How Not To Curb Executive Pay

The Wall Street Journal has an article out about the latest dilemma for the Obama administration's pay czar, Kenneth Feinberg. He's faced with the problem of limiting executive pay for employees at firms that received a bailout -- without nullifying contracts. It won't be easy.

The WSJ says:

Mr. Feinberg can't rip up legal contracts. But he is expected to push firms and employees to renegotiate payments he deems too high, said people familiar with the Treasury's plans. If that can't be done, they said, Mr. Feinberg is expected to factor the amount of a contract into an employee's overall pay and use that calculation to bring down total compensation. For instance, if an employee were legally guaranteed a $1 million bonus for 2009, Mr. Feinberg might subtract that amount from the employee's 2009 base salary, or cut the employee's future pay to compensate for that amount.

If you had signed a contract to be guaranteed a certain amount of money, would you be so quick to abandon that contract? I doubt many will. I think that's especially true for bankers guaranteed large pay packages in groups that had nothing to do with the financial crisis, such as mergers and acquisitions. They'll just argue that it wasn't their fault. Should they be penalized for the stupid/negligent/evil actions of others? (Vote below!)

Let's think about the alternative that Feinberg may take -- reducing salary or future pay. Here's an example from the article of one pay promise that Feinberg might find particularly troublesome involving Citigroup energy trader Andrew Hall:

It is unclear how Mr. Feinberg would rule on Mr. Hall's case. Citigroup hasn't yet submitted his or any other employee's compensation package for review. If Mr. Feinberg deems Mr. Hall's pay excessive, he would likely try to get Citigroup to lower the amount. If that isn't possible, Mr. Feinberg might apply that $100 million towards Mr. Hall's future earnings.

In this case, his salary certainly wouldn't help much; indeed, it wouldn't help much for many investment bankers. At the level where bankers are getting bonuses that exceed $1 million their salary is a small fraction of that amount. I wonder how long it might take for Feinberg to take a large quantity like $100 million out of future pay. After all, that's a lot of money to garnish from future bonuses in an economic climate where bonuses are already very likely to be much lower than in previous years for struggling bailout firms.

Additionally, why would an employee allow it? Let's imagine that for the next two years Hall would have received bonuses of $25 million and $50 million three years from now. That means his bonus would be approximately zero for the next three years if Feinberg has his way. You're Hall, and you've just been paid your $100 million under those conditions. What do you do the next day? I mean after the lavish party. Obviously, you quit Citigroup and join a firm where you will be paid more for the next three years. To earn that kind of a bonus, he must be a pretty talented trader, so people like him shouldn't have much trouble running to a Goldman, JP Morgan, Credit Suisse, Deutsche Bank or any other firm that Obama's pay czar has no control over.

The result, of course, would be that this strategy would prove effective at only one thing: insuring that talent is driven away as soon as those gigantic bonuses are paid out. That means, not only will these bankers still get their big bonuses, but they'll also still flee the bailout banks. If that happens, this plan would have a negative effect without the intended outcome.