Executive Compensation Restrictions Work In Everyone’s Favor

The core difference between the Bush and Obama administrations in terms of how they doled out government bailout funds was what, if any, terms came with getting the money. Former Treasury Secretary Paulson gave out the first half of TARP funds with no strings attached. Secretary Geithner, conversely, wanted to make sure the government funding came with restrictions, including how much executives of bailed out firms could earn while they still owed the taxpayer billions of dollars. Skeptics argued that this was a way for Washington to gain control of the private sector, but in reality it really was just a way to maximize the odds that the government got repaid.

The Obama administration’s auto task force required that GM CEO Rick Wagoner resign because they knew that under his leadership we would never get our money back, not because they wanted firm control over GM. In fact, the CEO they handpicked, Fritz Henderson, just resigned after the GM board (not the government) insisted he move faster in making necessary changes, something GM-lifer Henderson was unwilling to do.

Executive compensation restrictions have served as another way to increase the chances that TARP funds are repaid. The restrictions made it more difficult for Bank of America to find candidates to be the banking giant’s new CEO. As a result, BofA raised $19 billion in new capital last week in order to be in a position to immediately repay its $45 billion in TARP loans. I do not know anyone who expected the entire $45 billion to be repaid this quickly, and therefore it appears the pay restrictions did exactly what they were intended to do; give TARP recipients incentive to repay the money as fast as they could.

This is just one of the many reasons I think Treasury Secretary Geithner has done a very solid job so far. There will always be critics who blame everything they don’t like on certain people, but a lot of these decisions are proving to have worked.

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6 Thoughts on “Executive Compensation Restrictions Work In Everyone’s Favor

  1. Corey McGuire, CFA on December 8, 2009 at 8:02 PM said:

    I can see where you are coming from, the pay restrictions light a fire under their feet to pay TARP money back. But I respectively disagree. I think the pay restrictions at best are just a populist distraction for the public and a side show, and at worst are a serious impediment for these organizations to be professionally run. The Government (taxpayers) became preferred shareholders with equity warrants in these organizations. In Citi’s case, the government is an outright shareholder with a 35% equity stake in the company. If the government wanted to get its money back, along with the risk adjusted appropriate rate of return that it duly deserves, they should not meddle in the day to day minutia of how a bank is run. I can understand increasing regulatory capital requirements because lax capital levels are what caused their problems to begin with. Not some trader getting paid a percentage of his P/L or an I-banker getting a cut of the fee income he brought in the door.

  2. Chad Brand on December 9, 2009 at 8:02 AM said:

    Don’t you think the traders getting a percentage of the profit they generate is exactly how Lehman, Bear, and AIG went under? If you are paid a cut of the profit you make, but have no incentive to manage the downside risk, your firm can easily go under if there are enough traders who get paid like that on the payroll.

  3. David Haley, CFA Level I on December 10, 2009 at 7:01 AM said:

    I also respectfully disagree with your assertions on this topci and second the comeent by Corey McGuire, herein above.

    A deacde or more of populist sentiment alleging that home ownership was not only the holy grail of personal fiancial independence but also a right aided and abetted by government at every level led to a carrot and stick approach by that same governemnt in the form of initiatives such as the Community Reinvestment Act to virtually eliminate underwritng standards and due diligence for home loans such that this debacle was foreseeable and avoidable.

    To blame free markets that have not been “free and unfettered” for several generations is disingenuous and establishes precedence for an ever furhter reaching government to proceed down the totalitarian statist path.

    If Obama and Tim Geithner et al do not to manage GM on a long-term day-to-day basis as you imply then what is your respnse to the report tht Pay Czar Ken feinberg is now gouging into ever deeper and lower levels of GM to restrict pay?

  4. Chad Brand on December 10, 2009 at 8:27 AM said:

    To argue that the mortgage markets were not “free and unfettered” during the housing bubble is disingenuous. In fact, it was the largest consumer industry that was completely free from underwriting regulation.

    I must accept that the government was ill-advised in promoting home ownership with mimimal regard for affordability, but that argument doesn’t hold much water with me (in terms of it causing the bubble) because the FHA never allowed sub-prime, interest-only, or option-ARM loans. The banks, without aid from the government, gave out these loans on their own and could do so without any restrictions.

    All of the problem loan types were packaged and sold to non-governmental agencies and caused the bulk of the subprime losses globally. The government never insured or bought up loans that were given to people without documented income, without principal payments, or without any down payment.

    It is popular nowadays to blame the government for the housing bubble but the lenders are the culprits. You can certainly blame government (Greenspan, Bernanke, etc) for not identifying/catching it ahead of time and trying to diffuse it, but they certainly didn’t cause it in the first place.

  5. Corey McGuire, CFA on December 13, 2009 at 3:26 PM said:

    Chad, back to compensation limits. Its not exactly the job of a trader to set leverage or position limits. That’s what risk management departments do. They monitor Value at risk, and other measures and either dictate how much capital a trader is authorized to trade with, or they make recommendations to management about that, and management decides how much leverage to use. It was mistaken assumptions of the probable volatility in certain securities (like MBS or CDS) that led management to conclude that certain capital levels were sufficient. But that’s a different discussion.

    There are also ethical issues with having some government tool (like Feinberg) arbitrarily decide whats fair and not fair compensation levels. How fair do you think it would be for the government to cap Peridot Capital’s fee income in order to dis-incent you from taking too much risk in your clients’ portfolios? After all by your own logic, the larger Peridot’s AUM is, the more fee income your going to bring in so why not bet the ranch on risky investments because if they pay off, then your AUM will balloon in size. If you roll your eyes at that analogy then I think I’ve made my point.

  6. Chad Brand on December 14, 2009 at 9:11 AM said:


    If Peridot Capital was on the verge of dissolving and received a government bailout to stay in business, you really think I would complain that my top 0.001% of employees would have cash compensation capped at $500,000 per year until we repaid the loan? Remember, they are capping “cash” comp only (not long term awards) and it is only for three companies in the entire country; AIG, GM, and Chrysler (Citi is now out of the group).

    I would probably completely agree with you if these comp limits were somehow part of a new sweeping financial regulation bill that applied to all banks, but that is far from what is actually happening.

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