Truth, Lies, the Bailout and CEO Pay

Democratic lawmakers went into their bailout negotiations with Treasury Secretary Henry Paulson with some promising approaches for restraining executive pay.

We don't yet know what happened inside those negotiations, aside from a bit of reported shouting. But we do know what came out: a bailout that does precious little to limit the outrageously extravagant pay rewards that give top executives the incentive to behave outrageously.

Members of Congress who back the bailout, you may have noticed, have been singing a different tune. Rep. Barney Frank, a lead negotiator on the bailout bill, has even hailed the legislation's executive pay provisions as the first "restrictions on excessive CEO compensation" in U.S. history.

The bailout bill's one-page summary delivers the same celebratory message. The title for the summary's section on CEO pay: "No Windfalls for Executives."

The bailout now blessed by both the Senate and the House does, to be sure, include some long-overdue reforms on executive pay. The legislation has a ban on "golden parachutes," for instance, and language that lets the feds "claw back" executive earnings based on phony accounting.

And the legislation also includes a provision that places a $500,000 cap on the individual executive pay that bailed-out companies can deduct from their taxes. Any executive pay over that cap -- including pay in the form of stock options and other so-called "performance-based incentives" -- will now be taxed.

This represents a solid advance over current law. Our current $1 million deductibility cap on executive pay only applies to straight salary. Companies can deduct everything else, no matter how many millions that everything else ends up totaling.

All these executive pay restrictions in the bailout bill, listed like this, certainly do sound impressive. So what's the problem? Just this: Nearly every executive pay restriction in the bailout bill comes with a built-in loophole.

Take, for instance, that $500,000 cap on how much executive pay bailed-out companies can deduct off their taxes. This cap only applies when the Treasury Department buys up over $300 million of a company's "troubled assets" through an auction process. If Treasury Secretary Paulson's people buy up a company's troubled assets directly, the $500,000 deductibility cap doesn't apply. Nor does the "clawback" provision.

Even the bailout bill's celebrated ban on golden parachutes comes with a loophole. The golden parachute ban, in auction bailout situations, only applies to executives hired after the auction takes place. Those executives who led their companies into the bailout zone will be able to ride off, into the sunset, with saddlebags stuffed with windfalls.

But that's not the worst of it. In situations that don't involve auctions, the bailout legislation directs the Treasury secretary to "require that the financial institution meet appropriate standards for executive compensation." Who will define "appropriate"? The legislation leaves that up to Secretary Paulson.

That may not be a great idea. Secretary Paulson, as CEO of investment banking giant Goldman Sachs, amassed a personal stock stash worth over three-quarters of a billion dollars. His conception of what constitutes "appropriate" pay for bailed-out executives just might not gibe with the definition American taxpayers have in mind.

Still, in the end, should any of this really bother us? Does executive pay really matter all that much? Sure, we all want to punish the executives who created this mess. But isn't cleaning up the mess -- and getting credit flowing once again -- more important?

Cleaning up the mess must surely be a top priority. But avoiding more mess also needs to rate right up there on our priority list, and that's why we need serious restraints on the pay of bailed-out executives - not to "punish" the denizens of executive suites, but to prevent the reckless executive behaviors that have brought us face-to-face with so much economic peril.

The bottom line: The longer we as a society let executives chase after dazzling rewards, the more recklessness we encourage.

With the bailout, we have a shot at stopping the chase. The bailout legislation, as now passed, does establish the principle that we need "limits on compensation" that discourage financial executives from taking "unnecessary and excessive risks that threaten the value of the financial institution during the period that the Secretary holds an equity or debt position in the financial institution."

Lawmakers, as the next stage of the bailout process, now need to define specifically what these limits should be. We even have a "bipartisan" consensus of sorts on what a specific common-sense limit might be.

Senator John McCain, in an aside that gained relatively little public attention, last month called for capping the pay of bailed-out executives at the compensation of the highest-paid federal official. That highest federal compensation would be $400,000, the salary of the President of the United States.

Senator Diane Feinstein, a Democrat from California, has called for capping compensation for bailed-out execs at this same $400,000, and Senator Max Baucus, a Democrat from Montana, has proposed $400,000 as the cut-off for executive pay tax deductibility.

Is there anything magic about $400,000? Turns out there is. At $400,000, the President of the United States makes close to 25 times what the lowest-paid federal worker makes. The 20th century's most brilliant business thinker, Peter Drucker, considered the 25-times ratio the most appropriate pay gap standard for private-sector enterprises. Wider gaps, Drucker believe, create defective enterprises.

To succeed in the 21st century, we need effective enterprises. Let's start with the companies we bail out. No tax dollars to any reeling financial institution that pays its top exec over 25 times what that institution's lowest-paid workers take home.

Lawmakers didn't get that right on their first go-around with the bailout. In January they'll have another chance.


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