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Saturday, February 07, 2009

Executive Pay

Lucian Bebchuk says proposed restrictions on executive pay do not go far enough:

Pay Cap Debate: They Don't Go Far Enough, by Lucian Bebchuk, Commentary, WSJ: Critics of the administration's proposed guidelines on executive compensation say they are a dangerous intrusion into corporate boards' authority and would make it difficult for financial firms to fill executive positions. These criticisms are unwarranted. If anything, the guidelines are too modest...

Concern ... has been fueled by media coverage stressing the $500,000 cap on salaries. But ... the ... guidelines don't impose any cap on the total pay; they only influence its form. ... Even firms that receive "exceptional assistance" (such as ... AIG or Citibank...) will be permitted to compensate executives with unlimited amounts in restricted shares that can be cashed out after the government is paid back.

This is not excessive government meddling. As a major provider of capital to firms receiving exceptional assistance, the government has a legitimate investment interest in executives' being properly incentivized. ...

After a period of public comment, the Obama administration will finalize the guidelines... I believe the final version should impose tighter restrictions... To provide incentives to focus on long-term results, executives should be precluded from unloading restricted shares for a specified period, say three years, after they vest.

The proposed guidelines also make it too easy for firms ... to opt out of the restricted stock requirement and compensate executives in whatever form they choose. ... Furthermore, and importantly, because the government can be expected to hold investment rights (such as preferred shares) that are senior to those of common stockholders, these stockholders may prefer executive pay arrangements that would induce more risk-taking and short-termism than would be in the interest of the government as an investor.

In short, the guidelines are a useful step in the right direction. To ensure that executives of firms receiving government capital are well incentivized, however, the administration should use the comment period to significantly tighten them.

Uwe Reinhardt wonders if Lone Ranger loan arrangers are worth the high salaries they are paid:

Supply, Demand and Executive Pay, by Uwe E. Reinhardt, Economix: ...Whether or not [executive] compensation is fair depends on how you think about an employee’s contributions to the company. ...

[T]o apply [a] demand-supply framework to an understanding of executive compensation in the real world, economists ... make two crucial assumptions. First, they subscribe to the Lone Ranger theory of management that is so popular in an adulating financial press.

According to that theory, a firm’s chief executive is the main determinant of a firm’s market “capitalization.” ... Evidently, in the mind of economists, Lone Ranger C.E.O.’s can make truly astronomical contributions to a firm’s market capitalization, ceteris paribus, which justifies high bid prices for them. ...

The second crucial assumption in the economist’s narrative is that the supply of talented executives is strictly limited,... “the problem is that although every company wants a talented chief executive, there are only so many to go around.”

As a general proposition, of course, that argument may be no more valid than the idea that the supply of potential gold-medal winners at the Olympics is roughly equal to the number of athletes who actually won gold medals. But economists rest their case on it.

Using this theory, economists working at the empirical level have found what they believe to be a justification for the recent growth of executive compensation. ...[A] 2006 study ... argue[s] that the compensation of C.E.O.’s should vary directly with the market capitalization of the company. They then report that the market capitalization of large companies in the United States grew sixfold between 1980 and 2003, as did the compensation of their C.E.O.’s.

Readers may wonder about the survival of this theory, even among economists, as stock prices have begun to tumble sharply, starting in 2007.

Readers may also wonder why, in the United States, the ratio of total executive compensation ... to the comparable figure earned by non-management  employees rose from 50 in 1980 to 301 by 2003 for the ... largest corporations..., while that ratio typically has remained so much lower in Europe and in Asia. Are corporate executives in Europe and Asia so vastly inferior to their American counterparts...? ...

Another perspective:

Please Raise My Taxes, by Reed Hastings, Commentary, NY Times: I’m the chief executive of a publicly traded company and ... I’m very highly paid. The difference between salaries like mine and those of average Americans creates a lot of tension, and I’d like to offer a suggestion. President Obama ... should also take half of our huge earnings in taxes, instead of the current one-third.

Then, the next time a chief executive earns an eye-popping amount of money, we can cheer that half of it is going to pay for our soldiers, schools and security. Higher taxes ... can finance opportunity for the next generation of Americans.

Clearly, the efforts over the past few decades to control executive compensation haven’t accomplished much. ... The reality is that ... picking the wrong chief executive is an enormous disaster, so boards are willing to pay an arm and a leg for already proven talent. ...

Of course, it’s galling when a chief executive fails and is still handsomely rewarded. But with the concept of “tax, not shame,” a shocking $20 million severance package would generate $10 million for the government. ...

Another advantage is that it would also cover the sometimes huge earnings of hedge fund managers, star athletes, stunning movie stars, venture capitalists and the chief executives of private companies. Surely there is no reason to focus only on executives at publicly traded companies.

This week, President Obama proposed imposing a $500,000 compensation cap on companies seeking a bailout. It’s a terrible idea..., capping compensation at bailout recipients will just make it that much harder for those boards to hire and hold on to the executives who can lead their companies to compete and thrive.

Perhaps a starting place for “tax, not shame” would be creating a top federal marginal tax rate of 50 percent on all income above $1 million per year. Some will tell you that would reduce the incentive to earn but I don’t see that as likely. Besides, half of a giant compensation package is still pretty huge, and most of our motivation is the sheer challenge of the job anyway.

Instead of trying to shame companies and executives, the president should take advantage of our success by using our outsized earnings to pay for the needs of our nation.

One doesn't preclude the other, we could raise taxes and limit executive pay at firms supported with taxpayer money.

Robert Reich gets the last word:

More Lemon Socialism -- And Why The Limits on Wall Street Pay Are For Show, Robert Reich: Wall Street and its allies are in a tizzy over the Obama administration's proposed $500,000 limit on executive pay, saying it will threaten their ability to attract and retain executive talent.

I do not mean to deprecate Wall Street executives when I point out that the far higher level of compensation they received in recent years has not exactly elicited talent -- at least not talent for much of anything other than the accumulation of personal wealth at the expense of millions of investors and of the economy overall. Wall Street compensation has been geared to short-term bets on high-leveraged investments, after which players quickly collect any winnings and run for cover. ...

The plan itself is a bit of a ruse. If truth be told, the $500,000 seems little more than a symbolic gesture designed to reassure the public that the large amounts about to be asked for the next stage of bank bailout ... will not simply feather the nests of those who created the mess in the first place. The guidelines don't actually put a cap on total pay but only on salaries (usually a small portion of total pay), and even then apply only to firms receiving "exceptional assistance" -- presumably especially large bailouts..., such as went to Citigroup and AIG -- rather than to those receiving run-of-the-mill bailouts... Most firms getting bailouts may continue to pay their executives whatever they want ... as long as they disclose it to their shareholders and give shareholders an opportunity to express their views about it.

So why is Wall Street so upset about the faux $500,000 limit? Precisely because of its symbolism. It's as if the administration is planning to subject executives of the banks that take ... bailout money to a kind of public shaming -- the equivalent of a scarlet G, for greed -- when the executives don't view the bailout that way at all. Few if any of them think they did anything wrong in the first place; they don't even view the bailout as a "bailout" but rather as a necessary injection of liquidity to keep credit markets going. ...

    Posted by on Saturday, February 7, 2009 at 03:24 AM in Economics, Financial System, Regulation | Permalink  TrackBack (0)  Comments (29)


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