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.refl ects the current and/or prospective contributions of the executive." Automatic approval if total compensation for one executive is not more than$500,000 (with any additional compensation paid only in the form of long-term restricted stock in the amount of 1/3 of total annual compensation). Limiting Executive Compensation and Improving Boards 275More generally, Treasury Secretary Geithner announced five princi-ples for executive compensation at all publicly traded companies.Theseprinciples sensibly articulate functional guidelines, rather than rigidstandards for such companies: 271.Compensation should properly measure and reward performance.2.Compensation should be structured to account for the time hori-zon of risk.3.Compensation practices should be aligned with sound riskmanagement.4.Golden parachutes and supplemental retirement plans should be re-examined to determine whether they align the interests of execu-tives and shareholders.5.The process of setting compensation should promote transparencyand accountability.Accountable Capitalism and ExecutiveCompensationMany commentators predict that the combination of legislative andTreasury curbs on executive compensation will drive talented employ-ees out of banks receiving financial assistance.In combination, theserestrictions imply that many top executives of the country s largestbanks receiving federal aid are not likely to receive annual compensa-tion more than $500,000 in cash, plus $250,000 in restricted shares thatwould fully vest if and when the bank repaid all its federal assistance.Inaddition, the top executives could not receive any severance payments ifthey lost their job because of a hostile takeover of the bank or a debateabout bank strategy, despite strong performance.If you were a talentedexecutive vice president of a large bank who earned an average of $1.5million per year ($500,000 in base pay and $1 million in performancepay), would you accept these restrictions that would result in a 50 per-cent pay cut, or would you fi nd a job in another financial institutionnot receiving federal assistance and, therefore, not subject to such payrestrictions? Alternatively, would you take your group from the bankand form a new company that would perform similar functions for 276 t oo bi g t o s a ve ?the bank and other financial institutions without these restrictions onexecutive compensation?These questions illustrate the inherent limitations of any broad-based prohibitions on executive compensation.As shown by the priordiscussion on the impact of the two tax code revisions during the1980s and 1990s, lawyers are ingenious in circumventing these restric-tions, so the restrictions are rarely effective and sometimes are counter-productive.To avoid the statutory restrictions on executive bonuses, forexample, Wells Fargo raised the base salary of its CEO from $900,000to $5.6 million for the next year.Other banks are granting multimil-lion-dollar signing bonuses, because the bonus restrictions apply onlyto the highest paid bank executives in the prior year.28Moreover, the multiple rounds of federal restrictions on executivecompensation have undermined significant aspects of the government sefforts to clean up the banks.Because of these restrictions, some firmshave decided not to participate in the private-public partnerships tobuy toxic assets from banks (see Chapter 10).Although the TreasuryDepartment announced that the executive compensation restrictions donot apply to these partnerships, potential participants fear that Congresswill later pass retroactive legislation limiting or taxing their profits onthese partnerships.29In theory, a regulatory authority should articulate a set of compen-sation objectives that would be applied to a fi nancial institution by aboard of directors with extensive knowledge of that institution.In prac-tice, the boards of directors of large mega banks have generally done apoor job of establishing a compensation system for senior executives.The Sarbanes-Oxley Act increased the percentage of independentdirectors on boards, who now follow much more elaborate proce-dures in running their board committees.But the procedural approachembedded in SOX was ineffective in many instances.Although theboards at Merrill Lynch and Lehman Brothers were composed of over90 percent independent directors, they did not appear to have fullycomprehended the excessive risk taking by the bank s senior executives,and they rewarded these executives with huge bonuses.While I believe that executive compensation packages are bestcustomized for each financial institution by its board of directors, from myexperience I have developed a set of principles that would provide useful Limiting Executive Compensation and Improving Boards 277guidance on compensation for senior executives at large financial institu-tions.These principles are based on the realistic premise that top financialexecutives have job opportunities in many types of financial firms, whichthemselves can be located in various countries.These principles, designedto promote accountable capitalism, fall into three main categories:1.Base salary and bonus2.Stock-related awards3.Termination-deferral issuesBase Salary and Bonus1.Keep Base Salaries Low: Financial institutions should alwayskeep base salaries of senior executives as low as practical, with thebulk of the annual cash payment comprising a bonus based onperformance.Specifi cally, try to keep the salaries of the highest-paid executives and investment experts no higher than $300,000$400,000 per year.That salary is sufficient to support the monthlyneeds of any family, while allowing for a wide range of bonusesdependent upon performance.There is no need for most CEOs toreceive base salaries of more than $1 million in addition to theirnormal pension and health benefits.2.Extend the Period for Measuring Performance: Bonuses shouldbe based on performance over a period of three years, rather than juston the past year (with appropriate exceptions for new employees andthose on leave).If we want financial institutions to take a longer-termperspective, we need to expand the time horizon for determiningbonuses.However, financial markets move quickly, so a horizon offive to ten years is an eternity
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