New Financial Sector Pay Rules?

The Obama Administration is working on an initiative to overhaul compensation practices in the financial industry, including companies that have not received any government bailout and non-banking companies, like hedge funds and private equity firms, according to reports published in the Wall Street Journal and New York Times today. The Treasury is expected to issue new rules sometime in the next few weeks.

The administration is reported to be exploring both regulatory (using Federal Reserve’s or Securities and Exchange Commission’s powers) and legislative actions and is also considering issuing “best practices” to guide companies in structuring pay.

New compensation rules are likely to be issued as a part of broader financial-markets regulation reforms that the Treasury is currently working on. Earlier this year, the government had issued guidelines limiting salaries for top executives at firms that received bailout funds from the Troubled Asset Relief Program (TARP).

Currently many banks, including Goldman Sachs (GS), JP Morgan Chase (JPM), BB&T (BBT) and US Bancorp (USB) are preparing to repay TARP funds mainly to escape the government restriction and oversight on compensation. New rules would bring back these companies under government oversight on compensation.

An era of deregulation and a compensation structure that rewarded excessive risk-taking created the financial mess that we are in. While micromanagement of the financial sector by the government is undesirable, we certainly need to prevent any excessive risk taking behavior in the future, as also ensure that incentives are tied to long-term performance.

The European Union has already unveiled its draft guidelines on regulatory reforms for the financial sector, which includes standards for executive compensation practices across all financial firms.

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