Bank CEO Salary Cap Sucks

By Will Ashworth | February 09, 2009 AAA

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
(NYSE:THS)
70.4% (7.6%) (26.3%) $5.32M 84.6%
Carter\'s Inc.
(NYSE:CRI)
7.7% (120%) (24.1%) $1.30M 23.1%
Timberland
(NYSE:TBL)
(12.5%) (62.1%) (42.7%) $4.17M 70%
Wolverine World Wide
(NYSE:WWW)
9.1% 13.3% (12.7%) $2.87M 59.9%
Hansen Natural
(Nasdaq:HANS)
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.

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