Pay Czar Reduces Executive Pay for Firms Receiving Exceptional TARP Assistance

In an effort to tie compensation more closely to long-term performance and appropriate competitive levels, Special Master for TARP Executive Compensation Kenneth R. Feinberg has directed companies that received exceptional Troubled Asset Relief Program assistance to cut compensation for top executives by an average of 50 percent. While the pay cuts apply to only seven firms, the levels and structures could become a template for compensation at other financial institutions that participate in TARP. Feinberg also clarified that these firms are subject to the same corporate governance provisions that apply to other TARP recipients, including say-on-pay votes, clawbacks, compensation consultant disclosures, risk reviews, perquisite disclosures, prohibition on tax gross-ups and chief executive officer/chief financial officer certifications.

Guiding compensation principles
Feinberg’s mandate to approve pay at firms receiving exceptional assistance, which was enacted as part of the Emergency Economic Stabilization Act, applies to the five most senior executive officers and the next 20 most highly compensated employees at seven firms (American International Group, Citigroup, Bank of America, Chrysler, General Motors, GMAC and Chrysler Financial). Feinberg bases his conclusions on the Public Interest Standard promulgated in the Interim Regulations published on June 15, 2009. We have divided the rulings into five guiding principles.   

Principle 1: Align compensation practices with long-term value creation and financial stability. As required by statute and regulations, executives must receive almost all cash bonuses in company stock that may be sold only over the long term. Similarly, these companies must restructure promised cash “guarantees” in 2009 to pay them out in company stock that also must be held long term. Feinberg concluded that cash bonuses and guaranteed payments encourage executives to take short-term risks at the expense of the company’s long-term health or financial stability.

Principle 2: Significantly reduce compensation across the board. Feinberg reduced compensation for all executives, in terms of both cash and total compensation. 

• Cash compensation decreased by more than 90 percent from 2008, on average, with the reduction concentrated in annual cash bonuses and cash guarantees.
• Cash salary is generally limited to $500,000, consistent with the administration's Feb. 4 guidance on executive compensation for TARP recipients. The Department of the Treasury did not apply this salary limit to other TARP recipients in its Interim Rules. Feinberg approved base salaries of more than $500,000 for only three executives. 
• Total compensation decreased by more than 50 percent from 2008 levels. Feinberg sought to set compensation at the 50th percentile based on benchmark data for comparable positions.
• Exceptions were made as necessary to retain key talent critical to a company's long-term success and, ultimately, ability to repay the Treasury.

Principle 3: Pay salary in company stock that is held over the long term. The bulk of salary should be paid in fully vested stock, requiring executives to put their own funds at stake for the majority of salary not paid immediately as cash. Feinberg believes this structure minimizes incentives to take excessive risks. “Salary stock” may be sold only in one-third installments, beginning in two years. Stock received as salary may be sold in one-third installments beginning in 2011 (unless the Treasury is repaid earlier).

Principle 4: Pay incentive compensation as long-term restricted stock. Feinberg believes incentive pay can be undermined by compensation practices that set the performance bar too low or simply reward rising tides. Thus, to receive incentive pay, executives must achieve goals set in consultation with the special master or “pay czar,” and their achievement must be certified by a compensation committee made up entirely of independent directors. Incentive awards cannot be paid until the employee has worked for three years after the award is made. And under Treasury regulations, awards must be paid in the form of restricted stock that may not be paid until the company repays its TARP obligations.

Principle 5: Reform those practices not aligned with shareholder interests. Feinberg’s rulings place tough new restrictions on the following pay practices:

• Feinberg caps perquisites and “other” compensation at $25,000, with limited exceptions for unusual circumstances, which must be justified (citing the Conference Board Task Force on Executive Compensation).
• The prohibition on golden parachutes or severance now applies to the five senior executive officers and the top 20 (formerly five) most highly compensated executives during 2009.
• Feinberg’s rulings conclude that supplemental retirement benefits should not be provided because of the wealth these executives can earn from performance-based compensation while they are employed. As a result, he has prohibited accruals under supplemental executive pension programs and company credits to other nonqualified deferred compensation plans.