Failed chief executive Sir Fred Goodwin could have been awarded just half of the £16m pension pot he was given by Royal Bank of Scotland (RBS), the body in charge of managing the taxpayers' stake in the part-nationalised bank said today.
The controversial pension award was "partly discretionary", UK Financial Investments (UKFI) chief executive John Kingman told MPs.
He said the decision was taken by the RBS board, although the Government was aware of the size of the package.
Until last month, UKFI and the Government were under the impression that it was an unavoidable legal commitment.
Giving evidence to the Treasury Select Committee, Mr Kingman described the pension award as "extraordinary" and said UKFI was exploring all legal avenues to redress the situation.
"The reason it's discretionary is that his entitlement to an undiscounted pension from the age of 50 stemmed from a decision of RBS that he should be treated as retiring at the request of the employer," he said.
"Had those concerned decided instead simply to terminate the contract, as RBS could have chosen to do with 12 months' notice, the right to an undiscounted pension would not have applied.
"The consequence of this decision was roughly to double the value of Fred Goodwin's pension pot.
"UKFI immediately took legal advice because this decision does seem extraordinary and it remains unexplained."
Mr Kingman said UKFI, which manages the state's interests in all of the bailed-out banks, was investigating whether the RBS board had "full knowledge of the alternatives" when it granted Sir Fred his pension last year.
He added that there was evidence the Government had repeatedly told RBS there should be "no rewards for failure".
"I understand that the Government was informed at the time of the rough size of the pension pot that resulted from the decision," he said.
"What the Government was not told was that this payment was in any way discretionary."
He added: "Our view is that criticism should be redirected at those who took the decision.
"The decision was clearly taken by RBS, it was not approved or endorsed by the Government, but the Government was informed of the size of the pension pot."
He stressed that the RBS could have terminated Sir Fred's contract with 12 months' notice.
"Plainly the cost of that would have been a good deal less than the pension outcome that we now know followed from their decision and I think that is the crucial point," he added.
Mr Kingman and UKFI chairman Glen Moreno were strongly criticised by committee chairman John McFall at the start of the meeting for failing to provide details of remuneration and bonuses at Treasury-backed banks.
The committee had requested the information in advance on Friday, but Mr Moreno said today that he did not have it to hand for MPs.
Mr McFall said the committee was "appalled", adding: "I think that's scandalous, to be honest with you."
Sir Fred's pension deal was strongly criticised by Mr Moreno, who told the committee: "I regard this completely as reward for failure, what in America is called a 'golden parachute'. I think it is wrong."
Mr Kingman said the Government and UKFI had learned only on February 19 that part of the pension award was discretionary - four months after it was approved by RBS.
"The impression received by the Government, consistent with the principles that the Government had stressed, was that this was an unavoidable legal commitment," he said.
He said the two "key decision-makers" at RBS were the then chairman, Sir Tom McKillop, and the then chairman of the remuneration committee, Bob Scott.
Mr Kingman defended the role of City Minister Lord Myners, who was involved in the discussions with RBS during the bank bail-out in October, insisting that he was not in a position to block Sir Fred's pension deal.
"I don't see how he could have prevented it when he wasn't told very material facts that, clearly, he ought to have been told," he said.
"I don't think it is reasonable to have expected Lord Myners to have had sufficient detailed understanding of the rules of the RBS pension scheme to have known that the board was not sharing material facts."
But Michael Fallon, the senior Tory on the committee, said it appeared to be the result of either "a nod and a wink, banker-to-banker deal between Lord Myners and Fred Goodwin" or "sheer blundering incompetence".
According to Miller McLean, group general counsel and group secretary at RBS, Mr Scott "summarised" Sir Fred's pension terms for Lord Myners on 12 October last year, emphasising that it would be a "substantial figure".
While there were other discussions about Sir Fred's package, RBS does not believe there was any further discussion of his pension terms.
"The company has no record of whether any specific questions were raised about the pension terms by Lord Myners," Mr McLean wrote in evidence to the Treasury committee.
He said Sir Fred's pension was now valued at £703,000 a year - higher than previously thought.
Had he been dismissed and not granted the terms he was, he would be getting £416,000 a year, Mr McLean said.
If RBS had gone into administration, he added, one possibility would have been that the group pension fund would have been underfunded and so payments would have come out of the statutory Pension Protection Fund.
Such payments would have been capped at £27,770.72, Mr McLean said.
Mr Kingman said UKFI was continuing to take legal advice on whether it was possible to recover any of Sir Fred's pension.
"We are exploring every legal avenue that might provide any form or recourse in this situation," he said.
"We intend to take any opportunity to act. It would either be for us to act or the board of RBS to act. That is a very live issue."
Mr Kingman, a Treasury civil servant, previously chaired the Tripartite Committee - made up of the Treasury, the Bank of England and the Financial Services Authority - which was set up by Gordon Brown when he was Chancellor to ensure financial stability.
Pressed by MPs on the committee, he acknowledged that it had not been a "full success".
"I think the lessons that have emerged around the tripartite have been around its performance under stress in crisis conditions," he said.
"There probably are also lessons about the extent to which regulators, the Bank and the Treasury successfully anticipated problems. I am certainly not going to say that the Tripartite successfully identified every problem that might arise. It clearly did not.
"I would say it achieved a lot. Was it a full success? Plainly not."
Mr Moreno defended his own involvement with a Liechtenstein trust facing accusations of tax evasion. He said he assumed ministers had been aware of his links when he was appointed.
"It is a public fact, whatever people think of it. I don't intend to hide it," he said.
Following the announcement last month that he would not be seeking to make his position a chairman permanent, he said he had always intended that it would only be a temporary appointment.