While Main Street is revolting against lavish remuneration showered upon executives and investment bankers, it may just be possible that some of the actions being taken by legislatures could be causing more harm than good.

In the United States, where Wall Street and Greed have become virtual synonyms, Congress recently added eleven pages of pay restrictions onto its recent US$787 billion stimulus bill. As Fortune’s Geoff Colvin noted recently:

[The new laws] make pay for performance, otherwise known as bonuses, illegal beyond a modest allowance, yet they permit unlimited pay for non-performance.

An executive may be paid a guaranteed base salary of any size but may not receive a bonus exceeding one-third of total pay. And even that minor bonus cannot be based on profits; the rules prohibit any pay plan “that would encourage manipulation of the reported earnings” of the firm, which is of course what any plan based on profits would encourage. So paying top executives in any sensible way is forbidden.

The proposed bonus restrictions may apply to a company’s top five executives and at least the top 20 highest-paid employees if that company received TARP monies.

While the payment of several million taxpayer dollars to an employee is repugnant, the stench is decidedly less aromatic if that employee receiving the bonus had that year, generated profits of say, $20 million for the firm. In such an instance, it would be wise for a business owner to pay that employee a larger sum (known as a “bonus”) to prevent them leaving for another firm which did not receive TARP monies. (Rainmaker bankers or traders still utilize the firm’s capital or brand-name, so the bonus must be reflective of their specific value-add).

Taxpayers have invested billions in various financial firms and like any owner, require a satisfactory return on investment. That return may be substantially reduced if the bank is not able to earn satisfactory income due to its leading producers departing. Scott Talbott, senior vice president of government affairs at the Financial Services Roundtable, told the Wall Street Journal that “without the revenue [that top performers provide] these companies can’t survive.”

One leading Australian investment banker told Crikey that a large part of the problem with banker “bonuses” has been to do with branding. In many cases, “bonuses” are in effect “commissions”. Many bankers are paid an annual cash amount directly based on the income they produce for the business — in a similar manner to a real estate agent or car salesman. Calling the payment a “bonus” gives a lay onlooker the sense that the payment was made in an ex gratia fashion, rather than being directly based on income produced.

The above comments do not apply to executives at these firms, most of whom create no income for shareholders (but rather, are paid to allocate capital in an efficient manner), in which case, restrictions on performance bonuses appear more appropriate.

For large income producers at these firms, rather than imposing low limits on performance-based remuneration (but allowing higher fixed cash pay), the legislature would be advised to encourage such commission structures, but ensure that any payments are in the long-term interests of the company. For example, cash bonuses which exceed $1 million should be locked-up for a period of at least five years and be dependant on the continued success of the business. Payments above $3 million could be only by way of scrip which too, is escrowed for a longer time frame. These are structure already being put in place by some leading banks, such as UBS and Macquarie.

The past decade has seen a drastic rise in executive and banker remuneration — however, while many of those payments have been ill-founded, others have been rightfully deserved. Elected officials should by all means curtail the growth in executive remuneration, but when payments to a firm’s lifeblood is restricted, taxpayers may be worse off for it.

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Peter Fray
Peter Fray
Editor-in-chief of Crikey
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