WASHINGTON—The federal government's move to sharply cut compensation for a dozen American International Group Inc. executives could create more complications for the embattled company, some observers say.

The special master for executive compensation unveiled the plan last week to cut top-level salaries of targeted firms—including AIG—that received “exceptional assistance” from the government's Troubled Asset Relief Program.

Some experts said the move will hurt retention and recruitment at New York-based AIG. But others said the announcement came as little surprise, and noted that those executives who were likely to leave the company already were gone.

In a letter sent last week to AIG President and Chief Executive Officer Robert Benmosche, Special Master for TARP Executive Compensation Kenneth Feinberg said base salary paid in cash to top executives covered by the plan should “not exceed $500,000 per year” under most circumstances.

“In AIG's case, cash compensation for these employees will decrease 91% from 2008 levels,” Mr. Feinberg wrote. Although the changes affect only compensation for the rest of 2009, they will be used as the basis of a compensation review for 2010, he said.

Instead of cash, the majority of each individual's base salary will be paid in stock units “reflecting the value of a "basket' of four AIG insurance subsidiaries” to be determined through an analysis of their operations, according to the letter. The subsidiaries are American International Assurance Co. Ltd., American Life Insurance Co., Chartis Inc. and AIG Domestic Life & Retirement Services Group.

The letter said the pay restrictions are designed to encourage employees to stay at AIG and “to maximize the value of the businesses most important to its long-term stability while avoiding incentives for unnecessary risk-taking.”

Affected employees also could be eligible for long-term incentive awards via restricted stock. Other compensation and prerequisites would be limited to $25,000 per year under most circumstances.

Employees of AIG Financial Products Corp., which has been blamed for risky investments that brought AIG to the brink of collapse in September 2008, will receive only cash salary through the end of this year. Those who pledged to return previous retention awards have been told repay them immediately.

At a Treasury Department news conference last week, Mr. Feinberg noted that the restrictions do not apply to Mr. Benmosche, for whom the special master earlier this month approved a $10.5 million salary and stock package.

At the news conference, Mr. Feinberg said he did not know whether any executives of Chartis were among the dozen covered executives. AIG has moved to separate its commercial insurance operations into a special-purpose vehicle under the Chartis brand, in preparation for a partial or full spinoff.

However, in a filing with the Securities and Exchange Commission late Friday, AIG noted that it is paying previously agreed bonuses for executives totaling $12.1 million, including $1.6 million to Chartis President and Chief Executive Officer Kristian P. Moor, whom the filing calls a “Covered Employee.” These payments have been approved by Mr. Feinberg.

AIG, which has 30 days in which to request that the special master reconsider his determinations, was one of seven entities subject to the compensation review by the special master under the amended Emergency Economic Stabilization Act of 2008.

The special master was charged with reviewing compensation of the top five executives of each entity and the next 20 highest-paid employees of the firms.

The report noted that 13 AIG employees who would have been covered have left the company.

Claudia H. Allen, a partner with law firm Neal Gerber & Eisenberg L.L.P. in Chicago, said there is a “mix of politics and economics” here. “The question is: Is this really going to facilitate” the company being able to repay its loan?

The move may make retention of top executives more difficult, said John R. Cornell, a partner with law firm Jones Day in New York. “They may have problems retaining some of the key people that they would wish to retain, especially to the extent they would have other opportunities.”

It may also make recruitment difficult “if you're recruiting people at the level being reviewed by the special master,” Mr. Cornell said.

“They're going to have people that are not going to join, that might otherwise have joined, so you're locking in the people that brought you here in the first place, to a certain extent,” said Bill Bergman, an analyst with Morningstar Inc. in Chicago.

Others say the top-level pay cuts will have relatively little effect.

“They've been pounding AIG pretty hard now for some time, and having this pay cut should not be a surprise to anyone,” said Richard V. Smith, senior vp at Sibson Consulting in New York. Those who could move to a competing organization that would pay them their previous salaries “are probably already gone. I think the ones still there are probably going to stay and will work through this,” he said.

John A. Challenger, CEO of executive recruiter Challenger, Gray & Christmas Inc. in Chicago, said: “My guess is that most of the people have said, "I'm willing to live with it. It's a very tough job environment. There's an immense amount of work to do, and I'm in it for the long haul if they'll have me.'”

Anyone recruited by AIG “knows that they're getting into a difficult situation,” Mr. Challenger said.

The executive pay cut is only a short-term issue, said Catherine M. Marriott, chair of the employee benefits section at law firm Williams Mullen in Richmond, Va.

“In the long term, if the company is able to thrive, their pay structure and compensation will be governed by just general corporate governance, as opposed to the government imposing pay limits,” Ms. Marriott said.