Outrage over Outsized Executive Compensation: Who Should Fix It and How? - Wharton School of Busniess - 18 Feb 2009

Outrage over Outsized Executive Compensation: Who Should Fix It and How?

The
contrast is jarring. As thousands of Americans lose their jobs,
headlines are focused on excessive executive compensation and lavish
perks -- John Thain's $1.2 million redo of his executive suite at
Merrill Lynch (since repaid), Citigroup's plan to buy a new corporate
jet (since scrapped), and recent subpoenas to claw back bonuses handed
out at Merrill Lynch.

"It is shameful," President Obama said in the end of January in
reaction to a report that New York financial executives took in $18.4
billion in bonuses while the banking system was receiving billions in a
taxpayer-funded bailout. The people on Wall Street "who are asking for
help [need] to show some restraint, discipline and ... sense of
responsibility," Obama stated. Separately, vice president Joseph Biden
offered his take: "I'd like to throw these guys in the brig."

No one has been locked up, but on February 4, the president
announced a set of executive compensation limits aimed mainly at firms
that are the recipients of federal aid under the Troubled Asset Relief
Program (TARP). The rules place a $500,000 cap on salaries. Any
additional compensation will have to be in the form of restricted stock
grants that will not vest until after taxpayers are repaid. In
addition, all banks must accept new limits on golden parachutes,
requirements that shareholders be able to review and vote on
compensation packages (the vote would be non-binding), and tougher
disclosure rules for spending on travel, office renovations and
entertainment.

The new rules will not be applied retroactively to companies that
have already received TARP funds. Such firms must show that  they
complied with existing rules and agree to strict oversight.

Wharton faculty aren't surprised that the harsh economic climate and
resurgent role of government in business has turned a spotlight on
compensation. Whether the bonuses are justified or not, they say,
executives cannot afford to remain tone-deaf about the appearance of
large pay packages and perks at a time when taxpayers are being asked
to finance banks and corporations while their own savings shrink and
their jobs are at risk.

Before the new rules were announced, Wharton accounting professor Wayne Guay,
who has done research on executive compensation, saidit is likely that
the government, under the leadership of President Obama and a
Democratic-controlled Congress, will attempt to limit executive pay.
"It feels like something the public wants."

According to Guay, government programs that awarded billions in
emergency financing to firms make the public and Washington feel
entitled to attach strings, including limits on executive compensation.
Even before President Obama laid out the new rules this week, TARP
recipients faced limits on compensation, including prohibitions against
pay based on excessive risk, clawbacks for compensation paid based on
inaccurate earnings or other measures, a ban on golden parachutes, and
capping tax deductions for executive compensation at $500,000. Treasury
Secretary Timothy Geithner had said he would consider extending some of
the TARP provisions, including the $500,000 deduction cap, to all U.S.
companies.

Guay said furthercurbs on compensation might be justified if
proponents can prove that high pay packages contributed to the current
economic crisis. Given the global nature of the economic meltdown,
however, he suggested that the cause of the collapse was not supersized
U.S. executive compensation. "We don't have a massive corporate
governance breakdown in terms of ... executive compensation." At the
same time, "there are a lot of public relations issues floating around.
Many companies have come forward needing assistance, and they can't
afford to be giving the public a feeling that they're being excessive
in any way, shape or form."

Wharton finance professor Franklin Allen
sees little need to pay financial executives rich bonuses at a time
when the industry is shedding thousands of jobs. "Obama has roundly
criticized the high bonuses in Wall Street firms. I think this will
play for some time to come," Allen noted. "It is ridiculous that these
firms should take hundreds of billions of dollars from the government
and at the same time pay out $18 billion in bonuses."

'Self-serving Comparisons'

Wharton management professor Peter Cappelli
cited a number of explanations for the apparent disconnect between what
executives seem to feel they deserve and how the public perceives their
pay.

During the past decade, for example, CEO compensation has been going
up at twice the rate of overall pay. As a result, CEOs and other top
executives see these historically high rates as

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