Government Freezes CEOs' Pay, And Why That's A Good Thing

Apr.10.12 | About: American International (AIG)

On Friday, the Treasury Department announced that it has frozen executive pay at AIG (AIG), Ally Financial, and General Motors (GM). All three companies received significant government help during the financial crisis but have not fully repaid their public debt yet.

This can be a very good thing for taxpayers, the government, and likely shareholders of these companies.

Taxpayers will not necessarily be happy to hear that notwithstanding salary frozen, these executives will still take home millions of dollars. In the meantime, America's middle class are suffering from the aftershock of the financial crisis. But taxpayers would be a lot angrier if the executives of the bailed-out companies actually had a raise before they repay taxpayers. So to taxpayers, this is the best bad news.

In this election year, the government's move to freeze those executives' salaries is not exactly surprising. Although it does remind taxpayers that their money went to bail out certain companies, at least the government shows it is trying to ensure that the bailout money is not abused. To the government, this is the best they can deliver from a political point of view. It definitely is a more "fair" move compared to just leaving the companies themselves to decide top ranked executives' salary increase.

How can this be a good thing for the shareholders? Pay freeze gives these executives much more incentive to return the government's money as soon as possible. How much incentive exactly? Ford (F)'s CEO Alan Mulally was paid $29.5 million last year, while GM's CEO Dan Akerson's salary was frozen at $9 million. You do the math.

Back in 2009, banks that took TARP money, including Bank of America (BAC), Citibank (C), Goldman Sachs (GS), JPMorgan Chase (JPM), Sun Trust (STI), Wells Fargo (WFC), etc. had executive's bonus capped. Soon after, the banks returned TARP money earlier than planned. If history is of any reference value, freezing executive pay would only make things move faster.

AIG still owes the government $50 billion, GM $25 billion and Ally Financial $12 billion. Out of the two public companies, AIG had a trailing twelve month ("TTM") EBITDA of $15.69 billion. Its stock price appears to have broken out during the past year. GM had a TTM EBITDA of $13.16 billion. Based on these numbers, GM is capable of paying back the government money within two years, perhaps faster if its stock price picks up (so that government can sell its shares at a higher price). AIG is perhaps going to take longer to repay U.S. taxpayers.

Economists might argue that without a competitive pay raise, it will be hard for AIG and GM to attract the best talent in their respective top positions. Well, it is not exactly true. While searching for jobs, people are not just looking at one year of income, but future income as well. Being one of the top executives at AIG or GM means a large amount of future income once the government is fully re-paid. For them, it makes no sense to move around for a little more money this year. So at the end of the day, at least at the top level, these companies should be able to keep decent talent even with the pay freeze.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.