Better Compensation Restraints For Bailout Firms

Over on the Correspondents page, Richard A. Posner has a post about his take on Goldman's huge 2009 bonus pool. The following excerpt got me thinking:

So the argument goes: Without government aid then, no $20 billion-plus in bonuses for Goldman Sachs's employees in 2009? Maybe zero in bonuses, maybe indeed, no Goldman Sachs at all. Against that background, the bonuses seem egregious. It seems that the government drove a bad bargain when it bailed out Goldman, that it should have demanded a big chunk of Goldman's future profits.

How might the government have done better?

Restraints Should Be In Effect Through Year's End

I think the central problem here is that many people (correctly) perceive that Goldman's great year was due in large part to the government having saved them. They have paid back all their bailout cash, but retained much of it well into 2009. Is it fair that they can now pay themselves all of the profit resulting from the government propping them up?

Well, according to the law, yes, it's perfectly fair. Once you've paid the government back, it has no say on your business. But maybe the government should have structured its compensation restraints differently.

What if firms having accepted government assistance had to follow the government's compensation limits through the end of the year when the firm paid back its bailout money? In that case, Goldman, JP Morgan and others would still be under the close watch of President Obama's compensation czar until 2010. That would have been a more logical outcome, since a fair portion of 2009's success occurred while Goldman was still flush will bailout cash.

One of the problems with bailouts is that a company's survival is owed to the government. So even in 2010, when Goldman held no government money for the entire year, people could still complain that the firm wouldn't exist if it wasn't bailed out in 2008. But at some point, you need to concede that if you're willing to bailout a company, then you have to let it go back to business as usual eventually.

Where I object, however, is allowing it to go back to business as usual during a year when it still held bailout cash. If some of the profits that became a portion of its annual bonuses were made while holding government money, then the government should still have a say in how those profits are distributed.

Where Does The Cut Compensation Go?

I also have a completely separate question that was triggered by thinking about government compensation restraints. Yesterday, I noted that the pay czar decreased the compensation of executives at bailout firms by around 50%. What happens to the money that was supposed to be awarded to these executives? Presumably, the firm still holds onto it -- but what does it do with it? I'd imagine it's a case-by-case basis.

But what should happen to that money? If the company just puts the cash aside, it could simply pay that money out to those same executives a year later, after the government's loses control. That doesn't seem okay, as it essentially sidesteps the spirit of the compensation restraints.

This is also something that should have been considered in setting pay guidelines. In the case of Goldman Sachs, for example, even if its bonuses were still under government control, it could just hold back the denied compensation until it was allowed to pay it out at its own discretion. That could be happening now with firms like Citigroup, Bank of America, GM and Chrysler.