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February 06, 2009

Does Capping Executive Pay Hurt Corporate Leadership?

Catherine New
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President Barack Obama announced a plan this week that would limit executive compensation at companies seeking large amounts of government aid. The plan includes placing a $500,000 cap on the annual salary of senior executives and restricting the cashing in of stock incentives until government assistance is repaid.

But will the limits create a leadership void at these firms? Professor Nahum Melumad said that some of the proposal’s terms could hinder recruitment and retention.

“You need the best talent money can buy and that may be difficult without the right award,” said Melumad. “Currently the administration is saying that a company may pay a large amount in the form of stock options, but that executives will be allowed to exercise those only after the government has sold its equity positions. That may be too long a period to retain any incentive impact and to attract top managers."

“A better way might be to have executive compensation consist of two key components: a ‘reasonable’ base pay and an additional component that is a function of improved company performance,” Melumad said. “The latter should have significant upside potential to attract top managerial talent.”

Professor Sudhakar Balachandran points out that even if firms aren’t too concerned about losing talent, they’re still faced with the challenge of motivation.

“There have been some arguments that there will be an exodus, but I am not too worried because the job market and prospects are tougher now,” he said. “In the past we’ve seen turnover when a firm’s retention mechanisms fail. But today, if someone wants to leave, where would they go?”

“If there’s no upside potential, you now have to worry that people will not work hard or smart, but instead that they will just show up and check off the boxes,” said Balachandran.

Photo credit: White House/Pete Souza

Comments

by Robert Hynes | February 07, 2009 at 7:01 PM

Professors Melumad and Balachandran raise objections that have long been used to justify high levels of compensation on Wall Street. Professor Balachandran's assertion that motivation will fall off infers that the only "upside potential" seen by staffers impacted by these restrictions is the promise of higher pay. I would argue that if money is the only thing keeping these folks tethered to their positions, perhaps management should focus on recruiting those whose motivation is based upon a level of engagement that goes beyond their yearly bonus.

by Massiel Belliard | February 08, 2009 at 7:47 PM

Obama's cap on CEOs salaries and bonuses, whose companies will receive tax bailout, is not only relevant but also fantastic and crucial for this financial crisis of today. Hence companies in jeopardy will be able to reallocate that money in other operation activities. Perhaps companies can be save from failure and not lay off can occur. Indeed, CEOs who did not perform well their jobs will no longer be compensated like if they did.

by Ntale Lukama | February 10, 2009 at 12:28 PM

Although, I don't believe we ought to restrict CEO's compensations, the cap that was set was made only on companies which received government funding. And on that front, I believe it's necessary. Indeed, it's right for the government, as a temporary stakeholder, to dictate the conditions on any subsidies it provides to any economical agents to ensure the best use of taxpayers money. That's pretty normal.

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