A small provision slipped into the stimulus (PDF) by Sen. Chris Dodd is making big waves in the banking and finance industries. The last-minute addition to the bill, which pretty much no one noticed until after the legislation passed both chambers, places sharp limits on bonuses available to top executives and other high-earners.
How sharp? How about this:
[Title VII, Section 7001] A prohibition on any compensation plan that would encourage manipulation of the reported earnings of such TARP recipient to enhance the compensation of any of its employees.
So no more tying pay to performance.
But don’t worry, Sen. Dodd perhaps foresaw that complaint and so included a special allowance for “long-term restricted stock” that does not vest until the government has been paid back.
Think about that for a minute, and the problem becomes as clear as day. Here’s how Lucien Bebchuk (of all people!) puts it:
In such circumstances, restricted stock may provide incentives for executives to take excessive risks with the bank’s survival. Consider the case where an infusion of additional capital would greatly dilute the value of common shares but would be best for the bank, while failing to get that capital would put the bank’s future at risk. In such circumstances, compensation in restricted common shares would provide executives with an incentive to avoid raising capital (which would wipe out their shares’ value) and gamble on survival without additional capital.
While one might expect that Bebchuk’s solution to this sort of problem would be to let the courts figure it out or maybe hold weekly shareholder votes, even he recognizes that these new pay caps will cause distortions and perverse incentives.
More clearly, they will cause banks to think twice about participating in TARP and related programs. While that’s not a bad thing, it’s clearly not what the Obama Administration was hoping for, either.
(For more on the unintended consequences of pay regulations, see my previous posts on golden parachutes (which the Dodd insert bans), pay caps, and bailing out of TARP.)
