Will Managers Be More Careful if They Have Skin in the Game?

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Jeffrey Johnson is a legal writer with a focus on personal injury. He has worked on personal injury and sovereign immunity litigation in addition to experience in family, estate, and criminal law. He earned a J.D. from the University of Baltimore and has worked in legal offices and non-profits in Maryland, Texas, and North Carolina. He has also earned an MFA in screenwriting from Chapman Univer...

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UPDATED: Apr 2, 2015

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Businessman in Suit and TieAs reported by the New York Times, when big companies are required to pay civil penalties to the government, those fines are usually paid by the company’s shareholders. The managers who actually performed, ordered, supervised, or ignored the acts at issue rarely pay anything.

Economists call this a “perverse incentive.” Managers are encouraged to take big risks – including the risk of civil penalties – because if they get away with it they can benefit financially in the form of bonuses based on the company’s performance. If they don’t get away with it, most often they won’t face jail time or the loss of their own personal funds.

This is great for executives, but not so good for the companies that they manage, the shareholders, or the public at large.

Payback Time?

A paper in the Michigan State Journal of Business and Securities Law entitled “Ties That Bind: Codes of Conduct That Require Automatic Reductions to the Pay of Directors, Officers, and Their Advisors for Failures of Corporate Governance” suggests that top executives should be required to sign a contract that penalizes them if the company is fined.

The author, Greg Zipes, a trial lawyer for the Office of the United States Trustee, proposes that executives would have to pay back 25% of their compensation for the three years before the wrongdoing began. This would be the case whether or not the executives actually knew about the acts that happened during their watch.

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Citigroup Proposal

Another proposal will be put to the shareholders of Citigroup at this year’s annual meeting.

The proposal is being put forward by Bartlett Naylor of the nonprofit group Public Citizen in the wake of a $7 billion settlement between Citigroup and the US Justice Department last July.

That settlement related to Citigroup’s conduct in the packaging, securitization, marketing, sale and issuance of residential mortgage-backed securities.”

According to the Department of Justice press release,

As part of the settlement, Citigroup acknowledged it made serious misrepresentations to the public – including the investing public – about the mortgage loans it securitized in RMBS. The resolution also requires Citigroup to provide relief to underwater homeowners, distressed borrowers and affected communities through a variety of means including financing affordable rental housing developments for low-income families in high-cost areas. The settlement does not absolve Citigroup or its employees from facing any possible criminal charges.

Naylor’s proposal would require Citigroup executives to contribute a substantial portion of their pay each year into a pool that could be used to pay civil penalties. The money would need to stay in the pool for 10 years.

The money in the pool could be used even if the executives contributing to it were not directly responsible for the wrongdoing that led to the penalty.

According to Naylor,

Bank managers are paid to keep a bank compliant with the law. When the bank is not compliant, those managers should be held accountable. Docking their paycheck is one way to do that.

Citibank shareholders will vote on the proposal on April 28.

If you have questions about corporate compliance or governance, you may wish to consult a corporate law attorney.

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