Restricting CEOs' compensation packages through shareholders

THE news about ex-Merrill Lynch CEO John Thain's million-dollar office renovation or Citigroup's planned, then scuttled, purchase of a $42 million jet surprised investors as well as regulators. Now take a look at the compensation packages of top investment bankers for the year 2007: Lioyd Blankfein, Chairman and CEO of Goldman Sachs, got $68.5 million. Kenneth Lewis, CEO of Bank America, made $24.8 million. James Dimon, J.P. Morgan Chase's CEO got $27.8 million. Most surprisingly, Richard Fuld, CEO of "dead" Lehman Brothers, collected $480 million from Lehman in eight years before it went bankrupt. And, in 2008, firms in the Wall Street paid more than $18 billion in bonuses even amid the economic downturn.

President Obama says, "We believe success should be rewarded. But what gets people upset -- and rightfully so -- are executives being rewarded for failure, especially when those rewards are subsidized by US taxpayers." Thus, on February 04, 2009, President Barack Obama unveiled new rules on executive pay caps and expense disclosure. The plan, which represents the most aggressive assault on executive pay by federal officials, includes salary caps of $500,000 for top executives at firms that accept "extraordinary assistance" from the government. It also restricts severance packages, known as "golden parachutes," for dismissed executives and requires the disclosure of policies on luxury spending on things such as holiday parties, corporate jets and office renovations.

However, these rules do not apply retroactively, not even to those firms that have already been bailed out. But they will be imposed on all companies, for instance, financial, auto or other firms, receiving any future help. This includes those that have received assistance already. From a layman's perspective, President Obama's move was expected. One critic of high CEO bonuses says, "My view is that if a company takes taxpayer money, it's no longer a private enterprise and should absolutely be forced to live with the restrictions placed by the government".

What Wall Street did should be controlled doubtlessly. Using shareholders' money for luxury does not make sense. But isn't it a slap on the face of American version of free market concept? When the US is trying to sell this concept world wide, it even doesn't follow its own rule. Surely, Obama administration was under pressure to put a cap on CEO-related compensation packages. But a popular policy sometime might take the economy in the edge.

Who is the owner of a public listed firm? Yes, you are right: Shareholders. So, it must be the shareholders who should control CEO's compensation packages. Shareholders should be in the position to restrict packages, such as "golden parachutes," for dismissed executives and to require the disclosure of policies on luxury spending on things such as holiday parties, corporate jets and office renovations etc.

Unfortunately, shareholders can hardly restrict CEO compensation, luxury spending under the existing company law. Regulators, for instance, SEC or the Congress should find a way to empower shareholders so that they can participate effectively to control firm's unnecessary spending.

In a financial turmoil or in a recession leading to depression, government intervention in the market system becomes unavoidable. And, if we look back in the history, government intervention always prolonged the crisis even during the great depression in 1930s. The recent move by Obama administration will clearly work against market force. Private sector will surely respond negatively and won't feel safe from the government intervention which will lead to further deterioratation of the current situation. Banks are not lending anymore. So, there is indication of lack of faith in the market already, and government interference will give a wrong signal to the private sector. So, rather than getting involved directly, government should empower shareholders to cope with firm's greed traits.

1976's Nobel prize-winning economist Milton Friedman wrote, "the combination of economic and political power in the same hands is a sure recipe for tyranny." The US always had the political power. And, because of recent financial turmoil, economic power shifted from the private sector to the Obama administration, and looks like Friedman is right: the US started dictatorship in the market which surely not a wise move. This is the time to build some confidence in the market system which has evaporated about a year ago. However, dictatorship is much easier than building confidence, and choosing easier option won't lead any nation towards any "change".

*This article was published on the daily Financial Express in Bangladesh on February 15th, 2009.