Obama Calls for ‘Common Sense’ on Executive Pay:
resident Obama announced on Wednesday a salary cap of $500,000 for top executives at companies that receive the largest amounts of money under the $700 billion federal bailout, calling the step an expression not only of fairness but of “basic common sense.” The restrictions, however, allow an exception for restricted stock.
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“That is pretty draconian — $500,000 is not a lot of money, particularly if there is no bonus,” said James F. Reda, founder and managing director of James F. Reda & Associates, a compensation consulting firm. “And you know these companies that are in trouble are not going to pay much of an annual dividend.”
Mr. Reda said only a handful of big companies pay chief executives and other senior executives $500,000 or less in total compensation. He said such limits would make it hard for the companies to recruit and keep executives, most of whom could earn more money at other firms.
“It would be really tough to get people to staff” companies that are forced to impose these limits, he said. “I don’t think this will work.”
Megan Barnett at Portfolio contends this is a bad idea:
Oppenheimer’s Meredith Whitney said it tactfully: “You’re going to get a different variety of folks who are going to come in.” Translated, with less diplomacy, that means Wall Street is going to be run by executives with subpar experience and drive.
Money, Whitney notes, is what motivates people to come to Wall Street. It’s not a public service job, nor should it pay like one.
But perhaps most important, Obama’s compensation plan is a great example of misplaced power. The Treasury Department shouldn’t be wasting its time and effort on policing the payroll departments at the banks it now partially owns.
If the administration really wants to insert government into the troubled private sector, it should just go whole-hog and nationalize the banks that are teetering on the edge of the abyss.
I think Barnett is right that this is driven more by public relations than genuine fundamental problems with our economic system; executives may make too much money, but it’s a fraction of a rounding error on the books of these companies. That said, I agree with Megan McArdle:
Under ordinary circumstances, perhaps. But executives are already leaving these firms in droves, supervised by security guards who carefully watch them clean out their desks. The market for used investment bankers is, as they might say, extremely illiquid.
Under those circumstances, I think this is reasonable. And while I am not particularly offended by the size of investment banking paychecks–though why they persisted in an allegedly competitive market is still something of a mystery to me–I don’t think the taxpayer ought to be funding Swiss skiing chalets and Palm Beach Mansions. Get a house in Scarsdale and take the train like everyone else. If they don’t like it . . . well, there’s precious little evidence that any of them are the sole indispensible genius who can save their firm from the economic crisis, now, is there?
I think Megan hit the nail on the head when she talks about the supposed value-add of $10 million dollar executives. Our banking system is quasi-nationalized, it should be no surprise if the heads of these firms are going to be more in the mode of utility CEOs in the future. There is a lot of talk about zombie companies right now, banks which are insolvent and companies like Chrysler which really have no way of making more money than they lose. There’s no way that the best talent is going to save these companies, rather, the best outcome is probably to unwind them in a manner which isn’t catastrophic. “10 business rules for retards” is all you really need here, not a fine-grained understanding of financial mathematics. Other firms, such as Wells Fargo, probably have a potential future as profitable businesses, but right now their primary goal is to make it through tough times. Rather than risking-taking geniuses who increase value by being audacious, what companies like Wells need are non-retards who make sure not to put a gun in their mouths and pull the trigger (the fact that banks aren’t lending isn’t because they’re stupid and all the geniuses are gone).
Many people would contend that the “best talent” on Wall Street are very bright people. But, their brilliance was being applied to the task of capturing the maximum economic output for themselves as opposed to creating new efficiencies in the flow and allocation of capital. Consider an individual with a computer engineering degree from State U., and another with a Ph.D. in physics from University of Chicago. If both were hired by Intel, I believe that the likelihood of the second individual generating world-changing innovation is likely on the orders of magnitude greater than that of the first, but the salary difference may only be multiplicative. Now assume that the first individual becomes a community banker, while the second works on Wall Street. The difference in monetary reward might now be on the orders of magnitude (e.g., $1 mill salary + bonus vs. $100 K salary + bonus), but would the genuine value-added economic productivity gained by society due to the Wall Street banker actually be orders of magnitude greater than that of the community banker? As a point of fact many local banks are in good shape because they didn’t have the best and the brightest; these relatively pedestrian and dull individuals didn’t increased corporate “value” by engaging in risky but high pay-off decisions. Instead of changing the expected value of the increase in growth of a firm, I would suggest that the “best talent” increased the variance of the expected value. During times of plenty the risk translated into very high returns, but now that risk is dragging firms down. In an ideal free market the firms who took risk would go bankrupt. Perhaps there would even be clawback on compensation; after all, why not take massive risks if your upside is not balanced by a negative signed downside? But that’s not the world we live in.
Note: Wage & price controls are a bad idea. But like I said, our banking system is nationalized in all but name. Since we’ve socialized the downside, we need to socialize the upside. Secondly, the decline of retarded financial instruments on Wall Street means less credit for Main Street, and no more mailboxes stuffed with credit card offers. This is not a bad thing, because growth fueled on unending credit isn’t real growth at all. I think that in many ways the situations of Americans who engaged in the game of “flipping” is what happened on Wall Street writ small; some people got out in time with their gains, while others did not. Those who did not get out in time now want their own bailout. Those who did get out in time are not going to be asked to return their gains. Here’s the key: many flippers weren’t retards, they knew they were taking a big risk. Now we’re socializing the downside of that risk, those of us who didn’t crank up the variance around our expected value are going bailout those who did and got screwed by the game they were playing, while those who lucked out get to pocket their winnings.
Update: See Jim Manzi’s post:
The proposed limits on executive pay, if they have any teeth as they are really implemented, are likely to have several knock-on effects. People who are able to make millions per year in a competitive market will tend to drift away from these firms (even though these restrictions only apply to senior executives, they would change the compensation culture for the firm as a whole), and form new asset management firms, M&A advisory boutiques and so on. Along with limits on comp, the government-sponsored entities will have restrictions on investment behavior imposed by the government – they will not be issuing a lot of credit default swaps. This will mean these large institutions will be unable to offer very high rates of return as compared to the firms that don’t take government money, but will offer safety.
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