Corporate Governance

Executive Compensation and the Financial Crisis: A Problem In Search of a Solution (Still) (Part 1)

By J Robert Brown Jr.

Executive compensation was a hot topic during the financial crisis.  Concern existed on two fronts:  The absolute amount and the form of compensation.  The astronomical amounts contrasted sharply both with the high unemployment rate and sector's dependency on government bailout funds.  The form of compensation provided incentive to engage in short term profit making, irrespective of the long term consequences.

The approach to compensation demonstrated the failure of state law, the primary source of regulation for compensation, to impose any meaningful limits on compensation practices.  Even with compensation paid to the CEO, who invariably sat on the board of directors, Delaware courts allowed for the application of the business judgment rule rather than the more obviously applicable duty of loyalty.  As a result, compensation because a matter of process (and weak process at that), with the substantive terms (the amount, for example), largely becoming irrelevant to the compensation determination.  It resulted in compensation witout limits.  For more on this, see Returning Fairness to Executive Compensation. 

During the financial crisis, the government to some degree stepped in, at least with respect to companies taking bailout funds (which mostly involved banks and other financial institutions although some operating companies such as General Motors also received government funding).  With respect to the type of consideration, most of these companies were pressured or required to pay a higher portion of bonuses in the form of stock and to impose vesting schedules.  The theory was that this would remove much of the incentive to make short term profits and provide an incentive to manage in a manner that maximized the long term prospects of the company. 

With respect to limits on amounts, almost nothing was done.  For a time, limits were imposed on the size of bonuses relative to the base salary.  Nothing, however, prevented a company from raising base salaries.  Moreover, the limitation wholly exempted stock.  For the companies that received the largest dollops of government bailout money, their compensation scheme was subjected to review by the Pay Czar, Kenneth Feinberg.  He could not review past awards or contractual obligations and retained review authority only as long as TARP funds remained unpaid.  His oversight likely reduced compensation amounts but only on a short term, temporary basis.

The issue always was whether there would be any long term change in compensation practices. 

Full post as published by The Race to the Bottom on December 14, 2010 (boomark / email).