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What the Government May Demand in Return for Its Aid

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Friday, February 6, 2009

PRESIDENT Obama was undoubtedly speaking from the heart Wednesday when he unveiled new limits on executive compensation for financial companies that receive federal bailouts. "What gets people upset -- and rightfully so -- are executives being rewarded for failure, especially when those rewards are subsidized by U.S. taxpayers," he declared. Like him, we believe that government generally has no business dictating what banks can pay their executives -- but that when the banks are surviving on taxpayer money, the government is entitled to more of a say. This is a matter of fairness and political necessity. The president and his economic team are about to unveil a plan to channel additional hundreds of billions of public dollars into the banks. Ultimately, the public stands to benefit. But the plan won't fly with Congress or the public unless Mr. Obama very visibly extracts some sacrifices from Wall Street first.

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The countervailing consideration is that restrictions on executive pay will make it harder for banks to attract and retain talent at a time when they need it more than ever. From the text of Mr. Obama's proposal, it appears that he took such concerns into account. The toughest rule -- a cap of $500,000 on total annual pay, plus restricted stock awards that vest when the government has been paid back -- applies only to senior executives at the handful of firms, such as Citigroup, Bank of America and AIG, that have received "extraordinary help," and then only prospectively. Other companies could get waivers of the rules in return for full disclosure and, in some cases, a nonbinding shareholder vote.

No one should confuse this emergency package with a long-term solution to the broader issue of executive compensation. Many, including Mr. Obama, have suggested that executive pay incentives deserve part of the blame for the current economic crisis in that the incentives allegedly encouraged short-term thinking and excessive risk-taking. Perhaps they did. But if the rules are dysfunctional, it should be remembered that they grew out of past governmental attempts at reform. A 1993 law, urged by President Bill Clinton, limited the deductibility of executive salaries to $1 million -- except for "performance-based" pay linked to supposedly objective factors. As a result, companies paid chief executives in non-cash perks, stock options and bonuses linked to short-term corporate earnings.

The lesson: Like more prosaic kinds of wage controls, government regulation of executive compensation can lead to market distortions and unintended negative consequences. In the current emergency, such concerns necessarily take second place. But when the Obama administration turns to the long-term solution that he also promised this week, they will have to be squarely addressed.

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