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Future of CEO Compensation

Kenneth Feinberg, the Washington lawyer who’s stepping down this summer as Special Master for Executive Compensation (aka Pay Czar) to administer the $20 billion British Petroleum fund, offered his insights on the executive pay debate at Chief Executive’s CEO2GOV Summit. To follow are excerpts from his presentation.

My role has been articulated by statute. I work pursuant to a federal law enacted by the Congress which says that at those seven companies that received the most taxpayer assistance—GM, GMAC, Chrysler, Chrysler Financial, AIG, Bank of America, Citigroup—I must calculate the pay for the top 25 people at those companies. And if a company repays the taxpayer everything that is due, that company is no longer subject to my jurisdiction. At the end of the year, Citigroup and Bank of America borrowed money to get out from under my jurisdiction and repaid taxpayers. I no longer have any authority over them. They did what Congress intended: paid back the taxpayer. This year, Chrysler Financial announced repayment and they are out. So today my jurisdiction is down to just four companies—Chrysler, GM, GMAC and AIG.

So if my jurisdiction is so limited, why is there such national interest in what I’m doing? I think there are two reasons. First, in a time of great economic uncertainty, unemployment of over 9%, angry populace sentiment, there is a great deal of interest in what the bigwigs are getting. The gap between Wall Street and Main Street is historical and the context of today’s times encourages that type of frustration and anger.

The second reason there’s a lot of interest in what I do is I think I’m the only government official who has to turn these vanilla prescriptions about pay—pay shall be performance-based; pay shall be over the long haul; pay should not be guaranteed—that basically everybody agrees with into actual calculation of dollars. You will make $3 million. You will make $6 million. You will make $1 million. That focuses the attention of people.

When the President and the Secretary of the Treasury asked me to do this, I thought there would be a great deal of anger and controversy. The government is setting pay? It’s none of the government’s business. Absolutely not. There’s been very little criticism of what I’m doing. Why is that? Again, two reasons.

First, it’s only 175 people, now 100 people. It’s hard to get a little bit excited over the fact that your role was so limited to begin with and it’s shrinking. So I mean, if you’re going to roll out the big guns and criticize pay and what the government is doing in the private marketplace, what are you picking on him for? He’s got a very limited role. That’s one reason.

But there’s another more substantive reason that there’s very little criticism: people recognize that the taxpayer owns these companies. They only are in business because the taxpayer lent them the money. The idea that you owe the taxpayer and yet the taxpayer has no role to play as a creditor in the establishment of pay by the bigwigs? Nobody thinks that. It’s turned out that whether you’re from a red state, a blue state, a Republican, a Democrat, a liberal or a conservative , everybody seems to accept the argument that as to this limited number of companies and corporate officials, the taxpayer as a bottom-line creditor has the right to have a big influence, over what people ought to make.

Now, how do I go about determining what somebody ought to make? That’s sort of interest, I would think, to you guys. Under the law, what do I actually consider? Let’s look at the blueprint. One: I look at the statute. What guidance do I get from the statute? Well, I get some: The Special Master shall make sure that pay is competitive; that these companies will thrive financially so that they can repay the taxpayer. I have to make sure that the pay determinations are not vindictive, are not vengeful, and are tied to competitive pay in that industry.

But then the statute says, but also make sure that your pay determinations do not promote excessive risk. What does that mean? I have a perfect answer: I know it when I see it. That’s what I say. I know excessive risk when I see it. I’ll be able to look at it and know it’s excessive. The statute says pay should promote loyalty, long-term performance, objective base performance, no guarantees. So I have the statute to help me, at least in the broadest sense.

Then what do I do? I ask the companies, give me the data. Give me your employment compensation data. What do you think compensation data demonstrates should be competitive? CFO, $2 million. CEO, $5 million. Trader, $7 million. Vice president for human resources, $1.2 million. Give me the data so I can look empirically at what you say the data demonstrates.

Next, I get my own independent data. Company, you say that your CFO should get $2 million. Our data shows that the competitive compensation is $1.4 million, not $2 million. There’s a gap. They say, “Oh, well, you don’t know what our CFO does. She drives the limo, she works in the library, she does a lot more than just be a regular CFO. You’re not looking at the right comparables. ”

Then I go out and hire independent compensation consultants. Well, there are no independent compensation consultants. I couldn’t find any commercially independent compensation consultants. One way or another, they’re all tied into corporate America. So I did the next-best thing: I went out and hired two academics who help me in my determinations: Lucian Bebchuk at Harvard and Kevin Murphy at Southern Cal. Fabulous.

Then I invited each of the seven companies to come and give me their anecdotal evidence as to what their top 25 should make. And each company visited Treasury and I heard the same arguments: “She is indispensable. If we lose her, financial risk to the taxpayer getting its money back. “I said, “You know, the graveyards are filled with irreplaceable people.”

Then they said, “If this person leaves the company, he’s going to go to a foreign corporation. He will go to China and help the Chinese compete.” This is what you hear from companies. You wrap all of that together and you exercise your discretion and you come out with pay determinations for everybody that is subject to your mandatory jurisdiction. That’s exactly how you do it.

Now, when I announce my pay it’s not only the pay, but how the compensation should be paid. Here are the prescriptions.1.Cash-base salary should be very modest, below $500,000 a year.2. There should be no guaranteed compensation other than cash-base salaries. The rest of the compensation should be prospective and performance-based.3. Other than low-based, modest-based cash salary, the remainder of the salary should be in the form of stock, but stock that cannot be redeemed or transferred or sold except one-third after two years, one-third after three years, and one-third after four years. Longer-term performance where individual compensation is tied to the success and value of the company. If the company thrives, your stock goes up. If the company founders, you pay the piper. Your total compensation is some cash, but also a hefty portion in long-term stock that vests immediately by law. Don’t ask me why, that’s what the statute says. But it can’t be transferred for up to four years.

Finally, after five years, you will get more stock in the company. But that stock, after five years, cannot be redeemed until and unless the company repays at least 25% of what it owes to the taxpayer. So that is the formula. That is how we decided, what we considered in determining compensation. That is how we went about calculating compensation, and that is the prescription we used in finalizing compensation.

Now, a few final points. First: This is not rocket science. The people in this room could do exactly what I’m doing and maybe even do it better. But always remember when you talk about stuff like this, we live in a political economy. It’s always been called a political economy. Do not underestimate the politics. At the same time, the statute requires that I, delegated to me from the Treasury and the Secretary, calculate pay that is substantively grounded in the statute, the regulations and the rules. I have some political flexibility, but at the end of the day, it has to be a substantively sound principle decision. I think it is. Does that mean that somebody couldn’t do it differently? Somebody could do it differently. But that’s the way the statute reads, and that’s the role I play.

I’m always asked the same three questions:

1. How likely is it that your jurisdiction will be expanded? Very, very unlikely. There is absolutely no sentiment to expand my jurisdiction. The administration doesn’t want it, the President has said we do not want the government micro-managing these companies. This was a Congressional response to a unique economic crisis. And that is why my role will remain or will continue to shrink, not be expanded.

2. What impact have you had with your decisions on the rest of American business? Has the rest of American business voluntarily adopted your pay prescriptions? It’s too early to tell. We’ve only been doing this for a year. But there are some early signs that at least the major companies on everybody’s radar screen—Goldman, Morgan Stanley, Wells Fargo—are adopting the prescriptions. We’ll see. The memory of the American people is very short. But there are some early signs that I’ve had some impact beyond the limited role that I play.

3. Well, you’ve now done it twice. Did these officials leave and go elsewhere like they said they would? Are they now working in Beijing? Of the individuals whose pay I set in 2009, 85 percent of them are back at their desks in 2010. So empirically at least, this threat that people will depart has not been proven. To the contrary: they remain. Now, I don’t know why the 15 percent left. They may have died, they may have resigned to retire. They may have gone to a competitor for reasons quite unrelated to pay. I don’t know. We should find out, and we will. But most people remain at their desks.

4. Do your pay prescriptions make sense across a broad group of American companies? I’ll answer it this way: One size does not fit all. It’s a mistake to look at my pay/cash/stock prescriptions and assume that that ratio applies everywhere. Frankly, the American people don’t demonstrate a whole lot of interest in what I’m doing for the American automobile industry. All of the American-people media attention is on Wall Street—Bank of America, Citigroup, and to some extent, AIG. There’s very little interest in Chrysler and GM. Now, part of the reason is due to the salaries—the top three people at Bank of America got more money in 2009 than all 25 people at GM, which tells you something about the changing American business marketplace.

 

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