The current economic crisis has triggered heightened public and
governmental scrutiny of financial institutions with a view toward
exposing and regulating the practices and behaviors that triggered
the near collapse of the world banking system. For businesses that
are receiving U.S. government funding, executive compensation is
subject to particular public scrutiny and growing legal regulation.
However, the current climate has caused most American businesses to
rethink executive compensation and its effectiveness in achieving
organizational goals.
Executive compensation under TARP
Corporate recipients of federal funds under the Troubled Asset
Relief Program ("TARP") are subject to stringent laws affecting
executive compensation. For example, no golden parachute may be
paid to the top five most highly compensated unless the payment is
for services already performed or benefits accrued. Bonuses,
retention awards and incentive compensation (other than restricted
stock meeting certain requirements) are prohibited for covered
executives. TARP recipients are required to establish limits on
compensation to discourage inappropriate risk taking, and to claw
back any bonus, retention or incentive award to the top-paid 25 if
financial statements are materially inaccurate. In addition, each
TARP recipient is required to establish a compensation committee of
independent directors, establish company-wide policies limiting
excessive perquisites, and solicit nonbinding "say-on-pay"
shareholder votes to approve executive compensation. The tax
deduction on the deductibility of executive pay under Code §162(m)
is also limited to $500,000 for TARP recipients (as compared to $1
million for non-TARP public companies) with no exception for
performance-based compensation.
These rules became law under the Emergency Economic
Stabilization Act of 2008 ("EESA") and are widely viewed as an
impetus for more changes in executive compensation of public
companies.
Changes in practice
In the context of collapsing equity values, many features of
executive compensation are now being redesigned as a matter of
practice. Equity compensation, tax gross-ups and severance packages
for terminated executives in public companies are now particularly
subject to cutbacks and restructuring. Providing executives with
extra cash to pay excise taxes on golden parachutes, once a
negotiable point, for example, is now a nonstarter. Double triggers
(that is, requirements of both a change in control of the public
corporation plus the loss of the executive's job) are now becoming
standard pre-conditions for executive exit packages in public
companies.
Stock options, once a staple of executive compensation, are now
on the wane, in part because they subject executives to too little
downside risk and are thought to encourage too much inappropriate
risk taking by management to the detriment of the corporation.
Instead, equity compensation is being redesigned to give executives
a greater stake in both the long-term fortunes and misfortunes of
the corporation, and to reduce the amount of risk that short-term
equity compensation encourages executives to take.
As a result, performance-based, restricted shares are
increasingly replacing stock options. In addition, under many new
equity programs, vesting is triggered only if the company has both
increased value for its shareholders and performed well against its
peers.
Perquisites, such as country club memberships, company cars and
use of a private aircraft are subject to curtailment as well.
Similarly, long-term income and retirement programs for
executives of public corporations are being re-examined. Under
particular scrutiny are defined benefit retirement pay packages to
executives and death benefits to their families. These benefits are
expensive to fund and subject the corporation to market risk. They
also attract criticism, particularly if other employees' retirement
benefits are subject to market risks.
Also under scrutiny is the process by which public companies
determine executive compensation. It has been common, for example,
for boards of directors of public companies to be populated by
former CEOs and other insiders who have been lenient in setting and
increasing executive compensation. Congress, institutional
shareholders and public watchdog organizations have recently been
reviewing these practices with a view toward instituting structural
changes that add greater independence to the bodies overseeing
executive compensation. By replacing ex-CEOs and other insiders
with independent directors, and by requiring outside executive
compensation consultants on compensation committees, it is expected
that a greater balance of interests will inform the process of
setting executive compensation.
Possible law changes
At this writing, bills are now percolating in Congress which are
directed at regulating executive compensation of all public
companies. For example, one bill would require nonbinding
shareholder approval of executive compensation packages
("say-on-pay"). Other proposals of executive compensation in public
companies are aimed at further limiting the deductibility of
executive compensation; requiring clawbacks of compensation for
misstatements in financial reporting and other executive
malfeasance; requiring an independent outsider as chairman of the
board of directors; requiring the annual election of directors;
instituting risk committees on boards to monitor the behavior of
management, and prescribing by law the permitted ratio of executive
pay to the median pay of workers.
The current economic crisis has already proven itself a
watershed event. It is sure to be the triggering event of a host of
new regulations including changes designed to curb real and
perceived abuses affecting many executive compensation
programs.
The Author
Evelyn A. Haralampu is a partner
at Burns & Levinson LLP in Boston and heads its employee
benefits, executive compensation/ERISA practice. She speaks and
writes extensively on various ERISA, HIPAA, employee benefits,
executive compensation and tax-related matters. She is a
contributing author of the MCLE treatise, Massachusetts
Employment Law, and a recent panelist and author for the
Federal Tax Institute of New England.