At the beginning, the salary paid for the executive. But the money dripping in each month proved insufficient. Something more was needed for him to throw himself into his work and conduct business responsibly. In the United States, variable compensation policies hark back to the late 1890s, a century after the inauguration of the New York Stock Exchange. Controlling shareholders of public companies began to settle into administration boards and delegate management to specialized professionals. However, this alliance generated some disagreements. It was necessary to make employees feel like they owned the place. One of the first to grant long-term incentives by compensating employees with stocks was DuPont. The idea took hold, and other companies decided to create variations on the theme. Cash bonuses, stock options, bonuses divided into yearly installments, options with yearly vesting blocks appeared. There was no lack of creativity by human resources consultancies, or of criticism for the dimensions achieved by such compensation programs.

Nevertheless, the current crisis proves that the controversy surrounding executive income is far from over. It is part of the US$ 700 billion lifesaver package approved in the U.S. in September. This is not the first time that these gains have been treated as a State matter. With the “smartest guys in the room” scandal surrounding Enron and other companies, the subject came to the fore once again. Executives were being tempted to mask balance sheets in order to inflate their bonuses, thought the legislator. The Sarbanes-Oxley Act of 2002 forbade loans made by companies to their administrators and demanded more internal controls on the accuracy of disclosed accounting information. Now, the Emergency Economic Stabilization Act of 2008 seeks to restrict the financial gains of executives of companies aided by the fund, in three basic ways.

The first generically forbids compensations that encourage senior executives to take “unnecessary and excessive risks”. The other allows rescued institutions to take back the bonuses given out, based on provenly incorrect financial information (the clause known as “clawback”). The third keeps the company from paying any compensation for severance (“golden parachute”) while the Treasury is one of its investors. Companies that receive more than US$ 300 million will also lose the possibility of deducting salaries above US$ 500 thousand per year from their income tax.

POLITICAL MOBILIZATION – The Washington initiative caught the attention of people like Timothy Smith, manager of socially responsible investment at Walden Asset Management, in Boston. Smith has been one of the most engaged investors in the project transforming “say on pay”, the acclaimed right of shareholders to decide on the compensation of their companies’ executives, into law. He believes that this is a sign that the revindication will be listened to more attentively. The theme is also part of Democratic presidential candidate, Senator Barack Obama’s agenda. Like his Republican rival John McCain, Obama has spared no criticism in condemning sky-high salaries, echoing the people’s indignation. “Clearly, compensation was included in the debate because the average citizen got angry at executives getting away with fat earnings”, said Smith in the RiskMetrics group blog, one of the best indicators for corporate governance-related subjects.

Data from two non-governmental organizations, the Institute for Policy Studies and United for a Fair Economy, suggest how deep the dissatisfaction really is. In 2007, CEOs of companies that compose the S&P 500 index pocketed US$ 10.5 million on average, which is 344 times more than a typical U.S. worker. Illustrating this, at the turn of the 19th into the 20th century, J. P. Morgan limited CEO compensation to an innocent 20 times the average income of their workers, not including dividends. Richard Fuld, CEO of the now-extinct Lehman Brothers bank in 2007, reached the US$ 72 billion mark while he was at the institution, placing him 11th place on the Forbes’ highest-paid ranking list. All of this, by the way, in a cost reduction scenario brought about by the subprime crisis.

Fair or not, the fact is that the increase in executive compensation in U.S. corporations gathered momentum from the 1980s onward. In 1983, with Dow Jones at 1,258 points, Business Week magazine reported that each of the 25 highest-paid CEOs in the country made US$ 1 million a year in total earnings. After Dow Jones reached its 11,273 point peak in 2000, the same publication revealed that seven CEOs made more than US$ 100 million. It’s very likely that a large part of such gains came from stock options exercised at the height of the dot-com bubble. That’s what Bruce R. Ellig reports in his article The evolution of executive pay in the United States, in which he lists the numerous and creative forms of salary incentives that appeared over time.

Ellig, former vice-president responsible for human resources management at pharmaceutical company Pfizer, acknowledges that the excessive salaries of large company heavyweights have always been controversial. In this 2006 article, when only intractable pessimists foresaw the chaotic bursting of a different bubble – real estate –, he went out on a limb and said that further regulation on the theme was on its way. “We can almost guarantee that, if a significantly negative public reaction does not eliminate the problem, either the law or regulation will try to correct it”, he wrote. To a certain extent, Ellig was right.

While still in his first term, in 1993, as the president of the United States, Bill Clinton also tried to flatten the fantastic gains of corporate America’s representatives. He achieved the approval of a tax law by which any amount paid above US$ 1 million must be tied to performance in order to become income tax-deductible. The measure did not have the expected effect. Instead of reducing compensation, the companies beefed up their stock option packages.

In a recent chat with Late Show host, David Letterman, Clinton reaffirmed his theory, this time specifically targeting Wall Street bankers. He described, in very simple terms, how the situation became so dire. After the dot-com bubble burst, the low interest rate practiced by the Federal Reserve (Fed) spewed liquidity into the market. But, in Clinton’s view, the Bush administration did not make an effort to create opportunities for investment in the real economy. Attentions were focused on the real estate segment, which became the American GDP’s driving force in the past few years. Because the chance to multiply their money was there, bankers perfected the art of selling mortgages. They created mortgage backed securities with an extremely high nonpayment risk. They knew how dangerous these assets were, but what they were really concerned with were the returns. Especially because a generous percentage of those returns would go directly into their pockets, Clinton stressed.

TOO MANY INCENTIVES – Specialists agree that variable compensation policies were never as aggressive as today, and they only increase in relevance and propagation. A Hay Group survey points out that, in 2007, of the 200 largest American companies with earnings above US$ 5 billion, 129 were using performance assessment plans to compensate their CEOs, 5% more than in 2006. This doesn’t take place only abroad. In Brazil, according to a survey of 323 companies by Mercer, executive bonuses grew 8% to 9% and CEO bonuses jumped up by 20% from June 2007 to June 2008 – an average of 6 to 8 extra salaries. The targets to be beaten also rose by 6% to 10%. “The size of the risks that some executives take is obviously associated with the achievement of results”, says Pedro Pinheiro, director of the consultancy’s human capital department.

As complex as the root of the subprime crisis is, it’s undeniable that compensation packages are a part of it. The most harshly criticized systems are those that reward professionals when business goes well, but fail to punish them when the boat capsizes. According to Augusto Korps, senior partner of Stern Stewart in Brazil, many stock option programs suffer from this disease. “You win if the market rises, but you don’t lose if it falls.”

“If executives are rewarded for high risks and protected from things going wrong by contracts that will compensate them in any situation, this ends up leading to the scenario we are witnessing”, adds Paul Danos, dean of Dartmouth College’s Tuck School of Business. According to Florencio Lopez-de-Silanes, professor of finance and law and director of the governance research program at EDHEC Business School (Nice, France), companies should avoid elements that will excessively tie compensation to performance and risks. It’s not that rewards for risk are undesirable. The difficulty is in finding balance. Roy Snell, CEO of the Society of Corporate Compliance and Ethics, defends a model in which commanders of successful companies are spared. “As a way of limiting compensation, I would prefer that only executives from companies that have filed for bankruptcy take any punishment. Having to give back part of their earnings, for example.”

There are several mechanisms that aim to align the interests of shareholders and executives in the long term. Deep down, all of them aim to shrink immediate gains. However, it should be stressed that redesigning salary packages alone will not avoid new crossings of the dividing line between boldness and rashness. The crisis also exposed serious internal control and risk management issues. “The risk assessment processes of financial institutions crumbled”, says Danos. In theory, audit and governance committees should be capable of identifying companies’ vulnerable points. All of this should be re-examined carefully, warns Deloitte partner, Anselmo Bonservizzi. “The current model of reporting and accountability to the board of directors has failed.” Sidnei Ito, a KPMG partner, reminds us that Sarbanes-Oxley focused on fraud prevention. “In this aspect, it worked, for the number of frauds in the United States fell quite a lot.” It has now become clear that risk management must also undergo significant improvements, recommends the executive. This also goes for Brazil. Companies such as Agrenco, Sadia, and Aracruz have shown frailties, sometimes scandalous ones, in their cash management.

In any case, from 2002 to the present day, there were advances in company governance in general. However, Lopes-de-Silanes perceives banks to be stagnant regarding this matter. “Part of what we are seeing results from a lack of improvements to the banking industry.” Furthermore, as it is well known, the enfeebled independent investment banks were only subject to inspection by the Securities and Exchange Commission (SEC), which is much more flexible than the Fed’s surveillance, applied to other financial institutions. Placing the blame exclusively on seven-figure bonuses would be to simplify the matter, but improving vigilance over the natural temptations that lurk around the financial landscape could be a remedy.