Dodd's Desperation: His Executive Compensation Limitation Amendment

If financial institutions are taking federal funds under TARP, the government should have some say in how much they executives get paid, right? It's only fair.

That is the knee-jerk reaction of many people, and it is understandable to some extent as a gut feeling, but Chris Dodd is one of the few in government who thinks this is actually a good idea in the long run.

Dodd added an amendment, over strenuous objections from the Obama Administration, to the Democrats socialist spending plan that goes much further than the restrictions Obama/Geithner/Summers imposed, and will likely cause far more problems than they solve (see Dodd's plan for increasing minority home ownership that has crashed our economy for another example).

From the Harvard Business Review Blog, Obama's restrictions were as follows:

Hard caps ($500,000 in pay plus restricted stock that only vested when TARP money was paid back) applied just to companies who did "exceptional" deals with the government--but only prospectively. The initiative didn't apply to past special deals with AIG, Citi and Bank of America.

Soft caps applied, in the future, to all other TARP companies (those receiving "general" assistance with the same terms for all recipients). A similar $500,000 pay cap plus restricted stock with delayed vesting could be waived if the "general" TARP company does three things: Discloses compensation for senior executives; shows how the comp strategy encourages sound risk management; and puts the comp plan to a "say for pay" shareholder vote (which was coming this year in the financial services sector anyway).

The Administration hoped that companies would take these procedural prompts seriously and produce a variety of plans which would then be analyzed further to see if more regulation was needed to align compensation with proper risk management and long-term value and growth. It sensibly envisioned a public dialogue on this tough issue, not hard and fast rules now.

Well, that wasn't good enough for Dodd, who had to do something to deal with poll numbers that show his support vanishing faster than the questionable mortgage records he let reporters peek at earlier this month. So he adds this (again from HBRB):

In Dodd's amendment, TARP companies that receive more than $500 million are prohibited from giving the top five officers and 20 most highly paid employees (e.g. traders) a bonus of more than one-third of total annual compensation--and that bonus must be in restricted stock which doesn't vest until the government is repaid.

This rule applies to companies that have already received funds, not just to those that may in the future. Although it doesn't set a flat cap on salary, the cap on bonuses at one-third of total compensation is a flat rule. (The rule applies to fewer officers/employees if companies receive less than $500 million).

The numerous problems with Dodd's plan are being pointed out all over the place. For instance, the Chicago Tribune's Washington Bureau blog:

As sources quoted by the NYT and others say, one unintended consequence is that financial institutions will just raise the salaries to offset the limits on bonuses.

Another is the risk of a brain drain at the very time when the financial industry and the economy can least afford it.

Yet another possibility is that the financial institutions will repay the federal money they received sooner than they would have otherwise to get out from under the restrictions.

There's a requirement in the Troubled Asset Relief Program that if a bank repays the government it must then raise replacement capital in the private markets. Banks may just decide to go that route at greater expense and risk to themselves.

Then there's always the chance that banks that could use the cash to strengthen their balance sheets will forgo it altogether or wait until they are forced by federal regulators to take federal money.

Fearing any and all of these possibilities, the Obama Administration opposed Dodd's limits. Yet Dodd insisted on them.

From the New York Times:

So what? Goldman and 349 other banks have taken cheap loans from taxpayers. It’s only right that some limits should be imposed. The problem is that the restrictions work against the logical, capitalistic idea of offering incentives for workers to do a good job.

The goal of compensation reform should be to ensure that pay is more closely linked to performance, not less so as the stimulus bill’s provisions would require. Under the new rules, banks will have every incentive to increase salaries across the board to remain competitive with banks at home and abroad that aren’t subject to the restrictions, like Credit Suisse, Barclays, Deutsche Bank or UBS.

That would destroy one good thing about Wall Street — its flexible cost structure. By paying relatively low salaries, investment banks have historically adjusted pay according to earnings and economic circumstances.

The Harvard Business Review Blog concluded:

Questions remain about the amendment (does it apply to '08 bonuses?), but it's clearly more rigid and draconian than the Administration initiative. Critics have already argued that it encourages companies to set annual salaries too high and does nothing to relate compensation to longer-term performance (a critical goal). Critics also speculate it could start an exodus of talent from TARP companies, right when talent (including new faces not responsible for past transgressions) is needed most. Lastly, Dodd's plan may also force fast paybacks to the government when there are better uses of capital in a crisis.

[snip]

In sum, the Dodd Amendment will feed the populist impulse but, as a policy matter, may well impair efforts to fix the financial sector, unless the Administration can work out some future modification.

From The Day:

Administration officials also said they were worried Dodd's plan would still allow multimillion dollar paychecks, just not structured as bonuses...Dodd's plan provides no limit to base salary pay, which typically is relatively small but supplemented with gigantic bonuses.

From Politico:

Administration officials were at the forefront of some heavy lobbying against [Dodd's proposals], arguing that they could encourage executives to leave for much higher-paying jobs at firms that hadn't received government funds, and ultimately slow the flow of credit by creating an incentive for banks to repay bailout funds before they have enough capital of their own with which to provide loans.

Another downside, this one for Dodd, is that he is at the top of the list when it comes to campaign donations from the very people whose income he is restricting. Either Dodd truly does not understand the downside to his plan that everyone else seems to grasp, or he has calculated that he needs to gain votes from the "regular Joes" who believe him when he says this is a good idea, even if it means upsetting his big donors.

Take your choice: Chris Dodd is either too unintelligent to be our senator (which I don't believe) or he is a political panderer of the worst kind, willing to put the country at continued and greater economic risk for the votes of the people he has misled.

Either way, it is time for him to go.