At the start of the month, President Obama was proudly proclaiming an expansion on the existing rules restricting executive compensation for TARP firms:
President Obama is having his say on soaring executive pay. New rules unveiled Wednesday morning will cap annual cash compensation for executives at firms receiving future government aid at $500,000.
The guidelines prohibit payments above the $500,000 threshold in anything but company shares that must be held until the government's investment has been repaid.
The rules will apply foremost to companies that receive so-called exceptional aid from the government in the future. ...
Current rules bar such companies from taking a tax deduction for compensation above half a million dollars, but don't restrict how much executives can receive in salary and bonuses. In addition, the new rules will increase the bans on so-called golden parachute severance packages available for executives.
Good for the taxpayer? Maybe. Good for shareholders of TARP firms? Not according to a recent study by a Drexel finance professor:
Using 256 TARP recipients as a sample, I find that markets are mostly negatively reacting for the news on limiting the executive compensations. Although investors react quite positively for the initial announcement on the TARP on October 14, 2008, other announcements regarding compensation regulation including strict $500,000 salary cap are perceived as bad news in the market. The results is more supportive for the managerial talent hypothesis, which implies that investors concern for losing their talented executives due to the upper limit of the salary. Splitting the sample by various possible determinants for the CARs, I also find that firm size as well as financial performance is an important factor to decide the level of abnormal returns. In conclusion, shareholders for larger and better performed firms concern more for imposing the salary cap for the TARP firms, which is also the evidence of managerial talent hypothesis.
In other words, investors are worried that the pay caps are going to chase the best executives off to places like hedge funds where they can earn way more than $500K.
