If you're paying attention to the bank bailouts, you are probably familiar with the government-imposed provision that requires that companies receiving aid under the Troubled Assets Relief Program (TARP) limit annual salaries paid to top-five executives to $500,000 each. Any company wishing to compensate its executives above that ceiling must use restricted stock grants that vest only after the government is repaid. There are other conditions attached to the bailout funds, but CEO compensation is the biggest lightning rod for taxpayers - and who can blame them? In a January 29 press conference, President Obama described the bankers' pay in 2008 as "shameful". Personally I liked Joe Biden's line best.

"I'd like to throw these guys in the brig," he said in a January 29 interview with CNBC and The New York Times.

Who wouldn't? But a salary cap isn't the answer. (To learn more about shameful CEO practices, be sure to read Pages From The Bad CEO Playbook.)

IN PICTURES: 10 Biggest Losers In Finance

How We Got Here
In 1993, Congress introduced a $1 million cap on CEO salary deductibility, leading to the stock option mess we have today. According to the Conference Board's 2008 report on top executive compensation, 2007 saw a move away from cash compensation and toward performance-based stock compensation. Even with this change, two-thirds of the industries sampled for the report upped their cash payments to CEOs in the fiscal year. The big winner in all of this was insurance executives, who received a 34.4% increase.

I guess insurance pays after all.

The report goes on to suggest that the CEOs of the largest 10% of companies in the sample held stock and stock options worth 100 times their salaries. As I've said before, I'd be impressed with this figure if I knew these wonderful citizens borrowed funds to buy the stock on the open market. Sadly, we know this isn't the case.

Cap? What Cap?
If I were a higher-up in a leading financial institution today, I'd be licking my chops at the opportunity to take the helm at a bank turnaround. The upside potential of larger-than-normal performance-based stock option packages is astronomical. A $500,000 salary cap isn't much of a deterrent when the opportunity exists to make one of the biggest financial scores in banking history. I can't see how you could turn down an offer, knowing your employment agreement will be laced with stock options and grants to make up for the lack of salary. Sure, you'll have to wait until the job is successfully completed, but isn't that always the case? All a banker needs to do is right the ship and the pot of gold is his.

To illustrate why the salary cap makes little sense, I'll examine five companies (2007 fiscal year) with similar revenues, all operating consumer goods businesses. I think you'll find the way in which CEOs are paid today provides bankers little doubt they'll receive more than enough compensation down the road. So where's the downside? Anyone capable of running a major bank has surely amassed enough wealth to get by on $500,000 for a couple of years. This piece of the bailout sounds good but changes little.

CEO Compensation – 2007 Fiscal Year

Company Revenue Growth Pretax Income Growth Stock Appreciation Total Comp. % Long-Term Comp.
Treehouse Foods
70.4% (7.6%) (26.3%) $5.32M 84.6%
Carter\'s Inc.
7.7% (120%) (24.1%) $1.30M 23.1%
(12.5%) (62.1%) (42.7%) $4.17M 70%
Wolverine World Wide
9.1% 13.3% (12.7%) $2.87M 59.9%
Hansen Natural
49.3% 47.8% 31.5% $2.69M 78.1%

Bottom Line
With the exception of Carter's, each of the above companies provided its CEO with more than half his or her total annual compensation in the form of long-term performance incentives, including cash, stock options, stock grants and restricted stock units. Because of the $1 million deductibility limit set by the Treasury, companies have little choice but to back-end executive pay. For shareholders sake, I hope they revisit this. In the end, it's doing more harm than good.

Related Articles
  1. Investing Basics

    What Does Plain Vanilla Mean?

    Plain vanilla is a term used in investing to describe the most basic types of financial instruments.
  2. Stock Analysis

    5 Cheap Dividend Stocks for a Bear Market

    Here are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
  3. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  4. Options & Futures

    Pick 401(k) Assets Like A Pro

    Professionals choose the options available to you in your plan, making your decisions easier.
  5. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  6. Stock Analysis

    2 Oil Stocks to Buy Right Now (PSX,TSO)

    Can these two oil stocks buck the trend?
  7. Investing News

    What Alcoa’s (AA) Breakup Means for Investors

    Alcoa plans to split into two companies. Is this a bullish catalyst for investors?
  8. Stock Analysis

    Top 3 Stocks for the Coming Holiday Season

    If you want to buck the bear market trend by going long on consumer stocks, these three might be your best bets.
  9. Investing News

    Could a Rate Hike Send Stocks Higher?

    A rate hike would certainly alter the investment scene, but would it be for the better or worse?
  10. Investing News

    Corporate Bonds or Stocks: Which is Better Now?

    With market volatility high, you may think it is time to run for corporate bonds instead of stocks. Before you do take a deeper look into which is better.
  1. Do financial advisors need to meet quotas?

    Most financial advisors are required to meet quotas, particularly if they work for firms that pay base salaries or draws ... Read Full Answer >>
  2. Can mutual funds invest in options and futures?

    Mutual funds invest in not only stocks and fixed-income securities but also options and futures. There exists a separate ... Read Full Answer >>
  3. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  4. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  5. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  6. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!