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Corporate Governance

: The Race to the Bottom

Governance and the Government's Purchase of Equity (Part 1)

By J. Robert Brown

As we have noted, Treasury has led the charge to require Sovereign Wealth Funds (government investment funds) to adopt standards designed to promote good corporate governance and transparency.  Will Treasury live up to these standards?

Treasury plans to invest some $250 billion in the form of equity, with half invested in the largest financial institutions.  According to the New York Times, Treasury planned the following investments:  

• Citigroup and JP Morgan Chase were told they would each get $25 billion; Bank of America and Wells Fargo, $20 billion each (plus an additional $5 billion for their recent acquisitions); Goldman Sachs and Morgan Stanley, $10 billion each, with Bank of New York Mellon and State Street each receiving $2 to 3 billion. Wells Fargo will get $5 billion for its acquisition of Wachovia, and Bank of America the same for amount for its purchase of Merrill Lynch.

 

The investment will be in the form of preferred stock with a 5% dividend, a dividend that would increase to 9% after five years.  In addition, there will apparently be a provision for warrants to buy common stock.

All of the largest banks were essentially required to participate.  Senator Schumer explained the reasons for the approach in an editorial in the WSJ:

• Direct injections of capital will encourage all institutions to lend again. But because depositors and creditors may interpret an injection of government capital as a sign of weakness, we need to start by persuading a substantial cross section of major banks, even those in relatively good health, to accept capital. Widespread bank participation will reduce the risk that depositors may flee or that other institutions will refuse to do business with banks that accept or request public capital.
  

Not all of the banks were, apparently, happy with the required participation.  Perhaps this was because of the accompanying restrictions.  The banks were told that they would be prohibited from increasing dividends (absent government approval).  Henry Paulson, Secretary of the Treasury, also announced limitations on executive compensation, "including a clawback provision and a ban on golden parachutes during the period that Treasury holds equity issued through this program." 

It's not much, the limitations on executive compensation.  But the limitations will apply, apparently, to the largest financial institutions in the country since they will all be receiving investments from the government.  This in turn will likely affect the compensation practices beyond those legally obligated to conform to the limitation.  Ultimately, the limitations will demonstrate that the only way to reduce the excessive escalation of executive compensation is to take the matter away from Delaware and, in its place, impose federal limitations.  We will discuss these limits in one additional post.

Full post as published by The Race to the Bottom on October 14, 2008 (boomark / email).