How Will the Bailout Bill's CEO Comp Provision Play Out?

The $700 billion bailout package approved by Congress carries executive compensation limits for executives of the companies that benefit from the Treasury's program, and that is sparking debate among compensation experts. But the words of individuals who say that there's no direct link between CEO compensation and failure of firms involved in the bailout may fall on deaf ears as the public watches television coverage of a House oversight committee investigating the causes of the Lehman Brothers bankruptcy. Legislators are grilling former Lehman Chairman and CEO Richard Fuld about the hundreds of millions of dollars in incentive compensation that he took home since 2000.

In a nutshell, according to a Grant Thornton report, under the approved bill, "institutions that sell assets to Treasury outside of the bidding process must meet executive compensation standards that will prohibit golden parachute payments and take back bonuses and incentives paid based on materially inaccurate earnings statements. Participants in Treasury auctions who sell at least $300 million in assets will be subject to a different set of rules. These will limit the deductibility of executive compensation over $500,000, including performance pay, for covered executives. Golden parachutes will be completely prohibited for covered executives in the case of bankruptcy, insolvency, or receivership of the financial institutions."

However, sources interviewed by The Wall Street Journal say that because of vague language in the bailout bill that would bar incentives for "unnecessary and excessive risks," curbing executive pay may be easier said than done; the law doesn't specify how to determine what constitutes unnecessary and excessive risk.

Compensation experts and corporate directors are exploring ideas for achieving the results that the law intends through tools including deferred bonus arrangements, which tie pay to long-term results through various methods, such as by delaying payment for several years to ensure that performance results stick. But deferred bonus programs have a reputation for being hard to administer and legal challenges have arisen, such as a case this year in Ireland, the Davy case. A PricewaterhouseCoopers report explains that the legal challenges of that case include the fact that such awards are forfeited under most circumstances if the employee leaves the company and that the deferred awards could be construed by a court as a "restraint on trade" by penalizing the employee with the loss of the award if he or she leaves to join a competitor.