Kenneth Feinberg, the special master for Troubled Asset Relief Program executive compensation, has imposed strict salary and benefits package value caps on employees “26 through 100″ at American International Group Inc.

Feinberg, who set compensation levels for the top 25 executives at AIG, New York, (NYSE:AIG) and other “exceptional assistance recipient” companies in October, was supposed to set actual compensation levels for the top 25 executives at the companies and simply establish compensation structures for employees 26 through 100, according to U.S. Treasury Department officials.

Officials say Feinberg applied the following principles when establishing the compensation structures:

  • Reforming compensation to protect long-term value creation and financial stability, in part by requiring that a majority of pay be held over 3 years.
  • Restricting the use of short-term cash compensation, with most cash salaries capped at $500,000 per year, and at least 55% of the pay being made in the form of company stock.
  • Forbidding incentive compensation without real achievement of objective goals, and making all incentive pay subject to “clawback” if results prove illusory.
  • Ending pay practices that are not aligned with shareholder and taxpayer interests, such as “gold-plated executive severance and retirement pay.”

At AIG, cash salaries must be capped at $500,000, cash can account for only 45% of total compensation, half of compensation must be difficult to transfer for 3 years, and “each covered employee will be prohibited from engaging in any hedging, derivative or other transactions that have an equivalent economic effect that would undermine the long-term performance incentives created by the compensation structures,” Feinberg writes in a letter to AIG President Robert Benmosche.

AIG itself proposed that cash salary would account for about 40% of each affected employee’s total compensation, that the “Covered Employees” also would get short-term bonuses, and that AIG stock would represent the single largest component of total compensation.

“AIG also proposed that certain Covered Employees receive substantial cash amounts pursuant to previously existing retention contracts,” Treasury officials write in an appendix accompanying Feinberg’s letter. “AIG argued that these amounts were due under agreements providing for legally binding rights under valid written employment contracts…and thus were not subject to the review of the Special Master.”

Feinberg decided that AIG’s proposal was inconsistent with the public interest standard that he is supposed to apply.

In addition to getting the majority of compensation in the form of company stock, at least 50% of the compensation should be in a form that is not transferable for at least 3 years, officials write.

At other “exceptional assistance recipient companies,” Feinberg was able to arrange for the restructuring of “legally binding rights under valid employment contracts,” officials add.

Feinberg has decided that, because of the unique circumstances at AIG and the critical nature of some of the employees in slots 26 through 100, restructuring of those critical employees’ contracts “would not be consistent with the Public Interest Standard,” officials write. “Instead, the Special Master has reduced the maximum allowable percentage of the cash component of total compensation in all cases in which a Covered Employee 26-100 receives a payment pursuant to these contracts.”

In addition, AIG cannot provide a non-qualified deferred compensation plan, because plan performance would not depend on the performance of AIG or a company unit, officials write.

Employees 26-100 “should fund their retirements using wealth accumulated based on Company performance while they are employed rather than being guaranteed substantial retirement benefits by the Company regardless of Company performance during and after their tenures,” officials write.

AIG has 30 days to ask Feinberg to reconsider the compensation determinations.