Geithner's statement on compensation.

From: U.S. Department of the Treasury subscriptions@subscriptions.treas.gov
Date: Wed, 10 Jun 2009 11:40:09 -0500 (CDT)
Subject: Statement by Treasury Secretary Tim Geithner on Compensation

Statement by Treasury Secretary Tim Geithner on Compensation

June 10, 2009
TG-163

Statement by Treasury Secretary Tim Geithner on Compensation

WASHINGTON – Our financial system is built on trust and confidence. It requires rules and practices that encourage sound risk management and align the benefits for market participants with long-term growth and value creation – not only at individual firms, but for our financial system and the economy as a whole.

This financial crisis had many significant causes, but executive compensation practices were a contributing factor. Incentives for short-term gains overwhelmed the checks and balances meant to mitigate against the risk of excess leverage.

Today, I met with SEC Chairwoman Mary Schapiro, Federal Reserve Governor Dan Tarullo, and top experts to examine how we can better align compensation practices – particularly in the financial sector – with sound risk management and long-term growth.

In considering these reforms, we start with a set of broad-based principles that – with the help of experts like those we assembled today – we expect to evolve over time. By outlining these principles now, we begin the process of bringing compensation practices more tightly in line with the interests of shareholders and reinforcing the stability of firms and the financial system.

First, compensation plans should properly measure and reward performance.

Compensation should be tied to performance in order to link the incentives of executives and other employees with long-term value creation. Incentive-based pay can be undermined by compensation practices that set the performance bar too low, or that rely on benchmarks that trigger bonuses even when a firm's performance is subpar relative to its peers.

To align with long-term value creation, performance based-pay should be conditioned on a wide range of internal and external metrics, not just stock price. Various measurements can be used to distinguish a firm's results relative to its peers, while taking into account the performance of an individual, a particular business unit and the firm at large.

Second, compensation should be structured to account for the time horizon of risks.

Some of the decisions that contributed to this crisis occurred when people were able to earn immediate gains without their compensation reflecting the long-term risks they were taking for their companies and their shareholders. Financial firms, in particular, developed and sold complex financial instruments that yielded large gains in the short-term, but still presented the risk of major losses.

Companies should seek to pay top executives in ways that are tightly aligned with the long-term value and soundness of the firm. Asking executives to hold stock for a longer period of time may be the most effective means of doing this, but directors and experts should have the flexibility to determine how best to align incentives in different settings and industries. Compensation conditioned on longer-term performance will automatically lose value if positive results one year are followed by poor performance in another, obviating the need for explicit clawbacks. In addition, firms should carefully consider how incentives that match the time horizon of risks can extend beyond top executives to those involved at different levels in designing, selling and packaging both simple and complex financial instruments.