How much should Goldman pay its CEO?

(breakingviews.com) -- How much should Goldman Sachs pay Lloyd Blankfein?

A year after the investment bank's chief -- and virtually all his peers -- received what for them was a relative pittance, it's the big question on Wall Street. And so it should be.

Compensation for the head of the industry's top money-maker will set a new benchmark. That gives Goldman's directors a golden opportunity to show that the firm is less out of touch than critics suggest.

The first, and hopefully most obvious, step in deciding Blankfein's take -- which will also set standards for Goldman's other top executives -- is to throw out bubble-year pay precedents, and any spurious calculations that produced them.

Take the 0.6% of net income Blankfein was paid in 2007. Based on Goldman's expected net income this year, he would be in line for a 2009 payday of around $64 million, only just shy of the bumper $68 million he received two years ago. That would provoke justifiable uproar.

Yet back in 2007, Goldman (GS, Fortune 500) was far from the most egregious in setting executive pay. As a proportion of earnings, Blankfein's 2007 haul was just half what Lehman Brothers handed Dick Fuld. A year earlier, of the major investment bank bosses only Morgan Stanley's (MS, Fortune 500) John Mack received less, some 0.5% of profits. Bear Stearns' chummy board, meanwhile, awarded chief executive Jimmy Cayne a whopping 1.9 cents for every dollar the bank made the year before it effectively went bust.

The better paid of the bunch on this metric presided over some of the biggest failures of the past two years. It's ironic that, at the time, one argument for paying the likes of Fuld and Cayne more handsomely than rivals was that they had been in the job for more than a decade and were responsible for safely navigating their firms through a variety of crises as well as for recent growth.

Those and other justifications for towering paychecks proved false. The credit crisis of 2008 exposed deep flaws in a business where investment banks magnified returns with short-term debt financing. When that funding dried up, a taxpayer-funded relief effort was needed to prevent the industry from collapsing.

The recent history explains why Blankfein's pay this year is even more of a yardstick than usual for the industry. Not only is Goldman cranking out more money and better returns than any other firm, but changes of leadership at most rivals have made him one of the industry's elder statesmen -- just three years into the job. It'll be tough for others to justify paying chiefs more by almost any metric.

Figuring out the right level of pay is hard, though. For starters, while Goldman is on course to earn almost $11 billion this year, it has done so in part on the back of myriad taxpayer sponsored and funded programs to kick start capital markets.

Goldman still seems reluctant to admit that it, too, would have fared poorly without the government's intervention. But the continuing backlash over the nearly $20 billion in compensation and benefits the firm is expected to accrue through the year may tempt its board to keep Blankfein's pay in the single-digit millions to avoid public censure.

That, however, would be a flawed strategy. Firstly, it's not clear that critics of Wall Street and executive pay would oppose a $9 million payout any less than one twice as large.

And more to the point, Blankfein genuinely deserves to be rewarded for managing the firm through the worst crisis in decades. That's worth more than the $11 million or so average payout of an S&P 500 boss -- and a premium to the $9 million that Robert Benmosche is to receive for running government-owned AIG (AIG, Fortune 500) is certainly justified, too.

The right number may be somewhere around $20 million. And in a nod to concerns about limiting short-term incentives, Goldman could pay 90% of that in stock -- compared with 60% in 2007.

At a time of high unemployment, and after significant government assistance in bailing out the capital markets, even that may seem too generous. But it would be far less than boom-time bonanzas, and at 0.2% of earnings would set a more reasonable ceiling for Goldman's less profitable peers.