Pay versus Performance in TARP Recipient Firms

ABSTRACT Short-term incentives and excessive risk-taking that stem from executive compensation policies have contributed to the current financial crises which began in 2007 with the Bear Stearns financial woes (Kropp, 2009; Sloan, 2009). The U.S. government has been proactive in creating a stimulus package of unprecedented proportions, andas of June, 2009 there were 613 companies participating in the Troubled Asset Relief Program (TARP). The purpose of this paper is to analyze top TARP recipient firms to test whether compensation in these stressed companies is associated with performance measures. The prediction is that these companies will exhibit an increasing relationship between pay and performance from 2006 to 2008. Results indicate that performance measures are not significantly associated with Chief Executive Officer (CEO) compensation in 2006, butin 2007 stock returns, EPS, andreturn on equity are significantly associated with CEO total compensation. This implies that pay is linked with performance in 2007, which coincides with the SEC 's enhanced executive compensation disclosure requirements. In 2008, several performance measures are significantly associated with total CEO compensation, but unpredicted negative coefficients confirm prior research that earnings-related fundamentals are not useful in explaining compensation in loss years (Jackson, Lopez & Reitenga, 2008), even for these companies regulated by TARP. INTRODUCTION There has been much discussion in the business press about executive compensation and its alignment to performance and risk-taking, especially since many U.S. companies have received bailout funds from taxpayers (Benjamin & Goldman, 2009). It is widely believed that short-term incentives which stem from executive compensation policies have contributed to the current financial crisis, which began in June, 2007 with the meltdown of two Bear Stearns' hedge funds that speculated in mortgage-backed securities (Sloan 2009; Kropp, 2009). Numerous legislative packages passed by the U. S. Congress in a relatively short period of time have brought unprecedented amounts of bailout money to troubled U.S. companies. Included in the stimulus package totaling $12.2 trillion is the Troubled Asset Relief Program (TARP) which commits up to $700 billion for investment in companies in exchange for preferred stock which is held by the U.S. Treasury. Agency theory states that management should act in the interest of stakeholders, but according to Arthur Levitt (2005), America has seen the" breakdown of corporate governance and buildup in greed" which has compromised the fiduciary relationship between management and stakeholders. Huge executive pay "undermines corporate governance," since management becomes focused on short-term goals rather than the long-term interest of stakeholders (Levitt, 2005). Dating back to Enron's bankruptcy, we have seen Chief Executive Officers (CEO's) walk away with millions, leaving behind shareholders, debt holders, and employee retirement funds in shambles. In response, we now have an increased number of shareholder proposals, new disclosure rules from the SEC (2006) and enhanced limits on executive compensation under TARP, all reflecting the general public's interest in the pay versus performance debate. The purpose of this paper is to analyze top TARP recipients in order to test whether CEO compensation in these troubled companies is associated with performance measures during the period from 2006 through 2008. I extend prior executive compensation research to analyze total compensation in stressed companies. I test to see whether recent SEC executive compensation disclosure rules and the stringent limits of executive compensation under TARP have increased the relationship between pay and performance. Results indicate that performance measures are not significantly associated with CEO compensation in 2006, but in 2007 stock returns, EPS, and return on equity are significantly associated with CEO total compensation. …