Riddle Me This

April 17, 2009 at 9:36 am (By Maxwell James)

Everything I’ve read about caps on executive pay suggests that such measures are at best a bad joke. Not only do such measures impinge on the freedom of the marketplace*, but they are also impossible to enforce. Salaries can become bonuses, bonuses can become salaries. Executives can be compensated $1 on payroll, along with $9,999,999 in “consulting services.” And so forth.

So given this theory: why is the management of Goldman Sachs claiming that they are going to pay off their TARP financing as soon as possible? As this fellow points out, they have other obligations that constitute a greater burden on shareholder returns. Surely the executive compensation limits imposed by this financing are no burden for them to work around, right**?

* Presuming, of course, that the pay of finance industry CEO’s is presently determined by an actual market, rather than through cronyism laden with conflicts of interest.

** Never minding, of course, that as responsible agents under effective corporate governance they would NEVER put their own needs above those of their principals.

~ Maxwell


  1. PatHMV said,

    While the caps can be gotten around through the mechanisms you cite, doing so comes with a serious cost, so long as they are officially subject to a law capping the salaries. The executives (and the directors who approved their salaries… um, consulting contracts) will be hauled before Congress and raked over the coals. Barney Frank will call for an investigation by the DOJ to determine whether the “consulting contract” is a violation of the law (unless, of course, the executives work for Fannie Mae or Freddie Mac, in which case Barney will defend such fine worthy people instead).

    In short, even if work-arounds can absolve them of legal liability, the risk of investigations and political pressure from demagoguing politicians means that the salary caps DO place a substantial burden on the companies involved.

  2. amba12 said,

    It’s good to see you here, Pat! (Any time you’d like to post, or cross-post, just let me know and I’ll make you a key!)

    It seems to me that government bailouts should come with strings attached, and that companies that don’t want strings should forgo bailouts. The taxpayer should not have to underwrite disproportionate compensation for failed executives.

    All this “capitalism=evolution” talk becomes meaningless if failure is not a natural part of the equation. There is no such thing as an upside without a downside. Individuals and companies sometimes need and even deserve help, but it should not come without restrictions and requirements. Help is a time-limited chance to become fitter, not a ticket to survive as unfit. Help is rehab, not enabling.

    It makes no sense to scream that the government that is propping up these companies is interfering with the free market by imposing limits on them! What free market?

    That said, laws imposing broad limits on executive compensation generally are an entirely different story. I remember reading some time ago (this may have changed) that no Japanese executive made more than a certain multiple of the average worker in his company, but that may have been cultural or voluntary (a matter of shame) rather than mandatory. We can learn something from that, probably, but not to pass straitjacket laws. Among other things, circumstances are way too unique. What’s greedy or dishonest in one company may be incentive and well-earned reward in another. One size does not fit all.

    As with so many issues, cultural change seems to me the best regulator. For example, among high earners philanthropy, giving back in some way, has become almost de rigueur. Which makes it exactly the wrong moment to cut back charitable deductions! Idiots!!!

  3. PatHMV said,

    Oh, I agree absolutely that strings, and harsh ones, should be attached to bailed-out companies… even if those strings make it more likely that the entity will fail, leaving the taxpayer holding even more of the bag. I think the bailouts are hideously bad, on many levels. Every disincentive imaginable should be stuck in so that no private business in its right mind would ever accept them, and no even semi-rational policy-maker would offer one.

    Undoubtedly we need some cultural changes. I ran some numbers once, and discovered that if every person at a company the size of, say, GE, who makes more than $1 million were instead to work for free, that would only increase the average hourly wage of the other employees by something like $0.35 an hour. But as a matter of perception, it’s a huge deal.

    At a basic psychological level, experiments have pretty conclusively demonstrated that human beings have a built-in sense of what is and isn’t “fair.” I think I’ve pointed out before at Ambivablog the studies which take 2 people and give $20 to one of them (A). That one then decides how much of the $20 to give to the other person (B). Then B can either accept the amount given him, in which case both he and A keep the money, or reject it, in which case neither A nor B get anything. Looked at in isolation, B should keep any amount given him, because it will leave him with more than he would have otherwise. But in reality, experiments show that the smaller amount A gives to B, the greater the chance that B will reject it. B wants to punish A for an “unfair” split. Even non-human primates show some of the same tendencies.

    So as a society, I think companies need to recognize that, and see that they may gain a competitive advantage (better employee morale, etc.), by reining in the highest level of executive salaries. I also think that they seem to be doing a poor job of actually evaluating performance. I’m not sure that we’ve got the rules set just right to give board directors a strong incentive to bargain harder on executive salaries.

  4. Maxwell said,

    Well-said, Pat.

  5. lfineaux said,

    Quoting Taleb:

    “The higher up the corporate ladder, the higher the compensation to the individual. This might be justified, as it makes plenty of sense to pay individuals according to their contributions. However, and in general (provided we exclude risk-bearing entrpreneurs), the higher up the corporate ladders, the lower the evidence of such contribution.” –p. 254, Fooled By Randomness

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