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Compensation clash offers Obama political cover

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Albert R Hunt Bloomberg

A system that places a premium on short-term gains rather than long-term prosperity must go.

Dick Fuld, not a familiar name to most Americans, is nevertheless the poster boy for arrogant corporate greed. He may also be a catalyst for significant changes in executive compensation. The former chief executive officer of Lehman Brothers Holdings Inc, Fuld raked in almost half a billion dollars in the eight years before his company went bankrupt. Facing possible civil suits, he quietly sold his Florida mansion, valued at more than $13 million, for $100 to his wife.

That’s the stuff that infuriates struggling and scared average Americans, who are demanding a crackdown on corporate excess. As the government tries to rescue banks and other companies, Barack Obama’s administration is responding to the public outrage, starting last week by limiting compensation at financial firms that get major new government assistance.

 

Politically, this was essential. Even if Obama is unwilling to bite the bullet this week, he ultimately will have to ask for a lot more federal assistance, in the trillions, for the nation’s banks. This tough sell will be impossible if the out-of-work welder in Ohio, or the financially strapped nurse and single mother in North Carolina, are still seething over discredited Wall Street firms handing out billions in bonuses or lavishing perquisites on failed executives.

‘Political Cover’
The restriction of some financial-executive compensation “is the necessary creation of political cover,” says David Smick, a Republican economic expert and author of a book on the global economy. This “implicit deal,” Smick argues, might engender sufficient public support to avoid a “financial Armageddon.”

There’s more than just politics. Bloomberg News calculates that the five largest investment banks, Goldman Sachs Group Inc, Morgan Stanley, Lehman, Merrill Lynch & Co and Bear Stearns Cos (the latter three now gone), handed out $145 billion in bonuses in the five years preceding the crash, larger than the gross domestic product of countries like Pakistan and Egypt.

Much of this was based on short-term performance, increasing incentives for the risky investments that sowed the seeds of the banks’ destruction.

“The distorted incentives created by many of these financial arrangements was a major contribution to the financial crisis,” says Lucian Bebchuk, a law professor and director of the Program on Corporate Governance at Harvard University.

Government Intrusion
Some economic conservatives are complaining about too much government intrusion; Senate Republican leader Mitch McConnell of Kentucky warned that such actions may lead to the “nationalization” of business.

Nell Minow, one of America’s foremost corporate-governance experts, dismantles that argument: “The government isn’t acting as a regulator, it’s acting as a capitalist,” she says. “Any bailout organization — the government or a private equity firm or the Mob — asks for some givebacks.”

She worries that there are too many loopholes in what the president and Treasury Secretary Tim Geithner have laid out: The new rules only affect firms that receive “exceptional” assistance, and then only the very top officers. And the “clawback” provision, when bonuses have to be returned if based on false data, only applies in cases of fraud, not misstatement.

‘Shame and Blame’
Still, she praises it as a step forward and believes the “shame and blame” spotlight will force more accountability. Corporate compensation in America has become a scandal, not because some high-flying CEOs get rich; some should. It’s because it rewards mediocrity, and even outright failure, by placing a premium on short-term gains rather than long-term prosperity.

Critics say some firms will turn down federal assistance to avoid pay limits. If they can make it without government aid, that’s good for the taxpayers and the banks. This threat is exaggerated. Five years ago, the government handed out billions to the major airline carriers and, as a condition, imposed modest limits on executive compensation. Not one carrier turned it down.

Moreover, these once-celebrated corporate chieftains should read the history 30 years ago of Chrysler and its then-Chairman Lee Iacocca. The automaker got a government bailout, Iacocca slashed his own salary to $1 (though he eventually made millions from stock options), he became a national icon, the company recovered and taxpayers got their money back.

More Accountability
Minow and most corporate-compensation critics don’t want the government setting pay levels. There are other actions and pressures that can make this behaviour more transparent.

The Obama rules require more openness about activities and compensation from these financial institutions. In 2007, the Securities and Exchange Commission also moved in that direction, requiring publicly traded companies to disclose total compensation for their five highest-paid senior executives.

There are major loopholes: Perquisites, such as air travel and housing, don’t have to be disclosed, and under the guise of “competitive considerations,” the formulas used to set pay levels needn’t be revealed.

Sometimes executives rely on compensation consultants who are beholden to them because they may have other business dealings with the company. While it’s not the government’s business to regulate these arrangements, disclosure of such deals is a no-brainer.

Failing Grades
So is requiring more democracy and accountability for directors. Boards like Lehman’s, which included actresses, theatrical producers and a retired admiral, get failing grades from watchdogs like Minow.

Yet the SEC has permitted hand-picked directors to continue on boards, even over the opposition of a majority of shareholders, and sometimes made it exceedingly difficult for shareholders to nominate directors.

The climate is ripe for change, either by new regulations or legislation. Several years ago, before he was chairman of the House Financial Services Committee, Congressman Barney Frank tried for months to merely get a hearing on the issue of allowing shareholders to cast a nonbinding vote on executive compensation. The panel’s chairman at the time finally relented and let him have such a session on a Friday afternoon when most members were gone.

Now, Frank is weighing whether to revise this proposal so such votes would be mandatory. If he holds a hearing, there won’t be many members absent.

Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper

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First Published: Feb 10 2009 | 12:21 AM IST

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