G-20 has finally weighed in on the issue of executive compensation. Why should investors care what global financial policy leaders think about performance-related bonuses? Because reforms aimed at ending the financial incentive for executives to bet the house on risky securities will only work if they are adopted uniformly.
There is little mystery about the role that fat-cat compensation packages played in last year's financial crisis. Top management of investment banks enjoyed bonus packages that rewarded short term bets that could be disastrous for investors, while eliminating any downside risk to executives themselves. It should surprise no one that the result was a vast appetite for dangerous investments that would prove to have tragic long term consequences for investors and taxpayers.
In the Leaders' Statement from the September 24 - 25, 2009 Summit in Pittsburgh, G-20 leaders urged that reforming compensation packages is essential to any effort to increase financial stability. The leaders stated that reforms should ensure that compensation is aligned with long-term value creation for investors, rather than excessive risk-taking. They suggested that this could be accomplished by requiring that a large proportion of performance-related compensation be deferred and be tied to long-term performance. Moreover, they argued that such provisions should have teeth, in the form of claw-back provisions permitting companies to reclaim compensation from executives whose decisions land investors in hot water.
Of course, general statements of policy will be useless unless member countries enact rules enforcing restrictions on pay. A September 5, 2009 address to world leaders by Treasury Secretary Tim Geithner outlines the steps that are being taken in the U.S. to change executive pay structures. Geithner noted that the House has already passed proposals designed to tie compensation to long term performance, and stated that the Federal Reserve would be charged with enforcing the proposed new standards.
It remains to be seen whether any legislative effort to reform compensation can survive powerful lobbying efforts by management interests, but international cooperation on the issue is an encouraging sign.