Pay Czar Plays Chess Game With Numbers

By Heide B. Malhotra
Heide B. Malhotra
Heide B. Malhotra
April 6, 2010 Updated: April 6, 2010

WASHINGTON—It’s not an easy job knowing that some of the most powerful executives in corporate America thoroughly despise you.

“I can’t be vindictive, I can’t be vengeful, I can’t punish,” said Kenneth Feinberg, the U.S. “Pay Czar” in a Knowledge@Wharton (KW) report. “I have to make sure that the companies have the individuals necessary so that [they] will thrive and repay the taxpayer.”

Feinberg, officially known as Special Master for TARP Executive Compensation, determines reasonable compensation for the top 25 executives of American International Group Inc. (AIG), Chrysler Group LLC, Chrysler Financial Services, General Motors Co., and GMAC Mortgage.

Essentially, Feinberg rules on how much employees are compensated at companies receiving TARP bailout funds—and inside the walls of such firms, he is seen as public enemy No. 1.

It’s a tough balance to maintain. On one hand, Feinberg must determine the fair amount of compensation to allow companies to flourish and keep high-performing employees; on the other, he must paint a picture to populist America that he is tough on corporate executives.

Calculating Fair Pay

“My primary responsibilities include making determinations regarding the compensation of certain employees of TARP recipients that have received exceptional financial assistance,” Feinberg said in his recent testimony before the House Committee on Financial Services.

His task is to create a pay model that is based on paradigms, theories, and mathematical formulas, which take into consideration risks inherent in executives’ positions and the competition the firms are facing.

“The methodology is pretty clear: Take the statute, add the data, secure independent consultants … That’s how we did it,” said Feinberg according to the KW report.

In other words, executive compensation is simple math.

But the trouble is that compensation is also affected by indirect human factors, such as pride, satisfaction, and self-respect, which are difficult to quantify.

Feinberg is faced with a multitude of restrictions, especially since the entire compensation debate is wrought with issues surrounding transparency, authority, and control. Several different committees were established to address the issues separately and from different angles.

“I’m only involved in calculating awards. I’m not involved in the other issues involving pay [such as] corporate governance reform, regulatory reform … There’s a whole menu out there designed to rein in pay that has nothing to do with me,” Feinberg explained in the KW article.

Flexing Muscle

The rules promulgated by Feinberg apply only to the top 25 executives on the organizational chart. Any cash compensation is reduced by roughly one-third from 2009 gross pay and not calculated as take-home pay. With taxes being lower because of lower pay, take-home pay most likely would be less, but not by an unreasonable percentage.

Pay will be capped at $500,000 for about four-fifths of the executives, unless they can convince the pay czar’s team of their special value to the respective company.

Michael Carpenter, CEO of GMAC, elected not to receive cash compensation, but only stock options, which he must hold for an extended period of time. The other GMAC executives are faced with a $500,000 pay cap.

The Feinberg team made clear in a recent Department of Treasury statement that “executives should build savings for retirement based on performance—rather than through guaranteed retirement benefits provided at taxpayer expense.”

To guard against future reckless behavior, Feinberg instituted the clawback rule, which gives companies recourse to recoup pay from executives.

The clawback rule, which permits a firm or government regulator to take back a benefit if certain future conditions are not met, will be tackled next. The rule will not only apply to those companies that have not yet repaid TARP funds, but to all that received such funds, even if they paid them back.

Feinberg is quoted in the KW article as saying, “Repaying your top obligation does not immunize you as a company from the subjective discretion I have to seek to claw back compensation previously rendered.”

According to Feinberg, anyone should be able to be compensated fairly, based on responsibility inherent in and risks associated with a job, as well as the competitive forces a company faces in the market. Most importantly, pay should be coupled with the success or failure of the respective firm.

Feinberg heard no public outcry and the media was rather sedate to most news coming out of his office. At a recent lecture at the Wharton Business School, Feinberg said that the companies have a fiduciary responsibility to the American taxpayer for bailing them out.

AIG Bonuses

According to KW, Feinberg found many bonus packages “offensive” and “an outrage,” but terminating them was out of question. “Be very careful if government—especially the Treasury department—starts questioning and invalidating what everybody says are binding, old agreements. You can’t do that. That would be very bad public policy,” Feinberg is quoted as saying in the KW article.

While lawmakers and the general public were calling for AIG to rescind the bonuses, AIG argued that the contracts were signed and agreed upon prior to the company’s near collapse, and since AIG did not file for bankruptcy protection—it was bailed out—it could not nullify those bonus contracts under U.S. law.

While he could not tear up the contracts, Feinberg turned the tables by limiting and freezing 2010 AIG pay. All 2010 cash pay for AIG executives, with the exception of one, was frozen until $45 million in prior disputable retention pay is clawed back by the company.