we're all capitalists here we believe strongly in the capitalistic system and the reason this committee is moving and exploring this issue is because we care about the health of our economy at the heart of the health of our economy the heart of it is basically our financial services and so what we have here  incentives for short term gains overwhelm the checks and balances that were meant to mitigate the risk of excessive so the question is how can we better align our compensation align our compensation packages with management so that so that they properly pay for performance what is wrong with having shareholders have a one i truly think this is a situation of all upside no downside you're empowering shareholders with the ability to have stronger oversight you are forcing the company to think more seriously about what they do how it will be perceived and not just to go on automatic pilot doing practices that are not defensible simply because their peer group is doing it all kind  quickly knowing we have time issues is that i think that you need some type of some type of long term compensation or something process is looking at the underlying value or the long term risk and i think the hard part for all of us is that we don't simply create a world where everybody is out saying pay for performance and we haven't really looked carefully whether the performance we're now blessing is subject to manipulation itself and i think that's going to be more complex careful mixes of metrics like it was the chairman chairman i thank you for your leadership  it's been said that managers want to do things right and the leaders want to do the right thing i think we're doing the right thing and i'd like to have just a moment of because i'd to make some adjustment with reference to executive comp compensation in terms of how it can promote excessive risk taking and the auto workers have had their salaries the line they have been castigated for making too much money and it's unfortunate that there are those who would want to limit the salaries of auto workers but would take a firm stand against making endeavor to look into whether or not a risk by way of salary has driven some of th it hard to see that we can look into the type of legislation that we are considering today i have evidence of h r five which passed the house in two thousand  which would have placed the cap on the percentage of damages that lawyers can receive it would have kept him at the of over six hundred thousand dollars a lot of money not consumers we can also look at lawyers who represent corporations those who are not here today i just believe they want this bit because there are people who are suffering who have had their salaries cut who work in the auto industry people who are not getting bonuses that they used to buy second and third home or to buy additional cars what they lost was money for education money to pay money to sustain themselves and i find it quite frankly disenchanting to know that there are those who would want them to receive cut and not want to look at the compensation that these executives are receiving that can create excessive risk in the marketplace so i thank you m chairman for giving me this moment to voice the concerns of those who are not here the blue collar workers and the lawyers who represent the consumers who have gone to battle for them and made a difference in their lives and in the lives of people in this country by causing us to have products that are safe by virtue of knowing that that there are these lawyers who will take on these challenges and make sure that the consumer is protected consumer protection is important one of the best consumer protection systems in the world and it did not cost the government one penny because we had lawyers who were willing to stand up for those who could not stand have got to question when there is such a serious divide between management and ownership you know i'll take quest which is a big company in colorado one of our failed i think is very destructive to the kind of public trust in our financial system and so i think it really i think that goes to almost the heart of everything we're talking about how do you ensure that there actually is pay for performance i think part of that is shining a spotlight on whether people are just doing compensation based on what their peer group is whether it's acceptable to have the kind of compensation packages that allow this when there's been no performance and you know i'm heartened a little bit to see that you know i saw that a couple of the companies who were just paying back their tarp without any push from the government for that i think because of the focus put out statements saying they're just going to pay for performance they're going to give most of the compensation and stock to be held for a long time and they weren't having any golden parachutes so i think this goes to the heart of almost everything we're talking about just one more question when we say pay for performance is that going to be tied  so yes i mean the idea that the idea that performance is simply stock price i think it works bad both ways rewards amazing awards for people nothing to do with their performance just the overall economy's getting better on the other hand i don't have a problem with rewarding an executive doing an exceptional job and a terrible economic time but you don't see that symmetry the senses that people get paid a lot when they fail they get paid and they succeed chairman frank was in the paper their day saying had you when tails at least you don't lose on on on these packages but i do i do think one of the key points is just time to stock does have its risks and  obstacles to the kind of oversight that capitalism requires a risk factor and i was very pleased to hear the earlier panel talk about that the fed will now look at it but where are the other people who are looking at risk in the markets the rating two highly leveraged bets regular shareholders should also have the power to amend the corporate charter and to change the company's status incorporation finally decays of executive pay or more generally any thank you chairman frank and thank you for the opportunity to be here today and i applaud the leadership exhibited in the past when the house passed say on and it's unfortunate colleagues in the senate didn't share the same wisdom and so  in a large international semiconductor company as well as a small venture startup and served on the board of a fortune five hundred company as well as a small technology software company where entrepreneurship is very important perhaps one of the few if not the only person at the table today with that type of experience and perspective and there's no doubt in my mind that when it comes to influencing people's behavior in a company at the top level at the low level there is nothing like pay that drives what people do and committee to do unfortunately today the compensation committees are all too comfy with the c e o i've seen that on the boards that i've sat on and they're very reluctant if not absolutely against really reining in the compensation so we've got to  really put together a package that includes greater transparency greater accountability and some enforcement at the end of the day and for the sake of time let me jump in to some of the recommendations  they don't require disclosure of the key performance metrics the things that really drive how you get that package so we don't get the details on how it got to one hundred forty eight million we don't get the factors and we need to see those factors and require those factors be disclosed by the they made up voluntary a couple of years ago about half the companies given half the companies don't we need the companies on an appropriate level of detail that includes we need to get back and figure out what the value of the real equity grants are when they're given we've lost that we need to have disclosure about the compensation consultants and whether or not they're truly independent are they being hired directly by the comp committee or are they doing a lot plans hedge funds that aren't disclosing how they're voting on this stuff and we need transparency to it at a public pension fund i said on that has about thirty billion of assets in our state we recently went to disclosing our votes just so all of our members and people can see how we vote we think that's some accountability if we don't do it right lane while we do it the way we do it there needs to be something done with the way shareholders vote we can put in pay and i certainly support that strongly support by the way i don't view that as government intervention in any way shape or form and to the question of whether or not that would drive people offshore i absolutely don't believe it will drive people offshore many other countries around the world australia netherlands many of the european u k company countries many of the countries where there's a large market cap already half that so what are they going to lose do leave here to go to another country with the same regime i just think that's nonsense sensible but we do need to get the shareholders in mutual funds voting in the best interests of investors as i say my testimony almost ninety percent of the time the mutual funds  the barclays the world are voting with management and there's no requirement that they vote for their investors money they're managing as opposed to voting their own interest and fidelity bar all manage a tremendous amount of money for these large companies with tremendous that conflict not disclosed and it's shown time and time again they vote that way so i certainly encourage do something about the mutual angry coupled with our suspicions that the wall street bonus culture is the root cause of the ongoing financial crisis has led to an effective prohibition on cash bonuses for tarp recipients and this leading us today towards more sweeping regulation of compensation in financial services firms i agree that there are problems with compensation structures in financial firms animals other sectors but it is my opinion that the constraints are already currently on to destroy those organizations unless they can quickly  repay their government and avoid the constraint moreover it is my opinion that regulation regulating compensation in financial services more broadly will cripple one of our nation's most important and historically most productive industries the heavy reliance on bonuses has long been a defining feature of wall street compensation going back to the days when they were privately held partnerships such firms kept fixed costs under control by paying low base salaries and paying most of the compensation for most bonuses tied to profits this basic structure r intact when the investment banks went public but the cash bonuses were replaced with a combination of cash restricted stock and options the primary way that such structures can encourage excessive risk taking is to asymmetric awards and penalties that is high rewards for superior performance and essentially no penalties for failure financial firms provide significant penalties for failure in their cash bonus plans by keeping salaries below competitive market levels so that earning a zero bonus is actually a penalty and bonuses do fall in bad years average bonuses for executives and the top recipient firms were two percent lower in two thousand and eight than in two thousand and seven take away bonus opportunities in the bank will have to raise salaries or find other ways to pay or they will lose their top talent in addition to cash bonuses executives and financial firms receive much of their compensation in the form of restricted stock options in these instruments also provide penalties for failure the average intrinsic value of options held by executives in tarp recipients firms cell by cell ninety four percent from two thousand and seven to two thousand and eight and the value of their restricted stock holdings fell by seventy two percent and the statistics only include firms that continue to operate at the end of two thousand and eight thus ignoring the losses incurred by executives of bear stearns lehman washington mutual walk over and the other casualties of the crisis given the existing penalties for failure there is nothing inherent in the current structure that leads to obvious incentives to take excessive risks to the extent that the firms indeed took a risk we need to look beyond the pay structure to explain in particular the role of bonuses is likely dwarfed by the role of loose monetary policies social risks but this isn't a compensation problem another way the compensation can lead to risk taking is through inappropriate performance measures for example consider mortgage brokers paid for writing loans rather than writing loans that actually for the borrowers was actually payback we saw this happen at a washington mutual countrywide walkover and or scores of smaller lenders who aren't overly concerned about the default risk as long as home prices kept rising and as long as they could keep packaging and selling their loans to wall street a solution to this performance measurement problem is to pay people to write good loans and penalize them for writing bad loans the challenge is identifying a good loan without waiting up to up to thirty years to see whether the loners repaid the answer involves bonus base involved basing bonuses on subjective assessments of loan quality unfortunately most correct and projected regulations go in the opposite direction and require the bonuses be based soley on objective measures of performance such as the quantity of loans the regulatory demands of affectively substitute the judgment of government for the business judgment of directors and this is a dangerous path to go down in conclusion it is not my opinion the current compensation practices are optimal for example bonus plans could be improved by introducing wellness banks and claw back provisions and making sure we were awarded long term value creation rather than short term results and performance measurement can be improved by allowing more rather than less objectivity and discretion however i believe that regulation will systematically and predictably make things worse better rather than better indeed washington has a long history of attempts to regulate pay including caps on golden parachutes in the one nine hundred eighty s the million dollar pay gap in the ninety's more recent restrictions on d compensation and the most recent constraints on tarp recipients each of these attempts has created unanticipated side effects that have generally lead to higher levels of pay and less efficient pay to live raise i strongly recommend as a committee to consider carefully this history before  chairman frank ranking member baucus and distinguished members of the committee it's a privilege to testify in this forum today my name is jay to be read i'm an assistant professor at george mason law school and also a senior scholar at the mackay dissenters financial markets working group i also directed the corporate federalism initiative a network of scholars dedicated to studying the intersection of state and federal authority and corporate governance before i begin i also want to say that the particular honor to testify on a panel with  was a mentor without his guidance i wouldn't be a law professor today so that's a particular honor today i want to discuss executive compensation proposals currently under consideration i will also highlight a wall street norm of issuing and feeling pressure to meet quarterly earnings guidance which is a central cause of short term tunnel vision for wall street executives the role executive compensation plays in the current crisis is in fact on clear there is little difference and this is key there is little difference between the executive compensation approach of banks healthy enough to repay their tarp funds and those of banks likely to need additional objections of capital with executive compensation where the culprit the differences between executive compensation and healthy banks and executive compensation at bad banks would be much more apparent what is apparent is that executive pay packages or of necessity complex compensation packages are designed to link to an executive performance running the company without rewarding or punishing executives for factors outside of their control regulatory restrictions and say on pay requirements may limit of compensation committees flexibility to achieve this important goal there are no less than seven executive compensation initiatives either proposed or recently under way such a wide array of ideas from disparate corners offers to repeat the lack of coordination that contributed to the present crisis the multitude of proposal also threatens to override two important driven disclosure initiatives that offer some significant promise in this area former f c c chairman cox completed an extensive overhaul of executive compensation disclosure in two thousand six and chairmanship zero is promising further changes congress should study the effect of these disclosure rules before instituting prescriptive regulation i would also add that they should think about this studying disclosure rules and the f c c should consider disclosure rules for proxy advisory firms which is notably missing from the chairman's current proposal i would warn i would echo professor murphy's warning about the effect of unintended consequences and we've seen that before in one thousand nine hundred three lawmakers sought to limit the disparity in pay between executives and the average worker the result was that it was quite the opposite in fact executive compensation increased exponentially widening the gap between executives and the average worker do offer an unintended consequence already apparent for the current reform effort they restrictions have made it harder for american banks to retain talented executives immediately following the announcement of compensation restrictions by the obama administration deutsche bank of bank of america's highest performing executives and companies may motivate executives to look short term but the real question is why do companies term goals in the first instance the widely accepted convention of predicting quarterly earnings drives the short term approach pension funds mutual funds issuers with the pressure to predict quarterly earnings but companies feel that voluntarily opting out will be taken as a negative signal pressured to make quarterly predictions about their earnings companies frequently feel pressured to cut including financial companies and some but the shareholders and the company first and other executives but their own interests first and that's just people being people because of that we have to put a system in and in this country we put in from that important issue and in terms of specific policy prescriptions i would say i think that to the extent we want to lift the restrictions on executive compensation i think it could be tagged we could say if you were to our company would you adopt a bylaw  which is the executive compensation questions and question and ask you about the governance of all that i am concern that the federal government is getting more and more involved in the running of state law does play a very important role with respect to proxy access the current proposal is very clear that it says the federal government should say how proxy access should work how state law nomination should work a small subset of shareholders haven't been able to achieve through proposals just last year seventy proposals for say on pay were introduced that company two thousand and eight ten of them were successful the average vote was a sixty percent vote against  money accepting investments by the government that they have to accept some of the rules of government to go along with that and a part of that may be a say on pay  but i really interested in the shareholders and you just gave us some information that is surprising to me basically that the majority more than a majority of shareholders do not government's money simply back to the point though about investors on say on pay there's a couple other key key facts that you need to consider in those votes in some of those companies the compensation that investors might have in fact decided that compensation was satisfactory and in that case they tend not to vote for say on pay proposals i sit on two large institutional funds one being the public pension fund for colorado the quibbling of your funds to manage and they get tremendous fees for that and as a result of that they are going to vote against management they aren't going to pay because management team will go take those funds away from them and place them with another asset manager and so those votes become very problematic what we need is legislation that says when the pension fund or when the mutual funds vote on behalf of the investors in that fund they have to make that  on the best interest of those investors not their best interest as a mutual fund a prime example is a few years ago when there were but nominal almost two hundred million and payouts to an executive leaving at pfizer and there is a question about their board and all the pfizer management team to senior top people who are close personal friends flew to california met with barclays remind barclays said they were getting fourteen million in fees to manage  line and answer this question yes or no will get your million our problem as well that isn't the fact that we're dealing with faxes instead of buying a thousand we paid hundreds thousands or millions of dollars and instead of getting back the million dollars in profit we ended up with billions of dollars and write off that in fact today  touch my agent but i think ten thousand and way too low but i would just offer this hearings about systemic risk executive comp i would just rest of my testimony that if that were really such a strong link healthy banks that are about to get out of tarp and bad banks we could look  you were incentives is that best aligned with shareholder interests i mean in some cases yes in some cases no i would i would defer to negotiations between the shareholders and the board on that issue so how can the government  shareholders of that is the shareholder proxy vote on executive compensation the way to go i think say on pay can be particularly dangerous and i also think comparisons are deceptive for a lot of reasons the structure of in the u k is very different dominated by insurance companies and private pensions much more where the u s has more retail investors with a lower voting rate and also substantially more union pension ownership so i would say it's not the right  in the previous panel mr sperling testified that the corporate community setting best practices in regard to executive compensation do you think that's the way to go i think  generally i think we've seen some great best practices promulgated by metrics great practices promulgated by the council investors and great a best practice promulgated by the u s chamber of commerce in the business roundtable when the government does it i wouldn't call it a best the two thousand six hundred i think it's too early to tell because we've only had about two years of history there and it's that i think part of the issue is just there's not enough working history to really work from and i think part of what chairmanship heroes  a similar compensation system i mean been around that long i mean how can you be so sure based on the limited history that we have and why is that metric one that we should rely on when we determine whether or not  whether or not it is or it isn't can you tell me where i'm wrong about that mr b pay plans are so pervasive they have nowhere else to go at least within the united states so they do not have the opportunity for what is called the wall street walker my next question given the shareholders ability just to be able to two thousand and six but it doesn't really cover a lot of the kinds of issues that have been revealed by the financial meltdown and you had talked before about preventing bad compensation practices really little can be done before sticky wicket this issue is i would first like to point out though that paul volcker said it very succinctly very recently when he said the financial demise that we have just witnessed is the result of executive compensation that has been linked to riskier and riskier activities and i think a number of you have pointed that in your testimony i think that we tarp you bet i think we have a role to play now what we do have a role to play in other circumstances is empowering the shareholders that's what our focus should be and i think right now the game is performance requirements for bonuses he went to his board of directors and said we want you to weigh the requirement for performance in this situation even though we just lost six billion dollars american public is onto it so my question to all of you is since you can always manipulate the system where he actually had performance will quire in place for purposes of giving directors the f c c to the best of my knowledge never brought an action against any of the directors of enron never brought an action against any of the directors to world com only brought one action against the directors of tyco and that was because the guy had taken a bribe so for the most part given the way state laws operate which are very good and quite frankly the staff this committee has been urged to take up the proposal to allow you to shareholders  reincorporation and more shareholder friendly state which is an excellent proposal by the way but for the most part until you can hold directors accountable and in this way it's a proposal just be able to throw him out you're never going to get any action because the law an assumption at least in the paper that i think is absolutely correct that the fact that the moral hazard of government bailouts means the debt tends to not be affected too much when a bank sell is a fact i think that's an absolutely safe recognized thank you mr chairman and thank you members of the panel if i interrupt please forgive me i don't mean to be rude crude on reply and what i'm trying to make a point let me start by asking about the executives in the u k do they in the main make more than executives in the united states no executives in germany do they in the main make more than executives in the united states executives in france who they in the main make more than executives in the united states the question becomes this to those who contend that if we do anything to encroach upon the current system people will flee to other places and make ordinary amounts of money in other places leaving us with a brain drain the question becomes where do they go cannot accommodate the number of executives that we are talking about but the truth be told the argument is that we are going to lose them to other countries that's the argument that's being made and i'm not a proponent of trying to stifle the free market i want to see people make as much as they can but i don't want to see people drive a company into the ground and then walk away with huge bonuses there's something wrong with the american people there's something wrong with it and they're going to chastise us if we don't do something about it they really are i appreciate the notion that there are other places where people to go is what we're talking about and i think i think that there is something to try and i would like to see it done in a bipartisan way by the way i'm amenable to working with folks on the other side to try to come to some sensible center on this so that we can have bipartisan legislation but i that those workers who took that cut and who were taking cut they didn't get bonuses  cut they got bread and butter cut and there's a difference and there's not a big to do about what's happening to them thank you mr chairman back the balance of my time after having the opportunity to to speak for those who are not train slowed down for them a little bit but it's still rolling and i think that people find it frustrating and rightfully so what i'm worried about is that this don't go far enough because what they do is they say you don't get ideas i totally agree with you about the prostration and there needs to be accountability i think the f c c and their announcement just in the last week about countrywide and going after them is exactly what we're looking for i think there's also been process is important in this country and we don't want to run into cowboy justice but where due process is these people ought to be barred in the f c c has the authority to bar those people from ever being a director again and they haven't had a good track record  literally to destruction of a multi billion dollar institution how should we treat people like that not people who filed false statements with the government but people who destroy their companies and right now maintain control those companies only at the benefit only through the largest of the taxpayers what should we do with those people when you when you pass the sarbanes oxley act already to find that when they look at directors or officers and find that they're substantially unfit to fill those roles  they can borrow forever from serving in those roles at a public company and i think in some of the instances of these companies we're going to find that some of these directors are in fact substantially unfit to fulfill that role haven't demonstrated the fitness ability and the should forever bar them from being an officer director of another public company what do you think we should do in a situation where somebody who has a bank or a group of people who had a bank run the yet you could furnish your answer for the record and we could all thank you i would point out that criminal law can't be ex post facto but as i believe mr turner pointed out we can ban some of these people from ever serving on the board of a publicly traded corporation again we might also look at the civil law to see whether those whose actions have cost us perhaps seven hundred billion dollars perhaps less would be liable to the federal government ex post facto criminal laws much more constrained by the constitution i would think that wall street itself would keep some of these people off the boards except i could see some of them saying well these folks didn't show remarkably bad financial judgment they showed tremendous political skill they separated the taxpayers from seven hundred billion dollars of assets now nobody's moving to london let alone tokyo to make more money or very few are is there any economic theory that would say that if ten percent of the executives who work for publicly traded  banks then found themselves at the hedge funds that that would mean a diminution in the quality of financial management in this country a slight change in talent moving in this leaves the hedge funds whereas my understanding that for the most part you do have an incentive to take enormous risks that is i mean there's a lot of talk about well if the investment does well the management should do well if the investment goes poorly the management should do poorly i know of no hedge fund that structured it if they lose money the management writes a check out of their own pocket to the r is the typical structure of a hedge fund one that encourages excess risk by typical structure i mean one where the management puts in the one of its own money shares only in the profits has no real compensation except for the profits and in some cases doesn't share in till a five or ten percent rate of return is achieved and if are some of these hedge my next question is a fight between management and insurgent shareholders a fair fight or is it more like election in the venezuela do the minority shareholders right to go for that claw back and in that manner either the board can ask for the claw back and get it back or if they don't the board shareholders can someone on to go get that money back i think this goes to the disclosure issue  is that concentration of the proxy advisory firm has caused sort of a one size fits all solution to take hold in pay and i think it's better to have a flexible approach that compensation committees should have the if even if you do a vote sometimes negotiations happen overnight with respect to negotiating mergers and acquisitions and i think those sorts of agreements are very important sometimes they have to be approved very very quickly not in time to do s