Is bloated executive pay headed for a deflation?

New efforts are proposed to check pay for chief executives.

Washington Post

WASHINGTON — Angelo Mozilo, whose Countrywide Financial came to symbolize the failings of the mortgage industry, took home more than half a billion dollars from 1998 to 2007, including $121.7 million from cashing in options last year alone. Charles Prince, who led Citigroup to the brink of disaster, was awarded a retirement deal worth $28 million.

Now, in a show of purported restraint, top Wall Street executives are going without bonuses. What are we to make of all this?

If you’re angry that so many executives got paid so much for screwing up so spectacularly, you might take solace in the fact that shares they still hold have lost value, too. But if you think executive pay is finally succumbing to the force of gravity — if you’d like to believe that an epic destruction of investor wealth will fundamentally and permanently change the way chief executives are paid, or that you, dear shareholder, have the power to join forces with others just like you and create a more rational order — don’t bet on it.

The nation’s financial crisis could change the rules of executive pay, but if history is any guide, you’ll have a lot more to complain about in the years ahead.

Through nearly two decades of tinkering, each new twist in executive pay has proved flawed. Incentives meant to reward good management have done just the opposite, and efforts to reform the system have in some respects made matters worse. From the bursting of the dot-com bubble to the collapse of companies like Enron and WorldCom, from the rampant backdating of stock options to the current meltdown of the global financial system, the so-called pay-for-performance movement has led to colossal windfalls, reckless risk-taking and fraud.

At a time when the government is using taxpayer funds to rescue financial titans — when ordinary Americans are watching their retirement savings evaporate — announcing that top executives will forgo bonuses has obvious public-relations benefits. But unless a bonus was warranted, it’s a hollow gesture. And it does nothing to alter certain underlying realities.

For the most part, executive pay is set by executives. Executives dominate corporate boards, and corporate boards are self-perpetuating. As a practical matter, shareholders have little say in the selection of directors, and once directors are in the compensation boat, they have little incentive to rock it.

If you’re a director and you go along with generous chief executive pay, “you get to sit on more boards,” said Fabrizio Ferri, an assistant professor at Harvard Business School who studies executive compensation.

According to one school of thought, the scale of executive pay, if not the particular form, is unlikely to change substantially unless the balance of boardroom power changes.

There are several ways the crisis could shake things up.

First, short of a revolution in the way corporations are governed, there are efforts afoot to make it harder for executives to profit from mismanagement while investors are left holding the bag.

Some shareholder activists are calling on boards to hold incentive pay hostage to a company’s long-term fortunes, and investor anger could put pressure on directors to comply. The American Federation of State, County and Municipal Employees plans to ask shareholders to vote next year on resolutions urging boards to take two steps: stretch out the payment of annual bonuses over multiple years and hold on to a significant portion of equity awards until the executive has been gone from the company for two years.

The resolutions are purely advisory.

Second, through its bailout programs, the government can set conditions for companies that accept federal funds. For example, the government is requiring participating firms to eliminate incentives for executives to take “unnecessary and excessive risks that threaten the value of the financial institution.” It’s unclear how companies will apply such a nebulous standard. In the spirit of both the AFSCME proposal and the Treasury mandate, the investment firm Morgan Stanley recently said it will make a portion of annual bonuses subject to recapture by the company.

Third, either Congress or the Securities and Exchange Commission could make it easier for big shareholders to put their own candidates for board seats on the corporate ballot. In theory, that could make directors much more accountable. For it to work, shareholders, especially institutions like pension and mutual funds, would have to take a more active role than many have had the stomach to play in the past.

The plan could backfire. If executives are forced to confront shareholders with real power, would they be any less motivated to deliver short-term results, or the illusion of short-term results — even if those compromise the company’s interests over the long run?

Professors Michael Jensen and Kevin Murphy, co-authors of a 1990 Harvard Business Review article on the subject, predicted that executive pay will resume its upward climb.