Viewpoint: How Bailout Will Affect Executive Compensation

By Poerio, Mark | American Banker, October 10, 2008 | Go to article overview
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Viewpoint: How Bailout Will Affect Executive Compensation

Poerio, Mark, American Banker

Byline: Mark Poerio

The bailout legislation Congress passed last week aims an effective one-two-three punch at executive compensation.

Boards of financial institutions that participate in the bailout program will have to limit executive compensation in a manner that prevents the top five executives from receiving incentives to take "unnecessary and excessive risks that threaten the value of the financial institution during the period that the Secretary [of the Treasury] holds an equity or debt position."

Furthermore, these boards must reserve clawback rights against these executives for bonus and incentive compensation arising from financial results that are later proven to be materially inaccurate.

Finally, if the Treasury Department purchases more than $300 million of troubled assets, the legislation prohibits "any golden parachute payment" for the seller's top five officers during the period of the Treasury's investment, and it lowers the limit for allowable deductions for their compensation.

What should the executives of troubled financial institutions expect? In a nutshell, severance capped at three years' pay, and incentive pay and stock awards that vest only if there are years of future safe and sound performance by their employer.

Interestingly, neither of these outcomes is hard-wired into the bailout legislation. Its reference to "golden parachutes" goes undefined but probably anticipates the Code Section 280G limit of three times pay, though the severance could be even lower, because of the prohibition set forth under the Federal Deposit Insurance Corp. regulation that applies a one-year severance limit to executives of troubled institutions.

When it comes to incentive pay, annual bonuses will probably need to be de-emphasized. By nature, they depend on short-term operating results, and consequently they have the potential to encourage manipulation. These awards, if a focal point and substantial, could cross into the type of excessive risk-taking the bailout legislation forbids. Compensation committees and boards are likely to shift the emphasis for incentive compensation to long-term awards.

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