation of Human Resources But for companies that want more government aid, pay concessions were just the price of admission, says Rep- resentative Barney Frank (D-Mass.), chair of the House Finanetal Services Committee. Frank argues that without a show of pay contrition, and a better explanation of how they're spending the money already given, there's little chance that big financial institutions would be able to tap farther into TARP funds. Otherwise “the chances of talk- ing the American people out of this kind of anger is zero,” Frank said at a Feb. 3 press conference, ‘Others point out that Wall Street's huge bonuses reflect a tisk culture that contributed to the current crisis. Thus, a reordering of incentives might be welcome. In a hear’ ing before the Senate Banking Committee, former Fed- cral Reserve Chairman Paul Volcker said: "When you mix together those enormous compensation practices [and] enormous gains possible with obscure financial engineer ing, you had a recipe ... that came back to haunt us.” As for the creative talent that fucled the complexity, he said “1 wish more of it would go to building bridges instead of financial markets.” Penalty for Failure of Leadership Investor activists, meanwhile, have litle sympathy for the plight of the newly clipped. “This is the inevitable con- sequence of their failure of leadership,” says Nell Minow, co-founder of The Corporate Library. “It would have been really smart for the business community to clean up their own act instead of waiting for this to happen.” Minow sees 0 (N01 5 EERE ALE TES 1. We draw feely in this chapter on several literature reviews B, Gerhart and G. T. Milkovich, "Employee Compensation: Research and Practice,” in Handbook of Inusrial and Organi- sational Psychology, vol 3, Jd ed, ed, M. D. Dunnette and L: M. Hough (Pao Alto, CA: Consulting Paychologiss Press, 1992); B.Gethart and S. L Rynes, Compensation: Theory, Euidence, and Swag Implicaions (Thousand Oaks,CA Sage, 2003);B, Gerhart, “Compensation Strategy and Organisation Performance,” in S. L. Rynes and B. Gethart, eds, Compensation in Organitations: Curent Research and Practice (San Francisco: Jossey-Bass, 2000), pp. 151-94; B. Geshar, SL: Rynes, and I. S,Fulme, "Compen- sation," Academy of Management Annals 3 (2009). 2. B.Gethart and G. T. Milkovich, “Organizational Differences in Managerial Compensation and Financial Performance," Acad- ey of Management Jounal 33 (1990), pp. 663-91. 3. Decl and R. Ryan, Inrnsc Motivation and Self-Deternina- tion in Hunan Behavior (New York: Plenum, 1985); A. Kohn, “Why Incentive Plans Cannot Work,” Harvard Business Review, Septemiber-October 1993. 4 R.Benbugr and}, Cameron *Deinenta feof Revo ality of Myth?” American Psychologist 51, no. 11 (1996), pa 11532568 Lyre B- Gra nd Paks “Pon nel Paychology: Perfonnanee Evaluation and Compensation.” Annual Review of Prycholgy (2005), the government's move not as one a regulator made, but as something any capitalist-minded investor would demand. Better than most, Minow knows the frustration of watching compensation grow despite efforts to curb it. Her group has for years been fighting for corporate gov- ‘ernance reform. She agrees with Obama's support for “Say fon Pay” provisions that would allow shareholders to vote ‘on executive pay, but says even more important is fixing board compensation committees, which ultimately design and dole out pay “The focus should not be on the symptom, excessive ‘compensation, but on the disease, which is bad boards of directors,” Minow says. She advocates giving sharcholders the right to vote off board members who are not doing a good job, especially chose sitting on the compensation ‘committee. “They deserve to be under the microscope,” says Minow. Questions 1. What role did the executive bonuses described in the ‘chapter opening play in the executive pay restrictions announced by President Obama? ‘Are these restrictions a good idea? Explain the poten- tial pros and cons. 3. Should the federal government regulate executive pay? Will these restrictions actually contain executive pay in affected companies? which companies will be affected? SOURCE: Nanette Byenes and Theo Fanci, "Exective Pay: Wil he Big Bact Sop Here” Bunnie, Feboay 9, 2008 2 5. D.R, Dalton, M.A. Hit S. Con, and CM. Dalton, “The Fndanenal Ageney Problem ants Mitton: Iniepen- dence, Ean and the Markt for Coprate Cont” Acadamy ff Menagement Aral (2007), pp. 1-64, R.A, Laker and D. E Larcker "Exective Compensiton, Corporate Decision Making, and Shorchokler Westy” in Exccve Conpensitin, el F Ful es (Btn: Harvanl Bune Scho! Pres, 1939), pp. 287-309 6 LER. Gomes Mai, H. Tos, nd T: Hinkin, “Managerial Con- ol, Performance, and Executive Compensation,” Academy of Management Jourel 39 (1987), pp. 51-10, H. te Ts Je and LR. Gomer-Meja, “The Decoupling of CEO Pay and Perfor mance: An Agency Theory Penpective" Admisnate Soence Quarry 34 (1989), 169-89. 7. KOM. Bhenhort, "Agency Theor: An Assessment. and Review” Academy of Management Review 14 (1989), pp 57-74 8. RE, Hoskison, M, A. Hit and C. W. [Hil “Managerial Incentives and Investment in, R&D in Large Multiproduct, Fim" Onanianional Science 4 (1983), pp. 325-41; Me Bloom and G. T Mlkovich, “Relationships smong Risk, Incentive Pay, and Organizational Performance," Academy of Management Jowmal 41 (1998), pp. 283-97. 9. Eisenhardt, “Agency Theory." 10. Ibid; E. J. Conlon and J. M. Parks, “Effects of Monitoring and Ton on Compensation Arengements An Experivent