Realizing that executive pay has a lot to do with executive retention, the US government’ pay czar has approved a compensation package worth nearly $5 million for a top executive at AIG.

A top executive of American International Group has been granted a $4.3 million pay-package bump by the troubled insurance giant’s majority owner — the U.S. government — because the executive has decided to remain with the company. Kenneth Feinberg, the Obama administration’s pay czar, approved an AIG request to grant the executive a long-term compensation package that includes stock options with a current value of $3.26 million and an additional incentive award of up to $1 million. The package comes on top of the executive’s 2009 base salary of $450,000… The executive had been planning to leave the company and had not been granted long-term compensation benefits.

While many people have criticized executive pay, and despite government intrusion in such decisions for bailed out companies, the market typically drives such decisions. In this case, the executive in questions would have left AIG, and tekne his expertise with him, unless he was given comparable pay. The free market still works, even in the face of government meddling.