How Feinberg Set Executive Pay

Includes: AIG, BAC, KBE
by: Felix Salmon

Steve Brill has a very interesting 8,500-word story in this weekend’s NYT magazine, all about Kenneth Feinberg and the process he went through to determine the pay packages of companies the US government had bailed out.

The funniest part of the story is the bit where Feinberg reflexively tries to pay AIG executives in stock — which was trading at more than $40 a share at the time — only for both AIG and Treasury to tell him that really wasn’t fair, because AIG stock is, yes, fundamentally worthless. They were right on that point: Feinberg actually would have been foolish to pay AIG executives in common stock, because that stock only has any long-term value at all in the event that AIG takes enormous risks and they pay off. And that is not something we want AIG’s leadership to be doing, so I’m sad that Feinberg agreed to stock-based compensation at AIG “in appropriate cases”.

But Brill, who is a multi-millionaire in his own right, is not always a reliable guide to what constitutes fair pay. He’s got a friend who works at AIG Financial Products, and who he lets “make the case” for that company’s crazy retention-bonus plan. He quotes another friend talking sympathetically about how “really hard” these people are working, and a lawyer saying that

if people in these industries see that Congress can jerk them around whenever they want, they’re going to stop going into these businesses, just the way people have stopped becoming doctors.

He’s happy talking about how half a million bucks a year “is considered piddling” on Wall Street, and how a low six-figure salary doesn’t mean anything to people who are already millionaires. And he talks a lot about the risk that people will quit, or not work hard, if they aren’t paid lots of money — without giving a single example of that actually happening.

He also covers at length and with a perfectly straight face the bizarre creature invented by Feinberg and called “salarized stock”:

For base cash salaries, Feinberg suggested a sum that, on Wall Street, is considered piddling — typically no more than $500,000 a year. He also said there would be no cash bonuses. But he tempered that with a compromise: The firms could provide additional annual salary compensation if paid in company stock — stock that the executive would receive every payday but could not sell immediately.

This last provision came to be called “salarized stock.” It sounds like jargon only an M.B.A. could love, but it became a key element of the negotiations and a clever way for Feinberg and the bailed-out companies to work around a law passed in the early weeks of the Obama administration. Back in February, Senator Christopher Dodd, the Connecticut Democrat who is the chairman of the Senate Banking Committee, inserted what is now called the Dodd amendment into the President’s economic stimulus bill. A provision in that amendment limited any bonus compensation to 50 percent of the executive’s salary…

Because Feinberg’s salarized stock would be dispensed every payday, it could therefore be considered salary under the Dodd amendment.

How clever of Feinberg to “work around” a clear law like that! Of course “salarized stock” is simply a guaranteed bonus, payable in stock; since it vests over a period of years, it’s neither here nor there whether it’s paid annually or whether it’s paid monthly. But because Feinberg didn’t like the optics of guaranteed bonuses — and because Dodd had clearly made guaranteed bonuses illegal — he created this Frankenstein monster instead, waving his magic terminological wand and turning a bonus into salary, to the delight of Brill, who as a lawyer loves this kind of sophistry.

To be fair to Brill, he does show quite clearly that Feinberg ended up paying lots of money to senior executives in practice, while trying as hard as possible to make it look as though he was being very harsh. That’s probably what the government wanted all along: the main thing it was worried about was headlines. Feinberg’s job wasn’t to rein in pay, it was to rein in outrage about pay.

Brill’s also excellent at uncovering the silly game that Feinberg played with the banks: he invited them to submit their own proposals as the basis for negotiation, with the predictable result that the banks spent millions of dollars on compensation consultants paid to conclude that senior executives were all above average, and had to be paid as much as $21 million a year, in the case of BofA (NYSE:BAC). Feinberg could then announce multi-million-dollar pay packages as a low percentage of what the banks originally asked for, and seem tough in so doing.

But what Brill never really addresses is the question in the headline of his piece: how much are these bankers actually worth? And he also never addresses the question of the degree to which seven- and eight-figure salaries caused the crisis in the first place, or whether we actually want greedy people in these positions who won’t do their jobs unless they’re paid a hundred grand a week.

In Brill’s world, the only downside to an enormous salary is the optics of the thing: how it looks to the rest of us. “Business common sense,” he writes, “dictates that because the government owned them, these were the last companies the government should want to undercut with unilateral pay disarmament”. Does he give a single example of a company underperforming because it can’t pay well enough? Of course not: it’s just obvious to Brill that banks which pay modest salaries (like, say, most credit unions) will do worse than banks which pay enormous bonuses (like, say, Lehman Brothers (OTC:LEHMQ) or Bear Stearns). Well, it’s not obvious to me. Just like it’s not obvious to me that people have stopped becoming doctors.

Update: Thanks to reader Anthony Bongiorni for picking up on this:

Feinberg consulted regularly with Deputy Treasury Secretary Neal Wolin and others at Treasury, Wolin says, though he met with Geithner only three times. “We pushed back with him on some issues,” Wolin recalls, referring to Treasury’s desire to make sure that the companies would be able keep talented employees — and eventually repay the government.

It seems it was Wolin, at Treasury, who was pressuring Feinberg to pay more, rather than less. Wolin, in turn, entered Treasury straight from a senior executive position at The Hartford, which took $3.4 billion in federal bailout money, and surely wanted to be able to continue to pay its executives lots of money in future. Maybe they should send their friend Neal a thank-you note for helping to keep salaries high at bailout recipients.