Pay cuts at bailout companies: a real-life test case

The decision by Kenneth Feinberg, the Obama administration's "pay czar," to slash executive compensation at America's seven biggest "bailout" companies is good politics. But is it good business?

The country will find out as Mr. Feinberg tests vogue ideas about pay and corporate governance in his laboratory of business guinea pigs: AIG, Citigroup, Bank of America, General Motors, Chrysler, and the two automakers' financing arms.

(The nation's central bank, the Federal Reserve, will meanwhile police pay policies to discourage the kind of risk taking that contributed to the financial collapse.)

The federal government has so far injected $240 billion into the group of seven companies under Mr. Feinberg's watchful eye. Acting on a law passed by Congress, the Treasury Department's special pay master has examined the companies' salaries and bonuses and he has spoken: Senior executives at the companies will see their cash pay cut by an average of about 90 percent, while total compensation – which includes bonuses – will be cut by about 50 percent.

Main Street will like this, which is why the move amounts to smart politics. In 1965, the average US corporate executive earned 24 times what the average worker did. By 2007, the CEO advantage had spiraled up to 275 times.

The great recession was to have taught corporate America a lesson in excessive pay that bore little relation to performance – and in excessive risk taking. Both of those conditions contributed to economic calamity. But Wall St. must have skipped that class. Recovering financial institutions that were on the rocks just months ago plan to pay big bonuses for 2009.

"It does offend our values when executives of big financial firms, firms that are struggling, pay themselves huge bonuses even as they continue to rely on taxpayer assistance to stay afloat," President Obama said today.

As paymaster, the government has the right to cut compensation at the big seven, but it's not clear that this is the best way to return these companies to health.

The greatest talent may jump ship to European companies or Wall St. firms not under the government's thumb. The country will learn the outcome soon enough as this select group of 175 executives either stays – or goes to higher paying positions.

More intriguing, and perhaps more significant, is how the seven businesses will perform under Mr. Feinberg's changes in corporate governance. Among other things, he plans to pry apart the joint job of chief executive officer and chairman of the board, who are one and the same in many companies.

He also wants to create special corporate commissions to assess risk and to do away with entrenched staggered boards (directors on these boards are not all elected at the same time).

"Good governance" has been a topic in the boardroom for many years. The above measures – and others – are part of legislation in Congress. The aim is to remove conflicts of interest between boards and the publicly traded companies they govern so that CEOs respond more to long-term interests than short-term gains.

But each of these ideas has pluses and minuses. A CEO who is only a CEO can't run board meetings and set his or her own pay. On the other hand, what is the role of the chairman who is only chairman? Is a company setting itself up for a power struggle with this arrangement?

And while one has to wonder where the risk-assessment people were at the companies that fell under the spell of mortgage derivatives, don't most boards weigh the pros and cons of opening new plants or starting new lines of business? What about audits – don't they already perform a risk function?

The timing of board elections, too, has its positive and negative aspects. Staggered boards help prevent hostile takeovers, because it's not so easy for an outsider to topple everyone at once. But for shareholders who want more say over pay and other issues, being able to "throw the bums out" might be what's needed.

Might be. Maybe yes, maybe no. It depends on the company, the board, the business culture, and many other factors. That's what makes this government intervention in pay and governance so interesting – and so problematic.

Generally, government should not be setting pay rates (Congress tried that in 1992, when it put a ceiling of $1 million on salary that companies can deduct as a business expense; companies responded by raising salaries to $1 million and issuing stock options). And government should tread carefully in telling businesses how to run themselves.

What government can and should do is empower shareholders to influence compensation and governance decisions by making it much easier for them to elect and remove directors. Ultimately, it is the shareholders who have the long and lasting stake in a business. They will be looking closely at the federal government's real-life lab test.