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Treasury Department’s New Pay Restrictions

New restrictions on executive compensation have been issued by the Treasury Department in an effort

...to strike the correct balance between the need for strict monitoring and accountability on executive pay and the need for financial institutions to fully function and attract the talent pool that will maximize the chances of financial recovery and taxpayers being paid back on their investments.

US Department of Treasury (TG-15) , February 4th, 2009

Essentially, companies that receive assistance through programs that are widely available to most firms and have pre-determined terms and conditions will not be affected.  The Treasury Department identified the Capital Purchase Program as one such program in which participating companies will not currently be subject to these new restrictions - the Treasury Department will be taking comments on guidance they intend to propose in the future for firms participating in generally available capital access programs.

The Treasury Department's new restrictions will be applicable in the following instances:

If a firm needs more assistance than is allowed under a widely available standard program, then that is exceptional assistance. Banks falling under the "exceptional assistance" standard have bank-specific negotiated agreements with Treasury.  Examples include AIG, and the Bank of America and Citi transactions under the Targeted Investment Program.

US Department of Treasury (TG-15) , February 4th, 2009

The new restrictions embrace the tax deduction limit of executive compensation above $500,000 and take it a step further to actually limit executive compensation paid to no more than $500,000, with the explicit exclusion in this cap for the value of any  restricted stock grants.  However, any restricted stock awards are required to contain vesting restrictions linked to repayment of the government's investment or conditions that deem the government's investment repaid.  That's good news for taxpayers.

Among other key points in the new restrictions:

• Executive compensation strategy must be submitted to a non-binding shareholder resolution.
• The top ten executives will not be eligible for golden parachute payments if their employment ends.
• The next twenty-five executives will be limited to one year of severance under any golden parachute payment.

Presidio Pay's Thoughts -  It is both surprising and disappointing that common sense and sound compensation practices would need to be mandated by law.  This is another sign that executive compensation needs fundamental and structural reform.  The basic principles incorporated in the Treasury rules are good:  executives need to hold company stock so their compensation is at risk in the same way shareholder's investments are at risk.  Therefore, when an executive makes a poor decision, both the executive and the shareholders are subject to impact of those decisions.  The equity ownership structure is a position that we advocate and is captured in a Presidio Pay white paper that is available for download on our website entitled The Trouble With Options.

Expanded claw-backs also address this problem of asymmetry in incentive plans, whereby good short-term performance is rewarded but possibly at the expense of poor future performance, which up until now has not been appropriately penalized.  Limits on severance pay also make sense, since the objective of severance pay should be to help bridge a former employee to future employment, not rewards them for failure.

While these restrictions are currently limited to just a few financial companies receiving exceptional government assistance, the implications of these restrictions can be expected to shape the discussion of executive compensation programs among Compensation Committee members of public companies.  Major deviations from these practices will be harder for Boards to justify to shareholders, and "Say On Pay" shareholder votes will help shareholders send clear messages about pay arrangements that do not support shareholder interests.  All in all, this is a positive step toward more strategic executive compensation plan designs.

You can get more coverage of the story at the New York Times, the Los Angeles Times and the Wall Street Journal.  Brian Wingfield and Josh Zumbrun at Forbes go a step further and discuss how these limits could have some unintended consequences as well.