Pay Czar Slashing Salaries

I've written several times about the reign of President Obama's Pay Czar, Kenneth Feinberg. He has the rather difficult job of attempting to quell the anger of the masses in cutting pay for employees at firms having received bailout money, without damaging their competitiveness. It probably isn't possible, but it's fun to watch him try. His latest move, reported by the Wall Street Journal, is arguably his most controversial to date. He intends to cut salaries, replacing a portion with deferred stock awards.

Here's the WSJ's explanation:

Instead of awarding large cash salaries, Kenneth Feinberg is planning to shift a chunk of an employee's annual salary into stock that cannot be accessed for several years, these people said. Such a move, the most intrusive yet into corporate compensation, would mark the government's first effort to curb the take-home pay of everyone from auto executives to financial traders.

This matters if you think about how a responsible banker should spend his/her money. For example, let's say you're a vice president with a salary of $150,000 and an expected bonus each year of around $400,000 (numbers not far from reality). In theory, you never know what that bonus is going to be. It could be zero. To live responsibly, you should budget your money not expecting a lofty bonus, but essentially live off your salary and/or past bonuses.

For example, your rent or mortgage should ideally be able to be paid even in a bad year when you get a bonus of zero. But if you start messing with people's salaries, then you begin altering one's very bare bones expectations. This goes beyond fewer dinners at Masa: suddenly you might have trouble paying your bills.

Let me try to make this something the average American can relate to. Let's say you are a manager at Wal-mart and earn $60,000 per year. Imagine if Wal-mart has trouble and gets a government bailout. The pay czar then steps in and says that your pay will be $40,000 for the next two years, with the other $20,000 in stock that you can't cash out until the end of that period. That would probably screw up your budgeting and finances.

I'm not really attempting to drum up sympathy for the bankers who will get these pay cuts. Clearly, unless they lived extremely foolishly, they should still have an awful lot more savings to fall back on for the next few years than the average American. But what's more important is the effect this will have on the bailout firms' ability to retain employees. It's one thing to tell them that their bonus will be reduced or eliminated. But now you're reaching into their salary. That adds a whole new dimension to the motivation to flee to another firm.

The magnitude to which those salaries might be affected is also notable:

It's not clear what portion of an employee's salary will be diverted to stock but a person familiar with the matter said that in some cases it could be more than 50%. Indeed, Mr. Feinberg employed this strategy in his Oct. 2 ruling on pay for Robert Benmosche, the new chief executive of AIG. Mr. Benmosche's salary was broken into two pieces -- a $3 million annual cash salary and $4 million annually in AIG stock that cannot be accessed for five years.

This is an extreme example, but anything near 50% is a huge cut. Not all of those affected by the new constraints will have $7 million salaries. In fact, as a rule in banking, very few have salaries that exceed a few hundred thousand. At least, that was true historically.

I almost wonder if this move is a response to investment banks choosing to boost their salaries. Ever since Congress and the general public had a problem with their lofty bonuses, some banks began shifting the compensation mix towards higher salaries. I wrote about Citi playing this game and how it might backfire. Maybe that's what we're seeing here. Perhaps in order to keep compensation in a range that he deems reasonable, due to this change in pay style, Feinberg has no choice but to attack salaries.