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Bank CEO Pay: From Bad to Worse?

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American Banker just released our second annual bank Executive Compensation Special Report. It shows that the bosses of about 160 banks received median raises of 11% last year and a combined 28% over the past two years.

At a time when many workers consider themselves fortunate just to have jobs, and raises are minuscule to non-existent, such gains at the top run the risk of setting off a fresh wave of populist anger. That's especially true in banking, which is arguably the most vilified industry around.

Across all industries, CEO pay has swollen to 1,800 times what the average worker makes. One of the main culprits behind the top-dog pay inflation is "peer benchmarking," or the practice of paying bosses based on what similarly situated CEOs make, writes Broc Romanek, editor of CompensationStandards.com.

"For nearly two decades, compensation committees have routinely set CEO pay in the top quartile of that for their peers. This practice inadvertently created a slippery upward slope." in which the "average" inexorably rises, Romanek adds. It's like living in Lake Wobegon, where every CEO is above average.

To me, the fact that the top men and women make vastly more than the rank-and-file is not in itself a problem. I'm a capitalist — but one who believes vast wealth should only result from vast wealth-creation. Bill Gates built Microsoft from nothing. Sergey Brin and Larry Page did the same with Google. I don't begrudge them a dime. I'm less comfortable when the hired help is made hugely rich by taking risks with other people's money (especially taxpayers').

Under the current system, the inflationary pressure on CEO pay that's exerted by peer benchmarking is exacerbated by boards that are too cozy with management and big shareholders who are often too quick to go along. At times, it feels like a cloistered ruling cabal lives in its own dream world apart from the rest of us.

At JPMorgan Chase, CEO Jamie Dimon's compensation committee consists of three of the most richly paid members of America's ruling corporate elite. That helps explain how, even after the bank's London Whale debacle prompted the committee to cut Dimon's pay 19%, he walked away with $18 million.

What worries me about where executive pay is headed is that we risk stumbling from one highly flawed system to another that may be worse.

Regulators, for example, are pushing companies to replace peer benchmarks with "absolute" ones. Under the new regime, a company might declare that a CEO will receive a bonus if it achieves a set return on assets, regardless of how its peers do. The problem is that with nothing to compare the company to, boards may set the hurdles too low. Nor does such a system do anything to eliminate the risk that managers will fudge the numbers to hit their goals.

Regulators, it seems, are nevertheless fixated on reducing risky behavior by minimizing use of performance-based pay, especially stock options, Susan O'Donnell of the consultancy Pearl Meyer & Partners told me this week.

We certainly learned during the past two financial crises about the perils of lavishing bankers and other corporate bosses with too many options. From Enron to Lehman, the prospect of lavish paydays encouraged outsized risk-taking and resulted in corporate calamities that left millions of innocent victims in their wake.

Even so, getting rid of stock options is "unnecessary and inappropriate," argues O'Donnell. Part of her beef involves the replacements being pushed – most notably so-called performance shares, which are supposed to be tied to long-term performance, but have their own problems. These time-vested restricted shares are often granted to senior executives regardless of how their company performs. That's prompted some investors to label them giveaways.

"Shareholders don't want excessive risk. Nobody does. But they do want pay for performance," O'Donnell says.

A final direction that regulators are pushing executive compensation toward involves bigger proportions of fixed pay. The logic is that this will reduce executives' temptation to do naughty things, like prop up the stock price to cash in options.

The risk here is twofold. Eliminate performance pay and performance will likely suffer. Increase salaries and we'll saddle companies with high fixed costs, even in years when profits are low or nonexistent.

Imperfect as the current system is, it's given companies considerable leeway to adjust payouts to CEOs and other top execs, as this graphic shows. Take away such control and bankruptcies will likely follow.

A final force exerting itself on pay is Europe. There, the trend is toward capping executive pay outright, either via shareholder say-on-pay votes that directors are obliged to heed or bureaucratic fiat, notes Romanek.

If you think that sounds appealing consider a sports analogy. Would your favorite team be well advised to keep down ticket prices by capping pay and performance incentives for top athletes? Or would it end up with a bunch of scrubs and empty seats? Similarly, do you want the B Team running the company that issues your paycheck or the shares in which your retirement savings are invested?

Finding the right pay formula is a messy business. My personal preference is to leave it to shareholders and the market to sort out. One fascinating example of how that's happening involves North Carolina's Southern Community Financial, where would-be acquirers have tried to force executives to give up some of their goodies.

The alternative is to leave it to Washington to devise a one-size-fits-all solution. My guess is it would fit no company very well.

Neil Weinberg is the editor in chief of American Banker. This post previously appeared on LinkedIn. The views expressed are his own.

 

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