Should Executive Pay be Capped?

Robert Frank argues against capping executive pay (with one exception). He says that a high marginal tax rate is a better option:

Should Congress Put a Cap on Executive Pay? , by Robert Frank, Commentary, NY Times: It's no wonder that voters’ outrage over exorbitant executive pay is mounting. After all, the government just had to bail out financial firms that paid big bonuses last year to many ... executives who helped precipitate the current financial crisis.

Nor is it any wonder that Congress is considering measures to limit executive pay... One popular proposal would cap the chief executive’s pay ... at 20 times its average worker’s salary. But while Congress may well have compelling reasons to limit executive pay in companies seeking bailout money, voter anger is not a good reason to extend pay caps more generally.

To be sure, executive pay in the United States is vastly higher than necessary. Executives in other countries, whose pay is often less than one-fifth that of their American counterparts, seem to work just as hard and perform just as well. ...

So why not limit executive pay? The problem is that although every company wants a talented chief executive, there are only so many to go around. Relative salaries guide job choices. If salaries were capped at, say, $2 million annually, the most talented candidates would have less reason to seek the positions that make best use of their talents.

More troubling, if C.E.O. pay were capped and pay for other jobs was not, the most talented potential managers would be more likely to become lawyers or hedge fund operators. Can anyone think that would be a good thing?

In large companies, even small differences in managerial talent can make an enormous difference. Consider a company with $10 billion in annual earnings that has narrowed its C.E.O. search to two finalists. If one would make just a handful of better decisions each year than the other, the company’s annual earnings might easily be 3 percent — or $30 million — higher...

Critics complain that executive labor markets are not really competitive — that chief executives appoint friends to their boards who approve unjustifiably large pay packages. But C.E.O.’s have always appointed friends, so that can’t explain recent trends.

One reason for these trends is that companies themselves have become bigger. ... Beyond growth in company size, executive mobility has also increased. In past decades, about the only way to become a C.E.O. was to have spent one’s entire career with the company. ... Increasingly, however, hiring committees believe that a talented executive from one industry can also deliver top performance in another. ... This new spot market for talent has affected executive salaries in much the same way that free agency affected the salaries of professional athletes.

If the market for executive talent is competitive, critics ask, why are C.E.O.’s in an industry paid about the same, regardless of performance? That’s because no one knows with certainty how a particular executive will perform. ... Executives whose record predicts good performance command a high rate. Their leash, however, has grown shorter. In the past, a C.E.O. could often stay in the job for many years despite lackluster performance. Today, a C.E.O. who fails to deliver is often dismissed after a year or two.

In short, evidence suggests that the link between pay and performance is tighter than proponents of pay caps seem to think. Since the fall of the former Soviet Union, no one has seriously challenged the wisdom of relegating a high proportion of society’s most important tasks to private markets. And the market-determined salary of a job generally offers the best — if imperfect — measure of its importance.

The financial industry, however, may be an exception. A money manager’s pay depends ... on the fund’s rate of return relative to other funds. This provides strong incentives to invest in highly leveraged risky assets, which yield higher average returns. But as recent events have shown, these complex assets also expose the rest of us to considerable systemic risk.

On balance, then, the high pay that lures talent to the financial industry may actually cause harm. So if Congress wants to cap executive pay in financial institutions receiving bailout money, well and good.

Elsewhere, however, the more prudent response to runaway salaries at the top is to raise marginal tax rates on the highest earners, irrespective of occupation. Again, relative salaries drive job choices. The jobs with the highest pretax salaries will still offer the highest post-tax salaries, just as before, so this step will not compromise the price signals that steer talented performers to the most important jobs. ...

When I look at these markets and ask if the conditions for competitive markets are satisfied, conditions like free entry, homogeneous products (as opposed to "small differences in managerial talent [that] can make an enormous difference"), perfect information about product quality (as opposed to "no one knows with certainty how a particular executive will perform"), it doesn't seem to me like they are. So even with "free agency," I don't think the market necessarily provides the correct economic incentives, i.e. the correct relative prices (of, say, executive salaries relative to the salaries of painters). If this is true across the board for high salaries whether or not they are executives, for the most part anyway, then differential treatment of high incomes is not warranted. But the fact that these salaries are "vastly higher than necessary" does mean that a high marginal tax rate can be used to overcome the distortions that the higher than necessary salaries bring about. So in this case the tax would not be creating a distortion, it would be correcting one.

Since part of the column talks about the growth in executive salaries in recent years, it's probably also useful to note that much of the change in the distribution of income recently has been driven by high salaries in the financial services industry (and the vaunted spot market spread this huge distortion to other markets by raising compensation generally). Saying that these salaries - which were based upon bubble values rather than underlying fundamentals, and which put upward pressure on executive pay generally - provide the correct economic incentives is, it seems to me, hard to defend.

Comments

[mmckinl]

Higher taxes on salaries is a start ... say 60% after a million ...

Then there are those other compensation vehicles ... They have to be reigned in as well ... Salary sans bonus is actually a small problem, it's all the other compensation, especially when these CEOs leave the company and walk with tens even hundreds of millions of dollars. This cheats not only tax payers but investors as well as CEOs get tax deferred treatments while in many cases the company actually pays the CEOs taxes!

All compensation except for what is allowed under 401K deferment should be taxed and taxable to the CEO.

[Chris]

Yes indeed. We need to bring back high tax rates for the obscenely rich. If they had been in place during the last ten years, much of the damage would not have been done. People would not have been taking such risks in hopes of ridiculous "bonuses" from IBs.

[Bruce Wilder]

High marginal tax rates would seem pretty clearly to be better than a paycap.

One could ask some other questions, though, like whether the marginal tax should be assessed on the employer or the employee -- does that make any difference? It might not be obvious that it might.

Then, there's the status under tax law of deferred compensation -- special pensions, stock options, stock grants, required capital stock purchases. I, personally, think the sheer magnitude of compensation tends to overwhelm the web of other controls on executive behavior, but there's also a good argument to be made that both firms and the general society are likely to benefit from manipulating the risk faced by executives, to make executives more risk averse. Right now, executives not only pull down obscene sums, but they also face little downside risk -- pay is on a heads the executive wins, tails the company loses basis.

[odograph]

I don't see a need to cap executive pay, but on the other hand I think we can deride it for being absurd. There are special situations (Jobs at Apple, Gates at Microsoft - usually founders with equity anyway), but I'm sure most companies are running on their own organizational momentum. They have an interchangeable boss at the top.

If you ask me, executive pay is used in a kind of EMH to prove the worth of the payee. More likely it's a wealth effect of the corporations. Once they get to a certain size, how can they pay less? And why would they want to appear less wealthy than their corporate peers?

[odograph]

Shorter: why shouldn't companies pay for CEOs the same way they pay for art?

[Bruce Wilder]

The quoted article mentions, in passing, the increasing size of large business corporations, but this is also an issue for effective capital markets as well as control by actual capitalists.

Conglomeration could well be a strategy to insulate executives from both the potential for takeover by private capital, and to increase the farm size (sic - I mean "farm" not firm -- I'm suggesting the executives are "harvesting" their huge pay packages.)

The article appeals to a kind of rough-and-ready marginal productivity argument, to suggest that a better executive is like a better race car driver -- a slight advantage makes a big winner in a long race.

I would make a somewhat different argument for where huge executive pay comes from. What does manage do? Management controls. In a very Hayekian way, corporate management substitutes central planning for market transactions, authoritarian power for fair bargaining and competition.

If executive pay is roughly proportional to the size of the corporation, it may be because the top executives, in order to obtain large compensation packages, are skimming their fellow employees' rent, while insulating themselves from the informed demands of the capital markets, and overpowering competing or countervailing sources of power that would manifest in market-mediated transactions.

In Hollywood, changes in regulatory rules hotly sought after by the major Studios allowed the creation of massively integrated conglomerates, and the elimination of several sources of creative and financial competition, as well as the handicapping of the power of the labor unions. "Globalization" means stock productions of the "Idol" talent contest, Big Brother reality show, Gladiator fake sports contest, and other dreck on 4 continents and in 7 or 8 languages. If it seems like television worldwide is manufactured in automated factories, it is because it is. Factories have replaced the former cottage industry, with the practical elimination of the market transactions, that once separated network from studio, and producer from studio.

Personally, I doubt that you will find many companies actually controlled by capitalists routinely paying top executives more than one or two million per year, even at current income tax rates, and that ought to give us a clue, about just how far out of whack executive pay has gotten. But, there's no chance that a company the size and scope of, say, Time-Warner is going to be controllable by capitalists. No one has that much capital in one place. And, no company as diversified as Time-Warner is going to be subject to much capital market discipline, either. One share of Time-Warner stock is already a pretty diversified portfolio, and that cannot be good for market allocation of capital.

Moreover, the critical gateways of distribution have been locked down tighter and tighter, just as technology seemed to be multiplying them. We had more competition in television production, when we had 3 networks, than we now do in our 500 channel universe.

I am not unsympathetic to the marginal productivity argument. I look upon someone like Steve Jobs, and I can see how huge an impact a talented person can be in a position of such power. Jobs, as an individual, has added billions of value to Apple and Pixar. But, he's the exception, not the rule. Apple was paying millions to mediocre executives, who were obviously destroying the company's franchise, before he returned. And, those executives are typical.

Executives, mostly, are not analogous to sports stars -- great performers enmeshed in an organization in a way that amplifies their efforts just as a tractor amplifies the efforts of the farmer in the drivers' seat, only a thousand times more.

No. What executives do, is exercise power and control. They plan. They substitute command and control for negotiation and bargaining. There can be genuine benefits to that, too. Hayek, notwithstanding, planning can be economically beneficial; control can eliminate wasteful error. But, power is also problematic. Power can mean oppression and the elimination of competition and opportunity.

Higher top income tax rates would certainly be helpful. Reform of corporate governance and much more attention to antitrust could also be helpful.

[dilbert dogbert]

If there is a pay cap or taxes remember it is like squeezing a balloon - squeeze it here and it pops out there. The law would have to be carefully drawn to keep the balloon, pay or perks, contained. Good luck with that. A change of parties in power and all the good work would be for naught. It still would be pleasing to see the bastids kicked in the wallet for even for just a bit.

[S Brennan]

I'm not for capping executive pay, but this is complete crap:

"The problem is that although every company wants a talented chief executive, there are only so many to go around. Relative salaries guide job choices. If salaries were capped at, say, $2 million annually, the most talented candidates would have less reason to seek the positions that make best use of their talents." - Robert Frank, AKA useful tool

Absolute crap. What are they going to do? Move to another country for better pay?

[Ben Stein the Hack]

I agree with Mark that executive pay isn't reflective of market value. But I also don't think executive pay is necessarily the problem, so much as it is the symptom.

The problem is that executive pay is NOT an incentive to increase corporate income, as Robert Frank claims, as it is an incentive to increase SHORT TERM INCOME, or to be even more accurate, the appearance of short term income.

So firing a bunch of your workers and cutting R&D, or preselling goods at a steep discount, for example, might be a good way to increase your earnings over the next few quarters, for which a CEO can collect a ton on her salary and stock options, but it's not actually improving earnings over the life of the company.

And of course, in an era where corporate income is a matter of accounting interpretation, executive pay also strongly incents executives to take whatever measures they can (legally or even illegally) to increase stated income by using accounting wizardry.

So I'd say that a better solution might be to change tax policy to more heavily penalize short term capital gains, as well as to change accounting rules to better account for the real economic impact of certain corporate changes. If you take away the incentives to provide short term "fixes" to corporate governance that are actually detrimental to the company in the long run, then executive compensation would probably take care of itself.

[Long Memory]

"Jobs, as an individual, has added billions of value to Apple and Pixar"

Jobs, as an individual, is the reason that Apple doesn't occupy Microsoft's position in the software market. This being the case, I'd say that Job's overall effect on Apple's value has been huge and negative.

[James Kwak]

The idea that you get what you pay for (higher CEO salaries get you better CEOs) has logical plausibility, but I don't believe it's borne out by the people who have actually studied this topic empirically. Rakesh Khurana wrote a book on the CEO job market from which I remember two things: first, the market is incredibly distorted and inefficient, due largely by the fact that boards are driven more by the need to get brand-name CEOs to cover their asses than to actually find the best person to do the job (who is usually an insider who has never been a CEO before); and second, as a result, the superstar CEOs brought in from outside generally have worse performance than the senior insiders who are promoted.

[evagrius]

The Detroit Lions had a $93 million budget for their talented team- first ever to reach 0-16 record.

[Bruce Wilder]

Long Memory: "Jobs, as an individual, is the reason that Apple doesn't occupy Microsoft's position in the software market."

Actually, that honor goes to Jobs' successor, a brain-dead former Pepsi-Cola exec named Scully. Scully, in his memoir, actually describes how Bill Gates came to him, explained the opportunity inherent in selling the MacOS, offered to support the move, and Scully turned him down.

[Bruce Wilder]

CEO compensation, I believe, is better predicted by corporate size (employees, revenues) than performance, and performance gets harder and harder to measure as a firm becomes larger and more diversified. Wish I had time to pull together references, but I am being called away . . . away . . . awa . .

[Noni Mausa]

He tried to pull a fast one with this throwaway comment: Since the fall of the former Soviet Union, no one has seriously challenged the wisdom of relegating a high proportion of society’s most important tasks to private markets.

You mean, like water utilities in Great Britain, and health care and mercenary armies in the USA?

I remember two years ago, the city of Edmonton (Canada) had laid off staff and sold equipment and relegated snow clearing to private business. Then came the highest snowfalls for a century, and the city could not compete with businesses for the scarce snowplows, leading to the bizarre situation of clean parking lots all over, and the public streets choked with snow for three or four weeks.

People have "seriously challenged" this idea -- but apparently not the people Robert Frank meets from day to day.

Noni

[NLS]

In the near future we'll see smart companies increasing their market share by advertising how little their CEOs are paid relative to their employees vis-a-vis it's competitors. "Think that's efficient?! Wait till you see how cheap the TVs are!". At least that's what I'd do.

[cm]

S Brennan: "Absolute crap. What are [CEO candidates] going to do? Move to another country for better pay?"

Maybe they are going to withhold their labor, like the rest of the "lazy" and "spoiled" "American" workers. Then companies will have to bring in foreigners for the "CEO jobs that Americans won't do".

[Don]

I dunno, people spend millions of their own money and years of their life to be a Governor,Senator or President. Those jobs all pay way less than 2 Million. I think there are a lot of intangible rewards to being a Senator, or for that matter, for being a CEO. I have my doubts that a realistic salary cutoff would stop people from wanting the big Office on the top floor.

Also wouldn't a tax hike on mega-salaries tend to push the "top talent" away from American companies just as much as a salary cap?

That said I think we're more likely in the next 8 years to send a cow to the moon than actually limit CEO pay for non-bailout companies, so it's a moot point.

[Roger Chittum]

What exactly is the problem that requires any government intervention? Is it that top executives are taking advantage of shareholders? Is it that what should be a marketplace for executive talent has been captured and is not working properly, leading to misallocation of resources and economic "inefficiency"? Is it envy? Something else perhaps? Maybe not really a problem at all?

[Too Much Fed]

"One popular proposal would cap the chief executive’s pay ... at 20 times its average worker’s salary."

I think someone needs a math lesson. $40,000 worker times 20 equals $800,000. Now double the worker's salary to $80,000. $80,000 times 20 equals $1,600,000. Who is better off in this case. Although it would be fun to watch ceo's having to increase worker's wages to a get a pay raise instead of the other way around in a lot of cases.

says...

Roger doesn't seem to understand the distributional distortions that market failures bring about. Or he's in denial that these markets are, in fact, in failure.

On another point, top talent running away to other countries, they pay a lot less in other countries, lots, lots less - why would they do that?

[Too Much Fed]

"voter anger is not a good reason to extend pay caps more generally."

Oh yes it is! If the voter anger is because ceo's are using an oversupplied labor market and/or debt to lower the middle class' standard of living so that they can jack up the stock price and their own salaries, it definitely is!

[Patrick]

Clearly, there is a problem when shareholders get crushed but the executives get rich. This happens all the time.

Tax rates can provide the 'correct' incentives, especially for C-level executive compensation in large public firms. Tying the marginal tax rate inversely to the X (5?) year moving average of earnings and/or dividends (or some combination thereof) might be a way to do it. It should also be inversely proportional to some measure of the spread between executive pay and what the proletariat is payed.

[Patrick]

Oops. Should have said directly proportional to the spread on exec pay and worker pay; big spread means higher tax rate.

[Too Much Fed]

"If salaries were capped at, say, $2 million annually, the most talented candidates would have less reason to seek the positions that make best use of their talents."

I believe that is just plain WRONG!!!

If the salary is all the same, they will probably pick the best fit for them. Would Nardelli have gone to Home Depot if the salaries were all the same???

[Too Much Fed]

"More troubling, if C.E.O. pay were capped and pay for other jobs was not, the most talented potential managers would be more likely to become lawyers or hedge fund operators. Can anyone think that would be a good thing?"

There is an EASY solution. Tax the some of the lawyers and the hedge fund operators and the sports players and the media people and some of the doctors and the entertainers.

How about a new catch phrase? Instead of cap and trade, what about cap and tax???

[Too Much Fed]

"Critics complain that executive labor markets are not really competitive — that chief executives appoint friends to their boards who approve unjustifiably large pay packages. But C.E.O.’s have always appointed friends, so that can’t explain recent trends."

Well, yes it can. It keeps getting worse and worse because of things like stock options and tax cuts for the spoiled and the rich. It is also because the idiots in congress keep listening to the IMMORAL bankers like greenspan, paulson, and bernanke.

[Too Much Fed]

"The jobs with the highest pretax salaries will still offer the highest post-tax salaries, just as before, so this step will not compromise the price signals that steer talented performers to the most important jobs. ..."

Here is an important job for the "talented performers". Raise the standard of living for the lower class worldwide a good bit while continuing to raise the standard of living for the middle class worldwide instead of trying to lower the middle class worldwide to the level of the lower class worldwide (i.e. the chinese level). That means the spoiled and the rich may NOT be able to become MORE spoiled and RICHER!

[Roger Chittum]

says:

If top executive compensation goes down, do middle class incomes go up or do corporate earnings and share prices go up? Or does something else happen, or is it not predictable? I'd like to see rising middle class real incomes, but I don't see that reducing CEO compensation is in the top 3 best ways to do that. Please explain.

[cm]

Roger Chittum: There are at least two aspects here -- (1) addressing of the perception (to an extent cosmetic) that bailout money and other corporate welfare go directly to the pockets of the top echelon of management and their connections, which those outside the primary circle of "talent" consider an impropriety, to the big surprise and indignation of the big wigs and their water carriers, and (2) limiting the incentives to strip mine corporate assets (including the workforce and the future business outlook) for the purpose of goosing short term "performance" indicators that are used to award compensation. This goosing will only happen when there is a payoff.

In order for (2) to be effective, perks and deferred compensation have to be included. And once this avenue of extracting money is throttled, they will probably try to engineer other ways that will then have to be addressed (without going into details here).

To elaborate on (1), even though I classify it as "cosmetic", perceptions are important to most people, esp. when it comes to fairness and propriety. Those who think they got the short end of the stick (whether in absolute or relative terms) are especially sensitive of that. If you need other people's cooperation or merely tolerance, and eventually you will, you better get those "marginal" (to you) perceptions right.

And for (2), many here are probably working in environments where "metrics" of one sort or other are used to distribute the goodies or decide over career futures, and are familiar with how those metrics are manipulated at the expense of anything that is not measured. For example, in a previous job of mine some management figures got a cut from hours billed to projects external to our department, resulting in their pushing us to do overtime, maximally code our hours as billable on our time cards, and encouraging questionable business trips that would result in a lot of hours, at general corporate expense (unfortunately it turned out all those hours still went to the same project(s) and resulted in substantial cost overruns).

[baileyman]

Fortunately, we've been here before, in WWII. The unintended consequence then was the creation of private health care benefits to substitute for limited compensation. And we're still dealing with that monster.

[robertdfeinman]

Why do US based pundits ignore data from the rest of the world? Frank notes that CEO salaries are much less in Japan and Europe, but then draws nothing from this.

Are the CEO's in these countries worse than the higher paid ones in the US? Do the firms based there perform worse than US ones? No and no.

There have also been studies which show that when firms get larger than a certain size they become harder to manage and perform worse. Expecting a CEO to stay on top of the typical conglomerate is unrealistic, they usually break the firm into virtual sub-firms which are managed by their own CEO's. What does the top guy do that needs to be done in this case? What does GE's loan business have to do with light bulbs or jet engines? Where is the "efficiency" from bundling these businesses together?

One solution, for those that like to leave things to the market, is to change the regulations concerning the selection and responsibilities of boards of directors. Right now boards are generally picked by the CEO they are supposed to be overseeing. Furthermore the days of interlocking directorates have returned, anti-trust precedents notwithstanding.

Boards should consists solely of outside directors, they should be selected by competitive elections, and the nominations should be handled in an open manner. Directors should not be able to serve on more than one board and not in industries which have mutual business interests.

Voting should be weighted so that shareholders could assign their votes as they wish, so they could give all their votes to a single candidate if they wished. This way a minority group of stockholders could ensure that at least one board member represents their interests.

Boards should be required to have representatives from labor and perhaps suppliers and even the government. This might be a function of the size of the firm.

Companies should, once again, be prohibited from owning other companies, or if they are only part owners then they shouldn't be allowed to vote for the board.

Firms should lose their "personhood" and the privileges meant for living people eliminated. Firms have no right to free speech. Crimes committed by firms should not be settled solely by fines paid by the firm (that is by the stockholders), but should result in punishment for the management. Limited liability means limits on financial loss by the stockholders, not immunity for managers.

If the captain can go down with his ship, the CEO and board can suffer the consequences for illegal activity during their watch. This liability can extend to sweetheart deals like golden parachutes, backdated options and excessive compensation. If stockholders sue because their interests are not being addressed then the boards would have to provide compensation for the loss if the stockholders win the case. Firms should not be allowed to buy insurance to cover the fines and losses assessed against such individuals as they do now.

Put such changes in place and we will see the problem of the golden boy CEO go away by itself.

Raising marginal tax rates and eliminating favorable treatment on capital gains and unearned income is worthwhile for a variety of reasons, but has nothing to do with controlling the incestuous behavior between boards and CEO's.

[bakho]

Shareholders should have more say in CEO pay.

[Roger Chittum]

I agree corporate governance in big US companies is not the best way to do it. But all of the points raised above, and others, have been the focus of attention since at least the 1970s, and some efforts have been made to improve the system. IRC Sec. 162(m) limits the deductibility of executive pay in excess of $1 million unless "performance based." Improved disclosure of executive compensation. Shareholders have slightly improved ability to get votes on dissident proposals. (To the contrary and unfortunately, the rule that forfeited to the company "insider trading" gains from exercising employee stock options and selling within 6 months of each other was abrogated some time in the 1980s.)

I've not done a study, but my impression is that the worst executive pay abuses (I agree they are abuses) are in finance and industries in which financial transactions (such as roll-ups, refinancings, and generally "creating shareholder value" by balance sheet transactions rather than through operations) dominate the business plan. I attribute that (again without study) to the different traditions of compensation that grew up in investment banking from those in manufacturing and retail. The former, a deal-making tradition, was fee driven--taking a percentage of the value changing hands. The latter was driven by operations targets, like earnings, in businesses that took a longer view of things and prized "management skills."

Still, I see the struggle as being primarily between the shareholder class and the executive class without substantial implications for middle class incomes. And, again without research, my impression is that although CEO compensation can be far larger than is warranted, it's not in normal times many cents per share, which is I assume why shareholders grumble but still hold shares.

If y'all can make a persuasive link between changes in corporate governance and/or executive compensation, on the one hand, and getting the middle class moving again, on the other hand, I'll join the mob and bring my own torch and pitchfork. A shareholder rights movement would not have the same visceral appeal to me.

[Rusty]

The last time we tried to corral CEO pay with the tax code we set off the stock options boom - just saying.

The only hope for reform is to make the Boards accountable - how we do that is a difficult question.

There was a huge uproar when Alan Mullaly received $18 million for the Boeing money he lost when he moved to Ford, but Ford has gone for worst to first (still not really healthy). Was it worth it? ($18 million was considered pocket change on Wall Street during 2003 - 2007).

[Bryan]

Question: Has anyone done any studies on the impact of reduced capital gain tax rates on market volatility? Maybe this is naive thinking on my part (I'm a practicing tax attorney, not an economist), but I would think that eliminating the difference between ordinary rates and capital gain rates would decrease volatility and decrease the incentive to leverage to "play" in the financial markets and it would take some of the game playing away from the executive comp schemes I've seen.

[KThomas]

this article stinks. Frank hs his head up something....he should not have written this article.

[SnoopyDancing]

robertdfeinman, how does the growth in popularity of mutual funds impact this situation with directors? Mutual fund investors no longer have the ability to vote their shares.
Worse, from my past experience, portfolio managers of funds routinely vote with management. Dig into how the actual voting works and you may be surprised at how millions of shares' votes are cast by a single person at the proxy service -- unless things have change in the past few years.
Your website is an intellectual's playground, by the way. Thank you!

[Beezer]

Higher marginal tax rates is probably the cleanest answer, not only to bloated executive compensation but to income inequality as well. Top heavy compensation is also very disruptive down the line within a company. You lose competence in middle management when the income disparity between the boss, and his more immediate underlings, becomes huge. They know where the ideas and the real work is being done--and it's seldom in the top floor suite.

Punishing taxes on short term capital gains is another reform that's badly needed. Take out the short term on anything, and everyone's eyes begin to look out further towards the horizon.

[Roger Chittum]

The governance failures of government dwarf the governance failures within companies. Contrast this discussion about executive pay with The End of the Financial World As We Know It by Lewis and Einhorn in today’s NYT Opinion. http://www.nytimes.com/2009/01/04/opinion/04lewiseinhorn.html?_r=1&ref=opinion

Richard Fuld, the former chief executive of Lehman Brothers, E. Stanley O’Neal, the former chief executive of Merrill Lynch, and Charles O. Prince III, Citigroup’s chief executive, may have paid themselves humongous sums of money at the end of each year, as a result of the bond market bonanza. But if any one of them had set himself up as a whistleblower — had stood up and said “this business is irresponsible and we are not going to participate in it” — he would probably have been fired. Not immediately, perhaps. But a few quarters of earnings that lagged behind those of every other Wall Street firm would invite outrage from subordinates, who would flee for other, less responsible firms, and from shareholders, who would call for his resignation. Eventually he’d be replaced by someone willing to make money from the credit bubble.

The online version is preceded by focusing on definition of the problem to be solved: “We have a brief chance to cure ourselves. But first we need to ask: of what.” I see outlandish executive pay as a symptom, not a root cause. Dean Baker is on the right track here. http://www.cepr.net/index.php/op-eds-&-columns/op-eds-&-columns/a-financial-sector-small-enough-to-drown-in-a-bathtub/ Echoing Grover Norquist, he just wants to shrink it down to an appropriate size.

[Salary]

I think openness and justification for salary is the most important thing. http://www.salarylist.com is trying to do that. I think this will put some pressure on unfair pay

[robertdfeinman]

SnoopyDancing, thanks for the kind words!

As for stock ownership by mutual funds and pension funds this is an interesting problem. Some pension funds, especially Calpers and TIAA have taken public positions on corporate governance and have voted their shares for policies which lead to more meaningful elections of the boards.

These are public benefit corporations and don't have the same mandates as do for-profit funds, but it shows that funds don't have to blindly follow management's lead.

In the case of for-profit mutual funds there are several things that could be done, the fund holders could be allowed to vote their indirectly owned shares, or their wishes could be gathered up and the fund follow the accumulated positions.

With modern computerized systems this isn't technically difficult, I get proxy ballots for shares held by my broker all the time.

Another possibility is to disallow such funds the right to vote the shares as a variety of my suggestion about companies owning companies.

There may be other ideas that are also floating around, the fundamental problem is that there is no effective connection between "ownership" of a firm and actual control. This needs to be fixed.

[cm]

robertdfeinman: "... the fundamental problem is that there is no effective connection between "ownership" of a firm and actual control. This needs to be fixed."

I don't see how this will be fixed. Most investors are "absentee owners" (as in absentee landlord), and many "investment" or "savings" decisions are made at a rather high level of abstraction. When you take your money to the bank, do you intend to exercise control over what the bank does with it, do you intend to vote on companies that you hold through mutual funds, etc., to the degree of individual stock ownership voting that you may be imagining? And if you do want to have control, the control/voting should be informed by facts and not just by ideological stereotypes. I'm sure you are not proposing that stock should only be owned by people who have the time to inform themselves about their owned companies all day.

I think you need to make a distinction between owners in particular and stakeholders more generally. The stakeholders may be more qualified than the absentee owners to call the shots. The absentee owners can always vote with their feet, which they already do anyway. Stakeholders would include e.g. workers' representatives or community representatives.

BTW government accountability is a similar problem. Many abuses fly because the stakeholders don't have the time, expertise, and/or inclination to watch what is going on.

[Roger Chittum]

cm:

I realize I did not address your point about misuse of bailout money. I strongly agree with you that when government acts as an investor it should impose commercial terms, lest private investment be squeezed out. A debt or equity investment in a troubled company would normally include covenants limiting executive compensation, payment of dividends, etc. and even make the identity of the CEO and CFO subject to the approval of the investor. By not getting such controls in exchange for the TARP money, Treasury did the unthinkable.

My other comments addressed the situation where government is acting as rule maker for all businesses and not as an investor. I am cautious about the utility of that.

[Real Person from the Real World]

'cm says... robertdfeinman: "... the fundamental problem is that there is no effective connection between "ownership" of a firm and actual control. This needs to be fixed." I don't see how this will be fixed. Most investors are "absentee owners" (as in absentee landlord), and many "investment" or "savings" decisions are made at a rather high level of abstraction.'

If you own a few shares of a stock, how does your vote do much? One or two hundred shares of stock to vote has virtually no power. Look at stockholder proposals. They are easily voted down. AND then there is the Mutual fund manager. Why should he vote any different then the board of directors of a company wants? VOTING shares have little or no power anymore.

Over in Japan, the top guy gets a set percentage more than the worker. They may give all sorts of perks, but compensation is fixed, unless they changed it from the last time I heard. I am not sure if this is legislated by government, or is just cultural.

Basically it all comes down to the view of whether the CEO is a rockstar, who is one of a kind or one of a limited elite who is better than anyone else: someone you have to hire a highly paid executive search firm to locate, OR is just someone good at politics and fits in personally, with the rest of the good 'ol boys on the board, but acts pricey. Don't forget These guys all scratch each other's backs. I fix your salary you fix mine.

[Icarus]

A question...I understand the vitriole on this blog regarding executives who purportedly perform poorly, and still receive gargantuan spoils.

What about the opposite? Steve Jobs, or Lee Raymond, or a host of others...they saw their firms increase revenue by tens to hundreds of billions in their tenure.
Is it fair for the leader of an enterprise to receive a percentage of the gains they command over? Should firms be allowed to attract such talent by offering a portion of gains?

If so, we can see payouts in the hundreds of millions. Isn't it fair? If I bring billions in gains (revenue/profit) to a firm, shouldn't I be allowed to engage in market based negotiations to determine my compensation?

If a legitimate Board feels that it is prudent for their firm, shouldn't they be allowed to engage in market driven negotiations?

[reason]

Icarus
ex post or ex ante? (And are you sure you really believe the great man theory of the world?)

[Icarus]

Reason,

No, as a student of history, I find 'great man' theories quite unsatisfactory.

But, when it comes to an economic venture, yes, I do believe in the value of vision/leadership and execution.

I know we can all attribute the wealth an enterprise creates to the overall structure of society, and thus argue that all should share in the spoils...but, I find this argument disingenuine.

We are all free now to risk money, and start a business. Most of us would fail. Very few would break even...and a miniscule minority would build something great.

If my idea and execution thereof makes billions of dollars...yes, I deserve rewards in the billions.