Yesterday's double shot of action on corporate pay practices was designed to demonstrate to Main Street that Washington is serious about excessive pay practices on Wall Street. If so, the Treasury's Special Master for Compensation and the Federal Reserve accomplished their mission--lots of publicity, and headlines trumpeting dramatic pay slashes.
The reality is far more nuanced, and complex. As pointed out here, banks like Goldman Sachs and Morgan Stanley have largely amended their compensation practices to reflect contemporary best practices--less pay in the form of cash, long term stock vesting, and potential claw backs. In fact, prior to being acquired by Bank of America, Merrill Lynch's compensation program contained many of these leading practices as well.
Much has been said about the statutory authority placed on Mr. Feinberg's ability to influence compensation practices beyond the small universe of executives over which he has direct jurisdiction. Given the hand that he was dealt, Mr. Feinberg probably did as much as he could--and there is little doubt that his actions will have a degree of influence beyond those directly effected.
More problematic is the action taken by the Federal Reserve in its Proposed Incentive Compensation Guidance. By rejecting a "one-size fits all" approach the Fed correctly reasoned that hard and fast standards, pay caps and the like will hinder, not help the underlying problem of rewarding excessive risk taking. However, by issuing guidance which is so high level, and without meaningful detail, it is impossible to measure or assess how the Fed will do its job going forward. For example, the rubric of compatibility of compensation with risk management and controls, strong corporate governance, and a balanced view of risk and reward are fine standards. No doubt the banks at whom this guidance was aimed will claim adherence to much, if not all of it already, without the need for additional changes to their current practices.
Further, by moving its review of compensation into the supervisory arena, via a "special horizontal review" of the largest complex banking organizations, and through the normal way examination process for all others, the Fed has removed much needed transparency from the process. How will shareholders assess compensation details if cloaked in the secrecy of Federal Reserve examinations? The Fed is so notoriously secretive about the contents of its examination reports provided to banks, many institutions keep the reports literally under lock and key in secure file cabinets. Third parties desiring access to Fed examination reports need special dispensation to review their contents. So we have a system where the real action, the deals and the horse trading will take place beyond the line of sight of the Board and shareholders. Boards will be looking over their shoulders at what the Fed may or may not do while shareholders will be hard pressed to have meaningful input into the process except after the fact.
Finally, and maybe most interesting of all, the Fed guidance contains several sentences which go to the heart of the tension between shareholder primacy and corporate governance on the one hand, and prudential regulation and government intrusion on the other. In its introduction, the Fed notes "[s]hareholders have an interest in ensuring that incentive compensation arrangements do not encourage employees to take risks beyond the risk tolerance of shareholders." So far so good.
But then again, in the Fed's words: " [a]ligning the interests of shareholders and employees, however, is not always sufficient to protect the safety and soundness of a banking organization...shareholders...may be willing to tolerate a degree of risk that is inconsistent with...safety and soundness. Thus, a review of incentive compensation arrangements and related corporate governance practices to ensure they are effective from the standpoint of shareholders is not sufficient...."
And therein lies the issue. Granted, the FDIC safety net has correctly and historically been viewed as placing banks in a special category of American businesses. The more troubling question is, given the government's involvement in all types of business (automobiles, health care?), will any sector be safe from this line of reasoning? Is there any room for boards of directors in compensation at all? Where do shareholders fit into the puzzle? In the long run, the aftermath of the financial crisis may be a dramatic, and irreversible distortion of the balanced federal-state system of corporate governance which relies on shareholder interests overseen by independent boards subject to open, fair elections.
