Reactions to Bebchuk on the Administration’s Compensation Guidelines

The Administration’s compensation guidelines are available here, and a valuable outline of the guidelines by Davis Polk & Wardwell is available here.

In response to Lucian Bebchuk’s post from yesterday, Bernard Sharfman writes:

I also agree that the proposed salary caps are mainly symbolic. In 2008, Wall Street paid out $18.4 billion in bonuses to its approximately 164K plus employees. Based on this data and the limited number of firms and number of employees (5 per firm) the pay caps could apply to, I would say that 99.9% of Wall Street employees are safe from the wrath of the proposal. If you want to reduce large company wide bonus payouts in bad years, which I believe was the original intent of these proposed guidelines, that is not the way to do it. However, the real significance of the proposal may be as an implied threat to Wall Street to get its compensation act together or else face something real later on.

For a recently posted paper on how corporate law should respond to Wall Street compensation policies, see Bernard S. Sharfman, “Enhanced Duties for Excessively Risky Decisions.”

Another reaction has come from David Wilson, who writes:

A symbolic $500k salary cap may have unintended consequences. As Mr. Bebchuk points out, firms are still “free to make up for this reduction” with other forms of compensation. Because of this, the cap will alter the form in which executives are paid. Executives will require higher levels of incentive-based compensation to make up for the reduction in their “guaranteed” cash salaries.

Further, a dollar of incentive-based compensation is worth less than a dollar in cash. A CEO who sees his salary cut from $2m to $0.5m will not be in the same financial position if he receives an additional $1.5m in incentive-based pay. Michael Jensen, Kevin Murphy and Eric Wruck point this out in their 2004 paper “Remuneration: Where We’ve Been, How We Got to Here, What are the Problems, and How to Fix Them” ), in which they state “[r]isk-averse executives will ‘charge’ for bearing risk by discounting the value of the risky elements of pay.” If this is true, we can expect to see significant increases in equity-based incentives.

As Mr. Bebchuk points out, a myriad of issues that need to be addressed surround the use of equity incentives.

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