Corporate Governance

The Pay Czar and Government Intervention: Further Evidence on the Need for Federal Preemption

By J. Robert Brown

We are doing a series of posts on the Merck case, a decision recently accepted by the Supreme Court that will examine the standard for starting the statute of limitations period under Rule 10b-5.

The WSJ reported a poll that suggested the American people had concern with government involvement in the economy.  We've seen the government more or less buy companies (AIG and GM for one) or assume significant minority stakes (Citigroup), not to mention all of the non-voting preferred stock floating around.  The government has reputedly put pressure on companies to change directors and, in the case of GM, to fire the CEO. 

Yet the government will become more involved, at least in the case of executive compensation.  Treasury has announced the appointment of a Pay Czar.  The honor goes to Kenneth Feinberg, who came to the fore through his efforts as administrator of the fund compensating victims of 9/11.  For companies receiving TARP, their compensation (or at least to compensation of the top 100 highest paid persons) will be subject to review by Kenneth Feinberg.  Review will presumably involve analysis of amounts.  It will also likely involve analysis of the method of computation to ensure that in fact the pay scale contains no incentives to take unnecessary risks, the perceived cause of the current financial crisis.  Presumably Feinberg will be in a position to reject packages (including bonuses).

Not only is this the kind of thing that is worrying voters but it is also the kind of thing that is causing companies to flee the TARP program.   Nonetheless, the need, as usual, reflects the utter breakdown of the process for determining executive compensation.  The Delaware Model in short.  In other words, the Obama Administration cannot be confident that the current system will in fact result in reasonable amounts and risk taking incentives.  With the system utterly broken (broken suggests it once worked well, a dubious proposition), the government has no choice but to push aside the system, dispense with Delaware standards, and subject the decisions to direct review.  Boards won't care what Delaware requires.  They will now want to know that the Obama administration (as articulated by Feinberg) expects.

In addition to the unseemly nature of direct government involvement, the main problem is that this fixes nothing.  Once Feinberg moves on to his next appointment and the TARP money is gone (repaid or lost because of bankruptcy), financial institutions will be back with the Delaware model or, as we say here, compensation without limits (more on that can be found here: Returning Fairness to Executive Compensation).  If the Obama Administration wants to reduce its direct involvement in the economy, perhaps a permanent solution would be better than a pay czar.  While some are under consideration, none of them federalize the system for determining compensation, taking the matter away from Delaware.

Full post as published by The Race to the Bottom on June 18, 2009 (boomark / email).